As we wait for the SEC to issue regulations interpreting the clawback requirements under Dodd-Frank, some companies have pressed forward in adopting what they believe to be Dodd-Frank compliant clawback policies. While the intent of this proactive approach appears to be good governance and getting ahead of the curve, hidden amongst the details of these new and existing clawback policies may be unintended consequences that inadvertently trigger variable accounting treatment for share based compensation.
Huh? Say What?
In a May 2014 memo “Do Some Clawback Policies Trigger Variable Stock Plan Accounting?“, Towers Watson brought to light recent memos from two of the big four accounting firms that suggested that companies need to be very careful in designing their clawback policies in order to avoid variable accounting. Of primary concern is the amount of discretion given to the board or compensation committees around determining if a clawback has been triggered and other discretionary factors such as the type/amount of compensation to recoup. How would this trigger variable accounting? The argument cited is that if there is too much discretion in determining when the compensation committee would enforce a clawback, then “a grant date has not taken place because the employee cannot be certain what he or she might actually receive. This would mean that from the initial date of grant until the discretionary clawback period ends, the expense attributable to the equity grant would be valued on a mark-to-market basis, fluctuating along with the company’s stock price.”
Now, before I get a flood of emails pointing out that there seems to be previous guidance on that topic, let me address that (Towers Watson addressed it in their memo as well.) There is existing guidance on how clawbacks affect grant-date-fair value determinations. You can find it in ASC 718-10-30-24. It says: “A contingent feature of an award that might cause an employee to return to the entity either equity instruments earned or realized gains from the sale of equity instruments earned for consideration that is less than fair value on the date of transfer (including no consideration), such as a clawback feature (see paragraph 718-10-55-8), shall not be reflected in estimating the grant-date fair value of an equity instrument.” This basically says that clawback features will not impact the determination of grant date fair value for accounting purposes. However, there is one challenge, and this is where the accounting firms are appearing to raise a new question. The provision of ASC 718 that covers this was written during a time when clawbacks were rare, and it was with that understanding that they were excluded from impacting the grant date fair value. With Dodd-Frank now mandating clawback policies, and the SEC to issue final regulations, it seems that at least some of the accounting firms are suggesting that the prior guidance no longer applies based on concern over the amount of discretion companies are including in their clawback policies.
KPMG issued a memo titled “Effect of Discretion Clauses on Share Based Compensation“, and PwC did a 2013 study on clawbacks. Both firms have cited similar concerns over the amount of discretion they are seeing in a number of clawback policies. They do differ in some areas and situations as to how share based compensation may be impacted by discretion.
There’s not enough space in this blog to deep dive into all the potential issues around “discretion” in a clawback policy. Today’s we’ve just scratched the surface. For a more detailed analysis on this topic, visit the NASPP’s Stock Plan Expensing portal and view the Towers Watson memo.
Why Aren’t We Hearing More About This?
It seems that while concern exists, no official stance regarding the discretionary elements of these policies and their impact on accounting treatment has been taken. It appears that the accounting firms are awaiting the final Dodd-Frank rules before taking a more aggressive position (if at all) on this issue. However, if this opens up the potential for variable accounting treatment, this could land companies in a very tricky situation. Companies who have already adopted clawback policies, or are in the process of doing so, may be unpleasantly surprised to learn at some point down the road that the discretion afforded to their compensation committee in this area has triggered variable accounting. It seems that although the issue has been raised, there’s no clear or strong indication that clawback policies will often trigger variable accounting treatment for share based awards. However, it’s still a question that has been raised and needs to be clearly answered. Even with Dodd-Frank and the upcoming SEC regulations, clawbacks should still remain a rare situation (giving support to the argument that ASC 718-10-30-24 should apply, excluding these policies from impacting the grant date fair value determination). I echo the sentiment of Towers Watson – let’s hope that the SEC and the big four accounting firms come to some understanding about this before the final clawback regulations are issued and this all becomes a mute point.
The NASPP Welcomes Bernice Toy to Our Staff!
