July 22, 2004
House Votes to Kill Mandatory Expensing of All Stock Options, Sending Bill to Senate
by William Baue
The House's passage of the Stock Option Accounting Reform Act reverses Sarbanes-Oxley's commitment
to protect independence of FASB as the arbiter of accounting rules.
In 1897, the Indiana House of Representatives voted 67 to 0 to change the value of pi, or the ratio
of the circumference of a circle to its diameter, from 3.14159… to 3.2.
schoolchildren momentarily rejoiced over this simplification of their lives," said investment guru
Warren Buffet in a July 6 Washington Post op-ed piece referenced by Senator Peter Fitzgerald
(R-IL) on the Senate floor on Tuesday
of this week. "But the Indiana Senate, composed of cooler heads, referred the bill to the
Committee for Temperance, and it eventually died."
Sen. Fitzgerald referenced Mr. Buffet's
opinion piece while introducing on the Senate floor a resolution to maintain the independence of
the Financial Accounting Standards Board (FASB),
intending the tale to serve as an analogy to the actions then occurring in the House.
At the time, the US House of Representatives was voting 312-111 (10 no votes) to pass HR 3574, the Stock Option Accounting Reform Act, which would require companies to
report as an expense only those options granted to the five highest-paid employees. The act
specifically overrides the FASB, which sets financial reporting standards followed by the
Securities and Exchange Commission (SEC) and the
American Institute of Certified Public Accountants (AICPA). In March, the FASB released an Exposure
Draft of rules calling for the expensing of all stock options. Currently, companies can
choose not to expense stock options (or obscure them in footnotes) in their SEC filings
while at the same time fully deducting those same stock options as an expense in their Internal
Revenue Service (IRS) filings.
Fitzgerald's resolution reminds Congress of its commitment to protect the independence of FASB
recorded two years ago in the Sarbanes-Oxley Act. Mr. Buffet's tale provides further
analogy to Tuesday's House vote, with the technology community, which lobbied heavily in favor of
the bill, rejoicing like schoolchildren.
"There does not seem to be any doubt that the
rigorous lobbying campaign led by the tech industry exerted influence on many legislators," said
Carol Bowie, director of governance research services at the Investor Responsibility Research
Center (IRRC), an impartial proxy research firm.
Harris Miller, president of the Information Technology Association of America (ITAA), which supported the bill, did not respond to
SocialFunds.com's requests for commentary.
Critics of the bill find many flaws in it.
"Simply stated, stock options are an expense," said Rep. Cliff Stearns (R-FL) from the House floor on Tuesday. "A Congressional
mandate to ignore economic reality does not change economic reality."
One specific flaw is
the seemingly self-contradictory logic of expensing some stock options but not others.
"Economic reality dictates that the value of all options given as compensation to all employees
and executives, regardless of title, should be reflected as an expense in the income statement as
is done with the cost of bonuses, salaries and perks," said Lynn Turner, former chief accountant
for the SEC and managing director of Glass
Lewis, a proxy research firm. "The notion that one would include compensation costs for only a
portion of the work force has no logic--and it fails the test of common sense as well."
staffer of a Representative that voted for the bill, who spoke with SocialFunds.com on condition of
anonymity, explains that the bill was a compromise solution between proponents of expensing
all options and supporters of expensing none.
Other criticisms focus on the
bill's assumption that "the volatility of the underlying stock shall be zero."
investing for 62 years and have yet to meet a stock that doesn't fluctuate," said Mr. Buffet in his
Supporters of the bill contend that current models for estimating stock
option value are flawed.
"FASB's proposed rule would allow companies to either use Black
Scholes or a Binomial method to expense options," said Sen. John Ensign (R-NV) on the Senate floor, speaking in support of S 1890, the Senate's version of Stock Option Accounting Reform Act. "Both are flawed models
and will yield very different and certainly inaccurate results."
The anonymous staffer
noted that the bill is intended to be intermediary legislation, and instructs the Departments of
Labor and Commerce to conduct a joint study on the economic impact of mandatory expensing of all
stock options. While Section 3(b) of the bill directs the study to consider various impacts on the
business community, it does not specify studying impacts on the investment community.
staffer also pointed out that a provision preventing companies from voluntarily expensing all stock
options was removed from the bill at the last minute. Currently, more than 760
companies--including Microsoft (ticker: MSFT), General Motors (GM), Ford (F), and Coca-Cola
(KO)--voluntarily expense stock
options, according to research updated on Tuesday by investment banking and brokerage firm Bear
It remains to be seen whether the end of Sen. Fitzgerald's analogy (by way of Mr.
Buffet) will hold true and the Senate is "composed of cooler heads" and will kill the bill.
"As far as I'm aware, the signs are that the Senate won't vote on a comparable bill because it
won't get out of committee," Ms. Bowie of IRRC told SocialFunds.com. "But, I understand there is
talk that the provision will be attached [as a rider] to another bill that would likely pass, so
it's hard to say right now--in an election year, everything is potentially political."
"Given that control of the Senate is likely to be up for grabs in a very close and hotly
contested election by mid-October, I believe the opponents of the FASB and their checkbooks may
influence the outcome," Mr. Turner of Glass Lewis told SocialFunds.com.