November 30, 2006

Compliance Lawyers as Gangstas: Field Day for Litigators?

So much has been written already about the Committee on Capital Markets Regulation Interim Report - which was released this morning - but there still should be plenty of fodder for academic-oriented blogs to chew on for months. For me, I focused first on a Committee recommendation that hits close to home for corporate finance lawyers: that the SEC adopt regulations that rely on principles-based rules and guidance.

In yesterday's WSJ, Alan Murray scrutinized this recommendation in his column, which included an interview with someone who has tried to implement such a framework - the UK's Financial Services Authority recently has been down this road with mixed results. The column also delved into the dominance of lawyers in the rulemaking process and how the SEC would have to hire more economists to implement this Committee recommendation. While it might be reasonable for the SEC's Office of Economic Analysis to staff up and participate more in the rulemaking process, it could get dangerous if the OEA winds up dominating the process.

I fear that if there were a lack of specific and detailed rules (and guidance) from regulators, it would be too easy for companies to fall down the slippery slope of principles-based regulation. Not only are there plenty of executives out there not naturally inclined to implement sound practices (which is understandable because "compliance" is not a profit center), there are many companies that simply don't have the resources to figure out what "everyone else is doing" - and figuring that out would become even more important under a pure principles-based regulatory framework.

I like a middle ground here, such as the path that Corp Fin followed in its executive compensation rulemaking. That set of rules is comprised of a mix of principles-based rules and very detailed line items. Corp Fin Director John White has been out speaking on what his principles-based approach means in a series of recent speeches. I am convinced that under an overly principles-based framework, more litigation would erupt over vast grey areas - thereby, paradoxically creating much more work for lawyers (although the Committee's report has recommendations on how to neuter the plaintiff's bar). Let me know your 10 cents.

Summary: Committee on Capital Markets Regulation Interim Report

From FEI's "Section 404" Blog, here is a summary of the five broad areas where regulatory reform is needed, according to the Committee on Capital Markets Regulation Interim Report:

- competitiveness/"loosen capital controls" (e.g. to make deregistration from U.S. market easier for foreign companies; providing them easier exit may reduce their hesitation to enter),

- reform the regulatory process (SEC and SROs must do more rigorous cost benefit analysis before and after rulemaking; focus on principles-based approach; federal and state enforcement should not be used for ad hoc rulemaking),

- enforcement (SEC should resolve uncertainties arising from conflicting court opinoins as to Rule 10b-5 liability, particularly regarding materiality, scienter and reliance; DOJ should revise Thompson memorandum to prohibit prosectors from seeking denial of legal fees and waiver of attorney-client privilege; Congress should consider liability cap for auditors/preventing catastrophic liability; regulators should not indict entire firm unless exceptional circumstances; SEC should reverese longstanding position that indemnification of directors is against public policy, and increase ability of directors to rely on auditors and company exec's as part of due diligence),

- shareholder rights (e.g. supports majority voting over plurality voting; SEC should address shareholder access debate), and

- Sarbanes-Oxley Section 404 (Committee does not call for amendments to statute - Sarbanes-Oxley Act - but calls on SEC, PCAOB need to provide guidance to improve cost-benefit balance, such as revised definition of materiality, rotational testing in support of annual assessment, encourage more use of judgment. After these changes are in place, depending on result of updated cost-benefit assessment, Congress may need to consider if special treatment for smaller companies is necessary. However, Committee does not support one approach that has been suggested for smaller companies, to limit scope of auditors or management's report to "design" of control).

Another good summary is in this WSJ opinion column, written by two of the Committee's members.

MD&A Risk Factors (Nelson Rocks Preserve-Style)

As Bruce Carton shutters his "Securities Litigation Watch" Blog (he is moving on to a new job), I thought I would pay tribute by repeating the following blurb he penned a few months back:

Courtesy of Overlawyered.com, I found this inspiring Disclaimer on the Nelson Rocks Preserve website. Nelson Rocks Preserve is an outdoor recreation area located in West Virginia that is apparently tired of people suing them when they fall off cliffs, get bit by snakes, etc. They are responding with a disclaimer that reminds would-be users of the preserve of important things like "a whole rock formation might collapse on you and squash you like a bug" or
...climbing is extremely dangerous. If you don't like it, stay at home. You really shouldn't be doing it anyway. We do not provide supervision or instruction. We are not responsible for, and do not inspect or maintain, climbing anchors (including bolts, pitons, slings, trees, etc.) As far as we know, any of them can and will fail and send you plunging to your death. There are countless tons of loose rock ready to be dislodged and fall on you or someone else. There are any number of extremely and unusually dangerous conditions existing on and around the rocks, and elsewhere on the property. We may or may not know about any specific hazard, but even if we do, don't expect us to try to warn you. You're on your own.

Inspired by Nelson Rocks, I have come up with a securities disclosure version of their disclaimer, designed to meet all of the MD&A "Risk Factors" needs of your favorite public company. It looks like this:

ITEM 1A: RISK FACTORS
Risks Related to our Business and Ownership of our Securities

Our business is unpredictable and unsafe. The stock market, including the market for our securities, is dangerous. Many books have been written about these dangers, and there's no way we can list them all here. Read the books.

The path to success for our business is littered with land mines. Seriously-anything could happen. Our competitors try their best every day to crush us, and they could succeed. We could get rich and complacent following our IPO and fail to innovate. Our customers could abandon us. Key members of our management team could quit to sail their yachts around the world for a decade. We could grow so fast that our business spirals out of control. Any or all of these could occur and our business would go down the toilet, along with your investment.

Real dangers are present even if none of the above occurs. New technologies may be developed that will render ours obsolete. A patent troll could come along who claims to own the intellectual property rights to our technology, costing us tens of millions of dollars in defense costs (best case) or destroying our entire business (worst case). Third parties such as malicious hackers could emerge to undercut our business. Even the government could torpedo us by passing new laws that hurt our business. The bottom line is that our business and the stock market are unsafe, period. Live with it or stay away.

Totally unforeseen things can happen. There could be a SARS epidemic. There could be a terrorist attack. There could be a natural disaster, such as a hurricane. A herd of elephants could escape from the zoo and trample our headquarters, squashing our business and your investment you like a bug. Don't think it can't happen.

Even if none of these things happen, the stock market could go down for no reason whatsoever. That is to say, you may make a wise investment, we may work our tails off, our business may thrive, and you may still lose all of your money. It happens all the time.

If you engage in particularly dangerous trading such as uncovered options or naked short selling, you may lose everything you own. This is true whether you are experienced or not, trained or not, educated or not, or intelligent or not. It's a fact, such trading is extremely dangerous. If you don't like that, don't do it. You really shouldn't be doing it anyway. We do not provide supervision or instruction. We are not responsible for the financial ruin that may result. As far as we know, any of these types of trades can and will fail and send you plunging to your financial death. You're on your own.

Financial bail-out services are not provided by our company. If you lose your shirt investing in our company after reading all this, don't come running to us (or your class action lawyers). We assume no responsibility.

By investing in our business, you are agreeing that we owe you no duty of care other than not being crooks. We promise you nothing else. This is no joke. We won't even try to warn you about any dangerous or hazardous conditions not required of us by the SEC, whether we know about it or not. If we do decide to warn you about something, that doesn't mean we will try to warn you about anything else. We and our employees or agents may do things that are unwise and dangerous. In fact, we probably will. Sorry, we're not responsible. We may make bad decisions or give out mistaken guidance. Don't listen to us. In short, INVEST IN OUR COMPANY AT YOUR OWN RISK. And have fun!

