[Senate Hearing 108-671]
[From the U.S. Government Publishing Office]



                                                        S. Hrg. 108-671
 
                  OVERSIGHT HEARING ON EXPENSING STOCK
                 OPTIONS: SUPPORTING AND STRENGTHENING
                   THE INDEPENDENCE OF THE FINANCIAL
                       ACCOUNTING STANDARDS BOARD

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

                                HEARING

                               before the

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                                 of the

                              COMMITTEE ON
                          GOVERNMENTAL AFFAIRS
                          UNITED STATES SENATE


                      ONE HUNDRED EIGHTH CONGRESS

                             SECOND SESSION

                               __________

                             APRIL 20, 2004

                               __________

      Printed for the use of the Committee on Governmental Affairs


94-481 PDF

For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov  Phone: toll free (866) 512-1800; (202) 512-1800  
Fax: (202) 512-2250 Mail: Stop SSOP, Washington, DC 20402-0001



                   COMMITTEE ON GOVERNMENTAL AFFAIRS

                   SUSAN M. COLLINS, Maine, Chairman
TED STEVENS, Alaska                  JOSEPH I. LIEBERMAN, Connecticut
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
NORM COLEMAN, Minnesota              DANIEL K. AKAKA, Hawaii
ARLEN SPECTER, Pennsylvania          RICHARD J. DURBIN, Illinois
ROBERT F. BENNETT, Utah              THOMAS R. CARPER, Delaware
PETER G. FITZGERALD, Illinois        MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

           Michael D. Bopp, Staff Director and Chief Counsel
      Joyce A. Rechtschaffen, Minority Staff Director and Counsel
                      Amy B. Newhouse, Chief Clerk

                                 ------                                

     FINANCIAL MANAGEMENT, THE BUDGET, AND INTERNATIONAL SECURITY 
                              SUBCOMMITTEE

                PETER G. FITZGERALD, Illinois, Chairman
TED STEVENS, Alaska                  DANIEL K. AKAKA, Hawaii
GEORGE V. VOINOVICH, Ohio            CARL LEVIN, Michigan
ARLEN SPECTER, Pennsylvania          THOMAS R. CARPER, Delaware
ROBERT F. BENNETT, Utah              MARK DAYTON, Minnesota
JOHN E. SUNUNU, New Hampshire        FRANK LAUTENBERG, New Jersey
RICHARD C. SHELBY, Alabama           MARK PRYOR, Arkansas

                   Michael J. Russell, Staff Director
              Richard J. Kessler, Minority Staff Director
            Nanci E. Langley, Minority Deputy Staff Director
                       Tara E. Baird, Chief Clerk



                            C O N T E N T S

                                 ------                                
Opening statements:
                                                                   Page
    Senator Fitzgerald...........................................     1
    Senator Akaka................................................     5
    Senator Bennett..............................................     5
    Senator Levin................................................     7
    Senator Lieberman............................................    13

                               WITNESSES
                        Tuesday, April 20, 2004

Hon. Mike Enzi, a U.S. Senator from the State of Wyoming.........    16
Hon. Barbara Boxer, a U.S. Senator from the State of California..    20
Robert H. Herz, Chairman, Financial Accounting Standards Board...    23
Hon. Paul A. Volcker, Chairman, International Accounting 
  Standards Committee Foundation, and former Chairman, Board of 
  Governors, Federal Reserve System..............................    26
Jack T. Ciesielski, President, R.G. Associates, Inc..............    46
Damon Silvers, Associate General Counsel, The American Federation 
  of Labor--Congress of Industrial Organizations (AFL-CIO).......    49
Donald P. Delves, President, The Delves Group....................    51
Mark Heesen, Presdient, National Venture Capital Association.....    52
James K. Glassman, Resident Fellow, American Enterprise Institute    54

                     Alphabetical List of Witnesses

Boxer, Hon. Barbara:
    Testimony....................................................    20
    Prepared statement...........................................    77
Ciesielski, Jack T.:
    Testimony....................................................    46
    Prepared statement with an attachment........................    89
    Addition to written statement................................    97
Delves, Donald P.:
    Testimony....................................................    51
    Prepared statement with an attachment........................   100
Enzi, Hon. Mike:
    Testimony....................................................    16
    Prepared statement...........................................    73
Glassman, James K.:
    Testimony....................................................    54
    Prepared statement...........................................   112
Heesen, Mark:
    Testimony....................................................    52
    Prepared statement...........................................   105
Herz, Robert H.:
    Testimony....................................................    23
    Prepared statement...........................................    80
Silvers, Damon:
    Testimony....................................................    29
Volcker, Hon. Paul A.:
    Testimony....................................................    26
    Prepared statement...........................................    86

                                Appendix

Prepared statements from:
    American Institute of Certified Public Accounts..............   126
    Association for Investment Management and Research...........   128
    William R. Sweeney, Jr., Vice President, on behalf of 
      Electronic Data Systems Corporation........................   143
    Coalition to Stop Stock Options..............................   145
Letter to The Honorable Robert H. Herz from Senator Enzi dated 
  December 5, 2003...............................................   148
Article from the Wall Street Journal entitled ``FASB Chairman 
  Calls For Investors To Speak Up On Options,'' submitted by 
  Senator Enzi...................................................   150
Letter of clarification from Mark Heesen, President, NVCA, dated 
  April 30, 2004.................................................   152
``The Analyst's Accounting Observer,'' submitted by Mr. 
  Ciesielski.....................................................   153
The study entitled ``Corporate Governance, Executive 
  Compensation, and Strategic Human Resource Management From 
  1992-2002, A Portrait Of What Took Place,'' by Professors 
  Joseph R. Blasi and Douglas L. Kruse...........................   212
Questions and Responses for the Record from:
    Mr. Herz.....................................................   270
    Mr. Volcker..................................................   285
    Mr. Ciesielski...............................................   290


     OVERSIGHT HEARING ON EXPENSING STOCK OPTIONS: SUPPORTING AND 
 STRENGTHENING THE INDEPENDENCE OF THE FINANCIAL ACCOUNTING STANDARDS 
                                 BOARD

                              ----------                              


                        TUESDAY, APRIL 20, 2004

                                     U.S. Senate,  
                  Financial Management, the Budget, and    
                     International Security Subcommittee,  
                  of the Committee on Governmental Affairs,
                                                    Washington, DC.
    The Subcommittee met, pursuant to notice, at 2:33 p.m., in 
room SD-342, Dirksen Senate Office Building, Hon. Peter G. 
Fitzgerald, Chairman of the Subcommittee, presiding.
    Present: Senators Fitzgerald, Bennett, Akaka, Levin, and 
Lieberman.

            OPENING STATEMENT OF SENATOR FITZGERALD

    Senator Fitzgerald. This meeting will come to order. I 
would like to thank all of the witnesses who are here today to 
testify. Some of you came very long ways and made special 
arrangements in otherwise very busy schedules to be here, and 
we definitely appreciate that very much.
    This oversight hearing is to examine the new Financial 
Accounting Standards Board rule which will require companies to 
expense an estimate of the value of stock option compensation 
to their employees and management. I will state up front that I 
agree with FASB's new rule and that I favor it.
    Several bills regarding this issue have been introduced in 
Congress, both in the House and the Senate, and there is going 
to be a hearing on the House side tomorrow to examine some of 
those bills. We will hear today from Senator Enzi, who is a 
proponent of one of these bills. The bills in varying forms 
would move to disallow FASB's new rule or to mandate the 
treatment of stock option compensation for accounting purposes 
as a matter of Federal law.
    I disagree with those bills, and I oppose them for two 
reasons: One, I agree with the new FASB rule, although I think 
it could be stronger. I think it is actually thoroughly 
permissive, but I nonetheless support it. But two, I believe 
that political interference with our private sector standards 
accounting board is a dangerous precedent, and one can think of 
all sorts of other areas in which we could follow this 
precedent. What if Congress started usurping the authority of 
the Food and Drug Administration to allow a new pharmaceutical 
to be introduced on the market? I think it is a bad idea for 
politicians in the House and the Senate to be substituting 
political decisions for an expert agency, or in this case, an 
expert private sector accounting standards board.
    We have been down this road before. Back in 1993-94 FASB 
proposed a new rule that would have required the expensing of 
stock option compensation. At that time Senator Lieberman 
introduced a resolution in the Senate which condemned FASB's 
new rule. I think the vote was 88 to something. It was very 
lopsided in favor of Senator Lieberman's resolution. And a 
separate bill was introduced that would have effectively put 
FASB out of business if they did not back down from their new 
rule that would have required the expensing of stock options. I 
think Congress' interference with that 1993-94 proposal of FASB 
resulted in disastrous consequences.
    One of my most vivid recollections in my last 5 plus years 
in the Senate was sitting in on the Enron hearings in the 
Commerce Committee, where we saw a company which had its top 29 
executives cash in 1.1 billion in stock option compensation in 
the months immediately prior to the company's stock market 
collapse and eventual bankruptcy. I think that the Senate 
opened the floodgates to an anything goes accounting mentality 
in the late 1990's, and many other companies wound up like 
Enron, Global Crossing, WorldCom, and so forth.
    Opponents of the new FASB rule say that it is difficult to 
estimate the value of options. I am not sure I really agree 
with that. I think options can be sold for cash which makes 
them as good as cash. Warrants are similar if not functionally 
the same as options, and they are valued and sold all the time. 
Options on stocks are traded on markets all over the world. In 
Chicago we have the world's largest option exchange, the 
Chicago Board Options Exchange. My guess is that many 
executives who have copious amounts of options sometimes assign 
huge values to them on their own personal financial statements 
when they go to borrow from a bank. In fact, as a former 
banker, I recall seeing financial statements where executives 
holding large amounts of options would list them as a 
substantial asset on their personal financial statements.
    In any case, it is difficult to value a lot of other things 
for which we require companies to account. It is certainly 
difficult to estimate pension liabilities, the value of 
derivative positions. If you are a bank, it is very difficult 
and a matter of imprecision to estimate what your loan loss 
reserve should be. Impairment of goodwill is very difficult to 
assess, and even the age-old question of what is the useful 
life of plant and equipment. That is a very difficult 
accounting decision. Yet no one argues that for these other 
items, difficulty to estimate gives a company license to 
pretend that these expenses do not exist either.
    Opponents say that stock options require no cash outlay by 
a company and that they therefore need not be expensed. But 
depreciation, for example, requires no cash outlay either, and 
no one argues that we should not try to account for the real 
expense of the using up or the exhausting of plant and 
equipment that a company will have to replace. Furthermore, 
large amounts of stock options often later necessitate large 
cash outlays. Companies sometimes have to use more cash on 
share repurchases to stem shareholder dilution than they would 
have on cash compensation for their employees.
    Opponents say stock options are not a real expense to a 
company. If that is so, why do we allow companies to take a tax 
deduction for the expense of issuing stock options? If the 
opponents were consistent in their thinking, they would support 
changing the current IRS rules which allow for the tax 
deductibility of stock option compensation.
    Opponents say that requiring options to be expensed would 
penalize the earnings of young promising companies, and thereby 
make it more difficult for such companies to survive and 
succeed. But as Warren Buffett has written, ``Why then require 
cash compensation to be recorded as an expense given that it 
too penalizes the earnings of young promising companies?'' 
Going further, Mr. Buffett asks, ``Why not allow companies to 
pay all of their expenses in options and then pretend that 
these expenses don't exist either?'' In fact, I know that many 
companies have in fact paid a lot of their bills in options. I 
have talked to a lot of law firms in Chicago that took stock 
options in lieu of cash in the late 1990's for their legal 
bills.
    I would like to focus for just a moment on the shareholder 
dilution impact of stock options. Last night it occurred to me 
to pull out the classic 1934 edition of ``Security Analysis'' 
by Benjamin Graham and David Dodd. I looked to see if they had 
anything in there about stock options, and they do in fact have 
a whole section on what in 1934 they called ``stock option 
warrants,'' which seem effectively the same thing. They said 
stock option warrants were frequently paid to managers or 
insiders in companies or to promoters of stock. In the 1920's 
and early 1930's it was common when someone would sell your 
stock, you would give them stock option warrants as 
compensation. Benjamin Graham and David Dodd, I think, are very 
eloquent in describing what the effect is when companies issue 
options.
    In a company that has common shares only and no options, 
the common shareholders will capture 100 percent of any future 
rise in the value of the company. Common shareholders have an 
inherent right to the future enhancement or improvement in the 
value of a company. When you issue options, you are allowing 
someone else a claim on the future enhancement in the community 
that is diluting the formerly 100 percent claim on the future 
enhancement or growth in the company that the shareholders had. 
If a company's prospects for future revenue and earnings growth 
are strong, the value that is taken away from common 
shareholders by issuing stock options and given to the option 
holders can be quite substantial. In fact, if enough stock 
options are issued, nearly all of the common shareholders' 
stake in the future rise in the value of the company can be 
taken away from them. From my standpoint, there is nothing 
inherently wrong with taking a share of the future rise in the 
growth of a company away from the shareholders and giving it to 
the management or the employees or someone else. There is 
nothing inherently wrong with that. In fact, when we pay cash 
compensation, you are taking cash away from the shareholders 
and giving it to someone else.
    What troubles me is that this taking away, this subtraction 
from the shareholders' interest, is not disclosed to the 
shareholders or to other investors who may be looking at this. 
The trouble is that current accounting standard do not require 
that the taking away of value from the shareholders by virtue 
of the issuance of stock options be fully disclosed. Companies 
are not now required to reflect the expense of issuing options 
on their income statements. Moreover, the dilution of 
shareholders' claims to the earnings of the company is only 
disclosed for so-called ``in the money'' options, but is not 
required to be disclosed for options that have been issued and 
are not yet in the money.
    Benjamin Graham and David Dodd had a very simple way of 
looking at this. They said that the value of common stock plus 
the value of stock options equals the value of the common stock 
alone if there were no stock options. Thus, the way they put 
it, when you give stock options to someone, you are taking away 
something of value from the shareholders and this needs to be 
reflected. It should be reflected. If I could just read a 
paragraph from this book because Benjamin Graham went on to 
describe stock option warrants as a very dangerous device for 
diluting stock values. ``The stock option''--and he refers to 
it as the option warrant. I am just going to call it the stock 
option. ``The stock option is a fundamentally dangerous and 
objectional device because it affects an indirect and usually 
unrecognized dilution of common stock values. The stockholders 
view the issue of warrants with indifference, failing to 
realize that part of their equity in the future is being taken 
away from them. The stock market, with its usual heedlessness, 
applies the same basis of valuation to common shares whether 
warrants or stock options are outstanding or not. Hence, 
options may be availed of to pay unreasonable bonuses to 
promoters or other insiders without fear of comprehension or 
criticism by the rank and file of stockholders. Furthermore, 
the option device facilitates the establishment of an 
artificially high aggregate market valuation for a company's 
securities, because with a little manipulation large values can 
be established for a huge issue of options without reducing the 
quotation of common shares.''
    Under current rules, the financial statements of companies 
that do not expense stock option compensation are, in my 
judgment, fictitious. The Financial Accounting Standards 
Board's proposed new rule would make earnings reports more 
accurate and would move financial statements from the fiction 
to the nonfiction section of the public domain. When it comes 
to stock options, expensing them should not be an option. Truth 
in financial reporting should be mandatory.
    Finally, in closing, I would like to note that there were 
many companies lobbying furiously in support of the bills that 
would overturn FASB's new rule. They are all over. Lobbyists 
are swarming the halls of the Capitol, lobbying furiously. We 
asked several of them to appear before our Subcommittee and 
explain their views in public. None of them was willing to do 
so. I think the fact that none of them was willing to appear 
publicly and explain why the company is in favor of the bills 
suggests that they are sheepish about what they are doing, and 
that perhaps deep down, they too recognize the unwholesomeness 
of the fiction that they are hoping to perpetuate.
    Without further ado, I would like to turn it over to our 
Ranking Member, Senator Akaka from Hawaii. Senator Akaka, thank 
you for being here.

               OPENING STATEMENT OF SENATOR AKAKA

    Senator Akaka. Thank you very much, Mr. Chairman. It is 
always a pleasure to work with you, and I want to commend you 
for conducting this hearing today.
    I want to add my welcome to our friends and colleagues, 
Senator Enzi from Wyoming and Senator Boxer from California, 
and also our witnesses today.
    Mr. Chairman, Enron, WorldCom and other corporate 
governance failures demonstrate the dangers of not having 
independent accounting and auditing standards. The landmark 
Sarbanes-Oxley accounting reform and legislation included a 
provision that strengthened the independence of the Financial 
Accounting Standards Board, FASB, by providing a more secure 
funding mechanism through mandatory assessments on publicly-
traded companies. FASB is intended to be independent and make 
their accounting rules on the basis of its judgment.
    Now that FASB has proposed that all forms of share-based 
payments to employees, including stock options, be treated the 
same, the same as other forms of compensation by recognizing 
the related costs in the income statement, the reinforced 
independence of FASB will be tested.
    If Congress interferes with the FASB proposal, the 
dangerous precedent of intervention into accounting standards 
will be set. Congressional interference is detrimental to the 
independent nature of FASB, and accounting treatment of stock 
options is a matter best left to FASB to determine.
    We must have an independent organization establishing 
standards of financial accounting and reporting in an open 
environment that is both fair and objective. These standards 
are essential to investors having access to transparent and 
understandable information.
    The Securities Exchange Act of 1934 provides the Securities 
and Exchange Commission with authority over financial 
accounting and reporting standards for publicly-held companies. 
Throughout its history, the SEC has relied on the private 
sector for this critical function. We must protect the 
integrity of the standards for developing the process and 
exercise Congressional restraint on this matter to ensure that 
FASB is allowed to pursue policies that it considers to be in 
the best interest of the public.
    I thank you, Mr. Chairman, for this hearing, and look 
forward to the witnesses' testimony.
    Senator Fitzgerald. Thank you, Senator Akaka. Senator 
Bennett.

              OPENING STATEMENT OF SENATOR BENNETT

    Senator Bennett. Thank you very much, Mr. Chairman. I 
appreciate you holding the hearings.
    This is an issue that has been with us a long time, and it 
is an issue that does not seem to go away and does not seem to 
get resolved, and I am not quite sure I understand why, because 
there are good people of good faith on both sides of the issue. 
Let me outline that I am in favor of expensing stock options. 
Let me state that I am in favor of FASB independence, and agree 
that Congress should not be the one to be making accounting 
standards.
    Having said both of those things, and feeling very strongly 
about both of those things, I think FASB has missed the boat 
badly on this particular issue and is in danger of doing 
significant harm to our economy, and that raises the question 
of whether or not policy makers in the Congress should be 
heard, not because I do not believe in FASB independence and 
not because I am not in favor of expensing stock options. But I 
go back to the fundamental rule of medicine, which is do no 
harm, and there is a potential here for significant harm.
    I think the reason that there is this gulf between your 
position, Mr. Chairman, and my concern, is that we are assuming 
that a stock option is a stock option is a stock option, and 
they are clearly not. I am glad you quoted from the 1934 book, 
Mr. Chairman, because it represented an attitude in 1934 that 
all of these things are created equal, and they are either good 
or bad. They should be either expensed of not expensed. They 
are very clearly, in today's economy and in today's corporate 
world, nowhere near created equal. The kind of stock option 
that you were talking about, Mr. Chairman, which you said can 
be sold as cash, and you talked about a market for options in 
your home State of Illinois, is not a definition of the kind of 
stock option that has given rise to the concern here.
    Let me give you an example to illustrate this. The kind of 
stock option that can be traded immediately upon being granted, 
obviously has a significant value and a market, not that this 
kind exists, but theoretically a stock option that is 
exercisable only in 30 years has no value whatsoever. Well, 
nobody issues stock options that vest in 30 years, but I put 
those two as to outside parameters of where we are. There are 
people who give options that vest in 3 years and options that 
vest in 5 years, and options that vest longer period of time 
that are obviously on this continuum and somewhere away from 
the options that vest the day they are granted.
    When I was working for a New York Stock Exchange listed 
company in my youth and got some stock options, they were 
vested the day I received them, and back in the 1960's that was 
the norm, and therefore, a statement that they ought to have 
been expensed, to me was a logical statement. Today that is no 
longer the norm. Today you have these many gradations of the 
kind I have described, and so as I say, I am in favor of an 
expensing statement with respect to options, and I am in favor 
of FASB's independence, but I am tremendously disappointed that 
from all of the comments FASB has received from companies that 
extend options that vest at different times and have clearly 
different values, have received no consideration whatsoever in 
the FASB rule that has come down. Maybe I just do not 
understand the rule and that is why I am here at the hearings, 
but there is no question in my mind that the use of stock 
options in creative ways that an author in 1934 never 
contemplated has created significant economic value in our 
overall economy in ways that cannot be measured by either of 
the two methods that FASB had adopted.
    And to come back to the fundamental question that you 
raise, Mr. Chairman, where I am 100 percent in agreement with 
you on the principle, but in disagreement with you on the 
outcome. We want our financial statements to be accurate. We 
want our financial statements to record what is happening in 
the marketplace, and in my view, a financial statement that 
values an option that does not vest for 5 years at the same 
price as an option that vests in 24 hours is a financial 
statement that is inaccurate and misleading, and therefore, a 
problem for our investors.
    As I have talked to people on Wall Street about this, they 
have said, well, we are smart enough to figure out the real 
impact of these options, and we will ignore the article value 
being attached to these options by FASB because we understand 
that that information is wrong. So therefore, this whole thing 
will be a nullity. If that is the case, why in the world are we 
doing it if it is going to be a nullity?
    I have not signed on to Senator Enzi's bill. I have some 
problems with Senator Enzi's bill, but I have real problems 
with the way this whole thing has come down to an either/or, 
yes, you are in favor, no, you are not; yes, they should, no, 
they should not. I will sign up with the ``yes, they should'' 
guys as long as we understand that an option is not necessarily 
an option is not necessarily an option. Just because it has the 
same name, by no means says it has the same value. You have to 
look at the details of the option and value it according to 
those details before I will be comfortable with the position 
that FASB has taken.
    Thank you very much.
    Senator Fitzgerald. Senator Bennett, thank you. Senator 
Levin, I believe you were here first.

