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Thursday, July 25, 2002

Nearly 10 days ago, despite many members on both sides of the aisle claiming they were in favor of forcing executives to report the expense of stock options to investors, the amendment to the accounting bill that would have carried out that objective disappeared in a series of floor moves in the Senate and did not end up in the House bill either.

Warren Buffett, perhaps one of America's best-known investment bankers and chief executive of Berkshire Hathaway Inc., a large investment and holding company, wrote on the New York Times op-ed page Wednesday that the "most flagrant deceptions have occurred in stock option accounting and in assumptions about pension fund returns. The aggregate misrepresentation in these two areas dwarfs the lies of Enron and WorldCom."

Stock options are guaranteed opportunities to buy a company's stock at a price in the future usually well below what it is selling for on the stock market. Once confined largely to the executive suite, during the heyday of the dot-com industry, cash-short new companies used stock options to pay their employees.

However, the "dollar volume" of what these options cost still comes overwhelmingly from compensation programs for high executives.

In the wake of the Enron Corp. financial collapse in December, Capitol Hill geared up legislative proposals to regulate how "stock compensation" is handled in the executive suite.

A key piece of legislation addressing the issue of stock option accounting was introduced in March by Sen. Carl Levin, D-Mich. His "Ending the Double Standards for Stock Options Act" targeted the fact that huge sums of stock compensation to senior executives are legally kept off a company's earnings statements and away from the eyes of investors.

Buffett and others argue that, as Buffett wrote, "when a company gives something of value to its employees in return for their services, it is clearly a compensation expense. And if expenses don't belong in the earnings statement, where in the world do they belong?"

Under accounting rules, corporations can essentially not consider such compensation as being a business "expense," yet they can report it to the Internal Revenue Service to lower their tax bill.

Levin notes that the Enron bankruptcy has helped to highlight the issue of how some U.S. corporations use stock options to avoid paying U.S. taxes while overstating earnings.

According to a study by the Citizens for Tax Justice group, Enron reportedly did not pay any U.S. taxes four years out of the last five years, a period during which it earned $1.8 billion in income, in part due to $600 million in stock option tax deductions that were never reported as an expense on its financial statements.

The study noted that had the law required Enron to report this deduction on its books, its stockholders would have learned the company's income was one-third less than the $1.8 billion it disclosed. The CTJ conducted its study through a review of public filings by Enron and not based on a review of actual tax returns.

'Misleading Picture'

"Stock options are a stealth form of compensation because they do not, under current accounting rules, have to be shown as an expense on the corporate books even though they're treated as an expense to get a tax deduction. The result is a misleading picture of a company's finances," Levin said in a statement at that time.

Enron's financial collapse was the largest corporate bankruptcy filling in U.S. history at that time but was far surpassed Monday by WorldCom, which claimed $100 billion in assets and over $40 billion in debt.

The two collapses are part of a score or more of recent corporate debacles that pushed stocks down for nearly 10 weeks costing investors $1.4 trillion in lost assets, and which have sparked business reform legislation on Capitol Hill.

But despite the constant congressional speeches about taking action to protect investors, the reform of options almost mysteriously fell out of the legislation.

Senate plurality leader Tom Daschle, D-S.D., said he was for it. Levin offered a bill and later an amendment to the accounting bill. Sen. John McCain, R-Ariz., pushed for an amendment, as did several other senators, but business lobbyists pushed hard against it.

Congressional aides in both parties privately agree that the senators did not want to snip the options from the executives who are major contributors and direct contributions for their companies' political action committees.

Buffett agreed that lobbying is a factor. "Recently a few CEOs have stepped forward to adopt honest accounting. But most continue to spend their shareholders' money, directly or through trade associations, to lobby against real reform. They talk principle, but, for the most, their motive is pocketbook."

Copyright 2002 by United Press International.

All rights reserved.

Read more on this subject in related Hot Topics:

Corporate Scandals

Enron

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