November 29, 2006

NASD and NYSE Consolidate Broker/Dealer Regulation

As been bandied about for some time, the NASD and NYSE announced yesterday the signing of a letter of intent to consolidate their broker-dealer regulatory operations into a new self-regulatory organization. The new SRO will be named later and is expected to begin operations in the second quarter of 2007, and will operate from Washington DC; New York; and 18 District and Dispute Resolution office locations around the country. Here is a statement from SEC Chair Cox.

NYSE Regulation's CEO Richard Ketchum will serve as the non-executive Chairman of the organization's Board of Governors during a three-year transition period and remain CEO of NYSE Regulation; NASD Chairman and CEO Mary Schapiro will serve as CEO of the new SRO. According to this article, it is estimated that a single regulator could save the brokerage industry at least $100 million a year.

The Latest Privacy Policy Developments

In this podcast, Andy Serwin of Foley & Lardner talks about the latest privacy policy developments, including:

- What are the latest developments regarding companies losing their private data?
- Any state or federal legislative reactions?
- How can drafting policies and procedures protect a company?
- What do you recommend should be in a policy to protect social security numbers and other private employee or customer data?
- What should be in a policy to provide notification to affected parties in the event of a breach?

Patentability of Tax Advice and Tax Strategies

Mike Holliday notes a developing issue involving the patentability of tax advice and tax strategies which may be of interest, as noted in this article by the AICPA on "Patenting Tax Strategies." In August, the NYSBA Tax Section sent a letter to Congressional leaders on difficult policy and practical issues raised by the patenting of tax advice and tax strategies. In addition, a House Subcommittee held hearings on this issue in July.

The AICPA article and the NYSBA letter both refer to a pending case (Wealth Transfer Group LLC v. Rowe) filed in the US District Court in Conn. in January, claiming infringement of a patented tax strategy by a corporate executive-director. Apparently the alleged infringement was the defendant's transfer of nonqualified stock options to fund a Grantor Retained Annuity Trust (GRAT). The letter points out that although tax strategies in many cases may be embodied in confidential documents - e.g., a tax return and/or legal advice - tax strategies for publicly offered securities are disclosed in SEC filings. In addition, in the pending infringement case, the alleged infringement of transferring nonqualified stock options to a GRAT was reported in Forms 4 filed with the SEC. It has been suggested that the plaintiff apparently found out about the transfer through the SEC filing.

November 28, 2006

More Notes from PLI's 38th Annual Institute on Securities Regulation

We have posted more notes from PLI's 38th Annual Institute on Securities Regulation, including notes from the following panels:

- Current Accounting and Auditing Issues
- New Proxy Disclosure Rules
- Current Disclosure Issues
- Q&A Picnic Lunch
- Public Offering Developments

These notes can be found in our "Conference Notes" Practice Area.

Another December Open Commission Meeting

With the highly anticipated December 13th open Commission meeting looming, the SEC announced yesterday that it will hold an open Commission meeting next Monday, December 4th, to consider whether to, among other actions:

- propose a new rule under the '33 Act to revise the criteria for natural persons to be considered "accredited investors" for purposes of investing in certain privately offered investment vehicles;

- propose a new rule under the '40 Act to prohibit advisers from making false or misleading statements to investors in certain pooled investment vehicles they manage, including hedge funds;

- propose amendments to Rule 105 of Regulation M that would further safeguard the integrity of the capital raising process and protect issuers from manipulative activity that can reduce issuers' offering proceeds and dilute security holder value; and

- propose an amendment to the short sale price test of Rule 10a-1. In addition, the Commission will consider whether to propose an amendment to the "short exempt" marking requirement of Regulation SHO.

Coming Soon: Shorter Form 10-K Filing Deadline for Accelerated Filers

With a 60-day deadline coming up for accelerated filers, we have posted a new Time & Responsibility Schedule - courtesy of one of our advisory board members - in our "Proxy Season" Practice Area. Recently, CFO.com ran this article about the shorter deadline, which notes that many expect that a number of companies will need to utilize Rule 12b-25 to meet the new 60-day deadline.

November 27, 2006

The Latest Stock Option Backdating Studies

The stock option backdating scandal has now touched more companies than any other single scandal, except for the one involving illegal payments and bribes during the Watergate era (which incidentally led to the initial Congressional mandate - in the form of the Foreign Corrupt Practices Act - that companies maintain adequate internal controls; interestingly, internal controls over financial reporting of stock options include some basic controls for which some are now pushing to not be included as part of Section 404 testing).

As noted in the latest Glass Lewis study, the number of implicated companies has grown to over 200 companies - that is up over 70 companies since the Senate last heard testimony about backdating in September - which is when many believed that the worst was over.

Last week, the NY Times ran this article about a new study of backdated stock options conducted by professors from Harvard, Cornell, and the University of Chicago. The study finds that stock option grants were more likely to be backdated at companies where independent directors were a minority - and the study concludes that "old-economy" firms were more likely to engage in backdating compared to technology companies. Learn more about this study from the "D&O Diary" Blog.

We have posted these studies - along with a host of others - in the "Timing of Stock Option Grants" Practice Area on CompensationStandards.com.

The Art of Boardroom Etiquette and Confidentiality

We have posted the transcript from our popular webcast: "The Art of Boardroom Etiquette and Confidentiality."

Warren Buffett's "Tone at the Top"

A few months ago, Warren Buffett sent this memo to managers at Berkshire Hathaway:

To: Berkshire Hathaway Managers ("The All-Stars")
From: Warren E. Buffett

Date: September 27, 2006

The five most dangerous words in business may be "Everybody else is doing it." A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale.

Even worse have been the consequences from using that phrase to justify the morality of proposed actions. More than 100 companies so far have been drawn into the stock option backdating scandal and the number is sure to go higher. My guess is that a great many of the people involved would not have behaved in the manner they did except for the fact that they felt others were doing so as well. The same goes for all of the accounting gimmicks to manipulate earnings - and deceive investors - that has taken place in recent years.

You would have been happy to have as an executor of your will or your son-in-law most of the people who engaged in these ill-conceived activities. But somewhere along the line they picked up the notion - perhaps suggested to them by their auditor or consultant - that a number of well-respected managers were engaging in such practices and therefore it must be OK to do so. It's a seductive argument.
But it couldn't be more wrong. In fact, every time you hear the phrase "Everybody else is doing it" it should raise a huge red flag. Why would somebody offer such a rationale for an act if there were a good reason available? Clearly the advocate harbors at least a small doubt about the act if he utilizes this verbal crutch.

So, at Berkshire, let's start with what is legal, but always go on to what we would feel comfortable about being printed on the front page of our local paper, and never proceed forward simply on the basis of the fact that other people are doing it.

A final note: Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That's inevitable: We now employ well over 200,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. And culture, more than rule books, determines how an organization behaves. Thanks for your help on this. Berkshire's reputation is in your hands.

November 21, 2006

SEC Staff Clarifies How Whistleblower Law Works in the EU

In February, the Article 29 Working Party of the European Commission adopted a pan-European approach to Sarbanes-Oxley whistleblowing. Recently, the Article 29 Working Group and the SEC’s Office of International Affairs exchanged a total of four letters (although the SEC's letters are dated September, they were just recently posted). This is the first time we've seen the SEC Staff's views in writing on what the Europeans are doing in - and should dispel some of the confusion about how to implement whistleblower procedures taking into account multiple regulatory frameworks. We have posted this set of letters in our "Whistleblowers" Practice Area.

