TheCorporateCounsel.net

Monthly Archives: May 2007

May 31, 2007

Welcome Aboard, Mr. David Lynn!

We are honored to welcome David Lynn to our team. Dave left his post as Chief Counsel of the Division of Corporation Finance on Friday, after serving in that capacity for the past four years. This was his second tour of duty in Corp Fin, having spent some time at WilmerHale in between.

In addition to helping implement the record amount of rulemaking that occurred in the wake of Sarbanes-Oxley, Dave was one of the key point persons on the SEC’s proxy disclosure rules and, most recently, has been primarily responsible for the overhaul of the SEC’s Telephone Interpretations Manual. Dave and I worked together at the SEC a while back and I couldn’t imagine a better partner to spend the next few decades churning out the news and analysis for you on this site.

The “Skinny” on Dave

So what will Dave be doing? Initially, Dave will be providing badly needed help on TheCorporateCounsel.net, serving as an Editor of the site along with me – and even splitting blogging duties starting next week. Dave actually ran an internal blog in Corp Fin so he is not afraid to stick his neck out. Dave also will be helping out on CompensationStandards.com, run our secret special project division and weigh in with his ten cents on some of our print publications, like The Corporate Counsel.

As evident from his biography, Dave is a man of multiple talents. Who else could come up a “going away” speech in the form of a CD&A (actually, several CD&As). And Dave will be able to help all of us decipher some of the more interesting comment letters that get filed with the SEC. Dave can be reached at dave@thecorporatecounsel.net. Let him know how much you want to love him…

The Rise of the “B’s”

In our “Credit Ratings, Arrangements, & Facilities” Practice Area, we have posted a report on the rise in numbers of companies in the US with “B” credit rated debt. It notes the dramatic decline in percentage of companies with AAA/AA rated debt, as well as the percentage of companies with “B” rated debt that have filed for bankruptcy.

May 30, 2007

Recent Developments: The NYSE’s “Broker Vote” Rulemaking

Recently there has been some movement in the NYSE’s rulemaking to amend Rule 452 to eliminate broker non-votes in the director election context. First, there was some discussion on the topic during last week’s proxy process roundtable at the SEC. Jim McRitchie does a good job of summarizing what the roundtable participants’ positions have been, noting on CorpGov.net that the recommendations on broker voting appear to have broken into three categories:

- Stick with NYSE’s proposal to eliminate broker voting for directors – One variation would only eliminate it where there is an active no-vote campaign.

- Proportional voting – Where the broker uses voting instructions given by other retail investors to determine how to vote uninstructed shares. There were several variations on this theme.

- Client-directed voting – Under this framework from American Express’s Stephen Norman, retail investors would give general voting instructions to their broker when signing brokerage account agreements.

Second, as noted in this WSJ article, the mutual-fund industry got its wish and the NYSE has amended its proposal so that mutual funds would be excluded from any change in its rules (according to the article, after reviewing information supplied by the fund industry, the NYSE said its advisory panel concluded that mutual funds are different enough “that it was appropriate to treat such companies differently”).

Finally, some investors are demanding that this rulemaking go forward. Below is an excerpt from the ISS “Corporate Governance Blog” on this topic:

A close director vote at CVS/Caremark is fueling investor demands for the Securities and Exchange Commission to approve a New York Stock Exchange rule change to bar brokers from casting uninstructed investor votes in board elections.

“I think this vote will be Exhibit A in the deliberations of the NYSE and the SEC in the coming weeks,” said William Patterson, executive director of the CtW Investment Group, which has urged CVS/Caremark to request the resignation of director Roger Headrick. The Council of Institutional Investors (CII) plans to hold a conference call on May 29 to address the issue, Patterson said.

Headrick received 606.585 million “for” votes and 453.175 million “against” votes at company’s May 9 meeting, CVS/Caremark said in a regulatory filing. Based on those numbers, Headrick received a 42.7 percent negative vote. However, the vote results for five other proxy items reveal that 264.762 million “broker non-votes” were cast. If those broker votes are subtracted from Headrick’s “for” total, then the “against” votes would amount to 57 percent of the remaining votes.

