It is common for boards and compensation committees to have discretion over clawback provisions, either over determining whether the clawback provision has been triggered or, once triggered, whether it should be enforced. While this discretionary authority is useful from a design and implementation standpoint, it can sometimes be problematic from an accounting perspective.
Background
Under ASC 718, expense associated with an equity award is determined on the grant date, which cannot occur before an employee and employer reach a mutual understanding of the key terms and conditions of the award. Where a key term is subject to discretion, a mutual understanding of the key terms and conditions of the award may not exist until the point at which this discretion can no longer be exercised.
In the case of clawback provisions, if the circumstances under which the board/compensation committee might exercise their discretion are not clear, this could lead to the conclusion that the service or performance necessary to earn the award is not fully defined. This, in turn, prohibits a mutual understanding of the terms and conditions of the award and delays the grant date. This delay would most likely result in liability treatment of the award.
Recent Comments from SEC Accounting Fellow
Sean May, a professional accounting fellow in the SEC’s Office of the Chief Accountant, discussed this concern in a speech at the 2016 AICPA Conference on Current SEC and PCAOB Developments, held in Washington, DC. May distinguished objectively applied clawback policies from policies that “may allow those with the authority over compensation arrangements to apply discretion.” In addition, he made the following comments:
If an award includes a key term or condition that is subject to discretion, which may include some types of clawback provisions, then a registrant should carefully consider whether a mutual understanding has been reached and a grant date has been established. When making that determination, a registrant should also assess the past practices exercised by those with authority over compensation arrangements and how those practices may have evolved over time. To that end, registrants should consider whether they have the appropriate internal control over financial reporting to monitor those practices in order to support the judgment needed to determine whether a grant date has been established.
Clawbacks and Discretion are Common
68% of respondents to the NASPP’s 2016 Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting) indicate that their equity awards are subject to clawback provisions. 83% of those respondents, indicate that the board or compensation committee has some level of discretion over enforcement of the provisions.
If you are among those 83%, it might be a good idea to review the comments May made at the AICPA conference with your accounting advisers to make sure your equity awards receive the accounting treatment you expect.
With the impending Facebook IPO crowding out just about any other news in my Google alert these days, I’ve got private companies on my mind. I don’t have anything to add on the Facebook IPO, but there has been an interesting development recently relating to accounting standards for private companies.
Debate Rages Over Private Company Accounting There is apparently a heated debate in the accounting community (specifically between the Financial Accounting Foundation, which oversees the FASB, and the American Institute of Certified Public Accountants) over whether the FASB should have oversight of accounting standards for private companies. So much so that the AICPA put together the Blue-Ribbon Panel on Standard Setting for Private Companies (is that the BRPSSPC? what exactly is a blue-ribbon panel, anyway? I thought it was something related to 4H or maybe beer…) to evaluate the matter and make recommendations. In response to the panel’s recommendations, the FAF has proposed creating the Private Company Standards Improvement Council, which would review current US GAAP to determine whether exceptions or modifications should be made for private companies.
Any suggestions made by the PCSIC (is that pronounced “pic-sic”?) would be subject to approval by the FASB. The problem with this, however, is that the Blue-Ribbon Panel recommended creating a completely separate, independent entity that wouldn’t be beholden to the FASB. The AICPA seems to be vehemently opposed to any approach where the FASB still has authority over the standards for private companies, and has threatened to take their toys and go home to create their own standards setting authority if the FAF proceeds with its proposal. (See “AICPA Turns Up Volume on Call for Independent Board,” Matthew Lamoreaux, Journal of Accountancy, October 18, 2011.)
I have no idea what this might mean for how private companies account for stock compensation, but I can definitely think of a few things I’d like to change about ASC 718 if I were a private company. (Ok, heck, I can think of some things I’d like to change even if I were a public company. In fact, let’s just scrap the whole standard.) It does surprise me that when the rest of the world seems to be focused on convergence, we are actually considering bifurcating our accounting standards here in the U.S. Kind of seems like the wrong direction…
Why Can’t Public Companies Do This?
