June 29, 2006

Majority Vote Standards in Charters

In this podcast, Bob Smith, Associate General Counsel of Progress Energy, discusses how - and why - Progress Energy voluntarily proposed to change its charter to adopt a majority vote standard (a proposal which shareholders recently approved), a standard that ISS now refers to as the new "gold standard" in the majority vote area, including:

- What did Progress Energy’s board do recently that led ISS to call it the "gold standard"?
- Can you describe Progress Energy’s charter amendment?
- What reaction have you received from shareholders?

Prevalance of Majority Vote Reforms

According to this recent Washington Post article, nearly 145 of the companies in the S&P 500 now either have a majority vote standard or a director resignation bylaw or policy.

Growing Support for Majority Vote Proposals

As noted recently in the ISS "Corporate Governance Blog," shareholder support for proposals seeking majority voting in director elections has averaged 47.3% support at 80 meetings this season. Last year, those proposals averaged 44% at 60 firms. This season, majority vote proposals received an average of 54.5% approval at 33 meetings where companies had not previously announced board election reforms, such as a director resignation policy. Support was lower at firms with director resignation policies such as the one at Pfizer and over 90 other firms, averaging 42.1% at 47 meetings this season.

June 28, 2006

Death Blow to DOJ's Strongarm Tactics on Legal Fee Advancements?

Yesterday, Judge Kaplan of the US District Court of Southern New York handed down this opinion in U.S. v. Stein (for background on this case, see this blog). Keith Bishop notes: This is a stunning defeat for the Department of Justice. Judge Kaplan found that the government violated the Fifth and Sixth amendments to the U.S. Constitution by causing KPMG to cut off payment of legal fees and other defense costs upon indictment. Now, it seems that KPMG (with the government's acquiescence) will be under considerable pressure to advance defense costs. Judge Kaplan did not dismiss the indictment, but he left open that possibility if KPMG decides not to advance legal fees.

Judge Kaplan’s lengthy 88-page opinion is thoughtful and scholarly - full of the language of liberty and individual rights. Among other things, the Judge’s opinion states that “[t]he imposition of economic punishment by prosecutors, before anyone has been found guilty of anything, is not a legitimate governmental interest – it is an abuse of power.”

A lot of happy companies out there. For example, the Association of Corporate Counsel had joined in an amicus brief in this case - and now has issued this press release trumpeting the decision. We have posted a copy of the Stein opinion in our "Advancing Legal Fees" Practice Area - and check out the commentary regarding Judge Kaplan's opinion in WSJ's "Law Blog."

On the other hand, the practical consequences could be limited. Here is an excerpt from the "D&O Diary Blog":

"While Judge Kaplan's ruling is unquestionably a significant event that will impact pending prosecutions across the country, the specific practical consequences outside the KPMG tax shelters case will remain to be seen. His ruling is based on a detailed record of the particular facts and circumstances of that specific case. In addition, as the opinion of a U.S. District Court Judge, the decision has persuasive but not precedential authority. Nevertheless, Judge Kaplan’s opinion is important and will have ramifications, and raises a host of potentially interesting questions in connection with the indictment of the Milberg Weiss law firm, among many other pending cases."

As an aside, Keith points out Monday's U.S. Supreme Court's decision in U.S. v. Gonzalez-Lopez. That case also involved the Sixth Amendment's right to counsel. In the Stein case, Judge Kaplan found that the Thompson Memorandum - and the government's implementation of it - violated the defendants' right to counsel under the Sixth Amendment. More analysis of this case is available on the SCOTUS Blog.

The Evolving Relationship Between Lawyers and Auditors

We have posted the transcript from the recent webcast: "The Evolving Relationship Between Lawyers and Auditors."

Executive Compensation in the News

Heading out today to moderate a panel on executive compensation for the Society of Corporate Secretaries' Annual Conference and thought I would point out these two recent interesting articles:

- NY Times' "The Winding Road to Grasso' s Huge Payday" gives a detailed and fascinating account of the behind-the-scenes machinations (including some juicy e-mails) leading up the lawsuit that was filed three years ago - which already has cost the NYSE more than $40 million in legal fees!

- WSJ's "As Workers' Pensions Wither, Those for Executives Flourish" is a detailed article illustrating how much relative pay in this country has gotten out of whack, as executive officer pensions - covering just a few hundred employees in a large company - can stack up fairly nicely against the pension obligations for a workforce well exceeding 100,000. Includes some interesting stats on how executive pensions is a drag on earnings - and most of us already knew about the lack of disclosure of all this, as pointed out in the article...

CA Decides to Include Mandatory By-Law Amendment Proposal In Its Proxy Statement

Following up on yesterday's blog regarding VC Lamb's decision to dismiss Professor Bebchuk's lawsuit against CA without prejudice - because the issue wasn't "ripe" - Kaja Whitehouse of Dow Jones wrote an article noting that the company has decided to include Bebchuk's mandatory shareholder proposal that seeks to change the company's by-laws.

CA shareholders will now get to vote on this shareholder proposed by-law amendment at the company's annual meeting in August - and the rest of us will have to wait for another case to "ripen" before we find out what the Delaware courts decide in this important area. The floodgates for mandatory by-law proposals may soon open.

Here is an excerpt from the Dow Jones article:

"The company originally denied a request to add the proposal to its upcoming proxy statement, claiming the proposal was a violation of Delaware law. The rejection resulted in a court challenge by the drafter of the resolution, Harvard professor and shareholder rights activist Lucian Bebchuk.

A ruling by the court would have shed light on the currently murky issue of whether shareholders have the power to decide bylaw issues, which are normally governed by directors. A company's bylaws are the official rules that govern its management.

Shareholder proposals are typically advisory, meaning management has the option to adopt or ignore the recommended action. As part of a growing effort by shareholders to gain more control over how public companies are governed, more shareholders are looking to submit proposals that would require companies to adopt their plans if approved by a majority of shareholders.

The CA case has broader legal and governance consequences for corporations. For one, companies may be more reluctant to reject proposals that seek to change the bylaws. Companies can reject shareholder proposals for a number of reasons, including concern that a resolution would interfere with internal affairs.

Before definitively rejecting a proposal, however, corporations tend to seek the blessing of the Securities and Exchange Commission in the form of a "no-action" letter.

Before Bebchuk brought the case to court, CA sought a no-action letter from the SEC to test whether its rejection would pass muster. The SEC refused to issue a letter in this case, citing the pending ruling.

Without a clear answer from the Delaware courts on the legality of this issue, the SEC may not feel comfortable issuing no-action letters for similar requests, said Michael Barry, of Grant & Eisenhofer, the Wilmington, Del., law firm that filed the lawsuit on behalf of Bebchuk.

"They're hesitant to opine on matters of unsettled state law," said Barry, adding, "It would put then in an awkward position."

SEC officials declined to comment on the matter, said spokesman John Heine. Agency staff will make its position known when the issue comes up again, said Heine.

A lack of clarity from the court system, which indicates that Delaware judiciaries feel shareholders could have a right to change a company's bylaws, prompted CA's change of heart about the proposal.

"The Delaware Court has ruled that it should not decide the legality of the by-law [issue] until our stockholders have first voted on it," said Jennifer Hallahan, a spokeswoman for the company."

June 27, 2006

Delaware Court Watch: The Mandatory By-Law Amendment Saga Continues

A few weeks ago, I blogged about big things brewing in the Delaware courts that could shake up shareholder proposals and Rule 14a-8. On Thursday, Vice Chancellor Lamb of the Delaware Court of Chancery issued this opinion and order in Bebchuk v. CA. In his opinion, VC Lamb denied the request for declaratory relief without prejudice because the case isn't ripe yet. Importantly, the Vice Chancellor notes that Professor Bebchuk's by-law is not invalid on its face - so VC Lamb has tee'd up the issue about whether bylaws can restrict pill authority under the right circumstances.

Although it looks like CA ("CA" is the company formerly known as "Computer Associates") has avoided a bullet, it could be just temporary. I guess the next suit from Professor Bebchuk might be in federal court - if he trys to enjoin the mailing once CA files its proxy statement - as VC Lamb won't act before the vote is in.

And Another Rule 14a-8 Development for CA...

And there developments related to another CA shareholder proposal: this proposal relates to the removal of directors from the board. Last week, an investment fund submitted this reconsideration request asking the Commission to review a no-action response from Corp Fin. In that response, Corp Fin allowed the exclusion of a shareholder proposal under Rule 14a-8(i)(8) because the proposal seeks to give shareholders the power to remove directors outside the director election context. We have posted this reconsideration request and the VC Lamb opinion in our "Shareholder Proposals" Practice Area.

Although some commentators (such as this Sunday NY Times column) have raised the profile of this issue (ie. whether there should be democracy in the boardroom), I don't believe appeals regarding the SEC's (i)(8) position will work since the rule is pretty clear and the Commission already has considered this issue a number of times. Of course, the Commission sometimes does change it's position - so I guess it can't hurt to try...

NASPP's 14th Annual Conference: Las Vegas Baby!

With this year's NASPP Annual Conference including the entirety of the "3rd Annual Executive Compensation Conference" at no extra charge, an overwhelming number of attendees have already registered for this three-day event to be held October 10-13 in Las Vegas. Here is a detailed conference brochure providing descriptions of the 40+ breakout panels for the NASPP's Annual Conference.