The stakes are higher at CVS/Caremark, because the company, like scores of other large firms, now requires that board nominees receive a majority of votes cast in uncontested elections to be elected. “Before this proxy season, all of this was theoretical,” Patterson told Governance Weekly. At CVS/Caremark, “the broker votes were decisive and that’s clear.”

CtW, which manages funds for the Change to Win labor federation, targeted Headrick and a second former Caremark Rx board member over their handling of the pharmacy benefits company’s recent sale to CVS, the largest U.S. drug-store chain. In its regulatory filing, CVS/Caremark said “votes ‘against’ a director’s election count as a vote cast, but ‘abstentions’ and ‘broker non-votes’ do not count as a vote cast with respect to that director’s election.”

However, the vote results suggest that some of those broker votes were counted in Headrick’s election. The company’s filing indicates that a total of 1,059.76 million shares were cast either “for” or “against” Headrick. CVS/Caremark also reported that the total votes cast at the meeting were 1,091.671 million, or 31.91 million more. The vote results for five other proxy items indicate that there were 264.762 million broker votes, so it appears that 232.852 million broker votes were counted in Headrick’s election for his vote total to reach 1,059.76 million. Those 232.852 million votes exceed the 153.41 million difference between the “for” and “against” votes that the company reported that Headrick received.

Company spokeswoman Carolyn Castel told Dow Jones Newswires that the “broker votes were spread among the votes cast for and against the directors.” However, Patterson and other investor advocates contend that broker votes are routinely cast in favor of management nominees in uncontested elections. The Council of Institutional Investors has said these votes “taint the integrity of the proxy voting process by stuffing ballot boxes for management.”

Goldman Launches an Unregistered Stock Trading System

As noted in this recent WSJ article, Goldman Sachs has joined the ranks of those launching an unregistered securities trading exchange with its “GS TRue” platform. Here are one blogger’s thoughts on this development – and here are two excerpts from the WSJ article:

“Goldman Sachs Group Inc. ranks as the most profitable securities firm on Wall Street — reflecting its mastery of trading on the world’s public markets. Now Goldman is turning that franchise on its head, creating its own private system to trade the stocks of companies that don’t want the scrutiny and regulatory burdens of going public.

The new system, GS TRuE — short for Goldman Sachs Tradable Unregistered Equity — was announced two weeks ago and made its debut on Monday with an $880 million sale of a 15% stake in Oaktree Capital Management LLC, an alternative-investment manager. It is the first of several new, private exchanges like these being considered by Wall Street firms and others. Nasdaq is also planning its own new market for smaller, unregistered securities.

These markets will generally be closed to individual investors. For instance, Goldman’s market is open only to large institutional investors with assets of more than $100 million. That is because the stocks traded on GS TRuE aren’t registered with the Securities and Exchange Commission and issuers aren’t subject to SEC regulations designed to protect individual investors.

It represents the latest step in the creeping exclusion of individual investors from a growing proportion of financial-market activity. For instance, giant private-equity firms are busy buying public companies and delisting them from stock exchanges. The growing importance of hedge funds — which are generally limited to wealthy investors, institutions and endowments — also excludes individuals.”

“Bankers at rival firms — many of which are developing similar systems — predict that there will be consolidation among the different platforms. “History in other markets would indicate that this will converge into a single platform,” said Daniel Simkowitz, a managing director in capital markets at Morgan Stanley, which advised Oaktree on the issue.

Indeed, Nasdaq Stock Market Inc. is in the home stretch of getting approval for a similar unregistered trading facility for smaller companies called Portal. Another securities firm, Friedman, Billings, Ramsey Group Inc., has sold unregistered stock for numerous companies in real estate, energy and lodging.

Goldman executives said one reason they launched their own system solo, without asking other rival securities firms to participate, was to insure control over the number of investors in any particular security. That is crucial, they said, because any company that goes over 499 investors must register as a public company.

