TheCorporateCounsel.net

May 13, 2005

Accelerated Vesting of Underwater Options

As noted in this article, there is some controversy over companies that have accelerated the vesting of their underwater options in an effort to create higher earnings after they are forced to implement the FASB’s 123(R) standard.

On the NASPP site, there is a Bear Stearns report that has a chart of 102 companies – all of which have a market cap over $600 million – that have accelerated vesting of their underwater options. The chart includes numerous details about each company’s situation. Bear Stearns predicts more companies will be taking such action – and estimates that over $1 billion of option expense for future periods has been avoided by these companies. The NASPP site has other resources on accelerated option activity as well, including a June 9th webcast – “Q&A on FAS 123(R)” – during which Paula Todd of Towers Perrin and Reginald Oakley of the FASB are bound to answer questions on this technique.

Cisco Exploring Market-Traded Employee Options

Yesterday, both the NY Times and WSJ reported that Cisco Systems is considering the use of market-traded employee options as a possible solution to the huge option expense it will soon incur under the FASB’s new 123(R) standard. Here is the NY Times piece:

“Adding a new twist to the continuing fight over the expensing of employee stock options, Cisco Systems is seeking regulatory approval for a novel financial instrument that could allow the company to assign a lower value to the stock options than under current valuation models.

A lower value for the options, which under new accounting rules will have to be recorded as expenses on Cisco’s books starting this July, would reduce the impact expensing will have on Cisco’s profits and could lead other companies to adopt something similar. The company said that if it employed a traditional valuation standard like the Black-Scholes model for expensing its stock options, its reported profits would fall by roughly 20 percent.

Options give employees the right to buy stock for as long as 10 years at a price set when the option is issued, and thus can become very valuable if the stock rises over that period.

Cisco’s proposal is to create a market by selling new securities based on the employee options. By doing so, the company potentially could be changing the terms of the debate on expensing stock options. But details of the securities Cisco decides to sell, and the way it markets them, could prove crucial in determining how the approach works in practice.

The issue is important for Cisco because it grants options to all employees and because it will be one of the first companies to come under the new accounting rule that requires options to be expensed. That rule, adopted by the Financial Accounting Standards Board after a long and bitter debate, goes into effect on June 15 for fiscal years beginning after that date. Cisco’s fiscal year begins July 31.

In its last fiscal year, Cisco granted 188 million options to employees. It disclosed that had it been forced to take the value of options as an expense, its net income would have fallen by 28 percent, to $3.2 billion.

The securities would be sold only to institutional investors. Cisco would sell new securities when it issued options to employees, and would then use them to value those options on its books.”

A New Twist on the Quiet Period

Apparently, Led Zeppelin guitarist Jimmy Page entertained the NYSE with the band’s “Whole Lotta Love” at the opening bell Wednesday to kick off Warner Music Group Corp.’s IPO – but a few weeks earlier, one of the bands under contract to Warner had threatened to disturb Warner’s quiet period by trying to get out of its contract.

On May 3rd, the WSJ reported that Linkin Park wanted to end its contract with Warner because it was unhappy with the financial implications of the company’s IPO. Since Linkin Park is responsible for 10% of Warner’s sales, the mere threat by them to leave could have caused a problem in the quiet period – particularly since management was unable to publicly respond due to the quiet period’s restrictions. But it looks like Warner was able to get its IPO off the ground. That’s a new one for me, a client trying to get out of its contract – or renegotiate – and using the quiet period for leverage.