Whether you attend just on October 12th for the "3rd Annual Executive Compensation Conference" or the entire three-day NASPP Annual Conference, you will want to reserve your room at the conference hotel soon as it's filling up fast...

June 26, 2006

The SEC's Bad Day: Part I

Unfortunately, I couldn't get that American Idol song out of my head on Friday - you know, the one that is now omnipresent on the radio: "so you had a bad day..." (not that I ever would admit to watching American Idol). Anyways, some SEC Staffers were probably humming that tune Friday after the US Court of Appeals for the District of Columbia Circuit vacated the SEC's controversial rule - in Goldstein v. SEC - that had required most hedge fund advisers to register with the SEC. We have posted a copy of the court opinion under "Latest Developments" of our home page.

Based on this ambiguous statement from SEC Chairman Cox, it looks like the SEC will take some time to mull over its choices about how to best regulate hedge funds going forward: either appeal to the full Court of Appeals or the US Supreme Court; come back with a new proposal to regulate hedge funds that would satisfy the Court's concerns (or lobby Congress to amend the Advisers Act); or do nothing.

Interesting, the Court's decision hinged on fairly technical grounds, as it found that the SEC rules - which just became effective in February - treated investors in hedge funds as "clients" of the advisor, instead of treating each hedge fund as a single "client" for purposes of the statutory exemption from registration for advisors which advise fewer than 15 clients and meet certain other conditions. The last sentence of the decision is telling for the SEC: "This is an arbitrary rule."

The SEC's rulemaking process has been taking it on the chin lately, with the SEC recently submitting a status report to the same court regarding its mutual funds/director independence rules after the court forced the SEC to partially re-do that rulemaking. And other challenges impacting the SEC are looming, such as the challenge to the constitutionality of the PCAOB.

The SEC's Bad Day: Part II

On Friday, the SEC also had to stare down this NY Times article, which alleges that a SEC lawyer involved in an investigation of insider trading allegations at a prominent hedge fund was fired because he wanted to subpoena a bigwig at one of Wall Street's firms. This article was at the top of the NY Time's front page - page A1 - even though the SEC's inspector general said in an April report to Congress that his office had reviewed the SEC lawyer's claims and "failed to substantiate the allegations"! See this Washington Post article for that seemingly important IG tidbit.

So until we know the full story here, I will take the NY Times article with more than a grain of salt. Let me explain: it is very hard to get fired from the government. That's why people go work for the government; it has great job security. Once you are past the one-year probationary period, you have to get caught doing drugs at your desk or having inappropriate relations in the stairwell to get fired (other than high level Staffers who work much more "at will").

In fact, in my combined 5+ years at the SEC, I can only think of two Staffers who were fired - and both of them were fired right before the end of their probationary period - same as the guy who served as the basis for the NY Times article. So that is traditionally how the SEC's probationary period works: someone who performs poorly or who doesn't fit in is shown the door right before they essentially become eligible to be a "lifer."

Now, this guy's beef really might be legitimate - and it's clearly odd that he got a merit pay increase before he was let go - but my gut told me there might be other circumstances at play when I got to the end of the NY Times' lengthy article, which states:

"Before joining the S.E.C., Mr. Aguirre had a reputation as an innovative plaintiffs' lawyer in Southern California, representing victims of shoddy home construction. A 1992 article in California Lawyer magazine said he used "aggressive — some say temperamental" courtroom tactics to win several big cases."

Of course, that blurb sounds like the SEC should have known that it hired itself some trouble, as "aggresive" tactics don't mix well within the mold of a government agency. Then again, the SEC might have known that - as it looks like it dragged its feet hiring this guy, as the end of the article notes:

"Mr. Aguirre had been at odds from time to time with the S.E.C. When there was a delay in his hiring, he suspected that his age — he was then in his 60's — was the reason and he filed an administrative complaint with the Equal Employment Opportunity Commission."

Cross-Border Acquisitions: A Buyer’s Perspective

The second installment of DealLawyers.com's M&A Boot Camp for this summer is now available: "Cross-Border Acquisitions: A Buyer’s Perspective." Join Elizabeth ("Libby") Kitslaar and Phil Stamatakos of Jones Day as they walk us through the special issues that you will face in a cross-border deal.

If you are not a DealLawyers.com member, try a no-risk trial as we just launched our half-price “Rest of 2006” 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!

June 23, 2006

Another Contender: State Street for Governance Poster Child of the Year?

Way back on April 20th, the Boston Globe ran an article about a shareholder activist who was arrested at State Street's annual meeting because of the questions he was asking. Not much attention was paid to it at the time, because in the few instances where a shareholder has been arrested at a shareholders' meeting, the company doesn't normally doesn't press charges in the end.

Incredulously, I am told that State Street is pressing charges here - a clear message that shareholder input is not welcome. Although the excerpt from the Boston Globe article below highlights the fact that David Smith might have an axe to grind with State Street, it is absurd that a company would bring criminal charges for “trespass” against a shareholder who had a legitimate right to attend a meeting:

"David Smith has been many things at State Street over the past decade. He has been an employee, a corporate critic, and a shareholder activist. Yesterday, he was under arrest.

Smith's beefs with State Street go back to 1998, when he was fired. Smith said he was canned after complaining that a colleague revealed he was gay. He launched a public relations war that featured a website posting documents embarrassing to State Street and has dogged the company ever since.

Smith and his partner, Patrick Jorgstad, took front-row seats at the company's annual meeting yesterday. They rose to ask more than a dozen pointed questions, most of which seemed designed to bait the chief executive.

As the questions went on, comments from both sides grew increasingly snarky. Eventually, Smith dared Logue: ''Arrest me!" He complied.

Officers in the audience arrested Smith without incident and charged him with trespassing, a Boston police spokeswoman said. Stockholders applauded as he was led out.

Smith and Jorgstad have used many bombastic tactics with State Street; they also have advanced important shareholder interests. Jorgstad's proposal recommending the elimination of State Street's poison-pill defense was overwhelmingly approved by shareholders yesterday."

Meeting Notes: The SEC's Chief of M&A Speaks

Here is a recent blog from the "DealLawyers.com Blog": Last Friday, Brian Breheny, Chief of Corp Fin's Office of Mergers and Acquisitions was the guest speaker at a meeting of the Association of the Bar of the City of New York Special Committee on Mergers, Acquisitions and Corporate Control Contests. Brian discussed a number of topics of interest; following is a brief summary of those issues (as is always the case, Brian noted that his views were his own views and not the views of the Commission or his fellow staff members):

1. SEC proposed amendments to the tender offer best-price rule:

- the amendments to the tender offer best-price rule remain the office's top priority;
- it is unclear as to when the Commission may adopt the final rule amendments, although Brian thought it was possible that the amendments might be adopted this year;
- the staff is in the process of considering the comments received to the proposed amendments;
- Brian noted that it is likely that changes will be made before adoption to address some of the comments;
- he noted that expanding the proposed compensation exemption and compensation committee safe harbor to issuer tender offers was uniformly recommended and that he thought those changes would be consistent with the Commission's intention for proposing the amendments;
- he also noted, however, that certain of the other proposed changes, such as providing a carve out from the best-price rule for commercial arrangements or a de minimus ownership exemption, were given serious consideration during the proposing stage; and
- finally, Brian noted that he was keenly aware of the concerns raised by commentators about the need for the changes to result in an effective exemption and safe harbor.

2. Study of the cross-border tender offer rules:

- the office of mergers and acquisition continues to study whether recommendations should be made to the Commission to change certain of the cross-border tender offer rules;
- the data provided by bidders to date is that certain of the rules, such as the 30-day look back to determine share ownership levels, are difficult to comply with; and
- the office and, for purposes of Rule 14e-5, the staff of the Division of Market Regulation, is considering whether certain consistent relief granted since the adoption of the cross-border rules could be handled in a global exemptive order.

3. NASD proposed fairness opinion disclosure and policy/procedure rules:

- the staff of the office of mergers and acquisitions and the Division of Market Regulation is considering the comments received by the Commission to the NASD's proposed Rule 2290;
- the comment period closed in May 2006;
- 7 comments were received;
- certain language changes to the proposed rules may be necessary to address potential inconsistencies in the proposed language of the rule; and
- the ABCNY Committee reiterated concerns regarding requirement for policy/procedure re: differential compensation to officers, directors and other employees.

4. Section 13(d)/ beneficial ownership reporting compliance:

- the staff continues to view compliance with the beneficial ownership reporting rules as a high priority;
- the staff has heard concerns that hedge funds and/or others may knowingly be crossing the line and acting in concert pursuant to an agreement or arrangement without filing a Schedule 13D to reflect the Group's beneficial ownership and plans, etc.; and
- the staff will aggressively pursue willful violations of Section 13(d) if it becomes a aware of such conduct.

5. Fairness opinion disclosure:

- there may be a need to revisit the disclosure practices related to fairness opinions;
- the ABCNY Committee questioned the staff policy related to including a risk factor regarding contingent financial advisory fees and requesting (in a non Rule 13e-3 transaction) that filers provide the staff on a supplemental basis, copies of board materials not referenced in background section of the proxy/registration statement so that the staff could consider the need to refer to just board materials; and
- Brian and the Committee agreed to maintain a dialogue about these issues.

