[Congressional Record Volume 148, Number 108 (Thursday, August 1, 2002)]
[Senate]
[Pages S7942-S7946]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. LIEBERMAN (for himself and Mrs. Boxer):
  S. 2877. A bill to amend the Internal Revenue Code of 1986 to ensure 
that stock options of public companies are granted to rank and file 
employees as well as officers and directors, and for other purposes; to 
the Committee on Finance.
  Mr. LIEBERMAN. Mr. President, I rise in strong support of stock 
option reforms, and propose legislation that will make stock options, a 
powerful tool in the democratization of capitalism, even more effective 
as an incentive to spur innovation and create wealth.
  The waves of corporate abuse that our economy has suffered over the 
past ten months have been devastating to so many employees, 
shareholders, and families across America. The investments that people 
have counted upon to safeguard their retirement, send their children to 
college, buy a home, start a business-trillions of dollars have gone up 
in smoke, turned to ash while, for a few executives, those misfortunes 
turned to cash.
  That's maddening, as a result, the most productive economy in the 
world-in the history of the world-has been scarred. The American 
corporation, a great institution of democratic capitalism in which the 
public owns the company, has been stained. Potentially empowering 
innovations that enable individual investment, like the 401-k account, 
have been skewered.
  Today, I want to talk about another fundamentally decent idea that 
has been dragged into the quicksand of corporate corruption: stock 
options. We've discovered over the last ten months that too many 
companies and executives have been misusing and abusing them. In far 
too many cases, options have been turned into mere feed in the 
corporate trough by the greed of corporate executives.
  Stock options are a hammer. They can be used well or used poorly. 
We've seen corporate executives use this hammer to weaken the 
foundations of their companies, build rickety and top-heavy structures 
ready to collapse, and build themselves nice, secure shelters from the 
damage. That's unconscionable.
  The bill I propose today will correct this abuse by ensuring that the 
tool of stock options is put in the hands of more and more employees so 
it can be used as it was initially intended-to construct wealth, to 
build fortunes, to strengthen companies, and to incentivize the long-
term soundness and stability of a company.
  The way to fix this problem is not, as some have suggested, to 
require stock option expensing at the time an option is granted. That 
would, in fact, make the problem worse. It would disincentive the 
dissemination of options in the first place-and in the end, those at 
the top of the corporate food chain will still take care of themselves. 
No, the way to fix this problem is to ensure that stock options are 
more broadly shared by more and more employees of American 
corporations-that they truly are the democratizing tool that they can 
be.
  Our challenge is to fix the flaws that have been exposed without 
hurting stock options themselves. In the name of addressing this 
serious crisis in corporate accountability, let's not make the mistake 
of pushing through unwise reforms that threaten to further confuse 
investors and endanger the engines of entrepreneurship that make 
America's economy, for all its faults and flaws, the envy of history 
and of the world. It would be a terrible shame if we threw out the 
stock options baby with the corporate corruption bathwater.
  That's the spirit of my legislation: to mend, not end, stock option 
distribution.
  My legislation focuses on three critical reform issues regarding 
stock options, distribution, shareholder approval, and disposition by 
senior executives. I believe that my proposed reforms will ensure that 
stock options serve their highest purpose: that we give shareholders 
more control to ensure that stock options are issued consistent with 
their interests, while we do away with the perverse incentive for 
senior executives to cash in and bail out of their companies.
  The bill does not address the elephant in the room-the issue of 
whether or not companies should be required to account for stock 
options. That is because I remain firmly convinced that would fail to 
address the fundamental problems we face-and would, in fact, create new 
problems with which we will have to grapple.
  If the Congress were to require expensing of stock options, we can be 
sure that the fat cats would still get their milk. Top corporate 
executives would still take care of themselves. But the middle-income 
employees, who represent the vast majority of Americans who benefit 
from stock options, would have no option but to accept no options.
  Requiring the expensing of options will not give shareholders a 
greater say in approving stock option plans or ensuring that they are 
focused on effective incentives for growth. The reforms I propose today 
will. And requiring the expensing of options will not address the 
incentives that executives may have to manipulate earnings immediately 
prior to selling shares acquired through a stock option plan. The 
reforms I propose today will.
  The reform issues addressed in my bill are ones that are well suited 
for Congress because they are policy matters, not accounting rules.
  I have little doubt that FASB will again take up the stock option 
accounting issue. When it does, I think it will find, again, that 
expensing options at the time they are granted is not possible. This is 
the unsung issue with stock option accounting.
  There is no doubt that stock options are a form of compensation, but 
this happens when they are exercised, not when they are granted. 
Options that go ``underwater'', when the stock price drops, never 
become compensation and the options are worthless. We only know if 
options are compensation when they are exercised and only then do we 
know how much compensation has been received.
  This is the issue I have raised about expensing, not whether they are 
compensation, but when they become compensation and when the amount of 
the compensation can be measured. I said in 1994 and I say it again 
today, I do not believe at the time an option is granted that we know 
if or how much it is worth as compensation.
  I doubt if the champions of expensing can point to a single case 
where a company's disclosure of stock option costs at grant, now 
included in footnotes to the company's P&L statement, proved

