by Glenn Cheney

Washington — The long-simmering controversy over accounting for stock option compensation has flared up again as the House Financial Services Committee advanced legislation that could override a new standard that has been proposed — but not yet approved — by the Financial Accounting Standards Board.

However, the primary question — whether public companies should expense or merely disclose the value of employee stock option compensation — has become secondary to an issue of more far-reaching impact: whether Congress should set accounting standards.

While some see disaster if the federal government meddles with something as technical and, at times, partisan as generally accepted accounting principles, others warn of disaster if standards do not take into account their economic impact.

By a 45-13 margin, the House committee approved the measure — the Stock Option Accounting Reform Act — which would require companies to report as an expense only employee stock options granted to a company’s chief executive and its next four highest paid employees.

Sponsored by Rep. Richard H. Baker, R-La., the measure also exempts small businesses from expensing options, while newly public companies would be able to delay expensing in the first three years.

The Financial Accounting Foundation, which oversees FASB and appoints its members, has fired off a response reiterating its support of independent, non-governmental standard-setting.

The letter did not broach the issue of how good the proposed standard may or may not be, except to say that the FAF leaves the complex task of standard-setting to “the experts who comprise FASB.”

“We believe that once Congress starts setting accounting standards through its political process, the integrity of U.S. accounting standard-setting and the credibility of U.S. financial reporting will be dangerously compromised,” the release stated. “If Congress sends the message that special interests are able, through legislation, to overturn expert accounting judgment arrived at through open and thorough due process, necessary and timely improvements in financial reporting will likely become impossible.”

Rep. Michael G. Oxley, R-Ohio, chair of the House Financial Services Committee and co-author of the Sarbanes-Oxley legislation, supported H.R. 3574. “Passage of the Baker bill is an indication of the concern many members have about [FASB’s] proposal and its potential to negatively affect the economy,” Oxley said. “In addition, I have serious concerns about the proper valuation of stock options.”

However, Rep. Brad Sherman, D-Cal., one of two CPAs on the committee, was opposed to its passage: “I am disappointed that the committee approved this bill because by interfering with FASB’s process, we have actually interfered with our nation’s ability to attract capital from around the world.”

Sherman tried to amend the bill to correct what he saw as elements that would lead to critical underestimation of the value of options. The bill would have companies report the value of only the stock option compensation given to a company’s chief executive officer and the top five recipients of such compensation. It would assume no fluctuation in the value of the options in future years.

Only one of Sherman’s amendments passed.

It sets a one-year deadline for the U.S. Departments of Labor and Commerce to submit a study of the economic impact of expensing employee options. The bill required such a study but did not set a deadline.

“Those who support the bill say we have to compete with India and China,” Sherman said. “If we are competing for whose accounting standards are the most lax, the U.S. doesn’t stand a chance.”

A similar bill has been introduced in the Senate, but it is not expected to make much progress. Senate Banking Committee chair Richard Shelby, R-Ala., has expressed resolute opposition to any bill that encroaches on FASB’s power to set accounting standards.

Pros and cons
“My major criticism of the Baker bill would be that it creates inconsistency. If there’s good reasoning for expensing, then it should apply to all employees,” said Dr. Cindy Ma, an economist and CPA with economic consultancy NERA. “If there’s no good reason to expense, then you shouldn’t do it.”

“Why do you need another study?” she asked. “The market has already debated this thing to death. By this time, people are aware of the advantages and disadvantages of expensing. There isn’t a perfect solution. Exemptions create inconsistency. If some companies get an exemption for this and for that, then it becomes difficult for investors to do an across-the-board comparison.”

The bill’s progress in the House has been supported by the high-tech and electronics sectors. The International Employee Stock Options Coalition, an ad hoc association of over 50 companies and other interested organizations, has been leading the charge. The Washington lobbying firm Griffin, Johnson, Madigan & Peck has been representing the organization.

Jeffrey Peck, lead consultant with the firm, pointed out that the bill was supported by Republicans as well as Democrats.

“In an era of partisanship, this is a bipartisan exception to the way business is being done these days,” Peck said. “I think that tells us that ... parties on both sides of the aisle see very much the need to preserve broad-based stock option plans and are worried about the economic consequences of FASB’s proposal, and far from seeing this vote as congressional interference, they see it as their responsibility to take steps to protect the economy and preserve jobs.”

FASB’s proposed standard would bring the United States close to a proposed international standard that has been issued by the International Accounting Standards Board. FASB has an express intent to converge with international standards, and the IASB has been encountering less resistance than FASB.

FASB met similar corporate resistance when it tried to issue a similar standard on stock option compensation in the mid-1990s. The Senate passed a non-binding resolution asking the board to drop the project, and the large accounting firms failed to strongly back the board. The board backed down, and the consequent standard required only that companies disclose in footnotes the theoretical expense of stock option compensation.

Since then, two FASB members have joined the IASB, and a FASB project manager has become the IASB’s technical director. The IASB has proposed a standard similar to the one FASB originally proposed.

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