August 30, 2007

Auditors Must Help Stem Subprime Defaults? A Rebuttal

Lynn Turner notes: The Honorable Senator Charles Schumer's efforts described in this letter to the Big 4 are greatly misplaced (ed. note: the letter is posted in our "Credit Arrangements" Practice Area). Auditors did not make the problematic subprime loans, did not rate them or decide the terms on which the loans were made and certainly do not collect the loans. Now the Senator thinks auditors should fix the problem of subprime loans through greater obfusction and a lack of transparency by keeping these loans "off-balance sheet" in SPEs when the loans are restructured, as he pushes new accounting positions taken as a result of the credit and liquidity problems affecting the markets. He is also arguing auditors should get into the management of the loan portfolio and insist the loans be restructured. A unique role for independent auditors.

The Senator has jointly issued a report saying the US capital markets are not competitive. The current crisis also indicates they do not always act in a reasoned fashion, with appropriate pricing of risks. As a result, they are now requiring federal government intervention.

Unfortunately, some home owners and investors are both being hurt by the recent developments. Yet the reality of it is that borrowers will either have the ability to repay the required cash payments or some portion of the payments, or go into full default. If the borrowers can't pay all the required payments, someone (the ultimate lendor/investor) has incurred a loss, which is less than transparent in these SPEs. If a home owner in default doesn't make their payments, there is no way it doesn't result in an economic loss for investors.

(Interestingly, it was Senator Schumer who inserted the language into Sarbanes-Oxley requiring a study of off-balance sheet financings and their magnitude so there would be increased transparency. He initially discussed language that would have required all the SPEs to be on the balance sheet, but ultimately went the study route.)

When it comes to contributing factors to the subprime credit and liquidity problems, it was the Senate Banking committee - of which the Senator is a member - that stood idly by, after being forewarned a year ago about the lax underwriting standards that existed and which have directly contributed to the problem. Unfortunately, it is perhaps worth remembering that USA Today reported that Senator Schumer took very substantial sums of money from Enron - and returned it after being embarrassed by the company's scandal.

Perhaps even more important, on a going forward note, the banking regulators are considering a new regulation that will determine the amount of capital banks keep on hand, which provides them with a "cushion" of assets in the event of a financial crisis. This new regulation is called Basel II. However, the Chairman of the FDIC, which uses the backing of taxpayers to ensure deposits, has warned the new regulations if adopted without safeguards will INCREASE - not DECREASE - the susceptability of the financial system to a future crisis.

Will the Subprime Meltdown Affect the D&O Marketplace?

I feel like I could blog about the subprime meltdown continuously for weeks. Kevin LaCroix continues to do a great job as he analyzes how the meltdown might impact the D&O insurance market in his "D&O Diary" Blog.

Next Financial Crisis Starts Here

This Financial Times column by Clive Crook from last Thursday is worth reading:

"Washington is deserted in August, so demands for a political response to the financial-market debacle have been muted. Rest assured, this will change. The problem will not be dealt with by next month – things could easily get worse before they get better – and some appealing suspects are just asking for a regulatory beating. Enron and the other corporate scandals begat Sarbanes-Oxley. What will the subprime mortgage meltdown bring forth?

Observers of the subprime mortgage business (not counting those who work for it) had been predicting a breakdown for quite a while. Regulated banks do little if any such lending. Bank affiliates or independent mortgage companies have built the business – and they are, respectively, lightly regulated or virtually unregulated. They lent eagerly to borrowers of limited means, often on patently reckless terms (initially low “teaser” rates switching to expensive variable rates; interest-only loans; loans whose principal increased over time). Everything was premised on perpetually rising house prices.

The Federal Reserve was worried, but mainly on consumer-protection, not systemic-risk grounds. Lacking the will and the authority, it mostly failed to act and the business boomed. A lot of people who otherwise would have been unable to buy a house did so, which is good. How many of them hang on to their houses as this credit cycle unwinds, however, remains to be seen. Legislation will be needed to bring all mortgage lenders under the Fed’s supervision, so that basic standards of prudence can be enforced. This much seems likely to happen.

The harder question is whether new rules are needed for the wider financial system. On the face of it, the answer is Yes. One rationale for excluding non-bank lenders from Fed scrutiny is that they pose no systemic risk. So much for that. Wall Street financed the subprime boom by buying the loans – repackaged as securities, stamped AAA by the credit-rating agencies – and selling them on. This model, of course, made the original lenders even less attentive to loan quality. On the other hand, it spread the risk throughout the system, which was also thought to be a good thing – until the loans started to go bad. Then, it turned out, investors wanted to know where the risk was and nobody could say. Arriving as if from nowhere, that fear led to the freezing up of the credit system.

How are regulators to grapple with this? If the opacity of the system is the problem, then new scrutiny and disclosure requirements for secretive investors such as hedge funds and private-equity firms must be part of the remedy. But it could be that complexity, more than lack of transparency in its own right, is the issue. The accelerated pace of financial innovation and the ever-proliferating complication of modern financial instruments seem to defy the ability even of the products’ designers to fathom what is going on. And the new instruments are often thinly traded, if at all, so values are guessed by simulation or calculation, not in the market. Sophisticated investors are left poorly informed about the risks they are bearing; unsophisticated investors have not got a clue. Desirable as fuller disclosure by hedge funds and private equity firms may be, it is hard to believe that it will be enough.

In other words, financial innovation itself is the problem. This poses a dilemma. The benefits of modern finance are real: as its champions rightly say, it deserves much of the credit for the relative stability of the world economy in the past two decades. Stifling this innovation, or attempting to manage it, looks unpromising.

Part of the answer – and, along with fuller scrutiny, perhaps the best that can be done – is to create a climate where excessive risk-taking is more effectively discouraged, and punished when things go wrong. Here the role of the Fed is crucial, both in the boom phase of speculative cycles and in the bust. Fast-rising house and other asset prices have been buoyed by very low interest rates. It was enough for the Fed that consumer-price inflation was low; asset prices, in their own right, were not its concern. This set the scene for America’s remarkable debt-fuelled house-price surge – whose inevitable end was the proximate cause of the subprime collapse. The Fed’s long-maintained reluctance to weigh asset prices in its monetary policy calculations needs to go.

Then, when financial markets seize up, the Fed must take care, as far as possible, to avoid bailing out the culprits. As the economists, Willem Buiter and Anne Sibert, have argued, the Fed was wrong to cut the discount rate last week, and will compound the error if it soon cuts the more important Fed funds rate as many now expect – unless there is evidence of harm spreading to the real economy. Instead, honouring Walter Bagehot’s maxim, it should provide liquidity at a penalty rate (against conservatively valued collateral) to those so lacking in liquidity that they are willing to pay it. That memorably costly help should be available not just to banks, as now, but to hedge funds and other financial firms willing to accept the Fed’s terms.

It is a cliché, but nonetheless true, that the end of each financial crisis sows the seeds of the next. Better regulation has a place, but the Fed is the key to attacking that cycle."

- Broc Romanek

August 29, 2007

Chancellor Chandler Refuses to Dismiss Options Springloading Lawsuit - Again

On August 15th, Delaware Chancellor Chandler again refused to dismiss a lawsuit against Tyson Foods directors over the alleged “spring-loading” of stock options. Kevin LaCroix notes in his “D&O Diary” Blog that the Tyson ruling is noteworthy because of Chancellor Chandler’s conclusion the directors may have failed to provide the disclosure required by their fiduciary duties. The Chancellor's first refusal to dismiss came in February. Both court opinions are posted in our "Backdated Options" Practice Area on

More than 100 companies face lawsuits over option grant practices - and over 220 companies have disclosed that they are being investigated by regulators. Most lawsuits alleged backdating of option grants to coincide with share price declines; very few allege spring-loading. And, so far, all SEC Enforcement activity has challenged backdating, not spring-loading.

Backdating: Are the Lawyers to Blame?

Lately, the SEC has been charging quite a few lawyers over their roles in option backdating. In fact, the SEC charged one lawyer yesterday for her role in backdating at two different companies. Yesterday, ran this interesting article entitled "Backdating: Are the Lawyers to Blame?"

Backdated Options: AFL-CIO Pressures Big 4 Directly

Here is a copy of the letter that I understand went to each of the heads of each of the Big 4 accounting firms from the AFL-CIO. It provides a view on what auditors should know about option procedures and processes - and steps auditors should be performing when auditing issues related to options.

- Broc Romanek

August 28, 2007

The Executive Compensation Comment Letters: Analysis & Guidance

Last week, the SEC Staff began sending the first wave of comment letters on proxy statements, as part of Phase One of its compensation disclosure review project. We thank the many of you that sent your comment letters to us on a confidential basis. We have read all of them and have been busy putting pen to paper.

You will not want to miss the upcoming Sept-Oct issue of The Corporate Executive. In this issue, we will be providing important analysis and guidance regarding the SEC’s comments and concerns – in other words, specific guidance about how to respond and what types of changes most companies will need to make to their disclosures. This critical issue will be mailed right after Labor Day.

Act Now: If you are not currently a subscriber to The Corporate Executive, just take advantage of the no-risk trial—which will enable you to receive the balance of this year’s issues at no charge as part of the 2008 no-risk trial. You may also now renew your subscription to The Corporate Executive for 2008.

Introducing the "New" Herb Scholl

In Corp Fin, Patti Dennis is taking over Herb Scholl's old job as Chief of the Office of Disclosure Support (formerly known as the "Office of EDGAR and Information Analysis"). Patti had been serving as one of the Special Counsels in Corp Fin's Office of Enforcement Liaison.

Wanna New Client? Take Your Law Firm Public

Bruce MacEwen's "Adam Smith" Blog contains an interview with the Managing Partner of Australia's Slater & Gordon, the first law firm to do an IPO.

[Fyi, if you are interested in lawyers that blog, this annual free BlawgWorld guide contains representative samples from 77 leading law-related blogs, including yours truly.]

- Broc Romanek

August 27, 2007

Almost Half of Directors Serve on Only One Board: A Trend to Watch?

According to a PricewaterhouseCoopers/Corporate Board Member Study from earlier this year, 47% of directors sit on only one public company board - and a total of 78% sit on either one or two. Clearly, the issue of "overboarding" has come to director's attention (although a more likely factor is the growing time commitment of serving on a board). But this trend poses a new dilemma: is there now sufficient cross-fertilization on boards?

