[House Hearing, 106 Congress]
[From the U.S. Government Printing Office]





 
                      EMPLOYEE STOCK OPTION PLANS

=======================================================================

                                HEARING

                               before the

                       SUBCOMMITTEE ON OVERSIGHT

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

                            OCTOBER 12, 2000

                               __________

                             Serial 106-67

                               __________

         Printed for the use of the Committee on Ways and Means


                    U.S. GOVERNMENT PRINTING OFFICE
67-812 CC                   WASHINGTON : 2000




                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma                LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

                                 ______

                       Subcommittee on Oversight

                    AMO HOUGHTON, New York, Chairman

ROB PORTMAN, Ohio                    WILLIAM J. COYNE, Pennsylvania
JENNIFER DUNN, Washington            MICHAEL R. McNULTY, New York
WES WATKINS, Oklahoma                JIM McDERMOTT, Washington
JERRY WELLER, Illinois               JOHN LEWIS, Georgia
KENNY HULSHOF, Missouri              RICHARD E. NEAL, Massachusetts
J.D. HAYWORTH, Arizona
SCOTT McINNIS, Colorado


Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.



                            C O N T E N T S

                               __________

                                                                   Page

Advisory of October 5, 2000, announcing the hearing..............     2

                               WITNESSES

American Benefits Council, and Monsanto Company, Wilma Schopp....    19
Frederic W. Cook & Co., Frederic W. Cook.........................     6
National Association of Stock Plan Professionals, Sandra L. 
  Sussman........................................................    26
Proxicom, Inc., Christopher Capuano..............................    14
U.S. Chamber of Commerce, and Hewitt Associates, Michael J. 
  Butler.........................................................    27

                       SUBMISSION FOR THE RECORD

Amazon.com, Inc., Seattle, WA, Robert D. Comfort, letter.........    38


                      EMPLOYEE STOCK OPTION PLANS

                              ----------                              


                       THURSDAY, OCTOBER 12, 2000

                  House of Representatives,
                       Committee on Ways and Means,
                                 Subcommittee on Oversight,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 10:30 a.m., in 
room 1100, Longworth House Office Building, Hon. Amo Houghton, 
(Chairman of the Subcommittee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

                       SUBCOMMITTEE ON OVERSIGHT

                                                CONTACT: (202) 225-7601
FOR IMMEDIATE RELEASE

October 5, 2000

No. OV-24

       Houghton Announces Hearing on Employee Stock Option Plans

    Congressman Amo Houghton (R-NY), Chairman, Subcommittee on 
Oversight of the Committee on Ways and Means, today announced 
that the Subcommittee will hold a hearing to examine the 
Federal tax treatment of employee stock option plans under 
current law. The hearing will take place on Thursday, October 
12, 2000, in the main Committee hearing room, 1100 Longworth 
House Office Building, beginning at 10:30 a.m.
      
    Oral testimony at this hearing will be from invited 
witnesses only. Invited witnesses include representatives from 
the U.S. Department of the Treasury and the private sector, 
including representatives from trade organizations and benefit 
groups. However, any individual or organization not scheduled 
for an oral appearance may submit a written statement for 
consideration by the Committee and for inclusion in the printed 
record of the hearing.
      

BACKGROUND:

      
    Businesses generally can offer their employees one of three 
types of stock option plans: (1) non-qualified stock options, 
(2) incentive stock options, and (3) employee stock purchase 
plans. Each type of stock option is treated differently under 
the Internal Revenue Code (I.R.C.).
      
    Non-qualified stock options are the most utilized form, and 
their tax treatment is found in section 83 of the I.R.C. 
Typically, non-qualified options are granted by businesses to a 
set of employees on a date certain and must be exercised within 
a certain time limit. For publicly-traded companies, the price 
at which employees may purchase the options (the grant price) 
is generally the value of the stock at the close of the markets 
on the day that the options are granted. There are no tax 
consequences to either the employee or the business at the time 
of grant. When the employee exercises an option, he or she 
recognizes ordinary income on the difference between the value 
of the stock when exercised and the grant price. Income and 
employment taxes must be withheld. The employer is entitled to 
a deduction equal to the amount of ordinary income recognized 
by the employee. If the employee holds the stock for 12 months 
after the day he or she exercises the options before selling, 
he or she recognizes long-term capital gain on the difference 
between the sale price and the exercise price.
      
    A company may offer an unlimited amount of non-qualified 
options to its employees (subject only to shareholder 
approval). The company may offer non-qualified options only to 
its officers or to all of its employees; there are no tax or 
Employee Retirement Income Security Act (ERISA) requirements 
limiting the amount of options that may be granted to highly 
compensated employees vis-a-vis rank and file employees.
      
    The tax treatment of incentive stock options is found in 
section 422 of the I.R.C. Generally, incentive stock options 
may only be granted at a price, not less than the fair market 
value, on the day they are granted. The maximum value that may 
vest for the first time in any given year is $100,000 based on 
the value of the option on date the options are granted. 
Incentive options must also be exercised within 10 years of the 
date they are granted. There are no tax consequences to either 
the employee or the business when the options are granted. When 
the employee exercises the options, he or she does not 
recognize ordinary income but may be subject to the alternative 
minimum tax. If the employee holds the stock for longer than 
two years from the day the options are granted and more than 
one year from the day he or she exercises the options, he or 
she recognizes long-term capital gain on the difference between 
sale price and grant price. If the holding requirements are 
met, the company does not receive a deduction. If the holding 
requirements are not met, incentive stock options are treated 
as non-qualified options, and the employee generally recognizes 
ordinary income on the difference between the fair market value 
of the stock on the day of exercise and the price at which the 
options were granted. No withholding is required for 
disqualifying dispositions. In such circumstances, the company 
would receive a deduction equal to the ordinary income 
recognized by the employee.
      
    A company may offer incentive stock options to its officers 
or to all of its employees; there are no tax or ERISA 
requirements limiting the amount of options that may be granted 
to highly compensated employees vis-a-vis rank and file 
employees.
      
    The tax treatment of employee stock purchase plans is found 
in section 423 of the I.R.C. Employee stock purchase plans 
differ from non-qualified options and incentive stock options 
in that they must be offered to all employees. Typically, 
employees are allowed to contribute a percentage of their 
income (up to $25,000 per year), via a payroll deduction, 
toward the purchase of company stock. For example, an employee 
may contribute 10 percent of his income toward the purchase of 
company stock from January 1 through June 30 of a given year. 
On June 30, the amount contributed would be used to purchase 
stock (the exercise of the option) at a price set under the 
plan. The plan may allow the employee to purchase the stock at 
the price of the stock at closing of June 30, or, as many plans 
do, the plan may allow the employee to purchase the stock at 
the lower of the prices on January 1 and June 30. Plans may 
grant employees a discount of up to 15 percent below the price 
of the stock. Similar to incentive stock options, there are no 
tax consequences when an employee exercises the option for 
either the employee or the company. If the employee holds the 
stock for two years after the day they are granted and one year 
after he or she exercises the options, he or she will recognize 
ordinary income on the 15 percent discount but long-term 
capital gain on the appreciation of the stock. The company 
receives no deduction under these circumstances. If the 
employee does not meet the holding requirements, he or she 
recognizes ordinary income on the discount and short term 
capital gain on the remaining amount. In this instance, the 
company does receive a deduction. No income or employment tax 
withholding is currently required for either the discount or 
for disqualifying dispositions.
      
    In announcing the hearing, Chairman Houghton stated: 
``Stock option plans help employees become stakeholders in 
their companies, which leads to an increase in productivity and 
a sense of ownership within the business. We need to make sure 
the law offers attractive incentives for employers to offer 
stock option plans to all of their employees.''
      

FOCUS OF THE HEARING:

      
    The focus of the hearing is to examine the Federal tax 
treatment of stock option plans under current law and proposals 
to strengthen incentives for employers to offer such plans.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Any person or organization wishing to submit a written 
statement for the printed record of the hearing should submit 
six (6) single-spaced copies of their statement, along with an 
IBM compatible 3.5-inch diskette in WordPerfect or MS Word 
format, with their name, address, and hearing date noted on a 
label, by the close of business, Thursday, October 26, 2000, to 
A.L. Singleton, Chief of Staff, Committee on Ways and Means, 
U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written 
statements wish to have their statements distributed to the 
press and interested public at the hearing, they may deliver 
200 additional copies for this purpose to the Subcommittee on 
Oversight office, room 1136 Longworth House Office Building, by 
close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
    Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect or 
MS Word format, typed in single space and may not exceed a total of 10 
pages including attachments. Witnesses are advised that the Committee 
will rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.

      
    Note: All Committee advisories and news releases are 
available on the World Wide Web at ``http://
waysandmeans.house.gov.''

      
    The Committee seeks to make its facilities accessible to 
persons with disabilities. If you are in need of special 
accommodations, please call 202-225-1721 or 202-226-3411 TTD/
TTY in advance of the event (four business days notice is 
requested). Questions with regard to special accommodation 
needs in general (including availability of Committee materials 
in alternative formats) may be directed to the Committee as 
noted above.
      

                                


    Chairman Houghton. Good morning everybody. The hearing will 
come to order. We are delighted to have you here as a panel, 
and we want to welcome you. We are here to discuss, as you all 
know, the employee stock option plans. Promoting stock options 
may sound far removed from the everyday concerns of working men 
and women, but nothing could be further from the truth.
    Employee-owned stock holds the promise of transforming our 
free enterprise system. Two important features of the Federal 
Tax Code provided a tremendous security to middle-income 
Americans during the 20th century. First, the deductibility of 
mortgage interest transformed a nation of renters into a nation 
of homeowners; and secondly, tax incentives for employer-
sponsored pensions and for retirement savings have made it 
possible for millions of working people to be secure in their 
retirement years.
    So, think for a moment how different our country would be 
if we didn't have these incentives in our tax system. At the 
beginning of the 21st century, I believe employee stock options 
will make it possible for working middle-class, middle-income 
Americans to become greater stakeholders in our free enterprise 
system. Someone once said that the problem with socialism is 
socialists and the problem with capitalism is capitalists.
    That may be, but it seems to me that the only problem with 
the capitalists is that there are not enough of them. Today we 
are going to look at the tax treatment of stock option plans 
under current law and what, if anything, needs to be done to 
strengthen incentives for employers to offer them to a broader 
base of employees.
    Free enterprise is strong in America today because it has 
offered security to many. It seems obvious to me that the next 
step in broadening the base of our free enterprise system is to 
allow for more working men and women to own stock in the 
companies for which they work. So, I'm pleased to recognize our 
senior Democrat on our subcommittee, the distinguished Mr. 
Coyne from Pennsylvania, for an opening statement.
    Mr. Coyne. Thank you, Mr. Chairman.
    This hearing will provide the Ways and Means Oversight 
Subcommittee with valuable information about the current tax 
rules designed to encourage employers to offer employees the 
opportunity to obtain stock in the companies for which they 
work. Many hard-working Americans would like to have the chance 
to become stockholders, not just employees, of the corporations 
they work for.
    The bipartisan legislation proposed by Chairman Houghton 
deserves our close attention and support. Our tax laws 
currently provide for various employee stock option 
arrangements, which will be discussed today. In doing so, it is 
important that we consider what more can be done to provide 
employers with incentives to expand the availability of 
employee stock options and to provide employees with incentives 
to participate.
    I want to commend Chairman Houghton for taking this 
initiative to introduce the Universal Employee Stock Option Act 
of 2000. I also want to commend the chairman for the 
outstanding leadership that he has provided all through this 
106th Congress on the Oversight Subcommittee on so many various 
subjects that we have taken up.
    Thank you.
    Chairman Houghton. Thanks very much, Bill. I really 
appreciate that. It has been wonderful working with you and I 
look forward to doing so. Now, the distinguished gentlemen from 
Ohio, Mr. Boehner. I am sure you have an opening statement. At 
least, I hope so.
    Mr. Boehner. Well, Mr. Chairman, let me commend you for 
having this hearing today and thank you for the invitation to 
join your panel. I think when we think about the new economy 
today, we think in terms of technology. But the more important 
factor in the new-economy companies is teamwork. American 
businesses are learning that to compete successfully in the 
global marketplace, they need to engage the full talents of 
their workers, their teams, if you will, as never before.
    I think they are finding their most important asset is not 
their physical plant; it is the talent, cohesiveness and work 
ethic of their entire workforce. That is why team-building is 
replacing bureaucracy throughout our economy for companies that 
make sofas in southwestern Virginia, as well as companies that 
make Internet servers in Silicon Valley.
    The new economy is not just about the Internet or 
technology, rather it is about philosophies and technologies 
that make the most of the human talent in any company. A 
critical part of team-building is getting everyone on the same 
page, making sure that everyone is motivated by common 
interest. That is the value of stock options, by making the 
employees a shareholder, stock options also make them valued 
team members who see their interest and those of the rest of 
the team as one and the same.
    New-economy companies understand this. Stock options are a 
part of almost any compensation package in the high-tech 
sector, but increasing numbers of more-established companies 
also understand the power of stock options and make them widely 
available to their employees. Those companies range from 3M to 
Pepsi, to Merrill Lynch and CitiGroup. Unfortunately, for 
reasons that I think we will hear today, Federal law does not 
maximize the potential benefit to workers and to employers that 
stock options can't offer.
    I am here today because I share Chairman Houghton's deep 
commitment to changing that. He and I have introduced separate, 
but complementary, bills in this Congress to address these 
obstacles. I think this issue will be a compelling one, 
certainly for the next Congress. A new economy means new 
opportunities, and we in Congress should help our constituents 
embrace those opportunities. Working together, I believe that 
we will.
    Chairman Houghton. Thanks very much, Mr. Boehner.
    I would like to call the first panel and I would like to 
ask Mr. Frederic Cook, of Frederic Cook & Co. in New York, to 
begin the testimony.