               OPENING STATEMENT OF SENATOR LEVIN

    Senator Levin. Thank you, Mr. Chairman, and thank you for 
holding these hearings. It is a very significant subject that 
we are discussing here today, and there is a long history to 
it. As we all know, 10 years ago when the effort was made by 
FASB to address this issue in the way that they felt was the 
proper way to do it as an independent standard-setting body, 
the political pressure was so heavy that they had to back off, 
and I admire FASB for doing what they think is the right thing 
to do, and I am going to do everything I can to protect that 
independence.
    It is one of the toughest accounting issues that they have 
had in their history, but I think for us to intervene here and 
to say that we know better than they do how to set an 
accounting standard here in the Congress, would be to go in 
exactly the opposite direction as Sarbanes-Oxley which was to 
try to increase the independence of FASB, as Senator Akaka 
said, by giving it an independent source of revenue.
    The issue for me is not whether or not Congress is for or 
against stock options any more than whether or not we are in 
favor of bonuses or other forms of incentive pay. Those other 
forms of incentive pay, no matter how conditional they are, are 
all treated as expenses. They are all valued one way or 
another, the best way that you can. As the Chairman said, there 
are many things that are valued that are very difficult to 
value, but there are ways of valuing, the best way that 
accountants can figure out how to do it. There is an 
independent standards board to set those rules. Without that 
independence we are going to be politicizing accounting rules 
around here which is the worst thing we can do, as far as I am 
concerned, for this market.
    Stock options, since the 1980's, have provided the majority 
of CEO pay. Every year since then the CEO compensation has gone 
up, good times and bad, while leaving average worker pay 
further and further behind. JPMorgan once said CEO pay should 
not exceed 20 times the average worker pay. In 1990 the pay gap 
between CEOs and average workers was at 100 times the pay of an 
average worker. Average CEO pay in this country is now 300 
times the average worker pay. Stock options are the largest 
single factor in that pay gap. They operate as stealth 
compensation because most U.S. companies do not show stock 
option compensation as an expense on their books. Those 
companies do deduct stock option pay as an expense on their tax 
returns. That is the double standard. That is the gimmick that 
allows companies to show a huge compensation expense deduction 
on their tax returns but zero expense on their company books. 
Stock options are the only form of compensation that companies 
are allowed to deduct as an expense on their tax returns, 
although they do not appear as an expense on their books. There 
are many additional forms of compensation which are very 
difficult to value, as Senator Bennett pointed out, that are 
nonetheless valued as an expense on the company's books. So 
there is only one exception, and that is stock options. It is 
not because of the difficulty either. It is because of the 
political pressure against doing what the accounting board has 
long ago determined was the only way that you could properly 
reflect compensation expenses on a company's books, and that is 
to show it as an expense.
    FASB wants to end that double standard, and it seems to me 
that we should not intervene and say that somehow or other we 
know better than FASB. The International Accounting Standards 
Board, whose standards affect 90 countries, is now requiring 
stock option expensing. Canada began requiring stock option 
expensing this year. A 2002 survey of financial experts by the 
Association for Investment Management and Research found out 
that more than 80 percent support stock option expensing. All 
four major accounting firms also favor expensing.
    There are many arguments that have been used against it, 
and I am going to ask that part of my statement, addressing 
those arguments, be made part of the record, Mr. Chairman.
    Senator Fitzgerald. Without objection.
    Senator Levin. One claim which I will spend one minute 
addressing is that somehow or other if we allow FASB to proceed 
independently that is going to depress the share prices of 
individual companies but also damage the stock market or the 
economy as a whole, and well-respected financial analysts 
disagree. Goldman Sachs's Global Equity Research recently 
issued a report supporting stock option expensing and said: 
``We do not expect a material impact on the share prices of 
most firms.'' UBS Investment Research said that expensing is a 
``long past due change,'' and ``medicine for the long-term 
health of companies and investors. It will shed light on the 
true profitability of many companies, helping to separate those 
that deserve investor capital from those that do not.''
    Merrill Lynch says the argument that expensing options will 
harm U.S. technology leadership and job creation is based on 
``the following faulty logic. U.S. technology leadership and 
job creation depend on the systematic misrepresentation of 
financial statements.'' They went on, ``One might as well argue 
that money spent on R&D should not count as an expense because 
it provides employment and helps industries advance.''
    There is one additional point I want to make, and that has 
to do with the Enron investigation. I was chairing the 
Permanent Subcommittee on Investigations when we had the 
hearings into Enron, and even though I do not think Congress 
should be substituting its judgment on accounting standards, 
because I do not think we are the right people to do it, we 
sure as heck can reflect our experience when it comes to 
investigations of Enron. I could not figure out how it was that 
Enron executives could be cooking the books, making loans, for 
instance, look like income, and not run into the problem of 
their books showing these huge revenues which therefore inflate 
their stock price, which therefore make their huge amount of 
options worth more, but not have to worry about paying taxes on 
those revenues.
    How is it that somehow or another an executive could figure 
out that we could show phony inflated revenue over here but not 
worry about coughing up the bucks to pay Uncle Sam the income 
taxes on those revenues which we show on our books? This is a 
little known but a very important part of Enron. The answer was 
those same stock options that were used to enrich those 
executives in a company that went bankrupt. Those stock 
options, because they are taken as a tax deduction, allowed 
Enron, 4 out of 5 years, to pay no taxes despite huge apparent 
earnings shown on their books. Just the year they went 
bankrupt, CEOs at Enron took home $123 million from exercising 
stock options, the same year that so many lost their life 
savings.
    These stock options played a very vital but yet 
unrecognized role in the Enron scandal, and it was part and 
parcel of that scandal. It probably could not have happened but 
for the role of stock options being used as a tax deduction.
    For the last 5 years before it declared bankruptcy, from 
1996 until the year 2000, while Enron was telling the world it 
was earning these huge revenues, and claiming a 5-year U.S. 
profit of $1.8 billion, the analysis of Enron's public filings 
by the Citizens for Tax Justice, showed that they deducted $1.7 
billion in stock option compensation from its tax returns as a 
business expense.
    I think we ought to support the independence of FASB and we 
ought to base that, first, on their independence, and our 
determination hopefully to reflect their courage with our own 
courage; but second, we ought to base it on the experience that 
we have recently had with Enron that shows that the role of 
stock options is more than just giving huge amounts of grants 
mainly to executives, not exclusively, but probably 90 to 95 
percent overall to executives, but also to permit the kind of 
deceptive accounting practices to occur without being seen for 
what they are, which is deceptive accounting practices that 
made Enron look a lot better than it really was.
    Thank you, Mr. Chairman.
    [The prepared statement of Senator Levin follows:]
                  PREPARED STATEMENT OF SENATOR LEVIN
    Beginning in 2001, a wave of corporate scandals engulfed the U.S. 
business world. Enron, Aldephia, Quest, Tyco, Worldcom--an alphabet of 
corporate misconduct undercut investor confidence in our financial 
systems, our markets and our financial regulators. To stop the 
wrongdoing and restore investor confidence, Congress held hearings, 
issued reports, and enacted landmark legislation, the Sarbanes-Oxley 
Act of 2002. Our work focused in particular on halting the accounting 
abuses infecting so many corporate books. Among other measures, we 
created a new Public Company Accounting Oversight Board, required 
companies to disclose material off-balance sheet transactions, and 
strengthened the independence of the private sector body that sets U.S. 
accounting standards, the Financial Accounting Standards Board, or 
FASB, by providing it with independent funding.
    Today, because FASB has finally tackled one of the toughest 
accounting issues in its history by proposing to require companies to 
treat stock option compensation as an expense in their financial 
statements like all other forms of compensation, opponents of stock 
option expensing want Congress to override FASB's independent judgment, 
politicize the standard-setting process, and roll over FASB's 
independence. To do so would be to undermine key accounting reforms, 
signal that accounting maneuvers to prop up earnings is still 
acceptable, and turn our backs on the lessons of Enron. It would be a 
grave mistake.
    The issue isn't whether Congress is for or against stock options, 
any more than whether we favor bonuses or other forms of incentive pay, 
but whether FASB should be overriden when it determines that stock 
option pay should be accounted for on company books as an expense, just 
like every other form of compensation. All other forms of 
compensation--salaries, cash bonuses, stock grants, stock appreciation 
rights, golden parachutes, retirement pay--appear as an expense on a 
company's books. The only exception has been stock options. The issue 
today is whether FASB will be allowed to maintain its independence when 
it decides to eliminate that exception and treat stock options as an 
expense, like all other forms of compensation.
    In this country, stock options have typically been provided to 
corporate executives. Since the 1980s, stock options have provided the 
majority of CEO pay, boosting CEO compensation every year through good 
times and bad, while leaving average worker pay further and further 
behind. J.P. Morgan once said that CEO pay should not exceed 20 times 
average worker pay. In 1990, the pay gap between CEOs and average 
workers was already 100 times. Last year, CEO pay at about 350 of the 
largest U.S. public companies averaged $8 million, a 9 percent increase 
over the prior year. Average CEO pay in this country is now 300 times 
average worker pay, and stock options are the largest single factor in 
that pay gap.
    Stock options operate as stealth compensation, because most U.S. 
companies don't show stock option compensation as an expense on their 
books. But those companies do deduct stock option pay as an expense on 
their tax returns. That's the double standard, the gimmick that allows 
companies to show a huge compensation expense deduction on their tax 
returns but zero expense on their books. In fact, stock options are the 
only type of compensation that companies are allowed to deduct as an 
expense on their tax returns even if the stock options never appear as 
an expense on their books. FASB's proposal would put an end to that 
double standard by requiring companies to treat stock option 
compensation as an expense on their financial statements.
    FASB proposes taking this action because it views stock option pay 
as compensation. It has concluded that omitting this expense from a 
company's financial statement produces misleading accounting results, 
including making the company's earnings appear larger than they really 
are. FASB's view is the consensus position in the accounting field. The 
International Accounting Standards Board, whose standards affect 90 
countries, is requiring stock option expensing beginning next year. 
Canada began requiring stock option expensing this year. A 2002 survey 
of financial experts by the Association for Investment Management and 
Research found that more than 80 percent support stock option 
expensing. All four major accounting firms also favor expensing.
    But opponents predict a parade of horribles if FASB goes ahead with 
its plan. They predict this accounting change will stifle investment 
and innovation, hurt our stock markets, lead to outsourcing of high 
tech jobs, and wreak havoc in our economy. But a reality check shows 
these dire predictions are overblown. Since 2002, nearly 500 companies 
have voluntarily agreed to begin expensing stock options on their 
books. These companies represent about 20% of the number of companies 
on the Standard and Poor's index of companies and 39% of that index 
based on market capitalization. None of the predicted horribles has 
happened.
    Let's look at some of the claims more closely.
    Some opponents claim expensing stock options will stifle innovation 
in business. But many of the 500 companies expensing options are 
successful, high tech innovators like Microsoft, Netflix, and Amazon. 
They also include such diverse companies as General Motors, Dow 
Chemical, Boeing, BankOne, UPS, and Coca-Cola, each of which relies on 
technical innovation for business success. The CEO of Netflix, a high 
tech company that began expensing stock options last year, has stated: 
``[I]nnovation continues unabated. . . . We innovate because it thrills 
us, not because of some accounting treatment.''
    Other opponents claim that stock option expensing will lower their 
earnings which will, in turn, cause their stock prices to fall and 
devastate their investment prospects. But the facts, again, show 
otherwise. Just last month, a leading executive pay expert, Towers 
Perrin, issued a study examining 335 companies that switched to stock 
option expensing and found that stock performance was the same, on 
average, as the rest of the S&P 500 and mid-cap 400 indices. Expensing 
did not affect their stock prices.
    Despite this factual evidence, some opponents go even farther and 
warn that expensing will not only depress the share prices of 
individual companies, but also damage the stock market or the U.S. 
economy as a whole. Well-respected financial analysts disagree.

        -- Goldman Sachs Global Equity Research recently issued a 
        report supporting stock option expensing and stated: ``We do 
        not expect a material impact on the share prices of most 
        firms.''
        -- UBS Investment Research has stated that expensing is a 
        ``long past due change'' and ``medicine for the long-term 
        health of companies and investors. It will shed light on the 
        true profitability of many companies, helping to separate those 
        that deserve investor capital from those that do not.''
        -- Merrill Lynch says the argument that expensing options will 
        harm U.S. technology leadership and job creation is based on 
        ``the following faulty logic: U.S. technology leadership and 
        job creation depend on the systematic misrepresentation of 
        financial statements. One might as well argue that money spent 
        on R&D shouldn't count as an expense because it provides 
        employment and helps industries advance.''
        -- Credit Suisse First Boston Equity Research says: ``We expect 
        companies to pay closer attention to the economic cost of their 
        stock option plans. Companies don't focus much on costs that 
        they don't have to account for. . . . [W]e expect to see a 
        decline in the number of options granted, potentially replaced 
        by restricted stock, cash, incentive options, or nothing if the 
        company had been overcompensating its employees.''
        -- Congress' own economists at the nonpartisan Congressional 
        Budget Office have also forecast a minimal economic impact, 
        issuing a recent report which concludes: ``[R]ecognizing the 
        fair value of employee stock options is unlikely to have a 
        significant effect on the economy . . . however, it could make 
        fair value information more transparent to less-sophisticated 
        investors.''

Honest accounting, in other words, doesn't hurt the economy.
    Other leaders in the financial and accounting world also support 
stock option expensing as good for investors and good for markets. They 
include Federal Reserve Chairman Alan Greenspan, Treasury Secretary 
John Snow, SEC Chairman William Donaldson, Public Company Accounting 
Oversight Board Chairman William McDonough, former SEC Chairman Arthur 
Levitt, former Comptroller General Charles Bowsher, investors Warren 
Buffett, John Biggs and Pete Peterson, Nobel Prize Winners Joseph 
Stiglitz, Robert Merton and Myron Scholes, as well as respected groups 
such as the Council of Institutional Investors, the Investment Company 
Institute, Financial Services Forum, Consumer Federation of America, 
National Association of State Treasurers, Institute of Management 
Accountants, and The Conference Board's Commission on Public Trust and 
Private Enterprise.
    President Bush, who doesn't support expensing stock options, 
nevertheless opposes Congressional interference with FASB's independent 
accounting judgment.
    One of the newer claims of opponents is that stock option expensing 
will somehow force high tech companies to outsource more jobs. But a 
number of high tech companies, like Cisco, Dell Computers, IBM, and 
Intel, have already sent hundreds or thousands of jobs offshore, while 
opposing stock option expensing. Intel began outsourcing software 
research and development operations to India several years ago; in 
2003, its CEO was quoted by the Indian press as saying, ``I can tell 
you that the headcount in India will continue to grow and a lot of back 
office work is also coming.'' Cisco Systems announced in 2003 that it 
was ``going to increase outsourcing to India in all areas'' including 
software development, and in October announced a ``China-based staffing 
solution'' for Cisco's Global Technical Response Center.
    Dell Computer, which is based in Texas, recently set up customer 
and technical support centers in India, China, Morocco, Slovakia, and 
design centers in China. It also has manufacturing plants in Brazil, 
Malaysia and China. Although only 36 percent of its revenue comes from 
overseas sales, Dell has 23,000 employees in other countries and only 
22,000 here at home.
    These offshoring companies are increasingly paying third world 
wages for high-end products and handsome profits. The stock option 
expensing proposal is no excuse for their outsourcing decisions: these 
companies don't expense their stock options. Worse, by invoking 
outsourcing fears to justify Congress' overriding the expertise and 
independence of FASB, these companies undermine the integrity of our 
financial reporting systems and accounting standards setting process, 
both of which are critical to investor confidence and long-term capital 
investment in U.S. companies.
    Another red herring argument is that requiring stock option 
expensing will eliminate broad-based stock option plans and hurt 
average employees. The facts are to the contrary. Companies that 
currently offer broad-based plans to their workforce such as Home 
Depot, Wal-Mart, and Netflix, have already determined that they can 
expense options without having to terminate their stock option plans. 
Other companies, such as Microsoft, are replacing stock options with 
stock grants, but I haven't heard of their employees complaining about 
getting actual shares of stock. It is also important to remember that 
most U.S. employers, including many private companies, small 
businesses, and partnerships, don't offer stock option compensation to 
their employees; a nationwide survey by the Bureau of Labor Statistics 
in 2000, a banner year for stock options, found that only 1.7 percent 
of non-executive U.S. workers actually received any options that year. 
In short, honest accounting doesn't hurt average workers.
    A final argument used by many opponents is that precisely 
estimating the value of stock options is difficult. But that's true of 
many items on a financial statement, from the value of goodwill to the 
reserves required to protect against uncollectible receivables or 
loans. As Warren Buffett once said, the only value that everyone agrees 
is incorrect for a stock option is zero.
    The valuation issue, as well as other technical aspects of stock 
option accounting, ought to be resolved by the accounting experts, of 
which Congress isn't one.
    What Congress can add to the debate is its understanding of the 
role played by stock options in too many of the corporate scandals that 
have come before us. I chaired the Enron hearings before the Permanent 
Subcommittee on Investigations and saw how the books were cooked to 
make loans and fake sales look like income so Enron could impress Wall 
Street analysts and boost its stock price. Stock options were the fuel 
for Enron's dishonest accounting. Enron's CEO took home $123 million 
from exercising stock options in the same year the company went 
bankrupt, and so many lost their jobs and life savings.
    In addition to enriching executives, stock options played a second 
vital, but as yet unrecognized, role in the Enron scandal by enabling 
Enron to show huge paper profits without having to pay taxes on them. 
During our Subcommittee investigation, I wondered how Enron executives 
could create huge phony profits to increase the company's stock value 
and make their own stock options worth a fortune, without sapping the 
company's treasury to pay income taxes on the inflated income. I 
learned the answer was those same stock options, which at the same time 
they were enriching executives, provided Enron with a big enough tax 
deduction to eliminate any worries about taxes.
    For the last five years before it declared bankruptcy, from 1996 
until 2000, Enron told its stockholders that it was rolling in 
revenues, claiming a 5-year U.S. profit of $1.8 billion, according to 
an analysis of Enron's public filings by Citizens for Tax Justice. 
During those same years, Enron deducted about $1.7 billion in stock 
option compensation from its tax returns as a business expense--cutting 
its taxes by $600 million and eliminating its tax liability entirely in 
4 out of the 5 years. In other words, the stock option double standard 
allowed Enron to dole out this form of compensation to its executives, 
claim a huge tax deduction, and escape paying U.S. taxes, while not 
showing any stock option expense on its inflated financial statements. 
Enron had a lot of company, by the way, in benefiting from the stock 
option double standard.
    FASB and the folks we rely on to set accounting standards resisted 
enormous pressure from corporate executives when they decided to end 
the accounting that keeps stock options off corporate books as an 
expense, thereby making a company's earnings look better than they are. 
Hopefully, Congress will also stand up to the powerful political forces 
being brought to bear to overrule FASB. Congress should protect FASB's 
independence and its resolution of controversial accounting issues 
based on accounting expertise rather than political considerations. 
That's what we committed to do two years ago when we enacted the 
Sarbanes-Oxley Act, and it is critical that, in this first big test, we 
continue to champion, preserve, and fortify FASB's independence.

    Senator Fitzgerald. Thank you, Senator Levin. Senator 
Lieberman.

             OPENING STATEMENT OF SENATOR LIEBERMAN

    Senator Lieberman. Thank you, Mr. Chairman, for convening 
this discussion, I believe, of a seriously misunderstood 
problem, which is stock options and the abuse of stock options.
    For much of the past decade stock options have been the 
subject of an intense debate, which of course, heated up 
particularly after the collapse of Enron and the succeeding 
wave of crime by executives of a number of American 
corporations. Many people obviously believe that the silver 
bullet to stop this corporate crime is to change the accounting 
rules for stock options, force companies to count options as 
expenses when they are granted, they say, and the scams and 
rip-offs would stop.
    I wish it were that easy. Changing the accounting rules is, 
in my opinion, highly unlikely to change the unethical, illegal 
or scandalous behavior of a corporate executive who does not 
have the scruples to stop himself or herself from taking action 
that satisfies their own greed, and in the process rips off 
investors and employees and consumers. But I do fear that 
changing the accounting rules is likely to deny access to 
options to average workers who have done nothing wrong, and in 
the process put the brakes on the revolutionary democratization 
of capital in this country that has occurred over the last 20 
years or more. I hope that our goal, and I believe our goal 
should be to stop the abuse of stock options, not to stop the 
granting of stock options. I do not believe this proposed FASB 
rule will do that.
    Options are a very innovative way to help expand the 
winner's circle for millions of Americans and improve the 
growth and productivity of our economy. In other words, we must 
not throw the options baby out with the corporate corruption 
bath water. I believe the way to make sure we do not do that is 
to reform the way stock options are approved and distributed 
and ultimately widen access to them instead of restricting it. 
I have introduced legislation which I believe will do that.
    As has been said, my views and interest in this subject go 
back more than a decade to 1993 when FASB first floated that 
plan to require stock options to be treated as an expense 
against earnings on profit and loss statements at the time they 
are granted. Many of us who opposed that rule change did so for 
two reasons. First we believed it did not make sense; it was 
bad accounting. Second, we were concerned that it would 
significantly deter the kind of entrepreneurship that grows our 
economy and expands the middle class. I do not think any of us 
were primarily motivated by a desire to compromise the 
independence of FASB, but if FASB is about to promulgate a rule 
that we think, and thought then, would have an adverse effect 
on a lot of people in our country and on our economy generally, 
I take it to be my responsibility to express that point of 
view. Our goal here again should be to stop the abuse of stock 
abuse, not their granting.
    Let me go back to 1993. Why did we do that? We were never 
convinced that there is an accurate way to value an option on 
the day it is granted. I know Warren Buffett has now famously 
said that options are compensation and therefore compensation 
should be expensed. Of course options are probably 
compensation. I emphasize the ``probably.'' They are a form of 
compensation, but the compensation occurs not when they are 
granted, but when they are exercised. At the extreme, options 
that go under water when the stock price drops below the price 
on the day that the options were granted never become 
compensation at all. They are effectively worthless, as 
tragically, thousands of Enron employees can tell you. We only 
know, as far as I understand this, options are compensation 
when they are exercised. I hope most people listening to this 
or watching it understand we are talking about two dates, the 
date the company says, OK, John Smith, you have got options, 
but then there is another day that comes, usually after a 
holding period required of some years, in which the options are 
actually exercised, they are sold. That is when they become 
compensation.
    Incidentally, that is when the company can take as a 
deduction the difference between the price of stock on the day 
the option was granted and the price when it was exercised or 
sold and money was made. The employee on the date of exercise 
pays a tax on the difference and the company takes it as a 
deduction. That is the IRS. What we are talking about is 
accounting rules on the day that it is granted, and I continue 
to see no way you can actually value on that day.
    I wonder if the advocates of expensing stock options could 
point to a single case where a company's disclosure of stock 
option values and cost at the time of granting, which is what 
they have been required to do under the FASB compromise rule 
since 1995, has proved to be accurate. The Enron footnotes, for 
example, which I have looked at, estimated stock option values 
and costs that proved to be wildly inflated and inaccurate 
because they did not anticipate the collapse in Enron's stock 
price that came about as a result of the corrupt behavior of 
some Enron executives. So that is what, in 1993, we were not 
convinced of, that you could value an option on the day it was 
granted, but here is what we were convinced of, that mandatory 
expensing of stock options would inhibit their use, and that 
would hurt a lot of people who were getting stock options, not 
the top executives, and it would also hurt our economy because 
of the role that the options play in attracting innovative 
employees away from big companies to start-up companies. 
Experience has proven that options are an effective mechanism 
for doing that, and for spreading wealth, because they give 
employees a direct stake in their companies, and of course 
business leaders, particularly from the high tech community, 
made clear that they would issue fewer options if they had to 
subtract their estimated value from their profits on the 
statement as required.
    Much has changed since that original debate and vote here 
in the early 1990's, but I say with all respect that the 
problems that I have with FASB's approach have not changed. 
Requiring firms to predict the values of options at the time of 
granting still looks to me like bad accounting. I just do not 
know how you can do it, and I am still troubled that it would 
have damaging repercussions on our economy overall, on 
thousands of businesses or would-be start-up businesses, and 
certainly on millions of workers who would otherwise get these 
options.
    To be specific, it would significantly reduce earnings for 
many companies with option plans, which in turn would reduce 
the value of their stock in particular, maybe the market in 
general, and business would almost certainly decide to grant 
fewer options. Of course, the first to be cut out would not be 
the top executives including the relatively small number among 
business executives in America who have been proven to have 
acted unethically or illegally in the recent wave of corporate 
crime. What would be hurt? The guys at the top and the women at 
the top would be cutting out the other workers in the company 
from the opportunity to have options, and that is the last 
thing we need now with the average income of American workers 
dropping.
    I will give you an interesting statistic, Mr. Chairman. 
Just 12 years ago, around the time the first FASB debate 
occurred, a little bit before it, one million Americans owned 
stock options. Today more than 14 million people in this 
country hold stock options. It is astounding. And a growing 
number of companies, very diverse, like Staples, Intel, Wells 
Fargo and the Vermont Teddy Bear Company, to name a few that 
are diverse, offer broad-based plans that distribute most of 
the options to rank and file workers, not senior executives.
    Are there problems with options? Yes, there are. But again, 
I believe the FASB rule is very unlikely to solve them and will 
cause its own problems. Number one problem: Too high a 
percentage of options are still rewarded to high-level 
executives. The National Center for Employee Ownership 
estimates, ``That while the growth of broad-based options has 
been an important economic trend, our data nonetheless indicate 
that even in plans that do share options widely, executives 
still get an average of 65 to 70 percent of the total options 
granted.'' That is their right, but in my opinion, that is 
unfair, and it does contribute to the inequity in income 
distribution in our country. It is this skewed distribution, 
not the accounting, that I feel is the root of the problem. 
Obviously, we have seen examples where some executives, loaded 
up with tens of thousands of options, have engaged in the kinds 
of practices that have increased their earnings and their share 
price if cashed out at the right time, and then very often they 
have left the company.
    To counter these abuses, I have introduced what I believe 
is a better, tougher stock option reform proposal, and the 
purpose of my legislation, if you will allow me to put it this 
way, is to mend, not end, stock option distribution.
    First, my proposal will prohibit a company from deducting 
the cost of options when exercised if it does not offer the 
majority of those options to rank and file workers. I define 
that in the bill as those who make less than $90,000 a year, 
which is an existing standard, and are not among the firm's top 
20 percent of highest-paid employees.
    Second, my proposal would set a mandatory holding period 
for stock option grants and block top executives from selling 
their shares while they are employed by the company.
    Third, it would require all stock option plans to be 
approved by a majority of shareholders, guaranteeing greater 
accountability and transparency.
    I offer this, Mr. Chairman, as a tougher, more sweeping, 
and I believe ultimately more effective, response to stock 
option abuse and its consequences. Rather than retard the 
revolutionary democratization of capitalism in our country, 
this proposal will help accelerate it by putting more options 
and more wealth in the hands of more working Americans. That is 
a solution we can all count on, and I believe account for. 
Thank you very much.
    Senator Fitzgerald. Senator Lieberman, thank you.
    Now I would like to introduce our first two witnesses, 
Senator Enzi and Senator Boxer, and I understand Senator Enzi 
may have a scheduling conflict.
    Senator Enzi. I do not.
    Senator Fitzgerald. The normal tradition would be that 
Senator Boxer has seniority in the Senate, but she is----
    Senator Boxer. Senator, that is very kind, but I think 
because Senator Enzi has a bill that I am very supportive of, I 
think it is just fine if he goes first, and I am happy to go 
after him.
    Senator Fitzgerald. Thank you, Senator Boxer. Senator Enzi, 
I would just like to introduce you.
    Senator Enzi is the Senator from Wyoming, and was here to 
testify at our recent hearing on financial literacy. Senator 
Enzi was elected to the Senate in 1996, and he is an accountant 
and former small business owner. He serves on the Committee on 
Banking, Housing and Urban Affairs, where he chairs the 
Securities and Investment Subcommittee.
    Senator Enzi is the sponsor of S. 1890, the Stock Option 
Accounting Reform Act, which would require an issuer of 
registered securities to expense stock options granted to 
executive officers.
    Senator Enzi, thank you. Welcome back to our Subcommittee, 
and thanks for your patience as well.

