Expensing Stock Options and HR 3574: What the Experts Are Saying

What follow are excerpts from letters, editorials, statements, testimony, and other materials about the importance of the respecting the independence of the Financial Accounting Standards Board (FASB), and H.R. 1372/S. 979 and H.R. 3574/S. 1890:

Stock options are the 800 pound gorilla that has yet to be caged by corporate reform. Corporate scandals have shown how current U.S. accounting rules are fueling stock option abuses linked to deceptive accounting, excessive executive pay, and nonpayment of taxes by profitable corporations. Honest accounting of stock options would strengthen the accuracy of U.S. financial statements and help restore investor confidence in our financial markets. FASB and the International Accounting Standards Board have already proposed treating stock options as an expense, and over 275 U.S. companies have begun doing so on a voluntary basis. Legislation blocking requirements for stock option expensing is not only wrong on the issue, it is also an attack on FASB’s independence. The legislation would take the unprecedented step of directing the SEC, once FASB exercises its independent judgment on an accounting issue, not to recognize or enforce that accounting judgment. It sends exactly the wrong message to investors about our commitment to accounting reform.
-- The Honorable Carl Levin, United States Senate, May 1, 2003

I know there are several bills in Washington that could erode confidence in the FASB, including the Enzi-Reid Stock Option Accounting Reform Act. While I personally won’t tell you how to vote on that specific piece of legislation, it is absolutely critical that . . . you do everything you can to keep accounting standard setting in the private sector and preserve the role of the FASB. No accounting body has ever worked so well and it is unlikely that any replacement or increased government oversight will improve upon its performance.
--W. Steve Albrecht, Professor of Accounting and Associate Dean, Marriott School of Management, Brigham Young University, March 5, 2004

It is very disappointing to see that members of Congress are again threatening to veto FASB on accounting for stock options. It is in no one’s best interest to politicize accounting, and I hope that there will be a more evenhanded debate this time.
-- Dennis R. Beresford, Executive Professor of Accounting, The University of Georgia, and former Chairman of the Financial Accounting Standards Board, July 2003

I urge you to support the Financial Accounting Standards Board, its due process and the importance of maintaining the continuation of independent private-sector initiatives in the development and setting of accounting and financial standards.
--Richard H. Booth, President and Chief Executive Officer, HSB Group, Inc., March 3, 2004

Companies who voluntarily expense have already begun to demonstrate that it yields more accurate earnings numbers, restores investor confidence, and can be accomplished without eliminating the benefits for rank-and-file employees. While H.R. 3574 would delay the implementation of FASB requirements, I strongly believe we must act now to increase discipline within the system and strengthen investor confidence by ending the special treatment that stock options have enjoyed for decades.
--The Honorable Michael N. Castle, United States House of Representatives, March 3, 2004

Which brings me to the deeper and far more troubling core of what is wrong with this bill: the compromising of the FASB’s independence. I oppose the injection of Congressional bias into the independent standard-setting process of the FASB -- a process that was strongly endorsed by Congress during the development of the Sarbanes-Oxley Act, and ultimately embedded in the Act itself.
-- Jack T. Ciesielski, CPA, CFA, Owner, R.G. Associates, Inc., March, 1, 2004

The eagerness of lawmakers to work with Silicon Valley executives on legislation to control accounting standard-setting is a frightening sight to behold; it provides more evidence of the need for standard-setting that’s out of their direct political grasp. An independent FASB is the best hope of America’s individual investors, who don’t have a well-oiled lobbying machine and aren’t well-represented by elected officials.
--Jack T. Ciesielski, CPA, CFA, Owner, R.G. Associates, Inc., May 5, 2003

Until the properly authorized expert independent organization, FASB, acts to correct this problem, many companies will hide behind differing earnings treatments and disdain performance-based options even while recognizing that they are the better approach to executive compensation. Congress should be careful not to politicize this issue and should permit FASB to take on this issue on its intrinsic merits. The recent support of the FASB by SEC Chairman Donaldson is encouraging as to the view at the SEC.
--Peter C. Clapman, Senior Vice President and Chief Counsel of Corporate Governance, TIAA-CREF (a full-service financial services provider with approximately $262 billion in assets under management supporting the pensions of nearly 3 million individuals at nearly 15,000 institutions in the educational and research field), May 20, 2003

