FASB Appears In a New Light On Stock Options [WSJ]
Street Sleuth
Some Companies That Opposed Expensing Rule Are Caught Up In U.S. Probe on 'Backdating'
By DAVID REILLY
August 14, 2006; Page C1
When the nation's accounting-rule makers proposed in 2004 that companies treat employee stock options as an expense that cuts into profit, corporate executives all but stormed the Financial Accounting Standards Board's headquarters in Norwalk, Conn.
In letters and public statements, business leaders declared that such an accounting rule would damage their bottom lines, compromise their ability to attract talented employees and make them less competitive against foreign rivals that didn't face similar requirements. Their protests failed to sway FASB; the new rule went into effect this year.
Now, some of the same companies that opposed it are among those caught up in a widening probe by federal authorities of companies that allegedly "backdated" employee stock options, a practice in which executives retroactively pick an options-grant date at which the company's share price was at a low, meaning they potentially can lock in a greater profit. This could violate securities laws and lead to misstated financial results and tax problems. This turn of events casts the companies' arguments against expensing stock options in a different light and offers what some accounting-industry observers say is a vindication for FASB.
It isn't clear that a rule requiring the expensing of options would have prevented the abuses now believed to have taken place from the early 1990s until recent years. But expensing "would have served as a deterrent," because the related cost would have affected profit rather than being shown in a footnote, says Rebecca Todd McEnally, director of the capital-markets policy group at the CFA Institute, a financial-markets organization. "Auditors would have had to pay considerably more attention to [options grants] than they apparently did."
Some of the companies opposing an expensing rule argued in 2004 that options didn't actually "cost" companies anything and that investors had all the information they needed regarding this type of compensation. One executive at that time even insisted to FASB there was no way for her company to issue options in a way that would provide potentially greater gains for executives; the company, KLA-Tencor Corp., has since acknowledged that probably did happen.
Other companies complained to FASB that its proposal would give investors a distorted view of a company's finances. Patrick Erlandson, chief financial officer at UnitedHealth Group Inc., wrote in a June 2004 letter that "expensing stock options does not provide financial statement readers with the most appropriate reflection of the economic impact of stock-options grants on an entity's financial statements."
UnitedHealth this spring disclosed that its options-grant practices are the subject of an "informal" SEC inquiry and that the Internal Revenue Service has requested documents regarding the options. Federal prosecutors also are probing the Minnetonka, Minn., company, which has warned it may have to restate prior year's results. A company spokesman declined to comment on the letter.
Those favoring expensing of stock options "seem to do so for the wrong reasons," the then-top-three executives at Macrovision Corp., including Chairman John Ryan, wrote FASB in 2004. "They tend to focus on corporate greed," the letter said, referring to scandals such as the implosion of Enron. "Stock options in themselves do not make people corrupt," the letter added.
In June, Macrovision, based in Santa Clara, Calif., disclosed that the Securities and Exchange Commission had requested information about the company's options practices since 1997; later that month the company said it was subpoenaed by federal prosecutors.
"It's irrelevant what the thought process was three years ago," says James Budge, Macrovision's current chief financial officer, who wasn't in that position in 2004 and didn't sign the company's letter to FASB. "There is a rule there today and we live by it." But he adds that he doesn't think the expensing rule solves any of the problems related to backdating.
Stock options give employees the right to buy stock at a preset, or exercise, price at a future date -- typically the same as the company's closing price on the date the option is granted. Backdating the grant date to coincide with a recent low point in a company's share price essentially builds in an instant paper gain on the options.
FASB tried to put options expensing in place in the mid-1990s but got pushed back by companies and Congress. Then came Enron, and FASB tried again, and succeeded. Since the beginning of this year, all public companies have had to record a cost for issuing options on their income statements.
Some executives argued in 2004 that expensing could lead to abuses. The difficulty in assessing values needed to expense options would result in an "opportunity for creativity for those who might push the envelope," Nathan Sarkisian, chief financial officer at Altera Corp., wrote in a June 25, 2004, letter.
In May, Altera said the SEC and federal prosecutors were looking into its options-granting practices. The San Jose, Calif., company has since said there were problems with options granted between 1996 and 2000 and that it expects to restate nine years of financial results. A spokeswoman declined to comment.
In another letter to FASB, the KLA executive questioned the motives of those pushing an options-expensing rule. Maureen Lamb, then a vice president, finance, wrote that while there were flaws in the accounting rules for stock-based compensation, "the politically charged belief that the blame lies with executives unwilling to give up their ill-begotten compensation is backward and unproductive."
Ms. Lamb, who is no longer with the company, added that "KLA-Tencor does not currently have the ability to issue any equity-based compensation other than at-the-money stock options." At the time, only options with exercise prices below the current trading price -- "in-the-money" options -- had to be expensed. So-called at-the-money options have an exercise price equal to the grant day's trading price; they didn't have to be expensed back then, but under the new rule they do.
This June, a committee of KLA's board reached a preliminary conclusion that the price dates for certain grants likely differed from recorded grant dates. In other words, the options likely weren't "at-the-money" and should have been expensed. Federal regulators and prosecutors have requested information from the company.
KLA officials didn't return calls seeking comment. Ms. Lamb, now chief financial officer of Photon Dynamics Inc., a San Jose technology company, also didn't return calls seeking comment.
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