August 30, 2006

Number of Late Form 10-Qs Sets Record

A number of major newspapers ran similar stories about how the number of late Form 10-Qs set an all-time record this quarter, the kind of thing that I am convinced would not have been deemed newsworthy "but for" the option backdating scandal. Of course, without Glass Lewis providing statistics, I doubt the media would have been able to dig out the story.

One of the interesting items in these stories is that the SEC's Enforcement Division says 80 option backdating investigations are underway, but less than 50 companies have disclosed such investigations according to the Glass Lewis study - which begs the question: is there a duty to disclose the commencement of an SEC investigation? Learn the answer in our FAQs about Disclosure of SEC Investigations in our "SEC Enforcement" Practice Area. And we have posted a copy of the Glass Lewis study in our "Rule 12b-25/Late Filings" Practice Area.

Late Filings Lead to Bond Defaults

Yesterday, the WSJ ran this scary article outlining how some hedge funds are relying on late SEC filings as a way to accelerate repayment of outstanding bonds. Particularly scary is that acceleration of payment in one group of bonds could lead to a cross-default - and the forced acceleration of all the company's bonds. Here is an excerpt from the WSJ article:

"Traditionally, when companies missed a deadline for filing their financial statements, bondholders would look the other way and let the company work out the kinks -- even though, technically, the company was in default and bondholders could demand repayment.

But return-hungry hedge funds and other big investors have found an opportunity to profit, thanks in part to a spreading scandal over the practice at many companies of backdating stock-options that were granted to employees as a form of compensation. That practice has come under scrutiny by regulators, and dozens of companies are having to review whether their earnings statements accurately accounted for such compensation -- which, in some cases, is delaying their filings.

In one of the largest recent examples, a group of UnitedHealth Group Inc. bondholders last week formally warned the Minnetonka, Minn., insurance company in a letter dated Aug. 25 that it is in default for failing to file its second-quarter report with the U.S. Securities and Exchange Commission. If it doesn't file the paperwork within 60 days, the group says it has the right to declare the bonds due and payable immediately.

The amount UnitedHealth would have to pay: $800 million, not otherwise due until 2036. Investors would stand to make a quick profit because UnitedHealth's bonds are trading below face value; if the company is forced to pay full value to redeem them, the bondholders who bought at below par would make a tidy return on their investment."

Here is how UnitedHealth responded to the default letter, as described in a Form 8-K filed Monday: "On August 28, 2006, UnitedHealth Group received a purported notice of default from persons claiming to hold certain of its debt securities alleging a violation of the Company’s indenture governing its debt securities. This follows the Company's not filing its quarterly report on Form 10-Q for the quarter ended June 30, 2006. The Company believes it is not in default and intends to defend itself vigorously. The Company's indenture requires it to provide to the trustee copies of the reports the Company is required to file with the SEC, such as its quarterly reports, within 15 days of filing such reports with the SEC."

Gliffy is Here!

If you find diagrams as useful as I do to explain complicated matters, you need to check out, a new site that allows you to create diagrams easily online - and for free!

August 29, 2006

Some Important Conference Information

Only two weeks left until the blockbuster conference - "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now." Many of you are making the trek to Washington DC – and even more are will be taking in the Conference online (either live on September 11-12th or by archive). Here is check-in information if you will attend in DC - and here is testing information if you plan to watch by video or audio; you definitely should test in advance of the Conference to ensure that you have either Windows Media Player or RealPlayer properly installed.

We also gently remind you that only persons registered to attend are entitled to use an ID and password to access the Conference. In other words, it is illegal to share your ID and password with anyone else inside (or outside) your office - as well as a violation of the terms & conditions of attending the Conference. If you share your ID and password with someone that is not registered - you not only will lose access to the Conference, you also will not be entitled to a refund. If you feel the urge to share, you should upgrade your license now to accommodate more people - our HQ will apply any money you already spent on a license towards a larger one.

Unfortunately, we will be monitoring for this illegal activity. For some reason, people forget that stealing online is still stealing (remember the "Napster days" are long gone). You might recall that a few years back, Legg Mason was hit with a $20 million dollar judgment because its employees were sharing IDs/passwords for an online service.

Impact of ’33 Act Reform on M&A

In this podcast, Jim Showen of Hogan & Hartson analyzes the impact of the SEC’s ’33 Act reform on M&A transactions, including addressing these questions:

- It's my understanding that the SEC's securities offering reform rules that went into effect last December specifically do not apply to M&A transactions. Yet I have heard that there may be a couple of important considerations stemming from those rules that M&A practitioners ought to keep in mind. What are those?

- Since the WKSI test involves primarily size and compliance by the issuer - and acquisitions would presumably always make the company bigger - how could an acquisition cause a company to lose its WKSI status?

- How does the securities offering reform rules work in tandem with Regulation MA during the pendency of a registered merger?

Broadening of the SEC's Direct Registration System

Recently, the SEC adopted rule changes from the NYSE which would mandate that listed companies become eligible to participate in a Direct Registration System. Nasdaq and Amex have filed similar rule changes, which have been adopted by the SEC. The DRS has been in pilot program mode for years.

These three sets of rule changes provide for lengthy transition periods and there are some exceptions. Note there are differences in wording among the SEC orders, such as requiring certain listed securities to become eligible - versus requiring listed companies to become eligible.

August 28, 2006

NYSE Eliminates Annual Report Delivery!

Last week, the SEC approved changes to the NYSE Listed Company Manual so that Section 203.01 was changed to eliminate the NYSE requirement (a requirement which can be traced back to 1895!) for a listed company to physically distribute an annual report to shareholders - and allow a company to satisfy the annual financial statement distribution requirement by making its Form 10-K (or Form 20-F) available by a link to its corporate website, with a prominent undertaking in English to deliver a paper copy, free of charge, to any shareholder who requests it.

Listed companies also are required to issue a press release stating that its annual report has been filed with the SEC. This press release must specify the company's website address - and indicate that shareholders have the ability to receive a hard copy of the company's complete audited financial statements free of charge upon request. In addition, the NYSE added Section 303A.14, which requires listed companies to maintain a corporate website.

As I noted in this earlier blog, US companies are still obligated to distribute annual financial information under Rule 14a-3(b) - so the real benefits of these new NYSE standards won't be realized for them until the SEC adopts some form of its e-Proxy proposal. However, for those foreign private issuers that are exempt from the proxy rules - they should realize cost savings right away. I'm trying to figure out when these changes take effect, as that is not mentioned in the SEC's guess is that the NYSE rule change is immediately effective, which is the normal result under Section 19(b). The NYSE already has incorporated the change into the Manual.

Congress Takes On Options Backdating

When Congress gets back to work next week, the US Senate already plans to hold two separate hearings on stock option timing. On September 6th, the Senate Finance Committee will hold a hearing - and this Committee's Chair, Senator Grassley (R-Iowa), is making noise about the possible need for Congress to change the tax laws to tackle backdating. The Senate Banking Committee also plans to hold a hearing on option timing issues in the near future. Egads...

By the way, you might want to check out this San Jose Mercury News interview if you want another Silicon Valleyite's perspective of the backdating scandal.

SEC Issues Nasdaq's Proposal to Change "Independent Director" Definition

As I blogged about earlier this month, the Nasdaq has proposed to amend the definition of "independent director" - which has now been formally proposed by the SEC with a 21-day comment period. These changes make the Nasdaq rules more consistent with those of those of the NYSE. The proposed amendments would:

- modify the definition of "independent director" in Rule 4200(a)(15)(B) to provide that a finding of independence is precluded if a director accepts any "compensation" from the company or its affiliates in excess of $60,000 during any consecutive twelve month period within the three years prior to the independence determination (replacing the term "payments")

- amend IM-4200 to clarify that after the effective date of the rule change, a company's board may determine that a director who served as an officer of the company on an interim basis for up to a year is not precluded from being considered independent solely as a result of that service (including service that occurs before the approval of this proposed change)

- clarify that an exception to the audit committee requirements contained in Rule 10A-3(c)(2) for certain companies that have a listed parent also is applicable to Nasdaq’s audit committee requirements

- provide that a transition period for an independent director who becomes disqualified due to the amendments, which would allow the disqualified director to remain on the company's board for 90 days

August 24, 2006

Practical Guidance on Option Grant Practices

I continue to be astounded by the number of firm memos we are posting in our "Timing of Stock Option Grants" Practice Area on - and many of the more recent ones aim to provide practical guidance rather than rehash what is in the mainstream press.

My good friend Kris Veaco, who recently left McKesson Corporation (where she was Assistant General Counsel and ran the Corporate Secretary’s office) to start her own governance consulting firm, provides her own practical guidance for those grappling with how to establish sound option grant processes:

"Given all of the issues surrounding stop options these days, I was wondering what kinds of governance practices companies have in place with respect to their stock grants. I have heard from seasoned stock administrators that companies with few resources and/or a lack of appreciation for the complexities of stock administration would assign that function to the CEO's assistant or someone else with little or no qualifications in the area.