The integrity of financial reporting requires that U.S. companies expense all stock options, contrary to the proposal of the Stock Option Accounting Reform Act (S. 1890 & H.R. 3574). The expensing of only stock options held by the five most highly compensated executive officers has the effect of overstating the profitability and assets of a corporation, and thereby misleading investors.
-- Richard A. Curtis, Executive Director, The Highway Patrol Retirement System (a $625 million pension fund), February 5, 2004

While I am passionate about requiring the expensing of stock options, the principal purpose of this letter is to ask that the FASB be allowed to do its job. Congress should stay out of the debate. Congress has also been bashing auditors (partly justified) for not standing up to their clients. It is alleged that the auditors champion the interests of their clients for fear of losing fees. They are criticized of this even when the clients’ interests prove to be correct. Many members of Congress are guilty of championing the interests of their constituents, regardless of how senseless the cause, for fear of losing political contributions. A pretty safe, if not honorable, thing to do 10 years ago. Now, however, when (it is estimated) 500 companies are voluntarily adopting the expensing of stock options and many investor advocates have favored expensing, those in Congress must realize it isn’t only the ones that pass out all the contributions that have a vote!
-- Raymond L. Dever. CPA (Retired), Tucson, AZ, February 26, 2004

The supporters of this bill insult the intelligence of anybody with knowledge of accounting or finance. Not expensing employee stock options is accounting FRAUD. Chairman Alan Greenspan says options "should be expensed," and the argument that they can’t be accurately valued is "flat wrong." When it comes to options Silicon Valley will only be happy with options having a value of zero, anything else is not acceptable to TechNet. The Black-Scholes options’ pricing model is time tested, elegant, and accurate.
-- Andrew H. Dral, Sacramento, CA, December 30, 2003

Allow the Experts to Require Expensing of Options -- Keep Politics Out. Options are a critical compensation tool, but they are not free. Current rules allow companies to choose not to list options as an expense on their financial statements. When options are not expensed, financial statements do not accurately reflect a company’s true financial state. In addition, current rules can encourage executive pay packages bloated with options grants that appear “free” to the company. The Financial Accounting Standards Board has stated its intent to require companies to list the cost of stock options in their financial statements. In 1994, Congress blocked a similar effort. Edwards believes that, this time, Congress must keep out and allow FASB to require options expensing.
-- The Honorable John Edwards, United States Senate, July 7, 2003

H.R. 3574 would undo the progress made by the Sarbanes-Oxley Act of 2002 and recent Securities and Exchange Commission (SEC) Policy Statement reaffirming the Financial Accounting Standards Board (FASB) as the nation’s accounting standard setter. Protecting the standard-setting process from political intervention was an important reason for these recent steps. The role of FASB is to pursue transparency and accuracy in accounting standards, not to choose among competing public policies. The FASB designs the ruler. It is for others to decide what to do with the measurements.
-- The Honorable Paul E. Gillmor, United States House of Representatives, March 4, 2004

We should not be setting accounting standards on a political basis. Also, the failure to expense options provides false and misleading statements to shareholders, because it does not accurately report the true costs to the company and shareholders, which explains the broad support for stock options expensing by financial experts such as SEC Chairman William Donaldson, Federal Reserve Chairman Alan Greenspan, former Fed Chairman Paul Volcker and Warren Buffett.
-- The Honorable Paul E. Gillmor, United States House of Representatives, March 3, 2004

Requiring companies to expense only options granted to the CEO and the next four highest compensated executives, as proposed in S. 1890, is insufficient, and it appears to be based on a desire to report overly optimistic numbers rather than report comprehensive financial information. However, this is a decision that should not be made in Congress. Rather, the Financial Accounting Standards Board (FASB), an independent entity, is where this decision making should take place.
-- Laurie Fiori Hacking, Executive Director, Ohio Public Employees Retirement System (a $56 billion fund serving three quarters of a million Ohioans, making the system the 10th largest state pension fund in the U.S.), December 18, 2003

It may seem attractive to put off this fight once again, but it is not going away. H.R. 1372 is an understandable effort, but the studies contemplated by H.R. 1372 are no answer to the problem. They are only a reason for another delay.
-- The Honorable Roderick M. Hills, Former Chairman of the United States Securities and Exchange Commission, June 3, 2003

