August 31, 2005

KPMG and Deferred Prosecutions

The deferred prosecution of KPMG by the U.S. Department of Justice regarding KPMG's sale of abusive tax shelters to individuals continues to receive quite a bit of press. A "deferred prosecution" agreement is an agreement under which the government can still seek an indictment of the firm until if it violates the settlement during a certain period of time (in KPMG's case, until the end of 2006). The government is increasingly turning to deferred prosecutions as a means of protecting jobs and businesses.

We have posted a copy of KPMG's 28-page deferred prosecution agreement in our "Securities Litigation" Practice Area, where there also is this Wachtell Lipton memo on Bristol Myer's recent deferred prosecution agreement.

Interestingly, the PCAOB put out this statement about how it remains confident in KPMG's ability to perform high quality audits of public companies. In comparison, the SEC Chief Accountant's statement on KPMG is much more "regulator-like" in tone - notably, it states that KPMG's prior conduct "does not require or call for Commission action."

Sorry About that Reg FD Gaffe

As I wrote this Reg FD blog yesterday, I heard this voice call out, "dude, you need a Reg FD refresher." Sure enough, I received a few emails from astute members providing that refresher. Here is one of them: "You may have slipped down a slope. FD does not prevent all privileged access: only those to the enumerated financial audience. No problem showing a sneak preview to a bunch of movie reviewers, or telling a reviewer that you've signed Brad (aren't the reviewers like any news reporters - ok under FD) or even to showing it to a bunch of randomly selected college students, but if you are showing the movie to analysts, there is only one reason. Yes, they may be taking all of the fun out of the analysts' jobs, but it doesn't seem like a stretch."

FASB Reexamines GAAP Hierarchy

One of the first things I did when I got this job was post an explanation of the GAAP hierarchy, because that was always a confusing concept to me when I began my career as a corporate & securities lawyer - that explanation is posted in our "Accounting Overview" Practice Area.

Now, the FASB is considering changing the GAAP hierarchy, as noted by in this article - which I repeat: "These days, it's rare to find an accounting standard that's not awash in some type of controversy. But with its latest initiative, the Financial Accounting Standards Board has finally given Corporate America nothing to gripe about.

FASB insists that its proposed standard, The Hierarchy of Generally Accepted Accounting Principles, should have little or no impact on the practice of preparing financial statements, in part because it has been effective for decades under the American Society of Certified Public Accountants. The AICPA established the five levels of hierarchy in 1975 in Statement on Auditing Standard No. 69, which defines GAAP and provides accountants with guidance on where to turn for answers to certain questions: FASB standards, the Emerging Issues Task Force, and so on.

FASB and many other practitioners, however, have maintained that the board should issue its own standard, directed at companies and other reporting entities — which, after all, are responsible for selecting the accounting principles used in their financial statements — in place of the current standard, which is directed at auditors. In FASB parlance, its proposal "moves the GAAP hierarchy for nongovernmental entities from the auditing literature to the accounting literature."

Former FASB chairman Dennis Beresford observes that after all the "earth-shattering changes" introduced over the past couple of years, the business community will likely welcome the board's latest statement with a sigh of relief. Beresford, now an accounting professor at the University of Georgia, recalls that during his tenure at FASB, accountants would often joke with him that every once in a while, the board should "do something that isn't controversial." The hierarchy project comes pretty close, he says.

Last Wednesday the board reexamined certain areas of its exposure draft; for the most part, the board members stood by their conclusions and the staff recommendations. The one big issue that arose, as it did last November, concerned the elimination of an exception to Rule 203 of the AICPA Code of Professional Conduct. That exception allows auditors to deviate from the GAAP hierarchy in unusual circumstances — essentially, only when adhering to the GAAP pronouncements would render a company's financial statements misleading.

Beresford, for one, cannot remember a case where the exception has been invoked. The issue has disappeared over the years, he says, "in part because accounting firms didn't want to stick their neck out" and risk legal backlash.

Although 8 of the 32 respondents to FASB's exposure draft on the GAAP hierarchy argued that the Rule 203 exception should be retained, FASB board member G. Michael Crooch says that, in the end, "we determined that we would stick to our guns" and eliminate the exception. It "was almost never used," maintains Crooch, adding that it's very hard to come up with those "unusual circumstances" that would make financial statements misleading and the GAAP literature inappropriate.

Under the proposed rule, FASB's statement on the GAAP hierarchy will be effective for periods beginning after September 15. The date was chosen to coordinate with the effective date of literature from the AICPA and from Public Company Accounting Oversight Board that will be amended as a result of FASB's statement."

August 30, 2005

Hollywood's Troubles with the SEC: Now That You Are Publicly Owned

A number of members have sent me emails over the past few months about how Hollywood is being investigated by the SEC. After Friday's WSJ article about how the SEC has allegedly launched an informal inquiry into Pixar's recent DVD sales troubles of the "The Incredibles," I thought it was time to weigh in.

This latest development follows disclosure by DreamWorks a few months back that the SEC is looking into whether that company should have informed investors earlier of the problems it was facing regarding sales of "Shrek 2" DVDs. From the article, you get a sense that both companies are having trouble adapting to being publicly held and staying consistent on "message." In other words, the company's PR machines are saying optimistic things about DVD sales - but SEC filings are saying something else (and more realistic).

This important change in communication practices is always hard for newly public companies, but I gotta believe it's even harder for companies in the Hollywood spotlight.

When Do You Disclose That You Are Being Investigated?

The WSJ article highlights the fact that DreamWorks has disclosed the fact it is being informally investigated by the SEC, while Pixar has not. The end of article notes: "The question of whether companies are under obligation to inform the market if they are under investigation is a gray area: companies are under obligation to report matters they believe to be material events. After the wave of recent corporate scandals, some companies have been more conservative in assessing what constitutes a material event, however."

In our "SEC Enforcement" Practice Area, we have a set of "Disclosure of SEC Investigation FAQs" as well as sample disclosures of all kinds of SEC enforcement activity. The FAQs address:

- Is there a duty to disclose the commencement of an SEC investigation?

- Will the SEC make public the existence of the investigation on its own?

- When do companies typically disclose the existence of an SEC investigation?

- What should the company do once it decides to disclose the existence of an SEC investigation?

By the way, DreamWorks' disclosure is simple (first disclosed in this 8-K and repeated in this recent 10-Q): "In July 2005, we announced that we had received a request from the staff of the SEC and are voluntarily complying with an informal inquiry concerning trading in our securities and the disclosure of our financial results on May 10, 2005. The SEC has informed us that the informal investigation should not be construed as an indication that any violations of law have occurred. We are cooperating fully with the inquiry."

Regulation FD at the Movies

One curious item in the WSJ article is a mention that the SEC reportedly is exploring "industrywide topics such as whether showing a gathering of analysts a prescreening of a movie constitutes disclosure of material information to a group of select people." I guess the concern is that analysts attending sneak previews would have a leg up on whether a movie might be a blockbuster.

