July 25, 2005

The Challenges of Option Valuation for Expensing Purposes

As we move closer towards en masse adoption of option expensing, some members are finding valuation issues under 123R that surprise them. Many of these surprises have been covered on the NASPP website, either through webcasts or materials.

The surprises typically involve an auditing firm taking a position that because an option has a particular feature, it will be assigned a higher value under 123R or have a shorter expensing period (and thus have a higher current and near period expense). Some members are frustrated because these positions seem based on dubious – or at least unsubstantiated – reasoning.

For example, because an option becomes fully exercisable upon retirement (eg. above age 55) and the optionee is already over age 55, the general view appears that it should be assumed that the optionee will retire immediately and the option will fully vest and have a short life – and therefore the current period charge should be high.

Some members point out that the SEC’s guidance states that the best basis for determining option valuation is historic experience, unless there is some reason to view past experience as not representative of the future. If that’s right, these members argue that companies should be able to refute the higher valuation by showing that its insiders have not historically exercised as soon as an option became exercisable – and that optionees have not retired as soon as they were eligible to do so. So far, it doesn’t appear that those arguments are persuasive.

Among its 40+ panels at the “13th Annual NASPP Conference,” a total of seven panels will address different option expensing topics – and there is a horde of option expensing materials available on the NASPP site right now (including archives of a number of webcasts that include FASB members/staff and plenty of Q&A in the popular NASPP “Q&A Forum”).

Vicarious Liability for Global Firms

On July 14th, Judge Lewis Kaplan of the US District Court of the Southern District of New York ruled that a class-action suit brought by Parmalat investors can proceed against Deloitte Touche Tohmastu and Grant Thornton International, the international umbrella organizations, so that these umbrella organizations could be held liable for the actions of their Italian member firms.

While finding an agency relationship between the umbrella organizations and the Italian member firms, the judge declined to find a similar relationship between the Italian member firms and their United States counterparts.

The audit firms had argued that they should not be held responsible for the actions of their international affiliates, which are set up as legally separate and independent partnerships. In his ruling, Judge Kaplan said that the plaintiffs had proven that both Deloitte Touche Tohmastu and Grant Thornton International had acted as principals for their Italian affiliates, both of which had, at different times, audited Parmalat’s books.

The judge specifically noted that the firms market themselves as global organizations – despite disclaimers on their websites that each firm is a “separate and independent legal entity.” So this ruling means the use of independent affiliates as a means of limiting vicarious liability might have limited effectiveness going forward.

SEC Chair and Commissioners Hearings Set for Tomorrow

On Friday, the White House announced that President Bush intends to re-nominate Commissioner Roel Campos as SEC Commissioner for the remainder of a 5-year term expiring June 5, 2010 – and nominate SEC Market Reg Director Annette Nazareth for the remainder of a 5-year term expiring June 5, 2007. As I blogged last week, the US Senate Banking Committee previously scheduled hearings for Tuesday on “Pending Nominations,” which includes the previously nominated Chris Cox as SEC Chair.