Alternatively, those preparing the materials for the Compensation Committee (or other Board Committee with the authority to award stock grants) may not appreciate the corporate governance requirements necessary to have effective grants. The SEC's new requirements for disclosure in the proxy may address some of these concerns, but there may still be room for practical information on how the process should work.

Well in advance of the Committee meeting the process for determining who will receive grants, what kind and how many should occur so that by the date of the meeting the list of recipients is known and fixed. The materials presented to the Committee, including the draft resolutions for the Committee's approval, should provide the Committee with who is getting the grants, how many shares or options or units per recipient and in total, the vesting schedules, and the grant date (based on plan language) and how the price will be determined.

The plans I have seen establish that the grant price will be the closing price on the date of grant, which is very clear and easy to determine. The date of grant is usually the date of the meeting unless it is close to an earnings release or some other significant event, and then the regular practice might be that the grant date will be some period of time following the release of the earnings - 3 business days, 5 business days, 48 hours - something to allow the market to absorb the information and be reflected in the stock price.

If the grants are made via unanimous written consent, then the effective date of grant will be the date the last signature is received unless some other future date is noted in the resolutions. Of course, the minutes should reflect the Committee’s actions and include the list of recipients, and original signatures are required for the minute books for if the consent process is used.

Of course, if there are grants to any Section 16 insiders, then the process has to include advance notice to whoever files the Forms 4 as well as a follow up on the date of the meeting to ensure the numbers or terms did not change."

I'm hoping Kris will become a regular contributor to this blog as she clearly has a lot to offer! She is currently setting up her new business, but for the time being can be reached at

Latest Challenges for Compliance Programs

In this podcast, Jeff Kaplan, Founder and Partner of Kaplan & Walker, explains how to deal with the latest challenges on compliance programs, including:

- How are "best practice" companies dealing with compliance program challenges?
- What do you mean by third-party compliance? And how are companies responding?
- What are the challenges in dealing with the "tone at the middle"?
- Given how busy boards and senior executives are, what are effective strategies for meeting the new standards for compliance program oversight and management?

August 23, 2006

New York Courts Take Another Stab at Underwriter-Issuer Relationships

In late June, the New York State Supreme Court, Appellate Division decided in HF Management Services LLC v Pistone (with three judges concurring and two dissenting) that, despite last year's New York State Court of Appeals decision in EBC I v Goldman, Sachs & Co. (aka the "eToys" case), "New York courts and jurisdictions applying New York law have long recognized the non-fiduciary nature of the underwriter-issuer relationship" and "not only is a fiduciary aspect absent from the majority of underwriting relationships, such relationships are better characterized as adversarial since the statutorily imposed duty of underwriters is to investors." We have copies of both opinions posted in our "Underwriting Arrangements" Practice Area.

Though technically the decision relates to whether plaintiff's litigation counsel in an employment-related dispute should be disqualified, the case hinged on whether a fiduciary relationship exists between an underwriter and an issuer and such fiduciary relationship should be imputed to underwriter's counsel. In this case, HF Management had sued two former employees and WellCare for breach of a non-solicitation agreement. HF Management's counsel had previously acted as due diligence counsel to the underwriter of WellCare's IPO. The lower court had granted defendants' request to disqualify HF Management's counsel on the grounds that the underwriter owed a fiduciary duty to WellCare and plaintiff's counsel, as the underwriter's agent, shared the underwriter's fiduciary duty to WellCare.

This is a heartening decision for underwriters concerned that, in light of eToys, courts might too readily conclude that a fiduciary relationship was created by ordinary course communications and activities in connection with an underwriting. Nevertheless, there remains cause for concern, particularly in light of statements by the court that "[c]ertainly, there is no indication or suggestion that [underwriter] and WellCare enjoyed any type of pre-existing relationship, or that [underwriter] acted as an "expert advisor on market conditions" to WellCare in the same way that Goldman Sachs apparently advised eToys." The obvious concern is that ordinary course discussions regarding market conditions and timing could be deemed "expert advise" giving rise to a fiduciary obligation rather than, as arising from a commonality of interest in achieving a successful offering.

In light of eToys, most underwriters revised their forms of underwriting agreements to, among other things, require issuers to disclaim any fiduciary relationship, but (out of an abundance of caution) such provisions should be reviewed in light of the HF Management decision to ensure that they also disclaim any advisory responsibilities relating to the offering, regardless of whether the underwriter has previously or currently providing advisory services with respect to other matters. Thanks to Kevin Miller of Alston & Bird for these thoughts.

An Interview with Alan Beller

I am a big fan of former Corp Fin Director Alan Beller, who is back to work at Cleary Gottlieb and recently gave this interview to Catch Alan talking about the new CD&A and disclosure controls & procedures for executive compensation at our upcoming Conference in two weeks!

Zions Bancorp Auctions Market-Valued Employee Stock Options

A few months ago, I blogged about Zions Bancorp planning to register securities that would mimic employee stock options for public auction. Well, not only were those securities finally registered, but the complicated instrument was auctioned off at the end of June. Here is a copy of Zion Bancorp's final prospectus filed July 3rd - and a free writing prospectus with FAQs about ESOARs (employee stock option appreciation rights). And here is the ESOAR auction website, which includes more information about these novel securities.

Here is a Dow Jones article about the offering:

"An innovative Internet securities auction by Zions Bancorporation (ZION), set for Wednesday and Thursday, may provide an attractive opportunity to investors, but if it does, that could undermine the entire purpose of the auction. Bidding opens at 9:30 a.m. EDT for an offering of “Esoars,” a derivative security designed to mimic the value of employee stock options. Zions isn’t making the offering in order to profit directly, but instead hopes to create an accounting tool that will allow companies to reduce their reported expense for granting stock options. Zions intends to profit by selling that tool.

The Zions plan was spurred by a recent change in accounting rules that requires companies to record the expense of granting employee stock options. Opponents of the change had argued that there is no good way to assign a value to those options, but now that companies must do so, they say traditional valuation models exaggerate the expense.

Zions, of Salt Lake City, proposes to let the market decide, and to that end it is offering the derivative, which is formally named “Employee Stock Option Appreciation Rights Securities.” Cindy Ma, who was a member of the Financial Accounting Standards Board group set up to create option valuation guidelines, questions Zions’ strategy, saying that the intimidating complexity of the Zions derivative will deter investors from offering full value.

Joel D. Hornstein, chief executive of Structural Wealth Management LLC, agrees with Ma about the complexity of Esoars — and perceives an opportunity for a savvy investor. “Auctions create significant inefficiency if you don’t have smart, sophisticated bidders,” Hornstein said. “We hope to benefit from the fact that we may be the only sophisticated (investors), or one of the very few, in this auction process, and that should be good for us.” Hornstein won’t say how much he is willing to bid, but he does have a specific number in mind.

He said he came up with a valuation by estimating how long Zions employees are likely to hold their options, and applying those estimates to the Black-Scholes model, a common tool for valuing stock options that takes into account such factors as the options’ expiration date and the underlying stock’s volatility. He said he then discounted that result to ensure “a healthy margin relative to fair value.” He said he won’t bid if he doesn’t get that margin. “Our intention is to bid only if the price is a significant discount to the value we estimated using Black-Scholes,” Hornstein said.

Hornstein argues that the normal incentives in a stock offering are turned upside-down in the Zions case, making his bidding scenario more likely. Companies, after all, have reason to seek a higher price for their securities, while Zions’ purpose is to establish a value for stock options that is below the value produced by current accounting methods.

Ma, however, said if bidders do shy away from the auction and the Esoars price is therefore too low, Zions will have a tougher time convincing regulators that the auction provided a true value for accounting purposes. “The instrument may have appeal to really sophisticated institutional investors. I am very skeptical for individual investors,” said Ma, a vice president at NERA Economic Consulting. “They don’t have that sophistication to try to analyze the data.”

Each Esoars will allow holders the right to receive payments pegged to the exercise of stock options by employees, with Esoars holders receiving the same value that employees get when they exercise their options. Returns will be affected by the amount and timing of option exercises by employees, the vesting schedule of options and the trading price of Zions common stock. Henry Wurts, a vice president at Zions subsidiary Zions Bank, acknowledged that investing in Esoars is riskier than buying the company’s stock or regular options on that stock.

Wurts said that investors will — and should — take that risk into account when they bid. Because Zions has designed a fair auction, the auction’s result — whatever it is — will be the fair value of the options, he said. “To clarify, the price will depend on the bidders,” he said. “So the bidders themselves will determine what value they give to these.”