In my mind, this is a bit of a stretch - and if it came full circle, I guess all sneak previews would be shut down going forward. But if you followed the logic of that slippery slope, I would imagine a lot of Hollywood gossip could be actionable if attributable to the company - isn't the leak that Brad Pitt has signed on for a movie more material than seeing a sneak preview? Wrong - as I explain in tomorrow's blog.

August 29, 2005

Court Ruling May Prompt SEC to Alter Use of Civil Injunctions

Last Thursday, the WSJ ran this article regarding the recent 11th Circuit decision in SEC v. Smyth. Russ Ryan, a former Assistant Director of the SEC's Enforcement Division, who is now at King & Spalding LLP explains further:

"In a startling footnote 14 at the very end of the opinion, the court dropped a bombshell that questions the enforceability of just about every injunction the SEC has obtained in recent memory. The court essentially said an injunction can't be just a broad prohibition against future violations of a statute or rule, because all that does is tell the defendant to "obey the law" without specifying what particular acts are prohibited.

Although the footnote is dictum in a technical sense, the case could have far-reaching consequences for the SEC's enforcement program. The injunctions in Smyth were no different than any other SEC injunction, at least as far as settled cases go. That is, they simply tracked the language of the relevant statutes and rules, and told the defendants and their cohorts not to violate them again.

At a minimum, district courts within the 11th Circuit presumably won't be signing off on future settlements with similarly worded injunctions. So unless the 11th Circuit somehow retracts it criticism of such language, the SEC is going to have to get more specific in any injunctions it seeks within that circuit, or it will have to file its cases elsewhere. And, of course, if other federal courts are persuaded to follow Smyth's logic, they won't sign off on the usual form of SEC injunctive language either, and will probably dismiss any SEC contempt proceedings that are based on injunctions already out there.

But beyond forcing the Commission to reassess the breadth of its typical injunctions, I hope Smyth will get people thinking about whether the SEC should even be seeking injunctions in a lot of its cases. When many enforcement cases are filed, there is no ongoing misconduct or realistic threat of repetition, and the SEC can achieve adequate punishment and deterrence through monetary penalties, yet the Commission invariably insists on an injunction anyway, often tanking potential settlements. Smyth presents a good opportunity to consider whether that approach still makes sense in every case."

Believe It or Not: Sarbanes-Oxley for Dummies

A small blurb in Friday's WSJ alerted me to the upcoming publishing of a "Sarbanes-Oxley for Dummies" book, due sometime in February. A few immediate thoughts: Is there really a market for this stuff outside our small niche of compliance practitioners - and ain't it a little late?

By the way, if you are new to SOX and want to "one-stop" it (rather than drill down through the 200+ Practice Areas on our site) - we have highlighted some comprehensive memos about SOX in our "Sarbanes-Oxley" Practice Area. Surely, the Latham Watkins and Fried Frank memos posted there - both over 200 pages - will serve you better than a "Dummies" book...

KPMG Avoids Death Penalty

It is reported that KPMG has finalized an agreement that will not include an indictment for the firm itself - although indictments against some former KPMG partners, as well as members of investment banks and law firms who helped structure the deals, which is rumored to be announced separately today.

Apparently, there is a detailed and lengthy statement of facts in the agreement, in which KPMG admits to developing and selling questionable tax deals to hundreds of wealthy clients - and KPMG agrees to pay $456 million and submit its tax unit and compliance efforts to a stringent 16-month review by former SEC Chair Richard Breeden.

August 25, 2005

A New 10-K Disclosure Item

There is a new 10-K disclosure item created by the Jobs Act. This Cleary Gottlieb alert sums it up best: "This is to alert you to a new Form 10-K disclosure item that you will not find in any of the usual places. Section 811 of the American Jobs Creation Act of 2004 added a new Section 6707A to the Internal Revenue Code. Section 6707A(e) of the Code provides for the imposition of a tax penalty, in the amount of $200,000, for the failure by a taxpayer to disclose certain tax information in its Form 10-K filed with the SEC. On August 12, 2005, the IRS issued rules, in the form of Revenue Procedure 2005-51, implementing the disclosure requirement.

Generally, the Form 10-K disclosure requirement is triggered if the registrant, or any entity "required to be consolidated with [the registrant] for purposes of the" Form 10-K, is required to pay a penalty to the IRS arising from a failure to satisfy special tax return disclosure requirements applicable to certain types of transactions that have been identified by the IRS as abusive or that have a significant tax avoidance purpose.

The penalty under Section 6707A(e) of the Code also applies to a failure to include the required disclosure in the Form 10-K. Thus, the Revenue Procedure makes it clear that "the obligation to disclose on each successive Form 10-K filed will continue until the person actually discloses its requirement to pay each of the penalties [and] each failure to disclose . . . will give rise to a new, separate penalty . . . that also must be disclosed."

Generally, the disclosure is required in the Form 10-K for the year with respect to which the IRS demands payment of the applicable penalty. The Revenue Procedure includes specific instructions concerning the nature of the information required to be disclosed. It appears that this disclosure obligation does not apply to registrants that file on Form 20-F.

Obviously, we suggest that persons responsible for the Form 10-K coordinate with their tax colleagues to ensure that they are aware of any demand by the IRS relating to any tax penalty that may give rise to a disclosure obligation."

Implementing Fraud Prevention Training

In this podcast, Peter Goldmann, Editor & Publisher of the "White-Collar Crime Fighter," explains how to implement a compliance training module for fraud detection and prevention, including:

- How do companies know if they need to enhance their existing fraud prevention programs?
- How is Web-based learning effective for fraud prevention?
- How exactly do employees take these Web-based courses? How do you gauge their effectiveness?
- What other techniques are available to provide fraud detection training to employees?

We have added this podcast to our many resources in the "Compliance Training" Practice Area.

KPMG Looks Like It Will Remain In The "Final Four"

Today's WSJ runs an article noting that federal prosecutors were negotiating a possible settlement with KPMG - and have tentatively tapped former SEC Chairman Richard Breeden to serve as an outside monitor at the accounting firm. The article says the two sides were close to an agreement, under which the KPMG would avoid a criminal indictment in connection with its past sales of tax shelters to hundreds of wealthy individuals. That is good news - as we need the Final Four (as I blogged a few months back)!

August 24, 2005

Draft Time & Responsibility Schedules for '33 Act Reform Offerings

As part of our "Drill Down" series of webcasts on the '33 Act reform, we have posted draft T&R Responsiblity Schedules in our "Securities Act Reform" Practice Area to help you think about how deals will look like after December 1st. The samples below are just drafts as the reform is so new and there is some uncertainty as to how some of the rules will be interpreted - and how bankers/lawyers will apply them. Please send comments to me as you look at these:

- Draft Time & Responsibility Schedule - WKSI Equity Offering
- Draft Time & Responsibility Schedule - IPO Equity Offering
- Draft Time & Responsibility Schedule - Seasoned Issuer Equity Offering
- Draft Time & Responsibility Schedule - Unseasoned Issuer Equity Offering

More Disney Opinion Analysis

On, in addition to the opinion itself, we now have a horde of law firm memos analyzing the case in our "Disney Opinion and Analysis" section on the home page. In addition, Mike Melbinger has been blogging nearly daily on various aspects of the opinion in his "Melbinger's Compensation Blog." And to get a take on the case from some academics, check out the Conglomerate Blog.

