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Monthly Archives: March 2008

March 31, 2008

President Bush: Announces Intention to Nominate Democratic SEC Commissioners

Due to this White House press release from Friday, the status of Luis Aguilar and Elisse Walter to become SEC Commissioners has been upgraded from “rumor” to “announced intentions.” Once nominated – and if confirmed by the US Senate – they will fill out the Commission and both serve as Democratic Commissioners. Elisse’s appointment in particular is timely given the potential merger of the SEC-CFTC and she is a former CFTC General Counsel (as well as a former Corp Fin Deputy Director). Here is a Washington Post article about the coming nominations.

If these two are indeed nominated, it will prove me wrong that this Administration wouldn’t bother to fill the open Democratic slots – although these candidates have been “rumored” for months and nothing was done until now, so maybe I’m partially right?

Today’s a Big Day: Paulson’s Proposed Regulatory Overhaul

Today, Treasury Secretary Henry Paulson will unveil his final report that serves as a potential blueprint for a regulatory overhaul. This is the product of Paulson’s Committee on Capital Markets Regulation that has been working on reform efforts for the past year – efforts that began well before the market went south and the housing market exploded. Here is the executive summary of the report – and here is the 212-page report.

The report breaks down proposals into short-, intermediate- and long-term:

1. Short-term – Take action now to improve regulatory coordination and oversight now in reaction to the credit crunch by:

- Empower the President’s Working Group on Financial Markets (which would be expanded to add heads of banking regulators) to serve as the inter-agency body to promote coordination and communication for financial policy – and extend its authority over all of Wall Street rather than just financial institutions.

- Create the Mortgage Origination Commission set – and regulate – uniform minimum licensing qualification standards for state mortgage market participants.

- Ensure the Federeal Reserve the sole authority to draft regulations for national mortgage lending laws and clarify and enhance the enforcement authority for federal laws.

- Enhance the temporary liquidity provisioning process during those rare circumstances when market stability is threatened so that the process is calibrated and transparent; appropriate conditions are attached to lending; and information flows to the Federal Reserve through on-site examination or other means as determined by the Fed.

2. Intermediate – Eliminate some of the duplication of the US regulatory system

3. Long-term – Create an “optimal” regulatory framework, with an objectives-based regulatory approach, with a distinct regulator focused on one of three objectives— market stability regulation, safety and soundness regulation associated with government guarantees and business conduct regulation.

Here is a statement from SEC Chairman Cox, recognizing a need to integrate a reduced number of regulators; former SEC Chairman Arthur Levitt holds a similar view according to this NY Times article from Sunday (although Arthur doesn’t like the idea of the stock exchanges taking on more self-regulation).

Competing Democratic Reform Efforts: Here is a WSJ op-ed from Senator Schumer from Friday (remember that Schumer put out a reform report with NYC Mayor Bloomberg in early ’07). And Rep. Frank is ready to spring into action, as noted in this NY Times column.

My Ten Cents: Initial Reactions and a Bit of Cynicism

It’s hard to evaluate the Treasury’s broad plan without seeing it. I agree that we need regulators with the power to oversee a range of products that now stretch across the jurisdictions of too many agencies. So some change is definitely warranted. So without knowing the details yet, here’s a stab at an initial reaction:

The plan for reform makes Sarbanes-Oxley look like a drop in the bucket in terms of the magnitude of change. And a lot of it sounds great on paper. Sure, we have too many regulators. Can you believe there are at least six regulators for financial institutions in this country? The Fed, FDIC, OCC, OTS, NCUA and a myriad of state regulators. Merging them and the SEC-CFTC is nothing new and has only been stopped in prior years due to political maneuvering on the Hill.

Then, the cynic in me digs in. It’s easy to propose a lot of change for the sake of change in the face of a major crisis. But what’s it gonna cost? There is no way that a new government agency – or even a merged one – is gonna hit the ground running. New people get hired and need to be trained. There is no institutional memory to guide them. It’s true that the most ripe time to effect governmental reform is during a crisis (and during a Presidential election year) – otherwise folks argue for the status quo – but as many complain about SOX, it might not be wise to act too hastily when the chips seem down.

On the other hand, the new Grand Poobah role for the Fed seems like it would consist of little more than as an information gatherer until a crisis has developed. Being reactive rather than proactive is not gonna stop a reincarnation of the mess we are mired in today.

Much of the “meat” of the Paulson plan would seem to reflect the view that rules and agencies are no substitute for market discipline. But is market discipline really the right answer given what we are experiencing now? In my opinion, a lot of the blame for what is happening today is that Wall Street financially engineered itself into a hole. And it’s a dark hole, with a bottom that no one can understand. You can create all the regulators you want, but none of them will ever be able to understand the complex morass of securitizations, resecuritizations, swaps, etc. that have grown to trillions and can’t be explained. For me, this is the crux of the problem and can’t be solved by regulation. “No doc” mortgages were being originated because there were plenty of places to go and immediately sell them.

A decade ago, I spent a year in the Corp Fin branch that reviewed the asset-backed securities that were registered with the SEC. Most ABS aren’t registered and most of the complex instruments that have been created over the past 15 years have been traded over-the-counter. If you have ever read a resecuritization prospectus, you quickly realize that it’s mostly mumbo jumbo. And I’m sure the asset-backed market has become much more “sophisticated” since my very limited experience with it.

I also fall back on some of my in-house experiences. Watching a room full of bankers conduct a PowerPoint presentation to explain how smart it would be for the company to issue “tracking stock” (this was fashionable about a decade ago when a dozen or so companies got convinced of the need to create securities for which there were no voting rights and – arguably – no fiduciary duties to the holders; not the best governance framework nor not a sound investment as it turned out). Or enter into synthetic real estate leases to keep debt off the books because a company is too highly leveraged. More mumbo jumbo.

