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 "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 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 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.

March 16, 2007

Corp Fin Interpretive Letter: Form S-8 and SARs

A few days ago, Corp Fin issued this Beazer Homes USA interpretive letter that deals with the availability of Form S-8 for the exercise of stock appreciation rights and subsequent resale of underlying equity securities. General Instruction A.1(a)(5) of Form S-8 makes the Form available for the exercise of employee benefit plan options and the subsequent resale of the underlying securities by certain family members of an employee who acquired the options from the employee through a gift or domestic relations order.

The Staff was asked whether stock appreciation rights that may be settled in equity securities of the registrant may also be registered on Form S-8 in these situations. Given that the stock settlement of a stock appreciation right is economically equivalent to the cashless exercise of an option for the same number of shares, the Staff indicated that for purposes of General Instruction A.1(a)(5), in its view, the term “option” includes a stock appreciation right that may be settled in equity securities of the registrant.

Accordingly, when the other conditions of General Instruction A.1(a)(5) are satisfied, Form S-8 would be available for the exercise of stock appreciation rights and subsequent resale of underlying equity securities. This position is limited to stock appreciation rights that may be settled in equity securities of the registrant. All of this is not too much of a big deal as most practitioners haven't questioned whether SSARs were covered under an S-8 - as we have written about in The Corporate Executive in the past - but it’s nice to have it clearly stated in an interpretive letter.

Tackling Global Warming: Even Corporate Lawyers Need to Take Heed

With climate control becoming an inevitable issue that we all will have to deal with - both in our personal and professional lives - we have launched a new website to help you navigate how global warming will impact the corporate & securities laws. Sponsored by and the National Council for Science and the Environment, this full-day June 12th webconference is free to all - and the agenda is listed on Here is a snapshot of that agenda:

- What the Studies Show: A Tutorial
- The Business Case for Tackling Global Warming
- The Board's Perspective: Strategic Opportunities and Fiduciary Duties
- Why You Need to Re-Examine Your D&O Insurance Policy
- The Investor's Perspective: What They Seek and Their Own Duties
- Disclosure Obligations under SEC and Other Regulatory Frameworks
- How (and Why) to Modify Your Contracts: Force Majeure and Much More
- Due Diligence Considerations When Doing Deals

It is notable that law firms are ramping up their climate control practices (see this recent NY Times article) and that an environment group recently hired an investment banker to help them negotiate their interests in an energy merger.

2500! A Blistering Pace

In our "Q&A Forum," we have blown right through query #2500 (and even #2600) - which is really a higher number since many of these have follow-ups queries. As the pace has been blistering, I'm not sure if we can keep up with the growing pace of questions - you are reminded that we welcome your own input into any query you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply...

March 15, 2007

Not Better Late Than Never? Corp Fin's New Phone Interps

Perhaps to the chagrin of those finalizing - or have finalized - their proxy disclosures, Corp Fin posted a bunch of new "phone interps" yesterday (they're actually not called phone interps anymore; they are more formally known now as "Compliance and Disclosure Interpretations"). There four new sets of interps, including:

- Item 201 of Regulation S-K – Common Equity Information and Shareholder Matters

- Item 403 of Regulation S-K – Security Ownership

- Item 404 of Regulation S-K – Transactions with Related Persons

- Item 407 of Regulation S-K – Corporate Governance

SEC Plans to Adopt Foreign Private Issuer Termination Rules

The SEC announced an open Commission meeting for next Wednesday to consider adopting rules that would allow foreign private issuers to deregister more easily - and Chairman Cox gave a speech during which he said he opposes weakening Sarbanes-Oxley...

Pop Quiz! Proxy Season Reminders

A member sent over the following conference notes, which serve as a nice pop quiz to determine how well you are "informed" this proxy season. At the Corporate Counsel Institute held at Georgetown University Law Center last week, Corp Fin Deputy Director Marty Dunn provided 10 points to remember for this proxy season:

1. Companies should confirm that the certifications required in Form 10-K by Regulation S-K Item 601 are accurate. A number of companies have been found by the Staff to have not adhered to the precise language of the Item.

2. Companies should carefully follow Item 601(b)(10) of Regulation S-K regarding material contracts required as exhibits, particularly with respect to per se material agreements such as those involving named executive officers.

3. Companies are not required to deliver board committee charters to shareholders if such charters are made available via a web site link - but companies must reference the website link in its disclosure.

4. Pursuant to Item 407 of Regulation S-K, where a company adopts its own definition for “independence” of directors, it must disclose the web site link where the definition may be found or append the definition to the proxy statement every three years.

5. Regarding disclosure of related-party transactions under Item 404(b) of Regulation S-K, a company must disclose its related-party transactions policy even if it doesn't have any related-party transactions required to be disclosed under Item 404(a).

6. The beneficial ownership table required under Item 403 of Regulation S-K was amended pursuant to the new executive compensation rules to require disclosure of shares beneficially owned by directors and officers that are pledged as security.