SEC Charges Kmart CEO and CFO for Words, Not Numbers, Fraud

Yesterday, the SEC filed charges against the former top Kmart CEO and CFO for misleading investors about Kmart's financial condition in the months preceding the company's bankruptcy. According to the SEC's complaint, the former officers were responsible for materially false and misleading disclosure about the company's liquidity and related matters in the MD&A section of Kmart's Form 10-Q for the third quarter and nine months ended October 31, 2001, and in an earnings conference call with analysts and investors.

What's interesting in this case is that the SEC is alleging misleading narrative in the MD&A; not bad numbers. The SEC alleges that Kmart's MD&A section didn't disclose the reasons for a massive inventory overbuy in the summer of 2001 and the impact it had on the company's liquidity. For example, the MD&A disclosure attributed increases in inventory to "seasonal inventory fluctuations and actions taken to improve our overall in-stock position." The SEC alleges that this disclosure was materially misleading because, in reality, a significant portion of the inventory buildup was caused by a Kmart officer's reckless and unilateral purchase of $850 million of excess inventory.

August 23, 2005

Surprise! New Changes to the Form 10-Q Cover Page!

Yesterday, the shell company rules became effective - no big deal for many of us, right? Wrong! The shell company rules require all companies to include a new check box on the cover page of the following '34 Act forms: Form 10-K, Form 10-KSB, Form 10-Q, Form 10-QSB and Form 20-F. The new check box relates to whether the registrant is a "shell company" as defined in Rule 12b-2 under the '34 Act.

A cursory review of the 10-Q filings made yesterday indicate that many are not aware of this new requirement. Thanks to Steve Quinlivan of Leonard, Street and Deinard for a heads up - and for his contribution of this Word version of the new Form 10-Q cover page. Note that the SEC has not updated this blank Form 10-Q on its website to capture this change.

Whistleblower Hotline Conflicts Overseas

Last week, I blogged about the quagmire regarding whistleblowing obligations under Sarbanes-Oxley that conflict with some legal requirements in Europe (including the fact that we have posted English translations of the related French court opinions). In this podcast, Miriam Wugmeister, Head of the International Privacy Practice of Morrison & Foerster, explains how the whistleblower hotline conflicts have arisen in France and what companies might consider doing now, including:

- How might companies find that their whistleblowing obligations under Sarbanes-Oxley conflict with laws of other jurisdictions, particularly what is going on in France?
- How does that compare with what is happening in Germany?
- Is there anything that companies can do now to resolve these conflicts?
- What is the Coalition for Global Information Flows?

NYSE Affirmations Due August 30th for Foreign Private Issuers

As a reminder, foreign private issuers listed on the NYSE must file their annual affirmations for the first time by a week from today, August 30th. US companies have already been through this drill at least once. The NYSE has a set of forms applicable to foreign private issuers that is different from those for US companies - scroll down halfway on this "Corporate Governance Documents" page from the NYSE site. Here are instructions about when the affirmation is due and other related tidbits.

August 22, 2005

The Odds on 404 Relief for Small Business Issuers

Late last week, one member asked: "How about some commentary about the likelihood and timing of Section 404 relief for smaller issuers?" One thing immediately sprung to mind - was I being followed to my regular poker game? This is a 20-year old game that my Dad also plays in, so it's not part of the latest poker craze. So I suppose that is enough to qualify me as some sort of oddsmaker - so here goes nothing:

Based on the latest resolution from the SEC's Advisory Committee on Smaller Public Companies - which recommends that 404 compliance for non-accelerated filers should be delayed until mid-2007 - I would say it is fairly likely that the SEC will push back the 404 compliance date for small business issuers.

The odds are enhanced even more given that new SEC Chair Cox recognizes that some counterbalancing of SOX-related directives is now necessary (as it nearly always is after broad reforms) and that COSO might miss its target date to issue internal control standards applicable to small businesses. To put some numbers on it for Vegas purposes - let's call it 3-to-1 in favor of a delay happening.

Majority Voting: Two More Companies Amend Their Governance Guidelines

Following up on the three items that I blogged about Friday regarding majority vote governance guidelines, two additional companies have recently adopted similar policies to Pfizer and Office Depot. ADP amended their bylaws rather than its corporate governance guidelines - and Circuit City's standard is along the lines of Office Depot's version (which I call a "quasi-majority vote" standard for the reasons that I set forth on Friday).

- Circuit City's corporate governance guideline: "Any Director nominee in an uncontested election for whom greater than 50% of the outstanding shares are 'withheld' from his or her election shall tender his or her resignation for consideration by the Nominating and Governance Committee. The Nominating and Governance Committee shall recommend to the Board the action to be taken with respect to such resignation." Here is the related press release.

- ADP's bylaw amendment: "The directors shall be elected by the vote of the majority of the shares represented in person or by proxy at any meeting for the election of directors at which a quorum is present, provided that if the number of nominees exceeds the number of directors to be elected, the directors shall be elected by the vote of a plurality of the shares represented in person or by proxy at any such meeting." Here is the related Form 8-K.

Forget About Moving that Cheese

Went to a dinner party yesterday and saw one of my old law school friends who works in-house at a local public company. He just came back from a week-long strategic retreat for the company's managers over on the West Coast. In the leadership training arena these days, apparently "moving my cheese" is "out" and "teachable point of views" are "in."

Call me a naysayer but I think those retreats tend to be a waste of company resources - like falling backwards into the arms of my colleagues is going to turn a company around. Puh-leese. And in some cases, it can actually backfire. Last one I went to helped me realize that maybe it wasn't such a bad idea to get a new job. Hmmm, so maybe they are a good idea after all!

August 19, 2005

Majority Voting: Disney Latest to Amend Corporate Governance Guidelines A La Pfizer

As noted in this press release, the Walt Disney Co. announced yesterday that they have amended their corporate governance guidelines to provide that any director who receives a "withhold" vote representing a majority of the votes cast for his or her election would be required to submit a letter of resignation to the Board's Governance and Nominating Committee, which in turn would recommend to the full Board whether the resignation should be accepted.

Are There Different Flavors of Majority Vote Governance Guidelines?

Note that Disney's standard parallels the "Pfizer" guidelines (ie. based on a majority of votes cast); whereas Office Depot's standard requires a withhold or against from "a majority of the Company's shares." That sounds like it means a majority of outstanding shares would need to withhold, which is a higher standard - and arguably not even a "majority vote" standard because a majority of those voting could withhold and yet not trigger the guideline.

If Office Depot sticks with that type of standard, I wonder if they are going to add an "against" box to their proxy card? For some insight on the ramifications of such an action, continue reading below...

Analyzing the Majority Vote Proposals

Keith Bishop provides some interesting analysis of the outstanding majority vote proposals in this text interview, including addressing many practical (and legal) impediments, such as:

- How does failure to execute a proxy interplay with withholding votes?