This is not the first time FASB has attempted to require appropriate expensing of stock options. In the mid-1990’s FASB attempted to require option expensing, but was pressured by Congress to abandon its position. This thwarting of FASB’s role as an independent body did nothing to protect shareholders from the corporate collapses that have plagued investors over the past several years. This time, we hope Congress will respect FASB’s independence and not interfere with a process that we believe will result in providing shareholders with more transparent financial statements.
-- James P. Hoffa, General President International Brotherhood of Teamsters (representing 1.4 million active members and over 600,000 retirees, and individual pension and health and welfare benefit trusts with assets over $100 billion), March 3, 2004

Other leaders on Capitol Hill have agreed with me about the wisdom of protecting the independence of the Financial Accounting Standards Board. Earlier this year, Senator Shelby and Senator Sarbanes, the two most powerful members of the Senate Banking Committee, asserted their bipartisan opposition to intervening in the activities of the board. Chairman Oxley has also previously said that compromising the independence of the private board that set accounting rules "could negatively impact efforts to improve the transparency of financial reports." I wholeheartedly agree. Deciding what should be accounted for and how it should be accounted for is the job of the Financial Accounting Standards Board, not the Congress.
-- The Honorable Paul E. Kanjorski, Ranking Member, Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, Committee on Financial Services, United States House of Representatives, March 3, 2004

The expensing of stock options is long overdue. It will help bring corporate balance sheets into line with reality, and allow investors to measure the true value of executive compensation packages. . . . In the name of transparency, this bill would actually allow corporations to continue to obscure critical information. It is dramatically out of step with the increasing demand for openness and the transparency in the wake of the corporate scandals of the last two years.
-- Adam Kanzer, Director of Shareholder Advocacy, Domini Social Investments, March 14, 2004

Although Congress has an important oversight role with respect to financial accounting and reporting for public enterprises, Congress should not be getting involved in writing specific accounting standards. The FASB must be allowed to exercise its independence to study the issues and promulgate appropriate accounting standards under a full due process open to public debate. Congress should not override FASB’s expertise in accounting matters. The Board was established as an independent body to try and avoid undue influence by any single party. The Board’s thorough, open, and public due process is subject to active oversight by the private sector Financial Accounting Foundation and the United States Securities and Exchange Commission. We would be very concerned if political influence was brought to bear on a financial statement line item.
-- Claude Lamoureux, Interim Chair, Accounting and Auditing Practices Committee, The International Corporate Governance Network (an international network of institutional investors, shareholder advocates and corporate governance experts collectively holding more than $10 trillion in assets), February 2, 2004

The bill, which purports to bridge the gap between expensing and anti-expensing factions, does nothing of the sort. It would require expensing only of options granted to each company’s chief executive and the four other highest-paid executives -- and mandate the use of a valuation method that amounts to a cure worse then the disease.
-- Louis Lavelle, BusinessWeek, November 26, 2003

The Senate holds hearings today to discuss a bill that would once again place political limitations on the FASB’s ability to make decisions on what constitutes good accounting. AeA and other well-heeled lobbying groups have already spent enormous sums pressing their cases on why this is a disaster for American entrepreneurial spirit -- as is their right to do. While I find their arguments bankrupt and their attitude decidedly anti-shareholder, they’ve got the kind of currency that counts in the halls of Washington: big dollars.
-- Bill Mann, Senior Analyst, The Motley Fool, November 12, 2003

The expensing of stock options allows investors, analysts, corporate executives and employees, and auditors to properly understand the bottom line of corporations. This legislation blocking stock option expensing not only undermines FASB’s independence, but undermines the effort to restore confidence in our financial markets as well.
-- The Honorable John McCain, United States Senate, May 1, 2003

If you wanted to rename this act, it would be the Pander to Tech Companies That Fill My Campaign Coffers Act.
-- Patrick S. McGurn, Special Counsel, Institutional Shareholder Services, November 20, 2003

H.R. 3574 holds that if a pricing model is used to determine the fair value of an option, the assumed volatility of the underlying stock shall be zero. It is the case that under the assumption of zero volatility, any pricing model used will give about the same estimate of value. Thus, in effect, H.R. 3574 specifies the option-pricing model to use for expensing. This option valuation model is seriously flawed as an estimator of fair value. It is universally accepted that a large part of an option’s value is the result of the volatility of the underlying stock price. But there are no real-world traded stocks whose volatility is zero and furthermore, technology firms which issue large amounts of options tend to have above-average levels of volatility. Thus the mandated approach of H.R. 3574 will uniformly undervalue all options and for at-the-money options it will uniformly undervalue the options by a large amount. This one provision will de facto preserve the current and past practice of not expensing options issued at or out of the money.
-- Robert C. Merton, John and Natty McArthur University Professor, Harvard Business School, and 1997 recipient of the Alfred Nobel Memorial Prize in Economic Sciences, March 3, 2004

