PCAOB issues alert on stock option dating issues

By: Cydney Posner

After being held up until the SEC had issued its "guidance" on problematic stock option dating practices, the PCAOB has just posted its Staff Audit Practice Alert No. 1 Matters Related to Timing and Accounting for Option Grants. If you had any expectations of receiving helpful guidance for companies in the Alert, you'll be more than a little disappointed.  The Alert is aimed at auditors, advises them to be mindful of the risk of option dating problems and provides guidance as to the relevant issues and authorities that auditors must consider in approaching this risk.  For example, the Alert advises each auditor to "acquire sufficient information to allow him or her to assess the nature and potential magnitude of these risks. An auditor must use professional judgment in making these assessments and in determining whether to apply additional procedures in response."  In doing so, they need to review applicable financial accounting standards, taking into account materiality and possible illegal acts.  (Remember that, under SAB 99, small misstatements may be material if they arise out of intentional conduct, illegal acts or actions that could otherwise lead to a material contingent liability.)

In performing an audit and assessing the nature of the risks of option dating problems, auditors are directed by the PCAOB to consider the results of any investigations conducted by the issuer or by regulatory or legal authorities. direct inquiries of appropriate members of management and the board, available public information related to the timing of options grants by the issuer, the terms of option plans or policies (particularly those that allow below-market exercise prices or that delegate authority to management to make grants and the adequacy of countervailing controls) and patterns that may indicate "higher levels of inherent risk," such as "levels of option grants that are very high in relation to shares outstanding, situations in which option-based compensation is a large component of executive compensation, highly variable grant dates, patterns of significant increases in stock prices following option grants, or high levels of stock-price volatility."

In assessing the necessary audit procedures related to the issuance of options, auditors are advised by the PCAOB to consider the need for specific management representations as well as "the nature of matters included in inquiries of lawyers."  (That should be a fun discussion.)Auditors should also consider the result of tests of relevant internal controls and the need, based on risk assessment, for additional specific auditing procedures related to the granting of stock options.

Specific guidance is also provided in the context of auditors' consents in connection with registrations statements, consents by predecessor auditors and previously issued audit opinions.