The Securities and Exchange Commission, which will ultimately decide the validity of Zions’ proposed accounting technique, has said that a market-based method may be preferable to traditional options accounting models. “The SEC suggested they wanted a market price, and we are giving them the opportunity to see a market price,” Wurts said. “That is our goal. We are not trying to tell people how to price options. We are trying to help the SEC see a market price for these options.”

Wurts declined to estimate the value of Esoars. Evan Hill, a colleague of Wurts who helped to develop the derivative security, has said he expects the price to fall somewhere in a range of about $5 to the low teens. Using Zions’ current method for calculating option expense and taking into consideration assumptions used to value employee stock options last year, each Esoars would be worth about $16, Hill said.

The auction for 93,603 Esoars is to be hosted on the Internet Web site The auction is scheduled to open at 9:30 a.m. EDT Wednesday and close at 4:15 p.m. EDT Thursday. Zions’ Hill said that as of late Tuesday, there were 70 approved bidders for the auction. Hill said that regardless of how the auction turns out, Zions could seek SEC approval to use the result as part of an accounting method for valuing stock options. Wurts said that no matter the result, it will be a valid result for that purpose.

“We can explain any price that comes in,” he said. “If it comes in at $2, we can explain why that happened: There was a deep discount for risk. If it comes in at $15 we can explain how that happened: They didn’t take a deep discount for risk.”

August 22, 2006

The Latest ISS Proxy Season Update

ISS has released an updated version of its Proxy Season Scorecard, whose highlights include:

- Majority vote to elect director proposals received an average level of support of 47.8 percent, up from 43.7 percent in 2005

- Use performance-based vesting proposals received an average level of support of 41.5 percent, jumping more than nine percentage points from 2005

- Disclose political contribution proposals received an average level of support of 20.7 percent, which is more than double last year's average

Majority Vote Standards: The New Proxy Card

Several companies that have adopted pure majority vote standards have tweaked their proxy cards (and voting instruction forms) to allow for shareholders to vote "against" director nominees - we have posted several of these samples in our "Majority Vote Movement" Practice Area. It is important to note that ADP has the systems in place for those companies who need to make similar changes.

Incorporation by Reference and Written Statements: The PSLRA’s Safe Harbor

We seem to get a fair number of queries about incorporation by reference in our Q&A Forum, so I thought it would be informative to repeat this development (and analysis) from a recent Wachtell Lipton memo: "The Private Securities Litigation Reform Act of 1995 (the "PSLRA") creates a "safe harbor" from liability under the federal securities laws for earnings projections and other forward-looking statements, both written and oral, that are "accompanied by meaningful cautionary statements identifying important factors that could cause actual results to differ materially from those in the forward-looking statement."15 U.S.C. § 78u-5(c)(1). In the case of oral forward-looking statements made by or on behalf of an issuer subject to Exchange Act reporting requirements, the statute provides that "meaningful cautionary statements" contained in an identified written statement may be incorporated by reference. Id. § 78u-5(c)(2).

Because the PSLRA's "safe harbor" expressly permits incorporation by reference with respect to oral statements, shareholder plaintiffs have argued that a corporate defendant's written statement (e.g., a press release) that incorporates by reference the "meaningful cautionary statements" contained in another written document (e.g., the corporation's annual report) is not entitled to "safe harbor" protection.

This argument was recently rejected in Yellen v. Hake, 2006 U.S. Dist. LEXIS 47012 (S.D. Iowa July 7, 2006). The court reasoned that "[w]hile the Safe Harbor provision does not explicitly provide for incorporation by reference for written forward-looking statements," a defendant's ability to avail itself of the "safe harbor" in this manner was implicit in the statute. The court also noted that numerous federal courts have concluded that cautionary language is not required to be in the same document as the allegedly false statement for a defendant to get the benefit of the "safe harbor."

Although the decision in Yellen offers some comfort that a press release containing forward-looking statements can come within the PSLRA's "safe harbor" by incorporating by reference cautionary statements contained in prior SEC filings, the safer course remains for companies to avoid the issue altogether by simply repeating verbatim in their forward-looking press releases the same cautionary statements contained in their prior SEC filings." We have posted a copy of this memo in our "Forward-Looking Information" Practice Area.

August 21, 2006

Updating Policies: Prohibition on Tax Services

In the wake of the recent PCAOB rules on auditor independence, many companies have been updating their pre-approval policies regarding non-audit services. Some companies have even been cobbling new policies together that prohibit personal tax services from being performed by the independent auditor for persons in a financial reporting oversight role. In our "Pre-Approval of Non-Audit Services Policies" Practice Area, we have posted a sample of one of these new policies in a Word file.

The Big 2000

A few weeks ago, our "Q&A Forum" passed the 2000th question mark, which is really higher since a fair number of those include follow-ups. Quite a body of achievement if I must pat ourselves on the back as there is quite a bit of practical content buried in the Forum. I'm not sure if we can keep up with the growing pace of questions - and I remind you that we welcome your own input into any query that you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply...

Inspector General Recommendation: Continuous SEC Surveillance of Larger Companies

Last month, the SEC's Office of Inspector General issued this report which recommends that the Division of Corporation Finance engage in continuous surveillance of larger companies. According to the report, this recommended program would be operated in a manner similar to that used by the SEC's Office of Compliance Inspection and Examination for investment advisors. The report also recommends that Corp Fin better manage its workload and use risk factors more frequently during its preliminary screening of filings.

I beg to differ. I understand that a large portion of the overall US market cap consists of the huge capitializations of a relatively small group of companies - but these companies typically also have the most resources to devote to compliance matters. And as a general matter, it is my understanding that more frauds are perpetuated at smaller companies compared to larger ones. So using scant SEC Staff resources to continuously oversee the General Electrics of the world doesn't seem like the best way to protect investors...

August 17, 2006

Just Added! Corp Fin Director John White

We are excited to announce that the Director of the SEC’s Division of Corporation Finance - John White - will open our two-day Conference on September 11-12: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now," as noted in this detailed conference agenda. Learn what to expect from the SEC Staff from the Staffer who presided over the new rules!

And we just added a senior actuary from Towers Perrin - Tim Marnell - to the "The New Retirement Pay Tables" panel. When you hear what Tim has to say, you will realize how challenging those tables (and the related SCT column) will be!

A few Conference items to note:

1. Ensure you are registered, particularly if you delegated getting registered to someone else in your office. I have interacted with several members who thought they had registered - but it hadn't happened yet. We are dreading the inevitable last-minute rush during the week of Labor Day. Please don't procrastinate!

2. Ensure your registration is in the form you want it to be. Our experience with our popular annual Executive Compensation Conferences is that a lot of people show up in-person for the Conference - but they had only registered for webcast attendance (which is a little cheaper). We won't turn away those people at the door, but the processing takes some time. Save yourself the hassle!

Available in Word! The New Compensation Tables!

Thanks to Faegre & Benson, we have just posted a copy of the SEC's new compensation tables in Word on in our "The SEC's New Rules" Practice Area.

Proxy Statements: Disclosure of Rule 10b5-1 Plans

In reviewing this proxy statement, I saw something I haven't run into for a while: disclosure about the Rule 10b5-1 sales plans that have been implemented by various officers and directors - in a separate section following the discussion of employment contracts and certain transactions, the company identifies which officers and directors have entered into such plans on page 17.

While I've seen plenty of Rule 10b5-1 plans disclosed in press releases and Form 8-Ks, this is only the second time I've seen the topic covered in a proxy statement (Plantronics has had similar disclosure in its proxy statements for each of the past two years). Note that I am not advocating that companies make such disclosure nor do I claim that's it's required - I'm just pointing out some novel disclosure...

The Law Firm That We Know All Too Well

Some wise guy has written a fictitious book - "Anonymous Lawyer: The Novel" - about a crude law firm. I figure I don't need to read the book since I've already lived it (and re-lived it in my nightmares).

Much more interesting is the author's hilarious web site for the fake firm. My favorite lawyer is Patrick Weinberg - reminds me of my own associate skills back in the day!

August 16, 2006

Another Options Backdating Criminal Action

Last Thursday, the US Attorney General and the SEC brought criminal and civil charges against three former senior Comverse Technology executives for alleged option backdating manipulation. Here is the SEC's press release - and here is the SEC's complaint. Courtesy of the "WSJ Law Blog," here is the Criminal Complaint, which includes quite a bit of detail about the alleged fraud.

My favorite part of the complaints are when they reveal that the former Comverse executives secretly inserted fictitious names amid the names of actual employees on proposed option grantee lists, which then were submitted to Comverse's compensation committee for approval. This is what Jimmy Rockford would have done in the corporate world (if Jimmy ever went to the "dark side")! And it gets better - the former Comverse CEO is AWOL and on the lam! Some pretty crazy stuff - movie material perhaps? Read more about the Comverse allegations on Bruce Carton's "Securities Litigation Blog."