- Is the majority vote concept permissible under California law?

- What is the signficance and ramifications of including an "against" box on the proxy card?

- How does cumulative voting play into all of this?

So far, I hear that the ABA Task Force has received 27 comment letters on its discussion paper. Comments were requested by August 15th but I know they are still dribbling in - so keep them coming!

August 18, 2005

Internal Controls Update: The Big 4 Speak

I am busy working with the three panels for our special webcast series on the '33 Act reform - and pretty excited about how they are being structured (along the lines of a chronological walk-through of a new deal, broken out by type of issuer).

I am also very excited to announce a new webcast for October 3rd - "Internal Controls Update: The Big 4 Speak" - featuring a former SEC Corp Fin Director and the top 404 expert from each of the Big 4 accounting firms. This panel will analyze the current developments affecting Year Two of 404:

- John Huber, Partner, Latham & Watkins LLP
- Craig Crawford, Partner-in-Charge of the Audit Group of the Department of Professional Practice, KPMG LLP
- George Tucker, Partner and Director of International Auditing Standards, Ernst & Young LLP
- Garrett Stauffer, Senior Partner and Leader of US Corporate Governance Practice, PricewaterhouseCoopers LLP
- Steve Wagner, Partner and Leader of the US Center for Corporate Governance, Deloitte & Touche LLP

Now is the time to upgrade your license for to allow others in your company - such as your CFO and controller - to listen to the latest guidance on both the '33 Act reform and Section 404 at the reduced rates available in our "Rest of 2005" no-risk trial.

Fleshing Out the Board Evaluation Process

Lately, I have been having some interesting emails and conversations with members on how to approach the board evaluation process, particularly the role - if any - of outside counsel. In this podcast, Andy Tebbe of King & Spalding explains how to tweak the board evaluation process to make them more effective, including:

- Why are companies doing board evaluations?
- What types of questions should be asked on an evaluation?
- Do you have any recommendations for how to make the process go more smoothly?
- How many of your clients seek your help to compile board evaluation results and is their any typical profile of them?
- What is typical board evaluation process that uses third party to compile (oral, written, combo)?
- Does the attorney-client privilege apply?
- What do you recommend that your clients do with the findings? Destroy or document?

ABA's New Resolution on Attorney-Client Privilege

During the recent ABA Annual Meeting, the ABA's House of Delegates passed a fairly strongly worded resolution opposing government pressure on the attorney-client privilege - the resolution was adopted in the form of this ABA Task Force on Attorney Client Privilege Recommendation No. 111, which I also have copied below (and here is a professor's commentary on this new resolution):

RESOLVED, that the American Bar Association strongly supports the preservation of the attorney-client privilege and work product doctrine as essential to maintaining the confidential relationship between client and attorney required to encourage clients to discuss their legal matters fully and candidly with their counsel so as to (1) promote compliance with law through effective counseling, (2) ensure effective advocacy for the client, (3) ensure access to justice and (4) promote the proper and efficient functioning of the American adversary system of justice; and

FURTHER RESOLVED, that the American Bar Association opposes policies, practices and procedures of governmental bodies that have the effect of eroding the attorney-client privilege and work product doctrine and favors policies, practices and procedures that recognize the value of those protections.

FURTHER RESOLVED, that the American Bar Association opposes the routine practice by government officials of seeking to obtain a waiver of the attorney client privilege or work product doctrine through the granting or denial of any benefit or advantage.

August 17, 2005

More on Obtaining PCAOB Inspection Reports

Following up on a blog from a few weeks back, one member responded to my concerns by intimating that companies perhaps should not bother to ask for PCAOB inspection reports unless the inspection was not "routine." I think the problem with that selective approach is that auditors - and their clients - do not know when a PCAOB inspection is routine since it uses non-public criteria to guide its inspectors in pulling client files for review. And some of the PCAOB's non-public criteria are risk-based (but not all of the criteria, so having your file pulled doesn't necessarily mean that the company has been identified as risky either).

Since hindsight can always come back to haunt you, I think it's better for the audit committee to be safe than sorry and be aware of when regulators are sniffing around - just like it is now standard practice for the audit committee to be notified when the SEC issues any comments that impacts the company's accounting practices. I also would think the independent auditor would rather not be on the hook for determining when an inspection is routine, particularly since they are so skittish these days.

Karl Barnickol of Blackwell Sanders (always the voice of reason) weighs in on another aspect of the PCAOB’s process — disciplining the auditors after an inspection - as follows: "Seems to me that an audit committee should want to know if their auditor is in hot water with the PCAOB as part of their decision-making process on retaining an auditor.

Whether it is in fact a legal duty only time will tell, but not asking strikes me as risky if something goes wrong down the road. For example, if your auditor was KPMG, wouldn't you want an update on the possible DOJ/SEC action against KPMG before you decided to engage them for another year. What if they turn out to be the next Arthur Andersen? As a practical matter, since larger companies probably can't use any firm outside the Final Four - and since all 4 seem to be in trouble with the regulators to a greater or lesser degree all the time - enforcement information may not be all that helpful to the decision, but having considered the question makes a better record for the audit committee.

I have to say that while my firm is having some success getting commitments in our client's engagement letters to notify the company if its file is pulled in an inspection, to provide cc's of the correspondence, and to give the company a chance to talk to the PCAOB, getting engagement letter commitments about enforcement actions is another matter. That doesn't bother me quite so much since the Audit Committee will always have an opportunity to ask the engagement partner directly about enforcement actions before they make the engagement decision for the next year."

Sample Disclosures: Remediation of Material Weaknesses

In our "Internal Controls" Practice Area, we have posted samples of disclosures from companies that have remediated material weaknesses.

The Google IPO: A Year Later

The Wired GC blog captures a blurb from Monday's San Francisco Chronicle about Google's IPO filings with the SEC. Apparently, the Chronicle reporter conducted an extensive FOIA request to obtain Google's comment letters and responses (most of that correspondence transpired before the start date of the SEC's comment letter database) - and the reporter wasn't amused by the Tandy language requested by the SEC. It's not hard to imagine how the Tandy letter concept could be confusing to someone not "in the know," eh?

August 16, 2005

Whistleblower Hotlines: Conflicting Obligations in France; Confusion in Germany

Many members are asking about the recent decisions in France and Germany regarding whistleblower hotlines. In France, the French Data Protection Authority (aka "CNIL") has rendered two decisions prohibiting a subsidiary and division of two US companies - McDonalds and Exide Technologies - from implementing anonymous reporting systems. These systems were developed in compliance with Rule 10A-3, which the SEC adopted to comply with Section 301 of Sarbanes Oxley. The CNIL believes these hotlines violate French privacy law due to the anonymous nature of the accusers permitted by the hotlines.

Meanwhile, a German authority has struck down Wal-Mart's code of ethics, but not based on any kind of substantive rationale - rather, it appears to be due to a procedural snafu that turned on the failure of the company to consult with the German Works Council before implementing their code of ethics in Germany.