In this podcast, Mark Schreiber of Edwards Angell Palmer & Dodge discusses this latest development. Once you hear this podcast, you will realize that companies should now be creating whistleblower policies and procedures that comply with both Sarbanes-Oxley and EU data protection laws, which a number of companies are now doing.

Proposal: Nasdaq Listed Securities as "Covered Securities"

Last week, the SEC issued this proposal, based on a petition from Nasdaq, so that Nasdaq's listed securities would be considered "covered securities" under Section 18 of the '33 Act and thus exempt from state law registration. This proposal covers what used to be known at the Nasdaq SmallCap market and is now known as the Nasdaq Capital Market. The top two tiers of Nasdaq (which were all formerly Nasdaq National Market) are already covered securities.

I note that as part of getting the more favorable "covered securities" treatment for the Capital Market, Nasdaq has proposed raising the NCM listing standards. (See SR-NASDAQ-2006-032, filed 8/23/06). Sort of a "cod liver oil" feature. Getting covered securities treatment for NCM securities would be a big help for NCM-listed companies, who sometimes have trouble getting blue sky exemptions. The trade-off is that it will probably become harder to get on NCM. Thanks to Linda DeMelis for prodding my memory on some of this stuff...

Books & Record Demands: Recent Caselaw

Below are excerpted portions from Francis Pileggi's "Delaware Corporate & Commercial Litigation Blog" regarding a recent books & records case:

In Polygon Global Opportunities Master Fund v. West Corp., (Del. Ch., October 12, 2006), the Delaware Chancery Court addressed another request for books and records under DGCL Section 220 by a hedge fund and found it wanting, as explained in this thoroughly reasoned opinion. For another recent Chancery decision, Highland Select, denying a Section 220 request by an equity fund, due at least in part to the request being overly burdensome in scope, see the summary on this blog here. In that Highland case, trial was held about 6 weeks after the complaint was filed.

This case involved a trial that took place about 2 months after the complaint was filed. To state the obvious, the limited scope of the trial was for the purpose of determining entitlement to the documents sought--something that in the ordinary case one would obtain in routine discovery.

The court noted that the plaintiff hedge fund often invested in arbitrage situations and in this case heavily invested in the defendant corporation following the announcement of a going private transaction. The stated purpose of the demand under 220 was to: (i) value their stock; (ii) determine whether to seek appraisal; (iii) investigate breaches of duty; and (iv) communicate with other stockholders.

The court found no entitlement in this case under Section 220 because the plaintiff: (i) had already obtained "all necessary, essential and sufficient" data to determine whether to seek appraisal; (ii) did not have a proper purpose to investigate wrongdoing; and (iii) did not seek a stockholder list for a proper purpose.

Notably, after suit was filed, the court asked the plaintiff to "prepare a chart" linking :(i) the documents sought with (ii) the proper purpose for each document sought, as asserted in the demand for records (resulting in a pared-down list prior to trial).

The court made clear that valuation of shares is a proper purpose for a Section 220 demand, especially in the context of determining whether to pursue an appraisal--but if the data is already available in the public domain (e.g., in an SEC filing) the Section 220 claim may be obviated. It was also made clear that SEC Rule 13e-3 requires, as here, more data about valuation in a going private transaction than would otherwise be available. This highlights the different lens through which a demand involving a public company will be viewed as opposed to a closely-held one. Although there is no per se rule that a Section 220 claim for valuation purposes may be mooted in a squeeze-out merger subject to disclosures under SEC Rule 13e-3, in this case that was the result.

It was also made clear (as stated in many cases) that a Section 220 case is not a substitute for normal discovery in a regular lawsuit, nor will it be allowed as a substitute for discovery in a subsequent appraisal action. The scope of documents available in regular discovery under Rule 34 is much different than the scope of documents available under Section 220 (citations omitted).

Referring to DGCL Section 327 and related cases, the court emphasized the important public policy against "the evil of purchasing stock in order to attack a transaction which occurred prior to the purchase of the stock" (citations omitted)(i.e., purchasing a basis for litigation). Due to the claim here that the investigation into wrongdoing related to an event prior to the purchase of stock, the court observed that the plaintiff did not have standing for a derivative claim; nor did it have standing to make allegations based on entire fairness.

Regarding its alleged interest in communication with other stockholders, though the burden is on the corporation in this type of request to establish an improper purpose for the request of a stockholder list, and is rarely denied, here the reason for the request was based on the 2 prior reasons which were rejected by the court. (e.g., the list was not requested for a proxy solicitation but merely to "share" what it got from the Section 220 case and to inquire about anyone else who might be seeking appraisals.) In sum, on this point, the court said that simply because a stockholder may communicate with other stockholders based on Federal Securities Laws, that fact in and of itself does not support a proper purpose under Section 220.

Though it might be tempting to do so, I don't think this case can be read as imposing a higher hurdle for hedge funds making a Section 220 demand. Rather, the relevant background of the stockholder, to the extent it provides insight into the stockholder's intent in buying the stock, and its "end-game", will be part of the court's analysis of whether the requirement of a "proper purpose" has been satisfied.

November 20, 2006

ISS Releases its 2007 Proxy Voting Policies

On Friday, ISS released its US, Canadian and international 2007 proxy voting policy updates. ISS analysts will begin applying the new policies for all companies with shareholder meeting dates on - or after - February 1, 2007. As apart of its comprehensive policy formulation process, ISS collected more feedback this year compared to the past.

Here are some of the more noteworthy changes:

- ISS will generally support precatory proposals and binding by-law amendments related to majority voting for directors (provided it doesn't conflict with state law in the state where a company is incorporated and there is a carve-out for plurality voting in contested elections).

- ISS recommends that shareholders withhold their vote from the CEO, or even the entire board, of companies with "poor compensation practices"; last year, ISS recommended withheld votes in such circumstances only for directors sitting on the compensation committee. A non-exhaustive list of sample poor compensation practices is on pages 17-18 of the revised guidelines, which includes internal pay disparity, overly generous hire packages and excessive severance arrangements.

- ISS has tightened its guidelines on corporate performance, recommending withheld votes for directors of companies that significantly underperform their sector in both financial and share price terms for two years in a row.

The SEC's New Online Search Tool

Last week, the SEC launched a new full-text search tool that enables searches of the contents of any disclosure documents filed electronically on EDGAR, including same day filings and any others made sometime during the past four years. Here is the SEC's related press release.

Here are some reactions from David Copenhafer of Bowne:

- The SEC's new tool seems to work pretty well.

- Rather amazing that filings are indexed for text search on the same day as they are filed.

- The "hit list" doesn’t always show you the “hit.”

- Hits are not highlighted when you go to the filing; you have to use the browser to find the location of the hit(s).

- If you have several hits in one document, they seem to be “together” - in that they each line up under the previous hit. Good services collect all the hits from one filing and allow you to see more easily the context of each.

- Not sure about accuracy or completeness. For example, “exxon capital exchange” shows up with 2 hits in filings made this year using the SEC's tool, but 5 hits on a commercial service - the commercial service found hits in SEC comment letters, so the SEC’s search may not be vetting those.

- No apparent “help” screen, although it looks like standard Internet techniques work (e.g., quotes around several words performs search on that string). The Boolean operator "AND" seems to work. I didn’t try "NOT" or "OR."

UK Regulator Rejects Adoption of XBRL Due to Cost

According to this article, the United Kingdom's securities regulator, the Financial Services Authority, has decided against using extensible business reporting language (XBRL) for companies to file their regulatory returns on the grounds of cost. The FSA's decision to abandon XBRL means that UK regulators do not have to commit to backing XBRL for the foreseeable future.

