July 20, 2006

SEC to Consider Adopting Executive Compensation Rules

Yesterday, the SEC announced that it will hold an open Commission meeting next Wednesday – July 26th – to consider adopting the executive compensation rules. My guess it will then take the Commission at least a week to issue an adopting release.

Today’s WSJ includes an article that provides some predictions of changes to the SEC’s proposals – none of them shocking – such as scrapping the “Katie Couric” proposal that would include non-executives in the Summary Compensation Table, keeping the stock performance graph and requiring details of option granting practices. This will be Commissioner Casey’s first open Commission meeting fyi…

New Conference Dates – And Now Live in Washington DC!

Now that we know the new executive compensation disclosure rules will be adopted soon, we are meeting the overwhelming number of requests from members – who apparently couldn’t bear the thought of watching a two-day conference from their computer – so that our Conference (“Implementing the SEC’s New Executive Compensation Disclosures: What You Need to Do Now!“) will be held live in Washington DC at the Marriott Wardman Park (please wait a day to call the Marriott to get special room rates – we are still working on those arrangements). The Conference will still be video webcast live as well.

The Conference dates have been pushed up slightly – it will now be held on September 11-12, instead of September 13-14. These new dates were the only ones available at a hotel large enough to accommodate the Conference.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft – and review – disclosures during the proxy season.

An incredible number of members have already registered for the video conference – if you would rather attend live in DC, check out these FAQs to figure out the best way to change the nature of your registration.

If you haven’t yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

Audit Committees in Action: The Latest Developments

We have posted a copy of the transcript from the webcast: “Audit Committees in Action: The Latest Developments.”

Avoiding a Potential FAS 123(R) Trap: Anti-Dilution Provisions in Equity Plans

The Big 4 apparently are at it again with yet another restrictive interpretation of FAS 123R. This one would require an earnings charge in the event of an equity restructuring (e.g., stock split) or business combination if an equity plan has a permissive rather than mandatory adjustment provision. I have received dozens of e-mails over the past few weeks about this issue and am glad that the first batch of memos on the topic are now out.

Here is a brief snap shot of the issue from Dorsey & Whitney:

“Some major accounting firms are advising clients that the typical anti-dilution provisions of existing equity compensation plans may need to be amended in order to avoid potentially significant increases in compensation expense associated with adjustments to equity awards in connection with stock splits, stock dividends or other changes in the issuer’s capitalization.

The issue turns on whether the anti-dilution adjustment applied to awards under equity plans is determined to be mandatory or permissive. If the adjustment is determined to be permissive, then the award is deemed to be modified upon adjustment under FAS 123R, resulting in a re-calculation of the fair value of the award and a possible increase in the compensation expense for the company.

Many plans are written flexibly, allowing compensation committees to determine whether the corporate event is one triggering an appropriate anti-dilution adjustment. Companies should review the terms of their equity compensation plans and arrangements and consult with their external auditors concerning this issue well in advance of any change in capitalization requiring an adjustment of awards under their equity plans.”

And here is the take from Cleary Gottlieb: “We understand that the Big Four accounting firms recently reached a consensus concerning the application of FAS 123R in circumstances in which employee stock options and other equity awards are revised to reflect changes in the capitalization of the employer. It appears that the precise wording of a stock plan’s “antidilution” provision (or the absence of an antidilution provision) can make a world of difference in the accounting charges that might need to be taken in connection with a stock split, stock dividend, recapitalization, spin-off or other equity restructuring.

In sum, if a plan contains no antidilution provision or the antidilution provision provides for discretion on the part of the employer to adjust equity awards in connection with a change in capitalization (e.g., “the Committee may adjust awards as it deems necessary or appropriate to prevent enlargement or dilution of rights”), then such adjustment will be deemed to be a modification of the award, resulting in an adverse accounting consequence: any incremental fair value of the award after its modification compared to the fair value of the award prior to modification will need to be recognized as compensation expense. If, however, there is an antidilution provision and it does not permit any such discretion, (e.g., “the Committee shall adjust awards as it deems necessary or appropriate to prevent enlargement or dilution of rights”), then such adjustment will not be deemed to be a modification and no compensation expense would need to be recognized.

For purposes of determining any incremental fair value, the award’s fair value immediately prior to the modification is determined assuming that the equity restructuring will occur and no antidilution adjustments will be made. The award’s fair value immediately after the modification is determined by taking into account the adjustments made. For example, assume that an employer decides to effect a 2-for-1 stock split at a time when its stock is worth $50 per share. The employer determines, pursuant to the exercise of its discretion and not pursuant to a contractual obligation, to adjust outstanding options equitably to reflect the split.

As a result of the adjustment, a stock option for 10 shares with a strike price of $15 becomes a stock option for 20 shares with a strike price of $7.50. Assume that the value of a share of stock immediately after the split is $25. Under FAS 123R, we understand that the option would have to be valued both immediately before and after the split, in each case using the $25 per share value of the stock after the split. Using assumptions for a hypothetical company, based on a black-scholes valuation model, the compensation that would be required to be recognized for such option would be on the order of magnitude of $1,000.

We urge you to review your stock incentive plan antidilution provisions, to consult with your auditors concerning the matters described above and to consider adding or amending plans to provide for automatic and non-discretionary adjustments to be made in connection with certain equity restructurings. However, you need to carefully consider the consequences of making such changes. First, such changes may not avoid an accounting charge if made in anticipation of a capital change or restructuring. Second, any such change would give participants legal rights that they did not previously have. Third, it is not clear what effect a revision of an antidilution provision would have on outstanding stock options or other equity awards for purposes of Section 409A or, for incentive stock options, Section 422 of the Internal Revenue Code.”

The NASPP has posted related memos in its “Stock Option Expense” Portal.