  STATEMENT OF FREDERIC W. COOK, CHAIRMAN, FREDERIC W. COOK & 
                    CO., NEW YORK, NEW YORK

    Mr. COOK. Thank you, Mr. Chairman, Mr. Coyne, Mr. Boehner. 
It is a pleasure to be here today. My name is Fred Cook. I 
represent the firm of Frederick W. Cook & Co., which is a 
management compensation consulting firm. For 30 years, our firm 
and a predecessor firm have advised corporations on the design 
and administration of employee stock ownership and stock option 
plans.
    We are strong advocates of such plans and the sharing of 
ownership and wealth-creation opportunities broadly in the 
corporation because we believe that benefits our economy as a 
whole. Do the members have my charts that are accompanied by 
testimony, because I plan to speak from them?
    Chairman Houghton. I think we do.
    Mr. Cook. All right. On page one, I give a brief summary of 
the current tax situation, which I will not go into detail 
because it has been written up ably by the committee materials 
in advance. I would merely point out that, of the three types 
of plans available to employee stock options, please note that 
one of the major advantages of tax qualification is there is no 
tax at exercise. Tax is deferred until sale, at which time 
there is long-term capital gains tax on the appreciation above 
the value at grant if the holding period requirements are met.
    That has been fundamental in tax legislation on stock 
option since the 1950s. In exchange for that, on the two tax 
qualified plans, employee stock purchase plans and incentive 
stock options, the corporation forgoes its tax deduction. That 
is the balance of the tax equation between employees and 
corporations that was put in place with the Revenue Act of 1950 
and with minor modifications remains in place today.
    Let me next go to a quick summary of incentive stock 
options under Code section 422 on chart two. The basic things 
to have you focus on here, if I may, are that the employee 
exercises the option with after-tax money; that is line one. In 
line six, there is, as I mentioned earlier, no tax at exercise; 
however, the gain at exercise is subject to the alternate 
minimum tax as an item of tax preference. On line seven, to 
reiterate, there is no corporate tax deduction at exercise or 
at sale of the stock when capital gains applies to the 
employees.
    My comments here are that the imposition of the alternate 
minimum tax discourages holding of the stock, and the lack of 
corporate tax deduction is regarded by most corporations as 
financially inefficient. Please note here that in giving 
capital gains to employees versus ordinary income and thereby 
letting employees obtain the tax differential between capital 
gains and ordinary income, the corporation is giving up its 
full tax deduction, which it otherwise obtains in non-qualified 
plans.
    So, to provide an incremental benefit to employees, the 
corporation forgoes its full tax deduction in qualified plans. 
That is what I mean by tax inefficiency on the corporate side--
and discourages the use of incentive stock options for key 
employees. My comments and suggestions for consideration in tax 
legislation are on chart three.
    The basic ideas that I would present for the subcommittee's 
consideration are that in line four, we consider encouraging 
companies to spread the use of incentive stock options by 
imposing a requirement that at least half of the shares granted 
in any year go to non-highly-compensated employees, as defined 
under Code Section 401.
    With that in place, we would not really need the $100,000 
maximum annual vesting limit that is in line five. I would 
continue to exclude employee taxation at gain and would suggest 
that the committee amend the Code so that the gain at exercise 
of incentive stock option is no longer deemed an item of tax 
preference income subject to the alternate minimum tax.
    The employee taxation at sale, line eight, I would suggest 
that the gain at exercise be ordinary income, rather than 
capital gain and, in exchange for that, the company would be 
allowed to deduct the same amount at exercise that the employee 
is taxed as ordinary income when the stock is sold. That is a 
timing difference, but is otherwise a matching of deduction and 
personal income tax.
    I see that I have run close to being out of time. In 
summary, I would say that the tax compact set in the Revenue 
Act of 1950 was that the employee would get capital gains only 
at sale and the corporation would forego a tax deduction.
    For the next 50 years, I would suggest that we change that 
tax compact. We would continue to allow no taxation at exercise 
of the option for the employee; the employee would only be 
taxed at sale. We would permit the corporation to obtain a tax 
deduction at exercise, which would remove the financial 
inefficiency. And in exchange for that, the employee, when he 
is subject to tax, would pay ordinary income on the value at 
exercise and capital gains on the remainder.
    We would continue to strongly encourage companies through 
tax law to extend the benefits of stock options broadly 
throughout their organization. The purpose of this is to 
address the growing wage gap between the top and the bottom. 
Stock options are predominantly responsible for the rising wage 
gap between the top and the bottom. Instead of clamping down or 
placing limits on the top, the better way is to raise up the 
bottom. And raising the bottom should be done through 
encouraging employees through pre-tax compensation to become 
long-term stockholders of their company through stock options.
    Thank you Mr. Chairman, members.
    [The prepared statement follows:]

Statement of Frederic W. Cook, Chairman, Frederic W. Cook & Co., New 
York, New York

    Mr. Chairman, Mr. Coyne, members of the Subcommittee and 
Mr. Boehner, it is a pleasure to be here today. My name is Fred 
Cook. I represent the firm of Frederic W. Cook & Co., which is 
management compensation consulting firm. For 30 years, our firm 
and a predecessor firm have advised corporations on the design 
and administration of employee stock ownership and stock option 
plans. We are strong advocates of such plans and the sharing of 
ownership and wealth-creation opportunities broadly in the 
corporation because we believe that benefits our economy as a 
whole.
    My testimony today will refer to the charts which I believe 
are in your folders and available at the back of the room.

Current Situation (Chart 1)

    Under current tax laws affecting tax-qualified options (IRC 
Sec. 422 and 423), employee contributions are made with after-
tax dollars and, if certain requirements are met, the employees 
does not incur tax on gains at exercise and may claim long-term 
capital gains treatment at sale if minimum holding period 
requirements are met. The price for this favored treatment is 
the loss of a corporate tax deduction. Many regard these plans 
as financially inefficient for that reason. This has led to the 
growth of ``non-qualified'' stock option plans and also to the 
popularity of 401(k) plans which permit employee contributions 
with pre-tax dollars.

Incentive Stock Option Situation (Chart 2)

    Use of Incentive Stock Options (``ISOs''), tax-favored 
under IRC Sec. 422, is a declining practice. Many companies 
prefer non-qualified options (``NSOs'') for their key 
employees. The reasons are that (1) ISO gains at exercise are 
subject to the Alternative Minimum Tax which encourages selling 
the stock in the year of exercise to avoid this onerous and 
unfair tax, and (2) corporations receive no tax deduction for 
the option gain at exercise. Many regard ISOs as financially 
inefficient because they are giving up a full tax deduction to 
provide only an incremental benefit to employees (i.e., the tax 
savings between an ordinary income rate and the long-term 
capital gains rate).

Incentive Stock Option Proposal (Chart 3)

    Our proposals for changes in tax law to improve the 
effectiveness of ISOs are to exclude the gain at exercise from 
the alternative minimum tax, allow the employer a tax deduction 
equal to the gain at exercise, and get this back by taxing the 
employee when the shares are sold at ordinary tax rates on the 
gain at exercise, with excess gains treated as a capital gain. 
We advocate dropping the $100,000 annual vesting limit 
currently in ISOs, and substituting a requirement that at least 
half the shares granted as tax-qualified options each year 
(including IRC Sec. 423 shares) would need to be granted to 
``non-highly compensated employees'' as defined under IRC 
Sec. 414(q). This will insure that the ISO benefits don't just 
go to top management.

Employee Stock Purchase Plan Situation (Chart 4)

    Tax-qualified employee stock purchase plans also have been 
declining in popularity except in the high-tech sector. The 
reasons seem to be that (1) employee payroll deductions are in 
after-tax dollars which places these plans at a disadvantage 
versus IRC Sec. 401(k) plans, and (2) the same financial 
inefficiency that affects ISOs exists with these plans as well, 
namely no tax deduction for option gains at exercise.

Employee Stock Purchase Plan Proposal (Chart 5)

    We support the provision in Congressman Houghton's bill (HR 
4972) that employee contributions to IRC Sec. 423 employee 
stock purchase plans (``ESPPs'') should be permitted with pre-
tax dollars. As under present law, there should be no employee 
tax at exercise. Employees should be taxed only at sale of the 
stock, with ordinary income tax due based on the stock's value 
at exercise, and capital gains tax on any excess gain realized. 
Corporations should be allowed a tax deduction at exercise for 
the same amount taxable as ordinary income to the employee at 
sale. There should be no alternate tax or employment taxes 
imposed on amounts treated as ordinary income. ISO and ESPP 
taxation would be identical, thereby simplifying the Internal 
Revenue Code.
    For ESPPs, we advocate foregoing the 85 percent of market 
value option price and the ``look-back'' feature in exchange 
for pre-tax employee contributions and a corporate tax 
deduction at exercise. We believe the 85 percent pricing 
feature, while nice, is not necessary to encourage 
participation. And, like many, we believe the 85 percent 
``look-back'' feature is unfair to shareholders and encourages 
employees to ``flip'' the stock at exercise for ordinary 
income.
    ESPPs should retain the requirement that essentially all 
full-time U.S. employees would be eligible to participate, 
except that bargaining unit employees could be excluded, just 
like under 401(k) plans. These changes, taken together, would 
put ESPP on an even keel with 401(k) plans and be very 
positively received by companies and employees alike.

Summary Proposal (Chart 6)

    The present tax situation with respect to tax-favored 
employee stock option and purchase plans was put in place fifty 
years ago in the Revenue Act of 1950, and has been essentially 
unchanged since. Specifically, in exchange for no tax to 
employees at exercise and long-term capital gains at sale, 
companies are not allowed a tax deduction for option gains. 
This should be changed for the twenty-first century. Employers 
should be encouraged to adopt tax-qualified plans by being able 
to deduct gains at exercise, now only available under non-
qualified plans and through disqualifying dispositions under 
tax-qualified plans. Employees should be encouraged to 
participate in ESPPs by permitting payroll deductions with pre-
tax dollars. And employees should be encouraged to hold stock 
for the long run by deferring tax from option exercise to stock 
sale and by eliminating gains at exercise from being subject to 
employment taxes and the alternate minimum tax.
    The purpose of these changes is to address the growing wage 
gap between the top and the bottom. Stock options are 
predominantly responsible for rising pay at the top. Instead of 
clamping down or placing limits on the top, the better way is 
to raise up the bottom. And raising the bottom should be done 
through encouraging employees to become long-term shareholders 
of their company through stock options.
    Thank you for your attention to this important matter.

                                                                  A. CURRENT SITUATION
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     Employee Taxation                                  Corporate Deduction
                                                  ------------------------------------------------------------------------------------------------------
                                  Design Limits                                                                                             Employment
                                                       At Grant        At Exercise          At Sale         At Exercise       At Sale      Taxes on Gain
--------------------------------------------------------------------------------------------------------------------------------------------------------
Non-Qualified Options (NQOs)--  None.............  None...........  Ordinary Income..  Capital gain/loss  Yes...........  No............  Yes
 IRC Sec.  83.                                                                          on excess.
Incentive Stock Options         --100% FMV         None...........  None, except gain  Capital gains on   No............  No............  No
 (ISOs)--IRC Sec.  422.         --10 yr. term                        is subject to      full gain.
                                --$100,000                           AMT.
                                 vesting limit/
                                 yr.
Employee Stock Purchase Plans-- --All ees.         None...........  None.............  15% discount is    No............  No............  No
 IRC Sec.  423.                  eligible                                               ordinary income;
                                --Uniform terms                                         rest of gain is
                                 and opportunity                                        capital gain.
                                --100% FMV/5 yrs.
                                --85% FMV/27 mos.
                                --$25,000 mkt.
                                 value/yr.
--------------------------------------------------------------------------------------------------------------------------------------------------------


                                        B. INCENTIVE STOCK OPTIONS (ISOs)
----------------------------------------------------------------------------------------------------------------
                                    Current Provision                            Comment
----------------------------------------------------------------------------------------------------------------
1. Employee Exercise Funds.......  After tax..........                                         Accepted practice
2. Minimum Option price..........  100% FMV...........                                         Accepted practice
3. Maximum Option Term...........  10 years...........                                         Accepted practice
4. Anti-discrimination             None...............
 Requirements.
5. Individual Limits.............  $100,000 grant
                                    value vesting per
                                    year.
6. Employee Taxation at Exercise.  None; gain subject                    AMT applicability encourages early sale
                                    to AMT.
7. Co Deduction at Exercise......  None...............                  Discourages use; financially inefficient
8. Employee Taxation at Sale.....  Capital gains......
9. Employment Taxes..............  None...............
----------------------------------------------------------------------------------------------------------------



                                        B. INCENTIVE STOCK OPTIONS (ISOs)
----------------------------------------------------------------------------------------------------------------
                                    Current Provision                        Proposed Change
----------------------------------------------------------------------------------------------------------------
1. Employee Exercise Funds.......  After tax..........                                                      None
2. Minimum Option price..........  100% FMV...........                                                      None
3. Maximum Option Term...........  10 years...........                                                      None
4. Anti-discrimination             None...............      50% or more shares granted per year go to Non-Highly
 Requirements.                                                                             Compensated Employees
5. Individual Limits.............  $100,000 grant                                Drop; #4 change above is better
                                    value vesting per
                                    year.
6. Employee Taxation at Exercise.  None; gain subject                                      Exclude gain from AMT
                                    to AMT.
7. Co Deduction at Exercise......  None...............                               Gain at exercise deductible
8. Employee Taxation at Sale.....  Capital gains......    Gain at exercise is ordinary income; excess is capital
                                                                                                            gain
9. Employment Taxes..............  None...............                                                      None
----------------------------------------------------------------------------------------------------------------


                                    C. EMPLOYEE STOCK PURCHASE PLANS (ESPPs)
----------------------------------------------------------------------------------------------------------------
                                    Current Provision                            Comment
----------------------------------------------------------------------------------------------------------------
1. Employee Payroll Deductions...  After-tax..........         ESPPs disadvantaged vis-à-vis 401(k) plans
2. Minimum Option price..........  85% FMV at start or       ``Look-back'' feature encourages stock ``flipping''
                                    end of period.
3. Maximum Option Term...........  27 mos. if 85% FMV                                  Not a problem in practice
                                    price; 5 yrs. if
                                    100% FMV price.
4. Anti-discrimination             Essentially all       More stringent than Sec.  401 rules; discourages use in
 Requirements.                      employees must be                                           cos. with unions
                                    eligible.
5. Individual Limits.............  $25,000 grant value/                                Most sign up for far less
                                    yr..
6. Employee Taxation at Exercise.  None...............
7. Co. Deduction at Exercise.....  None...............                  Discourages use; financially inefficient
8. Employee Taxation at Sale.....  15% discount is
                                    ordinary income;
                                    rest of gain is
                                    capital gain.
9. Employment Taxes..............  None...............
----------------------------------------------------------------------------------------------------------------



