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Over the same period, the company's profit before federal income taxes totaled $1.785 billion. In none of these years was the company's profit less than $87 million.

[Page: S737]  GPO's PDF

    

LESS THAN ZERO: CORPORATE INCOME TAX PAYMENTS BY ENRON, 1996 TO 2000
[Dollars in millions]

	2000	1999	1998	1997	1996	96-00
U.S. profits before federal income taxes	$618	$351	$189	$87	$540	$1.785
Tax at 35% corporate rate would be	216	123	66	30	189	625
Less tax benefits from stock options	-390	-134	-43	-12	-19	-597
Less tax savings from other loopholes, etc.	-104	-94	-36	-1	-173	-409
Federal income taxes paid (+) or rebated(-)	-278	-105	-13	17	-3	-381

   At the 35 percent tax rate, Enron's tax on profits in the past five years would have been $625 million, but the company was able to use tax benefits from stock options and other loopholes to reduce its five-year tax total to substantially less than zero.

   Among the loopholes used to reduce the company's tax liability was the creation of more than 800 subsidiaries in ``tax havens'' such as the Cayman Islands.

--

   Summary of Levin-McCain-Fitzgerald-Durbin Ending the Double Standard for Stock Options Act, February 13, 2002

   The Enron fiasco has brought to light a long-festering problem in how some U.S. corporations use stock options to avoid paying U.S. taxes while overstating earnings. According to one recent analysis reported in the New York Times, Enron apparently failed to pay any U.S. tax in four out of last five years, despite skyrocketing revenues and an alleged five-year pre-tax income from 1996 to 2000, of $1.8 billion. To sidestep paying about $625 million in taxes on its $1.8 billion in income, Enron apparently claimed stock option tax deductions totaling almost $600 million. At the same time, Enron never reported this $600 million as an expense on its financial statements--an expense which, had it been reported, would have reduced Enron's income by one-third.

   Enron was able to employ this stock option double standard, because of accounting rules that allow stock option compensation to be kept off a company's books. Right now, many U.S. companies routinely give their executives large numbers of stock options as part of their compensation. When an executive exercises those options, the company can claim a corresponding compensation expense on its tax return, while at the same time employ accounting rules to omit reporting any expense at all on its books. The company can tell Uncle Sam one thing and its shareholders the opposite. That's just what Enron did--it lowered its tax bill by claiming stock option expenses on its tax returns, while overstating its earnings by leaving stock option expenses off its financial statements.

   The stock option loophole Enron used makes no sense, but when the Financial Accounting Standards Board--the board that issues accounting standards--tried to change the rules ten years ago, corporations and audit firms fought the Board tooth and nail. They demanded that companies be allowed to continue to keep stock option compensation off the books. In the end, the best the Board could get was a footnote noting the earning charge that should be taken on a company's books. But that stock option footnote--like so many Enron footnotes--doesn't tell the true financial story of a company.

   It's time to end the stock option double standard. The Levin-McCain-Fitzgerald-Durbin bill would not legislate accounting standards for stock options or directly require companies to expense stock option pay, but it would require companies to treat stock options on their tax returns the exact same way they treat them on their financial statements. In other words, a company's stock option tax deduction would have to mirror the stock option expense shown on the company's books. If there is no stock option expense on the company books, there can be no expense on the company tax return. If a company declares a stock option expense on its books, then the company can deduct exactly the same amount in the same year on its tax return. The bill would require companies to tell Uncle Sam and their stockholders the same thing--whether employee stock options are an expense and, if so, how much of an expense against company earnings. Enron has already shown how much damage, if not corrected, that the existing stock option double standard can inflict on company bookkeeping, investor confidence, and tax fairness.

   The bill cosponsors are Senators Levin, McCain, Fizgerald and Durbin, and the bill is expected to be referred to the Senate Committee on Finance.

   Section-by-Section Analysis of Ending the Double Standard for Stock Options Act

   SECTION 1. SHORT TITLE. The short title of the bill is ``Ending the Double Standard for Stock Options Act.''

   SECTION 2. STOCK OPTION DEDUCTIONS AND TAX CREDITS. This section of the bill would amend two Internal Revenue Code sections to address stock options compensation. The first tax code section, 26 U.S.C. 83(h), addresses employer deductions for employee wages paid for by a stock option transfer. The second tax code section, 26 U.S.C. 41(b)(2)(D), addresses employer tax credits for research expenses, including employee wages.

   Subsection (a) of this section of the bill would add a new paragraph (2) to the end of 26 U.S.C. 83(h) that would restrict the compensation deduction that a company could claim for the exercise of a stock option by limiting the stock option deduction to the amount that the company has claimed as an expense on its financial statement. This section would also make it clear that the deduction may not be taken prior to the year in which the employee declares the stock option income. In addition, a new subparagraph (2)(B) would require the Treasury Secretary to promulgate rules to apply the new restriction to cases where a parent corporation might issue stock options to the employees of a subsidiary corporation or vice versa.

