July 31, 2006

PCAOB Issues Guidance for Auditors on Option Backdating Issues

On Friday, the PCAOB issued an alert regarding stock options grants entitled "Matters Relating to Timing and Accounting for Options Grants." In the alert, the PCAOB advises auditors that backdating practices may have implications for audits and internal control reviews - and discusses factors that may be relevant to assess related risks.

Essentially, the PCAOB says that auditors should inquire about option grant timing at their clients to make sure that there are no misdating issues. Auditors are supposed to make these inquiries routinely as part of their year-end audit as well as whenever a prior audit is included in a registration statement. Not really a big surprise given that many auditors already have adjusted their procedures within the past few months to cover themselves going forward.

As the WSJ noted in this Saturday article, this guidance could unleash a wave of restatements. The article also notes that the PCAOB identified "springloading" as a potential problem - counter to SEC Commissioner Atkins' recent speech on the topic.

As an aside, note that this is Audit Practice Alert #1 from the PCAOB – a new type of guidance for them (intended to "highlight new, emerging, or otherwise noteworthy circumstances that may affect how auditors conduct audits under the existing requirements of PCAOB standards and relevant laws"). The PCAOB still has a long way to go to catch up with the SEC and its dozens of guidance avenues...

Director Liability and Responsibilities: After Disney

We have posted a copy of our CompensationStandards.com transcript for the webcast: "Director Liability and Responsibilities: After Disney."

A Funny Thing Happened On The Way To Convergence

From the "AAO Weblog": "The driver of the convergence bus decided to put it into neutral for a while. The International Accounting Standards Board released a bombshell yesterday that's gone pretty much unnoticed in the US press. (Though the Financial Times picked it up.) The IASB is declaring a moratorium on the effective date of any new International Financial Reporting Standards (IFRS) or major modifications of existing standards until after January 1, 2009.

The only other mention I could find in the world press was this from the Irish Examiner, who said the "Institute of Chartered Accountants in Ireland (ICAI) has welcomed the announcement by the International Accounting Standards Board (IASB) that it will suspend the introduction of new accounting standards until 2009." That's not what the IASB said: they said there'd be no new standards effective until 2009. They didn't say they wouldn't issue new standards until 2009. Keep your hopes in check, guys.

The idea behind the moratorium: give folks in the European Unionsome time to catch their breath. The transition to IFRS has been difficult in many countries, and this will give them a chance to evaluate their situations in less of a panic mode. Furthermore, the IASB will slow down some of its work with the FASB on a joint conceptual framework project.

And some of the comments of Sir David Tweedie in the Financial Times article, indicate the delay might also calm down some constituents "inflamed" by a February announcement of the IASB and the FASB to speed up "writing joint standards in 11 areas by 2008 and to examine existing standards in 10 other areas."

It's not a bad idea, and in fact it synchronizes well with the SEC's own convergence plans. (Recall that there's currently a requirement for a foreign company to reconcile the accounting used in its financial statements to US GAAP-based accounting. By 2009, the SEC wants to eliminate that requirement if IASB standards are used by a foreign company - provided the Commission is satisfied with the IASB standards in place by that time.)

The danger is that, rather than use the time to get on board with the IASB standards, companies will use the time to try and exploit politics to further avoid the standards or roll them back. And delays might become a serial habit, with or without political interference. Keep tuned. (For the next few years.)"

July 28, 2006

Hubbub Over Quarterly Earnings Guidance

Some pretty interesting commentary in the wake of Monday's Symposium sponsored by the CFA Centre for Financial Market Integrity and the Business Roundtable. During the Symposium, three principal messages were imparted: (1) companies should cease providing earnings guidance, (2) they should tie executive portfolio manager performance (and disclosure thereof) to long term metrics, and (3) they should provide greater communication and disclosure of long term strategies and metrics of long term value creation.

We have posted a summary of the Symposium proceedings in our "Earnings Releases" Practice Area. And it's probably about time for me to re-do this survey on earnings release practices and see what the results would look like now. Here is a more recent survey from McKinsey.

According to this WSJ article, SEC Chairman Cox said that these calls for companies to stop issuing quarterly earnings guidance are "healthy recommendations." And the WSJ reports that former SEC Chairman Bill Donaldson supports efforts to get companies to stop issuing quarterly earnings estimates, but that he warned groups pushing the issue Tuesday that any move in that direction should be balanced by increased disclosure of other factors, like long-term strategic goals.

But in an editorial from the Financial Times entitled "Misguided Guidance," a different perspective is presented. Below is the FT editorial:

"When both company bosses and fund managers agree that quarterly earnings forecasts harm US business it is time to listen. The Business Round-table Institute for Corporate Ethics and the CFA Institute say in a new report that the practice "leads to the unintended consequences of destroying long-term value, decreasing market efficiency, reducing investment returns, and impeding efforts to strengthen corporate governance". None of those consequences is good.

The investment community has, in effect, been asking companies to lie to them four times a year. Few investment projects deliver a return inside three months. Investments by an oil company in a new production field take decades and a quarterly forecast means nothing. What is worse, as any schoolboy will tell you, is that lies once told are not forgotten. Quarterly forecasts can only be met if a company is managed toward them. Pressure to hit quarterly numbers is one factor behind the culture of lies that devoured Enron.

It would be unfortunate, though, if efforts at reform made companies less open and transparent. Financial markets breathe information and forward-looking information is especially pure oxygen. Reform that increases investors' uncertainty over corporate prospects would harm investment returns just as surely as quarterly guidance. Nor should formal guidance be replaced by unofficial numbers, delivered to a favoured analyst over an expense account lunch. Privileged access to information was a feature of the dot-com era now rightly discarded.

Rather than starve the markets of information, companies should think afresh about what guidance best reflects their business, and how they give it. Investors want to know how much oil Shell will produce in 10 years' time. They want to know how Microsoft will deal with the competitive threat from Google. From small technology companies, however, which need to raise more capital, they want regular information about prospects. It is short-term guidance, not forecasting hard numbers, which causes the problem. In Japan, not known for a short-term outlook, all listed companies must forecast their turnover and profit for the year ahead.

The victims of scrapping quarterly guidance will be the financial journalists, sell-side analysts and hedge fund traders who profit from the use, abuse and interpretation of news. Their hunger for information has made it hard for any company, particularly a small company, to unilaterally end quarterly guidance, when it knows that doing so will mean less media coverage, less analysis and less liquidity in its shares. Companies have to be careful that stopping quarterly guidance is not seen as an attempt to cover up bad news.

Now, though, US corporations have the opportunity to guide their investors in a new direction. It is an opportunity they should embrace." Read more commentary in the "AAO Weblog" and the "D&O Diary."

I'll Trade You a Jeff Skilling for Two Dennis Kozlowskis

As the fourth anniversary of Sarbanes-Oxley approaches this Sunday, July 30th, it may be interesting to take a look back over the past four years to see how the legislation has affected businesses across the country. Yeah right - I would rather have a little Friday fun...

I was a big baseball card nut when I was a kid. So I shed a tear or two when I saw this deck of trading cards from the Slate with all the stars from this generation's corporate scandals (click on the cards to see them up close; the backs of the cards are hilarious). You can even recognize some of the borders as mimicking old Topps sets. Thanks to Andy Gerber for the heads up!

Con Artist Obtains Shareholder Data from ADP

There have been so many reported instances of security breaches at companies by hacking or an employee simply leaving a laptop in a cab, it was almost comforting to read about ADP being conned by an impersonator. According to media reports, including yesterday's WSJ, ADP gave shareholder lists to "an unauthorized party" who impersonated numerous corporate officers between November 2005 and February 2006.

