[Congressional Record (Bound Edition), Volume 148 (2002), Part 3]
[Extensions of Remarks]
[Page 3879]
[From the U.S. Government Publishing Office, www.gpo.gov]




 INTRODUCTION OF A BILL TO ``END THE DOUBLE STANDARD FOR STOCK OPTIONS 
                                 ACT''

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                        HON. FORTNEY PETE STARK

                             of california

                    in the house of representatives

                       Wednesday, March 20, 2002

  Mr. STARK. Mr. Speaker, I rise to introduce legislation to plug a 
corporate tax loophole that allows companies to hide stock option 
expenses from their Securities and Exchange Commission (SEC) earnings 
reports, but allows those same companies to take the deduction on their 
Internal Revenue Service (IRS) tax filings. My bill would force 
companies to report the stock option expense on their financial 
earnings records if they want to continue to take the deduction on 
their income tax filing. I'm pleased to be joined by Reps. Barney Frank 
and Lynn Rivers in introducing this important bill. Senators Levin and 
McCain have introduced companion legislation in the Senate.
  Under current law, companies can deduct stock option expenses from 
their income taxes as a cost of doing business, just like employee 
wages. However, companies are not required to report these business 
expenses on their SEC financial statement to stockholders. The 
Financial Accounting Standards Board (FASB), the self-regulated 
accounting board with SEC reporting oversight, recommends that 
companies record stock options as an expense on their financial 
earnings statement, but does not require that stock options be treated 
as an earnings expense. In fact, stock options are the only form of 
compensation not treated as an earnings expense at any time. Nearly all 
companies relegate their stock option expenses to a footnote in their 
SEC report, yet these expenses are not reflected in their bottom line 
earnings. Among the S&P 500 companies, only Boeing and Winn-Dixie 
follow the advice of FASB and actually record the cost of options on 
both the tax and earnings ledger.
  Right now, companies can replace wage compensation with stock option 
compensation without having to show reduced earnings on their financial 
statements. This loophole misleads investors, financial analysts, and 
workers who have their pension funds tied up in companies that offer 
stock options. Since companies costs are not reported on the financial 
earnings statement, companies' earnings appear greater than actual 
earnings should reflect.
  Let's take the case of Enron as an example of how misleading this 
loophole can be. According to a study by Citizens for Tax Justice, from 
1996-2000, Enron took a $600 million tax deduction for stock options. 
Over that same five-year period, Enron showed $1.8 billion in earnings. 
However, this earnings figure did not completely reflect Enron's true 
earnings. As we know, Enron used a number of accounting gimmicks to 
artificially inflate their earnings report, one of which was the 
decision to list all stock option compensation as a footnote in its 
earnings report and then exclude this compensation from its total 
expenses. Had Enron accurately recorded its stock option compensation 
it would have had to report a decrease in earnings by one-third! 
Furthermore, had Enron been required to report that one-third of its 
earnings were attributed to stock options, then employees and 
stockholders could have seen that company profits weren't based on real 
growth. According to an analyst with Bear Stearns, the earning reported 
by firms in the S&P 500 would have been 9 percent lower in 2000 if 
stock options were treated as an expense.
  As Enron leaders clearly realized, company executives can prosper by 
means other than simply building a great company. Executives can often 
increase their personal wealth by creating unrealistic expectations of 
their company from Wall Street, rather than the old fashioned way of 
consistently delivering impressive growth. Consider the following two 
hypothetical companies. One company has a stock price that has 
appreciated slowly. It started at $20 and gained $2 each year for five 
years, raising its price to $30 today. The second company's stock also 
started at $20 five years ago, then zoomed to $100 after a few years 
but has since fallen back to $20. By any reasonable measure, the 
leaders of the first company have done a better job at growing a solid 
company, worthy of its stock price. Their share price has grown 50 
percent, and they have avoided making grandiose predictions that cause 
Wall Street analysts to set silly targets. The second company's stock 
has under-performed over the long run, and scores of workers and 
investors have been burned by false hopes.
  If the top executives of both hypothetical companies had received 
similar amounts of stock and both sold their shares on a regular 
schedule, the executives of the second company would have earned more. 
These executives would have made so much money selling the stock when 
it was trading near $100 that they would become instant 
multimillionaires, despite the stock's ensuing, rapid decline. Thus, 
the practice of failing to report stock options on earnings reports 
could actually encourage executives to take stock options as a form of 
compensation. That way, they can earn millions of dollars, claim it as 
a tax deduction, and then hide it from investors. My bill corrects this 
perverse incentive and seeks to discourage reckless executive behavior. 
My bill also gives companies an incentive to report their stock option 
expenses in order to continue to take the tax deduction.
  If stock options are a cost of doing business for tax purposes, then 
they should be a cost of doing business for earnings purposes. But 
don't just take my word for it. In a March 7th Senate Banking Committee 
hearing, Alan Greenspan, Chairman of the Federal Reserve Board 
testified:
  ``The truth of the matter is that if you do not expense the granting 
stock options or their realization in the income statement, as, 
indeed,, we are required in our tax forms, then you will get a pre-tax 
income which is higher than one can argue you really had . . . Is 
income being properly recorded? And I would submit to you the answer is 
no.''
  Arthur Leavitt, former Secretary of the Securities and Exchange 
Commission, favors reporting publicly held stock options on SEC 
earnings reports. He told NPR:
  ``. . . If we decide to account for public stock options in a way 
that I think is in the public interest, I do not believe for a moment 
it would be the end of capitalism, nor do I believe it will have a 
significant negative impact on America's corporations.''
  Deloitte & Touche, one of the nation's premier accounting firms, as 
well as Arthur Anderson, Enron's disgraced accountant, both say options 
should be charged to a company's income statement. Many Wall Street 
analysts agree. Eighty-three percent of U.S. financial analysts who 
responded to a survey by the Association for Investment Management 
Research (AIMR) also support listing stock options in the financial 
income statement.
  The evidence is clear: this loophole should be closed. My bill to 
``End the Double Standard for Stock Options'' is a much-needed fix to 
help prevent companies from misrepresenting their financial status to 
stockholders and employees. I urge my colleagues from both sides of the 
aisle to cosponsor this important bill and to support its enactment 
this year.

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