Regulators yesterday expressed "significant doubts" about a Cisco Systems Inc. proposal on valuing employee stock options that might have eased the hit to the bottom lines of companies being forced to count options as expenses.
The rejection by the Securities and Exchange Commission comes a few months after officials ordered publicly traded companies to, for the first time, treat stock options as an expense. Options allow employees the right to purchase stock at a set price within a specific period of time.
Accounting experts and many investor groups say expensing options provides a clearer picture of a company's financial health.
But the drive to account for the cost of stock options, more than a decade in the making, has been fiercely opposed by technology firms that dole out options as a way to attract and retain workers. The companies argue it is difficult to accurately value them and complain that doing so will slash reported profits. The Cisco plan was seen as a last-ditch effort to soften the blow to companies.
San Jose, Calif.-based Cisco and several other companies have met with regulators since May to test new methods for valuing options.
Cisco's plan would have created a financial instrument, or derivative, designed to mimic a stock option. Under the Cisco proposal, the details of which remain murky, the derivatives would have been sold to a select group of institutional investors through auction. The company would calculate the value of the options as reflected in the market for the derivatives and the number of options it has awarded to come up with a total compensation expense to be reported on its books.
Cisco will start to reflect the cost of options in its financial statement due to be released in November. At least one large tech company, Microsoft Corp., already expenses them, as do other, non-tech firms.
In a memo issued yesterday, SEC Chief Accountant Donald T. Nicolaisen did not reject outright the idea of using financial instruments to price options. Instead, regulators said technical details in the method that Cisco employed raise questions about whether the plan would result in options being priced at "fair value."
Agency officials said they are unaware of any options instruments actually being bought or sold in the market so far. They said they hope to begin a broader dialogue with companies and investors about how to value options in the months ahead.
A Cisco official yesterday that the company is pleased that the SEC is open to more discussion on using market instruments to value options.
Opponents of expensing had hoped that incoming SEC Chairman Christopher Cox would derail the new rule. But Cox, a former California congressman who counted many technology companies among his constituents, told senators at his confirmation hearing in July that he would allow expensing to move forward.