[[Page S7943]]

to be accurate. The Enron footnotes estimated stock option costs that 
proved to wildly inflated and inaccurate because they did not 
anticipate the decline in Enron's stock price. In this bear market, I 
would think that every company's footnote estimates have proven to be 
wildly inflated and inaccurate.
  I doubt if the champions of expensing can cite a single stock broker 
or analyst who uses the Black-Scholes estimating method to pick stocks.
  I do not believe that these champions would be willing to put their 
own money behind a stock based on the Black-Scholes estimates. Anyone 
who finds a reliable way to estimate the price of a stock three to ten 
years in the future is bound to be rich, and will certainly win the 
Nobel Prize for Economics.
  These are issues that FASB will review and it is not an appropriate 
subject for this or any other legislation. This legislation focuses on 
reforms that address abuses. Expensing of stock options, whatever its 
merits as an accounting standard, do not address any of the key reform 
issues addressed in this legislation. Expensing is quite irrelevant to 
these reforms; it's a sideshow and a diversion. It's a false surrogate 
for reform.
  I have long championed broad-based stock option plans and I believe 
they are a great spur to productivity and competitiveness. A study by 
two Rutgers University professors found that over a three-year post-
plan period, companies that grant options to most or all employees show 
a 17 percent improvement in productivity over what would have been 
expected had they not set up such a plan. The return on assets of these 
companies went up 2.3 percent per year over what would have been 
expected, while their stock performance is either better or about the 
same than comparable companies, depending on how performance is 
measured. These were companies that granted options broadly, which 
unfortunately is still not the norm.
  On June 29, 1993, I introduced the ``Equity Expansion Act,'' S. 1175, 
to provide a tax incentive in favor broad-based stock option plans, 
options I referred to as ``performance'' stock options. The incentives 
were available only for options where ``immediately after the grant of 
the option, employees who are not highly compensated employees hold * * 
* share options which permit the acquisition of at least 50 percent of 
all shares which may be acquired * * *:
  In my statement about this bill I stated that the bill could ``spur 
the competitiveness and profitability of American companies by 
expanding the number of employees in all industries who will have the 
opportunity to receive part of their remuneration in the form of stock 
options.'' I argued that that bill was appealing because it ``America's 
best companies learned long ago that the key to success in the world's 
toughest markets is a dedicated work force that shares the common goals 
for their company.'' The bill required shareholders to approve the 
plans and the employees were required to hold the shares for at least 
two years. I noted that ``much of the criticism of stock options 
revolves around horror stories about a small number of extravagantly 
compensated executives.''
  My 1993 bill provided incentives for broad-based plans. It proposed a 
special capital gains incentive for the stock option shares. At the 
time, there was no capital gains preference; it had been repealed in 
1986. Since then, of course, the capital gains preference has been 
restored. At that time, and at all times since then, companies can 
deduct the ``spread'' on an option at the time the option is exercised. 
The ``spread'' is the difference between the grant price and the market 
price, the discount.
  There is a trend in favor of broad-based stock option plans. The 
National Center for Employee Ownership estimates that 7-10 million 
employees now hold stock options. The number of people who hold options 
has grown dramatically since 1992, when only about one million people 
held options. Stock options are a way to provide productivity 
incentives to many middle-class employees.
  Despite the trend in favor of broad-based stock option plans, I am 
not satisfied with the status quo. In companies with broad-based plans, 
NCOE finds that 34 percent of the options go to senior management, the 
average grant value for senior executives was more than $500,000 
compared to only about $8,000 for hourly employees and $35,000 for 
technical employees. In non-broad-based plans, of course, the 
distribution is even more skewed to senior management. The NCOE 
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 percent to 70 percent of the total options granted.''
  Similarly, estimates by the National Association Stock Plan 
Professionals finds in a 2000 survey that 26 percent of the plans only 
grant options to senior and middle management, and 43 percent to all 
employees. For high tech companies, the percentage of these top-heavy 
plans is only 4 percent, and 73 percent of the plans provide options to 
all of the employees. For non-high tech companies, the percentage of 
these top-heavy plans is 36 percent, and 29 percent of the plans 
provide options to all of the employees. So the prevalence of top-heavy 
plans seems to be concentrated in the non-high tech companies.
  If options are justified as incentives for company performance and as 
a way of giving employees a stake in the company performance, which I 
believe they are, then this is not fair and not appropriate. This is 
why we need to go beyond enacting an incentive in favor of broad-based 
plans. As the NCOE has stated, ``Options for ordinary employees can 
work out to a new car, college tuition, a down payment on a house, a 
great vacation, and maybe even a more secure retirement. Options for 
executives can amount to enough money to fund a small nation. The 
option packages some executives have received would amount to tens of 
thousands of dollars per employee in their company.'' This imbalance is 
not good public policy.

