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 FASBís 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.
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 wonít 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
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 oneís best interest to politicize
accounting, and I hope that there will be a more evenhanded debate this time.
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.
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.
Which brings me to the deeper and far more troubling core of what is wrong with
this bill: the compromising of the FASBís 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.
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 thatís out of their direct political
grasp. An independent FASB is the best hope of Americaís individual investors, who
donít have a well-oiled lobbying machine and arenít well-represented by elected
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.
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 clientsí 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 isnít only the ones that pass out all
the contributions that have a vote!
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 canít 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 optionsí pricing model is time tested,
elegant, and accurate.
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 companyís
true financial state. In addition, current rules can encourage executive pay packages
bloated with options grants that appear ďfreeĒ 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
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 nationís 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.
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.
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.
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.
This is not the first time FASB has attempted to require appropriate expensing of
stock options. In the mid-1990ís FASB attempted to require option expensing, but
was pressured by Congress to abandon its position. This thwarting of FASBís 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 FASBís independence and not interfere with a process that we believe will
result in providing shareholders with more transparent financial statements.
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 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.
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
FASBís expertise in accounting matters. The Board was established as an independent
body to try and avoid undue influence by any single party. The Boardís 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.
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 companyís 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.
The Senate holds hearings today to discuss a bill that would once again place
political limitations on the FASBís 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, theyíve got the kind of currency that counts in
the halls of Washington: big dollars.
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 FASBís independence,
but undermines the effort to restore confidence in our financial markets as well.
If you wanted to rename this act, it would be the Pander to Tech Companies That
Fill My Campaign Coffers Act.
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 optionís
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.
The tech lobby continues to argue against expensing options; we disagree and expose
the flawed logic. . . . Investors we surveyed donít accept the tech lobbyís 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.
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.
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.
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 investorsí 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.
These are highly difficult, complex questions, and Iím 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.
I donít 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.
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.
This new bill doesnít do anything. . . . This is just a veiled attempt to try and
let them [the tech industry] off the hook.
FASBís 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 companyís 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.
Worse still, Mr. Enziís bill would in effect block FASBís 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 itís 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 isnít this just the kind of decision that ought to be left to the accountants
at FASB not the non-accountants in Congress?
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 boardís move to require expensing of stock
You donít 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. Boxerís
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.
Ohioís 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.
Congressional interference on stock option expensing, or any other accounting issue,
is always inappropriate. The Council finds the current legislative efforts to impair
the FASBís 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.
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.
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."