May 29, 2023

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SEC Tightens Guidance on ‘Spring-Loaded’ Options

The U.S. Securities and Exchange Commission updated accounting guidance on Monday to help public companies determine the correct valuation of stock options awarded to executives ahead of the release of market-moving information.

According to the SEC’s Office of the Chief Accountant and the Division of Corporation Finance, non-routine “spring-loaded” options grants merit particular scrutiny by public companies and “those responsible for compensation and financial reporting governance” must consider the potential impact of an earnings release with better-than-expected results or disclosure of a significant transaction.

“In other words, companies should not grant spring-loaded awards under any mistaken belief that they do not have to reflect any of the additional value conveyed to the recipients from the anticipated announcement of material information when recognizing compensation cost for the awards,” the SEC said in a news release.

An FASB rule known as Topic 718 requires generally that all equity awards granted to employees and nonemployees be accounted for at “fair value.”

Spring-loaded options have the potential to soar in value once the market-moving news is made public. “The practice came to the public’s attention in July 2020 when a sudden surge in the stock price of Eastman Kodak transformed options given to its top executives into potentially millions of dollars in profits,” MarketWatch said.

The options had been granted just a day before the company announced a letter of interest from the U.S. government for a loan and, according to MarketWatch, the unusual timing “spurred Sen. Elizabeth Warren of Massachusetts to ask the SEC to investigate whether any laws were broken.”

The SEC said its guidance update would help companies estimate the “the fair value of share-based payment transactions in accordance with Topic 718 regarding the determination of the current price of the underlying share and the estimation of the expected volatility of the price of the underlying share for the expected term when the company is in possession of material non-public information.”

“It is important that companies’ accounting and disclosures reflect the economics and terms of these compensation arrangements,” SEC Chair Gary Gensler said.

Guidance, material nonpublic information, spring-loaded, stock options, U.S. Securities and Exchange Commission