October 31, 2006

John White on Related-Party Transaction Disclosures

A few weeks back, Corp Fin Director John White delivered his latest speech from his series on the SEC's new rules. This one is entitled "Principles Matter: Related Person Transactions Disclosure and Disclosure Controls and Procedures." Here is an excerpt regarding charitable donations:

"I have heard very intelligent people assert, quite emphatically, that a charitable donation cannot trigger required disclosure, allegedly because it cannot be a transaction ("it's only a gift") for these purposes. I respectfully disagree. Determining whether disclosure is ultimately required under Item 404 involves walking through the entirety of the analysis behind the principle and the key objective (including whether a related person has a direct or indirect material interest) but I do not think there is anything in the language of the rule or in the principle that forecloses the possibility that a charitable contribution may be a transaction or a related person transaction. Remember the broad definition the Commission uses for "transaction" as well as the rest of the key objective behind related person transaction disclosure.

Imagine this hypothetical. A company makes a sizeable (that is, more than $120,000) donation to an environmental organization which the company's CEO particularly likes. Is that a related person transaction that requires disclosure? Going back to our key objective, it seems attenuated to me, without more, to find a "direct or indirect material interest" for our hypothetical related person, the CEO, so disclosure may not be required. But it seems clear to me that it's a transaction based on the Commission's definition and discussion. It may be lack of materiality that precludes disclosure.

Change the facts a little. What if the environmental charity employs the CEO's son? What if the charity was in dire straits before the company's donation and the son was likely, like everyone else who works at the charity, to lose his job? The company's sizeable donation, however, allows the charity to remain in operation. That one seems fairly easy. In that hypothetical, the company's donation has allowed the CEO's son to keep his job, and I imagine most parents would have at least an indirect material interest in their children's employment and careers. Alternatively, what if the prominent and highly regarded head of the charity writes a letter (and pulls some strings) after the contribution is received and lands the CEO's daughter a prestigious internship with an international wildlife agency? I have no idea standing here today what the right answer to that one is, but I believe we could figure it out if we had all the relevant facts and walked through them with the principle in mind. Remember, it's the principle that matters. And I at least think that the fact that the Commission has designed Item 404 to be principles-based tells us pretty quickly that we can't shirk the analysis by saying that a charitable contribution does not fit into someone's preconceived notion of transaction. As an understanding of principles-based rules and disclosure make clear, lacking express language or a direct example in the rulemaking we must return to the principle. That is not at all the same as saying we can stop our analysis or conclude that disclosure is not required."

Valuing Warrants and Shareholder Approval

Nasdaq has begun to solicit comments on a new proposal regarding the method of valuing warrants when applying its shareholder approval requirement. Get your comments in by mid-January...

Happy Haunting

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October 30, 2006

Bank of America Tries a Different Majority Vote Approach

Check out this recent Form 8-K filed by Bank of America regarding their board's adoption of by-law amendments and governance guidelines to implement majority voting for directors. The points that you may find of interest are the bylaw provision cannot be amended without shareholder approval and the governance guidelines with respect to director resignation, which are different from those that have been adopted by most companies (e.g. directors must agree to submit resignation in advance of next annual meeting). Here is the related press release - and the amended corporate governance guidelines.

Ken Wagner of Bank of America has just joined the webcast panel - "Shareholder Access and By-Law Amendments: What to Expect Now" - to explain why his company took the approach that it did.

Stocks Populi

With the SEC's re-consideration of its outstanding shareholder access proposal on December 13th, reports of heated debates within the SEC regarding "what to propose" are not surprising - here is former SEC Chairman Arthur Levitt's opinion on the topic from Friday's WSJ:

"Ever since the recount of 2000, partisans of both parties have paid particular attention to everything from who votes to how they vote and how their preferences are recorded. Counting every vote is not only integral to our political life; it is central to our economic life as well. Shareholder capitalism enables our markets to thrive, our companies to grow and our economy to remain strong. And central to this system is the principle that shareholders can have a voice in the running of the companies that they own, that their votes will count.

This fall, the issue has been the focus of a series of court cases, decisions and now potential Securities and Exchange Commission action. How the SEC handles this can have a profound effect on the future of shareholder democracy, corporate governance and the future of our markets. It's a matter of interest to all investors.

For years, shareholder advocates have been working to gain better access to companies' proxies so that they can put forward resolutions and, most importantly, their own candidates for director slots. Even though boards of directors have improved considerably since the passage of new independence standards and disclosure requirements in Sarbanes-Oxley, the ability of shareholders to remove directors is critical when seeking to revive a moribund corporation. Yet currently, board elections are one-party affairs, with the incumbent board's choices winning in virtually every case. Shareholders can only put forward candidates after costly proxy campaigns. A director has a better chance of being struck by lightning than losing an election.

After failing to convince the SEC to pass a proxy access proposal in 2003, shareholder advocates tried to make changes in the bylaws of companies that govern the elections of directors in order to make them fairer. They argued that this was a matter of process under applicable law (that is, did not directly relate to the election of directors, a basis of exclusion), and thus management had to put such a proposal on its proxy card to shareholders. In September, in a case concerning AFSCME, the large public employee union that wanted to put forward these changes at AIG, an appeals court ruled that such a bylaw change was proper and that management would have to open its proxy to proposals regarding how directors were elected. (Full disclosure: I was retained by AIG's board to help restructure its corporate governance; I had no involvement in this matter.)

In response, the SEC rightly decided to re-examine this issue and clarify the law. An open hearing on the topic was scheduled in October but was delayed until Dec. 13. The outcome of this session is critical to the future of shareholder capitalism. The signal the commission sends is an important one. Support of the AIG decision will make it clear that the reforms of the past few years were not ephemeral, and that even though the markets are once again delivering high returns, the commitment to good governance will not falter.

The upcoming meeting is the right time and place for the commission to set expectations for our public corporations. Indeed, an understandable desire for consensus on such a difficult matter is less important than the clarity of the SEC's message. While passing an entirely developed proxy access plan may be too much to ask, the SEC can set a direction by making it clear that it will not ignore the issue of fairness that precipitated this latest litigation and put forward a series of steps that will strengthen shareholder democracy.

Part of this should include safeguards such as a minimum requirement of shares held in order to put forward director nominees. Other changes that can be made are: an increase in the number of exempt solicitations from 10 persons to 20 as long as those solicited are institutions or "accredited investors" so that investors can easily communicate with each other; the electronic transmission of proxy materials to those who desire them in that form, a move that can boost shareholder participation and reduce cost; and an endorsement of the principle of majority rule and schemes that bring this to publicly traded companies. A growing number of corporations have taken this last step, and it's important for the SEC not only to allow but also to affirmatively promote it as a best practice -- even urging the exchanges to include majority-voting among their listing standards.

By setting this tone, the SEC will make a strong statement about corporate governance. It will demonstrate that accountability is a principle that will not be compromised. It will bolster its admirable efforts on executive compensation; after all, disclosure provisions are toothless if shareholders are unable to act upon them. And an endorsement of shareholder democracy will show investors world-wide that in our markets, their voices matter and their votes count."

Sign On The Dotted Line

From "The Rule 10b-5 Daily Blog": Sarbanes-Oxley requires the chief executive officer and chief financial officer of a company to certify the accuracy of each periodic report containing financial statements. Plaintiffs often argue that these certifications can support the pleading of scienter (i.e., fraudulent intent) in cases alleging accounting misrepresentations.

In what appears to be the first circuit court opinion to address the issue, the U.S. Court of Appeals for the Eleventh Circuit has held that SOX certifications, by themselves, are not indicative of scienter. In Garfield v. NDC Health Corp., 2006 WL 2883238 (11th Cir. Oct. 12, 2006), the court found that SOX "does not indicate any intent to change the requirements for pleading scienter set forth in the PSLRA [Private Securities Litigation Reform Act of 1995]." Accordingly, a SOX certification "is only probative of scienter if the person signing the certification was severely reckless in certifying the accuracy of the financial statements."

Quote of note: "If we were to accept [plaintiff's] proferred interpretation of Sarbanes-Oxley, scienter would be established in every case were there was an accounting error or auditing mistake made by a publicly traded company, thereby eviscerating the pleading requirements for scienter set forth in the PSLRA."

October 27, 2006

Executive Compensation Disclosure: Canadian Regulators Cooking Up New Rules Too

From ISS' "Corporate Governance" Blog: "The Globe and Mail had an interesting article the other day by Janet McFarland and Elizabeth Church titled "New Disclosure Rules to Reflect Evolving World." The article states that Canadian investors will soon have the opportunity to learn more about executive pay packages as regulators prepare to revise compensation disclosure rules introduced more than a decade ago.

The Canadian Securities Administrators (CSA) expects to have a new set of rules ready early next year, requiring full disclosure of virtually every detail of executive compensation."

Rising CEO Pay

Yesterday, the NY Times ran this article about the highest paid CEO for this year, based on data from a recent report from The Corporate Library. In this podcast, Paul Hodgson of The Corporate Library discusses this recent 18-page special report on CEO pay trends, including:

- Why does your survey come out so late compared to others?
- What was the driving force behind the large increase in CEO pay?
- What happened this year with restricted stock grants to CEOs?
- Are stock options going to play as large a role in the future as they have in the past?
- Why is the increase in CEO pay so much lower for small cap companies compared to larger companies?