The information provided included names, addresses and number of shares owned by individual investors, but did not include account numbers, social security numbers or identify the brokers where shares were held. I'm not sure which particular companies were targeted as media reports don't disclose that information - for example, this older WSJ article only says:

"Fidelity Investments said 125,000 of its customers were among those whose information was breached. UBS AG said about 10,000 of its customers were affected, while Morgan Stanley said about 3,800 of its clients were affected."

July 27, 2006

SEC Adopts Executive Compensation Disclosure Rules

Yesterday, the SEC adopted new executive compensation disclosure rules (as well as related-party transaction and Form 8-K rules) as expected. The SEC appeased the mass media by focusing quite a bit on option backdating in its press release. Otherwise, there was not too much in the way of change from the proposals as described at a two-hour open Commission meeting - but that's not to say that the changes wrought by the new rules will not be dramatic! And of course, the adopting release will be key to ascertain the extent to which fine-tuning changes were made to the SEC's proposals other than the ones identified below.

Some useful information is in this opening statement from the Corp Fin Staff - and the SEC also issued this sample Summary Compensation Table. Here are Chairman Cox's opening remarks.

The new Compensation Discussion and Analysis remains the centerpiece of the SEC's new rules - and it is required to be "filed." In addition, a new Compensation Committee report is now required to be "furnished." This new CCR is designed to keep compensation committees on their toes, as it is required to address whether the committee has reviewed and discussed the CD&A with management. While the SEC is strictly neutral as to the level and design of compensation, we expect boards that have embraced sound practices will go beyond the statements required under this new rule and will proactively state that they consider the amounts paid to be reasonable and appropriate.

In the Summary Compensation Table, only above-market or preferential earnings (rather than all earnings) on non-qualified deferred compensation is required to be included. The required defined benefit pension plan disclosure is now limited to the actuarial present value of a Named Executive Officer's accumulated benefits.

In terms of gauging who should be identified as the NEOs, the SEC tweaked its proposal so that the metric is not the new Total Compensation column - rather, companies can back out the numbers from the two columns regarding preferential earnings on deferred compensation and increases in pension values when they identify their NEOs. This tweak addresses comments that using the Total Compensation numbers would unnecessarily skew inclusion of longer-term officers as NEOs.

I was surprised that the SEC re-proposed the so-called "Katie Couric" proposal (ie. requiring disclosure compensation for three employees who are not executive officers). As re-proposed, this rule would carve out non-executive officers with no responsibility for significant policy decisions and would only apply to large accelerated filers. This re-proposal likely will draw significant comment as before - and some clarification may be necessary because it's worded in the negative, so it's difficult to tell if it is intended to pick up Rule 3b-7 officers. To me, this part of the SEC's overhaul is extremely minor in the entire scheme of things; I'm consistently amazed how some incidental issue in a rulemaking project distracts so many from the bigger - and more pressing - issues.

More extensive notes - which identify a few other changes from the proposals known so far - are posted on CompensationStandards.com under “The SEC's New Rules.”

The new rules apply to the upcoming proxy season, compliance is required for fiscal years ending on or after December 15, 2006. For the new Form 8-K rules, compliance is required sooner - for triggering events that occur 60 days or more after the rules are published in the Federal Register. I'm still amazed the Staff got these rules out in such short order...

Act Fast to Get Your Washington DC Hotel Room

Now that the new executive compensation disclosure rules have been adopted, you need to act fast to reserve a hotel room for our Conference - "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" - which will be held live in Washington DC at the Marriott Wardman Park on September 11-12. Rooms are filling up fast - here is how to obtain special room rates.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft - and review - disclosures during the proxy season. The Conference is still available by videoconference if you can't make it to Washington DC on those days.

If you haven't yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

Option Backdating (And Much More) at the NASPP Annual Conference

With the option backdating scandal dominating the headlines and creating so much work for outside counsel, the NASPP has just added former SEC General Counsel Ralph Ferrara as the keynote speaker for its 14th Annual Conference in Las Vegas - and Ralph will join Stan Keller and Professor Jesse Fried on a panel to discuss "How to Avoid the Next Scandal (and Protect Yourself)." In addition, Stan Keller and Susan Daley will headline a new panel that will parse the issues implicated by the option backdating scandal.

This is in addition to more than 40 other panels on key compensation topics, many of them key to understand the practices that will now need to be described in next year's proxy statements. And the NASPP's Annual Conference includes the "3rd Annual Executive Compensation Conference" as part of the Conference - it falls on the middle day of the NASPP Conference - at no extra charge. Register today!

July 26, 2006

Using a Form 10-Q as a Free Writing Prospectus

Corel Corporation, a Canadian issuer, filed an IPO on Form F-1 that went effective on April 26. They filed their first Form 10-Q on May 5, and concurrently filed this free writing prospectus that basically just adds an FWP legend to their Form 10-Q.

Linda DeMelis of Heller Ehrman Venture Law Group notes: "I suspect Corel did this because they were in the immediate post-effective period of their IPO. Previously, they might have done a sticker supplement or even a post-effective amendment. The same strategy could probably be used to keep resale S-1's and SB-2s up to date; currently, those forms are a real problem to update because they don't permit forward incorporation by reference."

Issues Raised by Employee-Bloggers

As more companies are becoming aware of the numerous - and complex - issues raised when their employees blog (either anonymously or authorized), policies that address these issues have materialized. For example, Sun Microsystems has many employees that blog - and has made their blogging-related policy publicly available.

In this podcast, Karen Dempsey of Heller Ehrman analyzes the federal securities law issues raised when employees blog, including:

- What are some examples of company's authorizing employee blogs?
- How can a company tell if an employee is blogging anonymously?
- What are the Regulation FD implications of employee blogging?
- What about Rule 10b-5 implications?
- Do you have any thoughts on how companies can minimize the risks of employee blogging?

The Condiment Approach: Solicitation Via Ketchup

In the midst of a vicious proxy fight with activist shareholders, HJ Heinz is distributing ketchup bottles with its familiar label containing a message urging employee-shareholders to vote with management." A picture of this cool bottle is on the DealBooks.com Blog. I'm waiting for the insurgents' inevitable response that they are tired of Heinz "making them wait" for S-L-O-W growth. Remember the TV ads to the tune of "Anticipation?

From Jim McRitchie's CorpGov.net: "H.J. Heinz Company (NYSE:HNZ) said retail shareholders with "street name" holdings (shares held through brokers or intermediaries) of approximately 75 million shares (30% of outstanding shares) have been prevented by a combination of actions by the Trian fund and ADP Proxy Services from casting votes via the Internet or by telephone since July 17.

Street name shareholders trying to use the Internet or phone system receive an "error" message from the ADP system that their control number on their proxy card is wrong, when the real issue is that the Internet and phone system at ADP is not working. Until this problem is remedied, the only way for these shareholders to vote is by mail. (Heinz Retail Shareholders Prevented from Voting via Internet or Telephone, Pittsburgh Daily Business News, 7/24/06)

At an employee meeting this past week, the company distributed bottles of its signature product with labels urging them to re-elect the firm's slate of directors and reject those nominated by Peltz and his partners. Peltz and his New York-based Trian Group, an investment firm that owns 5.5 percent of Heinz's shares, are seeking to add his board nominees to implement an aggressive plan designed to boost shareholder returns. (Heinz Enlists Ketchup Ally, theday.com, 7/23/06) For a discussion of the issues, see Heinz Proxy Fight Heats Up, ISS Corporate Governance Blog, 7/24/06)."

July 25, 2006

The SEC's New Chief Accountant

Yesterday, SEC Chairman Cox appointed Conrad Hewitt as the SEC's new Chief Accountant. Hailing from Cox's home state of California, where he last served as California's Superintendent of Banking - Conrad has been retired for about 8 years, not typical for a Chief Accountant. Conrad currently serves on several boards and was a managing partner for Ernst & Young for 23 years.