7. Companies should be aware of the expansion of the plain English requirement from prospectuses to include executive compensation-type disclosure required under Items 402, 403, 404 and 407 of Regulation S-K.

8. Remember the requirement imposed in the securities offering reform rules that companies must make certain disclosures in their Form 10-K regarding unresolved comments from the SEC Staff.

9. Under the new executive compensation rules, companies are not required to disclose precise numbers if the amounts of salary and bonuses through the last calculable date cannot yet be determined. However, where companies do not do so and the compensation later becomes calculable, they are required to file a Form 8-K report disclosing these amounts pursuant to 5.02(f) of Form 8-K.

10. The peer index performance graph is no longer a proxy statement requirement but has not disappeared entirely. It is still required to be included in the “glossy” annual report required to be filed under Rule 14a-3.

Both Sides Declare Victory at H-P

Hewlett-Packard investors voted down a proposal that would have allowed shareholders who have owned at least 3% of HP's outstanding stock for at least two years proxy access to nominate two board candidates. About 1.61 billion shares, or 52% of the total shares voted, were against the proposal. More than 800 million shares, or 39% of the total shares voted, were in favor. The percentages were enough for both sides to declare victory. Learn more at

March 14, 2007

Delaware Chancery Court Decision: Compensation Not Fair

I started blogging about this executive compensation case way back in 2005 - and at long last, we have an opinion in Valeant Pharmaceuticals v. Panic & Jerney - a case that went all the way to trial in Delaware's Chancery Court (just like Disney). In the "Executive Compensation Litigation Portal," we have posted a copy of the opinion.

Here is a recap of the decision from Travis Laster of Abrams & Laster: Vice Chancellor Stephen Lamb of the Delaware Court of Chancery held that a transaction bonus received by a former director and president of ICN Pharmaceuticals, Adam Jerney, was not entirely fair. The Vice Chancellor ordered Jerney to disgorge the entire $3 million bonus. He also held Jerney liable for (i) his 1/12 share (as one of 12 directors) of the costs of the special litigation committee investigation that led to the litigation and (ii) his 1/12 share of the bonuses paid by the board to non-director employees. The Vice Chancellor also ordered him to repay half of the $3.75 million in advancements that INC paid to Jerney and the primary defendant, ICN Chairman and CEO Milan Panic, to fund their defense. The Vice Chancellor granted pre-judgment interest at the legal rate, compounded monthly, on all amounts.

The ICN decision is a must-read for any practitioner who advises boards of directors or compensation committees on compensation issues. It contains a number of key holdings and comments. Here are some highlights:

1. Vice Chancellor Lamb found that all of the members of the board were interested in the bonuses paid in connection with an IPO of ICN, because even the outside directors on the compensation committee received a minimum of $330,500 per director. The Vice Chancellor viewed this compensation as making the compensation committee members "clearly and substantially interested in the transaction they were asked to consider."

2. The Vice Chancellor was highly critical of the process followed by the compensation committee and its reliance on a compensation report prepared by Towers Perrin. The Vice Chancellor found that Towers Perrin was initially selected by management, was hired to justify a plan developed by management, initially criticized the amounts of the bonuses and then only supported them after further meetings with management, and opined in favor of the plan despite being unable to find any comparable transactions.

3. The Vice Chancellor rejected an argument that the Company's senior officers merited bonuses comparable to those paid by outside restructuring experts. "Overseeing the IPO and spin-off were clearly part of the job of the executives at the company. This is in clear contrast to an outside restructuring expert..."

4. The Vice Chancellor held that reliance on the Towers Perrin report did not provide Jerney with a defense under Section 141(e) of the General Corporation Law, which provides that a director will be "fully protected" in relying on experts chosen with reasonable care. "To hold otherwise would replace this court's role in determining entire fairness under 8 Del. C. sec. 144 with that of various experts hired to give advice...." The Vice Chancellor also held separately that Towers Perrin's work did not meet the standard for Section 141(e) reliance.

5. The Vice Chancellor held that doctrines of common law and statutory contribution would not apply to a disgorgement remedy for a transaction that was void under Section 144. Hence Jerney was required to disgorge the entirety of his bonus without any ability to seek contribution from other defendants or a reduction in the amount of the remedy because of the settlements executed by the other defendants.

As an aside, it bears noting that this case is one of the rare situations in which a special litigation committee has realigned the company as plaintiff and pursued the claims originally brought by a stockholder plaintiff as a derivative action.

The ICN opinion shows the significant risks that directors face when entire fairness is the standard of review. The opinion also shows the dangers of transactions that confer material benefits on outside directors, thereby resulting in the loss of business judgment rule protection. Although compensation decisions made by independent boards are subject to great deference, that deference disappears when entire fairness is the standard. "Where the self-compensation involves directors or officers paying themselves bonuses, the court is particularly cognizant to the need for careful scrutiny." Contrast, for example, the outcome in ICN, involving an interested board, and the quite different outcome in Disney, involving an independent board.

