SEC accounting guidance for "spring-loaded" compensation awards

ARTICLE | December 01, 2021

Authored by RSM US LLP

On November 29, 2021, the SEC Staff issued guidance regarding the proper recognition and disclosure of the compensation costs for “spring-loaded” awards made to executives. Spring-loaded awards are share-based compensation arrangements through which a company grants stock options or other awards while in possession of material non-public information to which the market is likely to react positively when the information is announced (e.g., an earnings release with better-than-expected results or the disclosure of a significant transaction).

The SEC staff believes that the accounting for and disclosures of spring-loaded compensation awards to executives should reflect the economics and terms of the related compensation agreements. Therefore, Staff Accounting Bulletin (SAB) No. 120 was issued to add interpretive guidance for public companies to consider when entering into share-based payment transactions while in possession of material non-public information. Specifically, SAB 120 provides additional guidance to companies for estimating the fair value of such share-based payment transactions in accordance with Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, Compensation – Stock Compensation.

For a valuation technique to be consistent with the fair value measurement objective and the other requirements of ASC 718, the SEC staff believes that a consistently applied method to determine the current price of the underlying share should include consideration of whether adjustments to observable market prices (e.g., the closing share price or the share price at another specified time) are required. In this regard, the SEC staff believes that non-routine spring-loaded grants merit particular scrutiny by those charged with compensation and financial reporting governance.

When a company is in possession of positive material non-public information, the SEC staff believes the company should consider the impact that the information will have upon release and whether adjustments to the current price of the underlying share or the expected volatility of the price of the underlying share for the expected term of the share-based payment award are necessary when applying a fair-value-based measurement method to estimate the cost of its share-based payment transactions. (In other words, when recognizing compensation cost for the award, the company should reflect the additional value conveyed to the recipients from the anticipated announcement of the material information.) SAB 120 includes examples where such adjustments may be necessary and reminds companies of their corporate governance obligations and disclosure obligations under U.S. generally accepted accounting principles with respect to share-based payment transactions, as well as the need to maintain effective internal control over financial reporting.

Additionally, SAB 120 rescinds portions and conforms portions of the interpretive guidance included in the SAB Series in order to bring the relevant staff interpretive guidance into conformity with the latest FASB updates to ASC 718.