Unanimous Written Consents: Analysis of Proper Effective Dates

Alan Dye points out that the Attorney General's and SEC's case against the former Comverse executives confirms what we wrote in the March-April 2006 issue of The Corporate Counsel - about it being improper to treat a unanimous written consent as being effective "as of" an earlier date than the date the last signature was obtained. In e-mails to us, we had a few members question our view, but we stood our ground - and now it's apparent that the government is taking the position that the grant date is the date on which the directors sign the consent and can't be some earlier date specified in an "as of" sentence in the consent.

The government also appears to be questioning the practice of not including a date line next to each signature line - it's perceived as a practice that is intended to facilitate backdating. So here's today's practice tip: start using datelines!

FCPA, Options Backdating, and D&O Exposure

Kevin LaCroix's "D&O Diary Blog" contains some excellent analysis of how the Foreign Corrupt Practices Act figures into the option backdating scandal, including this prior post about how one of the dangers from an FCPA enforcement proceeding is the possibility of follow-on litigation. Kevin also explains how the recent securities fraud lawsuit settlement below provides a glimpse into the way FCPA violations can spawn follow-on litigation:

"On August 9, 2006, Willbros Group announced that it had settled the 2005 class action lawsuit that had been filed against the Company and several of its directors and officers. The Complaint alleged that the company had been the subject of numerous of numerous investigations “because the Company engaged in a campaign of illegal and illicit bribery of foreign government officials in Bolivia, Nigeria and Ecuador to successfully obtain construction projects.” The Complaint alleged that the company was forced to restate several years of financial statements and to establish a reserve to accrue for possible fines and penalties for FCPA violations. The Complaint alleged that as a result of these violations, the Company had misrepresented its true financial condition. The Complaint alleged that the company’s share price declined 31% when these matters were disclosed.

In its August 9 press release, the Company did not disclose the amount of the securities class action settlement, but the press release did state that the amount of the settlement would be funded by the company’s insurance carrier.

The Willbros settlement illustrates the growing D & O risk that increased FCPA enforcement activity could represent. The threat is not so much from the underlying FCPA enforcement action itself; any FCPA fines and penalties likely would not be covered under most D & O policies. Rather, the threat is from the potential liability that could arise in any follow-on civil action, including any follow-on securities fraud lawsuit like the one filed against Willbros Group. Any settlement or judgments incurred in a follow-on action, as well as defense expenses, would usually be covered under the typical D & O policy.

As FCPA enforcement actions grow in number and magnitude, this exposure could pose an increasingly greater D & O risk."

August 15, 2006

New Market Reg Director: Erik Sirri

Yesterday, SEC Chairman Cox appointed Erik Sirri as the new Director of the Division of Market Regulation, the last remaining senior SEC post that was vacant. It has been open since Annette Nazareth moved up to Commissioner last year.

Eric currently is a Finance Professor at Babson College and served as the SEC's Chief Economist back in the late '90s, back when I was worked for Commissioner Unger - so I have seen Erik in action. It is not unheard of for an economist to be head of Market Reg - Rich Lindsey moved up from Chief Economist to Market Reg Director in the mid '90s.

SEC's IM Staff Provides No-Action Relief After Goldstein

Last Thursday, the Division of Investment Management Staff gave this no-action response to the American Bar Association's Subcommittee on Private Investment Entities to provide guidance to the hedge fund industry following June's decision from the US Court of Appeals for District of Columbia Circuit, Goldstein v. SEC.

The Goldstein decision vacated Rule 203(b)(3)-2, the intent and effect of which had been to require the registration of a substantial number of investment advisers to hedge funds. As Chairman Cox noted in this recent testimony on the Hill, the SEC has decided not appeal the Goldstein ruling - instead, the SEC will go back to the drawing board and propose new hedge fund rules in the near future.

Alleged Section 409 Violation: The Quoza Story

A new monitoring service from Quoza claims to track whether companies are posting their press releases on their websites before - or exactly - at the same time that information is otherwise disseminated. The origins of this service appears to be based by the requirement in Section 409 of Sarbanes-Oxley for companies to disseminate information on a "rapid and current basis."

Apparently, Quoza's software repeatedly checks the IR and PR web pages of companies - and Thomson began to block this monitoring/tracking software because it causes "performance degradation and impairs its ability to accurately understand website traffic, usage trends and analytics." Thomson operates the IR and/or PR web pages for a number of public companies. From what I gather, Thomson has requested a Cease & Desist order - and Quoza has made a number of complaints against Thomson, some of which are detailed on this page. Quoza also has sent this e-mail to a number of companies:

"You are in violation of section 409 of the Sarbanes- Oxley Act. Please stop blocking access to your website. This email is to inform you that is launched and available to the public. We invite you to visit and read the 'Why Us' section on the site. This section is self-explanatory and highlights the need and the mission to bring timely reporting, transparency and equal access to all material and mosaic news of your company to the masses and the small investor. Our objective is to bring all investors a fair system in real time that monitors information that leads to investment decisions. One way we do this now is bringing clear illustration thru compliance reports that show some locations where and possibly when information was distributed.

You may or may not be aware that we have had serious problems with one of the operating units of your subcontractor, The Thomson Corporation, stock symbol [TOC] which handles your website press release pages. They have been blocking and disrupting our attempts to bring timely reporting, transparency and equal access of your news to the masses.

The Thomson Corporation [TOC] is a company that has many services to add value to and integrate information. The Thomson Corporation [TOC] sells their services to many large financial institutions and the elite and helps distribute these services fast. Most of corporate America has been working to comply with section 404 of Sarbanes-Oxley. We note on our site that section 409 of Sarbanes-Oxley requires public corporations to distribute material information on a "Rapid and Current Basis". We would like to caution you that the blocks placed by The Thomson Corporation on access to all your news that is material and non-material (mosaic) disrupts our ability to bring your news to the masses on a rapid and current basis. This increases the liability for your company and places your company in violation of section 409 of Sarbanes-Oxley. It is clearly a conflict of interest for The Thomson Corporation to handle and control access to your press releases on your website, while using this information to sell value added services to large financial institutions and the elite.

Your company can increase fairness and distribution by releasing all material and non-material (mosaic) information on your website, at the very same time such information is released, distributed or sold to large financial institutions and the elite anywhere else. By releasing all material and non-material information on your website, even if any non-material information is later determined to be material, you can demonstrate that the information has been made widely available thru your website. This also reduces your company's liability and exposure.

Quoza gives the public the ability to extract your news from your company website, rather than the masses reading your edited company news on a third party websites. You are in total control of how you want your news story to be presented on your website along with other marketing material. Quoza's method of giving the public the ability to extract news from your company website carries with it marketing advantages for your company at no additional costs. Quoza's compliance reports on your news stories can also serve as a tool to decrease your company's exposure and liability by bringing transparency and equal access to all your material and non-material (mosaic) information.

Quoza is offering a 24-hour free trial period to all general subscribers and corporate sponsors. We believe once you view our product by visiting and read 'Why Us?' you will cooperate with us by asking The Thomson Corporation to stop blocks on our attempts to bring timely reporting and transparency of your company news on your web pages to the masses.

You can demonstrate your support for Quoza by becoming a corporate sponsor for an annual sponsorship USD 5000 per year. This fixed annual sponsorship fee is open to first 100 corporate sponsors at this time. The regular site sponsorship fee is USD 10,000 per year. You can also register as a general subscriber, which costs only USD 15.95 per month, but paid on an annual basis for a total cost of USD 191.40..

As a Corporate sponsor, Quoza will provide the service of giving the public the ability to extract news for your company directly from your website, along with the news time compliance reports. This service provided for news of corporate sponsors will be free to everyone and not just reserved for Quoza's paid subscribers.

We look forward to your support in our mission to bring timely reporting, transparency and equal access to all your material and non-material information. If you need to contact us you can do so through the contact us section on the registration page. If you want one of our representatives to call you, please include your contact information and the best time to reach you in your email."

My ten cents: This may very well be a novel case for a court to determine whether automated processes, such as crawlers, spiders, and other applications that scrape data or perform automated retrieval of content, are considered to be to legitimate users of web sites. In addition, I believe most of us presumed that the SEC's adoption of new Form 8-K rules in 2004 (ie. "real-time" disclosure) took care of what Congress envisioned in Section 409 of Sarbanes-Oxley. It will be interesting to see how this plays out...

August 14, 2006

Posted! The SEC's Executive Compensation Disclosure Adopting Release

On Friday, the SEC posted the 436-page adopting release for its executive compensation disclosure rules. The compliance dates appear on page 2 - but you should also read pages 195-197 for more information about those important dates, including transition details. And thanks to Faegre & Benson for this useful Table of Contents to slap on your copy of the adopting release. Hours after its issuance, Mark Borges already had made his first stab at analyzing the adopting release in his "Proxy Disclosure Blog."

