Risk & Compliance

Stock Option Standoff

Bill would place three-year moratorium on revising employee stock option accounting; angry Herz says the move could impair FASB's independence.
Craig SchneiderJune 9, 2003

It may be time for FASB to write its own Declaration of Independence — from Congress.

Last week, Financial Accounting Standards Board Chairman Robert Herz urged legislators to stop interfering in its independent standard-setting process. That urging came at a House subcommittee hearing on the expensing of employee stock options.

But was anyone listening? Since Herz’s testimony, the bill that threatens FASB’s impartiality has gained additional bi-partisan support from nine new co-sponsors, bringing the total backers to 44. (For an updated list, click here.)

As reported in RegWatch, FASB’s effort to change how companies account for employee stock options is facing an uncertain future, due to HR 1372, “The Broad-Based Stock Option Plan Transparency Act.” The bill was introduced by Rep. David Dreier (R-Calif.) and Rep. Anna Eshoo (D-Calif.) in March.

Specifically, the bill proposes greater disclosure on employee stock options. More importantly, the bill would also commission a three-year study by the Securities and Exchange Commission on the effects of stock options. During that time, the SEC would not recognize as GAAP any new accounting standards governing the expensing of stock options.

Such a moratorium would derail FASB’s initiative on stock option accounting. The board, which is currently considering that treatment, is expected to make a final decision on the subject by the end of the year.

In his testimony, Herz railed against the proposed three-year ban. “The moratorium,” Herz argued, “would likely establish a potentially dangerous precedent in that it would send a clear and unmistakable signal that Congress is willing to intervene in the independent, objective, and open accounting standard setting process based on factors other than the pursuit of sound and fair financial reporting.”

He added: “Such intervention would also appear to be inconsistent with the language and intent of the [Sarbanes-Oxley] Act and the related [SEC] Policy Statement, both of which were intended to enhance the independence of the FASB.”

This isn’t the first time FASB has had a run-in with Congress over stock options. In the early 1990s, FASB attempted to promulgate an option-expensing rule. But spurred by intense industry lobbying, Congress retaliated, threatening to strip the board’s standard-setting power. At that point, then-SEC Chairman Arthur Levitt urged FASB to back away from the fight. Ultimately, the standard-setting board retreated from the expensing rule idea.

Today, however, FASB has the backing of current SEC Chairman, William Donaldson, who has asserted that Congress should not be in the business of making up accounting rules.

Given some of the past bookkeeping tricks employed by Congress to help balance the U.S. budget, he may have a point. Rep. Eshoo even alluded to such issues in her remarks at the hearing: “Nothing in our bill requires Congress to get into the standard-setting business,” she said. “We have problems keeping up with our own books.”

Instead, Eshoo and Dreier say they oppose mandatory expensing of stock options because such an accounting treatment might harm the U.S. economy. By their lights, the change in accounting would likely sound the death knell for employee stock option packages. That, says Drier, would hobble the ability of startup companies to attract talent, and in turn, stifle innovation.

Bringing an end to stock option rewards would “hurt the risk-takers who are creating jobs and wealth in this country,” he claimed.

Herz countered by saying that the “usual dire prediction” about economic doom won’t play out once solid standards are in place. The FASB chief did acknowledge that stock option valuation methodology is a concern. Eshoo agreed, asserting that there are no effective valuation methods available. FASB intends to address the controversial issue as early as this month.

Eshoo and Dreier represent districts in California where high-tech companies rely on stock options as incentives for executives and employees. (To read the prepared testimony of the hearing speakers, click here.)

SEC Considers New Rules for Credit-Rating Agencies

The Securities and Exchange Commission is soliciting public comment on a wide range of questions regarding possible approaches it could develop in its regulatory oversight of credit rating agencies.

The various issues in its “concept release” include: whether credit ratings should continue to be used for regulatory purposes under the federal securities laws, and, if so, the process of determining whose credit ratings should be used, and the level of oversight to apply to such credit rating agencies.