That 499-investor limit, said one executive of a top private-equity firm, is one reason why such buyout firms aren’t likely to rush pell-mell into this type of new issue for their portfolio companies. The buyout firms want to attract far more investors to make sure they get the best prices for their stock, he explained.”

A Philosophy for Drafting Agreements

In our “Carl’s Corner”, we have posted the latest from Carl Schnider on “A Philosophy for Drafting Agreements.” Great practical stuff from Carl!

May 29, 2007

The Evelyn Y. Davis Show

As expected, Evelyn Davis was all entertainment during the SEC’s third proxy process roundtable on Friday. She is a “must see” on the video archive (her panel kicks off at the 1:22 mark; Evelyn starts at 1:27, but its worth hearing the calm voices of the other speakers before her for context). Note that the SEC upgraded the display of its open meetings from audio to video recently.

Marty Dunn did a fair job of keeping Evelyn under control – but she did get a few good ones in, such as screaming that she is prettier than Nell Minow. The SEC has posted a transcript of the first roundtable as well as briefing papers and panel statements for all three.

Private Equity M&A Nuggets

We have posted a transcript from the popular DealLawyers.com webcast: “Private Equity M&A Nuggets.”

Subprime Lending Developments

In this podcast, Stephen Ornstein of Thacher Proffitt & Wood provides some insight into what is happening in the subprime lending market, including:

- What are the latest developments in the subprime lending area?
- How bad is this market right now?
- For those companies that originate, purchase and underwrite securitizations with subprime loans, what is their respective primary exposure in today’s markets and how do these parties mitigate risk?

May 25, 2007

PCAOB Adopts AS #5

Yesterday, the PCAOB adopted Auditing Std. No. 5 (and here is the PCAOB’s press release). It is expected that the SEC will approve the PCAOB’s new standard on an expedited basis.

Memos on the SEC’s and PCAOB’s guidance will be posted in our “Internal Controls” Practice Area. And I am putting the finishing touches on a July webcast to explain all the new internal controls guidance, featuring John Huber and some Big 4 experts…

Corp Fin Issues Section 16 Interps

Yesterday, Corp Fin issued these Section 16 interps. As he has already been doing, Alan Dye will be blogging about the nuances of these new interps on his Section16.net Blog – as well as writing about them in the upcoming issue of Section 16 Updates. Try a no-risk trial to Section16.net today – half-price for the rest of 2007!

A New Staffer Hang-Out?

Congrats to SEC Staffer Amy Starr for founding a groovy coffee shop in Northern Virginia (below is a related Washington Post article): “David A. Starr talks real fast, not because he’s a lobbyist but because he is a professional coffee roaster on the side. He drinks about eight cups of his specialty brew a day.

Starr, a 48-year-old principal at the lobbying law firm Williams & Jensen, is an expert in tax and pension law. His clients include Brooks Brothers and the YWCA Pension Fund. But in recent years he and his wife, Amy Starr, a Securities and Exchange Commission lawyer, developed a passion for self-roasted coffee and this year they made it into a business, Beanetics Coffee Roasters in Annandale.

“We can roast 100 pounds of coffee — from green bean to bag – in an hour,” Starr said proudly. And yes, the beans, whether Costa Rican (his top seller) or Ethiopian, start off green before they are heated in the store’s roaster, which patrons can see through a window.

Starr began 10 years ago with a tabletop roaster in his kitchen and progressed to a bigger roaster in his garage. But his friends wanted more coffee than his hobby could provide them, so in February he opened shop not far from his home. “I scoot over on the way into work to check in,” Starr said, “and also have a great cup of coffee.”

May 24, 2007

SEC Adopts Voluntary 404 Guidance and Much More

Yesterday, the SEC adopted new guidance for management’s assessment of internal controls over financial reporting, which becomes effective 30 days after being published in the Federal Register. The new guidelines provide a principles-based framework, which is intended to promote a “healthy use of judgment” and provide companies with flexibility to establish an appropriate evaluation method. Here is Corp Fin Director John White’s opening statement, Chief Accountant Hewitt’s opening statement, Deputy Chief Accountant Zoe-Vonna Palmrose’s opening statement and a press release. FEI’s “Financial Reporting” Blog has more extensive notes about the meeting.