California Senate Amends Its Majority Vote Bill

At the end of June, the California majority vote bill wound its way through the Senate - SB 1207 (Alarcon) - and was amended. This bill would facilitate the ability of listed companies incorporated in California to amend their by-laws or articles to provide for the election of directors by a majority vote. Before amendment, the bill had required use of majority - rather than plurality - voting to elect a director of a publicly-traded, listed California corporation in an uncontested election and would have required an incumbent director who failed to receive a majority vote in an uncontested election to resign within 90 days of the election.

The bill supporters include CalPERS, CalSTRS, AFSCME and SEIU. In opposition to the mandatory requirements are American Electronics Association, California Bankers Association, California Business Roundtable, California Chamber of Commerce, California Hospital Association, the State Bar of California Corporations Committee of the Business Law Section and the United Hospital Association.

The "Skinny" on the California Bill Amendments

Our California law expert, Keith Bishop, provides this analysis: "There is a quite a bit of irony attached to this bill. For better or worse, California's General Corporation Law has been highly supportive of cumulative voting. In fact, the opportunity to vote cumulatively is mandated for nearly all California corporations and for those foreign corporations that are subject to California's pseudo-foreign corporation statute (Corporations Code Section 2115). It was many years after the adoption of the CGCL that the legislature finally relented to permit NYSE, AMEX and Nasdaq National Market listed issuers to eliminate cumulative voting.

One consequence of California's strong attachment to cumulative voting is that the CGCL has carefully drafted provisions regarding the removal of directors. Under Corporations Code Section 303(a), any or all of the directors may be removed without cause by the outstanding shares (i.e., the affirmative vote of a majority of the shares entitled to vote). For example, if a corporation has 100 shares outstanding, removal requires at least 51 affirmative votes. Furthermore, no director may be removed (unless the entire board is removed) if the votes cast against removal or not consenting in writing to removal, would be sufficient to elect the director if voted cumulatively at an election at which the same total number of votes were cast (or if the action is taken by written consent, all shares entitled to vote were voted). While this may sound complicated, the idea is not. Without such a requirement, the holders of a majority block could remove a director elected under cumulative voting. This, of course, would make cumulative voting illusory.

SB 1207 in its current form would gut these protections by allowing a corporation to amend its articles or bylaws such that in uncontested elections "approval of the shareholders" would be required to elect a director. Under the CGCL, "approval of the shareholders" means approved by the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present (which shares voting affirmatively also constitute at least a majority of the required quorum). For example, if a corporation has 100 shares outstanding and 51 are present at a meeting, then a director would need to obtain at least 26 votes to be elected. Thus, directors could be in effect removed by as few as 26% of the shareholders. Further, SB 1207 would allow these changes to the articles of bylaws to be effected by approval of the shareholders rather than approval of the outstanding shares.

Cumulative voting and majority voting are fundamentally incompatible. In fact, Hewlett Packard recently cited cumulative voting as a basis for opposing a stockholder majority vote proposal: "The HP policy also gives stockholders a meaningful role in the director election process without interfering with cumulative voting. The ability to cumulate votes in director elections is universally recognized as protecting stockholder rights. A majority voting standard may raise difficult issues in the context of cumulative voting. While the rules governing plurality voting are well understood, majority voting at companies that have cumulative voting presents technical and legal issues for which there is no precedent. These difficulties have led the American Bar Association Committee on Corporate Laws, the Council of Institutional Investors and the Institutional Shareholder Services Institute for Corporate Governance to indicate that majority voting should not apply to companies that allow cumulative voting. HP's voting system must be a reliable process for the election of qualified directors to represent the interests of all of our stockholders. In the absence of uniform, workable standards that can be consistently applied by all companies and that take into account the special circumstances of companies with cumulative voting, HP believes it would be inappropriate to adopt a majority voting standard."

Given the negative impacts of SB 1207 on cumulative voting, I find it ironic that this bill is being sponsored by CalPERS. By statute - Government Code Section 6900 - CalPERS is required to vote its shares to permit or authorize cumulative voting."

July 24, 2006

First Criminal Action Brought on Option Backdating

The media has been eating up Thursday's announcement from the DOJ and the SEC regarding their first criminal action brought against a company for option backdating (here are remarks from SEC Chair Cox). As noted in this press release (and litigation release and complaint), the former CEO and head of Human Resources for Brocade Communications are in the crosshairs. Here are some thoughts in the wake of this action:

- We’re going to see a quick succession of cases, the SEC said it has over 80 in its Enforcement pipeline

- Officers don't necessarily have to financially benefit personally to be a target of the DOJ and SEC

- Doctoring minutes and other corporate documents can lead to regulatory action (and regulators will pursue those doctoring documents, not just the officers who may have directed their subordinates)

See the White Collar Crime Prof Blog and the D&O Diary Blog for some more observations about the Brocade complaint. As the LA Times noted in this article, the US Attorney's office now has a task force to investigate improper option grants - which includes an unspecified number of FBI agents!

Disclosure of Your Option Granting Process

With the SEC's upcoming executive compensation rules likely to require disclosure about how companies make their grants, the first companies are voluntarily describing their granting processes in SEC filings. For example, Broadcom described a few details in this recent Form 8-K. I haven't seen similar disclosures in Form 10-Qs or 10-Ks yet, but most companies haven't been required to file those documents since backdating issues were thrust under the microscope. I would expect to see more of these disclosures when companies begin to file their Form 10-Qs for the quarter ended June 30th in the next week or so. We have about five dozen Form 8-Ks listed in our "Timing of Stock Option Grants" Practice Area on CompensationStandards.com.

By the way, the Council of Institutional Investors just started posting responses to their letter which asked companies if they had backdating issues - and these responses are available to the general public! In the past, they made responses to other letters they had sent to companies only available to CII members...

Creating an Stock Option Grant Policy

After boards review the allegations in the Brocade complaint, one reaction by the corporate community may be the disappearance of the fairly common practice of delegating authority to make option grants. State laws, such as Section 157(c) of the the DGCL, permit the board to delegate the authority to make option grants to one or more officers (who don't have to be directors) - and it hasn't been uncommon for boards to exercise their authority to delegate so that executive officers are the ones that make grants to employees below the executive level.

As I mentioned in our Q&A Forum on Friday, some companies appear to be considering adopting policies that would formalize their option grant processes, including implementing the concept of an open window period (eg. grants can be made only during a specified period of time each year, except for new hires) - similar to the use of such periods in insider trading policies which dictate when directors and officers are allowed to make trades in company stock.

For those companies with broad-based option plans, it probably is unrealistic that a compensation committee would get together to make decisions and sign resolutions for each of the many grants that would be need to be made during course of a year. So either delegation for lower level employee grants will continue to be delegated to executive officers - or perhaps practice will change and instead of new hires getting grants on their hire date, there will be a meeting held each quarter when the compensation committee makes grants to all employees hired during that quarter.

We will be exploring this developing area in the next issue of The Corporate Counsel as well as on this site. In addition, ISS's recommendations on page 7 of this Option Backdating White Paper might serve as a good starting point when looking for ideas when drafting such a policy. Let me know if you have already done so as I am researching what the trends are here...

30% of Companies Have Backdating Issues? The Witch Hunt Continues?

As I have blogged before, it seems like there is a lot of questionable thinking about stock options these days. The latest academic study - from Professors Erik Lie and Randall Heron - assert that over 2,000 companies have engaged in option backdating. My gut tells me there is something fishy about this one.

First, I deal with a lot of people that either administrate these plans - or advise those that do - and I did not become aware of such abuses until last year's Mercury revelation. And my experience jibes with anyone else that I talk to "on the inside." So many good people can't be lying.