Personal note - As a Michigan alumni, I am among those that demand a rematch at a neutral site! Go Blue!

November 17, 2006

Director Fees: Timing of Payments and Related Disclosure Issues

Recently, a member asked whether most companies pay their annual board retainers in monthly or quarterly installments or in a single lump payment? My sense is that for meeting fees, they are paid following each meeting (often as part of the next check) - and companies often pay the annual retainer in quarterly installments, but sometimes in an annual installment (sometimes in advance, but often in arrears). Many companies utilize a “compensation year” for director fee purposes that begins after each annual shareholders meeting. Essentially, there is no standard practice and companies often make changes to their fee payment schedule without regard to their fiscal year.

Also, most companies "1099" the fees, while others W-2 them. The difference impacts whether the company withholds taxes on option exercises; "1099" means no withholding on option exercises or restricted stock vesting.

So you ask, "why should we care when we pay directors?" Or more specifically, "does the timing of director fees impact what - and when - we need to disclose under the SEC's new compensation rules?"

The answer from Brink Dickerson of Troutman Sanders: Sort of. Let’s say that a company in 2005 decided to pay an annual retainer of $60,000 based upon a compensation year that began in April at the annual meeting and continued until the annual meeting in April 2006, at which they decided to pay $72,000. Under the old rules the 2007 proxy statement would report that directors receive an annual retainer of $72,000 (and under the new rules it may say that too). But the table is going to reflect what actually was paid.

Let’s say that the practice is to pay the retainer based upon fiscal quarters in arrears. So, in 2006 a director would have received $15,000 in January, $15,000 in April, $18,000 in July and $18,000 in October, for a total of $76,000. Let’s say that it is paid in six installments at the actual board meetings. That will result in an even different number. Let’s say it is paid in advance...

Former Directors - Subject to Disclosure?

On CompensationStandards.com, Mark Borges continues to blog about interpretations of the SEC's new executive compensation rules. For example, here is a recent entry: "Last month, I blogged about whether the compensation of a director who resigns or otherwise leaves the board of directors of a company before the end of the fiscal year needed to be included in the Director Compensation Table. At the time, I said I simply wasn't sure, as I could read the new rules both ways.

At a recent conference, I was on a panel with Corp Fin Staffer Anne Krauskopf who confirmed that these individuals are subject to disclosure, even though they may not be members of the board at the end of the last fiscal year. Essentially, she agreed with my analysis that Item 402(k)(1) places the focus on the total compensation paid to the board for the year, rather than on the individual amounts received by the current board members. Thus, each person serving as a director at any time during the last completed fiscal year should be included in the table."

Institutional Investors Seek Disclosure of Compensation Consultant Conflicts

Under the SEC's new executive compensation rules, companies are required to identify the use of any compensation consultants and describe their compensation-related work. A group of large institutional investors, which control nearly $850 billion in assets, have sent a letter to the 25 largest US companies asking them to disclose more about their compensation consultants than required under the SEC's new rules. In particular, these investors want to know:

- Does their compensation consultant provide other services?
- Do they have a policy prohibiting this?

This request is akin to what this group of investors (and a few others) commented upon earlier this year, as noted in footnote 495 of the SEC's adopting release. It will be interesting to see how many companies comply with the request. We have posted a copy of the letter from these investors in our "Outside Advisor Use" Practice Area on CompensationStandards.com.

November 16, 2006

Tales from the Hertz IPO

With the Hertz Global Holdings' IPO priced last night (and panned by some), it reminded me to circle back to when Hertz dropped Deutsche Bank from its IPO underwriting team a few weeks ago due to unauthorized email messages sent by an employee of the investment bank when the IPO was still "in registration."

As noted in this Bloomberg article, Hertz had no knowledge of the emails until after they were sent and asked Deutsche Bank to notify the institutional accounts who received them to disregard them. It's unknown what the email messages said; my guess is negative information - because if it was positive information (and accurate), there would be more pressure on the company to include that information in the prospectus.

In the "Risk Factor" below, excerpted from Amendment No. 7 to Hertz' Form S-1, the company disclosed it doesn't believe the e-mail messages constitute a violation of securities law on its part, but noted that it could possibly be held liable by anyone who received the messages and purchased shares (but that it would "contest the matter vigorously"):

Risks Relating to Our Common Stock and This Offering

We may have a contingent liability arising out of electronic communications sent to institutional investors by a previously named underwriter that will not participate as an underwriter in this offering.

We understand that, during the week of October 23, 2006, several e-mails authored by an employee of a previously named underwriter for this offering were ultimately forwarded by employees of that underwriter to approximately 175 institutional accounts. We were not involved in any way in the preparation or distribution of the e-mail messages by the employees of this previously named underwriter, and we had no knowledge of them until after they were sent. We have requested that the previously named underwriter notify the institutional accounts who received these e-mail messages from its employees that the e-mail messages were distributed in error and should be disregarded. In addition, this previously named underwriter will not participate as an underwriter in this offering.

The e-mail messages may constitute a prospectus or prospectuses not meeting the requirements of the Securities Act of 1933, as amended, or the "Securities Act." We, the selling stockholders and the other underwriters participating in this offering disclaim all responsibility for the contents of these e-mail messages. We strongly caution you not to place any reliance on the contents of the e-mail messages. The contents of the e-mail messages should be totally disregarded and should not be relied upon when making any investment decision regarding our common stock. All potential investors should base their investment decisions solely on information contained in this prospectus.

We do not believe that the e-mail messages constitute a violation by us of the Securities Act. However, if any or all of these communications were to be held by a court to be a violation by us of the Securities Act, the recipients of the e-mails, if any, who purchase shares of our common stock in this offering might have the right, under certain circumstances, to require us to repurchase those shares. Consequently, we could have a contingent liability arising out of these possible violations of the Securities Act. The magnitude of this liability, if any, is presently impossible to quantify, and would depend, in part, upon the number of shares purchased by the recipients of the e-mails and the trading price of our common stock. If any liability is asserted, we intend to contest the matter vigorously."

Crisis Planning and Crisis Response

In this podcast, Mike Tankersley of Bracewell & Giuliani provides some insight into crisis management, including:

- You recently authored a 120-page handbook, “Board Leadership for the Company in Crisis” that was published by the National Association of Corporate Directors. What led you to take on this subject, and what has the response been?
- It would seem like crisis planning would be something every company would do. Is that the case?
- What role do preparation and practice play?
- Why don’t companies engage in systematic, thorough crisis planning, preparation and practice?
- What are some examples of a failure to plan, prepare and practice crisis response and the problems that created for the affected company?
- What are some examples of crisis response planning paying off for companies?
- What is your best argument to a board or management team that they should invest time and money in advance planning?
- What role can counsel play in encouraging companies to take up crisis response planning, and in putting together effective plans?

Incorporation Rules Enable Fraud, Officials Warn Panel

Here is an article from yesterday's Washington Post: Lax state standards allow millions of companies to incorporate every year without their owners being identified, a practice that lets tax evasion, money laundering and securities fraud go undetected, federal officials told a Senate panel yesterday.

Leaders of the Senate Government Affairs Committee's permanent subcommittee on investigations sounded alarms about lenient rules that apply to about 2 million new businesses that incorporate in the United States every year. In most cases, states fail to seek basic ownership information from companies and often do not check what little data is provided in follow-up reports against criminal justice databases. Lack of transparency over who controls the companies amounts to "an unacceptable risk to our national security and our treasury," said Sen. Carl M. Levin (D-Mich.), whose staff initiated the investigation.