I’m excited to announce that Berni Toy has joined the NASPP team as our Programs Director. Berni brings a wealth of experience in the stock compensation field and was a founding member of the NASPP; I’m sure many of you know her from your presentations at NASPP Conferences and chapter events. As Programs Director, Berni will oversee the NASPP’s Stock Plan Design and Administration Surveys, NASPP Conference speakers, the Conference app, and various other programs. We are thrilled to welcome her to our team.
Last Chance to Submit a Speaking Proposal
All speaking proposals for the 23rd Annual NASPP Conference are due this Friday, February 27. We will begin reviewing the proposals as soon as the submission period closes so we cannot offer any exceptions to this deadline, no matter how dire the circumstances. Be sure to check out our Top Ten List for a Successful Proposal before you submit yours.
NASPP To Do List
Here’s your NASPP To Do List for the week:
Submit a speaking proposal for the NASPP’s 23rd Annual Conference. Get started today; all proposals are due by February 27—no exceptions!
ISS has released 104 additional FAQs on their corporate governance policy. That’s 44 pages of FAQs but they still haven’t answered the question we all want to know, which is how many points each of the tests in the Equity plan Scorecard are worth. In fact, a lot of the FAQs provide information that I thought was already general knowledge or is so a granular as to be applicable to only a small number of companies (I think ISS must be using the term “frequently” very loosely).
For what it’s worth, here are a few highlights from the FAQs on equity plans.
Excluding Certain Grants from Burn Calculations
ISS will exclude assumed or substitute grants issued as a result of an acquisition as well as grants issued pursuant to a shareholder-approved repricing from the burn rate calculation if these grants are disclosed separately in the plan activity table in the company’s Form 10-K. This explains why I see companies do this.
Disclosing Performance Based Awards
ISS generally counts performance based awards in the burn rate calculation in the year they are earned, provided that the company has included disclosures sufficient for this purpose. Separately report the number of performance awards granted and the number of performance awards earned when disclosing plan activity. Be careful about this: if ISS can’t figure out your disclosures, they could end up counting performance awards twice.
Updating Disclosures After Year-End
If circumstances for your company have changed so significantly since the end of the year that you want ISS to base the SVT and (presumably) other tests on new numbers, ISS will do this if you update “ALL” of the disclosures required for their analysis in your proxy statement (or in another public filing that the proxy statement references). See the FAQs for list of disclosures that must be updated; it sounds like ISS is going to be a stickler about this (the use of all caps for the word “ALL” was their idea).
Fungible Share Reserves and SVT
ISS calculates the cost of plans with fungible share reserves by running the SVT test twice; once assuming all shares are issued as stock options/SARS and a second time assuming all shares are issued as full value awards. The plan has to pass both tests. It isn’t clear from the FAQ what happens if the plan passes both tests but scores better on one than the other (the SVT score is scaled; plans can earn partial credit for scores within a certain range). Maybe the plan is assigned the lowest score.
Fungible Share Reserves and Plan Duration
The plan duration is calculated by adding the shares requested to the share available in the plan and dividing by the company’s burn rate multiplied by the company’s weighted shares outstanding. For purposes of calculating the burn rate in this formula, for plans with a fungible share reserve, the FAQs state that ISS will apply the share multiplier in the plan to full value awards. Normally, ISS has its own multiplier that it uses for burn rate calculations that is based on the volatility of the company’s stock, so this is a little surprising to me. I can only assume that it hurts companies in some way (not that I’m cynical); perhaps plan multipliers are typically lower than ISS’s multiplier, resulting in a lower burn rate, which would result in a longer plan duration.
Burn Rate Commitments
If you have made a burn rate commitment in the past three years, you aren’t off the hook. Even though these commitments are defunct under the scorecard, ISS expects companies to adhere to any commitments they’ve already made. If you don’t, they may take it out on your compensation committee members.
Fixing a Liberal Change-in-Control Definition
A liberal change-in-control definition is a deal-breaker; ISS will recommend against the plan regardless of how perfect the plan’s scorecard is. A liberal change-in-control definition is one that provides for single-trigger acceleration of vesting upon a trigger that could occur even if the deal doesn’t close (e.g., shareholder approval of the deal) or other triggers that are suspect (e.g., acquisition of a low percentage of the company’s common stock).
