March 31, 2006

SEC Chair Sounds Off on Executive Compensation

Yesterday, SEC Chairman Chris Cox gave a speech before the Council of Institutional Investors. I like the way he debunked the theory that movie stars and athletes currently get paid in the same manner as CEOs in today's world (by noting that market forces don't universally set the levels of both these days, as boards "don’t always negotiate at arms’ length with their executives"). And here is an excerpt from the Chairman's speech regarding why the SEC has proposed changes to executive compensation disclosures:

"Executive compensation matters — not only because if moral hazards inherent in these conflicts of interest are unchecked, executives will be paid too much, but also because it can play a valuable role in disciplining management across the board, and in protecting the entire range of shareholder interests.

By restraining executives from self-indulgent behavior — and using salary, bonuses, options, long term benefits, and other financial incentives in very purposeful ways — compensation committees acting on behalf of the shareholders can increase management’s incentives to improve corporate performance."

Director Attendance at Annual Meetings

Since the beginning of 2004, Item 7(h)(3) of Schedule 14A has required companies to disclose their policy, if any, with regard to directors' attendance at annual meetings, including stating the number of board members who attended the prior year's annual meeting.

Thanks to Jeff Hopkins of Equilar, below is some analysis of fifty S&P 200 companies that have recently filed proxy statements:

- 64% of these companies disclosed 100% attendance by directors at the last annual meeting
- 22% of these companies disclosed one director missing the last annual meeting
- 8% of these companies disclosed two directors missing the last annual meeting
- 4% of these companies disclosed more than two directors missing the last annual meeting
- the median attendance was 100% and the average attendance was 95%

Of these 50, the company with the lowest attendance was Coca Cola Enterprises with only 8 of 16 directors attending - in contrast, Coca Cola Company disclosed that 13 of their 14 directors attended their annual meeting.

As a sidenote, it appears that roughly 12% of corporate governance guidelines out there mention attendance at the annual meeting by directors (but not all require attendance). Thanks to The Corporate Library's Board Analyst for this last tidbit...

Interagency Advisory Impact on Auditor Engagement Letters

In this podcast, Barry Abbott of Howard Rice provides some analysis of a recent final interagency advisory - collectively issued by the Treasury Department, Fed Reserve, FDIC, OTS, OCC and NCUA - that informs financial institutions' boards and senior managers that they should not execute agreements that incorporate unsafe and unsound limitation of liability provisions in their engagements with independent auditors, including:

- What is the interagency advisory on external engagement letters? And what does it state?
- Should any company other than financial institutions worry about this advisory?
- How might the advisory impact engagement letters generally?
- What do you recommend that companies now do with their audit engagement letters (eg. disclose limitations, negotiate harder, etc.)?

March 30, 2006

Investors Placing Directors on Boards

I was piqued by some comments in the mainstream media last week that Ralph Whitworth's decision to accept a seat on the Sovereign Bancorp board in exchange for dropping his assault on the company was a "symbolic" move without much substance. These comments didn't comport with my conversations with some folks that have been placed on boards by investors. And so I called up one of those guys with "skills"...

In this podcast, Rich Koppes, a former General Counsel of CalPERS and now at Jones Day, provides some analysis – and personal experience – regarding the placement of an independent director by investors on a board, including:

- How did you come to sit on a board as a shareholder representative?
- How were you treated by your fellow board members?
- Do you feel that you have had an impact as a shareholder representative?
- Have you ever been given directions about how to perform your duties from the investors that helped place you on the board?

The PCAOB's New Implementation Dates for Independence Rules

On Tuesday, the PCAOB adjusted its implementation schedule for the ethics and independence rules that the SEC published for comment a few weeks back. Under this schedule, new Rule 3525 won't apply to any tax service that is pre-approved by the audit committee pursuant to a policy and procedure so long as the pre-approved service began within one year of the SEC's final approval. And as before, any tax service pre-approved on an engagement-by-engagement basis won't be affected if pre-approved within 60 days of the SEC's final approval.

Continuing Saga of SEC's Investigation Into's Allegations

As I blogged a month ago, the SEC reportedly is investigating allegations made by's CEO that analysts and journalists conspired against him (which inspired his "Sith Lord" analyst conference call). In yesterday's WSJ, Jesse Eisenger writes that communications made between him (and 8 other journalists) and the company's CEO have now been the subject of a subpoena - and how that irks him. [Interestingly, another company - Biovail - has sued the same independent analyst, Gradient Analytics, in a similar case.]

I agree with Professor Joe Grundfest's quote in Jesse's article: "While subpoenaing journalists directly was a "big mistake," says Stanford law professor Joseph Grundfest, "it shouldn't be surprising and it shouldn't disappoint anybody" that the agency is going after market participants' communications with journalists. "It would be a very strange world if people could be held liable for every lie they told except for the biggest lies they told to reporters," he adds."

The F Bomb

Here's a beauty from "The Wired GC" (perhaps time to read our "Security Breaches" Practice Area?):

"No, not that one. It’s the sort of bomb that Fidelity dropped on Hewlett-Packard when it disclosed that a company laptop containing personal information on 196,000 HP employees was recently stolen.

The laptop contained “… data including the participants’ names, addresses, birthdates and social security numbers.” It was reportedly being used for an offsite meeting. Fidelity is doing big-time damage control:

Fidelity, which provides financial services for about 21 million people, says it hasn’t detected any misuse of the information and that safeguards in place may prevent misuse. The application with the data had a temporary license that has expired, so the data would be difficult to interpret and “generally unusable,” a spokeswoman says. And the company is requiring additional authentication to access the affected HP accounts.

So if I’m an HP employee, I’m hopping mad. If I’m one of the other 20 million or so customers of Fidelity, I’m thinking the word “Vanguard” sounds rather inviting right about now, Paul McCartney ads notwithstanding (turn your speakers down).

In an age of growing concerns about customer privacy, I find it staggering that personal data is moving around on the laptops of a company as sophisticated as Fidelity. Particularly when it includes the Rosetta Stone: apparently unencrypted SS numbers. Do you think this is the only time this has ever happened at Fidelity? The only time it has happened in the financial services industry? What about the healthcare industry?

The politicians are still arguing about this stuff. Despite all the privacy protections instituted by many companies, if laptops or sync-able PDAs can copy and take offsite deeply personal customer information, legislation or regulation will soon follow. Thus the innocent are punished by the sins of the guilty.

It’s another reason why “privacy” is going to be a key word for GCs and their corporate compliance programs in the future. Like tomorrow. Fidelity employee stuck in traffic?"


March 29, 2006

Nasdaq Issues First Letter of Reprimand

It looks like Nasdaq has begun utilizing the new public letter of reprimand based on this Form 8-K filed by Paula Financial under Items 3.01 and 9.01. As I blogged in December, the Nasdaq recently added the letter of reprimand to its arsenal of enforcement tools. Previously, Nasdaq only had the delisting letter at its disposal - which was akin to going from zero to 60 in 60 seconds.

As noted in Paula Financial's related press release, the letter of reprimand was related to a failure to abide by Nasdaq's requirement that the board be comprised by a majority of independent directors. When two directors resigned, the company failed to maintain a majority - and failed to notify Nasdaq of the resignations and its non-compliance. The company then regained compliance and Nasdaq exercised its option to issue a letter of reprimand rather than a much more serious delisting letter.

Note that the letter of reprimand is voluntarily posted on the company's website, but it's not filed as an exhibit to the Form 8-K. As I read NASD Rule 4804(b), companies receiving a letter of reprimand have four business days following receipt to make a public announcement about it through the news media - but there is no Nasdaq requirement to file it with the SEC or post it (and Item 3.01 of 8-K requires filing an 8-K upon receiving the letter of reprimand - describing it, etc. - but it doesn't require filing of the actual letter).

A Director's Independence Saga

Along the same lines, I thought this Form 8-K filed recently under Item 3.01 by Applied Materials was interesting. The company disclosed that Nasdaq contacted the company and told them that, in their view, one of their audit committee members was not independent. The director had been a consultant prior to joining the board and had received an option grant. Nasdaq's interpretive view is that the option has to be assigned a value (but not necessarily using Black-Scholes) - and the value exceeded $60,000 in this case.

The director resigned from the audit committee - but not from the board - and fortunately the company had an audit committee that was sufficiently large so that they weren't immediately out of compliance. Note that if we are only talking about an option grant, the Nasdaq lookback period starts from the date of the option grant.