[Broc's Final Four Picks: Georgetown over Florida in the final, with Texas A&M and Kansas also making the last weekend; it was tough not to take Texas over Georgetown. I correctly picked Florida to win it all last year, so I can rest on those laurels for at least a decade, right?]

Backdated Options and ERISA Claims

In this podcast, John Gamble of Fisher & Phillips provides some insight into how ERISA claims will be brought in the options backdating lawsuits, including:

- For what we can tell, what were the backdating circumstances at Mercury Interactive?
- What role do you think human resource professionals played in backdating (compared to other employees)?
- How do ERISA claims come into play regarding backdating?

International Investors Endorse Say-on-Pay

From ISS' "Corporate Governance Blog": An international coalition of 13 institutional investors has endorsed the right of U.S. shareholders to have an annual advisory vote on executive compensation practices.

In a letter to Securities and Exchange Commission Chairman Christopher Cox, the investor group argued that advisory votes on executive pay would "improve communication between shareholders and directors; encourage pay-for-performance practices; increase focus on individual company circumstances and strategic goals in the development and evaluation of executive compensation plans; and provide a counter-weight to upward pressure on executive compensation from enhanced disclosure requirements."

The group urged the SEC to take action to establish shareholder votes on pay through regulatory action or through exchange listing standard changes. The investors also said they would support legislation to provide such a right. U.S. Rep. Barney Frank, the chairman of the House Financial Services Committee, introduced a bill in 2005 that called for votes on pay plans, but the measure stalled in Congress, which was then controlled by Republicans.

So far this proxy season, labor pension funds and other U.S. investors have filed more than 60 proposals seeking advisory votes on pay practices.

The Jan. 25 letter, which was orchestrated by the Universities Superannuation Scheme of the United Kingdom, was signed by eight other U.K. institutions, two from the Netherlands, one from Australia, and the Connecticut Retirement Plans and Trust Funds. Among the other signatories are ABP Investments from the Netherlands; Hermes Equity Ownership Services, F&C Asset Management, the Local Authority Pension Fund Forum, and Shell Pensions Management Services, all from the U.K.; and UniSuper Management from Australia.

Such advisory votes are required in the United Kingdom, Australia, and Sweden, while Dutch firms must submit pay policies to a binding shareholder vote. According to the international investor group, the votes in these markets have made companies more receptive to shareholders on compensation issues. The investors cited the example of British drugmaker GlaxoSmithKline, which adjusted its remuneration plan after a 51 percent negative vote in 2003. In Australia, shareholder opposition prompted gaming company Tabcorp to withdraw an options plan for its CEO last year, while packaging firm Amcor agreed to increase performance hurdles and extend vesting schedules, according to the investor group. Other firms in these markets now are using longer-term performance targets in incentive plans and have improved their pay disclosure.

March 13, 2007

More Reform Recommendations: The US Chamber of Commerce's Commission Report

Yesterday, the US Chamber of Commerce released a 179-page Report from a Commission it formed that makes a series of reform recommendations (here is an executive summary of the Report). This Report comes on the heels of a number of other reports urging reform, all of which are posted in our "Sarbanes-Oxley Reform" Practice Area; also noteworthy is today's NY Times article on CEOs mingling with Congress leaders and Bush adminstration officials over reform efforts.

Here are the six "primary recommendations" from the Report:

1. Modernize the SEC - Reform and modernize the federal government's regulatory approach to financial markets and market participants, including realigning its organizational structure (by forming a few new Divisions, including promoting a few offices to a Division such as the Office of International Affairs).

2. Give the SEC More Exemptive Authority - Congress should pass a law to provide the SEC with the flexibility to address issues relating to the implementation of the Sarbanes-Oxley, including folding SOX into the Securities Exchange Act of 1934.

3. Minimize Earnings Guidance - Companies should stop issuing earnings guidance altogether or move away from quarterly earnings guidance with a single earnings per share number to just providing annual guidance with a range of projected EPS numbers.

4. Protect Auditors - Policymakers should consider proposals to reduce the significant risks faced by auditors raised by litigation and criminal prosecution; consider the notion that auditors be allowed to raise capital from private shareholders rather than just audit partners.

5. More Retirement Savings Plans - Retirement savings plans should be multiplied by connecting all businesses with 21 or more employees which lack these plans to financial institutions that will provide such a plan.

6. Encourage More to Save for Retirement - Employers should sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-like plan.

There are quite a few recommendations in the Report beyond these six primiary ones. For example, in the accounting area, the Report encourages continued of convergence of international and US accounting and auditing standards and seeks a change to the SEC's existing approach to reconciliation (the Report recommends deciding whether to eliminate should be made on a country-by-country basis, with mutual recognition). The Report also would have the SEC's Chief Accountant conduct rulemaking about when a restatement of financials is required.