                                    C. EMPLOYEE STOCK PURCHASE PLANS (ESPPs)
----------------------------------------------------------------------------------------------------------------
                                    Current Provision                        Proposed Change
----------------------------------------------------------------------------------------------------------------
1. Employee Payroll Deductions...  After-tax..........                                                   Pre-Tax
2. Minimum Option price..........  85% FMV at start or                                         100% FMV at grant
                                    end of period.
3. Maximum Option Term...........  27 mos. if 85% FMV                                                    5 years
                                    price; 5 yrs. if
                                    100% FMV price.
4. Anti-discrimination             Essentially all              Permit cos. to exclude bargaining unit employees
 Requirements.                      employees must be
                                    eligible.
5. Individual Limits.............  $25,000 grant value/                                     $10,000/yr., indexed
                                    yr..
6. Employee Taxation at Exercise.  None...............                                                      None
7. Co. Deduction at Exercise.....  None...............                        Stock value at exercise deductible
8. Employee Taxation at Sale.....  15% discount is         Stock value at exercise is ordinary income; excess is
                                    ordinary income;                                                capital gain
                                    rest of gain is
                                    capital gain.
9. Employment Taxes..............  None...............                                                      None
----------------------------------------------------------------------------------------------------------------


                                                                  D. PROPOSED SITUATION
--------------------------------------------------------------------------------------------------------------------------------------------------------
                                                                     Employee Taxation                                  Corporate Deduction
                                                  ------------------------------------------------------------------------------------------------------
                                  Design Limits                                                                                             Employment
                                                       At Grant        At Exercise          At Sale         At Exercise       At Sale      Taxes on Gain
--------------------------------------------------------------------------------------------------------------------------------------------------------
Non-Qualified Options (NQOs)--  None.............  None...........  Ordinary Income..  Capital gain/loss  Yes...........  No............  Yes
 IRC Sec.  83.                                                                          on excess.
Incentive Stock Options         --10 yr. term      None...........  None, no AMT.....  Gain at exercise   Gain at         No............  No
 (ISOs)--IRC Sec.  422 --100%   --$100,000                                              is ordinary        exercise is
 FMV.                            vesting limit/                                         income; excess     deductible.
                                 yr.                                                    is capital gain.
Employee Stock Purchase Plans-- --All ees.         None...........  None.............  Stock value at     Stock value at  No............  No
 IRC Sec.  423.                  eligible except                                        exercise is        exercise is
                                 union                                                  ordinary income;   deductible.
                                --Uniform terms                                         excess is
                                 and opportunity                                        capital gain.
                                --100% FMV/5 yrs.
                                --$10,000 mkt.
                                 value/yr. pre-
                                 tax
--------------------------------------------------------------------------------------------------------------------------------------------------------

      

                                


    Chairman Houghton. Thanks very much, Mr. Cook.
    Mr. Capuano, Senior Vice President of Corporate 
Development, Proxicom, in Reston.

   STATEMENT OF CHRISTOPHER CAPUANO, SENIOR VICE PRESIDENT, 
    CORPORATE DEVELOPMENT, PROXICOM, INC., RESTON, VIRGINIA

    Mr. Capuano. Thank you very much, Mr. Chairman, for 
inviting me to appear today. My name is Chris Capuano and I am 
the Senior Vice President for Corporate Development for 
Proxicom, Inc. Proxicom, a Reston-based company, is the leading 
e-business consulting and development company that delivers 
Internet and wireless solutions for Fortune 500 companies.
    When I joined Proxicom in 1996, we were a small company of 
about 40 employees with a vision around the Internet. That was 
the year we implemented our broad-based stock option plan 
covering all employees. Today we are a profitable firm of 
approximately 1,300 employees, publicly traded, with offices 
around the United States and Europe.
    In a start-up company, all employees wear multiple hats; 
and one of the hats I wore when I joined Proxicom was as the 
creator of the Proxicom stock option plan. In designing the 
plan, our philosophy was very simple: Each and every employee 
is critical to the success of the company. Stock options, 
therefore, were and still are provided to each and every 
employee to align all of us with the success of the company and 
to share in the growth.
    From the receptionist who first greets our clients to the 
technical consultants to our project managers, all employees 
receive stock options. When the employee vests in the stock 
option, the employee may exercise the option and buy the 
underlying stock. As you know, on exercise of the option, our 
employees must also pay tax on the difference between the 
option price and the market value of the Proxicom stock, even 
if the employee has not sold any shares or actually pocketed 
any cash gain.
    It is a tax on the paper profit only. Many of our employees 
are forced to sell some of their Proxicom stock to pay this 
tax. Other employees who wish to hold onto their shares are 
forced to take loans. While we typically grant incentive or 
qualified stock options, which would normally defer tax 
payment, many of the options granted today are non-qualified 
stock options due to the tax code's quantitative limits on our 
ability to provide ISO's.
    In any event, the impact of the alternative minimum tax 
negates the benefit of the incentive stock options for many of 
our employees by taxing again the paper gain before any stock 
is actually sold. Many of our employees are therefore again 
forced to sell shares and thereby forego a stake in our long-
term growth to pay off the AMT.
    At Proxicom, our broad-based employee stock plans offer 
strategic benefits. The plans improve corporate productivity 
and profitability by helping to align employee and shareholder 
interests while providing a tangible and very visible tool to 
attract, inspire and retain our employees, something that is 
especially important in today's tight labor market.
    With many Proxicom employees coming from firms not offering 
stock plans, our ability to directly reward our employees based 
upon our overall success is key to our continued growth. From 
an alignment perspective, our stock option plan is a major 
component in threading together our shareholders, our corporate 
strategy and the individual desires of every employee.
    In a growing business like Proxicom, where resources are 
very tightly managed, share ownership through stock plans keeps 
our employees focused on teamwork, productivity and quality 
through the sharing of resources, best practices and knowledge. 
With our stock plans, our employees also fully appreciate the 
importance of both the short-term or quarterly results and the 
long-term. This understanding clearly drives our growth.
    The Proxicom stock plans also provide significant 
opportunity for individual employee financial gain. Many of our 
top recruits forego larger cash-based pay packages to have the 
opportunity to share in the overall success of the company over 
the long-term. This translates into an opportunity for long-
term financial savings and stability for our employees.
    In our opinion, the provisions of the Wealth to Workplace 
Act will greatly enhance the effectiveness of stock option 
plans like the Proxicom stock option plan by enabling our 
employees at all levels to continue to hold on to their 
company's stock after exercise, rather than selling the shares 
to pay the tax due. With this important provision, our 
employees will not be forced to give up the opportunity for 
long-term appreciation in our stock and Proxicom will grow 
stronger by having more dedicated, long-term employee 
shareholders.
    I also note for your consideration that the alternative 
minimum tax has a broad negative impact at Proxicom, depriving 
many of our employees of the tax deferral benefits of the 
qualified stock options. Proxicom also applauds the efforts 
behind the Universal Employee Stock Option Act. Because at 
Proxicom we fully appreciate the benefits of broad-based 
employee stock ownership, we can foresee implementing such a 
plan for our employees in addition to our current stock 
programs.
    In general, in our opinion, the more tools that are at our 
disposal to increase broad-based employee stock ownership, the 
better. In conclusion, the broad-based provision of stock 
options for Proxicom employees reflect and reinforce the 
entrepreneurial beginnings, spirit and culture of our company. 
The employee culture is one of teamwork and common goals, 
driving to the success of the overall business. This was true 
for Proxicom as a start-up and it is especially true for us 
today as a maturing organization.
    The Proxicom stock plans are very important tools in 
establishing and maintaining this culture. They serve as a very 
visible means for all employees to share in the long-term 
growth and success of our company.
    Thank you.
    [The prepared statement follows:]

Statement of Christopher Capuano, Senior Vice President, Corporate 
Development, Proxicom, Inc., Reston, Virginia

    Mr. Chairman and Members of the Subcommittee, thank you for 
inviting me to join you today to present testimony on the 
Federal tax treatment of employee stock option plans under 
current law and proposals, such as the Wealth Through the 
Workplace Act and the Universal Employee Stock Option Act of 
2000, that are aimed at amending such law. It is a pleasure to 
be here.
    My name is Christopher Capuano, and I am the Senior Vice 
President for Corporate Development for Proxicom, Inc.
    Proxicom, based in Reston, Virginia, is a leading e-
business consulting and development company that delivers 
innovative Internet and wireless solutions for Fortune 500 
companies and other global, forward-thinking businesses. Our 
strategy, creative and technology professionals provide 
specialized e-business development expertise across a number of 
industries including Automotive, Financial Services, Energy, 
Media and Telecommunications.
    Proxicom has developed and built internet-based solutions 
for such blue-chip companies as America Online, General 
Electric, General Motors, Merrill Lynch, Marriott International 
and NBC, among many others.
    Raul Fernandez, our entrepreneur-founder and Chief 
Executive Officer, started Proxicom in 1991 with $40,000 he had 
saved originally to purchase a home. When I joined Proxicom in 
1996 we were a small, high-energy company of about 40 employees 
with a vision about the Internet. That was the year we 
implemented our broad-based stock option plan covering all 
employees. Today, we are a profitable firm of approximately 
1,300 employees that is publicly traded on NASDAQ (``PXCM''), 
with offices across the United States and Europe.
    As Senior Vice President for Corporate Development, I am 
responsible for management of our employee stock plans, as well 
as business development, mergers and acquisitions, and 
international expansion. Over the course of my service with 
Proxicom I have also served as the General Counsel and a member 
of the Board of Directors.
    Prior to my joining Proxicom I was a lawyer in private 
practice, a consultant at Price Waterhouse, and an Adjunct 
Professor of Law at Georgetown University Law Center, teaching 
a course on taxation and compensation issues.
    On behalf of Proxicom, I would like to thank the 
Subcommittee for holding this important hearing. These are 
important issues that will play a critical role in growing 
businesses and helping employees realize the benefits available 
from company ownership through employee stock plans.

Stock Options at Proxicom

    In a start-up company, all employees wear multiple hats. 
One of the many hats I wore when I joined Proxicom was as 
creator of the Proxicom Stock Option Plan and later the 
Proxicom Employee Stock Purchase Plan. In designing the plans, 
our philosophy was very simple: each and every employee is 
critical to the success of the company. Stock options, 
therefore, were and still are provided to each and every 
employee to align all of us with the success of the company, 
and share in the growth. From the receptionist who first greets 
our clients, to our technical consultants, to the project 
managers, all employees receive stock options.
    Under our stock option plan, an employee receives a stock 
option on his/her starting date with the company. The option 
vests, or becomes exercisable, over 4 years; the option itself 
has a life of 10 years so that as long as you remain an 
employee, you have 10 years to exercise the option. The focus 
is on the long term.
    The price of the option is the fair market value of the 
stock when the individual joins the company. When we were a 
private company, we calculated the price based on the value of 
the business at various points in time, typically when we took 
in venture capital. As a public company it is very simply 
determined as the closing price of our stock on the day before 
the grant date.
    Proxicom employees also receive additional stock option 
grants every year they are with the company. These refresh 
grants also vest over the four years following the date of the 
refresh grant, thereby continuing to provide long term growth 
opportunities to our employees.
    When the employee vests in the stock option (for example, 
after the first year of employment), the employee may exercise 
the option and buy the underlying stock. As you know, on 
exercise of the option, our employees must also pay tax on the 
difference between the option price and the market value of the 
Proxicom stock, even if the employee has not sold any shares or 
actually pocketed any cash gain. It is a profit on paper only. 
Many of our employees are forced to sell some of their Proxicom 
stock to pay this tax; others who wish to hold onto the shares 
long term are forced to take out loans to pay the tax.
    While we offer qualified stock options, which would defer 
the tax payment, most of the options granted today are 
nonqualified stock options due to the tax code limits on 
qualified stock options. In any event, the impact of the 
alternative minimum tax negates the benefit of qualified stock 
options for many of our employees by taxing the paper gain 
before any stock is sold. Again, many of our employees are 
forced to sell shares, and thereby forego a stake in our long-
term growth, or take loans to pay off this tax on their 
exercised options.
    The Proxicom option process is fully internet-enabled, with 
the stock option plan document and all of the employee's 
specific option information, from vesting dates, to pricing to 
taxes, contained on the employee's personal web site and 
available any time day or night.

Impact of the Proxicom Stock Option Plan

    The impact of the Proxicom stock plans on our company and 
our employees is positive on many fronts. In short, share 
ownership through our stock plans promotes teamwork and 
provides a specific incentive for all our employees to 
understand and grow with our business through the long 
term. The 
stock plans bring strategic benefits to Proxicom, financial and 
personal benefits to employees, and overall contribute to the 
long-term growth of our company.

Strategic Benefits to Proxicom

    At Proxicom, our broad-based employee stock plans offer 
strategic benefits to Proxicom. The plans improve corporate 
productivity and profitability by helping to align employee and 
shareholder interests while providing a tangible and very 
visible tool to attract, inspire, and retain employees--
especially in our tight labor market. With many Proxicom 
employees coming from firms not offering stock plans, our 
ability to directly reward our employees based upon our overall 
success is a key to our continued growth.
    From an alignment perspective, our stock option plan is a 
major component in threading together our shareholders, our 
corporate strategy, and the individual desires of every 
employee. In a growing business like Proxicom, where resources 
are very tightly managed, share ownership through the stock 
plans keeps our employees focused on teamwork, productivity, 
and quality through the sharing of resources, best practices, 
and knowledge. Our employees understand that any other 
performance would only serve to sub-optimize the whole 
business.
    For example, in addition to their daily responsibilities, 
Proxicom employees design and deliver thousands of hours of 
internal training per year to help fellow employees learn and 
grow their skills as the company grows. Our employees regularly 
volunteer their free time to identify and implement improvement 
programs in each office.
    As a tool to attract, inspire, and retain employees, it has 
always been our philosophy that the employees should ``act and 
be treated as owners.'' The stock plans support this philosophy 
by providing the opportunity for personal wealth (attraction); 
rewarding employees for corporate success (inspiration); and 
encouraging long-term employment, learning, and collaboration 
(retention). ``Owners'' focus on improvement, results, the 
company as a whole and the success of others, instead of their 
specific piece of the pie.