 TESTIMONY OF HON. MIKE ENZI,\1\ A U.S. SENATOR FROM THE STATE 
                           OF WYOMING

    Senator Enzi. Thank you very much, Mr. Chairman, Senator 
Akaka, and Subcommittee Members, for allowing me to testify 
before you today.
---------------------------------------------------------------------------
    \1\ The prepared statement of Senator Enzi appears in the Appendix 
on page 73.
---------------------------------------------------------------------------
    I also want to thank Senator Boxer for all the work that 
she has done on the bill that we have, and all of the interest 
that she has shown and her knowledge in it.
    I would also like to associate myself with the remarks of 
Senator Bennett when he was talking about the independence of 
FASB, and the need to expense stock options.
    But having said that, I am here today to speak solely on 
behalf of the millions of small businesses in the United States 
that may or may not even be aware of the proposal by the 
Financial Accounting Standards Board to require expensing the 
stock options. I have to tell you, a reporter from Wyoming 
today at lunch asked me if I thought my bill would pass. I 
said, if FASB listens once, it will not have to pass, and if 
they do not listen, it could be a landslide to pass it. So that 
is the position that I am coming from.
    There are small businesses in the United States that number 
nearly 23 million, and they represent 99 and 7/10ths percent of 
the employers. They employ half of all private sector employees 
and they generate 60 percent of the net new jobs annually. In 
addition, small businesses produce 13 to 14 times more patents 
per employee than large patenting firms. It is not an 
exaggeration to state that the health and strength of our 
Nation's economy rests on the ability of small businesses, 
small businesses, to start and grow. Our Nation's 
entrepreneurial spirit and climate are the envy of the world. 
Today many countries are trying to replicate our small business 
system. In fact, news articles of late last year showed that 
China is trying to build its own Silicon Valley. You know what 
their business plan calls for? Stock options. Yes. We must be 
very careful not to cause unintended consequences that might 
disrupt small business and the job creation.
    The reason I am here today is to voice small business 
concerns that I believe are being overlooked or pushed aside as 
not relevant to the discussion of stock option expensing. At 
first glance, the question of whether to expense stock options 
appears to be very simple and media friendly. However, before 
getting to the question of expensing stock options, one must 
first ask how those will be valued?
    As the traditional saying goes, the devil is in the 
details. Based upon the recent proposal by FASB one must be 
versed in the differences between the fair value method, 
intrinsic value method, lattice structures, and binomial and 
Black-Scholes expensing valuation models. As an accountant, I 
found that these terms are not in the general accounting world 
but are unique to this particular accounting proposal. So for 
small business owners and their accountants that are 
encountering these terms for the first time, the evaluation of 
the FASB proposal will be daunting.
    The valuation approach, as proposed by FASB, would set up 
small businesses to wake up in a nightmare. The proposal itself 
is more than 230 pages long. This is the little document that 
small businessmen need to wade through to be sure they are not 
violating the accounting standard. Rather than addressing small 
business concerns head on, FASB has just thrown together a 
series of criteria for small business to consider.
    Small businesses have no choice but to hire expensive 
experts to delve into this voodoo valuation. Some believe that 
only the largest accounting firms would be able to produce the 
proper valuation models, and I am hearing that it could cost up 
to $500,000. Both small business and small accountants would be 
victims of the FASB proposal. A frequent concern heard by the 
Governmental Affairs Committee is that small business owners 
are very busy building and running their businesses, and cannot 
pay attention to many Federal regulators in Washington, DC--I 
know you have heard that a lot--for this sole reason: Congress 
created the Regulatory Flexibility and the Small Business 
Regulatory Enforcement Fairness Acts. These Administrative 
Procedure Act laws require Federal regulatory agencies to 
undertake economic analysis when a proposed regulation may 
disproportionately burden small entities. In addition, the law 
requires agencies to conduct vigorous outreach and establish 
compliance assistance for small business.
    FASB, as an independent standard setter, is not bound by 
the Regulatory Flexibility nor the Small Business Regulatory 
Enforcement and Fairness Acts. Accordingly, FASB, as a standard 
setter recognized by the Federal Government, should establish 
equivalent small business review practices for itself.
    In November, I held a hearing in the Committee on Banking, 
Housing, Urban Development entitled ``FASB and Small Business 
Growth.'' At that hearing we heard from a variety of witnesses 
that FASB's consideration of small business concerns on several 
different FASB proposals, not just stock options, several 
different FASB proposals, was severely deficient.
    At the hearing I requested that a Small Business Advisory 
Committee be established by FASB to listen and address small 
business concerns. I envision this Subcommittee to operate in 
the same manner as NASD's Small Firm Advisory Board, in that 
all proposals would be reviewed and evaluated by the 
Subcommittee. I even wrote a letter to Mr. Herz and asked if 
that was not the case.\1\ I did not get a response that said 
that that was not the case. But FASB has since indicated to me 
that the Small Business Advisory Committee would meet twice a 
year and would receive only proposals on an ad hoc basis.
---------------------------------------------------------------------------
    \1\ The letter to Mr. Herz from Mr. Enzi, dated December 5, 2003, 
appears in the Appendix on page 148.
---------------------------------------------------------------------------
    While I am pleased that FASB has established the committee, 
I still have serious doubts about FASB's commitment to 
listening on the small business issues. For example, 
immediately following the hearing, FASB conducted field tests 
with 18 businesses on stock option expensing. None of the 
businesses were small businesses. Now, as FASB is rushing to 
implement the proposal on stock option expensing by the end of 
the year, I am very much concerned that small business issues 
will be pushed aside or not addressed at all. For example, the 
proposal will apply not only to publicly traded companies, but 
also to privately held companies. Many of these privately held 
companies are start-ups and very small companies, and many that 
I have spoken to recently have no idea that this proposal will 
apply to them.
    In addition, FASB, without advanced warning, extended the 
proposal to include companies with employee stock purchase 
plans. Have you been talking about stock options or employee 
stock purchase plans? That is the smallest business thing that 
I know of where the mom and pop operation is trying to sell to 
their employees. They are going to have to pay attention to 
that now because they have been included. We did not know about 
that. It was a surprise to me when I looked through there and 
found that. While some of the companies will be able to 
participate in the two roundtables to be held by FASB in 
Connecticut and California, thousands of others may not find 
out about the roundtables until it is too late.
    In addition, the first meeting of the Small Business 
Advisory Committee is on May 11. However, an issue as complex 
as this may not be addressed fully. It is quite possible that 
the committee could spend all day on the proposal's glossary of 
terms in this 230-page book, and have very little time to 
discuss anything else.
    For this reason, a hearing has been scheduled next week by 
the Committee on Small Business and Entrepreneurship that will 
give a limited number of small businesses a chance to discuss 
the proposal on stock option expensing.
    As the Governmental Affairs Committee has jurisdiction over 
Regulatory Flexibility and Small Business Regulatory 
Enforcement Acts, I will leave the Subcommittee with a couple 
of questions that should be considered in this hearing.
    First: What are the duties and responsibilities of a 
standard setter, recognized by the Federal Government for 
analyzing the economic impact of proposals? Should those duties 
and responsibilities rise to the level of statutory mandates of 
Federal agencies?
    Second: What is the level of outreach that is required to 
ensure that small businesses throughout the country are able to 
participate in the standard-setting process?
    Third: What is the remedy for when a small business 
believes that the independent standard setter gets the standard 
wrong for small business, or that the standard setter has 
completely pushed aside small business concerns? Small 
businesses, pursuant to the Regulatory Flexibility Act, may sue 
a Federal agency to set aside a rule if the small business has 
been unjustly aggrieved. As one of the principal authors of the 
Sarbanes-Oxley Act, I support an independent accounting 
standard setter. However, an independent accounting standard 
setter has to live up to a very high standard. With respect to 
FASB's oversight of small business concerns, I believe there is 
still a significant way to go.
    Finally, I should mention that in today's Wall Street 
Journal there is an account of Chairman Herz conducing a 
conference call with institutional investors yesterday. In that 
call he urges institutional investors to make your views known 
to the people in Washington so that FASB can go forward with 
its proposal by the end of the year.
    I thought we were in a period of comment when FASB should 
be encouraging everybody, and particularly small business, 
particularly the small businesses that do not even know they 
are about to have this thrust on them, to be commenting on the 
rule, not to be lobbying Congress not to be interested in this 
rule. I am really disappointed in that. That is further 
evidence that Chairman Herz will bypass the due process for 
small businesses in order to impose his will upon process. I 
have been trying to get some recognition of small business 
since this first came up, and having a little difficulty with 
it.
    I do have an article that I would like to have made part of 
the record that covers that conference call.\1\
---------------------------------------------------------------------------
    \1\ The article from the Wall Street Journal entitled ``FASB 
Chairman Calls For Investors To Speak Up On Options,'' appears in the 
Appendix on page 150.
---------------------------------------------------------------------------
    Senator Fitzgerald. Without objection.
    Senator Enzi. Interestingly, Chairman Herz's call was with 
institutional investors, and recent news articles have shown 
that institutional investors, including public pension funds, 
readily invest in hedge funds. I find it extremely troubling 
that institutional and pension fund managers will invest in 
unregulated hedge funds, but cannot interpret stock option 
information that is currently available in extremely detailed 
notes of registered, publicly traded companies.
    In addition, I also would like to introduce a very recent 
study on the use of stock options into the record, and that is 
the study of Professors Joseph Blasi and Douglas Kruse.\2\ They 
found that stock options are widely held by true workers and 
middle management of many companies and not just used by 
executives.
---------------------------------------------------------------------------
    \2\ The study entitled ``Corporate Governance, Executive 
Compensation, and Strategic Human Resource Management From 1992-2002, A 
Portrait Of What Took Place,'' by Professors Joseph Blasi and Douglas 
Kruse appears in the Appendix on page 212.
---------------------------------------------------------------------------
    Senator Fitzgerald. Without objection.
    Senator Enzi. I would mention that to give you something a 
little more current than the 1934 book, that they have also 
written a book called ``In The Company of Owners: The Truth 
About Stock Options,'' which I highly recommend to everybody to 
understand how this revolution to stock options has resulted in 
the kind of an economy that we have come to expect in the 
United States and the value that has had.
    It is a matter of executive compensation. A recent article 
in the Washington Post detailed that with or without stock 
options, top executives will receive their compensation. 
Therefore, this proposal will hurt only small businesses and 
employees.
    I thank you for this opportunity to testify.
    Senator Fitzgerald. Senator Enzi, we appreciate your being 
here today. Thank you very much.
    Senator Boxer, thank you for waiting patiently.
    Senator Boxer. Mr. Chairman, you want me to try to do my 
testimony in 5 minutes; would that be your desire? I will try 
that.
    Senator Fitzgerald. We will not strictly enforce that, but 
we would appreciate it because we have two other panels coming. 
Thank you.
    Senator Boxer. I am going to try to do that. So first I 
will start off with putting my statement in the record, if that 
is OK with you.
    Senator Fitzgerald. Without objection.
    Senator Boxer. Then I will try to summarize this within 5 
minutes or a minute over.
    Senator Fitzgerald. That is great.

  TESTIMONY OF HON. BARBARA BOXER,\3\ A U.S. SENATOR FROM THE 
                      STATE OF CALIFORNIA

    Senator Boxer. First of all, thank you so much for this 
chance because this is a big issue to California, and I have 
been involved with it for a long time with Senator Enzi, going 
before that, Senator Lieberman, when I was a House member and I 
just came over to the Senate, Senator Allen, just a whole group 
of us from both sides of the aisle, and I just appreciate this 
chance.
---------------------------------------------------------------------------
    \3\ The prepared statement of Senator Boxer appears in the Appendix 
on page 77.
---------------------------------------------------------------------------
    What I would like to do is first of all comment on the 
various presentations each of you has made, first of all, to 
rebut them in some cases or to support them in others, but 
second, to prove to you that I was listening to you, that I was 
hanging on every word.
    I would start off with you, Mr. Chairman, kind of bemoaning 
the fact that the lobbyists did not come up here. Lobbyists 
should not be testifying in these meetings. I really believe 
that because there are lobbyists on both sides of every issue. 
They get paid for that and it is our job to ferret out what is 
in the best interest of the people, and it is our job to come 
up here and not their job. It would be awful, so I am sort of 
glad that did not happen.
    Second, to Senator Bennett's point, I think he makes--he is 
struggling with this deal because he believes in the 
independence of FASB, but yet he believes what I believe, and 
that is, that a one-size-fits-all kind of rule could have 
tremendous ramifications. I am the daughter of a CPA. I love 
accountants, so this is nothing against the accounting 
profession, but they do have blinders on when it comes to 
policy. That is their work. It is their job. They see things in 
a narrow fashion, and policy is not their thing. That is fine 
for a lot of things, but when you are dealing with options, 
when you are dealing with the potential ramifications here 
which have been stated by Senators Bennett and Lieberman, you 
are dealing with serious business, and of course, very 
eloquently stated by my colleague.
    I would agree that I do not think FASB has listened to us 
one bit. We gave them every chance. We had a hearing. Remember 
that one? What would you call it? A seminar. And we said, well, 
look, this does not make sense, and we went through how do you 
evaluate these and so on and so on. And then they just could 
not care. For those of you who wanted them to stick with what 
they came up with 10 years ago, do not worry, there is not a 
chance they will change to try to reach out and look at some of 
the ramifications of what they are doing. It is very 
discouraging. For me to be told, as a U.S. Senator who cares 
about jobs and cares about a middle class and cares about 
making sure there is prosperity, that I should not speak up 
against a group that I think is not considering the 
ramifications of their act, that is not a good approach with me 
because I think that is our job. Otherwise, things could go 
haywire around here, and they sometimes do.
    To Senator Akaka, who mentioned Enron and WorldCom and 
Senator Levin who did the same, these were crooks and thieves, 
these people. They made a false electricity crisis in my State, 
Enron did. I am familiar with what they did. They spent day and 
night trying to thieve from people, and they did, to the extent 
of $11 billion that I know of. That is what it cost my 
consumers in Enron's case. And options are not--they should be 
thrown I jail. Meanwhile, what is happening, because of their 
acts and because some people think options was the problem, not 
the fact that they were thieves, then what you are saying is 
not only the people there are at a disadvantage because they 
lost their jobs, they lost their pension, they lost everything, 
but as a result of FASB, we are going to have a whole group of 
other workers, who had nothing to do with these things, being 
punished. That would be just the ultimate irony, being punished 
for the likes of Enron and WorldCom when all they want to do is 
get a chance at the dream.
    So I hope you will think about that. After FASB gets done 
with their rule, the people at the top are going to get their 
options. Make no mistake about it. But the people that I fight 
for in my State, and Cisco Systems is a perfect case in point, 
I believe it is 95 percent of the employees there have options. 
So now you think you are doing this great thing to punish the 
fat cats, and you are hurting everybody else because the fat 
cats will still keep getting their options.
    Let me just, because I do not want to take too much of your 
time, I want to give you a sample of what some of my 
constituents are saying, maybe the ones that voices have not 
been raised yet, although they have been alluded to. Bill 
Griffin, who works for Auto Desk in Palo Alto, wrote to the 
FASB, ``Stock options are the last bastion of the hard-working 
middle manager. For 2 years the only thing that helped me pay 
for my two kids in college has been stock options. Without 
stock options mortgaging my home would have been my only 
option.''
    David Dorr from San Jose wrote to the FASB, ``In my 
opinion, stock option compensation at Silicon Valley companies 
is what helped form this valley in the first place. Do not 
destroy it because some companies abused it by only giving 
options to the top.''
    Listen to what Kelly Simmons wrote to the FASB. Quote, ``If 
you eliminate broad-based employee stock options from hard-
working individuals like me, you are taking away more than you 
think. You are taking away the dream of someday owning a home 
here in the Silicon Valley.''
    So FASB got lots of these letters, but they listened to 
them just as much as they listened to Senator Enzi and I, and 
Senator Lieberman and others. So I have respect and admiration 
for FASB, but I do not want to put the future of our economic 
expansion in the hands of folks who refuse to look up from 
their eyeshades and see the big picture, and the big picture 
has an impact on hard-working people, on shareholders and 
people who are only just doing the right thing every single 
day.
    Last, we have a great alternative. And by the way, I love 
Senator Lieberman's bill. I am going to look at it and 
hopefully go on it, but we have a great bill. Senator Ensign 
and I have worked with Senators Enzi and Reid, and others on 
legislation that would mandate the expensing of stock options 
for the top five executives at a company, but not for the 
options granted to rank and file workers. Start-up companies 
would be exempt. Let me just stop here.
    It just seems like everybody is frozen into their position 
except for Senator Bennett, who still looks like we can grab 
him, one side or the other. I just hope you will think a little 
bit about some of your premises, those of you who are just 
saying no legislation interfere. If it was a small matter, that 
would be one thing. This is a huge matter. It is going to 
impact the lives of real people who really believe, and have 
told me--and a lot of them are women, by the way, I have to 
tell you--who are telling me this is their only shot at the 
dream, and let us not take that away because of some rule that 
we do not want to interfere with some group of folks who are 
dedicated, and I respect them, but that is not their job to 
worry about policy. It is our job.
    Thank you very much.
    Senator Fitzgerald. Senator Boxer, Senator Enzi, thank you 
very much. We appreciate your being here and appreciate your 
interest in the subject. Thank you so much for coming.
    At this point we would like to invite our second panel to 
the witness table. We have two witnesses on our second panel. 
Our first witness on this panel is Robert H. Herz, who was 
appointed Chairman of the Financial Accounting Standards Board 
effective July 1, 2002. Prior to joining FASB, Mr. Herz served 
as PriceWaterhouseCoopers' North America Theater Leader of 
Professional, Technical Risk and Quality, and he was also a 
member of the firm's board. Mr. Herz has served as a part-time 
member of the International Accounting Standards Board, and has 
chaired the SEC Regulations Committee of the American Institute 
of Certified Public Accountants and the Trans-National Auditors 
Committee of the International Federation of Accountants. Mr. 
Herz has also served as a member of the FASB Financial 
Instruments Task Force and the American Accounting 
Association's Financial Accounting Standards Committee.
    Our second witness is the Hon. Paul A. Volcker, the former 
Chairman of the U.S. Federal Reserve Board, and the current 
Chairman of the International Accounting Standards Committee 
Foundation. Mr. Volcker has nearly 30 years of distinguished 
service with the Federal Government, and served two terms as 
the Chairman of the Board of Governors of the Federal Reserve 
System from 1979 to 1987. More recently, Mr. Volcker served as 
Chairman and CEO of Wolfensohn and Company, from which he 
retired in 1996 upon its merger with the Bankers Trust Company. 
Mr. Volcker currently serves as chairman, director of, or 
consultant to, a number of corporations and nonprofit 
organizations.
    Gentlemen, we deeply appreciate your taking the time to 
appear before this Subcommittee and we would like to invite you 
to offer your full written statements into the record. We can 
simply have them accepted as part of the record, and it would 
help if you could attempt to summarize your comments within 5 
minutes, so that we can then proceed with questioning. Thank 
you.
    Mr. Herz, would you please go first?

TESTIMONY OF ROBERT H. HERZ,\1\ CHAIRMAN, FINANCIAL ACCOUNTING 
                        STANDARDS BOARD

    Mr. Herz. Thank you, Chairman Fitzgerald, Ranking Member 
Akaka, and Members of the Subcommittee.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Herz appears in the Appendix on 
page 80.
---------------------------------------------------------------------------
    Mr. Herz. As you know, the FASB is an independent private 
sector organization. Our ability to conduct our work in a 
systematic, thorough, and unbiased manner is fundamental to 
achieving our role in the system--that is, to establish and 
improve standards of financial accounting and reporting for 
both public and private enterprises, including small 
businesses.
    The FASB's independence, the importance of which was 
recently reaffirmed by the Sarbanes-Oxley Act, is also 
fundamental to our mission because our work is technical in 
nature and designed to provide preparers with the guidance 
necessary to report on their underlying business transactions.
    Now, while the current efforts by certain parties to block 
our proposed improvements to the accounting for equity-based 
compensation may seem attractive to some in the short run, in 
the long run biased accounting standards are harmful to 
investors, to creditors, to the capital markets, and to the 
U.S. economy.
    Because the actions of the FASB affect so many 
organizations, our decisionmaking process must be open, it must 
be thorough, and it must be objective, as objective as 
possible. And so our rules of procedure require a very 
extensive and public due process.
    On March 31, as has been noted, we issued a proposal for 
public comment to improve the accounting for equity-based 
compensation. It covers not just stock options but a whole 
variety of equity-based compensation arrangements because we 
wanted to get consistent accounting and a level playing field 
between the various forms of equity-based compensation, as well 
as with other compensation.
    The proposal was a result of a very extensive public due 
propose that began in November 2002. That process included the 
issuance of a preliminary document for public comment, the 
review of over 300 comment letters and over 130 unsolicited 
letters, consultations with our advisory councils, field visits 
to companies--which, by the way, did include small businesses--
public and private discussions with hundreds of individuals, 
including users, auditors, and preparers of financial reports, 
valuation experts, compensation experts, and active, open 
deliberations at 38 public FASB Board meetings.
    The Board believes that our proposal will significantly 
improve the financial reporting for equity-based compensation 
transactions in many ways, including, as has been the main 
topic of discussion, the elimination of the existing exception 
for so-called fixed plan employee stock options, which, as 
Senator Levin remarked, are the only form of equity-based 
compensation that is not currently required to be recorded as 
an expense in the financial statements. Our proposal reflects 
the view that all forms of equity-based compensation should be 
properly accounted for as such, and that the existing exception 
for fixed plan employee stock options results in reporting that 
ignores the economic substance of those transactions.
    In that regard, I would note that when enterprises use 
stock options and other instruments, like long-dated stock 
purchase warrants, for purposes other than compensating 
employees--for example, to acquire goods and services, as you 
mentioned, Chairman Fitzgerald, to pay for legal services and 
the like--they have long been required to value those 
instruments and to properly account for them in the financial 
statements.
    We believe the elimination of the fixed plan stock option 
exception is also responsive to the demands and concerns 
expressed by numerous hundreds of individual and institutional 
investors, pension funds, creditors, financial analysts, the 
major accounting firms, and many other parties. We also believe 
it will provide greater transparency and consistency in the 
reporting of various forms of equity-based compensation and 
greater comparability between enterprises that compensate their 
employees in different ways and between the now nearly 500 
companies that have voluntarily chosen to account for the cost 
of employee stock options and the many others that continue not 
to do so.
    The proposal also has a secondary benefit--an important 
one, I believe--of achieving much greater international 
comparability in the area of accounting for equity-based 
compensation. In that regard, as noted, our international 
counterpart, the International Accounting Standards Board, 
issued a final standard in February of this year requiring the 
expensing of all equity-based compensation, including all forms 
of stock options. The IASB standard will be followed by 
companies in over 90 countries beginning next year.
    Our proposal includes a lengthy Notice for Recipients that 
highlights and describes over 20 specific issues that 
respondents may wish to consider in developing their comments 
to us, including a number of issues that focus on the 
proposal's measurement approach and on the special provisions 
that we have proposed relating to small business.
    The Board also plans to hold public roundtables, four of 
them, with interested users, auditors, and preparers of 
financial reports, and valuation and compensation experts to 
discuss the issues raised by the proposal. We also will be 
discussing the impact on small businesses and their views at 
the inaugural meeting of our Small Business Advisory Committee 
in a couple of weeks.
    Following the end of the comment period on June 30, we plan 
to redeliberate, at public meetings, the issues raised in 
response to our proposals. Those redeliberations will address 
all the key conceptual, measurement, disclosure, and cost/
benefit issues raised in the comments and will include careful 
consideration of the input received from all parties.
    Only after carefully evaluating that input at public 
meetings will the Board consider whether to issue a final 
standard. Our current plan is to complete the redeliberations 
and be in a position to issue the final standard in the fourth 
quarter of this year.
    I would like to conclude my statement by noting that we 
have all witnessed the devastating effects and loss of investor 
confidence in financial information that have resulted, at 
least in part, from companies intentionally violating or 
manipulating accounting requirements. Investors, creditors, and 
other consumers of financial reports are continuing to demand 
improvements in accounting and financial reporting. The 
existing accounting for equity-based compensation, not just as 
regards CEO compensation but the basic flaw in the accounting 
model, has been an area of great concern, and our proposal is 
intended to be responsive to that concern and to what we have 
seen in our extensive process of looking at the economic 
attributes of those instruments.
    Thank you, Mr. Chairman. After Chairman Volcker talks, I 
would be happy to respond to any questions.
    Senator Fitzgerald. Thank you very much, Mr. Herz.
    Mr. Volcker, thank you for being with us. You may proceed.

