Recent correspondence between the staff (Staff) of the Securities and Exchange Commission’s Division of Corporation Finance and Verizon Communications Inc. (Verizon) emphasizes the difficulties inherent in reporting executive compensation in the summary compensation table (SCT). In the correspondence, the Staff challenged the reporting of payments made pursuant to performance stock unit awards (PSUs) granted to Verizon’s chief executive officer (CEO) under Verizon’s Long-Term Incentive Plan (LTIP) and questioned whether the PSUs consisted of two discrete components: a stock award reportable in the amount of the grant date fair value in the year granted and a cash bonus reportable in full in the year paid. Noting that Verizon directors had discretion to pay out a portion of the CEO’s PSUs in cash based on their assessment of the CEO’s achievement measured against certain qualitative criteria, the Staff initially took the position that the full amount of the discretionary payment should have been reported in the SCT as a cash bonus in the year of payment, separate from the grant date fair value of the non-discretionary component of the PSUs. The Staff and Verizon ultimately agreed that in future filings Verizon would report the full amount of any discretionary payment under the PSUs in the Stock Awards column of the SCT for the year with which the performance period for the particular PSUs ended.

It is unclear whether the Staff’s position is limited to Verizon’s specific facts or will apply more broadly to similarly structured equity awards. Nevertheless, issuers should be aware that the Staff’s position could affect how they report equity awards that include a discretionary component or qualitative performance measures or may otherwise have more than one “component” in the view of the Staff.

Reporting Equity Compensation in the SCT

Issuers must report in their SCT (appearing in their proxy statements and appearing or incorporated by reference in their annual reports on Form 10-K and registration statements) the aggregate grant date fair value of stock awards made to their named executive officers (NEOs) with a grant date in the years covered by the SCT. Item 402(c)(2)(v) of Regulation S-K requires the value of stock awards to be computed in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation-Stock Compensation (ASC 718) (formerly Statement of Financial Accounting Standards 123R). Many issuers grapple with the vagaries of ASC 718 when determining the grant date of stock awards and, thus, the year for which to disclose the value of those awards in the SCT and the amount of compensation to disclose.

Verizon’s PSUs

General terms of the PSUs. Although the PSUs were payable solely in cash, Verizon concluded that the PSUs were “equity incentive plan”¹ awards and reported the PSUs as stock awards, accounting for them under ASC 718.² The PSUs provided that cash payments would be made to the award recipients if Verizon had a total shareholder return (TSR) over a three-year performance period that was at or above a certain threshold level relative to the TSRs of specified peer companies for that period. If Verizon achieved the threshold-level TSR, the amount of the cash payment depended on how Verizon’s TSR ranked against the TSRs of the peer companies.

Discretionary component applicable only to CEO’s PSUs. The PSUs awarded to the CEO had a discretionary component not present in the PSUs awarded to Verizon’s other NEOs. Pursuant to that additional component, upon the recommendation of the Human Resources Committee of Verizon’s board, the independent members of the Verizon board had discretion to increase the payment to the CEO with respect to his PSUs to an amount equal to the maximum possible payment with respect to those PSUs. The additional payment could be made only if some amount was earned under the PSUs based on Verizon’s relative TSR performance and that earned amount was not the maximum amount payable under those PSUs.

Discretionary factors. The additional payment under the discretionary component of the CEO’s PSUs was based on the directors’ assessment of Verizon’s performance in certain strategic initiatives, which were identified at the beginning of the performance period. For the PSUs with a performance period that ended with 2010 (2008 PSUs), Verizon’s 2011 proxy statement identified the following strategic initiatives: (1) developing Verizon’s executive talent pool and preparing Verizon’s succession plan; (2) maintaining Verizon Wireless’ market leadership position; (3) participating in and providing leadership to various industry forums and policy initiatives; (4) sustaining Verizon’s top line consolidated total revenue growth at five to six percent; and (5) producing double-digit consolidated earnings growth. According to Verizon’s 2011 proxy statement, the Human Resources Committee did not assign any specific weighting to any strategic initiative.

