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Monthly Archives: March 2007

March 30, 2007

Corp Fin’s Chief Accountant to Leave

As announced yesterday, Corp Fin Chief Accountant Carol Stacey has put in her notice and will join the SEC Institute in a month or so. Quite a healthy choice for Carol, who undoubtedly had many opportunities available to her. The SEC Institute is an executive training organization for financial types and has a very solid reputation. And Carol always has been one of the few highlights at legal conferences with her engaging and straight-forward speaking style. Carol, welcome to the world of working in your pajamas! In New Hampshire, no less!

Late Filings: Use of Rule 12b-25 By Large Accelerated Filers

In our “Rule 12b-25″ Practice Area, we have posted a Glass Lewis report that provides details about how many large accelerated filers failed to timely file their Form 10-Ks so far this year; this category of issuers filed late more than 47% compared to last year. Some of the companies noted in the report have been chronically late, so the newly shortened deadline doesn’t appear to be a factor…

But At Least, My Dog Didn’t Eat It!

As I head off on a spring break vacation (I will be blogging – but not working -next week), I thought it was time for a little humor by looking at this amended Form 10-Q filed by Neptune Industries. Under Item 5, the company discloses:

“On November 20, 2006, the Company filed its Form 10-QSB for the quarter ended September 30, 2006, pursuant to an extension notice on Form 12b-25 filed on November 14, 2006. The extension of the filing date was required because the Company’s accountants, Dohan and Company, CPAs, PA, of Miami, Florida, were unable to complete their review of the Form 10-QSB in a timely manner. The Company had previously complained to Dohan & Company regarding its lack of responsiveness and lack of attention to the Company’s account, which had resulted in previous extensions and late filings by the Company, including the Form 10-KSB for the fiscal year ended June 30, 2006, which was filed on the SEC EDGAR system on October 13, 2006, the extended due date, after the 5:00 PM filing deadline, due solely to additional, non-material changes first requested by Dohan & Company late on the afternoon of October 13, 2006, after previous requests for changes, also received by the Company on October 13, 2006 had been incorporated into the final filing.

The review of the Form 10-KSB and the audit of the Company’s financial statements for the fiscal year had been delayed for nearly six weeks, because the audit partner on the Company’s account had taken extended maternity leave, which was concealed from the Company despite repeated calls and e-mail communications to the audit partner, with no response. Eventually, the Company was advised that the audit partner familiar with the Company account would not be available, that the audit would be managed by a junior accountant with no experience in or knowledge of the Company account, and that an extension of the time to file the 10-KSB would be required. After repeated requests for a status report on the audit and review, the Company finally received its first communication with requested changes to the Form 10-KSB and the financial statements at the end of the first week of October, 2006.

The Company made all of the requested changes and provided all of the additional information promptly, but new and different changes were requested the following week, most of which were non-material changes to grammar, punctuation, style and formatting. On October 13, 2006, the extended due date for the Form 10-KSB, the Company received additional non-material changes, which it made and returned to the auditors with the understanding that the Form 10-KSB was then ready to be filed. The Company completed the EDGAR conversion for filing and was ready to file when Dohan & Company send a new demand for additional non-material changes late on the afternoon of October 13 2006. By the time these changes were incorporated and EDGARized, the Company was unable to file the Form 10-KSB electronically by the 5:00 PM SEC cut-off.

The Form 10-KSB was filed at 5:06 PM on October 13, 2006, but was reported on the SEC EDGAR web site as filed on Monday October 16, 2006, which resulted a notice from the NASD OTC Compliance Unit that the Company was not in compliance with its timely filing obligations. On November 20, 2006, the Company filed its Form 10-QSB on a timely basis, again pursuant to a Form 12b-25 extension request by Dohan and Company, because the auditor again was unable to complete its review on a timely basis. After completing a number of changes requested by the auditors to the Form 10-QSB, and providing extensive information and documentation which had already been reviewed and covered in Dohan and Company’s audit of the June 30, 2006 fiscal year, filed three weeks earlier, the Company on November 20, 2006, the extended due date, received one more set of requested changes, which it made and returned to the auditors for their final review, with the message that the Company intended to file this final reviewed version of the 10-QSB that day on a timely basis, unless there were still more, as yet undisclosed, changes that had not already been communicated on a timely basis.

