by Glenn Cheney

Washington — The House Subcommittee on Capital Markets, Insurance and Government- Sponsored Enterprises has approved a bill that would, for the first time, override a standard expected to be issued by the Financial Accounting Standards Board.

While proponents of the bill, H.R. 3574, the Stock Option Accounting Reform Act, say that the proposed standard would devastate job growth, opponents warn that congressional control over accounting standards could lead to a more serious economic disaster.

H.R. 3572, introduced by Rep. Richard H. Baker, R-La., would negate FASB’s proposal to require public companies to report employee stock option compensation as an expense at the grant date. The current standard requires only that financial reports show the estimated effect of such compensation in footnotes rather than on the balance sheet. The bill would require companies to expense only the stock options of a given company’s top five options recipients.

Rep. Baker said that he saw problems with the technicalities of FASB’s proposal, and he feared that it would bring about negative economic effects. He did not think that there was a serious issue of Congress overriding FASB.

“We aren’t trying to get into the intellect of FASB,” Baker said. “Where there are legitimate points to be discussed, I think it highly appropriate to discuss them, and if we’re wrong, we certainly will defer to FASB. I’m hoping that FASB’s folks will at least acknowledge that what the Congress has moved on is not without merit.”

Baker said that one reason his committee wrote the bill was to open a new opportunity for public comment.

“Ironically, FASB is asking all members of the public to comment except, apparently, members of Congress,” Baker said. “So I view our committee’s work as only contributing to that public comment, hoping to bring a perspective into the discussion which is not mandating any one industry’s view but merely acknowledging that the granting of options has contributed to the growth of job opportunities.”

Baker said that it was not fair for FASB to require the expensing of stock option compensation without telling companies how to do it. The FASB proposal allows companies to choose the most appropriate model. The Black-Scholes and binomial models are the most common.

“If you’re going to require somebody to do a certain task by way of law or regulation, you should describe how you do it to be compliant,” Baker said. “In other words, they should come up with a valuation methodology and say, ‘This is it.’”

Baker also cited chief executive officers who had testified that the proposed change in accounting standards could cause a radical change in a company’s bottom line, in some cases moving it from profitable to unprofitable.

While investors might be interested to know that stock option compensation is so integral to a company’s profitability, some CEOs, especially those in high-tech start-up companies, would prefer to keep the potential cost of such options off the books until they are exercised. In many cases, stock options are never exercised, despite the assumptions made at their grant date.

The more fundamental issue, however, is whether Congress should be setting accounting standards. Rep. Paul E. Kanjorski, D-Pa., said that it should not.

“In my opinion, choosing what companies should account for in their financial statements and how they should do the accounting is not the job of Congress. These are the duties of the Financial Accounting Standards Board,” Kanjorski said. “The Stock Option Accounting Reform Act restricts FASB’s independence and gets Congress involved in a political battle over what companies report as earnings. Moreover, the bill would deprive investors of comprehensive financial information. Congress cannot become an appellate court for accounting standards, and I maintain that FASB should remain an independent entity.”

Concerned that Congress might usurp FASB’s raison d’être and drag standard-setting into the realm of partisan politics, FASB chairman Robert H. Herz and board member George J. Batavick went to Washington and told the subcommittee what they think.

“H.R. 3574 would establish a dangerous precedent in that it would send a clear and unmistakable signal that Congress is willing to intervene in the independent, objective and open accounting standard-setting process based on factors other than the pursuit of sound and fair financial reporting,” Herz said. “That signal would likely prompt others to seek political intervention in future technical activities of the FASB.”

Robert Denham, chairman and president of the Financial Accounting Foundation, has backed FASB, which the FAF oversees, with a strong statement on the importance of independence.

“If Congress sends the message that special interests are able, through legislation, to overturn expert accounting judgment arrived at through open due process, necessary and timely improvements in financial reporting will likely become impossible,” Denham said. “H.R. 3574 pre-empts and overrides FASB’s ongoing effort to improve accounting for equity-based compensation through public due process. Once Congress starts setting accounting standards through its political process, the integrity of accounting standard-setting in this country will be dangerously compromised.”

Federal Reserve Chairman Alan Greenspan has expressed support for FASB’s proposal, and objected to Congress impeding FASB activities.

The CFO Institute, formerly known as the Association for Investment and Management Research, has sent a letter to Baker’s subcommittee and to its parent, the Financial Services Committee, expressing support for FASB’s proposal and objection to the bill.

“We think FASB deserves their independence and does a good job and that there shouldn’t be political intervention in the standard-setting process,” said Patricia Walters, CFO Institute senior vice president. “We think it’s unbelievable that after Sarbanes-Oxley and after Regulation Fair Disclosure that Congress would be intervening in the process.”

The institute’s letter to Baker’s subcommittee cited a recent survey of members, most of whom are institutional investors and financial analysts. The survey found that:

  • 88 percent of respondents believe that share-based or stock option plans are compensation;
  • 83 percent said that the accounting method for all share-based payments (including those given in employee stock option plans) should be expensed in the income statement; and,
  • 81 percent use information on the value of stock options when evaluating a firm’s performance and determining its value.

The letter warned of problems if standard-setting goes into the political arena.“Individual investors rarely have the political influence that corporations have and, hence, are disadvantaged when corporate influence adversely affects the information on which they rely when investing their savings,” the letter stated.
Senate opposition
Baker’s bill can expect to hit trouble if it reaches the Senate.

A Senate bill similar to the House bill has made little progress. Senate Banking Committee chair Richard Shelby, R-Ala., has already expressed his opposition in a recent op-ed piece.

“The preservation of FASB’s independence is fundamental to maintaining transparent, competitive and liquid markets,” Shelby wrote. “If the U.S. is to retain its credibility in the global marketplace, Congress must resist the temptation to interfere with FASB.”

A spokesperson for the Banking Committee confirmed that Shelby would take action to prevent any legislation that would override FASB’s standards.

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