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The Employee Ownership Update

Corey Rosen

July 20, 2004

(Corey Rosen)

House Votes to Block Options Expensing; FASB Says Delay Possible

On July 20, 2004, the House passed H.R. 3574, "The Stock Options Accounting Reform Act," by a vote of 312-111. The bill would limit proposed options accounting reforms in several ways:
  1. Publicly traded companies would have to report an expense for options granted to the top five executives using a fair value standard. Volatility would automatically be set to zero.
  2. When options are exercised, companies would be required to "true up" the difference between the cost they initially estimated and the actual spread.
  3. Non-public companies with (both) less than $25 million in revenue and $25 million in common stock value held by non-affiliates would be exempted from the requirement, and, if they go public, would be exempt for three years after an IPO.
  4. No accounting rules on options could go into effect until a one-year study is done by the Departments of Labor and Commerce on the economic impact of the changes, particularly on broad-based options.
  5. Companies would have to provide fuller and plainer disclosure of options, including the number of options granted, the weighted average exercise price, an estimate of how many options will vest, and an expanded discussion of dilution.

A sleeper provision in the bill is the one setting volatility at zero. Volatility is one of the two most important elements in options expensing formulas; setting it at zero would substantially reduce the estimated value at grant. The value of options to the top five executives is generally less than 20% in large public companies, so that too would minimize the declared cost.

Passage in the Senate still looks very doubtful. The chair and ranking minority member of the Senate Banking Committee are firmly opposed to the bill and have said they will not even hold hearings on it. The only chance for the bill this Congress would thus be for it to be attached to other legislation. But with time running out this session, opponents in the Senate would have multiple tools to block such a move. Neither presidential candidate has taken an active part on the discussion.

Indications are mounting, however, that the options rules may be delayed. SEC Chief Accountant Donald Nicolaisen said he would favor a one-year delay, and FASB board member Michael Cooch has said that the board is willing to consider requests for a delay. That would give Congress time next year to reconsider the issue.

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