What does Madonna have to do with the FASB? Well, nothing, except that they both use the term “material,” albeit to refer to different things. The FASB has issued two proposals relating to materiality recently; I read both of them today and now I can’t stop humming “Material Girl” by Madonna. That’s just the way my brain works.
Proposed Amendment to Financial Accounting Concepts
The first proposal would amend Statement of Financial Accounting Concepts No. 8 to remove the definition of materiality originally included therein and instead refer to the legal definition of materiality, as determined through “legislative, executive, or judicial action.” This would cause a misalignment with IFRS, but it seems preferable for the FASB’s definition of materiality to align with other definitions of this term as used in the United States. I’m not sure how significant an impact this change would have on stock compensation, but the FASB notes that IASB’s definition of materiality (which SFAC 8 originally aligned with) “generally would require disclosure of more information than would the legal concept of materiality in the United States.” I guess people outside the United States have a lot more time to read through tedious disclosures.
Proposed Accounting Standards Update
The second proposal would amend ASC 235 (Notes to the Financial Statements) to add a new section titled “Assessing Whether Disclosures Are Material.” This section would clarify that it is permissible to omit disclosures that are immaterial (apparently there has been a fair amount of confusion about this) and that this omission is not an error that must be disclosed to the company’s Audit Committee (there’s no point in omitting a disclosure if you still have to disclose it somewhere else). The amendment would further clarify that the materiality assessment applies to both quantitative and qualitative disclosures and is applied to each disclosure individually as well as in the context of the financial statements as a whole. The proposal states “Preparers…should be evaluating whether the disclosure is material, not the Topic itself.”
I read this to mean that, although overall, ASC 718 might be very material to a company’s financial statements (particularly where a significant portion of employee pay is in the form of equity), specific disclosures that would be otherwise required under ASC 718 can be omitted from the company’s financial statement notes if they are immaterial to that company.
The proposal would also amend each Topic in the Accounting Standards Codification that includes disclosures to refer to Topic 235 and remove any existing phrases that conflict with it. The proposal doesn’t describe how each individual Topic would be amended, but does include an example to generally demonstrate what the amendments might look like. Handily, the proposal uses ASC 718 as the example so I know what language would be changed therein:
In paragraph 718-10-50-1, the phrase “An entity with one or more share-based payment arrangements shall disclose information” would be changed to “Entities shall provide disclosures required by this Subtopic to the extent material.”
The phrasing in paragraph 718-10-50-2 that suggests that the disclosures identified in the standard are the minimum necessary would be eliminated. Instead, the new language would suggest that the identified disclosures are merely an example of how companies might satisfy the disclosure objectives of the standard.
Does it make me a nerd that I feel kind of special that, of the 40 Topics in the Codification that need to be amended, we were chosen to be the only example?
I leave you with “‘Cause we are living in a material world and I am a material girl. You know that we are living in a material world…”
As expected (and as I blogged last week), the SEC has issued a proposal for the pay-for-performance disclosure required under Dodd-Frank. Proxy disclosures aren’t really my gig, so I don’t have a lot more to say about this topic. Luckily, Mike Melbinger of Winston & Strawn provided a great bullet-point summary of the proposed disclosure in his blog on CompensationStandards.com. I’m sure he won’t mind if I “borrow” it.
The proposed rules rely on Total Shareholder Return (TSR) as the basis for reporting the relationship between executive compensation and the company’s financial performance.
Based on the explicit reference to “actually paid” in Section 14(i), the proposed rules exclude unvested stock grants and options, thus continuing the trend to reporting realized pay. Executive compensation professionals will need to sharpen their pencils to explain the relationship between these figures and those shown in the Summary Compensation Table.
For equity-based compensation, companies would use the fair market value on date of vesting, rather than estimated grant date fair market value, as used in the SCT.
The proposed rules also would require the reporting and comparison of cumulative TSR for last 5 fiscal years (with a description of the calculations).
The proposed rules would require a comparison of the company’s TSR against that of a selected peer group.
The proposed rules would require separate reporting for the CEO and the others NEOs—allowing use of an average figure for the other NEOs.
The proposed rules would require disclosure in an interactive data format—XBRL.
Compensation actually paid would not include the actuarial value of pension benefits not earned during the applicable year.