 TESTIMONY OF HON. PAUL A. VOLCKER,\1\ CHAIRMAN, INTERNATIONAL 
ACCOUNTING STANDARDS COMMITTEE FOUNDATION, AND FORMER CHAIRMAN, 
           BOARD OF GOVERNORS, FEDERAL RESERVE SYSTEM

    Mr. Volcker. Well, thank you. I will just summarize my 
comments briefly, but let me make two preliminary statements 
after listening to the earlier conversation.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Volcker appears in the Appendix 
on page 86.
---------------------------------------------------------------------------
    Expensing stock options is not about eliminating stock 
options. The question is how to account for them properly. And 
to the extent that stock options have been abused--and I have 
no doubt they have been abused in many cases to the extent that 
that abuse is related to the fact they are not accounted for, 
obviously that should be taken care of. That is in favor of 
expensing stock options. And nobody is saying in the accounting 
world that they must be eliminated. All we are saying is 
account for an expense in ways comparable to other expenses.
    The other point I would make is that small business has a 
problem in many elaborate accounting areas. They have gotten 
extremely complex for big businesses, I am afraid. That is a 
problem, and in my responsibilities with the International 
Accounting Standards Committee Foundation--a cumbersome word--
we are reviewing our procedures now to try to make sure that 
small businesses and their views and problems are sufficiently 
taken care of in determining accounting standards.
    I am the Chairman of the Trustees of the International 
Accounting Standards Committee Foundation. I emphasize that 
because our responsibilities are to appoint members of the 
board that make the decisions, not to make the decisions 
itself, but it is also our responsibility to satisfy ourselves 
that there has been sufficient consultation and due process 
before the board we appoint does arrive at conclusions.
    I have been interested in this. The only reason that I have 
agreed to become Chairman of the Foundation is that I think 
commonality in international accounting standards is a good 
thing. The world is globalizing. We are not going to stop that. 
The financial world is globalizing. If we are going to have an 
efficient system of international capital, you better have a 
common set of accounting standards. And, in part, that is what 
is at issue in this debate.
    As Mr. Herz just mentioned, the International Board has 
decided a standard on expensing stock options. That is somewhat 
controversial in other areas of the world, but not to the 
extent it is here. I have every reason to believe the Europeans 
will adopt that standard and it will become compulsory in 
Europe and most other major countries in the next year.
    Now, oddly enough, or maybe interestingly enough, there is 
another accounting standard that the International Board has 
put out that is extremely controversial in Europe, and it is 
not been yet adopted by the European Union, and there is 
intense political pressure in the European Union to reject that 
standard, so-called IAS 39, which involves, importantly, 
accounting for derivatives. In the European world, derivatives 
are not accounted for, and this standard is an important 
initiative to bring that important area of accounting on the 
books. It is not controversial in the United States because the 
standard already exists in the United States. It was 
controversial when it was applied in the United States some 
years ago, but American companies are now used to it, and I 
don't think anybody is suggesting that the United States should 
abandon that standard.
    Now, I point this out because we have political pressures 
on the standard setters, two different standards from different 
directions. And I think you have to ask yourself what are the 
prospects for finally achieving coherent, consistent, high-
quality international standards if the political authorities, 
whenever they find one they don't like, reject it. And that 
will obviously have a kind of snowballing effect. You will lose 
discipline in maintaining independence if in different cases 
considered important the independence is overcome.
    I am sensitive to that, and in Sarbanes-Oxley, and in all 
my conversations with the SEC and up here on the Hill when I 
agreed to this assignment, I kept getting drilled into me: You 
must be independent, you must have a framework that protects 
these decisions from political ``interference.'' That is the 
way our system is set up. The so-called constitution for the 
International Board is set up with elaborate arrangements to 
protect the independence. That is supposed to be part of my 
responsibility to protect that independence. So I feel rather 
strongly about it.
    I think that is the essence of my statement. I don't 
comment on the substance of the rule. I am not supposed to. 
That is the Board's idea. I am supposed to respect their 
independence. But I do think this is very important in terms of 
the overall objective of getting international consistency.
    Senator Fitzgerald. Mr. Volcker, thank you very much for 
that statement. I appreciate both of you being here.
    I would just like to make a couple of statements in the way 
of response to some of the things other Members have mentioned 
in their opening remarks, or the two Senators who were 
testifying.
    First of all, the book ``Security Analysis'' is still in 
print. I just happen to have the original edition because I 
wanted to buy that. You can still buy the original edition, but 
it has been republished and updated many times. It is one of 
the classic all-time books, and Benjamin Graham was updating it 
almost to when he died in the 1970's. Warren Buffett refers to 
Benjamin Graham's book, ``The Intelligent Investor,'' which I 
have also read, as the single best book on investing ever. And 
almost all of his books, as far as I know, are still in print 
and selling widely. It is just that I only have the classic 
edition on my home bookshelf, and that is why I cite it. There 
may well be some better language that I could have referred to 
in more recent editions.
    Also, I do, of course, recognize that the options that are 
traded on the Chicago Board Options Exchange or other exchanges 
are much different. However, they are similar in that they both 
represent a call on the future growth and profitability of the 
company. And so I just wanted to mention that, and certainly 
many options issued to employees or executives of a company may 
not be transferable by that employee or executive.
    I now have a few questions for Mr. Herz and Mr. Volcker. 
Mr. Herz, how many of the seven FASB Board members supported 
the issuance of this proposal? And how many of the seven Board 
members disagreed with the conclusions contained in the 
proposal?
    Mr. Herz. The proposal was voted out as a proposal 
unanimously by all seven Board members.
    Senator Fitzgerald. So there was not a single member of 
your expert Accounting Board who opposed the issuance of the 
proposal?
    Mr. Herz. That is correct. It was unanimous. Now, we all 
may have slightly different views on particular issues, minor 
differences. But you look at the proposal as a whole, its 
consistency, and decide whether or not to vote for it as a 
whole. And all seven Board members voted for that.
    Senator Fitzgerald. And how are the FASB Board members 
chosen? Who chooses them? And how do you get on that Board?
    Mr. Herz. They are selected by a group of trustees of the 
Financial Accounting Foundation. They are selected from diverse 
backgrounds. Right now we have three people from public 
accounting, two from industry, one was a senior global equity 
analyst, another person with a business background.
    Senator Fitzgerald. So you have two from industry.
    Mr. Herz. Yes.
    Senator Fitzgerald. Who aren't necessarily accountants? Or 
are they?
    Mr. Herz. They were CFO types.
    Senator Fitzgerald. OK.
    Mr. Herz. What we call preparers.
    Senator Fitzgerald. OK. So they are from companies that may 
be issuing options themselves.
    Mr. Herz. Yes. In fact, actually two of our Board members 
have been the recipients of options.
    Senator Fitzgerald. And, nonetheless, they supported the 
expensing of stock options.
    Mr. Herz. Oh, yes.
    Senator Fitzgerald. So of the seven Board members, you have 
two who are from public companies. How many of the Board 
members are CPAs, accounting professionals?
    Mr. Herz. Three.
    Senator Fitzgerald. Three. And then you have two other 
members?
    Mr. Herz. A business school professor, and a person from 
Wall Street who was a senior global equity analyst.
    Senator Fitzgerald. OK. So, it is fair to say that all of 
these people have great expertise. If you are a CPA, a CFO of a 
publicly traded company, a business school professor, or a 
respected Wall Street analyst, you are very sophisticated in 
this area.
    Mr. Herz. I think it is interesting to note that the 
International Board, who separately deliberated this whole 
issue, they have 14 people on their Board from nine different 
countries, and, again, a range of backgrounds in terms of 
preparers, auditors, users of financial information. I believe 
they were also 14-0.
    Senator Fitzgerald. Maybe Mr. Volcker could comment on the 
composition of the International Accounting Standards Board. 
You have 14 people?
    Mr. Volcker. Fourteen people, two of whom are part-time. 
But as I look at them here, I think there are four who are 
basically so-called preparers, chief financial officers; and 
four or five accountants or standard setters from other 
countries, past standard setters from other countries; and 
three of them are so-called users, analysts, with an analyst 
background. One professor.
    Senator Fitzgerald. Now both of you just generally, leaving 
aside the merits of the proposed rule--and you saw I am in 
favor of the proposed rule. Some of my other colleagues are 
also in favor of it; others are opposed to it.
    Leaving aside the merits of the proposal, what effect do 
you think it would have on our domestic Financial Accounting 
Standards Board if politicians were to step in, a political 
authority were to step in, and block the new FASB rule? And I 
think Mr. Volcker indicated in his opening remarks the likely 
effects on the international board if they were to see us in 
Congress step in. For a rule that actually isn't that 
controversial in Europe, it would have ramifications to the 
extent that some European companies which are opposed to a new 
rule on derivatives accounting that has already been widely 
accepted in the United States would possibly object to.
    But what would be the effect of political interference in 
either of your boards?
    Mr. Herz. Well, I think, as I said, there are a number of 
issues coming down the pike, major topics, where users of 
financial information believe that the current accounting 
standards are not as good as they might be, and even in some 
cases really need major revision. And some of those are areas 
like revenue recognition and reporting on financial 
performance, but also pension accounting has been severely 
criticized by a number of people, lease accounting.
    I think that any intervention at this point would kind of 
be a signal down the road that anytime you want to block 
something to maintain the status quo and block the proposed 
standard, go to Washington and lobby through the political 
process.
    Senator Fitzgerald. Would you care to comment on that, Mr. 
Volcker?
    Mr. Volcker. Well, I think if I was a member of FASB, I 
would be wondering what my responsibilities were. I know that 
in choosing the International Board and getting the kind of 
quality of people that we thought we got, what was important to 
them was that they had some independence. And if they lost that 
sense of independence and acceptability of their decisions, 
they would not be interested in serving. And I don't know who 
you would get to go on the Board. You are not going to get the 
kind of people that we got. I think that is simply the fact of 
the matter.
    But I must say, I think there is a balance here which, one 
way or another, much of what has been said both on that side of 
the table and here is relevant. These decisions cannot be made 
in a vacuum. They cannot be made by a group of abstract 
accountants kind of figuring out what they think of the 
theoretical niceties of an accounting rule and ending up with 
260 pages sometimes. They have to be exposed to the real world. 
And in a sense, I think that is my job and our counterpart's 
job in the United States to make sure that the Boards do have 
the kind of consultation that Mr. Herz was talking about and 
take it seriously and do testing and checking of their 
proposals.
    I should not be speaking as an old Federal Reserve 
Chairman--but it is easy to get isolated. We have to keep--in a 
way that is impossible to avoid for the Federal Reserve because 
you haul them up all the time--and you have these kinds of 
debates and criticism and comments. And I think that is an 
important part of the process.
    We happen to be reviewing the so-called constitution of the 
International Commitment now, and that is the main comment we 
have had, and that is the main concern that we have in 
reviewing the constitution, that there be ample and suitable 
consultation and testing.
    Senator Fitzgerald. Yes, Mr. Herz?
    Mr. Herz. I couldn't help pass that by when Paul mentioned 
the 260 pages and Senator Enzi the 230 pages. The actual 
proposed standard is eight or nine pages. The rest of the 
document is explaining our thoughts, rationale, alternatives we 
looked at and then lots and lots of different examples to help 
people. So, the whole thing of helpful guidance and explanation 
of our thought process is 230 pages, but the actual standard is 
very short.
    Senator Fitzgerald. It is eight pages, OK.
    Now, just one final question before I hand it over to my 
colleagues. Both Senator Boxer and Senator Enzi talked a lot 
about the effect on companies, small businesses. They raised 
the specter of employees being denied stock options. And I know 
Senator Lieberman talked about the democratization of company 
ownership via widespread distribution of stock options.
    But neither Senator Boxer nor Senator Enzi, at least the 
way I understood them, seemed to mention the effect on 
shareholders or investors. That is something I referred to in 
my opening statement, that by granting stock options, you are 
taking the existing common shareholder's right to own 100 
percent of the up side of a company, and you are transferring 
it to someone else. And that is OK, I said, as long as it is 
disclosed to the shareholders or prospective investors, that 
they know that somebody else has a claim on these future growth 
prospects of the company and the stock.
    But isn't there a problem with so many Americans owning 
stocks today? Just in mutual funds alone you have 95 million 
Americans who own mutual funds, for example. Either directly or 
indirectly today, well over half of Americans own equity 
securities. And many people are investing on their own without 
any professional advice and, I would venture to say, many 
without the ability to recognize the dilutive effect of options 
that have been issued because they are so buried.
    Was that at all a part of the thinking of the Financial 
Accounting Standards Board? Were you worried about that effect 
on shareholders of the dilution?
    Mr. Herz. Well, we are trying to measure the instrument 
that is granted as a cost to the company, and it is a cost to 
the company, and that cost is represented by exactly what you 
say. And it is measurable. It is measurable with well-
established models. It takes a little bit of work to do it in 
some cases, particularly when they are more complicated. But 
that is exactly the point, that there is a cost to the company, 
and that cost to the company should be measured just like any 
other cost to the company.
    Senator Fitzgerald. And if employees are paid in cash or in 
gold bullion, you require them to expense that. But it didn't 
seem logical if they are paid in stock options, because they 
don't have to reflect the cost?
    Mr. Herz. Yes, that is right. And just to get to--I would 
love to visit with Senators Bennett and Lieberman just to 
explain----
    Senator Fitzgerald. We would be happy to give you that 
opportunity.
    Mr. Herz [continuing]. How the measurement works and why 
they have been able to do it for 8 years, in audited footnotes, 
why many companies are now being able to do it, and why there 
are other very long dated type instruments like convertible 
bonds which may be contingently exerciseable. Those are valued 
every day.
    The other point I would make, which is, I think, a point 
that when we discuss this people say well, gee, it didn't turn 
out to be the right value. Well, we are measuring the value at 
a point in time. We are not predicting the future value of that 
instrument. Just as if you award a share of stock today, that 
is not predicting what it will be worth 5 years from now. It is 
the value of the instrument now. That is what is being valued, 
not the future prediction of its value.
    Senator Fitzgerald. And there is a present claim or call on 
the future growth of the company's prospects that is being----
    Mr. Herz. That is exactly what the model is.
    Mr. Volcker. And it does take account of the vesting.
    Mr. Herz. The vesting also, if you don't vest, there is no 
expense. There are adjustments in our proposal for vesting, for 
non-transferability, for restrictions and all the like.
    Senator Fitzgerald. Senator Akaka.
    Senator Akaka. Thank you very much, Mr. Chairman.
    Chairman Volcker, there are some opponents of the FASB 
proposal who argue that expensing stock options would slow job 
creation and potentially increase the use of outsourcing. What 
is your evaluation of these arguments?
    Mr. Volcker. They are not correct.
    Senator Akaka. Thank you.
    Mr. Herz, accounting rules have long required companies to 
estimate and report as an expense the cost for remediating 
environmental contamination, providing pension and post-
retirement benefits to employees, settling product liability 
claims and litigation, and providing warranty coverage on 
products sold to consumers. The question is: Will the proposed 
measurement approach for employee stock options result in a 
more precise measurement than approaches currently used for 
those other costs and can you give me the reasons why?
    Mr. Herz. Well, you are touching on a key aspect of what we 
considered: Is there sufficient reliability in our view behind 
these measures? And by that, we mean that the range of 
dispersion of the likely outcomes, if it is done correctly, is 
within acceptable limits. And we then thought about that and 
compared it with some of these other measurements that you are 
talking about and some that I think Chairman Fitzgerald talked 
about, loan loss reserves, insurance reserves, impairments of 
good will, sometimes just depreciation calculations because 
they involve estimates of life and salvage value. And we think 
that certainly the established models here--and, by the way, 
people say that you didn't choose a model. Well, they are just 
different parts, variations of the same financial economic 
theorem. They are not different models. One is more flexible or 
open than the other. You can put more inputs in it and get a 
more refined answer. But our basic conclusion is that these 
measures are of sufficient reliability to put in the financial 
statements and are far better than the current situation where 
the current accounting is totally unreliable and completely 
ignores an economic transaction.
    Senator Akaka. Mr. Volcker, what lessons regarding the use 
and accounting for stock options should be learned from the 
failures in corporate governance by companies such as Enron and 
WorldCom?
    Mr. Volcker. Well, my view is--and it has already been 
expressed in this hearing earlier--that I really do think stock 
options have been abused, and too much concentrated on 
relatively few officials at the top, and the incentives that 
have been created have been perverse. It has created a kind of 
concentration on the stock price that has led to manipulation 
of earnings and other manipulation in order to affect the stock 
price at the long-run expense of the company itself. And we 
have seen that demonstrated. It is very hard for me to justify 
the use of an instrument that has rewarded, as someone said 
earlier, tens of millions of dollars, even hundreds of millions 
of dollars, to executives of a company that went bankrupt that 
very year. It just does not make sense.
    What is evident and why people like stock options so much 
is that we have just in the 1990's had the greatest boom in the 
stock market in all of history. And if you had a stock option, 
you did very well. You did very well whether your company was 
doing relatively well or whether it was doing relatively 
poorly. Everything was going up, not because you were suddenly 
a great genius, but because the whole market was going up.
    I think we better think about it here. I don't make up the 
rules, but I think the effort is to put compensation in the 
form of stock options on a level playing field with other forms 
of compensation so that you do not distort the instrument that 
is used simply because it is accounted for differently, and 
accounted for in a way that logically is hardly sustainable.
    Senator Akaka. Mr. Herz, this month the Congressional 
Budget Office released a report which found that net income 
will be overstated if firms do not recognize as an expense the 
fair value of employee stock options measured when options are 
granted. What is your evaluation of CBO's conclusion?
    Mr. Herz. Their conclusion is exactly the same as our 
conclusion. It is the same as the IASB's conclusion. It is the 
same as the conclusion that has been reached after study by 
many different groups over a long period of time.
    Senator Akaka. Mr. Volcker, if Congress intervenes to block 
the FASB proposal, what impact will this have on investor 
confidence, on the financial markets, and the ability of 
analysts to evaluate the financial condition of public 
companies?
    Mr. Volcker. Well, I think the influence would be adverse 
in all those terms. I don't know how striking it would be. They 
have not been accounted for in the past so you are not changing 
the situation.
    What I am certain of, it would clearly undercut the efforts 
to get international consistency. And I think over time that is 
to the disadvantage of both companies raising money and 
investors investing money.
    You want both intelligent, comprehensive accounting 
standards, and you want them the same in different 
jurisdictions when both investors and companies are operating 
in a lot of jurisdictions. It is very difficult for our biggest 
companies--forget about the small companies--our biggest 
companies that may be operating in 60, 70, 80, or 100 countries 
to follow 100 different accounting rules. And the effort is to 
reduce those differences as much as possible.
    Senator Akaka. Mr. Herz, can you please describe for the 
Subcommittee the shortcomings of disclosing stock options in 
footnotes of financial statements compared to FASB's proposal?
    Mr. Herz. I think it is a longstanding principle in 
accounting and financial reporting that disclosure is not meant 
to be a substitute for wrong accounting. And that has been 
borne out by numerous academic studies in general and on this 
topic as well.
    I think the CBO report comments that individual investors 
do not comb the footnotes, and they just take the score as is. 
That is the score as reported, and that is the way they look at 
it.
    I think in talking with a number of institutional investors 
and quantitative analysts, they also do that because they take 
numbers from databases and don't take as adjusted footnote 
numbers. They just take the score. And so that is why we have 
gotten so many--all the surveys you see of investors, analysts, 
portfolio managers by an overwhelming margin say they want this 
number in the score.
    Senator Akaka. Thank you very much for your responses. 
Thank you, Mr. Chairman.
    Senator Fitzgerald. Senator Bennett.
    Senator Bennett. Thank you, Mr. Chairman.
    Let me say what I said in my opening statement again so 
that it is clear. I am in favor of expensing stock options. I 
am in favor of maintaining FASB's independence. The points that 
Paul Volcker is making are absolutely on point. We need to do 
what we can to standardize around the world. So let's not 
revisit that, OK? Let's deal with what I think the real 
problems are, which I think FASB has ignored.
    Let me give you a hard, firm example here. You say it is 
eight or nine pages, it is fairly simple. I am delighted. I 
have a stock option which, according to Black-Scholes, is worth 
$10. It can be exercised tomorrow. I give my employees a stock 
option with a 10-year vesting at the same strike price as the 
stock option that I get. What is that worth? What does the 10-
year vesting do? What is it worth? Look at your nine pages and 
give me a number.
    Mr. Herz. OK. The first stock option would be expensed all 
right now, $10. The $10 on the second one would be spread over 
10 years, but if the fellow left, there would not only be no 
more compensation, there would be no compensation.
    Senator Bennett. OK. So it is still worth $10, even though 
it can't be----
    Mr. Herz. Not from an accounting point of view.
    Senator Bennett. You just said that it would be----
    Mr. Herz. There is a measurement----
    Senator Bennett. You just said the $10 would be stretched 
over the 10 years.
    Mr. Herz. The measurement would be 10. It would be 
stretched over the 10 years, but only to the extent the person 
worked to get it. That was the deal.
    Senator Bennett. No. I am talking about putting it on my 
balance sheet as an accountant, putting it on my P&L. I have 
got one P&L I deduct $10. That is very simple. Do I deduct $1 
this year and $1 next year, etc., for the other one?
    Mr. Herz. As long as the guy kept working to get it, yes.
    Senator Bennett. So he drops dead of a heart attack in year 
9, and my balance sheet shows a cumulative expense of $9.
    Mr. Herz. The balance----
    Senator Bennett. In fact, do I get that $9 back?
    Mr. Herz. Yes.
    Senator Bennett. So that becomes profit.
    Mr. Herz. It is not on the balance sheet, by the way.
    Senator Bennett. Well, the P&L goes to the balance sheet. 
What happens to that $9? Does it become profit? Does it run to 
the balance sheet?
    Mr. Herz. Yes, it runs back through the income statement 
and back through equity that was never created.
    Senator Bennett. So in year 9, magically I have got $9 
worth of income. Do I pay taxes on that?
    Mr. Herz. Do you pay taxes on $9?
    Senator Bennett. On that $9 that suddenly comes back in 9 
years.
    Mr. Herz. The awardee of these stock options?
    Senator Bennett. The company. Forget the company. I have 
got to keep the books.
    Mr. Herz. No, the company does not pay any taxes. It is 
not----
    Senator Bennett. I get $9 worth of income and I do not pay 
any taxes on it? That is going to get Senator Levin really 
upset.
    Mr. Herz. That is accounting income.
    Senator Levin. I would like to hear his answer to that.
    Senator Bennett. Well, I would kind of like to hear the 
answer, too.
    Mr. Herz. Well, first of all, you would have estimated for 
the whole group on day one how many people were going to be 
there through the 10 years. So you would have made an estimate 
of what is called forfeitures.
    Senator Bennett. Right.
    Mr. Herz. But in that situation, you would take back the 
$9. The deal was never completed. You had estimated wrongly.
    Senator Bennett. But I got income on my income statement.
    Mr. Herz. That is correct.
    Senator Bennett. And I do not pay taxes on that income.
    Mr. Volcker. That would depend upon the IRS.
    Mr. Herz. Well, it would depend on--not in the United 
States you wouldn't, because the tax deduction, the stock 
option tax deduction actually occurs for the excess, the 
windfall of the value given.
    Senator Bennett. All right. Let's go back to the first one. 
The first one, no problem, Black-Scholes says it is $10. I put 
$10 as expense. Do I get a $10 tax deduction?
    Mr. Herz. Yes.
    Senator Bennett. So if I am a small businessman----
    Mr. Herz. You get the $10 tax deduction or a higher tax 
deduction when the person actually exercises the option.
    Senator Bennett. Well, wait a minute. I am drawing up my 
tax return for this year, and I have got $10 worth of expense.
    Mr. Herz. You have $10 of accounting expense.
    Senator Bennett. Right. Can I take a tax deduction to that?
    Mr. Herz. Not on your tax return. What you have is a 
deferred tax benefit for accounting purposes.
    Senator Bennett. OK. When do I get to take the tax 
deduction?
    Mr. Herz. As Senator Levin said, when there is an exercise 
of the option by the employee. Let's say when the employee 
exercises and that employee--let's say the stock has gone to 
$100, and he makes a profit of $50, say, because the strike 
price was, say, $50. The employee would declare taxable income 
of $50, and the company would get a tax deduction of $50 for 
taxable compensation.
    Senator Bennett. So I take the expense in year 1, but I do 
not get the tax deduction until, say, year 5.
    Mr. Herz. Right.
    Senator Bennett. And you say that is making the financial 
statements clearer and more accurate if I don't get the tax 
deduction in the same year that I take the expenses?
    Mr. Herz. Well, the Tax Code and accounting are not the 
same. They are not designed to be the same.
    Senator Bennett. Bingo.
    Mr. Herz. Right.
    Senator Bennett. That is the point that so many people are 
missing in this debate. The Tax Code and the accounting for 
expenses are different. So you are going to say to me as a 
company, you have to show in your statement to a shareholder 
that you just made no profit. Let us say the total cost of the 
options matches total amount I make, so you just show you have 
made no profit.
    Mr. Herz. Correct.
    Senator Bennett. In the footnote you have to say you have 
really got a lot of cash.
    Mr. Herz. We have a cash flow statement. There are four 
basic financial statements.
    Senator Bennett. Yes, you have got a cash flow statement. 
As a manager running a business, when I was running a small 
business, I looked for every deduction I could possibly find. 
Why? Because I didn't want to pay any taxes. I managed the 
business to make sure that we didn't earn a dime.
    Now, this is not a public company. This is a private 
company. I have run public companies and private companies. And 
I will tell you, private companies are a whole lot more fun. 
But we didn't want to earn any money, accounting-wise, because 
we needed every penny of cash to make that fledgling business 
survive. So I looked for every possible deduction.
    So you come along and say, Here, you can deduct the cost of 
your stock options, and I say, Wonderful, do as many as you can 
so I can build as many deductions so I can save cash. The IRS 
says, no, we don't recognize those as real expenses.
    Mr. Herz. That is right.
    Senator Bennett. Now, as soon as I go public, yes, FASB 
says they are real expenses, but IRS does not. I have to charge 
them against my income statement, and, therefore, they end up 
on the balance sheet as a lower reduction in retained earnings. 
But I do not get any tax benefit for doing that--except in 
certain countries, apparently, as we begin to go international.
    Mr. Herz. In certain countries, they have an economic 
valuation like we do for accounting, rather than an outcome 
approach.
    Senator Bennett. OK. The point of all this--and I will quit 
belaboring it. I am late to another meeting, and I apologize 
for just dumping this on you and having to leave. I want the 
financial statement to be as clear as possible, and so do you. 
That is why I favor expensing. But I am convinced that the way 
