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SEC Nomination Revives Debate on Options

Bush's pick to head the panel opposed forcing firms to expense the equity compensation.

June 10, 2005|Jonathan Peterson | Times Staff Writer

WASHINGTON — The political struggle over employee stock options seemed largely settled -- until last week, when President Bush named Rep. Christopher Cox (R-Newport Beach) as his choice to run the Securities and Exchange Commission.

Cox opposes a new rule requiring companies to count options as an expense against profits. People on both sides of the issue say Cox, who last year voted in favor of legislation to overturn the rule, could play a big role in determining how the measure is carried out if he is confirmed as SEC chairman.

"I had a conversation yesterday morning with Chris Cox on the whole issue of mandatory expensing of stock options," Rep. David Dreier (R-Glendora), a key opponent of the rule, said Thursday. "He said that he totally concurred with me on this. That was a great indication."

Companies grant stock options as a way to reward and motivate workers by giving them the right to buy shares for a set price in the future. If the stock soars, options can be lucrative; if the stock plunges, they can be worth nothing.

Over the hard-fought opposition of the technology industry, the Financial Accounting Standards Board last year approved a rule that would require companies to report options as an expense beginning this year. Although many firms grant options, they are particularly common among tech start-ups, which complain that the rule will drastically reduce their reported profits.

Supporters of the rule say it is needed to accurately reflect a company's financial strength, and they are concerned that an SEC under Cox could find a way to water down the requirement.

Because there is no market for options granted to employees, a key issue is determining how the options are valued. The SEC already has issued technical guidelines for valuing options, but those guidelines grant companies leeway -- and some observers worry that the agency could be too lax in upholding the spirit of the rule.

Cox's posture "is very much a potential concern," said Carol Bowie, director of governance research at the Investor Responsibility Research Center. "No question about it."

Cox declined to comment, referring questions to the White House. He almost certainly will be asked about stock options during his Senate confirmation hearing, which has not yet been scheduled. The rule will be phased in starting Wednesday, depending on when a company begins its fiscal year.

To critics of the rule, including many high-tech companies, the prospect that an ally may soon be the nation's chief financial regulator represents a major turn of events.

"It definitely adds new hope," said John P. Palafoutas, senior vice president of AeA, formerly the American Electronics Assn., which lobbied against the option expensing rule for years.

The tech industry and its allies argue that the government approach will lead to distorted earnings reports and cut their profits by billions of dollars. Tech lobbyists were pressing their case within hours of the White House announcement on Cox.

"I wanted to remind them that Mr. Cox has been a proponent of the high-tech position for quite a while," Palafoutas recalled of his call to a Cox aide. "It's not a bad thing to remind your friends about what they stand for."

It is not clear that Cox needs reminding. Last July, he co-sponsored legislation to block the impending rule. On the House floor, he warned that efforts to estimate the cost of options would misfire, because "nobody knows what they're worth."

The rule would give managers "a new tool to manage earnings," he said, adding: "That is exactly what Enron taught us we should not do."

The bill passed 312 to 111 but went nowhere in the Senate. Four months ago, Cox again co-sponsored legislation with the same goal.

On the other side, advocates of the option rule argue that investors deserve the transparency of full, mandatory reporting, and that there are reasonable ways to count stock options. The lack of such a rule, they maintain, has encouraged some firms to go overboard in awarding options, even contributing to the climate that led to corporate fraud.

Bowie said public support for stricter accounting has increased, with shareholder resolutions for such policies winning support of an average of 59% of votes cast this year. As many shareholders see it, "corporate scandals proved that stock options were not necessarily the ideal tool that everybody thought they were," Bowie said.

To be sure, it would be unusual for a new chairman to wipe out a long-debated rule that was passed by the standards board and recently reaffirmed by the staff of the SEC, which oversees the accounting panel. But technical questions on various methods of valuing options remain.

"If Cox has an opportunity to weigh in on this issue, he's likely to nudge the remaining unresolved issues in our favor," said Ralph Hellmann, top lobbyist for the Information Technology Industry Council.

Options are now typically valued using formulas such as the Black-Scholes model. But San Jose-based networking giant Cisco Systems Inc. has sought SEC support to create a financial derivative instrument based on its options that could be sold to institutional investors to create a market price for the options. The new method could reduce Cisco's earnings less.

Cisco executives lavished praise on the White House's choice. "Throughout his career, Rep. Chris Cox has keenly understood the important intersection of technology, business and policy and its impact on our economic growth," said spokeswoman Robyn Jenkins-Blum. "He makes an excellent choice to head the SEC."

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