   Subsection (b) of this section of the bill would add a new clause (iv) to the end of 26 U.S.C. 41(b)(2)(D). This new clause would restrict the research tax credit that a company could claim for employee wages paid for by the transfer of property in connection with a stock option by saying that the amount of the credit shall not exceed the amount of the corresponding stock option deduction allowed under 26 U.S.C. 83(h).

   The purpose of both new statutory provisions is to ensure that any stock option deduction or credit claimed on a taxpayer's return will mirror, and not exceed, the corresponding stock option expense shown on the taxpayer's financial statement. If no stock option expense is shown on the taxpayer's financial records, there can be no expense taken as a deduction or credit on the taxpayer's return. If a taxpayer declares a stock option expense on its financial statement, then the taxpayer is permitted to claim a corresponding deduction or credit on its return in the same taxable year for exactly the same amount of expense.

   Subsection (c) of the bill provides that the amendments made by the Act apply only to wages and property transferred on or after the date of enactment of the Act.

--

   I recently asked Enron to consider funding the FASB Trust pursuant to a Steve Samek request.

   Today, Rick Causey called to say that Paul Volker had called Ken Lay (Enron Chairman) and asked Enron to make a 5 year, 100k per year commitment to fund the Trust Fund of ``the FASB's International equivalent'' (best Rick could remember). Lay is asking Causey if this is something that they should do.

   While I believe Rick is inclined to do this given Enron's desire to increase their exposure and influence in rulemaking broadly, he is interested in knowing whether these type of commitments will add any formal or informal access to this process (i.e., would these type commitments present opportunities to meet with the Trustees of these groups or other benefits). I think any information along this front or further information on the current strategic importance of supporting these groups for the good of consistent rulemaking would help Enron with its decision to be supportive.

   Could any of you guys help me out with more information or point me to someone who could? Thanks.

--

   Enron's Fall Fuels Push for Stock Option Law

   The Enron implosion has breathed life into legislation that business leaders thought they had killed in the mid-1990s.

   In a highly controversial move, at least three senators want to end the legal tax deductions companies take for stock options they issue to executives and workers unless they subtract the same expense from their earnings.

   As it is, almost every company takes a tax deduction for options, but ignores them when it comes to reporting their profits. Among the S&P 500, only Boeing and Winn-Dixie follow the advice of the Financial Accounting Standards Board in recording the cost of options on both ledgers, says David Zion, analyst with Bear Stearns. The rest are like Enron, which took a $625 million tax deduction for options from 1996 to 2000, yet legally included the $625 million on its earnings.

   If stock options were treated as an expense, the earnings reported by firms in the S&P 500 would have been 9% lower in 2000, Zion says. Technology companies, more likely to use options for rank-and-file compensation, would be harder hit. Fourteen companies, including Yahoo and Citrix Systems, would have posted losses in 2000, rather than gains. Microsoft and Cisco take large tax deductions for options.

   Options are contracts that allow the purchase of stock , usually within five years, at today's price. If the stock rises, the stock can be bought at a discount.

   Conventional wisdom has long held that options align the goals of executives and workers with those of the shareholders. Enron has given pause to that thinking because its executives artificially boosted the stock price at the risk of shareholders.

   Outright frauds is rare, but at least a half-dozen academic studies have concluded that

[Page: S738]  GPO's PDF

   Sens. Carl Levin, D-Mich., John McCain, R-Ariz., and Peter Fitzgerald, R-Ill., are dusting off the tax-deduction proposal that was defeated by a vote of 88-9 in 1994. At the time, Home Depot founder and CEO Bernard Marcus said he had ``never been more strongly opposed to anything.''

   Citigroup CEO Sanford Weill was quick out of the chute Thursday, warning on CNBC's Squawk Box not to get into an Enron frenzy and hurry through bad legislation.

   But Matt Ward, CEO of WestWard Pay Strategies, an options consulting firm in San Francisco, says he fears the legislation stands a better chance of passing this time because of what he calls the ``Enron thieves'' and because technology companies have been weakened by the economy and don't have the resources or energy to influence Washington.

   Ward says a law change would result only in rank-and-file employees losing their stock options. CEOs would continue to get theirs, he says.

   ``Noises are coming from Washington because some oil company guys have been greedy,'' Ward says.

   David Yermack, associate professor of finance at New York University's Stern School of Business, says he doubts if stock options could have pushed Enron executives into hiding millions of dollars of losses in off-book partnerships. That said, there is no reason options should not count against earnings jut as cash compensation does.

