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The Employee Ownership Update

Corey Rosen

April 24, 2003

(Corey Rosen)

FASB Votes to Require Options Expensing; ESOPs, ESPP Issues to Be Covered as Well

On April 22, FASB voted unanimously to require companies to expense options and other equity compensation. Now FASB must figure out just how this expensing will occur. FASB said it hopes to have a standard available for comment early next year and for the requirement to be effective by the end of next year. While much of the attention on this issue has focused on options and employee stock purchase plans, the project actually covers all forms of equity compensation. FASB has said it will look separately at how ESOPs should be accounted for as part of the process. Unlike options, ESOP costs are currently charged to compensation, but the project could result in changes in how that is done.

Comprehensive Retirement Reform Bill Would Have Minor Impact on ESOPs

The "Pension Preservation and Savings Expansion Act of 2003" (H.R. 1776), introduced by retirement plan reform leaders Rob Portman (R-OH) and Benjamin Cardin (D-MD), would make sweeping changes in retirement plan law, but most of the changes would affect pension plans and employee savings plans, not ESOPs. The bill is given a good chance of passage and has already attracted wide support. The only provisions that would directly affect ESOPs are:
  1. Vesting must be completed either 100% after three years or gradually over six years.
  2. The minimum distribution rule would be amended so that distribution rules start at age 75, not 75.
  3. The bill incorporates the diversification rules for company stock in 401(k) plans, including those combined with ESOPs in public companies, that are in H.R. 1000, the pension reform bill that recently passed the House Education and the Workforce Committee.

Shareholders, SEC Continue to Press Companies on Options

Shareholder proposals to link options to performance and to require companies to expense them continue to gain momentum. The Investor Responsibility Research Center recently reported that 319 shareholder proposals have been filed on executive pay this year, up from 106 last year. Most ask that options be treated as an expense and that the formulas for granting them to executives be changed. There have been 26 proposals submitted to GE alone, including one from CALPERS, the California pension system, to limit GE executives to performance-based options. Meanwhile, the Securities and Exchange Commission staff has told Fluor Corporation that it cannot exclude a shareholder proposal that all future executive options be performance-based.

Repricing Options Cuts Broad Employee Turnover, But Not for Executives

A new study by Mary Ellen Carter at The Wharton School and Luann Lynch of the Darden School of Business titled "The Effect of Stock Option Repricing on Employee Turnover" finds that repricing executive options has no impact on turnover, while repricing options for non-executives in broad-based plans reduces turnover about 9% over what would have been expected. The study was based on 1998 repricings in high-tech and non-high tech companies. The study can be accessed through a Web search on the title.

ESOP's Holding of Employer Stock Does Not Violate ERISA

In Steinmen v. Hicks, C.D. Ill. No. 00-3260, 3/21/03), a U.S. District Court ruled that the trustees of an ESOP were not liable for losses in a profit sharing plan when it was terminated and merged into an ESOP. Moorman Manufacturing had a profit sharing plan that was 65% invested in company stock. In 1997, ADM acquired Moorman and terminated its profit sharing plan, merging it into its ESOP. ADM allowed Moorman participants to roll their account balances into ADM's ESOP or an IRA, or they could take a distribution in cash. This process took two years; in the meantime, Moorman profit sharing assets were invested in ADM's ESOP. During that time, ADM stock fell from $23 to $15.56. Former Moorman profit sharing plan participants sued, arguing that ADM's ESOP trustees should have diversified, especially given the short time between termination of the profit sharing plan and distribution. The court disagreed, saying that the plan was intended to be "used both to foster employee ownership and as a technique of corporate finance." Trustees could not be held responsible for market fluctuations they could not have anticipated, the court concluded.

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