The Company then filed the Form 10-QSB as indicated on a timely basis on November 20. 2006 after receiving no further comments from the auditors. Later on November 20, 2006, after the Form 10-QSB had been filed and after the EDGAR filing deadline had passed, Dohan and Company sent an e-mail to the Company advising that it might still have further comments. Approximately two weeks later, the Company received additional suggested changes to the Form 10-QSB, none of a material nature and nearly all involving formatting (capitalizing of certain items on the cover page and revising the entries on the Table of Contents), adding of commas to certain parts of the text, suggesting style changes to certain text language, and similar items. The only numerical items involved the change of several entries by a one dollar amount to reflect rounding differences, and the change in the number of shares of common stock outstanding from 11,349,051 to 11,349,269, to reflect the issue of 218 shares as a result of rounding in the reverse split which occurred during the last fiscal year.”

There’s even more about this matter disclosed about this diatribe…but I’ll spare you…

March 29, 2007

SEC to “Discuss” Internal Control Proposals at Open Commission Meeting

The SEC has scheduled an open meeting for next Wednesday to “discuss” the PCAOB’s internal controls auditing standard (AS #5) and the SEC’s own management report proposal. Based on the wording of the SEC’s announcement, it doesn’t seem like they will adopt anything – rather, the Commissioners and Staff will discuss the comment letters received to date (including the oft-mentioned alignment of the PCAOB’s and SEC’s proposals) and approaches available to the SEC. The SEC seems “on plan” to adopt something by May.

Maybe my memory is foggy, but I don’t recall an open Commission meeting being held during which rules were not being proposed or adopted. In the past, these were fairly scripted affairs (but not as much over the past several years) and a discussion like this one would be conducted behind closed doors. Maybe its driven by a desire to ensure the standards are harmonized without treading on some “government in sunshine” restrictions about the SEC’s dealings with the PCAOB…

The FASB’s Appointment Process

Yesterday’s WSJ included this article on recent changes to the selection process used to select members of the board of trustees for the Financial Accounting Foundation (FAF) and the Financial Accounting Standards Board (FASB). The article recounts the back and forth between the SEC and the FAF over how much power the SEC should have regarding the selection process at the FASB.

You might recall that Section 108 of Sarbanes-Oxley gave oversight power to the SEC over the FASB – and the SEC outlined its role in a 2003 policy statement. In that statement, the SEC said that, given its oversight responsibilities, the FASB should give the SEC “timely notice of, and discuss with the Commission” its intention to appoint new members. According to the article, “timely notice” became an issue for the SEC in recents months and an agreement reached this month defines “timely” as generally 45 days but not less than 30 days before the FAF nominates members to its board or FASB members.

Critics of the SEC’s oversight power worry that the SEC could hold reappointment over the heads of FASB or FAF members while important votes are being considered. They also point to the fairly recent experience at the PCAOB, where some appointments by the SEC were not made very timely (and eventually made when votes on significant issues were on the table).

A Closer Look: SEC Chief Accountant Conrad Hewitt

Yesterday, the Washington Post ran this interesting article about relatively new SEC Chief Accountant Conrad Hewitt.

E&Y Censured Over Independence (Again)

On Monday, the SEC announced a $1.5 million settlement with Ernst & Young relating to alleged independence violations for its work at two clients, AIG and PNC Financial, in 2001. You might recall that E&Y had been censured just a few years ago for its PeopleSoft audit because E&Y’s consulting arm profited from recommending PeopleSoft software to customers.

Here are some thoughts from Lynn Turner: “Some in the auditing profession argue investors should rely on an audit firm itself to assess its independence and put in place safeguards if it is questioned. The three cases cited in this WSJ article regarding E&Y in recent years strongly arues against any such approach. Interestingly enough, in April 2001, the partner then in charge of the E&Y national office declined a request to meet with the SEC staff to discuss progress that E&Y was making in instituting a system to ensure its independence on a global basis, citing he did not need anyone at the SEC telling him what the independence rules were. (The other 7 largest firms accepted such an invitation).

It is also interesting an E&Y partner is a leader of the current effort to obtain what is in essence, an indemnification of auditors by their clients. Certainly, these are matters of concern for investors and audit committees.”