The proposed rules would phase in of the disclosure requirements. For example, in the first year for which the requirements are applicable [2018?], disclosure would be required for the last 3 years only.
The proposed rules exclude foreign private issuers and emerging growth companies, but not smaller reporting companies. However, the proposed rules would phase in the reporting requirements for smaller companies, require only three years of cumulative reporting, and not require reporting amounts attributable to pensions or a comparison to peer group TSR.
A Few More Thoughts
In the NASPP’s last Domestic Stock Plan Design Survey (co-sponsored by Deloitte Consulting), usage of TSR targets for performance awards increased to 43% of respondents. With this new disclosure requirement, will even more companies jump on the TSR-bandwagon?
At least there’s one bit of good news: the disclosure covers only the NEOs, not a broader group of officers as was originally feared.
More Information
To learn more about the proposed regs, check out our NASPP alert, which includes a number of practitioner memos. The memo from Pay Governance includes a nifty table comparing the SEC’s definition of “actual” pay to the SCT definition of pay, traditional definitions of realized and realizable pay, and the ISS definition of pay.
It’s beginning to look this is going to be the year of Dodd-Frank rulemaking at the SEC. We may have the CEO pay-ratio disclosure rules by the end of the year, the SEC recently proposed rules for hedging policy disclosures, and now the SEC appears poised to propose the pay-for-performance disclosure rules this week.
Readers will recall that Dodd-Frank requires the SEC to promulgate rules requiring public companies to disclose how executive compensation related to company financial performance (see my blog entry, “Beyond Say-on-Pay,” August 5, 2010). In his April 24 blog on TheCorporateCounsel.net, Broc Romanek noted that the SEC has calendared an open Commission meeting for this Wednesday, April 29, to propose the new rules.
Broc’s Eight Cents
Broc offered eight points of analysis on this disclosure:
1. Companies can get the data and crunch the numbers. I don’t think that the actual implementation itself will be difficult.
2. But I think what could be particularly worrisome is having yet another metric to figure out what the CEO got paid and trying to explain all of it.
3. You know how companies have different schemes for granting equity, including type and timing. If the rules tend to try to fit everyone into a narrow bucket in order to try to line everyone up for comparability, and a company’s program doesn’t quite fit neatly into it, then the disclosure can get even more complicated.
4. There are two elements: compensation and financial performance. What is meant by “financial performance” for example? Maybe the SEC will just ask for stock price, maybe they’ll go broader.
5. A tricky part likely will be the explanation of what it all means—and how it works with the Summary Compensation Table.
6. I don’t think it will be difficult to produce the “math” showing the relationship of realized/realizable pay relative to TSR and other financial metrics, so long as:
– There’s a tight definition of realized pay
– We know what period to measure TSR (and if multiple periods can be used)
– We know what other performance measures can be included (if any) and if they can be as prominent in the disclosure as TSR
7. Another area of potential difficulty is explaining why there is not a tight or tighter correlation with TSR (“we use metrics other than TSR to drive our compensation; thus, the correlation is not very strong; on the other hand, our compensation is based on Revenue Growth and EBITDA Margin, and as Exhibit II demonstrates, the correlation is very significant”).
In addition, Dodd-Frank has no requirement for a relative ranking, and companies will need to decide if TSR and Pay should be put in some type of relative context (“relative to our peers, our realizable pay was well below the peers; so even though compensation is not tightly aligned with stock price performance the last 3 years, we did not pay our bums very much).
8. I think what may be the most difficult to address is a requirement to discuss what the Compensation Committee plans to change—and why is it now that it has performed the analysis?
Let’s Make It a Dime; Here’s My Two Cents
I’m not sure that the problem with executive compensation is that companies aren’t disclosing enough information about it. Isn’t this what the CD&A is for? Isn’t this why the stock performance graph is included with the executive compensation disclosures?
Moreover, does anyone think that any company will just come out and say that their executive compensation is not based on or tied to company performance in any way? I’m just not sure that public companies need one more disclosure to try to convince their shareholders that the amount of compensation they are paying to their executives is justified by the company’s performance.