   ``If Enron has made them reconsider this horrible position, there is silver lining to this debacle,'' Yermack says.

   More than 80% of financial analysts and portfolio managers agree with Yermack, according to a survey by the Association for Investment Management and Research.

   ``I'm dissatisfied with using fuzzy numbers in doing accounting,'' says Dick Wagner, president of the Strategic Compensation Research Associates.

--

   Even Last Year, Option Spigot Was Wide Open

   Surprise, surprise. Early reports suggest that top executives across America got a bigger dollop of stock options last year as part of their pay.

   As corporate earnings and cash flow have ebbed and stock prices have fallen, boards have been doling out options as a cheap, balance-sheet-friendly way of compensating mangers. The annual proxy season, when companies reveal compensation, is just starting. If the disclosures show the trend toward larger option grants holding after a year that most companies would lie to forget, it would seem to make a mockery of the concept of pay for performance. That was the reason options grew so popular in the first place. Yet while some companies are trying to make options better reflect their fortunes, most other simply contend that options are primarily a motivational tool and have never been a reward for performance.

   With stock prices stalled, options may not seem attractive now. But executives who receive them can usually count on rich rewards eventually, even if a company does only marginally better. The increase in options, however imposes additional costs on shareholders; the more options granted, the lower the return for investors, since their holdings are, one way or the other, diluted.

   But the options keep coming. Chief executives who received more of them last year, even as their companies suffered, include Daniel A. Carp of Eastman Kodak, John T. Chambers of Cisco Systems, Scott G. McNealy of Sun Microsystems and Harvey R. Blau of Aeroflex

   And Henry B. Schacht, returning to the helm of troubled Lucent, received annual options grants almost five times the size of those his predecessor received--and more than 17 times the size of the last grant he received the year he retired. ``Fiscal 2001 was rather challenging for Lucent, so the grants were made to ensure Henry had management stability through the turnaround,'' said Mary Lou Ambrus, a Lucent spokeswoman, in explanation.

   Changes are, many chief executives received bigger options awards, as proxy statements, filed each March and April by most companies, are expected to show, experts say. Some were no doubt issued to make up for previous grants that had been rendered worthless by tumbling stock prices.

   At the same time, the market's recovery has revived hopes that old option grants will not be worthless. ``Options typically run for 10 years, and already many of the ones issued in the last year are back in the money,'' said John N. Lauer, chief executive of Oglebay Norton, a shipping company. ``If the economy recovers, those issued in previous years will also regain value.''

   Mr. Lauer has gained notoriety in corporate circles for his insistence on being paid entirely in options priced well above Oglebay's stock price. Though Oglebay's performance has improved somewhat, options he received five years ago are still worth nothing.

   ``In a social setting where I'm in a room with other C.E.O.'s, someone will teasingly suggest that they pass the hat for me because I'm not making any money,'' he said. ``I think they figure I'm loony or something.''

   Mr. Lauer is not the only executive to have high performance goals, but it is safe to say that most executives keep drawing large salaries, plus more and more options. According to a survey done in the third quarter of last year by Pearl Meyer & Partners, a human resources consulting firm in New York, the number of options granted by 50 major companies that will report their 2001 compensation this spring was up an average of 12 percent from 2000.

   Consultants expect that trend to continue as companies report 2001 compensation practices this spring. ``It's a great time to give options,'' said Pearl Meyer, president of the firm. ``They're cheap because they involve no charge to earnings, and that's important at a time when profits are down and boards are trying to make up for the fact that salaries and bonuses are both down.''

   But Ms. Meyer and many others in the field--as well as, they say, the members of corporate compensation committees--are not happy to see the increase in options grants. Their expressions of concern are striking because of compensation consultants have been among the biggest champions of the use of options as performance incentives.

   The consultants are worried, in part, about the option ``overhang''--options outstanding, plus those shares that investors have authorized but that have yet to be granted. More fundamentally, they suggest that the links between a manager's pay and a company's performance--as measured by, say, profitability, market-share growth and smart acquisition strageties--have become more tenuous.

   Ms. Meyer suggests that the at-risk components of executive pay be viewed as the legs of a stool; the legs reflecting stock performance has grown longer and longer, while those reflecting business and financial performance have become shorter.

   ``We have overdosed on options and the stock market,'' she said. ``We're dependent on the stock market for executive compensation, pension payments, directors' compensation, 401(k) plans--our whole economy, practically, is dependent on the market's performance.''

   That reliance has produced an overhang that dangles like a sword of Damocles over investors. Eventually, their stakes will be diluted--either when companies issue vast quantities of new shares to make good on options grants, or when they undertake share-repurchase programs that eat up cash they might use for operations.

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