March 28, 2007

Corp Fin Issues Global Relief on Tender Offer Prompt Payment – 409A Issue

Yesterday, Corp Fin’s Office of Mergers & Acquisitions issued this global exemptive order – even though the order is in response to a request from Chordiant Software, which is not unusual for global no-action relief – relating to Section 409A and the tender offer prompt payment rules. During the past few weeks, OM&A had issued three separate exemptive orders (these orders are posted in the CompensationStandards.com “Backdating” Practice Area) – and now with this global relief, it can cut down on its workload going forward.

Posted: Foreign Private Issuer Deregistration Adopting Release

Yesterday, the SEC posted its adopting release on non-US issuer deregistration. Here’s a first – the SEC even put out a press release to indicate that the adopting release was posted…

Lawsuit Targeting Sarbanes-Oxley and PCAOB Dismissed

Last week, the lawsuit filed by Free Enterprise Fund seeking to abolish the PCAOB was dismissed. The lawsuit claimed that Congress acted unconstitutionally by creating the regulator because it operates independent of government supervision. In his decision, U.S. District Court Judge James Robinson disagreed by noting that the PCAOB is accountable to federal officials because the SEC Commission can remove its members. The Judge also said that the plaintiff raised “nothing but a hypothetical scenario of an overzealous or rogue PCAOB investigator.” The Free Enterprise Fund plans to appeal.

Sarbanes-Oxley and Pornography

As noted in this article, a prominent defense attorney alleged to have destroyed child pornography evidence has been charged with obstruction under Section 1519, a obstruction provision added by Sarbanes-Oxley that is stronger than pre-Sarbanes-Oxley tampering statutes. Under Section 1519, there need not be an investigation in place (or even imminent) as a predicate for prosecution.

Here is a quote from another article: “Every criminal defense lawyer in the country has to be alarmed at the indictment,” said New York University law professor Stephen Gillers. “It’s going to upset a lot of assumptions about how lawyers can represent clients. I think this is a boundary-pushing case.” This is not the first attempt to bring obstruction claims under Sarbanes-Oxley for alleged pornography use, as this blog notes, the former head of Bowne was similarly charged back in 2005.

March 27, 2007

SEC Chairman Cox Expounds on CD&A and Plain English

A few weeks ago, I blogged several times about SEC Chairman’s Cox’s first comments on the incoming executive compensation disclosures. Last Friday, Chairman Cox gave another speech during which he delves deeper into why he believes that executive compensation disclosures – particularly – the CD&A is not in plain English. The part of Chairman’s speech that deals with compensation disclosures is quite long – below are just a few excerpts to give you a sense of his message:

– “I have to report that we are disappointed with the lack of clarity in much of the narrative disclosure that’s been filed with the SEC so far. Based on the early returns, the average Compensation Disclosure and Analysis section isn’t anywhere close to plain English. In fact, according to objective third-party testing, most of it’s as tough to read as a Ph.D. dissertation.”

– “For starters, the executive pay disclosures in the study were verbose. We had it in mind that they’d be just a few pages long, but the median length for the CD&As was 5,472 words, over 1,000 words more than the U.S. Constitution.”

– “Just as the Black-Scholes model is a commonplace when it comes to compliance with the stock option compensation rules, we may soon be looking to the Gunning-Fog and Flesch-Kincaid models to judge the level of compliance with the plain English rules.”

– “So where do you think our new Compensation Disclosure and Analysis sections come in, seeing as how they’re newly minted in “plain English” for the average investor? In these tests, the average Fog Index for the CD&As in the sample was 16.45. That’s about the same as an academic paper, such as a Ph.D. dissertation here at USC.”

– “But the SEC’s own qualitative review of this year’s proxy statements indicates that we have far to go before we can say that legalese and jargon have truly been replaced by plain English. It’s clear that many companies are letting lawyers have the final say on the CD&A. As the firm that undertook this study points out, many of the problems could easily have been fixed in just a few hours by a qualified copy editor. Retail investors deserve better.”

My Ten Cents: Compensation Disclosures So Far

Just like the Chairman’s last compensation disclosure speech, some lawyers are disturbed and sending me e-mails expressing their dismay (eg. they missed the point in the SEC’s adopting release that indicates that the CD&A should only be a few pages long). For those out there that have truly worked hard to meet the extensive new requirements, I can understand their frustration and expect that the SEC will be providing us with guidance to clarify their CD&A expectations for next year.