And just look at the results from this recent NASPP survey. Among other questions, it was asked "In light of the controversy over grant dates, are you undertaking an internal investigation of your grant dating procedures? There were over 600 respondents who indicated:

- Yes, already completed it - 17.0%
- Yes, in progress now - 18.5%
- Planning to do so but haven't started it yet - 2.7%
- Still deciding whether this is necessary - 7.0%
- No, we already know we're okay - 53.6%
- Not unless we're forced to by investors or regulatory authorities - 1.2%

Just glancing at the articles written about the study, I have some questions for Professors Lie and Heron. For example, can it possibly be correct to assume, as the they do, that the baseline for stock growth or decline following any given option grant is that "half should be positive and half should be negative?" In the context of steadily rising markets, don't stocks go up more often than they go down?

I suppose I should read the study before launching a critique - but based on what I have read so far and from my own experience, I remain skeptical that illegal backdating problems are so universal. Those Section 16 reports can be tricky to interpret and may account for the discrepancy between my gut and the Professor's 30% level. Thanks to Rick Wood of Kirkpatrick Lockhart for his thoughts!

July 21, 2006

Packaging the Corporate Investigation for Prosecution

In this podcast, John Kocoras, Managing Director and Regional Counsel in the Business Intelligence & Investigations division at Kroll, provides some insight into white-collar prosecution developments, including:

- What trends do you see in white-collar prosecutions?
- What effects do you see these trends having on companies?
- What investigative tips can you give in-house counsel when they are advised of potential wrongdoing by high-level employees?

Forward-Looking Information Safe Harbor: Incorporation By Reference Case

From "The 10b-5 Daily Blog":The PSLRA's Safe Harbor for forward-looking statements is designed to encourage companies to provide investors with information about future plans and prospects by limiting their potential liability for these statements. Under the first prong of the Safe Harbor, a defendant is not liable with respect to any forward-looking statement if it is identified as forward-looking and is accompanied by "meaningful cautionary statements" that alert investors to the factors that could cause actual results to differ.

In the case of oral forward-looking statements, the PSLRA specifically provides that the meaningful cautionary statements can be incorporated by reference in a readily available written document. The statute is silent, however, about whether this is also true for written forward-looking statements. A surprisingly small number of courts have addressed this issue, but the trend appears to be in favor of finding that a company's incorporation by reference is sufficient.

In Yellen v. Hake, 2006 WL 1881205 (S.D. Iowa July 7, 2006), the court addressed a securities class action brought against Maytag Corp. The court found that "[w]hile the Safe Harbor provision does not explicitly provide for incorporation by reference for written forward-looking statements" it is implicit in Congress' direction that courts consider "all information and documents relevant to a determination of whether a defendant has given adequate warnings." Accordingly, the court agreed to consider warnings contained in Maytag's 2004 Annual Report that were incorporated by reference in the press release and investor presentations that allegedly contained false or misleading forward-looking statements.

Michael Eisner: He Ain't No Larry King

More summer fun...flipping around a few nights ago and came across former Disney CEO Michael Eisner's new cable talk show: "Conversations With Michael Eisner." From this article, it doesn't seem like the show has "legs."

It was painful to watch. Eisner clearly is not a natural at drawing others out; not surprising for a guy used to having his way for decades. I'm sure I was projecting onto him, but I half-expected him to reach out and grab Goldie Hawn by the throat - even though they seemed to be friends. Here are some pretty funny Eisner anecdotes from DealBreaker.com.

July 20, 2006

SEC to Consider Adopting Executive Compensation Rules

Yesterday, the SEC announced that it will hold an open Commission meeting next Wednesday - July 26th - to consider adopting the executive compensation rules. My guess it will then take the Commission at least a week to issue an adopting release.

Today's WSJ includes an article that provides some predictions of changes to the SEC's proposals - none of them shocking - such as scrapping the "Katie Couric" proposal that would include non-executives in the Summary Compensation Table, keeping the stock performance graph and requiring details of option granting practices. This will be Commissioner Casey's first open Commission meeting fyi...

New Conference Dates - And Now Live in Washington DC!

Now that we know the new executive compensation disclosure rules will be adopted soon, we are meeting the overwhelming number of requests from members - who apparently couldn't bear the thought of watching a two-day conference from their computer - so that our Conference ("Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!") will be held live in Washington DC at the Marriott Wardman Park (please wait a day to call the Marriott to get special room rates - we are still working on those arrangements). The Conference will still be video webcast live as well.

The Conference dates have been pushed up slightly - it will now be held on September 11-12, instead of September 13-14. These new dates were the only ones available at a hotel large enough to accommodate the Conference.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft - and review - disclosures during the proxy season.

An incredible number of members have already registered for the video conference - if you would rather attend live in DC, check out these FAQs to figure out the best way to change the nature of your registration.

If you haven't yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

Audit Committees in Action: The Latest Developments

We have posted a copy of the transcript from the webcast: "Audit Committees in Action: The Latest Developments."

Avoiding a Potential FAS 123(R) Trap: Anti-Dilution Provisions in Equity Plans

The Big 4 apparently are at it again with yet another restrictive interpretation of FAS 123R. This one would require an earnings charge in the event of an equity restructuring (e.g., stock split) or business combination if an equity plan has a permissive rather than mandatory adjustment provision. I have received dozens of e-mails over the past few weeks about this issue and am glad that the first batch of memos on the topic are now out.

Here is a brief snap shot of the issue from Dorsey & Whitney:

"Some major accounting firms are advising clients that the typical anti-dilution provisions of existing equity compensation plans may need to be amended in order to avoid potentially significant increases in compensation expense associated with adjustments to equity awards in connection with stock splits, stock dividends or other changes in the issuer's capitalization.

The issue turns on whether the anti-dilution adjustment applied to awards under equity plans is determined to be mandatory or permissive. If the adjustment is determined to be permissive, then the award is deemed to be modified upon adjustment under FAS 123R, resulting in a re-calculation of the fair value of the award and a possible increase in the compensation expense for the company.

Many plans are written flexibly, allowing compensation committees to determine whether the corporate event is one triggering an appropriate anti-dilution adjustment. Companies should review the terms of their equity compensation plans and arrangements and consult with their external auditors concerning this issue well in advance of any change in capitalization requiring an adjustment of awards under their equity plans."

And here is the take from Cleary Gottlieb: "We understand that the Big Four accounting firms recently reached a consensus concerning the application of FAS 123R in circumstances in which employee stock options and other equity awards are revised to reflect changes in the capitalization of the employer. It appears that the precise wording of a stock plan's "antidilution" provision (or the absence of an antidilution provision) can make a world of difference in the accounting charges that might need to be taken in connection with a stock split, stock dividend, recapitalization, spin-off or other equity restructuring.

In sum, if a plan contains no antidilution provision or the antidilution provision provides for discretion on the part of the employer to adjust equity awards in connection with a change in capitalization (e.g., "the Committee may adjust awards as it deems necessary or appropriate to prevent enlargement or dilution of rights"), then such adjustment will be deemed to be a modification of the award, resulting in an adverse accounting consequence: any incremental fair value of the award after its modification compared to the fair value of the award prior to modification will need to be recognized as compensation expense. If, however, there is an antidilution provision and it does not permit any such discretion, (e.g., "the Committee shall adjust awards as it deems necessary or appropriate to prevent enlargement or dilution of rights"), then such adjustment will not be deemed to be a modification and no compensation expense would need to be recognized.

For purposes of determining any incremental fair value, the award's fair value immediately prior to the modification is determined assuming that the equity restructuring will occur and no antidilution adjustments will be made. The award's fair value immediately after the modification is determined by taking into account the adjustments made. For example, assume that an employer decides to effect a 2-for-1 stock split at a time when its stock is worth $50 per share. The employer determines, pursuant to the exercise of its discretion and not pursuant to a contractual obligation, to adjust outstanding options equitably to reflect the split.

