Stock options come under Senate's review
By Marilyn Geewax
Washington Bureau
Sunday, March 17, 2002
WASHINGTON -- Powerful senators, outraged by the way Enron Corp. executives used stock options to enrich themselves, last month launched an effort to crack down on options. But this month, stock-option supporters have fought back so ferociously they now say they may be gaining the upper hand.
With personal visits to Capitol Hill and an avalanche of news releases and letters, tech executives have been throwing all the clout they can muster into this legislative battle.
Last week, when word spread that a stock-option amendment might hitch a ride on an energy bill, the Senate Republican High-Tech Task Force shot off a letter to the Senate leadership.
"Stock options are a vital and powerful tool," said the task force's chairman, Sen. George Allen, R-Va. "Limits on stock options would seriously harm many of our most innovative companies."
Tech leaders "believe in their heart of hearts that stock options are critical" to the success of their industry, said Rick White, chief executive of TechNET, a lobbying organization that represents 300 tech companies. "They have an absolutely passionate interest in this; it's central to our people."
The focus of their attention is a bill that would require companies to count the cost of employee stock options as an operating expense, just like salaries, if they also take a tax deduction for them.
The legislation would significantly reduce reported profits at many companies, and the tech industry in particular says it would severely limit an important tool for compensating employees and driving company success.
It would have a considerable impact on tech companies such as Dell Computer Corp., which gives options to every new hire. Based on the latest figures available for Dell, as of February 2001, the company had 344 million options outstand- ing.
Options give employees the right to buy company stock at a set price at a future date. If the company prospers and the stock price rises by the time they can exercise the options, they can buy the stock at the reduced price, sell it at the market value and pocket the profit.
Options have been a part of executive compensation for a long time. During the tech boom of the 1990s, they also became increasingly common for rank-and-file employees as companies competed for a tight pool of talent. For startups, they are a way to attract top talent without having to pay big cash salaries.
An estimated 10 million U.S. workers had stock options last year, according to the National Center for Employee Ownership.
The theory behind options is that they give employees at all levels a direct stake in the success of the company and the chance to strike it rich. At Microsoft Corp., for example, secretaries and clerks ended up millionaires as that company's stock price soared.
During the late 1990s, when Dell's stock was splitting each year, its compensation package was heavily weighted toward stock options. Local compensation experts have estimated that Dell paid salaries 10 percent to 15 percent below market average, thinking that lucrative stock options would more than make up the difference.
Critics of options, such as legendary investor Warren Buffett, say they are unfair because they give managers fewer risks and greater rewards than long-term shareholders.
On Capitol Hill, opponents of the legislation say they are not opposed to options themselves but to how companies account for options.
Unlike cash salaries, companies do not include the cost of stock-option plans as an expense in their financial reports. The information appears only as footnotes to the annual report, leaving it up to investors to calculate the impact on earnings.
But companies declare the options as expenses on their tax returns, a practice that can generate considerable benefits.
Enron, for example, deducted nearly $600 million in option payouts from 1996-2000, which helped the company pay no tax in four of those years.
Critics say this dual treatment amounts to keeping two sets of books -- one for the tax collector and one for the shareholders.
For example, a study released in July by R.G. Associates Inc., a Baltimore-based investment adviser, said that in 2000, not reporting the cost of stock options collectively overstated the earnings of S&P 500 companies by 9 percent on average. In the information technology sector, the figure was 33 percent, the study said.
Concerns about how options distort the earnings reports have led the Council of Institutional Investors, which represents 200 pension funds and investment firms, to support changes in accounting for options.
A bipartisan group of five senators, led by Sens. Carl Levin, D-Mich., and John McCain, R-Ariz., has introduced the Ending the Double Standard for Stock Options Act, which would force companies either to recognize the cost of stock options on their financial statements or to give up option-related tax deductions.
"This bill doesn't reduce earnings," said Sen. Peter Fitzgerald, R-Ill., another co-sponsor. "It reduces what companies are reporting as earnings."
Fitzgerald said that as he looked into the Enron case, he was "constantly searching for why" executives would either approve or turn a blind eye to questionable practices, such as the hundreds of off-the-books partnerships that allowed Enron to hide losses and debt from investors.
He concluded that instead of managing for long-term growth, the executives operated a "pump-and-dump scheme" that allowed them to make millions off of their stock options before the disclosure of the partnerships drove Enron into bankruptcy.
Tech lobbyists reject Fitzgerald's reasoning, saying options have been used successfully by vast numbers of companies. What happened at Enron was that "bad guys were doing bad things," said John Palafoutas, lobbyist for AeA, the largest tech industry lobby organization.
The options bill has been sent to the Senate Finance Committee, which is expected to hold a hearing in April. Palafoutas said that because McCain and Levin are "powerhouses" in the Senate, he expects the bill will get serious consideration.
But the tech lobby also has weighty friends in Congress. On March 6, when TechNET executives held a luncheon in Washington, they were joined by Senate Finance Committee Chairman Max Baucus, D-Mont., Senate Governmental Affairs Committee Chairman Joseph Lieberman, D-Conn., and Senate Rules Committee Chairman Christopher Dodd, D-Conn.
Those three, like the Republican High Tech Task Force, have promised to beat back the Levin-McCain bill in the Senate.
In 1993, the tech industry succeeded in killing a similar proposal.
Jim Schneider, chief financial officer at Dell, doesn't think this version will pass either.
"It's been talked about for years and years," Schneider said last month on a conference call after Dell reported fourth-quarter earnings. "One of the difficulties is how to measure a charge for stock options. There's never been a consensus on it, and that's why it's died over and over."