With just a few weeks left, folks are registering in droves for our two-day 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 (and the Conference will be archived if those dates are conflicted for you).

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.

Sample Executive Compensation Disclosures

Even in advance of our comprehensive Conference coming up in a few weeks, many of you are - wisely - drafting mock disclosures to figure out how the SEC's new rules impact your unique circumstances. To assist you, we have organized a horde of Mark Borge's blogs from the past year - each of which provides analysis about how a particular company attempted to meet a component of the SEC's then proposed rules - in these sample disclosures. These sample disclosures are posted in's "The SEC's New Rules" Practice Area.

As new proxy statements are filed, you can be sure that Mark will be analyzing how they stack up against the new SEC requirements in his "Proxy Disclosure Blog."

Insider Trading Law Quirk?

A few bloggers are eating up the story about Dallas Mav's owner Mark Cuban's new site (which I blogged about pre-launch) and the revelation that Mark is selling short in some of the companies for which the site does investigative reporting to find a company's warts. Gary Weiss does a juicy job - and has been battling Cuban - in his blog: see Round I, Round II and Round III. And Bruce Carton gives us the full-on legal analysis in his "Securities Litigation Watch" Blog.

August 11, 2006

Huey Lewis & The News to Play NASPP Annual Conference

Like last year's blowout with Hootie & the Blowfish, this year's NASPP Annual Conference - in Las Vegas - will include a special entertainment event. The NASPP, along with Fidelity Investments, is excited to announce that immediately after the Gala Opening Reception on October 10th, all Conference attendees are invited to join the NASPP and Fidelity on the beach at Mandalay Bay for an exclusive private concert featuring Huey Lewis & The News!

The concert is offered to NASPP Conference attendees only. There is no additional charge to attend - but space is limited and you must register with Fidelity in advance. Alas, major conferences will never be the same for me...

The Pension Protection Act of 2006

Last Thursday, the US Senate passed the Pension Protection Act of 2006, a pension reform bill approved by the House of Representatives on July 28th. The Act addresses a wide range of employee benefit-related issues, including the first change to the definition of "plan assets" under ERISA since 1986. Among many other changes, this Act will now permit managers of hedge funds, funds of funds and other investment vehicles that accept investments from public and private, non-US and US ERISA plans - that do not otherwise qualify for an exception or exemption from the plan asset rules - to accept significantly more capital from ERISA plans.

We have been posting law firm memos about the implications of the new Act in our "Pension Plans" Practice Area.

Former SEC Secretary Jack Katz on an "Overlawyered" SEC

Former long-time SEC Secretary Jonathan "Jack" Katz penned an editorial for Tuesday's WSJ, following up on Harvey Pitt's recent editorial about the SEC being over-lawyered. Jack agreed with Harvey's identification of the problems at the SEC - but Jack doesn't think that hiring more economists and fewer lawyers solves the problem.

Instead, Jack wants the SEC to play a more active role in monitoring rules once they’re adopted: “Over-lawyering is not merely a reflection of the personnel working at the SEC, it’s also a product of the institution’s definition of itself.” Jack's thoughts are consistent with recently departed Commissioner Glassman's emphasis on the need to discern the real-world implications that SEC rule-making initiatives will have before the so-called problem-solving is effectuated. It's rather jolting to see Jack's name on something other than an SEC order - and he certainly has a world of experience as he sat "in the room" for more than two decades at the SEC.

August 10, 2006

More Internal Controls Deadline Relief!

Yesterday, the SEC issued two releases to grant smaller companies and many foreign private issuers further relief from compliance with Section 404 of Sarbanes-Oxley. This relief reflects the "next steps for Sarbanes-Oxley implementation" announced in May and includes some new initiatives not previously announced. Here is the related press release - and below is a summary of the SEC's actions:

- Accelerated Foreign Private Issuers Get One More Year - In this adopting release, the SEC extended its Section 404(b) auditor attestation deadline for those foreign private issuers that also are accelerated filers (but not those that are large accelerated filers, who still must meet the earlier deadline of fiscal years ending on or after the July 15th that just passed) to fiscal years ending on or after July 15, 2007. Note that foreign private issuers still have to file their Section 404(a) management reports under the existing deadline of fiscal years ending on or after the July 15th that just passed.

- Proposed Five-Month Deadline Extension for Non-Accelerated Filers - In this proposing release, the SEC proposed to extend the Section 404(a) management report deadline for non-accelerated filers (both US companies and foreign private issuers) to fiscal years ending on or after December 15, 2007 - and would extend the Section 404(b) auditor attestation deadline for non-accelerated filers to fiscal years ending on or after December 15, 2008. If this proposal is not adopted, non-accelerated filers would have to begin filing their Section 404 reports for fiscal years ending on or after July 15, 2007.

The SEC also proposed to deem the Section 404(a) management report included in a non-accelerated filer's annual report (as well as for foreign private issuers that are accelerated filers (but not large accelerated filers)) during the first year of compliance to be "furnished" rather than "filed" for purposes of Section 18 of the '34 Act, unless the filer specifically states that the report is to be considered "filed" or incorporates it by reference into another filing.

- Proposed One-Year Relief for New Filers - In this proposing release, the SEC proposed a one-year stay for companies coming off IPOs (as well as those doing registered exchanges or any other first time filers with the SEC, regardless if they are US companies or foreign private issuers), so that they would not have to provide any Section 404 reports (ie. neither a management report nor an auditor attestation) in their first annual report. However, this relief would not be available if a company already had filed at least one Section 404 report.

More on Nasdaq's Transition as an Exchange

In connection with Nasdaq's transition to an exchange (see more in this blog), the SEC's Market Reg and Corp Fin Staff issued this no-action letter that essentially permits companies and third-parties to satisfy, through EDGAR filings, their obligations to provide copies of most '33 Act and '34 Act filings to Nasdaq. Thanks to Alan Singer of Morgan Lewis for the heads up!

More on Blue Sky Issues and Nasdaq's Exchange Transition

Recently, I blogged about possible blue sky issues related to Nasdaq's transition to an exchange. Showing that I am indeed fallible, I overlooked Footnote 7 in Nasdaq's amended rule filing which states that "The Nasdaq Global Market, including the Global Select segment, will be the successor to the National National Market. As such, Nasdaq believes that all securities listed on the Global Market, including those on the Global Select Market, will be "covered securities," as that term is defined in Section 18(b) of the Securities Act of 1933, 15 U.S.C. 77r(b)."

Given that the SEC was silent on this point when it approved Nasdaq's rule filing, practitioners can take some comfort that the position in this footnote holds some water.

By the way, we are still waiting for the SEC to approve Nasdaq's rulemaking petition to designate securities listed on the Nasdaq Capital Market (f/k/a Small Cap) as "covered securities." This rulemaking petition was made in February and I understand that the Nasdaq intends to file some changes to its Capital Market listing standards soon to address comments from the SEC Staff reviewing the petition, so some progress is being made...

August 9, 2006

John White Speaks at the ABA Annual Meeting

On Monday, Corp Fin Director John White addressed the ABA's Business Law Section in Hawaii. I couldn't swing that hall pass, but the program was available via teleconference. We have put together notes from John's remarks and posted them in our "Conference Notes" Practice Area. John covered some ground on the new executive compensation disclosure rules - and he did say that the adopting release will be available this week, coming in at over 400 pages!

Now that the adopting release will be out soon, 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.

Corp Fin Phone Interps: Regulation AB Interps Updated

Earlier this week, Corp Fin updated its Telephone Interpretations pertaining to Regulation AB, adding these items: 11.02 - 11.04, 15.02, and 17.03 - 17.05. Phone interp aficionados will recall that the Reg AB interps were the first new interps since Harvey Pitt became SEC Chair. No word on when the other interps will be updated...

How to Develop a Whistleblower Compliance Program Today

We have posted a transcript of our popular webcast: "How to Develop a Whistleblower Compliance Program Today."

Litigation Update: How the Courts are Ruling on Stock Compensation

Tune in tomorrow for the NASPP webcast - "Litigation Update: How the Courts Are Ruling on Stock Compensation" - which can help provide guidance about:

- What the courts are saying about contract ambiguities and other employment disputes
- Tips on how to stay out of court
- What the IRS is saying about equity compensation tax shelters
- How to keep abreast of recent legal and regulatory developments

August 8, 2006

Whether Silence is Golden for Anti-Dilution Provisions of Equity Plans

A handful of members dropped me a line responding to my query last week regarding silence in anti-dilution provisions of stock option plans and FAS 123: the question of whether as a matter of contract construction, an option plan (or warrant) that was silent about adjustment could be adjusted if the stock was split.