I note that Nasdaq's interpretive advice in this case is consistent with the SEC's Telephone Interpretation in the 1999 supplement on the valuation of stock options for 404(a) purposes (Black-Scholes or binomial). For those not aware, it is noteworthy that the Nasdaq Staff continues to monitor compliance with its board independence rules by reading proxy statements...

Legal Fees for Indicted Employees

Yesterday's WSJ ran this article on how prosecutors have been pressuring companies to not advance legal fees to indicted officers. It's a reminder for companies to draft more balanced indemnification agreements so that the company isn't faced with huge legal bills to defend someone that stole from shareholders. I am not suggesting that companies throw indicted employees to the wolves, but I do get troubled when fraudulent officers "use up" D&O insurance (and company's assets) at the expense of innocent directors and officers.

Here is an excerpt from the article: "The fee-payment issue has gained prominence in recent years, following a 2003 U.S. Justice Department memo that advised prosecutors to credit companies that cooperate with the government in an effort to avoid indictment. The memo, written by former Deputy Attorney General Larry Thompson, advises that a company's willingness to advance legal fees to "culpable employees" may signal a lack of cooperation. A spokesman for PepsiCo Inc., where Mr. Thompson is now the general counsel, says he wouldn't discuss the memo.

Until now, the nonpayment of legal fees has been most heavily debated in the government's ongoing tax-shelter case against former executives of KPMG LLP, which is scheduled for trial in New York in September. Yielding to government pressure, the accounting firm hasn't reimbursed these executives since 2004 in what Stanley Arkin, an attorney for one of the defendants, calls "a way of unfairly breaking down the defendants' ability to resist the government." KPMG declines to comment.

In their investigation of accounting fraud at HealthSouth Corp., federal prosecutors informed the company that the payment of fees to indicted executives would be viewed as a sign of noncooperation, according to lawyers in the case. The company later withheld fees to former chief executive Richard Scrushy, the only indicted executive who pleaded not guilty to federal charges. A jury in Birmingham, Ala., acquitted him of fraud in 2005.

Federal prosecutors also encouraged Symbol Technologies Inc. to withhold fees from executives charged in an alleged accounting fraud at the New York maker of bar-code scanners, according to company counsel Andrew Levander. Last month, in Central Islip, N.Y., U.S. District Judge Leonard Wexler ended the trial of three former Symbol executives after jurors said they were deadlocked.

Symbol was able to pay the executives' fees after it convinced prosecutors that company bylaws required it to do so, Mr. Levander says. "The government is not sensitive to the fact that a failure to indemnify can harm a company's ability to attract talented officers and directors in the future," the lawyer says."

March 28, 2006

Disclosure of Unresolved SEC Staff Comments

As part of the ’33 Act reform that became effective December 1, 2005, large accelerated filers and accelerated filers are now required to disclose - under new Item 1.B of Form 10-K - whether they have unresolved written SEC Staff comments on their periodic or current reports issued more than 180 days before the end of the fiscal year. These companies also must disclose the substance of any of the unresolved comments that they believe are material - and can include their position on the unresolved comments if they so desire.

In our "SEC Comment Process & Analysis" Practice Area, we have posted the first dozen examples of this type of new disclosure.

The disclosures made so far vary quite a bit; some specify the number of unresolved comments and provide detailed information regarding the nature of them - other disclosures are much more general. And a few companies state their position regarding outstanding comments - for example, see this Form 10-K recently filed by Getty Realty Corp. (on page 11, the company describes its rebuttal to the Staff).

SEC's 2007 Performance Budget

No big surprises in this 2007 Performance Budget for the SEC. Corp Fin's rulemaking schedule is on page 6. As noted on page 12, the SEC expects to review 44% of total reporting issuers during '07, down from 47% in '06. On page 13, the SEC predicts a ramp-up of demand for searches of EDGAR filings - 600 million in '07, nearly a 36% increase from the 379 searches in '05 (ie. XBRL). And on page 19, referrals to Enforcement from Corp Fin continues to grow at a very healthy clip...

The Watchdog That Didn’t Bark

In his AAO Blog, Jack Ciesielski describes what is in the PCAOB's two new releases on inspection reports in much more detail than I did last week in this blog. For example, Jack writes:

"The second report is a bit more interesting; it details some of the steps taken by firms to improve their quality controls. Among them:

- changing the organizational structure so that there’s separation of the audit performance function from responsibility for ethics, independence, client acceptance, and audit quality monitoring. (Seems so basic, you wonder why it had to be brought up.)

- adding internal guidance requiring more experience audit personnel review the contractst carry the most risk for material misstatement. (Another common-sense step.) - increasing the number and depth of the firms’ own inspections and evaluations of audits. (This refers to the fact that audit firms have their own internal auditing functions; they inspect how effectively the firm has carried out their engagements.)- changing the way partners are compensated and promoted by increasing the emphasis on technical auditing skills and decreasing the emphasis on “rain-making.”

- tightening up on the criteria for client continuation

There’s plenty more, but you get the drift: what were once habits are now recognized as vices. The dog didn’t bark this time; there’s nothing to bark about. The firms kept their end of the bargain and straightened their respective houses. But let’s hope the watchdog stays awake."

March 27, 2006

Do You Believe in Miracles?

Ever cry at a basketball game? Or make love to 20,000? Took my boys yesterday to see the basketball miracle of the century as my George Mason Patriots beat the prohibitive favorite to win the national championship, UConn.

For those that don't follow basketball, George Mason was the last team to receive a bid into the tournament and many believed that they were not worthy of getting in at all. Against all odds, they have beaten three former national champs to earn a place in the Final Four. Boy, the place was rocking at Verizon Center; scared my 8-year old plenty... george mason.jpg

Practical Considerations: Implementing a Majority Vote Standard

Tomorrow's webcast - "Practical Considerations: Implementing a Majority Vote Standard" - will focus on the practical considerations and consequences of implementing a majority vote standard or director resignation guideline and will include these experts:

- Keith Bishop, Partner, Buchalter Nemer LLP
- Joshua Cammaker, Partner, Wachtell, Lipton, Rosen & Katz LLP
- Peggy Foran, SVP-Corporate Governance, Assc. General Counsel & Secretary, Pfizer Inc.
- David Katz, Partner, Wachtell, Lipton, Rosen & Katz LLP
- Cary Klafter, VP-Legal & Govt. Affairs; Director of Corporate Affairs & Secretary, Intel Corporation
- Charles Nathan, Partner, Latham & Watkins LLP
- Stephanie Schaeffer, Vice President, Chief Legal Officer, Paychex, Inc.
- Thomas Welch, Jr., Vice President – Legal, General Corporate Counsel, Dell Inc.
- Honorable Norman Veasey, Partner, Weil, Gotshal & Manges LLP

With Alaska Air Group, Altera and Safeway being the latest to join the ranks of those adopting pure majority vote standards - as noted by ISS on Friday - this is a program you don't want to miss!

The Latest Proxy Compensation Disclosures

In his "Proxy Disclosure Blog" on, Mark Borges continues to blog daily on the latest compensation disclosures as proxy statement are being filed. Here are two of his latest entries:

Comcast Execs Pay Their Own Way

My recent posts on perquisites don't necessarily tell the entire story of what's going on in this area. Take, for example, the Comcast proxy statement. While a footnote to the Summary Compensation Table notes the amounts that each named executive officer received as perquisites and to cover tax liabilities, it also discloses that, pursuant to a company policy regarding management perquisites, the NEOs paid the company certain amounts for items that otherwise would have been personal benefits.

The Board Compensation Committee Report sets out the company's perquisites policy:

"Comcast’s policy on the provision of executive perquisites with respect to Messrs. Brian L. Roberts, Ralph J. Roberts and Burke is to allow each of them to receive perquisites up to a maximum taxable value of $50,000. If the executive receives benefits that would otherwise be considered perquisites in excess of this amount (generally calculated based on the associated tax value), he is required to pay Comcast the amount of such excess. With respect to the other named executive officers, they are generally required to pay Comcast for the full taxable value of any benefits that would be considered perquisites, other than the provision of parking at Comcast’s headquarters.

In addition, Comcast pays, or reimburses, premiums on life and executive long-term disability insurance policies for all named executive officers who participate in these plans and provides a tax gross-up with respect to certain of these payments."

It appears that the policy has been in place for a few years, so it isn't a response to the SEC proposals. It also appears that the policy calls for the NEOs to reimburse the company based on the tax value of the benefit, with the company disclosing the incremental difference between that amount and its cost in the SCT. That's why, in spite of the policy, some perk amounts wind up in the table. Thanks to Ron Mueller for pointing out this disclosure.

