To require the mandatory expensing of stock options granted to executive officers, and for other purposes.

Summary: Stock Option Accounting Reform Act - (Sec. 2) Amends the Securities Exchange Act of 1934 to require an issuer of registered securities to show as an expense in its annual report the fair value of all stock purchase options granted after December 31, 2004, to: (1) all individuals serving as the chief executive officer of an issuer, or acting in a similar capacity, during the most recent fiscal year, regardless of compensation level; and (2) the four most highly compensated executive officers (other than a chief executive officer) that were serving as executive officers of an issuer at the end of the most recent fiscal year ("named executive officer").

Defines the fair value of an option to purchase such stock.

Exempts small business issuers from the Act's requirement.

(Sec. 3) Amends the Securities Act of 1933 to prohibit the Securities and Exchange Commission (SEC) from recognizing as "generally accepted" any accounting principle relating to the expensing of stock options unless it complies with both: (1) specified expense recomputation requirements; and (2) a required joint study by the Secretaries of Commerce and of Labor of the economic impact of the mandatory expensing of employee stock options.

Requires the recomputation and re-reporting of the expense of a stock purchase option that is exercised, to equal the difference between the price of the underlying stock and the exercise price.

 Requires the re-reporting as a reduction of the total expense originally required to be reported if the option expires or is forfeited.

(Sec. 4) Directs the SEC to require each issuer to include in its periodic report more detailed information regarding stock option plans, stock purchase plans, and other arrangements involving an employee acquisition of an equity interest in the company, including: (1) a discussion, written in accordance with the Plain English Handbook published by the SEC Office of Investor Education and Assistance on the dilutive effect of stock option plans; (2) expanded disclosure of the dilutive effect of employee stock options on the issuer's earnings per share; (3) prominent placement and increased comparability and uniformity of all stock option related information; (4) the number of outstanding stock options; (5) the weighted average exercise price of all outstanding stock options; and (6) the estimated number of stock options outstanding that will vest in each year.

SECTION 1. SHORT TITLE.

    This Act may be cited as the ``Stock Option Accounting Reform 
Act''.

SEC. 2. MANDATORY EXPENSING OF STOCK OPTIONS HELD BY HIGHLY COMPENSATED 
              OFFICERS.

    Section 13 of the Securities Exchange Act of 1934 (15 U.S.C. 78m) 
is amended by adding at the end the following:
    ``(m) Mandatory Expensing of Stock Options.--
            ``(1) Named executive officer.--As used in this subsection, 
        the term `named executive officer' means--
                    ``(A) all individuals serving as the chief 
                executive officer of an issuer, or acting in a similar 
                capacity, during the most recent fiscal year, 
                regardless of compensation level; and
                    ``(B) the 4 most highly compensated executive 
                officers, other than an individual identified under 
                subparagraph (A), that were serving as executive 
                officers of an issuer at the end of the most recent 
                fiscal year.
            ``(2) In general.--Subject to paragraph (4), every issuer 
        of a security registered pursuant to section 12 shall show as 
        an expense in the annual report of such issuer filed under 
        subsection (a)(2), the fair value of all options to purchase 
        the stock of the issuer granted after December 31, 2004, to a 
        named executive officer of the issuer.
            ``(3) Fair value.--
                    ``(A) In general.--The fair value of an option to 
                purchase the stock of the issuer that is subject to 
                paragraph (2) shall--
                            ``(i) be equal to the value that would be 
                        agreed upon by a willing buyer and seller of 
                        such option, who are not under any compulsion 
                        to buy or sell such option; and
                            ``(ii) take into account all of the 
                        characteristics and restrictions imposed upon 
                        the option.
                    ``(B) Pricing model.--To the extent that an option 
                pricing model, such as the Black-Scholes method or a 
                binomial model, is used to determine the fair value of 
                an option, the assumed volatility of the underlying 
                stock shall be zero.
            ``(4) Exemptions.--
                    ``(A) Small business issuers.--This subsection 
                shall not apply to an issuer, if--
                            ``(i) the issuer has annual revenues of 
                        less than $25,000,000;
                            ``(ii) the issuer is organized under the 
                        laws of the United States, Canada, or Mexico;
                            ``(iii) the issuer is not an investment 
                        company (as such term is defined under section 
                        3 of the Investment Company Act of 1940 (15 
                        U.S.C. 80a-3));
                            ``(iv) the aggregate value of the 
                        outstanding voting and non-voting common equity 
                        securities of the issuer held by non-affiliated 
                        parties is less than $25,000,000; and
                            ``(v) in the case of an issuer that meets 
                        the criteria in clauses (i) through (iv) and is 
                        a majority-owned subsidiary, the parent of the 
                        issuer meets the requirements of this 
                        paragraph.
                    ``(B) Delayed effectiveness.--The requirements of 
                this subsection shall not apply to an issuer before the 
                end of the 3-year period beginning on the date of the 
                completion of the initial public offering of the 
                securities of the issuer, and shall only apply to an 
                option to purchase the stock of an issuer granted after 
                such date.
            ``(5) Voluntary expensing.--Notwithstanding the 
        requirements of this subsection, issuers may elect to expense 
        the fair value of all officer and employee stock options in the 
        annual report of such issuer under subsection (a)(2), in 
        accordance with the expensing alternative of Statement of 
        Financial Accounting Standards Number 123, and any such issuer 
        making such election in the annual report for a fiscal year 
        shall not be subject to paragraphs (2) through (4) of this 
        subsection for such fiscal year.''.

SEC. 3. PROHIBITION ON EXPENSING AND ECONOMIC IMPACT STUDY.