June 22, 2006

More, More, More on Option Misdating

The articles just keep coming as the media is loving this backdating scandal. And it looks like the plaintiff's bar is gonna love it too according to this Red Herring article, which quotes a lawyer from Lerach's firm observing: "He sees the damages to investors reaching billions of dollars and plans to press for the replacement of board directors who allowed the backdating of options to go on." The D&O Diary Blog contains some good "food for thought" on possible statutes of limitations defenses.

And according to this article and this article (and this WSJ article from Tuesday), D&O insurers might refuse to renew policies with implicated companies.

In addition, members of Congress are calling for the SEC and the DOJ to step up with their enforcement actions on this issue - see this article - which is now approaching 50 companies under investigation. As the accounting industry begins to come under fire, the SEC's acting Chief Accountant, Scott Taub stated last week that the PCAOB needs to give guidance to auditors on when a grant of options may be considered suspicious.

And the Council of Institutional Investors has sent this letter to 1500 companies, asking them to disclose whether they are under investigation (and the AFL-CIO and CalPERS are doing something similar - here is a copy of CalPERS' letter, which was sent to 24 companies).

Coming soon! We provide more guidance on the issues implicated by options misdating in the May-June issue of The Corporate Counsel, which just went to the printers (this nicely complements what we wrote in the March-April issue) - and we continue to upload articles and research reports about option timing unto our "Timing of Stock Option Grants" Practice Area on CompensationStandards.com.

A Different Kind of Backdating Witch Hunt

In his op-ed yesterday, the WSJ's Holman Jenkins joins me in using the term "witch hunt" to describe some of the attention being paid to the options backdating scandal. The source of this op-ed is curious given that the WSJ has been running at least one article per day on the topic (e.g. yesterday's article was about Microsoft).

But Holman's rationale for using the term is a far cry from my rationale. I am just worried that innocent companies might be caught up in the sweep to find out who the next culprit might be. Holman thinks that backdating in itself is no big deal. He thinks that folks are caught up in bunches because of "ever-shifting accounting, regulatory and tax standards." In other words, I think he is saying that those standards shouldn't really matter - instead, he believe that "overseeing CEO incentives is among the most important board responsibilities, and boards should keep control of it and do it clearheadedly."

I obviously agree with Holman's point - who doesn't? - but I would argue that Holman contradicts himself somewhat because if a board doesn't realize that options were backdated (or that proxy statements were misleading because they erroneously disclosed that boards granted options with exercise prices set on the grant date), that might illustrate that the board wasn't in control and was lacking that whole "tone at the top" thing that is so easy to say, but so tough to do...

The Shrinking SEC

While Congress is asking the SEC to do more investigating about options backdating, Congress also is cutting the SEC's budget from total program costs of $917.7 million (for the year ending September 30, 2005) to $888.1 for this year - with a budget request of $904.8 for the next fiscal year. The SEC staffing levels for the Division of Enforcement are down to 1216 this year from 1232, with a budget request of 1187 for fiscal 2007 (see page 53 of the SEC's 2005 Annual Report - and pages 1-3 of the 2007 budget request).

As has been happening in Corp Fin for nearly two years, I understand that quite a few enforcement positions are not being filled as staffers leave. Given Chairman Cox's connections on the Hill, I imagine that trend could be reversed if he pushed hard for more money...

Mavs Owner Invests in Stock Fraud News Website

Given that the Dallas Mavs just tanked, I thought it was appropriate to blog about their owner's - Mark Cuban - latest adventure: ShareSleuth.com (not yet launched) that will employ investigative journalists to ferret out and blow the whistle on corporate fraud. For those that don't follow sports, Mark is the most zany sports owner since Bill Veeck, who hired a midget to play baseball as a gag in the '50s. And Mark maintains his own blog - "blog maverick" - and even allows fans to e-mail him. Clearly a New Age sports team owner, who has already accrued over $1.5 million in fines from the NBA for his conduct. Bruce Carton blogged at length about this new development recently in his "Securities Litigation Watch."

June 21, 2006

Majority Voting: ABA Finalizes Amendments to the Model Business Corporation Act

Yesterday, the ABA issued a press release containing final amendments to the Model Business Corporation Act adopted by the ABA's Committee on Corporate Laws relating to Voting by Shareholders for the Election of Directors. We have posted these amendments in our "Majority Vote Movement" Practice Area.

3rd Annual Executive Compensation Conference: Early Bird Expiration

Yesterday, I got many frantic e-mails and calls from members rushing to get a check cut for the Early Bird Discount rate available for the "3rd Annual Executive Compensation Conference."

Even though the deadline ended last night, we will still process any last minute takers of our "firmwide for $995" offer for qualifying members of CompensationStandards.com. Just call our HQ at 925.685.5111 - or email info@compensationstandards.com (or use the online registration mechanism as the old pricing will still be up there for the next day or two).

Audit Committees in Action: The Latest Developments

Check out tomorrow's webcast entitled “Audit Committees in Action: The Latest Developments” featuring Amy Goodman of Gibson Dunn; Lydia Beebe of Chevron; Susan Wolf and Steve Koehler of Schering Plough; Jennifer McCarey of MCI; Amy Corn of Pitney Bowes; and Linda Wackwitz of Quovadx. Among the topics of this program are:

- What are the latest developments for audit committee charters, agendas and meetings
- How should the audit committee manage its relationship with the independent auditor, including conducting an evaluation of the auditor
- What issues should be considered when changing independent auditors, reporting a material weakness in internal controls and restating financials
- When should audit committees hire their own experts – and what should be considered before hiring those experts
- How should an audit committee interact with the internal auditor – and ensure management cooperates with the internal auditor

Tune in on July 18th for the third installment of our webcast series dealing with audit committees and their advisors: “How to Develop a Whistleblower Compliance Program Today” - we just posted our half-price no-risk trial for the rest of 2006, so try us out if you haven't before...

Understanding Whistleblower Hotlines

In this podcast, Alice Peterson, President of Syrus Global, provides some insight how whistleblower hotlines work, including:

- How does your hotline work?
- What are the most common queries asked by potential clients?
- What characteristics should a company look for from a third-party hotline provider?

June 20, 2006

The PCAOB Gets a New Chair: Mark Olson

Yesterday, SEC Chairman Cox named Mark Olson as the new Chair of the PCAOB, replacing Acting Chair Bill Gradison (who continues on as a Board Member). In addition, Kayla Gillan got her wish and was reappointed for a second term as a Board Member (after waiting more than six months for the news!).

As this press release indicates, Mark has served as a Federal Reserve Governor since 2001 - before that he served as the Staff Director of the US Senate Securities Subcommittee of the Banking, Housing, and Urban Affairs Committee for two years, was a Partner at E&Y for 11 years and a CEO of a state bank for over a decade. It must feel peculiar for the SEC Chairman to appoint someone to a position that pays over 3x what he makes...

PCAOB's Chief Auditor Weighs In: Evaluating Internal Controls

A few weeks back, the PCAOB's Chief Auditor, Tom Ray, delivered this speech with a notable message: hop onto that learning curve, auditors. His speech directly addressed the “over-documentation” complaints making the rounds. Learn more about the speech from the AAO Weblog.

More on Harmonization (Or Lack Thereof) of Global Regulations

Not soon after I blogged on Friday, the SEC issued this warm and fuzzy fact sheet that globalization and merger of exchanges would not ultimately lead to mandatory registration of non-US exchanges (here is a related WSJ article from yesterday). Not surprising given SEC Commissioner Nazareth's recent comments on this topic.

What is curious about this development is that the SEC put out its message via a "fact sheet." This "fact sheet" is posted on the SEC's website under "Press Releases" rather than the seemingly more appropriate "Other Commission Orders, Notices, and Information." The question remains: do we now add "fact sheets" to the dozen or so other vehicles by which the SEC provides guidance to market participants?

DOL Panel Backs Order of Whistleblower Reinstatement

As noted in this Washington Post article, the Cardinal Bankshares whistleblower saga continues as the Department of Labor's Administrative Review Board ruled that the company must reinstate its former CFO. The DOL panel denied a request by the company to stay a Labor Department judge's earlier order that it take the CFO back - and afterwards, the company said it would not bring the CFO back until it is compelled to do so by the US District Court for the Eastern District of Virginia (ie. Welch v. Cardinal Bankshares Corp, as I first blogged about well over a year ago; see these law firm memos to follow the saga to date). So this is not over until it's over.

In my mind, a reinstatement remedy is simply unworkable; there has got to be some other way. Can you imagine firing your CFO and then being forced to rehire him? That wouldn't seem to bode well for overall company morale, not to mention collegiality among senior officers...

[Will you still read me…when I’m 64? So much craziness over Paul McCartney's 64th birthday. That's twenty years away for me - God willing - and if I'm still blogging at 64, I vow to do something spectacular for those of you still reading this dribble...not sure what, but I promise it will be glorious and you will be thankful for having patiently waited. Maybe something that Nacho would do...]