Bank of America’s Proxy Statement

Bank of America’s recent proxy statement filing follows the recent trend of incorporating elements of the SEC proposals into the executive compensation disclosure. Here are some of the highlights:

Director Compensation

BofA begins with a description of its standard fees arrangements and then provides a table showing the amounts received by each director. The table starts with a total compensation column and then lists various cash and stock fees and retainers. This information is followed by a description of changes to the company’s director compensation program that go into effect in 2006. There is also a discussion of stock ownership guidelines for directors and a description of a retirement arrangements with one of the directors.

Summary Compensation Table

Like the director table, the Summary Compensation Table includes a Total Compensation column. The Other Annual Compensation column is supplemented by a perquisites table (which itemizes each perquisite without regard to the minimum disclosure threshold) and the All Other Compensation column includes pension accrual amounts. For the majority of the named executive officers, these pension accruals reflect the amount of compensation credits under the company’s qualified and non-qualified pension plans with respect to plan-eligible compensation paid each year.

Pension Benefits

BofA provides summary descriptions of its multiple pension plans – two tax-qualified plans (including one for former employees of Fleet Bank) as well as various pension restoration plans and supplemental executive retirement plans. These descriptions are followed by a simple table setting forth the years of service and estimated annual benefits for each NEO.


These enhancements typify what I’m seeing in 2006 proxy disclosure. While some companies are making subtle refinements to their board compensation committee reports, most efforts appear to be devoted to improving tabular disclosure, both through the use of a Total Compensation column and perquisite and director pay tables. This makes sense, as these modifications are relatively easy to make, don’t involve difficult interpretive issues, and are consistent with next year’s disclosure regime.

March 24, 2006

New Items for Upcoming 10-Qs

Thanks to Stephen Quinlivan and Jill Radloff for this memo that lists the areas that you should bear in mind as you are preparing your upcoming Form 10-Q. I have posted the memo in our "Form 10-Q" Practice Area.

Understanding the Sell Side

If you need a laugh, check out this hilarious voicemail from a sell side research analyst. [Did I mention that I teach a class at George Mason, the Cinderella darlings of the tournament! Not that I picked them to even beat Michigan State. Go Patriots!]

US Litigation Overseas: Impact of the UK's Company Law Reform Bill

The UK's Company Law Reform Bill is a hot topic with the securities bar in England, specifically whether the Bill's proposed reforms should be considered as a step towards the import of US-style securities litigation into the UK. In this article, which looks at the Bill from an American point of view, Werner Kranenburg - a London law student with a flair for writing - argues that the US securities bar needn't be too interested in this Bill and seek to relocate to England soon, as the Bill's reforms fall well short in providing a system that encourages and effectively facilitates shareholder representation.

Werner argues that, likewise, the Bill's influence in the US should be neglible, citing four recent actions against three UK corporate defendants to highlight the differences of the existing approaches to private civil actions in the UK and US.

March 23, 2006

More Companies Disclosing Political Contributions

As noted in this LA Times article, Bristol-Myers Squibb and Staples recently agreed to disclose - and have their directors oversee - soft money political contributions made with corporate funds. Last year, Morgan Stanley, Johnson & Johnson, Schering-Plough, Pepsico, Coca Cola and Eli Lilly adopted similar political transparency and accountability policies. Under a typical policy, all soft money political contributions are reviewed at the Board level on an annual basis and the company posts a complete list of corporate political contributions as well as their guidelines for their political giving.

In addition, according to this press release, Amgen recently became the first company whose board endorsed a shareholder resolution calling for disclosure and board oversight of the company’s soft money giving. This development is part of a movement fostered by the Center for Political Accountability, among other groups.

Keith Bishop also notes that a bill was recently introduced in California that would require disclosure of political contributions related to California by corporations. The corporation would be required to make refunds or contributions to charities for objecting shareholders. We have posted a copy of the bill in our new "Political Contributions" Practice Area.

Overboarded Directors

Yesterday's WSJ ran an article (not available electronically) about CEOs that serve on multiple boards that caught my eye. Back in the day before I knew better, my dream was to serve on a few boards to pass time once my kids moved out of the house. Now after serving five years on the board of a local domestic violence non-profit, I realize the serious time commitment that serving on a board really entails (putting aside the liability concerns).

So I can't understand how a CEO of a major company could have the time to serve on more than one or two boards in addition to his/her own company. I would think even one extra board seat would be a challenge. Yet the article lists a few CEOs that serve on more than 10 boards! How do they even schedule board meetings without multiple conflicts?

ISS policy is that it generally will recommend withholding from directors who are CEOs of publicly-traded companies who serve on more than three public boards, i.e., more than two public boards other than their own board (but not recommend withholding at the CEO's own company unless the overextension is particularly problematic or the company's performance is poor).

And remember that the SEC only requires directors to disclose the public company boards that they sit on - directors aren't required to disclose private company or non-profit directorships, which can be quite time-consuming too. If I sat in the shoes of a major investor, I want a CEO that spends some time with their family...

How to Handle a SEC Enforcement Inquiry Today

We have posted the transcript from the recent webcast: "How to Handle a SEC Enforcement Inquiry Today."

Remembrance of Regina Baker

For those SEC alumni out there, I am sad to note that long-time Corp Fin Staffer Regina Baker passed away Tuesday after an extended illness. Regina was one of my favorite Staffers and I believe that anyone who worked alongside her - during her 40-year tenure - felt the same way. She was a very special person and we will all miss her. My condolences to her family and friends.

March 22, 2006

US Supreme Court Upholds Reach of SLUSA

Yesterday, the US Supreme Court ruled unanimously in favor of Merrill Lynch in a decision that limits the ability of shareholders to bring so-called "holders" class action lawsuits in state court - even if the claim is only that shareholders were induced to hold on to their stocks, not to buy or sell - because such lawsuits were found to be preempted by the Securities Litigation Uniform Standards Act of 1998.

In vacating the decision from the US Court of Appeals for the Second Circuit (and overruling the majority of courts that have addressed this issue), Justice John Paul Stevens' opinion rejected the argument that SLUSA only preempts lawsuits involving a purchaser or seller by narrowly constructing SLUSA and finding it would give rise to wasteful and duplicative litigation - thus, the phrase "in connection with the purchase or sale" of securities was given a broad reading.

As you might recall, after the enactment of the PSLRA, plaintiffs began to bring more state law securities class actions in state courts - and after SLUSA was passed, plaintiffs commenced the filing of "holders" class actions in state court. These practices should be over now; wonder what will be the next angle sought by the plaintiff's bar? Lots of blogs will undoubtedly analyze this decision as they love the Supreme Court stuff, like Ideoblog and The 10b-5 Daily.

Here is the court opinion in Merrill Lynch v. Dabit (04-1371) - and we have begun posting law firm memos on this development in our "Securities Litigation" Practice Area.

Nifty Chart: Initial and Continuous Listing Standards of US Trading Markets

They say it couldn't be done! Many thanks to Neil Kaufman and Chris Seamster of Davidoff Malito & Hutcher for this handy one-page chart that compares initial and continuous listing standards of the US trading markets, including the NYSE, Nasdaq, Amex, OTC Bulletin Board and pink sheets.

It's amazing that so much information can be boiled down onto one page! I tend to get excited about simple things like this, but I know more than one of you are reading this saying, "What. Ever." I have posted this chart in a number of our Practice Areas, including "NYSE Guidance," "Nasdaq Guidance," "Small Business" and "IPOs."

PCAOB's Two Releases on Auditor Process to Address Quality Control Criticisms

Yesterday, the PCAOB issued two releases concerning the implementation of the Sarbanes-Oxley provision that gives registered accounting firms incentive to address quality control criticisms included in PCAOB inspections reports within 12 months after the reports have been issued. Specifically, Section 104(g)(2) of Sarbanes-Oxley provides that “no portions of the inspection report that deal with criticisms of or potential defects in the quality control systems of the firm under inspection shall be made public if those criticisms or defects are addressed by the firm, to the satisfaction of the Board, not later than 12 months after the date of the inspection report.”

The first release details the PCAOB's process for determining whether a registered accounting firm has addressed quality control criticisms included in an inspection report to the Board's satisfaction.

The second release describes the efforts undertaken by the Big Four audit firms to address quality control concerns included in the August 2004 reports regarding limited PCAOB inspections. This release includes a general summary of some of the steps taken by the firms to address the PCAOB's quality control concerns.

