SEC Increases Scrutiny of “Spring-Loaded” Compensation Awards

Capital Markets

On November 29, 2021, the Securities and Exchange Commission (SEC) staff issued Staff Accounting Bulletin (SAB) No. 120, which alerted companies that the SEC will give particular scrutiny to “spring-loaded” compensation awards made to executives and provided guidance on how to properly recognize and disclose compensation cost for such awards.

As defined in SAB No. 120, spring-loaded awards are share-based compensation awards granted when a company is in possession of material nonpublic information to which the market is likely to react positively once the information is announced, such as an earnings release with better-than-expected results or the disclosure of a significant transaction.

SAB No. 120 expresses views of the SEC staff regarding the interaction between certain SEC rules and regulations and Financial Accounting Standards Board (FASB) Accounting Standards Codification (ASC) Topic 718, Compensation — Stock Compensation. FASB ASC Topic 718 is based on the underlying accounting principle that compensation cost resulting from share-based payment transactions be recognized in financial statements at fair value.

For a non-spring-loaded, routine annual grant to an employee, the SEC staff confirmed that the observable market price of the underlying share on the date of grant is a “reasonable and supportable estimate”. However, in the case of a spring-loaded award, the closing price on the date of grant, prior to a positive market-moving announcement, 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”.

In SAB No. 120, the staff also 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.

Lorna Knick is a member of the Capital Markets practice group of Wyrick Robbins, which represents public company clients across a broad range of industries in connection with their SEC reporting and corporate matters, and significant financing transactions. The Capital Markets group publishes Client Alerts periodically as a service to clients and friends. The purpose of this Client Alert is to provide general information, and it is not intended to provide, and should not be relied upon as, legal advice.