We have posted a number of law firm memos analyzing these overseas problems in our "Whistleblowers" Practice Area - and Tom White and Carrie Wofford of Wilmer Cutler Pickering Hale and Dorr have graciously provided copies of the two French CNIL opinions, including informal translations of them into English.

A number of groups, such as the Privacy Matters Committee of the World Law Group, have approached the French and German authorities - as well as the SEC and the NYSE - but right now, these issues are still lurking as there has not been any further word from any of these regulators. More inevitably to come...

New Form 144 Posted

One of our more popular sample documents is a Word version of Form 144. We have posted a new one that reflects changes in the form that the SEC has made (the SEC might have made these form changes a while ago; let me know if you ever see any outdated content on the site).

Speaking of Rule 144, don't forget that we have a "Rule 144 Q&A Forum," where members post Rule 144 questions - and long-time practitioners Bob Barron and Jesse Brill endeavor to provide some guidance. You can access this Forum on home page from the tool bar at the top.

Doing M&A Inhouse

Some of the younger lawyers out there might wonder if they could land a job in-house that would allow them to do M&A. In this podcast, George Villasana, Senior Counsel - Corporate Law of AutoNation (who has also worked in two different law firms and at the SEC), describes what it's like to do M&A in-house, including:

- What types of M&A activities he undertakes?
- What is his daily life like?
- How he found his job?
- How being in-house compares to being in a firm?
- How being in-house compares to working at the SEC?

August 15, 2005

SEC Chair Cox Speaks on Executive Compensation Practices

Below is an excerpt from this transcript of an interview held last Wednesday with new SEC Chair Chris Cox on the PBS' "Nightly Business Reports":

DHUE: Runaway executive pay has long been criticized. Is that something that the agency is going to take out?

COX: Executive compensation is much in the news and there have been some very notorious cases of apparent excess. It should be, of course, in the main up to shareholders to discipline that kind of activity, but in order for shareholders to do that, they`ve got to have good information. I think you can look in the near future to the SEC for some improved rules on disclosure to make sure that, for example, shareholders can have one number, that the different kinds of executive compensation add up to a number that`s comparable executive to executive and company to company and at the same time that this information is provided in a timely way before rather than after the fact.

DHUE: Shareholder activists have also tried to rein in executive pay through the proxy process. Do shareholders need greater access to the proxy so they can be the watchdog on corporate management?

COX: Of course investors and particular equity owners own the company and it`s very much in shareholder interests to discipline executive compensation and make sure it`s in line with the market, making sure they`re getting full value and also to make sure that everything else about the company is running well and with a view to doing well and good at the same time. Shareholders, I think, will find it increasingly easy going forward to look after their interests because technology is making it possible for information to move so much more quickly. We can have better analysis, more cheaply in the hands of investors more quickly than ever before. And the SEC is going to look at every possible way of making sure that our disclosure requirements are up to date and providing investors what they truly need.

Looks like Chairman Cox might be in favor of tally sheet use! We continue to post new sample tally sheets in the "Tallying Up Total Compensation" Practice Area of In addition, our "2nd Annual Executive Compensation Conference" includes a session entitled "How to Devise the Appropriate Tally Sheets" featuring Mike Kesner, who is head of Deloitte's Exec Comp Practice and Pearl Meyer, who is the Chair of the firm that bears her name.

M&A Accounting Issues

On, the last leg of the popular M&A Boot Camp is available - Howard Dicker of Weil Gotshal does a great job parsing through accounting issues, both basic and those that relate to M&A.

It's not too late to catch the entire 5-part series of the "M&A Boot Camp," as all five are now up and available! If you are not a member, try a no-risk trial and take advantage of our half-price “Rest of 2005” rate – believe it or not, a license for a single user is only $100 and there are similar reduced rates for offices with more than one user! Among the many other resources, you can catch the upcoming webcast on September 21st – “Winning Strategies in Auctions” – featuring David Katz of Wachtell Lipton and Eileen Nugent of Skadden Arps.

Bueller? Anyone?

As a fan of the movie "Ferris Bueller's Day Off" - I grew up in Chicago and attended Lane Tech HS before moving to Bethesda in 10th grade - I was taken aback to see a column blurb entitled "Bueller? Anyone?" in Friday's WSJ (scroll down halfway through the column). Kudos to the WSJ for a light moment!

The article describes how a roll call of director nominees at a recent annual shareholders' meeting semi-paralleled the movie's sarcastic take on high school roll calls. I always thought I was cool because I answered "Yo" in response to the teacher's call of my name - did I mention I never went on dates? That was a classic scene from the movie - here is a web site that provides a script, etc. from the movie...

August 12, 2005

FASB Issues "Milestone Draft" to Sort Out Financial Instruments

In late July, the FASB offered an advance preview of its project that will sort out the wide variety of financial instruments available in the market - which also will determine where these instruments belong on the balance sheet - by issuing a "milestone draft" that summarizes the FASB's findings so far.

This is a comprehensive project that will define the differences for accounting purposes between liabilities, equities and assets. While the definitions of each used to be clear-cut in the accounting rules, the lines have blurred with the proliferation of complicated financial instruments - in many cases, new instruments hold characteristics consistent with more than one category on the balance sheet.

FASB Chair Bob Herz Lays Out Global Conceptual Framework

Earlier this week, FASB Chair Bob Herz addressed the 2005 Annual Meeting of the American Accounting Association and laid out an outline of the global conceptual framework that will help set international accounting standards - see this outline in a PowerPoint from Chair Herz. This global project is a joint effort with the IASB - in order to have common standards, it is necessary to have a common framework to base the standards on. The framework has not been revisited for several decades and is being looked at relative to creating consistency in when to use fair value vs. historical cost, and to address relevance vs. reliability, etc.

How to Handle Data Security Breaches

There has been a lot of press - and legislative activity - lately regarding companies that have had data stolen, particularly personal information of their customers. Obviously, this can have serious liability implications for companies.

In this podcast, Ben Wright, a well-recognized Internet lawyer, explains how companies can protect themselves in the face of growing breaches in security that lead to data theft, including:

- What has led to the rash of announced security breaches?

- What type of reactions are legislators having to these publicized

- How many of these breaches do you think go unannounced?

- What risks do companies face if they do not announce a breach?

- What type of policy changes can companies make to help protect themselves
from breaches?

August 11, 2005

More on the FASB's Option Expensing Position on Grant Dates

A phenomenal number of members asked questions in the wake of Mike Melbinger's blog two days ago on the FASB's position on option grant dates. To clarify, the FASB's position only applies under FAS 123(R), so it will not become relevant until a company makes its first grants after it adopts 123(R) and there should be no direct tax impact from the FASB's actions. This article from the WSJ yesterday explains how the FASB's grant date position emanates from overlooked language in 123(R).