March 21, 2006

Survey Results: Auditor Inspection Reports and Engagement Letters

Here are the survey results regarding auditor inspection reports and engagement letters:

1. Have you requested information from your independent auditor about the non-public portions of the PCAOB’s inspection report (ie. Part II of the report) that could impact your company’s audit?

- Yes, our auditor agreed in the auditor engagement letter to provide a copy of the inspection report - 3.3%
- Yes, our auditor agreed informally to provide a summary or a copy of the inspection report - 40.0%
- Yes, but auditor refused our request to receive information regarding the non-public portions of the inspection report - 13.3%
- No, we have not made such a request from our auditor - 43.3%

2. Does your most recent engagement letter with your independent auditor include a provision that imposes a cap on the auditor’s liability (ie. no liability except for willful misconduct and gross negligence)?

- Yes - 63.3%
- No - 36.7%

3. Does your most recent engagement letter with your independent auditor include a provision that waives a jury trial?

- Yes - 70.0%
- No - 30.0%

New Survey: Trading Policies for Outside Directors

Please take our new survey on trading policies for outside directors.

SEC Files Amicus Brief in At Home Corp. v. Cox Communications

A few weeks back, the SEC filed its amicus curie brief with the Second Circuit in At Home Corp. v. Cox Communications, Inc., a case discussed in the November 2004 issue of Section 16 Updates. Below is some commentary from Alan Dye snipped from his Blog:

Interestingly, 12 of the 24 pages of legal argument are devoted to the level of deference courts should pay to the views of the SEC as expressed in amicus briefs. On that issue, the SEC argues that the Commission’s interpretations of its own regulations are “binding, unless they are plainly erroneous or inconsistent with the regulations,” and that its interpretations of federal securities statutes should be considered “controlling,” or entitled to “Chevron deference,” if the statute is ambiguous and the SEC’s interpretation is reasonable.

The facts of the At Home case are discussed in an August 17, 2004 posting in the Litigation Corner. Briefly, Cox, Comcast and AT&T at one time shared control of At Home, and on March 28, 2000, AT&T agreed to purchase shares of At Home stock from both Cox and Comcast based on a hybrid pricing structure. In Cox's case, AT&T agreed to purchase shares for a purchase price of $1.4 billion. If the price of At Home's stock on the date of exercise were $48 per share or less, the number deliverable would be determined by dividing $1.4 billion by $48. If the price of At Home's stock exceeded $48 per share (based on the market price during the 30 trading days beginning 15 days before Cox's exercise of the right), then the number of shares deliverable would be a number having a value of $1.4 billion. Cox exercised the right on January 11, 2001, when the market price of At Home's stock was $7.72 per share, and therefore Cox was entitled to the fixed price of $48 per share. (Because AT&T would have incurred significant tax liability had it purchased the shares, the parties worked out an agreement in on May 18, 2001 whereby AT&T satisfied its liability to Cox by allowing Cox to keep the shares and also to receive shares of AT&T stock.) Comcast entered into substantially identical transactions with AT&T.

At Home ended up in bankruptcy, and the bankruptcy trustee brought an action against Cox and Comcast, alleging that their put rights were not derivative securities because they did not have a fixed price. As a result, the trustee alleged, the exercise of the rights resulted in non-exempt purchases, matchable with the "purchase" of the shares back from AT&T within less than six months. As an alternative theory of liability, the plaintiff alleged that Comcast’s establishment of the put was a sale, matchable with Comcast’s purchases within six months of three cable companies which also owned At Home securities in their portfolios. Judge Buchwald dismissed the complaint, holding that the put rights were hybrid securities, having both a fixed exercise price and a floating exercise price, and that the rights therefore were derivative securities from the time they were created in March 2000. The exercise of the rights at the fixed price, in turn, was exempt from Section 16(b) by virtue of Rule 16b-6(b). Comcast’s purchase of the three cable companies was held to be outside Section 16 under the unorthodox transaction doctrine.

The SEC’s brief reaches some interesting conclusions. The opening section states that the SEC “agrees with the district court that defendants are not liable under Section 16(b).” The Commission then goes on to argue that (i) the puts were hybrid securities, and therefore were derivative securities to the extent of their fixed price component, (ii) the establishment of the puts on March 28, 2000 constituted “sales” of the stock that could sold at the fixed price, (iii) the puts were never effectively exercised on January 11, 2001, because the underlying stock was never delivered, and (iii) the options were “cancelled for value” on May 18, 2001, resulting in a “purchase” of the underlying shares on that date (more than six months after the March 28, 2000 sales).

The SEC disagreed with the district court’s conclusion that the unorthodox transaction doctrine applies to Comcast’s purchases of the three cable companies, arguing that the doctrine applies only to “forced” transactions that present no potential for speculative abuse because the insider has no access to inside information. The SEC asserted instead that Comcast’s purchases of the cable companies were not “purchases” of At Home stock as the term “purchase” is defined in Section 3(a)(13) of the Exchange Act. While that definition is broad enough to pick up Comcast’s purchases of the cable companies, the SEC argues that the lead-in to the definition says “unless the context otherwise requires.” The Commission argues that a change-of-control transaction typically is not motivated by a desire to purchase the acquiree’s portfolio securities and therefore should be presumed not to be a purchase for purposes of Section 16(b) (because the “context otherwise requires”). The Commission argues that the plaintiff would have the burden of rebutting the presumption, such as by proving that the acquisition of another company was a subterfuge for purchasing the underlying securities.

It likely will be several months before the Second Circuit issues its decision.

March 20, 2006

More Companies Adopt Majority Vote Standard

Thanks to this comprehensive survey by Claudia Allen of Neal, Gerber & Eisenberg, there are a surprising number of companies that have recently adopted a pure majority standard without fanfare. These companies include Motorola, Allied Capital, Texas Instruments, Career Education, Freeport-McMoRan Copper & Gold and United Technologies. We have added all these companies to our own "Majority Vote Chart" and posted Claudia's survey in our "Majority Vote Movement" Practice Area.

Of 116 companies listed in Claudia's survey as having taken definitive action since the emergence of the majority vote movement, 78% adopted policies, 18% adopted bylaws, and 4% adopted both a policy and bylaw. Of course, the more important stats relate to which companies adopted pure majority vote standards versus director resignation provisions. Check out Claudia's survey for more info on that - as well as our chart which is even more comprehensive: we show about 75 companies with a pure majority vote standard (that # likely is comprehensive for that category) and another 50 with a director resignation policy (that # likely is not comprehensive, as these policies are harder to track). And don't forget about our March 28th webcast: "Practical Considerations: Implementing a Majority Vote Standard."

Voting Results on First Majority Vote Proposals of the Proxy Season

Last week saw the first voting results from this proxy season on the Carpenters' Union proposal to implement a majority vote standard. These results indicate that such proposals may not fare too well this year at companies that have adopted director resignation policies.

The proposal received a 35% vote at Analog Devices; 31% at Ciena and 45% at Hewlett-Packard; all of these companies had adopted a director resignation policy in advance of their annual meetings. In comparison, majority vote proposals received an average level of support of 44% last year, as noted in the ISS "Corporate Governance Blog."

Update on CII and the Majority Vote Movement

Last June, the Council of Institutional Investors asked the 1,500 largest US companies to adopt a majority vote standard for director elections, as covered in this popular podcast with Ann Yerger, Executive Director of CII. About 200 response letters were received.

A few weeks ago, CII completed two follow-up mailings: one letter geared to companies considering the reform, and the other letter pressing non-responders for action. CII already has received 30 responses to the follow-up mailings and more are pouring in every day.

Over 65 companies replied that a form of majority voting was in place, and well over 100 responses said the Council's request would be taken under consideration at an upcoming governance committee or a full board meeting.

For Those With a New Majority Vote Standard: A Word to the Wise

You will hear more from Cary Klafter of Intel about this - and more - on next week's webcast - "Practical Considerations: Implementing a Majority Vote Standard - but thought I would blog his suggestion for those facing this issue right now:

"For those companies using some form of 'majority voting' arrangement for directors this proxy season: You should give an early heads-up to your transfer agent and to ADP if you plan to have director vote choices on your proxy other than the traditional Yes and Withhold. Intel is using For, Against and Abstain this year, and that affects the proxy card and the ADP Voting Instruction Form (VIF). For example, on the VIF each of the director nominees will be treated like a separate proposal in terms of formatting, numbering of proposals, etc.

Our transfer agent, Computershare, and ADP were each a bit surprised when we raised the point and it took some discussion to resolve the matter. ADP says that it is now fully prepared, but it only knows if you are using a non-traditional vote choice when it gets your proxy statement or if you contact in advance. Advance notice to your service providers would be useful."