Justice Department and Internal Revenue Service officials who investigate financial wrongdoing testified that they are frequently stymied by the problem. "We have important investigations that are hitting brick walls because no one has the ownership information," said Stuart D. Nash, associate deputy attorney general.

Immigration and Customs Enforcement investigators pointed authorities to a Nevada company that received nearly 3,800 suspect wire transfers totaling $81 million over two years. But the case did not move forward because authorities could not identify who owned the business, lawmakers said. The FBI has opened 103 investigations into stock market manipulation, most of them involving shell companies whose owners are unknown to authorities. The bureau said shell businesses have been used to launder as much as $36 billion from countries in the former Soviet Union. A previous report by the Justice Department disclosed that Russian officials used shell companies in Delaware and Pennsylvania to siphon $15 million that was supposed to pay for safety upgrades for former nuclear power plants.

In many cases, states do not have an incentive to seek detailed information about business owners because the lure of incorporation fees and related funds is too great. In Delaware alone, nearly one-quarter of the state's revenue comes from such fees, according to a Government Accountability Office report on the issue released in April.

Technology that allows companies to incorporate online without requiring the owners to appear in person in a state office is also raising concerns. In some states, including Delaware and Nevada, corporations can pay an extra fee to complete the incorporation process in an hour, lawmakers said. "What is needed is a level playing field, a system that avoids a race to the bottom," said Sen. Norm Coleman (R-Minn.).

Fixing the problem could be difficult. States and the federal government have clashed over who has the authority to regulate business. At the hearing, senators asked law enforcement officials to look more closely at the problem and to recommend a solution. Some state regulators argue that seeking more information could raise privacy considerations. And Yvonne Jones, director of the financial markets team at the GAO, said that state officials interviewed by her staff expressed concern that widespread change could require action by state legislatures and could increase fees.

November 15, 2006

Notes from PLI's Securities Law Institute

In our "Conference Notes" Practice Area, we have begun posting notes from some of the panels from the recent PLI’s Securities Law Institute, including the popular Q&A with the Corp Fin Director and "Current Disclosure Issues" panel.

Liability Reserves and Waiver of the Attorney-Client Privilege

A recent decision from the Texas Court of Appeals on a discovery dispute is a good reminder of the need to limit access to the details about liability reserves in order to avoid waiving the attorney-client and work product privileges. (In Re BP Products North American Inc. (10/13/06; 1st District Texas Ct of Appeals).

BP had reported in a Form 6-K filed with the SEC that it established a reserve of $700 million to resolve estimated liability for personal injuries and fatalities from an explosion at a BP refinery. The reserve figure was computed by an in-house attorney at BP. Plaintiffs sought production of documents the attorney reviewed or used to compute the figure and the methodology. Only the $700 million figure had been disclosed.

The trial court ordered production of those documents, and BP objected claiming that the documents were protected by the work-product and/or attorney-client privilege. The appellate court found that BP had not waived the privileges by disclosure of the $700 figure to third parties - i.e., the SEC and the media - because disclosure was limited to the $700 million figure and there had been no disclosure of BP's methodology outside of BP personnel. The court distinguished an US Fifth Circuit case that found waiver of the privileges where a company had reported the amount set aside for projected tax liabilities to the SEC AND also had disclosed its analysis to its independent auditors who verified the analyses (United States v. El Paso Co., 682 F.2d 530 (5th Cir. 1982)). The court in BP found that the company had limited disclosure to the figure itself, and that there had been no disclosure of BP's methodology outside of BP personnel.

The waiver issue is discussed at the end of the opinion (pages 14-17); the rest of the opinion considers the procedural posture of the case and whether BP had established that the privileges applied to the documents, as opposed to whether BP had waived the privileges. Thanks to Mike Holliday for the info!

Companies Bill Ushers in Key Changes for U.K. Companies

A significant development took place last week in the UK, the adoption of the "Companies Bill," a topic that I blogged about in March. From the latest "ISS Friday Report": Some of the most sweeping changes for U.K. companies since passage of the Companies Act of 1985 took effect this week when the Companies Bill became law on Nov. 8. The 696-page bill, considered Britain’s longest piece of legislation, is intended to enhance shareholder engagement and promote a long-term investment culture, among other objectives.

The new law would implement several key changes such as requiring more detailed reports on environmental and social impacts, and calling for shareholders to ratify directors’ acts. The latter is standard practice in several European countries, including Germany, the Netherlands, Austria, and Switzerland.

Other changes include requiring shareholder approval of director severance contracts that allow for awards of more than two-times a director’s annual salary, as well as provisions allowing for auditor indemnification with shareholder approval.

Investors also have focused on measures that ostensibly place greater liability on directors, though some experts believe that the new rules allowing shareholders to sue directors who “don’t promote the success of the company,” will not lead to an up-tick in lawsuits against directors. “I don’t think this act will make a blind bit of difference to my practice,” Edward Sparrow, a partner at London-based Ashurst, told Bloomberg News. Sparrow noted it is more difficult to prove fraud in England than it is in the U.S., and that lawyers had little incentive to take on such cases because the law barred them from receiving a percentage of winnings when working on a contingency basis.

Other experts warn that rules empowering investors to go after directors could be far-reaching but that it is too early to determine their precise impact. The new law also affects rules on mergers and acquisitions. The new Companies Bill codifies European Union rules on takeovers, replacing the City Code on Takeovers. Britain’s Takeover Panel will remain the regulatory authority overseeing such transactions and will receive greater statutory powers. The new law will include squeeze-out and sell-out rights under which a bidder has the right to buy out minority shareholders, and minority shareholders have the right to require a successful bidder to acquire their shares, respectively. Both provisions would come into effect once a bidder has acquired 90 percent of the target firm’s shares.

Meanwhile, companies whose reporting years begin after Nov. 1 must disclose compliance with new provisions of Britain’s Combined Code on Corporate Governance, a set of best practice requirements that govern all London Stock Exchange-listed companies. The code, dubbed Britain’s governance “bible,” was last revised earlier in the year.

The changes will:

- Amend the existing restriction on the company chairman serving on the remuneration committee. The changes would allow the chairman to do so (but recommends against serving as chair of the committee) if the chairman is deemed independent on appointment.

- Provide a “withheld” vote option on proxy appointment forms to enable shareholders to indicate if they have reservations on a resolution but do not wish to vote against. Many listed companies already provide this option. A “withheld” vote is not a vote in law and would not count in the calculation of the proportion of the votes for and against the resolution.

- Enable companies to meet the requirement to make the terms of reference of board committees available by placing them on their Web sites.

November 14, 2006

Shareholder Access and By-Law Amendments: What to Expect Now

Tomorrow, join us for the joint TheCorporateCounsel.net/ DealLawyers.com webcast - "Shareholder Access and By-Law Amendments: What to Expect Now" – to hear Rick Alexander of Morris, Nichols; Rich Ferlauto of AFSCME; Richard Koppes of Jones Day; Professor Brett McDonnell; Ken Wagner of Bank of America and Beth Young of The Corporate Library not only analyze what the SEC proposes in the wake of the 2nd Circuit Court rejecting the SEC’s interpretation of the shareholder proposal rule (in AFSCME v. AIG), but also analyze the latest majority vote developments, including the effectiveness of by-law amendments and director resignation policies – as well as look at what shareholder activists are planning for this proxy season.