June 19, 2006

Nasdaq Proposes to Modify Director Independence Cure Period

Last week, the SEC issued a Nasdaq proposal that would lengthen - in certain circumstances - the cure periods available to listed companies that lose an independent director or an audit committee member that causes the company to fall out of compliance with Nasdaq's director independence rules (ie. a majority of the board must be independent and there must be at least three independent directors on the audit committee).

Under current rules, a company must cure any deficiency by the earlier of the next annual shareholders meeting or within one year of the event that caused the deficiency. The Nasdaq proposal would change the cure periods so that a company would have at least have 180 days from the date of a deficiency event to cure the deficiency.

Companies can't rely yet on this proposed rule change, but the Nasdaq proposal states that, upon SEC approval of the rule change, Nasdaq will allow any company still within the prior cure period to use the new minimum 180-day cure period from the date of the deficiency, even if the deficiency occurred before the date of SEC approval.

Conducting Due Diligence: Through the Eyes of the Associate

The first installment of DealLawyers.com's M&A Boot Camp for this summer is now available: "Conducting Due Diligence: Through the Eyes of the Associate." Join Deborah Bentley Herzog and Mike Woodard of McGuire Woods for an entertaining session that teaches the basics of what you need to know about conducting due diligence, with an emphasis on what issues and traps associates should seek to spot and resolve.

If you are not a DealLawyers.com member, try a no-risk trial as we just launched our half-price “Rest of 2006” 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!

[Congrats to my boss, Jesse Brill, for being named one of the "100 Most Influential People in Finance" in this Treasury & Risk Management article for his executive pay reform efforts! I don't think many lawyers would ever imagine landing on a finance list...]

"Passive Voice Press Releases" and the "Vigorous Defense"

Last month, I blogged about "passive voice press releases" by noting an entry from Adam Savett, a plaintiff's lawyer. The following is some of his latest work: You've seen them discussed separately, but now we have them together. A complaint about a so-called "passive voice press release" and a vigorous defense proclamation by a defendant.

Passive voice press releases are those issued by law firms that have not yet filed a complaint. They typically announce that a securities class action "has been filed." This is distinguished from the active voice releases, which state things such as "[the firm] filed a complaint" or "[the firm] has filed a complaint."

The practice is most often pointed out by one of the firms that filed a complaint, not by the defendant corporation, as we have here. Earlier this week, InfoSonics Corporation issued a press release, stating:

"While at least seven law firms have publicly disseminated press releases over the past few days implying that they have filed lawsuits against InfoSonics Corporation, the Company's preliminary investigation has revealed that two lawsuits seeking class action status have been filed (by three of the firms that issued press releases this week). The remaining four law firms that implied in their press releases that they also filed lawsuits had not done so at the time of their releases and the Company has no knowledge that they have since filed actual lawsuits."

This is the classic passive voice press release issue, discussed by The 10b-5 Daily here and here and by Securities Litigation Watch here and here.

InfoSonics couldn't resist the lure of the vigorous defense language having read in these pages earlier in the week about a recent successful use of that phrase, and went on to state:

"The Company believes its actions raised in the lawsuits were appropriate and intends to vigorously defend them."

Now if only we could find a passive voice press release that indicated the law firm intended to "vigorously pursue" the claims that they have not yet alleged.

June 16, 2006

Protection of Audit Documents in Internal Investigations

As so well illustrated during yesterday's popular webcast (audio archive now available) - "The Evolving Relationship Between Lawyers and Auditors" - the tension between lawyers and accountants has never been greater and there has been a lot of understandable confusion as old relationships have suddenly evolved.

In this podcast, Todd David and Jessica Corley of Alston & Bird provide some insight into this court order from the recent case - Polymedica Securities Litigation – dealing with the protection of audit documents in internal investigations, including:

- What did Judge Young find in the Polymedica case?
- What were the facts of that case?
- In the wake of the decision, what guidance would you provide you companies regarding their audit documents?

DOJ Seeks Dismissal of Sarbanes-Oxley Lawsuit

A few weeks back - even though the US was not a party to the case brought by the Free Enterprise Fund - the DOJ weighed in on the lawsuit seeking to overturn Sarbanes-Oxley by seeking of dismissal of the case on procedural grounds. The DOJ said the challenge was "brought at the wrong time, in the wrong court'' as part of its statement of interest in support of the PCAOB. Arguments are scheduled to be heard soon. We have posted all the pleadings filed in this case - Free Enterprise Fund and and Beckstead & Watts vs. Public Company Accounting Oversight Board - in our "Sarbanes-Oxley" Practice Area under "5. Debate of Legal Authority of SOX".

Debate over the Impact of Sarbanes-Oxley on World Markets Intensifies

Speaking of Sarbanes-Oxley, the House Subcommittee on Regulatory Affairs will hold a hearing on Monday, June 19th in New York City to examine the impact that the SEC's implementation of Sarbanes-Oxley has had on US markets. The hearing is entitled: "A Balancing Act: Cost, Compliance, and Competitiveness After Sarbanes Oxley" and will be held at the U.S. Customs House at 10 am (oddly, I can't find any information about this hearing on the Web).

This topic is likely to continue to gather momentum. The pending merger of the NYSE and Euronext has raised the profile of the impact of SOX to high levels all over the world. Yesterday's NY Times listed all the European market leaders that have expressed concerns that the merger could result in applying Sarbanes-Oxley to foreign issues. In the same article, SEC Commissioner Nazareth countered that "the notion that this is a backdoor means of exporting Sarbanes-Oxley requirements internationally is completely misguided."

The topic of the impact of Sarbanes-Oxley on listing on US exchanges even took up a big chunk of time during this week's "Past Enforcement Directors' Roundtable" at the SEC, as noted in FEI's "Section 404" Blog. I'm sure we haven't heard the last word on this topic - globalization ain't easy...

June 15, 2006

Change in Executive Compensation Disclosure Conference Dates

With SEC Chairman Cox quoted widely in yesterday's papers about the SEC planning to adopt the executive compensation disclosures rules by the end of the Summer (see this WSJ article and Wash Post article), we have moved up our conference - "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" - by two weeks so that it will be held on September 13-14th.

We recognize that two weeks matters when your directors and clients are clammering for the practical consequences of the new rules - so we have bumped up the conference dates to meet your needs. Of course, if the SEC doesn't act that fast, we can easily push back the dates - that's the beauty of the videoconference format as I blogged about a few days ago.

If you have questions about the Conference, check out our FAQs, e-mail me or contact our HQ. I will continue to flesh out the FAQs as I am getting many good queries, such as how long will the video archive be up? (answer: the end of '07, which is roughly 15 months) or will the video archive be posted in modules? (answer: yes, each panel will have its own archive, so it will be easy to refer to later when you are drafting and reviewing disclosures).

[By the way, quite a few members have already submitted their vote for "Most Outdated Photo" in our Speaker Bios - hands down winner is Alan Kailer. Alan wins a full body massage and facelift after the Conference to maintain that youthful glow.]

Analysis of the Delaware Supreme Court's Disney Decision

As I blogged last week, the Delaware Supreme Court has delivered its long-awaited opinion - written by Justice Jacobs - affirming the Chancery Court's decision in the Disney litigation. Clearly affirming the business judgment rule, the Supreme Court flatly rejected the notion that a lack of good faith could be equated with gross negligence, which is the standard for finding a violation of the duty of care.

Most observers were not surprised by the outcome as the embattled plaintiffs' counsel – Steven Schulman, the Milberg Weiss lawyer who was recently indicted for allegedly paying plaintiffs in class action cases - did a poor job of trying the case and basically failed to prove their claims factually.

Moreover, it is quite difficult to win a compensation case where the directors are not self-interested. Some commentators view the Valeant v. Panic case as a much more winnable compensation case compared to Disney. The decision in this case is expected sometime in the Summer of ’06.

On CompensationStandards.com, we have just announced this webcast - "Director Liability and Responsiblities: After Disney" - featuring John Olson and Charles Elson. And we have begun to post law firm memos on the Delaware Supreme Court's decision in the "Liability Issues" Practice Area of CompensationStandards.com.

Where Do We Stand on the Duty of Good Faith?

A lot has been written about the duty of good faith since Chancellor Chandler's opinion last year in the Disney litigation. In its opinion, the Delaware Supreme Court acknowledged that the contours of the duty of good faith remained “relatively uncharted” and were not well developed.

Addressing this hot topic, the Supreme Court identified two categories of fiduciary behavior that do constitute a breach of the duty of good faith. The first category is the so-called “subjective bad faith,” which is evidenced by “fiduciary conduct motivated by an actual intent to do harm” to the company or its stockholders.

The other category has been a focal point of the Disney litigation: “intentional dereliction of duty, a conscious disregard for one’s responsibilities.” In concurring with the Chancellor and determining that such conduct was neither exculpable nor indemnifiable, the Supreme Court explained as follows:

"The universe of fiduciary misconduct is not limited to either disloyalty in the classic sense … or gross negligence. Cases have arisen where corporate directors have no conflicting self-interest in a decision, yet engage in misconduct that is more culpable than simple inattention or failure to be informed of all facts material to the decision. To protect the interests of the corporation and its shareholders, fiduciary conduct of this kind, which does not involve disloyalty (as traditionally defined) but is qualitatively more culpable than gross negligence, should be proscribed. A vehicle is needed to address such violations doctrinally, and that doctrinal vehicle is the duty to act in good faith."