March 17, 2006

Poison Pill Proposals Found Excludable Upon Reconsideration

From my Blog: Last week, the SEC Staff issued a batch of no-action responses, where on reconsideration the Staff said that Bristol Myers (and other companies) could exclude John Chevedden's poison pill shareholder proposals. The Staff originally took the position that the companies could not exclude the proposals under Rule 14a-8(i)(10), even though the companies had eliminated their poison pills and adopted a policy that any new pill would be put to a stockholder vote. The basis for the Staff's initial refusal was that the proposal asked for the policy to be "in the bylaws or charter if practicable." Upon reconsideration by the Commission, the Staff then overturned its earlier refusal and now has allowed exclusion of the proposals. We have posted a copy of the reconsideration responses in's "Poison Pills" Practice Area.

Interestingly, the Staff's responses in the reconsideration included this commentary:

"We note that there is a substantive distinction between a proposal that seeks a policy and a proposal that seeks a bylaw or charter amendment. In this regard, however, we further note that the action contemplated by the subject proposal is qualified by the phrase `if practicable' and that the company has otherwise substantially implemented the proposal."

One possible interpretation of this commentary is that the Staff hung their hat on the "if practicable" language and the Staff believes that there is a substantive distinction between a corporate policy and a bylaw provision.

I think a fairer reading is that the Staff simply changed its mind on this one, but that it still believes that a policy is not as binding as a bylaw. The truth of the matter is that the phrase "as practicable" is pretty subjective - and a company would still have to convince the Staff that it is not practicable to adopt the poison pill change requested by the proposal.

This also crosses paths with the majority vote issue and the position the Staff took that a Pfizer-type policy does not substantially implement a majority vote proposal. Some practitioners believe that it was the "location matters" argument (policy vs. bylaw) that the Staff relied upon for their conclusion in those letters. It seems that Time-Warner and other companies may be testing this theory when they recently adopted a director resignation policy, but put it in their bylaws.

And then you have to consider the complaint in the lawsuit against Hewlett-Packard for repayment of Carly Fiorina's severance. Some view that as taking the recent News Corp. decision to the next level, arguing that disclosure regarding policies in proxy statements makes them binding contracts.

Towards Better Online SEC Filings

Going back to my roots in this podcast, during which Rhoda Anderson, CEO of EZOnlineDocuments, provides some insight into how companies can improve the effectiveness of their online proxy materials and other SEC filings (here are samples of what EZOnlineDocuments can do), including:

- What are most companies doing with their financial documents or shareholder communications today?
- What are common limitations in a typical SEC filing that is posted online?
- Why isn’t a PDF good enough for shareholders’ purposes?
- Why is it challenging to get online documents into the HTML format?
- What characteristics do effective online documents have?

The Canadian Approach to Internal Controls

Recently, the Canadian Securities Administrators announced a change in approach for Canada's version of Section 404, which would be implemented as early as December 31, 2007. At this time, the Canadian securities regulators have decided not to require companies - of any size - to have an auditor attestation on internal control, stating: "After extensive consultation, the CSA has decided not to proceed with an earlier proposal that would have required companies to obtain from their external auditors an audit opinion in respect of management’s evaluation of the effectiveness of internal controls over financial reporting."

Further details regarding the status of the Canadian proposals is provided in CSA Notice 52-313. In essense, the Canadian regulators have proposed a new element for the existing Section 302-like certifications requirements to include a Section 404-a like management assertion as to the effectivess of internal control over financial reporting - but not require a Section 404-b like auditor attestation.

A fuller description of the Canadian approach is available in FEI's Section 404 Blog - there also are related law firm memos in Section 3.F of our "Canadian Law" Practice Area.

March 16, 2006

Corp Fin Reverses WKSI Automatic Shelf Registration Position

Last week, I blogged about a position announced by Corp Fin at "SEC Speaks" that they would object to a takedown from a WKSI's automatic shelf filed between filing of the 10-K and the proxy statement unless a company filed either an amendment to its 10-K or its proxy statement to include Part III information - or unless it included the Part III information in a prospectus supplement to the automatic shel.

From a bunch of kind members, I have heard that the SEC Staff has now withdrawn that position and the Staff's current position is that they will not object to such a filing or a takedown during that period - rather, the Staff will leave it up to companies to make their own decisions as to whether the registration statement and prospectus satisfy applicable requirements. This position is consistent with the Staff's traditional position regarding shelf takedowns.

However, the Staff stated that they have not changed their position - as historically stated in Telephone Interpretation H-6 - regarding their unwilliness to declare a non-automatic registration statement effective during the period between filing of the 10-K and the proxy statement unless the current year's Part III information is included in the filing or incorporated (but not forward incorporated).

A Parody

March Madness begins (here is some tourney history)! Check out this video of an Ipod/Microsoft parody. No, I didn't get it from Office Pirates, Time Warner's new site designed to look like it was developed by renegades (just like "independent films" are now produced by the big movie studios).

Should Auditors Be Airport Screeners?

From Gary Zeune - who did this interesting podcast with me a while back - as posted on

"To test terrorism readiness, British authorities conducted Threat Image Projection (TIP) and digitally inserted one of 250 images of guns, knives and other banned objects into luggage. Initially the screeners’ performance was mediocre. But with practice it improved dramatically. Then the images were changed, and the screeners’ performance dropped like a rock to no better than when the program started. But why? There are several reasons.

First, because we ‘see’ only what we expect to see. It’s the same reason you don’t see the bottle of beer on the shelf in your fridge, RIGHT IN FRONT OF YOU, because you’re hunting for, and expect to see, a CAN of beer. So when the images of the grips on the guns or the orientation of the knives were changed, the screeners detection skills were back at the starting gate. For accountants, this means that if they haven’t received significant training in what the ‘red flags’ of fraud look like, they likely won’t detect fraudulent financial statement items.

Second, is ‘distractions’ or ‘noise’. That is, the more items in the bag, ‘noise’ or distractions, the more likely the screeners failed to detect the weapon. One’s ability to pick out a single item declines when it’s part of a complex scene, loaded with similar items. That may be why screeners at the Newark, NJ airport missed a butcher knife in a cluttered handbag. Likewise, financial statement auditors look at hundred or even thousands of transactions, journal entries, and events. So finding the one or few fraudulent items is difficult at best, and near impossible at its worst.

Cognitive scientist J. David Smith at State University of New York, Buffalo, used origami-like items. The 88 participants studied not just the original shape but variations and orientations. They eventually the spotted up to 76% of the targets. Then Smith slightly changed the target and performance fell off a cliff. Why? Because the screeners were looking for the original shapes and orientation, not the variations. Just like screeners have trouble applying their knowledge to new situations, might auditors not recognize a fraud or misstatement because they’ve not seen it, or been trained to look for it, before?

The failure to recognize variations of learned items is specific-token strategy. Screeners recognize the Beretta 9mm but not the 32 caliber revolver or the Beretta packed upright in the bag instead of lying flat.

Just to be sure the nature of the origami items was causing the poor results; Smith had the participants look for actual guns, knives and scissors in over-packed suitcases. Again, their ability to spot the items started low then eventually increased to 90%. But as soon as new banned items were inserted in the luggage, the number of missed items soared 300%.

Statement on Auditing Standards Number 99 says, “The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether caused by error or fraud.” Thus, auditors have a positive affirmative duty to detect fraud. So, the question is whether auditors will detect methods of cooking the books if they haven’t been trained on those methods? Of course, there are about a bazillion ways to cook the books. In light of the specific-token phenomenon, is there any amount of training that will allow auditors to fulfill their obligation under SAS 99?

In the final analysis the question is, how do auditors train their brains to generalize their fraud detection skills to recognize fraud indicators that they haven’t been trained on? So far, I’m not aware of anyone has figured out how to do that."

March 15, 2006

The AIM Market in Play

Those following the tussle for control of the London Stock Exchange know that one of the reasons why the LSE is so attractive is that many of the IPOs during the past year have chosen to list there rather than on the Nasdaq or the NYSE (read Sarbanes-Oxley). In fact, I had announced this upcoming webcast - "How to Go Public on the London Stock Exchange’s AIM" - a few weeks back, before Nasdaq made its recent offer for the LSE (which clearly is still alive as Nasdaq reportedly is meeting with LSE's largest shareholders).

In a somewhat related note, the newly-public NYSE Group filed this Form S-1 yesterday in an effort to remove a barrier to it making its own offer for the LSE. This registration statement will allow current shareholders (ie. former seat holders) to liquidate some of their new-found wealth (and lists Nasdaq's LSE bid in the "Risk Factors" as well as discloses the pay levels of top NYSE executives).

