Lawyer Article

Published in the April 20, 2005 issue of the Southeast Tech Wire

The Staff of the Securities and Exchange Commission ("SEC") recently issued two publications designed to assist companies in their adoption and implementation of the Financial Accounting Standards Board's Statement of Financial Accounting Standards No. 123 (revised 2004), "Share-Based Payment" ("FAS 123(R)"). FAS 123(R), which requires companies to recognize an expense for stock-based compensation, will become effective for public companies (other than small business issuers) as of the first reporting period beginning after June 15, 2005. For private companies and small business issuers, the statement is effective as of the first reporting period beginning after December 15, 2005.

On March 29, 2005, the Staff of the SEC's Division of Corporation Finance and Office of Chief Accountant released Staff Accounting Bulletin No. 107 ("SAB 107") (available here), which provides interpretive guidance regarding the valuation of stock-based payment transactions for public companies and the interaction between FAS 123(R) and the SEC's rules and regulations. Topics covered in SAB 107 include:

• Share-based payment transactions with nonemployees;
• Transition from private to public company status;
• Valuation methods (including assumptions used therein);
• Treatment of redeemable financial instruments;
• Presentation of non-GAAP measures of stock-based compensation;
• Initial adoption of FAS 123(R) in an interim period;
• Capitalization of compensation costs;
• Accounting for income tax effects of FAS 123(R);
• Modification of employee stock options prior to adoption of FAS 123(R); and
• Disclosures in MD&A.

In SAB 107, the SEC acknowledges that there is a wide range of conduct that an issuer might use to comply with FAS 123(R). Among the key points are the following:

• As long as a company makes a good faith fair value estimate of a stock option's value in accordance with FAS 123(R), subsequent changes in the actual option value will not call into question the reasonableness of the grant date fair value estimate.
• A company may change its valuation technique or model as long as the new technique or model meets the fair value measurement objective in FAS 123(R). However, the Staff would not expect frequent changes, and the reason for any change should be disclosed.
• If a company presents a measure of net income before the effect of accounting for share-based payment transactions, that measure would be considered a non-GAAP financial measure and would trigger compliance with Regulation G and Item 10 of Regulation S-K.
• A company that accelerates vesting of certain outstanding options in anticipation of FAS 123(R) should specifically disclose such modifications, including the reasons for the modifications.
• With respect to share-based transactions with nonemployees, companies should apply the guidance in FAS 123(R) unless other authoritative accounting literature more clearly addresses the appropriate accounting or the application of FAS 123(R) would be inconsistent with the terms of the share-based payment arrangement.

The SEC's Office of Economic Analysis has also issued guidance for compliance with FAS 123(R). The March 18, 2005 memorandum entitled "Economic Perspective on Employee Option Expensing: Valuation and Implementation of FAS 123(R)" is available here. The memorandum addresses certain topics related to the economics of FAS 123(R), including the following:

• Benefits from the expensing of employee options;
• Suitable models for estimating option values;
• Reliable parameters and inputs for estimating values of employee options;
• Third party verification of employee stock option values; and
• Common errors and misconceptions in stock option valuations.