‘Option Accounting Is Legitimate’
Source: The Kansas City Star (Kansas City, Missouri)
Amid a storm over stock options and top executives’ personal finances, Sprint Corp.’s chief financial officer on Thursday reiterated that the company’s accounting for options is clean.
“Sprint’s treatment on the exercise of options is entirely consistent with IRS rules and regulations,” said Robert J. Dellinger, executive vice president and chief financial officer, in an interview with The Kansas City Star. “We complied fully with all tax rules and requirements.”
Dellinger’s comments came in response to a story in The Wall Street Journal that appeared to raise questions about $678 million in “tax benefits” Sprint reaped when employees exercised stock options in 1999 and 2000.
The report prompted a brief sell-off in Sprint shares before they recovered some ground. Sprint FON shares closed for the day at $12.15, down 41 cents. PCS shares closed at $3.68, down 14 cents.
Sprint officials said the Journal story, which they said implied that Sprint’s accounting for stock options inflated company results, was misleading and contained factual errors.
In a memo to employees Thursday afternoon, Dellinger and J. Richard Devlin, Sprint’s general counsel, told employees to “be assured that our financial reporting is accurate and in full accordance with the law and accepted accounting principles.”
Taking a corporate tax deduction on gains when employees exercise their stock options is a commonly accepted and perfectly legal accounting practice, Dellinger said.
“Our tax treatment of options is consistent with IRS rules and regulations, and the accounting treatment is consistent with U.S. GAAP (Generally Accepted Accounting Principles),” Dellinger said.
The rare public response from a top Sprint executive came near the end of a third week of tumult for the Overland Park telecom giant.
Sprint’s board of directors is working to replace William T. Esrey as CEO with Gary Forsee, a former Sprint executive and current BellSouth Corp. vice chairman. Forsee’s arrival in Kansas City, however, has been delayed by ongoing litigation brought by BellSouth and Cingular, a wireless company owned by BellSouth and SBC Communications Inc.
Both Esrey and Sprint’s president and chief operating officer, Ronald T. LeMay, who also is expected to leave the company, will stay in their current positions at Sprint until a new CEO is on board.
The tortuous management transition was prompted, at least in part, by the two executives’ personal financial problems.
Esrey and LeMay used tax strategies recommended by Ernst & Young, which also is Sprint’s corporate auditor, to shelter taxes on stock option gains in 1999 and 2000. The Internal Revenue Service is auditing the tax shelters, which Ernst & Young continues to defend.
Sprint’s independent directors, apparently concerned by potential tax problems for Esrey and LeMay that could put them at odds with the company’s auditor, have chosen to bring in new management.
Despite the management turmoil and the executives’ personal financial issues, accounting experts say the way Sprint has accounted for options has been normal and aboveboard.
Accounting rules require a company to offset on its balance sheet the value of stock options exercised by employees. The company is allowed to deduct that value as an expense against its tax bill.
“That’s no different than your salary,” said Lavern Krueger, an associate professor of accounting at the University of Missouri-Kansas City. “It shows up on your W-2 and your employer gets a deduction. There’s a balance sheet here. One party gets compensation and the other party gets a deduction.”
If a company loses money in the years that options are exercised — as was the case for Sprint during 1999 and 2000 — the company can reserve the deduction for up to 20 years to deduct against future profits.
One compensation expert said Sprint’s situation may have raised eyebrows at the IRS because the executives’ part of the equation may not have materialized.
Graef Crystal, an executive compensation consultant and columnist who has written critically about Esrey’s and LeMay’s compensation and performance, said the IRS may be disturbed that when tax shelters are used, companies are able to take full deductions, but the executives may not be paying what the IRS considers the full taxes.
Despite that concern, accountants agreed that Sprint would not be on the hook for how its employees handled the options. Once options are exercised, the employee can do with them what he or she chooses. And once options are vested, the company has no control of when they are exercised.
According to regulatory documents, Sprint booked a $254 million tax gain for stock option gains in 1999, a $424 million tax gain in 2000, and — as the company’s stock value plummeted — a $17 million tax gain in 2001.
The suggestion that Sprint could manipulate when options are exercised so the company could benefit financially simply doesn’t pan out, Sprint officials and outside accounting experts said. For one thing, Sprint has no control over when an employee decides to exercise options, which triggers the accounting adjustments.
“Options can only be exercised when they’ve been vested under the option agreement and at the discretion of the option holder,” Dellinger said. “The company does not determine when options are exercised.”
Dellinger and other Sprint officials declined to discuss another twist to the unfolding story.