Additional payment under 2008 PSUs. Based on the assessment by the Human Resources Committee and independent directors of the CEO’s performance as to the strategic initiatives, Verizon made an additional payment of approximately $13.8 million to the CEO pursuant to the discretionary component of the 2008 PSUs. As the Staff noted in its initial comment letter, “neither of the two objective measures (revenue and earnings growth) were met,” which meant that the decision to increase the payout under the PSUs was based on the strategic initiatives that were qualitative in character. The CEO had received similar discretionary awards under PSUs having performance periods ending with 2007 and 2009.

Verizon’s PSU Disclosure

SCT disclosure. In its 2011 proxy statement, Verizon reported in the SCT the grant date fair value of the PSUs, calculated in accordance with ASC 718, for the years in which the PSUs were awarded. Verizon treated the PSUs as a single award with a grant date as of the date the award was approved by the directors. The SCT did not separately report any compensation relating to the discretionary payments that might be made to the CEO either for the years in which the PSUs were granted, the years with which the performance period ended or the years in which those additional payments were actually made. The footnotes to the SCT relating to each year in which the CEO’s PSUs had originally been granted reflected the maximum amount that could be received by the CEO under such awards, but did not separately describe any portion of that maximum amount as possibly being payable at the board’s discretion.

CD&A disclosure of additional payments. Elsewhere in Verizon’s 2011 proxy statement, the compensation discussion and analysis (CD&A) contained extensive discussion regarding the additional payment made to the CEO with respect to the 2008 PSUs, including the amount of the additional payment and discussion of the reasons why that additional payment was made. Verizon’s 2008 and 2010 proxy statements contained similar CD&A discussion of prior additional payments to the CEO pursuant to the discretionary component of prior PSU awards. In addition, in a narrative discussion associated with the Option Exercises and Stock Vested table in its 2011 proxy statement, Verizon reported the total amount paid under the 2008 PSUs and noted that a part of the total amount reported for the CEO was attributable to the additional payment discussed in the CD&A, but did not separately disclose the amount of the additional payment.

Correspondence between the Staff and Verizon

Staff’s positions on Verizon’s PSUs—bifurcated awards not properly disclosed. The Staff’s correspondence with Verizon commenced with a letter³ commenting on Verizon’s Form 10-K for the year ended December 31, 2010, which incorporated by reference the SCT and the other executive compensation disclosure from Verizon’s 2011 proxy statement. The Staff’s initial comment letter asked Verizon why the additional payments made under the CEO’s PSUs, which the Staff characterized as “discretionary payments,” should not be treated as cash bonuses and disclosed in the SCT. The Staff noted in a subsequent comment letter that the “treatment of the discretionary component of the PSU Award as part of [Verizon’s] equity incentive plan has had and, may in the future, have the effect of under reporting compensation in the [SCT].”⁴

The Staff also indicated its belief that the discretionary component of the PSUs was a “second discrete award with grant date commensurate with settlement.” In reaching this conclusion, the Staff focused on the definition of “grant date” in ASC 718-10-20 and the additional guidance in ASC 718-10-55-81 through 55-83, which requires that the company making the award and the award recipient reach a mutual understanding of the key terms and conditions of a share-based payment award for the grant date of the award to have occurred. The Staff noted that it believed that Verizon and its CEO did not have a mutual understanding of the key terms and conditions at the time the PSUs were awarded. The Staff based its position on the Human Resources Committee of Verizon’s board having sole discretion to determine the amount of any additional payment to be made⁵ and the “highly subjective nature of ‘strategic initiatives’” other than revenue and earnings growth. The Staff viewed the date of settlement of the additional payments (which was in the year following the end of the PSUs’ performance period) as the grant date for the discretionary component of the PSUs.

