Cisco's New Options Instrument Faces Opposition

July 15, 2005 ( - Cisco System's new options instrument, which would help determine a market value for employee stock options, is receiving criticism from some of the largest institutional investors, including the Council of Institutional Investors and Ohio and Florida state pension funds, according to a Bloomberg report.

In response to  FAS123 , which requires employer expensing of stock options, Cisco proposed to the Securities Exchange Commission (SEC) the creation of employee stock option reference securities (ESORS), which it would sell to institutional investors when it issued options to its employees (See  Cisco Proposes New Options Instrument ).   Since stock options are not publicly traded, standard valuation models are currently used to determine their value.   ESORS would provide a market value for these options.

In letters to the SEC, the investors argued that the derivative investments may cut the cost of expensing options by as much as 90% compared with valuation models and they want the regulators to hold public hearings on the proposal, according to Bloomberg.   Cisco argued that they can’t know if the derivatives will lower option costs until they sell them.

Damon Silvers, associate general counsel of the AFL-CIO, the nation’s largest labor federation, said the SEC shouldn’t be examining Cisco’s plan behind closed doors and the union is preparing a letter to the SEC echoing the concerns of the investors, Bloomberg reports.

SEC Chief Accountant Donald Nicolaisen agrees that investors need to be included in the examination, but backs the idea of using the market approach.   Bloomberg quotes him saying, “There have been so many attacks on the use of existing valuation models for employee stock options for so many years that I welcome testing the results of models against actual market transactions.”

Public hearings would delay the SEC’s approval of the proposal.   Cisco is required to reflect the expense of stock options after its next earnings report, Bloomberg’s report said.