Valuations in Financial Valuations in Financial Reporting Reporting May 9, 2007 Cheryl Tjon-Hing Valuation Specialist Office of the Chief Accountant 1
Disclaimer Disclaimer As a matter of policy, the Securities and As a matter of policy, the Securities and Exchange Commission disclaims Exchange Commission disclaims responsibility for any private publication or responsibility for any private publication or statement of any SEC employee or statement of any SEC employee or Commissioner. The comments herein Commissioner. The comments herein express the author's views and does not express the author's views and does not necessarily reflect those of the necessarily reflect those of the Commission, the Commissioners, or other Commission, the Commissioners, or other members of the Staff members of the Staff 2
3 SEC STAFF AND SEC STAFF AND VALUATIONS VALUATIONS
The SEC Staff and Valuations: The SEC Staff and Valuations: Division of Corporate Finance Division of Corporate Finance � Committed to taking valuation issues seriously � Committed to taking valuation issues seriously � Look for / ask questions to ensure: � Look for / ask questions to ensure: − Valuation is in compliance with GAAP − Valuation is in compliance with GAAP − Overall fair value conclusions and related key − Overall fair value conclusions and related key assumptions make sense based upon facts and assumptions make sense based upon facts and circumstances circumstances − Appropriate valuation methodologies applied − Appropriate valuation methodologies applied − There are sufficient disclosures for investors to − There are sufficient disclosures for investors to make their investment decisions make their investment decisions � May seek advice from OCA as deemed necessary � May seek advice from OCA as deemed necessary � Common Responses to Valuation Queries � Common Responses to Valuation Queries − “ − “What my peers are doing What my peers are doing” ” − “ − “Use of methodology in other filings Use of methodology in other filings” ” 4
The SEC Staff and Valuations: The SEC Staff and Valuations: Office of the Chief Accountant Office of the Chief Accountant Registrant Consultations (Pre- -filing) filing) Registrant Consultations (Pre � Different from the � Different from the “ “comment letter comment letter” ” process process � Valuation consultation issues may include : � Valuation consultation issues may include : − Appropriate methodologies − Appropriate methodologies − Valuation factors to consider − Valuation factors to consider − Relevant financial reporting guidance to consider − Relevant financial reporting guidance to consider − Review overall reasonability of numbers given facts − Review overall reasonability of numbers given facts and circumstances and circumstances � Do request that issues be discussed and tried � Do request that issues be discussed and tried to be resolved with auditors first before to be resolved with auditors first before seeking consultation with OCA seeking consultation with OCA 5
The SEC Staff and Valuations: The SEC Staff and Valuations: Office of the Chief Accountant Office of the Chief Accountant Registrant Consultations (cont’ ’d) d) Registrant Consultations (cont � Guidance for resolving ‘pre-filing’ questions is posted on the SEC’s website www.sec.gov/info/accountants/ocasubguidance.htm � Companies should provide OCA with a written submission (commonly referred to as a “pre- clearance” submission) − Auditor participation − Audit committee participation 6
SEC STAFF COMMENTS, SEC STAFF COMMENTS, OBSERVATIONS & AREAS of OBSERVATIONS & AREAS of CONCERN CONCERN 7
Expertization Issues Issues Expertization � Written consent of Experts (Rule 436) � Written consent of Experts (Rule 436) − Filed as exhibit to 1933 Act filings − Filed as exhibit to 1933 Act filings − States that the named expert consents to any − States that the named expert consents to any quotation/summarization of the expert report and/or quotation/summarization of the expert report and/or reference as an expert in the filing reference as an expert in the filing � Registrant needs to obtain Written Consent: � Registrant needs to obtain Written Consent: − Any reference to the use of an expert (e.g. − Any reference to the use of an expert (e.g. valuation consultant) in 1933 Act filing valuation consultant) in 1933 Act filing � Any portion of the expert � Any portion of the expert’ ’s report/opinion is s report/opinion is quoted/summarized quoted/summarized � If it is stated that any information in the filing has � If it is stated that any information in the filing has been reviewed/passed upon by a person whom the been reviewed/passed upon by a person whom the registrant relies upon as an expert registrant relies upon as an expert 8
Expertization Issues Issues Expertization � SEC Executive Compensation Disclosure � SEC Executive Compensation Disclosure − Effective for: − Effective for: � Fiscals ending after 12/15/2006 � Fiscals ending after 12/15/2006 � 8Ks filed after 11/07/2006 � 8Ks filed after 11/07/2006 − Corporate Governance Disclosure 407 (e)(3): − Corporate Governance Disclosure 407 (e)(3): “the company will be required to describe its processes the company will be required to describe its processes “ and procedures for the consideration and determination and procedures for the consideration and determination of executive and director compensation including:… …. .any any of executive and director compensation including: role of compensation consultants in determining or in determining or role of compensation consultants recommending the amount or form of executive and recommending the amount or form of executive and director compensation, identifying such consultants identifying such consultants … …. . director compensation, − 407 Application Q&A − 407 Application Q&A – – no consent required no consent required www.sec.gov/divisions/corpfin/guidance/execcomp407intep.htm www.sec.gov/divisions/corpfin/guidance/execcomp407intep.htm 9
Employee Stock Option Valuation Employee Stock Option Valuation Issues Issues Market Based Option Valuations Market Based Option Valuations � SEC staff has only commented on the design of � SEC staff has only commented on the design of ESOARS, subject to some adjustments on ESOARS, subject to some adjustments on forfeiture considerations forfeiture considerations − No different from the logic behind other option − No different from the logic behind other option pricing models - - Law of One Price ( Law of One Price (“ “LOOP LOOP” ”) ) pricing models � � BSOP BSOP – – European call value = European call value = value value of a levered of a levered position in the underlying stock position in the underlying stock � Have � Have not not commented on the following: commented on the following: − An appropriate market pricing mechanism; − An appropriate market pricing mechanism; − Credible information plan − Credible information plan (see August 31, 2005 letter from OEA to OCA) (see August 31, 2005 letter from OEA to OCA) 10
Employee Stock Option Valuation Employee Stock Option Valuation Issues Issues Analytical Approaches - - Valuation Models Valuation Models Analytical Approaches � Limitations of Black � Limitations of Black Scholes Scholes vs. attributes of target vs. attributes of target award award Expected Term - - Simplified Method Simplified Method Expected Term � At this time, still expected to sunset at December � At this time, still expected to sunset at December 31, 2007 (as stated in SAB 107) 31, 2007 (as stated in SAB 107) 11
Employee Stock Option Valuation Employee Stock Option Valuation Issues Issues Discounts/Premia Premia Discounts/ � Reference to studies not appropriate as primary � Reference to studies not appropriate as primary support for discounts/premiums applied support for discounts/premiums applied Tax Issues Tax Issues � Not consider tax implications to employees � Not consider tax implications to employees − Value to employee consideration and not to the − Value to employee consideration and not to the issuer of the award issuer of the award 12
Equity Value Allocation Issues Equity Value Allocation Issues � Valuation methodology used must be consistent � Valuation methodology used must be consistent with target share attributes as well as facts and with target share attributes as well as facts and circumstances surrounding the valuation circumstances surrounding the valuation � Current method issues � Current method issues − In the majority of situations, the Staff believes the − In the majority of situations, the Staff believes the use of the current method is likely inappropriate in use of the current method is likely inappropriate in any IPO reporting period any IPO reporting period − May be appropriate for: − May be appropriate for: � Companies where liquidation is imminent � Companies where liquidation is imminent � Early stage development companies � Early stage development companies 13
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