On the other hand, far too many CD&As look eerily similar to compensation committee reports from the past and don’t really provide much in the way of analysis – despite the verbosity of the CD&As! In a prior blog, I noted that some members have told me of their efforts to cut through the HR department’s attempt to put boilerplate in the proxy statement. Since then, I have heard from plenty of non-lawyers with horror stories about lawyers who don’t understand how to narrate in plain English and worse (eg. hiding things in footnotes). Clearly, the drafting process will need to be better managed next year for many companies.

I won’t even get into the horror stories I continue to hear about dysfunctional compensation committees and boards, as that is a different topic. We are re-tooling our “4th Annual Executive Compensation Conference” to ensure it’s as practical as can be – with a theme of “lessons learned.” And our companion conference – “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference” – will include a panel regarding the drafting process and how to manage it. So save the dates of October 9-11…

Some Compensation Disclosure Statistics

In his speech, Chairman Cox threw out a few statistics, as noted in this excerpt:

“A private sector investor relations firm, Clarity Communications, has analyzed 40 companies’ CD&As for their level of compliance with the plain English requirement. They determined that all 40 of them fall far short of accepted standards of readability. In fact, they found that most of the disclosure documents failed even to meet the readability standards that states require for insurance forms. For starters, the executive pay disclosures in the study were verbose. We had it in mind that they’d be just a few pages long, but the median length for the CD&As was 5,472 words – over 1,000 words more than the U.S. Constitution. And the longest was more than 13,500 words – a far sight longer than a full-length feature in the New Yorker.”

Here are few more statistics from a recent DolmatConnell & Partners survey:

– The median length of the CD&A was 4,726 words, nearly five times longer than many original estimates.

– Only approximately one-third (36%) of companies chose to include exact financial performance targets (for short-term incentives) in their CD&A. The remaining firms did not disclosure specific targets, presumably because these firms believe such disclosure would cause competitive harm.

[Sidenote: Broc's favorite perk so far - Footnote 1 to the perquisites table on page 34 of Anheuser Busch’s proxy statement regarding “beer for personal use and entertaining.”]

March 26, 2007

Posted: March-April issue of Deal Lawyers print newsletter

We have just sent our March-April issue of our new newsletter – Deal Lawyers – to the printer. Join the many others that have discovered how Deal Lawyers provides the same rewarding experience as reading The Corporate Counsel. To illustrate this point, we have posted the March-April issue of the Deal Lawyers print newsletter for you to check out at no charge. Feel free to share it with your deal-minded brethren.

This issue includes pieces on:

– Private Equity Clubs: Seller Beware? Latest Developments and Practice Tips
– Falling into the “Going Private” Trap: A Cautionary Tale for Private Equity Fund Buyers
– In Vogue: The “Entire Fairness” Doctrine
– The Practice Corner: Special Committees
– The “Sample Language” Corner: Providing for a California Fairness Hearing
– An M&A Conversation with Chief Justice Myron Steele

Try a no-risk trial today; we have special introductory rates and a further discount for those of you that already subscribe to The Corporate Counsel. If you have any questions, please contact us at info@deallawyers.com or 925.685.5111.

John White on IFRS and the US Capital Markets

On Friday, Corp Fin Director John White gave this speech on IFRS and the US Capital Markets. In his speech, John recaps the themes of the recent IFRS roundtable held at the SEC’s HQ, including some points about the costs associated with reconciliation. For those who need to know more, here is a transcript of the SEC’s IFRS roundtable.

The Global Director

In this podcast, George Davis of Egon Zehnder provides guidance on how to recruit globally for boards:

– What is driving the need for international experience on boards?
– What industries are at the forefront of this movement?
– Where are companies finding directors with global experience?
– What other skills are most in demand on boards today?

March 23, 2007

Big Decision in Enron Securities Class-Action Litigation

On Monday, the US Court of Appeals for the Fifth Circuit issued a decision in the Enron securities class-action litigation that generally affirms that bankers, accountants, and others who work with publicly traded securities are not subject to securities-fraud claims that arise due to fraud committed by the issuer. There is some useful analysis of the decision in “The 10b-5 Daily.”