Just when you thought you were finally getting a handle on the executive compensation disclosures, the SEC is considering changing them. According to an alert by McGuireWoods, the SEC staff has reviewed the disclosure requirements of Reg S-K (all of them, not just the disclosures relating to executive compensation) and issued a report that includes recommendations for further review. The JOBS Act of 2012 (not to be confused with the Jobs Creation Act of 2004) required the study with respect to disclosures by emerging growth companies, but the SEC expanded it to cover all companies.
The staff’s recommendations with respect to the executive compensation disclosures are fairly vague; they point out that these disclosures can be quite lengthy and technical and further review might be warranted on this basis, as well as to confirm that the information disclosed is useful to investors. The staff also suggests that the disclosures be reviewed to determine if they need to be made simpler for smaller companies.
So maybe the disclosures will change and maybe they won’t. According to the report, there weren’t any comments submitted to the SEC’s JOBS Act website on the executive compensation disclosures. Interestingly, there were two comments suggesting that the table disclosing the number of shares outstanding and available for grant under stock plans approved by shareholders and not approved by shareholders could be eliminated (and one comment that this table shouldn’t be eliminated, proving once again that you can’t please all the people, all the time).
According to McGuireWoods, at this time, the SEC is still formulating an action plan with respect to the study; a time frame hasn’t been specified for completing any further reviews called for under the study, much less promulgating and transitioning to any new rules.
Did You Know?
I did learn a couple of interesting tidbits when reading the section of the SEC’s report that covered the executive compensation disclosures. I thought you might be interested to know that:
The executive compensation disclosure rules have been amended more often than any other rules for disclosures required under Reg S-K.
The executive compensation disclosures, albeit in a very different format, have been around since the very first registration statement (Form A-1) implemented in 1933.
Back in 1933, the disclosure was required for any directors, officers, or other persons earning in excess of $25,000. This seems like a pretty low threshold, but then I ran the amount through the Bureau of Labor Statistic’s inflation calculator. In today’s dollars, that’s around $450,000.
In 1972, the threshold for disclosure was increased to compensation in excess of $40,000. According to the inflation calculator, that’s around $223,000 in today’s dollars.
It wasn’t until 1992 that the threshold was increased to $100,000. In today’s dollars, that’s about $166,000. $40,000 in 1972 was the equivalent of about $134,000 in 1992, so my guess is that we have a ways to go until the SEC decides to increase the threshold again.
Realizable pay has quickly emerged as a hot topic for this proxy season. In today’s blog, I offer a few thoughts on realizable pay as it relates to stock compensation.
Why Realizable Pay?
Realizable pay has emerged as a method for evaluating whether executive pay aligns with company performance. It’s an alternative to comparing company performance to total pay as disclosed in the Summary Compensation Table. For equity awards, pay is disclosed in the SCT at grant and is based on the grant date fair value. Arguably, the pay disclosed in this table is for future performance, not current performance. Also, the grant date fair value is not necessarily a predictor of how much compensation execs will actually receive under the arrangement.
Realizable pay, however, is based not on grant date fair value but on the current value of the company’s stock. Thus, where equity awards are a significant component of executive pay, realizable pay can make for a more compelling story for shareholders: high levels of realizable pay are likely the result of an elevated stock price, which in turn probably means that the company is performing well. On the other hand, poorly performing companies have lower stock prices, resulting in underwater stock options and low levels of realizable pay.
What Is Realizable Pay?
Realizable pay is not a mandated disclosure, so there is no standard definition for it. Generally, it can be expected to include cash compensation paid during the year, plus the intrinsic value of options and awards held by the executive. But, of course, it’s more complicated than that.
Which awards/options? Awards typically vest and pay out in three to four years, but options can be outstanding for up to ten years. The standard that is emerging seems to be to include only options and awards granted within a specified period (e.g., three years). The idea is that the grants that are generating the company’s current performance are the ones made in recent years; grants made earlier generated performance in an earlier time frame.
Vested and Unvested? Technically, executives can really only realize the value of options and awards that are vested. Most companies, however, seem to include both vested and unvested options and awards in realizable pay.
Performance Awards? Where execs hold performance awards, a decision also need to be made as to whether to include these awards at threshold, target, or maximum. These awards could also be included at the level at which they are currently expected to pay out, but companies may be uncomfortable with this approach as it potentially signals management’s expectations as to future company performance.
