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[Page: E402]  GPO's PDF
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• Mr. STARK. Mr. Speaker, I rise to introduce legislation to plug a corporate tax loophole that allows companies to hide stock option expenses from their Securities and Exchange Commission (SEC) earnings reports, but allows those same companies to take the deduction on their Internal Revenue Service (IRS) tax filings. My bill would force companies to report the stock option expense on their financial earnings records if they want to continue to take the deduction on their income tax filing. I'm pleased to be joined by Reps. BARNEY FRANK and LYNN RIVERS in introducing this important bill. Senators LEVIN and MCCAIN have introduced companion legislation in the Senate.

• Under current law, companies can deduct stock option expenses from their income taxes as a cost of doing business, just like employee wages. However, companies are not required to report these business expenses on their SEC financial statement to stockholders. The Financial Accounting Standards Board (FASB), the self-regulated accounting board with SEC reporting oversight, recommends that companies record stock options as an expense on their financial earnings statement, but does not require that stock options be treated as an earnings expense. In fact, stock options are the only form of compensation not treated as an earnings expense at any time. Nearly all companies relegate their stock option expenses to a footnote in their SEC report, yet these expenses are not reflected in their bottom line earnings. Among the S&P 500 companies, only Boeing and Winn-Dixie follow the advice of FASB and actually record the cost of options on both the tax and earnings ledger.

• Right now, companies can replace wage compensation with stock option compensation without having to show reduced earnings on their financial statements. This loophole misleads investors, financial analysts, and workers who have their pension funds tied up in companies that offer stock options. Since companies costs are not reported on the financial earnings statement, companies' earnings appear greater than actual earnings should reflect.

• Let's take the case of Enron as an example of how misleading this loophole can be. According to a study by Citizens for Tax Justice, from 1996-2000, Enron took a $600 million tax deduction for stock options. Over that same five-year period, Enron showed $1.8 billion in earnings. However, this earnings figure did not completely reflect Enron's true earnings. As we know, Enron used a number of accounting gimmicks to artificially inflate their earnings report, one of which was the decision to list all stock option compensation as a footnote in its earnings report and then exclude this compensation from its total expenses. Had Enron accurately recorded its stock option compensation it would have had to report a decrease in earnings by one-third! Furthermore, had Enron been required to report that one-third of its earnings were attributed to stock options, then employees and stockholders could have seen that company profits weren't based on real growth. According to an analyst with Bear Stearns, the earning reported by firms in the S&P 500 would have been 9 percent lower in 2000 if stock options were treated as an expense.

• As Enron leaders clearly realized, company executives can prosper by means other than simply building a great company. Executives can often increase their personal wealth by creating unrealistic expectations of their company from Wall Street, rather than the old fashioned way of consistently delivering impressive growth. Consider the following two hypothetical companies. One company has a stock price that has appreciated slowly. It started at $20 and gained $2 each year for five years, raising its price to $30 today. The second company's stock also started at $20 five years ago, then zoomed to $100 after a few years but has since fallen back to $20. By any reasonable measure, the leaders of the first company have done a better job at growing a solid company, worthy of its stock price. Their share price has grown 50 percent, and they have avoided making grandiose predictions that cause Wall Street analysts to set silly targets. The second company's stock has under-performed over the long run, and scores of workers and investors have been burned by false hopes.

• If the top executives of both hypothetical companies had received similar amounts of stock and both sold their shares on a regular schedule, the executives of the second company would have earned more. These executives would have made so much money selling the stock when it was trading near $100 that they would become instant multimillionaires, despite the stock's ensuing, rapid decline. Thus, the practice of failing to report stock options on earnings reports could actually encourage executives to take stock options as a

  [Page: E403]  GPO's PDF

  form of compensation. That way, they can earn millions of dollars, claim it as a tax deduction, and then hide it from investors. My bill corrects this perverse incentive and seeks to discourage reckless executive behavior. My bill also gives companies an incentive to report their stock option expenses in order to continue to take the tax deduction.

• If stock options are a cost of doing business for tax purposes, then they should be a cost of doing business for earnings purposes. But don't just take my word for it. In a March 7th Senate Banking Committee hearing, Alan Greenspan, Chairman of the Federal Reserve Board testified:

• ``The truth of the matter is that if you do not expense the granting stock options or their realization in the income statement, as, indeed,, we are required in our tax forms, then you will get a pre-tax income which is higher than one can argue you really had ..... Is income being properly recorded? And I would submit to you the answer is no.''

• Arthur Leavitt, former Secretary of the Securities and Exchange Commission, favors reporting publicly held stock options on SEC earnings reports. He told NPR:

• ``..... If we decide to account for public stock options in a way that I think is in the public interest, I do not believe for a moment it would be the end of capitalism, nor do I believe it will have a significant negative impact on America's corporations.''

• Deloitte & Touche, one of the nation's premier accounting firms, as well as Arthur Anderson, Enron's disgraced accountant, both say options should be charged to a company's income statement. Many Wall Street analysts agree. Eighty-three percent of U.S. financial analysts who responded to a survey by the Association for Investment Management Research (AIMR) also support listing stock options in the financial income statement.

• The evidence is clear: this loophole should be closed. My bill to ``End the Double Standard for Stock Options'' is a much-needed fix to help prevent companies from misrepresenting their financial status to stockholders and employees. I urge my colleagues from both sides of the aisle to cosponsor this important bill and to support its enactment this year.
  

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