I asked NASPP Executive Director Barbara Baksa for her views on what companies might do now - here is Barbara's insight on the two alternatives posed in Mike's blog (and two new alternatives):

"I believe alternative #2 could be problematic under 409A, but we don't know for certain yet as the IRS and Treasury are still developing their interpretations. The grant date for tax purposes most likely will still be the date the board approved the grant. Thus, if the market value declines before the option price is set, you’ll have a discounted stock option under 409A. I think a discounted option under 409A is probably a much worse result than the differential in fair value. Also, this alternative creates a lot of administrative work without really accomplishing much. For these reasons (and more in this NASPP alert), I don’t expect #2 to be popular.

There is a third alternative, which is to simply try to minimize the amount of time between when the board approves the grant and when the terms are communicated to employees. Unless the market value moves dramatically during this time period, this isn’t likely to have a significant impact on the option fair value. For these reasons - and more in this NASPP alert - I expect that this third alternative is the approach most companies will take. With the emergence of online grant communication, many companies have already begun tightening up their practices in this area and this will probably just further that trend.

And there is a fourth alternative, which is to communicate the material terms (except for the option price) of the grant to employees in advance. For example, in a new hire situation, I would expect that it isn’t completely uncommon for the material terms of the grant to be included in the employee’s offer letter (the company would probably still have to follow-up with employees to let them know that the grant was approved, but this could be a relatively short and simple communication). For annual grants, the company might communicate the terms in advance or have managers review with employees the grants that will be recommended for them, then just send out a global communication that grants were approved at X price on the date the board approved them."

More on this is available in the NASPP's "Option Expensing Portal," including a number of firm memos and the NASPP alert on this topic.

Office Depot Amends Corporate Governance Guidelines Ala Pfizer

Last week, Office Depot amended their corporate governance guidelines so that any director who receives a majority withheld vote is required to tender their resignation, just like Pfizer did a few weeks ago. Here is an excerpt from the latest ISS Friday Report: "Heeding a 52 percent shareholder vote, Office Depot Inc. announced this week that it had adopted a modified majority standard for director elections. The company joins Pfizer Inc. and more than 20 other U.S. companies that have some form of majority voting.

While Office Depot's new policy is not, strictly speaking, a majority election standard, the company's move adds to the growing shift from the plurality system that most U.S. companies use to elect directors. So far this year, a majority of investors in at least 14 U.S. companies, including Dell Inc. and Supervalu Inc., have supported shareholder proposals on the issue.

In another recent development, the American Federation of State, County and Municipal Employees (AFSCME) has submitted the first binding resolutions seeking majority elections. Those proposals were filed at Sysco Corp. and Paychex Inc.

Office Depot's policy change is also noteworthy because company CEO and Chairman Steve Odland also chairs the Business Roundtable's corporate governance task force. The BRT is an influential trade association that has urged "careful consideration of the complications any new standard would present."

Another Blow to SEC's Mutual Fund Governance Rules

Late yesterday, the US Court of Appeals in DC unanimously granted an emergency motion for a stay pending court review of the latest lawsuit filed by the Chamber of Commerce. This stay puts on hold the SEC's new mutual fund governance rules that require mutual fund boards to be comprised of 75% independent directors and have independent chairs. As you might recall, the SEC re-adopted these rules on June 29th, just before former SEC Chair Donaldson left office.

These new rules were to take effect January 16, 2006. The Court directed the parties to provide briefs on the issue of whether the SEC had the authority to adopt the rules, in light of the fact that the Court had not yet issued its mandate sending the case back to the SEC. The Chamber of Commerce is asking the Court to order the SEC to put the modified rule out for public comment, which could force the SEC to hold yet a third vote.

August 10, 2005

Sigh of Relief in the Boardroom: Disney Directors Absolved of Personal Liability

Yesterday, Delaware Chancery Court Chancellor William Chandler delivered his long-awaited opinion in the Disney case by holding that the Disney directors didn't violate their duties by ratifying Eisner's decision to fire Ovitz in a way that entitled Ovitz to a huge severance package.

More analysis to come soon as there is an interesting discussion on good faith in the opinion. It's important to remember that Chancellor Chandler was applying existing law to the facts in this case - the standard for personal liability was created last year in this Chancellor Chandler opinion when the case first survived a motion to dismiss.

We have posted a copy of the new 174-page opinion in the "Compensation Litigation Portal" on In addition, don't forget that our "2nd Annual Executive Compensation Conference" will open with a panel on director duties featuring Delaware Supreme Court Chief Justice Myron Steele; Delaware Vice Chancellor Stephen Lamb; and Professor Charles Elson, Director of the U. of Delaware Center for Corporate Governance.

Tweaks to D&O Questionnaire for E&Y Independence

My good friend Linda Wackwitz of Quovadx informs me that she has learned that in connection with their settlement, E&Y is now required to scrutinize independence more closely than previously - so E&Y was going to require the Quovadx directors to complete a detailed E&Y independence questionnaire. Instead, Linda convinced E&Y to leverage off of the company's existing D&O questionnaire by having the company add the following question to it:

"Do you or any member of your immediate family have any business relationships with Ernst & Young LLP or any of its affiliates or have an ownership interest in, or serve as an officer, director, or substantial stockholder of, any company (public or private) that has any business relationships with Ernst & Young LLP or any of its affiliates? If so, please specify the name of the person or entity that has the business relationship, a description of the business relationship, and the dollar amounts involved."

Lessons Learned from WorldCom Mid-Manager Sentencing

Last week, Bruce Carton had the following interesting observations in his Securities Litigation Watch: Betty Vinson, a former WorldCom mid-level accounting manager who pleaded guilty in October 2002 to participating in the financial fraud at the company, was sentenced to five months in prison and five months of house arrest. Although her sentence won't get even one-thousandth of the press coverage that Martha Stewart's sentence did, it is far more important in terms of the impact it may have on deterring fraud in the future.

Vinson represents the typical "pawn" in a financial fraud--a lower or mid-level accounting person who by all accounts had no interest and no desire to commit fraud. Nonetheless, the fraud came to her. She was instructed by her boss, former CFO Scott Sullivan, to make improper accounting entries to make WorldCom's numbers appear better than they really were, supposedly at the ultimate direction of CEO Bernie Ebbers. Vinson testified that "I felt like if I didn't make the entries, I wouldn't be working there."

Vinson was deeply troubled by this instruction and went so far as to draft a letter of resignation in protest. But at this key juncture in her life, she did not quit. Instead, she stayed with the company and made many of the fraudulent accounting entries that enabled the financial fraud at WorldCom. She apparently did so for personal financial reasons and because of the personal appeals from Sullivan "not to jump out of the plane . . . [to] hang in there and help him get through the situation for the third quarter." Vinson chose to believe Sullivan that this was a "one-time thing" that he would correct.

People placed in the excruciating position that Vinson found herself in need to know that the issue is not merely whether they should quit their job. They need to know that the consequences for participating in and enabling a financial fraud are severe--you may well go to prison as a convicted felon. As Judge Barbara Jones who sentenced her correctly observed,

"Ms. Vinson was among the least culpable members of the conspiracy at WorldCom," Jones said. Still, she said, "Had Ms. Vinson refused to do what she was asked, it's possible this conspiracy might have been nipped in the bud."