you have drawn this up is going to make the financial statement 
absolutely incomprehensible to somebody that does not have the 
kind of experience and background you do. And I guarantee you 
that Senator Enzi's concern about small business is not ill-
placed.
    Mr. Herz. Well, for Senator Enzi and small business, we 
have proposed an alternative method, which is like the tax 
method.
    Senator Bennett. So as soon as you get above a certain 
level, the rules change.
    Mr. Herz. No. It is because for a private company you do 
not have liquid stock. There is a cost/benefit issue, and we 
think that makes--it is not pure, but it is a decent 
alternative, just like what you are saying.
    Senator Bennett. How can you be sure that we do not have 
liquid stock if we do not have a public market? My brother-in-
law might want my stock.
    Mr. Herz. Well, then we are going to let you--the 
alternative then would be to do the right method and value it 
economically.
    Mr. Volcker. Brothers-in-law are not usually very liquid. 
[Laughter.]
    Senator Bennett. Each of us is a prisoner of his own 
experience. And my experience running little companies, 
handling start-up companies, one or two of which actually 
became big companies and ended up listed on the New York Stock 
Exchange--and they were a lot more fun to run, again, when they 
were private before we had to deal with analysts. It tells me 
that--sorry to disagree with my tall friend--there are some 
consequences that will affect the economy if this thing does 
not become a whole lot more user-friendly to the brand-new kind 
of stock option that has just grown up in the relatively recent 
future where you say we are going to have long-term vesting and 
we are going to have wide participation and it is going to be 
in start-ups. And that has helped fuel the growth of the 
American economy, and I do not think you have paid enough 
attention to that.
    At the end of the day, I am still with you that we ought to 
expense. I am still with you that we ought not to pass 
legislation. But I am very troubled that the consequences of 
what you have done seem to be so skewed towards the public 
company, the General Motors, the Coca-Colas, and the Microsofts 
of this world, that you could do significant harm in the 
entrepreneurial area. And that is what Senator Boxer is saying.
    As I say, I have not signed on to the Enzi bill. I have 
been under a lot of pressure to do it. I look at the Enzi bill, 
and I see a lot of things wrong with it. But I hope I have 
gotten across to you that even though technically I am in your 
camp, I am very troubled at the results that I see in the work 
that you have done.
    Mr. Herz. Well, if I could respond?
    Senator Bennett. Sure.
    Mr. Herz. First, as I said, we have still a lot of due 
process left. We are meeting with the Small Business Advisory 
Committee. We have specifically crafted questions about not 
only private companies but small business issuers as to what 
ought to be appropriate there.
    As I said, we have proposed an alternative method, which is 
closer to what you are proposing, which would not require 
option pricing models, which would be more on what you seem to 
favor in general, what is called an exercise date type 
approach, which is kind of the accounting version of the Tax 
Code. And those are all things that we have invited comment on. 
So, rest assured we will be looking at all that, and we are 
very sensitive to the cost/benefit burdens, to the 
understandability. We have a question specifically in the 
notice to recipients about understandability. That is why we 
have lots of examples, as I said, in the document.
    So, I hope you will also have an open mind, and maybe we 
can visit with you.
    Senator Bennett. I would be delighted to. Thank you, Mr. 
Chairman.
    Senator Fitzgerald. Thanks, Senator Bennett. Senator Levin.
    Senator Levin. It seems to me there are two key issues: One 
is the difficulty, allegedly, of valuing something at a date 
which it is given to the employee, because you have got to 
estimate its value and it is not exercisable until some future 
date. And I would like to get some more examples from you as to 
how they work and about other forms of compensation which are 
also based on uncertainties where we do value. You have used 
two terms that I do not think--at least I am not familiar with 
one of them. Long-dated stock warrant, I think was the term. 
Another one was a convertible bond. And I think if you could 
just give us a word or two on each of those, it might be useful 
to show this is not some unusual, novel feature here, that we 
apparently do value things which are difficult to value.
    Now, we talked about good will and a number of other things 
which we are familiar with, even depreciation. But just in 
terms of these kinds of--I think you called them equities. What 
is a long-date stock warrant? And how is that similar to----
    Mr. Herz. Well, companies will use stock purchase warrants, 
which are like a stock option. It gives the counterparty, the 
holder, the person that you grant it to, the ability, the right 
to buy your stock, a share of your stock at a fixed price for a 
fixed term. And it may have various conditions in it. For 
example, it may be to a provider of services to your company 
that says you can do this as long as, if you are a lawyer, we 
win the next following five cases. Or if we only win four 
cases, then the terms of the warrant will change a little bit. 
I mean, these can get quite complicated, but----
    Senator Levin. Are they valued now?
    Mr. Herz. Yes, they have been required to be valued for 
many years and accounted for.
    Senator Levin. At the time that they are granted?
    Mr. Herz. Yes.
    Senator Levin. All right. So there are models, there are 
ways of valuing those kinds of conditional grants or transfers 
of stock.
    Mr. Herz. Right.
    Senator Levin. What about the convertible bond?
    Mr. Herz. Well, a convertible bond is a bond that contains 
a stock option in it. It basically allows at a fixed price the 
person to convert the bond into a certain number, a pre-
specified number of shares. And those terms can go out 10, 15, 
20, or 30 years. There has been in vogue recently what are 
called contingently convertibles, which not only have that 
feature but you can only actually do the conversion based upon 
some kind of formula of the stock price in the future meeting 
certain target levels. It only gets contingently triggered, yet 
you have to----
    Senator Levin. Those contingent triggers are, nonetheless, 
valued in some way.
    Mr. Herz. Sure. The instruments are valued every day in the 
marketplace.
    Senator Levin. But these can't be valued in the 
marketplace, I gather--or can they?
    Mr. Herz. Yes, they can. The convertible bonds are traded--
--
    Senator Levin. No, I am talking about the stock option 
given to an employee. Can they be valued in the marketplace 
since they cannot be exercised by anyone other than that 
employee?
    Mr. Herz. No, they do not trade in the marketplace, 
although as the CBO report comments, individuals, if you have 
enough of them, you can find ways to extract the value, protect 
the value through hedging devices.
    Senator Levin. So through a hedging device you actually can 
extract, as you put it----
    Mr. Herz. You can monetize the value at a point in time.
    Senator Levin. Even though it cannot be exercised by anyone 
other than the employee?
    Mr. Herz. Right.
    Senator Levin. OK.
    Senator Fitzgerald. They are not transferable, is that why 
they cannot be sold?
    Mr. Herz. That is correct. And as part of our methodology, 
we recognized that, and, in fact, there is a big hair cut 
effectively for that in the modeling.
    Senator Levin. All right. Now, that is extremely helpful 
information, I believe, because one of the issues we hear a lot 
from people who want to override FASB is you cannot value 
these. And you are saying there are all kinds of contingent 
instruments, conditional instruments, which are valued all the 
time that are similar to these instruments.
    Mr. Herz. And often more complicated.
    Senator Levin. And even more complicated.
    Now, the other issue has to do with, I think, your 
conversation with Senator Bennett, if I followed it, and that 
had to do with there may be an option open to small businesses 
where you are going to allow them--particularly if they are not 
publicly owned, I gather--to opt into the certainty of saying, 
OK, you do not want to do that when they are exercised, if they 
are exercised, if you take a tax deduction at that point they 
show up on your books. Did I hear you correctly?
    Mr. Herz. Yes, well, what we are doing is saying take, as 
you go along, what the difference between the current value of 
the stock and the strike price is, and then finally at exercise 
date, you would have the final measurement there. So it is kind 
of each period you would be showing what the status is.
    Senator Levin. Would it be the same as a tax deduction?
    Mr. Herz. The final measurement overall would be the same 
as a tax deduction for non-qualified stock options.
    Senator Levin. All right.
    Mr. Volcker. Then you know what the value of the stock is, 
and there is no----
    Senator Levin. Excuse me, Mr. Volcker. What were you 
saying? Repeat that so we can all hear it.
    Mr. Volcker. I don't know how you keep adjusting the value 
of the option when there is no market for the stock.
    Mr. Herz. You would value the stock just like you do for 
tax purposes in order to figure out the tax deduction.
    Senator Levin. But at the end of the day----
    Mr. Volcker. You don't have a market.
    Senator Levin. Wait a minute, if you are going to speak, 
which is fine, I think we have got to get this on the record so 
we understand what you two guys are saying. This is an unusual 
hearing in this regard, but it is welcome, provided we can--I 
would welcome it on my time, providing I understand what you 
are saying to each other.
    Now, at the end of the day, however, the amount of the tax 
deduction would equal the amount of the expense shown on the 
books under that option. Is that correct?
    Mr. Herz. The cumulative expense, yes.
    Senator Levin. OK, but that is the bottom line at the end 
of the day.
    Mr. Herz. That is right.
    Senator Levin. Putting aside the difficulty that Mr. 
Volcker is talking----
    Mr. Herz. By the way, we have also said that if you are a 
public company and you really don't think you can do the grant 
date valuation with sufficient reliability, and you convince 
your auditors of that, and possibly you might get chosen for 
SEC review and you would have to convince them. But you could 
use that alternative method in that circumstance as well.
    Senator Levin. That is the certainty approach. Have you 
gotten much support from the business community for that 
approach?
    Mr. Herz. No, and I think for two reasons. One is--I think 
they believe that the value--the cost is the grant date because 
that is the date the deal is made and it is based on today's 
price and you kind of figure out what the value is then.
    Senator Levin. So the business community wants the grant 
date to be the date that the valuation takes place, and yet it 
is the same community that says you cannot value on that date.
    Mr. Herz. Well, I think certain elements of the business 
community.
    Senator Levin. Well, it is part of the business. But part 
of the argument you get from the opponents is you cannot value 
on the date that you give the right away. But part of the 
opposition we also hear is you cannot value on that date. It 
seems to me that those are two inconsistent arguments. At least 
the same person should not make both arguments.
    Mr. Herz. I agree.
    Senator Levin. Now, do you know how many companies now 
expense stock options? There are quite a few that are actually 
now doing it.
    Mr. Herz. The last tally I saw that either already are or 
said they will be in the near future was about 500.
    Senator Levin. And those would be fairly significant size 
companies?
    Mr. Herz. Yes. I mean, there are, as I remember, about 115 
of them are in the S&P 500 and----
    Senator Levin. And have they shown any loss in stock price 
as a result, do you know? Have you seen any studies on that?
    Mr. Herz. I saw a study by Towers Perrin recently that said 
they didn't.
    Senator Levin. Did not?
    Mr. Herz. They did not suffer a loss in stock price. I also 
saw another study by some professors--I think one was at 
Stanford as I remember--that said they actually got a very 
short-term bounce, probably on the view that they got some 
reward for better accounting, better corporate governance.
    Senator Levin. Thank you. My time is up.
    Senator Fitzgerald. Thank you. Senator Lieberman.
    Senator Lieberman. Thank you, Mr. Chairman. This has been a 
really interesting and important hearing. I wanted to share an 
observation and then ask a few questions, and it is about this 
question of the independence of FASB, which I respect.
    We are not accountants up here. Senator Enzi happens to be 
the only accountant in the Senate, as far as I know. So why did 
I get interested a decade ago? Because I was concerned hearing 
from people in business about the impact of the accounting 
change that FASB was proposing on the economy, on millions of 
workers who are benefiting from options, etc.
    If I understand the history here, you are essentially a 
private group--really, a professional group, exercising an 
authority that has significant public effects. And if I get it 
correctly, this is a public authority that was granted by 
statute to the SEC to set accounting standards, which it in its 
wisdom delegated to FASB.
    So you have got a situation where a public authority has, 
for reasons that make a lot of sense in most cases--because we 
should not be doing accounting standards. That is not our 
business. But you have got a public authority granting this 
power to a private entity, and then it makes a judgment that 
has, at least in my opinion, and obviously a lot of others, in 
this case a big effect on public policy, on the economy. And 
yet part of my concern is that with independence in this case 
comes no accountability. So your decisions cannot be appealed 
to court, can they?
    Mr. Herz. I am not sure about that, but----
    Senator Lieberman. Can I ask one more question and then let 
you respond? Just as a factual basis, can the SEC--I assume--
let me state it as my on-one-leg opinion--that the SEC retains 
the authority to override a FASB ruling. Is that correct?
    Mr. Herz. Yes, that is exactly correct, and we are subject 
at the technical level to very detailed oversight, monitoring, 
and involvement by the SEC staff. They have been following 
every aspect of what we do on this project and every other 
project. They can and have on occasion said, gee, we don't 
agree with what you are coming up with, either stop or we will 
override it. That has happened on one occasion in the past, on 
another occasion back in the 1960's with the investment tax 
credit Congress overrode the then Accounting Principles Board.
    You raise a good point, and it is, to a certain extent, a 
difference in philosophies or public goods. The view of 
accounting standard setting, whether it be our Board or the 
International Board, is that we really have to be unbiased and 
neutral as to the economic consequences. The economic 
consequences do flow from better information. What you measure 
matters and the like, and that is the best way to assist the 
capital markets and the credibility of overall financial 
information.
    Now, there are other people who would assert another public 
policy good, but that is not, in fact, in the SEC document that 
re-recognized us after Sarbanes-Oxley, it basically said, 
reaffirmed that what we do has to be objective and neutral.
    Senator Lieberman. Right. So that gives me some comfort, if 
you will, and I would welcome your responding in writing 
afterward about my assumption that FASB's rulings are not 
subject to appeal in court. But the way to balance what FASB's 
independence brings and the possibility whether in this 
decision or another one--let's assume that this decision is a 
debatable one. Arguably, FASB might do something that most of 
us up here and in America would think was lunacy, whatever it 
is.
    The accountability and the public interest in that then 
goes to the SEC, which has the authority to override, and 
obviously that is something that they can consider as this 
particular proceeding goes on.
    Listening to Senator Bennett, he said he is for the 
expensing of stock options, but I think his questioning really 
brought out why those of us who have said we are not for the 
expensing of options at the time of granting have such a 
problem with this, because we do not know how you can do it 
accurately. At one point, I think you said if the value--the 
point here is to try to put a value on the option now, on the 
day it is granted. But the only value that I can see that the 
option has on the day it is granted that I would have any 
confidence in is the stock price on that day, the market price 
on that day. But, of course, it is not going to be exercised.
    You said earlier that since 1995, when FASB required the 
footnote disclosing, according to Black-Scholes, the value of 
the options that people have been doing it and living with it. 
But is there any basis for--in other words, they have been 
applying the formula, but is there any basis for having any 
confidence that it is accurate, that the result of it is 
accurate?
    Mr. Herz. Well, it is accurate based upon the accuracy of 
the valuation. Again, these valuations are based upon models 
that are basic financial economic theorems and that are tested 
every day in the markets for these other instruments. There are 
certain adjustments you make for employee stock options because 
of the transferability aspects, the vesting aspects, and those 
kinds of things. But the basic models themselves are tried and 
tested in the marketplace.
    Senator Lieberman. Let's say that on the day of granting, 
the market price is $10 a stock and, according to Black-
Scholes, the value of it is $20.
    Mr. Herz. No, it cannot be more than the stock.
    Senator Lieberman. I am sorry. It is the--well, OK. I am 
sorry. I am going to the deductibility.
    Here is my point. Let's say that when we get to the date of 
exercise there is an obvious difference between what Black-
Scholes predicted and what the value really was to the 
employee. Is there any way to alter the expenses if they turn 
out to be inaccurate so that the company is not--this is, I 
guess, in a way what Senator Bennett was asking you--is not 
stuck with the impact of having expensed at a greater, or even 
a lesser rate, in the interest of equity, than it turned out to 
be?
    Mr. Herz. Well, we are continuing to talk a little bit past 
each other, but because, again, the grant date value is the 
value at the grant date, the model takes into account Black-
Scholes, a million different possibilities of where the stock 
might end, not just----
    Senator Lieberman. Yes, but that is my problem. It is only 
going to end in one place.
    Mr. Herz. That is correct. But I would commend you to read 
the CBO report as to why the grant date is the right cost to 
the company.
    Senator Lieberman. I will. Let me ask this question: If the 
Black-Scholes system has been working so well, why in the 
released exposure draft have you urged companies to use the 
binomial or lattice model to value employee stock options?
    Mr. Herz. The lattice models are--it is like taking Black-
Scholes and opening it up. Black-Scholes is kind of hard-wired. 
You have to put a set of uniform assumptions into it, and then 
it cranks out a value. The binomial model allows you to, for 
example, say, well, I am going to sell division and, therefore, 
my volatility and dividend policy is going to change next year. 
It allows you to take the assumptions and change them by 
periods, just as you would if you were going to, for example, 
value an intangible or value an in-process R&D project, which 
are regularly done. It is taking the Black-Scholes and opening 
it up.
    So what it means is that you can, getting the right 
information, you can get a more refined estimate than just the 
simple Black-Scholes because it is less flexible.
    Senator Lieberman. My time is running out, and I want to 
let the next panel come on.
    Why not avoid all of these problems that we have talked 
about, about the difficulty of predicting the value of a stock 
a year or 5 years or 10 years forward, when there are so many 
variables, by requiring the expensing to occur on the day it is 
granted, when to me it has no value. The value comes to the 
employee, as the tax system recognizes, when he exercises it 
because he pays a tax on the spread between the price of the 
stock on the day he got the option and the price of the stock 
that he exercised it--and, incidentally, as has been pointed 
out, the company gets to deduct the spread.
    So in what Senator Levin refers to as a double standard, we 
disagree on that--the same thing is bothering both of us but we 
have come to different conclusions. Why not resolve the problem 
by requiring an expensing of stock options on the date of 
exercise?
    Mr. Herz. Well, we could do that. We do not think it is the 
proper measure of the compensation. It is what the individual 
actually gets out of it, but it is not the measure of the cost 
to the company.
    Again, I would commend you to the CBO report to understand 
why----
    Senator Lieberman. Talk a little bit about that. It is what 
the individual gets out of it. It is what the company----
    Mr. Herz. As Chairman Fitzgerald said, once you issue this, 
what happens is there is a wealth transfer that goes on after 
that between the existing stockholders and these new equity 
owners.
    Senator Lieberman. But it is of indeterminate value.
    Mr. Herz. No, it can be valued----
    Senator Lieberman. It dilutes the stock to some extent, but 
we don't know how much until it gets exercised.
    Mr. Herz. You don't know the final measure of what that is, 
but you know the value at any point in time.
    Now, we could do that, but then the question would be: 
Would we also do that for every other instrument that takes 
these same kinds of things, like a convertible? If I issue to 
you a convertible and 15 years down the road you may convert 
that, and although you only paid $1,000 for that bond, you may 
convert it--this was a very successful company--at $30,000. 
Should we measure the expense to the company at $30,000?
    I will give you another example: Stock purchase warrants 
that are issued to suppliers. I give you 10 of my stock 
purchase warrants for 10 of your widgets, and we will agree 
that your widgets are each worth $5 and my warrants are each 
worth $5, so we have a fair value exchange of $50. Those 
warrants entitle you to exercise or to buy the stock at a fixed 
price for 10 years. Nine years down the road, I am, again, a 
successful company; you exercise it for $300. Should we have 
said that the cost of the goods that I got from you, the five 
widgets, was $300, not $50? It is incongruous.
    Senator Lieberman. My time is up, but I would really urge 
you to do everything you can to open up the hearings that you 
are going to hold and make sure you hear from people on all 
sides and think about what they say. And then obviously I hope 
that the SEC will follow what you are doing and exercise the 
authority that it has delegated to you if it thinks that FASB 
has done something that is not right. Thank you very much.
    Incidentally, this is very difficult for me to go through 
this debating process with Mr. Herz because he and FASB, I am 
proud to say, are located in Norwalk, Connecticut.
    Senator Fitzgerald. Well, thank you, Senator Lieberman.
    I have just a couple of wrap-up questions. Have you had any 
indication from the SEC as to their views on this new rule? 
They haven't given any indication that they----
    Mr. Herz. Well, they completely support our process. I 
think both the chairman and the chief accountant have said they 
are in favor of expensing. Many of their staff have been 
involved and actually helped with crafting a lot of suggestions 
along the way, more in terms of crafting the questions and the 
like. But they will continue to----
    Senator Fitzgerald. So we have the SEC, Alan Greenspan, his 
predecessor Paul Volcker, Warren Buffett, and others, all 
supporting the concept of expensing stock options.
    On the Tax Code and accounting, isn't it true that what 
companies tell the IRS is that their earnings are far less than 
what they report to the public? In fact, companies now report 
to their shareholders many times the earnings than what their 
earnings are that they report to the IRS. We used to have 
pretty good parity between what you reported to the IRS as your 
earnings, probably until the early 1960's or so. As an investor 
I would like to see the tax returns that a company I might 
invest in submitted to the IRS, because I tend to believe their 
real earnings are closer to what they report to the IRS than 
what they report to the public.
    Mr. Volcker.
    Mr. Volcker. I think there is no question that there is a 
discrepancy. It seems to be increasing, and something ought to 
be done about it. But if the accounting is correct, presumably 
something ought to be done about it from the tax side.
    Senator Fitzgerald. That is right.
    Now, I just wanted to clarify one point. Senator Boxer said 
that it was not appropriate for lobbyists to be testifying. I 
did not invite lobbyists to testify. I invited the CEOs of 
Cisco, Intel, Hewlett-Packard to testify or send a high-ranking 
corporate official, CFO or other officer. None of them wanted 
to do that. We tried other companies, as well. Nobody who was 
refusing to expense stock options wanted to come and trumpet 
that to America in a public hearing. I thought that was very 
telling because I thought they weren't necessarily really 
wanting--they were not really proud of what they were doing. 
They are a little bit sheepish about it.
    And, with that, I want----
    Senator Levin. Could I just ask Mr. Volcker if he might be 
willing to expand for the record, perhaps, his one-word answer, 
``No,'' when he was asked by Senator Akaka whether or not he 
thought this rule would increase the amount of outsourcing or 
slow job creation? I know that we have taken a lot of time now, 
but if he would be willing for the record just to expand on 
that answer.
    Mr. Volcker. Well, all I mean to say is that nobody is 
prohibiting stock options, if that is considered a uniquely 
advantageous way of rewarding people, and it may be for some 
start-up companies. But I don't think the way they are going to 
account for it should dominate that consideration, and that if 
it is really the right way to compensate, go ahead and do it. 
If you don't compensate that way, do it some other way. But it 
will appear as an expense.
    Senator Levin. Thank you, Mr. Chairman.
    Senator Fitzgerald. And somebody mentioned China, too. 
Isn't it true that China will require the expensing of stock 
options?
    Mr. Volcker. I believe so. [Laughter.]
    Senator Fitzgerald. OK.
    Mr. Volcker. China will follow international accounting 
standards, which apparently will--I mean the present 
international accounting standard requires.
    Senator Fitzgerald. Well, thank you, gentlemen. We are 
delighted that you were here today, and your testimony was 
interesting. Senator Bennett is also on the Banking Committee, 
and he declined an opportunity to question Alan Greenspan at 
his hearing to be here to talk to both of you. So thank you 
both very much for being here.
    Senator Fitzgerald. At this point I would like to invite 
our third and final panel up to the witness table. I have to 
warn everybody that I have to leave at 5:30 p.m. If Senator 
Levin is still here, I would be happy to allow him to take 
over, but this is going to necessitate that we move pretty 
rapidly through our final panel.
    Our first witness is Jack T. Ciesielski, the owner of R.G. 
Associates, Inc., an investment research and portfolio 
management firm located in Baltimore, Maryland. Mr. Ciesielski 
is the publisher of ``The Analyst's Accounting Observer,'' an 
accounting advisory service for securities analysts. Before 
founding R.G. Associates in 1992, he spent nearly 7 years as a 
security analyst with the Legg Mason Value Trust. From 1997 to 
2000, Mr. Ciesielski served as a member of the Financial 
Accounting Standards Advisory Council, which advises the FASB, 
and he currently serves on the FASB's Emerging Issues Task 
Force.
    Our second witness on the panel is Damon Silvers, who is an 
Associate General Counsel for the AFL-CIO. Mr. Silvers' work at 
the AFL-CIO includes corporate governance, pension, and other 
business law issues. He is a member of a number of boards and 
advisory groups, including the Public Company Accounting 
Oversight Standing Advisory Group, the Financial Accounting 
Standards Board User Advisory Council, and the New York Stock 
Exchange Stock Options Voting Task Force. Prior to his work at 
the AFL-CIO, Mr. Silvers was the Assistant Director of the 
Office of Corporate and Financial Affairs for the Amalgamated 
Clothing and Textile Workers Union.
    Our third witness is from my home State, Donald P. Delves, 
who is the President and Founder of The Delves Group, which 
works to foster the growth and development of businesses 
through evaluating and building effective total compensation 
systems. Mr. Delves, as I said, is from Illinois and he has 
over 20 years of consulting experience in the area of 
compensation and incentive systems. He is a popular speaker on 
executive compensation, stock options, and corporate 
accountability. He recently sent me a copy of his new book, 
``Stock Options and the New Rules of Corporate Accountability: 
Measuring, Managing,'' which was published just last year, in 
October 2003. Mr. Delves, thank you for being here.
    Our fourth witness is Mark Heesen, who is President of the 
National Venture Capital Association, NVCA. The NVCA is a 
member-based trade association that works to maintain high 
professional industry standards and foster an understanding of 
the importance of venture capital in the United States and 
global economies. Since 1991, Mr. Heesen has worked on behalf 
of the venture capital community to enact a wide range of 
policies that benefit the venture capital and entrepreneurial 
communities, including the significant capital gains 
differential securities litigation reform, accounting treatment 
of stock options, and reform of the Food and Drug 
Administration's pre-market approval process.
    Our final witness is someone whose columns I love reading 
in the Sunday Washington Post. They are normally very 
insightful and very good, and the column was very good this 
past week. It is James K. Glassman, who is a resident fellow at 
the American Enterprise Institute for Public Policy Research, 
AEI. Mr. Glassman's research addresses such areas as Social 
Security, economics, the Federal budget, interest rates, the 
stock market, and taxes. During the past 10 years, Mr. Glassman 
has written a weekly syndicated column for the Washington Post 
on investing. He is the author of ``The Secret Code of the 
Superior Investor.'' He has written two books geared toward 
small investors and has published numerous articles on 
investing topics in publications such as the Reader's Digest 
and the Wall Street Journal.
    Again, I would like to thank you all for being here. As I 
said, we are going to have to end at 5:30 sharp. I am, 
therefore, asking you to please submit your lengthier written 
statements for the record. But please try and summarize your 
remarks in 5 minutes or less so we can finish on time. In fact, 
that won't leave us much time even for questions, so the 
quicker, briefer, and more succinct you can be in your opening 
statements, we would really appreciate it.
    Mr. Ciesielski, will you begin. Thank you.