The Court left open the possibility that the duties of good faith and due care could overlap - and the Court also pointed out that its opinion did not address the issue of whether the duty of good faith can serve as an independent basis for imposing liability on directors or officers. As evident from the law firm memos written so far - and the blogs from academics - there are many issues that will continue to be debated. For example, here is a list of issues to consider from Professor Larry Ribstein:

1. The future of due care and Van Gorkom. What does this case say about the nature of gross negligence?

2. What are the case's implications for bad faith and the application of 102(b)(7)? What kinds of facts might constitute bad faith? Given the court's view of bad faith, is there any longer a meaningful role for gross negligence?

3. What, if anything, does the case say about how it might address the undecided questions, such as the application of the bjr to officers.

4. What does the case imply about Roe's thesis concerning federal law's impact on Delaware?

5. What can be said now about the relation between Delaware and the federal law of corporate governance? Has federal law taken over the Caremark business just as it has disclosure?

6. What, if any, role do theories of "good governance" and best practices have on directors' liabilities after Disney?

7. What are the decision's implications for the executive compensation debate?

8. What's likely to be the single biggest effect of this decision?

SEC to Push Ahead on Considering Mutual Fund Governance Rules

On Tuesday, the SEC filed a status report with the US Court of Appeals for DC in connection with its embattled board independence and independent chair rules. In April, that court held that the SEC violated the Administrative Procedure Act by failing to seeks comments on the cost estimates of those two rules - but instead of vacating the rules, the Court ordered the SEC to file a status report within 90 days and reopen the rulemaking record for comments on the costs.

With a month to spare, the SEC issued this proposal, with comments due by August 21st. The five Commissioners unanimously voted to solicit comment - but reportedly are split on whether to finalize the rules again (here are the dissents by two Commissioners from the last go around; although we will soon have Commissioner Casey in the mix, replacing Commissioner Glassman). No doubt the US Chamber of Commerce and other commentators will be furiously battling this rulemaking again...

June 14, 2006

Delaware Court Watch: Mandatory By-law Amendments Could Subsume Rule 14a-8

As I blogged about recently, there are big things brewing in the Delaware courts that could shake up shareholder proposals and Rule 14a-8 as we so fondly know it.

Keir Gumbs of Covington & Burling notes: "Corp Fin has put the issue of shareholder-proposed bylaw amendments squarely in the lap of Delaware courts. Last Monday, the Division declined to address Computer Associates' arguments that a mandatory by-law proposal submitted by Lucian Bebchuk could be excluded as contrary to state law. Although not unprecedented, this may be the first time that the Division has followed the "pending litigation" exception to its general practice of responding to shareholder proposal-related no-action requests when the proposal was a mandatory by-law proposal currently being litigated in a Delaware court.

The stakes are pretty high. With Hilton's recent experience with shareholder proposed by-law amendments, Computer Associates' may be faced with the tough choice of including the proposal in its proxy materials and risking shareholder approval of a by-law amendment it does not support - or waiting out the Delaware court and hoping that a decision is made before it mails its proxy materials. Not an enviable position, but other companies that are watching the development should be holding their breath as well. If the Delaware court sides with Professor Bebchuk, the floodgates for mandatory by-law proposals may soon open.

Interestingly, Grant and Eisenhofer, the firm that is representing Bebchuk in the case, already has tasted victory in this arena. Last year, it represented a group of shareholder-plaintiffs in Unisuper v. News Corporation, a case in which a Delaware Chancery court upheld the validity of terms of a contested agreement which would have required shareholder approval of the decision to adopt a poison pill. This case suggests that a by-law such as that proposed by Professor Bebchuk may not be invalid under Section 141 of the DGCL."

On Sunday, the NY Times carried this column that touched on Computer Associates' recent Rule 14a-8 request - but oddly, the column stated that the Staff had not yet made its decision even though it appears that it had...

Round Two: Market-Valued Employee Stock Options

Last September, you may recall that the SEC rejected Cisco's proposal to issue exchange-traded employee options. At that time, the SEC stated that it was open to other ideas about how market instruments could be used to value employee options (and the SEC's Office of Economic Analysis even suggested two alternatives, although the SEC's Chief Accountant expressed skepticism about whether companies would quickly embrace them).

Last Thursday, the WSJ ran an article that Zions Bancorp planned to register securities that would mimic employee stock options for public auction - and the price fetched at auction would become a "market" value for the securities that the company could use to determine the expense it must book for awarding options to its employees. I don't believe the registration statement is filed yet.

Here is an excerpt from the article:

"Buyers of the securities receive payments from Zions when employees exercise their options. If the options expire worthless or aren't exercised by employees, holders of the securities receive no payments and lose the entire value of their investment. Essentially, Zions is creating what looks and feels like a so-called asset-backed security, with the underlying asset in this case being the options. The bank expects high-net-worth individuals and sophisticated investors to buy the securities. Among other things, these investors would be betting Zions's stock will continue to rise and thus push Zions employees' options "into the money."

The bank hopes the auction will produce a truer -- read: lower -- value for employee stock options than would be derived from valuation methods such as Black-Scholes, the standard formula that has been used for years. That would happen, Zions argues, because investors would take into account factors unique to each company's employee options program that aren't reflected in most pricing models."

It will be interesting to see if the SEC will approve Zions's method - one key difference from Cisco's rejected proposal: Zions will sell the securities at the highest, "market-clearing" price it receives at the auction rather than sales through private placements. And if the SEC approve's Zion's deal, it remains to be seen whether there will be enough competition among bidders to ensure a real market emerges. I don't much about Zions Bancorp but I can't imagine the appetite for a security based on its options would be anywhere near the level of a company like Cisco...

The Evolving Relationship Between Lawyers and Auditors

Join us tomorrow for the first in a webcast series dealing with audit committees and their advisors: "The Evolving Relationship Between Lawyers and Auditors." Among other topics, Stan Keller of Edwards Angell Palmer & Dodge; Dick Rowe of Proskauer Rose; and Stacey Geer of BellSouth will address:

- What are the latest developments for auditor engagement letters and how do they affect independence
- What are the latest developments for audit inquiry/response letters, including how to handle non-conforming requests
- What issues arise from Interpretation 47 of FAS 143 regarding Conditional Asset Retirement Obligations (essentially environmental contingencies) – and why you should care
- How are comfort letter procedures changing – and how do these changes impact legal opinions and other aspects of deals
- How do the efforts of the ABA Task Force on Attorney-Client Privilege impact audit matters

Vonage's IPO Travails Continue

Over the past few weeks, I have blogged about the challenges faced by Vonage's recent IPO, including the disclosures about possible securities law violations involving the lack of links to a prospectus from a Directed Share Program solicitation. The inevitable class action lawsuits have now been filed in the US District Court for New Jersey; so far, three of them have been filed.

We have posted a copy of the complaint from one of these lawsuits in the "Rescission Offering" Practice Area. I'm always looking for content from our members, but I particularly would like to enhance the content in this Practice Area if you have something hidden in a drawer that could benefit the community...please email me if you do...

June 13, 2006

Just Announced: Our "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" Conference

As I blogged yesterday, the SEC seems to be "on target" with adopting executive compensation rules by the end of the summer. For the past few months, I have been jamming to put together what I promise will be the most practical conference on how to implement these executive compensation rules. In fact, we are so confident that this Conference will meet your implementation needs, we are offering a money-back guarantee - see these "Five Good Reasons" why you should attend the conference.

As you should be able to tell from this detailed conference agenda, we have worked hard to ensure that you will be able to hit the ground running once the new rules are adopted - and we have worked hard to produce a remarkable line-up of panelists, including the SEC Staffers who are slaving over the rules right now. You probably even can use our detailed agenda as a checklist of issues that you will need to master. We obviously will tweak the agenda once the rules are finalized to adapt to any changes the SEC makes from its proposals (eg. I am still working on one panel).

Your Budget Will Not Take a Beating

As a "thank you" to our members, this Conference is priced at a fraction of what other conferences cost these days. By taking advantage of our "Early-Bird Discount," you can attend this conference for only $495 if you are a member of TheCorporateCounsel.net or CompensationStandards.com.

And the savings are much greater if more than one person from your organization plans to attend – in fact, everyone in you entire company or firm can attend (and have ongoing access to the video archive and critical course materials) for only $1495! This is lower than what some conference providers charge today for just one attendee. You must act by July 20th to get these special Early-Bird rates!

Why You Will Benefit from the Videoconference Format

We have decided to conduct this Conference by video webcast primarily for two reasons. One reason is to provide you with guidance right away - so that you will be on top of the new rules right after they are adopted (ie. right when your CEO and directors and clients will be asking about them in the wake of the inevitable widespread media coverage).

Another reason for this format is to provide you with an archive of the entire videoconference (and the related practical course materials) so that they will be right there at your desktop to refer to - and refresh your memory - when you are actually grappling with drafting or reviewing the disclosures during the proxy season and beyond. Of course, this format also spares you the time and expense of traveling, etc. Register today and take advantage of the Early Bird discount!