CEOs as Independent Directors

From CorpGov.net: In 1990, out of the largest 500 American companies, 358 active CEOs served on outside boards filling 794 seats. As of June 2006, only 265 served on an outside board filling 376 seats, a 53% decline. CEOs who continue to serve have reduced their seats by 36%. Service on outside boards for CEOs of the largest 100 companies went from almost 90% to less than 60%.

Jim Drury, founder and CEO of search firm JamesDruryPartners, argues companies need to make outside board service a priority for their own CEOs. "CEOs learn a lot when serving on boards other than their own. After all, many companies deal with the same issues: international expansion, global sourcing, product innovation, technology enhancement. When a CEO gains an inside look at how other companies handle these crucial problems, she can be a more effective leader in her own firm. And CEOs can work more effectively with their own boards if they've experienced life on the other side of the table." "With CEOs abandoning the boardroom, it’s time for reformers to remember that 'too much of a good thing is never a good thing.'” (Boardroom Brain Drain, Forbes.com, 10/16/06)

Directorship views the picture from a somewhat different perspective. "The good news is that once a nominating committee is willing to look beyond the traditional specifications, the pool of talented potential directors widens considerably." One obvious source of supply is the cohort of recently retired CEOs; another is active CFOs and the retired managing partners of the big accounting firms. Women and minorities are viewed as a third source. "The emphasis on skill sets is steering some nominating committees toward candidates with particular expertise rather than particular titles." "With boards under pressure to represent shareholders' interests more visibly, some observers think the universe of investor relations professionals could be a future source of potential directors." "A seat on the board of a public corporation is increasingly seen as necessary training for up-andcoming executives." (Who Will Sit on Tomorrow's Boards?, Directorship, 10/06)

Shaping Strategy from the Boardroom, argues that CEOs should have more influence over who sits on the board, not less. Nominating committees have been given too much control over board composition. CEOs should have more say in picking directors who know the business. But boards should be more involved in driving corporate strategy. Boards must also make strategy as important as compliance when they manage their work and reform their processes. Industry expertise may be more important than previous board experience. (The McKinsey Quarterly, 10/18/06)

Many reformers would be happy to have CEOs of their companies sit on another board to get such cross-fertilization of ideas, if the CEO of their board is nominated by shareholders of the other company. Board loyalties tend to be to those who brought them to the dance (to paraphrase Nell Minow). Its about time that at least some of the invitations go out from the owners.

October 26, 2006

More on Overvoting

We have posted the transcript from our recent webcast: “Understanding Overvoting and Other Tricky Voting Issues.” The webcast panelists went beyond the "big picture" - but this big picture is noteworthy, including:

- there are a lot more close votes than many of us realize (in other words, there's a lot more overvoting than meets the eye)

- overvoting is on the rise

- over-voters are almost always short-termers and not even "owners" at all

- there are a number of unresolved legal issues and/or ambiguities

Bush 'Astounded' by CEO Pay, Urges Link to Performance

According to the following excerpt from a Boston Globe article from Tuesday, President Bush said he is "astounded" by the size of some executive pay packages and urged companies to tie salaries to performance, while stopping short of advocating government action.

"These compensation packages can get out of hand," he said in an interview on CNBC. While incentives for performance are necessary, he said, companies should "make sure the incentive pay is rational." The president, who didn't mention any executives or companies by name, encouraged investors to pressure corporate boards on compensation. "I don't think government should control salaries," Bush said, "but I would hope shareholders would take a close look at some of these compensation packages."

Thanks to FEI's "Section 404" Blog for pointing this article out...

"Paulson Committee" May Soon Recommend Dramatic Limits on Securities Class Actions

The Boston Globe article then went on to note: "The president also said he and Treasury Secretary Henry Paulson are looking at ways the Sarbanes-Oxley Act can be "fine tuned" to make sure it's not driving capital away from US public markets. Congress passed the legislation, which subjects companies to stricter auditing rules and stiffer penalties for financial crime, in 2002 after accounting frauds at Enron Corp. and WorldCom Inc. eroded investor confidence. 'One way you become less competitive is through overregulation,' Bush said. 'Secretary Paulson and I have spent a lot of time talking about this issue.'"

Here is more on a related topic from the "Securities Litigation Watch Blog": Since early September 2006, a committee composed of "independent ... U.S. business, financial, investor and corporate governance, legal, accounting and academic leaders" has fairly quietly been conducting a study into how to improve the competitiveness of the U.S. public capital markets. Next month this committee (The Committee on Capital Markets Regulation, also referred as the "Paulson Committee" because it will present its recommendations to US Treasury Secretary Henry Paulson), will issue an interim report with recommendations on several topics. Most notably for this blog, these topics include "Liability issues affecting public companies and gatekeepers (such as auditors and directors) with a focus on securities class action litigation...."

John Coffee, a professor at Columbia University School of Law, said at a recent ALI-ABA conference that he is an adviser to the panel and has suggested several reforms designed to mitigate the threat of securities litigation. According to the article, Coffee believes that in the "near future," the Paulson Committee can be expected to make recommendations "to impose limits on securities class actions" and that the "SEC could take some action to change the role of [the] securities class action" in the next 6 months.

Among the possible changes that could result, Coffee said, were the eye-opening ideas that:

1. The SEC could "dis-imply" a private cause of action under Rule 10b-5 against corporations, leaving enforcement of that rule to the government, not private plaintiffs. The SEC might also "dis-imply" such a private cause of action with respect to the corporation only when the SEC has sued the corporation. Coffee states in the article that "That idea does have some support"; or

2. "Stock drop" cases could be moved out of the courts and into the arbitration arena.

The Paulson Committee's recommendations are due out by the end of November 2006. If either of these ideas are among them, look for a barrage of deafeningly loud disapproval from the plaintiffs' bar and consumer groups.... Stay tuned.

October 25, 2006

NYSE Proposal: Eliminate Broker Voting Starting in 2008

Yesterday, the NYSE filed this proposal with the SEC to amend Rule 452 and eliminate broker discretionary voting for director elections (as such elections would no longer be considered "routine") for any shareholder meetings held on - or after - January 1, 2008. The proposal is subject to approval by the SEC.

The NYSE's proposal dovetails with a set of recommendations from its Proxy Working Group issued in June. Surprisingly, the proposal notes that the NYSE didn't receive any comments on the Proxy Working Group's recommendations (although the NYSE Staff only had solicited comments back in June to share with the SEC, not the public). Interesting that the NYSE acted so soon, given that it was reported that this proposal would be postponed just a month ago.

This proposal amplifies the stakes in the majority vote movement/shareholder access debate and will be discussed during our upcoming webcast: "Shareholder Access and By-Law Amendments: What to Expect Now."

Survey: Compensation Committee Meetings/Disclosure Committee Meetings

As our perk survey continues, we have posted a new quick survey regarding meetings of the compensation committee and disclosure committee, including:

- In the wake of the SEC’s new compensation disclosure rules, our compensation committee has the following people attend their meetings

- Does someone from your independent auditor attend your disclosure committee meetings

- If someone from your independent auditor attends some or all of your disclosure committee meetings, does that person

- If someone from your independent auditor attends some or all of your disclosure committee meetings, what is the purpose for attendance

Please take a moment to participate in both these surveys.

NYSE's Elimination of Annual Report Delivery: What to Do Now

As I blogged a few months back, the NYSE amended Section 203.01 of its Listed Company Manual regarding the provision of annual financial reports to shareholders. The amended rule is intended to allow listed companies to satisfy the NYSE's annual financial statement distribution requirement by a website posting of a company's Form 10-K (but this only benefits foreign private issuers until the SEC adopts e-Proxy and amends Rule 14a-3).

As a follow-up to its revised 203.01, the NYSE Staff recently issued this message:

"Companies have asked whether they can still satisfy the NYSE's requirements by traditional physical delivery of the annual financial statements, without the necessity of making the website postings and simultaneously issuing a press release as provided for in the amended rule. The answer is yes.

As the NYSE stated in its rule filing with the SEC, the rule amendment was intended to "provide significant efficiencies to listed foreign private issuers exempt from the proxy rules under Exchange Act Rule 3a12-3." The NYSE recognized in the filing that "the proposed rule changes will have minimal effect on domestic companies subject to the proxy rules", and as noted above, the entire proposal was presented as a mechanism by which companies would be allowed to achieve compliance with NYSE requirements to provide annual financials to shareholders. Accordingly, the NYSE will deem companies that distribute annual financials to shareholders in compliance with the SEC's proxy rules to be in compliance with the requirements of Section 203.01."