In a subsequent letter to Verizon, the Staff restated its belief that Verizon had not properly reported the CEO’s PSU compensation, and also challenged the application of ASC 718 to the discretionary component of the PSUs. In that letter, the Staff noted:

the discretionary second component of [Verizon]’s equity incentive plan should be evaluated separately from the non-discretionary first component of the plan. In addition and after considering further the substance of the discretionary second component, particularly as it is impacted by the high level of Board discretion and the limited relationship to Verizon’s common stock price, we believe the second component does not fall within the scope of ASC 718. Accordingly, to avoid underreporting in the future, any awards made pursuant to the discretionary second component of the plan should be reported in your Summary Compensation Table as a cash bonus for the year awarded in accordance with Item 402(c)(2)(iv) of Regulation S-K.⁶

Verizon’s position—single award properly disclosed. Verizon responded in detail to the Staff’s numerous comments, consistently maintaining that it had properly reported the PSUs and the additional payments under those awards in accordance with the requirements of Item 402(c)(2)(v) and ASC 718.⁷ Verizon viewed each PSU as a single equity incentive plan award that was a share-based payment transaction to which ASC 718 was applicable and that had a single grant date, which was the date the PSUs were approved by the directors. Verizon based its conclusion as to the grant date of the PSUs, including the discretionary component, on its belief that Verizon and its CEO had a mutual understanding of the key terms and conditions of the PSUs, including those of the discretionary component, at the date the PSUs were approved.

Resolution of the Staff’s comments. Perhaps because the exchange of letters showed little promise of resolving the Staff’s comments, Verizon and the Staff spoke to discuss the matter. While the contents of their discussions are not part of the public record, Verizon and the Staff appear to have struck a compromise. Verizon subsequently wrote to the Staff and agreed that, in the future, it would treat any amounts awarded with respect to the discretionary component of the PSUs as stock awards granted on the last day of the applicable performance period and report those awards in the Stock Awards column of the SCT for the year with which the performance period for the particular PSUs ended.⁸ With that, the Staff noted that its review of the filing was completed and did not require Verizon to amend its 2011 proxy statement. The Staff appears to have abandoned its position that the discretionary component of the PSUs was a cash bonus not covered by ASC 718 and should be reported in the SCT as a bonus.

Implications of the Staff’s Position

Uncertainty regarding reporting share-based awards. The Staff’s comment letters and Verizon’s responses tell a cautionary tale of the uncertainties that surround reporting share-based awards in the SCT. The Staff had not previously announced a position similar to the one it took with Verizon in any interpretation or disclosure guidance. Although each PSU issued to the CEO under the LTIP had the appearance of a single award that might reasonably be construed to be a “share-based payment transaction” under an “equity incentive plan” as contemplated by ASC 718, the Staff viewed the PSUs as two separate awards. Furthermore, before ultimately allowing Verizon to treat the discretionary component of the PSUs as stock awards, the Staff took the position that any additional payment made under the discretionary component of the PSUs was a cash bonus not covered by ASC 718.

In light of the nature of the Staff’s analysis, we must also wonder whether the Staff’s comments were driven by its view that the compensation ultimately awarded under the PSUs was significantly underreported, as the amount reported in the SCT did not reflect any potential award for the discretionary portion. Were the additional payments under the discretionary component of the PSUs so significant that the Staff applied a new analysis, even though Verizon reported the awards in a manner that might reasonably be seen as complying with Item 402(c)(2)(v)?

The Verizon correspondence illustrates once again the problems inherent in the reporting principles used for executive compensation. Current reporting principles often lead to the reporting of compensation amounts that differ markedly from the actual compensation that the NEOs receive in a particular year, with reported amounts often reflecting compensation opportunities that may or may not result in actual payouts of cash or stock. Moreover, the Staff’s extensive questions as to the nature of the discretionary component of the PSUs may reflect discussion among the Staff as to the appropriate reporting of some equity awards under Item 402(c)(2)(v).

Issuers should prepare to defend their fact-intensive determinations. The correspondence between Verizon and the Staff does not reveal exactly how the two parties reconciled their conflicting views. However, the Staff appears to have prevailed in its positions that the discretionary component of the PSUs should be treated as a separate award for reporting purposes and that Verizon and its CEO arrived at a mutual understanding of the key terms and conditions of the discretionary component of the PSUs only at the end of the performance period. To achieve such a result, the Staff challenged Verizon’s application of ASC 718 to its equity compensation awards, as well as Verizon’s fact-intensive determination of when a mutual understanding of the PSUs’ key terms and conditions had occurred between Verizon and its CEO. Other issuers should prepare to defend compensation disclosure decisions that turn on similar fact-intensive determinations.

