[Congressional Record Volume 149, Number 168 (Wednesday, November 19, 2003)]
[Senate]
[Pages S15188-S15190]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. ENZI (for himself, Mr. Reid, Mr. Ensign, Mrs. Boxer, Mr. 
        Allen, Mrs. Murray, Mr. Allard, Mr. Burns, and Mr. Smith):
  S. 1890. A bill to require the mandatory expensing of stock options 
granted to executive officers, and for other purposes; to the Committee 
on Banking, Housing, and Urban Affairs.
  Mr. ENZI. Mr. President, I rise to introduce the Stock Option 
Accounting Act. This bill has been a long time in the making. It is a 
strong bipartisan bill that addresses the important role stock options 
play in our economy.
  As an Accountant, and as a member of the Senate who was a small 
businessman for many years, I tend to believe most of the issues we 
address in Congress should be examined with an eye toward preserving 
the strength and integrity of our small business sector, and ensuring 
that the regulations that govern it are fair and preserve and promote, 
rather than discourage, innovation and competition.
  I think that's something we can all agree on, so I know I won't have 
to go into too much detail about the importance of our small business 
sector, especially our small, high tech businesses. When it comes to 
small businesses, especially our high technology centers, we truly are 
the envy of the world. Our talented and creative engineers and 
inventors have paved the way for innovations in advanced technologies 
and computer software that other countries will always try to imitate.
  Here in the United States, our Small Business Administration is well 
aware of the importance of that sector to our Nation's economy. Nearly 
23 million strong, small businesses represent more than 99.7 percent of 
all employers, employ more than half of all private sector employees, 
generate 60 to 80 percent of net new jobs annually, create more than 50 
percent of nonfarm private gross domestic product (GDP) and produce 13 
to 14 times more patents per employee than large patenting firms.
  Last week, I chaired a hearing in the Banking Committee's 
Subcommittee on Securities and Investment that featured testimony from 
the Financial Accounting Standards Board (FASB) and the small business 
community. It became quite evident during the hearing that FASB is ill 
equipped to conduct economic impact studies of the accounting standards 
that it adopts even through its one of their precepts. FASB may be able 
to conduct a cost analysis of an accounting standard proposal 
determining the costs of computers and additional manpower necessary to 
implement a new statement. But, it does not have the expertise to look 
at the comprehensive impact a new standard may have on the economy.
  In addition, as the hearing progressed, it was evident that FASB is 
not listening to small businesses, and not taking their concerns 
seriously about a standard that FASB Board members stated was ``set in 
concrete'' prior to an official comment period on any draft proposal.
  At the hearing, small business witnesses testified about how they are 
worried that the expensing of stock options would make this form of 
employee compensation prohibitive. They said it would make it very 
difficult if not impossible to attract and retain talented employees. 
It would also have a detrimental effect on the entrepreneurial nature 
and spirit of our country. In all of my years listening on this issue, 
not one small business owner has spoken in favor of expensing stock 
options.
  After the hearing, I was more convinced than ever that legislation 
like this bill was needed to address the issue of the expensing of 
stock options.
  A key element of FASB's current structure is its independence and I 
want to make it clear that I support that principle. FASB's 
independence, like freedom, must be earned--and it's independence does 
not provide a shield that absolves FASB of accountability and due 
process.
  When it comes to the issue of stock options, a case can be made that 
FASB took up the project with a pre-ordained result in mind. It's no 
surprise, therefore, that the process that was established to pursue 
the matter seems to reflect a project that was begun with the end in 
mind. There is enough evidence there to at least make one wonder.
  First, FASB doesn't seem to have given much consideration to the more 
than 200 public comment letters they received. The public comments made 
by FASB Board Members seem to also reflect a skewed process, as does 
the lack of response to the many high tech companies that have visited 
with FASB in the past several months. In addition, FASB has refused to 
conduct real road tests to actual valuation methods.
  According to the FASB website ``Facts about FASB 2003-2004,'' the 
Board follows certain precepts in the conduct of its activities. They 
are: 1. To be objective in its decision making and to ensure, insofar 
as possible, the neutrality of information resulting from its 
standards. To be neutral, information must report economic activity as 
faithfully as possible without coloring the image it communicates for 
the purpose of influencing behavior in any particular direction. 2. To 
weight carefully the views of its constituents in developing concepts 
and standards. However, the ultimate determinant of concepts and 
standards must be the Board's judgment, based on research, public input 
and careful deliberation about the usefulness of the resulting 
information. 3. To promulgate standards only when the expected benefits 
exceed the perceived costs. While reliable, quantitative cost-benefit 
calculations are seldom possible, the Board strives to determine that a 
proposed standard will meet a significant need and that the costs it 
imposes, compared with possible alternatives, are justified in relation 
to the overall benefits. 4. To bring about needed changes in ways that 
minimize disruption to the continuity of reporting practice. Reasonable 
effective dates and transition provisions are established when new 
standards are introduced. The Board considers it desirable that change 
be evolutionary to the extent that it can be accommodated by the need 
for relevance, reliability, comparability and consistency. 5. To review 
the effects of past decisions and interpret, amend or replace standards 
in timely fashion when such action is indicated.
  Precept number 3 greatly interests me. I am very concerned that FASB 
has repeatedly refused to consider the economic consequences of its 
decisions. The mandatory expending of all employee stock options has 
serious economic, labor, trade and competitiveness implications. These 
issues fall squarely within the jurisdiction and oversight of Congress. 
It's not hard to imagine what would be said of Congress if we failed to 
take note of the economic implications of the actions we take on the 
floor.
  Simply put, at the end of the day, if FASB is going to earn its 
independence, it will have to adhere to a process that is objective, 
fair, open and balanced. So far, FASB seems to be more concerned about 
getting the job done--than in getting it right.
  That is why I am offering legislation that will expense the stock 
options given to the top five executives of a company, exempt small 
businesses and start up companies, and set conditions for the expensing 
of broad-based options for the remaining employees. I treat the three 
groups differently in this matter because a very real and strong 
accounting distinction exists between the two types of workers.

