I discussed, or had e-mail exchanges about, the CVI Report with a number of leading valuation, accounting and auditing experts, including current and former accounting and auditing standard setters and regulators (and including Mr. Balsam). The general consensus of those experts was that they agreed with Mr. Ross’ conclusions. Many of those experts also indicated that Zions ESOARS, as currently structured, violates the spirit of the principles-based fair value measurement guidance set forth in FASB Statement no. 123(R), Share-Based Payment .

As a leading voice for credible financial reporting of stock option compensation costs, the Council of Institutional Investors believes that the CVI Report should be required reading for every chief financial officer, audit committee member, external auditor and regulator of a company that is currently using, or is contemplating the use of, Zions ESOARS to value their employee stock option costs. To ignore such information raises issues of professional responsibility, particularly for auditors and other CPAs.

Jeff Mahoney, CPA
Washington
Mahoney is general counsel
for the Council of Institutional Investors.

Author’s reply: I have reviewed the CVI report. Dr. Ross, the primary author, is a renowned academic, known in particular for his role in developing the binomial model many now use for valuing stock options. Consequently, his views are not to be taken lightly.

As pointed out in my article, the SEC, while finding ESOARS acceptable (with the emphasis on “acceptable”), set conditions that should be met for each auction to qualify as an appropriate market-pricing mechanism. Those conditions (for example, the size of the offering, number of bidders, etc.) are similar to those pointed out by Dr. Ross, and need to be considered by auditors before they accept the results of the auction for valuation purposes.

I should note that my article merely attempted to give a balanced account of the ESOARS, and the issues surrounding it. While I find ESOARS to be an innovative attempt to attach a market value to employee stock options, corporations need to consider the benefits and costs of ESOARS in deciding whether the security is right for them. As a postscript, please note the SEC, after considering the concerns of the Council of Institutional Investors, recently gave Zions Bancorp the final clearance to use ESOARS.

Steven Balsam, CPA, Ph.D.
Philadelphia

The most insightful question was, “How can more principles-based standards work in the U.S….?” His answer was, “No one wants to exercise judgment…it is less predictable how the courts would react to the judgment calls made by preparers or auditors….”

So my second question is this: When did “rules-based accounting” replace the preparer’s and the auditor’s judgment? What standard was that? Who decided this? Have courts and regulators thoroughly and completely discredited our judgment? If so, then why do states license us?

By way of reference, consider the article, “ It’s Time to Simplify Accounting Standards,” (March 99, page 65) by Dennis Beresford. A reprint of that may be timely. Today, international standards, a “principles-based” approach, are on the verge of overwhelming our arcane, brittle and increasingly obsolete U.S. GAAP.

I applaud the JofA for its interview with Pozen. Please continue to actively cover the continuing demise and collapse of “rules-based” accounting.

Samuel H. Coppock, CPA
Chandler, Ariz.

Editors’ note: In general, bylines in the JofA are reserved for authors. In the case of the interview with Mr. Pozen, the JofA solicited potential questions from a variety of technical experts. Several members of the JofA staff worked together to edit the questions and coordinate various elements of the interview.

Mr. Beresford’s article is available here.

Audit committees should function at varying stages of performance—in the same manner as does a manager in relation to new employees, a president in relation to senior executive vice presidents, a nation in relation to its neighbor nations. As reliable evidence of quality performance persists, oversight responsibilities are reduced. I was reminded of this when I read one sentence in the article—a potentially powerful one: “Members of the audit committee are role models.” By its performance, the audit committee may elevate performance throughout the company and, therefore, change the nature of the committee’s oversight strategies.

I would like to see the insightful authors explore the observations, the reports, the insight from conversations with management that are critical for a reliable judgment of executive leadership quality. What evidence gives an audit committee—as well as the board—assurance that executive leadership has reached a level of consistent behavior that trust is warranted?

Effective, wise oversight leads to less need for such oversight, not more. Wise parents, wise supervisors, wise company heads implement this simple observation. While it appears somewhat Utopian, it is attainable for an audit committee, too.

Mary Ellen Oliverio, CPA
New York City