Risk & Compliance

SEC Issues Alert on Stock-Option Expensing

With a nod to smaller businesses, the regulator extends its deadline for using the simplified method of estimating option values.
Sarah JohnsonDecember 21, 2007

The Securities and Exchange Commission has issued a staff bulletin that allows some companies to continue using the simplified method of estimating stock-option expenses.

Nearly three years ago, the SEC said publicly traded companies would have to stop valuing their share-option grants using the simplified method by December 31, 2007. Without the extension, companies that lacked historical exercise data for option grants would not have enough information on which to base their expense estimates.

Under FAS 123R, Share-Based Payment, companies are required to expense stock options based on the fair value of the options on the grant date. This is often done by using the Black-Scholes-Merton model, and requires management to estimate the expected term of the grant by sifting through several layers of data. If data is not accessible, companies are allowed to use what the SEC calls a simplified approach to calculate the grant term — which is done by averaging the time to vesting and the full term of the option.

When the SEC staff issued its original bulletin in 2005 (SAB 107), it reckoned that adequate data about employees’ exercise behavior — such as industry-specific information — would be widely available by the end of this year. Based on that assumption, the SEC set the 2007 deadline for disallowing the simplified calculation. But the commission miscalculated: many smaller companies still don’t have enough data to make the term estimates. As a result, the SEC issued its new bulletin, SAB 110, on Friday to extend the deadline.

There is a catch, however: companies have to show the SEC that its own corporate exercise data is insufficient to base expected-term estimates on. “Once relevant detailed external information about exercise behavior becomes widely available for companies to make more refined estimates of expected term, the staff will no longer accept use of the simplified method,” according to a statement issued from the SEC’s chief accountant and corporation finance divisions.

The staff predicts the deadline extension will mostly benefit smaller companies.