SEC staff issues SAB 110 extending use of "simplified method" to estimate option term under FAS 123R

By Cydney Posner

Today, the SEC's OCA and Corp Fin released SAB 110, which will allow public companies to continue to use the "simplified method" in valuing stock option grants to employees for income statement purposes. Under FAS 123R, companies may rely on algorithms, such as Black-Scholes, to determine the amount of stock option compensation expense; however, these models typically require the company to estimate the expected terms of option grants. The simplified method allows companies that do not have sufficient historical experience to provide a reasonable basis for an estimate to instead estimate the expected term of a "plain vanilla" option by averaging the time to vesting and the full term of the option. ("Plain vanilla" options are options with the following characteristics: (1) the options are granted at-the-money; (2) exercisability is conditional only upon performing service through the vesting date; (3) if an employee terminates service prior to vesting, the employee would forfeit the options; (4) if an employee terminates service after vesting, the employee would have a limited time to exercise the options (typically 30 to 90 days); and (5) the options are nontransferable and non-hedgeable.) Under SAB 107, companies could use this simplified method until Dec. 31, 2007. The new SAB will provide a limited extension so long as a company concludes that its own historical share option exercise experience does not provide a reasonable basis for estimating expected term. Once relevant detailed external information about exercise behavior becomes widely available to make more refined estimates of expected term, the staff will no longer accept use of the simplified method.

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