Benefits to Proxicom Employees

    The Proxicom stock plans provide a significant opportunity 
for individual employee financial gain. Many of our top 
recruits forego larger cash base pay packages to have the 
opportunity to share in the overall success of the company over 
the long term. This translates into an opportunity for long-
term financial savings and stability. This ownership link 
between company and individual success is the cornerstone to 
our ability to attract, inspire and retain talent while 
delivering superior results to our clients.
    In addition to volunteering for internal projects and 
working on weekends, it is not uncommon for employees to 
support non-profit endeavors as a way to help the company 
succeed. Rather than contribute cash, many of our employees 
contribute stock purchased through the stock option plans to 
charitable causes, which, of course, benefits the community as 
well.
    The law as it currently stands erodes the financial benefit 
of certain stock options and lessens their positive impact for 
our employees. The current proposals before you, however, would 
help to restore the value of such options and allow every 
employee to fully share in the long-term success of the company 
at which they choose to work.

Impact on Proxicom's Growth

    Because we are a ``people business,'' our broad-based plans 
aimed at our employees are critical in helping Proxicom grow. 
Growth is achieved not only by aligning employee and corporate 
interests and promoting teamwork, but also by offering long-
term incentives to employees to deliver quality work over time. 
With our stock plans in place, our employees understand the 
importance of short-term (quarterly) and long-term success. 
This understanding clearly helps to drive our continued growth.
    Current law reduces the long-term benefit of certain stock 
options by forcing our employees, in many cases, to sell stock 
before they wish to in order to pay taxes. This affects the 
majority of our employees, and most often the less financially 
stable employees who cannot not afford to pay the tax unless 
the shares are sold. The current proposals would help alleviate 
this need to sell and instead restore the long-term performance 
incentives and long-term savings benefit of such stock options, 
thus benefiting both employees and companies on which the 
strength of the economy is based.

The Proposals

    In our opinion, the provisions of the Wealth Through the 
Workplace Act will greatly enhance the effectiveness of stock 
plans like the Proxicom Stock Option Plan by enabling our 
employees at all levels to continue to hold on to their company 
stock after exercise, rather than selling the shares to pay the 
tax due on the stock's paper gain. With this important 
provision, our employees will not be forced to give up the 
opportunity for long-term appreciation in our stock, and 
Proxicom will grow stronger by having more dedicated, long-term 
employee shareholders. Also favorable is the provision 
preserving the ability of the company to take the deduction. 
This is a financially sound approach for business that shows 
long term thinking by this Committee.
    I also note for your consideration that the alternative 
minimum tax has a broad negative impact at Proxicom, depriving 
many of our employees of the tax deferral benefits of the 
qualified stock options, thus forcing our employees to sell 
their stock to pay the tax.
    Proxicom also applauds the efforts behind the Universal 
Employee Stock Option Act of 2000. Because Proxicom fully 
appreciates the benefits of employee stock ownership, we can 
foresee implementing such a plan for our employees in addition 
to the current stock programs offered. In general, the more 
tools at our disposal to increase employee stock holdings, the 
better.

Conclusion

    The broad based provision of stock options for Proxicom 
employees reflects and reinforces the entrepreneurial 
beginnings, spirit and culture of our company. The Proxicom 
culture is one of teamwork and common goals, driving to the 
success of the business. This was true for Proxicom as a start 
up and it is true today for us as a maturing organization. The 
Proxicom stock plans are very important tools in establishing 
and maintaining this culture. They serve as a very visible 
means for all employees to share in the long-term growth and 
success of the company.
    We strongly support the enactment of provisions that will 
facilitate employee stock ownership and restore the long-term 
value of such options, thus allowing every employee to fully 
share in the long-term success of the company at which they 
choose to work.
    Thank you for asking me to join you today. On behalf of 
Proxicom, I thank you for holding this hearing and I stand 
ready to answer any questions you might have.
      

                                


    Chairman Houghton. Thanks very much, Mr. Capuano.
    Now, Miss Wilma Schopp, the Human Resources Leader, Global 
Compensation and Benefits at Monsanto.

   STATEMENT OF WILMA SCHOPP, HUMAN RESOURCE LEADER, GLOBAL 
    COMPENSATION AND BENEFITS, MONSANTO COMPANY, ST. LOUIS, 
      MISSOURI, ON BEHALF OF THE AMERICAN BENEFITS COUNCIL

    Ms. Schopp. Good morning and thank you, Mr. Chairman, for 
the opportunity to appear. I am Wilma Schopp, Human Resource 
Leader for Global Compensation and Benefits at Monsanto, a 
subsidiary of Pharmacia Corporation. I am here representing the 
American Benefits Council, formerly APPWP. I want to thank you, 
Mr. Chairman, for holding this hearing and for your leadership 
in creating a positive environment for extending the benefits 
of stock ownership to American workers, as exemplified by your 
introduction of the Universal Stock Options Act of 2000.
    Broad-based stock ownership programs, which have become 
increasingly prevalent in the U.S., provide value to both 
employees and employers. They enable workers to become owners 
of their companies and provide a significant vehicle of wealth 
accumulation. Employers value stock option ownership programs 
as an important recruitment, retention and motivational tool in 
a competitive labor market.
    Moreover, a recent Rutgers University study found that 
companies with broad-based stock plans have significantly 
higher productivity levels and growth rates than companies 
without such plans. At Monsanto, both the company and our 
employees are firm believers in the benefits of equity 
ownership. We provide stock options to all of our employees 
worldwide. We also have an employee stock purchase plan, an 
employee stock ownership plan and offer Monsanto stock as an 
investment option in our 401(k) plan.
    However, many Americans lack the opportunity to participate 
in an employer-sponsored stock plan. We believe a top priority 
for the next Congress should be to build on your efforts, Mr. 
Chairman, to provide enhanced incentives for broad-based stock 
plans. Your legislation, H.R. 4972, would provide employers 
with a significant new incentive to offer stock ownership plans 
and will encourage employee equity ownership by coupling the 
power of payroll deduction with increased tax incentives.
    Employees would be empowered to hold stock for longer 
periods, facilitating capital appreciation and a continued 
ownership stake in the corporation, since shares will be taxed 
at sale rather than exercise. Moreover, the bill's accelerated 
deduction for employers will encourage the establishment of new 
broad-based plans.
    We note that legislation introduced by Representative John 
Boehner, H.R. 3462, contains many of the same positive 
features.
    Mr. Chairman, we hope you will pursue your legislation in 
the new Congress and continue your efforts to encourage broad-
based stock plans. As you do, we offer the following items for 
your consideration:
    We believe that it will be important to clarify that any 
new stock option or stock purchase design will not displace or 
lead to adverse consequences for existing arrangements.
    While it is appropriate to include coverage requirements in 
any new stock plan legislation that provides substantial tax 
advantages, we feel such requirements should be carefully and 
flexibly crafted so as not to preclude employers from using the 
new incentives.
    Finally, we recommend that, as with your bill, any 
legislation establishing a new stock plan design be placed 
within the Internal Revenue Code, as has been the historical 
practice.
    As you look to future legislative initiatives in this area, 
we would also ask you to address the following barriers that 
have the potential to erode employee stock ownership programs 
even as you seek to expand them. First, we are very concerned 
about the recent change in position by the IRS that payroll 
taxes should be imposed whenever options are exercised under a 
Section 423 employee stock purchase plan.
    The IRS has also taken the view that Federal income tax 
withholding is required on disqualifying dispositions under 
employee stock purchase plans. Moreover, the IRS had sought to 
impose these withholding obligations retroactively, despite 
clear and directly contradictory guidance.
    Mr. Chairman, we appreciate your efforts to point out that 
these new tax obligations will create substantial burdens for 
employers and will make employees less likely to retain shares 
after exercise because they will have to sell them to cover the 
additional tax liability. We are very concerned that the IRS 
and Treasury are nonetheless poised to issue guidance that 
could support the imposition of employment tax withholding on 
employee stock purchase plans and perhaps even incentive stock 
option transactions.
    Because of the counterproductive results of such an 
approach for employees and employers alike, we believe that 
legislation will likely be needed to clarify that income and 
payroll tax withholding obligations do not apply for employee 
stock purchase plans and incentive stock options.
    Second, because the application of the alternative minimum 
tax to stock option transactions discourages workers from 
holding company stock, the council strongly supports 
legislation to exempt the exercise of stock options from the 
alternative minimum tax.
    Third, as provided under H.R. 1102, the pending retirement 
savings legislation, an employer tax deduction should be 
allowed for dividends employees reinvest in unleveraged ESOPs, 
encouraging the accumulation of retirement savings.
    Fourth, with many U.S. companies, such as Monsanto, 
operating overseas, the council urges the Congress to help 
promote more uniform treatment for employees of U.S. companies 
by investigating the special problems of offering equity 
ownership to American employees working in other countries.
    I want to thank you, Mr. Chairman, Ranking Member Coyne and 
the other members of the subcommittee for your interest and 
dedication to promoting equity ownership by American workers.
    [The prepared statement follows:]

Statement of Wilma Schopp, Human Resource Leader, Global Compensation 
and Benefits, Monsanto Company, St. Louis, Missouri, on Behalf of the 
American Benefits Council

    Good morning and thank you, Mr. Chairman, for the 
opportunity to appear today. I am Wilma Schopp, Human Resource 
Leader for Global Compensation and Benefits at Monsanto 
Company. I am here representing the American Benefits Council 
(the Council--formerly APPWP), of which Monsanto is a member. 
The Council is a public policy organization representing 
principally Fortune 500 companies and other organizations that 
assist employers of all sizes in providing benefits to 
employees. Collectively, the Council's members either sponsor 
directly or provide services to employee benefit plans covering 
more than 100 million Americans.
    I want to thank you, Mr. Chairman, for holding these 
hearings on stock option and other stock benefit plans, and for 
your leadership in creating a positive environment for 
extending the benefits of stock ownership to American workers, 
as exemplified by your introduction of H.R. 4972, the Universal 
Stock Options Act of 2000. Employee stock option plans are an 
important part of the benefits package offered by many of our 
member companies, and we support the goal of expanding these 
plans. In fact, a recent American Benefits Council survey 
revealed that a clear majority of our members support providing 
additional tax incentives for broad-based equity ownership 
plans.\1\ My testimony today will briefly review the national 
trends in stock ownership, highlight the many advantages of 
stock plans for employers and employees alike, provide 
commentary on H.R. 4972, and describe several other pressing 
stock ownership issues that the Council believes also merit 
congressional attention. We are pleased to offer our voice on 
this important policy issue, and we appreciate your 
consideration of our views.
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    \1\ The full survey and its results can be found on the web site of 
the American Benefits Council at www.americanbenefitscouncil.org.

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Stock Ownership Programs Are Varied and Growing

    No longer just a prerogative of executives, stock ownership 
programs in a wide variety of forms are increasingly becoming 
part of the benefits package of non-managerial, unionized, and 
hourly employees. The diversity in stock plan design is 
reflective of both the goals and employee demographics of 
individual companies. Many employers, including many Council 
member companies, extend the benefits of stock ownership to 
their employees through stock option programs, employee stock 
ownership plans (ESOPs), employee stock purchase plans (ESPPs), 
use of company stock in 401(k) plans, and other innovative 
equity participation arrangements. Looking just at stock 
options, recent surveys show that approximately 6 million non-
management employees are accumulating wealth through stock 
options,\2\ and 39 percent of major companies now have stock 
option plans that cover over half of their workforce, up from 
17 percent in 1993.\3\ Most notably, this growth in stock 
option holdings has spread to rank-and-file employees. In fact, 
in a 1998 survey of 389 companies that granted stock options, 
34 percent made grants to such employees.\4\
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    \2\ Current Practices in Stock Option Plan Design, National Center 
for Employee Ownership, 2000.
    \3\ Broad-Based Stock Options--1999 Update, William M. Mercer, 
Inc., 1999.
    \4\ The 1998 Stock Plan Design and Administration Survey, 
PricewaterhouseCoopers, 1998.
---------------------------------------------------------------------------
    While some think of stock ownership programs as being 
particular to start-up and high technology firms, stock 
ownership and participation arrangements are actually found 
across the whole spectrum of American industry. A glance at the 
50 largest U.S. companies with broad-based stock option plans 
demonstrates that companies in such fields as manufacturing, 
banking, shipping, household products, aviation, insurance, 
food products, retail, rail transport, and cable TV are 
offering stock options to their rank-and-file employees.\5\ The 
depth and breadth of stock ownership programs reflected in the 
figures I have cited indicates that the extension of equity to 
rank-and-file employees is becoming an increasingly common 
business practice.
---------------------------------------------------------------------------
    \5\ Employee Ownership Report, National Center for Employee 
Ownership, May/June 1999.

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Benefits of Stock Ownership Programs

    Broad-based stock ownership programs prove valuable to both 
employees and employers. Foremost, they enable workers to 
become owners of their company, creating a personal stake on 
the part of employees in the corporate venture and often 
providing workers with a greater sense of commitment to the 
company's mission. Such programs also provide a significant 
vehicle of wealth accumulation for many workers. Two recent 
studies put the average annual value of stock option grants to 
employees at roughly $1,700.\6\ This wealth accumulation aspect 
can contribute meaningfully to employees' retirement security.
---------------------------------------------------------------------------
    \6\ Employee Ownership Report, National Center for Employee 
Ownership, January/February 2000, and David Lebow et al., Recent Trends 
in Compensation Practices, Board of Governors of the Federal Reserve 
System, Finance and Economics Discussion Series, No. 1999-32, July 
1999.
---------------------------------------------------------------------------
    Employers appreciate stock ownership programs as an 
important recruitment, retention, and motivational tool in a 
competitive labor market. Moreover, a recent study found that 
there is evidence that companies with broad-based stock plans 
have significantly higher productivity levels and annual growth 
rates as compared to companies without broad-based stock 
plans.\7\ This latter effect may translate into a benefit for 
the general economy as the number of companies with broad-based 
stock ownership plans increases.
---------------------------------------------------------------------------
    \7\ Public Companies with Broad-Based Stock Options: Corporate 
Performance from 1992-1997, National Center for Employee Ownership and 
Blasi, Kruse, Sesil, and Kroumava, 2000.
---------------------------------------------------------------------------
    While many American workers feel fortunate to have stock 
ownership plans, other workers lack this opportunity because 
their employers cannot, for a variety of reasons, provide such 
benefits. We believe that a top priority for the next Congress 
should be to build on your efforts, Mr. Chairman, to provide 
enhanced incentives for broad-based stock plans and to remove 
the existing barriers that can deter employers from extending 
the opportunity for employee equity ownership.