In the enforcement area, the Report believes the SEC should implement - with Congressional support via targeted legislation - an enhanced "prudential" role over financial intermediaries and recommends that the DOJ and SEC should not consider the waiver of privilege as a factor in determining whether there was cooperation in an investigation. The Report also urges the SEC to study whether its enforcement program is effective (as well as the PSLRA’s impact on the effectiveness of the federal securities laws).

The Report tackled the thorny issue of formal vs. informal guidance from the SEC Staff - although informal guidance from the SEC is encouraged in the Report, "all parts of the SEC - including the Office of Chief Accountant - should adhere to the notice and comment procedures of the Administrative Procedures Act for significant changes in policy." That sounds fine in principle but I get worried that all Staff guidance will be shut down (and the queries in our Q&A Forums will triple).

Other bloggers have analyzed this Report, including the D&O Diary and FEI's Financial Reporting Blog.

Fixing CEO Pay From "Within"

Congrats to our own Jesse Brill for being profiled in today's front-page WSJ article for his efforts to rein in CEO pay. Working with Jesse for these past 4-plus years has taught me a lot - including how important it is for us lawyers to speak up and say what we think, regardless of how unpopular the message might be. Somewhere over the past few decades, the legal profession changed and has tended to look more and more like a pack of sheep. Jesse has a lot of backbone and isn't afraid to use it.

All I Ever Wanted Was a Human...

Thanks to Jim McRitchie of for pointing us to, a site that blissfully lists how to get ahold of a human on the phone rather than the automated mazes we encounter too often in our daily life. Of course, the human you get may very well be far away in India or some exotic locale...

March 12, 2007

Counterpoint: Executive Compensation Disclosures Not "Overlawyered"

On Friday, I blogged about Chairman Cox's speech during which he noted that some explanations of executive compensation in proxy statements are running more than 40 pages and yet are not telling investors enough about how the bosses are being paid. He also noted that there is a lack of plain English in some CD&As. And he used the term "overlawyered."

I received quite a bit of feedback from members that have been working long hours on these disclosures and took offense to the Chairman's "overlawyered" comment. First, they noted that no one should be surprised that compensation disclosures are running more than 30 pages. This was the page count predicted by most when the new rules were adopted - and this was the length of Pfizer's compensation disclosure last year when that company made proxy disclosures that roughly complied with the proposed rules that existed at the time.

Some members noted that the new rules are very extensive and companies are concerned about being sued by the SEC or the plaintiffs' bar if they have not completely described everything. For many companies, there is a need for lengthy narrative disclosure explaining the numbers in the Summary Compensation Table as well as the other tables (eg. yesterday's NY Times' column cites an example of a negative "total" number in a a recently filed SCT; that circumstance surely requires some narrative explaining). In fact, as I noted on Friday, I believe that some companies have not provided enough disclosure as it's hard to follow the dots in their compensation story.

More importantly, quite a few members note that it is the lawyers who are helping to cut through the HR department's attempt to put boilerplate in the proxy statement. They worry that the Chairman's comments may backfire as people now have a basis for rejecting the lawyer's comments, for example: "We don't really have to disclose the performance goals; you're just overlawyering this."

"Say-on-Pay": What Would Disclosures Look Like?

If Congress passes a law requiring companies to put their compensation arrangements to a non-binding vote by shareholders, what would the disclosures look like? In my mind, that really is the key issue in the debate over whether "say-on-pay" is a good idea. If this issue is resolved, I don't have a beef with the concept of "say-on-pay" since it would not be Congress attempting to dictate the level of CEO pay through the tax code. Rather, a "say-on-pay" law would merely be Congress allowing shareholders to have a clearer voice on executive compensation arrangements. The risk of unintended consequences is much lower for this type of law compared to tax code shenanigans.

Looking at what other countries that already require "say-on-pay" can help. In the United Kingdom, there are two provisions that make up their law: companies prepare an annual "remuneration report" as required by Chapter 46, Part 15, Chapter 6, Sections 420-422 (ie. the Companies Act 2006) - and companies are required to put the report to an advisory vote by Chapter 9: Section 439.

Here is an old renumeration report from GlaxoSmithKline. This 2003 renumeration report is perhaps the most cited example of such a report because it had just over 50% of the company's shareholders disapprove of it - and the law then was in its first year of existence. Fyi, in late 2006, the UK adopted the Companies Act 2006 to amend and restate almost every facet of English law that applies to companies - "say -on-pay" was already on the books and restated in the Companies Act 2006. Looking at what UK companies disclose, I think the SEC's new rules - if properly complied with - elicit the type of disclosure that should allow investors to make an informed voting decision.

How to Find Those CD&As

Some members asked how to find those hundreds of new proxies with CD&As now on file at the SEC. The easiest way is to go to the SEC's free-text search tool and plug in the search term of: "compensation discussion & analysis" (include the quotation marks).