When Is Realizable Pay Not Realizable?
When ISS calculates it, of course. ISS includes the current Black-Scholes value of options in realizable pay, rather than just their intrinsic value (see “Proxy Advisor Policies for 2013,” November 27, 2012). The Black-Scholes value is generally always going to be higher than the intrinsic value (think fast: ten points if you can name two situations where the Black-Scholes value would not be significantly higher than intrinsic value), so this has the effect of increasing the pressure to outperform peers.
By now, you are probably finishing off any remaining leftovers from Thanksgiving. On that theme, I have a few leftover items for the blog and now seems like a good time to use them up. Sort of like making a casserole out of turkey, mashed potatoes and stuffing, but not quite as tasty.
Update on Proxy Disclosure Lawsuits On November 6, I blogged about plaintiffs’ attorneys that are now bringing lawsuits alleging that companies’ disclosures related to their stock plan or Say-on-Pay proposals are inadequate (“Martha Stewart and Your Proxy Statement“). The lawsuits seek an injunction to delay the shareholder votes on these proposals (which, in effect, delays the annual meetings); companies targeted by these attorneys are faced with settling and paying out plaintiffs’ attorney fees in the six figures (up to $625K) to avoid a delay.
Last week, Mike Melbinger provided an update on this issue in his Compensation Blog on CompensationStandards.com. To date, 20 companies have been targeted and at least six have settled, meaning that they agreed to make additional disclosures and pay fees to the plaintiffs’ attorneys. At least one company (Brocade Communications) also had to delay the vote on their stock plan proposal (although they did hold their annual meeting on time). At least three companies (Clorox, Globecomm Systems, and Hain Celestial) got courts to reject the injunction. And Microsoft got the law firm that filed the complaint (Faruqi & Faruqi, which has initiated most of these suits) to withdraw it. The article “Insight: Lawyers Gain from Say-on-Pay” Suits Targeting U.S. Firms,” published by Reuters on November 30, has a good summary of the various suits.
This is an opportunity for you, as a stock plan administrator, to demonstrate the value that you bring to the table. Make sure that your legal department is aware of the potential for these lawsuits, so that if your company is targeted, they aren’t caught offguard. You also might want to forward the memo we’ve posted from Orrick to legal (“New Wave of Proxy Statement Injunctive Lawsuits: How to Win & Prevent Them“), which include thoughts on strengthening your disclosure so they will be more likely to withstand one of these lawsuits.
IFRS: Hot or Not? An article published on November 13 in Accounting Today (“SEC Still Has Reservations about IFRS” by Michael Cohn) reports on comments by SEC officials at FEI’s 31st Annual Current Financial Reporting Issues conference on where the SEC stands on IFRS. The upshot is that SEC researchers have identified a number of concerns with adopting IFRS in the US and that the SEC is still taking a wait and see approach. Some of the areas the researchers looked at were the cost of conversion, whether or not IFRS makes sense for US capital markets, the interpretative process, the impact on private companies, investor understanding, and what our exit strategy might be if the US adopts IFRS and it backfires. Based on this report, I’d say we still have a long ways to go before we are under IFRS (or some sort of equivalent) here in the US.
Of course, things may change now that there will be a new chair at the SEC.
Even the SEC Makes Mistakes The next time someone finds a typo in something you’ve written, you can point out that you are in good company. In his blog for Allen Matkins, Keith Bishop notes a number of errors on the Form 10-K posted to the SEC website (“The SEC’s Form 10-K: ‘In Endless Error Hurled,'” April 11, 2012), including cites to regulations that don’t exist and outdated instructions. I feel a lot better now about the myriad typos I’m sure can be found in my blogs. If the SEC isn’t perfect, how can the rest of us be expected to be error-free?
More Than You Ever Want to Know About Stock-for-Stock Exercises I spent an hour or so today drafting a 1,200-word essay in response to a question in the NASPP Discussion Forum about stock-for-stock exercises. I’m so pleased with my response that I wish I had another use for it. But I don’t, so I’m mentioning it here in the hopes that a few more people will read it. If you want to understand what a tax-free exchange of property is (and what it isn’t), check out Topic #7391.