Now, I imagine some of you that work for public companies are thinking: “Hey! Wait a minute here. If private companies can ignore the FASB and create their own standards setting organization, why can’t we?” Private companies can do this because, for the most part, their financial statements aren’t filed with the SEC, which requires the statements to be prepared in accordance with GAAP as determined by the FASB. Since private companies don’t file their financial statements with the SEC, they don’t have to follow the SEC’s rules (at least with respect to financial statements–there are other securities laws they still have to comply with, more on this in a future blog). And, other than the authority vested in FASB by the SEC, there’s no law that says that FASB is the supreme ruler of GAAP. So private companies can do whatever they want with their financial statements, so long as any investors and lenders that might want to review their financials are willing to accept them. Public companies, however, are still stuck with the FASB, unless you can somehow convince the SEC to let you do what you want, too. Good luck with that.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
As of June 15, 2011, SAS 70 is being replaced as the U.S. auditing standard for service organizations. Today, I explore some of the background for a SAS 70 report and why it’s being superseded.
Acronym Soup and Background Information
The Auditing Standards Board (ASB), which is a part of the American Institute of Certified Public Accountants (AICPA), issues guidance for auditors including the Statements on Auditing Standards (SAS). SAS No. 70 (SAS 70) is specifically guidance for auditors to use when “auditing the financial statements of an entity that uses a service organization to process certain transactions.” (See the AICPA site for more information.)
Section 404 of the Sarbanes-Oxley Act requires public companies to report on the effectiveness of the internal controls relating to their financial statements. The Public Company Accounting Oversight Board (PCAOB) issued Auditing Standard No. 2 in 2004–superseded by Auditing Standard No. 5 in 2007–which identified how the independent auditor evaluating a public company may rely on a “service auditor report” like the SAS 70 Type 2 report. The process breaks down like this:
An independent auditor for an issuing company must evaluate the controls that are in place to ensure the accuracy of financial reporting. If that company outsources administration processes that could impact financial reporting, the independent auditor should evaluation the controls in place at the service provider as well. A SAS 70 report can provide the necessary opinion of not only that the controls are suitably designed (i.e., a Type 1 report), but also that service company has effectively maintained each of those controls over a period of time (i.e., a Type 2 report). The issuing company auditor is, therefore, able to review the information in the Type 2 SAS 70 report instead of assessing the service provider’s internal controls directly. This saves a huge amount of time, money, and energy for both the issuing company and the service provider. The SAS 70 report has become a standard request for companies evaluating or using third-party stock plan administration service providers.
SSAE 16
The Standards on Standards for Attestation Engagements No. 16 (SSAE 16) replaces SAS 70 as of June 15, 2011. The new standard is intended to bring U.S. auditing practices more in line with the international standard, ISAE 3402. Like SAS 70, SSAE 16 consists of a Type 1 and a Type 2 evaluation, Type 2 being the necessary follow-up to determine if controls are being effectively performed over time. Companies with a current Type II SAS 70 report may transition directly to the Type 2 SSAE 16 report. You can tell the essential difference between SAS 70 and SSAE 16 in their names alone. SAS 70 is an audit standard that requires only the auditor’s assessment of controls. SSAE is an attestation standard that requires the company to also demonstrate the effectiveness of controls. SSAE 16 requires management at a service organization to provide not just a description of the controls in place, but of the system as a whole. (SAS 70 only requires a description of controls.) In addition, management must attest to the suitability of the system in a written statement that includes a description of the criteria used to make this assertion and the risks that could threaten the company’s ability to effectively maintain the system.
A Little Appreciation, Please
If you’re at an issuing company and the SAS 70 report is something you ask for–or better yet, something you automatically receive–from your stock plan administration service providers, I think it’s time to take a moment to appreciate the effort that’s going to go into the new standard. When you do get your hands on that SSAE 16 report, give it a good look before you pass it on to your auditors. It will give you some serious insight into what controls your service provider feels are essential, which can help you design some of your own internal controls. It can also shed light on what procedures you may need to update in order to help your service provider achieve the control objectives in the report, which in turn helps your company get through that portion of your audit.