  In addition, if it turns out that companies are forced to expense 
their options at the time of grant, many of us fear that the first 
options that would be cut are those for middle-income and rank and file 
employees. We fear that the senior executives and their allies on the 
Board would take care of themselves, and drop or not enact broad-based 
plans. The legislation I propose here would help to ensure that this 
will not happen.
  The bill I introduce today takes a direct and forceful approach and 
provides that this tax deduction is limited to the spread on options 
that are granted on a broad-basis to the employees of the firm. The 
intent and thrust of the bill is the same as the one I introduced in 
1993, and the definitions are the same. The approach is more direct and 
forceful.
  The bill, called the ``Rank and File Stock Option Act'', states that 
the ordinary and necessary business expense deduction attributed to the 
spread on the exercise of stock options (deducting the ``spread'' 
between the strike and exercise price) is limited on a pro rata basis 
to the extent stock option grants for the taxpayer are not broad-based. 
So, when the three-year average of the stock option grants is broad-
based, as defined in the bill, there is no limitation on the deduction. 
In terms of a pro-rata reduction, the deduction would be limited by the 
same percentage to which the percentage of highly compensated employees 
options exceeded the broad-based standard.
  This test goes to the number of options granted, not the exercise 
price or any other weighting or valuation. No deduction is allowed if 
the options granted to senior management are different in form and 
superior to those granted to rank and file employees, which will help 
ensure that there are no efforts to evade the purpose of this 
legislation.
  The stock option grants are deemed to be broad-based when, 
immediately after the grant of the options, employees who are not 
highly compensated employees hold share options that permit the 
acquisition of at least 50 percent of all shares that may be acquired 
pursuant to all stock options outstanding (whether or not exercisable) 
as of such time. The bill does not require that stock option grants be 
made to literally every employee, but as a practical matter such grants 
to every employee may be necessary to meet