As a result of the adjustment, a stock option for 10 shares with a strike price of $15 becomes a stock option for 20 shares with a strike price of $7.50. Assume that the value of a share of stock immediately after the split is $25. Under FAS 123R, we understand that the option would have to be valued both immediately before and after the split, in each case using the $25 per share value of the stock after the split. Using assumptions for a hypothetical company, based on a black-scholes valuation model, the compensation that would be required to be recognized for such option would be on the order of magnitude of $1,000.

We urge you to review your stock incentive plan antidilution provisions, to consult with your auditors concerning the matters described above and to consider adding or amending plans to provide for automatic and non-discretionary adjustments to be made in connection with certain equity restructurings. However, you need to carefully consider the consequences of making such changes. First, such changes may not avoid an accounting charge if made in anticipation of a capital change or restructuring. Second, any such change would give participants legal rights that they did not previously have. Third, it is not clear what effect a revision of an antidilution provision would have on outstanding stock options or other equity awards for purposes of Section 409A or, for incentive stock options, Section 422 of the Internal Revenue Code."

The NASPP has posted related memos in its "Stock Option Expense" Portal.

July 19, 2006

Expires Tomorrow: Early Bird Discount for Executive Compensation Disclosure Conference

Warning! Tomorrow is the last day for the Early Bird Discount for the important conference: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" Check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

The Early Bird expires tommorrow, July 20th - so take advantage of the huge savings while you can. For example, the Early Bird member rate for a single attendee is only $495, after July 20th - it goes up to $750 (which is still reasonable, but 50% more than the Early Bird rate).

Practical Guide to Tax Accounting Under FAS 123(R)

Tune in tomorrow for the NASPP webcast - "Practical Guide to Tax Accounting Under FAS 123(R)." Among other topics, this program will cover:

- How to account for excess tax deductions and shortfalls under FAS 123(R)
- Special procedures necessary to account for disqualifying dispositions of ISOs and ESPPs
- How to account for tax benefits (or lack thereof) of grants to overseas employees
- Administrative considerations, including practice pointers and internal controls for period-end reporting
- The FASB’s alternative approach for calculating your FAS 123(R) paid-in-capital starting balance

The Trending of Stock Option Grants

The Sunday NY Times included this article that confused me because it described a new academic study that indicates that stock option grants to executives continue to trend up - the study even claims that grants are now at the highest level since the end of the Internet boom in 2000. Since this is contrary to loads of anecdotal commentary I have heard about how option grants are down, I decided to poll some of the compensation consultants on the CompensationStandards.com Task Force. [By the way, the study is unpublished.]

The universal response was that the consultants were also confused by the article, as they noted that the surveys and studies they have seen (as well as their daily experience) show that option grants are down significantly and that restricted stock grants are up by roughly the same amount. They noted that long-term incentive (LTI) values overall have been fairly level - and that there has been a pronounced shift away from time-vested restricted stock to performance-vested restricted stock.

Many of the consultants expressed a view that a major problem with the study is that it focused on the number of shares awarded, not the value - and that it is unclear how anyone could conclude options are expanding if they only looked at the number of shares. For example, if a company splits its stock and grants twice as many shares to provide the same value, the Professor would have concluded the company doubled the amount of an executive's awards.

Here are some more specific thoughts from the Task Force:

Jim Reda of James Reda & Associates says: "This is definitely flawed data. He is using number of shares. Most companies award to value. If stock price goes up, number of shares go down. Moreover, a lot of companies are phasing in LTI strategy. You will not see effect until 2006. The study looked at 2005 data. In fact, most companies' fiscal year did not begin until 1/1/06. The strategy was to award stock options, vest them immediately or front load to avoid future expense.

Our experience shows a dramatic drop in LTI value from 2002 to 2005, depending on the industry. Some industries experinced 50% drop in LTI multiple and others 30% drop. Combined with stock price increases, this can translate into substantial drop in shares of stock options. But, as stated, companies were taking advantage of last days of expense free option awards."

Robbi Fox of Hewitt states: "I obviously would have to look at his study in more depth, but I believe his conclusions are flawed. I don't know how he calculates "value" - that may not be done correctly. One can't really look at the number of options granted to determine change in stock option granting practices because if the stock price is declining you would expect a company to issue more options in order to have the same economic value. We know for a fact there has been a large shift of option value to full value shares as well such as restricted stock and performance shares. Also, just looking at SEC filings is misleading because most of the takeaway has been at the lower levels. Lastly, many companies are moving to a portfolio approach so options still make up some piece of the long-term pie so prevalence of companies granting options should not change much."

And Myrna Hellerman of Sibson Consulting notes: "My clients have been trying to wean themselves from purely stock option grants but have encountered some obstacles including: (a) plan documents that allow for only stock options or they are bumping up against available quota of full-value shares and they don't want to go back for more authorization because they fear they might not meet ISS tests, and/or (b) a culture within the company (especially those in the growth mode) that options are the way to go. Companies seem very cognoscente of the expense associated with option grants and are concerned that they are not getting sufficient "value" for that expense.(especially true in companies whose stock has high volatility thus causing a high Black-Scholes value for FAS 123R purposes).

Another consideration about what's happening with stock option grants is that while the size may be the same (or bigger) we're also seeing more conditions attached to the grant [e.g. premium pricing, more rigorous vesting (performance vesting rather than time, vesting over a longer period of time -for instance 0% first two years 20% next two years, 60% last year), holding requirements, etc.].

Admittedly not all grants are done as thoughtfully as suggested above, but I have found that at least with the Compensation Committees I serve, there has been an increased focused on the 'what, why, how, how much, how often' of equity grants."

July 18, 2006

Survey Results on Free Writing Prospectuses

Below are the results of our Quick Survey on free writing prospectuses:

1. Since ’33 Act reform became effective, the most pieces included in a "disclosure package" in a deal that I have worked on has been:

- 1 piece - 4.6%
- 2 pieces - 22.7%
- 3 pieces - 27.3%
- 4 pieces - 40.9%
- 5-6 pieces - 4.6%
- 7 pieces or more - 0.0%

2. Since ’33 Act reform became effective, the average number of pieces included in the “disclosure packages” in deals that I have worked on has been:

- 1 piece - 13.4%
- 2 pieces - 45.5%
- 3 pieces - 36.6%
- 4 pieces - 4.6%
- 5 pieces or more - 0.0%

On the question of which free writing prospectuses is the most interesting, we had a clear-cut winner with 75% of the vote: Chipotle's IPO road show with all those catchy songs!

New Survey on Executive Sessions

Now it's time to participate in our new Quick Survey, this one is an Executive Session Survey. Please answer four quick questions on the frequency of board's executive sessions; frequency of audit committee executive sessions; who's in the room during an audit committee executive session, and who meets with the audit committee in executive session.

Japan's Proposed Corporate Governance Reform

Recently, Japan's regulator - the Financial Services Agency - has proposed steps that would improve the infrastructure involving their capital markets and likely make them more competitive. This has included steps to strengthen the quality of their audits, as described in this WSJ article and this Financial Times article.

In these significant FSA proposals, Japan proposes to enhance protection for investors through such steps as:

- Broading the definitions of investment schemes including financial instruments

- Enhancing disclosures through quarterly reporting, reporting on internal controls by management and auditors, and reviewing regulations on tender offers

- Increasing penalties against market fraud

- Providing for self regulatory structures

July 17, 2006

Last Call: Early Bird Discount for Executive Compensation Disclosure Conference

Warning! Only three days left until the Early Bird Discount expires for the important conference: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" Check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules (which many expect to be adopted next week by the SEC!).

The Early Bird expires this Thursday, July 20th - so take advantage of the huge savings while you can. For example, the Early Bird member rate for a single attendee is only $495, after July 20th - it goes up to $750 (which is still reasonable but 50% more than the Early Bird rate).