For example, Professor David Yermack of New York University noted that a seven-year old Delaware case - Sanders v. Wang, 1999 Del. Ch. Lexis 203 (11/8/99) - considered the very issue of a Computer Associates equity compensation plan that was silent about what to do in the event of a stock split. A very large restricted stock award to the CEO and several top managers was split in line with the company's stock splits. A shareholder sued, alleging waste of corporate assets, since the plan had no provision for such an adjustment to a share award. The court agreed and ordered the top three executives to return the extra shares - 9.5 million shares since their restricted stock plan had no provision for increasing the inventory of shares when the stock split - which cost them close to $600 million on paper. Interestingly, Dick Grasso was one of the outside directors/defendants in the suit.

And Ken Stuart of Holland & Knight noted that in December 2001 - in Reiss v. Financial Performance Corporation, 97 N.Y.2d 195, 764 N.Y.S. 2d 658 (2001) - the New York Court of Appeals held that where a warrant was issued without any provisions for adjustment in the event of a stock split (or a reverse stock split), the Court would not read such provisions into the warrant in the case of a one-for-five reverse split. Thus, the holder could exercise for the full number of shares stated in the Warrant and not the after-split amount. The lower court had relied on a First Circuit case - Cofman v. Acton Corp., 958 F2d 494 (1992) - which had held that the parties there had not given any thought to dilution and that an essential term of the contract was missing, so it could be given effect by the court. However, the N.Y. Court noted in dicta that if they were dealing with a forward stock split, they might give effect to dilution on the theory that the holder did not intend to acquire nothing.

Is It Time to Merge the SEC and CFTC?

In Saturday's WSJ, former SEC Chairman Arthur Levitt opines that the SEC and CFTC should be merged into one in this editorial. I'm not sure many would disagree since the two agencies have overlapping constituencies to some extent. But why stop there? There are a number of federal agencies that should be merged out of existence - but the "gov" is so tough to downsize. That's why we have six federal agencies to regulate financial institutions (Fed Reserve, OCC, OTS, FDIC, OTS, NCUA)...

Spinning Off: ADP's Proxy Delivery & Voting Business

Last week, ADP announced plans to spin off a combination of its brokerage, securities clearing and outsourcing divisions - which includes the proxy delivery and voting services that it offers to its broker clients (which result in services offered to beneficial owners). The spin-off is expected to be in the form of a tax-free dividend, paid by the middle of next year.

Since mother ADP is not expected to control the new spun-off entity, it should give more freedom to the folks running the proxy delivery/voting services to be innovative, etc. - and it shouldn't adversely impact companies or their shareholders.

August 7, 2006

Securities Litigation Continues Downward Trend

This recent study on class action securities litigation - "2006 Mid-Year Securities Fraud Class Action Filings Report" - from Stanford Law/Cornerstone Research shows that securities litigation continues to trend downwards with a 45% decline in the number of securities class actions filed during the first half of 2006 compared to the same period of the prior year. We have posted a copy of the study, along with other securities litigation studies, in our "Securities Litigation" Practice Area. Can you believe that only one new securities class action was brought against an audit firm in the first half of 2006?

The Study posits some reasons for this trend, including the dissipation of the ill effects from the boom and bust period of the late '90s, the cleansing effects of Sarbanes Oxley, and the absence of stock market volatility. Kevin LaCroix of the "D&O Diary" is a bit more cynical and believes that this downward trend is partially due to Milberg Weiss' troubles and the disappearance of the paid plaintiff.

I believe Kevin's hunch is correct - but also agree with the Study's theory that the downward trend probably has been helped along by the morass of regulatory changes wrought by Sarbanes-Oxley, which has provided ample incentive for executives and boards to improve their governance practices. Another factor I would add is the spate of recent court decisions that have raised the benchmarks that must be met for successful cases, such as last year's US Supreme Court decision of Dura Pharaceuticals.

Given that there were a record number of restatements in 2005 - and I understand that restatements in 2006 are ahead of that pace so far - I would hazard to guess that this downward trend will continue (except perhaps the option backdating lawsuits that are now being filed in droves will reverse the trend).

The Art of Predicting the Securities Law Class Action

In related news, The Corporate Library released an update to its continuing study of the correlation between its corporate governance ratings and the risk of securities class action lawsuits. The findings include:

- Companies rated "D" or "F" are more than 3x as likely to be hit with a securities class action lawsuit than those rated "A," "B" or "C"
- Excessive CEO compensation is the single most predictive factor of being sued
- Other predictive factors include director age, tenure, over-commitment and lack of independence
- Takeover defenses are less important as a predictive factor
- Nearly all securities class action lawsuits are filed against companies with more than $485 million in market capitalization

A "Stolen" Parachute

What struck me as offensive about the article below from Sunday's NY Times is not the political angle - but that a CEO got a $28 million severance package when he voluntarily quit his job to run for the US Senate (here is a related LA Times article - and here is the complaint amid other materials from the plaintiff):

"Someone has finally made executive compensation an explicit campaign issue. Emma Schwartzman, who says she is a great-great-granddaughter of a founder of what later became the Safeco Insurance Company, has sued the company’s recently departed C.E.O., Michael S. McGavick — now the Republican candidate for the United States Senate from Washington state — over his $28 million severance package. In her suit, filed in Federal District Court in Seattle, Ms. Schwartzman, 27, said Mr. McGavick was entitled only to his last paycheck and that he had forfeited all other compensation, including bonuses and stock options, when he resigned.

According to the suit, the board agreed to let Mr. McGavick remain on the payroll for an extra four months and then to provide freelance “transition services” for two more months. That agreement, she contends, let Mr. McGavick keep stock options and other compensation that he otherwise would have had to forsake, under the terms of his original employment contract.

Mr. McGavick, who is trying to unseat Maria E. Cantwell, a Democrat, said in a statement that the allegations were 'without merit and politically inspired.'” Safeco described the departure package as 'reasonable.'

Ms. Schwartzman’s lawyer, Knoll D. Lowney, said the case was about “corporate corruption, not partisan politics.' But he also insisted that Mr. McGavick return the money to Safeco and not spend it on his campaign."

What in the world was the Safeco board thinking when they allowed this severance payment to be made (not to mention keeping him on the payroll, etc.)? Particularly with the SEC's new executive compensation rules requiring more disclosure about a board's pay strategies, boards and their advisors should heed the responsible pay wisdom that will be imparted during the "3rd Annual Executive Compensation Conference," available live in Las Vegas or by nationwide video webcast. Register today!

August 4, 2006

Nasdaq Proposes to Amend "Director Independence" Definition

Last week, Nasdaq filed a proposal with the SEC to modify its definition of "independent director" with the result that the Nasdaq rules would be more consistent with the NYSE's definition of independent director. This is different than the Nasdaq's outstanding proposal to modify the independence cure period that I blogged about a month ago.

If adopted, the changes could result in sitting directors no longer meeting the revised Nasdaq independence requirements - so Nasdaq also proposed a 90-day transition period after rule approval for compliance with the new standards. The next step is for the SEC to publish the Nasdaq's proposal for public comment - seems like 90 days for a transition could be a little short since an average director search takes nearly six months these days...

The Stock Market: 1950s Style!

For Friday fun, how about enjoying this cartoon from 1952 from the NYSE - "What Makes Us Tick." This is a "cartoon promoting the stock market as the engine of America's prosperity." Thanks to Howard Dicker for pointing me to this antique video!

Delaware First

Here is a nice piece from Jim McRitchie's "": Delaware, the first state, is also the most important state for corporate governance, since more than half of America's publicly traded businesses are incorporated there and must live by its statutes. Additionally, states that want to keep up, frequently adopt Delaware rules. The Delaware Court of Chancery produced a 180-page tome with the legal opinion it rendered last year in the Disney case.

An article entitled Delaware Rules in (8/1/06) gives us a glimpse of what Chancellor William B. Chandler III sees as questions the court will face in upcoming cases. For example, can shareholders adopt bylaws that trump board decisions? If they do, can the board then turnaround and negate their decision? "That issue has never been directly faced or answered in Delaware," says Chandler, "but I think it's inevitable that it will be decided."

The author of the article, Roy Harris, believes that "what Chancery rulings say in the near future could establish standards that rival anything that Sarbanes-Oxley and the Securities and Exchange Commission have offered." To back that up, he quotes Charles Elson. While the court must wait for cases to be brought before it — "ultimately the Delaware Chancery Court will have a significant role in changing governance," he says. Elson adds, "Traditionally, the court's view was that shareholders were not sophisticated and needed to be protected from their own foolishness," he says. "Today what they need to be protected from is managerial overreaching." Signs of new directions:

- director independence - Beth I. Z. Boland, a partner in the Boston law firm of Bingham McCutchen LLP, believes the court will now "look beyond quantifiable measures to go into soft issues" in determining who is independent."