Although we don’t have the text of the new guidance yet, the SEC Staff said that the proposed core principles remain unchanged in their final form – but the Staff stated that there are some changes, mainly to align the guidance with what the PCAOB will adopt today at their meeting. The core principles are that management should evaluate whether it has implemented controls that adequately address the risk that a material misstatement in the financials would not be prevented or detected in a timely manner – and that management’s evaluation of evidence about the operation of its controls should be based on a risk assessment.

The SEC stated that its guidance makes clear that management can look to the principles-based guidance for carrying out its responsibilities. The new guidance doesn’t include examples because the SEC wants to avoid the unintended consequence of creating a “one size fits all” box. The SEC Staff stated that many larger companies have developed acceptable procedures for Section 404 reporting that differ from the interpretive guidance and that such procedures may continue to be used.

The SEC amended Rule 12b-2 and Rule 1-02 of Regulation S-X to codify the term “material weakness” substantially as proposed (the Staff stated that the PCAOB will adopt the same definition) to “a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility of leading to a material misstatement that will not be prevented or detected on a timely basis). The Staff explained that most of the material weakness situations seen so far involve accounting related issues within the areas of more complex accounting standards, such as taxes, revenue-recognition and the treatment of derivatives – and the new guidance addresses these areas.

The SEC amended Rules 13a-15(c) and 15d-15(c) to eliminate the requirement that auditors attest to management’s process of evaluating internal controls. In addition, the SEC amended Rules 1-02(a)(2) and 2-02(f) of Regulation S-X to require the expression of a single opinion directly on the effectiveness of internal control over financial reporting by the auditor in its attestation report.

The SEC also proposed a new definition of the term “significant deficiency,” which is intended to clarify those weaknesses that are considered to be less severe than a “material weakness.” Unlike “material weakness,” the proposed “significant deficiency” doesn’t include a probability threshold.

What the SEC Didn’t Do? Extend the Smaller Company Deadline Again

The SEC didn’t extend the deadline for smaller companies (those with less than $75 million in market capitalization) to comply with Section 404 since the new guidance provides scalable and flexible ways for these companies to meet the December 31st deadline. So unless the SEC reverses itself – which is still possible since Commissioners Atkins and Casey said they are still considering it – three delays was the charm. Following the SEC meeting, Senators Kerry and Snowe issued a press release saying it was a mistake not to adopt a fourth delay.

By the way, the SEC has announced the agendas and panelists for today’s and tomorrow’s proxy process roundtables (Evelyn Davis is on the Friday agenda; that alone should make it worthwhile). And the SEC adopted rules yesterday related to the Credit Rating Agency Reform Act of 2006.

The SEC’s Proposed Overhaul of Smaller Company Capital-Raising

Yesterday, the SEC also proposed a new framework for smaller company capital-raising. Here is an opening statement from the Corp Fin Staffers who shepparded this project. According to this press release, the proposals would include:

- A new system of securities regulation for smaller public companies that would make scaled regulation available to a much larger group of smaller companies (ie. up to $75 million in public float; up from $25 million), including killing the S-B system by integrating Regulation S-B into Regulation S-K and rescinding the SB Forms

- Modified eligibility requirements so companies with a public float below $75 million can use shelf registration

- A new Regulation D exemption from ’33 Act registration requirements for sales of securities to a newly defined category of “Rule 507 qualified purchasers” for which limited advertising would be permitted

- Shortened holding periods under Rule 144 for restricted securities (ie. reduced from one year to six months, unless a short sale is involved) and a few changes to Rule 145

- Two new exemptions for compensatory employee stock options so ’34 Act registration requirements would not be triggered solely by a company’s option granting practices

- Electronic filing of Form Ds

Hewlett-Packard’s Boardroom Leak: SEC’s Enforcement Brings a Form 8-K Case

So I guess filing those director resignation 8-Ks do matter after all. According to this press release, the SEC yesterday filed settled administrative charges with a cease and desist order (no fines or penalties) against Hewlett-Packard for failing to disclose the reasons for a director’s abrupt resignation in the midst of H-P’s controversial investigation into boardroom leaks.