How to Develop a Whistleblower Compliance Program Today

Don't forget tomorrow's webcast - "How to Develop a Whistleblower Compliance Program Today" - featuring Dixie Johnson of Fried Frank; Mark Schreiber of Edwards Angell Palmer & Dodge; Carrie Wofford of WilmerHale; Jim Brashear of Sabre Holdings; and Kathy Combs of Exelon. This is our third webcast in a series dealing with audit committees and their advisors.

Selling the Venture-Backed Company

The fourth installment of DealLawyers.com's M&A Boot Camp is now available: "Selling the Venture-Backed Company." Join Phil Torrence and David Parsigian of Miller Canfield as they teach us about “everything you need to know” to understand the basics of the issues typically present in a sale of a venture backed company with multiple class of stock and varying liquidation preferences.

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!

July 14, 2006

Internal Controls: Key Facts at a Glance

In our "Internal Controls Practice Area, I have posted an interesting Grant Thornton memo that was just released entitled "Section 404: Key Facts at a Glance." Below is the executive summary from that memo:

1. Prior to SOX 404, quality of financial reporting processes in many companies was inadequate. For example, we now know that nearly 1 in 6 large companies had material weaknesses in internal controls over financial reporting.

2. Solid evidence suggests that smaller companies have even weaker financial reporting processes than larger companies. Historically:

- They have twice the risk of restating their financial statements
- They are more likely to have material weaknesses in internal controls
- They are more likely to be the subject of fraud

3. SOX 404, where applied, has helped to significantly improve the quality of financial reporting information

- By Year 2 (through early May 2006), only 1 in 15 large companies had material weaknesses in their internal controls
- Smaller companies will realize similar improvement

4. SOX 404 implementation costs have been high because the requirement was new; the application guidance has been continuously evolving; and because of a generally high level of deferred maintenance on corporate internal controls—but cost is coming down.

5. Exempting certain companies from SOX 404 (or allowing compliance to be voluntary) will result in four negative consequences:

- Non-compliant companies will continue to produce financial reporting information that is increasingly inferior to compliant companies;
- Over time (once investors experience the reality of the above disparity) the market will adjust the cost of capital to reflect this differential;
- In the meantime, investors in smaller companies will lose money, and litigation will increase for non-compliant companies, their management, boards and auditors;
- Insurance costs, litigation costs and audit costs will increase for the non compliant companies to offset the increased level of risk.

6. We can improve the efficiency of implementing SOX 404—and improve the quality of financial reporting—without eliminating the requirement to evaluate and audit internal controls.

A Little Summer Fun

This article wins in the "silly funny" category...

“Selective Waiver” Doctrine Developments

In this podcast, John Williamson of Morris, Manning & Martin analyzes issues raised by a recent 10th Circuit opinion - In re Qwest Communications International Inc. – where the court rejected the so-called "selective waiver" doctrine (i.e., the doctrine that companies may turn over privileged materials, such as interview memoranda and reports to the Board in internal investigations, to the SEC and the DOJ, but still withhold them from private litigants), including:

- What are the facts behind the Qwest Communications opinion?
- What is the significance of the Qwest Communications opinion?
- What do you recommend that in-house counsel do now?

July 13, 2006

Delaware Adopts Majority Voting Amendment

I previously blogged that Delaware was considering an amendment to the Delaware General Corporation Law that would modify director voting rules. This amendment has now been adopted - and will be effective August 1st - and primarily addresses two items with respect to director elections:

- It amends Section 141(b) to provide that a director resignation can be made effective upon the happening of a future event, coupled with the authority to make such a resignation irrevocable if the director fails to achieve a specified vote for re-election. This amendment allows Delaware corporations to voluntarily switch to a voting standard that is different from a plurality one.

- It amends Section 216(b) to provide that a by-law adopted by shareholders that prescribes the vote required for director elections may not be further amended or repealed by a Board of Directors.

We continue to post law firm memos regarding this development in the "Majority Vote Movement" Practice Area.

FASB and IASB Publish First Draft Chapters of Joint Conceptual Framework

Last week, the FASB and IASB published the first installments of their joint conceptual framework - globalization is here! Here is the related press release and the draft chapters.

SEC Issues NYSE's Proposal to Eliminate Annual Report Delivery

A few weeks ago, the SEC issued a NYSE proposal (which had just been amended since it was first submitted to the SEC last September) in an effort to eliminate the current NYSE requirement that a listed company "physically" distribute an annual report to shareholders. Note that this proposal would have the biggest impact on foreign private issuers, who aren't subject to the SEC's proxy rules - US companies would still be required by Rule 14a-3(b) to deliver proxy statements that are accompanied or preceded by annual reports meeting the requirements of Rule 14a-3 (at least until the SEC's e-Proxy proposal is adopted).

The NYSE's proposal would allow a company to satisfy the annual financial statement distribution requirement by making its annual report available on its corporate website, with a prominent undertaking to deliver a paper copy, free of charge, to any shareholder who requests it - listed companies would also be required to issue a press release stating that its annual report has been filed with the SEC and that shareholders have the ability to receive a hard copy of the company's complete audited financial statements free of charge upon request. The NYSE's proposal would also specifically require listed companies to maintain websites.

July 12, 2006

SEC Issues Concept Release on Internal Controls

Yesterday, the SEC issued this concept release, as earlier promised under the SEC's Four-Point Plan. The SEC seeks input on 35 questions related to assessing risks, identifying controls, evaluating effectiveness of internal controls and documenting the basis for the assessment. Comments are due in 60 days - doesn't it feel like folks have commented on internal controls at least a dozen times?

The SEC still intends to announce an additional postponement of the deadline for compliance by non-accelerated filers, including foreign private issuers that are non-accelerated filers. The current deadline for non-accelerated filers is their first fiscal year ending on or after July 15, 2007.

COSO Issues Internal Controls Guidance for Smaller Companies

Yesterday, COSO announced the release of its guidance for small public companies (including an archive of a webcast held yesterday about the guidance). Here is a perfunctory statement from the SEC.

Although the guidance should prove helpful, I wouldn't be surprised to hear complaints from small issuers that it doesn't go far enough to reduce their burdens. For instance, I have heard some small issuers say that some of the controls are undocumented and that it would be expensive if they had to start anew to document those controls. One suggestion was that maybe the auditor could rely on extra levels of management review to compensate for fewer documented controls. On yesterday's COSO webcast, one of the panelists said that - although the documentation could in some instances be less extensive for smaller companies - there still needs to be some level of documentation so that the auditors would be able to review and test the controls. Thanks to Bob Dow of Arnall Golden Gregory for the heads up and his thoughts!

The Evolution of Law Review Articles?

I'm not a big fan of law review articles generally - and not because I was the ultimate slacker on my own law review squad - as I often find they don't provide much in the way of practical guidance. So I was surprised to see this paper (warning: don't click if you are offended by profanity) which I am told will be published soon as a law review article. Ah, the changing nature of scholarship...

July 11, 2006

Dissecting the Options Spring-Loading Controversy

The media - and others - are expending quite a bit of effort commenting on SEC Commissioner Paul Atkins's speech before the International Corporate Governance Network last week (eg. Saturday's WSJ article). This is notable in itself just for the fact that a SEC Commissioner - not the SEC Chairman - has made a speech that has garnered so much attention.

In his speech, Commissioner Atkins states that he believes that the practice of "spring-loading" stock options (ie. setting the grant date and exercise price of an option at a time shortly before the release of positive corporate news) should not be considered insider trading, as he questions whether there was any "legitimate legal rationale" for pursuing any theory of insider trading in connection with option grants.