Prison time for Betty Vinson was the right outcome, and public companies should be training their employees that prison is a realistic outcome for anyone--not just the ringleaders--who would betray the integrity of the company's financial reporting.

August 9, 2005

The FASB Speaks: Confirming the Worst on Option Expensing

Following up on a coupla of recent blogs, Mike Melbinger blogged yesterday on as follows: Confirming our worst fears, we are told that during a Friday conference call with the Big 4 accounting firms, the FASB confirmed its view that companies cannot fix the equity grant date at which expensing would begin until the material terms of the award have been communicated to employees.

This dramatic reversal of the accounting rules under APB 25, FAS 123 (and common sense), seemingly made wholly outside the regular review and comment process, means that companies will have to completely revise the way they have made equity awards for the last 50 years or risk negative accounting and tax consequences.

Inasmuch as the exercise price for a stock option (and expense date for other awards) will need to be set as of the date the material terms of the award are communicated to optionee, at this point according to Mike, companies would seem to have a few choices:

1. Prepare option award agreements in advance so that they may be sent to optionees on the same date as approved by the Board (or Compensation Committee), or

2. Have the Board resolution specify an option award date sufficiently in the future to give the plan administrator time to prepare and send the award agreements, with the exercise price for the option award determined only on that future date.

On the NASPP's site, there is more info on this issue, including this Q&A. More to come on this...

SEC Staff to Issue Transitional Guidance on '33 Act Reform

Yesterday at the ABA's Annual Meeting, Corp Fin Director Alan Beller noted that the Staff was putting together transition guidance regarding '33 Act reform. A number of transition issues remain open, such as how to deal with open shelfs. No timetable was given for the upcoming guidance, but it likely will be well before the December 1st effective date.

PUHCA Repealed!

If you don't work with utility holding companies, you might not be aware of PUHCA (pronounced "puke-ah") - this odd moniker relates to legislation enacted in 1935 that regulates holding companies for utilities and was controversial from day one. A small group of folks in the SEC's Division of Investment Management work primarily on PUHCA issues.

Yesterday, PUHCA was repealed as part of President Bush signing the new energy bill - and replaced with a less onerous Public Utility Holding Company Act of 2005. Learn more in this memo from McGuire Woods.

August 8, 2005

SEC Chair Cox Already Gives First Speech

Upon my return from vacation, I was surprised to see that new SEC Chair Chris Cox already had delivered his first speech - in the form of a welcoming statement to the SEC Staff.

In this Washington Post article, Chairman Cox's speech was characterized as "gently chiding analysts and media reports that predicted he would take a less investor-friendly approach than Donaldson, who frequently cast his vote with the agency's two Democrats to impose new regulations on industry."

An interesting sidenote from the article was "The agency also faces an October deadline for naming a candidate to the Public Company Accounting Oversight Board. Kayla J. Gillan, a former lawyer at the California Public Employees' Retirement System and a favorite of investor advocates, has expressed interest in being reappointed to her slot on the accounting board. In a telephone interview yesterday, Cox said he would be "careful and deliberate" about the appointment process. "It's going to take a few weeks to determine an approach to those issues," he said." Looks like the PCAOB member appointment process could become a little dicey for SEC-PCAOB relations; the bond among the members of the PCAOB's Board is quite strong even though they have differing backgrounds.

As a former Staffer, I can tell you that the mere fact that Cox addressed the SEC Staff early on in his tenure will boost employee morale; not that morale suffered under former Chair Donaldson. I don't recall a new Chair addressing the Staff on his first day in office - and it definitely is the first address from a Chair to the Staff that was simultaneously webcast to the world.

[Beach note - my sole purchase during vaca was a T-Shirt that says "The Beatings Will Continue...Until Morale Improves." My kids love it!]

Thomson Financial Buys LivEdgar

Recently, Thomson Financial continued its buying spree in the legal market by acquiring Global Information, which operates the popular LivEdgar service. Before the days of EDGAR, some of us will remember when the three founders of LivEdgar rode their bikes to pull copies of Schedule 13Ds from the SEC's Public Reference Room. Those founders decided to stay on and are now Thomson Financial employees.

Registration Statement Review: Old School Style

For the first vacation in some time, I fended off the urge to work and didn't check email, etc. Gotta do that more often. During the week, I read a fascinating biography of William Randolph Hearst called "The Chief" - and was intrigued about the description of how Hearst hired Joe Kennedy in 1936-37 (after Kennedy had served as the first SEC Chair) to help him reorganize his embattled media empire.

As part of Hearst's bailout, Kennedy's staff filed two registration statements to sell bonds which Time magazine called "two of the most remarkable registration statements ever filed" which were filled with "many a Hearst publishing secret, many a Hearst business oddity..."

The review process back then was to allow the public to file their own comments on registration statements (and the Commissioners themselves would review the disclosures themselves and issue comments!) - and apparently that was done in droves as Hearst was widely disliked at the time. Not only that, but Hearst never kept his personal funds separate from those of his various corporations and was a monumental spender. Today, he would be considered more of a crook than Bernie Ebbers - but commingling was fairly common in those days.

Although not entirely clear, "The Chief" intimates that the registration statements were amended to add disclosures based on public comments - and according to this information that I found on the Web when I got home, the registration statements were ultimately withdrawn ("The Chief" merely said there was a lack of investor interest in the bond offerings, but didn't indicate whether the offerings were ever completed).

To learn more about the beginnings of the SEC, check out this interesting transcript from the SEC Historical Society about the legacy of the second SEC Chair, James Landis. Note that first Chair Joe Kennedy didn't stay at the SEC for much more than a year, but his appointment was absolutely critical to help gain Wall Street acceptance of the notion of being regulated, as Kennedy was among the foremost movers and shakers on the Street before his appointment.

August 4, 2005

Cox’s First Day

Christopher Cox became the 28th Chairman of the SEC yesterday when he was sworn in by Federal Reserve Chairman Alan Greenspan. Since its inception in 1934, the SEC’s Chairs have been pretty evenly split between the two major political parties, with 15 Republicans versus 13 Democrats. Here’s a list of all past Chairmen and Commissioners.

Chairman Cox’s first official day is today. He is scheduled to address the Staff in the Commission's auditorium at 10:30 eastern, which appears will be accessible to non-Staffers by webcast. I like the transparency already!

New Section 16 Adopting Release

The SEC took care of some Section 16 business yesterday, adopting amendments to Rules 16b-3 and 16b-7 in response to the Third Circuit’s ongoing Levy v. Sterling Holding Company case. For the background and current status of the Levy case, check out Alan Dye's blogs on - most recently in June 2005 and July 2005.

As you know, Rules 16b-3 and 16b-7 are exemptive rules, which provide that transactions that satisfy their conditions will not be subject to Section 16(b) short-swing profit recovery. The amendments clarify the regulatory conditions that must be present for the exemptions to apply – and do not represent substantive interpretive changes in the application of the rules.

