Hi CB, here's a response to Berkeley's letter on Options to the FASB.
The title "Nasdaq: Release the Bozos!" pretty much sums up the author's conclusion.
biz.yahoo.com
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Many don't realize Nasdaq actually operates as a corporation. It puts out quarterly reports and has a board and management. But it needs to think about creating a new executive position. Let's call it the Minister of Common Sense.
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If Nasdaq had a Minister of Common Sense, a recent letter by its vice chairman, Alfred Berkeley, would've never seen the light of day. Berkeley sent it to the Financial Accounting Standards Board (FASB) in response to its request for public comment on a proposal to consider the expensing of stock options put forth by the International Accounting Standards Board (IASB).
Now, those who have read my past columns know I think stock option accounting in the U.S. is tantamount to theft with a pen. So, let's just assume I'm not apt to look upon arguments to the contrary with great kindness. Berkeley's arguments were emphatically contrary. I'm just not sure what they were contrary to.
Berkeley produced a seven-page screed in which he lambasted Europe, "the shareholder rights crowd," the media, fund managers, the plaintiff's bar, and accountants, among others -- all in the name of defending the rights of companies to grant stock options. Berkeley did his best to call stock options a great American institution, likening them to the Homestead Act of 1862, which offered the incentive of free land to people who settled in the West. We'll come back to this particular comparison in a moment.
Now, I can certainly understand Berkeley's desire to protect his turf. Technology companies are among the leading opponents and biggest users of stock options, and the Nasdaq is heavily loaded with technology companies. But it might have occurred to a Nasdaq Minister of Common Sense that it's a bad idea to call accountants a "special interest group," for the simple reason that his letter was addressed to the most powerful group of accountants in the country, perhaps even the world. It's sorta like writing Tony Blair and telling him not to listen to "those Limeys."
Speaking of "Limeys," Berkeley aimed some of his harshest words at Europe. He claims IASB's push for stock options expensing is a way for Europe to "pull us down to their own miserable levels of performance," and that they plan to "lower America to their own level [sic] of innovation...." I hope European companies listed on Nasdaq, which include Reuters (Nasdaq: RTRSY - News), Ericcson (Nasdaq: ERICY - News), Ryanair (Nasdaq: RYAAY - News), WPP Group (Nasdaq: WPPGY - News), ARM Holdings (Nasdaq: ARMHY - News), Business Objects (Nasdaq: BOBJ - News), and Shire Pharmaceuticals (Nasdaq: SHPGY - News), paid attention to his contempt. He even mentioned Communism as the root of the drive to expense stock options. Oh, and never mind that the IASB has exactly as many American trustees (six) as Europeans, along with seven others from around the world. And, also never mind that former Federal Reserve Chairman Paul Volcker is the chief trustee.
Berkeley went to great lengths to show he has the workingman's interest in mind. Options provide a way for hardworking people "to have a way to earn ownership." He even used the words, "brown, black, yellow, white" to describe the good soldiers who have only stock options to count on to reach for their piece of the pie.
Interestingly, though, as soon as these folks become shareholders, Berkeley's concern for them seems to stop in full. Berkeley complained that the U.S. "shareholder rights crowd" operates in the most shareholder-friendly environment in the world, and yet it's not enough. He also argues that those in the media who were most critical of stock option accounting were "wage-slaves" essentially jealous of a route to income to which they have no access.
It's never smart to make fun of the ones who buy ink by the barrel. Further, the last time I checked, most of the big newspapers are, or are components of, publicly traded companies. If stock options are for the little guy, as Berkeley claims, reporters at Washington Post Co. (NYSE: WPO - News), Gannett (NYSE: GCI - News), or Dow Jones (NYSE: DJ - News) are exactly the "smart, hardworking people" he believes "have a way to earn ownership."
The trouble with all of this, beyond the silliness of Berkeley's arguments, is that no one is saying stock ownership and stock incentives for employees are bad things. It's the accounting for stock options that's the problem. Restricted stock -- shares granted outright to an employee with limits on sale -- would create exactly the same incentives for employees. Ah, but restricted stock doesn't have the same accounting treatment, and as such, it's not as attractive to many companies. And as such, you have the Brocades (Nasdaq: BRCD - News) and Activisions (Nasdaq: ATVI - News) of the world issuing 19% or more of their share counts to employees in a single year. And while many companies do have broad-based grants, you'd still have a Steve Jobs of Apple (Nasdaq: AAPL - News) receiving 43% of all options granted by the company in 2001. Jobs, by the way, already owned 4.4% of the company -- it's highly unlikely that his incentive for success was insufficient.
But the reason Berkeley and others are fighting so hard against accounting for stock options is that the shareholder-financed gravy train would come to a stop. It's a gravy train that has failed magnificently to do what it was intended to do: align shareholders' and management's interests. Instead, it has become a fantastic way for companies to understate employment costs and enrich managers.
Companies managed to stop FASB in 1995, but the Board has agreed to seek the standardization of U.S. accounting practices with IASB's. And IASB forces companies to expense options. And for many companies that have hit the options well hard, that's a nightmare. Cisco Systems (Nasdaq: CSCO - News), for example, would have reported a combined loss over the last five years, were the cost of options properly accounted for. I say, "reported a loss" instead of "lost" money because regardless of the accounting, the net effect to shareholders is identical. They have to fight against expensing because it will make their financials look worse. Whether the financials are a more accurate depiction is beside the point.
This brings us back to Berkeley's Homestead Act argument. He claims the net benefit of stock options is similar to the benefit of the Act that helped America spread its population westward. It's a false premise.
Share ownership is, of course, a wonderful device. We have no problem there. But share ownership is accomplished by methods other than stock options. And even so, as much as I think stock options are a net negative for shareholders, we must remember the only reason Berkeley (and the American Electronics Association) brought up the benefits of stock options is that companies, themselves, have said they'll cut back use of options if they're forced to expense them. That's right -- they're going to quit using them, not because of any economic change, but because their financials will look worse.
Here's a thought -- maybe it's comforting, maybe not. After the abuses of the 1990s (I'd say late 1990s, but the abuses ran on well before anyone noticed), a good number of investors became quite cynical about companies' reported earnings. So did Standard & Poors, which is why they now issue "core earnings," including stock options grant expenses. Whether or not FASB says you must account for them, we're accounting for them, and our methods for doing so may be substantially more aggressive than Black-Scholes. Companies can no longer issue options low, and then buy back shares high to hide the dilutive effect without anyone noticing.
This past summer, I sold several companies that were members of the AeA, refusing to own companies that worked so hard to counter shareholder interests. I'm not going to suggest the same after Berkeley's letter -- I can't imagine his venom having much of an effect. Not on FASB, at least. But Nasdaq, by not having its Minister of Common Sense put the kibosh on Berkeley's letter, has managed to paint itself as the exchange that actively disdains shareholders, Europeans, and even accountants.
The Nasdaq has, in the past few years, been host to the lion's share of companies with no business being listed, profitless companies, even revenueless infant companies. It's also the namesake of the market's recent and spectacular crash. One would think the Nasdaq would work hard to convince shareholders that its primary interest is the protection of their assets.
Apparently Berkeley felt he would send a different message... like telling FASB that accountants are a special interest group. Classic.
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