And yesterday, the SEC and its UK counterpart, the Financial Services Authority, agreed to cooperate more closely in what they called a "landmark cooperation regulatory agreement" - these regulators also said they have discussed a possible deal marrying the London Stock Exchange with a top US exchange.

The Latest on Attorney-Client Privilege Waivers

Last week, the House Judiciary Committee held a hearing on attorney-client privilege waivers, primarily as part of a campaign spearheaded by a number of major big business groups (including the American Chemistry Council, Business Roundtable, Financial Services Roundtable, National Defense Industrial Association and U.S. Chamber of Commerce).

The National Association of Criminal Defense Lawyers (NACDL) and the Association of Corporate Counsel (ACC) are coordinating this attack on the "culture of waiver," collaborating on their main piece of evidence - which is a survey of NACDL’s 13,000 members and ACC’s 15,000 members.

Here's information relating to the first hearing; the second hearing was postponed for now. This story in the Corporate Crime Reporter does a good job of summarizing this development.

And don't forget you have only until March 28th to submit comments on the US Sentencing Commission's Sentencing Guidelines Commentary on Waiver of Attorney-Client Privilege and Work Product.

AICPA Issues Proposed Statement on Auditor Communications

Last week, the AICPA published this proposed Statement of Auditing Standards: The Auditor's Communication With Those Charged With Governance. The proposed statement would replace SAS No. 61 and would establish standards for auditor/audit committee communications. Comments must be submitted by May 31st. Since the PCAOB lists this topic among its priorities for this year, I'm not sure why the AICPA is also tackling it...

March 14, 2006

ABA Committee Issues Majority Vote Report

Yesterday, the Committee on Corporate Laws of the ABA's Section of Business Law released its Report containing proposed amendments to the Model Business Corporation Act. Now the 3rd comment opportunity commences, which ends on May 30th - so the Report isn't quite "final." We have posted a copy of the Report in our "Majority Vote Movement" Practice Area.

In the Report, the Committee concluded that the “failed election” consequences make it unwise to change the statutory plurality default rule - because it would apply universally to all companies governed by state statutes adopting the Model Act provisions. Rather, the Committee decided that the statutory framework should facilitate individual corporate action.

Among other proposals, the Committee would permit shareholders - or directors by private ordering - to adopt a bylaw providing for a form of majority voting. Thus, the heart of the Committee’s proposal is a carefully-tailored majority voting bylaw standard that can be adopted unilaterally by either the board of directors or the shareholders. This approach, coupled with other measures described in the Report, would normally have the effect of not seating, for more than a 90-day transitional period, a director whose election or reelection has effectively been rejected by a majority of votes cast.

In response to concerns regarding the validity of voluntarily-adopted board policies, the Committee also is separately proposing to adopt a statutory method expressly to facilitate and enforce resignations tendered by directors. The Report raises a number of specific questions that the Committee seeks input on - last chance to speak up!

Hear more about this important Report in the upcoming webcast - "Practical Considerations: Implementing a Majority Vote Standard" - whose panel includes the Committee Chair Norman Veasey.

FASB and IASB Seek Comments on Fair Value Accounting

As highlighted in this recent podcast with Jack Ciesielski, this is the year of fair value accounting. Last week, the FASB and IASB issued this request for comment about the financial analysis of companies that report some - or all - financial instruments at fair value. Here is some background on the request - and here is the related questionnaire. Responses are sought by April 14th.

Reminder: Careful with Your Voicemails!

I got a kick out of this voicemail that was discussed in Sunday's NY Times column by Gretchen Morgenson. It was left by a retail investor for analyst Michael Krensavage.

Brought back memories from my days working in Corp Fin's Office of Chief Counsel, where you spend hours each day talking to whomever calls OCC's hotline and receive some quacky voicemails. Also reminded me of the voicemail left by an associate working on a deal that made the online rounds a few years back, as so eloquently blogged by Wilson Chu on the Blog.

Is Hiring A Defense Attorney Obstruction of Justice?

From the White Collar Crime Prof Blog: "The Second Superseding Indictment in the case of United States v. Singleton provides some fascinating language in Count Ten, an obstruction charge under 18 USC 1512(c)(2). It seems that comments made by an employee during an internal investigation are now being used to form the charge of obstruction. The indictment actually states that the defendant "informed the Outside Lawyers that he had retained an attorney and wanted to reschedule the interview for a time when his attorney could be present.....The attorney was a criminal defense attorney."

This approach of using employee statements during an internal investigation to form the basis of a charge in an indictment was seen in the case of Computer Associates (see post here).

The ramifications of the government taking this approach is that employees will be less likely to participate in internal investigations. Such an approach will not be beneficial to the company, not assist the shareholders, and certainly destroys any trust between a company and its employees. And if the conversations will no longer take place, then the government will get nothing. This is not an impressive move by the government. Is it really worth getting the information in these two cases to cause such damage to the corporate environment?"

March 13, 2006

Form 10-K Confusion: Voluntary Filer Status

As companies fill out the new checkboxes on the cover of their Form 10-Ks, there appears to be a bit of understandable confusion regarding the checkbox that relates to "voluntary filer" status (eg. see #1569 in our Q&A Forum; in addition, a number of companies that have already filed checked the wrong box). This checkbox states:

"Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ___ Yes ____ No"

Rest assured that if "yes" is checked for this checkbox, that means the company is stating that it is a voluntary filer (and the EDGAR nest in the header should also be "yes").

I can understand how the double negative in the checkbox causes some confusion; we probably would have been better off with a single box - like the Item 405 checkbox - rather than being faced with a "yes/no" set of boxes.

Comments on the SEC's E-Proxy Proposal

The comment period closed on February 13th for the SEC's E-Proxy proposal and final rules shouldn't be expected anytime soon given that the new Corp Fin Director hasn't started work yet. Scanning through the comment letters, it appears that the nature of the comments are all over the lot, with some fully supporting the idea and others not favoring it at all.

One of the more interesting comments came from AARP, which polled its members regarding their Internet use - 1500 retirees responded! - and found that 84% have access to the Internet at home (with 64% of those having high-speed access - we have posted the full survey results). Even despite the relatively high level of Internet use, it's not too surprising that this group favors regular mail for their proxy materials.

In this podcast, Carl Hagberg provides his thoughts on the E-Proxy proposal (here is the comment letter that Carl submitted to the SEC), including:

- What are the primary issues that you see in the SEC’s e-proxy proposal?
- What should companies consider doing regarding these issues?
- What are your recommendations to tweak the SEC’s proposal?
- Does the SEC’s proposal change the playing field at all?

SEC Proposes PCAOB's Independence and Ethics Standard

Last week, the SEC finally issued the PCAOB's proposal - which was sent to the SEC last July! - that would prohibit auditors from engaging in aggressive and abusive tax services, among other matters. The SEC and PCAOB staff had a lot of interatction on this proposal before it was ever proposed by the PCOAB, so it is certainly due. Comments are due 35 days from publication in the Federal Register.

March 10, 2006

US Chamber of Commerce's Report on the SEC's Enforcement Efforts

Yesterday, the US Chamber of Commerce issued a 44-page report on the SEC's enforcement program. This Reuters' article includes a reply from SEC Chairman Cox.

The Chamber seeks a special advisory committee to study - and possibly reform - the SEC's Enforcement Division and its procedures. In addition, here are some of the report's 15 recommendations noted on pages 7-8:

- review of whether the SEC is using its litigation and settlement positions to attempt to shift standards for civil liability, such as "materiality" and "scienter," to an inappropriately low level

- refrain from interpreting or expanding the SEC's regulatory reach through enforcement actions and clarify legal standards before initiating enforcement actions for violation of those standards

- greater SEC reliance on formal reprimands instead of enforcement actions to remedy inappropriate corporate behavior

- avoid blurring the line between civil actions and appropriate criminal prosecutions and ensure that SEC referrals to DOJ for securities violations are reserved for clearly egregious cases

- clarification that a waiver of attorney-client privilege or work product protection is not required to be viewed as cooperating with an SEC investigation

- refrain from imposing fines on companies entirely for lack of cooperation during investigations (because the SEC already has adequate tools through subpoena enforcement actions, threat of such actions, and rules on document maintenance to command cooperation)

- over the last several years, the investigative process has become more adversarial and less objective in finding the facts and determining whether a violation has occurred (so there should be more open dialogue and a reconsideration of the practice of industry sweeps due to overly broad requests for information)

What About Periodic Updates from Enforcement on Open Matters?