Although it's too early to tell, I think this trend is not problematic if most of those directors serving on only one board have sat on other boards previously (which I think will likely be the case). This trend could become a problem a decade or so in the future as it becomes less likely that directors have extensive board experience. And of course, it all depends on the individual - seem people are willing to ask the hard questions right off the bat. But most need to sit in a boardroom for a while to understand the boardroom dynamic and learn the mindset of what it means to be a director.

A Dust-Up over a Ditty

Recently, the "Above the Law" Blog has had a spat with Nixon Peabody over a song that celebrates the firm's "Best Places to Work" recognition. Apparently, the song was not supposed to be released to the public. Unfortunately, the firm appears to be making a stink out of the song posting and there are dozens of critical comments posted on the blog's site, including someone who went to the trouble of transcribing the text of the song. Here is a follow-up blog.

I did find the song somewhat funny (you know, "funny" in that nerdy way that lawyers can sometimes get), but not offensive in any way. In fact, if the song had been used for marketing purposes, I would have applauded the firm for doing something novel to set it apart. Law firms should be leveraging the Web for its multi-media abilities.

I first heard the song because it was e-mailed to me and I went to their home page to confirm they are an innovator - and indeed, it seems they are: they have posted an ad campaign and branded their practice as being "Legally Green." Pretty forward-thinking stuff, as I think the legal profession should stop pretending that it's not a business and start marketing like one...

Delaware Gloss on Advancement of Legal Fees

From Travis Laster: The scope of an individual's advancement rights is an issue frequently implicated by criminal, regulatory or internal investigations, particularly where a company is concerned about advancing expenses to someone believed to be a wrongdoer. Delaware case law traditionally has dealt with mandatory advancement rights and has consistently held that mandatory provisions must be enforced according to their terms. A recent Delaware decision, Thompson v. The Williams Companies, Inc., C.A. No. 2716 (July 31, 2007), sheds light on the types of conditions a board of directors can place on permissive, i.e. non-mandatory, advancement rights. This case is an under-the-radar decision that offers particularized guidance to practitioners.

The Thompson case involved an employee who was first investigated and later indicted for participating in a conspiracy to manipulate the price of natural gas. The corporation's bylaws provided for permissive advancement to directors and officers. For employees, the bylaw stated, "Such expenses incurred by other employees and agents shall be paid upon such terms and conditions, if any, as the Board of Directors deems appropriate." Vice Chancellor Strine had no difficulty holding that this was a permissive grant of advancements and that the stray use of "shall" did not convert the provision into a mandatory right.

The board of directors in Thompson conditioned its willingness to grant advancements on (i) financial statements or other evidence from Thompson substantiating his ability to repay the funds if he were not indemnified, (ii) dollar for dollar security for the funds, in the form of a bond, letter of credit, or similar arrangement, and (iii) a certification by the employee that he believed himself entitled to indemnification. The employee challenged each of these conditions as unreasonable.

VC Strine held that in determining whether to grant advancements, the board could impose any condition that was not "arbitrary" and was "rationally related to a proper corporate interest." As examples of arbitrary conditions, the Court offered "a requirement that Thompson walk a tight-rope between skyscrapers ... or ... post security worth five times the amount advanced." The decision to impose conditions on a permissive advancement right is thus a matter of business judgment.

The Court found that each of the proposed conditions was one that "rational directors might believe necessary to protect [the corporation's] legitimate interests" and therefore represented an appropriate business judgment. The board did not have any duty to offer the employee "terms and conditions that permit him to receive advancements." Nor did the board have a duty to treat all persons receiving advancements equally. VC Strine declined to "read 14th
Amendment-like protections against unequal treatment into discretionary contracts governing the relationship of corporations and their executives." VC Strine upheld each of the conditions imposed by the corporation.

Given the lack of precedent on permissive advancement rights, the Thompson decision provides a helpful guide for both the types of conditions that are appropriate and the standard by which conditions will be judged. Note, however, that the case involved a disinterested board addressing advancements for an employee. The case did not involve a board granting discretionary advancements to itself, which remains a self-interested decision to which entire fairness applies under Havens v. Attar, C.A. No. 15134 (Jan. 30, 1997).

- Broc Romanek

August 24, 2007

Five Majorities for "Say on Pay" So Far

Over the past few weeks, five separate shareholder proposals asking for an annual advisory vote on executive pay have received a majority vote. According to ISS' "Corporate Governance" Blog, a majority vote has been achieved at Valero Energy, Ingersoll-Rand, Motorola, Blockbuster and Verizon Communications.

So far this year, “say on pay” proposals have averaged 42.4% across 37 meetings in the first half of 2007 where results are known. In 2006 - the first year the proposals appeared on US ballots - seven proposals went to a vote and averaged 40% support.

Divining "The Future of the World"

Come and enjoy the latest installment of "The Sarbanes-Oxley Report" entitled "The Future of the World." There's a nod to "The Graduate" hidden in it...

Governance Posterchild of the Year: The Smithsonian

It's early, but I doubt any institution will trip up on governance this year as much as the Smithsonian. The fascinating 112-page internal investigation report provides shocking details regarding a cover up of expenses of the Smithsonian's former top executive. It also highlights severe weaknesses in governance, internal controls and financial reporting that existed for an extended period of time.

Part of the Report's "shock and awe" is that the Smithsonian Board includes the Chief Justice of the Supreme Court, the Vice President of the United States (who I understand never attended a meeting) as well as other notable US Senators and Representatives. We have posted a copy of the Smithsonian report in our "Internal Investigations" Practice Area.

August 23, 2007

Looming 409A Deadline: Large Group of Law Firms Plead for Postponement

Quite a few law firms have been sending memos to clients in recent days warning of the pitfalls of the upcoming 409A deadlines, which will require many companies to make changes to their deferred compensation arrangements. A few days ago, 92 of America's most prominent law firms sent a letter to the IRS and Treasury asking that the 409A deadline get pushed back to the end of 2008. We have posted this letter in the "Deferred Compensation Arrangements" Practice Area on

The New "Billable Hour" Gold Standard: $1,000 Per

Yesterday, the WSJ ran this article about the growing number of attorneys that now charge $1,000 per hour. Certainly makes our humble websites seem like a bargain...

A Second Night of Music

The NASPP is excited to announce a second night of music and dancing at the 2007 NASPP Annual Conference. On Thursday, October 11th, Merrill Lynch is sponsoring a gala reception featuring the band "Café R&B." We hope you will join the NASPP for this high-energy rhythm and blues band, which promises to be an exciting evening of entertainment. Note that the concert is offered to NASPP Conference session attendees only; advance registration is not required.

Register Now for the 2007 NASPP Annual Conference: Don't miss this year's keynote presentation by the SEC's Division of Enforcement Director Linda Chatman Thomsen, catch the latest on Section 409A from current and former IRS and Treasury staff, and learn about best practices and developments in 123(R) and stock plan accounting. The NASPP Conference features a full two and a half day program of critical updates and practical guidance; read the "Top Ten Reasons You Need to Attend." As a bonus, the Conference includes’s “4th Annual Executive Compensation Conference."

- Broc Romanek

August 22, 2007

They're Here! Corp Fin Comments on Executive Compensation Disclosures

It appears that the SEC Staff has begun sending its first wave of comment letters on proxy statements, as part of Phase One of its compensation disclosure review project (Phase Two will involve a Staff report that summarizes what the Staff has seen overall - and more importantly, what the Staff expects next year). Often, Corp Fin Staffers are calling in advance to warn of a comment letter being faxed. A few members have already forwarded a few of these letters to me - and I hear that the flood gates are about to open.

If you receive a comment letter, please share it with us. I promise we will not post it nor forward it (nor publicize it or the company in any way); we just want to observe the comment letter trends since we will be providing guidance regarding how you should be drafting executive compensation disclosures going forward in the upcoming Sept-Oct issues of The Corporate Executive and The Corporate Counsel. Both of these special issues will be mailed sometime after Labor Day. To receive these issues, try a "No-Risk Trial" at 1/2 price for the rest of the year.

And of course, join John White and Paula Dubberly of Corp Fin - as well as a host of other exec comp disclosure experts - for our upcoming Conference: “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference.” You can attend either live in San Francisco or by nationwide video webcast. Register today!

Now Available: SEC's Comment Letters on Blackstone's IPO

Speaking of comment letters, I note that the Staff has posted its comments on the Blackstone IPO prospectus. The SEC's database can be a bit hard to navigate, so here are direct links to the comment letters:

- Form S-1

- Amendment No. 1

- Amendment No. 2

- Amendment No. 3 (accounting comments)

- Amendment No. 3 (tax opinion comment)

- Amendment No. 4

The responses are embedded in the cover letter of the amended filings (we wrote about the practice of burying responses within filings on page 6 of our Nov-Dec 2005 issue of The Corporate Counsel) as follows:

- Response to comments on Form S-1

- Response to comments on Amendment No 1

- Response to comments on Amendment No. 2

- Response to comments on Amendment No. 3

- Response to comments on Amendment No. 4

If you're wondering when comments are typically made public, you might recall that the Staff's informal policy is that comments and responses will be posted "no earlier than 45 days from when comments are cleared."

Improving the Public Comment Process

Here's an entry from Professor Bainbridge's Blog that I have been meaning to share for quite some time: "The US PTO has come up with a very interesting idea: The Patent and Trademark Office is starting a pilot project that will not only post patent applications on the Web and invite comments but also use a community rating system designed to push the most respected comments to the top of the file, for serious consideration by the agency's examiners.

Why not do the same thing for other administrative actions? For example, like all other federal agencies, the SEC currently invites public comments on rulemaking prceedings, but lacks the community rating system. Given the widely available technology for creating such a system, however, there's no reason why the SEC couldn't follow in the PTO's footsteps. Comments by respected securities law academics (ahem) presumably would get pushed up, while duplicate astroturf comments presumably get pushed down. Or maybe not, as we might see astroturf campaigns to affect the ratings. Yet, it seems a worthwhile experiment.

If adopted, an area of particular interest will be the possible intersection with judicial review. Suppose the most respected commenters propose A, but the agency adopts B. Should a reviewing court give less deference to the agency in such cases?"