But there’s good news—this is fixable. You can modify the CIC provision in your plan (the FAQs provide suggested language). ISS is good with this, even if the modification only applies to new awards.
Other Matters
Most of the FAQs (75 of the 104 questions) relate to Say-on-Pay votes and other corporate governance considerations, rather than directly addressing equity plan matters. These are beyond the scope of things I care about, so I didn’t read them. It’s possible they are more scintillating than the FAQs on equity plan matters.
Here’s what’s happening at your local NASPP chapter this week:
Denver: Andrew Schwartz of Computershare presents “2015 Regulatory Update & Review.” (Tuesday, February 24, noon)
Orange County: Nathan O’Conner of Equity Methods presents “What to Expect in 2015 in Stock Compensation.” (Wednesday, February 25, 11:30 AM)
Sacramento: The chapter hosts a roundtable on equity compensation events in 2014 and planning for chapter events in 2015. Does miss your choice to help shape the chapter! Wednesday, February 25, 11:00 AM)
Silicon Valley: Tara Tays of Deloitte Consulting, Hoffman-Friedes of Seagate Technology, and Susan Berry of Infoblox present “Silicon Valley—How Different Are We? A Look at LTIP and ESPP.” (Wednesday, February 25, 11:30 AM)
Los Angeles: Nathan O’Connor and Yan Zhao of Equity Methods present “Updating Your Option Valuation Practices and Considering TSR Awards.” (Thursday, February 26, 11:30 AM)
NY/NJ and Philadelphia: The chapters host a joint meeting featuring Tim Hale and JoAnn Grady of Bank of America Merrill Lynch on “Cost Basis Reporting Changes, Wash Sales and Taxation Update.” (Thursday, February 26, 8:15 AM)
I’ll be attending the Silicon Valley chapter meeting; I hope to see you there!
Today I’m going to dissect a concept that’s existed in equity compensation for a long time. In fact, it’s nothing “new” per se. Yet, some recent trends, governance practices and changes in other industry areas have brought about new life to the idea. So much that I’m officially calling it the “buzz word” (okay, words) of the month. What is it? Post-vest holding periods. In this week’s blog I’ll explore why the renewed attention to this previously under-used practice. In a later installment we’ll get down to the more detailed mechanics.
What is a Post-Vest Holding Period?
Just to make sure we’re all on the same page, the post-vest holding period that I’m talking about is an additional holding requirement imposed on vested shares. Once vested, you must hold them for a period of time (1 year? 2 years?). This is different from holding the shares until they vest (aka the service or vesting period). Typically a company would include this type of holding period in the governing plan and agreement language, in addition to vesting details.
Participants Are Already Subject to Vesting – Why an Additional Holding Period?
This is where the old concept turned hot topic comes into play. While the idea of holding shares has been around for a long time, we are seeing recent and renewed interest in implementing post vesting holding requirements. There are a number of reasons why this may be attractive to a company, including:
Clawbacks: Having a holding period after vesting maintains a “reserve” of retrievable stock in the event the company needs to clawback income from an executive. After all, once an executive liquidates stock and spends the money, it’s next to impossible to recoup those shares or proceeds in their original form. Does the company really want to try and repossess the executive’s vacation home or new yacht?
ISS Scorecard: When ISS released their new Equity Plan Scorecard (see previous blog on this topic), it became clear that the existence of post-vest holding periods count for something. This is one of the items eligible for points on the scorecard.
Prevalence of Stock Ownership Guidelines: We’ve seen the steady rise of stock ownership guidelines over the past several years, with recent data showing more than 90% of public companies having some form of stock ownership guidelines. Post-vest holding periods can help an executive achieve their ownership targets.
In addition to the reasons outlined above, there are other interesting considerations emerging. In talking with Terry Adamson of Aon Hewitt, he pointed out that in addition to the above, companies may be able to reduce their ASC 718 accounting expense on awards with post vest holding periods. Why? Because the “lack of marketability” of the award deserves a discount.
