SEC Approves Zions Bancorp's Market-Based Option Valuation Method

In a January 25, 2007, letter to Zions Bancorp, SEC Chief Accountant Conrad Hewitt approved the bank's proposal to value its employee stock options based on the bank's auction of a tracking security called employee stock ownership appreciation rights (ESOARS). ESOARS pay a pro rata share of the net positive value realized by employees when they exercise employee stock options from the option grant applicable to the ESOARS issuance. As the Web site explaining the approach describes, "if a company grants 1,000,000 employee stock options and ESOARS represent 10% of the value realized, ESOARS holders as a group will receive 10% of the value realized by employees when the employees exercise the options. 'Value realized' is the amount, if any, by which the (a) trading price of the security underlying the employee stock options at the time of exercise exceeds (b) the exercise price of those options, multiplied by the number of options exercised." The options vest in three years. The idea is that the ESOAR price is a market-derived value for employee stock options rather than one derived by a formula.

The auction is available to any buyer who registers with Zions Bancorp for the offer. The buyers may be restricted as to the number of units they can buy. The market price for the bids that are accepted is based on the lowest price that clears the market given the number of total units available. In the first auction, there were 57 bidders. A market clearing price of $7.50 resulted in 21 bidders being accepted. That turned out to be about half of what a Black-Scholes formula would have indicated for employee options.

The SEC had turned down an earlier, similar proposal from Cisco, largely because it was structured in a way that left the agency concerned there would not be enough buyers to create a real market. Subject to certain changes in the structure of the offer, the SEC said that it would allow Zion to use the price from the next auction to determine the compensation expense from the options for FAS 123(R) accounting purposes. However, each auction will be separately assessed to assure there is an adequate market that can generate real values.

As of this writing, the SEC letter was not yet public. Information about the ESOARs is available at www.esoarsauction.com/pma/faq/.