October 24, 2006

Survey Results: More on Regulation FD

Here are the survey results from our latest quick survey on Regulation FD (which fits neatly with last year's Regulation FD survey):

1. Our company posts information on its corporate website and takes the position that this is sufficient to satisfy Reg FD:

- Yes, our company takes this position for anything posted on its corporate website - 3.8%
- It depends, our company takes this position for certain items posted on its corporate website (but not all) - 28.3%
- No, our company does not yet take this position - 67.9%

2. Our company has a written policy addressing Reg FD practices:

- Yes, and it is publicly available on our website - 5.6%
- Yes, but it is not publicly available on our website - 60.4%
- No, but we are in the process of drafting such a policy - 15.1%
- No, and we do not intend to adopt such a policy in the near future - 18.9%

3. Regarding reaffirmation of earning announcements, our company uses one of the following rules of thumb regarding private reaffirmations:

- We do not allow private reaffirmation - 60.8%
- Rule of thumb allowing for private reaffirmations of one week or less - 7.8%
- Rule of thumb allowing for private reaffirmations of one to two weeks - 13.7%
- Rule of thumb allowing for private reaffirmations of two to three weeks - 9.8%
- We permit private reaffirmations - but never use a rule of thumb, instead we require confirmation of no material change with CEO, GC, etc. - 7.8%

4. At our company, our CEO and other senior managers: (multiple answers apply, may total more than 100%):

- Are not permitted to meet privately with analysts - 6.7%
- Are only permitted to meet privately with analysts so long as someone else accompanies them (such as general counsel or IR officer) - 35.0%
- Are permitted to meet privately with analysts after briefing by IR officer, general counsel, etc. - 18.3%
- Are only permitted to meet privately with analysts during certain designated times - 18.3%
- Are not permitted to talk about certain topics - 33.3%

Regulation FD Dissemination: The Blogging of Material Information

On the heels of our survey on whether dissemination of material information through the Web satisfies a company's Regulation FD obligations, Sun Microsystems CEO Jonathan Schwartz - who is one of those rare CEO bloggers - has asked the SEC to allow companies to disclose significant financial information through blogs. Mr. Schwartz' letter to the SEC is copied in his blog.

Here are some thoughts from Stan Keller on this topic: "Absent definitive guidance from the SEC, I believe that if you want to disseminate information by means of your website to satisfy Regulation FD, you should file a Form 8-K (or issue a press release) saying you have done so. The 8-K should be descriptive enough so that investors will know the subject matter - like a release noticing an FD compliant call."

SPACs: How to Use a Special-Purpose Acquisition Company

We have posted a transcript from our recent DealLawyers.com webcast: "SPACs: How to Use a Special-Purpose Acquisition Company." And today, catch Jim Freund, Mediator and former Partner of Skadden Arps Slate, Meagher & Flom LLP - and one of the foremost M&A lawyers of any generation - on the DealLawyers.com webcast: "M&A Dispute Resolution: Getting Deal Lawyers Into the Game."

October 23, 2006

Sample Director Confidentiality Agreement

Reading the latest details about how H-P's hired gumshoes closely followed a WSJ reporter gave me the shivers. Folks, feel free to sift through my trash anytime - trust me, there's nothing in there too interesting save maybe some old boxers (my wife is now applying a one-year rule).

In our "Board Duties" Practice Area, I just posted a sample director confidentiality agreement contributed by a member.

Another member asked me recently: "On the issue of director confidentiality, because of some of the “defects” with regard to common law duties of confidentiality, we ask directors to sign a confidentiality agreement. We’ve purposely made it as benign as possible, under the theory that it supplements, rather than supplants, common law director duties and it is too difficult to negotiate with prospective directors over the terms of their confidentiality agreements. So far, we’ve had no issues with directors signing it. We’ve wondered about the types of things that would cause concern and the only context we could come up with is in the case of some sort of investigation—would a director be compelled by the terms of the agreement to not disclose something to a regulator?"

This question will be posed to the panel during our upcoming webcast, "The Art of Boardroom Etiquette and Confidentiality." During a recent prep call I held with the panel, most agreed that entering into confidentiality agreements with directors is a bad idea - because directors already are bound by their fiduciary duties and thus there is no reason to bind them with contractual obligations. On the other hand, the use of agreements can be useful to remind directors that their obligations to the company are very real. This issue will be discussed during the webcast, but I’d be interested to hear your own thoughts on this practice.

A Record-Breaking IPO

Did you catch the numbers for Friday's record-breaking IPO of Industrial & Commercial Bank of China? Not only did the IPO raise $21.9 billion, the total volume of orders was $430 billion! $350 billion of demand from global investors and $80 billion within China. Mind-boggling! And according to this WSJ article, demand for Chinese IPOs has been stimulated all year; last month, China Merchants Bank had $100 billion of demand for its $2.4 billion IPO.

With the ICBC deal under its belt, the Hong Kong Stock Exchange surpassed the London Stock Exchange for the highest aggregate volume of IPOs for 2007 so far (with the NYSE way back behind both). A global shift seems to have occurred...

First Shareholder Access Proposal Submitted for this Proxy Season

As Pat McGurn of ISS notes, investors are chanting "I want my MTV," meaning majority threshold voting standards. He predicts that over 200 companies will receive shareholder proposals calling for majority vote standards to be adopted; over 150 were submitted this year and they garned average support levels of 47%. As noted below, and as will be discussed during our upcoming webcast: "Shareholder Access and By-Law Amendments: What to Expect Now" - the first proposals seeking shareholder access have been submitted (as well as the first letters to the SEC opposing access, see this Business Roundtable letter that I just posted in our "Shareholder Access" Practice Area).

From the ISS Corporate Governance Blog: "Four pension funds this week submitted a resolution that seeks to allow shareholder-nominated candidates to run for seats on Hewlett-Packard's board of directors. This was the first proxy access proposal filed after a Sept. 5 federal court ruling that the Securities and Exchange Commission improperly allowed American International Group to omit a 2005 access resolution by the American Federation of State, County, and Municipal Employees Pension Plan (AFSCME).

The proposal at H-P was filed Sept. 25 by AFSCME, the New York State Common Retirement Fund, the Connecticut Retirement Plans and Trust Funds, and the North Carolina Retirement Systems. The resolution asks the company to change its bylaws to allow any shareholder group holding 3 percent of the shares outstanding for at least two years to nominate one or more directors. Collectively, the pension funds own more than 30 million H-P shares with a market value of $675.9 million, according to their press release.

"Proxy access is critical to insuring shareholder rights," New York State Comptroller Alan G. Hevesi said in a press release. "While we wait for the SEC to rule on this topic regarding all corporations, we are moving forward on a case-by-case basis to establish what should be a basic right for all shareholders."

H-P had no immediate comment on the shareholder proposal. The Palo Alto, California-based computer manufacturer has been embroiled in a controversy over a boardroom leak investigation authorized by former Chairman Patricia Dunn. Dunn resigned Sept. 22, two weeks after the company acknowledged that it hired a private investigator to obtain the phone records of directors and journalists. The SEC, federal prosecutors, and California Attorney General Bill Lockyer are investigating the company's handling of the leak probe, while U.S. lawmakers are holding hearings on the matter.

"The H-P board is completely dysfunctional and has been for a long time, which is an example of why shareholders have fought so hard for proxy access," Richard Ferlauto, AFSCME's director of pension investment policy, told Governance Weekly. "We seek to nominate directors at H-P who will make the board do its job better through an election process that is not stacked against investor interests."

October 20, 2006

Trying to Curb My Enthusiam: Judge Finds Grasso Breached Duties

I know I can't hide my grin today. Yesterday's partial summary judgment from New York State Justice Ramos validates a lot of what our mission has been about on CompensationStandards.com over the past three years - at many companies, the process of setting pay levels has been broken for years. The fixes are relatively simple; the hard part is convincing CEOs and boards that the gravy train is over.

True, the NYSE is a New York non-profit and the circumstances are fairly unique - but the real message for me here is that the courts are "loaded for bear" when evaluating pay packages. Interestingly, Justice Ramos is presiding over the In re Viacom Inc. Shareholder Litigation case slated for trial in a few months.

Here is an excerpt from an article in today's WSJ:

"Among Justice Ramos's findings: that the NYSE board wasn't made aware of a huge chunk of the retirement pay Mr. Grasso was due and that Mr. Grasso had a duty to disclose that pay to the board. The justice also had harsh words for the board.

"That a fiduciary of any institution, profit or not for profit, could honestly admit that he was unaware of a liability of over $100 million, or even over $36 million, is a clear violation of the duty of care," Justice Ramos wrote in a partial summary judgment, a pretrial ruling on certain aspects of a case. The case is particularly striking because the Big Board boasted an all-star roster of directors, including the chiefs of some of Wall Street's largest financial companies, each of whom made tens of millions of dollars in annual pay.

Jim Barrall, head of the global executive-compensation and benefits practice at Latham & Watkins LLP in Los Angeles, described the findings as "stunning." "I have never heard of a court decision finding a breach of fiduciary duty based on the failure to disclose all the numbers" about the size of a supplemental pension. At a minimum, Mr. Barrall suggested, corporate CEOs will have to make sure "the board understands the numbers and all the elements of the [leader's] pay package and how they work together." At many companies, the size of an executive's supplemental pension swells along with the magnitude of bonuses and equity awards."