  First of all, in a very real sense the top five executives of an 
organization

[[Page S15189]]

are different from the general employee group in the manner in which 
they are treated by the SEC and the manner in which their compensation 
is defined and distributed from an accounting perspective.
  The top five executives, for instance, are treated differently when 
it comes to their compensation and a wide range of other matters. Proxy 
rules, for instance, require significant additional disclosures from 
the top five executives than they do of any other group.
  Second, from an accounting perspective, there is a clear distinction 
between executives and the broad employee group. In their recent book, 
In the Company of Owners, Professor Joseph Blasi and Douglas Kruse 
concluded, based on extensive research, that options granted to all but 
the top executives in a company are not labor income, but a form of 
capital income.
  To quote from their book, ``They represent risk sharing profits that 
workers receive on top of their normal market wages and benefits. As 
such, it makes little sense to deduct the value of those options from 
profits.''
  In addition, Blasi and Kruse found that, ``options turn employees 
into economic partners in the enterprise. As such, they stand to share 
in the stock appreciation that they help to bring about. . . . Options 
provide an additional dimension to their employment relationship, 
allowing workers to participate in both the risks and the rewards of 
property ownership. . . . There's substantial economic evidence that 
options bring workers capital rather than labor income. . . . The 
earnings workers get from options comes on top of their regular market 
wage.''
  In contrast, options for top executives function more as labor 
income, particularly in companies without broad based option plans. 
These top executives bargain for their entire ``compensation'' package 
and, in many cases, stock options represent a large part of the total 
package. Their negotiations about compensation are distinctly different 
than other employees.
  That brings me to our bill and its purpose--or, to continue with my 
line of reasoning--If these two groups should be compensated 
differently for their efforts when it comes to stock options, how 
should it be done?
  Our legislation would mandate a valuation method of the options given 
to the top five executives that does not require companies to predict 
their future stock price volatility. One of the members of the Option 
Valuation Group, Fred Cook, appointed by the FASB strongly recommended 
this method--one where stock price volatility is set at zero so that 
companies don't have to use a crystal ball and try to predict their 
future stock price.
  Another key principle in our legislation is the requirement that FASB 
develop a method of ``truing up''--or correcting errors--that are made 
when stock option estimates are made at grant date. There are several 
other areas where estimates are made in financial statements, and then 
corrected over time as the precise facts are learned. Today, no such 
corrections are made in the stock options area--a fundamental flaw in 
the system.
  To address these issues, the bill has three major components. First, 
the bill would target executive compensation. A company would be 
required to expense immediately options of the top five highly 
compensated individuals at a company. The Securities and Exchange 
Commission already requires this information in annual statements and 
proxy statements. In addition, it would provide investors with a 
clearer understanding of the stock options of top company officials. 
This also would work in conjunction with the self-regulatory 
organization's rules, approved last week by the Securities and Exchange 
Commission, to require shareholder approval of stock option plans.
  Second, small business would be exempt from expensing stock options. 
The exemption for small businesses would follow the current SEC rules 
for defining small businesses. The bill would allow small companies a 
3-year grace period after an initial public offering prior to a company 
being required to expense stock options. This would allow a sufficient 
period of time to work out any initial volatility after the initial 
public offering.
  Finally, the bill would not permit the Securities and Exchange 
Commission to recognize a stock option expensing standard unless two 
things happen. First, companies must be able to recognize the true 
expense of stock options on their financial statements. Currently, FASB 
wants companies to expense stock options upon the grant date of an 
option. Unfortunately, the current valuation models for stock options, 
Black-Scholes, binomial, Crystal Ball, and others, are horrible 
indicators of the true cost to a company stock options.
  The bill would require that a company be able to ``true-up'' its 
financial statements when a stock option is exercised, lapses or is 
forfeited. If the cost goes up then the company must record the 
increase when an option is exercised. Likewise, if an option lapses or 
is forfeited then a company should be able to wipe those previously 
taken expenses off its balanced sheet. This is only fair.
  The second item prior to an accounting standard to be recognized is 
the completion of an economic analysis study by the Secretary of 
Commerce and the Secretary of Labor. This study would look at how the 
use of stock options may stimulate economic growth in our nation's 
economy. In addition, the study would relate how stock options 
expensing could effect the competiveness of U.S. companies in 
international markets.
  I strongly believe that this bill is essential to our economic 
strength. It is clear that FASB is not listening to small business and 
therefore is not listening to the future of our country. FASB is 
therefore ill equipped to make the economic analysis decisions to 
determine the true effect of stock option expensing on our economy.
  In addition, the bill also targets the invasion's need for greater 
information on executive compensation. I ask my colleagues to take a 
serious look at this bill and to support its passage.
  I ask unanimous consent that a summary of the bill be printed in the 
Record.
  There being no objection, the summary was ordered to be printed in 
the Record, as follows:

  Summary of Key Provisions of the Enzi-Reid Stock Option Accounting 
                               Reform Act


mandatory expensing of stock option held by highly compensated officers

       The legislation requires that the chief executive officer 
     and the next four most highly compensated executive officers 
     shall expense their stock options in the annual reports filed 
     with the Commission.
       Expensing the options granted to the CEO and next four most 
     highly compensated executive officers would go into effect 
     immediately.
       This is consistent with information that must be filed with 
     the Commission as part of Securities Exchange Commission 
     Regulation S-K and part of proxy statement filings pursuant 
     to Securities Exchange Act Rule 14.
       The section would require that the '`fair value'' of a 
     stock option would be equal to the value that would be agreed 
     upon by a willing buyer and seller taking into account all of 
     the characteristics and restrictions imposed upon the stock 
     option.
       In light of the extreme inaccuracy of existing stock 
     valuation models (e.g., Black Scholes, binomial, etc.), 
     particularly with regard to the factor that requires 
     companies to predict the volatility of their stock price, the 
     legislation requires that the assumed volatility of the 
     underlying stock option shall be considered zero.


                        small business exemption

       The legislation exempts from the top five expensing 
     requirement all small businesses as defined currently by the 
     Securities and Exchange Commission pursuant to Regulation S-
     B.
       The legislation also delays stock option expensing of a 
     small business issuer until three years after an initial 
     public offering has taken place. This would allow a small 
     business issuer's stock to settle down from the initial 
     volatility of the initial public offering.


   prohibition on expensing; ``truing up'' requirement; and economic 
                              impact study

       The legislation prohibits the SEC from recognizing any 
     stock option expensing accounting standard set by a standard 
     setting body unless and until: 1. The expensing standard 
     recognizes the true expense of the stock option on a 
     company's financial statement when the option is exercised, 
     expires or is forfeited, a ``truing up'' requirement; and 2. 
     A comprehensive economic impact study has been conducted by 
     the Departments of Commerce and Labor.
       As to the first requirement above, currently, stock options 
     must be expensed based upon the grant date of the option. 
     There is no ``truing up,'' or correcting, errors made at the 
     time of grant when subsequent events prove the initial 
     estimates to be inaccurate. The legislation requires that 
     when an option is exercised, expires or is forfeited, the 
     company would reconcile the actual expense to

[[Page S15190]]

     the company to the amount expensed previously upon the date 
     of grant.
       As to the second requirement, the legislation requires the 
     Secretary of Commerce and the Secretary of Labor to conduct 
     and complete a joint study on the economic impact of the 
     mandatory expensing of all employee stock options. The study 
     will address: 1. the use of broad-based stock option plans in 
     expanding employee corporate ownership to workers at a wide 
     range of income levels with particular focus on non-executive 
     workers; 2. the role of such plans in the recruitment and 
     retention of skilled workers; 3. the role of such plans in 
     stimulating research and innovation; 4. the effect of such 
     plans in stimulating the economic growth of the United 
     States; and 5. the role of such plans in strengthening the 
     international competitiveness of United States' businesses.

  Mr. REID. Mr. President, I want to thank Senators Enzi, Ensign, 
Boxer, and Allen for their hard work and continued efforts on this 
issue.
  It is with pleasure that I introduce bipartisan legislation, the 
Stock Option Accounting Reform Act of 2003, that is good for economic 
growth and the American way.
  We have to protect investors and stockholders by ensuring that our 
Nation's accounting standards are transparent, open and balanced. At 
the same time, we don't want to choke the entrepreneurial spirit of 
start-up companies with too much bureaucratic red tape.
  This legislation achieves just the right balance. It gives regulators 
a framework to protect the integrity of the accounting process, but it 
doesn't stifle free enterprise.
  This bill requires a joint study by the Department of Labor and 
Department of Commerce to help FASB (Financial Accounting Standards 
Board) treat stock options fairly. It will help regulators valuate 
stocks for accounting purposes. It will curb stock option abuse by 
requiring the top five executives at large companies to expense their 
options. This will provide a true picture of a company's financial 
health.
  Finally, it will protect small businesses and start-ups that rely 
upon stock options to attract good employees.
  This bill is good for emerging companies and good for consumers. It's 
a balanced approach that deserves broad bipartisan support.
                                 ______