Section 404 Reform: Rumors Abound

What happened Sunday when SEC Chairman Cox and PCAOB Chair Olson met to discuss how far to go when they rein in internal controls regulation? Hard to gauge what transpired as there are differing accounts. This article says the two Chairs are at odds; this article says they are near an agreement. We'll find out the real story come the December 13th open Commission meeting...

Forsooth!

I'm taking this whole lawyer's holiday seriously by paring back my blogging today. It's "Talk Like Lawyers Write Day"! Go ahead and hug a lawyer...and speak forsoothly...

November 13, 2006

Updating This Year's D&O Questionnaire

There are so many new issues to consider whey you update this year's D&O questionnaire, some of which you need to ponder and address beyond what is in the sample D&O questionnaire that we recently posted. Please send me your thoughts as you work your way through these new issues.

For instance, one member noted that one possible new item might be some sort of explanation of what constitutes a "pledge" of securities - or to even break down that question into subparts, such as: "How many shares do you hold in a brokerage margin account?" Let me know your reaction to this set of thoughts.

D&O Questionnaires: Director Independence

Below are combined thoughts from several members that recently emailed me about the challenges of capturing director relationships in a questionnaire: "I don't think many independence questionnaires currently capture relationships like that between the UnitedHealth director Spears and the company's CEO, Dr. McGuire. I think some re-thinking is a good idea as the UnitedHealth revelation highlights one of the weaknesses of the current focus on independence: the existing tests all deal with relationships between the director (or his family members or entities) and the company, rather than individual members of senior management. We all know intuitively that loyalty typically runs to people, not institutions. So not taking into account relationships with the CEO or other senior executives misses much of the true 'relationship action.'

Maybe a solution is to add new items to the D&O questionnaire keyed off of - or cloned from - the ISS independence test (or the CII equivalent) that the D&O questionnaire reach transactions/ relationships between a director and management and putting these into a stand-alone independence questionnaire. Maybe they get couched in terms of 'information the company may want in connection with institutional investor concerns' or '...corporate governance rating/ proxy advisory service concerns.'"

D&O Questionnaires: Related-Party Disclosures

And here is a member reaction to Corp Fin Director John White's recent speech on related-person disclosures: "The import of the excerpt from John White's speech posted on your blog is pretty stunning. It seems as though companies will need to learn a whole lot about the circumstances surrounding all kinds of transactions in order to decide whether they have to be disclosed. Imagine what the questionnaire will look like now: 'Did the company donate to a charitable organization that employed one of your family members, which was in dire financial straits before the donation was made?' Yikes!"

November 9, 2006

The Big 4 Speak: Auditors Want to Change Their Liability Exposure and Client's Reporting Model

At a symposium yesterday, the CEO's of the six largest auditors issued a joint paper seeking input on a number of topics; foremost among them is reduced liability for auditor work and changes to how clients report results. There are some far-reaching ideas in the paper, including eliminating the quarterly-reporting framework and having clients conduct forensic audits on either a regular or "as needed" basis (eg. when shareholders vote to have such an audit conducted). The auditors' CEOs published this opinion editorial, which summarizes their paper, in yesterday's WSJ.

Options Backdating: The SEC's Enforcement Perspective

A few weeks ago, the SEC's Division of Enforcement Director Linda Chatman Thomsen delivered this speech on option backdating. [Speaking of SEC speeches, I am missing today's PLI Securities Institute - first time I have missed that conference in quite a few years. We still will be posting some notes from the Conference next week.]

PCAOB Postpones Prohibition of Tax Services

A few weeks ago, the PCAOB postponed the implementation date of the prohibited tax services rulemaking, which now will allow audit firms to perform tax work for executives of the companies they audit for another six months.

As you might recall, the PCAOB adopted Rule 3523 in July 2005, but the SEC didn't approve the rule until April 2006. The original implementation schedule allowed auditors to provide tax services that were "in process" when the SEC approved the rule, so long as the services were completed by October 31, 2006. Now, the revised implementation schedule allows these services to continue to be performed until April 2007. [And here is your reminder about updating your pre-approval of non-audit service policies.]

November 8, 2006

Should an SEC Chairman Leave Comments in the Blogosphere?

As widely reported, SEC Chairman Chris Cox posted a response to a letter from Sun Microsystem's CEO Jonathan Schwartz by leaving a letter in the form of a "comment" on the CEO's blog. As I blogged a few weeks ago, Sun's CEO sent a letter - that he posted on his blog - to Cox requesting that the SEC recognize that blog postings were considered "widely disseminated" for Regulation FD purposes.

In his response, Chairman Cox applauds the use of corporate websites as “as a source of information to the market and investors” and is open to the idea of information posted on the Web as potentially being considered “widespread dissemination.” No real surprise here as the SEC has been soliciting comments in various rulemakings for this type of notion for years, even before Regulation FD was born! (eg. May 2000 interpretive release).

Even though Chairman Cox's "comment" is in the form of a letter, I get a little uncomfortable with the idea that regulators might start leaving comments on blogs. How are we supposed to know that the comment is indeed from the SEC Chairman? Anyone can post a comment and claim they are Chris Cox simply by pushing a button. I think regulators should use more formal channels of communication, partly for their own sake so that they don't get caught in a heap of bad publicity due to a prankster's act of impersonation.

As an aside, the Chairman is getting criticism (eg. like this critic) for the content of his letter to the Sun CEO because he didn't take a specific view. This criticism is unwarranted in my opinion, as I think careful study is necessary before the SEC assumes that we all read the Sun CEO's blog on a regular basis; read some of the comments submitted on the e-Proxy proposal for conflicting views on the topic (some of which echo the thoughts near the end of this article about the use of established news channels to satisfy Regulation FD).

Disclosure Committees: The Latest Disclosures

In updating our "Sample Disclosures about Disclosure Committees", we were surprised to see how much information that some companies - including one foreign private issuer we came across - were providing about their disclosure committees in their proxy statements this year. Here are a few of the examples we have posted:

- Starwood Hotel's Proxy Statement filed April 7, 2006: "The Company has a Disclosure Committee, comprised of certain senior executives, to design, establish and maintain the Company’s internal controls and other procedures with respect to the preparation of periodic reports filed with the SEC, earnings releases and other written information that the Company will disclose to the investment community (the “Disclosure Documents”). The Disclosure Committee evaluates the effectiveness of the Company’s disclosure controls and procedures on a regular basis and maintains written records of the disclosure controls and procedures followed in connection with the preparation of Disclosure Documents. The Company will continue to monitor developments in the law and stock exchange regulations and will adopt new procedures consistent with new legislation or regulations.

- Harley-Davidson's Proxy Statement filed March 30, 2006: "Q: Does the Company have a Disclosure Committee?

A: Yes. The Company has a Disclosure Committee comprised of members of management responsible for considering the materiality of information and making disclosure decisions on a timely basis. The Disclosure Committee Guidelines, as amended, provide, among other things, that the Disclosure Committee: (1) has access to all Company books, records, facilities and personnel, as well as the Company’s independent registered public accounting firm and outside counsel; (2) design, establish and maintain disclosure controls and procedures for the SEC reporting process and modify them from time to time, as appropriate; (3) create and review all financial press releases; (4) review SEC filings on Form 8-K, Form 10-K, Form 10-Q and the Company’s annual proxy statement; (5) suggest appropriate disclosures or opine on disclosure issues; (6) evaluate changes in SEC, New York Stock Exchange (“NYSE”) and Financial Accounting Standards Board disclosure rules and make recommendations regarding their impact on the Company; (7) receive and review regular updates from the Company’s management, internal auditors and independent accountants; (8) discuss material items with employees in the internal audit function, independent registered public accounting firm and the Company’s management to ensure appropriate disclosure; (9) arrange for necessary training to ensure effective implementation of the disclosure controls and procedures; (10) periodically review and reassess the performance of the Disclosure Committee; (11) maintain written records necessary to evidence procedures followed in connection with the preparation and approval of any disclosure documents; (12) annually review and reassess the adequacy of the Disclosure Committee Guidelines; and (13) undertake any other responsibilities delegated to it from time to time by any senior officer of the Company to assist that senior officer in fulfilling his or her responsibility for oversight of compliance with the disclosure controls and procedures. The Company formally established the Disclosure Committee in October 2002.

