SEC staff issues guidance on restatements for errors in accounting for stock options

By: Cydney Posner

The SEC accounting staff has just posted its long-awaited guidance related to restatements for errors in accounting for stock option grants.  (Don't be deterred by the reference to oil and gas.) The guidance is in the form of a sample letter from Carol Stacey, Chief Accountant at Corp Fin, and assumes that, as a result of errors in accounting for grants of stock options, the recipient company plans to restate previously issued financial statements for multiple periods. Materially different circumstances, including filing delinquencies and restatements for other reasons, could result in a different conclusion by the staff.

The letter makes clear that, normally, companies are required to amend previously filed reports containing financial statements determined to be materially misstated. However, because this restatement would affect a significant number of years, the company would be "unduly burdened" by amending all previously filed reports and investors' understanding of the restatement may be adversely affected by the sheer volume of filings, the staff will allow a less onerous approach. Accordingly, in this circumstance, a company may avoid refiling all reports if it amends its most recent Form 10-K and includes in that amendment specified comprehensive disclosure. (If the company's next Form 10-K is due to be filed within two weeks of the Form 10-K amendment that would be filed in response to this guidance, the next Form 10-K may instead contain the comprehensive disclosure.)

The SEC staff's position is premised upon the 10-K including the following comprehensive disclosure:

• An explanatory note at the beginning of the Form 10-K amendment that discusses the reason for the amendment.
• Selected Financial Data for the most recent five years as required by Item 301 of Regulation S-K, restated as necessary and with columns labeled "restated."
• MD&A based on the restated annual and quarterly financial information, explaining the company’s operating results, trends and liquidity during each interim and annual period presented. (Companies may incorporate discussions related to interim periods into the annual--period discussions or present them separately.)
• Audited annual financial statements for the most recent three years, restated as necessary, with columns labeled "restated."
• If interim period information for the two most recent fiscal years as required by Item 302 of Reg S-K is required to be restated, the information presented for the balance sheets and statements of income should be at a level of detail consistent with Reg S-X Article 10-01 (a)(2) and (3) and appropriate portions of 10-01(b). Columns should be labeled "restated." (Note that there is no need to present cash flow information as it is not required by Item 302.)
• Footnote disclosure reconciling previously filed annual and quarterly financial information to the restated financial information, on a line-by-line basis and for each material type of error separately, within and for the periods presented in the financial statements (audited), in selected financial data, and in the interim period information (see paragraph 26 of FAS 154).
• The disclosure referred to in the Chief Accountant’s September 19, 2006 letter  that applies to the restatement.
• Audited financial statement footnote disclosure of the nature and amount of each material type of error separately that is included in the cumulative adjustment to opening retained earnings.
• Audited financial statement footnote disclosure of the restated stock compensation cost in the following manner:
  • For the most recent three years: restated net income and compensation cost and pro forma disclosures, required by paragraph 45.c. of FAS 123, as clarified and amended by FAS 148, for each annual period presented in the financial statements for which the intrinsic value method of accounting in APB Opinion 25 was used, with columns labeled "restated" as appropriate.
  • For each annual period preceding the most recent three years: disclosure of the information required by paragraph 45.c.2. of FAS 123, the restated stock compensation cost that should have been reported for each fiscal year. The total of the restated stock-based compensation cost should be reconciled to the disclosure of the cumulative adjustment to opening retained earnings. While the disclosure required by paragraph 45.c.2. is net of tax, material tax adjustments related to the accounting for stock-based compensation should also be disclosed by year. Companies may also voluntarily elect to provide the full restated information previously disclosed pursuant to paragraph 45.c. of FAS 123, for each period prior to the most recent three years, either in the audited financial statement footnotes or elsewhere in the filing.
  • For companies that adopted
    • FAS 123 using the retroactive restatement method specified in FAS 148 and/or
    • FAS 123R, using the modified retrospective application method for all prior years for which FAS 123 was effective,

the disclosure outlined in the preceding two bullets should include the restated stock-based compensation pursuant to FAS 123 and also the restated stock-based compensation cost that should have been reported under the accounting principle originally used for each period, presumably APB 25.

• Appropriate revisions, if necessary, to previous disclosure under Items 9A and 9B:
  • As the SEC discussed in "Staff Statement on Management's Report on Internal Control Over Financial Reporting " (May 16, 2005), in disclosing any material weaknesses that were identified as a result of the restatement and/or investigation, a company should consider including in its disclosures:
    • the nature of the material weaknesses,
    • the impact on the financial reporting and the control environment, and
    • management’s current plans, if any, for remediating the weakness.

While there is no requirement for management to reassess or revise its original conclusion regarding the effectiveness of internal control, management should consider whether its original disclosures are still appropriate and should supplement its original disclosure to include any other material information that is necessary to avoid misleading disclosures.

This content is provided for general informational purposes only, and your access or use of the content does not create an attorney-client relationship between you or your organization and Cooley LLP, Cooley (UK) LLP, or any other affiliated practice or entity (collectively referred to as “Cooley”). By accessing this content, you agree that the information provided does not constitute legal or other professional advice. This content is not a substitute for obtaining legal advice from a qualified attorney licensed in your jurisdiction and you should not act or refrain from acting based on this content. This content may be changed without notice. It is not guaranteed to be complete, correct or up to date, and it may not reflect the most current legal developments. Prior results do not guarantee a similar outcome. Do not send any confidential information to Cooley, as we do not have any duty to keep any information you provide to us confidential. This content may be considered Attorney Advertising and is subject to our legal notices.