The above only touches upon the surface. Questions I haven’t explored today include the types of equity that make the most sense to cover with a post-vest holding period and whether this makes sense to implement on a broad basis.
We’ve got some great resources in the works to provide you with those additional details. With Dodd-Frank requirements for clawbacks on the horizon, the new ISS Equity Plan Scorecard coming into play this proxy season, ongoing corporate governance changes and continued interest in minimizing accounting expense, we think the concept of post-vest holding periods may be more than just a passing trend.
For additional information now, check out our latest podcast episode “Hold After Vest” (featuring Terry Adamson of Aon Hewitt). For even deeper details, we’ve got a great team of presenters assembled to address all of the points raised in this blog (including the possibility of reducing accounting expense) in our next webcast: Post-Vest Holding Periods on March 11th.
In the coming weeks I’ll touch on more of the nuances that make this topic so interesting.
In somewhat of a surprise announcement, last week the SEC proposed rules to implement the requirement under the Dodd-Frank Act that companies disclose their policies with respect to hedging by employees and directors.
This Has Nothing to Do With Yard Work
Hedging is a means by which investors protect themselves against downside risk—think “hedging your bets.” This is all well and good for the average investor, but when the investor in question is an officer or director of the company who has received compensatory awards of stock and/or options, hedging can be problematic. Companies grant equity awards to align their officers and directors with shareholders and to motivate them to increase the value of the company’s stock. If the officers and directors can use hedging instruments to protect themselves from downside risk, they might be less motivated by their equity awards.
Likewise, where a company has implemented ownership guidelines, if officers and directors can hedge against the stock they own to comply with the guidelines, then the guidelines aren’t terribly effective because officers and directors haven’t really assumed the risk of ownership.
More Controversial Than You Might Think
The proposal was issued via written consents of the Commissioners, rather than an open meeting, which is why it caught many of us by surprise. An open meeting would have been announced in advance and people that follow the SEC’s meeting schedule would have known it was happening.
I thought that this ought to be relatively simple—essentially, “disclose your hedging policy”—especially since companies are already doing this for their NEOs in the CD&A. But I guess nothing that the SEC does is very simple; the proposing release is 103 pages long. That is, however, shorter than the CEO pay ratio disclosure proposal, which clocked in at 162 pages.
Part of the complexity is that there are virtually an infinite number of possible types of arrangements and instruments that can be used to hedge a financial position. Complicated strategies like equity swaps, variable prepaid forward contracts, and collars (in case you are wondering, I have no idea what any of these things are, except that I do know that an equity swap is not the same thing as a swap exercise) and more straightforward transactions such as a short sale (I know what that is: a short sale is selling stock you don’t own yet—you are hoping the stock price will decline before you have to buy the stock to close out your position).
The SEC requests comments on a number of matters related to the rules, including:
Should the disclosure apply to all employees (the language included in Dodd-Frank) or just officers and directors (the individuals investors are probably most concerned about when it comes to hedging)?
Should the rules be part of corp governance disclosures under Reg S-K Item 407 or part of the Say-on-Pay disclosures under Item 402? The proposal includes them under Item 407, which means that shareholders technically aren’t voting on them as part of Say-on-Pay.
Types of equity securities that should be subject to the disclosure.
Should companies be required to disclose hedging activities that employees, officers, and directors have engaged in?
Should smaller reporting companies or emerging growth companies be exempted from making the disclosure or subject to a delayed implementation schedule?
Comments should be submitted to the SEC by April 20, 2015.
Cooley’s blog has a nice summary of the proposal, if you don’t want to read all 103 pages.