Act Now: We continue to receive numerous requests for access to the video archive of last week’s “3rd Annual Executive Compensation Conference.” Apparently word is spreading – particularly about the need to take specific actions now - including implementing the three key analytic tools that need to be discussed in your upcoming CD&A.

You should watch the three separate panels on how to implement tally sheets, wealth accumulation, and internal pay equity - so that you will know how to disclose what your company is doing in these areas.

Market-Valued Employee Stock Options

In this podcast, Ben Stradley of Towers Perrin provides some insight into what the new financial instrument that mimics an employee stock option, the employee stock option appreciation right (also known as an "ESOAR"), including:

- What are ESOARs?
- Why would a company want to issue ESOARs?
- What are potential problems?
- What were the results of the Zions’ auction?
- What issues should companies consider regarding ESOARs?
- Are there other market-based approaches companies could consider?

At Last, There Goes My Innocence...

...guess I'm finally a grown-up now. The latest report from The Corporate Library on backdated options claims that director interlocks played a big role in the backdating scandal. Here is an excerpt from their press release:

"A new study by The Corporate Library of the 120 companies now implicated in the options backdating scandal finds new evidence that the practice of backdating stock options may have been spread by word of mouth through the network of directors sitting on the boards of more than one company. Director interlocking relationships now appear to be the most important governance characteristic and indicator of backdating problems.

The number of companies implicated in the options backdating scandal has more than doubled since The Corporate Library's first report on this subject, rising from 51 at the end of June 2006 to 120 companies at the end of September 2006. At the same time, the number of companies with directors sitting on other companies implicated in the scandal has risen almost fivefold, from 11 to 51. The most important relationships involve several directors who served on boards prior to 2002, when most backdating activity occurred, and continue to serve now, including Scott Kriens and Stratton Sclavos. Kriens and Sclavos, for example, are responsible for the central position of Juniper Networks within the network of linked companies, and between them sit on four other implicated boards.

In analyzing the director network, the authors of the report also found a wealth of intertwined relationships involving the Silicon Valley law firm of Wilson Sonsini Goodrich & Rosati. A number of the firm's senior partners, including Larry Sonsini, played multiple roles at many companies implicated in the backdating stock option scandal."

October 19, 2006

SEC Adopts "Best Price" Rule Amendments

Yesterday, the SEC adopted long-awaited amendments to the best-price rule, Rule 14d-10, which brings the M&A world back to "normal" in the wake of conflicting decisions among the US Circuit Courts in this area during the past few years. Here is an opening statement from Corp Fin - and here is an opening statement from Chairman Cox.

As expected, the amendments:

- clarify that the rule applies only with respect to the consideration offered and paid for securities tendered in a tender offer

- clearly exclude compensation arrangements, so long as they meet certain requirements

- provide a safe harbor for compensation arrangements that are approved by independent directors

- include an exemption that contains specific substantive standards that must be satisfied

Join two of the SEC Staffers who drafted the rule amendments - as well as two former SEC Staffers who served in Corp Fin's Office of Mergers & Acquisitions - in this newly announced DealLawyers.com webcast: "The Evolving ‘Best Price’ Rule."

Good News for Section16.net Members!

For the many of you that are members of Section16.net, we have just tweaked our database so that you can use your ID and password for Section16.net to access the thousands of pages of content on Section16Treatise.net.

We have made this switch now, since the two sites will be combined next year - creating an even more comprehensive resource for all your Section 16 needs. Try a no-risk trial for 2007 if you are not yet a member (and get the rest of 2006 for free) - or if you already are a member, renew your membership today (as all memberships are on a calendar-year basis).

Watch Out for those "Stealth" Restatements II

A few members reacted to my blog on "stealth" restatements. Here is one of those reactions: "I saw the WSJ article on “stealth restatements” and pulled the Form 8-Ks referenced in the article. My take on it is that the SEC Staff, through the comment letter process, is “informally” changing its policy on when an Item 4.02 Form 8-K is required.

The crux of an Item 4.02 filing is that a company’s Board, or the chief accounting officer, or the company’s external auditor concludes that previously issued financial statements “should no longer be relied upon because of an error in such financial statements” as addressed in APB No. 20. There are lots of situations – including, it would appear, the Sun Microsystems and Inter-Tel restatements - where a company restates its financial statements to correct and error, but the restatement does not cause the company or the external auditors to conclude that the prior financial statements cannot be relied upon. My reading of Item 4.02 is that a Form 8-K would not be required in those instances. By their comment letters, the SEC Staff seems to be expanding Item 4.02 to reach restatements where that critical conclusion has not been made. I don’t see any basis for that in the instructions to Item 4.02 or in the FAQ’s. Am I missing something in this analysis?"

Feel free to weigh in with your own analysis or experiences on this one by shooting me an email.

October 18, 2006

PCAOB Staff Issues Option Valuation FAQs

Yesterday, the PCAOB Staff issued a set of 22 FAQs entitled "Auditing the Fair Value of Share Options Granted to Employees." The FAQs address auditing the fair value measurements associated with determining compensation cost. It highlights risk factors that auditors should be aware of and addresses the auditor’s consideration of the process for developing a fair value estimate, significant assumptions used in options pricing models, and the role of specialists in fair value measurements.

M&A Dispute Resolution: Getting Deal Lawyers Into the Game

Next Tuesday, catch Jim Freund, Mediator and former Partner of Skadden Arps Slate, Meagher & Flom LLP - and one of the foremost M&A lawyers of any generation - in the DealLawyers.com webcast: "M&A Dispute Resolution: Getting Deal Lawyers Into the Game." Settling the all-too-frequent post-closing disputes spawned by M&A deals is too important to be left solely to the litigators! Transactional lawyers should step up to the plate to help achieve commercially-sound solutions through negotiation or mediation.

Among other topics, Jim will cover:

- Why is resolving disputes such tough work
- How deal lawyers can add real value for their clients in the mediation process
- What are some common pitfalls in M&A disputes – and how to overcome them
- What are the keys to persuading a mediator as to the merits of your cause

And now you can catch this program at no cost if you take advantage of our no-risk trial for 2007 (and get access to DealLawyers.com for the rest of 2006 for free).

Sovereign Bancorp: "I Pity the Fools"

Last week, Sovereign Bancorp "fired" its CEO. You may recall that Sovereign Bancorp was last year's "governance posterchild of the year" in my humble opinion. Of course, I use the term "fired" loosely since the company's board didn't remove the CEO "for cause" - why do that when you can pay the guy a bushel of the shareholder's money on the way out the door? I pity Sovereign Bancorp's shareholders.

Here is a related WSJ article from Saturday:

"By all appearances, Jay S. Sidhu was forced out in the past week as chairman and chief executive of Sovereign Bancorp Inc. Under his employment agreement, that could allow him to walk away with a severance package valued at tens of millions of dollars.

Several board members at the Philadelphia bank had been pressing for Mr. Sidhu's dismissal due to concerns about the company's earnings outlook, its stock performance - it trades at a discount to peers - and about deals he has engineered. But there is a catch: Sovereign's official explanation for his departure didn't match what was happening behind the scenes. The company said Wednesday that Mr. Sidhu "resigned and retired...for family health related reasons."

If he jumped from the plane on his own volition as Sovereign says, compensation experts argue, Mr. Sidhu isn't entitled to the golden parachute he appears to have gotten.

Nobody expected this to keep Mr. Sidhu from securing a rich goodbye package. His contract doesn't include poor performance as a reason to deny him severance, so pay experts say he deserves the money if he was effectively fired. And Sovereign is hardly the first company to gloss over the reasons for an executive departure. But critics in the corporate-governance community say the company's story should match its actions.

"It isn't acceptable if he is being terminated to say that he is leaving voluntarily, nor is it acceptable for the company to pay him severance if he is leaving without good reason," says Paul Hodgson of research firm Corporate Library. A Sovereign spokesman declined to comment. Mr. Sidhu didn't respond to requests for comment.

Late Friday, Sovereign disclosed in a regulatory filing that Mr. Sidhu would, in fact, collect more than $40 million in payments stemming from his departure. And the company acknowledged that "the resignation and retirement came in the face of a threatened termination by the company."

October 17, 2006

UnitedHealth's Latest Revelation: Compensation Committee Chair Handled CEO's Money

As the mainstream media drools over the imminent departure of UnitedHealth's CEO for option backdating, I was stunned to see that one of the company's directors, William Spears, resigned in the wake of revelations that Mr. Spears was handling some of Dr. McGuire's financial investments at the same time he was presiding over the company's compensation committee. The details of the financial entanglements are laid bare in this 14-page Special Committee Report prepared by Wilmer Hale (but this relationship was not disclosed in the company's latest proxy statement).

One area where the plaintiffs' bar continues to press in lawsuits is the lack of director independence. For example, the In re Viacom Inc. Shareholder Litigation case is scheduled to go to trial in January after New York Supreme Court Justice Charles Ramos denied Viacom's motion to dismiss this past June. As you might recall from an earlier blog, 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.

