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2004 Comment Letter

10 May 2004

The Honorable Richard H. Baker
Chairman
Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises
U.S. House of Representatives
2129 Rayburn H.O.B.
Washington, D.C. 20515

The Honorable Paul E. Kanjorski
Ranking Member
Subcommittee on Capital Markets, Insurance and Government Sponsored Enterprises
U.S. House of Representatives
2129 Rayburn H.O.B.
Washington, DC 20515

Dear Chairman Baker and Ranking Member Kanjorski:

On Wednesday, May 12, 2004, your subcommittee is expected to consider H.R. 3574, the Stock Option Accounting Reform Act. CFA Institute (formerly the Association for Investment Management and Research^® (AIMR^®))* opposes this bill which would permit companies to mislead investors by obfuscating the total cost of employee compensation and, even more importantly, interfere with the Financial Accounting Standards Board’s independent standard-setting process, which has resulted in a globally-recognized, high quality financial reporting and disclosure regime.

Since 1993, CFA Institute has publicly advocated recording the fair value of employee stock options as an expense on the income statements of companies that use them. We believe that failure to do so violates the conceptual framework that underpins all financial reporting and disclosure and distorts financial statements to achieve ends that are not only inappropriate but act contrary to the needs and rights of shareowners and investors. It is inconceivable to us that in the wake of Regulation Fair Disclosure and the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes-Oxley) that Congress would seek to overturn a financial reporting standard that was developed by an independent standard-setting body, the Financial Accounting Standards Board, after appropriate due process and that clearly improves transparency to investors.

The Financial Accounting Standards Board Must Be Independent and Free from Political Intervention

CFA Institute actively supports the work of the FASB and, prior to the change in the FASB’s funding mechanism, provided financial support to the Financial Accounting Foundation. Recognizing the critical nature of financial statement information to the investment decision-making process, CFA Institute staff and its member-volunteers continue to work hard to ensure that the investor viewpoint and user community needs are included in the deliberation and debate that result in financial accounting standards, such as the proposed Share Based Payments.

Individual investors rarely have the political influence that corporations have and, hence, are disadvantaged when corporate influence adversely affects the information on which they rely when investing their savings. CFA Institute strongly believes that your subcommittee and other Congressional representatives must demonstrate their conviction, so adequately articulated in Sarbanes-Oxley, that only an independent standard-setter can achieve the necessary balance across divergent interests and needs. Furthermore, we are convinced that the FASB process is inclusive and fair to all affected parties: corporations and other preparers of accounts, auditors, investors, regulators, and others. As investor advocates, we can testify to the FASB’s continuing adherence, in the face of strident opposition, to precepts of objectivity and fairness, and to its efforts to carefully balance the costs and benefits to users against the costs to preparers and auditors.

Now is the time for you to support the FASB in its endeavor to achieve a financial reporting result that investors have been waiting 10 years to be implemented. After the billions of dollars that investors have lost in the last four years, due partly to weaknesses in the financial reporting system, CFA Institute urges Subcommittee members and their colleagues to refrain from intervening in the independent standard-setting process and permit the FASB to move forward with its proposal for expensing employee stock options.

Investment Professionals Use Fair Value Information about Employee Stock Options; Individual Investors Deserve Easy Access to the Same Information

There is compelling evidence that investment professionals use the information currently available in the footnote disclosures to adjust expenses and earnings. In 2001, as the debate about expensing employee stock options heated up, CFA Institute surveyed 18,000 of its members to determine the relevance of information about the fair value of employee stock options. Over 1,900 investment professionals responded, including equity and fixed income analysts at investment management firms (26 percent of respondents) and brokerage houses (15 percent), as well as fund managers for institutional or private clients (38 percent). Seventy-five percent of respondents were from North America, 13 percent from Europe, and 10 percent from the Asia-Pacific region. Disclosure of information about stock option plans was shown to impact a significant number of analysts and portfolio managers, with 85 percent of respondents saying the companies they evaluate have such plans.

The survey results provide evidence that supports expensing employee stock options:

88 percent of respondents believe share-based or stock option plans are compensation
83 percent said the accounting method for all share-based payments (including those given in employee stock option plans) should be expensed in the income statement
81 percent use information about the value of stock options when evaluating a firm's performance and determining its value.

With the confirmation that investment professionals are “expensing stock options” on their own (even without the conceptual accounting arguments in favor), CFA Institute gives its full support to the FASB proposal because we firmly believe that all investors, no matter how unsophisticated, would be better off if this information were made transparent by recording it as an expense. When so many investment professionals use this information, we believe it is simply a question of fairness to make it easily accessible to individual investors.

Investors Need Companies to Expense Employee Stock Options at Fair Value

It is well understood, and unarguable, that investors need accurate, complete, consistent, comparable, and unbiased information from competent sources to make informed investment decisions and to allocate their hard-earned money wisely among investment alternatives. In other words, when financial information lacks these characteristics, investors cannot make appropriate investment decisions, and markets cannot be efficient or effective in their primary role of allocating capital. Indeed, these principles underlie the Congressional mandate, in the Securities and Exchange Acts of 1933 and 1934 and later amendments, to the Securities and Exchange Commission (SEC) to oversee the formulation of accounting standards and the required audit of all SEC registrants.

Summary

Finally, CFA Institute urges you, the Subcommittee members, and other senators and congressional representatives to fully support the independence of the Financial Accounting Standards Board and avoid the temptation to interfere in this independent process by passing legislation on this issue. The standard-setting process does not always create standards that fully meet the needs of investors and shareowners, but we strongly believe that the process is fair and works to balance the often conflicting needs and concerns of its constituents. Politicizing the process can only work to destabilize it and will ultimately be detrimental to those investors who have the least ability to gather political influence.

CFA Institute appreciates the opportunity to comment to the Subcommittee on the independence of the Financial Accounting Standards Board and the need for expensing of employee stock options at fair value. These issues are of critical importance to investors and other users of financial statements as well as to financial markets generally. If you, the Subcommittee members, or their staffs have questions or seek additional comments, please feel free to contact me at 1.434.951.5315 or patricia.walters@cfainstitute.org.

Sincerely,

/s/

Patricia Doran Walters, PhD, CFA
Senior Vice President
Professional Standards & Advocacy

Cc:
Members
Financial Services Subcommittee Capital Markets
Insurance and Government Sponsored Enterprises
Thomas A. Bowman, CFA, President & Chief Executive Officer
Raymond DeAngelo, Executive Vice President, Member & Society Division
Rebecca T. McEnally, CFA, Vice President, Advocacy

* CFA Institute is a global, non-profit organization whose members include more than 70,000 investment professionals and educators in 116 countries, as well as 129 affiliated professional societies in 48 countries. CFA Institute mission is to lead the investment profession globally by setting the highest standards of education, integrity, and professional excellence. Most notably, CFA Institute is known for the Chartered Financial Analyst® (CFA®) curriculum and examination program, the globally recognized standard for measuring the competence and integrity of financial analysts and fund managers. Almost 57,000 CFA Institute members are holders of the CFA designation. CFA Institute is also known for the development and implementation of its Code of Ethics and Standards of Professional Conduct. Additional information about CFA Institute is available through its website (www.cfainstitute.org) or in its annual report.