July 22, 2002

Stock Options Reform Kept Off the Senate Corp-Gove

WASHINGTON (HedgeWorld.com)--Amid the complicated parliamentary maneuvering on the Senate floor Monday, preparatory to the unanimous passage of a bill sponsored by Senator Paul Sarbanes (D-Md.) aimed at reform both of the accounting industry and of corporate governance, there was also a flurry of activity by Senators who wanted to add a provision that would push corporations toward the expensing of the stock options that they offer as part of a compensation package. That effort seems, for now, to have come to naught.

Two amendments to this effect came under consideration: one, pushed by Senator John McCain (R-Ariz.), would have required U.S. companies to treat stock options as an expense on their balance sheets if they wanted to treat them as such for tax purposes; another, offered by Senator Carl Levin (D-Mich.) would simply have asked the Financial Accounting Standards Board to look into the issue of the expensing of stock options and to report on its conclusions within a year.

No vote was taken on either amendment, in part due to procedural objections raised by Senator Phil Gramm (R-Texas). "The Senator told me that we should have voted on McCain's if we're going to vote on Levin's," said Angela de Rocha, the communications director for the Republicans on the Senate banking committee.

The over-all bill, formally S. 2673, "The Public Company Accounting Reform and Investor Protection Act of 2002," passed 97-0 in the late afternoon but can't reach President Bush's desk without clearing further hurdles. This bill is markedly different from the bill the House passed in April, sponsored by Rep. Michael Oxley (R-Ohio), H.R. 3763, "The Corporate and Auditing Responsibility, Transparency, and Accountability Act of 2002." Although both bills create auditing oversight boards, the Sarbanes bill gives that board a more sweeping set of responsibilities and powers. Such differences will have to be resolved by a conference.

The President believes in the goals of both bills, the White House spokesman said Friday.

"The President believes [that] the Sarbanes bill and the Oxley bill in the House are very close to each other. The House bill is a tough bill; the Senate bill is a tough bill. And he's looking forward to signing a tough bill into law," said Press Secretary Ari Fleischer.

"We will see a bill," that the President can sign, said John Baker, an attorney with the Washington law firm Stradley, Ronon, Stevens & Young, which represents many hedge funds, "and it will look more like the Senate than the House bill."

Greenspan Vs. Pitt

The final bill now seems unlikely to include a mandatory stock options provision, since neither chambers' bill now does. But little can be said for certain. Rep. John J. LaFalce (D-N.Y.), the ranking Democrat on the House Financial Services committee, said Monday evening that the Oxley bill "should now be relegated to the dustbin of ancient history." He believes the House should either accept the Senate bill as is, or work through the conference to create an even more stringent bill.

The more stringent bill he would like to see would include "provisions related to the approval of stock option plans by shareholders and the expensing of stock options," Rep. LaFalce said.

On May 3, and again on May 10, Alan Greenspan, chairman of the Federal Reserve Board, spoke on behalf of options expensing, (Previous HedgeWorld Story). The case for such expensing is straightforward, he said. A corporation by issuing options potentially dilutes the value of the shares in the marketplace. This should be treated as an expense simply because it is an expense for the shareholders.

On July 14, Harvey Pitt, chairman of the Securities and Exchange Commission, appeared on NBC's Meet the Press. He argued against the idea of mandatory expensing. He called it a "quick fix" rather than a good policy. He said also that it's hard to tell what effect it might have, but it might stifle valuable innovations in corporate finance.

"The first thing we have to do is change the way [stock options are] awarded, then we can concern ourselves with how they're reported," he said.

In a related development, Coca Cola Co., Atlanta, announced that it would begin expensing its own stock options. It will ask two investment banks to price the options as if they were up for bid, and then take the average price from the two estimates.

Corporations have long reported the likely value of their employee stock options, using the Black-Scholes option pricing formula, and have left the result of that calculation in the footnotes of their regulatory prominence. Sen. McCain's proposal would give the figure more prominence, but as Mr. Baker said, the more sophisticated market participants, including hedge funds, are already doing the math. Mr. Baker declined to speculate whether a new rule would affect the market for options generally.

A spokeswoman for the Chicago Board Options Exchange observed that the options that companies issue to their employees are "a completely different animal" from those traded at the CBOE. On the other hand, she said, companies that do issue options as compensation may then use the CBOE as a hedge.

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