The SEC found that several months before the public revelation of the company’s leak investigation, an H-P director objected to the company’s handling of the matter and resigned from the Board, yet H-P failed to disclose the reasons for his resignation as required under Item 5.02(b) of Form 8-K. Here is the SEC’s administrative release.

May 23, 2007

The Independence of Compensation Consultants

A few weeks ago, Rep. Henry Waxman (Ca.-D) sent letters to a number of compensation consultants seeking information about potential conflicts, ahead of a likely hearing on the topic. Here is an excerpt from a recent NY Times article:

“Members of Congress are looking into the potential conflicts among executive compensation consulting firms that do other lucrative work for the companies whose pay they help devise. The chairman of the House Committee on Oversight and Government Reform has asked the largest companies in the industry for details on their client relationships and the revenues these ties have generated over the last five years.

The companies — Hewitt Associates; Mercer Consulting, which is a unit of Marsh & McLennan; Towers Perrin and Watson Wyatt Worldwide — confirmed yesterday that they had received a letter dated May 8 from Henry A. Waxman, the California Democrat who is chairman of the oversight committee.

Mr. Waxman asked the consulting firms to identify which companies among the nation’s 250 largest they had provided both executive pay consulting and other services for and to disclose total revenues received for each type of service. Mr. Waxman asked that the companies supply the information by May 29.”

Personally, I’m not convinced that these consulting conflicts are “real” since the folks that advise on exec comp are not the same as those that consult on other HR stuff (ie. general workforce pay, retirement and health benefits) within these consulting firms – but perception often can be as important as real conflicts. Of course, as noted in the D&O Diary blog, there can be instances where a consultant can be implicated in some shenanigans…

Executive Compensation Disclosure Proposal: Et Tu, Canada?

Last month, Canadian regulators proposed an overhaul of their executive compensation disclosure rules, including a new CD&A and a total column in their Summary Compensation Table. Similar to last year’s overhaul in the US, the Canadian proposal would be the first update of these rules since 1994. Learn more in CompensationStandards.com’s “International” Practice Area.

Top Trends in Stock Plans for Overseas Employees

Tune in tomorrow for this NASPP webcast – “Top Trends in Stock Plans for Overseas Employees” – and learn:

- Trends in the design and usage of stock options, restricted stock, performance-based awards, and ESPPs for overseas employees
- Changes in stock compensation for overseas employees as a result of 123(R)
- Worldwide participation in ESPPs and changes in these plans post-123(R)
- Policies and procedures for tax withholding on both stock options and restricted stock
- Common practices for monitoring compliance with local laws, grant documentation and employee education, and compliance with data privacy laws and the EU prospectus directive

And just yesterday, the SEC announced a roundtable of five SEC Chairs that will take place today. Not too much in the way of advance notice for this program – and the announcement doesn’t indicate what the topics will be (and this roundtable will convene at 5 pm, well after this morning’s open Commission meeting that includes 8 agenda items). The CFO.com blog speculates as to what the topics might be…

May 22, 2007

Trouble for Glass Lewis

Glass Lewis suffered a blow when it was announced over the weekend that two of its key staffers – Lynn Turner and Jonathan Weil – have resigned (Jonathan has already left; Lynn leaves in two weeks). This article indicates the flap is over a dispute involving Glass Lewis’ parent company, China-based Xinhua Finance Media Ltd. The dispute revolves around inadequate disclosures regarding the Chinese parent’s CFO in the parent’s IPO prospectus (which has led to a class action lawsuit). This WSJ article indicates the flap is generally over the parent’s conduct (and the article raises questions about ISS’ and Glass Lewis’ new ownership; Glass Lewis’ parent went public last year and ISS’ parent may go public soon).

Lynn was the Managing Director of Research and a former SEC Chief Accountant and Jonathan was Managing Director and Editor of Financial Research and a former WSJ reporter who broke the Enron scandal wide open. I believe Barron’s first reported on this development in this article.

