Herz to Congress: Butt Out

FASB boss tells Congress to steer clear of stock option expensing; but Dreier says accounting treatment of options not an accounting issue. Huh? Plus: insiders selling. And: market rise won't help pension plans much.


As reported in RegWatch this week, the issue of expensing stock options came before Congress this week. In fact, the topic was the subject of a heated debate during Congressional testimony on Tuesday.

Robert Herz, chairman of the Financial Accounting Standards Board, the independent body that writes U.S. accounting rules, warned lawmakers to steer clear of setting bookkeeping standards, lest they politicize the process.

“It would send a clear and unmistakable signal that Congress is willing to intervene in the independent, objective and open accounting standard-setting process based on factors other than the pursuit of sound and fair financial reporting,” he said. Herz added that Congressional meddling now would set a “dangerous precedent” for future Congressional intervention into FASB’s technical agenda.

At the crux of Herz’s ire is a bill sponsored by House Rules Chairman David Dreier (R-Calif.) and Anna G. Eshoo (D-Calif.) that would prohibit FASB from doing anything about the treatment of stock options while the Securities and Exchange Commission study the issue for three years. Currently, FASB currently recommends that companies expense stock options. The board is expected to make a final decision about the accounting treatment by the end of the year. Observers say it’s likely FASB will move to require corporates to expense employee stock options — if Congress doesn’t intervene first.

According to the Congress DailyAM, Drier claims that expensing stock options “is a public policy issue … not an accounting issue,” and therefore requires lawmakers to weigh-in on the matter. By his lights, requiring the expensing of stock options would likely sound the death knell for employee stock option packages. That, says Drier, would hobble the ability of startup companies to attract talent, and in turn, stifle innovation. Bringing an end to stock option rewards would “hurt the risk-takers who are creating jobs and wealth in this country,” Drier claims.

Herz countered by saying that the “usual dire prediction” about economic doom won’t play out once solid standards are in place. The FASB chief did acknowledge that stock option valuation methodology is a concern. Eshoo agreed, asserting that there are no effective valuation methods available.

Both Drier and Eshoo represent districts in California where high-tech companies rely on stock options as incentives for executives and employees.

This isn’t the first time FASB has had a run-in with Congress over stock options. In the early 1990s, FASB attempted to promulgate an option expensing rule, but Congress retaliated, threatening to strip the board’s standard-setting power. Then SEC chairman Arthur Levitt urged FASB to back away from the fight, and the standard-setting board retreated from the expensing rule idea.

Today, however, FASB has the backing of current SEC Chairman, William Donaldson, who has asserted that Congress should not be in the business of making up accounting rules.

Given some of the past bookkeeping tricks employed by Congress to help balance the U.S. budget, he may be right.

Does Insider Sell-off Portend Market Drop?

Executives unloaded their company shares at a breakneck pace last month, as insiders sold more than $3.1 billion in shares in May. Based on analysis from Thomson Financial, that’s the highest volume of insider selling in 24 months.

The run-up in sales easily topped the first four months of the year. Insider stock sales never broke $1.4 billion during those months, with January registering as a particularly cold month with a paltry $630 million worth of sales recorded.

Some experts say the uptick in selling is not necessarily a sign that the market is about to head down again. In fact, a report in The Wall Street Journal noted that it’s hard to pin down the real reasons executives divest their holdings. Some corporate managers might just need to pay expenses, the article indicated, while others are looking to diversify their portfolio.

And in fact, stock sales tend to pick up in May because many companies are emerging from first-quarter lockup periods. During lockup periods, executives are restricted selling and buying company holdings.

Still, other financial pundits believe the insider sell-off means the recently resurgent stock market is about to cool off. Some analysts believe insider activity is a reliable predictor of market direction — mainly because inside investors know the most about a company’s near-term prospects. Says Bijal Shah, senior equity strategist for Societe Generale: “Directors tend to sell stock in their own companies if they believe their company will miss analysts’ forecasts — and buy if they believe it will beat forecasts. The ratio of directors selling relative to directors buying is an excellent indicator of the outlook for company profits.”

Interestingly, another camp of market watchers believe new SEC rules, like Regulation Fair Disclosure, make watching insider trading even more crucial. With Reg FD, executives cannot give analysts early warning about a company’s financial health. As a result, tracking the trades of insiders may be the only way to gauge what executives really think about future operating results.

The Journal story noted that some fairly smart executives, like Microsoft’s CEO Steve Ballmer and Dell Computer’s Michael Dell, parted with a sizeable number of stock shares in May.

Reportedly, Ballmer sold close to $1 billion in shares recently, and then issued a press release saying, he “remain as committed to Microsoft as ever.” The chief executive still holds $10 billion worth of Microsoft shares.

Dell sold about $300 million in shares in May, more than doubling the total value he cashed-in for during 2002 ($120 million). Still, Dell remains the largest shareholder of Dell Computers, with nearly $9 billion in stock and options.

Pension Obligations Rise on Falling Interest Rates

Don’t expect the recent climb in share prices to help stabilize underfunded pension obligations.

