Expensing Stock Options. There are valid arguments on both sides of the question whether grants of stock options should be a charge to earnings as of the date of grant. The question is more nuanced than it appears in many of the commentaries, some bordering on polemics, published on the issue. Assuming the question remains optional for U.S. public companies, it can be confidently predicted that debate will continue to rage and managers and boards of public companies will be discomfited and troubled, particularly if the company elects not to adopt some form of expense formula. Those noncompliant with a practice now styled as a "reform" will be faced with complaints and criticism, much of which is ideologically driven, to the effect that the financial reports are overly rosy, by omitting a significant item of compensation expense.
The board, including the outside directors, may genuinely believe (as I do) that the question is much closer than many critics will admit but nonetheless feel uncomfortable in appearing to be somehow unethical or shady by not going along with the current wave of "reform". To those boards which feel inclined to resist, I suggest there is an entirely appropriate (and potentially bullet proof) solution . . . that is, to take advantage of another primary element in the reform "package", shareholder democracy, and put the question to the shareholders at their next meeting. I recommend that the board put together, in the proxy statement, an outline of the arguments pro and 'con' (and I suggest a number of critics will be surprised at the validity of the con argument), add pro forma comparative income statements (pointing out that expensing the option grants, among other things, creates a double count when earnings per share are calculated) and then see what the owners of the company have to say. In the final analysis, it is their view which should be determinative. They as the current owners have a direct and personal interest in the outcome of the debate. A potential shareholder, particularly one who believes that the decision not to expense means that the accounts are not fairly stated, can vote effectively by not purchasing the shares some academic critics may think the decision should come out in a given direction. It is interesting but irrelevant as a practical matter. As the old saying goes, "money (in this case share ownership) talks and 'you know what' walks."
The Whistleblower Risk. The second issue has to do with the fixing the major problem, again on behalf of well meaning boards of directors. Now that errors and omissions in public financial disclosures have been criminalized, board members and managers are looking desperately for ways to control what is otherwise an unconscionable risk. a potential prison term and life long disgrace if, somewhere along the line, a material error is made. And the real danger (as indeed has always been the case in situations like these) is the disgruntled employee, regardless of the employee's grievance, telling an alarming story to the regulators and prosecutors.
The danger for the managers is acute at both ends of the equation. The punishment, if the employees story is believed, is severe; in addition, the rewards to the whistle blower whether the "scandal" genuine or not, are significant, both in terms of revenge for the perceived grievance and, in fact, monetary rewards in the form of damages if the story is believed. One way of looking at the new landscape is to conclude that, as in Germany, professional employees have lifetime tenure. You fire somebody and, the next thing you know, you are testifying before a grand jury. Again there is a pretty obvious fix or at least a powerful tool for alert management. Thus, my recommendation is that each existing professional employee or new hire be issued a card which states something like the following:
We invite and encourage any employee to be alert to irregularities in our financial controls and methods of reporting our results to the public. If for any reason you conclude, or even suspect, the existence of an irregularity, a questionable decision, an error or omission, whether deliberate or innocent, we urge you to report the same to the following telephone number and/or email address. You may do so anonymously if you wish. The only individual with access to the voicemail/email address is the Rev. Dick Tracy, Chairman of our Audit Committee, an independent director with no affiliation whatsoever with our company. The system has been constructed and maintained by Kroll Associates, internationally recognized security consultants, in order to insure that your anonymity will be preserved and that no retaliation is possible. If for any reason you are concerned that (because of the nature of the alleged irregularity, for example), the complaint can be traced back to you, you are encouraged to call, again anonymously the following number at Kroll Associates, and Captain Poirott, retired chief of the New York City Homicide Bureau, will work with you to develop the appropriate protections. If the item or items you cite are deemed worthy of corrections or improvement, after a review by the firm of independent forensic accountants we have hired to provide oversight in the event of a meritworthy challenge, you can be rewarded at your option with an compensation comparable to that you would receive under Section 802 of the Sarbanes-Oxley Act. We are serious, as managers of your company, on preserving the integrity, accuracy and completeness of our financial disclosures and we enlist your aid in making that happen, for the benefit of all of us . . . our shareholders and your fellow employees included.
Online classes and how to spot financial shenanigans are also available on streaming video at www.creativeaccounting.com. Each employee of course will be asked to acknowledge in writing that he or she has read the statement and understands it.
Will this bullet proof management, by stopping employees from ratting the management out in subsequent periods? The answer has to be 'not necessarily' in an egregious case, but most probably in all others. The real question is not, however, whether the system will work in every conceivable instance; rather it is what is against trying it out. You may wind up, to be sure, with a lot of junk in the secure mailbox . . . personal grievances and the product of chronic malcontents. But good management deals intelligently with those complaints in any company. And junk is a small price to pay, in my opinion, for the protection this system can offer. It is certainly better than requiring terminated employees to sign a release (based on recent case law at least) in exchange for three month severance.