In late 2000, as concerns about personal tax liabilities mounted, Sprint executives reportedly looked into rescinding stock options for that year so executives could avoid tax liability. As Sprint’s stock dropped in price, the stock options became worth less than the tax liability incurred when they were exercised.
Although top Sprint executives explored rescinding the options, they decided not to. A source familiar with the situation said the decision was made by Esrey and LeMay and not by the board.
Even though Esrey and LeMay knew rescinding the options could help them deal with their personal tax situations, sources familiar with the situation said, they opted not to pursue it after determining that reversing the transaction would be harmful to the company’s shareholders.
LETTER FROM WILLIAM T. ESREY TO SPRINT EMPLOYEES:
As a company, we’ve weathered some difficult times over the past few years. The entire telecom industry has been engulfed in an almost perfect storm. We are all aware of the issues and challenges — destructive pricing practices, oversupply of capacity, stock price collapses, work force reductions — the list goes on.
During this tumultuous period it would have been easy for each and every one of you to be distracted, to complain, or even jump ship. But I never saw any of you waver and, in fact, you worked even harder to make Sprint successful and financially sound.
I know that it pains you to see Sprint at the center of what I can only describe as a media frenzy. I can handle the rumors and speculation aimed at me personally. But I become quite angry when I see misguided articles and suppositions that question the viability of our company, the successes that you have created and achieved, our ability to compete and our future prospects.
With all the commotion, it is easy to lose sight of what is Sprint’s real story — groundbreaking innovation, improving operating performance, and a growing number of satisfied customers. That’s testimony to the tens of thousands of associates who operate this company with unquestioned integrity. You never missed a beat. Our 2002 financial results dramatically demonstrate that even in very difficult times we still are quite profitable, and I believe our prospects for 2003 are even brighter. While others crumbled, we persevered.
Amid the distractions, rumors and gossip, it is important not to lose sight of what draws us together. Sprint is more than just another telecommunications company. It is an institution that has been passed from one generation to the next. Our 103-year-old company has grown from servicing the back roads and byways of rural America to become a global telecommunications force.
Just look at what we have accomplished. Back in the mid-1980s we were called foolish by the “experts” for even considering building a nationwide all-digital, fiberoptic network. AT&T had just laid out a 30-year capital improvement plan that said by around 2010 it would have an all-fiber network. One analyst questioned at that time, “Why would anyone try to build fiber across the Rocky Mountains?” But Sprint accomplished what many said couldn’t be done and our long-distance operation was born. To catch up, AT&T built its own fiber network and in the process was forced to write down billions of dollars in assets.
In the mid-1990s, we spun off to shareholders our small cellular operation to focus on constructing a nationwide digital wireless personal communications network. We were criticized then for choosing CDMA, a new technical standard that held great promise but was different from the GSM technology employed in Europe. But the facts speak for themselves. Sprint PCS went from no revenue to $10 billion in revenues faster than has ever been done in the history of American business.
Have we made some mistakes? Sure, we have. With 20-20 hindsight we should have ended our investment in ION sooner in response to changing market conditions. In the same vein, we should have realized earlier that our Clear Pay PCS product needed revamping as the credit quality of the customers slipped.
What about the future? I think we are just scratching the surface with our wireless network, and with our ability to offer integrated products and services, we have a great opportunity. I know some say there is no growth left in either the telecom industry or with Sprint. Well, all I can say to that is to take a hike and go elsewhere. We’ve proven the critics wrong so many times that I get tired of talking about it.
Sprint has been successful, and will continue to be successful, because you have repeatedly found a way to combine our vision, values and rich heritage with your work ethic, dedication, skills and professionalism.
Nothing that the industry has faced in the past three years (or that has been reported in the media) changes what Sprint stands for. Sprint is enduring. Sprint is a leader in an industry that needs leadership. Sprint is solid. Sprint is a part of every one of us who works here, and we are each a part of Sprint.
Every year, when the Employee Attitude Survey results come in, I have been impressed, but not surprised, by the top scoring category — “I am proud to work here.” The Sprint spirit does not ebb and flow. It is a steady, calming influence during tough days, and a grounding value in the best of times. The Sprint spirit transcends uncertainty and reminds us of our duty.
I want to thank you all for your continued focus on our business, our customers, our shareholders and each other. I continue to be impressed by your dedication. Thank you for living and working the Sprint way. If you keep that spirit, and I know you will, the rest will take care of itself.
Sincerely,
Bill Esrey
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(c) 2003, The Kansas City Star, Mo. Distributed by Knight Ridder/Tribune Business News.
FON, BLS, SBC, T, PCS
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