June 12, 2006

Executive Compensation Rules Appear On Track for Adoption

SEC Chairman Chris Cox gave this speech late Thursday, which makes it seem pretty likely that the SEC will indeed adopt rules relating to its executive compensation proposals sometime this summer so that they apply to the '07 proxy season. His speech also included some interesting comments on option backdating, a topic that I blogged about again on Friday (the Chairman's remarks are also analyzed in this Washington Post article).

Here is a notable excerpt from the Chairman's speech:

"The Commission is even now considering further adjustments to our executive compensation proposal to deal with the issue of backdating options. Our staff in the Division of Corporation Finance are collating all of those thousands of comments and will make a recommendation to the Commission at an open meeting soon.

As part of that review process, we will consider the need not only for any changes to the rule, but also for additional guidance to address further the backdating of stock options. So stay tuned. We want this matter settled in time for next year's proxy season, and I have every reason to expect that it will be."

Not sure how soon that open meeting will be - but my bet is it will be held sooner than most of us would have thought possible. Quite an undertaking by the Staff considering the sheer volume of the proposals and the number of comments submitted...

Isn't It Ironic? Option Misdating Forces Boards to Reconsider Compensation Practices

I was all set on the theme of this blog even before this article appeared on the top of the Business section of Friday's NY Times. The article condemns the option granting practices of yet another company, although these grants were allegedly made just before favorable company news was announced; so this is not another misdating allegation. Some of you may remember that this topic was the thrust of a speech by then-SEC Enforcement Director Stephen Cutler way back in early '04. So this is not a new topic.

As option backdating allegations have been around for more than a year, I wonder why all the media attention is peaking now? I'm not sure. Perhaps because this scandal offers a concept that the general public can fairly easily understand on its face - even though the laws related to it are pretty complicated (see the March-April 2006 issue of The Corporate Counsel). Or maybe it's the last straw of greed that the general public can handle.

Ironically, it looks like this narrow problem could be the motivator that finally forces laggard boards to look deeply into their own executive compensation practices and clean up their act. I consider it ironic because the dollar amounts and misguided rationales related to other practices really dwarf the issues related to option misdating. But I will take responsible actions any way I can get them - and for that, I am glad for this issue to peak now.

Is the Option Misdating Furor Becoming a Witch Hunt?

But I do get concerned that the option misdating furor could - or already has - become a witch hunt as I continue to upload articles and research reports about option timing unto our "Timing of Stock Option Grants" Practice Area on CompensationStandards.com at an incredulous rate - even though just a few dozen companies have announced that they are being investigated so far.

And the key word here is "investigated." I know the studies and reports place impossible odds on coincidental timing, but the integrity of these documents should be fully evaluated before given too much credability. After speaking with some of my in-house friends, I am now taking some of these studies with a grain of salt - as allegations of option misdating sometimes appear to be based on small samplings, incorrect data or misused data.

For example, consider this situation: a research report names a company as having option misdating issues when only four option grants were used in the report's sampling - of which two were annual grants that were given to the entire population of plan participants (and which were granted in the normal course at a regularly scheduled meeting of the company's compensation committee). Another grant was given to a newly elected President in connection with his promotion - and the last grant in the sampling was to a lower level officer for whom the related exercise prices were much higher than the company's stock price as of the grant date because premium-priced options were used. Despite accurate proxy disclosure regarding the exercise prices, the report plainly got it wrong.

Given the regulator, media and market reaction to allegations of option misdating, this seems irresponsible and I imagine there can be other companies that might have similar stories. Of course, it seems clear that there also are companies that truly did engage in nefarious behavior as 15 officers have already lost their jobs in the wake of this scandal so far. But the message is that care should be taken - and facts checked - before publishing studies, reports and media articles on this topic...

How to Go Public on the London Stock Exchange’s AIM

We have posted the transcript for the recent webcast: "How to Go Public on the London Stock Exchange’s AIM."

June 9, 2006

Delaware Supreme Court Finally Rules on Disney Case

Excuse me if I'm cranky, but I had decided to take a day off blogging today in honor of my half-birthday - been trying to get my wife to celebrate it for years to no avail - but the Delaware Supreme Court didn't cooperate. Late yesterday, the Court released it's long-awaited opinion - written by Justice Jacobs - affirming the Chancery Court's decision in the Disney litigation. We have posted a copy of the 91-page opinion in CompensationStandards.com's "Compensation Litigation" Portal. Analysis to follow next week...

Option Grants to Get Attention in Final Compensation Disclosure Rules

From Mark Borges' "Proxy Compensation Disclosure" Blog yesterday: "The brewing scandal about possible stock option grant timing abuses could lead to significant changes in the final executive compensation disclosure rules. As reported in several media outlets, yesterday SEC Chairman Chris Cox indicated that the Commission is considering revisions to the proposals in response to concerns about option dating. In fact, one article notes that Cox is going to address the subject later today - I'll update this post once his comments have been made public.

As you probably know, one of the items included in the proposed Compensation Discussion and Analysis would require companies to consider discussing the timing of their option grants as part of this report. Proposed Item 402(b)(2) includes, as one example of the type of material information that may need to be discussed in the CD&A, "[f]or equity-based compensation, how the determination is made as to when awards are granted."

At this point, I suspect that the changes under consideration would go much further than just revising this particular item. If you want to get a flavor of what might be under discussion, take a look at the comment letter of the CFA Centre for Financial Market Integrity (which was submitted on May 30th). The CFA recommends four specific enhancements to the current proposals to cover option timing concerns:

- The dates for all prior-year compensation committee meetings be disclosed in the CD&A;

- The dates on which the compensation committee approves equity awards be disclosed on an on-going basis in Form 8-K filings and, by reference, in the proxy statement;

- The effective grant dates for all equity awards that differ from the previously-disclosed approval dates be disclosed on an on-going basis in Form 8-K filings and, by reference, in the proxy statement; and

- The compensation committee be required to determine and disclose if any effective grant date was selected to take advantage of the pending release of material information about the company, and whether executives are permitted to select or recommend grant dates for their options.

It's unclear whether the Commission is entertaining any of these recommendations or what other ideas it may be considering. However, as the investigations into option grant timing continue to expand, it seems a virtual certainty that the disclosure rules are going to get adjusted to address this issue."

Broker Votes vs. Broker Non-Votes II

After I initially blogged on this issue a few days ago, I went back and tweaked my entry after numerous responses from members addressing what is the proper meaning of "broker non-votes." I continue to get conflicting e-mails from members, so proxy mechanics is an area where more education appears necessary for many of us. Here is one member's thoughts on the topic:

"Broker non-votes" has a specific meaning and is not the same as broker votes on behalf of their customers. A broker non-vote occurs when a broker's customer does not provide the broker with voting instructions on non-routine matters for shares owned by the customer but held in the name of the broker. For such matters, the broker cannot vote either way and reports the number of such shares as "non-votes."

Like abstentions, broker non-votes are counted as present and entitled to vote for quorum purposes. Unlike abstentions, at least for Delaware corporations, broker non-votes are not the equivalent of an "against" vote on those items that require the affirmative vote of a majority of shares present in person or by proxy and entitled to vote. Proxy statements must discuss the treatment of "broker non-votes," and in Item 4 of Part II of Form 10-Q, registrants must report, for each item voted on at the shareholder meeting, the number of "broker non-votes" along with the number of shares cast for, cast against or withheld, and abstained.

And one more from another member:

Rather than being the same thing as a broker vote, I would say that a broker non-vote is the flip side of a broker vote. Both broker votes and broker non-votes relate to the ability of the broker to vote shares with respect to which the broker has not received specific voting instructions from the beneficial owner of the shares. But a broker vote occurs in a situation where NYSE Rule 452 does not prohibit the broker from casting a discretionary vote with respect to uninstructed shares, so the broker goes ahead and votes those uninstructed shares in its discretion, whereas a broker non-vote occurs in a situation where NYSE Rule 452 does prohibit the broker from casting a discretionary vote with respect to uninstructed shares, so the broker is unable to vote those uninstructed shares.

Broker votes show up as a "for," "against" or "abstain" vote, depending on how the broker casts its discretionary vote, whereas broker non-votes are excluded from the "for," "against" and "abstain" counts, and instead are reported by the company as broker non-votes. Depending on the approval standards applying to a particular matter, broker non-votes may or may not have an impact on the outcome of the matter.

June 8, 2006

New EDGAR Text Search Tool

The SEC recently added this new beta version of an EDGAR search tool that allows for text searches. Give it a whirl...

And You Thought the American Proxy Season Was Crazy!

With the proxy season now behind most calendar year companies here in the US, I thought it would be interesting to note that nearly all Japanese companies hold their annual meetings within a few days of each other - after providing shareholders with just two weeks notice as to the agenda! This really causes problems for shareholders who want to follow more than a handful of meetings.

Learn more from ISS' description of the Japanese proxy season:

"Most Japanese firms send meeting agenda notices to shareholders just two weeks - the legal minimum - before annual meeting dates. The short notice leaves investors only a few days at most before voting deadlines to translate, analyze, and execute votes for their holdings.

Equally problematic is the concentration of shareholder meetings on a few days each year. The perennially lopsided distribution was illustrated again last year. Of the 80 percent of Japanese firms tracked by ISS that held their annual meetings in June, 83 percent scheduled their meeting on June 24, June 28, or June 29.

