21-4, SEC Issues Staff Accounting Bulletin on “Spring-Loaded” Awards (December 3, 2021)

SEC Issues Staff Accounting Bulletin on “Spring-Loaded” Awards

by Sean May and Katy Rossino, Deloitte & Touche LLP

Background

On November 29, 2021, the SEC issued Staff Accounting Bulletin (SAB) No. 120. SAB 120:

Provides the SEC staff’s views on the measurement and disclosure of certain share-based payment awards granted when entities possess material nonpublic information (i.e., “spring-loaded” awards).
Revises SAB Topic 141 to conform references to guidance from ASC 7182 to the current wording in ASC 718, and to rescind guidance that no longer applies.

Spring-Loaded Awards

In SAB 120, the SEC staff describes a spring-loaded award as follows:

A share-based payment award granted when a company is in possession of material nonpublic information to which the market is likely to react positively when the information is announced is sometimes referred to as being “spring-loaded.”

The new SAB amends SAB Topic 14.D3 to add considerations related to spring-loaded awards. Under SAB 120, an entity that grants a share-based payment award while in possession of positive material nonpublic information should consider whether adjustments to the following are appropriate when determining the fair-value-based measure of the award: (1) the current price of the underlying share or (2) the expected volatility of the price of the underlying share for the expected term of the share-based payment award.

Current Price of the Underlying Share

Accounting Considerations

Before the amendments in SAB 120, the guidance in SAB Topic 14.D helped public entities develop assumptions related to (1) expected volatility and (2) expected term in connection with meeting the fair value measurement objective in ASC 718. SAB 120 adds guidance to SAB Topic 14.D on a third assumption: current price of the underlying share (including considerations for spring-loaded awards). An entity would use this guidance to determine when an adjustment to the observable market price of the underlying share is necessary.

In accordance with ASC 718-10-55-27, companies typically adopt an accounting policy for determining the current share price of a share-based payment award. That guidance indicates that “an entity might use the closing share price or the share price at another specified time as the current share price on the grant date in estimating fair value, but whichever method is selected, it shall be used consistently.”

SAB 120 acknowledges that entities should use significant judgment when determining whether an adjustment to the observable market price is necessary. It notes that it is not uncommon for entities to possess nonpublic information when entering into share-based payment transactions, and that an observable market price on the grant date is “generally a reasonable and supportable estimate of the current price of the underlying share in a share-based payment transaction, for example, when estimating the grant-date fair value of a routine annual grant to employees that is not designed to be spring-loaded.” The SAB goes on to note that “companies should carefully consider whether an adjustment to the observable market price is required, for example, when share-based payments arrangements are entered into in contemplation of or shortly before a planned release of material non-public information, and such information is expected to result in a material increase in share price.” The SEC staff observes that to identify such awards, entities should look to the change in the market price of the company’s shares after the release of the material nonpublic information. If there is a material increase in the share price, such increase would indicate that a market participant would have considered adjusting the market price to reflect that information.

To illustrate how to apply the amended guidance, SAB 120 adds the following example to SAB Topic 14.D:

Facts: Company D is a public company that entered into a material contract with a customer after market close. Subsequent to entering into the contract but before the market opens the next trading day, Company D awards share options to its executives. The share option award is non-routine, and the award is approved by the Board of Directors in contemplation of the material contract. Company D expects the share price to increase significantly once the announcement of the contract is made the next day. Company D’s accounting policy is to consistently use the closing share price on the day of the grant as the current share price in estimating the grant-date fair value of share options.

Question 1: Should Company D make an adjustment to the closing share price to determine the current price of shares underlying share options?

Interpretive Response: Prior to awarding share options in this fact pattern, the staff expects Company D to consider whether such awards are consistent with its policies and procedures, including the terms of the compensation plan approved by shareholders, other governance policies, and legal requirements. The staff reminds companies of the importance of strong corporate governance and controls in granting share options, as well as the requirements to maintain effective internal control over financial reporting and disclosure controls and procedures.