[[Page S7944]]

the test. Requiring that all employees receive some options involves 
complex issues about part-time employees and new employees. The 50 
percent test is tough enough to ensure that the options are broad-
based.
  The definition of a ``highly compensated employee'' includes all 
employees who earn $90,000 or more and are among the firm's top 20 
percent highest paid employees. This is similar to the current test 
applied to prevent ``discrimination'' in 401K plans.
  In addition, under the legislation no deduction is allowed if more 
than 5 percent of the total number of options is granted to any one 
individual. And no deduction is allowed if more than 15 percent of the 
stock option grants go to the top 10 officers and directors of the 
firm.
  The legislation applies only to public companies. The Treasury 
Department shall issue regulations to implement this provision. The 
effective date is for stock grants after December 31 of this year. 
During the remainder of the year, corporations granting stock options 
must disclose grants in filings to the SEC within 3 days.
  To be clear, the legislation does not prevent a company from adopting 
a stock option plan that does not meet the terms of this legislation. 
It simply denies them a tax deduction on the spread when they do so. 
This should ensure that broad-based stock option plans become the norm 
and that senior executives do not hoard the options for themselves to 
the detriment of their companies and shareholders.
  There is ample precedent for the limitation on deductions. Deductions 
are only permitted for ``ordinary and necessary'' business expenses and 
Congress has frequently intervened to define what this means. There is 
no right for corporations, or any other taxpayer, to avoid taxes on any 
and all expenses that they choose to incur.
  There is also ample precedent for limiting the deduction for non-
broad based stock option plans. We have similar limitations in the law 
defining contributions for 401K plans, the compensation in closely held 
corporations is regulated to prevent abuse, and we have limits on 
excessive compensation paid to executives of non-profit entitles.
  To make sure that an employer's 401(k) plan does not unfairly favor 
its higher-paid workers, there are also rules governing highly-
compensated employees or HCEs. The term highly-compensated employees 
may include a person who was a 5 percent owner at any time during the 
current or prior year or an employee who earned more than $90,000. An 
employee whose salary ranked in the top 20 percent of payroll for the 
prior year might also be considered an HCE. Generally, to make sure a 
401(k) plan is compliant, each year the plan must pass a non-
discrimination test.
  These tests generally compare the amounts contributed by and on 
behalf of highly compensated employees to those contributed by and on 
behalf of the non-highly compensated employees. As long as the 
difference between the percentages of these two groups is within the 
Internal Revenue Code's guidelines, the plan retains its tax-qualified 
status. If the plan does not pass the tests, the plan must take 
corrective action or lose its tax-favored status.
  With regard to closely held corporations, the deduction for ordinary 
and necessary expenses is limited to ``reasonable'' compensation for 
services performed by the shareholders/employees. A corporation paying 
excessive compensation to a shareholder-employee is required to 
reclassify the excess as a dividend (provided there are 
adequate corporate earnings and profits). This has unfavorable tax 
consequences, since dividends are not deductible. In addition to an 
employee's salary, employer-provided benefits should be considered in 
determining whether an employee's compensation is reasonable. This 
includes pension and welfare benefits, as well as fringe benefits such 
as the use of a company car.