The Monsanto Experience

    At Monsanto, both the company and our employees are firm 
believers in the benefits of equity ownership. We provide stock 
options to all of our employees, worldwide. For rank-and-file 
workers, we grant a fixed number of options per employee at 
each grant occasion. For management employees, the number of 
options we grant is tied to the individual manager's role and 
responsibilities within the company. For our employees in the 
United States, Monsanto will also allow workers to purchase 
shares of Monsanto stock through an employee stock purchase 
plan. We also have an employee stock ownership plan (ESOP) and 
offer Monsanto stock as an investment option in our 401(k) 
plan. As you can see, equity ownership is central to our vision 
of how to reward Monsanto employees. We are grateful, Mr. 
Chairman, for your efforts to make this system one that will 
work even more effectively for employees and employers alike.

H.R. 4972, The Universal Stock Options Act of 2000

    Turning to a discussion of your bill, Mr. Chairman, the 
Council believes that H.R. 4972 marks a major step forward in 
the debate on improving our nation's compensation and benefits 
policy. Your bill would provide employers with a significant 
new incentive to offer stock ownership plans. If enacted, the 
bill would accelerate and enhance the existing trend toward 
providing broad-based employee stock option and stock purchase 
plans and could create a large new generation of employee stock 
owners. The potential improvements in productivity, employee 
economic well-being, and employment satisfaction for millions 
of Americans could be substantial.
    H.R. 4972 would accomplish these important goals by 
encouraging employees to use tax-favored payroll deductions to 
purchase employer stock. Employees would be able to deduct 
amounts from their pay, up to the annual limit specified by 
Internal Revenue Code section 402(g), and all contributions, as 
well as any shares purchased by such contributions, would be 
placed in a trust. Employees would be taxed neither on amounts 
saved through payroll deduction nor on the value of the shares 
of stock when purchased. Employers would be allowed a deduction 
when options are exercised and the shares are transferred to 
the employee, and the deduction would be equal to the fair 
market value of the stock at the time of exercise. Upon sale of 
the stock, the employee recognizes ordinary income equal to the 
stock's fair market value at exercise and capital gain 
treatment on the amount, if any, that exceeds the exercise 
price.
    The bill encourages both employee savings and equity 
ownership by coupling the power of payroll deduction with 
increased tax incentives. Our members can testify to the 
powerful effect in the 401(k) context of combining payroll 
deduction and pre-tax deferrals, and we believe that similarly 
positive results would occur with stock plans. We also believe 
that employees and employers will respond in a positive way to 
the tax incentives contained in H.R. 4972. The chief benefit of 
these incentives will be that employees will no longer have to 
sell stock as soon as they purchase it in order to cover their 
tax liability. Rather, they will be empowered to hold stock for 
longer periods, allowing an opportunity for long-term 
appreciation in value and a continued ownership stake in the 
corporation. Moreover, the Council supports the bill's 
accelerated deductions for employers as an important tool to 
encourage the establishment of new broad-based plans.

H.R. 3462, The Wealth Through the Workplace Act

    In addition to H.R. 4972, the current Congress saw the 
introduction by Representative John Boehner (R-OH) of H.R. 
3462, the Wealth Through the Workplace Act. H.R. 3462 creates a 
new broad-based stock option design that combines positive 
elements of both qualified and non-qualified stock options. 
H.R. 3462 would generally allow workers to defer taxation on 
their stock options until they sell their shares and then to 
have their gains taxed at capital gains rather than ordinary 
income rates. These are benefits that employees with qualified 
(or ``incentive'') stock options currently enjoy. At the same 
time, employers would be able to take a tax deduction for the 
increased value of the stock option upon the employee's 
exercise of the option (as sponsors of traditional non-
qualified stock options may currently do).
    H.R. 3462 would encourage employees to save for the future 
by providing that the bill's favorable capital gains tax 
treatment applies only to stock options that are held for two 
years from the grant date and one year from the exercise date. 
By providing favorable rules for employees who hold their stock 
options for the specified periods, H.R. 3462 not only provides 
a vehicle for workers to accumulate wealth, but also encourages 
workers to take the long-term view with respect to their own 
financial security. In this way, the bill encourages employees 
to remain ongoing stakeholders in our economy and helps them 
achieve retirement security.

The Future for Stock Option Incentives

    Mr. Chairman, the Council recognizes that, notwithstanding 
the strong merits of H.R. 4972 and H.R. 3462, it is highly 
unlikely that these bills will be enacted in the closing days 
of the 106th Congress. However, these bills provide an 
important starting point for deliberations by the new Congress. 
As an aside, Mr. Chairman, we understand that you and 
Representative Boehner have discussed possible joint 
initiatives in the future concerning stock options, and we 
would certainly applaud and encourage such cooperation. As you 
and others look to continue your efforts to encourage and 
facilitate broad-based stock option plans, we wish to add to 
our comments above the following items for the Subcommittee's 
consideration:
     The Council believes that it will be important to 
clarify that any new stock option or stock purchase design will 
not displace or lead to adverse consequences for existing 
arrangements. Clear protection of existing programs will help 
new stock plan legislation gain broad-based support from the 
business and benefits communities.
     While we believe it is appropriate to include 
coverage requirements in any new stock plan legislation that 
provides substantial tax advantages, we feel such requirements 
should be carefully and flexibly crafted so as not to preclude 
employers from making use of the new incentives or designs.
     Historically, equity arrangements like stock 
option plans have been established within the Internal Revenue 
Code and regulated by the Treasury Department and Internal 
Revenue Service. We strongly recommend that any future 
legislation continue this historical practice rather than 
placing stock plans within the Employee Retirement Income 
Security Act (ERISA) and subjecting them to regulatory 
oversight by the Department of Labor.
     We understand that some Members of Congress may be 
concerned about preventing substitution of stock options for 
existing wages. We believe this concern is misplaced. Employers 
make determinations about workers' wages and benefits in the 
context of the appropriate level of total compensation and 
decide upon the relative place of cash wages and other benefits 
based on what is competitive in the marketplace. These 
competitive pressures will not allow companies to reduce cash 
compensation below what workers demand and what competitor 
firms provide. We believe, therefore, that legislation to 
prevent the substitution of options for wages is unnecessary 
(and would in any case be highly unworkable).

Other Public Policy Issues Related to Stock Ownership Programs

    Mr. Chairman, there are a number of other pressing issues 
related to stock ownership programs that I would like to 
address in my testimony this morning. As a champion of 
extending equity ownership to more American workers, Mr. 
Chairman, you have been sensitive to these issues, and we at 
the Council appeal to you and other members of this 
Subcommittee to devote your substantial energies to addressing 
these matters. The barriers and burdens I will describe today 
have the potential to erode employee stock ownership programs 
even as you seek to expand them.
    Tax Withholding Obligations under Stock Option Plans--A 
disqualifying disposition of stock under a qualified Incentive 
Stock Option (ISO) plan results in income to the employee. 
However, the IRS has provided consistent guidance for nearly 30 
years that the employer that grants the ISO does not have any 
income tax withholding obligation with regard to that income, 
nor is such income from either a qualifying or disqualifying 
disposition considered wages for FICA or FUTA withholding 
purposes. Since the same statutory provisions interpreted by 
the IRS guidance also apply to employee stock purchase plans 
(ESPPs) governed by section 423 of the Internal Revenue Code 
and since the IRS has provided similar guidance for ESPPs, 
employers generally have not paid employment taxes or withheld 
income on ESPP income.
    In contrast, and despite the historic IRS guidance, the IRS 
has recently taken the position that FICA and FUTA taxes should 
be imposed whenever options are exercised under an ESPP. The 
amount of such tax would be based on the difference between the 
option price and the fair market value of the stock at the time 
of exercise. The IRS has also taken the view that Federal 
income tax withholding is required on disqualifying 
dispositions under ESPPs. Moreover, the IRS has sought to 
impose these withholding obligations retroactively despite 
clear and directly contradictory guidance in the ISO area.
    Mr. Chairman, you have been an articulate advocate for 
ESPPs and have pointed out the many adverse consequences that 
will result from the IRS' recent change of position regarding 
withholding obligations. You have recognized that imposition of 
these tax obligations will create new and substantial burdens 
on employers, acting as a deterrent to the sponsorship of 
broad-based stock purchase programs. Moreover, if withholding 
is applied, you have noted that employees, particularly rank-
and-file employees, are less likely to retain shares after 
exercise of ESPP options because they will have to sell the 
stock to cover the additional tax liability. This hinders 
employee wealth accumulation and frustrates the opportunity for 
long-term appreciation in share value. In addition, the new 
demand for tax withholding increases tax and administrative 
costs and discourages employers from offering stock options to 
rank-and-file employees.
    As you know, Mr. Chairman, these withholding issues are 
currently being litigated in the Federal Court of Claims, and 
the Council has urged the IRS to return to its long-standing 
position that income and payroll tax withholding obligations 
for ESPPs should parallel those for ISOs. We have greatly 
appreciated your leadership in urging the IRS to desist from 
its current enforcement efforts and return to its prior 
practice. We are very concerned, however, that the IRS and 
Treasury are poised to issue guidance that could support the 
imposition of employment tax and withholding obligations on 
certain ESPP and perhaps even ISO transactions.\8\ Because of 
the counter-productive results of such an approach for 
employees and employers alike, we believe that legislation will 
likely be needed to overturn the agency guidance and clarify 
that income and payroll tax withholding obligations do not 
apply for ESPPs and for ISOs.
---------------------------------------------------------------------------
    \8\ While we expect to take issue with the substance of any 
forthcoming guidance reaching such a conclusion, we feel strongly that, 
at a minimum, such guidance should be prospective in nature and should 
be issued in proposed rather than final form. Issuance of retroactive 
guidance and/or denying the public an opportunity to comment would 
impose an unfair burden on the many employers who have reasonably 
relied on the IRS' long-standing and contrary position.
---------------------------------------------------------------------------
    Alternative Minimum Tax--A major obstacle to extending 
equity ownership to working Americans has been the application 
of the alternative minimum tax (AMT) to stock option 
transactions. Upon exercise of an ISO option, the difference 
between the fair market value of the stock and the exercise 
price is includible in AMT income even though this amount is 
not includible in ordinary income. The application of the AMT 
to stock options discourages workers from holding company stock 
and thereby frustrates many of the goals of stock ownership 
programs. The Council strongly supports legislation to make 
clear that the AMT would not apply with respect to the exercise 
of options under ISOs.
    Employee Classification Issues--Employee stock purchase 
plans (ESPPs) are generally required to cover all common law 
employees of the corporation. However, employers may exclude 
certain narrowly defined groups of workers based upon their 
status as part-time, short service, highly compensated or new 
employees. Litigation has arisen over whether temporary and 
part-time workers are entitled to participate in ESPP plans, 
and questions also exist with respect to whether certain 
foreign employees must be covered under these plans. Employers 
who sponsor ESPPs and other stock ownership programs need 
flexibility in managing benefits for a workforce with changing 
demographics. This needed flexibility would be impaired by 
legislating aggressive new coverage mandates (as some Members 
of Congress have proposed), the result of which would be fewer 
stock plans that include rank-and-file workers. Particularly in 
light of the already broad coverage requirements of ESPPs, we 
urge Congress to stand firm against such mandates and to 
continue to allow employers needed flexibility in administering 
their benefit programs.\9\
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    \9\ There are also ways in which the existing ESPP rules work to 
exclude workers inappropriately from participation in these plans. The 
current rules require that in order to participate in an ESPP, an 
employee must work for a corporation (rather than for a partnership or 
limited liability company (LLC)) and that at least 50 percent of that 
corporation must be owned by the firm sponsoring the ESPP. Both of 
these rules exclude workers from ESPP participation, particularly in 
start-up firms that often take the form of partnerships or LLCs and in 
joint ventures where the 50 percent ownership threshold is not met. We 
urge Congress to review these rules.
---------------------------------------------------------------------------
    ESOP Dividends Reinvestment--Employee stock ownership plans 
(ESOPs) allow employees to share in the benefits of equity 
ownership through the vehicle of a tax-qualified retirement 
plan. The Comprehensive Retirement Security and Pension Reform 
Act, H.R. 1102--of which many members of this Subcommittee are 
cosponsors--includes an important change in the tax treatment 
of ESOP dividends that would provide employees with a greater 
opportunity for enhanced retirement savings and stock 
ownership. Under Code section 404(k), employers may take a tax 
deduction on dividends paid on employer stock in an unleveraged 
ESOP only if the dividends are paid to employees in cash; thus, 
the deduction is denied if the dividends remain in the ESOP for 
reinvestment. Under H.R. 1102, deductions would also be allowed 
when employees choose to leave the dividends in the plan for 
reinvestment, encouraging the accumulation of retirement 
savings through the employee's ownership interest in the 
employer. This provision will make ESOPs even more effective 
retirement savings plans. This important ESOP dividend 
reinvestment provision is but one of the many reasons the 
Council is working actively with Congress to see H.R. 1102 
enacted into law in the remaining days of this congressional 
session.
    Information Reporting of Stock Option Transactions--
Nonqualified stock option plans are the most common type of 
stock option plan in use by employers. Upon exercise of such 
options, the employee receives income equal to the excess of 
the fair market value of the stock over the option exercise 
price, and such income is reported on the employee's Form W-2. 
The employee typically sells the stock on the same day that the 
option was exercised (unless a restriction applies). The broker 
handling these transactions is required to report on Form 1099-
B the payments of gross proceeds to individuals from such same-
day sales (even though typically no gain or loss is realized). 
The end result is that the employee receives duplicative 
reporting for the same transaction (on both the W-2 and the 
1099-B), which can cause confusion. Moreover, if the employee 
has not provided a certified taxpayer identification number on 
Form W-9, the broker is required to backup withhold 31 percent 
from the gross proceeds of the sale in addition to withholding 
employment taxes. For many employees, particularly those 
working abroad, unintentional errors in W-9 reporting can lead 
to unfairly large tax burdens. The Council recommends that the 
Congress examine these issues and explore ways in which the 
reporting requirements of the Code can be simplified and 
streamlined in order to minimize confusion and reduce needless 
tax burdens.
    The Effect of Auditor Independence Rules on Stock Plan 
Participation--We also wanted to bring to the Subcommittee's 
attention the effect that the Securities and Exchange 
Commission's (SEC) requirement that accountants be independent 
of their corporate clients can have in the stock plan context. 
These independence rules require that no dependents of the 
accountant may own shares in a company that the accounting firm 
audits. These rules are incredibly complex to apply and often 
exclude the spouses and children of accountants from the stock-
related plans their employers offer. The result has been not 
only a burden on the non-accountant working spouses (who must 
sacrifice valuable benefits their employers provide) but also a 
barrier to attracting the best and brightest to the accounting 
profession (as potential candidates choose other professional 
paths rather than navigate these rules and sacrifice the 
attendant economic benefits). While independence rules are 
essential to maintaining the integrity of corporate audits, we 
believe the effect of these rules in the stock plan context is 
worthy of examination. As Congress continues its oversight of 
the SEC's revision of the auditor independence rules, we urge 
attention to the issue of stock plan participation by auditor 
family members.
    International Concerns--Many U.S. companies operating 
internationally find that offering stock and stock options to 
employees overseas is difficult because of the differing tax 
treatment of stock offerings, dividend distributions, and sales 
of shares across different countries. The Council urges the 
Congress to help promote more uniform treatment for employees 
of U.S. companies by investigating the special problems of 
offering equity ownership to U.S. workers working in other 
countries.