- British Sky Broadcasting Form 20-F filed July 31, 2006: "The Company maintains disclosure controls, procedures and systems that are designed to ensure that information required to be disclosed in the reports filed under the Securities Exchange Act of 1934, as amended, is recorded, processed, summarised and reported within the time periods specified in the SEC’s rules and forms, and the Company’s UK listing obligations. The Company has established a disclosure committee. The committee is chaired by the Company Secretary and its members consist of senior managers from group finance, legal and investor relations. It has responsibility for considering the materiality of information (including inside information) and on a timely basis, determination of the disclosure and treatment of such information. The committee also has responsibility for the filing of reports with the SEC and overseeing the process for the formal review of the contents of the Company’s Annual Report."

Don't forget to take our latest quick survey on disclosure committees!

November 7, 2006

Reminder: New Form 8-K Rules Effective Today!

Remember that any Form 8-Ks with triggering events that occur today - and afterwards - have to comply with the SEC's new executive compensation rules. We have posted some memos regarding the changed 8-K rules in our "Form 8-K" Practice Area on both TheCorporateCounsel.net and CompensationStandards.com. The cover page of the Form 8-K remains the same...

Shareholder Access vs. Majority Voting Standards

Following up on my blog about the shareholder proposal regarding shareholder access recently submitted to Hewlett-Packard, Keith Bishop notes: "I think that it is interesting to compare the situation at Hewlett Packard to companies with majority vote proposals. At Hewlett-Packard's 2006 annual meeting, its stockholders rejected a majority vote proposal. In opposing that proposal, Hewlett-Packard argued that 'the plurality voting standard is compatible with HP's cumulative voting provisions, which allow stockholders to aggregate their votes for a single director nominee, and therefore provide stockholders a meaningful ability to express their preferences in the election of directors.'

In companies like Hewlett Packard, however, cumulative voting is only a potentiality. The reason is the high cost of soliciting proxies. Cumulative voting is only meaningful when there is a contested election. Approval of a stockholder access proposal at Hewlett-Packard's next meeting therefore could open the door to the actual (as opposed to potential) use of cumulative voting as a means to express stockholder preferences. Majority voting, in contrast, offers only a negative - the potential to cause someone not to be elected. Any vacancy that results from a majority vote rule is filled by appointment and not shareholder election."

The Board’s Role in Compliance

In this podcast, Maggie Bavuso of Compliance Systems Legal Group provides some insight into how boards should monitor a company’s compliance function, including:

- What has changed board responsibilities relative to compliance programs
- What is the impact of the revised Federal sentencing guidelines on the board’s compliance obligations
- What are the oversight responsibilities that boards now have
- How should a board handle an H-P type of investigation

November 6, 2006

General Electric CEO Jeff Immelt on Internal Pay Equity and More

Here is a "must read" article and free video from Friday's Financial Times: "Jeffrey Immelt, chairman and chief executive of General Electric, has urged company leaders in the US to ensure their pay does not dramatically outstrip that of their senior managers and to limit the influence of compensation consultants.

Mr. Immelt's intervention in the debate over executive pay - featured in a video interview with the Financial Times - underlines the growing importance of the issue for shareholders and executives of America's largest companies. "These are public jobs, there were so many abuses in the late 90s and in the early part of this century and that created concerns," he said.

Mr. Immelt argued that chief executives should not have multi-year contracts, which could lead to large pay-offs if they were dismissed, and the bulk of their compensation should be linked to performance. Yesterday, the FT revealed that a group of leading public pension funds had urged the top 25 companies in the US, including GE, to ban pay consultants from advising the board and working on other company matters.

Mr. Immelt, who took over the leadership of the industrial conglomerate five years ago from Jack Welch, did not mention the letter but said the board should be the final judge of executive pay. "I think it should be based on the good judgment of the compensation committees, the board and the CEO," he said. "I don't think consultants should be involved."

In a separate conversation with the FT, he said that, to motivate staff and avoid excesses, chief executives' pay should remain within a small multiple of the pay of their 25 most senior managers. "The key relationship is the one between the CEO and the top 25 managers in the company because that is the key team. Should the CEO make five times, three times or twice what this group make? That is debatable, but 20 times is lunacy," he said. Mr. Immelt, who last year received $3.2m in salary and no cash bonus, added that his pay was within the 2-3 times range."

SEC Gains Another Deputy General Counsel

On Friday, the SEC announced that Alexander Cohen has agreed to leave Latham & Watkins' Hong Kong Office (and Co-Chair of the firm's Corporate Finance Practice Group) to serve as the agency's Deputy General Counsel for Legal Policy and Administrative Practice. Alexander joins Andrew Vollmer, who is Deputy General Counsel for Litigation and Adjudication. Looks like SEC GC Brian Cartwright is "getting the band back together" by luring a colleague from his former firm...

What Do Tomorrow's Elections Hold in Store for Sarbanes-Oxley Reform?

With President Bush and Vice President Cheney making comments about Sarbanes-Oxley reform during the past few weeks, it is evident that the debate over reform is reaching new levels. As described in detail in The D & O Diary, some of the issues to be tackled by the recently-formed Paulson Committee are truly far-reaching, such as the elimination of the use of Rule 10b-5 in private litigation!

This article from Saturday's WSJ gives us an idea what Congressman Barney Frank (who is the ranking Democrat on the House Financial Services Committee and slated to chair that committee if the Democrats win the House on Tuesday). In the article, Rep. Frank "says he has no intention of reopening the landmark Sarbanes-Oxley corporate-accountability law, but would be willing to let regulatory agencies adjust their rules in light of business criticism that the law is being applied too stringently."

And there has been plenty of other "reform/no-reform" rhetoric lately, such as this recent op-ed in the WSJ by Senator Charles Schumer and NYC Mayor Michael Bloomberg about American competitiveness and regulatory burden; Senator Schumer and Mayor Bloomberg noted four themes that have emerged so far from a study they commissioned from McKinsey & Company. Some of the themes echo those coming from others, including the Paulson Committee.

Personal note: With the page scandal festering as a campaign issue, I am compelled to note that I served as an intern on the Hill when I was in high school in the '70s (I moved from Chicago to Bethesda in 10th grade). Complete with long hair, braces and platform shoes - and no untoward experiences. I was among the last of the interns as the program was soon abolished, leaving the pages as the sole body of underage staffers.

The experience was grand; I worked for the late Paul Simon from southern Illinois, who was in the House at the time before he became a Senator. Talk about an ethical guy; he was the epitome of what every politician should aspire to be...

November 3, 2006

Posted: CD&A Template and Checklist

A few weeks ago, I blogged about Jesse Brill's warning to be wary of CD&A mock-ups that were not up to snuff. We have just posted a "CD&A Template and Checklist" by ExeQuity that begins to address the kind of analysis that will be necessary. It is posted in the "CD&A" Practice Area on CompensationStandards.com.