In estimating the grant-date fair value of share options in this fact pattern, absent an adjustment to the closing share price to reflect the impact of Company D’s new material contract with a customer, the staff believes the closing share price would not be a reasonable and supportable estimate and, without an adjustment the valuation of the award would not meet the fair value measurement objective of FASB ASC Topic 718 because the closing share price would not reflect a price that is unbiased for marketplace participants at the time of the grant. [Footnote omitted]

Throughout SAB 120, the SEC staff reminds registrants of “their corporate governance obligations and disclosure obligations under U.S. GAAP with respect to share-based payment transactions, as well as the need to maintain effective internal control over financial reporting.”

Connecting the Dots

Companies may find it necessary to implement more robust or make changes to existing processes and controls related to identifying material nonpublic information and accounting for spring-loaded awards.

Disclosure Considerations

The staff also provides the following disclosure expectations regarding spring-loaded awards:

How the entity determined the share price when calculating the awards’ grant-date fair-value-based measure.
The entity’s accounting policy for determining an adjustment to the market price and how it determines that amount (including significant assumptions made), if material.
Information about spring-loaded awards may need to be disclosed separately from other share-based payment arrangements.4
An entity “should consider the applicability of MD&A and other disclosure requirements, including those related to liquidity and capital resources, results of operations, critical accounting estimates, executive compensation, and transactions with related persons.”

Expected Volatility

Accounting Considerations

SAB 120 notes that “careful consideration is required to determine whether material non-public information is currently available (or would be available) to the issuer that would be considered by a marketplace participant in estimating the expected volatility.” Accordingly, when valuing spring-loaded awards, an entity needs to determine whether a marketplace participant would consider the material nonpublic information when estimating expected volatility.

When performing this valuation, an entity should also consider whether (1) the existence of such material nonpublic information affects the extent of reliance on implied volatility and (2) the material nonpublic information should be factored into the determination of implied and historical volatility when estimating expected volatility.

Disclosure Considerations

SAB 120 states that the SEC staff expects a registrant that grants a spring-loaded award to disclose “how it determined any significant adjustments to historical volatility.”

Connecting the Dots

Determining the fair-value-based measure of a share-based payment award can be complex, and estimating the fair-value-based measure of spring-loaded awards introduces additional complexity. Although SAB 120 discusses circumstances in which a registrant may be required to make adjustments to expected volatility and the current share price, it does not provide guidance on how to determine the amount of such adjustments. Accordingly, when making these determinations, a registrant should assess the specific facts and circumstances that led to the adjustment and consider consulting with its valuation specialists and accounting advisers.

Conforming Changes and Rescission

SAB 120 amends SAB Topics 55 and 14 to conform references to guidance from ASC 718 to the current language used in ASC 718. The amendments rescind SAB Topic 14.A6 as a result of amendments in ASU 2018-077 that make the guidance in SAB Topic 14.A irrelevant. The rescission and conforming changes bring existing guidance into conformity with ASC 718, as updated by ASUs 2019-08,8 2018-07, and 2016-09.9

For more SEC highlights, stay tuned for our Heads Up on the 2021 AICPA Conference on Current SEC and PCAOB Developments (December 6–8, 2021), which we expect to issue the week after the conference.

Footnotes

SEC Staff Accounting Bulletin Topic No. 14, “Share-Based Payment.”

FASB Accounting Standards Codification (ASC) Topic 718, Compensation — Stock Compensation.

SEC Staff Accounting Bulletin Topic No. 14.D, “Certain Assumptions Used in Valuation Methods.”

See ASC 718-10-50-1 and ASC 718-10-50-2(g).

SEC Staff Accounting Bulletin Topic No. 5, “Miscellaneous Accounting.”

SEC Staff Accounting Bulletin Topic No. 14.A, “Share-Based Payment Transactions With Nonemployees.”

FASB Accounting Standards Update No. 2018-07, Improvements to Nonemployee Share-Based Payment Accounting.

FASB Accounting Standards Update No. 2019-08, Codification Improvements — Share-Based Consideration Payable to a Customer.

FASB Accounting Standards Update No. 2016-09, Improvements to Employee Share-Based Payment Accounting.

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