Nasdaq Seeks to Reestablish PORTAL as a 144A Trading Market

Recently, Nasdaq has filed a proposal with the SEC seeking to reestablish PORTAL as a facility for broker-dealers to publish quotes for qualified Rule 144A securities and trade these securities, among themselves and with QIBs.

This is similar to how PORTAL was originally intended to operate when it was launched many years ago. PORTAL never thrived as a marketplace – and NASDAQ’s current role with PORTAL (which it assumed when it separated from the NASD and commenced operations as a national securities exchange) is limited to the review of whether an issue of privately placed securities meets the eligibility requirements of Rule 144A. This role would change if the proposal is adopted.

Don’t forget our upcoming June 5th webcast – “The Nasdaq Speaks: Latest Developments and Interpretations” – to hear key Nasdaq Staffers talk about all the latest…

UK’s Securities Regulator May Act on IPO Concerns

A month ago, the Financial Times published this article: Financial regulators yesterday gave the first official recognition of intensifying City concern about the impact some overseas listings are having on the standards and reputation of London.

The Financial Services Authority said it will canvass opinions in the City about how to clarify the regulations to make clear whether companies have chosen light-touch listing methods, which can offer investors less protection. It said it was calling for formal debate about the balance between attracting new flotations and maintaining quality.

The decision comes a day after John Thain, chief executive head of the newly merged NYSE Euronext exchange group, took a thinly veiled swipe at the London Stock Exchange, criticising corporate governance and inadequate protection for minority investors offered by some Russian companies. There has been a steady flow of Russian and Kazakh companies seeking to raise capital in London.

The FSA’s decision to formalise an already rumbling debate followed private pressure brought to bear by a group of large shareholders this year. There are widespread worries among institutional investors about the ability of companies with weak corporate governance standards to raise capital on the LSE. In February, a group of important investors, including Hermes, Fidelity, State Street, Royal London, Barclays Global Investors and M&G, warned the FSA the quality of the market was under threat. “In a less benign [economic] environment some decisions being taken now might come back to haunt the regulators,” a fund manager told the FSA.

Hector Sants, managing director for wholesale business at the FSA, said new issues from non-traditional markets and European regulations designed to open up competition made it important to consider the balance: “This is a very important debate because of the changing nature of capital markets.” Peter Montagnon, head of investment affairs at the Association of British Insurers, said investors were concerned about confusion between different types of London listings. These include primary, with traditional corporate governance standards; secondary, which need no primary listing elsewhere and have minimum regulation; and global depositary receipts, only available to professional investors.

The LSE also operates the Aim junior market with weaker regulation. “There’s a risk of confusion here, and there’s a risk that if we are not careful we could sacrifice some of London’s reputation for quality and with it one of the reasons it is an attractive market,” he said. Even some investment bankers – who make large fees from listings – are concerned. A senior industry figure said: “Has it gone too far? Not yet, but we’re close.”

The LSE has been successfully promoting itself in Russia but is keen to head off investor criticism, which surfaced last year when several big groups attacked the listing of Rosneft, Russian oil producer. The LSE welcomed the debate. “We are particularly keen to have clear labelling of the different forms of listing, giving investors the choice but making sure it is very clear exactly what they are being given,” it said.

May 21, 2007

Google’s Transferable Option Program

Google’s transferable option program has gone “live” and it’s readily apparent that Google and Morgan Stanley have put a great deal of thought into the program. The May-June 2007 issue of The Corporate Executive – which was just mailed – is dedicated to analyzing every aspect of this program, from the ’33 Act registration issues to the insider trading blackout issues, and much more.

Take advantage of our “1/2 Off for the Rest of 2007″ no-risk trial and obtain this valuable issue of The Corporate Executive. In addition, come watch a panel of those that put this transferable option program together as part of our “Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks.” You can catch this panel by video webcast or live in San Fran (either just for the day or as part of the 3-day NASPP conference).

