Mr. Chairman, Senator Akaka and Committee members, thank you for this opportunity to testify before you on the issue of expensing stock options.  I am here to speak solely on behalf of the millions of small businesses in the United States who may or may not be aware of the recent proposal by the Financial Accounting Standards Board (FASB) to require the expensing of stock options. 

Small businesses in the United States number nearly 23 million strong and they represent 99.7 percent of all employers.  They employ half of all private sector employees and generate 60 percent of net new jobs annually.  In addition, small businesses produce 13 to 14 times more patents per employee than large patenting firms.  It is not an exaggeration to say that the health and strength of our nation’s economy rests on the ability of small businesses to start and grow. 

Our nation’s entrepreneurial spirit and climate are the envy of the world.  Many countries are trying to replicate our small business system.  In fact, news articles of late last year showed that China was trying to build its own Silicon Valley.  We must be very careful to avoid any unintended consequences that might disrupt small business and job creation.

I wanted to appear before you to voice the concerns of small businesses around the country that I believe are being overlooked or pushed aside as not relevant to the discussion of stock option expensing.  At first glance, the question of whether to expense stock options appears to be a very simple and media friendly question.  However, before getting to the question of expensing stock options, one must first ask how those options will be valued.  That is important because, as we have hear it said so many times, the devil is in the details. 
To fully understand the implications of the recent proposal by FASB, one must be well versed in the differences between the fair value method, the intrinsic value method, lattice structures, and binomial and Black Scholes expensing valuation models. 

As a trained accountant, I have found that these terms are not generally in use in the accounting world but are unique to this particular accounting proposal.  For small business owners and their accountants that are encountering these terms for the very first time, the evaluation of the FASB proposal must be daunting and intimidating. 

The valuation approach as proposed by FASB would turn the American dream of running a small businesses into a nightmare.  The proposal itself is more than 230 pages long including appendixes.  Rather than addressing small business concerns head-on, FASB has just thrown together a series of criteria for small businesses to consider.  Small businesses have no choice but to hire expensive experts to delve into the Voodoo valuation.  Some believe that only the largest accounting firms would be able to produce the proper valuation models and maybe even charge upwards of $500,000 for them.  Both small businesses and small accountants would be victims of the FASB proposal.

A frequent concern heard by the Government Affairs Committee is that small business owners are very busy building and running their businesses and they cannot pay attention to the many federal regulators in Washington, DC.  For this sole reason, Congress created the Regulatory Flexibility and the Small Business Regulatory Enforcement Fairness Acts.  These Administrative Procedure Act laws require federal regulatory agencies to undertake economic analyses when a proposed regulation may disproportionately burden small entities.  In addition, the laws require agencies to conduct vigorous outreach and to establish compliance assistance for small businesses.

FASB as an independent standard setter is not bound by the Regulatory Flexibility nor the Small Business Regulatory Enforcement Fairness Acts.  Accordingly, FASB, as a standards setter recognized by the federal government, should establish equivalent small business review practices for itself. 
In November, I held a hearing in the Committee on Banking, Housing, Urban Development entitled, “Financial Accounting Standards Board and Small Business Growth”.  At that hearing, we heard from a number of witnesses that FASB’s consideration of small business concerns on a variety of FASB proposals was severely deficient.  At the hearing, I requested that a Small Business Advisory Committee be established by FASB to listen to and address small business concerns.  I envisioned this Committee would operate in the same manner as the NASD’s Small Firm Advisory Board in that all proposals would be reviewed and evaluated by the Committee. FASB has indicated to me that the Small Business Advisory Committee would meet twice a year and would receive proposals only on an ad-hoc basis.  While I am pleased that FASB has established the Committee, I still have serious doubts about FASB’s commitment to listening to the small business issues.For example, immediately following the hearing, FASB conducted field tests with eighteen businesses on stock option expensing.  None of those businesses were small businesses.  

As FASB is rushing to implement the proposal on stock option expensing by the end of the year, I am very much concerned that small business issues will be pushed aside or not addressed at all.  For example, the proposal will apply not only to publicly traded companies but also to privately-held companies.  Many of these privately-held companies are startups and very small companies and many that I have spoken to recently are completely unaware that this proposal would apply to them.  In addition, FASB, without advance warning, extended the proposal to include small companies with employee stock purchase plans.

While some of the companies will be able to participate in the two roundtables to be held by FASB in Connecticut and California, thousands of others may not find out about the roundtables until it is too late.  In addition, the first meeting of the Small Business Advisory Committee is on May 11th.  An issue as complex as this may not be addressed fully, however, it is quite possible that the Committee could spend all day on the proposal’s glossary of terms and have very little time to discuss anything else.

For this reason, a hearing has been scheduled next week in the Committee on Small Business and Entrepreneurship that will give a limited number of small businesses a chance to discuss the proposal on stock option expensing.

As the Government Affairs Committee has jurisdiction over the Regulatory Flexibility and the Small Business Regulatory Enforcement Fairness Acts, I will leave the Committee with a couple of questions that I hope that you will consider exploring in this hearing:

1) What are the duties and responsibilities of a standard setter recognized by the federal government for analyzing the economic impact of proposals?  Should those duties and responsibilities rise to the level of the statutory mandates of federal agencies?

2) What is the level of outreach that is required to ensure that small businesses throughout the country are able to participate in the standard setting process? And,
      
3) What is the remedy available to a small business that believes that the independent standard setter got the standard wrong for small businesses or that the standard setter has completely pushed aside small business concerns?  Small businesses pursuant to the Regulatory Flexibility Act may sue a federal agency to set aside a rule proposal if the small business has been unjustly aggrieved.
As one of the principal authors of the Sarbanes-Oxley Act, I support an independent accounting standard setter.  However, an independent accounting standard setter has to live up to a very high standard.  With respect to FASB’s oversight of small business concerns, I believe that there is still a significant way to go.

Finally, I should mention that in today’s Wall Street Journal there is an account of Chairman Herz conducting a conference call with institutional investors yesterday.  In that call, he urges the institutional investors “to make your views known to the people in Washington” so that FASB can go forward with its proposal by the end of the year.  This is further evidence that Chairman Herz will by-pass the due process for small business in order to impose his will upon process.  I would like to introduce this article into the hearing record.

Interestingly, Chairman Herz’s call was with institutional investors.  Recent news articles have shown that institutional investors, including public pension funds, readily invest in hedge funds.  I find it extremely troubling that institutional and pension fund managers will invest in unregulated hedge funds but cannot interpret the stock option information currently available in the extremely detailed footnotes of registered publicly traded companies.

In addition, I also would like to introduce a very recent study on the use of stock options into the record.  The study by Professors Joseph Blasi and Douglas Kruse, found that stock options are widely held by the true workers and middle management of many companies.  They are not just used by executives.  As a matter of fact, a recent article in the Washington Post detailed that with or without stock options, executives will still receive their compensation.  Therefore this proposal will hurt only small businesses and employees and their families.

Thank you very much for allowing me to testify today.