And here is some analysis of the decision from Gibson Dunn: In a decision having important implications both for the scope of liability under the securities laws and for class certification in general, on March 19, the Fifth Circuit ruled that a securities fraud action against certain financial institutions that participated in transactions with Enron Corporation could not proceed as a class action. The decision, Regents of the University of California v. Credit Suisse First Boston (USA), Inc., No. 06-20856, 2007 WL 816518 (5th Cir. March 19, 2007), adds to a growing body of federal caselaw that places limits on efforts by plaintiffs’ lawyers to plead securities fraud claims against secondary actors such as investment banks and other professional advisors, who did not themselves make any misrepresentations or omissions. The Fifth Circuit joins the Eighth Circuit in narrowly construing the scope of liability under such theories, and helps solidify a circuit split with the Ninth Circuit, which recently adopted a more liberal standard.

The Fifth Circuit’s decision denying class certification also represents another recent example of how federal courts are beginning to impose more rigorous standards for certification of investor classes in securities cases, and are permitting defendants to present more sophisticated “merits-based” arguments opposing class certification in appropriate cases. In December 2006, the Second Circuit reached a similar conclusion in the high-profile In re IPO Public Offerings Securities Litigation case, and denied class certification in that case as well.

More ABA Spring Meeting Notes

In our “Conference Notes” Practice Area, we have posted notes from the ABA Spring Meeting relating to accounting and the law.

IRS Provides Guidance for Reporting Tax Shelter Penalties to SEC for Non-10-K Filers

On Monday, the IRS issued Revenue Procedure 2007-25 (pg. 761) to provide guidance to companies that don’t file Form 10-Ks (egs. for those that file 10-KSBs, 11-Ks, 20-Fs, etc.) about how to disclose tax shelter penalties to the SEC. These rules were originally established in the American Jobs Creation Act of 2004 when Congress added Section 6707A to the Internal Revenue Code. In 2005, the IRS provided its initial guidance for Form 10-K taxpayers in Revenue Procedure 2005-51.

March 22, 2007

SEC Adopts Foreign Private Issuer Deregistration Rules

Yesterday, the SEC adopted long-awaited rules that will make it easier for foreign private issuers to deregister and terminate their SEC reporting obligations. New Rule 12h-6 and related Form 15F will enable a foreign private issuer meeting specified conditions to terminate its ’34 Act reporting obligations. The final rules are similar to those re-proposed with some technical adjustments. Here are opening remarks from Corp Fin – and here are comments from Commissioner Atkins, Nazareth, Casey and Campos.

The new rule will be effective 60 days after publication of the SEC adopting release in the Federal Register – it is expected that the adopting release will be published by mid-April so that the rules will be effective by the middle of June. If this happens, calendar year companies will be able to avoid filing a 2006 Form 20-F (for large accelerated filers, the first to require internal control reports under Section 404 of Sarbanes-Oxley).

Below is some analysis of the adopted rules from Cleary Gottlieb: Under the new deregistration rule, a company can deregister equity securities if its average U.S. trading volume over a 12-month period represents 5% or less of its worldwide trading volume, so long as it meets the other requirements described below. While the basic test is identical to the December 2006 proposal, the SEC has refined the test in three respects:

– The 5% threshold will be calculated by comparing a company’s U.S. trading volume to its worldwide trading volume, rather than comparing it to trading volume in the company’s one or two primary markets.

– Off-market trading will be counted worldwide, and not only in the United States, so long as the information source is reliable and not duplicative of exchange-reported trading.

– Convertible and other equity-linked securities will no longer be counted in the threshold calculation.

Like the December 2006 proposal, the final rule provides that companies that terminate their listings or ADR programs will have to wait one year before deregistering. In contrast to the proposal, however, the waiting period will only apply to companies that are above the 5% threshold when they terminate their ADR programs (this was true for terminating listings, but not ADR programs, in the proposal). There will also be a transition rule for companies that terminated listings or ADR programs during the year preceding the adoption of the rule.