- liability - Chandler says, "my view is that our law doesn't expect different standards to be applied to different directors based on their expertise, their skill, or their training."

- directors are agents - Chandler argues that it "would be a strange thing to invoke your fiduciary duties as a sword to break a contract that you had made with shareholders."

- compensation - "The board is ultimately going to have to decide compensation for executives," Chandler says, "but could shareholders adopt bylaws that place limitations or constraints in either the scope or magnitude of that compensation, or on the procedures that boards must follow before it awards compensation to a particular executive?"

Charles Elson provides insight into the way the Court of Chancery works. "Delaware doesn't get its jollies holding people liable," he says. "Its message is that 'the next time I see this conduct, I'm likely to rule differently.' It's a delayed impact that defines the parameters of behavior." Good discussion of the issues plus one sentence summaries of two decades of important cases.

August 3, 2006

More on Anti-Dilution Provisions and FAS 123(R)

Following up on my blog from a few weeks ago, in this podcast, Jon Lewis of Fried Frank Harris, Shriver & Jacobson analyzes the issues raised by applying FAS 123(R) to anti-dilution provisions in equity plans, including:

- What are the Big 4 saying about anti-dilution provisions in equity plans?
- What are examples of situations, such as changes in capitalization and restructurings, that might cause problems?
- Will the FASB weigh in on this issue?
- What should companies do now to determine if they have an issue? And if they do have a problem, how can they fix it?

And the impact of this problem is starting to be felt - as noted in this Form 8-K, Core Labatories recently cancelled a planned stock-split after being alerted to the accounting problems raised by this issue.

As an aside, a member e-mailed me wondering if anyone would feel that an option plan that was silent about adjustment for stock splits would be allowed to adjust as a matter of contract construction, at least in the context or warrants or other contractual rights to receive stock. Has anyone yet dealt with that? Shoot me an e-mail if you have (and I will keep your identity hidden if you wish).

ISS on "Does Cumulative Voting Complement Majority Voting?"

As a result of the ongoing debate festering on this blog, ISS weighed in with its voting policy regarding cumulative voting and majority vote on the "Corporate Governance Blog": "An interesting post ran last week on Broc Romanek's Blog. If one agrees, as mentioned in the piece, that cumulative voting helps protect shareholder rights--which ISS policy does--then majority vote standard and cumulative voting compliment each other. Without majority vote standard, cumulative voting in an uncontested election has no teeth because then a director could still be elected if he/she receives one single vote.

As for cases of contested elections, it is a non-issue because plurality voting standard would remain the election standard maintaining the status quo. Having majority vote standard in an uncontested situation would actually serve as a takeover defense. Therefore, in evaluating shareholder proposals requesting majority vote standard, ISS looks for such carve-out for contested elections in the language of the resolution.

Regarding ISS' policy on cumulative voting with respect to majority vote standard, we would not support a cumulative voting shareholder proposal if the company has majority vote standard in place. This is not because the two are incompatible, as many companies have been arguing. Rather, the rationale behind this policy is to provide an incentive mechanism (the carrot) for companies to move toward a majority voting standard for electing its directors.

It is true that cumulative voting can be viewed as a vehicle to allow special interest shareholders to make their voice heard in that, in theory, it makes it easier for a minority holder to get at least one director elected. However, many would say this isn't necessarily a negative byproduct. ISS' current policy is willing to "trade off" a cumulative voting provision if the company is willing to adopt a majority vote standard."

New Treasury Secretary Doesn't Like Sarbanes-Oxley's Impact

From a Dorsey & Whitney alert: "Hank Paulson, the former head of Goldman Sachs worldwide who left that position last month to become the new US Secretary of the Treasury, has used the occasion of his first public address as Secretary to suggest that the US Sarbanes-Oxley Act of 2002 has caused too much damage to US competitiveness internationally and should be revised.

Early in his speech, Paulson noted that the US had taken "corrective measures to address corporate scandals and increase investor confidence" following the Enron and WorldCom failures. But, he added, "often the pendulum swings too far". He said that the US now needed to follow its initial corrective measures with "a period of readjustment", and that "the challenge" facing the US is "to achieve the right regulatory balance to allow us to be competitive in today's world".

The Secretary of the Treasury has no authority to amend SOX or the rules that have been promulgated under it, and he has no authority over the US SEC or the PCAOB (Public Company Accounting Oversight Board), the new agency that drafts SOX auditing rules. Changes to SOX must be made principally by the US Congress, which itself wrote most of the detail in SOX about which non-US companies complain.

Nevertheless, the person serving as Treasury Secretary is usually listened to carefully by US legislators and regulators when speaking on broad policy issues. And, this particular Treasury Secretary will likely be listened to even more closely, due to his personal background as a top international financier and his position as a late entry in the Bush cabinet charged with finding solutions to a number of economic issues that are currently worrying Washington.

Paulson's swipe at SOX is part of a general concern in the US that may soon lead to real efforts to change the law. The US has its next Congressional elections in November 2006, at which time both Senator Paul Sarbanes and Representative Mike Oxley, the sponsors of the law, plan to retire from office. The Congress that meets following this election will likely be more open to amending the statute, which at that time will be over four years old and will have generated a substantial track record that should help SOX critics argue for meaningful revisions. And, at that time, Hank Paulson should still be Treasury Secretary." Here is more commentary about Paulson's speech at

August 2, 2006

Nasdaq Emerges as an "Exchange"

On Monday, the SEC issued this press release announcing that companies listed on the Nasdaq Stock Market will transition to registration under Section 12(b) of the Securities Exchange Act of 1934 effective as of Monday. The Nasdaq Stock Market commenced operation as a national securities exchange yesterday.

As I have indicated would happen in prior blogs, under an order issued by the SEC, all Nasdaq companies became Section 12(b) registrants instead of 12(g). Among other consequences, this means that these companies will need to indicate such on the front of their Form 10-Ks (listing common stock under the 12(b) line, instead of 12(g)) - and that companies de-registering will need to file a Form 25 with Nasdaq in addition to a Form 15 with the SEC, and that deregistration will not be based solely on the number of stockholders (see our Q&A Forum for a recent question regarding a company de-registering right now, which poses really tricky transition issues). Other consequences of this transition were covered in recent issues of The Corporate Counsel.

In addition, the SEC issued an exemptive order allowing Nasdaq members, brokers and dealers to execute trades until August 1, 2009, in 13 Nasdaq-listed firms that were previously exempted from SEC registrations. Nasdaq sought the relief saying an immediate registration requirement could prompt the firms - four insurance companies and nine non-U.S. firms - to withdraw from Nasdaq trading altogether.

Congrats to Nasdaq after wading through a prolonged regulatory process. In fact, outgoing SEC Commissioner Glassman alluded to how long it took for Nasdaq to obtain regulatory approval of its exchange application - which I believe is in the 6-7 year range - in her outgoing speech...

Nasdaq as an Exchange: Blue Sky Implications?

Nasdaq's transition to an exchange and its related name changes may give rise to some blue sky interpretive questions. As you may recall, the National Securities Markets Improvement Act of 1996 (known as "NSMIA") preempted state qualification/registration requirements for "covered securities" which include a security that is listed on the "National Market System of the Nasdaq Stock Market (or any successor to such entities)". The bifurcation of the National Market System into the Global National Market and the Global Select Market as proposed by the Nasdaq proposed rule change creates some ambiguity as to whether both markets will be considered as successors.

A further wrinkle is added by the continuing value of state level exemptions for options or warrants to acquire listed securities. The NSMIA did not clearly preempt state qualification requirements for options or warrants to acquire covered securities, as discussed in May-June 2003 issue of The Corporate Counsel. This "gap" is filled by exemptions that continue under some state blue sky laws.

For example, California Corporations Code Section 25100(o) exempts a security listed or approved for listing on the National Market System (or any successor) as well as any warrant or right to purchase or subscribe to the security. California also requires that offers or sales of any security in a nonissuer transaction must be qualified or exempt from qualification. Corporations Code Section 25101(a) exempts from this qualification requirement any security (i.e, not just a covered security) that is issued by a person that is the issuer of any security listed on a national securities exchange or the National Market System (or any successor).

Finally, California has an exemption from its constitutional usury provisions for evidences of indebtedness if the issuer has any security listed or approved for listing upon notice of issuance on a national securities exchange or on the National Market System (or any successor). In each of these cases, the National Market System must be certified by rule or order of the California Commissioner of Corporations. See, e.g., Release 87-C (revised) and Release 88-C. All this is to explain that the move to exchange status and the name changes should give rise to some interpretive questions under state law. Thanks to Keith Bishop for his input here.