On a somewhat related note, on Tuesday's webcast - "How to Handle a SEC Enforcement Inquiry Today" - Russ Ryan mentioned proposed legislation that would require the SEC to provide regular updates to companies under investigation. This would go a long way towards solving the dilemma discussed on the webcast - to quote Jay Dubow: "Do you want to call and get that confirmation or are you afraid you’re going to wake the sleeping dog; that it was on someone’s back burner and now they’re going to relook at the open matter?"

A few members asked for the name of the proposed legislation. It is the bill that seeks to reform OCIE called "HR 4618: Compliance, Examinations, and Inspections Restructuring Act of 2005."

A Peek at

Howard Dicker sent me over to to get a taste of what OMB is up to these days. By plugging "securities" and "exchange" into the search tool, I found that the SEC's OCIE received a "moderately effective" grade in 2005. In 2004, Enforcement received a "not performing" - and Corp Fin received a "not performing" in 2003.

March 9, 2006

Notes from PLI's "SEC Speaks"

We have posted notes from the Corp Fin and Accounting panels from PLI's "SEC Speaks" conference in our "Conference Notes" Practice Area. Notes from Corp Fin's Office of Mergers & Acquisitions are posted on's "Conference Notes" Practice Area.

One-Time "Hall Pass" to Fix Cash Flow Classifications

One issue not discussed by the SEC Staff at PLI's "SEC Speaks" is the SEC's informal position that provides companies with an opportunity to fix erroneous cash flow classifications - in the discontinued operations context - without having to restate. This issue was first raised at the AICPA's National Conference in December when Corp Fin Staffer Joel Levine stated that companies had better start paying attention to their cash flow classification. Joel also identified certain presentation formats that the Staff considers inconsistent with SFAS No. 95. Here is Joel's speech and his PowerPoint from that conference.

Then, on February 15th, the AICPA issued CPCAF Alert #90, which notes which presentation formats are acceptable to the Staff - and that the Staff will allow companies to amend their classifications in their next Form 10-K or Form 10-Q without having to treat such amendments as a correction of an error. The Alert also states that any issues discovered and corrected in a later SEC filing will be treated as a correction of an error and require amendments of prior filings.

I don’t know why the SEC staff didn’t mention this position at the conference as I think it’s important for companies to know of this position if they have not been reporting cash flows relating to discontinued operations the way the SEC wants them to.

Talk About Having a Bad Day

As a former in-house lawyer, the thing that struck me about Google's gaffe -that led to some internal projections being included in an "Analyst Day" presentation posted on the company's IR web page - is that it might have cost some lawyer his or her job. Being in-house is tougher than you might imagine if you haven't "been there, done that." First, non-lawyers are your ultimate boss - and they often don't like lawyers at all (since lawyers are the ones who say "no"). Second, one simple mistake like this and you can cost the company 5% of its market cap. Third, I often worked harder when I was in-house than when I worked in law firms - meetings all day, real work at night.

Now, we don't know if a lawyer was to blame for Google's gaffe (it depends on whether the unintended projections were included in a draft that the lawyer reviewed; I sure hope lawyers are involved in vetting analyst presentations!). In fact, the projections could have been added after it was reviewed and most in-house lawyers are absolved of any responsibility once a document leaves their hands. But this gaffe highlights the need to include double-checking on what is about to be filed with the SEC or posted on the company's IR web page as part of a company's disclosure controls and procedures. This mundane task clearly is as important as drafting the original disclosure since the end result is what really matters to investors. Here is Google's Form 8-K that describes its gaffe.

March 8, 2006

Hewlett-Packard Sued Over Severance Pay

According to this NY Times article, two large shareholders sued Hewlett-Packard on Tuesday, contending that a $21.4 million severance package for former CEO Carly Fiorina violated the company's policy on executive compensation. The lawsuit was filed in US District Court in the Northern District of California; we have posted a copy of the complaint in the "Litigation Portal" (remember there are two other compensation lawsuits heading to trial shortly!).

Here is an excerpt from the NY Times article:

"The suit says Ms. Fiorina's severance pay exceeded a limit shareholders approved in 2003 that restricted such compensation to 2.99 times an executive's base pay plus bonus. The lawsuit seeks to recover the money paid to Ms. Fiorina, who was forced to resign in February 2005.

A Hewlett-Packard spokesman said the company "believes the suit is without merit" and declined to comment further. A spokesman for Ms. Fiorina said she had not seen the suit and would not comment.

The lawsuit shows that executive compensation is of increasing concern to owners of public companies, said Gary Lutin, an investment banker at Lutin & Company in New York who advises institutional investors in corporate control battles. "The lawsuit indicates a growing sense of shareholder responsibility for controlling the diversion of corporate assets by the property managers," he said, "especially by the ones who failed."

In the most publicized case, Disney shareholders fought their company to rescind the $140 million severance package that was given to Michael S. Ovitz, who was fired after 14 months as president. Disney won that case last year when the judge ruled that the Disney board "fell significantly short of the best practices of ideal corporate governance," but it did not violate its fiduciary duty.

It was shareholder outrage at the size of Hewlett-Packard's award of about $17 million to Michael D. Capellas, who was Hewlett's president for seven months, that prompted stockholders to approve the policy that limited future severance awards. The shareholder proposal was sponsored by the Service Employees International Union.

The lawsuit notes that Ms. Fiorina's severance package of $21.4 million was 3.75 times her $5.6 million salary and bonus. The suit contends that her severance package could be worth as much as $42 million when the potential value of her stock and options and her pension are factored in. Under the company policy, any award that exceeds the limit must be approved by shareholders.

The crux of the case depends on how one defines the bonus that Ms. Fiorina received under what Hewlett calls the long-term performance cash program. The three-year incentive plan, approved by shareholders in May 2003, provided bonuses to executives if certain financial targets were met. However, the plan stated that executives who were fired would not receive the bonuses.

The board gave Ms. Fiorina $14 million, which was 2.5 times her salary and regular bonus, and an additional $7.38 million from the long-term bonus plan. "It is a severance payment no matter what they call it," said Michael Barry, a partner at Grant & Eisenhofer, which filed the lawsuit on behalf of the unions.

The company changed the terms of that plan to apply to fired executives after Ms. Fiorina received her severance in February 2005. The suit says the plan was amended secretly."

House Representatives Oxley and Baker Support SEC Authority

On Monday, following the request for comment on the SEC's Advisory Committee on Smaller Public Companies Final Report, House Financial Services Committee Chairman Michael Oxley (OH) and Capital Markets Subcommittee Chairman Richard Baker (LA) wrote a letter to SEC Chairman Cox to express their view that the SEC holds the necessary authority to act on the Committee's recommendations should it choose to do so.

The letter likely was in response to Committee member Kurt Schacht, Director of the CFA Center for Financial Market Integrity, who wrote in dissent that "it is unclear to many whether the broad exempting recommendations of this subcommittee are even within the commission's legal authority."

Nasdaq Seeks "Covered Securities" Relief for Listed Companies

Last week, Nasdaq filed a rulemaking petition with the SEC so that securities listed on the Nasdaq Capital Market are considered "covered securities" for purposes of Section 18 of the '33 Act (and hence be preempted from the reach of blue sky laws).

Particularly since NASAA doesn't oppose Nasdaq's request, it certainly seems like a "no-brainer" that the SEC would make this rulemaking, which is why I found it unusual that Nasdaq filed a rulemaking petition rather than informally ask the SEC to act. But since Nasdaq is allowed to file these petitions by statute, it's not a bad move to provide people with an opportunity to comment (and voice their support, which perhaps might spur the SEC to take faster action).

March 7, 2006

The SEC's Compensation Proposals: Our Comments and Critical Fixes

Last week, Jesse Brill submitted a comment letter to the SEC regarding the executive compensation disclosure proposals. Jesse's comments are embedded in the Jan-Feb 2006 issue of The Corporate Counsel, which was mailed over the weekend (and a copy of this issue is posted on We hope you will read these 8 pages as "food for thought" as you consider what issues you intend to comment upon.

Meet Our Compensation Consultants: Ratchet, Ratchet and Bingo

In this year's 23-page letter to shareholders, Warren Buffett takes his annual swing at excessive CEO pay. My three favorite quotes from this year's letter:

1. "The deck is stacked against investors when it comes to the CEO's pay. Outlandish 'goodies' are showered upon CEOs simply because of a corporate version of the argument we all used when children: 'But, Mom, all the other kids have one.'"

