FairTax, doom, and net-net

James Rogers jamesr at best.com
Thu Apr 10 12:30:12 PDT 2003

From: Russell Turpin
> Yeah, there is some nitty-gritty there. You
> didn't name the obvious biggie: stock options
> in companies that aren't yet public. But
> really, I don't think it would be that much
> of a problem. (a) In the case of a fungible
> intangible with current or future market
> value, such as stock options, the tax is paid
> in kind. An agency similar to the Resolution
> Trust Corporation is created to hold and sell
> such instruments at such time as they become
> liquid.

Employee stock options are a problem in no small part because of how the SEC
structures and regulates securities.  I think the problem could largely be
fixed by a simple SEC rule change.  Specifically, eliminating the "qualified
investor" rule or greatly relaxing the restrictions.  The existing rules
actually break the standard models of financial theory for these instruments
and in a sense trap the investor in ESOs because the current regulations
essentially prevent savvy investor behavior for these "non-securities".

A preferable model would be treat employee stock options more like warrants,
which is essentially what they are, except that warrants are securities and
therefore have a qualified investor restriction.  Unlike employee stock
options, warrants don't have to be monetized to be "securitized" and behave
essentially like marketable call options with very long expiration periods.
The only tweak would be to defer the granting tax hit until the security had
been sold or exercised.  Additionally, because warrants are securities they
have always immediately shown up in the corporate bottom-line, without the
monkey business that has surrounded option accounting.

Financial theory generally states that it is suboptimal to exercise options
early, but the perverse arrangement of the ESOs not only encourages this
behavior but aggravates the risks.  By making ESOs have most of the
essential properties of stock warrants, I think you could clean up the vast
majority of the tax and accounting problems surrounding them.  


-James Rogers
 jamesr at best.com

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