And even if directors are not conflicted, they might be treated as a conflicted persons if they are "dominated" by someone who has a conflict, including an executive or another director. Based on recent caselaw, a court would probably investigate the extent to which other directors were dominated by Mr. Spears or Dr. McGuire - and perhaps apply a "director-by-director" analysis as done in Emerging Communications and Emerald Partners.

What about personal liability for those directors who went along with Mr. Spears, as head of the compensation committee? Personal liability requires greater culpability than a mere lack of independence. However, there are claims that could be brought (for example, corporate waste) that could give rise to personal liability - at which point, tricky indemnification and D&O insurance issues are raised. And remember that other issues are raised by lack of a compensation committee's independence, such as the loss of the exemption under Section 16(b) - see our "Director Independence" Practice Area for more analysis.

Yesterday, the UnitedHealth board announced this series of actions it intends to take (including a pat on the rump for Director Spears). After the plaintiffs' bar is through with them, me thinks this list will grow a wee bit longer...

A Conference Recap

I was pleased to be quoted in Sunday's NY Times article by Gretchen Morgenson (who also cited both last week's "3rd Annual Executive Compensation Conference" and our 2nd Annual Conference as well), but I didn't agree with the characterization of Fred Cook as someone who has caused many of the compensation problems that we now face. At a time when quite a few compensation consultants are still afraid to step up to the plate and provide responsible advice to their clients, Fred Cook remains a bright beacon who is not afraid to say what he thinks is right, regardless of what those that defend the status quo might think.

For example, Fred has spoken about internal pay equity as an alternative benchmark at our past two conferences. Very few consultants are willing to speak on the topic, perhaps because they view it as an admission that their long-standing reliance on peer benchmarking was in error.

I was happy to speak to a few consultants in our audience who said that they were "coming around" and now recognize the utility of internal pay equity. I wouldn't be surprised for internal pay equity to become as ubiquitous as tally sheets over the next few years.

Mourning for Larry the Mailroom Guy

The SEC is mourning the loss of one of the true great characters on the Staff. I had countless conversations with Larry during my two tenures at the SEC and he always brightened my day. Below is a note from Chairman Cox to the Staff:

"This is a grim day for the SEC, because we are mourning the loss of one of our community. Larry Levine, whose passing late Tuesday has saddened all of us, in many ways exemplified what is best about our organization.

At death we remember and celebrate life -- and there was much about Larry's life worthy of remembrance and celebration.

Despite being born with a developmental disability and being legally blind as an adult, Larry earned an AA degree at Montgomery College. He then made a career here at the SEC, for 28 years. Larry didn’t just put in his time here, but reveled in the fact that he was part of our mission. Like all of us, he was honored to wear the SEC badge. At times when the agency had early departure -- whether because of inclement weather or building malfunction -- Larry wouldn’t leave. He would just say to a supervisor or colleague, “brother, I have work to get out.”

Larry was a dedicated worker who never lost sight of how important his task was. In nearly three decades his sense of duty never wavered. His excitement carried over to his personal life -- including a love of horse racing, and the Dallas Cowboys. He loved his family, and was a loyal son to his parents Frances and Albert, a dedicated brother to sister Cindy and brother Rusty, and an adoring uncle to his niece.

Larry overcame the odds and served his country, and America's investors, with distinction. His example of transcending difficulty and meeting life's challenges with enthusiasm will remain an example to us all."

October 16, 2006

California: Majority Vote Law Enacted

Back on September 30th, California Governor Schwarzenegger did signed SB 1207 into law (a topic that has been the subject of several blogs). Here are a few thoughts from Keith Bishop:

1. The amendments allows a "domestic corporation" that is also a "listed corporation" to amend either its articles of incorporation or bylaws.

2. Not every publicly-traded corporation is a "listed corporation". A "listed corporation" is defined as a corporation with outstanding "shares" listed on the NYSE or the AMEX or a corporation with outstanding "securities" listed on the National Market System of the Nasdaq Stock Market (or any successor to that entity). Cal. Corp. Code Section 301.5(d).

Note that California has not yet amended Section 301.5(d) to take into account the recent change in status and name of the Nasdaq markets. Publicly traded companies with only debt securities listed on the NYSE or AMEX, shares traded on the OTC Bulletin Board or the Pink Sheets will not be affected by the new law.

3. The new law doesn't require a majority vote - it requires "approval of the shareholders" which is defined a little bit differently. Under California law, "approval of the shareholders" requires the affirmative vote of a majority of the shares represented and voting at a duly held meeting at which a quorum is present. This requirement is similar to a majority of the votes cast (i.e., abstentions don't have a negative effect).

However, California adds an additional requirement that the shares voting affirmatively must also constitute at least a majority of the required quorum. For example, assume that a corporation has 100 shares issued and outstanding and 51 shares are present at a meeting. If 25 votes are cast FOR, 24 votes are cast against and 2 votes are abstention, the first part of the test will be met. 25 votes represents a majority of the shares represented and voting (25/25+24 = 51%). However, the second part of the California test will not be met. The required quorum is 51 and 26 votes would be required to constitute at least a majority of the required quorum.

4. The new law does not limit the right of the board appoint a candidate who fails be reelected to special circumstances. The bill simply provides that a vacancy may be filled in accordance with existing Section 305 of the Corporations Code. That section generally allows vacancies (other than by removal) to be filled by "approval of board" or if the number of directors then in office are less than a quorum by (i) the unanimous written consent of the directors then in office; or (ii) the affirmative vote of a majority of the directors then in office.

This rule may be abrogated by the articles or bylaws. Thus, it is important to check them. If the vacancy is the result of a removal, the directors may not fill a vacancy unless the articles or a bylaw adopted by the shareholders so provides. Although the failure to be reelected has the effect of a removal, I don't believe that a vacancy occurring by reason of a failure to be reelected should be treated as a removal for purposes of Section 305. I hope that this and other drafting problems with the new law will be corrected in the future.

5. As a result of the enactment of SB 1207, California domestic corporations that are listed corporations must now decide whether to retain (or even re-adopt) cumulative voting (in which case the provisions of the new law won't be available). If they elect to opt out of cumulative voting or have already done so, the board (unless the power to amend or adopt bylaws has been restricted or eliminated) or the shareholders could choose to adopt the new voting procedures.

Wave of Class Actions Filed Against Sponsors of 401(k) Plans

From a recent Gibson Dunn memo (which is included in our "ERISA Securities Litigation" Practice Area): "A wave of putative class action lawsuits were filed last week against sponsors of 401(k) plans and other defined contribution retirement plans. The lawsuits were filed in federal courts throughout the country against some of the largest and best known companies in the U.S. The lawsuits, alleging violations of the Employee Retirement Income Security Act of 1974 ("ERISA"), target the fee structures found in some plans that offer mutual fund investments as well as plans that permit participants to invest in a fund comprised solely of the sponsor's stock. Several observers have predicted that additional similar lawsuits will be filed in the future against other companies and their 401(k) plans or other defined contribution retirement plans.

While each lawsuit is founded on the specific terms of the plans in question, they all have several common characteristics:

1. The named defendants are the corporate plan sponsors, the administrative committees for each plan, and, in some instances, the individual members of the board of directors for the corporate sponsor.

2. Each lawsuit asserts that the compensation paid to investment managers and other service providers is excessive, thereby violating the prohibited transaction rules of ERISA. The complaints allege that, in addition to “hard dollar” forms of compensation, many of the investment managers and/or administrative service providers are compensated by undisclosed revenue sharing for having steered plan investments to a particular investment vehicle. These allegations echo complaints made by investors and others in the past few years against brokerages and mutual funds for not disclosing certain fees and compensation paid to the broker for making the fund available to investors.

3. Several of the plans in question are ERISA § 404(c) plans that permit participants to select the investment fund in which their account balances will be invested. The class action suits allege that the failure to disclose the true compensation arrangement for service providers constitutes a violation of the disclosure rules under ERISA.

4. Some of the lawsuits challenge the fees charged participants in connection with funds in which the participant can invest in the sponsor's stock.

October 13, 2006

The SEC: Ready to Take Action

On Wednesday, the SEC announced that it will take action on a number of items, including:

- adopting changes to the tender offer best price rule next Wednesday, October 18th

- delaying a proposal to amend Rule 14a-8 from next Wednesday to December 13th (remember this is the AFSCME case response from the SEC)

- proposing guidance on internal controls on December 13th (part of the SEC's recommended package of 404 relief announced by the SEC a few months ago)

- adopting rules for foreign private issuer deregistration on December 13th

- adopting rules for e-Proxy (i.e., Internet proxy delivery) on December 13th

Based on the SEC's notice about next week's "best-price" rule consideration, it appears that the SEC will apply the amendments to both issuer and third-party tender offers and will clarify that the best-price rule (i) does not apply to securities that are not tendered in a tender offer; and (ii) does not apply to consideration paid according to employment compensation, severance or other employee benefit arrangements with securityholders. It does not appear that the amendments will provide similar exemptive relief or a safe harbor with respect to other agreements with securityholders (e.g., commercial arrangements) or that they will include a de minimus exception.

And as the shareholder proposal rule amendment quickly became a political issue - and potentially a 3-2 vote along partisan lines if shareholder access was not included as part of the SEC's proposal - my guess is that the delay might have been to move it to a post-election date...