These hurdles to voting have sparked complaints by international investors since many began voting their Japanese shares in the early 1990s, as well as by Japanese institutions that have started to systematically vote their domestic holdings in recent years.

Two rules that have helped sustain short notice and meeting concentration practices remain in the law, but as companies take advantage of the dividend approval deregulation, their justifications may start to ring hollow.

Because shareholder approval of profit allocation has long been a requirement before dividends could be paid, there has been a rationale for requiring that each year's annual shareholder meeting be held within three months of the fiscal year close, so that the year-end dividends could be paid in a timely manner. This requirement in turn presents a scheduling challenge, since audited profit figures are necessary for any profit allocation resolution, and they must be circulated to shareholders in meeting notices some time before the meetings.

In most international markets, annual meeting agenda notices reach shareholders three weeks or more before the meeting date, but Japanese companies have argued that they must rush to complete audits in time to meet even a two-week notice requirement. Even after the amendments, Japan's company law would still allow companies to wait until just two weeks before the meeting date before mailing the agenda.

However, if the bulk of Japanese firms ultimately opt to waive this dividend approval requirement, this justification used to defend the old practices will vanish.

Some institutions this year are expected to vote for proposals to delegate dividend and profit allocation authority to Japanese boards, in the hope that this may one day lead to further legal and regulatory reform that will enable a more manageable proxy voting calendar in Japan. Other investors who have developed policies concerning dividends may oppose granting boards discretion over income allocation, concluding that there's no guarantee that companies will then decide to actually hold their meetings substantially earlier."

Section 404 and Small Business

In this podcast, Ralph Martino of Cozen O’Connor provides some thoughts on internal controls and the likely impact on smaller companies, including:

- Why do you think the SEC refused to exempt small public companies from the provisions of Section 404?
- Do you think Section 404's long term effect on small public companies and their capital formation will be positive or negative?
- Do you think Section 404 provides material protection from financial fraud?
- What do you think the SEC was getting at when it stated - in its four-point plan - that it was going to work with the PCAOB in the application of Section 404 to small business?

June 7, 2006

NYSE's Proxy Working Group Recommends Elimination of Broker Voting for Director Elections

Last week, the NYSE's Proxy Working Group unanimously adopted six recommendations embodied in this Final Report and Recommendations. As I blogged last month, the principal recommendation is the one that would amend the NYSE's Rule 452 (commonly known as the 10-day broker voting rule) to make director elections a non-routine matter. This means that brokers would no longer be permitted to vote the shares of beneficial owners who do not provide specific voting instructions within 10 days of the close of proxy voting. As many of you know, brokers typically side with the board and management when they vote for directors. Here is a related article from BusinessWeek.

Coupled with hedge fund activism, this could mean that directors who are subject to withheld votes will find it much more difficult to obtain a majority vote. Add in the growing majority vote movement and this is a whole new ballgame folks! It is not hard to find director elections this year where directors received a majority vote- but would not have done so if this rule had been effective.

I predicted as much for the recent Home Depot election. Consider how high the level of withhold votes was there without the extended media and Web campaign that took place at Disney a few years ago. Wake up and smell the coffee Mrs. Bueller, the playing field is shifting all around us! The NYSE wants the SEC to approve the rule change so it can be effective for the 2007 proxy season! Better lock in your favorite proxy solicitor now because demand is gonna be sky high!

Thankfully, the Proxy Working Group rejected the idea of totally eliminating broker voting, recognizing that it plays an important role in allowing companies to achieve a quorum for regular meetings.

The six recommendations from the Proxy Working Group are:

1. The elimination of discretionary broker votes for director elections by amending the NYSE's Rule 452.

2. The SEC's review of the OBO-NOBO rule to make it easier for companies to communicate with their street-name shareholders.

3. The NYSE's engagement of an independent party to analyze and make recommendations to the SEC regarding the structure and amount of fees paid to ADP.

4. The SEC's study of the role of groups like ISS and Glass Lewis that impact the voting decisions over shares in which they have no ownership and no economic interest. The Proxy Working Group believes that there is the potential for conflicts of interest and/or other issues given the multiple roles that such groups play in the proxy season.

5. The NYSE's taking a lead role in efforts to educate investors about the proxy voting framework.

6. The NYSE's monitoring of the impact of amending Rule 452 to make director elections a "non-routine" matter.

The NYSE Staff seeks comments by the end of June - it will share these comments with the SEC. After reviewing these comments, the NYSE Board will consider them and any proposed rule changes will then be filed with the SEC so that the SEC can then directly solicit additional public comment. So for those of you worried about the tight window period for commenting now, recognize that the public will have two opportunities to comment. Lots more to come on these groundbreaking recommendations!

Study on Investor Attitudes

As part of the NYSE's Proxy Working Group process, they had this Investor Attitudes Study prepared by the Opinion Research Corporation to gain a better understanding of investors' knowledge of the existing proxy voting process.

No surprise that the study results show that investors generally are confused about proxy mechanics since so few of us professionals fully understand how it all works. In fact, I was floored that 25% of the respondents understood that their brokers get to vote in their place if they didn't respond. My guess is that no more than 5% of shareholders would have understood that...

Broker Votes vs. Broker Non-Votes

Some of you may wonder what is a "broker non-vote" - and how it differs from a "broker vote"? They are one and the same thing, just different terminology (except sometimes people refer to broker non-votes as being "non-routine" meeting agenda items for which brokers aren't entitled to use discretion to vote; this stuff is confusing!). One of my favorites John Wilcox, formerly of Georgeson and now at TIAA-CREF, taught me long ago that the proper terminology is "broker non-vote" because the broker gets the discretion to vote due to non-voting of the beneficial owner.

But it's entirely a "tomato, tomahto" thing and reminds me of this recent exchange among academics regarding whether "shareholder" or "stockholder" is the appropriate term under Delaware law...

June 6, 2006

Notices of Effectiveness Now Online

As I blogged a month ago, the SEC recently announced that it will use EDGAR to post notices of effectiveness for registration statements (and post-effective amendments). The SEC has now begun posting these notices on this web page - and here is an example of what these online notices look like. Notices of effectiveness can also be found by searching for the EDGAR form type "EFFECT."

The SEC states it will post these notices on the morning after the filing is declared effective and will no longer mail out paper copies (although it will continue to notify registrants by telephone that a registration statement or post-effective amendment has gone effective).

Who could possibly care about all this? Well, I guess it's a big deal for the associates and paralegals who no longer will have to try to track down paper notices for a deal closing; they often were mailed by the SEC weeks and weeks after effectiveness in the past.

Alan Beller Rejoins Cleary Gottlieb

Following the footsteps of former SEC General Counsel Giovanni Prezioso, Alan Beller has decided to also return to his old law firm, Cleary Gottlieb Steen & Hamilton. Alan will practice in the firm's New York office.

Yesterday, the SEC announced that it had woo'ed Andy Vollmer from his partnership at Wilmer Hale to serve as Deputy General Counsel of the SEC. Andy, who specializes in internal investigations, will nicely complement General Counsel Brian Cartwright, who specialized in Corp Fin issues during his private practice days.

Remembering Ken West – In Gratitude and Deep Respect

I am sad to say that Ken West passed away recently. Those of you that heard Ken speak at last year's "2nd Annual Executive Compensation Conference" know what a source of strength he was for all of us endeavoring to "do the right thing." Below is a remembrance from Don Delves (and here is a brief article written by Ken for Directors & Boards):

"The corporate governance community lost one of its finest members with the recent passing of Ken West. As long-time Chairman of the NACD, Governance Consultant to TIAA-CREF, and board member, Ken fostered a tremendous amount of positive change in the operation and effectiveness of countless boards. He worked quietly, behind the scenes, gently wielding a big stick and systematically persuading wayward boards to adopt better practices.

He did so as a gentleman and veteran business leader, talking to other business leaders about how they might operate with greater integrity and higher standards. Ken used his position as an extraordinarily well-liked and well-respected member of the director community to challenge that community--our community--to recognize our shortcomings and to be our best. He was also a mentor and advisor, encouraging many of us to take thoughtful, measured and sometimes risky stands for changes we thought were in the best interests of company and shareholders. We will miss Ken for his candor, his courage and his friendship."

June 5, 2006

Lessons Learned from the Fannie Mae Settlement

I held off blogging about Fannie Mae's agreement to a $400 million fine - as reflected in this SEC press release and Fannie Mae press release - until I got a chance to read the 348-page OFHEO report. Here is a summary of the report - and the related OFHEO settlement agreement.

My first thought in reading the OFHEO report was to compare it with Richard Breeden's "Restoring Trust" WorldCom report - which is now three years old. The Breeden report seemed so novel at the time; the Fannie Mae report is also fascinating, but not as shocking since we have all read so many of these things by now.

