June 29, 2010
New SEC Interpretation Raises Accounting and Disclosure Issues for Performance Share Awards Subject to Discretion
– Andy Restaino, Towers Watson
As we recently noted in this article, a recent SEC interpretation raises some potential accounting and disclosure implications for stock-settled performance share awards in cases where a company retains the discretion to modify the number of shares otherwise earned under a performance share award formula (i.e., the compensation committee has the ability to exercise “negative” discretion). Companies that award performance shares subject to discretion will want to review the SEC interpretation carefully and may want to modify their performance share plans to avoid adverse accounting consequences.
Example: A company awards stock-settled performance shares in January 2010. The award is subject to a performance period that runs from January 1, 2010 through December 31, 2012. The ultimate number of shares that will be delivered after the end of a three-year performance cycle (i.e., early in 2013) will vary based on an objective formula involving a performance or market condition (as defined in ASC 718). However, the plan allows the compensation committee to reduce the number of shares that would otherwise be delivered based solely on the objective performance formula.
Because of the committee’s ability to exercise negative discretion on the ultimate number of shares delivered, it’s possible that such a performance share award would not have an ASC 718 “grant date” until the award is settled, thus jeopardizing fixed accounting treatment for the award. Further, the proxy disclosure rules control the timing of disclosure by generally requiring equity awards to be disclosed in the compensation tables based on the award’s accounting grant date.
If this standard applied to a performance share award of the type described above, the award would not be reported in the tabular disclosure until the discretion is exercised or lapses, typically years after the awards were initially communicated to executives. However, the recent SEC guidance indicates that even though there might not be a grant date for an award of performance shares for accounting purposes, disclosure of the fair value should not be delayed if the “service inception date” (an accounting concept discussed below) precedes the grant date.
It’s worth noting that the use of negative discretion in determining the payout of performance share awards is not a new concept. This approach has been common at least since Section 162(m) of the tax code came on the scene in the mid-1990s. We can only speculate as to why auditors appear to be increasingly sensitive to the potential accounting implications of such discretion with regard to equity awards. Note also that performance awards denominated and settled in cash do not pose the same accounting issue because they could never qualify for fixed accounting treatment.
Read more about the accounting and disclosure implications of this SEC position in our article.