On May 12, the U.S. House of RepresentativesSubcommittee on Capital Markets, Insurance, and Government-Sponsored Enterprises, part of the Financial Services Committee, passed HR 3574 – the Stock Option Accounting Reform Act – by a voice vote.   The bill is sponsored by committee chair Richard Baker (R – Louisiana).

As the language of the bill originally read, only stock options granted to a company’s top five executives would be required to be counted as an expense on corporate financial statements.  This would be in contradiction to the Exposure Draft – Share-Based Payment, an Amendment of FASB Statements No. 123 and 95 – issued by the nation’s accounting rulemakers, the Financial Accounting Standards Board (FASB), in March requiring stock options to be counted as an expense on the grant date for all employees (See FASB Hands Down Option Expensing Proposal ). 

>Additionally, the legislation contains provisions exempting small businesses from mandatory option expensing and requiring an economic impact study of any accounting principle in regards to option expensing passed by the FASB before the regulation can be generally accepted.   Speaking about the potential impact of mandatory expensing on small businesses George Batavick, chairman of FASB’s Small Business Advisory Committee, said the effect might be minimal.  Testifying before the sub-committee prior the mark-up, he said approximately 95% of small businesses do not grant employee stock options.  Further, small businesses tend to be privately held enterprises, which are not required to follow FASB standards, Batavick added.

Mark-Up Session

For the most part, the bill remained intact following the May 12markup session.   The subcommittee only added to minor amendments to the measure.  “Today’s strong bipartisan vote is a clear first victory for finding an approach to this issue that doesn’t throw the baby out with the bathwater,” Baker said.  “The real lesson of Enron, WorldCom, and Freddie Mac was not solely an accounting issue and the manipulation of numbers, but also a corporate governance issue and the executive compensation incentives behind the manipulations.  Momentum is now building for common sense insistence on sound corporate management, coupled with protecting millions of rank-and-file American workers.”

As Baker said, support for the measure has been broad and bipartisan, with 107 cosponsors, including House Minority Leader Nancy Pelosi (D-California) (See  Pelosi Backs Executive Option Expensing Bill ).  Further, similar legislation has been proposed by Senator Michael Enzi (R- Wyo ming), which has garnered support from 16 co-sponsors. 

Critics of FASB’s proposal, which are heavily concentrated among the high-tech and venture capital firms, argue mandatory stock option expensing would devastate their current compensation practices.   However, supporters of mandatory stock option expensing blame stock options for inflating corporate earnings by tempting executives to pump up stock prices.  In fact, FASB has considered requiring their expensing before, but backed away from the idea in 1994 under pressure from the Senate.

Legislative Road

Next up for the proposed legislation: the full Financial Services Committee, chaired by Michael Oxley (R-Ohio).   Baker expects markup for the bill to happen sometime in June in the Finance Committee, even though he has not yet spoken to Oxley about a schedule for such action.   Should the bill gain approval of the whole committee, it would then go before the House floor, which Baker hopes to have a vote on before the August recess.

The Senate though does not look likely to apply pressure to FASB this time around as any bill seeking to impose limits on FASB’s power has apassage that is fraught with danger through the Senate.   Senator Peter Fitzgerald (R – Illinois) said he “will do everything possible to block the bill in the Senate and to protect FASB’s independence.”   In a news release, Fitzgerald called the House bill misguided, saying that stock option compensation is an expense that should be recorded on a company’s income statement and that companies not expensing stock option compensation are misleading investors.  

“Stock option compensation is a real expense with a real cost.   That cost should and must be reflected in corporate earnings reports,” Fitzgerald said.   “My friends on the House subcommittee are misguided in seeking to overturn this important accounting reform.   Should their bill clear the full House, I will do everything I can to block it in the Senate.”

Fitzgerald is not alone in his sentiments.   Try ing to prevent encroachments from U.S. lawmakers on the accounting rulemaking policyRichard Shelby (R-Alabama) and Paul Sarbanes (D-Maryland), have urged Congress to drop legislative attempts at rerouting the option expensing proposals.  This group maintains FASB should remain an independent rulemaking body free from Congressional influence. 

Shelby in particular wields a significant amount of influence in the matter.   Enzi’s version of the bill must begin its journey in the Senate Banking Committee, chaired by Shelby.