To
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549
Re.: File Number S07-04-01
By Dipl.-Kfm. Hendrik Vater, University of St. Gallen (Switzerland)
I. Introduction
Equity compensation plans have been quite popular in the past. More and more companies grant equity based instruments to its employees and top managers. The SEC's aim of presenting its proposal, "Disclosure of Equity Compensation Plan Information" is to improve disclosure requirements within the fields of equity based compensation plans. Financial reporting and disclosure rules are widely discussed. For example The International Accounting Standards Board (IASB) has recently put this topic on its agenda. Further standardsetters in Germany, Switzerland or Canada are at the moment developing exposure drafts on accounting implications of the use of equity based compensation plans.
II. Proposed Disclosure Redundancies with US-GAAP
The basic question is: In how far does the SEC Proposal "Disclosure of Equity Compensation Plan Information" result in a duplication of disclosures? FAS 123 "Accounting for Stock Based Compensation" contains a wide variety of disclosure items which have to be publicated by a registrant in its annual report. Under FAS 123 Par. 45-48 the disclosure of the following information is required:
45. Regardless of the method used to account for stock-based employee compensation arrangements, the financial statements of an entity shall include the disclosures specified in paragraphs 46-48. In addition, an entity that continues to apply Opinion 25 shall disclose for each year for which an income statement is provided the pro forma net income and, if earnings per share is presented, pro forma earnings per share, as if the fair value based accounting method in this Statement had been used to account for stock-based compensation cost. Those pro forma amounts shall reflect the difference between compensation cost, if any, included in net income in accordance with Opinion 25 and the related cost measured by the fair value based method, as well as additional tax effects, if any, that would have been recognized in the income statement if the fair value based method had been used. The required pro forma amounts shall reflect no other adjustments to reported net income or earnings per share.
46. An entity with one or more stock-based compensation plans shall provide a description of the plan(s), including the general terms of awards under the plan(s), such as vesting requirements, the maximum term of options granted, and the number of shares authorized for grants of options or other equity instruments. An entity that uses equity instruments to acquire goods or services other than employee services shall provide disclosures similar to those required by this paragraph and paragraphs 47 and 48 to the extent that those disclosures are important in understanding the effects of those transactions on the financial statements.
47. The following information shall be disclosed for each year for which an income statement is provided:
An entity that grants options under multiple stock-based employee compensation plans shall provide the foregoing information separately for different types of awards to the extent that the differences in the characteristics of the awards make separate disclosure important to an understanding of the entity's use of stock-based compensation. For example, separate disclosure of weighted-average exercise prices at the end of the year for options with a fixed exercise price and those with an indexed exercise price is likely to be important, as would segregating the number of options not yet exercisable into those that will become exercisable based solely on employees' rendering additional service and those for which an additional condition must be met for the options to become exercisable.
48. For options outstanding at the date of the latest statement of financial position presented, the range of exercise prices (as well as the weighted-average exercise price) and the weighted-average remaining contractual life shall be disclosed. If the range of exercise prices is wide (for example, the highest exercise price exceeds approximately 150 percent of the lowest exercise price), the exercise prices shall be segregated into ranges that are meaningful for assessing the number and timing of additional shares that may be issued and the cash that may be received as a result of option exercises. The following information shall be disclosed for each range:
A look on existing US-GAAP requirements in FAS 123 shows that the FASB already requires information on the potential dilution from outstanding earned and unearned equity awards and the number of shares authorized for grants. Further, the FASB requires the disaggregation of data on different types of awards when required to understand the implications of those awards on the company` s financial statements.
Basically, it is the authors view that the proposed disclosure by the SEC duplicates the disclosure requirements by FAS 123 in many points.
This in not whishable and should be avoided. In order to avoid duplications, the SEC should work together or influence the FASB to improve its disclosure requirements.
Redundancies in reporting between SEC and US-GAAP requirements have been generally critizised in the recently issued report of the GAAP-SEC disclosure requirements working group.
A further question is if the disclosure of the required information in FAS 123 is sufficient and always correct. The author believes that the disclosure of FAS 123 is not sufficient and correct in all of its points.
In the author's opinion it is useful to provide information on the plan design. Especially, the issuing company should provide additional data concerning the method used to meet ist obligation concerning the options issued. If the company uses own shares from a share buyback in order meet its obligations regarding to the options issued, no information about dilution is needed, because there is no dilutive effect.
Further it is important under the point of understandability that all information will be presented only once and in one place.
The SEC should focus on an other problem: FAS 128 provides informations on the potential earnings diluton resulting from executive stock options and other equity instruments issued. While FAS 128 uses on the one hand the net income which has been diluted by the personal expenses recognized for the stock option grants and the dilution effect by the issue of new shares corresponding to the stock option grants on the other hand, the result is a doble-effect. From the point of view of an owner (shareholder) the diluted earnings per share are doble-diluted, once by the personal expense and once by the dillution effect from the issuance of the new shares.
