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2004 shaping up as a busy year.

Most observers expect 2004 to be an exceptionally busy year in Congress as both parties jockey for position before the November elections. Corporate governance remains a popular topic, with both houses turning their attention to the mutual fund industry and the perceived problems of late trading and market timing. An international tax reform measure must be finished before March 1 if the United States is to avoid punitive trade sanctions by the European Union.

Also on the tax front, Congress must decide whether to extend numerous expiring tax provisions, many of which expired in 2003. Healthcare remains a hot-button issue, and will almost certainly consume Congress' time. Given this crowded legislative agenda, many are asking what has become of the stock option issue, and whether Congress will continue trying to change stock option accounting standards.

The principal stock option accounting bills under consideration are the Dreier/Eshoo bill in the House (H.R. 1372) and the Ensign/Boxer bill in the Senate (S. 979). These companion bills, entitled the "Broad-Based Stock Option Transparency Act(s) of 2003," direct the Securities and Exchange Commission (SEC) to require enhanced disclosures of employee stock options, and to study the economic impact of broad-based stock option plans.

Enhanced disclosures required in the bills include: 1) a discussion of the dilutive effect of stock option plans (written in accordance with something called the "Plain English Handbook"); 2) expanded disclosure of the dilutive effect of stock options on the company's earnings per share number; 3) prominent placement and increased comparability of all stock option-related information; and 4) a summary of stock options granted to the five most highly compensated executive officers, including their outstanding options.

Of great importance to foes of stock option expensing, H.R. 1372 places a three-year moratorium on the SEC recognizing any new accounting standard relating to stock options. At the end of that period, the commission would be required to report to Congress on the effectiveness of the new disclosures. Finally, the bill would require a Commerce Department study on the impact of broad-based employee stock option plans on expanding corporate ownership, recruiting skilled workers, stimulating research and innovation, and growth in the U.S. economy.

Both proposals have been quietly gaining support. The Dreier/Eshoo bill currently has 106 co-sponsors, while the Ensign/ Boxer bill has 19. However, neither the Senate Banking Committee nor the House Financial Services Committee has scheduled hearings on these bills.

"More Provocative' Bill Last Nov. 19, Sen. Michael Enzi (R-Wyo.) introduced a more provocative stock option bill, which had by early December garnered eight co-sponsors. The bill, the "Stock Option Accounting Reform Act" (S. 1890), would require the mandatory expensing of stock options granted to executive officers. "Executive officers" is defined to include the chief executive officer, as well as the four next most highly compensated officers.

The Enzi proposal sets the fair value of an option at "the value that would be agreed upon by a willing buyer and seller of such option, who are not under any compulsion to buy or sell such option." Given the extreme inaccuracy of existing stock valuation models (Black-Scholes, binomial, etc.), particularly with regard to predictions about the volatility of companies' stock prices, the legislation requires that the assumed volatility of the underlying stock option shall be considered zero.

In addition, the legislation exempts small business issuers, defined as issuers with annual revenues under $25 million. The legislation also prohibits the SEC from recognizing any stock option-expensing accounting standard set by a standard-setting body unless and until: 1) The standard recognizes the true expense of the stock option on a company's financial statement when the option is exercised, expires or is forfeited (a "truing up" requirement); and 2) a comprehensive economic impact study has been conducted by the Departments of Commerce and Labor.Rep. Richard Baker (R-La.) has introduced a companion bill in the House (H.R. 3574).

Meanwhile, the Financial Accounting Standards Board (FASB) has concluded that stock-based compensation should be recognized as an expense in income statements, and the amounts should be recorded at their fair value, measured at the date of the award granting. FASB hopes to finalize a standard in February.

While Congress will certainly be preoccupied with other matters this year, it is not inconceivable that stock option accounting legislation will be passed. Most of the legislation under serious consideration would forestall SEC recognition of new stock option accounting methodologies while the impact of different approaches is studied. However, the academic community strongly favors stock option expensing, and both FASB and FASB are clearly marching in that direction. With passionate advocates on both sides, the issue is certain to remain on the Congressional agenda for some time.

Mark Prysock ( is Director of Public Affairs and General Counsel for FEI.
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Title Annotation:washington Insights
Author:Prysock, Mark
Publication:Financial Executive
Geographic Code:1USA
Date:Jan 1, 2004
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