Shout-Out Finally, a shout-out to Sara Spengler at Facebook for suggesting the Thanksgiving tie-in for today’s blog entry.
If you are an issuer that will be submitting a request for additional shares for your stock plan to a shareholder vote in the upcoming proxy season, you need to read this blog. I’m filing this under “don’t say I didn’t warn you.”
What Does Martha Stewart Have to Do With This?
A while back, a short blurb about Martha Stewart Living Omnimedia caught my eye and I put it in my back pocket for a future blog entry if I ever figured out what the heck it was about. The blurb appeared in Mark Borges’ proxy disclosure blog on CompensationStandards.com:
Martha Stewart Living Omnimedia Inc. was the target of a shareholder class action lawsuit alleging that the company’s disclosure in connection with a proposal to increase the share reserve of its omnibus stock plan was inadequate.
This intrigued me because:
In my other, non-stock compensation life, I secretly want to be Martha Stewart (but with better hair and no insider trading scandal), so I’m fascinated by anything involving her. (Don’t scoff–I’m very crafty! I make all my own window treatments, can refinish a dining room table, and can whip up some pretty tasty jams and jellies.)
It involved the company’s stock plan, which falls squarely into the category of “things I care a lot about.”
Now, thanks to Mike Melbinger’s Oct 26 blog entry on CompensationStandards.com, I’ve finally figured out the implications of the lawsuit and determined that, if you are an issuer, it should be something you care a lot about as well.
Lawsuit Over Stock Plan Disclosures Could Delay Shareholders Meeting
There have now been several similar lawsuits filed. The lawsuits allege that the company’s disclosures relating to stock plan or Say-on-Pay proposals are inadequate and seek to delay the shareholders meeting. As Mike explains it:
[Companies] are forced to decide between (a) paying the class action lawyers hundreds of thousands of dollars of attorneys’ fees and issuing enhanced disclosures or (b) fighting the matter through a preliminary injunction hearing, which may have the effect of delaying [their] shareholder meeting (and create additional legal fees).
One company has already paid $625K to plaintiff attorneys to settle a similar lawsuit and, while they didn’t have to delay their entire annual meeting, they still had to delay the vote on their stock plan and file a supplement to their proxy statement with additional disclosures about the plan.
What Can You Do?
Mike asks “Does that sound like Armageddon?” and I’d say that it sure sounds like that me. Mike says that it is too soon to panic but suggests taking extra care in drafting your disclosures relating to any stock plan proposals and your Say-on-Pay propoals. A recent memo we posted from Orrick has suggestions for fortifying both types of disclosures against attack. Here are their suggestions for disclosures relating to any stock plan proposals:
Disclose the number of shares currently available for issuance under the stock plan and explain why the existing share reserve is insufficient to meet future needs. Consider citing your current burn rate and anticipated shares needed for new grants over the next year.
Explain how the remaining shares in the reserve and the new shares will be used and how long the new share reserve is expected to last.
Describe how you determined the number of shares you are requesting approval of.
It’s been months since I last discussed anything related to the Dodd-Frank Act so in today’s blog, I provide an update on SEC rulemaking related to the Act.
More Delays
The SEC recently updated its calendar for rulemaking activities pertaining to Dodd-Frank to delay a number of projects, including:
Requirements for companies to adopt clawback policies for compensation paid to executives.
Disclosure of the ratio of CEO pay to the median pay of all employees.
Disclosure of the relationship of executive compensation to corporate financial performance.
Disclosure of hedging policies for employees and directors.
Final rules on these projects are now scheduled to be issued no earlier than July and possibly as late as December 2012. This means we won’t have final rules in time for this year’s proxy season (but you had probably already figured that out for yourself). The SEC expects to issue proposed rules during the first half of 2012.
Accredited Investors
The SEC has amended the definition of an “accredited investor” to exclude the value of primary residences from net worth. This is an important definition under Regulation D, which provides a number of exemptions from registration for offerings of stock, some of which limit the number of nonaccredited investors that can participate in the offering.
Next up, the SEC is set to finalize rules prohibiting “bad actors” from participating in Rule 506 offerings. At first I thought this meant that Pauly Shore and David Caruso wouldn’t be able to participate in unregistered offerings, but it actually relates to felons and others that have been convicted of or sanctioned for securities fraud and similar activities.