Additionally, the SEC amended S-K Item 405 to delete the ability, on the part of the issuer, to presume that a Section 16 form it receives within three calendar days of the required filing date was filed with the SEC by the required filing date. The SEC thought that in light of the two-business day due date generally applicable to Form 4 and the requirements of mandatory EDGAR filing (and website posting), this presumption no longer is appropriate.

For more insight into this release and other updates on Section 16 – be sure to check out

Settlement Pipeline Grows

As Broc pointed out in his July 18th blog, class action settlements have soared over the last year. Yesterday, Time Warner said it had agreed to settle its class-action litigation with shareholders for $2.4 billion and Arthur Andersen agreed to pay $25 million to settle a lawsuit brought by investors over its role in the collapse of Global Crossing Ltd. On Tuesday, CIBC agreed to pay $2.4 billion to settle fraud claims by investors who lost money in Enron Corp.

But perhaps even more astounding than these settlements (if that's possible) was when former Cendant vice chairman E. Kirk Shelton was sentenced yesterday to 10 years in prison and ordered to pay full restitution for his role in an accounting scandal in the amount of $3.27 billion. The $3.27 billion would cover what Cendant spent to settle shareholder litigation, pay its legal fees and conduct audits. The payment schedule will be $15 million by October 2005 and then monthly payments of $2,000 per month once he is out of prison. That will make him approximately 135,685 years old before the debt is paid off (excluding interest).

August 3, 2005

More 123R Valuation Challenges

Following up on Broc’s July 25 blog on the challenges of option valuation under FAS 123R for expensing purposes, Mike Melbinger blogged the following on his blog, which has been getting a lot of attention:

“Apparently one of the Big Four accounting firms is taking the position that under FAS 123R the stock option grant date does not take place when the Board of Directors approves the size of the grant and the grant price, but only when a letter describing grant price, size of the award, and the terms and conditions is received by the employee.

If this extraordinary interpretation holds up, many companies will need to reconsider their current process for making stock option grants, or face negative accounting and tax implications Code Section 409A.

For example, if the Board or Compensation Committee makes a stock option award on day 1 when the price of the stock is $25, but the terms of the award are not reduced to writing and delivered to optionees until day 8 when the price is $27, then for accounting purposes the company will be deemed to have issued a discounted option, according to this Big Four firm - exercise price is $25 but FMV at the date of grant is $27.”

As Mike noted, companies may well want to contact their outside audit firm to determine the audit firm’s view on this issue.

Smaller Public Companies Ask for Comments

The SEC’s Advisory Committee on Smaller Public Companies published a series of 29 questions yesterday to solicit input from investors and companies on ways to improve the current regulatory system for smaller companies.

The questions are categorized in the following areas: general impact of SOX; SOX 404/Internal Controls; Accounting/Auditing; Corporate Governance/Listing Requirements; and the Disclosure System. Comments are due by August 31, 2005. The Advisory Committee will use the responses as it prepares its recommendations to the Commission, to be delivered by April 2006. Next up for the committee is its meeting on August 9-10 in Chicago, which will be webcast on the SEC’s website.

For more on the Committee’s work to date, check out our July-August 2005 issue of The Corporate Counsel.

Securities Act Reform in Federal Register

Today, the Securities Act Reform Release (33-8501, July 19, 2005) was published in the Federal Register, making December 1, 2005 official as the effective date. For those of you who have been carrying around the release in your briefcase waiting for a chance to read it, you may want to print out the Federal Register PDF version. If you can live without the Cost-Benefit Analysis, Regulatory Flexibility Analysis, etc., you can get the release down to 102 pages (print pages 1-68 and 78-111), unlike the 468 pages from the SEC’s pdf version.

August 2, 2005

Bigger Compensation Equals Bigger Credit Risk

This article discusses a new study (posted on issued by Moody’s that examines the empirical relationship between executive compensation and credit risk. Moody’s took three components of CEO compensation – salary, bonus, and stock option awards – to discover compensation that deviates substantially from expected pay based on firm size, past performance, etc. (described as “unexplained” compensation). They then took the “unexplained” compensation and related it to the risk of default and large rating downgrades between 1993 and 2003.

Ultimately, Moody’s found that large, positive, unexplained bonus and option awards are predictive of both default and large rating downgrades. Variations in salaries, however, do not appear to be predictive of credit risk. Moody’s concludes that high levels of unexplained compensation may indicate that board oversight is lax and, as a result, management has insufficient pressure to deliver good financial performance. Large performance-based compensation packages, in particular, may induce managers to: deliver strong short-term financial results and obscure longer-term structural problems, and pursue high risk strategies with very strong positive, but also very adverse, potential payoffs.

Shooting Fish in a Barrel ….

Last week, the SEC filed a complaint against two stock promoters in an alleged scam designed to mislead investors into believing they had inadvertently received a confidential stock tip faxed from a stockbroker to his client. The handwritten fax (available here) had the appearance of an urgent message from a financial planner intended only for his client, urging the purchase of a stock that was about to "tripple" in price. The fax was sent to more than one million recipients across the country – including the SEC’s San Francisco Office! - by stock promoters who made over half a million dollars unloading their shares on duped investors.

Inside Track with Broc Posted

Check out Broc’s interview on the return of the IPO market with M. Ridgway Barke, Chair of the Corporate Finance and Securities Practice Group at Kelley Drye & Warren, and Randi-Jean G. Hedi, Partner in the Corporate Finance and Securities Practice Group at Kelley Drye & Warren.

August 1, 2005

Senate Approves Commissioners' Nominations

On Friday, the full Senate voted to confirm Rep. Christopher Cox as Chairman of the SEC and Roel C. Campos and Annette L. Nazareth to the two open Democratic seats. Cox's term will run until June 2009; Nazareth's expires in June 2007 and Campos's expires in June 2010.

In this rather lengthy press release, Rep. Cox says he intends to resign his House seat on Tuesday, August 2 at 6 pm PDT and hopes to be sworn in as Chairman of the SEC on Wednesday, August 3. That would make Thursday, August 4 his first day on the job.

Securities Act Reform Effective December 1, 2005

The SEC’s website is reporting that the Securities Act Reform rules become effective December 1, 2005. As adopted, the rules were set to go into effect 120 days after publication in the Federal Register. By my calculations, December 1 is 122 days away from today, so that means we can expect the Federal Register publication to be this Wednesday.

The Federal Register is the official publication place for rules, proposed rules, and notices of Federal agencies and organizations, as well as executive orders and other presidential documents. Whatever gets printed in the FR is the official text of the rules. The FR is published on all Federal work days and is available online (usually available by 6 a.m. each day).

The Staff has been saying that early compliance with the newly adopted rules will not be allowed. No word on the particular implementation of some of the rules, such as whether current shelf registration statements will be grandfathered or subject to the new three year life rule.

Carl’s Corner Posted

In this latest edition of “Carl’s Corner,” Carl Schneider, Of Counsel to Wolf, Block, Schorr and Solis-Cohen in Philadelphia, is discussing the sometimes tricky issue of how to identify your client.