Impact on proxy disclosures and NEO determinations. Determinations of how and when an issuer will report in the SCT its stock awards with discretionary components also affects other proxy statement disclosures, including disclosure in the CD&A and other compensation tables. More importantly, if discretionary awards are granted to senior executives other than the issuer’s chief executive officer and, in the case of an issuer that is not a smaller reporting company, chief financial officer, the timing of reported compensation can affect who the issuer’s NEOs will be for particular fiscal years.

Issuer Response to the Staff’s Position

If the Staff’s position sets a new standard, issuers must analyze their equity plans and awards to determine if the awards have more than one component, the proper characterization of each component of a multiple component award (equity award or cash bonus), whether the components have different grant dates and whether the grant date for the discretionary component of an award must be the date of settlement.

As a result of the Staff’s comment letters to Verizon, issuers should proceed even more cautiously in determining the grant date of any part of a share-based award that relies on a discretionary determination of the NEO’s performance, especially performance measured against qualitative standards. In determining grant dates, issuers should evaluate carefully whether an award with a discretionary payment component, especially one turning on qualitative standards, has a single grant date on the date the award was made. If the Staff continues to take the position that an issuer and executive cannot achieve a mutual understanding of the key terms and conditions of a discretionary stock award, such as the CEO’s PSUs, until the end of the performance period, total reported compensation as to the award may increase (to reflect the payment of discretionary amounts) and reporting of a part of that compensation may be delayed until the amount of any discretionary payment is determined.

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1. Item 402(a)(6)(iii) of Regulation S-K defines an equity incentive plan as “an incentive plan or portion of an incentive plan under which awards are granted that fall within the scope of [ASC 718].” ASC 718 provides guidance regarding share-based payment transactions with employees. Share-based payment transactions are defined in ASC 718-10-20 as transactions that, among other things, result in an entity incurring liabilities to an employee, the amounts of which are based, at least in part, on the price of the entity’s shares. In the case of Verizon, the final value of a PSU is based on the closing price of Verizon’s stock on the last trading day of the applicable performance period and includes accrued and reinvested dividends.

2. See Letter, dated July 22, 2011, from Mr. Robert J. Barish, Verizon’s Senior Vice President and Controller, to Mr. Larry Spirgel, Assistant Director of the Securities and Exchange Commission’s Division of Corporation Finance, available at http://www.sec.gov/Archives/edgar/data/732712/000119312511194826/filename1.htm (July 22nd Letter).

3. See Letter, dated June 28, 2011, from Mr. Spirgel to Mr. Ivan G. Seidenberg, who was then Verizon’s Chairman and CEO, available at http://www.sec.gov/Archives/edgar/data/732712/000000000011039378/filename1.pdf.

4. Letter, dated August 5, 2011, from Mr. Spirgel to Mr. Lowell C. McAdam, Verizon’s President and CEO, available at http://www.sec.gov/Archives/edgar/data/732712/000000000011047689/filename1.pdf.

5. The Staff appears to have glossed over the role of the independent directors in such determinations, although it is unlikely to have reached a different decision had it focused on the role of those directors in deciding whether to make any additional payments.

6. Letter, dated September 7, 2011, from Mr. Spirgel to Mr. McAdam, available at http://www.sec.gov/Archives/edgar/data/732712/000000000011053381/filename1.pdf.

7. See July 22nd Letter; Letter, dated August 19, 2011, from Mr. Barish to Mr. Spirgel, available at http://www.sec.gov/Archives/edgar/data/732712/000119312511227484/filename1.htm; and Letter, dated September 26, 2011, from Mr. Barish to Mr. Spirgel, available at http://www.sec.gov/Archives/edgar/data/732712/000119312511256362/filename1.htm.

8. See Letter, dated November 8, 2011, from Mr. Barish to Mr. Spirgel, available at http://www.sec.gov/Archives/edgar/data/732712/000119312511302471/filename1.htm; and Letter, dated November 9, 2011, from Mr. Barish to Mr. Spirgel, available at http://www.sec.gov/Archives/edgar/data/732712/000119312511304758/filename1.htm.