The Effects of the SEC Executive Compensation Clawback Rules on F&A Leaders

In October 2022, the U.S. Securities and Exchange Commission (SEC) voted to adopt rules that will require companies to “claw back” incentive-based compensation that a company awarded to executives in the event that misreported financials resulted in an accounting restatement.

While the SEC has had some ability to claw back incentive-based compensation based on Section 304 of the Sarbanes-Oxley Act, that only allowed it where a restatement was the result of misconduct. Interestingly, the new rules state a company’s clawback policy should be triggered by both “Big R” and “little r” restatements and regardless of whether the restatement was caused by intentional fraud, accidental error, or any other factor. Howard Berkenblit, Head of Capital Markets at Sullivan & Worcester notes, “many restatements are not the result of fraud, they’re just mistakes, so that will be an adjustment.”

The new rules apply to compensation paid in the three years leading up to the restatement and apply to public companies of all sizes. The rules apply to officers, including the CEO, CFO, CAO, or any VP in charge of a principal business unit, along with other policy-making officers.

For accounting and finance leaders in public companies, this ruling emphasizes just how careful they must be and the level of confidence they must have in their numbers. Of course, it’s always been important, but it’s become even more critical, and personal, for leaders to take all necessary steps to ensure financials are correct before signing off.

Executive bonuses are often tied to financial targets, like earnings per share (EPS) or earnings before interest, taxes, depreciation, and amortization (EBITDA). If an accounting mistake—for example, miscalculating revenue or understating expenses—skews a compensation metric (with the presupposition that the financials error increased business performance) and caused an increase in compensation, companies will be forced to recalculate and adjust their financials and reclaim money from their executive leader(s) over the defined period.

Gary Gensler, Chairperson of the SEC, noted, “why should executives be getting paid incentive comp on financials that were inaccurate?”

In addition to forced reclamation of compensation, other detrimental consequences of accounting mistakes include:

1) Negative effects on stock pricing

2) Time and resources spent recalculating and reissuing statements

3) Reputational risk by inviting litigation, increased investigator and investor attention, and negative press coverage

One of the strategies F&A leaders can employ to increase confidence in financial processes and results and mitigate misreporting risk is the intelligent use of automation. Automation of end-to-end accounting processes, done correctly, helps to reduce manual entry errors and increase the quality of your numbers, thereby increasing certainty in the final statements. Accounting automation software employs embedded logic to consistently book entries and leverages workflows to allow for the necessary oversight to produce consistently accurate results. When compared to processes that are manual and error-prone, there really can be no debate: automation provides optimal results.

In addition to the confidence you’ll gain in your financials, automating manual, transactional work frees up time and capacity for F&A teams, so more time can be spent “downstream” on flux analysis, proactively identifying anomalies in the data, and ensuring the integrity of the financial reporting. It also allows for earlier views of the financial reports to proactively address issues.

The clawback rules are designed to promote compliance with applicable accounting rules. It goes without saying that accounting and finance teams strive to produce timely, accurate, consistent, and compliant financial reporting. However, the application of the new rules on a no-fault basis means that executives could be penalized based on inadvertent failures within complex accounting systems. Manual processes and relying too much on spreadsheets can contribute to unintentional errors.

Introducing BlackLine automation into your end-to-end accounting processes will significantly enhance the quality of your financial reporting results. Our solutions serve to automate upstream transactions allowing for more time to review and interpret the data. Our powerful workflow and reporting engine allows for transparency and visibility of the results throughout the monthly/quarterly accounting cycles. Solutions like our account reconciliation module can allow for an intelligent approach to risk.   

For example, we have customers where a small subset of the accounts can effectively cover the vast materiality component of the balance sheet. By using auto-certification on the immaterial accounts, as appropriate and with the right governance, you can focus your compliance and attention on the accounts that matter. This is just one example of how BlackLine solutions help companies ensure they maintain the highest degree of financial reporting integrity.

As the market leader of cloud software that automates and controls critical accounting processes throughout the accounting and reporting life cycle, BlackLine continues to evolve as regulations and laws change. The strength of the BlackLine platform, including from a compliance lens, is critical. Companies must take a smart, risk-based approach to their activity and ultimately, their financial reporting. BlackLine can help.

Learn more about our financial close management, accounts receivable automation, and intercompany financial management solutions.