March 9, 2007

SEC Chair: "Overlawyered" Executive Compensation Disclosures

Yesterday, SEC Chairman Cox gave a speech during which he said that incoming executive compensation disclosures are in some cases suffering from "overlawyering" and need to be written in plain English - and that some explanations of executive compensation in proxy statements are running more than 40 pages, yet not telling investors enough about how the bosses are being paid. Having read a few CD&As myself so far this proxy season, I agree that some feel like they have considerable gaps when it comes to describing the company's compensation arrangements.

The Chairman also said the SEC Staff would be electronically tagging the executive compensation data in proxy statements and posting the interactive data around June, which would allow the public to compare compensation data for several hundred of the largest companies.

Shareholder Access in '08?

According to this WSJ article, SEC Chairman Cox indicated that the Commission has made progress towards proposing a shareholder access rule and is hopeful to have something adopted in time for next year's proxy season.

Executive Compensation: House's Financial Services Committee Hearing

As reflected in this WSJ article, there were no real surprises during yesterday's House Financial Services Committee hearing on Rep. Barney Frank's "say-on-pay" bill. Here is the prepared testimonies of the hearing witnesses - and here is a related Reuters' article.

Internal Pay Equity Legislation: Another Angle for Legislators to Cap Pay

For those following our musings on, you hopefully know that we have been touting internal pay equity as a simple balancing methodology to help handle the challenges of utilizing peer group benchmarking to set CEO pay levels.

Recently, two Maryland state senators, Paul Pinsky and Richard Madaleno Jr., have sponsored a bill to prohibt Maryland corporations from deducting executive pay as a business expense if it exceeds 30 times what the lowest-paid worker earns. I doubt this bill will go anywhere - and I don't think legislating pay levels is the way to go - but it illustrates that pay practices need to change voluntarily before they are changed for you...

March 8, 2007

Another Record Year for Restatements

As nicely laid out in this article, restatements reached a new high last year - not too surprising given option backdating, etc. In our "Restatements" Practice Area, we have posted copies of several recent studies.

Here is an excerpt from the article: "Companies with U.S.-listed securities filed 1,538 financial restatements in 2006, up 13 percent from what had been a record number in 2005, according to an annual study by Glass, Lewis. Out of that total, 118 restatements were made by foreign issuers.

All told, the number of companies that restated last year—1,244 U.S. companies and 112 foreign companies—filed 1,538 financial restatements to correct errors represent 9.8 percent of all U.S. public companies. In 2005, only one in 12 companies restated their financial results. More interesting, in 2006, there was a 14 percent decrease in the number of restatements from companies that were mandated to comply with Section 404 of the Sarbanes-Oxley Act, "a sign that larger companies are making progress on cleaning up their books," the proxy research firm asserted. However, restatements rose a whopping 40 percent among companies that haven't yet been required to comply with Sarbox 404—smaller companies."

Not that it matters, a different study noted in this WSJ article found even greater numbers of restatements last year...

US and EU Will Accept Global Financial Reporting Rules

At Wednesday's Roundtable on International Financial Reporting Standards, SEC Chairman Cox announced that he and EU Internal Markets Commissioner Charlie McCreevy have struck an agreement that would eliminate the reconciliation to U.S. GAAP by 2009. In other words, US and European regulators pledged to recognize each other's rules by 2009 for how companies report financial data, a move that may facilitate more international investing and reducing corporate compliance costs. Here is a related Washington Post article - and here are FEI's notes on the Roundtable.

This development was a long time in the making, here is a timeline:

- 1996 - Congress passes the "National Capital Markets Efficiency Act, which directs the SEC to respond to the growing internationalization of securities markets by giving "vigorous support" to the development of "high-quality international accounting standards as soon as practicable."

- 2000 - SEC issues a Concept Release that solicits comment on whether we should consider accepting International Financial Reporting Standards in the US.

- 2002 - FASB and IASB began in earnest to achieve short-term convergence between their respective sets of accounting standards after signing the "Norwalk Agreement."

- 2002 - European Parliament and the Council of the European Union determine that all listed European Union companies have to prepare their consolidated financial reporting using IFRS, beginning in 2005.

- 2005 - SEC lays out International Financial Reporting Standards "Roadmap."

Proposed Tweaks to FASB's FIN 48

Last week, the FASB proposed guidance for FIN 48, the new standard that requires companies to state the value and risks of uncertain tax positions more clearly. Proposed FSP FIN 48-a provides guidance regarding when a position is “settled” and thus no longer is in need of a FIN 48 review. Comments are due by March 28th.

March 7, 2007

Section 11 and the Reliance Requirement

Last month, the Eleventh Circuit affirmed a district court's dismissal of a complaint filed under Section 11 brought by investors who were 30% shareholders in a company that merged with defendant company in APA Excelsior III L.P. v. Premiere Technologies. This case is about whether the sophisticated investors who signed traditional lock-ups/irrevocable proxies at the outset of arms-length merger negotiations should be able to recover under Section 11 based on the subsequently filed registration statement for a stock-for-stock merger.

