The SEC staff has issued interpretive guidance to help companies properly calculate and disclose compensation cost for “spring-loaded awards” given to executives.
This is when a company grants stock options shortly before announcing market-moving information such as better-than-expected financial results or a significant transaction.
“SEC staff believes that as companies measure compensation actually paid to executives, they must consider the impact that the material nonpublic information will have upon release,” the SEC said on November 29, 2021. “In other words, companies should not grant spring-loaded awards under any mistaken belief that they do not have to reflect any of the additional value conveyed to the recipients from the anticipated announcement of material information when recognizing compensation cost for the awards.”
The guidance, Staff Accounting BulletinSAB) No. 120, provides the staff views related to the fair value estimates of share-based payment transactions in FASB’s Accounting Standards Codification (ASC) Topic 718, Compensation—Stock Compensation, when a company has material non-public information.
“Non-routine spring-loaded grants merit particular scrutiny by those responsible for compensation and financial reporting governance at public companies,” the SEC said.
SAB 120 was prepared by the SEC’s Office of the Chief Accountant (OCA) and the Division of Corporation Finance (CorpFin). It was issued on November 24 and becomes effective upon publication in the Federal Register.
“It is important that companies’ accounting and disclosures reflect the economics and terms of these compensation arrangements,” SEC Chair Gary Gensler said in a statement. “This gets to the SEC’s remit to protect investors.”
SAB 120 modifies portions of the interpretive guidance in SAB Series to better conform with Topic 718 because the FASB has updated standards related to share-based payment, including:
- Accounting Standards Update (ASU) No. 2019-08, Compensation—Stock Compensation (Topic 718) and Revenue from Contracts with Customers (Topic 606): Codification Improvements—Share-Based Consideration Payable to a Customer, in November 2019;
- ASU No. 2018-07, Compensation—Stock Compensation (Topic 718): Improvements to Nonemployee Share-Based Payment Accounting, in June 2018; and
- ASU No. 2016-09, Compensation—Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, in March 2016.
SAB 120 provides explanations with illustrations of certain facts and circumstances. It is in a question and interpretive answer format.
For example, on valuation methods, fair value is emphasized. But if observable market prices of identical or similar equity or liability instruments are not available, FASB Topic 718 describes the fair valuation technique or model that complies with the measurement objective in the standard.
“The measurement objective for equity instruments awarded to grantees is to estimate at the grant date the fair value of the equity instruments the entity is obligated to issue when grantees have delivered the good or rendered the service and satisfied any other conditions necessary to earn the right to benefit from the instruments,” SEC staff stated in describing ASC 718.
A question asks whether there are certain preferable valuation techniques in meeting the fair value measurement objective in the accounting rule.
SAB 20 responds that the FASB standard clarifies that it does not specify a preference. But it says that a company should select a valuation method that is applied consistently with the fair value measurement objective and should be based on established principles of financial economic theory and reflects all substantive characteristics of the instruments.
“The chosen valuation technique or model must meet all three of the requirements stated above,” the SEC staff interpretive bulletin states. “In valuing a particular instrument, certain techniques or models may meet the first and second criteria but may not meet the third criterion because the techniques or models are not designed to reflect certain characteristics contained in the instrument. For example, for a share option in which the exercisability is conditional on a specified increase in the price of the underlying shares, the Black-Scholes-Merton closed-form model would not generally be an appropriate valuation model because, while it meets both the first and second criteria, it is not designed to take into account that type of market condition.”
A company may consider using multiple methods before making its selection as to what its appropriate method would be. And the bulletin noted that the staff would not object to a company’s choice of method as long as the method meets the fair value measurement objective.
“For example, a company is not required to use a lattice model simply because that model was the most complex of the models the company considered,” the staff guidance states.
This article originally appeared in the December 1, 2021 issue of Accounting & Compliance Alert, available on Checkpoint.