Conclusion

    I want to thank you, Mr. Chairman, Ranking Member Coyne, 
and the other members of the Subcommittee for your interest and 
dedication to promoting equity ownership by American workers. 
We look forward to continuing to work with you and other 
interested Members to enact new incentives to extend broad-
based stock plans to more American employees and to develop and 
advance solutions to the barriers and burdens confronting stock 
plans today. Both steps will help us to maintain the positive 
trend in our economy toward broad-based employee stock 
ownership.
    Thank you, and I would be pleased to answer any questions 
you may have.
      

                                


    Chairman Houghton. All right. Fine. Thanks very much, Ms. 
Schopp.
    Now, Ms. Sussman, who is the Executive Director of the 
National Association of Stock Plan Professionals.

 STATEMENT OF SANDRA L. SUSSMAN, EXECUTIVE DIRECTOR, NATIONAL 
    ASSOCIATION OF STOCK PLAN PROFESSIONALS, SILVER SPRING, 
                            MARYLAND

    Ms. Sussman. Good morning, Mr. Chairman. Thank you for the 
opportunity to appear before the subcommittee on behalf of my 
organization and its members. My name is Sandra Sussman. I am 
the Executive Director of the National Association of Stock 
Plan Professionals, which is a professional association for 
individuals who are involved directly or indirectly with the 
design and administration of employee stock plans.
    The NASPP was formed in January of 1993 and currently has a 
little over 6,000 members who are in-house securities and tax 
attorneys, human resources professionals, accountants, 
compensation and benefits professionals and stock plan 
administrators, as well as outside providers of stock plan-
related services, such as outside counsel, compensation 
consultants, software vendors, brokerage firms, third-party 
plan administrators, communications professionals and web-based 
service professionals.
    Our membership represents roughly 2,500 public companies of 
all sizes and industries, all of which have one-or-more 
employee stock plans in place. Based in part on the results of 
our biannual plan design and administration surveys, we believe 
that the current applicable corporate tax treatment of equity 
based compensation and awards has led most companies to grant 
non-qualified stock options to employees; that is, because non-
qualified awards ultimately involve a tax deduction for the 
company, as my colleagues have already expressed.
    We also believe, perhaps more importantly, that the current 
tax treatment has resulted in most companies not discouraging 
disqualifying dispositions of stock acquired through the 
exercise of incentive stock plans or through Section 423 
employee stock purchase plans, even though employee equity 
ownership is most certainly becoming desirable.
    While our members have not to date expressed any real 
opinion about either Representative Houghton's proposal, that 
is, the Universal Employee Stock Option Act of 2000, H.R. 4972, 
or Representative Boehner's Wealth Through the Workplace Act, 
H.R. 3462, we do believe our member companies would very much 
appreciate the availability of an alternative approach that 
would provide for more favorable tax treatment for companies 
and their employees alike, thereby encouraging greater employee 
ownership.
    Toward that end, the NASPP would strongly encourage the 
reintroduction next year of legislation that would improve the 
tax advantages of employee stock options. Going forward, we 
will be pleased to provide input to the staff drafting the 
legislation based upon the views of our regional leadership, 
which we will indeed solicit.
    Thank you again for this opportunity. I am happy to take 
any questions that you have.
    [The prepared statement follows:]

Statement of Sandra L. Sussman, Executive Director, National 
Association of Stock Plan Professionals, Silver Spring, Maryland

    Good morning, Mr. Chairman. Thank you for the opportunity 
to appear before the Subcommittee on behalf of my organization 
and its members. My name is Sandra Sussman. I am the Executive 
Director of the National Association of Stock Plan 
Professionals, which is a professional association for 
individuals involved, directly or indirectly, in the design and 
administration of employee stock plans. The NASPP was formed in 
January of 1993 and currently has over 6,000 members who are 
in-house securities and tax attorneys, accountants, human 
resources professionals, compensation and benefits 
professionals and plan administrators, as well as outside 
providers of stock plan related services, such as outside 
counsel, compensation consultants, software vendors, brokers, 
third party administrators, communications professionals and 
web-based services professionals.
    Our membership represents roughly 2,500 public companies, 
of all sizes and industries, which have one or more employee 
stock plans in place. We believe that the current applicable 
corporate tax treatment of equity-based compensation and awards 
has led most companies to grant non-qualified stock options to 
employees, that is, because non-qualified awards ultimately 
involve a tax deduction for the company. We also believe, 
perhaps more importantly, that current tax treatment has 
resulted in most companies not discouraging disqualifying 
dispositions of, say, stock acquired through Section 423 
employee stock purchase plans, even though employee equity 
ownership apparently is becoming more desirable.
    While our members have not, to date, expressed an opinion 
about Representative Houghton's proposal (that is, the 
Universal Employee Stock Option Act of 2000, H.R. 4972), we 
believe our member companies would very much appreciate the 
availability of an alternative approach that would provide more 
favorable tax results for companies and their employees, 
thereby encouraging greater employee ownership. Toward that 
end, we would strongly encourage the re-introduction next year 
of legislation to improve the tax advantages of employee stock 
options.
    We would be pleased to provide input to the staff drafting 
the legislation, based upon the views of our regional 
leadership that we will solicit.
    Thank you. I am happy to take any questions you might have.
      

                                


    Chairman Houghton. Thank you, Ms. Sussman.
    Now, Mr. Butler is the Principal, Practice Leader of 
Employee Ownership Programs at Hewitt Associates.

STATEMENT OF MICHAEL J. BUTLER, PRINCIPAL AND PRACTICE LEADER, 
   EMPLOYEE OWNERSHIP PROGRAMS, HEWITT ASSOCIATES, ROWAYTON, 
     CONNECTICUT, ON BEHALF OF THE U.S. CHAMBER OF COMMERCE

    Mr. Butler. Mr. Chairman and members of the subcommittee, 
Mr. Boehner, thank you for the opportunity to participate in 
this hearing. My name is Michael Butler. I'm a principal with 
Hewitt Associates, a global management consulting firm 
specializing in all aspects of employee benefits, compensation 
and human resource solutions.
    Hewitt Associates has extensive experience with broad-based 
employee ownership and equity compensation programs, both 
domestic and global. I presently serve as Hewitt's Global 
Practice Leader for Employee Ownership Consulting Services. 
Hewitt Associates is a member of the U.S. Chamber of Commerce, 
where we serve on the Employee Benefits Committee. I am here 
today at the request of the Chamber to share our perspective on 
employee stock options and other forms of broad-based employee 
ownership based on our experience working with literally 
hundreds of client organizations on all aspects of employee 
ownership.
    In recent years, as has been noted, we have seen a 
significantly heightened interest in stock options as an 
innovative way to compensate and reward employees. I am pleased 
that Congress and this committee in particular have taken an 
interest in this issue and I applaud your leadership and Mr. 
Boehner's in this important area.
    In my remarks today, I would like to touch on four primary 
observations that I think may be helpful in framing your 
consideration of this issue. The first deals with the explosion 
in popularity of employee ownership. As has already been noted, 
there has been a dramatic increase in practice in the use of 
both stock options and stock purchase plans. The National 
Center for Employee Ownership estimates that somewhere between 
seven to ten million Americans are receiving stock options 
today.
    A 1999 survey by the same organization indicates that there 
were approximately 4,000 stock purchase plans covering 
approximately 16 million U.S. participants at the end of 1998, 
and those numbers are certainly higher today. Add in ESOPs and 
the use of company stock within 401(k) plans and other 
mechanisms and the numbers jump even higher.
    In other words, employee ownership in the U.S. is thriving 
today under existing law. While additional tax and other 
incentives such as those contemplated by your legislation and 
Mr. Boehner's would certainly be welcomed by employers and 
would certainly be productive in the sense of creating 
additional mechanisms for extending ownership, a key goal that 
we hear from our clients is basically retaining the overall 
simplicity and flexibility that is inherent in today's 
structures.
    One of the reasons that the United States is leading in 
this area globally is that our laws permit the kind of 
adaptation, flexibility and experimentation that are difficult 
to pursue elsewhere. We are seeing very interesting experiments 
currently among our clients with things like accelerated 
vesting provisions, indexation of options to reflect broader 
industry performance and the inclusion of performance-oriented 
features to reward specific kinds of achievement.
    Any provision that adds additional tax incentives will 
certainly be welcomed and appreciated, but we need to be 
careful not to hamper the kind of flexibility that currently is 
so important in driving the success we have seen in this area 
so far. Echoing your comments, Mr. Chairman, I think it is 
important also to note that the extension of employee ownership 
certainly has contributed to the remarkable performance of our 
economy over the past 10 years.
    The study by Rutgers noted earlier, as well as other 
research we have done in conjunction with Northwestern 
University and other studies clearly indicate that there is a 
strong correlation between the broad sharing of employee 
ownership and superior economic results. I do not think it is 
too far-fetched to suggest that the effective use of employee 
ownership strategies is contributing to the overall 
competitiveness of U.S. business and has, in fact, been a 
factor in the remarkable performance of our economy recently.
    The point really is the effective use of ownership. Simply 
extending ownership without changing other corporate practices, 
we have found to be of limited value. As a couple of the prior 
witnesses noted, the extension of employee ownership in the 
context of teamwork, broader sharing of information, broader 
encouragement of empowerment among the broad workforce is 
really what drives these results. Ownership in and of itself is 
certainly desirable. Ownership in conjunction with enlightened 
corporate practices is really what we see driving results.
    The third point I would like to touch on is the 
international perspective. This explosion in interest in 
employee ownership programs is not strictly a U.S. phenomenon. 
We have worked with over 20 major U.S. employers to extend 
broad-based option and purchase plans to literally hundreds of 
thousands of employees in well over 100 countries. We have also 
worked with dozens of non-U.S. employers in implementing broad 
equity programs for employees in their home countries and 
increasingly for their employees around the world.
    At the present time, we are actively working with clients 
in more than one dozen countries outside the U.S. and are aware 
of activity in several more. In considering legislative 
initiatives to encourage and expand employee ownership 
practices, I think we need to look beyond our borders to 
understand the global context within which these plans 
increasingly operate.
    A program that confers tax or other advantages in the U.S., 
but might lead to some degree of inflexibility and make a 
program unsuitable for global implementation, could cause some 
difficulties for the growing number of U.S. multi-nationals 
that are extending employee ownership to their people around 
the world, as well as non-U.S. employers looking to extend 
ownership to their employees in the United States.
    In summary, employee ownership is a significant and growing 
force here and abroad. Used effectively, it certainly has a 
demonstrable connection with superior economic results and the 
utility of this approach is increasingly being recognized 
around the world. The U.S. has been a pioneer in this area 
largely because of the flexibility of our broad ownership 
mechanisms. There are certainly opportunities to build on this 
success by creating new opportunities and new mechanisms, but 
we must be careful not to trigger unhealthful side effects by 
adding too much complexity or burdensome regulatory 
requirements in our quest to improve on what is already a very 
successful array of practices.
    Thank you for the opportunity to testify today. I would be 
happy to respond to any questions and follow up with the 
committee staff with further information.
    [The prepared statement follows:]

Statement of Michael J. Butler, Principal and Practice Leader, Employee 
Ownership Programs, Hewitt Associates, Rowayton, Connecticut, on Behalf 
of the U.S. Chamber of Commerce

    Mr. Chairman and members of the subcommittee, thank you for 
the opportunity to participate in this hearing. My name is 
Michael Butler. I am a Principal with Hewitt Associates, a 
global management consulting firm specializing in all aspects 
of employee benefits, compensation, and human resources 
solutions. Hewitt Associates has extensive experience with 
broad-based employee ownership and equity compensation 
programs, both domestic and global. I presently serve as 
Hewitt's global practice leader for employee ownership 
consulting services.
    Hewitt Associates is a member of the U.S. Chamber of 
Commerce, where we serve on the Employee Benefits Committee. I 
am here today at the request of the Chamber to share our 
perspective on employee stock options and other forms of broad-
based employee ownership, based on our experience working with 
hundreds of client organizations on all aspects of ownership 
programs.
    In recent years, we have seen a significantly heightened 
interest in stock options as an innovative way to compensate 
and reward employees. I am pleased that Congress is taking an 
interest in this issue as well.
    In my remarks today, I will outline four observations that 
may be helpful in framing your consideration of the stock 
option issue:

     Growth in Popularity of Stock Options in the U.S.