These changes probably don’t impact the operation of most companies’ stock plans. Public companies generally register all the shares issued under their stock plans and private companies are generally relying on Rule 701 for an exemption from registration. Either way, neither has to worry about accredited investors or complying any with of the Regulation D exemptions (including Rule 506). But where a private company has exceeded the limitations in Rule 701 (10 points if you know what they are off the top of your head–no Googling) or where either public or private companies are making private sales of stock to investors outside of their stock plans, the Regulation D exemptions can come into play.
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.
Indecent Disclosures: Polishing and Perfecting Disclosures under ASC 718 By Elizabeth Dodge, Stock & Option Solutions
Disclosures under ASC 718 are a dreaded topic for nearly all my clients. The standard is unclear in some areas and flouts common sense in others, so what is a company to do? The answer? Do your best and try not to sweat the small stuff, unless your auditors force you to do so. In this entry, I’ll review one confusing part of the standard relating to disclosures and suggest ‘the right’ approach to take.
What Are “Shares of Nonvested Stock”?
In FAS 123(R), pre-codification, paragraph 240(b)(2) required the disclosure of:
The number and weighted-average grant date fair value…of equity instruments not specified in paragraph A240(b)(1) (for example, shares of nonvested stock), for each of the following groups of equity instruments: (a) those nonvested at the beginning of the year, (b) those nonvested at the end of the year, and those (c) granted, (d) vested, or (e) forfeited during the year. [emphasis added]
Paragraph 240(b)(1) asked for the number and weighted-average exercise price of options (or share units) outstanding. So what the standard seemed to require in the paragragh I quote above is the number and grant-date fair value for instruments other than options and share units, such as “shares of nonvested stock.” Clear as mud, so far? What is a share of nonvested stock, you ask? See footnote 11 on page 7 of the standard which reads:
Nonvested shares granted to employees usually are referred to as restricted shares, but this Statement reserves that term for fully vested and outstanding shares whose sale is contractually or governmentally prohibited for a specified period of time.
As if the standard wasn’t complicated enough, the FASB needed to define their own terms and use terms we thought we understood to refer to something else. Great idea. So a share of nonvested stock is therefore a restricted stock award (not a unit, but the kind of award on which you can file a Section 83(b) election). Here the FASB is lumping options and units (RSUs) together and separating out RSAs into a separate category. Perfectly logical, because RSUs are much more like options than RSAs, wouldn’t you agree? (And if you’re not getting the depth of my sarcasm, try re-reading the text above.)
Okay. So what do we use for weighted average exercise price for an RSU? Most RSUs that I’ve encountered don’t have an exercise price (and in fact, aren’t even exercised!). So obviously you should report zero here?
And most audit partners are unfamiliar with this issue all together. The good news is that most of them seem to ignore the actual language of the standard and, instead, require the same disclosures for RSUs and RSAs, which honestly does make a lot more sense, but isn’t what the standard calls for.
Unfortunately many systems/software providers were reading the standard carefully when they designed their disclosure reports, so often the RSU disclosures have “exercise price” but lack grant date fair value, so you’re often forced to calculate some of these numbers manually.
So now you’re thinking, but the Codification cleared all this confusion right up, didn’t it? Well, no… it did change the language just slightly. It removed “(for example, shares of nonvested stock).” It also added a link to the definition of “Share Units,” which reads: “A contract under which the holder has the right to convert each unit into a specified number of shares of the issuing entity.” Sounds like an RSU to me.
So where does all this leave us? My conclusion: Listen to your auditor, follow their guidance, which may not follow the standard to the letter, but makes more sense. Other folks are unlikely to notice the issue in the first place, but your auditors will.
Don’t Miss the 19th Annual NASPP Conference The 19th Annual NASPP Conference will be held from November 1-4 in San Francisco. With Dodd-Frank and Say-on-Pay dramatically impacting pay practices, you cannot afford to fall behind in this rapidly changing environment; it is critical that you–and your staff–have the best possible guidance. The NASPP Conference brings together top industry luminaries to provide the latest essential–and practical–implementation guidance that you need. This is the one Conference you can’t afford to miss. Don’t wait–the hotel is filling up fast; register today to make sure you’ll be able to attend.