Year End Reprieve: SEC Extends Safe Harbor for Estimating Expected Term

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By Gary Levine - Are you concerned about estimating your stock option expense because you are a company that has little or no historical exercise data and you thought you’d be losing the simplified method under SAB 107?

If so, you’ve been granted a reprieve by the SEC.

The safe harbor of SAB 107 (released in March 2005) for estimating the expected term for employee stock options has been extended beyond Dec. 31, 2007 by SAB 110, released by the SEC on Dec. 21, 2007.

While most companies are saying thank you, the rest are saying “it’s about time.” One of the single most asked questions related to using the Black-Scholes formula had been “what were companies with no data to estimate the expected term supposed to do when SAB 107 expired?” With 10 days to go, the SEC finally responded.

A nice summary is available in the SEC press release at:

As a result of SAB 110, eligible companies, both public and privately-held, are able to continue to use the simplified method under SAB 107 for estimating expected term if their own historical experience isn't sufficient to provide a reasonable basis for such an estimate.

As stated in Release 2007-267:

Specifically, SAB 107 provided a simple rule for estimating the expected term of what it called a "plain vanilla" option: it would be just the average of the time to vesting and the full term of the option. Companies could use this simplified method until Dec. 31, 2007. The new assistance that is being issued today, SAB 110, extends the opportunity to use the simplified method beyond Dec. 31, 2007.

The Interpretive Response section of SAB 110 states:

… the staff understands that an entity that is unable to rely on its historical exercise data may find that certain alternative information, such as exercise data relating to employees of other companies, is not easily obtainable. As such, some companies may encounter difficulties in making a refined estimate of expected term. Accordingly, if a company concludes that its historical share option exercise experience does not provide a reasonable basis upon which to estimate expected term, the staff will accept the following "simplified" method for "plain vanilla" options consistent with those in the fact set above: expected term = ((vesting term + original contractual term) / 2) …” Note: the Staff uses a weighted-average formula for “vesting term.”

At the same time, the SEC has modified its previous position and now only permits the use of the SAB 107 method if the “company does not have sufficient historical exercise data to provide a reasonable basis upon which to estimate expected term.” In the past, a company could have used the simplified method even if it had a greater amount of historical exercise data.

The SEC explained that at the time that SAB 107 was released, it had expected that historical information about employee exercise behavior from other companies, such as actuarial studies, would soon be readily available. This was the basis for the statement in SAB No. 107 that the staff would not expect a company to use the simplified method after Dec. 31, 2007. Since such information is not yet available, the Staff removed the deadline. It is likely that once such data is available, the SEC may again prohibit the use of the SAB 107 simplified method.

SAB 110 is available on the SEC Web site at:

Gary D. Levine, President and CEO
Two Step Software, Inc.

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