Treasury Department Announces Accounting Industry Task Force

On Thursday, Treasury Secretary Hank Paulson announced the formation of a non-partisan task force, headed by former SEC Chair Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen, to examine the world of auditing, including tackling key issues such as firm concentration and how to strengthen the industry’s financial soundness and enhance its ability to attract and retain qualified personnel. It sounds like the task force’s work won’t be done for at least a year; they won’t even begin deliberations until the Fall.

This task force serves as the first step in the Treasury Department’s capital market plan to enhance the US markets competitiveness. Hank’s plans were fleshed out in this Financial Times opinion column (which doubled as a Treasury press release).

A Mid-Season Proxy Review

If you’re wondering how various types of shareholder proposals are faring at the polls this proxy season, check out ISS’s “mid-season proxy review.”

May 18, 2007

Audited vs. Unaudited

From Lyle Roberts’ “10b-5 Daily” Blog: A recent decision by the U.S. Court of Appeals for the Second Circuit offers some interesting clarifications on the scope of accountant liability for securities fraud. In Lattanzio v. Deloitte & Touche LLP (2d Cir. Jan. 31, 2007), the court addressed whether Deloitte could be held liable for statements in audited and unaudited financial filings.

As to the company’s unaudited financial filings, the court found that Deloitte’s regulatory obligation to review the company’s quarterly statements did not turn those statements into accountant’s statements. Even if the public understood that Deloitte was engaging in these reviews, the accountant’s “assurances were never communicated to the public.” The court also rejected plaintiffs’ argument that the reviews created a duty to correct the quarterly financial statements if false and that a breach of this duty amounted to a misstatement by Deloitte. The court noted that there is a distinct difference between the duties and liabilities created by a review of interim financial statements and those created by an audit of annual financials.

As to the company’s audited financial filings, the court dismissed the relevant claims based on a failure to adequately plead loss causation. The court held that the “plaintiffs had to allege that Deloitte’s misstatements [in the company's annual reports concerning accounts payable and inventories] concealed the risk of [the company's] bankruptcy.” Given that Deloitte had issued a going concern warning – along with the disclosed (if understated) collapse in the company’s value – the risk of bankruptcy was apparent. Accordingly, the court found that the plaintiffs had not alleged facts showing that Deloitte’s misstatements were the “proximate cause of plaintiffs’ loss; nor have they alleged facts that would allow a factfinder to ascribe some rough proportion of the whole loss to Deloitte’s misstatements.”

Holding: Dismissal affirmed.

Quote of note: “Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public’s understanding is based on the accountant’s articulated statement, the source for that understanding – whether it be a regulation, an accounting practice, or something else – does not matter.”

More on Auditor Liability

Recently, the Second Circuit reversed a lower court decision and held – in Overton v. Todman – that an auditor has a duty to correct prior certified opinions and may be held liable under Rule 10b-5 if it fails to do so. In other words, once an auditor knows their opinion is wrong, they ought to do something about it and tell people they should no longer rely on it. We have posted a copy of the opinion (and memos that analyze it) in our “Auditor Liability” Practice Area.

More specifically, the court holds that “an accountant violates the ‘duty to correct’ and becomes primarily liable under § 10(b) and Rule 10b-5 when it (1) makes a statement in its certified opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading; (3) knows or should know that potential investors are relying on the opinion and financial statements; yet (4) fails to take reasonable steps to correct or withdraw its opinion and/or the financial statements; and (5) all the other requirements for liability are satisfied.”

This case appears to be the first in the Second Circuit to hold that an auditor has such a duty and may be primarily liable under the federal securities laws. The Second Circuit noted that its holding did not conflict with Central Bank of Denver v. First Interstate Bank of Denver, the 1994 Supreme Court case which held that there was no secondary aiding and abetting liability under Section 10(b), as the auditor in Overton had acted in a primary capacity.

PCAOB Report: The Auditors’ Duty to Uncover Fraud

Way back in late January, the PCAOB issued a report that discusses auditors’ implementation of PCAOB interim standards regarding the auditor’s responsibility regarding fraud. The PCAOB issued the report to nudge auditors to be more diligent about their responsibilities vis a vis uncovering fraud and providing information that audit committees may find useful in working with auditors.