    There has been an explosion of interest and activity in 
this area over the past ten years. The National Center for 
Employee Ownership conservatively estimates that seven to ten 
million U.S. employees are receiving stock options. A 1999 
survey by the NCEO indicates that there were more than 4,000 
stock purchase plans with approximately 16 million U.S. 
participants at the end of 1998. Those numbers are certainly 
higher today. Add in employee stock purchase plans (ESOPs), 
company stock in 401(k) plans and other mechanisms, and the 
numbers jump dramatically.
    In other words, employee ownership in the U.S. is thriving 
under existing law. While additional tax and other incentives 
would certainly be welcomed by employers, and could stimulate 
and channel activity in this area, a key goal should be 
retention of the overall simplicity and flexibility inherent in 
today's environment.
    There is a great deal of experimentation going on today as 
employers adapt to meet competitive pressures and extend their 
plans globally. For example, over the last several years in 
Silicon Valley, it has become popular to utilize a very rapid 
vesting schedule for stock options. Whereas prior to the late 
1990s, a three or four year vesting schedule was typical, now 
it is common to have 50 percent of options vest at one year, 
with the remainder vesting monthly after that.
    Tax or other incentives that come with provisions that 
hamper this creativity or limit employer flexibility would be a 
mixed blessing at best, and quite possibly counterproductive.

     Desirability of Stock Option Plans

    Maintaining the vitality of the existing environment is an 
issue for our economy as a whole, not just employers and 
participants in these plans. There is a considerable and 
growing body of research, from a variety of sources, strongly 
supporting the proposition that, all else being equal, 
organizations providing a meaningful equity stake to the broad 
workforce generally outperform those that do not, especially 
when combined with participative workplace practices. For 
example, researchers at Rutgers University have documented a 16 
percent improvement in productivity and two percent improvement 
in return on assets by firms beginning a broad-based stock 
option plan.
    In light of these findings, it is not too farfetched to 
suggest that effective use of employee ownership strategies is 
contributing to the overall competitiveness of U.S. business, 
and has been a factor in the remarkable performance of our 
economy over the past decade.
    Broader employee ownership may be desirable as a matter of 
social policy for a number of reasons. But, from a business 
perspective, it is the effective use of these mechanisms that 
matters. In evaluating different approaches, keep in mind that 
there is a distinction between simply incenting employee 
ownership, and use of broad employee participation and 
involvement as a source of competitive advantage. For example, 
Hewitt research has shown that there are three necessary 
components to using stock options to enhance productivity:
     Explaining to employees their role in the company 
and what the company needs to do to stay competitive, should 
not be left to the board room, but instead, should be broadly 
disseminated;
     Fostering an environment that encourages 
individual and collective success, provides a steady flow of 
relevant business information, and empowers employees; and,

     Sharing equity in the company.

    My point here is that broad employee ownership is desirable 
not only in terms of fairness and broader sharing of wealth, 
but also as a matter of national competitiveness. Governments 
from the U.K. to China have explicit policy objectives aimed at 
increasing employee ownership, because they see a connection 
between our practices in this area and the extraordinary 
productivity of our economy. In considering legislative 
alternatives aimed at fostering greater employee ownership, we 
must not lose sight of the connection to results.

     The International Perspective

    As noted earlier, the stock option explosion is not just a 
U.S. phenomenon. Hewitt Associates has worked with over 20 
major U.S. employers to extend broad-based stock option and 
stock purchase plans to hundreds of thousands of employees in 
well over 100 countries. We have also worked with dozens of 
non-U.S. employers in implementing broad equity programs for 
employees in their home countries, and increasingly, for their 
employees around the world. At the present time, we are 
actively working with clients based in at least a dozen 
countries outside of the U.S., and are aware of activity in 
many more.
    In considering legislative initiatives to encourage and 
expand employee ownership practices, we need to look beyond our 
borders to understand the global context within which these 
plans exist. A program that confers tax or other advantages in 
the U.S., but which is inflexible or structurally unsuitable 
for global implementation could cause serious difficulties for 
the growing number of U.S. multinationals extending ownership 
world wide, as well as for non-U.S. employers looking to extend 
equity participation to their U.S. employees.
    For example, one common obstacle we often face in a number 
of other countries is the inability to modify or eliminate a 
stock option program once it has been put into place. This is 
not a problem in the U.S. because of flexible law that enables 
companies to adapt to the changing business environment on an 
ongoing basis.
    In another instance, one U.S. multinational employer has 
established a global stock purchase plan, complete with payroll 
deductions and an employer match. While not fully aligned with 
the U.S. plan, due to differences in the law, the goals of the 
foreign and domestic plans are the same: to encourage employee 
equity in the company. Flexibility in U.S. law has enabled 
employers to mimic plans in other countries, expanding the 
global reach of employee ownership.

     Refrain from ERISA-like Regulation

    In considering legislation to expand the use of stock 
options, I urge Congress to keep stock option plans separate 
and distinct from qualified benefit plans that are regulated 
under the Employee Retirement Income Security Act (ERISA). 
Requirements such as nondiscrimination testing, contribution 
limits, compensation limits, that are at the heart of ERISA 
will create an enormous disincentive for employers to offer 
stock options on a broad basis to their workers.
    In summary, employee ownership is a significant and growing 
force here and abroad. Used effectively, it has a demonstrable 
connection with superior economic results, and the utility of 
this approach is increasingly being recognized around the 
world. The U.S. has been a pioneer in this area, largely 
because of the flexibility of our broad ownership mechanisms. 
There are certainly opportunities to build on this success by 
creating new vehicles and enacting new incentives, but we must 
be careful not to trigger unhelpful side effects by adding too 
much complexity in our quest to improve an already very 
successful array of practices.
    Thank you for the opportunity to testify before the 
Subcommittee today. I'd be happy to respond to any questions or 
follow up with further information.
      

                                