The court found that the plaintiffs made a legally binding investment decision when they signed their shareholders' agreements, months before the registration statement was filed - so that the plaintiffs weren’t entitled to an implied presumption of reliance on the registration statement when they made their investment decision. The court highlighted that these particular types of investors have access to even better information than what is traditionally disclosed in the registration statement by virtue of their due diligence rights.

As Section 11 does not normally require a showing of reliance, the court looked to the legislative history of the liability provision to interpret it as setting forth a presumption of reliance - not a strict liability statute - and further found the presumption was rebutted here due to the "pre-registration commitment theory."

What Might Be the SEC's View of the APA Excelsior Decision?

A decade ago, when the SEC proposed the Aircraft Carrier package of reforms, the SEC provided an interpretation that shares in these types of mergers could be registered on a Form S-4, even if investors were really making their investment decision at the time they entered into these types of shareholders' agreements. In the Aircraft Carrier proposing release, the SEC stated it would be “codifying” a Staff position - and since the Commission voted to propose the release, I think an argument can be made that the SEC blessed the Staff's interpretation of the issue even though the proposed rule never got adopted.

Here is the relevant excerpt from the Aircraft Carrier proposing release: "The use of lock-up agreements in business combinations has become common. As part of the negotiations for these combinations, the acquiring party usually requires that management and principal security holders of the company to be acquired commit to vote for the acquisition. These so-called "lock-up" agreements are made when the acquisition agreement is finalized, before any action by the public security holders. These agreements could be considered investment decisions under the Securities Act. If they are, the offers and sales of securities were made to persons who entered into those agreements before the business combination is presented to the non- affiliated security holders for their vote. Under this reasoning, those offers and sales could not be included in the registration statement for the offering to the persons not entering into lock-up agreements.

In recognition of the legitimate business reasons underlying the practice, the staff has permitted the registration of offers and sales under certain circumstances where lock-up agreements have been signed. We propose a rule that codifies this position. Our proposed rule would allow registration of those offers and sales when: (i) The lock-up agreements involve only executive officers, directors, affiliates, founders and their family members, and holders of 5% or more of the voting equity securities of the company being acquired; (ii) The persons signing the agreements own less than 100% of the voting equity securities of the company being acquired; and (iii) Votes will be solicited from shareholders of the company being acquired who have not signed the agreements and who would be ineligible to purchase in an offering under Section 4(2) or 4(6) of the Securities Act or Rule 506 of Regulation D.

The first condition would assure that the only persons who signed the agreements were insiders with access to corporate information who arguably would not need the protections of registration and prospectus disclosure. The last two conditions would make certain that registration under the Securities Act is required to accomplish the business combination. Where no vote is required or 100% of the shares are locked up, no investment decision would be made by non-affiliated shareholders and the transaction would have been completed via the lock-up agreement. If the non-affiliated shareholders were able to purchase under one of the private offering exemptions from registration, the entire transaction would be more akin to a private placement and registration of only resales would follow from that characterization."

After McNulty: Changes in the Attorney-Client Privilege and Investigations

Tune in tomorrow for our webcast - "After McNulty: Changes in the Attorney-Client Privilege and Investigations" - to hear David Becker of Cleary Gottlieb, Peter Moser of DLA Piper, Keith Bishop of Buchalter Nemer, Joseph Burby of Powell Goldstein, and Christian Mixter of Morgan Lewis discuss the changing processes of government and internal investigations after the long-awaited McNulty memo, which provides prosecutors with a revised set of corporate fraud charging guidelines, including new policies on waiver of the attorney-client privilege and the advancement of attorney’s fees to employees under investigation. As an aside, here is a speech by Attorney General Alberto Gonzales at last week's ABA White Collar Crime Conference.

The SEC’s 8-K Rule Changes: How They Impact You

We have posted the transcript from the webcast: "The SEC’s 8-K Rule Changes: How They Impact You."

March 6, 2007

Warren Buffett's Frustration Over CEO Pay Practices

Always a fascinating read, here is Warren Buffett's 23-page 2007 letter to shareholders. Warren always has something to say about executive compensation practices and this year's letter is no exception. On page 19, he notes that he has served as a director on 19 boards and he has been the "Typhoid Mary" of compensation committees. "At only one company was I assigned to comp committee duty, and then I was promptly outvoted on the most crucial decision that we faced. My ostracism has been peculiar, considering that I certainly haven't lacked experience in setting CEO pay. At Berkshire, after all, I am a one-man compensation committee who determines the salaries and incentives for the CEOs of around 40 significant operating businesses."

