House Commerce Subcommittee Holds Hearing on Stock Options Bill

July 8, 2004. The House Commerce Committee's Subcommittee on Commerce, Trade and Consumer Protection held a hearing titled "FASB Proposals on Stock Option Expensing". Members of the Subcommittee disagreed about the merits of the bill, but were in agreement that the House Commerce Committee should aggressively assert jurisdiction on this issue.

This was neither a legislative hearing on HR 3574, the "Stock Option Accounting Reform Act", which was overwhelmingly approved by the House Financial Services Committee last month, nor a markup of the bill. The House Commerce Committee has asserted jurisdiction, but not yet received a referral by the House Parliamentarian.

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

HR 3574, which is sponsored by Rep. Richard Baker (R-LA), and 129 other members of the House, requires public companies to expense only those stock options granted to the CEO and the next four highest paid officers. It also provides an exemption for small businesses. As for the top five employees, the bill requires companies to follow the FASB standards, but with a zero volatility assumption. The bill also requires the Securities and Exchange Commission (SEC) to promulgate a rule that requires each issuer filing a report under Sections 13(a) or 15(d) of the Securities Exchange Act "to include in such report more detailed information regarding stock option plans", including a discussion of "the dilutive effect of stock option plans".

On June 15, 2004, the House Financial Services Committee approved HR 3574, the "Stock Option Accounting Reform Act", by a vote of 45-13. See, story titled "House Financial Services Committee Approves Stock Options Bill" in TLJ Daily E-Mail Alert No. 919, June 16,  2004. See also, story titled "Capital Markets Subcommittee Approves Stock Options Bill" in TLJ Daily E-Mail Alert No. 897, May 13, 2004.

Rep. Clifford Stearns (R-FL), the Chairman of the Subcommittee, presided. He criticized HR 3574. He asserted that it "may effectively forbid the more than 575 companies that are voluntarily expensing options from doing so in the future." However, he did not cite any section of the bill that imposes this requirement. He also condemned the zero volatility assumption of the bill, for the top five employees, whose stock options must be expensed. He added that "If this legislation moves to the Floor, I would encourage Members on both sides of the issue to support amendments that would cure these two defects."

Rep. Joe Barton (R-TX), the Chairman of the full Committee, refrained from criticizing the bill, and offered support for the rationale behind the bill. He wrote in his prepared statement, which he read at the hearing, that "I am concerned about FASB's proposal. It is difficult to value a stock option at the time it is granted. Sometimes the stock price goes up and the option becomes extremely valuable. Other times, stock price is stagnant and options expire worthless. I don't think we should mandate the expensing of options that turn out to be worthless."

Rep. Barton (at right ) continued that "Financial analysts analyze companies for a living. They are aware of the stock option grants and the impact they have on earnings and presumably have already discounted that into the price of a company's stock. The question then becomes how requiring mandatory expensing will change the valuation of a company? If it does not affect the valuation of a company, what is gained?"

He concluded, in his oral statement, that "What is certain, is that a change to the accounting standards that would require expensing would transform corporate governance, and would change methods of compensation, and possibly impact our international economic competitiveness. That is a very very very serious issue, and needs to be seriously addressed." He added that if the Committee has jurisdiction, "We will work to report a responsible bipartisan bill."

Rep. John Shadegg (R-AZ), who is a cosponsor of HR 3574, praised the bill. He argued that giving employees a stake in their companies is a step in the right direction, and that the FASB proposal to mandate expensing would harm technology companies that now give employees stock options. Rep. Gene Green (D-TX), another cosponsor, also spoke in support of the bill.

Several members of the Subcommittee offered impassioned criticisms of the bill, with frequent references to indictment of Ken Lay, Enron's accounting practices, and accounting fraud at other companies.

Rep. John Dingell (D-MI), the ranking Democrat on the full Committee, was the most vehement. He said, "As for the Baker bill, all I can say is ``What were they thinking?´´ I thought we had enough of phony accounting and its devastating impact on companies, investors, and retirees. It is a case study in why Congress should not be in the business of writing accounting standards."

Rep. Bart Stupak (D-MI) criticized HR 3574. He argued that the Congress should not set accounting standards because "Congress can't balance its own books." Rep. Sherrod Brown (D-OH) also condemned HR 3574.

The Subcommittee heard testimony from four witnesses. David Walker, the head of the General Accounting Office (GAO), opposed HR 3574 in his prepared testimony [8 pages in PDF]. Similarly, Robert Herz, Chairman of the FASB, opposed the bill.

In contrast, former Rep. Rick White (R-WA), who is now the head of two groups involved in this issue -- TechNet and the International Employee Stock Options Coalition -- spoke in support of HR 3574. Steven Mayer, CFO of Human Genome Sciences, also spoke in favor of the bill.