During 2014, stock-based compensation remained an area of focus for the SEC in their comment letters to registrants. In their report released in February 2015, “Employee stock compensation, 2014 comment letter trends”, Price water house Coopers LLP (“PWC”) found that 52% of the comments relate to disclosure, 30% to valuation and 18% related to accounting recognition. Many of the comments related to the additional disclosures required for an initial public offering (“IPO”). PWC performed the analysis by looking at 223 comments the SEC staff made to registrants between September 15, 2013 and September 15, 2014 related to stock-based compensation.
There were a number of comments requesting additional disclosure related to share-based payments and a number of the comments related to companies that issued stock prior to an IPO.
The following is a sample of several disclosure comments related to stock-based compensation for 2014:
- More fully explain in the disclosure the increase in fair value of your ordinary shares from XXX to XXX. Quantify the effect of each factor that caused a change in the fair value. Specify what events occurred between XXX and XXX and the effect of that event on the fair value.
- Please disclose the intrinsic value of outstanding vested and unvested options as of the most recent balance sheet date based on the estimated IPO price. Please provide quantitative and qualitative disclosures explaining the difference between the estimated offering price and the fair value of each equity issuance.
The SEC staff continues to challenge how companies value employee stock compensation during the period before the company goes public. The valuation of stock options issued as compensation while a company is privately held can be considered “cheap stock” if the value of the underlying stock at the grant date is below the ultimate IPO price. If valuations performed during the 12 months prior to an IPO are significantly lower than the company’s ultimate IPO pricing range, the SEC will often ask management to explain why.
The SEC staff also often requests additional information regarding the inputs and assumptions used to determine the fair value of stock-based compensation. Management needs to be able to support its assumptions and estimates used to estimate the fair value of its securities underlying share-based payments.
Some examples of comments related to stock-based compensation valuation in 2014 include:
- Accordingly, please expand to provide a specific discussion of each key factor contributing to any significant difference between the estimated fair value of your common stock and the estimated offering price (or pricing range) for the 12 months prior to the contemplated offering.
- Please tell us about each significant factor contributing to the difference between the estimated IPO Price and the fair value of your shares for each grant in fiscal 2013, the first quarter of fiscal 2014 and any subsequent grants through the date of your response. In your response, please tell us about significant intervening events and reasons for changes in assumptions, as well as the weighting of expected outcomes and selection of valuation techniques employed
While there are fewer comments related to accounting than those related to valuation and disclosure issues, it is an area that continues to be mentioned in comment letters. Areas of comment included those related to expense recognition and whether an award should be recognized as equity or a liability.
Examples of disclosure comments for 2014 include:
- It is unclear to us how you determined the $4.5 million in expense recorded in 2013. In this regard, we note that the total expense related to these options is $10.8 million and the options vest over a four-year period. Please provide us with your calculation supporting the $4.5 million in expense recorded in 2013.
- We note your disclosure regarding the options issued to officers that are subject to acceleration upon an exit event which, according to your disclosures, includes this offering. Please tell us how you are accounting for these options and explain how the acceleration at the IPO impacts your accounting. Please refer to the authoritative guidance that supports your accounting
The report issued by PWC related to stock-based compensation comment letter trends is a “good read” that contains information and examples that may be useful to both registrants and their auditors.