The final rule retains a number of other provisions from the December 2006 proposal, including a requirement that a deregistering company be listed in one or two foreign markets that together represent at least 55% of its worldwide trading for a year prior to deregistration, that it have at least a one-year SEC reporting history at the time of deregistration, and that it not have sold securities in an SEC-registered offering for a year prior to deregistration. Companies that deregister are automatically eligible for the registration exemption of Rule 12g3-2(b), meaning that their deregistration will be permanent so long as they publish English versions of their home country reports and financial statements on their web sites.

Under the December 2006 proposal, a company could also deregister debt or equity securities if the securities were held by no more than 300 U.S. residents (based on improved “look-through” counting rules) or 300 holders worldwide (without applying “look-through” rules). While a number of comment letters suggested raising the threshold for debt securities, the SEC did not refer to any modification of the threshold during the open meeting.

It remains to be seen whether a significant number of foreign private issuers will use the new rules. Many of the largest European issuers have informally indicated that they intend to stay registered, at least for the time being. Many of these issuers will wait to see whether the SEC eliminates the U.S. GAAP reconciliation of IFRS financial statements (currently targeted for 2009), a change that would substantially reduce the costs of a U.S. listing. Several of the Commissioners expressed support for this objective during the open meeting.

The most significant practical impact may come from a provision of the new rule that allows companies that use their shares to acquire foreign SEC registrants to avoid registering themselves as “successor issuers” (assuming this provision remains in the final rule in the form proposed in December). This provision could facilitate cross-border M&A transactions that previously would have been blocked by the successor registration requirement.

Senate May Hold Proxy Access Hearing

According to this Reuters article, the Senate’s Subcommittee on Securities, Insurance and Investment may hold a hearing on process acces in mid-2007. Barney Frank, who chairs the House Financial Services Committee, said that if his “say on pay” bill becomes law, but is widely ignored by board compensation committees, he would expect Congress to look into proxy access as the next step in addressing shareholder rights.

Deal Protection: The Latest Developments

We have posted the transcript from the recent DealLawyers.com webcast: “Deal Protection: The Latest Developments.”

Assessing Fraud Risk

In this podcast, Jennifer Meiselman of BDO Seidman provides insights into how companies should be assessing their fraud risks, including:

– How do companies move to away from “siloed” SOX, internal audit and compliance programs to a holistic risk assessment while continuing to manage and monitor by department?
– Why have so few companies undertaken a thorough fraud risk assessment? Why are corporate boards the most likely source for these initiatives?
– What is involved in assessing fraud risk?

March 21, 2007

Investors Express Concerns over Option Valuations

After SEC’s Chief Accountant Conrad Hewitt blessed the ESOARs arrangement proposed by Zions Bancorp, the Council of Institutional Investors wrote a letter to the SEC expressing concerns as to whether market instruments can appropriately value options, particularly given that Zions is activately marketing its valuation approach to other companies. Conrad recently sent this letter to CII noting that the SEC will continue to analyze – and accept input – on this issue.

In ISS’ “Corporate Governance Blog,” ISS has provided some analysis about the challenges that companies and investors face when determining the fair value of options. In addition, ISS recently held a webcast to discuss the complexities of option expensing as well as has begun publishing a regular “Options Expensing Alert” to help evaluate the accuracy and reliability of specific expense calculations.

Grumblings from investors about unfair option values seem to fall into a number of discrete categories, including questionable assumptions set forth by companies; auditors not challenging those assumptions; and wide lattitude from the SEC regarding what assumptions are acceptable.

Option Backdating Cases: Deadline Looming? Disclosure-Only Charges?

Like this recent Financial Times article notes, a number of commentators have been talking about whether SEC and other enforcement officials will beat applicable statute of limitations deadlines in the numerous option backdating investigations pending.

An Associate Director in the SEC’s Enforcement Division caused a stir a month ago when she said that she “wouldn’t be surprised” if the agency brings some backdating enforcement actions that do not involve fraud, but rather would allege misleading disclosures only. According to this related Reuters article, the SEC has established guidelines to determine which matters will be prosecuted. Those factors include the duration of the misconduct, the “quantitative materiality of the compensation charges,” the quality of the evidence and whether the company is filing a restatement.