Warren goes on to wax about a pack mentality regarding executive compensation, which results in: "CEO perks at one company are quickly copied elsewhere. 'All the other kids have one' may seem a thought too juvenile to use as a rationale in the boardroom. But consultants employ precisely this argument, phrased more elegantly of course, when they make recommendations to comp committees.

Irrational and excessive comp practices will not be materially changed by disclosure or by an independent comp committee. Indeed, I think it's likely that the reason I was rejected for service on so many comp committees was that I was regarded as too independent. Compensation reform will only occur if the largest institutional shareholders - it will only take a few - demand a fresh look at the whole system. The consultants' present drill of deftly selecting "peer" companies to compare with their clients will only perpetuate present excesses."

CD&As Pouring In

As the proxy season heats up, proxy statements are now being filed in droves (Mark Borges blogged about a bunch of them last night). This Temple-Inland proxy statement is noteworthy because they decided to write the entire CD&A in a Q&A format.

Shareholder Access: SEC Looks Abroad

The Financial Times reports that SEC Chairman "has commissioned a study of how Europe and other foreign jurisdictions handle shareholder voting rights as the regulator grapples with whether to relax rules allowing shareholders access to company proxy documents. The move will be welcomed by large European shareholder groups which have warned that the US risks falling behind in corporate governance standards and that limiting access to proxies could discourage foreign shareholdings in US companies." Meanwhile, the European Parliament approved the "Proposal for a Directive on Shareholder Voting Rights." And today's Washington Post contains a blurb stating that the SEC may hold public hearings on access in the near future.

As an aside, one of the two outstanding shareholder proposals on access has been withdrawn at Reliant Energy; the proponent did not provide a reason for the withdrawal of the proposal. And ISS has backed the shareholder access proposal coming up for a vote at Hewlett-Packard.

March E-Minders is Up!

We have posted the March issue of our monthly email newsletter.

March 5, 2007

Another 409A-Related Deadline: California Developments Linked to Backdated Options and Section 409A

Tahir J. Naim of Fenwick & West provides this timely warning about a March 15 deadline from the California Franchise Tax Board: California's Franchise Tax Board has implemented a program related to collection of its taxes for 2006 income recognized by certain taxpayers due to Section 409A that parallels the IRS program described in IRS Announcement 2007-18. The deadline for participation in this program is March 15, 2007.

It is the position of California's Franchise Tax Board that, as of 1/1/05, California's Revenue and Taxation Code Section 17501 automatically incorporated into California law the provisions (including the 20% tax and interest) of Section 409A of the Internal Revenue Code.

In other words, California taxpayers whose deferred compensation arrangements trigger the application of the federal 409A tax will also have a commensurate California tax liability for a total tax liability of at least 85% (federal = 35% + 20% + 1.45% + 409A interest + CA of 9.3% + 20% + CA 409A interest) on income which in at least some instances the taxpayer will not yet have received.

Executives who are "specified employees" (as defined in Section 409A) will want to pay particular attention to ensuring their severance arrangements include the 6-month delay on any payments that would trigger the tax under Section 409A (more broadly, this will also heighten the need of issuers with employees in California to have backing for the position that their stock option exercise prices are no less than fair market value of the underlying shares on the date of grant).

Although the law was effective with respect to 2005 income, it may be that California - like the IRS - will concentrate its focus on the collection of taxes arising in 2006 and thereafter. For example, it is only with California's 2006 Form 540 that mention is made of 409A taxes (see the instructions to Line 33 of the form).

If you need more information, contact the California Franchise Tax Board at 916.845.7057. [And speaking of 409A, Corp Fin has issued its second tender offer prompt payment exemptive letter.]

Pay Bosses More! Gimme a Break...

I keep thinking we have seen the last of the WSJ opinion columns urging that CEOs be paid more. Wrong again! This recent opinion column from two senior fellows at the Cato Institute really takes the cake.

You know we are in for a laugher when the column starts off with the theme of: "Excessive executive compensation harms no one but perhaps the stockholders who put up with it." Getting past that excessive compensation does indeed hurt employee morale (not to mention how leaders are viewed by many in this country, etc.), I don't see how these senior fellows make their argument that "stockholders are putting up with it" with a straight face.

First, shareholders haven't known how high levels of CEO compensation have really gotten because the SEC rules historically haven't elicited the full compensation story from companies (these rules were changed last summer, but the new and expanded disclosures aren't in quite yet). For that matter, most boards themselves didn't know how much they are paying their own CEOs until tally sheets became a mainstream practice within the last year or so. As tally sheets have begun to be used for the first time, the "Holy Cow" surprise felt by the NYSE board in the Dick Grasso incident has proved not to be an isolated event.

Second, many shareholders simply aren't putting up with it. Unfortunately, they have only limited tools at their disposal to try to effectuate change: submitting nonbinding shareholder proposals to companies to place on annual meeting ballots, and more recently, "just vote withhold" campaigns against director nominees. This soon may change as the movement to force annual shareholder advisory votes on executive compensation is gathering momentum on Capitol Hill (and with companies as Aflac just became the first US company to agree to do it in 2009).