This is not a new issue. As well covered in past issues of The Corporate Counsel and The Corporate Executive, the underlying “offense” has sparked considerable debate ever since then-SEC Enforcement Director Stephen Cutler first commented on the practice at the 2004 Northwestern Law School Securities Regulation Institute in January 2004. Here is an excerpt from the November/December 2004 issue of The Corporate Counsel:

"Some see it as a legitimate, time-honored way to get the best price for optionees (choosing to ignore that, as with most equity compensation grants, top executives receive most of the benefit). The same skeptics also question whether, or how, Rule 10b-5 would be implicated, since (i) the grantor/issuer (obviously) is aware of the undisclosed information, and (ii) the grantee either knows or the information, being favorable to the grantee, isn’t material to the grantee in this context.

Others (e.g., investors) see evils here, e.g., the dilution/waste caused by committing to sell stock below market value, violation of the option plan requirement to price options at (or above) FMV, non-disclosure of the practice, an accounting problem (a higher fair value charge; even under APB No. 25, there is an earnings charge for discounted stock options), and just plain bad governance. Our purpose here is not to resolve the debate, but to point out that Enforcement does not appear to be stopping to argue."

I don't begrudge - or even disagree with - Commissioner Atkin's opinion on whether spring-loading constitutes insider trading. However, I was miffed that he spoke out on this practice as constituting a "cheap" way to compensate officers. Putting aside the disclosure, accounting, etc. issues that would clearly need to be addressed, I just don't see how springloading fits into a properly designed pay package, where pay is supposed to facilitate better corporate performance - what amounts to discounted options really doesn't seem to do the trick.

At the end of the day, however, the springloading debate just doesn't get me very excited since there aren't many instances of positive news that continue to impact stock prices over the entire length of an option's vesting period. The biggest issue for me is the perception that this practice holds for investors. Given today's media and investor fascination with option granting practices, "perception" is critical and should be sufficient incentive for companies to simply avoid the controversy and use other pay design techniques.

SEC Commissioner Atkins on Option Backdating

On the other hand, I wholeheartedly agree with Commissioner Atkins' thoughts on the witch hunting aspect of the option backdating scandal. He is the voice of reason when he says:

"But it is worth taking a step back before we plunge headlong into wholesale condemnation of all options practices. We need to distinguish scenarios that are black-and-white fraud from legitimate practices that are being attacked with attenuated theories of liability. With respect to the former, there have been many reported stories of clear-cut doctoring of documents done knowingly by executives and/or directors. I will not quibble with the vigorous pursuit of the knowing perpetrators of this kind of activity: a fraud is a fraud. Attempts to evade legal obligations through intentional alteration of documents or deliberate flouting of internal controls cannot be tolerated, because they strike at the core of our system of corporate governance.

Backdating of options sounds bad, but the mere fact that options were backdated does not mean that the securities laws were violated. Purposefully backdated options that are properly accounted for and do not run afoul of the company’s public disclosure are legal. Similarly, there is no securities law issue if backdating results from an administrative, paperwork delay. A board, for example, might approve an options grant over the telephone, but the board members’ signatures may take a few days to trickle in. One could argue that the grant date is the date on which the last director signed, but this argument does not necessarily reflect standard corporate practice or the logistical practicalities of getting many geographically dispersed and busy, part-time people to sign a document. It also ignores that these actions reflect a true meeting of the minds of the directors, memorialized by executing a unanimous written consent."

In some cases, I think companies now caught up in the option backdating scandal were probably just trying to be fair way back when those options were granted in the '90s. Newly public companies really struggle with the idea that option price differs by grant date, so an employee hired this month could end up with a totally different price than an employee hired last month. Particularly if you have a highly volatile stock, the randomness of option prices can seem very unfair.

These companies were used to the way it was when they were private, where everybody hired during the year had the same price. So they came up with some bizarre pricing procedures in an attempt to be fair. Then, unless someone questions them early on, those procedures get formalized - and here we are ten years later with a scandal on our hands...

Director Liability and Responsibilities: After Disney

Don't forget tomorrow's CompensationStandards.com webcast - "Director Liability and Responsibilities: After Disney" – featuring John Olson and Professor Charles Elson.

Warning! Less than 10 days left until the Early Bird Discount expires for the important conference: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" The Early Bird expires on July 20th - so take advantage of the huge savings while you can. For example, the Early Bird member rate for a single attendee is only $495, after July 20th - it goes up to $750 (which is still reasonable but 50% more than the Early Bird rate).

The Role of Investment Bankers

The third installment of DealLawyers.com's M&A Boot Camp is now available: "The Role of Investment Bankers." Join Kevin Miller of Alston & Bird, who is a former in-house lawyer for an i-bank, for an entertaining session that teaches the basics of what you need to know about what investment bankers do - and the top issues that bankers face today.

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!

July 10, 2006

Common Comments on Form 10-Q

Although it appears that the SEC still is considerably behind in the monumental task of uploading comments/responses to its comment letter database, Steve Quinlivan and Jill Radloff have put together this excellent memo that identifies commonly-given comments from the SEC Staff on Form 10-Qs. This memo is posted on our home page in the "Hot Topics Box" as well as in our "Form 10-Q" Practice Area.

State Comparison of Mandatory By-Law Amendments

In light of CA's recent by-law proposal dispute with Professor Bebchuk, it is interesting to compare some of the different state approaches to by-law amendments. Keith Bishop provides us with the following analysis:

- Delaware - Section 109 of the DGCL provides that after a corporation has received any payment for its stock, the power to adopt, amend or repeal bylaws is in the hands of the stockholders. However, Section 109 permits the certificate of incorporation to confer the same power on the directors. The statute makes it clear that conferring such power on the directors does not divest the stockholder of the power. Thus, Delaware has an "opt-in" approach to the power of directors to adopt, amend or repeal bylaws.

- California - California takes a different approach. Section 211 of the California Corporations Code confers the authority to adopt, amend or repeal bylaws on the shareholders and on the board. The required vote of the shareholders is a majority of the shares entitled to vote. In addition, the articles of incorporation or bylaws may restrict or eliminate the power of the board to adopt, amend or repeal bylaws. Finally, only the shareholders can change a bylaw changing the number of directors or the range of directors. Thus, California has essentially an "opt-out" approach with respect to the board's authority to change bylaws.

- Nevada - Nevada has its own approach. Under NRS 78.120(2), directors have the authority to "make" the bylaws. The statute further provides that unless prohibited in a bylaw adopted by the stockholders, the directors may adopt, amend or repeal any bylaw (including any bylaw adopted by the stockholders). Unlike California, however, Nevada does not require approval by a majority of the shares entitled to vote. The default vote required is a majority of the votes cast and this can by changed by the articles or bylaws. Some companies, such as Amerco, have specified higher shareholder vote requirements such as 2/3 of the shares entitled to vote. A big difference is that Nevada (unlike both Delaware and California) permits the articles of incorporation to vest authority to adopt, amend or repeal bylaws exclusively in the directors. Thus, Nevada corporations have the ability to divest shareholders of the right to change bylaws."

Query: Item 5.04 of Form 8-K

As the number of questions in our Q&A Forum rapidly approaching the "Big 2000" mark, I feel bad because someone e-mailed me the query below and I erased it before I could send some thoughts on it (and I can't remember who sent it). So I decided to blog the query - and my thoughts - with the hopes that it will reach the inquisitive mind who sent it:

Question: A public company has a 401(k) profit sharing plan under which the company matches a portion of its employees' contribution in cash. The company's stock is not used to fund the plan, nor is it an investment option for employees under the plan. The company intends to discontinue some of its investment choices under the 401(k) plan and automatically route the discontinued funds to a new fund unless the participant directs the company to do otherwise. Neither the discontinued funds nor the new funds have any company stock. The company will be required to temporarily suspend trading by participants during this process.

