SEC Open Commission Meeting - January 17, 2006

These notes were prepared by FEI staff based on listening to the webcast of the Securities and Exchange Commission's Jan.17, 2006 open commission meeting.

In general, the Summary Compensation Table (requiring disclosures of all types of compensation for the last three (3) fiscal years for executives) and the Directors Compensation Table (requiring disclosure of all types of compensation for the past fiscal year for directors), will include disclosure of the dollar value, computed at full fair value at date of grant, computed pursuant to (i.e., using the same valuation methodology and assumptions the company uses for financial statement purposes) under Financial Accounting Standards Board (FASB) Statement of Financial Accounting Standards No. 123(R), "Accounting for Share-Based Payment" (FAS 123(R)).

Following are specific issues raised by commissioners with respect to the stock option related disclosures during the open commission meeting.

• Diference in timing - "full fair value" in executive compensation table, annual expense in financial statements: As discussed in the webcast, Alan Beller said that "The proposal takes the measurement methodology of FAS123(R) and applies to option and stock grants for executive compensation disclosure purposes. The difference in our approach is that, for financial statement purposes -under the accounting rule [FAS 123(R)], a company recognizes expense over the period of service (vesting period). Our proposal is that the executive compensation table would reflect the full fair value (FV) at time of grant."
• No difference in valuation method used for financial statements and for executive compensation disclosures:
  • Also as discussed later in webcast, Chairman Cox noted and Alan Beller agreed that, under the proposed executive compensation disclosure rules, for any particular company, "There can be no difference in valuation method [an individual company chooses to] use under FAS 123(R)" for purposes of determining the related financial statement disclosures and for purposes of deterimining the proxy disclosures for executive compensation.
  • Additionally, Chairman Cox asked Beller, "If [company] made election to treat differently those two categories of people, [would they] have to make the same election for financial reporting and executive compensation disclosure purposes?" Beller replied, "Yes…companies, in making their valuation determinations, could make different assumptions particularly regarding option term for different categories of employees. For example, if they thought the right option term under their model for executive officers differs from option term for all other employees, and that was the model they used for financial statement purposes, then for the named executive officers, they would look for valuation for the group of named executive officers."
• Concern about double-counting due to repricing and modifications of grants treated as new grants in the executive compensation proposal, not incremental (as treated for financial statement purposes under FAS123(R)) There was also some discussion later in the webcast between Commissioner Glassman and Alan Beller , when Beller said that the proposal views "repricing or other change in terms [as] a new grant, and should be reflected for comp purposes at its grant date FV without netting out grant date fair value of what had been granted before." Commissioner Glassman noted FAS123R would treat this as an incremental expense, not as a new grant per se, and questioned if this would be an overcounting or overstatement of compensation. Beller said comments would be solicited on this point in the proposal.
• "Tracking the life of stock options" thru the proposed executive compensation disclosures was described in webcast by Alan Beller as follows:
  • Grant date FV would be reflected in year of grant for the named exec officer in the table. That number, once reflected in table, assuming no repricing or amendment, that grant date number would never be reflected again in the summary comp table.
  • Thereafter, in the second table, equity interest table, if option has vesting period of three (3) years, at end of each of the next three (3) years, you would see that option reflected with its grant date and strike price and differentiated if in the money or not.
  • In year exercised, the second table in the equity interest section would show if exec exercised option and if in the money.
  • Table would show number exercised, value realized, and "reach back into the past and throw into third column grant date FV." Purpose of that, according to Beller, is for investors to avoid double counting. Way back on day one there would have been grant date FV ascribed to the option.
• Concern about potential lack of comparability: Commissioner Glassman asked, if we are looking for comparability, why don't we just assume executive will stay through the vesting period and not assume forfeitures? Beller replied SEC is soliciting comment on this point, whether we they should require a FAS 123(R) valuation methodology or some other methodology for these disclosures - looking only at assumptions applicable to named executive officers as opposed to some other class; "We are where we are at proposal stage partly for reasons of simplicity and partly for reasons of our desire to follow assessment by the FASB and not do something different," said Beller. He added that, "for expense purposes, companies have to make assumptions that may be different for diff groups of employees, and if the granularity works for financial statement purposes as the FASB has concluded, we wanted to maintain the same granularity - the simplicity point is just that companies won't have to do additional calculations. The issue that leaves unresolved," said Beller, "which I believe our solicitation for comment will try to sharpen for you and for us, is that what might be materially completely adequate for financial statement purposes across a larger number of officers might be somewhat off - we're not quite sure how far off - if you are just looking at level of granularilty for the named officers." Glassman added her concern is that, "by looking at company specific turnover rates, you are losing comparability, across the companies, even at the executive level."
• Ex ante vs. ex post valuations of stock options, and double counting: In response to a question from Commissioner Atkins, in which he stated he is also concerned about double counting, SEC staff clarified that valuation at date of grant is ex ante; "when the option is realized, valuation will reflect relatively good information, often far into the money." SEC staff added that, "There is some complexity when one thinks about trying to match up ex post (valuation) and ex ante. If options expire out of the money, ex ante measure of valuation reflects states of the world where options are exercised and not. Awkwardness of nature of the two measures. "Commissioner Atkins responded, "That is one of the inherent problems with FAS 123(R) which we can debate at another time."

Prepared Jan. 19, 2006 by Edith Orenstein (eorenstein@fei.org), Director of Technical Policy Analysis, Financial Executives International (FEI, and Cheryl de Mesa Graziano (cgraziano@fei.org), VP Research and Operations, Financial Executives Research Foundation (FERF), based on listening to the webcast of the SEC meeting. This summary does not represent FEI opinion, unless specifically noted above.