To get some guidance on what boards should not do, I recommend focusing on pages 287-330 of the OFHEO report; here is a smattering of the many lessons from the report that I found worth considering:

1. Boards should question any fast-tracked settlement of whistleblower claims (pg. 281 of the PDF)

2. Any failure of the audit committee is also a failure of the Board (p. 283)

3. Boards should ensure the audit committee charter doesn't limit the ability of the audit committee to challenge management (p. 293-294)

4. Audit committees should actively oversee the internal audit department, including ensuring that the internal auditor's compensation is not tied to corporate performance (p. 296-298)

5. Compensation committees should ensure that their charter doesn't create a bias in their oversight role (nor should the charter include standard statements that they can't comply with, such as "pay-for-performance" and reliance on stock-based compensation to align management's interests with shareholders) (pg. 310-312)

6. Compensation committees shouldn't allow management to script out their meetings in advance (p. 313)

7. Compensation committees shouldn't allow the CEO to influence which independent compensation consultant they hire (p. 314)

8. Boards need to stay informed about the corporate strategy (p. 315)

9. Boards need formal policies as to how (and when) to approve large transactions and if (and when) management needs to inform directors about them (p. 319)

10. Boards need to act fast in a crisis, including launching an independent investigatons (p. 324-329)

Here are some joint remarks from SEC Chairman Cox and the head of the OFHEO - and the SEC's litigation release and complaint.

SEC Historical Society's Annual Meeting

Check out tomorrow's SEC Historical Society annual meeting, which includes this free webcast program: "Who's Counting? The Critical Role of Financial Reporting in the Capital Markets."

Growing Importance of Computer Forensics in Litigation

In this podcast, Stephanie Weiner, Director of Computer Forensics in BDO Seidman’s Litigation & Fraud Investigation practice, provides some insight into why computer forensics will begin to play an even greater role in trial preparation (ie. beginning December 1, 2006, when new Federal Rules of Civil Procedure go into effect) as new rules require parties to discuss issues pertaining to discovery of electronically stored information (ESI) at the initial rule conference, including:

- What is ESI, and what role does it play in court cases?
- What questions should you ask to determine if ESI is accessible or non-accessible?
- How can computer forensics assist in establishing a timeline to comply with electronic discovery requests?
- What is the impact of electronic discovery on budgets and what are some ways to minimize cost?

June 2, 2006

Spotlight on Legality of Binding Anti-Pill Bylaw Amendments

Following up on a recent blog, this Wachtell Lipton memo lays out this development: "Stockholders of Hilton Hotels Corporation recently approved a labor union-initiated proposal to amend Hilton's bylaws to provide that Hilton "shall not maintain a shareholder rights plan [sometimes known as a `poison pill'] . . . unless such plan is first approved by a majority shareholder vote." The passage of this proposal is lamentable as a matter of policy. It also puts a spotlight on the so-far-unanswered question of whether binding, shareholder-initiated bylaws of this nature are valid under Delaware law.

For very fundamental reasons, we believe that a binding bylaw of the type voted upon at the Hilton meeting is not valid under Delaware corporation law. Hilton, based on the opinion of Delaware counsel, reached the same conclusion, and has stated that its board will treat the proposal as a non-binding recommendation. We believe this approach is correct. Under Delaware Code Section 141(a), directors have not only the power, but the obligation to at-tempt actively and in good faith to protect and advance the interests of the corporation and its stockholders.

This fiduciary obligation requires that directors exercise their informed judgment in the circumstances as they appear from time to time. In our view, a majority of the voting shares may not in a bylaw limit the board's power to take such action as the board itself believes in good faith is necessary or appropriate to protect and advance the interests of the corporation and its stockholders. Should a majority of shares wish to pursue a policy of board disempowerment, as the union is attempting to do with its bylaw proposal at Hilton, the corporation law does not leave them without means to do so. Stockholders are free to elect new directors with different views of the best way to advance the purposes of the corporation.

In addition, an amendment to the corporation's certificate of incorporation could validly constrain the powers of the board. That these alternative avenues for the enhancement of shareholder power over management are more difficult to effect is not, in our view, a flaw of the long-existing law, but rather a recognition that the complex governance of the large modern business corporation is a most serious matter that requires greater deliberation than is likely to occur in a single vote on a bylaw amendment.

Moreover, the use of shareholder-initiated binding bylaws to disable directors from fulfilling their obligation to protect the interests of stockholders is bad policy. The statutory duty to be active in protecting the interests of all stockholders is never more important than when a company is evaluating a potential sale of control or responding to activist stockholders seeking to influence or control the company for self interested purposes.

A board's ability to adopt and maintain a rights plan is among the most powerful and flexible tools available to enable directors to fulfill their obligations. Rights plans are also critical to the ability of a public company to conduct an orderly auction in the event the company seeks to sell itself. Repeated shareholder referenda are no substitute for board judgment, and are likely to prove impractical, ineffective and vulnerable to abusive tactics of small but vocal groups of shareholders whose interests may not be aligned with, or may be hidden from, stockholders generally. A bylaw that effectively demands director passivity at the very moments when active business judgment is most keenly needed contradicts the fundamental principles of our corporate law and does not serve the best interests of corporations or stockholders generally."

Home Depot: Calling Off the Dogs

In the wake of shareholder outcry at the way Home Depot's annual meeting was handled last week (as I blogged about a few days ago - also see this WSJ editorial), Home Depot issued this press release yesterday noting that next year's shareholder meeting will return to "normal" (ie. shareholders will be permitted to ask questions and directors will attend).

In addition, the company announced that it intends to implement "majority vote measures" since a shareholder proposal seeking a majority vote standard received support from 56% of those voting. It will be interesting to see what those "measures" comprise of given that 10 of Home Depot's 11 directors received high levels of withheld votes: over 30% (the only director not receiving a similar level is a brand new director). According to this WSJ article, these high levels are mainly due to anger over CEO pay. Depending on the math, if broker non-votes were not counted and a majority vote standard had been in place, this board might have been gone!

Interestingly, Home Depot has landed near the top of the ISS CGQ scoring system in recent years (99.6% right now) - which can be taken one of two ways, either the conduct of this meeting was an aberration or CGQ scores should be taken with a grain of salt...

June Eminders is Up!

The June issue of our monthly email newsletter is now posted.

June 1, 2006

More on Nasdaq Becoming an Exchange

Recently, the SEC approved the rule change to rename the Nasdaq National Market as the Nasdaq Global Market and to create the Nasdaq Global Select Market, a new tier within the Nasdaq Global Market with higher initial listing standards. Even though Nasdaq's transition to an exchange has been delayed, it is proceeding with the Global Select Market - and the renaming of National Market to Global Market - so that these changes will be effective July 1st. The rule filing to do so under the NASD rules was filed a few days ago. As for the timing of Nasdaq's transition to an exchange, it now looks like that might take effect on August 1st - see this Nasdaq Head Trader Alert.

Here are some issues not addressed by previous blogs about the impact of this transition:

- Delisting - Once Nasdaq becomes an exchange, a company will have to file a Form 25 to delist. The Nasdaq has filed a rule change to incorporate the SEC’s new requirements relating to delisting (Rule 12d2-2) into the rules of the Nasdaq exchange.

- Rule 144 - One issue that occurred to me is that when Nasdaq becomes an exchange, will affiliates who sell under Rule 144 have to file a Form 144 (if required under 144(h)) with both the SEC and Nasdaq as Rule 144(h) refers to the "principal exchange on which such securities are so admitted"? Our Rule 144 expert Bob Barron has authored a great 6-page article on this topic, located in our "Rule 144" Practice Area. Nasdaq also has updated its FAQs on Exchange Registration to address the Form 144 question, where the penultimate paragraph states:

"After NASDAQ becomes operational as a national securities exchange, Section 16 and Form 144 filings related to Nasdaq-listed securities will have to be filed with NASDAQ. However, NASDAQ has requested, and expects to receive, relief from the Securities and Exchange Commission that will allow the electronic filing of Section 16 reports and Forms 144 through the SEC's EDGAR system to satisfy the obligation to file these reports with NASDAQ. A copy of Section 16 and Form 144 Filings not made using the SEC’s EDGAR system should be sent to Listing Qualifications."

More on Option Backdating

Following up on this blog from a few weeks back, we have been uploading articles, research reports and Form 8-Ks to the "Timing of Stock Option Grants" Practice Area on CompensationStandards.com at an incredulous rate. The most recent media reports are tossing out numbers like "10%" as to the number of companies at risk. That's one figure cited in a NPR segment noted in this excellent memo - and this article quotes the Professor who uncovered this scandal as predicting that 20% of companies don't timely report their option grants on Form 4! These numbers are so high! Maybe I am in denial, but I simply don't believe that it could be so bad.

And as Mike Melbinger blogged about yesterday (and as noted in this WSJ article), McAfee just dismissed its General Counsel because of stock option "improprieties" during 2000. I imagine this will not be the last in-house lawyer to be handed his/her head - and reputation - over this type of issue.

What About Rule 10b5-1 Trades?

With the option backdating scandal being kicked off by an academic study from last year, perhaps it's time to look at what other potential problems have been uncovered by studies. This recent LA Times article delves into a study by a Stanford Professor who claims that stock sales made under Rule 10b5-1 plans precede bad news more often than good news.

I was surprised at the results of this study, but perhaps the period of time covered (i.e. 2003 and before) may offer an explanation? We have posted a copy of the study and several related articles in our "Rule 10b5-1" Practice Area. Thanks to Keith Bishop for keeping me on my toes!