    (a) Prohibition.--Section 19(b) of the Securities Act of 1933 (15 
U.S.C. 77s(b)) is amended by adding at the end the following:
            ``(3) Prohibition on expensing standards.--
                    ``(A) In general.--The Commission shall not 
                recognize as `generally accepted' any accounting 
                principle relating to the expensing of stock options 
                unless--
                            ``(i) it complies with the requirements of 
                        subparagraph (B); and
                            ``(ii) the economic impact study required 
                        under section 3(b) of the Stock Option 
                        Accounting Reform Act has been completed.
                    ``(B) Requirements.--A standard referred to in 
                subparagraph (A) shall require that--
                            ``(i) if an option to purchase the stock of 
                        an issuer that is subject to the requirements 
                        of section 13(m) of the Securities Exchange Act 
                        of 1934 is exercised--
                                    ``(I) any expense that had been 
                                reported under that section 13(m) with 
                                respect to such option shall be 
                                recomputed as of the date of exercise 
                                and shall be equal to the difference 
                                between the price of the underlying 
                                stock and the exercise price; and
                                    ``(II) to the extent the recomputed 
                                amount differs from the amount 
                                previously reported under section 13(m) 
                                with respect to such option, the 
                                difference shall be reported in the 
                                fiscal year in which the option is 
                                exercised as a reduction or increase, 
                                as the case may be, of the total 
                                expense required to be reported under 
                                that section 13(m) during that fiscal 
                                year;
                            ``(ii) if an option to purchase the stock 
                        of an issuer that is subject to the 
                        requirements of section 13(m) of the Securities 
                        Exchange Act of 1934 is forfeited or expires 
                        unexercised, any expense that had been reported 
                        under that section 13(m) with respect to such 
                        option shall be reported in the fiscal year in 
                        which the option expires or is forfeited as a 
                        reduction of the total expense required to be 
                        reported under that section 13(m) during that 
                        fiscal year; and
                            ``(iii) to the extent that any reduction 
                        required under clause (i) or (ii) exceeds total 
                        option expenses for any fiscal year, such 
                        excess shall be reported as income with respect 
                        to options to purchase the stock of the issuer.
                    ``(C) Exception for voluntary expensing.--Nothing 
                in this paragraph or in any other provision of the 
                Stock Option Accounting Reform Act shall prevent the 
                Commission from continuing to recognize the expensing 
                alternative of Statement of Financial Accounting 
                Standards Number 123 as part of generally accepted 
                accounting principles for issuers that elect to expense 
                the fair value of all officer and employee stock 
                options in the annual report of such issuer pursuant to 
                section 13(m)(5) of the Securities Exchange Act of 
                1934.''.
    (b) Economic Impact Study.--Not later than 1 year after the date of 
enactment of this Act, the Secretary of Commerce and the Secretary of 
Labor shall conduct and complete a joint study on the economic impact 
of the mandatory expensing of all employee stock options, including the 
impact upon--
            (1) the use of broad-based stock option plans in expanding 
        employee corporate ownership to workers at a wide range of 
        income levels, with particular focus upon non-executive 
        employees;
            (2) the role of such plans in the recruitment and retention 
        of skilled workers;
            (3) the role of such plans in stimulating research and 
        innovation;
            (4) the effect of such plans in stimulating the economic 
        growth of the United States; and
            (5) the role of such plans in strengthening the 
        international competitiveness of businesses organized under the 
        laws of the United States.

SEC. 4. IMPROVED EMPLOYEE STOCK OPTION TRANSPARENCY AND REPORTING 
              DISCLOSURES.

    (a) Enhanced Disclosures Required.--Not later than 180 days after 
the date of enactment of this Act, the Commission shall, by rule, 
require each issuer filing a periodic report under section 13(a) or 
15(d) of the Securities Exchange Act of 1934 (15 U.S.C. 78m, 78o(d)) to 
include in such report more detailed information regarding stock option 
plans, stock purchase plans, and other arrangements involving an 
employee acquisition of an equity interest in the company. Such 
information shall include--
            (1) a discussion, written in ``plain English'', in 
        accordance with the Plain English Handbook published by the 
        Office of Investor Education and Assistance of the Commission, 
        of the dilutive effect of stock option plans, including tables 
        or graphic illustrations of such dilutive effects;
            (2) expanded disclosure of the dilutive effect of employee 
        stock options on the issuer's earnings per share;
            (3) prominent placement and increased comparability and 
        uniformity of all stock option related information;
            (4) the number of outstanding stock options;
            (5) the weighted average exercise price of all outstanding 
        stock options; and
            (6) the estimated number of stock options outstanding that 
        will vest in each year.
    (b) Definitions.--As used in this section:
            (1) Commission.--The term ``Commission'' means the 
        Securities and Exchange Commission.
            (2) Issuer.--The term ``issuer'' has the meaning provided 
        in section 2(a)(7) of the Sarbanes-Oxley Act of 2002 (15 U.S.C. 
        7201(a)(7)).
            (3) Equity interest.--The term ``equity interest'' includes 
        common stock, preferred stock, stock appreciation rights, 
        phantom stock, and any other security that replicates the 
        investment characteristics of such securities, and any right or 
        option to acquire any such security.

SEC. 5. PRESERVATION OF AUTHORITY.

    Nothing in this Act shall be construed to limit the authority over 
the setting of accounting principles by any accounting standard setting 
body whose principles are recognized by the Securities and Exchange 
Commission under section 19(b)(1) of the Securities Act of 1933 (15 
U.S.C. 77s(b)(1)).

            Passed the House of Representatives July 20, 2004.

            Attest:

                                                 JEFF TRANDAHL,

                                                                 Clerk.