- Broc Romanek

August 21, 2007

Activism on the Rise: CalPERS Doubles Shareholder Proposals

Recently, the California Public Employees’ Retirement System announced that it had doubled the number of shareholder proposals submitted to companies in fiscal 2007, bringing the number of proposals to 33. CalPERS reports that only six out of the 33 proposals actually appeared in proxy materials, with several proposals withdrawn “mostly in response to companies’ agreement to adopt the proposed corporate governance practices.” CalPERS also noted that all six of its proposals appearing in proxy ballots received investor votes averaging over 60 percent.

CalPERS increased its proxy solicitor pool from one to three in order to campaign for more votes. Further, CalPERS reports that it stepped up “policy reform engagements” with the SEC, the NYSE, the European Union and the Tokyo Stock Exchange.

One interesting trend is that while activism by organizations such as CalPERs has certainly increased, the workload for the SEC on shareholder proposals has steadily declined over the past few years. In a speech last week, John White indicated that the Staff has received and responded to 356 no-action letter requests seeking to exclude shareholder proposals this fiscal year, compared to 370 for the same period last year. These numbers are down sharply from roughly 450 no-action requests in 2005 and 2004. Less no-action requests at the SEC no doubt signals more success on the negotiation front, and perhaps more instances of companies running shareholder proposals rather than going through the process of seeking to exclude them.

Carol Stacey Speaks on Interaction with the SEC Staff and Current Accounting Issues

Former Corp Fin Chief Accountant Carol Stacey has been on the interview circuit these days in her new role as a Vice President at the SEC Institute. In this interview with, Carol talks about such things as her perspective on communications with the SEC Staff, complexity, and the future of IFRS and convergence.

On the topic of further SEC guidance on materiality, Carol notes: “I think the staff of the SEC and potentially the commission itself will look at some other areas of materiality, as the staff has already talked publicly about doing. There are some areas that people struggle with all the time, like if you find an error in a quarter, what’s material to a quarter versus a year? That’s one area the staff is looking seriously at and they're talking to some groups from the outside to get their views. I wouldn't be surprised to see the staff come out with something along those lines. So far it’s been staff-level guidance in the form of staff accounting bulletins, and I wonder if the commissioners are thinking at some point about whether they need to provide guidance themselves. There have been so many calls for them to do something.”

In terms of what this sort of SEC materiality guidance might look like, Carol states: “The qualitative factors in, for instance, SAB 99, suggest to investors that if you somehow trip one of these qualitative factors, it’s material. A lot of people have struggled with that because the qualitative factors are mainly geared toward a small error being qualitatively material. And there are other situations where you could have a quantitatively larger error that's immaterial and it could be for various reasons, such as it’s a break-even year. But there are no good quantitative factors that address that in SAB 99, so the SEC could step back and say they need more robust materiality guidance that really covers a lot more fact patterns that the one that SAB 99 covers. Maybe they won’t issue a new definition per se but more helpful guidance to help people in different situations.”

FCPA Legislation Introduced

Two members of the House of Representatives are interested in significantly raising the stakes for violations of the Foreign Corrupt Practices Act. Earlier this month, Congressman Gene Green (D-TX) and Congressman Tim Ryan (D-OH) introduced a bill that would require persons and entities to certify that they have not violated foreign corrupt practices statutes before being awarded government contracts. The bill has been referred to the House Committee on Oversight and Government Reform. The recent high profile of FCPA cases has no doubt attracted this Congressional interest, and the business implications of this legislation would be severe for the multinational companies that you typically see as the subjects of FCPA investigations.

Reputation and Communications Implications of the Whole Foods Message Board Fiasco

While the Whole Foods Markets takeover of Wild Oats Markets was put on ice yesterday by the U.S. Court of Appeals for the DC Circuit, perhaps the most notable thing to date arising from that transaction has been the revelation last month that Whole Foods CEO John Mackey had been posting anonymous messages about his company and Wild Oats Markets on a Yahoo message board.

In this podcast, Rhoda Weiss, the National Chair and CEO of the Public Relations Society of America (PRSA), provides insight on the corporate reputation and communications issues arising in the Whole Foods situation, including:

- What is the PRSA?
- How important are ethical considerations to public relations professionals in their day-to-day work and in the way they advise clients and senior management?
- What does PRSA’s Code of Ethics basically say, and how does it apply to an executive’s misuse of Internet-drive communications and social media?
- From PRSA’s standpoint, what are the ethical implications of corporate executives engaging in online discussion forums under an assumed name – particularly in discussing anything of material significance about their own companies?
- What should the recent Whole Foods situation in general tell CEOs and other corporate executives about the do’s and don’ts of using social media?
- What about the trust factor – what is the impact on the level of trust that people have in a company when a key executive is accused of wrongdoing?
- How might a company best respond when faced with “white-collar” crises that are management driven?

- Dave Lynn

August 20, 2007

Earnings Guidance: Beginning to Take the Long View?

Broc recently blogged about efforts to move away from the quarterly earnings guidance grind, including the desire by many CFOs to see the practice of quarterly earnings guidance go the way of the dinosaur. A recent NIRI survey suggests that while there are some encouraging developments on the earning guidance front, radical change in this practice is certainly not going to happen overnight.

Of the companies responding to the NIRI survey, 34% indicated that they had discontinued guidance within the past 5 years. Those who discontinued guidance reported a relatively indifferent reaction from the investor community (62% reported indifference from the sell side while 47% reported indifference from the buy side), along with a generally positive reaction from senior management (88% reported a positive management reaction). For those survey respondents discontinuing guidance, most reported either a neutral impact on the company’s stock valuation (45%), or no opinion about the impact on stock valuation (42%).

Among those companies that continue to provide guidance, the vast majority reported providing guidance on earnings per share and revenue. Of the survey respondents providing guidance, 82% cited the need to ensure sell-side consensus and that market expectations are reasonable as the reasons for continuing to provide guidance on quantifiable financial measurements. Only 27% of the companies reported providing guidance for quarterly estimates, with 58% reporting that they provide annual estimates. 82% of the companies providing guidance indicate that they were not considering changing the frequency with which they provide that guidance. Unfortunately for all of those CFOs out there who would like to see an end to earnings guidance, a surprising 90% of the survey respondents indicated that their company was not considering any change to the policy of providing earnings guidance.

We will continue to update our “Earnings Releases” Practice Area with information on the latest earnings guidance developments.

Options Backdating: Former Brocade CFO Charged With Turning a Blind Eye to Misconduct

On Friday, the SEC announced charges against the former CFO and COO of Brocade Communications Systems for his involvement in the company’s options backdating efforts. These charges come shortly after the criminal conviction of former Brocade CEO Gregory Reyes, which Broc blogged about earlier this month.

According to the SEC’s complaint, Michael J. Byrd was allegedly involved in the backdating practices in his role as CFO and later as COO of Brocade. The allegations point out Byrd’s involvement with backdated grants to new employees through the company’s so-called “part-time” program, where, in order to establish a tortured basis for meeting an accounting interpretation of the definition of an “employee,” new hires were to be paid for “four hours a week until they start.” It is alleged that option grants were made through offer letters dated well in advance of the actual hiring decision, along with directives to treat the employees as part-time from the date the options were granted. Byrd is also alleged to have been involved with interviewing and hiring candidates – thus fully aware of the timing of these events – while at the same time signing minutes of purported Committee meetings designating earlier (and advantageous) hiring dates. The complaint alleges that Byrd received one backdated grant, and he is charged with filing a false Form 5 reporting that grant.

As noted in this article, Byrd was originally expected to testify at the criminal trial for Reyes, but for unknown reasons the prosecution never called him as a witness. The article states: “In a follow-up interview with, Potter [Byrd’s attorney] said he did not know why Byrd was never called, but said his client had cooperated fully with both the SEC and the DoJ as a witness, and that at no point in the investigation had his client assumed status as a target of federal prosecutors. ‘He never entered into a cooperation agreement,’ Potter told ‘He volunteered his cooperation as a witness.’”

Interestingly, despite Linda Chatman Thomsen’s statement in the press release that “[t]his case confirms the Commission’s commitment to pursuing not just those who perpetrate financial fraud, but the corporate gatekeepers who allow it to happen on their watch,” no officer and director bar is sought for Byrd. The SEC is seeking only disgorgement and civil money penalties in this particular case, raising the question: “what does it take to get an O&D bar these days?”

Hewlett-Packard Sued by CNET Reporters over Spying Fiasco

Nearly a year has gone by since the details of Hewlett-Packard’s investigation into a boardroom leak began to surface, and there is no doubt that at this point H-P would like to move on from this scandal. Now, as reported last week in this CNET article, three reporters at CNET and members of two of the reporters’ families have decided to sue H-P in California state court. The plaintiffs seek unspecified damages for invasion of privacy, intentional infliction of emotional distress and violations of a state law prohibition against “unfair, fraudulent and deceptive practices.” Former H-P board of directors chair Patricia Dunn and former H-P attorney Kevin Hunsaker are also named as defendants in the lawsuit suit.

Prior to this lawsuit, justice had been relatively swift for H-P. The company had settled civil charges with California’s Attorney General, and also settled SEC disclosure charges earlier this year. Criminal charges against Dunn, Hunsaker and two others were dismissed. The practice of “pretexting” was also addressed in a surprisingly quick manner by Congress with the enactment of the Telephone Records and Privacy Protection Act of 2006, which was signed into law by the President back in January of this year.

- Dave Lynn

August 17, 2007

Update on Corp Fin Developments

At the American Bar Association meeting earlier this week, John White delivered this speech entitled “Corporation Finance in 2007 – An Interim Report.” The speech provides an update on the status of a number of projects that are happening in Corp Fin. Here are some highlights:

1. There are no plans for any further extensions for Section 404 compliance by non-accelerated filers.

2. The Staff is interested in hearing about experiences with implementing E-proxy so that they can make any changes necessary to maximize benefits while minimizing problems associated with the process.

3. On the executive compensation front, no rule changes are anticipated for this year. The Staff is getting ready to issue the first round of comment letters coming out of its exec comp review program. No letters have yet been issued, as the Staff has been holding on to them in order to ensure consistency. The Staff’s report on the first year of disclosures under the new rules will be out in time for next year’s proxy season. The big things that the Staff has been looking at in the course of its reviews are:

- analysis of the different components of compensation and change of control and termination payments;

- the adequacy of disclosure about performance targets;

- the justification for not disclosing performance targets, and the adequacy of the “degree of difficulty” disclosure provided instead;

- disclosure about benchmarking; and

- who makes the compensation decisions, including the role of the CEO and others in the process.

