As I mentioned in my blog on Tuesday, we are starting to see some movement towards repeal or revision of at least parts of the Dodd-Frank Act. The Administration’s executive order isn’t the only action that has been taken; here are a couple of other developments:
CEO Pay Ratio—The SEC Weighs In
On Monday, February 6, Acting SEC Chair Michael Piwowar issued a statement on the CEO pay ratio disclosure. Piwowar requests comments on “unexpected challenges that issuers have experienced as they prepare for compliance with the rule and whether relief is needed,” and encourages detailed comments to be submitted within 45 days. Piwowar also notes that he has directed the SEC staff to “reconsider the implementation of the rule based on any comments submitted and to determine as promptly as possible whether additional guidance or relief may be appropriate.”
While that’s pretty vague, is does indicate that, in addition to the Secretary of the Treasury and the Financial Stability Oversight Council, the SEC is also looking at the CEO pay ratio rule. Even so, it’s hard to say what this means. As we all know, and as an article in the Wall Street Journal notes (“GOP-Led SEC Considers Easing Pay-Gap Disclosure Rule of Dodd-Frank“), it is difficult for the SEC to move quickly on matters like this:
Republicans on the SEC could be stymied by the commission’s own procedures on the pay-ratio rule because undoing a regulation is handled by an often lengthy process that is similar to creating one. It also is difficult for the SEC to delay it outright, because of the commission’s depleted ranks. There are just two sitting commissioners—Mr. Piwowar and Kara Stein, a Democrat—meaning the SEC is politically deadlocked on most matters. Ms. Stein on Monday signaled opposition to efforts to ease the pay rule. “It’s problematic for a chair to create uncertainty about which laws will be enforced,” she said.
And Then There’s Congress
An article in Bloomberg/BNA reports that the Financial Choice Act is likely to be reintroduced into Congress this year (“Dodd-Frank Rollback Bill Expected in February, Duffy Says“). Originally introduced last year, this bill would repeal or restrict major parts of the Dodd-Frank Act, including reducing the frequency of Say-on-Pay votes, limiting application of the clawback provisions, and repealing the CEO pay ratio and hedging disclosures. Jenn Namazi blogged on the Act last year (see “Post Election: Things to Watch – Part I” and “Part 2“).
The Financial Choice Act is bigger than Dodd-Frank. The bill would also require a joint resolution of Congress before any “major” rulemaking by the SEC and a number of other agencies could go into effect. Mark Borges notes in his blog on CompensationStandards.com (“Acting SEC Chair Weighs in on CEO Pay Ratio Rule“) that the bill is expected to require the major proxy advisory firms to register with the SEC and, among other things, disclose potential conflicts of interest.
Poll: What Are You Doing?
It’s hard to know what to do in response to all this. Preparing for the CEO pay ratio disclosure requires a lot of time and resources, which most on the corporate side would view as wasted if the disclosure is eliminated. But if the disclosure isn’t eliminated, stalling preparations now could result in an implementation time crunch.
In his blog on CompensationStandards.com (“As Predicted—Hitting the Pause Button on the CEO Pay Ratio Rule“), Mike Melbinger says: “Postponement and revision of the rule seems likely. Now might be a good time to stop spending time and money on this calculation.” Take our poll to tell us what your company is doing (click here if the poll doesn’t display below).
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.
PricewaterhouseCoopers has published a summary of SEC comments on stock compensation (“2013 SEC Comment Letter Trends: Employee Stock Compensation,” available in the NASPP’s Surveys & Studies Portal). The comments were made in the course of the SEC’s review of various types of public filings (mostly Forms S-1, but also some Forms 10-K and other filings). I thought it would be interesting to take a look at what PwC found for today’s blog.
Companies Targeted
The majority (79%) of the companies to receive comments were technology, pharmaceutical, and life science companies. But don’t read anything into this–as noted above, the majority of the SEC’s comments were on S-1 filings, and these industries represented the majority of IPOs last year (particularly IPOs where employees held substantial amounts of stock compensation).
Areas Commented On
81% of the SEC’s comments related to information on stock compensation included in the MD&A. Of the comments related to the MD&A, 90% related to the discussion of critical accounting policies, et. al., for stock compensation. Based on the sample comments excerpted by PwC, it seems that many of these comments requested more information on the valuation of the company’s stock on grant dates.
Types of Comments
PwC found that, overall, 50% of the comments related to disclosure, 41% related to valuation, and 9% related to other accounting issues. Of the 41% of comments related to valuation, many of these seem to relate to the valuation of the company’s underlying stock on grant dates, rather than the valuation of stock options. Also, a little over one-third of the comments that PwC classified as disclosure-related were on the disclosures related specifically to valuation. Another 29% were on disclosures related to IPOs; many of these comments focused on valuation of the company’s stock (specifically on the differences between the most recent valuation and the IPO price).
Accounting Recognition Comments
Not much here. PwC notes that:
“Interestingly, we did not come across many comments related to some of the more complex areas of stock compensation accounting. For example, we saw only one comment on classification of awards as equity verses liability, no comments on expense attribution methodology, one comment on award modifications, and no comments on determination of the grant date.”
Key Takeaways
Overall, it seems that the SEC either (1) focused primarily on stock valuation-related issues in their review of stock compensation info in public filings, or (2) focused on everything but simply didn’t find much to comment on beyond the stock valuation issues.
If you are a public company, this is probably good news. Because your stock is publicly traded, so long as your grant dates are accurate, there’s not a lot for the SEC to question with regards to your stock value. But if you are a private company, you’ll want to make sure your house is in order when it comes to grant date stock valuations.