The NASPP Blog

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.

-Jenn