4. The Staff is committed to putting together a rule this fall from the two competing shareholder access proposals. The Staff is continuing to consider what to do about other issues that came up during the May proxy roundtables, including NYSE Rule 452, empty voting, over-voting, and shareholder communications.

5. With regard to interactive data, the Staff is working on a second prototype XBRL tool, which it hopes to release soon. This prototype will feature enhanced graphics and an easy search function. Expanded taxonomies are expected to be released for public testing and comment this fall. The much anticipated “Executive Compensation Disclosure Viewer” (it has a catchy name now) is still anticipated, and will be available some time this year. More progress on implementation of interactive data is expected in the near future.

6. On the PIPEs front, the Staff hopes that the pending proposal for opening up primary offerings on Form S-3 to smaller issuers and the proposal to shorten the holding period for Rule 144 will help give smaller issuers some alternatives to PIPEs financing.

7. The Staff still has the topic of “stealth restatements” and disclosure under Item 4.02 of Form 8-K on its agenda, although no proposals are ready on these issues.

8. The Staff is still considering possible rule proposals or guidance dealing with voluntary filers.

The Rise of Alternative Trading Platforms

This seems to be the summer of alternative trading platforms for unregistered securities. As Broc noted in the blog back in May, Goldman Sachs launched its new system called GS TRuE – short for Goldman Sachs Tradable Unregistered Equity. Earlier this week, Nasdaq rolled out its new and improved PORTAL trading platform, which is described as a centralized trading and negotiation system for Rule 144A securities. Now Citigroup, Lehman Brothers Holdings, Merrill Lynch, Morgan Stanley and Bank of New York Mellon announced that they are pulling together their considerable resources to launch OPUS-5, which is short for Open Platform for Unregistered Securities (I love the name on this one). OPUS-5 is expected to begin operations next month.

These trading platforms are popping up in an environment where there is an unprecedented amount of private money sloshing around the financial system. As noted in this Washington Post article on the PORTAL Market “[f]or the first time last year, corporate America raised more money – $162 billion – from private investors than from initial public offerings, which raised $154 billion from the three major U.S. stock markets – Nasdaq, the New York Stock Exchange and the American Stock Exchange.”

The SEC Staff recently issued an interpretive letter facilitating trading of the securities of foreign private issuers on the Nasdaq PORTAL Market. In the letter, the Staff indicated its view that a foreign private issuer would continue to be eligible to claim the exemption from SEC registration under Exchange Act Rule 12g3-2(b), notwithstanding the fact that the securities would be traded through the PORTAL market, because PORTAL would not be deemed an “automated inter-dealer quotation system” under Rule 12g3-2(d)(3).

There is no doubt that one thing we need right now is more liquidity in the markets, and that seems to be what these new trading platforms are all about.

Credit Rating Agencies Face Scrutiny

It has been a wild ride in the markets over the last few weeks, and that has got to mean somebody, somewhere is at fault. It is time once again to look for some gatekeepers who were not manning their gates, and it looks like the credit rating agencies are one of the prime targets this time around. A page one article in Wednesday’s WSJ noted:

“It was lenders that made the lenient loans, it was home buyers who sought out easy mortgages, and it was Wall Street underwriters that turned them into securities. But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets. S&P, Moody’s Investors Service and Fitch Ratings gave top ratings to many securities built on the questionable loans, making the securities seem as safe as a Treasury bond.

Also helping spur the boom was a less-recognized role of the rating companies: their collaboration, behind the scenes, with the underwriters that were putting those securities together. Underwriters don’t just assemble a security out of home loans and ship it off to the credit raters to see what grade it gets. Instead, they work with rating companies while designing a mortgage bond or other security, making sure it gets high-enough ratings to be marketable.

The result of the rating firms’ collaboration and generally benign ratings of securities based on subprime mortgages was that more got marketed. And that meant additional leeway for lenient lenders making these loans to offer more of them.”

This is by no means the first time that the credit rating agencies have to take the heat for market troubles. This time around, however, they will be facing scrutiny as SEC-regulated entities. Back in June, final rules implementing the Credit Rating Agency Reform Act of 2006 and certain provisions of that Act went into effect, and the rating agencies filed their registrations with the SEC. The SEC’s new rules regarding rating agencies are outlined in this press release and in this adopting release. Check out our "Rating Agencies" Practice Area for more information.

While on the topic of the choppy markets, check out this timely music video from “Merle Hazard.” Thanks to Jack Ciesielski’s AAO Weblog for pointing out this gem. With this kind of competition, Billy Broc and Dave “the Animal” are going to have to tune up their crooning voices!

- Dave Lynn

August 16, 2007

Chicago to Play NASPP Annual Conference

As in past years, the NASPP Annual Conference – this year in San Francisco from October 9 through October 12 – will kick off with a Gala Opening Reception sponsored by Fidelity Investments on October 9. The NASPP and Fidelity are excited to announce that immediately following the opening reception, all Conference session attendees are invited to the San Francisco Concourse Exhibition Center for an exclusive private concert featuring the multi-talented, multi-platinum group, Chicago!

The concert is offered to those registered to attend the full NASPP Annual Conference sessions only. There is no additional charge to attend the concert, but space is limited and you must register in advance.

The NASPP Annual Conference features a full two and a half day program of critical updates and practical guidance – check out the “Top Ten Reasons You Need to Attend.” As a bonus, the Conference includes’s “4th Annual Executive Compensation Conference” at no extra charge, and you definitely don’t want to miss the critical pre-conference programs, “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference” and “The Fundamentals of Stock Plan Administration.”

US Solicitor General Files Brief in Stoneridge Case

Despite some last minute lobbying by Senator Christopher Dodd (D-CT), the government filed a brief as amicus curiae in the case of Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc. As Broc noted in the blog earlier this summer, President Bush and Treasury Secretary Paulson had blocked the SEC’s effort to weigh in on the case with its views, and now the Solicitor General has filed a brief that comes out on the opposite side of the SEC with respect to the core issue of “scheme liability” under Section 10(b) and Rule 10b-5.

On Tuesday, Senator Dodd, Chairman of the Senate Committee on Banking, Housing and Urban Affairs, announced that he had sent a letter to President Bush and a letter to Solicitor General Paul Clement, asking that they not file an amicus brief “advocating views inconsistent with the views of the SEC.” Dodd noted that such a move would “compound the damage” already caused by the government’s decision to not advocate the SEC’s views on the case.

The government’s brief cites significant policy concerns with the promotion of “scheme liability,” a theory of primary liability for third parties that have been involved in a public company’s fraudulent conduct. In stating the government’s interest in the case, the brief notes that “private securities actions can be abused in ways that impose substantial costs on companies that have fully complied with the applicable laws. The United States also has responsibility, through, inter alia, the federal banking agencies, for ensuring that entities providing services to publicly traded companies are not subject to inappropriate secondary liability.”

The brief advocates a position that is generally consistent with the SEC’s views on the point that the lower court erred in holding that Section 10(b) reaches only misstatements, omissions made while under a duty to disclose, or manipulative trading practices, stating “[t]he plain language of Section 10(b) demonstrates that it potentially reaches all conduct that is ‘manipulative’ or ‘deceptive’” and “[t]his Court’s cases provide no support for the conclusion that non-verbal deceptive conduct is somehow beyond the reach of Section 10(b).”

On the more critical point of third party liability, however, the brief argues:

“It would greatly expand the inferred private right of action under Section 10(b) and Rule 10b-5 if ‘secondary actors’ could be held primarily liable whenever they engage in allegedly deceptive conduct, even if investors do not rely on (and are not even aware of) that conduct. Such a rule would expose not only accountants and lawyers who advise issuers of securities, but also vendors (such as respondents) and other firms that simply do business with issuers, to potentially billions of dollars in liability when those issuers make misrepresentations to the market. Such a rule would thereby considerably widen the pool of deep-pocketed defendants that could be sued for the misrepresentations of issuers, increasing the likelihood that the private right of action will be ‘employed abusively to impose substantial costs on companies and individuals whose conduct conforms to the law.’ Tellabs, Inc. v. Makor Issues & Rights, Ltd., 127 S. Ct. 2499, 2504 (2007). Moreover, extending liability to vendors could have the effect of substantially expanding liability for foreign companies that trade with publicly listed companies. Likewise, creating new and unpredictable liability for closely regulated entities like banks could create particular problems and greatly complicate the task of regulators. And the expansion of liability would raise difficult questions concerning the apportionment of liability where, as here, the conduct of the secondary actor relates only to a small part of a broader fraudulent scheme. See, e.g., 15 U.S.C. 78u-4(f)(3)(C) (providing that, in apportioning liability, the trier of fact should consider ‘the nature of the conduct of each covered person found to have caused or contributed to the loss incurred by the plaintiff or plaintiffs’ and ‘the nature and extent of the causal relationship between the conduct of each such person and the damages incurred by the plaintiff or plaintiffs’).”

The case is set for oral argument before the Supreme Court on October 9. Check out the many other briefs filed in this case in our “Securities Litigation” Practice Area.

Black Box Revisited: Helpful Interpretive Guidance in the SEC’s Reg. D Proposing Release

Earlier this month, the SEC posted its long awaited proposing release on possible revisions to Regulation D. While the ultimate outcome of these proposals may not be known until later this Fall (Corp Fin Director John White recently said that the SEC’s goal was to approve all of the small business capital-raising proposals this year), the release includes some currently applicable interpretive guidance that is worth taking a look at now.

Responding to concerns expressed by the Advisory Committee on Smaller Public Companies, the SEC revisited the integration safe harbor in Regulation D with a proposal to shorten the timeframe from six months to 90 days. While doing so, the SEC states its views on issues related to private capital-raising transactions occurring around the time of a public offering. In particular, the SEC weighs in on the ability to do concurrent public and private offerings, which to date has largely been a topic for the staff’s consideration in interpretive letters such as Black Box and Squadron Ellenoff and in countless registration statements filed over the years.