The tech lobby continues to argue against expensing options; we disagree and expose the flawed logic. . . . Investors we surveyed don’t accept the tech lobby’s argument that job creation and U.S. competitiveness require keeping option expense out of the income statement. Investors also shun creative legislative attempts such as limiting expense to five executives and exempting newly public companies for three years.
-- Steven Milunovich, CFA, First Vice President, and Richard Farmer, Assistant Vice President, Merrill Lynch Global Securities Research & Economics Group, Global Fundamental Equity Research Department, Merrill Lynch, February 3, 2004

I firmly believe that Congress should continue to leave accounting standard setting in the private sector, with the understanding that the SEC already has ultimate authority with respect to accounting at publicly traded companies. By not supporting this legislation, you would be acting to maintain high-quality independent private-sector financial-accounting standard setting in the United States.
-- Mark W. Nelson, Eleanora and George Landew Professor of Management and Professor of Accounting, Cornell University’s Johnson Graduate School of Management, March 3, 2004

As the 10th largest institutional investor in the U.S., OPERS has a fiduciary duty to protect the financial futures of its retirees and members. The bill would allow corporations to continue to report overly optimistic numbers rather than report more accurate and comprehensive information. . . . Any effort to diminish the important role of FASB as an independent body will only serve to further harm investors who have already experienced a loss of both money and confidence in the U.S. capital markets.
-- Cynthia Richson, Corporate Governance Officer, The Ohio Public Employees Retirement System (with assets of approximately $58.7 billion, OPERS is the largest state pension fund in Ohio, the 10th largest state pension system in the U.S. and the 17th largest in the world), January 14, 2004

Just a year after giving near unanimous approval to legislation designed in part to allow FASB to develop accounting rules free from the threat of outside interference, some members of Congress have already reneged on that promise and are trying to prevent FASB from adopting a stock options expensing rule that it believes is in investors’ best interests. . . . If they succeed, they will not only undermine the transparency of corporate financial disclosures, they will deal a fatal blow to the independence of the accounting standard-setting process.
-- Barbara Roper, Director of Investor Protection, Consumer Federation of America, August 13, 2003

These are highly difficult, complex questions, and I’m frank to tell you I think they ought to be left to . . . the Financial Accounting Standards Board, and the Congress ought not to be legislating in this area.
-- The Honorable Paul S. Sarbanes, Ranking Member, Committee on Banking, Housing, and Urban Affairs, United States Senate, March 1, 2004

I don’t think we should make those rules in the Banking Committee or even in Congress. . . . [FASB] understands the implications. There are economic implications here, but it also gets into corporate governance and honesty in financial statements.
-- The Honorable Richard C. Shelby, Chairman of the Committee on Banking, Housing, and Urban Affairs, United States Senate, June 30, 2003

For these reasons, we strongly oppose the "Broad-Based Stock Option Plan Transparency Act of 2003" (HR 1372), which would prohibit the SEC from recognizing as GAAP any new accounting standards related to the treatment of stock options for more than three years. More is at stake here then just option accounting or executive compensation. Our markets will be damaged if it appears that our accounting standards are still being held hostage to the political dynamics that prevented effective regulation in the 1990s. The credibility of the American capital markets is at stake.
-- Damon Silvers, Associate General Counsel, AFL-CIO (representing more than 66 national and international unions and their membership of more than 13 million working women and men, and with union-sponsored pension plans with $400 million in assets), June 3, 2003

This new bill doesn’t do anything. . . . This is just a veiled attempt to try and let them [the tech industry] off the hook.
-- The Honorable Pete Stark, United States House of Representatives, November 20, 2003

FASB’s decision to require stock option expensing in 2005 will strengthen investor confidence in the financial statements of large and small businesses, thus lowering their cost of capital. The efficient allocation of capital to the most economically valuable business activities depends on consistent accounting rules. For this reason, we believe all businesses should expense stock options, so that stock options do not artificially boost any company’s reported reports. Congress should let FASB do its job. -- Richard L. Trumka, Secretary-Treasurer, American Federation of Labor and Congress of Industrial Organizations (representing 13 million members, benefit plans with $5 trillion in assets, and pension plans holding almost $400 billion in assets), March 3, 2004