  Finally, the 1993 Taxpayer's Bill of Rights enacted Section 4958 
which imposes an excise tax on transactions that provide excessive 
economic benefits to top executives of non-profit charitable groups. 
The Internal Revenue Service finalized regulations implementing this 
law on January 10, 2001. The regulations define what constitutes 
excessive compensation and benefits.
  The limitation on the deduction proposed in my legislation serves a 
constructive public policy purpose. The only purpose of the limitation 
on deduction we find in S. 1940, the lead bill on expensing of stock 
options, is to coerce companies into expensing their options at grant. 
If the companies do not expense options at grant, as S. 1940 prefers 
that they do despite FASB's current rule that this is not necessary, 
then they lose their tax deduction. If this legislation is effective, 
and companies are forced to expense their options at grant, the likely 
result is that fewer options will be granted, especially to rank and 
file employees, although not for top executives. My legislation is 
directed at protecting the stock options of rank and file employees.
  In addition to ensuring that stock options are broad-based and 
performance oriented and not just allocated to the top executives, we 
need to make sure that shareholders are involved in the decision to 
implement these stock option plans.
  The legislation provides that not later than one year after the date 
of enactment of this Act, the Commission shall finalize rules pursuant 
to the Securities and Exchange Act of 1934 to ensure that shareholder 
approval is required for stock option plans and grants, stock purchase 
plans, and other arrangements by public companies by which any person 
may acquire an equity interest in the company in exchange for 
consideration that is less than the fair market value of the equity 
interest at the time of the exchange.
  This approval would apply to any stock option plan, not just a stock 
option plan that meets the terms for a broad-based plan.
  In securing this approval, prior to submission of such plans to 
shareholders for approval, the company must give its shareholders 
detailed information about the stock option plans and grants, including 
(a) the economic rationale and interest of shareholders in the plan or 
grant; (b) a detailed description of the anticipated distribution of 
the plan or grant among directors, officers, and employees and the 
rationale such distribution; (c) the total number of options reserved 
or intended for grants to each director and officer, and to different 
classes of employees; (d) the maximum potential future earnings per 
share dilution of investors' shareholdings assuming the exercise of all 
in-the-money options with no adjustment for the use of the Treasury 
stock method, as stock price varies; (e) the terms under which stock 
option grants may be cancelled or reissued; and (f) the number, 
weighted average exercise prices, and vesting schedule of all options 
previously approved or outstanding.
  The Commission shall ensure that all disclosures required by this 
Section shall increase the reliability and accuracy of information 
provided to shareholders and investors.
  Such shareholder approval requirement may exempt stock option grants 
to individual employees under terms and conditions specified by the 
Commission. Such exemptions shall be available only where the grant is 
(1) made to an individual who is not a director or officer of the 
company at the time the grant is approved; (2) necessary, based on 
business judgment; (3) represents a deminimus potential dilution of 
future earnings per share of investors' shareholdings; and (4) made on 
terms disclosed to shareholders of the grant that is made in the next 
filing with the Securities and Exchange Commission.
  Such approval requirement may exempt stock option plans and grants of 
any registrant that qualifies as a small business issuer under 
applicable securities laws and regulations or to such additional small 
issuers as the Commission determines would be unduly burdened by such 
requirements as compared to the benefit to shareholders. The Commission 
is authorized to phase in the applicability of this rule both as to the 
applicability and to its effective date so that it can determine the 
size of issuer to which this rule will apply and the extent to which 
the rule should apply to plans that exclude officers and directors.
  The bill also focuses on the issue of the incentives stock options 
give to executives as they manage a company.

[[Page S7945]]

Questions have been raised about whether the options are partly 
responsible for the deception and fraud that has occurred at Enron and 
other companies. The charge is that the options gave these executives 
an irresistible rationale to deceive shareholders and investors to pump 
up the stock price and increase the value of the options. Charges have 
been made that these manipulations were timed to occur immediately 
before options were exercised and shares were sold.
  While there is intuitive appeal to this argument, it is difficult to 
establish the role of stock options in these acts of deceptions, fraud 
and manipulation. The concerns are sufficient, however, that we need to 
turn to the Securities and Exchange Commission to evaluate them and 
determine what restrictions might be imposed on the sale of stock 
acquired through stock options. The bill directs the SEC to conduct an 
analysis and make regulatory and legislative recommendations on the 
need for new stock holding period requirements for senior executives. 
The Commission is directed to make recommendations regarding minimum 
holding periods after exercise of options to purchase stock and maximum 
percentage of stock purchased through options that may be sold. These 
recommendations would include transactions involving sales to company, 
sales on public markets, and derivative sales.
  We need the expertise of the Commission on this complicated issue. It 
would probably not be reasonable to bar executives from selling any 
shares during their employment with the firm. Executives may need the 
proceeds of these sales to finance the college education of their 
children and many other completely legitimate reasons. The Commission 
is in a better position to evaluate the incentives, the opportunities 
for fraud, and other key factual and policy questions.
  Stock options have been under attack. We need to focus on how to 
prevent abuse of stock options, not just abandon these incentives. They 
are a uniquely American idea, they provide a way to increase 
productivity and broaden the winner's circle. As with any economic 
incentive, they can be abused and we need to focus on these abuses. By 
reforming stock options, we can ensure that these incentives will be 
even more effective.
  I believe that the reforms I have proposed will address the abuses we 
have seen. It is unfortunate that the accounting for stock options has 
become a surrogate for any and all issues regarding stock options. I 
continue to believe that accounting for stock options as an expense at 
the time they are granted is not appropriate or possible. But 
irrespective of the outcome of this debate, the reforms I have proposed 
here address the real issues, the real abuses, and the real 
opportunities to ensure that stock options continue to provide a 
powerful incentive in favor of economic growth and democratic 
capitalism.
  I ask unanimous consent than the following outline of the legislation 
and the text of the legislation be printed in the Record.
  There being no objection, the material was ordered to be printed in 
the Record, as follows:

