Changes to FASB Stock Option Expensing Proposal
August 24, 2004
Mark A. von Bergen- Portland
A proposal by the Financial Accounting Standards Board (FASB) would require
expensing of stock options and other equity awards to employees. The proposal
has generated criticism from technology companies that rely on stock option
awards to attract and retain workers, as well as from some of the lawmakers that
represent them. The proposal is the subject of a contentious debate in
Congress, and there currently is uncertainty about when, and in what form, the
proposal eventually will be implemented.
The FASB Proposal
In March 2004, FASB released a proposed statement titled “Share-Based
Payment: an amendment of FASB Statements No. 123 and 95.” If adopted, the
statement would require publicly traded companies to expense the “fair value” of
stock options, restricted stock and other equity awards to employees for fiscal
years beginning after December 15, 2004 (or December 15, 2005 for private
companies).
A company would be required to recognize a compensation expense for every new
award made after that date, as well as for unvested portions of outstanding
awards. FASB also expressed some criticism of the widely used “Black-Scholes”
formula and suggested that an alternative “lattice model” might be preferable
for estimating the fair value of an award. Hundreds of companies already
expense options on a voluntary basis, but the FASB proposal, if implemented,
would make the practice mandatory.
Lawmakers Aim to Curb the FASB Proposal
Although widely supported by many groups, the FASB proposal encountered a
hail of criticism soon after it was published. Notably, a number of lawmakers –
especially those representing western states with concentrations of
high-technology companies – decried the proposal and argued that the change in
accounting would cut into companies’ reported profits and would hinder
technology companies’ ability to attract and retain qualified workers.
Technology companies generally, and start-up companies in particular, often use
stock option grants to recruit new talent and to provide incentives to existing
workers.
The issue came to a head in July of this year on Capitol Hill, when the U.S.
House of Representatives, in a rare showing of bipartisan consensus, passed a
bill by a vote of 312-111 to drastically limit the FASB proposal. Among other
things, the bill passed by the House would require companies to expense stock
options granted only to the top five executives, rather than to all employees.
The bill also would exempt companies with annual revenues of less than $25
million and would grant newly public companies a three-year reprieve.
Notwithstanding this clear victory for opponents of the proposal, the debate now
turns to the U.S. Senate, where the Senate Banking Committee is scheduled to
take up consideration of the bill. There, the bill faces an uphill battle,
insofar as the Committee’s chairman, Richard Shelby (R-Ala.) strongly opposes
any efforts to undermine FASB’s independence.
Possible Delay in Implementation of the FASB Proposal
Sources have reported that FASB is considering postponing implementation of
the expensing rule requirement by up to one year because it is concerned that
public companies are struggling to meet the requirements of regulations
promulgated under Sarbanes-Oxley. “We may need more time,” FASB Chairman Robert
Herz is quoted as saying. “We are hearing people say they are stretched to the
maximum.”
Possible Special Treatment for Some Stock Options with “Graded Vesting”
At its August 18, 2004 meeting, FASB tentatively decided to allow companies
to use alternative methods for calculating the expense for stock options with
“graded vesting” schedules. “Graded vesting” – which is popular among Silicon
Valley companies – involves, for example, an award that partly vests after one
full year of service, then on a monthly basis thereafter. It differs from
“cliff vesting,” where stock options vest at the end of a specified term.
Under the scheme originally proposed in FASB’s March 2004 proposal, awards
with graded vesting would have been treated as if the shares vesting on
different dates were separate awards with specified vesting periods. It is
widely believed by those opposed to the FASB proposal that such treatment would
have caused “front-loading” or greater “up-front” reported expenses for affected
companies. While cheered by the proposal’s opponents, FASB’s tentative decision
to depart from its original proposal in cases involving awards with graded
vesting, and to instead allow alternative methods of accruing the expense, would
put the FASB rules at odds with certain final rules recently adopted by the
International Accounting Standards Board.
Recommendations
In light of the fierce debate surrounding FASB’s proposed rule change, the
uncertain fate of the related measure due before the Senate and the questions
regarding the proposal’s target implementation date, it is imperative that both
public and private companies keep abreast of developments in this area. Among
other things, implementation of a final rule by FASB likely would necessitate
close consultation between management and the company’s accountants on how best
to estimate, and account for, the new expense. Holland & Knight will issue
additional alerts on this topic as events unfold.
For more information, e-mail David Wang or Mark von Bergen at
david.wang@hklaw.com or
mark.vonbergen@hklaw.com,
respectively, or call toll free, 1-888-688-8500.
Related Practices