Assuming that no notice to the company is required pursuant to Section 101(i)(2)(E) of ERISA, we believe that because the plan does not permit investments in the company's equity securities, the suspension of trading under the plan does not require disclosure pursuant to Item 5.04 of Form 8-K. Do you have a different view?

Answer: I agree. If there's no issuer stock in the plan, I don't think that Item 5.04 is triggered.

July 7, 2006

PCAOB Issues Q&As on Predecessor Auditors

A few weeks back, the PCAOB issued Q&As on adjustments to prior period financials audited by predecessor auditors, including addressing issues when companies change auditors and then have to restate or adjust prior financials.

Nasdaq's New Tier System is Effective

The Nasdaq's new market tiers went into effect this past Monday, July 3rd. Here is a memo explaining how the new tier system will work (including the new abbreviations) - and here is a list of the companies included in the new Nasdaq "Global Select Market" tier. Note that the Nasdaq hasn't yet officially become an "exchange" - that is expected next month...

Future of Hedge Fund Registration

In this podcast, Erik Greupner of Gibson, Dunn & Crutcher analyzes the recent opinion from the US Court of Appeals for the District of Columbia Circuit that vacated the SEC's controversial rule - in Goldstein v. SEC - that had required most hedge fund advisers to register with the SEC, including:

- Why did the D.C. Circuit Court vacate the SEC's rule that required most hedge fund advisers to register with the SEC pursuant to the Adviser's Act?
- Will hedge fund advisers - that recently registered with the SEC under the Advisers Act as a result of the vacated rule – now de-register in droves?
- What do you think the SEC will do next?

July 6, 2006

Viacom Executive Compensation Case Moves Forward

Yet another executive compensation case appears to be heading to the courtroom. On June 23th, New York Supreme Court Justice Charles Ramos denied Viacom's motion to dismiss, finding that there was sufficient evidence supporting the plaintiffs' claims to let the case go forward. The case next moves to the discovery phase and then on to trial.

The case, In re Viacom Inc. Shareholder Litigation, was brought in 2005 by two shareholders alleging that Viacom’s directors breached their fiduciary duty in approving nearly $160 million in compensation to three executives in 2004 (a year when the company reported a $17.5 billion loss and the stock price declined 18%). The case also involves a claim for unjust enrichment against the three executives: Viacom's then-chairman and CEO, Sumner Redstone, and co-president and COOs, Tom Freston and Leslie Moonves. The plaintiffs are demanding that the executives pay back the money and for Viacom to enact stricter corporate-governance rules.

In its motion to dismiss, Viacom claimed that a majority of its board (seven of twelve of its directors) were independent, but Justice Ramos found that there was sufficient evidence to doubt the independence of one of the seven, who was a former chairman of Bear Stearns - and Bear Stearns had advised Viacom on a number of major transactions.

This case is different than Disney because a finding that the board wasn't independent likely would change the standard against which to measure the board’s conduct - from a "business judgment" standard to the more challenging "entire fairness" standard. An entire fairness standard would put the onus on Viacom's directors to prove that they acted fairly in determining the amount of compensation.

Two week warning! Only two weeks left until the Early Bird Discount expires for the important conference: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" The Early Bird expires on July 20th - so take advantage of the huge savings while you can. For example, the Early Bird member rate for a single attendee is only $495, after July 20th - it goes up to $750 (which is still reasonable but 50% more than the Early Bird rate).

Reminder: Accelerated Filer Testing Date

As I have blogged about before, don't forget that last Friday - June 30th - was the testing date for calendar year-end companies as to whether or not they are "accelerated filers"...

DOL's Administrative Review Board Hands Down Important Whistleblower Decision under Section 806

At the end of May, the Administrative Review Board of the US Department of Labor handed down an important decision in a whistleblower case under Section 806 of Sarbanes-Oxley. In Klopfenstein v. PCC Flow Techs. Holding, the Review Board held that a private subsidiary (or its employees) may be covered by Section 806 under an agency theory of liability - and that it did not matter that the employee did not believe that anything fraudulent had occurred so long as the employee reasonably believed a SEC rule, or other subject in "the realm covered by the SOX," had been violated. The Review Board adhered to the letter of the DOL regulations in applying a low standard for causation, concluding that a terminated employee need prove only that retaliation was a "contributing factor" in the discharge decision, and not the only or even the main reason for his termination.

This is the first ruling by the Review Board on the question of whether non-public subsidiaries are covered under the Act. We have posted a copy of the decision and order - as well as related law firm memos - in our "Whistleblowers" Practice Area.

This is a big deal because of who issued the ruling. It is the Administrative Review Board, which is the appellate (ie. higher) authority in the DOL. So what the Review Board says matters a lot, as it will now guide future Adminstrative Law Judge decisions, as ALJs are supposed to follow the Review Board. All the whistleblower decisions under Section 804 of Sarbanes-Oxley have been handed down by ALJs until this one.

July 5, 2006

Last Gasp Amendments to New York's New LLC Law

As I blogged last month, there are significant developments for any LLC that does any business in New York. In her podcast last month, Monica Lord provided some analysis of the coming changes in New York's LLC laws and she had identified some potential problems.

Just one day before the June 1st effective date, New York Governor George Pataki signed an amended bill into law that removed most of these problems. For example, as noted in this Kramer Levin memo, the original bill would have changed New York's procedures to require that published notices disclose the names of the ten persons who hold the most valuable membership interests - but the amended legislation deletes the "ten person" requirement from the published notice - so that the form of the notice now reverts essentially to the form that old law required. Other law firm memos on this topic are posted in our "Limited Liability Companies" Practice Area.

July E-minders is Up!

Our most recent issue of our monthly e-mail newsletter is posted.

Attack on Foreign Private Issuer Exemption Beaten Back

Jay Kesner and Scott Musoff of Skadden Arps give us this news: A recent decision in favor of Tower Semiconductor is significant for foreign companies that access U.S. capital markets. The Second Circuit Court of Appeals affirmed the SEC's authority to exempt foreign private issuers from certain sections of the '34 Act. Had the Court not ruled in our client's favor, the result would have been a chilling effect on foreign issuers accessing US markets.

The Second Circuit's decision resolved the novel issue of the SEC’s authority to exempt foreign private issuers from Section 14(a) and Rule 14a-9. Shareholders alleged that Tower issued a proxy statement that was false and misleading in violation of those federal securities laws. Skadden argued that, as a foreign private issuer, Tower was exempt from the strictures of Section 14(a), including the antifraud provisions of Rule 14a-9, by virtue of Rule 3(a)(12)-3.

Plaintiffs argued that the SEC exceeded its authority in exempting foreign private issuers from Section 14(a) and Rule 14a-9 because it failed to make a formal finding as to the need for a such an exemption - and because the exemption was inconsistent with Congress' mandate that any exemptions adopted by the SEC be consistent with the public interest and the protection of investors.

The Second Circuit agreed with Tower, holding that although “novel,” plaintiffs’ argument was ultimately unpersuasive. “3(a)(12)-3 weathers this storm not because of its impressive longevity. Rather, Rule 3(a)(12)-3 survives [plaintiff’s] challenge because it was promulgated pursuant to the Commission’s statutory mandate.”

The Court explained that although "[t]he rule exempting foreign private issuers from section 14(a) is nearly as old as section 14(a) itself," – and virtually no rationale for it had been expressed at that time – in 1965, the SEC published a notice of proposed rulemaking to amend Rule 3a12-3 that included the Commission's underlying rationale for the amendments. The considerations included "the available protections for investors in foreign securities – the quality of foreign corporate law, the nature of foreign stock exchange rules, and the amount of information voluntarily disclosed . . . . [and] determined that these protections were adequate in light of the important goal of 'maintaining existing markets in foreign securities.'" The Court rejected as illogical and unsupportable plaintiff's contention that "the Commission may not sacrifice any investor protection, regardless of the public interest an exemption might serve."