We are hoping to see more examples that actually show, for example, that the compensation committee has utilized the key tools that are now expected to be used as part of the board’s analysis and decision-making — and then provide the assessment of the results and the basis for the decisions that followed. We encourage our members to re-read the “CD&A Pointers” provided in the September-October issue of the The Corporate Counsel - as well as the points made about the CD&A in the Special Supplement to that September-October issue.

CEOs and Country Club Memberships

Yesterday, USA Today ran this article that shows that some CEOs belong to three, four and five country clubs at once. It will be interesting to see how the USA Today research compares against what is disclosed in next year's proxy statements.

Country club memberships can pose interesting disclosure challenges, ranging from whether it is even a perk (depending on how its used and by whom) to how to value the membership when it is considered a perk. Our ongoing "Perk Survey" poses some questions about these topics.

Sidenote: I have a quote in the article about the practice of companies paying taxes for these memberships and how that is "radioactive"; this quote is out of context as my real intent was that I believe that gross-ups are foremost on shareholder's minds when it comes to abusive pay practices. This MarketWatch quote on a different topic is more on the money...

Available: Adopting Release for Best Price Rule Amendments

Yesterday, the SEC posted the adopting release for its best price rule amendments. They will become effective 30 days after publication in the Federal Register.

November E-Minders is Up!

The November issue of our monthly email newsletter is now available.

November 2, 2006

Canada Enacts a New Tax on Popular Income Trusts

Yesterday's NY Times article about a new Canadian tax starts with this excerpt, "In a move that surprised Canada’s stock markets, the Canadian government announced late Tuesday that it would tax income trusts. Companies with market values totaling about 70 billion Canadian dollars have changed from conventional stock structures to trusts this year. Once transformed, companies largely avoid corporate taxes by paying out most of their profits directly to shareholders. About 200 billion Canadian dollars held in Canadian markets are now invested in trusts. While the large, regular cash payments have made trusts popular with investors, the trend has come in for considerable criticism.

My first reaction was to wonder: "what will happen to income deposit securities?" Jeffrey Singer, an income fund expert with Stikeman Elliott LLP in Toronto addressed my concern: "IDS and similar "income security" issuers may be one of the few lights shining through the otherwise dark shadow cast by the Canadian federal government's proposal to tax income funds. Based on available details, the current proposal would not seem to effect IDS structures. In fact, many are considering whether the structure ought to be applied to domestic issuers in much the same manner as it had heretofore been applied to northbound cross-border issuers. However, the likelihood of such a market emerging in the short term and without prior rulings from Finance is unlikely, given the strong contrarian bias of the federal government towards flow-through entity structures expressed, and the overt statement in its background paper that 'if there should emerge structures or transactions that are clearly devised to frustrate those policy objectives, any aspect of these measures may be changed accordingly and with immediate effect.' Ironically, this move by the Federal Government ostensibly taken in the best interests of Canada and its economy may have created some significant opportunistic acquisition targets for, among others, foreign and primarily US-based acquirers."

We have posted other analyses of this new law from several bankers in our "Income Deposit Securities" Practice Area.

RiskMetrics Group Acquires ISS

Yesterday, RiskMetrics Group, a financial risk management firm, announced it has acquired Institutional Shareholder Services, the largest proxy advisor. According to the press release, the merger reflects the broader vision of both companies to expand beyond their core businesses of financial risk management and corporate governance to offer a broad range of data, analytics and advice to investors. Here is an article about the deal from today's Washington Post.

What’s Next for Boards? Ten Landscape-Altering Trends

Here is a list of ten board trends from John Wilcox, SVP and Head of Corporate Governance of TIAA-CREF, from this recent article in the Directors & Boards e-Briefing:

1. Majority voting and the right of shareholders to vote against directors will become the norm, replacing the plurality vote standard in U.S. director elections.

2. Executive compensation will be brought into line by a combination of factors: enhanced SEC disclosure requirements, an advisory shareholder vote on compensation committee reports, and recognition of the need for internal pay equity.

3. Separating the roles of chairman and CEO will become more common at U.S. companies, encouraging boards to worry less about preserving power and more about developing and incentivizing the best executive talent.

4. The model of the imperial, celebrity CEO will be replaced by the stewardship model, with Reginald Jones unseating Jack Welch as the role model.

5. Sustainability and corporate social responsibility, formerly relegated to gadflies and special interest groups, will be recognized as key corporate governance responsibilities for which directors should be held accountable.

6. Shareholder communications and proxy voting systems will be revamped by the SEC to make better use of technology, reduce costs, increase efficiency, and improve a board’s ability to identify and communicate with shareholders.

7. Shareholder resolutions will be overtaken by other forms of constructive engagement, and shareholder activism will become less confrontational, more responsible--and more effective.

8. The definition of beneficial ownership will become more complicated and problematic as stock lending and derivative investment strategies enable investors to separate voting rights from any economic interest in the underlying stock.

9. The spotlight will shift from the governance of companies to the governance of institutional investors, with a focus on how institutions should best fulfill their conflicting duties to maximize returns while acting as responsible owners.

10. Companies will come to recognize that corporate governance is not just a matter of regulatory compliance and accountability but a strategic means to lower the cost of capital, reduce risk, create value, and strengthen the long-term performance of the corporate enterprise.

November 1, 2006

Another Sample Related Party Transaction Policy

In our "Related Party Transaction" Practice Area, we have posted another sample policy with respect to related-person transactions. As you probably know, newly amended Item 404(b) of Regulation S-K requires companies to disclose their “policies and procedures for the review, approval, or ratification” of any related person transaction requiring disclosure under Section 404(a) of Regulation S-K - and Item 404(b) provides that the disclosure of the material features of such policies may include a statement as to “whether such policies and procedures are in writing and, if not, how such policies and procedures are evidenced.”

In addition, companies must identify any related person transactions reported under Item 404(a) that did not require review, approval or ratification under the policies and procedures or where such policies and procedures were not followed. So everyone should be busy creating such policies (and updating them if they already have them...

Shareholders: Interested in Director Election Results This Proxy Season

Clearly, investors will be watching director election results this proxy season more closely than ever with shareholder access "back on the table" and the majority vote movement going strong. Keith Bishop notes: Back in August, the Delaware Chancery Court addressed - in Accipiter Life Sciences v. Helfer - whether a company inequitably manipulated the election machinery by including the announcement of its annual meeting in press release largely devoted to financial results.

The primary reason why this opinion is interesting is because the plaintiffs apparently thought that they had enough of a shot at winning to file the lawsuit. In this case, a shareholder admitted that two of its employees actually read the press release, but somehow skipped the "hidden" paragraph announcing the annual meeting. Under the company's advance notice bylaws, the plaintiff had ten days from the announcement to submit nominations. The plaintiff failed to meet the deadline and filed suit. The Delaware Chancery Court ruled for the defendants finding that nothing in the actual language, the placement of the disclosure in the press release, or the absence of headings obscured the disclosure so as to escape all notice.

The Art of Boardroom Etiquette and Confidentiality

Tomorrow, join us for the webcast - "The Art of Boardroom Etiquette and Confidentiality" - as Professor Charles Elson; Diane Frankle of DLA Piper; Carl Metzger of Goodwin Procter; and Richard Truesdell of Davis Polk discuss a myriad of legal issues (corporate, securities, privacy and listing standards) as well as sound governance practices in the context of boardroom leaks (both before and after a leak occurs).