Option Lies May Be Costly for Directors

Here is an interesting backdating column by the NY Times’ Floyd Norris from last month:

“For companies that played games with employee stock options, the possible penalties are growing. New rulings in Delaware indicate that directors will be personally liable if options were wrongly issued. And the Internal Revenue Service has decided that employees who innocently cashed in backdated options in 2006 face a soaring tax bill. The service has given companies two weeks to decide whether to pick up the tax for the workers. That means directors must decide whether to spend corporate assets on bailing out workers, possibly angering shareholders, or leave the workers to shoulder huge tax bills.

In two rulings issued this month, Chancellor William B. Chandler III of the Delaware Chancery Court made it clear that the backdating of options was illegal. That was no surprise, but he went on to say that the same applied to “spring loading,” the practice of issuing options just before the release of good news.

“It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which a fiduciary may declare that an option is granted at ‘market rate’ and simultaneously withhold that both the fiduciary and the recipient knew at the time that those options would quickly be worth much more,” Chancellor Chandler wrote.

That decision creates the possibility of significant liability for directors, particularly those on compensation committees. Issuing options is an area over which they had specific authority. And since the decisions came in suits filed by shareholders of Tyson Foods and Maxim Integrated Products, they open the way to similar suits by owners of other companies.

Chancellor Chandler’s opinions go well beyond anything that the Securities and Exchange Commission has said. The S.E.C. has denounced backdating, the practice of saying an option was issued earlier than it was, when the share price was lower. It has forced companies to restate financial results and pay penalties.

But on spring loading, the only official comments from the commission have come from its chief accountant, who said there was no need to revise accounting, and from one commissioner, Paul S. Atkins, who suggested that the practice was just fine with him. “Isn’t the grant a product of the exercise of business judgment by the board?” he asked in a speech last year. “For example, a board may approve an options grant for senior management ahead of what is expected to be a positive quarterly earnings report. In approving the grant, the directors may determine that they can grant fewer options to get the same economic effect because they anticipate that the share price will rise. Who are we to second-guess that decision? Why isn’t that decision in the best interests of the shareholders?”

Chancellor Chandler, without mentioning Mr. Atkins, had an answer for him. It is possible that a decision to issue spring-loaded options “would be within the rational exercise of business judgment,” he wrote. But, he added, that could be true only if the decision were “made honestly and disclosed in good faith.” No such disclosures were made by spring-loading companies.

Chancellor Chandler’s opinion counts because Delaware is where most major companies are incorporated. He cleared the way for a suit against Tyson directors who approved options that appear to have been spring loaded, although that has not been proved. He also ruled that companies could not use the statute of limitations to avoid such suits. Even if the options were issued years ago, the fact that the directors hid the practice means that they can be sued now, when the facts have come out.

The tax issue stems from a law that took effect in 2005 regarding deferred compensation. It was not aimed at backdated options, but the I.R.S. says it applies to them if they were vested — that is, if the employee got the right to exercise them — after the end of 2004. Options can vest up to five years after they are issued, so some old option grants are partly covered.

If a taxpayer exercised such an option in 2006, the effective tax rate rises from 35 percent of the profits to 55 percent, and interest penalties could make the figure even higher. The I.R.S. gave companies until Feb. 28 to notify it if the company would pay the excess taxes for employees who exercised such options last year, and said the employees must be notified by March 15.

Directors of companies that issued backdated or spring-loaded options may now try to shift the blame. One can imagine directors contending they were deceived by executives or by corporate counsel, and that they, not the directors, should pay. Personal liability, in other words, can concentrate a director’s mind.

March 20, 2007

ABA Spring Meeting Notes: Dialogue with the Corp Fin Director

In our “Conference Notes” Practice Area, we posted some notes from this weekend’s Spring Meeting of the ABA’s Business Law Section. This includes notes from the popular panel: “Dialogue with the Director of the SEC’s Division of Corporation Finance” – and notes from an executive compensation disclosure panel.

Corp Fin Review of Executive Compensation Disclosures

Here is an excerpt from the notes from the Corp Fin Director Dialogue panel regarding the Staff’s plans to review compensation disclosures:

“The Staff is gearing up for an organized review of the new executive compensation disclosures, which will include review of the disclosure provided pursuant to revised Item 404 of Regulation S-K and new Item 407 of S-K. Mr. White said the Staff will select a “critical mass” of companies for review (in the hundreds) and targeted reviews will be performed. Comment letters will not be issued immediately, but instead the Staff will wait until it has seen enough filings to ensure that the comments will be consistent when issued. Mr. White would not offer any assurance that companies would only receive futures comments, and that they may need to amend their Form 10-Ks because the Staff considers these disclosures to be “live.”

