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."