SEC Issues NYSE's Proposal to Eliminate Treasury Stock Exception

Last week, the SEC issued the NYSE's proposal to eliminate the treasury stock exception from the requirements for shareholder approval under Section 312.03. Under current rules, listed companies have to calculate the number of shares issued to determine whether the shareholder approval requirement is triggered. This calculation may be affected if the company reissues treasury stock. Historically, this rule has not applied to any issuance of treasury shares. Under the NYSE's proposal, listed companies would be required to include treasury stock in that calculation. There is a 21-day comment period for the proposal.

If adopted as proposed, the NYSE's proposal would also:

- require listed companies to notify the NYSE when they issue treasury stock

- clarify that the shareholder approval requirement for related-party issuances to a "series of related transactions"

- clarify that "market value" means the official closing price as reported to the Consolidated Tape immediately before entering into a binding agreement selling securities

The NYSE also put companies on notice that any agreements entered into after 5 business days from the date the SEC publishes notice of this proposal in the Federal Register will not be grandfathered. Not much of a transition period and something to be aware of as this window period will close shortly.

You Ain't Really Done Vegas...

...until you can say you have done time in her emergency rooms. I spent Wednesday night in a Vegas emergency room. Food poisoning or food allegery. Started puking at noon and by 9 pm, I thought I was gonna die. Couldn't breathe nor swallow.

The ER was a trip; no proof of insurance required - so standing room only and folks appeared to be near death left and right. So my case was just like anyone else and the wait was loooong. So now I can say I have really done Vegas! I'm so happy to be alive!

October 12, 2006

A Deeper Look: How Contested Elections are Inspected

I hope you caught last week's webcast - "Understanding Overvoting and Other Tricky Voting Issues" - and if not, it's never too late as the audio archive is available. One of the panelists, Bill Marsh, President of IVS Associates (the largest independent tabulator), responded to my recent blog that wondered why it would take so long to finalize the results of the recent contested election at Heinz. Here is some education from Bill:

IVS was the tabulator and inspector of election for Heinz and was the focus of questions regarding the length of the tabulation process. Such questions are not unusual and, for the most part, inspectors are used to it. Some things to bear in mind:

- Proxy fights often take several weeks, and even longer, for inspector certification.

- The inspectors' tally begins after the polls have closed (according to IVS practices). No additional votes are accepted by the inspectors under any circumstances.

- In proxy contests, record holders (those who hold certificated shares) are generally mailed three or more proxy cards from each side and sometimes have the ability to vote electronically(telephonic or Internet). Of course, how many times they vote really does not matter as far as the outcome is concerned; only the latest-dated valid vote counts. The point is that the tabulator spends many hours sifting through proxy votes (both hard copy and electronic voting files) to find the last-dated valid instruction for all the record holders. Some of the larger contests have well over 25,000 record holders.

Also, there is the “street vote” (beneficial holders through banks and brokers) - as administered mostly by ADP. This part of the tabulation involves gathering data from printouts of often more than a hundred pages and entering it into a database. If there are overvotes (a bank/broker voting more shares than assigned by the depository), the inspectors contact the bank/broker (usually through ADP) to get them resolved (per Delaware Law, which IVS follows if other states are silent).

When the inspectors have completed the preliminary tabulation, attorneys and solicitors from each side of the contest have the right to review all votes and present challenges to the inspectors. This process can last anywhere from several hours to several days - several weeks even.

The entire process is time consuming and tedious. Also, speed is the not the major concern- accuracy and the integrity of the voting results are. Shareholders and advocates should take comfort in the time and diligence that is put into the tally and getting it right so the holders votes are what carry day.

October 11, 2006

How to Watch Tomorrow's Conference

If you are attending tomorrow's "3rd Annual Executive Compensation Conference" by webcast, remember that the panel times are Pacific/West Coast time, which means Las Vegas is 3 hours behind the Eastern seaboard (but the four "bonus" panels are already posted and can be listened to at any time).

Course materials for each panel are posted directly beneath the links available for that panel. As always, each panel has a set of "talking points" posted, which are very helpful for taking notes. I have combined them in a PDF, if you want to print off a complilation of the talking points created for this year's Conference. And there are many other materials listed below each panel's links.

To gain access to the Conference, simply go to the home page of CompensationStandards.com and follow the prominent link that will be at the top of the page and input your ID/password (which should be the same ID/pw for CompensationStandards.com if you are a member that registered for the Conference). Then, you have three choices: (1) watch the panels consecutively live; (2) watch a specific panel live; or (3) watch a panel by archive (it will take 5-6 hours for a panel to be archived after it is over).

One technology item to note: You need approximately 600k of continuous incoming bandwidth in order to view a panel through a 500k link. If that high level of bandwidth is not available for you, your player will either not open or continuously buffer (i.e., freeze). If you experience this type of problem, it is highly recommended that you switch to a 56/100k link to watch the video. Here are other troubleshooting tips if you need them. If you're coming to Las Vegas, see ya there!

CLE Credit: We also have posted this list of states with the status/number of hours available for CLE credit, divided into two categories: those attending online and those attending in DC. If you are in a state for which the Conference is accredited for online CLE - please register for CLE for webcast attendance and follow the instructions there (then, approximately 3-4 weeks after the Conference, we will e-mail you a Certificate of Attendance).

No Secrets: How Funds Vote Your Shares

Last week's WSJ included this article about how mutual funds vote their shares; here is an excerpt:

"A burgeoning number of researchers are focused on the data, with two general conclusions so far: The biggest mutual-fund companies overwhelmingly do vote with management, more so than at least one leading independent adviser recommends. But they don't appear to favor companies where they run 401(k) retirement-savings or other investment programs. And on select issues -- those seen as directly affecting stock returns, such as votes over anti-takeover provisions -- fund companies have proved willing to go to battle.

Mutual funds of the nation's biggest and best-known money-management companies voted in support of management 92% of the time during the 12 months ended June 30, 2005, according to a study by Corporate Library, a governance-research firm in Portland, Maine. When it came to resolutions sponsored by shareholders, which managements generally oppose, the funds voted in favor less than one-third of the time, or 30%. (These statistics don't include so-called socially responsible funds, which often vote against managements.)

In contrast, during the same period Glass Lewis & Co., one of several prominent firms that provide so-called proxy-vote recommendations to institutional investors like foundations and pension plans as well as mutual-fund companies, recommended that its clients vote for 80% of management-proposed resolutions and more than half -- 53% -- of shareholder resolutions."

October 10, 2006

Food for Thought: Delaware Law Concerns and Majority Vote By-Law Amendments

Here is another pearl of wisdom from Kris Veaco:

I learned something the other day during a conversation about majority voting with John Johnston of Morris Nichols that I think is worth raising since the majority vote movement is in full swing. Morris Nichols has just written a memo entitled “The Nuts and Bolts of Majority Voting” that raises some significant concerns about the effectiveness - under Delaware law - of certain by-law amendments being adopted to implement majority voting.

As we know, a number of companies have adopted some form of a majority vote standard - and of those, some have elected to amend their by-laws to accomplish that, instead of amending their governance guidelines. For those Delaware corporations that have used by-law amendments like the one below, or are contemplating doing so, it sounds like a conversation with Delaware counsel may be in order. I just looked through Broc’s spreadsheet on those companies with majority voting standards and picked out this representative by-law provision:

"Except as provided in Section 3 of this Article II, each director shall be elected by the vote of the majority of the shares cast with respect to the director at any meeting of stockholders for the election of directors at which a quorum is present, provided that if at the close of the notice periods set forth in Section 13 of Article III, the Presiding Stockholder Meeting Chair (as described in Section 14 of Article III) determines that the number of persons properly nominated to serve as directors of the Corporation exceeds the number of directors to be elected (a “Contested Election”), the directors shall be elected by a plurality of the votes of the shares represented at the meeting and entitled to vote on the election of directors. For purposes of this Section, a vote of the majority of the shares cast means that the number of shares voted “for” a director must exceed the number of votes cast “against” that director. If a director is not elected in a non-Contested Election, the director shall offer to tender his or her resignation to the Board of Directors. The Governance and Nominating Committee of the Board of Directors, or such other committee designated by the Board pursuant to Section 5 of this Article II for the purpose of recommending director nominees to the Board of Directors, will make a recommendation to the Board of Directors as to whether to accept or reject the resignation, or whether other action should be taken. The Board of Directors will act on the committee’s recommendation and publicly disclose its decision and rationale within 90 days following the date of the certification of the election results. The director who tenders his or her resignation will not participate in the Board’s decision with respect to that resignation."

The Morris Nichols memo points to those features of the current by-law provisions that are troublesome - and offers some alternatives. For example, they note that by-laws requiring a director to resign appear to be contrary to Section 141 of the DGCL, and that the new provision of Section 141(b) allows a director to tender an irrevocable resignation conditioned on the failure to receive a specified vote.

