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Project on Government Oversight

POGO Letter to Cost Accounting Standards Board, Dr. Rein Abel Regarding Advance Notice of Proposed Rulemaking (ANPRM) on Accounting for the Cost of Employee Stock Ownership Plans (ESOPs)

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November 18, 2003

Dr. Rein Abel
Director of Research
Cost Accounting Standards Board
Office of Federal Procurement Policy
725 17th Street, NW, Room 9013
Washington, DC 20503

Via facsimile: (202) 395-5105

ATTN: CASB Docket 00-03A

Dear Dr. Abel:

Thank you for the opportunity to comment on the Cost Accounting Standards (CAS) Board's Advance Notice of Proposed Rulemaking (ANPRM) on "Accounting for the Cost of Employee Stock Ownership Plans (ESOPs)" by government contractors (68 FR 50111, Aug. 20, 2003). The Project on Government Oversight (POGO) is a non-partisan, non-profit organization that has, for over 22 years, investigated, exposed and worked to remedy abuses of power, mismanagement and subservience to special interests by the federal government. POGO has a keen interest in government contracting matters, especially those relating to the ongoing activities of the CAS Board.

POGO strongly supports the concept of ESOPs, as pointed out in POGO's response dated November 14, 2000 to the CAS Board's Staff Discussion Paper on this topic (65 FR 56008, September 15, 2000). ESOPs are a powerful tool in promoting capital ownership by workers and managers at employing corporations. Notwithstanding POGO's continuing support for ESOPs among government contractors, as well as all segments of the American business community, we have strong concerns about accounting for ESOP costs under government contracts. Unfortunately, the CAS Board's ANPRM appears to mostly concede to government contractors significant issues relating to ESOP cost measurement. While POGO understands the rationale for the CAS Board's adoption of the so-called "contribution" approach for cost measurement, we believe that the Board's approach falls far short of what is needed for clear transparency in government contract costing.

A Positive Aspect of the CAS Board's Proposal

POGO supports the CAS Board's proposal to require that ESOPs be accounted for in a uniform manner, without regard to the form of the ESOP (i.e., its classification as either a so-called "pension" or "deferred compensation" ESOP). The Board's proposal to amend CAS 9904.415 "Accounting for the Costs of Deferred Compensation," to require that all ESOPs be accounted for under that Standard, and no other Standard, is sound. The Board's proposal will increase uniformity among government contractors in like circumstances, and reduce the options available for disparate accounting treatment of ESOP expense (i.e., whether to account for ESOPs under CAS 9904.412 or 9904.415).

CAS Board Concessions to Industry

While POGO commends the CAS Board for eliminating ESOP accounting alternatives among government contractors, we believe that the CAS Board has failed in one significant aspect of its proposal. Permitting contractors that sponsor leveraged ESOPs to treat the entirety of the ESOP contribution as a form of employee compensation under CAS 9904.415, masks the true nature of the underlying economic transaction.

POGO notes that the CAS Board has proposed to account for ESOPs using an approach similar to the one originally prescribed by the American Institute of Certified Public Accountants (AICPA) in its Statement of Position (SOP) 76-3. However, unlike the present CAS Board proposal, SOP 76-3 required separate disclosure of the interest and compensation elements of ESOP expense. As the CAS Board is aware, SOP 76-3 was superseded by SOP 93-6, which adopted a different approach that focused on shares transferred to individual employee accounts. The present CAS Board ANPRM stipulates that shares of stock should be valued when a contribution is made to the trust (i.e., employee stock ownership trust). On the other hand, current GAAP, as outlined in SOP 93-6, prescribes that shares should be valued when they are irrevocably transferred to individual employee accounts. It is POGO's understanding, from the preamble to the ANPRM, that use of SOP 93-6 valuation principles raised concerns among some that the government might share in the risks associated with contractor stock price fluctuations.

Nevertheless, POGO believes that the CAS Board's proposal is seriously flawed in one very important respect. The CAS Board's proposal will permit contractors to mask interest expense incurred to finance leveraged ESOPs as a form of "employee compensation." This is because the Board's proposal defines measurement of periodic ESOP expense as the amount contributed to the ESOP (i.e., ESOT) by the contractor. In essence, this will permit contractors to treat the entire contribution paid to an ESOT - including interest expense incurred to finance a leveraged ESOP, along with the principal repayment - as deferred compensation. This approach appears to be designed to mask the fact that substantial sums are being expended by taxpayers to finance leveraged ESOP arrangements among government contractors. These arrangements are used to make additional liquid capital available to contractors. There appears to be no assurance that this infusion of capital, the cost of which is reimbursed by taxpayers, will be used to benefit contractors' operations that benefit the federal government customer. From a contractor's perspective, the ability to charge this interest expense to taxpayers is, no doubt, quite attractive. However, the proposed changes to CAS 9904.415 will mask transparency of financial data submitted by government contractors.

POGO believes that interest expense incurred to finance leveraged ESOPs should be reflected as such under government contract cost accounting rules. Accordingly, we strongly oppose any attempt by the CAS Board, or government contractors and their allies, to mask interest expense as anything other than what it is -- taxpayer provided corporate financing.

POGO understands that one reason for industry pressure on the CAS Board in this regard, is because if the CAS Board adopts a rule requiring the accounting segregation of interest expense for leveraged ESOPs, current government cost allowability rules (FAR 31.205-20), would probably require these costs to be disallowed. This would have the effect of disallowing hundreds of millions of dollars a year in taxpayer provided financing for contractors.

Clearly, there are public policy concerns associated with allowing interest costs for leveraged ESOPs to be financed with public funds. However, the CAS Board should not be a party to this debate from an accounting perspective. The role of the CAS Board should be to foster financial transparency. Whether Congress, or the Executive Branch agencies, chose to allow or disallow interest costs associated with leveraged ESOP financing should be discussed and debated as public policy matter separate and apart from the CAS Board's accounting role in defining and measuring contract costs.

Unfortunately, the approach being proposed by the CAS Board seems to pretend that there is no interest being paid to contractors. One irony of this approach is that current GAAP as reflected in SOP 93-6 requires that the interest component of a leveraged ESOP (i.e., the so-called "financing element") be disclosed in financial statements. During the past several years, contractors have often blindly called for the replacement of CAS with GAAP. However, in this specific instance, when GAAP appears to requires greater financial transparency than CAS, no such calls are being heard from contractors.

Conclusion

POGO is pleased to see the CAS Board move to address the issue of ESOP contract cost accounting. We commend the Board for requiring that ESOPs be uniformly accounted for under one Standard. However, we strongly disagree with the Board's approach with respect to the treatment of interest costs for leveraged ESOPs. At a minimum, the Board's proposal should be amended to require the segregation of the components of periodic ESOP expense, so that repayments of loan principal can be distinguished from interest expense.

Any discussion of whether interest expense on leveraged ESOPs should be an allowable cost under cost-based government contracts is an issue where the CAS Board's only concern should be one of financial transparency and full disclosure.

Again, as in the past, POGO urges the CAS Board to place greater importance on the financial implications for taxpayers, rather than those of contractors.

Sincerely,

Danielle Brian
Executive Director

cc: CAS Board Members
Executive Secretary, CAS Board

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