This is not acceptable. That is why the SEC should force the FASB to revise the concerning paragraphs within FAS 128 in order to remove this redundancies. The doble-effects misleade investors to evaluate the company's earning power correctly.
III. Need for additional information in absence of security-holder approval
The autor thinks that the absence of security-holder approval is not a matter of SEC rules. The absence of security-holder approval is a matter of state or federal law only and should not trigger the need for disclosure.
IV. Would narrative disclosure be preferable to the proposed tabular format?
The disclosure should be presented generally - as proposed by the SEC - in a tabular format with a short and precise narrative description.
V. Should provided information be presented in aggregated or disaggregated form?
The proposed form is precise and clear and gives investores a good overview about equity based compensation plans in force. The danger lies in cases where companies have several plans in use. For example Lucent Tecnologies Inc. has at the moment approximately 40 different plan in use. This leads to the possibility that shareholders will be overhelmed with pages of information in case of a plan by plan reporting. That is why companies should be allowed to aggregate similiar plans. As well, such aproceed is in accordiance with IAS 19 which allows companies to aggregate information regarding similiar compensation plans. Individual arrangements corresponding to board members should be presented in a disaggregated form. All other individual arrangements should be reported in a aggregated form. It might be useful to distinguish different classes of individual arrangements.
VI. Is it sufficient to require the disclosure of such plan's ,,material features", or should we identify the specific terms and conditions of the plan that must be disclosed (such as exercise price, vesting and expiration date information, or the existence of reload, stock swap, loan or option repricing features)?
It is crucial to identify and disclose the specific terms and conditions of the equity based compensation plans. The disclosure of information regarding exercise price, vesting and expiration date information, or the existence of reload, stock swap, loan or option repricing features or the assumed volatility is imported for investors analysing the registrant. Only the publication of such specific data allows the analyst to evaluate the real character of the equity instrument grant.
VII. Is it useful to disclose information about the number of securities awarded and the number of options, awards or rights granted during the last completed fiscal year?
Yes definetely. This information is useful to all investors in order to understand the registrant`s compensation schemes and the related activities during the reported period. Furthermore data concerning cancellations and repricings is helpful for a complete and precise analysis.
VIII. Is it necessary, as proposed, for registrants to provide totals for the information set forth in each column of the tabular disclosure?
The author recommends that totals should be disclosed because it might be helpful for users to evaluate and understand the full impact on equity based compensation plans.
IX. Should disclosure be required if the plan was adopted in a year prior to the most recently completed fiscal year?
Yes. In my opinion all equity compensation plans should be disclosed regardless of when the plan was first adopted by the registrant.
X. In lieu of, or in addition to, the disclosure required for an equity compensation plan that has been adopted without security-holder approval, should a registrant be required to file any such plan as an exhibit to the registrant's annual report on Form 10-K for the fiscal year in which the plan was adopted?
Yes. Any important event, especially the grant of equity instruments should be reported in Form 8-K. The information should contain all related information to the compensation plan.
XI. Should specific disclosure about equity compensation plans that involve the use of repurchased or "treasury" shares be required?
Yes. It is important to know whether the compensation plan is based on a share increase or a share buyback. In case that the transaction is based upon the use of repurchased or "treasury" shares, there is no dilution effect. The disclosure might prevent manipulation or misleading information as well.
XII. Lack of clarities within the proposal
The SEC proposal "Disclosure of Equity Compensation Plan Information" disposes of different lack of clarities:
XIII. Costs vs. Benefits of the Proposal "Disclosure of Equity Compensation Plan Information"
For example Lucent Tecnologies Inc. evaluated the proposal related reporting costs for its printing and mailing costs worth $ 300.000. The costs related to the proposal concern in first place reporting, consulting, printing and mailing costs. The SEC evaluation of costs corresponding to its proposal "Disclosure of Equity Compensation Plan Information" have been widely critized in recent comments. The AICPA SEC Regulation Committee believes the proposed costs significaly understated. The decisive question is which benefit can be obtained of the SEC's proposal "Disclosure of Equity Compensation Plan Information" in relation with the large overlaps with existing accounting rules. The proposed costs are generally acceptable for companies using equity based compensation instruments such as stock options.
XIV. Summary
The SEC cited the need to provide investors and analysts with information in order to promote their ability to understand and evaluate equity based compensation plans used by registrants. Therefore the SEC proposed new disclosure rules for these transactions, resulting in its proposal "Disclosure of Equity Compensation Plan Information". But the proposed rules show wide overlaps with FAS 123 and other related accounting-guidelines. It is doubtful, if the proposed rules are useful in this context. The SEC might reconsider the need for a new regulation and focus on a streamlining reporting. The current form of the proposal might lead more to confusion than to more and better information.