In the report, the PCAOB notes a number of deficiencies in the performance of audits, where audit procedures required to enhance the detection of fraud have not been performed, or have failed to measure up to professional standards, not unlike problematic audits of the past – and the report provides a list of areas for audit committees to probe the auditor on regarding how a particular audit is being conducted.

[I'm on the road for a few days so I took the liberty of posting some blogs I had drafted long ago but had never posted...plenty more of those in the cellar.]

May 17, 2007

Big Week: SEC Open Commission Meeting and More

In addition to hosting two more proxy process roundtables next week, the SEC will hold an open Commission meeting next Wednesday with lots of Corp Fin stuff going on, including whether to:

1. adopt interpretive guidance for management regarding its evaluation and assessment of internal control over financial reporting

2. adopt rule changes that would make it clear that an evaluation that complies with the Commission’s interpretive guidance would satisfy the annual management evaluation required by those rules.

3. adopt rule changes to require the expression of a single opinion directly on the effectiveness of internal control over financial reporting by the auditor in its attestation report.

4. make rule proposals addressing the registration and disclosure requirements for smaller companies, as well as private offerings, including:

- increase the number of companies eligible for the scaled disclosure and reporting requirements for smaller reporting companies;

- expand the eligibility requirements of Form S-3 and Form F-3 to permit registration of primary offerings by companies with a public float of less than $75 million, subject to restrictions on the amount of securities sold in any one-year period;

- create exemptions from the registration requirements of the ’34 Act for grants of compensatory employee stock options by non-reporting companies;

- create a new Regulation D exemption for offers and sales of securities to a newly defined subset of “accredited investors,” as well as to propose revisions to the Regulation D definition of “accredited investor,” disqualification provisions, and integration safe harbor and to provide interpretive guidance regarding integration;

- make revisions to Form D and mandate electronic filing of Form D; and

- amend Rule 144 to revise the holding period for the resale of restricted securities, simplify compliance for non-affiliates, revise the Form 144 filing thresholds, and codify certain staff interpretations, as well as to propose amendments to Rule 145.

5. adopt rules to implement provisions of the Credit Rating Agency Reform Act of 2006

And according to this Washington Post article, the House Financial Services Committee hearing with the five SEC Commissioners testifying on whether they are too soft on business is likely to be held during the week of June 25th.

Next Thursday: PCAOB to Act on Internal Controls

Next Thursday, the PCAOB will vote on a new standard – Auditing Standard No. 5 – that will supersede the Board’s existing internal controls standard, Auditing Standard No. 2. The PCAOB also will vote on two recommendations to amend the Board’s rules on the frequency of inspections – to remove the requirement that the Board regularly inspect each registered public accounting firm that plays a “substantial role” in audits but does not issue audit reports and whether to keep Rule 4003(d) in place beyond the June 30, 2007, tentative sunset date. Neither amendment would affect the annual inspection cycle for firms that audit more than 100 issuers.

Internal Controls Costs Down; Auditor Fees Unchanged

Yesterday, FEI published a summary of survey results showing that internal control costs for accelerated filers dropped 23% from 2005 to 2006 (and 35% since 2004, which was the first year of implementing Section 404). Audit fees were essentially unchanged between ’05 and ’06. This CFO.com article notes that audit fees could drop by 10% under new AS #5.

Posted: May-June issue of Deal Lawyers print newsletter

We have just sent our May-June 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 May-June issue of the Deal Lawyers print newsletter for you to check out. This issue includes pieces on:

- Wake Up and Smell the E-proxy Coffee: Changes Ahead for Online Solicitations
- Lessons Learned: A Practical Look at the Caremark Trilogy
- Understanding the Real Meaning of Deal Certainty: Debunking a Few Myths and Suggesting a Few Solutions
- What’s in a Choice of Law Clause?
- Unauthorized Management Buyout Proposals: It’s Time to Reevaluate Corporate Policies

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