TESTIMONY OF JACK T. CIESIELSKI,\1\ PRESIDENT, R.G. ASSOCIATES, 
                              INC.

    Mr. Ciesielski. Thank you. Chairman Fitzgerald, Ranking 
Member Akaka, and Members of the Subcommittee, I am Jack 
Ciesielski, President of R.G. Associates. It is my pleasure to 
be participating in this hearing, and I look forward to 
answering your questions if we have time.
---------------------------------------------------------------------------
    \1\ The prepared statement with an attachment and an accompanying 
addition to the written statement of Mr. Ciesielski appear in the 
Appendix on pages 89 and 97 respectively.
---------------------------------------------------------------------------
    I have a brief prepared statement, and I would respectfully 
request that the entire text of my testimony and the 
accompanying written statement be entered into the public 
record.
    Senator Fitzgerald. Without objection.
    Mr. Ciesielski. Let me preface my remarks with a brief 
description of my business and how it relates to this hearing. 
My firm, R.G. Associates, Inc., is primarily an independent 
investment research firm and is dedicated to the analysis of 
corporate accounting issues. We have a small asset management 
business, but our main focus is the publication of a research 
service entitled ``The Analyst's Accounting Observer,'' which 
analyzes and explains accounting trends to both buy-side and 
sell-side analysts.\1\ Frequently, Observer reports are devoted 
to new or pending pronouncements of the Federal Accounting 
Standards Board. Our client base of approximately 70 firms is 
diverse. Readers of our research range from some of the world's 
largest mutual fund families and well-established brokerage 
firms and rating agencies, all the way down to money management 
firms with only a handful of employees and assets under 
management. In short, our client base is a unique cross-
sectional view of the many different kinds of financial 
statement users.
---------------------------------------------------------------------------
    \1\ ``The Analyst's Accounting Observer,'' appears in the Appendix 
on page 153.
---------------------------------------------------------------------------
    I have been writing the Observer for over 12 years, and as 
I have composed reports about new FASB standards, I have had 
plenty of interaction with the Board and its staff. I have 
participated in the Board's hearings and roundtables on 
proposed standards, and as a member of the Financial Accounting 
Standards Advisory Council and Emerging Issues Task Force, I 
have had ample opportunity to observe the deliberations and the 
due process that goes into the development of FASB standards. I 
have had the chance to see how the standard-setting process 
benefits from the inputs provided by accounting firms and 
financial statement preparers--from people who are close to the 
issues being considered by the Board and whose experience with 
those issues helps the Board develop more durable standards. In 
my view, the FASB's system of listening, learning, and then 
improving their proposals works very well as it exists.
    With that, I would like to turn my attention to the purpose 
of this hearing. On the surface, this hearing is all about an 
accounting standard dealing with stock options given to 
employees, but there is a much larger issue that merits our 
attention. That issue is the independence of the FASB, for if 
there were not attempts by some parties to legislate action 
that robs the FASB of its independence, we would not be having 
this hearing today.
    The FASB plays a unique and indispensable function in our 
country's capital market system--as is the role of any standard 
setter. Progress in society would be impossible if there were 
not uniform standards for many of the things we take for 
granted: For instance, something as simple as the design of 
electrical outlets. That is what makes the FASB's role 
critical: By being the independent arbiter of principles at the 
foundation of financial reporting, investors benefit from 
financial information that is more comparable and robust than 
would exist if every preparer had their own way of presenting 
information.
    In my years of observing the standard-setting process, I 
have seen the Board develop improved accounting standards with 
an unmatched level of openness and fairness. Their standards 
will not make everyone happy--in addressing the complicated 
issues they are charged with, it is impossible to satisfy all 
parties involved. The reason we are here is because some of 
FASB's constituents are so unhappy with their attempts to 
reform the accounting for stock option compensation that they 
have pulled Congress into the process. They are seeking a 
legislative answer to an accounting rule they oppose and, in 
doing so, usurping the FASB's authority to set standards. I 
believe that the FASB's ability to develop impartial standards 
resulting in robust information for investors to use would be 
seriously hampered if legislative intervention becomes the norm 
for disagreeing with their pronouncements, and a blueprint for 
such behavior was created the last time the Board attempted to 
remedy option compensation accounting 10 years ago. While it 
may benefit a few of the Board's constituents to preserve the 
present broken accounting model, in the long run our capital 
markets would likely suffer and result in capital being 
misallocated in the economy at large.
    I would like to focus the remainder of my remarks more 
specifically on the accounting issue under consideration, 
arguably the most contentious project ever taken up by the 
FASB. Despite the claims of vocal opponents, I do not view the 
FASB's proposal for equity-based compensation accounting as 
somehow dangerous or reckless. In my judgment, the Board has 
listened fairly to the views of its constituents and learned 
much as this project has wended its way from an ``invitation to 
comment'' document in 2003 to the exposure draft of a standard 
at the end of March.
    I believe that the issuance of a final standard requiring 
the recognition of stock option compensation would 
significantly benefit the users of financial statements. I 
believe the argument that options cannot be valued and, 
therefore, should reflect no compensation expense when given to 
employees is without merit. Companies use option pricing models 
such as the Black-Scholes model to value illiquid options and 
warrants they hold in their corporate portfolios. They use them 
to value options on their stock given as consideration in 
making acquisitions. Yet they will claim that the same models 
cannot be used to value options given to employees as 
compensation. It seems that the only acceptable value such 
options can have is zero.
    Some of the opponents of FASB's proposals claim that the 
option compensation information should be relegated to a 
footnote as it is currently displayed. I disagree. The current 
presentation is a substitution of disclosure in place of paper 
accounting. It resulted from a Board that was badly compromised 
in 1994 due to the political actions that interfered with its 
independence. The information reported in the footnotes since 
1996 were real transactions that occurred with employees, and 
financial statements are supposed to contain transactions that 
occurred in a firm for a given period. By our count for the S&P 
500, net earnings were overstated by more than $175 billion 
from 1993 to 2002. That is information about transactions which 
was presented only once a year to investors rather than as it 
occurred each quarter, and it directly related to the resources 
under the firm's disposal, which management is supposed to 
employ for the benefit of its shareholders. That is one of the 
tenets of capitalism and one that has been ignored when it 
comes to reporting equity-based compensation.
    Opponents of the FASB proposal often claim that stock 
prices will fall if option compensation is recognized in 
earnings. I cannot think of a more patronizing argument. 
Markets are supposed to allow capital to flow to wherever it 
can best earn the best return. Information about how capital is 
being managed allows capital providers to make rational 
investment decisions. If stock prices fall because capital is 
not being allocated properly in certain firms, then markets are 
allowing capitalism to function as it should.
    For decades, accounting standards have done a poor job in 
depicting how capital is being used when it comes to equity-
based compensation, and consequently, we have seen how capital 
has been misallocated in the past.
    The interference surrounding the FASB equity compensation 
project is very much like a decade ago, when the Board proposed 
that health care benefits promised to employees----
    Senator Fitzgerald. I'm going to have to ask you to wrap 
up, because we have to keep on going. We've gone past 5 
minutes.
    Mr. Ciesielski. OK. The situation is similar to the one we 
had the tussle over accounting for other post-employment 
benefits. The world didn't come to an end. We now have a 
referendum on how these things should be managed.
    Earlier in my comments I mentioned that a large variety of 
financial statement users contacted me in connection with the 
accounting observer. One question that they continually asked 
from analysts of all stripes is not can we stop this from 
happening. The most frequent question I hear is when will this 
go into effect. We want to start adjusting our models.
    Investors and analysts are ready now for such information, 
and would like to roll back the uncertainty that surrounds the 
way they will do their jobs. That will diminish if the FASB 
completes its project independently.
    Senator Fitzgerald. Thank you very much. Mr. Silvers.

  TESTIMONY OF DAMON SILVERS, ASSOCIATE GENERAL COUNSEL, THE 
      AMERICAN FEDERATION OF LABOR-CONGRESS OF INDUSTRIAL 
                    ORGANIZATIONS (AFL-CIO)

    Mr. Silvers. Thank you, Mr. Chairman. I will do my best at 
shortening this up. I am here on behalf of the American 
Federation of Labor and Congress of Industrial Organizations, 
of our 13 million members who have $5 trillion invested in the 
capital markets, in retirement plans.
    The AFL-CIO strongly supports the Financial Accounting 
Standards Board in its effort to close the accounting loophole 
that has allowed corporations to radically understate the trust 
cost of executive compensation. We strongly oppose S. 9769, S. 
1890, and other efforts to exempt stock options from the normal 
accounting rules and the normal processes by which accounting 
rules are made.
    In the mid-1990's, as many of the previous witnesses have 
discussed, FASB attempted to require option expensing but was 
pressured by Congress into abandoning its position. We believe 
that this thwarting of FASB's role as an independent body was a 
key contributor to the chain of events that led to the 
corporate scandals of the last several years that did profound 
damage to our members and our funds.
    Ten years later, there can be no doubt that this issue has 
been studied to death, most recently by the Congressional 
Budget Office. The Big 4 auto firms, the Conference Board, the 
chairs of the SEC and the PCAOB and every investor organization 
we are aware of agree, that at long last Congress should simply 
let FASB do its job.
    Against this background, efforts to prevent FASB from 
acting on its conclusions in the name of further study would 
simply lead to continued subsidy of excessive executive 
compensation, and at the cost of undermining the integrity of 
our accounting rules and the processes by which they're made.
    Substantively, the AFL-CIO views stock options as one 
appropriate form of medium-term compensation for line 
employees. However, we think options are a poor form of 
executive compensation because they do not fully expose 
executives to downside risk in the same way that shareholders 
are. Options are also an inappropriate substitute for the basic 
wages and benefits needed to support a family. Not 
surprisingly, nonexecutive options are generally held by upper 
income Americans, whose base salaries already meet their 
fundamental economic needs.
    At the height of the stock market boom in 1999, only 1.7 
percent of private sector employees received stock options, 
according to the BLS, and that was heavily concentrated among 
individuals earning more than $75,000 a year. Only 0.7 percent 
of those earning under $35,000 received options.
    Consequently, the labor movement opposes giving options 
preferential accounting treatment over other more important 
employee benefits, such as wages, pensions, or health care. 
Nonetheless, we do agree with the conclusions of the CBO study, 
that options expensing will not end option use or anything like 
that at cash short firms where they make strategic sense. And 
we're fine with that. We think that's a good thing, that those 
firms continue to use options.
    Two bills in this Congress, S. 1890 and H.R. 3574, purport 
to require the expensing of stock options for the top five most 
highly paid executives. However, that is a sham. These bills 
would require companies using an option pricing model, like 
Black-Scholes, to assume that the underlying stock prices has 
zero volatility. This minimum value approach allows companies 
to set the exercise price of the option equal to the current 
market price and book the value of the option at zero.
    Of course, in real life, the prices of publicly traded 
stocks are volatile, and these executive stock options have 
real value. Passing a bill that says that public company stock 
prices do not move and directing FASB to run an accounting 
system on that basis is the equivalent of passing a bill saying 
the Earth does not move around the sun, and then asking NASA to 
run a space program on that basis. You can do it, but don't be 
surprised if something crashes.
    This slight of hand involving volatility is the latest 
example of misleading arguments surrounding the technical 
details of option valuation. My written statement goes into 
that in detail and I would be happy to answer questions on it.
    Today, the executives of the international stock options 
coalition have one billion dollars in options, in the money 
option value held, not one penny of which has been expensed. It 
should not be any mystery as to what their motives are. What is 
mysterious is how these executives of companies like Texas 
Instruments and Hewlett-Packard reconcile the expenditures they 
are making in the cause of distorting their financial 
statements against the express wishes of the majority of their 
shareholders at both companies who voted on this, with those 
same executives' fiduciary duties of loyalty and care.
    What is the bottom line of all of this? Let me refer you to 
the congressional testimony of former Enron CEO Jeffrey 
Skilling. As he put it, ``You issue stock options to reduce 
compensation expense and, therefore, increase your 
profitability.'' Surely we have learned enough from Enron not 
to mandate by statute that the Enron approach to not accounting 
for stock options be the law of the land.
    Thank you very much.
    Senator Fitzgerald. Thank you very much, Mr. Silvers. Mr. 
Delves.

 TESTIMONY OF DONALD P. DELVES,\1\ PRESIDENT, THE DELVES GROUP

    Mr. Delves. Thank you very much, Mr. Chairman.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Delves with an attachment appears 
in the Appendix on page 100.
---------------------------------------------------------------------------
    I have been advising boards of directors and management on 
executive compensation for almost 20 years. Based on my 
experience, there is absolutely no question in my mind that we 
must have an expense for options, and it must be meaningful, 
significant, and soon. And there is no question that the FASB 
should decide how that expense will be determined.
    Ten years ago, the FASB tried to implement an expense for 
options. Congress intervened and the FASB backed down. Let's 
look at the results. Over the last 10 years, executive pay has 
spiraled out of control, mostly due to excessive grants of 
stock options. Stock options use has more than tripled and 
boards of directors have done a poor job of getting more 
performance from this unprecedented increase in compensation.
    I believe that had the FASB been allowed to do its job and 
implement an expense 10 years ago, we would not be in the mess 
that we're in today with regard to executive pay and corporate 
governance.
    Now let's look at what's happening around the country 
today. Because the FASB has put this expense out there, and 
most companies are taking this seriously, the good news is that 
in board rooms across the country boards of directors are 
reexamining their use of stock options and are coming up with 
new solutions and, in some cases, they're even lowering 
executive pay.
    Boards are asking tougher questions about the true cost of 
options and what they're getting in exchange for it. For 
example, we were asked to do an analysis for a company to show 
the board what the total cost to the shareholders had been of 
their stock option program. We were able to show that board of 
directors, over 10 years, $1.2 billion of shareholder wealth 
had been transferred from shareholders to executives. There was 
no way that we could have done that using publicly available 
data.
    Now, interestingly, we also showed that same board that, 
over that 10 year period, had they expensed options using 
FASB's proposed method, the expense would have been $600 
million, roughly half of the total cost to shareholders.
    Now, our research shows that we expect that to be true over 
time and across companies, that roughly 50 percent of the 
ultimate cost to shareholders will be captured in the 
accounting expense. However, that expense occurs up front when 
the options are granted. If it's a high performing company and 
the stock price goes up, the total cost to shareholders could 
be much greater. But for the poor performing company, the cost 
to shareholders could be much lower. It could even be zero.
    For that reason, I prefer the intrinsic value method that 
Mr. Herz discussed, which is the alternative method that is 
allowed for certain private companies. I think it does a better 
job of capturing the true cost to shareholders. It would 
provide better information to board of directors and could 
result in more creative solutions in executive pay.
    However, the debate over how the expense should be 
determined belongs with the FASB. I look forward to engaging 
with them in that debate according to their proscribed process.
    So, in summary, there must be a significant and meaningful 
expense for stock options, and FASB must decide how.
    Thank you.
    Senator Fitzgerald. Thank you, Mr. Delves. Mr. Heesen.