In the release, the SEC says that “[w]hile there are many situations in which the filing of a registration statement could serve as a general solicitation or general advertising for a concurrent private offering, the filing of a registration statement does not, per se, eliminate a company’s ability to conduct a concurrent private offering, whether it is commenced before or after the filing of the registration statement. Further, it is our view that the determination as to whether the filing of the registration statement should be considered to be a general solicitation or general advertising that would affect the availability of the Section 4(2) exemption for such a concurrent unregistered offering should be based on a consideration of whether the investors in the private placement were solicited by the registration statement or through some other means that would otherwise not foreclose the availability of the Section 4(2) exemption. This analysis should not focus exclusively on the nature of the investors, such as whether they are ‘qualified institutional buyers’ as defined in Securities Act Rule 144A or institutional accredited investors, or the number of such investors participating in the offering; instead, companies and their counsel should analyze whether the offering is exempt under Section 4(2) on its own, including whether securities were offered and sold to the private placement investors through the means of a general solicitation in the form of the registration statement.”

The SEC goes on to provide some examples of the application of these principles, and notes that this guidance does not foreclose the ability to rely on the Staff interpretive guidance in Black Box and other similar letters.

While this guidance recognizes the practical approach that the Staff has taken to these issues over the years, the interpretive statement in the release should provide more certainty and perhaps a little more flexibility as potential capital raising opportunities come up before and during public offerings.

- Dave Lynn

August 15, 2007

BDO Seidman Faces a $521 Million Jury Verdict

On Tuesday, a Miami jury ordered accounting firm BDO Seidman to pay $351 million in punitive damages, in addition to $170 million in compensation that BDO was previously ordered to pay to Banco Espirito Santo, a Portuguese bank. BDO was found negligent for failing to uncover a massive fraud during the course of its audits of a Miami-based financial services company.

An article appearing in today’s Washington Post notes: “In court filings, BDO Seidman had warned that a loss of $170 million could trigger massive layoffs and cause the company to lose its standing as the fifth-largest accounting firm. The jury was barred from issuing damages that could destroy a company.

In testimony Tuesday, BDO Seidman attorney Adam Cole asked the company’s chief executive, Jack Weisbaum, whether the firm’s financial operations would stay the same if it had to pay punitive damages.

‘Probably not,’ Weisbaum said. ‘It would be very difficult. We certainly wouldn't look the way we do now.’

The jury decided Monday that BDO Seidman must compensate the bank and provide punitive damages for failing to reveal massive fraud at the bank's former partner, E.S. Bankest. The same jury found the accounting firm grossly negligent in June.

BDO Seidman said it will appeal the jury’s verdicts, so it will post a $50 million bond as it appeals. This is the second trial in the dispute, with the first ending in a mistrial in March. The fraud also led to prison time for former E.S. Bankest executives.

Cole showed the jury financial statements for fiscal 2006, which showed the firm's net worth of $171 million. BDO Seidman argued that the punitive damages should be based on net worth, but the bank contended that it should be based on revenue.

For the fiscal year ended June 30, BDO Seidman reported revenue of $589 million, according to a news release on its Web site. Weisbaum said the company has 2,800 employees in 34 offices nationwide.

BDO Seidman attorney Arturo Alvarez laid the blame on ‘thieves’ at E.S. Bankest who defrauded the bank and said the accounting firm did not intentionally bungle the audits. He asked the jury for no punitive damages.

‘We were victims, too,’ Alvarez said. ‘We never knew [the fraud] was happening.’

At least seven people, including E.S. Bankest directors Eduardo and Hector Orlansky, have already been convicted or pleaded guilty to federal criminal charges related to the fraud and sentenced to prison. In criminal trials, E.S. Bankest was accused of inflating the value of the accounts receivable it bought and presenting fake audited financial statements.”

Small Changes to SEC Forms May Prevent Big Headaches

It is good to know that the SEC’s Commissioners can still agree on something without putting out competing proposals (or putting out any proposals for that matter). Amid the flurry of releases published on August 6th, the SEC published final rules making minor but nonetheless important changes to Form 144, Forms 3, 4 and 5, and Schedules 13D, 13G and TO. The SEC has finally deleted all requirements (or in some cases, an option) for filing persons to include an IRS identification number in these filings. With respect to the Section 16 filings, the SEC had already removed provisions allowing reporting persons to include IRS identification numbers, but some clean-up of those forms was still necessary. The IRS identification number of issuers is still required on the cover page of most Securities Act registration statements and Exchange Act reports, but for what purpose it is hard to say. In the adopting release for these most recent amendments, as well as in the 2003 adopting release for the changes to the Section 16 forms, the SEC said that the IRS identification number was not useful to the SEC for tracking or processing purposes.

One of the problems that references to IRS identification numbers has caused over the years is that sometimes natural persons thought that they had to provide a Social Security number in lieu of an IRS identification number. Filing anything on EDGAR that includes a Social Security number obviously puts people at risk for identity theft, and it remains virtually impossible to get anything pulled down or changed once it gets filed on EDGAR.

A good practice tip is to always have someone check filings, and in particular exhibits, for Social Security numbers and other personal information. This also goes for no-action letters and other correspondence. A little bit of diligence on the front end can prevent some big headaches down the road.

Recent IPO Trends

In this podcast, John Partigan of Nixon Peabody provides some insight into how the IPO market is changing (and provides some gloss on this recent “IPO Trends Study”), including:

- Why did Nixon Peabody and Mergermarket conduct a study of IPO trends?
- What companies did you survey?
- Did your evaluation find any big surprises?
- Any insights into IPO market conditions for the rest of 2007?

- Dave Lynn

August 14, 2007

Releasing Information on Company Websites: Sun Breaks New Ground

Last Fall, Sun Microsystems CEO Jonathan Schwartz asked the SEC to consider allowing companies to use their websites, including blogs on their websites, as a means for satisfying public disclosure obligations under Regulation FD. In what had to have been an SEC first, Chairman Cox responded to the request by posting his letter as a comment to Jonathan Schwartz’s Blog. While by no means definitive, the Chairman’s response certainly opened the door to a dialogue about whether the public disclosure requirement of Regulation FD could be satisfied through a company’s website.

The Chairman’s openness on this issue echoed the SEC’s reaction to the same question way back in 2000, when Regulation FD was originally adopted. In the adopting release for Regulation FD, the SEC indicated that “[a]s technology evolves and as more investors have access to and use the Internet, however, we believe that some issuers, whose websites are widely followed by the investment community, could use such a method. Moreover, while the posting of information on an issuer’s website may not now, by itself, be a sufficient means of public disclosure, we agree with commenters that issuer websites can be an important component of an effective disclosure process. Thus, in some circumstances an issuer may be able to demonstrate that disclosure made on its website could be part of a combination of methods, ‘reasonably designed to provide broad, non-exclusionary distribution’ of information to the public.”

It now looks like Sun is going forward with a website-based approach to disseminating its earnings release, although it will not use the company’s website as the exclusive means for disseminating this information. As described in Jonathan Schwartz’s blog, Sun simultaneously posted its July 30th earnings release on the company’s website, disseminated that information to subscribers through RSS feeds, and filed a Form 8-K with the SEC. Ten minutes after the internet publication and SEC filing, Sun distributed the information through the traditional news wires. Schwartz argues that this approach “will place, for the first time, the general investing public - those with a web browser or a cell phone - on the same footing as those with access to private subscription services.”

Sun’s approach does not really seem to be a “sea change” as Jonathan Schwartz describes it, but perhaps it represents a healthy step in the right direction on public dissemination of important company information. Sun’s new earnings release procedure notably does not cut out the third party news dissemination services, it just gives the RSS subscribers and followers of the Sun website (or the SEC website, for that matter) a little jump on the news. The extra step that Sun is taking can only mean more widespread availability of the information, but it is still hard to say at this point whether web-based disclosure without a news release will ultimately meet the test of being reasonably designed to provide broad, non-exclusionary distribution of the information to the public.

Increasingly, the SEC has been willing to permit website posting of information as a means of making the information publicly available, including: director independence standards in the recently adopted executive compensation rules; committee charters; processes for security holder communications with the board of directors; and code of ethics waivers reportable under Item 5.05 of Form 8-K. Perhaps at some point in the not too distant future, the SEC or its Staff will provide some follow-up on the statements made in the Regulation FD adopting release and recognize how far we have come since 2000 on the use of corporate websites for widespread information dissemination.

Impact of FCPA Investigations on Deals

In this podcast, Homer Moyer of Miller & Chevalier describes the latest trends in Foreign Corrupt Practices Act investigations, including:

- Why has there been a rise in FCPA investigations?
- How can these investigations impact a merger or acquisition?
- What can a company considering a deal do to minimize the risk from a potential FCPA investigation?

Early Bird Expires Tomorrow: 3rd Edition of Romeo & Dye Section 16 Treatise

Peter Romeo and Alan Dye are hard at work updating their two-volume Section 16 Treatise. The Treatise is the definitive work in this area with thousands of pages of reference material.

Order your set by tomorrow, August 15th, to receive a pre-publication discount - you can order online or by fax/mail with this order form. The Treatise will be completed and delivered to you in the Fall.

- Dave Lynn

August 13, 2007

Corp Fin Updates Executive Compensation and Related Person Transaction Interps

When the new Corp Fin “Compliance and Disclosure Interpretations” were launched back at the beginning of the year, the Staff promised more frequent updates to the Division’s interpretive material. The Staff delivered on that promise last week with some new and revised interpretations on Item 402 of Regulation S-K and Item 404 of Regulation S-K.

For the most part, these new and updated interpretations cover positions that are already pretty well known at this point, including some of the interpretations reflected in the notes that we posted from the 2007 JCEB meeting. As such, it does not appear that this update represents the more comprehensive guidance that everyone has been expecting in advance of the proxy season.

On the Item 404 front, the Staff indicated in new Interpretation 2.12 that, with respect to employment arrangements, the “amount involved in the transaction” would include all compensation paid to the employee, not just salary. This interpretation is consistent with the way the Staff had restated old Telephone Interpretation I.35 in Compliance and Disclosure Interpretation 2.07, where it changed a reference to a child’s “salary” to “compensation.” New Interpretation 2.13 deals with a relatively straightforward application of the rule to a situation where an executive officer’s compensation is not disclosed under Item 404 by operation of Instruction 5.a. to Item 404(a), yet the compensation paid to that executive officer’s immediate family member who works for the company must be disclosed, because the immediate family member does not have the benefit of Instruction 5.a. given that person’s non-executive officer status.