                     Rank and File Stock Option Act

       Legislation focuses on three critical reform issues 
     regarding stock options--distribution, shareholder approval, 
     and disposition by senior executives.
       Requiring expensing of stock options at the time they are 
     granted is likely to discourage the use of stock options, but 
     it will not prevent senior executives from hoarding options--
     it will probably encourage it. It will not give shareholders 
     a greater say in approving stock option plans and ensuring 
     that they are focused on effective incentives for growth. And 
     expensing will not address the incentives that executives may 
     have to manipulate earnings immediately prior to selling 
     shares acquired through a stock option plan.
       A. Broad-based Options. This provision of the bill is based 
     on the structure and elements of a bill introduced by Senator 
     Lieberman on June 29, 1993, the ``Equity Expansion Act,'' S. 
     1175.
       This bill limits the ordinary and necessary business 
     expense deduction attributed to the spread on the exercise of 
     stock options to the extent stock option grants for the 
     taxpayer are not broad-based.
       The stock option grants are deemed to be broad-based when, 
     immediately after the grant of the options, employees who are 
     not highly compensated employees hold share options that 
     permit the acquisition of at least 50 percent of all shares 
     that may be acquired pursuant to all stock options 
     outstanding (whether or not exercisable) as of such time. The 
     bill does not require that stock option grants be made to 
     literally every employee, but as a practical matter such 
     grants to every employee may be necessary to meet the test. 
     Requiring that all employees receive some options involves 
     complex issues about part-time employees and new employees. 
     The 50% test is tough enough to ensure that the options are 
     broad-based.
       The definition of a highly compensated employee includes 
     all employees who earn $90,000 or more and are among the 
     firm's top 20 percent highest paid employees. This is similar 
     to the current test applied to prevent ``discrimination'' in 
     401K plans.
       B. Shareholder Approval. The bill provides that not later 
     than one year after the date of enactment of this Act, the 
     Commission shall finalize rules pursuant to the Securities 
     and Exchange Act of 1934 to ensure that shareholder approval 
     is required for stock option plans and grants, stock purchase 
     plans, and other arrangements by public companies by which 
     any person may acquire an equity interest in the company in 
     exchange for consideration that is less than the fair market 
     value of the equity interest at the time of the exchange.
       C. Holding Period For Executives. Finally, the bill 
     requires the Securities and Exchange Commission to conduct an 
     analysis and make regulatory and legislative recommendations 
     on the need for new stock holding period requirements for 
     senior executives to reduce incentives for earnings 
     manipulations.

                                S. 2877

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE.

       This Act may be cited as the ``Rank and File Stock Option 
     Act of 2002''.

     SEC. 2. DENIAL OF DEDUCTION FOR STOCK OPTION PLANS 
                   DISCRIMINATING IN FAVOR OF HIGHLY COMPENSATED 
                   EMPLOYEES.