NASPP Chapter Meetings Here’s what’s happening at your local NASPP chapter this week:
Carolinas: John Roe of ISS Corporate Services presents “ISS in 2015: Equity Plan Score Card, Pay for Performance, and More.” (Wednesday, February 18, 11:00 AM)
Connecticut: Terry Adamson of Aon Hewitt and Louis Taormina of Frederic W. Cook and Co. present “Post Vest Holding Periods: The Intersection of Corporate Governance, Plan Design, & Financial Accounting.” (Wednesday, February 18, 1:00 PM)
Ohio: Tim Hale from Merrill Lynch presents “Cost Basis Reporting Changes, Wash Sales and Taxation Update.” (Thursday, February 10, 10:00 AM)
San Diego: Megan Arthur of Cooley and Raenelle James of Equity Methods present “Understanding the Complexities in Proxy and Disclosure Reporting.” (Thursday, February 19, 11:30 AM)
Online Stock Plan Fundamentals
Our acclaimed online program, “Stock Plan Fundamentals,” begins again in April. Taught by the industry’s leading experts, this course is the definitive training program for stock plan professionals and covers both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. Don’t wait to register–the early-bird rate is only available through this Friday, February 20.
NASPP To Do List
Here’s your NASPP To Do List for the week:
Register for the NASPP’s acclaimed online Stock Plan Fundamentals program—don’t wait, the early bird rate is only available through this Friday, February 20.
Submit a speaking proposal for the NASPP’s 23rd Annual Conference. Get started today; all proposals are due by February 27—no exceptions!
We recently issued a call to our members to give us feedback on your online experience, and boy did you answer! Thank you to all who participated in the survey. In today’s blog, I’ve got to get some important business out of the way – announcing the winners of the drawing for those who completed the survey. And, I’ll share some key findings from the survey – so keep reading!
And the Winners Are…
We drew 10 names from the group of survey participants that submitted their contact details. Each winner will receive a $50 Amazon.com gift card. Thank you again to all who participated. The winners are:
Eddie Pelatti, Fidelity Investments
Gilbert Szeto, Kranz & Associates
Helen Hauge, Seagate Technology
Kate Cordenner, AvalonBay Communities, Inc.
Patty Brown, Solium
Robert Veillette, Nordson Corp.
Sheila Matias, Red Hat
Vicky Quaranta, Verint Systems, Inc.
Wei Sun, SVB Financials
Charles Phillips, Tandem Diabetes Care, Inc.
A Peek at the Data
The results of the survey generally won’t be made public, because the intent of the survey was to gather information to help make your experience and interaction with the NASPP even better. We asked, you answered, and now it’s up to us to take what we’ve learned and apply the information to useful initiatives. That said, there were some data points we thought would be fun to share with our members. Here goes.
Preferred Portals
Many NASPP members know that a lot of the information and resources on our web site are categorized by topic and housed in what we call a “portal”. There are currently 46 portals on the NASPP.com website. Which were our members’ favorites? Here are the top 5 portals accessed most frequently:
Tax Withholding and Reporting
Restricted Stock
Global Stock Plans
Employee Communications, Employee Stock Purchase Plans, Executive Compensation, Administrative Tools (this was a 4-way tie)
Accounting/Stock Plan Expensing
There weren’t a lot of surprises there. I did notice an irony – in last week’s NASPP Blog (while the survey was still open), I wrote about our Global Stock Plans portal and the many resources available there. I had no idea at the time that it was going to be in the top 5 list for this blog, but it certainly reiterates that global issues remain high on the radar. If you want a refresh on the resources, check out last week’s blog.
You Want More Love
Well, this is Valentine’s week, so you know I had to find a way to incorporate the word “love” into the blog. What nearly half of survey participants actually said is that they want to engage even more with the NASPP (yay!). Zero (yes, 0%) respondents said that they want to engage “less” with the NASPP (double yay, you love us too!). So rest assured, we hear you loud and clear and are looking for even more opportunities for quality interaction. Some things I can think of immediately to raise your engagement:
Follow us on social media (links in the next section)
Join our Question of the Week Contest to keep your equity compensation knowledge on the cutting edge!