Mark Borges has already posted his analysis of some of the new and revised executive compensation interpretations on his blog, with more to come. One of the notable new executive compensation interpretations is a definitive Staff position on the disclosure of negative numbers arising from amounts recognized for compensation from equity-based awards. For this significant interpretation, Mark notes:

“As you know, given the reporting requirements for equity awards in the Summary Compensation Table, it is possible that, in any given fiscal year, the amount reportable for an award may be a negative number (because the previously reported compensation expense has been reversed under SFAS 123(R), because the award was forfeited during the fiscal year, achievement of a performance-based condition has been determined to be no longer probable, or, in the case of an award accounted for as a liability accounting, the stock price has declined during the year. New Q&A 4.11 asks what portion of an award that was previously expensed and has been reversed under SFAS 123(R) may be deducted from the amount reported in, or shown as a negative number in, the Stock Awards or Option Awards column?

As expected the Staff has taken the position that only the previously expensed portions of awards that were previously reported in the Summary Compensation Table may be reversed in the Summary Compensation Table. As a result, an expensed amount relating to a period or periods before the new rules became effective or, perhaps more importantly, before a person became a named executive officer should not be deducted from the amount reported in, or shown as a negative number in, the Stock Awards or Option Awards column.

While everyone will not agree, this answer seems sensible to me, as it minimizes the distortive effect of negative numbers on the Total Compensation column in the table. In other words, a company gets to reverse an expense amount in the Stock Awards or Option Awards column (and, thus, affect an NEO's total compensation for the fiscal year) only to the extent that the amount being reversed was previously reported in the SCT (and in total compensation) under the new rules.”

Farewell to Commissioner Campos

This has been a summer of many farewells at the SEC (including my own), and now the greener pastures fever has spread to the tenth floor of SEC headquarters. Last week, Commissioner Roel Campos announced that he will be leaving the Commission. I’ve got to say that Commissioner Campos is truly a class act – it was always a great pleasure to work with him and his very talented staff. His broad range of experience, including work as both a prosecutor and a business executive, was evident whenever he judiciously weighed the pros and cons of matters before the SEC. Investors will be losing a true friend on the Commission when Campos leaves for the private sector.

The departure of Commissioner Campos explains (in part?) a cryptic statement that Chairman Cox made while testifying last month before the Senate Committee on Banking, Housing and Urban Affairs. When pressed about his vote for two opposing approaches to shareholder access issue, Cox stated: “In order to put a rule in place, I’ve got to have a clear idea of what the Commissioners want to do and which Commissioners I’m voting with – which Commissioners by the way are members of the SEC – all of these things somewhat up in the air right now.” If you also consider Commissioner Nazareth’s continued service following an already expired term, there is no doubt that we will see a significant change in SEC dynamics as important rule changes come up for adoption this autumn and into next year.

Access Proposals: Should They Stay or Should They Go?

The Council of Institutional Investors is seeking a straight answer on whether or not the SEC Staff will agree that access proposals may be excluded from company proxy materials under Rule 14a-8(i)(8) (the director election basis for exclusion). In this letter to Chairman Cox, the CII requests clarification on what the Staff intends to do with access proposals now that the SEC has published its release containing both an interpretation of Rule 14a-8(i)(8) and proposed changes to the text of the rule designed to implement that interpretation.

At the open meeting for the rule proposals, Commissioner Campos asked Corp Fin to explain how the Staff would respond to a no-action request seeking to exclude a shareholder access proposal. John White indicated that, based on their current thinking, the Staff would approach any such proposal the same was as they did last season, which apparently was a reference to the Staff’s “no view” response to HP. In his recent Senate testimony, Chairman Cox completely avoided the issue when asked about it by Senator Dodd. Then, in a speech a couple of weeks ago at the Federal Reserve Bank of Chicago, Commissioner Atkins indicated that the interpretive portion of the release “governs our administration of that provision, [and] will provide the necessary clarity and uniformity for both investors and companies alike until an amendment is adopted in the future.”

The CII wants some certainty on how things are going to proceed, which may be all the more important now as the departure of Commissioner Campos raises questions about where things are headed on the shareholder access front.

- Dave Lynn

August 10, 2007

Brocade CEO's Backdating Verdict: A Wake-Up Lesson For All of Us

By the time you read this, this old dude will be off on vacation - so I can afford to be "preachy" and run. To me, the lesson for all of us in the Brocade CEO's guilty verdict involving option backdating is to not always "go along with the crowd." Just because "we've always done it this way" doesn't mean it's right.

I know this sounds obvious - but if you are lucky to live long enough, my bet is that you have at least a 50% shot at coming across circumstances in your professional life where you stop and think about whether you are in a grey area that feels a "little too grey." It's not worth your career - not to mention your personal life if it goes too far astray - to take big chances. I have a friend who has more integrity than most - yet, he fell into exactly this type of trap and just emerged from a year in prison (he didn't concoct nor benefit from the scheme; rather, he found out about it and continued to sign sub-certifications). Sure, he's happy to now be out, but his career is in tatters and his personal life has changed dramatically.

I think it's just a matter of time before the next widespread scandal breaks. Will it be Rule 10b5-1 plans? I don't know - but come hear SEC Enforcement Chief Linda Chatman Thomsen discuss how the SEC Staff is looking at these plans during the “Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks.” You can catch this Conference in San Francisco on October 10th - or watch it by video webcast on that date (or anytime thereafter). Or take advantage of the "Member Appreciation Package" discount to watch all three of our critical October Conferences online.

"Pretty" Disclosure: Internal Controls Remediation

In our "Internal Controls" Practice Area, we have a list of filings reporting remediation of material weaknesses. Here is an interesting one that Bob Dow recently brought to my attention: 3d Systems Corp (Form 10-K/A filed 8/2/07). I have seen a couple of other long remediation disclosures, but this one is a lot more organized and includes more details about the company's remediation plans.

Future of the Legal Profession

Our members asked for it. "Billy Broc" and Dave "The Animal" weigh in on the "Future of the Legal Profession." The music at the end is appropriate for the mood...

- Broc Romanek

August 9, 2007

The Big 3000!

In our "Q&A Forum," we have reached query #3000 (which is really a higher number since many of these have follow-ups queries). I'm so happy Dave is on board; answering those sure can be stressful. 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...

Posted: SEC's IFRS Concept Release

Yesterday, the SEC posted a 42-page concept release relating to allowing US issuers to prepare their financials according to IFRS rather than US GAAP. This is a "biggie"...

Becoming a Blogger

The benefits of blogging yourself are many. Do you have what it takes? I'm always happy to discuss this with you if you are interested in trying. In this podcast, Kevin O’Keefe of LexBlog provides some insight into what you should consider if you decide to become a blogger, including:

- Why should corporate lawyers blog?
- How can a lawyer determine whether they have what it takes to blog?
- What are elements of a blog that will attract an audience?
- What are your favorite blogs - and why?

Payments to Terrorists: Chiquita Brands and the Role of the Board of Directors

In his "The Race to the Bottom" Blog, Professor J. Robert Brown recently posted this interesting analysis regarding a troublesome situation involving a former SEC Chairman:

"There was an interesting article in the WSJ last week about Chiquita Brands International Inc. and payments made to a violent group in Colombia designated by the Department of State as terrorists. According to the article, Roderick M. Hills, the former Chairman of the SEC, went to the Justice Department in his capacity as chair of the audit committee to disclose the payments. Despite having self reported, a criminal prosecution resulted with Chiquita ultimately agreeing to a plea of one count of engaging in transactions with a specially-designated global terrorist and topay a fine of $25 million. A grand jury is now apparently weighing a possible indictment of Hills.

The implication of the article was that companies confront heightened risk if they self report their own misdeeds. As the article noted: "The investigation illustrates the recent posture taken by U.S. authorities to prosecute aggressively even when companies turn themselves in for breaking the law."

But in fact it illustrates no such thing. This is not the usual case of a company discovering improper behavior, putting a stop to it, and self reporting to the government. This is a case that involves a fundamental breakdown in the system of corporate governance.

First, this was not the only payment problem incurred by Chiquita's Colombian subsidiary. It had already been found to have made improper payments to government officials by the SEC, with Chiquita subjected to a $100,000 fine. See SEC v. Chiquita Brands International, Inc., Litigation Release No. 17169 (D DC Oct. 2. 2001). In other words, the board and management was on notice that there were problems with this particular subsidiary, specifically in connection with the making of improper payments.

Second, the payments in Colombia were made to Autodefensas Unidas de Colombia (AUC), an organization described in the factual proffer as "a violent, right-wing organization" (a copy of the Proffer is posted on the DU Corporate Governance web site). As one US Attorney described in the WSJ article:

"I regarded this as a murder investigation," from the start, says Roscoe Howard Jr., former U.S. Attorney for Washington, D.C., who helped lead the Chiquita prosecution before he left his position in 2004. "Even though Chiquita didn't murder anyone, that's what the money was used for -- to buy weapons."
Moreover, the role of the AUC was not lost on the US Government. It was designated as a foreign terrorist organization in September 2001.

Third, the payments had been discussed and apparently approved by persons in the highest echelons of management. Again, according to the Proffer:

"Defendant CHIQUITA'S payments ot the AUC were reviewed and approved by senior executives of the corporation, to include high-ranking officers, directors, and employees. . . An in-house attorney for CHIQUITA conducted an internal investigation into the payments and provided Individual C [listed only as a high ranking official] with a memorandum detailing that investigation. The results of the internal investigation were discussed at a meeting of the then-Audit Committee of the then-Board of Directors in defendant CHIQUITA'S Cincinnati headquarters in or about September 2000."
In other words, this was not a case where a company's management discovered improper behavior and went right to the authorities. This behavior was apparently widely known among top management and allowed to continue.

Fourth, as the WSJ Article indicated, Hills joined the board in 2002 and almost immediately learned about the payments. Nonetheless, it took a year before he reported them to the Justice Department. Moreover, the decision to self report only occurred after the matter was brought to the attention of outside counsel and the entire board. Outside counsel (apparently Kirkland & Ellis), according to the Proffer, indicated that the company "must stop [the] payments." A report was made to the full board and at least one member "objected to the payments." It was after that meeting that officials met with officilas at the Department of Justice.