       (a) In General.--Section 162 of the Internal Revenue Code 
     of 1986 (relating to deduction for trade and business 
     expenses) is amended by redesignating subsection (p) as 
     subsection (q) and by inserting after subsection (o) the 
     following new subsection:
       ``(p) Deductibility of Stock Options Not Widely Available 
     to All Employees.--
       ``(1) In general.--If--
       ``(A) an applicable taxpayer grants stock options during 
     any taxable year, and
       ``(B) the taxpayer fails to meet the overall concentration 
     test of paragraph (2) or the individual concentration tests 
     of paragraph (3) for such taxable year with respect to the 
     granting of such options,
     then the deduction allowable to such taxpayer for any taxable 
     year in which any such option is exercised shall be limited 
     as provided in this subsection.
       ``(2) Overall concentration test.--If the total number of 
     shares which may be acquired pursuant to options granted to 
     applicable highly compensated employees by an applicable 
     taxpayer during a taxable year exceeds 50 percent of the 
     aggregate share amount, then the deduction allowable under 
     this chapter with respect to the exercise of any option 
     granted by the applicable taxpayer during such taxable year 
     to any employee shall be reduced by the product of--
       ``(A) the amount of such deduction computed without regard 
     to this subsection, and
       ``(B) a percentage equal to the number of percentage points 
     (including any fraction thereof) by which such total number 
     exceeds 50 percent.
       ``(3) Individual concentration tests.--
       ``(A) Options granted to single employee.--If the total 
     number of shares which may be acquired pursuant to options 
     granted to any applicable highly compensated employee by an 
     applicable taxpayer during a taxable year exceeds 5 percent 
     of the aggregate share amount, then no deduction shall be 
     allowable under this chapter with respect to the exercise of 
     any options granted by the applicable taxpayer to such 
     employee during such taxable year.
       ``(B) Options granted to top employees.--
       ``(i) In general.--If the total number of shares which may 
     be acquired pursuant to options granted to employees who are 
     members of the top group by an applicable taxpayer during a 
     taxable year exceeds 15 percent of the aggregate share 
     amount, then no deduction shall be allowable under this 
     chapter with respect to the exercise of any options granted 
     by the applicable taxpayer to such employees during such 
     taxable year.
       ``(ii) Top group.--For purposes of this subparagraph, an 
     employee shall be treated as a member of the top group if the 
     employee is a covered employee (within the meaning of section 
     162(m)(3)).
       ``(C) Exception.--Subparagraphs (A) and (B) shall not apply 
     to any taxable year if the applicable taxpayer granted an 
     equal number of identical options to each employee without 
     regard to whether the employee was highly compensated or not.
       ``(4) Rules relating to tests.--For purposes of this 
     subsection--
       ``(A) Aggregate share amount.--
       ``(i) In general.--The aggregate share amount for any 
     taxable year is the total number of shares which may be 
     acquired pursuant to options granted to all employees by an 
     applicable taxpayer during the taxable year.
       ``(ii) Certain options disregarded.--Except as provided in 
     regulations, if the terms of any option granted to an 
     employee other than a highly compensated employee during

[[Page S7946]]

     any taxable year are not substantially the same as, or more 
     favorable than, the terms of any option granted to any highly 
     compensated employee, then such option shall not be taken 
     into account in determining the aggregate share amount.
       ``(B) Options granted on different classes of stock.--
     Except as provided in regulations, this subsection shall be 
     applied separately with respect to each class of stock for 
     which options are granted.
       ``(5) Definitions and special rules.--For purposes of this 
     subsection--
       ``(A) Applicable taxpayer.--The term `applicable taxpayer' 
     means any taxpayer which is an issuer (as defined in section 
     3 of the Securities Exchange Act of 1934; 15 U.S.C. 78c)--
       ``(i) the securities of which are registered under section 
     12 of that Act (15 U.S.C. 78l), or
       ``(ii) which--

       ``(I) is required to file reports pursuant to section 15(d) 
     of that Act (15 U.S.C. 78o(d)), or
       ``(II) will be required to file such reports at the end of 
     a fiscal year of the issuer in which a registration statement 
     filed by such issuer has become effective pursuant to the 
     Securities Act of 1933 (15 U.S.C. 77a et seq.), unless its 
     securities are registered under section 12 of the Securities 
     Exchange Act of 1934 (15 U.S.C. 78c) on or before the end of 
     such fiscal year.

