Form 4 Reporting for Performance Awards

When it comes to Form 4 reporting, performance awards are different than service-based awards. This blog entry explains the SEC's requirements and offers some best practices.

Most Performance-Based RSUs Are Reported at Vest

It feels a little counter-intuitive, but the SEC has indicated that performance awards in which vesting is contingent on anything other than stock price (including stock price targets in combination with other targets) are not considered granted until the performance conditions have been satisfied. Thus, the awards do not have to be reported for Section 16 purposes until that time. (For readers who subscribe to Section16.net, see Model Form 148 of Alan Dye's Section 16 Forms and Filings Handbook for more information.)

For example, if an executive is granted an award in which vesting is contingent on the company's revenue over a three-year time period, that award does not have to be reported on a Form 4 until the revenue target is achieved at the end of that three-year period. If the revenue target isn't achieved and the award is forfeited in its entirety, the award never has to be reported. (At least, not on Form 4. If the executive is a named executive officer, the award would still be discussed in the CD&A and included in other executive compensation-related disclosures in the company's proxy statement.)

Report Grants Contingent Solely on Stock Price Targets at Grant

When vesting in an award is contingent solely on stock price targets (with or without service conditions), the award must be reported at grant as the acquisition of a derivative security (with code A).

The Problem with Voluntary Reporting at Grant

Of course, there’s no penalty for reporting early, so it’s certainly permissible to report performance awards on a Form 4 at grant and some companies do so.  But this practice presents a couple of challenges.

The first challenge is how many shares to report. If an award can pay out at anywhere from say, 25% of target to 200% of target, how many shares do you report as granted on Form 4? One strategy is to report the target amount (if the award pays out above target, the additional shares earned would be reported at vest). Another strategy is to report the max payout. My preferred strategy, however, is to hold off reporting the award until it vests and you know how many shares will be paid out.

It’s also not clear that voluntarily reporting the award at grant relieves the insider of the obligation to report the grant of the award at the time it is earned. While a forfeiture might not be reportable, if the award is earned, the insider might have to report the grant again. This is likely to be confusing to investors (and other users of Form 4 reports, such as the media).

Relative TSR ≠ Stock Price

We often equate TSR with stock price targets because the FASB views the two as equivalent. The SEC takes a different position, however. For Section 16 purposes, TSR is considered to be equivalent to a stock price target only if the TSR goal is absolute (not relative) and if the company either doesn’t pay dividends or pays only nominal dividends. Thus, even most TSR awards are reported as I’ve described above.

How Should Settlements of Performance Awards Be Reported?

How settlements of performance awards are reported will depend on whether the grants have already been reported and whether the awards are settled in cash or stock.

Most Common Scenario: Award Not Reported Until Vest

As noted above, in most cases, it is not necessary to report performance awards until the performance conditions have been achieved. Here’s how the settlement would be reported (or not) in this scenario:

Settlement in Stock: Settlement of the performance award in stock upon vesting is typically reported as an acquisition of common stock (using code A).

Settlement in Cash: If the award is settled in cash, it may not be necessary to report anything on Form 4. According to Model Form 149 of the Handbook, “…the cash settlement involves neither the acquisition nor the exercise of a derivative security, nor the acquisition or disposition of underlying common stock, and therefore should not be reportable.” However, the Handbook points out that some practitioners disagree with this position and believe that cash settlement of a performance award should be reported as an acquisition and simultaneous disposition of common stock.

Award Reported at Grant

If the award was reported as a derivative security at grant, settlement of the award at vest is reported as a disposition of the derivative security (using code M) and acquisition of common stock (also using code M). If the settlement is in cash, a third transaction representing the disposition of the common stock back to the company is also reported.

End of Performance Period vs. Certification Date

Performance awards often are not paid out immediately at the end of the performance period; the company’s financial results may not be known for some time and the results typically have to be certified by the compensation committee before awards can be paid out.

In my example above of an award in which vesting is contingent on a three-year revenue target, the target must be achieved by the last day of the company’s fiscal year. But before the award can be paid out, the financial reports for the year must be completed and audited and then the compensation committee must review the audited financial results and certify that the revenue target was achieved. All these steps provide important control measures that ensure accurate and appropriate award payouts.

For Section 16 purposes, the award is typically not reportable until the compensation committee has certified that the performance goal has been achieved; until then, the executive is not irrevocably entitled to the shares underlying the award.

What If the Award Is Subject to Additional Service Conditions?

Sometimes performance awards are subject to additional service-based vesting conditions after the performance conditions have been achieved (sometimes referred to as a “service tail”). Where the award can be settled only in stock, this additional service requirement doesn’t have to change how the award or settlement is reported on Form 4. This is because RSUs that are settled only in stock can be reported simply as an acquisition of common stock. See Model Form 150 in the Handbook for more information.

Let’s return to our earlier example and say that once the three-year revenue target has been achieved, the award is not immediately paid out but is instead conditioned on the executive continuing to provide service to the company for an additional year. Let’s also stipulate that the award can be settled only in stock.

The award could still be reported in the manner described above. The award itself is not reportable until the compensation committee certifies that the revenue target was achieved at the end of the three-year performance period. At that time, the award can be reported as an acquisition of common stock. The only difference might be to include a footnote describing the one-year service condition when reporting the acquisition of common stock.

Alternatively, RSUs can be reported as derivative securities. If we want to take this approach, once the compensation committee has certified that the revenue target was met, we’d report an acquisition of a derivative security representing the RSU (with code A) in Table II. At the end of the one-year service period, we’d report the conversion of the derivative security into common stock (as a disposition of the derivative security and an acquisition of common stock, using code M for both transactions). If the award could be settled in cash, we would have to report it in this manner. 

What About Forfeitures?

Where an insider waits until the performance conditions are satisfied to report performance awards, it’s clear that it is not necessary to report the forfeiture. In that case, it’s as if the grant never existed.

Even where the award was reported at grant, it is not clear that the forfeiture is reportable. The mechanics of how a transaction is reported generally don’t change the substance of the transaction. Because performance awards aren’t considered granted until vested; when they don’t vest, they arguably weren’t ever granted and thus, the forfeiture would not be reportable, even if the grant has been reported already.

In addition, performance awards that are in the form of units are considered derivative securities (even if reported as an acquisition of common stock, as is permitted by the SEC when the award can be paid out only in stock). Cancellations of derivative securities for no value also aren’t reportable.

Thus, where a performance award reported at grant is forfeited, the award could simply drop off the insider’s filings with no explanation. (If the award was reported as an acquisition of common stock, however, the insider’s aggregate common stock holdings should be updated to reflect the forfeiture on the insider’s next filing).