The Employee Ownership Update
April 1, 2005
SEC Staff Issues Soothing Guidelines on New Equity Expensing RulesIn Staff Accounting Bulletin No. 107, the SEC staff has issued guidelines intended largely to assure companies that it will provide some leeway in implementing FAS 123(R) to allow for a variety of "reasonable" interpretations. Most significantly, it will allow a number of valuation formulas. While the staff expects practice to normalize over time, initially, companies must simply show that their approach is one that would reasonably imitate what an outside purchaser of an equity award would offer at the time the award is granted. If future events provide the estimating technique inaccurate, that, in itself will not be a problem. Volatility assumptions can also use a variety of data and make defensible arguments about why certain data should be weighed more heavily.
The 62-page document provides guidance on a variety of other points, such as:
- Companies going public could continue to use a calculated value method for unvested awards granted prior to going public once they do go public, but fully vested awards would have to be modified to reflect their fair value after going public. These companies could not restate their awards using fair value methods after going public.
- Companies should not consider the fact that awards cannot be hedged or transferred as reducing their value.
- A formula for expected term is provided for companies that have difficulty in gathering enough data to provide a number. For instance, a 10-year option with graduated four-year vesting would have an expected term of 6.25 years.
- In certain cases, companies issuing equity awards provide rights for cash payments or other attributes. The guidance provides that these may be subject to accounting rules under ASR 268 dealing with redeemable financial instruments.
- When accelerating vesting for of out-of-the money options accounted for under APB 25, companies can reflect the resulting compensation cost as pro forma disclosures under FAS123.
IRS Issues Correction to Anti-Abuse Regulations for ESOP S CorporationsOn March 12, 2005, the IRS issued a correction to regulations issued in December designed to curb abuses of ESOPs in S corporations. In those regulations, family attribution rules that generally apply in the tax law (such as considering a spouse's ownership as ownership of the other spouse) were incorporated into tests under the ESOP regulations for who is a disqualified person. Many ESOP experts believed that this was overly broad, and the IRS has now said it is deleting this provision. As we went to press with this, the notice was not yet posted on the IRS site.
Canned Plan ESOPsDoes your ESOP come from a box? It's possible to buy a "standard" ESOP plan from developers of such documents, fill in the blanks, and send it off to the IRS. (For example, the NCEO has a Model ESOP publication.) While these plans may have been carefully developed, in talking with users of these plans, we have often found that they did not provide for the maximum flexibility in plan design or failed to incorporate very recent changes flowing from regulations or law. For instance, one standard plan did not allow a company to hold shares repurchased from departed employees in a suspense account for up to five years before reallocating them (a provision a company might want in the plan to accommodate issues arising from break-in-service rules).
While these plans save up-front costs by possibly several thousand dollars, we believe they are appropriate to use only if a company also engages a qualified ESOP attorney to review them and to serve as a source of advice and feedback on how the plan might be modified over time to meet changing circumstances. Having the right plan can save a tremendous amount of money, as well as keeping the plan appropriate to what you are trying to accomplish.