   TESTIMONY OF MARK HEESEN,\1\ PRESIDENT, NATIONAL VENTURE 
                      CAPITAL ASSOCIATION

    Mr. Heesen. Good afternoon.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Heesen appears in the Appendix on 
page 105.
---------------------------------------------------------------------------
    I'm going to address this question as it really relates 
around private companies and newly public companies. That's 
where the venture capital industry concentrates and that's 
where 11 percent of the employment opportunities are right now.
    Almost without exception, young, growth oriented venture 
backed companies use options to attract the brightest talent at 
a time when cash is scarce, just as Senator Bennett was saying. 
These employees take a considerable risk to work at unproven 
companies, knowing that through their stock option program they 
may be rewarded, if and only if the company succeeds.
    Should FASB's proposal go through, we believe stock options 
will be artificially too costly for many of these young 
companies to offer to all their employees, thus seriously 
hindering their ability to attract human capital to compete and 
providing a false picture of their financial health, which will 
ultimately lengthen their reliance on venture capital.
    This is the important point from our angle. The longer 
these companies stay artificially in the red, the longer it 
takes our companies to be acceptable to the public. Because 
there aren't analysts following these kinds of companies, we 
will have to continue to work with those companies at the 
expense of putting new money into new companies. That means 
fewer venture backed companies will be funded, fewer new 
technologies will be funded, because our industry does not 
scale. There are only a certain number of venture capitalists 
who know how to basically grow companies, and they will only be 
able to do so much in this period.
    We have seen this in the past. You will see a reduction in 
the number of emerging growth companies being funded by venture 
capital.
    One of the largest challenges of mandatory option expensing 
for small companies is the burden of valuation, which we've 
been talking about. FASB has put forth three models for 
valuation. The first two models, Black-Scholes and the lattice 
method, require a volatility number as a critical input. Yet, 
the underlying shares of a privately held company have never 
been liquid, so there is no precedent to derive a volatility 
number, thus creating a significant and costly accounting 
quagmire.
    When issuing FAS 123 in 1994, FASB agreed. They stated the 
Board recognizes that estimating expected volatility for the 
stock of a newly formed entity that is rarely traded, even 
privately, is not feasible. The Board therefore decided to 
permit a nonpublic entity to omit expected volatility in 
determining a value for its options. The result is that a 
nonpublic entity may use the minimum value method.
    Rather than to continue to offer private companies the 
minimum value method, which sets volatility at zero, FASB now 
advises these organizations to use Black-Scholes, the lattice 
method, or as we've been hearing a lot here today, the 
intrinsic value reporting. We believe that this intrinsic value 
reporting model really is akin to offering no choice at all.
    In its proposal, FASB has modified the intrinsic value 
calculation to require that the share options and similar 
options be remeasured at intrinsic value at each reporting 
period through the date of settlement. Historically, this 
calculation has taken place only once, recognizing that 
companies rarely have the information to reset a stock price 
that is not tradeable. A continuous recalculation of intrinsic 
value is too costly for most organizations to bear, resulting 
in invariable accounting which is the result--which experts 
have recognized is unwieldy and impractical, but a gold mine 
for newly admitted valuation consultants, accountants, and 
let's not forget the trial board.
    Unfortunately, GAAP is not a matter of choice for private 
companies. Most start up and report their financials under GAAP 
because they expect or hope to ultimately move through an 
initial IPO process or be acquired by a public company. Again, 
by placing this accounting burden on young companies, FASB is 
lengthening the reliance on expensive, high risk capital to the 
start-up sector.
    Should FASB move forward with its current stock option 
accounting mandate, the Board will be acting in direct conflict 
with its stated goals: ``The cost imposed to meet that standard 
as compared to other alternatives are justified in relation to 
the overall benefits from improvements in financial 
reporting.'' The Board has long acknowledged that the cost of 
any accounting requirement falls disproportionately on small 
entities because of their limited accounting resources and the 
need to rely on outside professionals.
    As the Chicago Tribune stated in its April 6 editorial, 
``Expensing isn't a panacea for investors and it carries a cost 
that could hurt entrepreneurship.''
    Thank you.
    Senator Fitzgerald. Thank you.
    Before I go on to Mr. Glassman, because I'm from Illinois, 
I have to respond to the Chicago Tribune. I have Mr. 
Ciesielski's Analyst Accounting Observer Report that shows that 
the Tribune Company, which owns the Chicago Tribune--and I love 
the Chicago Tribune, I've read it all my life, and they always 
endorse me. They're a wonderful paper.
    But the last time I checked, their earnings were overstated 
more than any other company in my State. According to this 
report, their earnings in 2003 were overstated by 10 percent by 
virtue of their failure to expense stock option compensation. 
They are heavy users of stock option compensation. Their 
earnings per share, as reported last year, were $2.61. If they 
had expensed their stock option compensation, it would be 
$2.38.
    I only wanted to disclose that because I thought they 
should have disclosed that in the editorial they wrote opposing 
the new FASB rule.
    Mr. Heesen. And I would love to see the Washington Post do 
the same thing, frankly, on the other side, with Mr. Buffett 
owning a good chunk of the Washington Post. That would also be 
helpful.
    Senator Fitzgerald. Mr. Buffett does, and he favors the 
expensing of stock options----
    Mr. Heesen. And we would never see----
    Senator Fitzgerald. Also, I think they have a shareholder 
there, Donald Graham, who doesn't want to give all his value 
away necessarily, so he's really watching the company. He's an 
owner more than just a manager, and he's representing the 
interests of the owners. We'll leave some time for questioning, 
though. Mr. Glassman works for the Washington Post, but 
apparently does not share their editorial viewpoint.
    Thank you, Mr. Glassman.

 TESTIMONY OF JAMES K. GLASSMAN,\1\ RESIDENT FELLOW, AMERICAN 
                      ENTERPRISE INSTITUTE

    Mr. Glassman. Thank you, Mr. Chairman, and thank you for 
the kind introductory remarks, Senator Levin.
---------------------------------------------------------------------------
    \1\ The prepared statement of Mr. Glassman appears in the Appendix 
on page 112.
---------------------------------------------------------------------------
    Let me just comment on what you just said. I obviously have 
no reaction to what you're saying about the Washington Post. I 
do have a number of very good friends who work for the Chicago 
Tribune at upper management levels, and I can tell you that one 
of the reasons they are there and diligently working is, 
indeed, because of their stock options, which they talk to me 
about all the time.
    Let me begin my testimony. One in two American families own 
stock, and one in eight U.S. private sector workers hold stock 
options. Senator Lieberman calls this revolutionary 
democratization. I agree with that.
    The FASB proposal of March 31 will adversely affect these 
Americans. The proposal is likely to depress the value of 
securities and, for many firms, it will lead to the elimination 
or reduction of broad-based stock options, 94 percent of which, 
according to a new study, go to employees below the top 
management level. Discontinuing or reducing these options 
programs will have an adverse effect on U.S. competitiveness, 
innovation, and job creation. It will needlessly damage the 
U.S. economy.
    In 1972, when FASB's predecessor first looked at this 
question--not 10 years ago, but 1972--it decided against 
expensing options when issued. The reason, ``Because of the 
concern that stock options could not be reliably valued at the 
exercise date.'' That is still true.
    Now, the current regime gives investors the information 
they need in the form of copious material and financial 
statements. Mr. Chairman, with your permission, I would like to 
enter into the record--this is the Intel Corporation annual 
report. You can look at virtually any annual report of a 
company that issues options. Here under earnings per share it 
lists the effect of the dilution of stock options, reducing 
earnings per share, which is what investors care about, and it 
goes on for three pages with notes on stock options. That's 
more information than most companies include on things that I 
think are a lot more important, such as the sources of their 
revenue, other forms of compensation, patents, debt, all sorts 
of things. This information is in these annual reports.
    Now, I would just like to focus briefly on the issue of 
FASB's accountability. Much has been made of FASB's 
independence. But accountants need to be accountable, too. As 
Mr. Volcker just said, they need to be exposed to the real 
world--that is, to the people's representatives. America's 
elected representatives not only have the authority, they have 
the moral and legal responsibility to oversee the activities of 
FASB just as they oversee the activities of the SEC, which in 
1973 ceded responsibility itself for these standards to FASB.
    Now, this does not mean modifying or overruling common, 
day-to-day decisions. Of course, not. But it does mean 
carefully examining the impact of a tremendously important 
decision like this one on options and accounting. This is not 
interference. This is not intervention. This is not tampering. 
This is a responsible execution of your job.
    FASB has a single mission, which it states this way: ``To 
establish and improve standards of financial accounting and 
reporting for the guidance and education of the public, 
including issuers, auditors, and users of financial 
information.'' FASB executives have said clearly that the 
economic consequences of their decisions do not concern them, 
and they're right. But you, as Federal policy-makers, have a 
far broader mission: Encouraging economic growth, preserving 
and increasing jobs, innovation and competitiveness.
    Now, even if FASB's expensing proposal were cogent from an 
accounting and financial viewpoint--and in my opinion it is 
not--it would be the duty of Congress to consider its economic 
impact.
    Finally, FASB on the one hand states that it is 
independent, so hands off. On the other, it has been vigorously 
lobbying. As I believe Senator Enzi originally said, there is 
an article today in the Wall Street Journal, and let me just 
quote from it, about a conference call yesterday:
    ``During the conference call Monday, Sir David Tweedy, 
chairman of the International Accounting Standards Board, said 
to institutional investors, it would be a `real disaster' if 
Congress blocked FASB. `We would be horrified if politicians in 
the United States stepped in,' he said.''
    Sorry, Sir David. Congress has work to do, and I 
congratulate you, Mr. Chairman, on holding this hearing and 
doing that work.
    Thank you.
    Senator Fitzgerald. Mr. Glassman, thank you.
    On your remarks about Intel disclosing their in the money 
options, they don't disclose in that footnote their stock 
options that aren't in the money; isn't that correct?
    Mr. Glassman. Well, they disclose the number of them that 
are not in the money. In other words, they say there are--
believe it or not, there are a lot of----
    Senator Fitzgerald. They're disclosing the dilution, 
though, in the earnings per share, and they disclose the 
dilution in the earnings per share of only in the money 
options.
    Mr. Glassman. That is correct. And that is the rule----
    Senator Fitzgerald. And then in the footnote, do they show 
the potential dilution from all the options, not just the ones 
that are currently in the money?
    Mr. Glassman. I'm not sure they make the calculation. I 
can't actually--I think that they do. But I can tell you that 
in the P&L, where they do the earnings per share, they show the 
dilution of stock options that are in the money, and they tell 
you the number of stock options which are not in the money--By 
the way, as I remember, I just flipped a page and missed it, 
but I think I've got it down within a few million. There are 
100 million options in the money, and 400 million out of the 
money. I think this shows the problem, in fact, in trying to 
value stock options when they are issued.
    Unfortunately, as everyone here knows, stock prices have 
dropped for a lot of tech companies, and a lot of these options 
are way out of the money.
    Mr. Heesen. They call that super dilution. There have been 
a lot of companies who said they would love to put that 
information out. A couple of business periodicals have actually 
said, if we could do that, that would be fine as an additional 
part of the disclosure, to put in basically the worst case 
scenario. If tomorrow, every option you had was exercised, what 
would that impact be on your company.
    Senator Fitzgerald. OK. Just going back to Mr. Glassman, 
you are on an advisory board for Intel, right?
    Mr. Glassman. That is correct.
    Senator Fitzgerald. You heard my opening statement where I 
was quoting from Benjamin Graham's book, ``Security Analysis--
''
    Mr. Glassman. A great book. I congratulate you for quoting 
from it.
    Senator Fitzgerald. I haven't read the whole thing, but I 
looked up the part on what he called stock option warrants.
    Do you agree with him when he said the basic fact about 
options--he calls them option warrants--is that it represents 
something which has been taken away from the common stock? The 
equation is a simple one. The value of the common stock, plus 
the value of stock options, equals the value of the common 
stock alone if there were no options.
    In other words, if you own a company--let's say you own 100 
shares of a company and that is all the company has in 
outstanding shares--you own all of it. All of a sudden the 
company gives me 100 options to buy shares in your company. 
Something has been taken away from you, right? You're going to 
share equally with me now in the upside participation of any 
future enhancement or rise in the profitability of the company.
    Do you agree with that?
    Mr. Glassman. I do agree with it. But what is being taken 
away is something that is extremely contingent and difficult to 
value. If you're simply giving out warrants, which are things 
that anybody can convert immediately into stock, and that are 
tradeable in most cases, that's one thing. But if you're giving 
me an option which requires me, for example, to stay in the 
company and not get fired, not leave for a number of years, and 
I don't know whether the price is going to go up or down, 
that's something that is contingent, which I think is handled 
quite well, and I think has been for decades----
    Senator Fitzgerald. I agree it's difficult to value, but 
depreciation is difficult to measure, the wearing out of a 
useable life of plant and equipment, that's an age old debate, 
but it nonetheless is a real expense to a company. As a capital 
asset runs out of its useful life and approaches obsolescence, 
the company is actually going to have to expend cash to buy new 
plant and equipment. It is a real expense and we do try to 
capture it. We don't argue that we'll just ignore that expense 
and pretend it doesn't exist, too. The same with pension 
liabilities, amortization of good will or impairment of good 
will, and the value of derivatives. Those are all difficult 
questions, aren't they?
    Mr. Glassman. They are difficult questions, there's no 
doubt about that. I think, however, that we're going down 
exactly the wrong road here. What we're trying to do is take a 
lot of information, which is, indeed, provided to investors, 
and shoehorn it into one number, which is not going to be an 
accurate number.
    I don't think that really helps investors at all. I think 
the current regime actually helps investors a lot more than 
trying to pluck a number out of the air, which is almost 
certainly going to be inaccurate. All but the back testing has 
shown that whatever system is going to be used is not going to 
produce accurate numbers. That's the problem.
    What I find somewhat ironic, I know that Mr. Herz has made 
comments in the past about the importance of really getting to 
work at the true challenge for accounting, which is how, in a 
knowledge-based economy, can you provide the proper information 
to investors. I don't think that proper information is one 
number to represent a very complex phenomenon.
    Senator Fitzgerald. OK. I have a meeting I'm going to go to 
in the anteroom, and I'm now going to turn the questioning over 
to Senator Levin. Then I'm going to try and come back and 
continue on with my questions.
    Senator Levin [presiding]. Mr. Glassman, I think you said 
somebody from the International Accounting Standards Board said 
he would be horrified if Congress acted?
    Mr. Glassman. He said he would be horrified. He didn't say 
Congress. He said if politicians--I guess he was referring to 
Congress--in the United States stepped in.
    Senator Levin. I thought you said, in introducing that 
comment, said it was FASB that was lobbying us. Did FASB put 
them up to it, the IASB?
    Mr. Glassman. I don't know if they put them up to it, but 
there was a joint conference call which FASB, according to the 
Wall Street Journal, held with a number of institutional 
investors yesterday.
    You heard from the testimony, obviously, that part of the 
impetus here is to have a convergence of international 
accounting standards and U.S. accounting standards----
    Senator Levin. That's just stating a position, right? Is 
that lobbying, what you would call it? If they're just stating 
their position as to why they're doing what they're doing, and 
we call them in front of us today and they gave us their 
position--I just want to find out something else.
    Are you suggesting that FASB somehow or other has urged 
people to lobby for their rule, because I would like to hear 
from Mr. Herz on that.
    Mr. Glassman. I think Mr. Herz will tell you that FASB has 
at least one full-time lobbyist on its--a registered lobbyist 
on its staff.
    Senator Levin. Let's find out what the lobbying is.
    Mr. Herz is sitting out there. What lobbying do you do?
    Mr. Herz. Our registered lobbyist is Mr. Mahoney, who is 
here as a staff person to answer your staff's questions and 
help prepare my testimony. It is to provide people on the Hill 
and Federal agencies information when they ask----
    Senator Levin. OK. I just wanted to clear that up. Anyway, 
Sir David Tweedy is on the International Accounting Standards 
Board.
    The next question. Is the problem that you two have, Mr. 
Heesen and Mr. Glassman, is it mainly on the valuation issue, 
or if they were easily valued, readily valued, would you still 
object to them because they're such a valuable incentive for 
folks to join companies and invest their time and so forth? 
Which is the bigger issue for you?
    Mr. Heesen. We have a fundamental issue with the idea that 
these should be expensed, that these options----
    Senator Levin. Even if they were easily valued?
    Mr. Heesen. No. But having said that, under where we are at 
this point, we believe that the valuation issue is extremely 
important, particularly for young, privately held companies, 
where it's almost impossible to come up with a logical number.
    Senator Levin. Are you saying it's more difficult than 
other kinds of valuations which we've heard about this 
afternoon?
    Mr. Heesen. It's more difficult, and it's going to be more 
costly, particularly for small companies.
    Senator Levin. More difficult than the convertible bonds 
and long dated stock warrants and all those other things?
    Mr. Heesen. A young company is not going to be using any of 
those things. It's great for Cocoa Cola, but we're not in that 
boat.
    Senator Levin. But it's more difficult than all the other 
items that are difficult to value that you heard about today?
    Mr. Heesen. All the other things that a small community 
would use at the end of the day are going to get trued up. 
That's the important thing. The stock options, you put them out 
and that valuation is wrong, it's not going to get trued up at 
the end of the day. You're going to have to carry it forward 
with that bad number.
    Senator Levin. One easy way to do it is the alternative way 
of valuation. Do you have a problem with that?
    Mr. Heesen. Yes. As I stated in my statement, intrinsic 
value is not--what we believe, when we looked at it carefully, 
it is not a way, a proper way of doing accounting.
    Senator Levin. I was referring to the alternative way which 
I heard at the end of the testimony by Mr. Herz, about small 
businesses being able to take the same valuation on their books 
as they do on their taxes.
    Mr. Heesen. That we have not looked at. I have not 
specifically looked at that at this point.
    Senator Levin. I thought that was part of your proposal.
    Mr. Heesen. No. The intrinsic value----
    Senator Levin. No, something else.
    Mr. Herz, what do you call that alternative approach that 
you were thinking about having small businesses have the option 
to use? Is that the intrinsic value approach?
    Mr. Herz. Yes.
    Senator Levin. OK. Thank you. Then I'm wrong. The intrinsic 
value approach I guess is what they call that.
    Mr. Heesen. Exactly. And as I stated in my statement, what 
that does is force you, instead of only once, to go out and get 
a valuation consultant to do this quarterly, so the cost 
imposed really does not make this a choice at all at the end of 
the day.
    Senator Levin. If you were given a choice, if small 
business were given a choice of simply taking the same figure 
that they take on their tax returns and putting it on their own 
books, would that be a problem for you?
    Mr. Heesen. I don't know. We would have to look at that.
    Senator Levin. Well, it's been out there for 10 years, Mr. 
Heesen. I've been around and around with folks on that issue 
for 10 years, and then people say they've got to take a look at 
it.
    Mr. Heesen. Well, the difference is----
    Senator Levin. Logically, is there any problem with that?
    Mr. Heesen. I don't know, because tax accounting is very 
different, as the chairman of FASB said, as opposed to 
accounting.
    Senator Levin. It usually is. But if you're looking for 
certainty and you want to make sure that no one is trying to 
figure out how to do something in advance which is difficult to 
assess, then one way to do it is to say, OK, we'll give you a 
choice. You can either take it the complicated way, which you 
think is a complicated way, or you can take it the simple way, 
which is, if you want a tax deduction for a business expense, 
show that on your books. That's real simple.
    You're not telling me that you're willing to do that?
    Mr. Heesen. We would have to look at that. I'm not going to 
say that a small business, when they have all these other 
issues in front of them, is going to take that very quickly. I 
don't know.
    Senator Levin. OK. Will you let the Subcommittee know?
    Mr. Heesen. Absolutely.\1\
---------------------------------------------------------------------------
    \1\ Letter of clarification from Mr. Heesen, dated Apri. 30, 2004, 
appears in the Appendix on page 152.
---------------------------------------------------------------------------
    Senator Levin. Mr. Glassman, do you have a problem with 
that?
    Mr. Glassman. No. I think that, just as a principle, I 
think tax accounting, and whatever we want to call this 
reporting accounting, GAAP accounting, ought to be as close as 
possible to the same thing.
    Senator Levin. So that if we gave small businesses, let's 
say, an option of putting the same business expense on their 
books as they take as a tax deduction on their taxes, you would 
say that makes good sense to you?
    Mr. Glassman. I guess I would have to answer the question 
in a broader way, which is that tax accounting and GAAP 
accounting should be the same. But I think that would mean we 
would need to look at the entire Tax Code as a result. I think 
we should, but----
    Senator Levin. I don't know that we're going to be able to 
look at the entire Tax Code as a result of looking at one bill. 
Since that's your general principle, would you apply it here?
    Mr. Glassman. Yes.
    Senator Levin. OK. That's helpful. I think that's going to 
be a very useful alternative, and I predict to you what the 
outcome will be when we consider that alternative. It will be 
the same throwing up of hands and saying no, we don't want to 
do that. That's even worse than what FASB is proposing, because 
that frequently is a bigger number than what FASB is proposing. 
But I will predict right now, Mr. Heesen--I shouldn't predict 
your answer, but I look forward to your answer with unbaited 
breath.
    Now, the only reason I say that, by the way, is because 
I've been around that track before. About 10 years ago I made 
that suggestion, and the immediate instinct was hey, that makes 
sense, and then within 24 hours, folks who opposed FASB came 
back and said they're very much opposed to that. I hope your 
answer is different.
    Mr. Heesen. And I'm looking at it from a small business 
perspective, not from probably the people you were talking 
about, from the bigger companies 10 years ago.
    Senator Levin. No, these weren't the bigger companies. 
These were start-up companies. OK. At any rate, thank you for 
getting back on that.
    The only other question I think I will ask before I ask our 
Chairman to come back is the numbers, Mr. Glassman, that you 
gave us, and then I would like to talk to Mr. Silvers about the 
number of workers that hold stock options in the private 
sector. You said one in eight employees in the private sector--
--
    Mr. Glassman. Yes. This is in my written testimony.
    Senator Levin. It was a Harvard study or something----
    Mr. Glassman. You had two Rutgers professors and one 
Harvard professor.
    Senator Levin. OK. Then it's a Rutgers study in that case.
    Mr. Silvers, is that your experience at the AFL-CIO, about 
the one in eight?
    Mr. Silvers. That's about 12 percent. That doesn't sound 
off the track. The professor, Professor Blasi at Rutgers, is a 
recognized expert in this area.
    Senator Levin. In the one question I have on that study, 
are these people who own stock options as a result of getting 
them at work as part of their compensation?
    Mr Glassman. Yes, sir. It's part of the compensation stock 
options. Actually, it's very interesting because the figure 
that they use is 13 percent. I just made it one out of eight, 
which is 12\1/2\ percent, including 57 percent of workers in 
computer services, 43 percent of workers in communications, and 
27 percent in the finance industry.
    Senator Levin. And that other figure that you cite, 94 
percent of options being held by employees below the top levels 
of management?
    Mr. Glassman. That also comes from the same study.
    Senator Levin. What is that level? That's a much 
different----
    Mr. Glassman. Actually, I don't know that.
    Mr. Silvers. Senator, if I might, I think part of the 
confusion here is that the 94 percent number is broad-based 
plans. If you look at all options, I believe the correct number 
is the National Center for Employee Ownership number that 
Senator Lieberman mentioned earlier in the hearing, which is, I 
guess, about 70 percent of the options that are out there in 
total, that are issued by employers to employees at all levels, 
are held by the very top level of management.
    Senator Levin. And do we know how ``top level'' is defined?
    Mr. Silvers. I believe in that number--I'm not sure. My 
guess is that number is looking at the SEC disclosing top five 
executives. I may be wrong, though. It may be a slightly larger 
slice.
    Mr. Glassman. I'm pretty sure that is correct.
    Actually, if I could just intervene for a second, you asked 
me the same question you asked Mr. Heesen. I think this would 
be my answer to your original question, which is more 
important. I think it's very important that more and more 
Americans have the opportunity to own stock options and other 
ways to participate in ownership of the companies that they 
work for.
    Senator Levin. I agree.
    Mr. Glassman. I think that's a great thing, and this----
    Senator Levin. I think all of us would agree with that.
    Mr. Glassman. Clearly, according to just about everyone who 
has opined on this subject, from whatever position, this will 
discourage that. There is no doubt about that. I think you can 
take that into----
    Senator Levin. How about grants of stock?
    Mr. Glassman. I like grants of stock. The problem with 
grants of stock is that they do not provide as much of an 
incentive to many employees as options, because there's much 
more leverage in options, obviously.
    Senator Levin. Say you have a stock grant that is 
conditioned upon the company reaching certain levels.
    Mr. Glassman. I think that's fine, and I really do believe 
that----
    Senator Levin. Is that treated as compensation on the 
books?
    Mr. Glassman. I don't know the answer to that.
    Mr. Heesen. Yes, it is.
    Senator Levin. Sure, it is. So why is this different? 
They're both valuable.
    By the way, I agree with you. I'm all for stock grants 
conditioned on companies doing well. I think it's great. I'm a 
big Aesop man. Russell Long taught us about that. I believe in 
stock options. I think it's fine. The only question is how you 
account for them, and why would we want to account differently 
for conditional stock grants on how a company does and stock 
options based on how a company does? What's the logic in 
treating those two things differently? Mr. Glassman.
    I'm stalling here while our Chairman comes in.
    Mr. Glassman. It's a good question. I guess I would turn 
the question around and say, why do we need to make a change if 
this information is broadly available to investors and anyone 
else who wants to make a decision about valuing a company. It's 
all right there. By making the change, you are actually going 
to incent businesses or push businesses into abandoning these 
programs, which are good programs.
    Senator Levin. The reason for the change is honest 
accounting according to the Independent Accounting Board. 
That's the reason for the change. The answer to the question is 
how do you logically treat those two conditional grants 
differently. In fact, as I understand it, even a grant of a 
stock option dependent upon whether a company does certain 
things or the stock goes up in value is also valued under 
current law, under current standards.
    The one exception to all these uncertain types of 
compensation, the one exception is stock options. If I tell 
you, if you will come with my company, you're going to get a 
thousand shares of stock, if you can double the value of this 
stock within the next 10 years, at any time during that 10 
years, that grant, conditional as it is, uncertain as it is--we 
don't know if the company stock is going to go up or down or 
not--but I offer that to you to get you to come to my company, 
to be an executive at my company, that is expensed now. But the 
stock option isn't, and there is no logical basis that I can 
see for differentiating there, and there's no reason why we 
ought to say you get a tax deduction for the expense but you 
don't have to show the expense on your books.
    Why should we then give a tax deduction? If you want the 
accounting to be the same, OK, maybe we then ought to say you 
don't get a tax deduction. Would that then satisfy your rule 
about keeping tax accounting the same as regular accounting? 
You don't get a tax deduction?
    Mr. Glassman. Well, the tax deduction doesn't come until 
the end----
    Senator Levin. Right. But it's still not shown as an 
expense on your books. Wouldn't we then, to follow your rule, 
say OK, we won't show it as an expense on the books, but we're 
not going to give you an expense on your taxes, either. That 
would then be consistent with your generic accounting 
principle, would it not?
    Mr. Glassman. I guess it would. I think those things ought 
to be consistent. But I think the main principle here is that 
broad based stock options have been tremendously beneficial to 
the U.S. economy, whether they're exactly in concert with this 
kind of incredibly complex GAAP accounting system we have now, 
with some other instrument or not. They are very valuable in 
real life to our real economy. This measure will cause 
companies, will certainly incent companies, to abandon these 
programs.
    I must tell you, I don't think that's very good. I do think 
this is the responsibility of Congress to examine and to see 
what it can do about it. I don't think that in any way impairs 
the independence of FASB, not in the least.
    Senator Levin. I'm for incentive pay of any kind, frankly. 
I think it does perform a very important economic function, 
subject to some of the qualifications which Mr. Silvers put out 
there, too, where the main beneficiaries are, depending upon 
how you incentivize it. But I happen to agree with the 
principle that incentive pay is a good thing, but that is the 
only form of incentive pay which is treated the way it is. That 
makes no sense----
    Mr. Glassman. Well, maybe all the other ones should be 
treated the same way that options are, because I think, as 
public policy, we want to encourage this. We really do. We 
don't want to encourage companies to be sloppy and to take 
undue risks and to do all sorts of other things, so we would 
have to watch it. But in general, we want to encourage this 
kind of practice, and this will discourage it. That's my only 
message.
    Senator Levin. Thank you.
    Senator Fitzgerald [presiding]. Senator Levin, thank you 
for covering for me.
    I now would ask for unanimous consent--and I will grant it 
to myself--to introduce Mr. Ciesielski's April 2004 Analyst's 
Accounting Observer Report into the record.\1\
---------------------------------------------------------------------------
    \1\ ``The Analyst's Accounting Observer,'' appears in the Appendix 
on page 153.
---------------------------------------------------------------------------
    You developed tables, and one table shows the 50 companies 
whose unreported stock compensation caused earnings to be 
overstated by 10 percent or more, ranked by descending order of 
overstatement.
    The company which most overstated its earnings was Yahoo!. 
It overstated its earnings by 640 percent. You derived that 
calculation by looking at their earnings per share as reported, 
which was 37 cents per share in 2003, but if they had expensed, 
I assume, using the Black-Scholes model--is that right?
    Mr. Ciesielski. I believe that's what they used. Only a 
handful had used other than binomial, and I can remember those.
    Senator Fitzgerald. OK. If they expensed their stock option 
compensation, their earnings per share would have been reduced 
from 37 cents a share to 5 cents a share. So their 
overstatement of their earnings to the public was 640 percent. 
That's a pretty whopping deception in my judgment.
    But when you think about it, I noticed just looking last 
night on the computer, it looked like Yahoo! was now selling at 
a trailing 12-month PE of 128, which is a humongous PE. But 
that PE assumes that their real earnings were their reported 
earnings. If one looks at their real earnings as their earnings 
as reported minus an expense item for stock option 
compensation--if I were to do the math on their closing price 
at December 31, their closing price was $45.03, and their 
earnings per share were 5 cents a share--then their PE at 
December 31, 2003 looks to me to have been 900. So am I 
correct, that investors would be paying $900 to get a claim to 
one dollar's worth of earnings?
    Mr. Ciesielski. That's the linear math, yes.
    Senator Fitzgerald. Am I doing that----
    Mr. Ciesielski. I think you're doing that correctly. I 
don't have a calculator to verify, but it sounds like it's in 
the ballpark.

