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Video:Stock Options
Video:Employee Stock Option Rally in Palo Alto, CA
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Issue
Expensing stock options.
The International Accounting Standards Board (IASB) has passed a global accounting standard that would require the expensing of employee stock options on income statements. The US Financial Accounting Standards Board (FASB) has reversed US policy -- in effect since 1994 -- to require expensing in the name of harmonization of US and International accounting standards. The European Union (EU) is also changing its policy to require expensing to synchronize international accounting standards.

Business Impact
If FASB and the EU prevail and broad-based employee stock option plans are required to be treated as an expense, such plans will be threatened. The financial impact could be measured in billions of dollars. If adopted, Cisco will have to evaluate the affordability of its rank-and-file broad based options program and the likely result would be a far reduced broad based options program. This would remove a major retention and recruitment tool and result in a major change in company culture: loss of employee ownership.

Status
The Financial Accounting Standards Board (FASB) issued an exposure draft, which requires employee stock options to be treated as an accounting expense beginning in 2005; the exposure draft was open for public comment until June 30, 2004. On June 24th at a FASB roundtable in Palo Alto, CA, Cisco's Chief Financial Officer, Dennis Powell testified that we do not agree with the proposal to expense employee stock options. Stock options are already accounted for, when exercised, as the earnings per share (EPS) is impacted. You can read Cisco's full letter to the FASB here. All of the FASB comment letters, the vast majority of which are very much against expensing.

Powell again spoke before the full FASB in September 2004. He presented an alternative valuation for stock options, if they are to be expensed. Also participating in the presentation were Richard Grannis, Qualcomm Treasurer, and Genentech CFO, Lou Lavigne.

In October, 2004 the FASB announced that its proposed rule regarding employee stock options would be delayed by six months and would take effect June 15, 2005. On December 16, 2004, the FASB issued its final statement on "share-based payments" or stock options.

With regard to the U.S. Congress, the House of Representatives passed a bill in July 2004 which would only expense the stock options of only the top five officers of a company (HR 3574). The House sent a strong message that broad-based employee stock options are about jobs, competitiveness and employee ownership - not accounting. The bill passed the full House by a 312-111 vote with very strong support from both political parties.

In the Senate, in October 2004, 53 bipartisan Senators sent letters to Securities and Exchange Commission (SEC) Chairman Donaldson urging a delay in expensing stock options until field testing can be conducted and an accurate valuation model can be achieved. The SEC has oversight over the FASB. The Senate companion bill to HR 3574 (S.1890), had a total of 31 bipartisan cosponsors. Congress did not include stock options legislation in a final omnibus appropriations measure that was passed in November 2004. Efforts to work with the Congress on stock options legislation will continue in 2005.

In Europe, the International Accounting Standards Board (IASB) has already recommended that stock options be expensed. France, Italy, Spain and Belgium recently vetoed an IASB compromise on a derivatives issue -- demonstrating unequivocally that IASB standards are not self-executing; that the European Union Member States can and will weigh in to block standards that they do not like.

The IASB proposal on expensing is now being reviewed by the European Commission, which is divided on this issue, and the EU Member States' Accounting Regulatory Committees.

Cisco Position
Options should not be expensed: it is bad accounting.
The potential dilution of each investor's share of company ownership is the real cost of employee stock options. Earnings Per Share (EPS) already considers the impact of employee stock options.
Accurate, consistent and useful information about employee stock options already must be disclosed on a quarterly basis.
Shareholders should have approval over stock options plans, as they do at Cisco.
To protect broad-based plans, Cisco is supportive of legislative efforts which would require the expensing of options of only the "top five" officers of all companies.
Cisco congratulates the House of Representatives for recognizing the importance of broad-based employee stock option plans, especially at a time when U.S. job growth and competitiveness are of utmost importance.

Key Messages
Broad-based stock option plans give employees at all levels a chance to own a "piece of the rock" and increase productivity for the company.
Options programs keep companies competitive in recruiting and retention - especially needed in time of global competition for engineering talent.
As other countries are graduating many more engineers and math and science PhDs than the US - which lead to innovative new technologies and research - stock options must remain a key tool for recruitment and retention for companies.
Employee stock options fuel innovation and the entrepreneurial spirit.
More countries are also recognizing that the promise of company ownership motivates all workers. China, for example, has the utilization of stock options at the center of its five-year economic expansion plan.
Expensing options could lead to elimination or curtailment of broad-based options plans.
Currently there is no accurate, reliable and consistent way to value options - the current valuation method (Black-Scholes) is for options that can be freely traded, whereas employee stock options are often restricted - subject to vesting over years.

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Resources
International Employees Stock Options Coalition (IESOC)
International Accounting Standards Board (IASB)
Financial Accounting Standards Board (FASB)
The Beyer Institute
National Center for Employee Ownership

As of January 2005