After this review, the Staff will issue a report of their observations regarding the new disclosures, similar to the Fortune 500 Report issued in 2003 (now available on Corp Fin’s Accounting and Financial Reporting webpage). The Staff may also issue new interpretations or even propose revisions to the rules based on this review. Mr. White expects these projects to be completed by the Fall (which in his view goes through December) so that any revisions will be completed in time for next proxy season.

Moreover, the Staff will be data tagging the executive compensation data from a select group of companies, probably the 500 largest or some such number of large companies, including their Summary Compensation Table. The Staff will not be tagging the footnote disclosure, but will provide links to the proxy statements where that information can be retrieved.

Mr. White also said that the data tagging will allow users to not only compare disclosure across companies, but will allow them to manipulate the data. For example, a user will be able to replace the FAS 123(R) numbers in the SCT with the fair value numbers and recalculate compensation based on those new values. This project is also expected to be completed by the Fall.”

By the way, the tagging of data was discussed during yesterday’s SEC Roundtable on XBRL – here are notes about that roundtable from FEI.

Latest Analysis of How Funds Vote

With each proxy season wilder than the last, keeping track of how funds vote becomes more important. The Corporate Library has now published their analysis of how mutual funds voted last year. The report analyzes the 2006 voting records of 29 large mutual fund families, which includes the voting records of 702 funds, amounting to more than 1.2 million voting decisions.

Here are some of the study’s findings:

– Funds supported 92% of management-sponsored proposals in 2006 on average, up from 89% in 2004. A small number of management resolutions propose reforms that shareholders have called for in the past, yet receive much higher support when proposed by management. For example: Dreyfus, which voted in favor of no shareholder resolutions to declassify the board in 2006, voted for 98% of management proposals to adopt the same reform.

– Putnam was the fund family least likely to support management-sponsored resolutions, with an average 79% support. American and Ameriprise had the highest levels of support for management resolutions, with average support of 97%.

– Funds voted in favor of 37% of shareholder-sponsored resolutions, on average. Governance-related resolutions, which comprised 76% of all shareholder-sponsored resolutions published in proxies in 2006, received 44% support from funds. This figure has increased over the three years spanned by this study for 14 of the largest fund families, from 37% in 2004.

– Among shareholder resolutions, those proposing board declassification received the highest level of fund support – 87.7%, on average – in the 2006 proxy season. The largest category of shareholder resolution, those urging majority affirmative support for uncontested director elections, achieved 60% support from funds, on average, up significantly over the past three years.

March 19, 2007

Cisco’s General Counsel on the Future of Practicing Law

Back at the end of January, at the Northwestern Conference in San Diego, Cisco’s general counsel, Mark Chandler, gave a provocative speech about how he sees the future of legal practice. Here is an excerpt from that speech that pretty nicely illustrates how Mark provides food for thought in his speech:

“First, how is technology driving change in knowledge-based industries? Second, what are the key areas of vulnerability in the legal services business to these technological changes? And third, what will it take to succeed in this changed environment?”

I think many of us would be more than happy to see the death of the billable hour. Aren’t you tired of reading articles like this one that implicitly makes a mockery of our profession?

Rethinking Your Legal Department

In this podcast, Rees Morrison of Hildebrandt International provides some insight into law department management issues, including:

– How do you help in-house legal departments?
– What do you see as the biggest challenges faced by those departments today?
– How do you see the practice of law changing?

Doing It “J-SOX” Style

Last year, the Japanese Diet passed a comprehensive governance reform to create the “Financial Instruments and Exchange Law.” Some commentators view this as a modified verison of the US’ Sarbanes-Oxley and have dubbed it “J-SOX.” This new law will impact all 4000 Japanese public companies when its implemented on March 31, 2009 (most Japanese companies have a 3/31 year-end). All of the details regarding what will be required have not yet been worked out.

There are some notable differences between J-SOX and what we have here in the US. For example, under J-SOX, an auditor attestation will not be required. Learn more in our “J-SOX” Practice Area.