SEC: 'A range' of Reasonable Conduct Acceptable in Options Expensing

The Securities and Exchange Commission’s (SEC) Office of the Chief Accountant and its Division of Corporation Finance released  Staff Accounting Bulletin (SAB) 107 about the Financial Accounting Standards Board’s (FASB) options expensing requirement scheduled to go into effect later this year (See  FASB Releases Stock Option Expensing Rule ).

According to the SEC, the guidance covers:

• share-based payment transactions with nonemployees
• the transition from nonpublic to public entity status
• including disclosures within filings made with the SEC relating to the accounting for share-based payment transactions
• valuation methods (including assumptions such as expected volatility and expected term)
• the accounting for certain redeemable financial instruments issued under share-based payment arrangements
• the classification of compensation expense
• non-GAAP financial measures
• first-time adoption of (the rule) in an interim period
• capitalization of compensation cost related to share-based payment arrangements
• the accounting for income tax effects of share-based payment arrangements upon adoption of the expensing rule
• the modification of employee share options prior to adoption of the rule
• disclosures in Management’s Discussion and Analysis after adopting the rule.

“The SEC staff believes the interpretive guidance in SAB 107 will assist both public entities in applying the provisions of (the options rule) and investors and other users of financial statements in analyzing the information provided under that (rule),” the SEC said    in announcing the release of the new guidance.

As was previously publicly reported, the SAB tried to reassure corporate officials that they will have a certain amount of leeway in implementing the rule requiring options to be disclosed as a corporate expense ( Report: SEC to Ease Some Options Expensing Worries ) .

SEC staff members included the promised soothing words. “The staff recognizes that there is a range of conduct that a reasonable issuer might use to make estimates and valuations and otherwise implement (the options rule) and the interpretive guidance provided by this SAB, particularly during the period of the (rule’s) initial implementation,” the SEC wrote in the guidance document released Tuesday.

“Thus, throughout this SAB the use of the terms ‘reasonable’ and ‘reasonably’ is not meant to imply a single conclusion or methodology, but to encompass the full range of potential conduct, conclusions or methodologies upon which an issuer may reasonably base its valuation decisions. Different conduct, conclusions or methodologies by different issuers in a given situation does not of itself raise an inference that any of those issuers is acting unreasonably. While the zone of reasonable conduct is not unlimited, the staff expects that it will be rare when there is only one acceptable choice in estimating the fair value of share-based payment arrangements under the provisions of (the options rule) and the interpretive guidanceprovided by this SAB in any given situation.”

As corporate officials and regulators get more experience in the rule's implementation, both sides will eventually figure out the best way to proceed on the options expensing issue, the SEC document asserted.

"Over time, as issuers and accountants gain more experience in applying (the options rule) and the guidance provided in this SAB, the staff anticipates that particular approaches may begin to emerge as best practices and that the range of reasonable conduct, conclusions and methodologies will likely narrow," the document said.

Another key aspect of Tuesday document came in the issue of how to measure fair value and how it might be affected by future corporate events - one of a series of particularly controversial potential sticking points hotly debated since the rule was first proposed.

SEC staff members suggested Tuesday that "the estimate of fair value should reflect the assumptions marketplace participants would use in determining how much to pay for an instrument on the date of the measurement (generally the grant date for equity awards). If a company makes a good faith fair value estimate in accordance with the provisions of (the options rule) in a way that is designed to take into account the assumptions that underlie the instrument's value that marketplace participants would reasonably make, then subsequent future events that affect the instrument's value do not provide meaningful information about the quality of the original fair value estimate. As long as the share options were originally so measured, changes in an employee share option's value, no matter how significant, subsequent to its grant date do not call into question the reasonableness of the grant date fair value estimate."

According to the SEC, the valuation technique chosen should be one that

• is applied in a manner consistent with the fair value measurement objective and other requirements of (the options rule)
• is based on established principles of financial economic theory and generally applied in that field
• reflects all substantive characteristics of the instrument.

Later Tuesday, after the SEC document was release, one trade group put out a statement applauding regulators for trying to ease the transition period, but still promised to study the latest guidance carefully to see if regulators went as far as some in the options arena wanted.

"We appreciate the SEC's efforts and our experts will now review this announcement with a keen eye to how it affects our nation's companies, competitiveness and financial reporting," said Rick White, President of the International Employee Stock Options Coalition, in the statement. "While we continue to believe that FASB's mandatory expensing standard is fundamentally flawed, it appears at first blush that the SEC is trying to address some of the problems with the standard. We are hopeful that the SEC has made progress toward developing a workable valuation approach and providing protections from meritless litigation for well-intentioned preparers of financial statements."