There are just four firms designated as nationally recognized statistical rating organizations, or NRSROs. They are: Moody’s Investors Service, Inc., Fitch, Inc., Standard & Poor’s (a division of The McGraw-Hill Companies, Inc.), and Dominion Bond Rating Service Limited.

Critics argue that the criteria for NRSRO designation impose barriers to entry into the business and that the recognition process is not transparent enough. Others criticize credit rating agency performance in the wake of corporate scandals and economic downturns. NRSROs continued to rate Enron “investment grade” four days before bankruptcy; California utilities “A-” two weeks before defaulting; and Worldcom “investment grade” three months before bankruptcy.

Lawmakers on Capitol Hill appear to be pressing the SEC for action. The commission made great mention of its “concept release,” responding in a letter to questions from House Capital Markets Subcommittee Chairman Richard Baker (R-La).

SEC Chairman William Donaldson told Baker that its staff has been “working diligently” to review issues including potential conflicts of interest, alleged anticompetitive or unfair practices by recognized rating agencies, and potential regulatory barriers to entry into the credit rating business.

To read the full letter to Chairman Baker, click here.

To read the SEC’s concept release with its 56 questions, click here. Comments should be received within 45 days of publication in the Federal Register.

EU on Sarbanes-Oxley Plan: Get Lost

U.S. policies — and policymakers — seem to be in the doghouse these days.

First, new findings by the Pew Global Attitudes Project says that America’s image deteriorated precipitously during the month of May, mostly because of the way the government is handling post-war issues in Iraq. Now, it seems as though the souring of public opinion on the U.S. is extending into the accounting sector.

Finance ministers in the European Union are outraged about new trans-Atlantic directives coming from Sarbanes-Oxley Act, and are taking aim at the Public Company Accounting Oversight Board (PCAOB), one of the groups charged with implementing the new law. As a result, this week the EU ministers demanded a “full exemption” from the rules. This according to a report from international news service AFP.

The U.S. Sarbanes Oxley Act requires that public accounting firms register with the newly created accounting industry oversight board. EU officials aren’t happy that accounting firms have to register with a U.S. regulatory entity.

In a letter sent to SEC Chairman William Donaldson and U.S. Treasury Secretary John Snow after the PCAOB finalized its rules in April, EU Internal Market Commissioner Frits Bolkstein threatened retaliation if the PCAOB rules were not rescinded.

On behalf of the 15 EU member countries, Bolkstein condemned the PCAOB’s registration process, calling it “unacceptable given the major conflicts of law that may ensue.”

He encouraged the SEC, which oversees the PCAOB, to redraft the entire plan and negotiate an alternative pact with the E.U. that recognizes the audit controls of all parties.

According to the current PCAOB rules, European firms will have to register with the board by May 2004. U.S. firms are required to register by October. The underlying threat: unregistered accounting firms would be banned from performing audit work for U.S. issuers.

AFP estimates that 280 E.U. companies either have a dual listing in the U.S. or are a subsidiary of an American-based public company.

If the E.U.’s call to redraft is not met, Bolkstein noted in the letter that U.S.-based accounting firms operating in the E.U. would be forced to register. And not just with the E.U., mind you, but with all 15 member states, as well as the 10 countries joining the E.U. new May.

(Editor’s note: The advent of the PCAOB, along with the recent spate of corporate scandals, has put accounting firms squarely in the regulatory hot seat. The upshot? External audits may never be the same again. To find out how audits will change in the next few years, read The New Rules of Engagement”, a CFO.com exclusive.)

Short Takes:The Federal Communications Commission lifted ownership restrictions for media companies earlier this week. Now, The New York Times reports that Senate Democrats and Republicans are bucking to overturn the three-day old deregulation effort (apparently, House members are more sympathetic to the FCC’s free-market view).

Certainly, lawmakers in the Senate have the public support to nix the FCC’s vote to deregulate. The commission’s decision has touched off a veritable firestorm of protest, and from some strange political bedfellows. Both the National Organization for Women and the National Rifle Association, for instance, oppose the FCC’s decision. Washington watchers say public outrage over the decision could have Congress rethinking the FCC’s move.