2. "The upshot is that a mediocre-or-worse CEO – aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo – all too often receives gobs of money from an ill-designed compensation arrangement."

3. "Comp committees should adopt the attitude of Hank Greenberg, the Detroit slugger and a boyhood hero of mine. Hank's son, Steve, at one time was a player's agent. Representing an outfielder in negotiations with a major league club, Steve sounded out his dad about the size of the signing bonus he should ask for. Hank, a true pay-for-performance guy, got straight to the point, 'What did he hit last year?' When Steve answered '.246,' Hank's comeback was immediate: 'Ask for a uniform.'"

New Disclosure Requirement? How Much You Got Paid to Draft Those Compensation Disclosures

Got a chuckle reading Evelyn Y. Davis' comment letter to the SEC regarding the executive compensation disclosure proposals. If you don't know about Evelyn, here is some background information.

Evelyn asks the SEC to require disclosure of "all outside legal fees." Not sure how that would work within the SEC's proposed framework nor am I sure what that would accomplish (do shareholders really want to know how much companies pay each vendor they work with?). She appears incensed that one company paid $800 million in legal fees in a one year period - I agree that sounds more than a tad bit high.

Why Rules Can't Stop Executive Greed

This NY Times article from Sunday is among the best I have seen on the complexities of pay-for-performance metrics. It also addresses the importance of boards taking charge to tackle the perils of excessive executive compensation. I recognize that shareholders have a role here, but the burden truly does rest on the board's shoulders.

March 6, 2006

WKSIs: Automatic Shelf Registration Issue

As many WKSIs will soon be filing 10-Ks that forward incorporate Part III information from a proxy statement, be aware that an automatic shelf registration statement may not be available if the WKSI has not already made the Part III information publicly available. The issue relates to the filing of an automatic shelf registration statement by a WKSI registrant after filing a Form 10-K (that forward incorporates by reference the Part III information) and before filing the proxy statement.

Historically, the Staff had the policy (as set forth in the Telephone Interpretations Manual H.6) that they would not declare effective a registration statement on Form S-3 until the company either amended its 10-K to include the Part III information or filed its proxy. Informally, however, the Staff did allow registrants to do shelf takedown offerings from a shelf registration statement that had been declared effective prior to the filing of a Form 10-K.

At PLI's "SEC Speaks" on Saturday, Corp Fin Chief Counsel David Lynn fleshed out this issue as follows. The Staff says that an automatic shelf registration statement filed during this period will continue to be automatically effective as set forth in the new rules. However, the Staff believes that the prospectus contained in the registration statement does not satisfy the requirements of Section 10(a) of the Securities Act and therefore cannot be used by a WKSI until: it files either an amendment to its 10-K or its proxy statement to include Part III information - or unless it includes the Part III information in a prospectus supplement to the automatic shelf.

The bottom line: while a WKSI technically can file an automatic shelf registration statement after filing its Form 10-K and before filing its proxy, it cannot conduct an offering under that newly-filed automatic shelf registration statement until such time as the Part III information is filed (via 10-K/A, proxy statement or prospectus supplement). We will be posting more notes from "SEC Speaks" soon...

SEC Chair Cox Discusses Disclosure of SEC Investigations

This Reuters article from last week quotes SEC Chairman Cox on the issue of when companies should disclose the existence of an investigation or the offer of a settlement. For Chairman Cox, the disclosure threshold is that "material" disclosures should be made - but he confessed that determining what constitutes "materiality" is difficult. The article notes a recent speech by Commissioner Atkins during which he expressed frustration with companies that disclose tentative SEC settlement agreements before the Commissioners had an opportunity to vote on whether to further pursue the Enforcement action. Here is an interesting excerpt from Commissioner Atkin's speech:

"Often in the SEC enforcement process, public companies, or sometimes their regulated subsidiaries such as broker-dealers, decide to pursue a settlement with the Commission. In the settlement process, the settling party deals directly with our enforcement staff, but the staff does not have the authority to bind the Commission to the terms of a settlement. Simply put, the settling party is offering to the enforcement staff to settle the matter based on certain violations of the securities laws, with certain remedies such as bars, penalties, or disgorgement, and in return the enforcement staff is agreeing to recommend to the Commissioners that they approve the settlement as offered.

At this stage nothing is final, and because of that lack of finality I find it hard to believe that the agreement by the staff to recommend settlement to the Commission is, by itself, necessarily an event that must be reported to shareholders. Although we Commissioners have deep respect for the work of enforcement staff, I can assure you that the next step in the process is not a rubber stamp approval by the Commission."

So when is the appropriate time to make disclosure? Find out what four former SEC Enforcement Staffers think during our webcast tomorrow: "How to Handle a SEC Enforcement Inquiry Today."

Request for Comments on Small Business Advisory Committee Draft

On Thursday, the SEC released a draft of the Final Report of the Advisory Committee on Smaller Public Companies and seeks comment by April 3rd. This draft isn't much different that the draft report released before the Committee's last meeting - the recommendations are the same, but some of the language has been fleshed out. Since the Advisory Committee is required to unwind in April, the Final Report is expected no later than April 23rd.

March 2, 2006

New York Supreme Court Takes Expansive Interpretation on "Spinning"

A few weeks back, the New York Supreme Court sided with Eliot Spitzer by partially denying summary judgment and finding the former CEO of McLeodUSA liable for "spinning" (i.e. accepting IPO shares from the same brokerage firm that his company used as an investment banker). Here is a copy of the court's decision - and a copy of the complaint.

Here is an excerpt from a related WSJ article: "A New York state court recently found former telecommunications executive Clark E. McLeod liable for receiving hot new stocks in his personal brokerage account. The rationale: His company was sending business to the same securities firm, Citigroup Inc.'s Salomon Smith Barney, that doled him the new stocks.

That is a big change. Previously, "spinning" of initial public offerings of stock involved a direct quid pro quo. In a common form, securities firms allocated IPOs to the personal accounts of corporate executives, so the shares could then be sold, or "spun," for quick profits -- in exchange for business from the executives' companies.

IPO shares are coveted because they often surge on their first trading day. Spinning has raised concerns among investors that the IPO market is rigged.

Bottom line: Senior executives now could skate on thin legal ice if they receive IPO shares from a Wall Street firm with which their company at some point does business, and don't disclose it to their board or shareholders."

Disclosures of Internal Controls Remediation

We continue to update our "Internal Controls" Practice Area in a variety of ways, including this section on "Remediation of Internal Controls." Thanks to Bob Dow, we just added Form 10-K disclosures from Maxtor Corp.; Flowserve Corp.; and ITT Educational Services.

March E-Minders is Up!

We have posted the March issue of our popular email newsletter. I'm heading to "SEC Speaks" tomorrow and unlikely to blog. Ugh, the Corp Fin panel is not until early Saturday morning...

March 1, 2006

FASB and IASB Issue MOU on Converging Accounting Standards

On Monday, the FASB and IASB issued a memorandum of understanding in which they laid out a detailed work plan to narrow differences between their standards - with a goal of substantially completing this process in eleven specified areas by 2008 (and take a hard look at ten other areas).

For those following this important development closely, you know that the SEC's willingness to downsize its requirement that non-US issuers fully reconcile their financials when registering securities in the US is conditioned on this convergence effort. Reconciliation is unpopular in the European Union - but convergence hasn't been widely popular either as there are concerns that it could lead to the creation of overly theoretical accounting standards. Learn more in our "Globalization of Accounting Standards" Practice Area.

How to Find a Company's CGQ

Occasionally I get asked how someone can check a company's corporate governance rating, as assigned by ISS (ie. the "CGQ"). You can obtain a company's CGQ by going to Yahoo Finance, entering the company's stock symbol in the "Get Quotes" search tool - and then hit "company profile" on the bottom right side of the page.

Then, you will see the CGQ on the right side under a "Corporate Governance" header. Two separate ratings are generated for each company; one compared with other companies in the same index and within the company's industry group. Oddly, I don't believe you can obtain these ratings on ISS' own site. Learn more about how CGQ ratings are compiled in our "Governance Ratings" Practice Area.

ISS' New "Corporate Governance" Blog

ISS has launched a new "Corporate Governance Blog" and it looks quite promising. I wonder what the average shelf life of a blogger is these days. It seems that many blogs start off with a bang amid much enthusiasm - and then they trail off within a few months.

Much like the typical New Year's resolution (here is a history lesson on why we even bother to make those resolutions every year). How you doing on your resolutions? Did you hoard a box of Tamiflu like you promised yourself?