       ``(B) Applicable highly compensated employee.--The term 
     `applicable highly compensated employee' means--
       ``(i) any highly compensated employee who is described in 
     subparagraph (B) of section 414(q)(1), and
       ``(ii) any director of the applicable taxpayer.
       ``(C) Incentive stock options not taken into account.--An 
     incentive stock option (as defined in section 422(b)) shall 
     not be taken into account for purposes of applying this 
     section.
       ``(D) Aggregation.--All corporations which are members of 
     an affiliated group of corporations filing a consolidated 
     return shall be treated as 1 taxpayer.
       ``(6) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary to carry out the purposes of 
     this subsection, including regulations to prevent the 
     avoidance of this subsection through the use of phantom 
     stock, restricted stock, or similar instruments.''
       (b) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2002.

     SEC. 3. SHAREHOLDER APPROVAL.

       (a) Rules Required.--Not later than 1 year after the date 
     of enactment of this Act, the Securities and Exchange 
     Commission shall finalize rules pursuant to the Securities 
     Exchange Act of 1934 to ensure that--
       (1) shareholder approval is required for stock option plans 
     and grants, stock purchase plans, and other arrangements by 
     public companies by which any person may acquire an equity 
     interest in the company in exchange for consideration that is 
     less than the fair market value of the equity interest at the 
     time of the exchange; and
       (2) prior to submission of such plans to shareholders for 
     approval, such shareholders are given detailed information 
     about the stock option plans and grants, including--
       (A) the economic rationale and interest of shareholders in 
     the plan or grant;
       (B) a detailed description of the anticipated distribution 
     of the plan or grant among directors, officers, and employees 
     and the rationale of such distribution;
       (C) the total number of options reserved or intended for 
     grants to each director and officer, and to different classes 
     of employees;
       (D) the maximum potential future earnings per share 
     dilution of investors' shareholdings, assuming the exercise 
     of all in-the-money options with no adjustment for the use of 
     the Treasury stock method, as stock price varies;
       (E) the terms under which stock option grants may be 
     canceled or reissued; and
       (F) the number, weighted average exercise prices, and 
     vesting schedule of all options previously approved or 
     outstanding.
       (b) Reliability and Accuracy.--The Commission shall ensure 
     that all disclosures required by this section shall increase 
     the reliability and accuracy of information provided to 
     shareholders and investors.
       (c) Exemption Authority.--Shareholder approval rules issued 
     in accordance with this section--
       (1) may exempt stock option grants to individual employees 
     under terms and conditions specified by the Commission, 
     except that such exemptions shall be available only in cases 
     in which the grant--
       (A) is made to an individual who is not a director or 
     officer of the company at the time the grant is approved;
       (B) is necessary, based on business judgment;
       (C) represents a de minimus potential dilution of future 
     earnings per share of investors' shareholdings; and
       (D) is made on terms disclosed to shareholders in the next 
     filing with the Commission; and
       (2) may exempt stock option plans and grants of any 
     registrant that qualifies as a small business issuer under 
     applicable securities laws and regulations, or to such 
     additional small issuers as the Commission determines would 
     be unduly burdened by such requirements as compared to the 
     benefit to shareholders, except that such exemption may be 
     phased in, both as to applicability and to its effective 
     date, so that the Commission may determine the size of issuer 
     to which such exemptions will apply and the extent to which 
     the rule should apply to plans that exclude officers and 
     directors.

     SEC. 4. HOLDING PERIOD FOR EXECUTIVES.

       Not later than 1 year after the date of enactment of this 
     Act, the Securities and Exchange Commission shall conduct an 
     analysis of, and make regulatory and legislative 
     recommendations on, the need for new stock holding period 
     requirements for senior executives, including--
       (1) recommendations to set minimum holding periods after 
     the exercise of options to purchase stock and to set a 
     maximum percentage of stock purchased through options that 
     may be sold; and
       (2) an analysis of sales to company, sales on public 
     markets, and derivative sales.
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