Fifth, Justice Department officials, according to the Proffer, informed Chiquita officials (including, apparently, Hills) that the payments to the AUC "were illegal and could not continue." Moreover, several months later, officials at Chiquita were told by outside counsel that DOJ officials "have been unwilling to give assurances or guarantees of non-persecution; in fact, officials have repeatedly that they view the circumstances presented as a technical violation and cannot endorse current or future payments." Nonetheless, the payments continued until February 2004.

Finally, the WSJ left the impression that Chiquita and Hills were being treated harshly. Compare that to an article in the LA Times which suggested that some in the US Attorneys Office wanted more rigorous prosecution at an earlier date and were possibly stymied by higher ups in the Justice Department. That Article indicated that Congress was conducting an investigation. Id. ("As part of an inquiry into corporate payments to violent groups in Colombia, a group of congressmen wants more details about the Justice Department's handling of the Chiquita Brands International Inc. case, including whether the department was too lenient and why it took four years to file criminal charges after the banana company admitted making payoffs.").

This is not, therefore, a case where a company learns about a bad practice and immediately coming clean. It is the story of illegal payments that were known at the top levels of management, continued for seven years, went to a violent terrorist group, and were self reported only when the entire board and outside counsel learned about them. Indeed, the history of payments apparently went back beyond 1997. As the WSJ article noted, "Chiquita had previously paid another violent group until it was declared a terrorist organization in 1997."

There were no doubt moments when Chiquita was truly in a difficult spot. The articles indicate that the payments were made to ensure the security of employees in Columbia. But that might explain the payments for the time it took to either provide adequate security or exit the country. In fact, the payments to AUC continued for seven years, from 1997 to 2004.

Whatever happens to Hills, as a director with fiduciary obligations to shareholders, he (and the entire board) should, once they knew, have put an end to these payments. That they did not is a remarkable failure of governance."

- Broc Romanek

August 8, 2007

Survey Results: Earnings Releases and Earnings Calls

Here are the results from a recent survey on earnings releases and earnings calls:

1. Regarding the archiving of earnings calls on our corporate web site:

- We archive them for one quarter - 30.8%
- We archive them for six months - 1.5%
- We archive them for between 6 and 12 months - 6.2%
- We archive them for 12 months - 41.5%
- We archive them for over one year - 7.7%
- We don’t archive our earnings calls - 12.3%

2. When we make/provide our earnings calls and related materials timely by a broadly available webcast and/or teleconference:

- We always file (or “furnish”) the transcript and related materials on a Form 8-K - 5.8%
- We sometimes file (or “furnish”) the transcript and related materials on a Form 8-K - 4.4%
- We never file (or “furnish”) a transcript and related materials on a Form 8-K (unless material information was disclosed during the earnings call that was not disclosed in the earnings release) - 89.9%

3. During the past few years:

- We have changed our earnings release practices, so that such releases coincide with our 10-Q filings - 12.9%
- We have kept our earnings release practices the same, and they get released a few weeks before our 10-Q filings - 40.0%
- We have kept our earnings release practices the same, and they get released a few days before our 10-Q filings - 24.3%
- We have changed our earnings release practices, so that they get released closer to the time of our 10-Q filings - 14.3%
- Our earnings releases have always been released at the same time as the 10-Q filings - 8.6%
- We decided to no longer provide earnings releases at all - 0.0%

4. In the near future:

- We definitely intend to revise the timing of our earnings releases so that they coincide with our 10-Q filings (or no longer provide earnings releases at all) - 3.2%
- We might revise the timing of our earnings releases so that they coincide with our 10-Q filings (or no longer provide earnings releases at all) - 11.1%
- We don’t need to change our earnings release practices because we recently did so - 23.8%
- We are comfortable with our earnings releases being issued before our 10-Q filings and don’t need to review those practices - 61.9%
- We already no longer provide earnings releases at all - 0.0%

5. We issue our earnings releases:

- Immediately before the start of the earnings calls - 23.2%
- Two hours before start of the earnings calls - 37.7%
- More than two hours before the start of the earnings calls - 37.7%
- During or immediately after earnings calls - 1.5%
- After, but within four business days of the earnings calls - 0.0%

6. We disclose earnings guidance:

- In the text of the earnings release - 16.9%
- During the earnings call, but not in the text of the earnings release - 8.5%
- On a Form 8-K filing, but not in the text of the earnings release - 4.2%
- In the text of the earnings release as well as during the earnings call - 31.0%
- On a Form 8-K filing and in the text of the earnings release - 2.8%
- During the earnings call, on a Form 8-K filing and in the text of the earnings release - 14.1%
- We do not give earnings guidance - 22.5%

7. We provide archives of our earnings calls (eg. calling them “podcasts”; here is an example):

- On our website only - 85.3%
- On iTunes only - 0.0%
- On both our website and iTunes - 1.5%
- We do not provide audio archives of our earnings calls - 13.2%

New Survey: Lead/Presiding Directors

Please take a moment to take part in our new Quick Survey on Lead/Presiding Directors, which asks these queries:

- Does your board have a lead or presiding director?
- What is the term of the lead/presiding director?
- Are there "term limits" for the lead/presiding director?
- What are the responsibilities of the lead/presiding director?
- Does the lead/presiding director receive extra compensation for these additional responsibilities?

SEC Staff Adds a Few More Auditor Independence FAQs

The SEC's Office of the Chief Accountant has added a few more auditor independence FAQs (look for the ones marked with a "2007" date). The last update of these FAQs was in 2004.

Early Bird Extended One More Week: 3rd Edition of Romeo & Dye Section 16 Treatise

Peter Romeo and Alan Dye are hard at work updating their two-volume Section 16 Treatise. The Treatise is the definitive work in this area with thousands of pages of reference material.

Order your set by August 15th to receive a pre-publication discount now - you can order online or by fax/mail with this order form. The Treatise will be completed and delivered to you in the Fall.

- Broc Romanek

August 7, 2007

Marty Dunn: Short-Timer Extraordinaire

After two decades of service, Corp Fin Deputy Director Marty Dunn is leaving the SEC at the end of August and will join the DC office of O'Melveny & Myers. During his tenure, Marty probably has worked on every standing Corp Fin-related rule in the book. Not only is Marty a superb securities lawyer, he is a great guy and I'm sure he will be sorely missed in the Division. Here is the related press release.

With the Chief Accountant and Chief Counsel jobs still vacant, Corp Fin now has its hands full with all of these empty big shoes...

Today's Webcast: Broadridge Speaks - Demystifying E-Proxy’s Implementation

Today is our webcast - "Broadridge Speaks: Demystifying E-Proxy’s Implementation" - where senior Broadridge executives explain the nitty gritty about how they will help implement e-proxy. I ended up pre-recording this webcast - so you can listen to it at your leisure and not necessarily wait until 2 pm eastern. Note that there won't be a transcript for this particular webcast.

Broadridge (formerly known as ADP) is driving the e-proxy process and has addressed all the items on this detailed agenda during the webcast. This is a great companion program for our popular June 2-hour webcast on e-proxy (audio archive and transcript now available).

Twist on California E-Proxy Conflict? Delaware Slant

Here is a recent question posted in our Q&A Forum: "Following up on Broc's recent blog on a California conflict of e-proxy, has the issue of how the "notice only option" under the final e-proxy rules will jive with Delaware General Corporation law section 232, Notice by Electronic Transmission? Specifically, DGCL 232 permits notice by "electronic transmission consented to by the stockholder to whom to whom notice is given." Query whether such consent may be implied by receipt of the prescribed form of notice under the "notice only option" or whether consent must be obtained in some other way prior to that?"

John Grossbauer of Potter Anderson helped me craft an answer here (as he often does on Delaware law issues): "Our understanding of the rules is that you need to send out a 1 page document - in hard copy - that notifies shareholders that the proxy statement is available on the Web. Our thinking is that 1 page notice could be drafted (which might be postcard-sized) to satisfy the Delaware notice of meeting requirements, which are very minimal: time, place, date, and, if a special meeting or if required by the bylaws, notice of what's to be voted upon."

Posted: Adopting Release for Regulation M Amendments

Yesterday, the SEC posted this adopting release relating to short selling in connection with a public offering by amending Rule 105 of Regulation M, etc.

- Broc Romanek

August 6, 2007

FASB Proposals: Separate Accounting for Conversion of Convertible Bonds and Applying "Shortcut Method" of Hedge Accounting

Companies with converts beware! A soon-to-be released proposed FASB Staff Position would require companies with convertible debt that may be settled in cash to account for the debt and equity components separately. The proposal would require separate accounting to be applied retrospectively to both new and existing convertible instruments - and would thereby affect net income and earnings per share reported by many issuers of these convertible instruments. Learn more in our "Convertible Debt Offerings" Practice Area.

Also, the FASB has proposed guidance that would require companies to evaluate previous and new hedges of interest rate risk, with fewer of them qualifying to use the simplified “shortcut method” of hedge accounting under Statement 133’s requirements. More companies may therefore need additional systems to track the data and the evaluations for far more demanding hedge accounting. Learn more in our "Derivates" Practice Area.

Congressional Report Released: Aguirre Firing and Hedge Fund Investigation

On Friday, the Senate Finance and Judiciary Committees issued a joint report (108 pages, 711 pages with exhibits) regarding the investigation into the SEC’s firing of former Enforcement Staffer Gary Aguirre, who had been investigating suspicious trading at Pequot Capital Management, a hedge fund. Among other criticisms of the SEC, the report notes that the SEC had unnecessary delays in the Pequot investigation, high-level Staffers disclosed sensitive case information to lawyers that represented those under scrutiny and the appearance of “undue deference” to a prominent Wall Street executive that resulted in the postponement of his interview until after the case’s statute of limitations had expired. This is all not too far from the findings of the interim report issued six months ago.

Saturday's NY Times included this lengthy article on the final joint report.