Let’s Be Social
One thing of note was that many of our survey respondents were willing to follow the NASPP on LinkedIn (more than 77%), but many expressed that they didn’t know the NASPP was even on LinkedIn. Let’s fix that right now! We do post a lot of content on LinkedIn – when we have new information on our website, or upcoming programs (such as webcasts and online education), we’re out there on LinkedIn talking about it. If there’s a new development, you can bet we’ll put something out via LinkedIn with information on a resource. We also have Facebook and Twitter pages, too. All 3 are great ways to get information real-time. It’s the quickest way available to us to disseminate information. So if you’re not following us, take a moment to do so! This will help with the “more love” request above. Click on the link(s) to get started: LinkedIn, Facebook, Twitter.
I want to again express thanks to everyone who participated in the survey. Your feedback has been very helpful. Even if you didn’t participate, you’ll still reap the benefits of whatever enhancements we’re able to offer.
Online Stock Plan Fundamentals
Our acclaimed online program, “Stock Plan Fundamentals,” begins again in April. Taught by the industry’s leading experts, this course is the definitive training program for stock plan professionals and covers both the regulatory framework and day-to-day administrative procedures key to overseeing stock plans. Don’t wait to register–the early-bird rate is only available until February 20.
Register Now for NASPP Conference Early-Bird Rate
The 23rd Annual NASPP Conference will be held in San Diego from October 27-30. Registered by April 24 for the early-bird rate. You know you want to be there—don’t pay full price if you don’t have to.
Submit a Speaking Proposal for the NASPP Conference
Interested in speaking at the 23rd Annual NASPP Conference? Submit your speaking proposal by February 27.
To Do List
Here is your NASPP to do list for this week:
I blogged back in October that the FASB has announced amendments to ASC 718 (Proposed Amendments to ASC 718 – Part I and Part II). Some of you may be wondering what happened with that project. The answer is that the FASB is still working on it. They have been meeting to discuss transitional issues and other projects related to the simplification of ASC 718.
The FASB met last Wednesday, February 4, to decide a number of transitional matters. I listened to the meeting; here are my observations. First, even though February 4 was my birthday, the FASB did not appear to be celebrating this in any way. In fact, it appeared that they did not even know it was my birthday. Go figure.
Share Withholding
The FASB debated whether the transition to the new share withholding guidance should be on a modified retrospective basis (essentially, companies switch over to the new method for all outstanding awards with an adjustment in the current period to account for the change) or a prospective basis only (the guidance would only apply to new awards) and decided on the modified retrospective approach. The discussion on this matter seems largely theoretical to me. The transitional guidance would only be a concern for companies that are currently subject to liability treatment due to their share withholding practices. In my experience however, there are very few, if any, companies that fall into that bucket. Most companies have carefully structured their share withholding procedures to avoid liability treatment so they don’t need to worry about any transition.
Estimated Forfeitures
The transition for changing from estimating forfeitures to accounting for forfeitures as they occur garnered even more discussion, with one FASB staffer recommending that companies be given a choice between the modified retrospective and prospective approaches. I guess there was a concern that companies wouldn’t be able to figure out the appropriate adjustment necessary to switch over to the new guidance using the modified retrospective method. But Board members were worried about confusion resulting from two different transition methods, so they decided to require the modified retrospective method.
I think that this whole area is so confusing as to be completely inscrutable to investors. Your auditors barely understand it. So while I appreciate the concern about confusion, personally I can’t see that a modicum more confusion is going to make any difference here.
But, having said that, I also can’t believe that companies would want to switch over to accounting for forfeitures as they occur on a prospective basis. That would leave companies applying an estimated forfeiture rate to awards granted prior to specified date but not after that date (or maybe to employees hired before a specified date—it was a little unclear from the Board’s discussion). That seems crazy complicated to me. My guess is that if companies can’t figure out the adjustment necessary to switch over to accounting for forfeitures as they occur, they’ll just continue to apply an estimated forfeiture rate.
Tax Accounting
For as controversial at it is, there was very little discussion among Board members of the transition to accounting for all excess benefits/shortfalls in the P&L. I guess the accounting is controversial but the transition is relatively simple. The Board decided on prospective approach. As I understand it, once the amendments are in effect, companies will just switch over to recognizing benefits/shortfalls in the P&L—the journal entries they were making to paid-in-capital to account for tax effects will now be made to tax expense.