In other words, there is a way to accomplish the goal, but it requires the director to have made an election to resign in advance. For example, the annual D&O Questionnaire could include an advance irrevocable election to resign made by each director that the Board would then use if the director failed to gain the required vote. In addition, they raise concerns about the recusal provision and the language about contested elections.

Nasdaq Proposes Consistency Change for Related-Party Transactions

Last week, Nasdaq filed a proposed change to the threshold in its director independence rule from $60,000 to $120,000 to be consistent with the SEC's new related-person rules.

Transcript Available: John Olson on "The Board Presentation"

Due to popular demand, we have posted a transcript of John Olson's keynote presentation from our September executive compensation disclosure conference. The video archive of John's remarks is still available at no charge - and continues to get rave reviews!

October 9, 2006

John White: Executive Compensation Disclosure and the Important Role of CFO's

Last week, John White delivered another speech in his series on the SEC's new executive compensation rules. Speaking before a group of CFOs, John discussed:

- CFOs' involvement in the substance of disclosure, particularly the new Compensation Discussion & Analysis

- CFOs' involvement in refining and adjusting disclosure controls and procedures

- CFOs' involvement with compensation committee and its new Compensation Committee Report

What is a Director's Duty to Go Beyond Management's Board Book?

In the General Motor's recent development - Jerome York quitting the board (York was placed on the GM board by 9.9% shareholder Kirk Kerkorian) - the issue of what is a director's duty to look beyond the board materials prepared by management is raised. York claims one of the reasons he quit was because "I have not found an environment in the board room that is very receptive to probing much beyond the materials provided by management (and too often, at least in my experience, materials are not sent to the board ahead of time to allow study prior to board discussion)." This is an excerpt from York's resignation letter filed as an exhibit to this Form 8-K. An interesting question that is discussed, among others, in our "Board Materials" Practice Area.

New Whistleblower Decision Provides Clarification on Protected Activity

From a recent Gibson Dunn memo (related memos are posted in our "Whistleblowers" Practice Area): In one of the most important Sarbanes-Oxley " "whistleblower" decisions to date, the Department of Labor's Administrative Review Board ("ARB," or "Board") has reversed the decision of an Administrative Law Judge and ruled that FLYi, Inc. did not violate the Act. Platone v. FLYi, ARB Case No. 04-153 (September 29, 2006). The case, which was handled before the ARB by Gibson, Dunn & Crutcher LLP and Ford & Harrison LLP, provides important new guidance on what constitutes protected "whistleblowing" under Sarbanes-Oxley ("SOX").

The complainant, Stacey Platone, was employed as a labor relations manager for FLYi (then known as Atlantic Coast Airlines). As part of its collective bargaining agreement with the Air Line Pilots Association ("ALPA"), FLYi paid certain pilots for time that they spent on union activities when they otherwise would have been flying. The union was then to reimburse the Company for this "flight pay loss." Platone alleged - and reported to her superiors - that some pilots were abusing the system by intentionally scheduling flight time on days they otherwise would have taken off, but that they knew were reserved for union business. By then dropping the flights to attend to union-related business, Platone charged, the pilots were able to collect flight pay.

At about the same time, it was learned that Platone was romantically involved with a pilot who was an influential member of ALPA. After an investigation, her employment was terminated due to what the Company judged to be an undisclosed conflict of interest.

Platone filed suit under SOX, claiming that her employment was terminated because she had reported mail, wire, and securities fraud within the meaning of the Act. Specifically, she claimed, the alleged flight loss abuses were improperly funneling money to certain pilots at the expense of the union or - in the event the union refused reimbursement - at the expense of the Company. The ARB, overruling an earlier decision by an Administrative Law Judge, concluded that Platone's internal reports did not constitute protected activity under SOX, and that FLYi's decision to terminate her therefore did not violate the Act.

The ARB's decision provides important guidance on protected activity under SOX:

- By its terms, protected activity under SOX includes reporting what one reasonably believes to be a violation not only of the securities laws, but also of the federal criminal mail, wire, and bank fraud statutes. However, the ARB made clear in Platone, an allegation of mail or wire fraud "must at least be of a type that would be adverse to investors' interests" in order to be protected by SOX. Slip Op. at 15. Thus, in this case for example, to the extent Platone was reporting potential losses to the union (which reimbursed the flight pay loss), she was not engaged in Sarbanes-Oxley protected activity.

- Sarbanes-Oxley protected activity "must relate 'definitively and specifically' to the subject matter of the particular statute under which protection is afforded," the Board said. The Act "does not provide whistleblower protection for all employee complaints about how a public company spends its money and pays its bills." Id. at 16 (emphasis added). "Thus, for example," the Board continued, "an employee's disclosure that the company is materially misstating its financial condition is entitled to protection under [SOX]." Id. at 17. In this case, however, Platone "raised a possible violation of internal union policy and she expressed concern on how this might affect [FLYi's] ability to collect a debt, but nothing approximating fraud against shareholders." Id. at 18.

- Third, the ARB made clear, where the purported protected activity involves reported fraud against shareholders, the materiality of the potential loss is significant. The materiality of a misrepresentation or omission is a "basic element[ ]" of a securities fraud claim, the Board elaborated, but "Platone testified to less than $1,500 of potential losses" to FLYi. "It is unlikely that a reasonable shareholder would find a loss of less than $1,500 material." Id. at 21. This statement by the Board contrasts with earlier pronouncements by Labor Department administrative law judges that materiality is irrelevant to SOX whistleblower claims.

Because Platone did not engage in protected activity, the ARB reversed the decision of the Administrative Law Judge and dismissed the complaint.

The ARB declined to address other issues in the appeal, including the important question of when a parent company that does not directly employ the complainant is a proper respondent under Sarbanes-Oxley. In another case before the Board, the Solicitor of Labor has submitted an amicus brief arguing that the familiar four-part "integrated employer" test should determine whether a company is a covered employer under the Act. See Brief of the Assistant Secretary of Labor for Occupational Safety and Health, Ambrose v. U.S. Foodservice, Inc., ARB Case No. 06-096 (Sept. 1, 2006).

October 6, 2006

Updated Sample D&O Questionnaire Now Available!

On both TheCorporateCounsel.net and CompensationStandards.com, we have posted an updated sample D&O questionnaire; updated for the new SEC rules. Note that this is a mere "sample," so the typical disclaimers apply...

Sample Compensation Disclosure Checklist

Thanks to Todd Rolapp of Bass Berry, I also have posted a "compensation disclosure checklist" in a Word file in "The SEC's New Rules" Practice Area of CompensationStandards.com. This is not a mock-up; rather it's a document that can be used as a starting point to help get a head start on preparing next year's proxy - you can use it to assign sections to the appropriate persons within the company responsible for gathering certain types of data (and it can help get people motivated and not drag their feet in getting this big job done).

Section 409A Deadlines Extended!

On Wednesday, the IRS and the Treasury Department issued a notice which deals with the Section 409A regulations, including discounted stock option grants (here are some memos analyzing this notice). Here is some analysis from "Mike Melbinger's Compensation Blog" on CompensationStandards.com: I try not to blog twice in one day, but this news is too good not to share. Just moments after I sent my previous Blog, the IRS published Notice 2006-79, which provides transition relief from the December 31, 2006 deadlines of 409A by:

- Announcing that the final regulations will not become effective until January 1, 2008,

- Generally extending through 2007 the transition relief provided for 2006 in the preamble to the proposed regulations except with respect to certain discounted stock rights,

- Providing additional transition relief for certain payment elections in linked plans and certain collective bargaining arrangements, and

- Extending the amendment date for certain plans that took advantage of transition relief provided for 2005.

October 5, 2006

Our "What is a Perk?" Survey is Up!

As promised, we have posted our Quick Survey on "What is a Perk?" with fourteen different scenarios for your input. I received dozens of other suggested scenarios from members - but I didn't want to overwhelm you, so I picked the ones that appeared most likely to be universally applicable. Please take a moment to complete the survey now.

And thanks to Brink Dickerson of Troutman Sanders, we have posted this list of potential perks in CompensationStandards.com's "Management Perks" Practice Area to help you identify the types of items/services you should be on the lookout for as you enhance your disclosure controls & procedures.

"Perk Tester" Flow Chart, Sample Board Presentations and More

In "The SEC's New Rules" Practice Area on CompensationStandards.com, I continue to post all sorts of useful information, including a few sample PowerPoint presentations that can be tailored for a board presentation and a nifty flow chart from Lou Rorimer of Jones Day to help ascertain "what is a perk?"

Emissions Reduction as a Corporate Governance Issue

One area that I intend to cover more are the "social" issues that have emerged as real business issues. In this podcast, David van Hoogstraten of Hunton & Williams explains how emissions reduction has emerged as a corporate governance issue, including:

- In what ways are greenhouse gas emissions reductions now seen as a corporate governance issue?
- What are shareholders doing to push for more disclosure of emissions?
- How are the markets and investment banks fostering sustainable production as a hallmark of the well-governed company?
- Why do we see more internal evaluations of companies’ sustainability efforts?
- Why should lawyers be involved in the preparation of public environmental reports?

