Cisco Proposes Option for Options

When the new rules regarding the expensing of options go into effect over the next year, technology firms, like Cisco Systems Inc., will be among the hardest hit. Billions of dollars are stake in Silicon Valley with its high concentration of technology firms. But unlike other firms that are scrambling to meet the new requirements in the next fiscal year, Cisco is seeking approval from the Securities and Exchange Commission (SEC) for an innovative method of accounting for employee stock options.

The new method was proposed to the SEC by Cisco in March, 2005, an anonymous source told MarketWatch. The plan calls for Cisco to sell a small number of option-backed securities through an investment bank each time the company issues stock options to employees. The securities, which would be available only to large institutional investors, would carry the same terms and restrictions as employee stock options. These securities would be priced using the same Dutch method used by Google, Inc. for its initial stock sale last year, however, the restrictions are expected to reduce the value of the securities. Cisco would account for options issued at the same time at the same price as the securities, rather than at the price as it would be set under current rules. It is anticipated that since the price would be lower the dent made in earnings by expensing the options would also be reduced.

“In order to get an accurate valuations for stock option valuation, Cisco is working on a market instrument that would match the same attributes of an employee stock option,” Cisco said in a statement to MarketWatch on Thursday. “We are awaiting guidance from regulators on this instrument.”

In response to a reporter’s question, William Donaldson, chairman of the SEC said: “I think it’s a very interesting approach.”

Others have been more forthcoming.

“It’s a step in the right direction,” Rick White, who heads TechNet, an industry lobbying group, told the Mercury News. “The one problem with it is this is probably something only a large company could do effectively.”

Another problem is that some companies, like Cisco, could develop their own market-based method of valuation while others would rely on current rules leading to confusion among investors about the effect options have on a company’s financial statements and condition, when the goal of the Sarbanes-Oxley Act was to put everyone on a level playing field.

“Otherwise investors and analysts are going to be looking at companies and looking at the effect of granting stock options, and wondering, ‘Well, which method are they using?’” Paul Hodgson, a compensation expert with the Corporate Library told the Mercury News.

The Financial Accounting Standards Board (FASB), have long been advocating market-based valuations, according the Mercury News.

“If they now have real-world investment bankers willing to put real money on transactions like that, that’s exactly what the FASB is trying to do,” Dennis Beresford, an accounting professor at the University of Georgia who once headed the FASB told the Mercury News. “I would say, ‘Hurray for them.’”

Cisco hopes the SEC will make its decision before July 31 when Cisco’s next fiscal year begins and the current regulations and methods of valuation would go into effect.

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