With more disclosure in their hands and a vehicle to express dissatisfaction, I believe we will soon have pretty solid proof that shareholders don't want to "put up with it"; they've just been stuck with it as boards continue to follow outdated - and ill-formed - processes that have led to mind-boggling compensation packages to CEOs. As I have long contended, I don't believe most directors want to overpay CEOs - it's just that the processes put in place over a decade ago led to some unintended results.

This cycle must end. It's incumbent on boards to fix these problems and have some backbone to realize that layering on a few more million won't really incentivize a CEO to perform just a wee bit more when the CEO is already sitting on a pay package worth tens of millions. Arguing otherwise doesn't seem to be a logical read of human nature.

Deal Protection: The Latest Developments

Join tomorrow for a webcast – "Deal Protection: The Latest Developments" - and hear about the latest deal protection developments from Cliff Neimeth of Greenberg Traurig and Ray DiCamillo and Bill Haubert of Richards Layton.

No registration is necessary - and there is no cost - for members. Take advantage of our no-risk trial for this timely webcast.

March 2, 2007

Corp Fin Issues Exemptive Letter on Tender Offer Prompt Payment - 409A Issue

At the top to the year, I blogged extensively about issues arising from tender offers for backdated options. One of the issues related to the "prompt payment" requirement in the tender offer rules (because new Section 409A of the Internal Revenue Code requires that any cash amounts paid in connection with an option repricing be paid in the year after the option repricing; a requirement which contravenes the SEC’s prompt payment rules).

Yesterday, Corp Fin's Office of Merger & Acquisitions issued the first exemptive letter - to CNET Networks - relating to Section 409A and the tender offer prompt payment rules.

Rep. Frank Re-Introduces Legislation re: Shareholder Advisory Votes on Executive Pay

As noted in this press release, yesterday, House Financial Services Committee Chairman Barney Frank, joined by 21 other Representatives, introduced legislation that would require public companies to include a non-binding advisory shareholder vote on their executive pay plans on their ballots. The bill, H.R. 1257 - the "Shareholder Vote on Executive Compensation Act" - would not set limits on pay, but would allow shareholders to voice their approval or disapproval on the company's executive pay practices through an advisory vote (then, the board would have discretion as to how to react to that vote).

The bill also would require a non-binding advisory vote if a company provided a new, not yet disclosed, "golden parachute" while simultaneously negotiating to buy or sell a company. This is a different formulation compared to the last time this bill was introduced; the former bill required shareholder approval of any golden parachute payments in an acquisition (ie. a binding vote).

A House Financial Services Committee hearing on this bill will be held next Thursday, March 8th. Rep. Frank said he expects House passage of this bill as soon as April...

General Electric Files Proxy Statement

In his blog, Mark Borges has been providing some detailed analysis of the proxy statement filed recently by General Electric (as well as other newly filed proxy statements).

March 1, 2007

A Qualitative Review of SEC Comment Letters

When preparing financial statement footnotes and other disclosures, practitioners may need more than the guidance provided by FASB statements and SEC rules. They may also need information about other companies’ disclosures. By identifying and measuring the most common practices and variations of disclosures, this research can aid companies as they strive to improve the quality of their own disclosures. Based on a review of publicly available comment letters on the SEC website posted during the first eight months of 2006, this report provides a recap of reporting topics and trends and the most common comments made by the Staff. Categorization of each comment type included a review of each comment and, if available, the company response to the comments. Many of the key areas identified in the report (refer to the table in the executive summary) seem to be consistent with other information provided by the SEC.

Directors Harder to Recruit

As reported by Financial Week back in November: An executive from Korn Ferry estimated that 10 years ago it took roughly 90 days to fill a directorship; it can take up to 180 days these days. Of 391 new directors hired by S&P 500 companies, only 29% are active CEOs, a 38% decline from 2001. Meanwhile, the number of CFOs and other high-ranking execs among the new director hires jumped 67% over the same time period, and this year accounted for 15% of all new slots, according to executive search firm Spencer Stuart.

Shearman & Sterling's Annual Corporate Governance Survey

Shearman & Sterling's 4th annual survey examines the corporate governance practices of the 100 largest US public companies, including these notable trends:

- Poison pills and classified boards continue to decline. The number of companies with poison pills fell by nearly 50% over the past two years and the number of companies with classified boards fell by over 30% in that same period.

- Of the 24 top 100 companies at which separate individuals serve as chairman and CEO, six have adopted policies requiring separation of the two functions.

- A majority of companies continue to exceed the minimum independent director requirements of the NYSE and NASDAQ. Independent directors continue to comprise 75% or more of the boards of the majority of companies.

- The number of board and committee meetings continues to increase. Given this increased time commitment, investors have focused on the number of boards on which directors serve.