WSJ Article re Proxy Reporting of Award with Significant Discretionary Component

News Brief

By Cydney Posner

In this article, the Wall Street Journal reports on correspondence between the SEC and Verizon regarding a disagreement about the reporting of an award in the summary comp table that, after a lengthy correspondence that started in June and ended in November, resulted in the company's being required to add millions to the total comp reported for its former CEO. Companies that grant awards with a payout that, in whole or in part, involves a significant level of board discretion may want to take this example into consideration in determining how to report the awards in their proxies.

The company had reported that, for the 2008-2010 award cycle, the CEO received a Long-Term Incentive Award Performance Stock Unit Agreement, which included in an addendum to the agreement the potential for additional units based on specified performance conditions related to the achievement of strategic corporate initiatives. In the SCT, the company reported the value of the 2008-2010 award as part of the CEO's compensation for 2008, the corresponding year of grant (that is, the date in 2008 that the Committee approved the award and, shortly thereafter, communicated its terms to the CEO). The strategic objectives set forth in the addendum to the CEO's award included goals such as developing the company's executive talent pool, preparing for its succession plan, maintaining the company's wireless market leadership position, and participating in and providing leadership to various industry forums and policy initiatives. So long as the company achieved a total shareholder return (TSR) for the three-year award cycle at a specified rank relative to its peers, the Human Resources Committee had the sole discretion to determine the payout based on whether these strategic initiatives had been achieved. The company reported the award in the proxy as an equity incentive plan award, even though payable in cash, because the award was, in the company's view, within the scope of ASC 718 as (i) it became payable based, in part, on relative TSR rank and (ii) the ultimate cash settlements were determined based on (and limited by) amounts that were directly linked to the company's closing stock price. In determining the grant date fair value of the CEO's award for the SCT, the company did not attribute any additional amounts to the discretionary opportunity included in the addendum on the basis that it was not probable at the grant date in 2008 that the "outcome of the performance conditions would result in a discretionary adjustment to [the CEO's] award by the Committee." In accordance with instructions to the SCT, the company reported in the "Stock Awards" column of the SCT the grant date fair value of the award based on the probable outcome of the specified performance conditions and reflected in a footnote to the column the value of the award assuming achievement of the highest level of performance conditions.

The SEC staff took a different view, observing that the company's treatment of the discretionary component of the award (reflected in the addendum) had the effect of underreporting in the SCT approximately $13.8 million in compensation. Instead, the staff contended that the discretionary component of the award was really a second discrete award that should have been separately evaluated and reported in the SCT. In addition, the staff argued that, in light of the high level of Committee discretion and the limited relationship of the second component to the company's stock price, the second component did not even fall within the scope of ASC 718. As a result, the staff advised the company that, to avoid underreporting, the discretionary component of the award should really have been reported separately as a cash bonus. Moreover, because of the Committee's sole discretion to determine the size of any additional payment and the highly subjective nature of the strategic initiatives, the staff did not believe a mutual understanding of the key terms and conditions occurred between the company and the CEO in the first quarter of 2008. Rather, in the staff's view, the grant date for this second component of the award occurred upon settlement of the award.

Apparently, the staff ultimately accepted the company's argument that the award constituted a share-based payment transaction within the scope of ASC 718. Although the staff continued to maintain that the second discretionary component was a separate award, the company appears to have argued successfully that, even though the Committee retained significant discretion, the strategic objectives, which were both quantitative and qualitative in nature, met the criteria for "performance conditions" as defined in ASC 718. As a result, it was agreed that the SCT would be revised in future filings to report the payout amount for the second component under the Stock Awards column (i.e., not as a cash bonus).

With regard to the grant date issue, the company contended that the partly qualitative nature of the performance measures did not undermine the parties' mutual understanding of the key terms and conditions of the grant, including a mutual understanding of the performance required of the CEO or the company to achieve the performance conditions. For example, the company argued that the understanding of some of the metrics the board would consider in its evaluation was based on historical practice and contemporaneous discussion. It appears from the correspondence, however, that staff did not accept this argument. At the end of the day, the company was required, in the future, to treat the discretionary component of the awards for the 2008-2010 award cycle and any similar strategic component of the CEO's awards as discrete stock awards granted on the last day of the applicable performance cycle and to report them as stock awards for the applicable year. As a result, in its 2012 proxy, the company will need to include in the SCT amounts awarded with respect to the strategic components of the CEO's 2007-2009 award and his 2008-2010 award in the Stock Awards columns for 2009 and 2010, respectively. Hat tip to thecorporatecounsel.net blog for the article.

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