Last Word: Cumulative Voting and Majority Voting

Yesterday's blog contained a rebuttal from CalPERS on the topic of cumulative voting and majority voting. Here is a counterpoint from Keith Bishop: "There is a very sound reason for not allowing majority voting when a corporation has cumulative voting available to stockholders. At its core, majority voting establishes a significantly less burdensome way to remove directors without cause. California Corporations Code Section 303 protects directors from removal when those directors were elected by cumulative voting. This is true even when a majority of the outstanding shares has voted for removal. There is a very sound reason for this.

If removal could be effected by a majority of the shareholders, then the right to elect directors cumulatively would be largely meaningless. While SB 1207 does not amend Section 303, it creates a total end-run on the minority protections of Section 303 and cumulative voting rights in general. Delaware and Nevada provide similar (but not exactly the same) protections to for cumulative voting in DGCL Section 141(k)(2) and NRS 78.335 (Note that Nevada requires a 2/3 vote for removal).

The implications of SB 1207 are illustrated by the following example. A corporation has 7 directors and 1000 outstanding shares. If a meeting is held to elect all 7 directors and all 1000 shares are voted, a minority group holding 126 shares could elect a director under cumulative voting. Without Section 303(a)(1), the holders of 501 (a majority of the outstanding shares) could take action to remove this director without cause. Obviously, electing a director only to have her removed would be pointless. Under Section 303(a)(1), however, cumulative voting is protected.

For example, assume that the majority shareholders seek removal at a meeting. If 800 shares are present and voting at the removal meeting, the holders of 101 shares could block removal of the director. Note that Section 303(a)(1) implicitly assumes that abstentions and other shares that are note voted should not be counted as supporting removal. If SB 1207 is enacted, removal in the above example could be effected by as few as 251 shares! This is far less than the 501 votes that would be required for removal even without the special cumulative voting rule in Section 303(a)(1). SB 1207 can thus have the effect of turning majority rule into minority rule - especially if the minority is held by a few shareholders and the majority is widely dispersed.

I believe that my views regarding the incompatibility of cumulative voting and majority voting are very much in the mainstream. The ABA's amendments to the Model Business Corporation Act do not allow majority voting if a corporation has cumulative voting."

August 1, 2006

New Compensation Rules Raise Many Complexities

Mark Borges continues to work wonders on his "Compensation Disclosure Blog" on Here is one of his latest: "Although we won't see the final rules for several more days, it hasn't stopped me from attempting to parse the SEC's eight-page press release and related materials to try to figure out what they will look like. Here are a couple of items that I've identified that seem a little, shall we say, curious.

NQDC Earnings

It appears that final rules will only require disclosure of above-market or preferential earnings on nonqualified deferred compensation in the Summary Compensation Table. So far, so good. It didn't seem to me (and many others) appropriate to treat all earnings on NQDC as compensatory and subject to disclosure. The final rules go on, however, to exclude these above-market earnings (along with changes in the actuarial present value of accumulated pension benefits) from total compensation when determining a company's most highly-compensated executive officers.

That seemed to be the right result when all earnings were being included in total compensation; I'm not sure it's still necessary when only the above-market portions are considered. After all, everyone agrees these amounts are compensatory. I think companies may have caught a break here.

Earnings on Equity Awards

The final rules do not require disclosure of earnings (such as dividends and dividend equivalents) on outstanding equity-based awards where the earnings are already factored into the grant date fair value of the awards. This result is likely to be controversial. In fact, I've already heard some observers suggest that this could lead to underreporting and, perhaps, even encourage the use of this benefit.

The concern stems from the belief that the incremental portion of a stock award's fair value representing the future dividend stream is relatively small compared to the actual dividends that an NEO will receive during the award's vesting period. The change in the final rules appears to be in response to commenters who pointed out that, by requiring dividends to be reported in the SCT, these amounts were being included twice - once as part of the fair value calculation and then again when the dividends were paid. The SEC made a policy choice to eliminate the doublecounting. This covers one issue, but leads to other nuances.

For example, what happens where a company issues an award on dividend-paying shares, but the recipient is not entitled to dividends (or equivalents) during the vesting period? SFAS 123(R) seems to say that the fair value of a share that does not participate in dividends during the vesting period is less than that of a share that fully participates in dividends. Will a company be able to reduce the value disclosed in the SCT in this instance? SFAS 123(R) says yes - you reduce the share price of the award by the discounted present value of the dividends expected to be paid on the shares during the vesting period to determine fair value. Presumably, companies would be permitted to make this adjustment.

The larger lesson here is that options may not be the only instrument where computing fair value is going to involve some work. In talking about the proposals over the past few months, I frequently said that, for most equity-based awards (other than options), the amount to be reported in the SCT would equate to the award's market value on the grant date. I'm starting to see that this may not always be the case.

These rules are getting complicated, and they aren't even out yet."

Act Today!
Mark is a key speaker at our two-day conference: "Implementing the SEC's New Executive Compensation Disclosures: What You Need to Do Now!" He will participate on four separate panels dealing with the new CD&A, retirement pay disclosures, the revised Summary Compensation Table and the tricky world of perks.

August E-Minders is Up!

The August issue of our monthly newsletter is available.

Cumulative Voting and California's Majority Vote Bill: CalPERS' Perspective

Below is a rebuttal from CalPERS to last week's blog from Keith Bishop:

CalPERS appreciates the opportunity to respond to Keith Bishop’s analysis of SB 1207, currently being considered by the California Legislature. SB 1207 does not weaken the cumulative voting provisions currently contained in California’s General Corporation Law or conflict in any way with Government Code Section 6900. In fact, SB 1207 supports the ability of all companies to adopt or preserve cumulative voting, including those companies that opt into a majority voting rule. SB 1207 does this by allowing a company to utilize majority voting for uncontested elections and cumulative voting for contested elections. There is no “fundamental incompatibility” in a system that accords a corporation the opportunity to choose between majority voting for one kind of election and cumulative voting for another.

SB 1207, as currently drafted, changes only one aspect of director elections: it provides a listed corporation with the ability to implement majority voting in "uncontested" elections. The bill does not change the existing process for contested elections (i.e. directors who receive the highest number of votes are elected; if a shareholder has elected cumulative voting, each shareholder may multiply the number of votes to which the shareholder’s shares are entitled by the number of directors to be elected, and distribute the votes among the candidates as the shareholder sees fit; subject to the ability of a listed corporation to eliminate cumulative voting under Section 301.5(a)). This approach provides corporations with maximum flexibility in addressing director elections, while also preserving to the fullest extent possible California's tradition of cumulative voting.

Those who propound a “fundamental incompatibility” argument would require a corporation to make an "either/or" choice between majority and cumulative voting. In other words, they would permit California corporations to adopt majority voting in uncontested elections only if they were willing to eliminate cumulative voting in all elections, whether contested or uncontested. We think that choice is best left to each corporation and its shareholders. Corporations already have the ability under Corporations Code Section 301.5 to opt-out of cumulative voting if they wish to do so. There is no reason to force a choice.

Put another way, is there a reasonable justification as to why the Corporations Code should, as a matter of law, prevent a corporation from selecting a majority voting system for uncontested elections and a cumulative voting system for contested elections? We think the answer is “no.” Each system serves different purposes, and both can co-exist quite well. The policy goal of majority voting is to provide a means for shareholders to vote against incumbent directors. The purpose of cumulative voting is to ensure minority representation on a board.

While the policy purposes may overlap, they don't necessarily conflict. Given California’s historic policy and the current practice of most California corporations favoring cumulative voting, we believe that the approach of letting each corporation and its shareholders determine whether to adopt majority voting for uncontested elections (as opposed to an “either/or” choice between majority voting and cumulative voting) represents a strong reason to support SB 1207. Delaware has adopted such an approach, and we believe this approach is in the best interest of California corporations and their shareholders.

With regard to the removal issues raised by Mr. Bishop, we believe that his concerns are overstated. SB 1207 does not amend Corporations Code Section 303 relating to removal. Thus, the protections afforded directors elected or supported by a group of minority shareholders remain intact: no director may be removed without cause if the votes cast against the director’s removal would be sufficient to elect the director if voted cumulatively at an election at which the same number of votes were cast.

Further, candidates in contested elections would not be impacted by majority voting since majority voting does not apply in contested elections. Only candidates in an uncontested election must achieve the affirmative vote of a majority of votes cast. In such an election, a minority shareholder whose candidate would not gain a majority of votes cast may be required to force a contested election in order to maintain a board seat. However, as a practical matter, when a company knows that a minority shareholder is assured a board seat through cumulative voting, it often nominates that shareholder’s candidate to avoid the contest.

Thus, while it is possible that a scenario could arise where a minority shareholder is required to force a contested election, we think this would be rare. In our view, Mr. Bishop’s concern with the removal of cumulatively-elected directors is not so significant to prevent corporations from being given the option to select majority voting, and does not further the argument that SB 1207 either is inconsistent with or undermines cumulative voting.