                        EVENING SESSION [6 p.m.]

    Senator Fitzgerald. Now, going back, Mr. Glassman, to where 
we were talking about--you said you agreed with Benjamin 
Graham's analysis, that the value of common stock plus options 
equals the value of common stock if there were no options.
    Let's assume the new FASB rule does deter companies from 
issuing as many options. Let's assume it deters them from 
issuing options altogether and a company like Yahoo! stops 
issuing options. I don't think that will happen. I think they 
will just start expensing them and be more discreet about 
issuing them. They won't be gorging themselves on stock options 
any more.
    Going back to that company that you and I talked about that 
had 100 shares, and you own all the shares, and we no longer 
give 100 options to me or anybody else in your company. Then 
aren't your 100 shares in your company worth more because 
you're back to having a 100 percent claim on the future 
earnings of your company, and you're not giving options to 
participate in the future appreciation to anyone else? Wouldn't 
your shares be worth more?
    Mr. Glassman. Well, except for the fact that my company, 
the company whose shares I own, would not have been able to 
attract the kind of people that Yahoo! has attracted, that 
Microsoft has attracted, that Intel has attracted, that Dell 
has attracted, because of employee broad-based stock options. I 
mean, this is the reason these options are offered. They are 
offered to attract really good people. I think anyone in 
Silicon Valley will tell you----
    Senator Fitzgerald. Where are these employees going to go, 
though, in the new world where the same accounting rules apply 
to everybody?
    Mr. Glassman. I hope the new world is competitive so that 
we don't have converging--we could do that with the tax codes, 
too.
    Can I just comment on what Mr. Ciesielski's work----
    Senator Fitzgerald. But isn't it possible your stock price 
could go up because now there's no longer these options out 
there diluting you?
    Mr. Glassman. Maybe. It really depends on what investors 
think. If all of a sudden Yahoo! said ``well, we're giving up 
our stock options; we don't think they're going to work'', 
investors may feel well, that's fine, so now the value is 
higher or it's the same. But they may get very distressed by it 
and say, well, that happens, and then Google is going to take 
all the good people that Yahoo! had.
    This issue of Mr. Ciesielski's work, where he found the 640 
percent overstatement, the information that he got, I'm pretty 
sure, is public information. Every investor, every smart 
analyst like Mr. Ciesielski, is----
    Senator Fitzgerald. But he had to spend a lot of time and 
he has been a life time professional doing this. Do you think 
the average guy could do this?
    Mr. Glassman. Well, guess what? He just published it. So 
one would expect that other people then get the information. 
It's the way markets work.
    Senator Fitzgerald. They pay him.
    Mr. Glassman. According to your theory, that would drive 
the price of this stock down to virtually nothing, or certainly 
about a sixth of its value. But the fact is people already know 
about this.
    Senator Fitzgerald. I think you're right, and that's why I 
don't think stock prices will necessarily go down. In fact, I 
think they may go up because the shareholders of Yahoo! will 
then get all of the future rise in the value of the company 
which inherently belongs to them anyway. They won't have to 
give a part of their stake in the future of the company to 
anyone else, so I think their stock could actually go up.
    Let's go back to Mr. Heesen. Initially you said the longer 
a company stays artificially in the red--I don't agree with you 
that it's artificially in the red; I think it's artificially in 
the black when you are bringing them to the market now, and I 
think we will have a more accurate picture once the FASB rules 
go into effect. But you said it will take longer to bring them 
public.
    But don't you think that I should be, as a government 
policy maker, concerned not just about the venture 
capitalists--who want to unload their investment on the public, 
close out their fund, and make a big return--but about the 
people out there who are going to buy the shares in this 
company that you're going to try to unload on them?
    Mr. Heesen. Absolutely. If you look at the venture-backed 
companies versus nonventure-backed companies on NASDAQ, they 
have traditionally done much better. So if you're going to be 
looking at companies between whether they're venture backed or 
not venture backed----
    Senator Fitzgerald. Over how long a period?
    Mr. Heesen. That's been historical for 20 or 30 years, 
since the venture capital industry has been in existence by and 
large.
    Senator Fitzgerald. They've done better than other 
companies for how long, though, after they've gone public?
    Mr. Heesen. They have consistently gone--going out, and 
long run, because they are----
    Senator Fitzgerald. Twenty, 30 years down the road 
companies that had venture capitalists at the start?
    Mr. Heesen. When you look at the Federal Expresses, the 
Cisco's, the Intels, the entire buyer technology industry, 
literally has all been financed by venture capital at one point 
or another. Those are the companies that are driving this 
economy and continue to drive it.
    Just this quarter, you look at the venture-backed IPOs that 
went out, there were 13 venture-backed IPOs. One of those was 
the biggest venture-backed IPO ever that went public in the 
United States. Unfortunately, it's a Chinese semiconductor 
company, so that's how we're starting to see the changes here, 
and that company is giving options and it's going to be a very 
effective company.
    And you know what? All the institutional investors like 
that company and they're putting money into it and it's doing 
very well right now. That's kind of where we're going in this 
environment.
    Senator Fitzgerald. Mr. Delves, you looked like you had 
your hand up.
    Mr. Delves. Yes, thank you. I wanted to make a comment on 
the discussion you were having with Mr. Glassman. You were 
debating the cost to shareholders of stock options versus the 
benefits to shareholders of the incentive provided by options. 
That debate can't happen and doesn't happen, and hasn't 
happened, in board rooms because there's no expense for stock 
options.
    With an expense for stock options, boards of directors can 
now start having that debate and balance the cost versus 
benefits to shareholders.
    Mr. Heesen. I would disagree on that from a small company 
perspective, in the respect that venture capitalists happily 
dilute their ownership in a company, and knowingly do that, to 
give those options to employees, because they know at the end 
of the day those companies are going to grow as a result of it.
    Senator Fitzgerald. But it also, as you said, allows you to 
bring a company to an IPO sooner.
    Mr. Heesen. Yes, but also, if you look at----
    Senator Fitzgerald. So you have a good reason to suffer 
that dilution because, otherwise, you might have to hold on to 
it longer.
    Mr. Heesen. Yes, but as a Harvard study 2 years ago put 
out, a venture backed company actually takes longer to go 
public than a nonventure backed company, contrary to popular 
belief.
    Senator Fitzgerald. Now, I know venture capitalists all 
over the country; I know people in the Texas Pacific Group out 
West; I know the Madison Dearborn Partners people in my State. 
I know Ned Heiser, who brought----
    Mr. Heesen. Most of the buyouts are not venture capital, 
but----
    Senator Fitzgerald [continuing]. Federal Express public 
many years ago. And I know Thayer Capital, the Carlyle Group, 
and so forth. The venture capitalists I have talked to from the 
Midwest and the East have had a different approach than those 
coming from the Silicon Valley area--the Kleiner, Perkins of 
the world--that are very heavily invested in high tech. I do 
think there's a big difference between the midwestern venture 
capitalists. They are simply not as concerned about the 
expensing of stock options as the ones out West, based on----
    Mr. Heesen. Well, I think that's a definitional issue, in 
that venture capital in the Midwest is more buyouts, to be 
perfectly honest, than it is true venture capital.
    The other unfortunate thing there is when you look at a 
Milken study that just came out last week, you look at where 
they are looking at, where are the next science and technology 
centers in the country are going to be, and they rated each 
State. In the Midwest, there was only one State in the Midwest, 
Minnesota, that broke the top 20, in the ability to attract 
companies that are science and technology based to their 
States. Maybe there is something that the middle part of the 
country should be looking at, that the East coast and West 
coast have been.
    Senator Fitzgerald. Clearly, there is a much greater 
reliance on options in the high tech industry. The 
overstatement of the earnings of the top 100 NASDAQ firms, last 
year was 44 percent, I think it was.
    Mr. Ciesielski. I didn't do that study.
    Senator Fitzgerald. No, I think that was Bear Sterns' 
analysts who did that study. It's high tech firms primarily and 
a few other industries that rely so heavily on options.
    Going back to Jeffrey Skilling's testimony, who brought up 
the Skilling's testimony? Mr. Silvers, I'll let you comment on 
this.
    I remember him testifying. We were talking about how the 
executives at Enron, the top 29 executives cashed out a billion 
one in options in the 3 years before the company's stock 
collapsed and it filed for bankruptcy, and there was a pattern 
that I detected of executives cashing in their options and then 
leaving the company. Remember the Army Secretary, Tom White, he 
cashed out his options and left? The fellow who committed 
suicide, unfortunately, Frank Baxter, he cashed out his options 
and had left the company? Skilling, of course, cashed out $70 
million in options in 1991, and then left the company in July 
or August.
    Ken Lay cashed out about $250 million in options and had 
lined up a job apparently as the CEO of another company. He had 
to come back as CEO at Enron because otherwise he was left 
holding the bag.
    The one who blew the whistle in the Enron case, came 
forward, they had made a mistake. They allowed an executive 
into Fastow's office who didn't have stock options. Her name 
was Sharon Watkins. She wrote that famous memo, ``I ain't 
getting nothing out of this. Why am I going to go along with 
the deception?'' Implying that everyone else was going along 
with the deception. It was a very simple Ponzi operation and 
the company was borrowing money and booking it as earnings. 
Almost all their transactions boiled down to that, and they 
parked the borrowings on off-the-books partnerships, but they 
would borrow money and book it as earnings. They had very 
little in the way of legitimate operations that I could tell.
    They were doing this, in my judgment, because they were 
getting very rich very quickly, pumping up their share prices, 
cashing in their options, and then they leave the company 
before the whole house of cards collapsed.
    We were talking to Skilling about the options and the fact 
that they were taking tax deductions for it, that they were 
just gorging themselves on stock options, and that there is no 
expense being reported for that so their earnings were grossly 
overstated, just by virtue of their failure to expense options. 
Skilling came right back at us and said, I agree, the 
accounting rules are absurd, but it's Congress that interfered 
with FASB that allowed that to go on, so you should be looking 
in the mirror.
    Now, I wasn't in the Senate when that happened. Senator 
Lieberman was leading the fight against FASB back in those 
days. Believe me, we met with a lot of ordinary shareholders 
who really got taken in by that whole scam. They lost all their 
life savings, and all the employees who had been encouraged by 
company executives to keep buying Enron stock and tucking it 
into their 401(K) plan, they lost everything. A lot of people 
lost everything on that. A lot of that was due to the 
incentives of the excessive issuance of options, in my 
judgment.
    Mr. Silvers.
    Mr. Silvers. Senator, let me say that in the AFL-CIO I 
represented a number of those people who were the victims of 
that situation, who were left with nothing but severance, and 
not even that. We were very proud to do that. I think they 
would have a view on some of these discussions.
    There are systematic reasons why options tended the 
direction you indicated. This is why in the brief formal 
testimony I gave I indicated we feel that options are an 
inferior form of executive compensation. It's not just that the 
accounting is not correct; it's that substantively they're not 
a good form of executive compensation.
    The reason is--and some of the reasons are fixable, meaning 
that the typical executive stock option is a three-vesting 
period, historically. Some of that is changing right now. That 
could be changed easily. That 3-year period makes it pretty 
easy to cash out and leave. To manage the company with an eye 
towards maximizing your cash out at that moment, it's a pretty 
bad thing from the perspective of a pension fund that's holding 
the company long term.
    But there are other aspects of stock options that simply 
cannot be fixed in relation to this problem, which is why we 
favor restricted stock as a means of linking--long-term 
restricted stock as a means of linking paid performance.
    Senator Fitzgerald. Explain the difference between 
restricted stock and stock options.
    Mr. Silvers. Restricted stock is simply stock in the 
company. It is not an option. It is only the upside. You have 
the full exposure to the upside and the downside. The 
restrictions around restricted stock are similar and can be 
stronger than those associated with options, restrictions in 
terms of when you can sell it, in terms of vesting periods and 
so forth.
    The critical difference here is that when an executive is 
not exposed----
    Senator Fitzgerald. If you have restricted stock, then you 
don't just have a call on the future price.
    Mr. Silvers. Precisely. You have----
    Senator Fitzgerald. If the stock goes down--it's a two-way 
elevator.
    Mr. Silvers. A two-way elevator, exactly.
    Mr. Glassman. No, it's exactly the opposite. If you're 
given restricted stock--anybody can buy stock, and then there's 
a downside. But the way restricted stock works is that you are 
given the stock. So let's say you're given the stock at $20, 
you pay zero, usually, and now it goes down to $15, now you've 
got $15, which you never had before. That's the difference.
    In fact, if the stock price goes down and you've got an 
option, you've got zero.
    Senator Fitzgerald. So it's really no better than options, 
except that it does have to be expensed.
    Mr. Glassman. It's not better. It's not worse. It's a 
choice. With options, basically you're getting more leverage. 
In other words, if it goes up, you make a lot more. If it goes 
down, you make nothing.
    Senator Fitzgerald. OK. What's the public policy rationale 
for requiring issuance of restricted stock to be expensed but 
not the issuance of stock options?
    Mr. Heesen. In our view, it's pay for--in restricted stock, 
it doesn't matter. You get it today at $20, you've got $20, and 
if it goes down to $10, you still have $10. If you work a 
little hard, it might get up to $30. But if you have an option, 
you have nothing until----
    Senator Fitzgerald. But we require the issuance of 
restricted stock to be expensed because we recognize we're 
taking away something from the company.
    Mr. Heesen. You are taking from the company at that point, 
exactly. That's a very different thing than an option.
    Senator Fitzgerald. You don't think they're taking anything 
from the shareholders?
    Mr. Heesen. Dilution, absolutely. And we talk about that, 
and that's why when we look at this, we look at shareholder 
dilution as being the main key here.
    Mr. Silvers. Senator, these gentleman are simply wrong. Let 
me explain why, if they will allow me to do so without being 
interrupted.
    Senator Fitzgerald. OK. You go ahead.
    Mr. Silvers. As a shareholder, you care a great deal if 
your company is in trouble, whether at the end of the day the 
value of your stock--for example, say you bought it at $40. If 
the company is in trouble, you care a great deal about whether 
or not at the end of the day the stock price is $10, $20 or 
$30. It makes a big difference.
    If you hold an option and the exercise price is at $40, and 
the company gets in trouble, you don't care. It's true that 
options involve a lot of leverage, and perhaps leverage is a 
good thing. That's a public policy decision that I disagree 
with. But what they're wrong about is that options are a better 
of way of aligning the interests of executives with the 
interests of shareholders in a stressed situation, which is 
what Enron was. The reason why options encourage people to 
cheat and lie in distressed situations is because financially, 
if they can somehow get the stock price over the exercise 
price, they win. And it doesn't matter to them if the true 
value of the company----
    You see, if the true value of the company is, say, 30, and 
it's trading--they know it's 30 and they're insiders--and it's 
trading at 40, they have got to figure out some way to get that 
thing over 40 long enough to exercise. If they do that, they 
win.
    Senator Fitzgerald. And then they dump the stock.
    Mr. Silvers. Yes. But even if the strategy they have for 
getting it over 40 is so risky, that it's actually money 
losing--for instance, cheating, that's very risky. If you're 
caught cheating, things tend to collapse completely and all the 
value drains out of the firm.
    WorldCom, for example, is a classic instance of this. There 
was real value in WorldCom. They cheated and they blew it up. 
This is why stock options are so dangerous to our corporate 
governance system as opposed to restricted stock.
    I would like to also add another point here, which is 
again----
    Senator Fitzgerald. And you favor the FASB rules that 
impose discipline on their issuance. You don't favor doing away 
with the stock options?
    Mr. Silvers. What we favor is the replacement--I think 
there are unique issues involved in private companies, in their 
transition issues, and I think those are complex and the FASB 
process ought to deal with them.
    In terms of public companies, we favor restricted stock 
over options. We don't favor banning options as a statutory 
matter. We believe that if they are properly accounted for, 
that the corporate governance process will act to reduce their 
use and substitute restricted stock for them. In fact, that is 
what is going on right now.
    Senator I would also add, if you will allow me, that a 
great deal has been made in this debate of two points by the 
opponents of stock options expensing. One point is the notion 
that the information is already there and so it's not 
necessary. The other point is the notion that, if it's 
expensed, somehow managerial practices in relation to options 
will change radically, particularly with respect to broad-based 
options at companies that are cash limited.
    You can't hold those two positions simultaneously. Either 
one or the other has to be true. Both cannot be. If you believe 
that the one that's true is that there will be radical 
managerial behavior changes as a result of option expensing, 
what you're actually saying is that the current accounting 
rules, and what some would urge the public policy and law of 
the United States should be, is that we will, by hiding the 
true cost of stock options, subsidize that form of employee 
compensation. And some arguments have been put forward for why 
we should subsidize them.
    I would suggest that if we're subsidizing employee 
compensation, we might not want to focus on a form of 
compensation 70 percent of which is going to the top five 
officers, and that perhaps we might want to look at things like 
the 40 million Americans who have no health care if we were in 
the business of subsidizing one form of employee compensation 
over another.
    Senator Fitzgerald. Mr. Heesen, do you personally own any 
stock options in any companies?
    Mr. Heesen. No.
    Senator Fitzgerald. Mr. Glassman.
    Mr. Glassman. I have to say that I made a very lucrative 
deal with my partner, the former Chairman of the SEC, Arthur 
Levitt, when we were partners in Roll Call, which is a 
congressional newspaper. It is not a publicly traded company, 
but my incentive was, indeed, options. I had options to buy 
shares of the company, which originally Arthur owned most of, 
and I did so, and we eventually sold the company.
    I can tell you that the spur of options was quite 
substantial to me. I think it was very important. I certainly 
can sympathize with people, with the 14 million Americans who 
own stock options. I think it's a good thing.
    By the way, I just want to be clear, Mr. Silvers, I am not 
wrong. The reason that I intervened was because you were saying 
something that was incorrect about restricted stock. In fact, 
if you get restricted stock and the price goes down, you lose 
whatever the price decline was, but if you get options and the 
price goes down, you get nothing. That's the whole point.
    I absolutely did not say--and I'm not sure whether Mr. 
Heesen did--I absolutely did not say that I prefer one over the 
other. Quite the contrary. I think that those are decisions 
that need to be made by businesses themselves, their boards of 
directors and their shareholders: What is the best way to 
compensate employees. Sometimes it's restricted stock; 
sometimes, as in the case of Warren Buffett, whose stock I 
own----
    Senator Fitzgerald. But you favor accounting rules that 
would prefer stock options to any other form of compensation?
    Mr. Glassman. I think that's another--I think that's a 
different issue.
    Senator Fitzgerald. You don't think the accounting rules 
should be neutral, though. You believe that all employee 
compensation should be expensed, except stock options, correct?
    Mr. Glassman. I think that the current regime, which 
handles the very thorny issue of how to value stock options, by 
providing investors with the kind of information I just showed 
from the Intel statement and for just about any other statement 
you want to look at, is the best way to do it. That is my 
belief right now, and that we don't need this change.
    Senator Fitzgerald. Mr. Delves, very quickly, and then I 
will have to adjourn the hearing. I absolutely have to leave.
    Mr. Delves. Thank you very much.
    My point is that it is not this simple. This is what I do 
for a living, as I design incentives. Stock options work. They 
make people take more risks than they ordinarily would. If you 
grant too many of them, they take too many risks.
    Senator Fitzgerald. Performance stock options are better, 
though, right?
    Mr. Delves. Anything tied to performance is better, 
including restricted stock.
    Senator Fitzgerald. But we require performance stock 
options to be expensed, but not ones that are not tied to 
performance?
    Mr. Delves. That's correct.
    Senator Fitzgerald. So sometimes the stock options that 
maybe come into money just because the economy is good and the 
market is going up, it's like rewarding the weatherman because 
the weather turns out well.
    Mr. Delves. If we don't have an expense, we can't make the 
tradeoffs between one type of incentive versus another and come 
up with the best one.
    Senator Fitzgerald. Thank you. All of you have been 
wonderful witnesses. You have been great, and I wish we could 
have had another hour, but we do not.
    The record will remain open until the close of business 
next Tuesday, April 27, for any additional statements or 
questions.
    If there is no further business to come before the 
Subcommittee, this hearing is now adjourned. Thank you all very 
much.
    [Whereupon, at 6:25 p.m., the Subcommittee adjourned.]


                            A P P E N D I X

                              ----------                              

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

[GRAPHIC] [TIFF OMITTED] 

                                 
