NAREIT Submission to FASB on Stock Compensation
June 29, 1999
Mr. Timothy S. Lucas
Director of Research and Technical Activities
Financial Accounting Standards Board
401 Merritt 7
P.O. Box 5116
Norwalk, CT 06856-5116
RE:Proposed Interpretation - Accounting for Certain Stock Transactions involving Stock Compensation - an interpretation of APB Opinion No. 25
Dear Mr. Lucas:
The National Association of Real Estate Investment Trusts (NAREIT) is pleased to have the opportunity to respond to the Financial Accounting Standards Board's (the Board) proposed interpretation of APB Opinion No. 25 (the Interpretation). NAREIT is the national trade association for REITs and publicly traded real estate companies. Members include real estate investment trusts (REITs) and other businesses that develop, own, operate, and finance income-producing real estate, as well as those firms and individuals who advise, study, and service these businesses.
The business of developing, owning and operating income-producing property often involves the use of stock-based compensation to employees and others providing services to the company. In this context, the standards for accounting for stock-based compensation is important to producing useful financial reports for publicly traded real estate companies.
Although NAREIT generally agrees with the Board's conclusions in the Interpretation, we request that the Board consider modifying its conclusions with respect to the following two issues: (1) stock options issued to employees of an unconsolidated subsidiary; and (2) stock options issued to independent members of an entity's board of directors.
Stock Options Issued to Employees of an Unconsolidated Subsidiary
REITs exist under specific provisions of the Internal Revenue Code whereby 95% of a REIT's gross income must be derived from "qualifying income" including rents, dividends and interest. In addition, REITs may not own more that 10% of the voting shares of a taxable entity. In order to transact business that does not generate qualifying income, REITs or their consolidated operating affiliates (collectively "Parent") widely utilize tax-paying subsidiary entities. The typical ownership structure has the Parent owning less than 10% of the voting shares and generally 90% to 100% of the non-voting preferred shares, with the Parent entitled to 90% to 99% of the economic interests of the taxable entity. The entities are commonly known as "Preferred Stock Subsidiaries" or "Third Party Subsidiaries."
To comply with the REIT rules, management of these subsidiary entities is generally carried out by individuals who are technically not employees of the Parent - they are employees of the subsidiary entity. At the same time, these individuals are treated like any other employee of the Parent in terms of compensation programs, benefits, etc., including stock-based compensation. More importantly, the Parent-company management generally exerts significant influence over when, where and how results are achieved by managers of these Preferred Stock Subsidiaries. Therefore, in accordance with paragraph three of the Interpretation, the employees of the Preferred Stock Subsidiary are, for economic purposes, employees of the Parent company.
Under current accounting standards, the great majority of these taxable REIT subsidiaries are not consolidated, but are instead accounted for using the equity method. Pursuant to paragraph 10 of the interpretation, options granted to these employees would not be accounted for under Opinion 25. We request that the Board provide an exception in its interpretation specifically for employees of unconsolidated Preferred Stock Subsidiaries in which the REIT or its operating affiliate, through its preferred stock ownership, is entitled to substantially all of the economic benefits of the subsidiary. For purposes of creating an objective criteria, "substantially all" could be "at least 90%."
Stock Options Issued to Independent Members of an Entity's Board of Directors
Although a company's independent directors are, by definition, not employees of the company, they have a unique relationship between the company and its stakeholders. On one hand, these directors must maintain an appropriate level of independence from management and manage conflicts between the interests of shareholders and management. At the same time, in order to align director interests with the interests of shareholders to an appropriate extent, the shareholders of many public companies have approved stock option plans for independent directors. Because of this unique position of independent directors and due to wide-spread use of option grants to directors, we urge the Board to provide in the Interpretation that these grants be accounted for under Opinion 25.
If you have any questions regarding this response, please call George Yungmann at (202) 739-9432, David Taube at (202) 739-9442, or me at (713) 866-6054.
Stephen C. Richter
Treasurer, Weingarten Realty
Co-Chair, NAREIT Accounting Committee