October 4, 2006

Watch Out for those "Stealth" Restatements

A few weeks back, the WSJ ran this article about the SEC Staff's push for more companies to disclose their restatements under Item 4.02 of Form 8-K. Apparently, a lot of companies are restating without filing a Item 4.02 8-K - rather these companies are including the new financials in their next 10-Q or 10-K, despite the fact that FAQ 1 of the SEC's 8-K FAQs says you can't do that.

The Staff is busy issuing comment letters to companies who have not filed the Item 4.02 8-K, because investors rely on seeing a 8-K to signal that a restatement has taken place. The comments often ask the reasons why a Form 8-K wasn't filed - rather than demand that one be made - because Item 4.02 isn't triggered for every restatement, just "material" ones. So companies get an opportunity to argue why a 8-K wasn't necessary.

Of course, companies aren't going to always win this argument. Apparently, Inter-Tel (a company quoted in the WSJ article) apparently didn't file the 8-K because they determined that the changes made in the restatement were immaterial to any prior quarter or reporting period, but the Staff reportedly asked that they go back and highlight the restatement in a specific filing.

How Does SAB 108 Work Here?

Juxtapose these stealth restatement situations to newly-issued SAB 108 which states, as noted in this press release: “The Staff will not object if a registrant records a one-time cumulative effect adjustment to correct errors existing in prior years that previously had been considered immaterial – quantitatively and qualitatively - based on appropriate use of the registrant’s previous approach.” SAB 108 describes the circumstances where this would be appropriate as well as the required disclosures that must be made.

I guess the bottom line here is to go ahead and clean up the balance sheet to correct those immaterial errors - but if you determine that you need to restate, don't skip the 4.02 8-K filing.

New FAS 158 on Pension Plan Accounting

On Friday, the FASB issued FAS 158 on "Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans." Here is a summary of FAS 158. This is quite a complex statement that covers retiree health care benefits in addition to pension plans. The impact on companies will vary - and could be quite significant for some. The resulting balance sheet changes could have effects on contractual provisions (e.g. loan agreements) and measurements for other purposes, such as net worth or shareholder's equity.

FAS 158 requires employers to recognize the overfunded or underfunded status of a defined benefit post-retirement plan (other than a multi-employer plan) in the statement of financial position, measured as the difference between plan assets at fair value (with limited exceptions) and the benefit obligation. It also would recognize - as a component of other comprehensive income, net of tax - the gains or losses and prior service costs or credits that arise during the period, but pursuant to FAS 87 and 106 are not recognized as components of net periodic benefit cost. There also are disclosure requirements.

The recognition and disclosure requirements are effective for fiscal years ending after December 15, 2006 - so it will apply this year for calendar year companies. There are separate effective date and transition provisions for a new measurement date requirement to measure plan assets and benefit obligations as of the date of the employer's fiscal year-end statement of financial position.

FAS 158 is phase one of the FASB's project on pension and other post-retirement benefit plans. Phase two will address other issues, including income statement treatment of pension plan adjustments.

October 3, 2006

Overvoting: The Next Big Scandal?

As overvoting has been my pet peeve for quite some time, I'm pretty excited about tomorrow's webcast - "Understanding Overvoting and Other Tricky Voting Issues" - where a group of experts will educate us about what overvoting is all about and why you should care.

Education is important because there is so much misinformation out there on the topic and it's pretty hard to pin down exactly what is going on "behind the scenes" when it comes to director elections. For example, did anyone find it peculiar how it was reported that it would take one month for tabulators to finalize the results of the recent contested election at Heinz? One month!

As evident from this press release, the NYSE is paying more attention to overvoting issues these days as it recently fined UBS, Goldman Sachs and Credit Suisse for permitting overvotes to occur. Here is an excerpt from the NYSE's press release:

"There are no standard industry procedures that govern a Tabulator’s approach to dealing with over-voting. Depending upon the procedure implemented by the Tabulator, certain customers’ voting instructions may not be represented as originally given. Enforcement’s investigations have not uncovered any instance in which an over-vote improperly affected the outcome of a proxy vote or any instance in which a shareholder who attempted to vote was disenfranchised.

However, by submitting an over-vote, a member firm subjects its customers to the risk that the Tabulator would not accept their votes. Through an under-vote, a member firm subjects its customers to disenfranchisement by the broker-dealer’s own actions."

In my view, it's only a matter of time before an overvote will "improperly affect the outcome of a proxy vote" as majority vote standards become more common and investors increasingly challenge boards and management. At a minimum, the time clearly has arrived for standard industry procedures! Floyd Norris of the NY Times recently focused on overvoting and related issues in this column, "Time to Bring Share Lending Into the Light." And we have posted some overvoting articles in our "Annual Stockholders' Meetings" Practice Area.

The Impact of Short Selling Tactics

Among the topics to be discussed on tomorrow's webcast is how lending shares and short selling plays into the quagmire of vote outcomes. Naked short selling has caught the attention of the SEC, as the agency recently proposed to amend Regulation SHO (see our new "Short Sales" Practice Area). And there are groups whose sole purpose is to tackle this issue, such as the National Coalition Against Naked Shorting.

Companies with smallish floats likely are the most vulnerable to short selling tactics in elections. One of our webcast panelists, Carl Hagberg, supports that view and disagrees with those that assume that small floats would lead automatically to higher borrowing costs. Carl believes that those that don't think illiquid companies are vulnerable fail to account for the facts that (a) you only need to borrow stock for one day (ie. the record date) to get the votes; (b) a lot of "lenders" never even have stock to "lend" - and no one can ever tell since the "loan" is effected by a mere "bookkeeping entry"; and (c) there no penalties if the stock never really moves (who's checking? no one!) - or if bookeeping "errors" are simply reversed later! Carl's latest issue of his Shareholder Service Optimizer shows how there is fairly compelling evidence that the Hewlett-Packard/Compaq merger would not have been deemed to have been approved by shareholders "but for" overvoting making the difference.

There clearly are a lot of thorny issues involved - although why some of these issues are thorny is beyond me. For example, if the brokers can keep track of who gets a dividend, why can't they keep track of who has voted? And why is the disclosure about the ramifications of having one's shares lent so unclear in most brokerage agreements (what a place for plain English!)? We shall learn more about these tricky issues during tomorrow's webcast.

October Eminders is Up!

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

October 2, 2006

Our Upcoming Perk Survey

Responding to numerous member requests who are grappling with "what is a perk?," I am in the process of compiling items/thresholds to include in an online survey to help gauge what consensus there might be among practitioners in this area. Please email me any items/thresholds that you want folks to vote upon - your identity will remain anonymous.

At Last! An Opportunity to Comment on ISS' Proxy Policies

Last week, ISS commenced its first-ever public comment period, allowing anyone to provide input into its 2007 proxy policies. In the past, input was privately solicited from a small diversified group of market players. In my mind, this comment opportunity is at least as important as the SEC's rule-making process. With director elections no longer routine, ISS' proxy policies are more important than ever.

The comment period ends next week on October 11th. ISS has made it very easy to submit comments - you can submit your thoughts using their online form; no need to write a separate letter. There are online forms for these six topics:

- Director election reforms and majority voting
- Definition of an independent director
- Corporate performance test in evaluating the effectiveness of directors
- Options backdating and springloading policies and equity plan language
- Auditor ratification as a ballot item
- Climate change reporting and disclosure for shareholders

And ISS wants to hear from everybody, individuals as well as groups. Take advantage of this opportunity or else they might conclude that we don't want it and not offer it next year! ISS intends to announce its 2007 policies in mid-November.

Investors: Mad about Backdating and Ain't Gonna Take It Anymore

Speaking of ISS, I taped the bonus panel for the "3rd Annual Executive Compensation Conference" with Pat McGurn and Martha Carter of ISS last week and some of the information was staggering. I knew backdating was a big deal - but getta load of this:

"In ISS’ 2006 Policy Survey, 85% of the respondents indicated that backdating of stock options is very problematic, on a scale of “not at all problematic” to “very problematic.” In situations where a company admits to backdating, 78% of the respondents supported recoupment of the windfall associated with the backdating as a remedy at the company. (Other actions included resignation of any executive involved, including the CEO, and the resignation of the company’s chair of the compensation committee.)" Clawback provisions clearly are "in."

Next Thursday, hear this ISS bonus panel as well as catch the panel about "how to do clawbacks?" On October 12th, join the 2000 that will participate in Las Vegas – or the more than 3000 that will watch by nationwide video webcast - for the "3rd Annual Executive Compensation Conference." To be able to understand the practices that you will be describing in the CD&A, etc., you need to attend this major one-day conference that has become a "must" for all directors and all those involved with executive compensation. Note that registration rates are more than half-off for CompensationStandards.com members.

By looking at our agenda for this Conference, you can see that this year's conference will be even more crucial than before to watch live or by archive. Register today.

Keeping Abreast with Mark Borges: More Analysis and SEC Guidance

I just posted an October Supplement on CompensationStandards.com that compiles the latest blogs from Mark Borges. Mark continues to amaze with his daily insights into the new executive compensation rules, including some recent notes he took on an ABA teleconference in which he participated with Corp Fin's Associate Director Paula Dubberly.