SEC Posts Trio of Releases

On Friday, the SEC posted these three releases:

- proposing release for revision of Regulation D limited offering exemptions

- adopting release for definition of "significant deficiency"

- adopting release for prohibition of fraud by advisers and accredited investors

- Broc Romanek

August 3, 2007

Congressional Interest in Shareholder Access

At a Senate Banking Committee hearing on Tuesday, Committee Chair Christopher Dodd (D-Ct.) warned SEC Chairman Cox that he will consider legislation to resolve the question of proxy access if the SEC doesn't adopt access rules. Here is Chairman Cox's statement from the hearing.

ISS' "Corporate Governance Blog" notes: "Cox, a former Republican Congressman from southern California, was questioned by Dodd on the likelihood that investors would be able to file a proposal calling for access, given the threshold of 5 percent could keep 'even large institutional investors such as Calpers' from filing.

Cox defended the threshold, noting it aligns with the commission’s existing 13D/G regime, which requires investors to disclose holdings above the 5 percent level and whether or not they intend to exert control. Cox also noted that groups could pool holdings to meet the threshold and questioned whether a group unable to meet the 5 percent requirement could muster 50% support to pass an access bylaw.

Echoing past assurances, Cox told committee members that the issue of access would be resolved, one way or another, within months. 'There will be a rule in place this fall … so [investors filing proposals for the 2008 proxy season] will know how to conform their conduct to the law,' Cox said."

Also, there are two entries about this hearing on

The Changing Pink Sheet Market

Last Sunday, the Washington Post ran this article that nicely describes how the Pink Sheets have evolved over the past decade - including the new categorization system to alert investors about the ability and willingness of individual issuers to provide adequate public disclosure in a timely manner. Beware the skulls and cross-bones!

A few months ago in our Q&A Forum, we received a question regarding the attorney letter requirement for the new Pink Sheets tiers. The Attorney Letter Agreement is now available. Learn more in our "Pink Sheets" Practice Area.

Mailed: July-August Issue of The Corporate Counsel

We just mailed the July-August 2007 issue of The Corporate Counsel. Try a no-risk trial for half-price for the rest of the year.

The July-August issue includes analysis of:

- Fixing The Rule 144 Proposals
- Majority Voting—Uncontested Elections Only?
- Section 13 Reporting of Short Positions
- Revised 8-K Items 5.02 (and 1.01)
- Accessing on Edgar Exhibits That are Incorporated by Reference—No Hyperlinking!
- Non-Voting Shares—Proxy/Information Statement Required?
- S-K Item 404—Is the Spouse of a Stepchild a Related Person?
- More Item 404—Calculating the "Amount Involved" When a Family Member is an Employee of the Issuer
- S-K Item 402—Options Assumed In Merger—Which Compensation Tables Do They Go In?
- When to Include Post-FYE Deferred Bonus in Non-Qualified Deferred Compensation Table
- Not Filing the Proxy Statement Within 120 Days After Yearend—Follow-Up on Delinquent 1934 Act Reports and S-3 Use/Eligibility

- Broc Romanek

August 2, 2007

Posted: Summer Issue of Compensation Standards Print Newsletter

We have just posted a complimentary copy of our "Summer 2007" issue of Compensation Standards. This issue includes articles on:

- The Debate Over “Say on Pay”
- Independence of Compensation Consultants: A Growing Issue
- Severance and Termination Payouts: A Whole New Ballgame
- Respected Consultant Calls Severance and CIC “Huge Embarrassment for Corporate America”
- The True “Walk Away Number”
- Leading By Example: The True Leaders Speak Up

If you wish to receive complimentary copies of the Compensation Standards print newsletter in the future, please sign up today for complimentary copies: for you and your directors!

You might ask: Why do we give this newsletter away for free? Because we believe in responsible compensation practices. Learn more about how to implement responsible practices by registering for our upcoming "4th Annual Executive Compensation Conference." This Conference provides practical "how to implement" guidance - unlike any other conference.

Third Circuit Court Weighs In: The Attorney-Client Privilege in the Parent-Sub Context

A few weeks back, the U.S. Court of Appeals for the Third Circuit issued a noteworthy opinion - In re Teleglobe Comm’cns Corp., No. 06-2915, (3rd Cir. 7/17/07) - regarding the attorney-client privilege under Delaware law in the context of a parent-subsidiary joint representation. The case involved claims by subsidiaries against their former parent for abandoning them after they started faltering.

The Third Circuit held that a parent could not be compelled to produce documents on the ground that the parent and subsidiary were jointly represented. The Court reasoned that the sub cannot unilaterally waive a joint privilege with its parent - and that the parent's consent would also be required to waive the joint privilege. We have posted a copy of the opinion and related memos in our "Attorney-Client Privilege" Practice Area.

Rule 3500? Ah, That Rule 3500...

In this recent installment of "The Sarbanes-Oxley Report" - entitled "Rule 3500 is a Crock" - Billy Broc provides some critical analysis of Rule 3500. If you don't recall Rule 3500, this is an important rule and I recommend that you have a summer associate look it up immediately. (And it's coincidental that "3500" is the Office of Chief Counsel's voicemail extension.)

Internal Controls Update: AS #5, Management Reports and All that Jazz

We have posted the transcript from our recent webcast: "Internal Controls Update: AS #5, Management Reports and All that Jazz."

- Broc Romanek

August 1, 2007

GAO Report on Proxy Advisors: No Smoking Guns

I know a lot of people have been waiting a long time for the Government Accountability Office's report on the state of the proxy advisor industry. The GAO report - which had been requested by two members of Congress - was finally released to the public on Monday.

I guess the big surprise from the report is that there really was not much in the way of surprise. It appears that the primary purpose of the report was to hone in on ISS' conflicts of interest (ie. taking on both investors and issuers as clients). But since ISS fully discloses its conflicts - and investors told GAO that it was comfortable with these conflicts - this proved to not be much of an issue for the report.

Here are some of the GAO's reports "notables":

1. There are over 28,000 public companies worldwide that send out proxy statements with over 250,000 separate issues. Nice stats to know. (pg. 6)

2. Most institutional investors report conducting due diligence to obtain reasonable assurance that ISS is independent and free from conflicts. But in many cases, this consists of just reading ISS' conflict policy. (pg. 11)

3. Other potential conflicts consist of owners that do other business to issuers and investors (and the owners of advisory firms serving on boards of other companies). To me, this is the real conflict risk that exists in the industry. (pg. 11-12)

4. A chart shows how dominant ISS is within the industry, with more clients than the other 4 proxy advisory firms combined. I have to admit I had not heard of Marco Consulting Group before - and its been around nearly 20 years. (pg. 13)

5. Many of the investors that GAO contacted said that they do not vote their proxies; they hire asset managers to do that for them. (pg. 21)

So What Did the GAO's Proxy Advisor Report Miss?

I would not place much stock in commentary that the GAO report means that ISS' influence is overblown; if you have any actual experience with shareholder meetings, you know that ISS' recommendation often is the difference between a controversial matter being approved by shareholders or not. So as many members e-mailed me yesterday, when it comes to ISS' influence on votes, the report does not ring completely true.

Here are some "beefs" that members have sent me regarding the report:

1. Failure to interview impacted constituents - It appears that the GAO failed to talk to anyone other than investors and regulators. What about other key players? The issuer community? The proxy solicitors? Investor relations personnel?

2. Flying at a "1000 foot" level - One gets a sense that the GAO investigators didn't really learn much. For example, the report mentions that issuers feel the need to get help from ISS to get a favorable recommendation - but then leaves it at that - without exploring what that means. The report should have clarified that this isn't a “pay to play” (ie. vote buying) situation - and it also should have explained that the bulk of ISS' corporate consulting money comes from equity plan design; not helping with governance rating (ie. CGQ) scores.

Given the influence that ISS has on institutional shareholders - coupled with the proprietary equity plan methodology that ISS uses - many issuers feel pressure to sign-up for ISS' consulting services to make sure their plan will be approved by shareholders.

3. Understating the extent of ISS' influence - In footnote 14, the GAO cites a recent study that examined the extent to which recommendations can influence vote outcomes and stock prices. But the report didn't delve further into that important topic. Any proxy solicitor will tell you that ISS’s influence on voting issues can often be as high as 25% of the shares outstanding.

A prime example of ISS' influence is the bumps felt by recent private equity deals when ISS recommended voting against them (egs. Clear Channel, Biomet). Not that that is a bad thing for shareholders, but it illustrates ISS' influence.

4. Lack of investigative research - A big flaw in the report was taking at face value that many of these institutional investors said they make independent decisions. Yes, some do. But how many of them, when asked, would be expected to say: “Yep, most of the time I just vote the way they tell me.” Not any of the smart ones, because they have a fiduciary duty to vote.

Remember that most of these investors hold positions in thousands of companies; it would be a monumental task to conduct independent research about each item for each issuer's ballot. To do so, an investor would have to have a staff along the lines of a proxy advisor to adequately do the job. The reality is that investors are trying to keep their expense ratios down - and even the larger investors typically have only a few employees dedicated to vetting voting issues.

5. Misses the "real" barrier to entry - Although the report talks about barriers to competition, it ignores the real issue connected with that topic: vote execution. No sane institutional investor is going to assume the risk inherent in moving thousands of accounts and ballots from ISS to another provider. The chance that accounts would be lost, not voted, or voted incorrectly is far too great. An ISS competitor has a rough road to try to duplicate the sophisticated vote execution platform that ISS has built over the years.

6. Short shrift to looming conflict issue - One wonders if the conclusions of the GAO report change if the rumors are true that ISS’ parent company, RiskMetrics, goes public?

I don't blame the GAO for missing the boat; this is a complex area to tackle if you don't have any "hands on" experience. They did better than the Washington Post, which ran an article yesterday on the GAO report with a picture of the ISS executive team from about six years ago -including Ram Kumar, who was infamously ousted because he had represented himself as a law school graduate to ISS, a degree he did not possess...

PCAOB Inspection: KPMG Not Up to Snuff on Testing

Last week, the PCAOB released its report related to a 2006 inspection of KPMG and cited the firm for 14 audit deficiencies, which occurred at seven clients. The deficiences included the failure to identify accounting errors and material weaknesses in internal controls. As noted in this article, the firm had not identified and reported in material weaknesses on audits as it fell behind in its testing. Perhaps the pressure that Congress and the SEC has brought to bear on audit firms to reduce testing could have a systemic impact?

Our August Eminders is Posted!

We have posted the August issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!

- Broc Romanek