Capital Markets Subcommittee Approves Stock Options Bill

May 12, 2004. The House Financial Services Committee's Subcommittee on Capital Markets amended and approved HR 3574, the "Stock Options Accounting Reform Act".

The Subcommittee approved an amendment in the nature of a substitute offered by Rep. Richard Baker (R-LA) (at right), the Chairman of the Subcommittee, and lead sponsor of the bill.

On March 31, 2004, the Financial Accounting Standards Board (FASB) released a document titled "Exposure Draft, Share-Based Payment, an Amendment of FASB Statements No. 123 and 95" that proposes that companies must expense stock option plans for all employees.

The FASB stated that "The exposure draft covers a wide range of equity-based compensation arrangements. Under the Board's proposal, all forms of share-based payments to employees, including employee stock options, would be treated the same as other forms of compensation by recognizing the related cost in the income statement. The expense of the award would generally be measured at fair value at the grant date. Current accounting guidance requires that the expense relating to so-called fixed plan employee stock options only be disclosed in the footnotes to the financial statements."

The FASB's comment period for the exposure draft ends June 30, 2004. See, story titled "FASB Proposes Expensing of Stock Options" in TLJ Daily E-Mail Alert No. 867, April 1, 2004.

The FASB exposure draft has been condemned by technology companies and the trade groups that represent them, which argue that broad based employee stock option plans incent innovation, and enable new start up companies to compete.

Rep. Baker stated that this bill "would simply require the expensing of stock options for the top five employees of each corporation".

The bill defines the top five employees as "all individuals serving as the chief executive officer", and "the 4 most highly compensated executive officers". It would require the issuer of stock to "show as an expense .. the fair value of all options to purchase the stock of the issuer".

FASB Independence. Rep. Paul Kanjorsky (D-PA), the ranking Democrat on the Subcommittee, spoke in opposition to the bill. He argued that HR 3574 constitutes political interference with the accounting standards setting process. He stated that "To strengthen investor confidence and promote international convergence of corporate reporting standards, FASB must proceed with diligence, and without political interference".

He offered an amendment in the nature of a substitute. It stated in its enumeration of purposes that "Investors benefit from independent and fair accounting standards that are free from undue political interference" and that "The rulemaking authority and credibility of the accounting standard-setting process may be irreparably damaged by legislation that preempts the existing public, fair, and deliberative process."

This amendment would have removed the Congress from the accounting standards setting process.

Rep. Darlene Hooley (D-OR) responded to the argument that the Congress should not engage in political interference. She said that this is what the Congress does.

Rep. Baker attacked the political process followed by the FASB in this matter. He said that the FASB announced its conclusion before its received public comments, that it refused to conduct field tests, that it refused to consider proposals, and that it otherwise failed to conduct in standards setting process in an open and professional manner. He said that the "FASB has not met their own standard".

This amendment failed on a voice vote.

Expensing of Stock Options Over $100,000. Rep. Brad Sherman (D-CA), who was the most vocal opponent of the bill at this markup, offered numerous amendments. One amendment would have allowed companies not to expense employee stock options, but only for the first $100,000 per year for each employee. It would have required the expensing of any stock option amount over $100,000.

This amendment failed on a voice vote.

Capitalization of Research Projects. Rep. Sherman also offered an amendment that stated, "The amendments made by this Act shall cease to be effective 60 days after a recognized standard setting body shall establish a principle, or the Commission shall promulgate a rule, providing for capitalization of research projects."

He argued in support of his amendment that the failure to allow capitalization of research projects "treats high tech unfairly", and that "expensing research discourages research".

Rep. Spencer Bachus (R-AL) argued against this amendment. He said that "there is no guarantee that research and development will be successful". Hence, "in most cases there is no asset created from research and development". Yet, he argued, the amendment would treat this situation as though there were an asset.

This amendment failed on a voice vote.

Zero Volatility Assumption. Rep. Sherman also offered an amendment to the bill's provisions regarding the valuation of those stock options of the top five employees. The bill basically follows the FASB method, but then assumes zero volatility. This Sherman amendment would have removed the language regarding zero volatility. Rep. Sherman stated that zero volatility "is a phony system".

Rep. Pat Toomey (R-PA) and Rep. Ed Royce (R-CA) argued against the amendment. Rep. Royce argued that if you remove the zero volatility assumption then you will penalize companies with volatile stock prices. And this, said Rep. Royce, includes technology companies in California. He also argued that removing the zero volatility assumption would affect these companies ability to attract top talent.

This amendment failed on a voice vote.

Increased Stock Option Reporting Disclosures. Rep. Bob Ney (R-OH), who supports the bill, offered an amendment that would have required more detailed reporting to the Securities and Exchange Commission (SEC) regarding stock option plans, including a discussion of the dilutive effect of stock option plans on earnings, "the number of outstanding stock options", "the weighted average exercise price of all outstanding stock options", and "the estimated number of stock options outstanding that will vest in each year".

He explained that, in order to incent innovation, and to enable small companies to compete with incumbents, there should be no requirement that stock options be expensed. But, investors, such as pension plans in his state of Ohio, need more information about stock option plans.

Rep. Ney withdrew his amendment after Rep. Baker promised to work with him before the full committee markup on language that would accomplish this purpose.

The Subcommittee approved one technical amendment offered by Rep. Sherman, with little discussion.

There were no roll call votes. Rep. Baker spoke with reporters after the markup. He stated that "we had done fairly significant pre-mark up whipping." He added that had there been a roll call vote "the outcome would have very decisive" and "bipartisan".

He suggested that full committee markup could come in June. Moreover, he wants "floor consideration before August".

The Senate has not yet passed related legislation.