New research released by Credit Suisse First Boston says that record-low interest rates will cancel out any gain provided by rising stock prices.

Indeed, CSFB estimates that the stock market, up 20 percent from its March lows, has pushed the value of typical pension portfolios up 8.5 percent since January. The bank defines a typical portfolio as having 65 percent of its assets invested in stocks and the rest in fixed income instruments.

There’s a hitch though. As reported by Reuters the precipitous drop in interest rates actually inflated pension obligations by 10 percent, says the CSFB report. Why? Because when interest rates drop, the discount rate used to calculate what companies will payout in pension benefits also falls. That, in turn, increases pension obligations.

In September, CSFB officials announced that pension plan funding for companies listed in the S&P 500 index would improve by about $37 billion between 2002 and 2003 — if plan assets grew by 8.5 percent, and the discount rate rose by 25 basis points in 2003.

But since the beginning of the year, CSFB reports a drop of 79 basis points in Moody’s Aa corporate yield bond, which closely tracks the discount rate used to value pension plan obligations. If the discount rate falls by the same amount, CSFB predicts that pension plans in the S&P 500 index would shrink by $95 billion. At the end of 2002, those plans already were underfunded by $212 billion.

Few CFOs Trust Their Own Numbers

Only 27 percent of global CFOs are very confident about the quality of their financial data. And barely 17 percent say they have confidence in the interpretation and analysis of their numbers. This, according to a new survey of financial executives at 150 of the world’s largest companies.

Perhaps more worrisome, the survey — commissioned by Paris-based Cartesis SA — found that five percent of the CFOs polled had total lack of confidence in the figures; with 10 percent having no faith in interpretation and analysis.

According to Cartesis, the findings suggest that company executives are failing to see financial data in any great depth or context. This is puzzling because 74 percent of the finance chiefs said that it is a business priority to present figures to their stakeholders, and then deliver the story behind the numbers.

The severity of the disconnect was not lost on the respondents — 66 percent of them contend that lack of detail can be dangerous for a company’s health.

The CFOs also had some thoughts on correcting the quality problems. For instance, 67 percent cited “converting data into meaningful information,” as a priority, while 59 percent voted “speed of data flows” as being their top focus.

“This research shows a number of worrying trends,” asserts Cartesis CEO Marie Noelle Gauthier. For starters, “CFOs don’t trust the quality of information” they receive from colleagues and subordinates. That, in turn, carries substantial regulatory, legal and financial risks — as well as operational risk, she claims.

Gauthier added that, in most situations, the problem “is not a case of questioning integrity and corporate governance,” but rather honing the ability to deal with the sheer quantity of data that a CFO is presented with.”

Cartesis is a business performance management specialist.

Short Takes

  • Everything is coming up roses for green activists, who apparently have convinced 10 of the world’s leading banks to adhere to international environmental and social-impact standards when financing infrastructure projects, such as dams, power plants, and pipelines. The Globe and Mail reports that Citigroup, ABN Amro Bank, WestLB, Barclays, Credit Suisse First Boston and five other banks plan to stick to strict (albeit voluntary) standards developed by the World Bank’s International Finance Corp. Those standards are intended to prevent construction projects from poisoning the air and water, stripping forests, and destroying the livelihoods of local populations.
  • Companies spend an average of $280 per employee helping to pay for injuries that workers and their dependents suffer at home, according to the Home Safety Council. The new research also says that when companies begin to absorb “off-the-clock” car crashes, the aggregate cost will shoot up to $19.5 billion.
  • Spam — or unsolicited commercial e-mail — accounted for 51 percent of all messages received in the workplace during May, says MessageLabs. It’s the first time workplace spam reached that lofty pinnacle.
  • Michael J. Graham plans to step down as CFO of Aegis Communications Group on June 13. Graham was part of a turnaround management team hired by the Aegis board to get the marketing services company back on track. He’ll be taking a senior financial position with a Fortune 100 company in his hometown of Chicago. The Irving, Texas-based Aegis company will begin the search for a new CFO immediately.
  • After commuting between northern and southern California for more than 18 months, Steven M. Neil has resigned as CFO of Sunnyvale-based SOLA International Inc. The eyeglass lens manufacturer moved its corporate finance function from its northern California location to San Diegoe in December 2001. Neil stayed on to establish a new corporate finance team in San Diego. The company is currently looking for a new finance chief.
  • Salt Lake City-based Paradigm Medical named Greg Hill as the company’s new CFO. Hill replaces Heber Maughan who is leaving to pursue other interests. Prior to joining the medical equipment manufacturer, Hill was CFO at Lineo, a company which was purchased by Motorola. He is the former treasurer of Quark Inc., and Mattel’s Tyco Toys.
  • Coinstar Inc. named Brian V. Turner CFO. Turner comes to the Bellevue, Wash.-based company after serving as CFO and treasurer of RealNetworks Inc, and CFO of Radisys Corp. He is a former Price Waterhouse director of finance.

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