    Chairman Houghton. Thanks very much, Mr. Butler.
    Now I would like to ask Mr. Coyne to inquire.
    Mr. Coyne. Thank you, Mr. Chairman.
    Mr. Cook, based on your long experience in this field that 
you outlined earlier, what do you consider is the key to 
getting employees to participate in these stock option plans?
    Mr. Cook. Sir, the question was what is the key to getting 
employees to participate. I believe the key, as identified in 
Chairman Houghton's bill, would be to permit employee 
contributions to be made on a pre-tax basis. They now are 
required to be made on a post-tax basis. That puts employee 
stock purchase plans at a disadvantage versus Section 401(k) 
plans, where pre-tax contributions are made. That is my answer, 
sir.
    Mr. Coyne. Ms. Sussman, I wonder if you could profile what 
types of employees currently participate in these plans.
    Ms. Sussman. What types of employees currently participate 
in all sorts of plans?
    Mr. Coyne. Yes. Who are the ones that generally take 
advantage of this? Is there a profile to these employees?
    Ms. Sussman. We don't have a profile, per se. But based 
again on the surveys that we conduct every other year, what we 
have seen is plans are typically a little bit more top-heavy, 
but over the last couple of years plans have been pushed 
further down into the ranks. So, at this time, I still think 
there are more higher-level employees that are involved in 
employee stock plans, the incentive stock options, the 
restricted stock awards, those types of things. But broad-based 
plans are becoming a little bit more prevalent and they tend to 
participate in employee stock purchase plans, non-qualified 
options. But management versus rank-and-file is really where we 
see the differences in employees. Does that answer your 
question?
    Mr. Coyne. Yes.
    Mr. Capuano, is that the experience you have seen in your 
company?
    Mr. Capuano. Proxicom is generally considered to be part of 
the high-tech industry and we do not have a culture of 
management and rank-and-file. In the high-tech industry, 
everybody participates. The participation creates a passion 
that exists within the company, to succeed. High-technology is 
a very competitive industry. It is a global industry, and these 
options create a real sense of ownership and passion in our 
employees to succeed, to have the company succeed.
    So, because it is a competitive industry and we need this 
passion to succeed, there is no management and rank-and-file, 
and everybody typically participates.
    Mr. Coyne. So, you don't see this separation from the 
higher-paid employees versus the lower-paid employees in taking 
advantage of these stock options?
    Mr. Capuano. Oh, absolutely not. Absolutely not. Everybody 
needs to be incented across the board in this industry. 
Absolutely not. Everybody participates.
    Mr. Coyne. Thank you.
    Chairman Houghton. Mr. Boehner?
    Mr. Boehner. Well, thank you, Mr. Chairman. Again, thank 
you for having the hearing and thank you for inviting me to 
come. Let me thank the witnesses for what I think was very 
excellent and helpful testimony.
    Mr. Capuano, the purpose of stock options is obviously to 
help employees think like owners. But, as you described, when 
workers exercise their option, the current tax treatment of 
many of those options really does, in fact, force them to sell 
their shares.
    I guess my concern is what happens to the employee? What 
happens to the management team in terms of the incentives for 
the employee to be a strong member of the team, as opposed to 
the idea that we have been discussing about encouraging 
employees to hold their shares for longer periods of time?
    Mr. Capuano. The employees, by being forced to sell shares 
of stock in a company such as Proxicom that they have a passion 
to build, creates a couple feelings. There is a sense almost of 
disappointment, and I have had and I have seen, as the 
employees come knocking on my door, trying to figure a way of 
how they should deal with this situation, a true sense of 
disappointment that they have to sell shares in a company that 
they are passionate about building.
    In the bigger scheme of things, we feel it creates an 
unnecessary risk that our shareholder employees are becoming 
detached from the long-term success of the company. We want all 
of our shareholder employees to be long-term holders. That is 
not to say that they are not going to sell over time, but it 
definitely creates an unnecessary division between long-term 
ownership and the success of the company. I hope that answered 
your question.
    Mr. Boehner. Well, let me expand on that just a bit. Can 
you paint a picture for me of what you think would happen to 
your fellow employees if, in fact, the company got a deduction 
for the value of the stock option, if the employee had no tax 
treatment until such time as they actually sold the shares, but 
not at exercise, and, thirdly, if, in fact, they held those 
shares for at least a year, they got capital gains treatment?
    What you think the advantages or disadvantages to both the 
company and to your employees would be?
    Mr. Capuano. The real advantage to the company will be very 
strategic. The employees, again because they are--especially in 
this very competitive industry--very, very excited about being 
owners of our company, they will hold the stock. I am not going 
to say everybody will. But I know the Proxicom employees. They 
will hold the stock. They will be shareholder owners and it 
will drive our growth that much more.
    What we sacrifice by having them sell early is up-side to 
both the company and the employees. And it is real and you see 
it when you have the employees knocking on your door, 
disappointed about having to sell early. They want to share in 
the up-side. They want to drive the up-side of the company.
    So, you have two areas of concern. Again, from a strategic 
perspective, we see a real value in having our employees be 
long-term shareholders. We know that drives our bottom line, 
profitability. From our employees, we also see that they 
sacrifice gain. And I have seen it from a very real perspective 
when they are forced to sell early and the stock has 
appreciated.
    Mr. Boehner. To Ms. Schopp and Mr. Butler, my interest in 
this is trying to find a way to encourage more companies to 
offer stock options to a wide array of their employees. 
Clearly, I would hope that companies that would take advantage 
of this idea, if it becomes law, would encourage them to all of 
their employees.
    My question is do you think that--either the package--and 
not that I want to get into a debate about my package versus 
Mr. Houghton's--but do you believe that the concept that we are 
both talking about would encourage more employers to offer a 
wide array--offer stock options to a wider array of their 
employees?
    Ms. Schopp. It has merit for both employers and employees. 
I think the bills provide the flexibility for employers to be 
able to pick the elements that make sense within their strategy 
and their focus and it allows employees to really have the 
opportunity to take an ownership interest in their company. I 
think from a real example perspective, Monsanto first granted 
broad-based stock options to all employees worldwide in 1996.
    So, we have had the opportunity over that time frame to see 
the real impact that that has had on our people. As we go to 
our plants around the world and we see our hourly technicians 
really taking a real interest in the performance of Monsanto 
and the stock price and what they can be doing on a day-to-day 
basis to make Monsanto a better place to work and more 
economically viable, it has really been a real learning 
experience for us in the design of our programs.
    So, I would really encourage continued emphasis on the 
areas that you have been both focusing on, because I think that 
they both have a real place in the ownership needs of companies 
and employees going forward.
    Mr. Butler. If I can add to that, yes--I think the simple 
answer is yes, additional tax incentives will tend to 
accelerate the trend that we are already seeing playing out. 
There are larger forces at work in terms of competitiveness, 
the shift to a knowledge-based economy and so forth that are 
leading employers to look to alternative forms of compensation 
like this already.
    I think making it more attractive from a tax perspective on 
both the employer and employee sides will certainly accelerate 
and extend that trend. One additional point, though, I think 
there is an important distinction to keep in mind and it points 
to a common area of confusion for people delving into this area 
for the first time, and that is simply the nomenclature of 
stock options versus stock purchase plans.
    Obviously, there is a good deal of overlap and there are 
good reasons that the term "stock options'' is often used in 
the context of stock purchase plans, but there is a fundamental 
structural difference between the two. If we are looking for 
the broadest application and the broadest participation in 
company equity, generally speaking, that leads you towards a 
true stock option kind of alternative.
    We see that being used for broad-based programs, where 
companies are extending options to very broad populations on 
essentially an automatic basis. There is no payroll deduction 
required. There is typically no out-of-pocket money required, 
and therefore it is very easy for a company to say we are going 
to essentially extend this practice to all employees or some 
other very broad definition.
    When you are dealing with a voluntary, contributory kind of 
plan, typically stock purchase plans, where you are asking 
people to sign up for payroll deduction (and this gets to the 
point Mr. Coyne was mentioning before), you do tend to see 
somewhat skewed participation because the simple reality is you 
are asking people to allocate a limited pool of discretionary 
dollars.
    So, you do see participation in voluntary plans like stock 
purchase plans somewhat skewed towards the higher end of the 
pay scale because the simple reality is lower-paid people do 
not necessarily have the additional discretionary income to 
participate. So, extending the plan is one thing; actually 
getting a broad cross-section of the population participating 
is another, and the broadest participation tends to come with 
options rather than purchase plans because it is simply easier 
to do that on an automatic basis.
    Ms. Schopp. If I could add one item; over the years, 
employees have really now understood the advantage of pre-tax 
contributions and payroll deductions, I think as Mr. Cook 
mentioned earlier. And I think that the features in the 
employee stock purchase plan that would add those features to 
stock purchase plans would really be valuable and I think 
employees would understand them very quickly because they are 
used to those kind of features in 401(k) plans.
    Chairman Houghton. Thanks very much.
    Mr. Weller?
    Mr. Weller. Thank you, Mr. Chairman, and I want to commend 
you for conducting what I think is an important hearing; and, 
of course, I also salute you and Mr. Boehner for your 
leadership on initiatives to promote what I label worker 
capitalism. I am a strong believer in giving the workers equity 
and giving them an opportunity to have a stake in the success 
of a company; and I certainly believe it not only rewards 
workers, but it motivates workers to move their company and 
their organization forward.
    Mr. Butler, I would like to direct my first question to 
you. I am one who believes that our tax code has an impact on 
global competitiveness. I believe our tax code has an impact on 
our ability not only to compete overseas, but also to attract 
and keep employment here in America, whether it is our outdated 
depreciation treatment of various assets or other tax issues.
    But the question I have for you, you have indicated that 
your company does business around the world.
    Mr. Butler. Yes.
    Mr. Weller. And I was just wondering, from your 
perspective, do you believe encouraging employee ownership and 
giving employees a greater personal ownership stake in 
individual companies helps the United States from a global, 
competitive standpoint?
    Mr. Butler. Not only do I believe that, certainly our 
clients believe that; and interestingly so do an increasing 
number of foreign governments. There are specific policy 
initiatives in the U.K. and China, for example, that are 
explicitly aimed at increasing the level of employee ownership 
because they understand--they believe very firmly--that one of 
the components of our economic success has been our ability to 
use these kinds of broad ownership mechanisms very effectively 
to drive economic performance.
    Some of my colleagues are currently working with senior 
officials in the Ministry of Finance in China, providing 
technical advice on creating a framework for stock options in 
China. So, yes, I firmly believe it. Our clients firmly believe 
it, and increasingly people who have looked at the issue around 
the world believe that an effective structure that not only 
permits, but promotes broad employee ownership is absolutely a 
contributing factor to economic success.
    Mr. Weller. Well, China and many of these other companies 
are competitors of ours on an economic front; and obviously we 
want free and fair trade with them. Of course, with the 
enactment of permanent normal trade relations with China, we 
have made that commitment to our friends in China. Let me ask 
you this. These other countries that you are helping develop 
policies to encourage greater employee-and worker-ownership of 
companies, do they have policies that we do not have which are 
better and that are working there?
    Mr. Butler. Let me give you the two specific examples I 
mentioned, the U.K. and China. In the U.K., there actually is 
new legislation just passed this summer that creates a vehicle 
that in many ways reflects elements of both Mr. Boehner's and 
Mr. Houghton's bills. It is essentially a pre-tax payroll 
deduction, stock purchase opportunity with a matching feature 
that resembles these proposals in many respects.
    So, yes, in the U.K. in particular, there is a program in 
place it is expected to contribute significantly to the 
extension of employee ownership. They have a long tradition of 
it already and it is generally felt in the ownership community 
that the new legislation will, in fact, promote broader use of 
these approaches.
    In China and lots of other less-developed countries, the 
issues are rather different. It is not so much do they have 
programs that we do not or tax or other structures that we do 
not that would encourage it. In fact, in a number of countries 
like China, the real barrier to effective use of these programs 
is that they do not have a well-developed structure of property 
rights and contract rights and clarity around tax and 
securities treatment.
    Increasingly, that is being addressed around the world and 
I mentioned the other countries--
    Chairman Houghton. Can I just interrupt, Mr. Butler? We 
really do have a time crunch here. So, if you could shorten 
those answers so Mr. Weller can ask some other questions.
    Mr. Weller. I will let him finish answering the question 
and then I will be done. How about that, Mr. Chairman?
    Chairman Houghton. Thank you.
    Mr. Butler. The point is really that around the world an 
increasing number of countries are in the early stages--
primarily outside of Europe--in the early stages of developing 
an infrastructure that will allow for the further development 
of these kinds of practices. I think it is fair to say the U.S. 
is head and shoulders above the rest of the world. The U.K. and 
France have fairly well-developed practices. But outside of 
those two examples, we clearly have been the pioneers, are 
continuing to be the leaders. And with these kinds of 
initiatives, I think we will maintain our leadership position.
    Mr. Weller. Thank you. May I ask one more?
    Chairman Houghton. Yes.
    Mr. Weller. Thank you, Mr. Chairman. Actually, let me 
direct my last question--I know we have a vote here and we are 
a little limited on time--to Ms. Sussman, from the perspective 
of the National Association of Stock Plan Professionals. The 
public perception of stock options is that it is a new-economy 
thing. You hear of these high-tech start-ups that are a few 
days old and they are offering stock options to attract talent 
to come to work for them.
    What is, from your perspective, the more traditional, 
older, established old-economy companies? Are you seeing more 
and more of the older, more-established companies looking at 
setting up stock option plans and what are some of the 
challenges that they have converting to that type of employee 
benefit?
    Ms. Sussman. I think older, more-established companies have 
always had stock option plans. I think they have typically been 
more geared toward the higher-level employees, senior 
executives, key employees, even though all employees are 
technically eligible to participate. I think, as the new-
economy companies have come into being, the challenges for the 
older, more-established companies has been to offer more, 
bigger option packages and push those further down into the 
company so that they can, in fact, retain the workers that 
would otherwise be going to the .coms.
    It has become a big issue. It is a big challenge for the 
bigger companies and what we have seen are different types of 
option programs coming into being that pretty much can compete 
with the .com companies. There are other restricted stock 
awards that have come into play; gosh, all sorts of other 
things, huge bonuses and retention packages, all of those 
things that are keeping people or are trying to keep people 
from going off to the .coms.
    But I think they have always had them. They have just had 
to take on a different face in order to compete successfully 
and keep those workers.
    Mr. Weller. So, the older, more-established companies, from 
what you are saying, are now looking at not just giving this 
benefit to their senior management, but also to the assembly 
line worker and their clerical help and administrative help in 
the offices?
    Ms. Sussman. Yes, even though it may be a token sort of 
plan. I mean, we have seen a lot of that, too; 100 shares for a 
founder's grant or 100 shares annually or 100 shares every 
three years or something like that. I mean, they are very token 
plans in many cases and very simple; and they set them up so 
that they are very simple to administer. But, yes, there seems 
to be sort of a trend toward that.
    Mr. Weller. Will Chairman Houghton's legislation, as well 
as Mr. Boehner's legislation, would that help these older, 
more-established companies make this kind of conversion so that 
the little guys and little girls in the old-economy companies 
will also be able to participate?
    Ms. Sussman. To the extent that most of the broad-based 
plans that I have seen are non-qualified in any event, it is 
not clear to me how that would really make that much of a 
difference. I think, for employee stock purchase plan 
participation, some of the initiatives to make that a pre-tax 
payroll deduction, greater tax incentives along those lines--I 
think would help that sort of plan. The broad-based plans that 
I have seen are typically non-qualified anyway, which companies 
are happy to do because of the tax deduction that that 
involves. So, it is not really clear to me how that would play 
out.
    Mr. Weller. What is the biggest challenge these old-economy 
companies have in making that kind of conversion, to giving 
their employees further down the pecking order the opportunity 
to participate? What is the biggest roadblock?
    Ms. Sussman. Administration. The bigger the company, the 
bigger the administrative issues are involved. You know, you 
get an IBM or any other huge company that has got 30,000 or 
40,000 employees here and abroad to grant a one-time grant of 
100 stock options to every employee worldwide and it becomes 
sort of an administrative challenge, especially if it is going 
to be just a one-time thing or if everybody is going to be 
cashing out immediately through a cashless exercise sort of 
mechanism.
    I would say that that is probably the biggest issue.
    Mr. Weller. Thank you.
    Thank you, Mr. Chairman, for holding this hearing.
    Chairman Houghton. Not a bit. Thanks very much, Mr. Weller.
    We have got a time crunch. You have never heard that 
before--have you--because we have got to go over and vote now. 
But let me just sum up in my own mind here. If I understand 
what you are saying, that the basic building blocks of either 
Mr. Boehner's or my bill does what you want; in other words, 
all employees, virtually all employees are eligible; the tax 
consequences in terms of pre-tax contributions for employees 
are what you want; the deduction at fair market value the day 
of exercise for employers is right; and have no implications 
for the AMT on the exercise of these options.
    Am I summing that up right? Are there any other things--
because if I am and we want to keep in touch with you, then we 
are going to go right ahead and plow through this. Have you got 
any comments?
    Mr. Cook. Mr. Chairman, I think that is an excellent 
summary. I would merely only add one, and that is that the 
legislation should address the employment tax, FICA and 
Medicare obligations on employees when they pay ordinary income 
tax. That would be a very important feature, too. The AMT 
broad-based participation, pre-tax and corporate tax deduction, 
as you summarize, those are the foundations of encouraging 
companies to offer these plans more and to encourage the 
employees to participate at a greater level of participation.
    Chairman Houghton. Well, look, I am sorry that time is 
running out and I really appreciate this. I think this is very, 
very, very important stuff and we are only going to begin this 
process now. If we can get this thing through, we can do other 
things which are important in terms of trying to narrow this 
gap between the very, very top-paid individuals and the people 
who are down the line.
    So, thanks so much.
    [Whereupon, at 11:28 a.m., the hearing was adjourned.]
    [A submission for the record follows:]
                                           Amazon.com, Inc.
                             Seattle, Washington 98108-1226
                                                   October 18, 2000

The Honorable Amo Houghton
Chairman, Subcommittee on Oversight of the
Committee on Ways and Means
United States House of Representatives
1102 Longworth House Office Building
Washington, DC 20515

1Re: Hearing on Employee Stock Option Plans

Dear Chairman Houghton:
    We appreciate the opportunity to comment on proposed changes in the 
Federal tax treatment of employee stock option plans. In short, 
Amazon.com would strongly support any proposals that would encourage 
widespread employee stock ownership and promote vigorous competition by 
innovative new enterprises.
    Amazon.com must attract, retain, and motivate the most talented and 
versatile employees if it is to succeed in its drive to become the 
earth's most customer-centric merchandiser. It offers its employees an 
opportunity for challenge, growth, and hard work in an exciting and 
rewarding environment as part of a team of unusually talented 
individuals.
    The intensely competitive nature of Amazon.com's business, its 
emphasis on rapid growth, and the demands of a global Internet business 
require that employees make a serious commitment of time and energy to 
it. Amazon.com believes that all full-time employees should be 
"owners'' of the business, in order to align incentives, encourage 
responsible and owner-like commitment, and to ensure that any rewards 
that result from building stockholder value are shared throughout the 
company. It is committed to the philosophy of employee ownership and to 
fostering a work environment grounded in mutual respect. Accordingly, 
all regular full-time employees of Amazon.com currently receive stock 
options upon their hire.
    While Amazon.com offers both qualified and nonqualified stock 
options, the majority of the options issued are nonqualified, because 
of the Federal income tax limitations placed on qualified options. 
Under Amazon.com's stock option plan, an employee receives stock 
options on his employment start date. The options vest, or become 
exercisable, over 5 years and are generally exercisable over 10 years, 
provided that the employee remains an employee of Amazon.com during 
such time.
    The price of the option is determined on the employee's start date 
and is equal to the fair market of the stock at that date. The fair 
market value is the average of the high and low price at which the 
stock was traded on the NASDAQ exchange on the employee's start date.
    Once an employee's options vest, the employee may exercise his 
options and acquire Amazon.com stock at the exercise price provided in 
the option. If the options at issue are nonqualified stock options, the 
employee recognizes compensation income upon exercise. If the options 
are qualified options, and there is no disqualifying disposition, the 
employee recognizes no income upon exercise of the option. In either 
case, on the exercise date, the employee has received no cash. Thus, in 
order to pay the tax assessed at the exercise date for nonqualified 
options, an employee must sell some of his Amazon.com stock or take out 
a loan. A similar result occurs with respect to the alternative minimum 
tax on qualified options.
    As noted above, Amazon.com relies on its stock option plans to 
attract, reward, and retain employees in a very tight labor market. 
Additionally, cash is always at a premium for a start-up company. 
Absent the ability to offer equity-based compensation, Amazon.com could 
not compete with established companies in cash-rich industries for the 
premier talent necessary to help it achieve its overall business goals. 
The barriers to entry for a company in an Internet environment are low, 
resulting in significant competition for scarce resources. The lure of 
the upside equity potential has been the single most effective tool 
enabling Amazon.com to attract experienced financial and technical 
personnel to work in the dynamic and fast-paced environment in which it 
operates. Moreover, the employees are truly owners, and their 
compensation is tied to the success of the company. Employees accept 
less cash compensation than they could get elsewhere, in return for the 
opportunity to share in the future success of the company through stock 
options.
    Of course, the fact that Amazon.com is allowed a Federal income tax 
deduction with respect to the exercise of nonqualified options may one 
day help us to minimize cash expenditures, in the form of income tax 
payments. This deduction, however, is not a tax subsidy, in that it 
accurately reflects the employer's net income under Federal income tax 
principles. In other words, the employer is compensating its employees 
by carving out and granting them a portion of its equity. It could 
achieve the same economic effect by selling its shares and using the 
cash proceeds to compensate its employees. In that economically 
indistinguishable case, no one would deny that a compensation deduction 
was warranted.
    We appreciate this opportunity to express our support for changes 
in the Federal income tax law that will encourage employee stock 
ownership and facilitate a long-term ownership commitment on the part 
of both employers and employees.
            Sincerely,

                                          Robert D. Comfort
                               Vice President of Tax and Tax Policy

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