To put the matter most pointedly. If the U.S. Congress, or political authorities in other countries, seek to override the decisions of the competent professional standard setters -- including those of the IASB for which I have responsibility -- accounting standards will inevitably lose consistency, coherence and credibility, weakening the fabric of the international financial system.
-- The Honorable Paul A. Volcker, Chairman of the Trustees of the International Accounting Standards Committee Foundation, and former Chairman of the Federal Reserve System, June 3, 2003

Worse still, Mr. Enzi’s bill would in effect block FASB’s own expensing rule from taking effect while a "comprehensive economic impact study" is conducted. And Mr. Enzi would require FASB to adopt a "truing-up": requirement under which the actual cost of the option (once it’s exercised, expires or is forfeited) is ultimately reflected on the corporate books. There are legitimate criticisms of the complexity and manipulability of the expensing models that FASB is considering, and truing-up may be a reasonable approach, but isn’t this just the kind of decision that ought to be left to the accountants at FASB not the non-accountants in Congress?
-- The Washington Post, January 2, 2004

At the same time, there are disturbing signs of backsliding. Less than a year after affirming the importance of maintaining the independence of the Financial Accounting Standards Board, which writes the non-auditing rules for accountants, lawmakers are foolishly weighing interfering with the board’s move to require expensing of stock options.
-- The Washington Post, July 30, 2003

You don’t need to know where you come out on this arcane dispute to know who ought to be deciding it -- and who ought to keep their noses out of it. This is a matter for accountants, not politicians, and it would have been handled by the accountants long ago were it not for the political clout (and the campaign checks) of high-technology companies. In the Senate, for example, one of the leading opponents of expensing is California Democrat Barbara Boxer, who this month hosted a -- roundtable -- discussion of the issue that was largely devoted to bashing the FASB. A week earlier a group of Silicon Valley executives had issued an open letter backing Mrs. Boxer’s reelection bid and lauding her support for their position on options. Mrs. Boxer and her anti-expensing allies -- including Sens. George Allen (R-Va.) and John Ensign (R-Nev.) and California Reps. David Dreier (R) and Anna G. Eshoo (D) - ought to leave accounting to the accountants.
-- The Washington Post, May 21, 2003

Ohio’s public pension fund managers strongly support the independent authority of FASB in setting accounting standards, which would be severely undermined by H.R. 3574. This legislation would be a significant setback in the new era of honest accounting that has been ushered in by the Sarbanes-Oxley Act.
-- Daniel K. Weiss, CPA, JD, Chief Financial Officer, Highway Patrol Retirement System, On Behalf of the State of Ohio Public Employee Pension Funds (representing one-and-a-quarter million members and beneficiaries, and combined invested assets of 135 billion dollars), March 3, 2004

Congressional interference on stock option expensing, or any other accounting issue, is always inappropriate. The Council finds the current legislative efforts to impair the FASB’s independence particularly disappointing during a time when investors have collectively suffered tremendous losses in the U.S. capital markets, due in part to corporate scandals resulting from overly-aggressive or fraudulent accounting practices. Any efforts to stonewall the FASB will ultimately hurt millions of U.S. investors.
-- Ann Yerger, Deputy Director, The Council of Institutional Investors (an association of more than 140 corporate, public and union pension funds collectively responsible for more than $3 trillion in pension assets), March 2, 2004

Requiring companies to expense only options granted to the CEO and the next four highest compensated executives, as proposed in S. 1890, is insufficient, and it appears to reflect an interest rooted more in attractive numbers then comprehensive information. But this is a decision that should not be made in Congress in the first place.
-- Ann Yerger, Deputy Director, The Council of Institutional Investors (an association of more than 140 corporate, public and union pension funds collectively responsible for more than $3 trillion in pension assets), November 21, 2003

As a partner in a Wall Street law firm and the author of the text Accounting Irregularities and Financial Fraud, I have been becoming increasingly concerned over the prospect of political considerations potentially influencing the formulation of generally accepted accounting principles. That is particularly the case with S. 1890, insofar as the political analysis is apparently to include an assessment of the "economic impact" of the accounting standard rather than solely the overriding objective of reporting the truth. At public companies, allowing the "economic impact" of an accounting decision to influence the public reporting of financial results is often labeled "fraud."
-- Michael R. Young, Partner, Wilkie Farr & Gallagher LLP, March 8, 2004

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