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The Office of Economic Analysis: In The Spatt-light

Location: Blogs AAO Weblog (Public)
Posted by: Jack Ciesielski	9/12/2005 7:14 AM
The SEC's Office of Economic Analysis has probably seen more press in the last four months than in its entire existence; recent speeches by its boss, Chester Spatt, have been parsed with the same care and attention usually given to the Federal Reserve Bank chairman. That's because of the last-ditch proposal to pollute the effectiveness of Statement 123R brought to you by Cisco Systems last May. On Friday, the SEC gave the plan a thumbs down from chief accountant Don Nicolaisen and a thumbs-down-with-a-wink from chairman Chris Cox. Chief economist Spatt gave a thumbs down on the existing plans - but offered a blueprint for the design of future instruments that might make the cut. There were a couple of problems with the existing instrument designs. First of all, the only thing that's been offered to the SEC so far is the design of an instrument - and there's more to the issue of the fair value of an instrument than just its design. As Mr. Spatt outlined: "A market-based approach must have three elements in order to generate a market price that is a reasonable estimate of the fair value of an employee stock option grant. In order to meet the objectives of Statement 123R, each element of the market-based approach must be consistent with the measurement of fair value: * A market instrument that confers net payments on its holder that are equal in value to the fair value of all or part of the employee stock option grant. * A credible information plan that enables prospective buyers and sellers to price the instrument. For example, the plan should provide information about the exercise behavior of the employees in the grant. It should be easily accessible to all market participants to reduce the potential for adverse selection. * A market pricing mechanism through which the instrument can be traded to generate a price. It should encourage participation in the market in order to promote competition among willing buyers and sellers." The plans designed so far didn't make it on the first criterion because they were "terms and conditions" models They attempted to mime the restrictions placed on the employees, rather than actually tracking the ultimate values of employee options. And apparently there wasn't going to be enough "credible information" available to enable prospective buyers and sellers to price the options. By outlining what would be acceptable to the Commission, however, Spatt has probably made some investment bankers very busy over the weekend. His memo will serve as a Rosetta Stone for the development of new products and pitches. I don't think this is the last we'll hear of these instruments.

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