And I would imagine that this is just a drop in the bucket. I haven’t worked on Wall Street and I’m not privy to her dark secrets. But I think I know enough to give my ten cents in asking for some of those on Wall Street to change their philosophy and stop looking for fees at the expense of the financial health of this country. There has to be accountability at the top. As said so often during the Sarbanes-Oxley reform debates, you can’t regulate ethics and morality.

I like the idea of what has happened in the United Kingdom. In the wake of the Northern Rock failure, the Financial Services Authority went out and conducted a post-mortem and issued a report saying “what they missed, what needed to be corrected and what they were doing about it.” Hopefully, this is part of the Paulson plan that will be released today, but I doubt it. We need to know what went wrong before we fix it, right? Or maybe this crisis runs so deep that no one really knows the extent of what went wrong. Even if that’s true, let’s understand and learn from that as part of such a report to start…

The Bottom Line: Smarter people than me will offer more cogent arguments “for” and “against” various aspects of the numerous proposed reforms. And I’m grateful for that. All I ask is that if new governmental agencies are formed, please avoid the cartoonish names that are mentioned in the Paulson plan. The “Business Conduct Regulator” sounds like it came from the Flintstones…

- Broc Romanek

March 28, 2008

New Century: Deja Enron?

Have you had a chance to read about the 580-page examiners report about what happened at New Century Financial, a sub-prime lender in bankruptcy, leading up to its collapse? It eerily has some similarities with the audit of Enron. Here is a WSJ article on the report.

In the report, the bankruptcy examiner strongly condems the role of the independent auditor – KPMG – and its work performed in connection with the 2005 and 2006 audits of New Century, including the firm’s judgments, independence and objectivity. It discusses potential disputes among the professionals – just as it occurred at Enron – as well as notes a lack of adequate experience among some of the staff and a lack of documentation that would provide a basis for their judgments and conclusions, and rationalization of materiality. The report also heavily criticizes the company’s audit committee and internal auditors.

Remember that KPMG – until recently – had a court-appointed monitor as a part of their tax shelter sanctions (and subsequent deferred plea agreement with the DOJ). It appears the alleged problems with the New Century audit may have occurred during the time period when the monitor was in place, albeit his role was primarily focused on the firm’s tax practice. Here is the first complaint filed against New Century…

Notably, the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR) is looking at recommendations that could further relax regulation with respect to some of these matters. Also notable is that this report comes at a time when auditors are pressing hard to limit the ability of bankruptcy trustees to bring litigation against them.

Nasdaq Revises Its SPAC Listing Proposal

Last week, the Nasdaq revised its proposed rule change regarding SPACs that it originally filed a few weeks ago. Under the revised proposal, SPACs would not be required to use cash in completing a qualifying business combination as was originally required in Nasdaq’s proposal.

Speaking of SPACs, Goldman Sachs made news this week for jumping on the SPACs bandwagon with a new breed of them – see this DealBook blog and the Liberty Lane Acquisition Form S-1 filed by Goldman.

American Greed: The TV Show

I guess it was just a matter of time before the people that run television would come up with a reality-based show solely about greed. “American Greed” is in its second season on CNBC and has run episodes already on quite a few situations that you likely are familiar with (eg. WorldCom).

- Broc Romanek

March 27, 2008

More on Confidentiality of “Material Contracts”

A few weeks ago, I blogged about Canada’s new material contract filing requirements and waxed about what might happen if the same standard applied in the US. A member responded as follows:

Unrelated to your pessimism regarding the lengths to which some pracitioners may go to further their clients efforts to avoid disclosure of terms of material contracts is the consideration that boilerplate used for many agreements includes a general confidentiality provision relating to the agreements’ terms. In many of those cases, there is a simple “as required by law” exception to the confidentiality provision.

The exception often is used by a party required to file reports with the SEC as authorization to file the contract with the SEC as a material contract, subject to a request for confidential treatment for those portions of the contract that, consistent with applicable regulations, are permitted to remain confidential. And, after its review and processing of the related confidential treatment request, whatever the SEC Staff allows to remain confidential, so remains; whatever the Staff objects to remaining confidential, gets disclosed to the public in one form or another, consistent with applicable regulations.

Of course, in many instances where one party REALLY does not want to have certain terms disclosed and it is unclear whether these terms are of a type for which the Staff will grant confidential treatment, the typical confidentiality provision can be much more elaborate – for instance, allowing the counterparty to intercede with the government seeking to require disclosure and, perhaps, more significant remedies, such as the right to terminate a commercial-type agreement.

All of this being said (and again leaving your pessimism aside), I have noticed agreements where concepts meant to remain confidential are relegated to schedules, and the report, which includes the agreement as an exhibit, simply omits the schedules. Presumably, the basis for omission of the schedules relates to the provisions of the second sentence of Item 601(b)(2) of Reg S-K which states: “Schedules (or similar attachments) to these exhibits shall not be filed unless such schedules contain information which is material to an investment decision and which is not otherwise disclosed in the agreement or the disclosure document.”

Notably, Item 601(b)(10) of Reg S-K doesn’t contain an analogous provision. However, most practitioners are aware of a variety of practices that have developed in relation to the filing of exhibits and schedules to contracts, whether the contracts are filed pursuant to Item 601(b)(2) or (b)(10). Specically, many practitioners are aware of registrants which have omitted schedules to (b)(10)-filed contracts.

Presumably, these registrants have concluded that the omission is immaterial in light of other disclosure. In addition, many practitioners are aware of registrants which have omitted exhibits that are forms of contracts executed contemporaneously with a filed material contract and simply file that executed versions of these contracts. While the immateriality of these forms is undeniable (unless the exhibits are not filed in executed form contemporaneously with the primary contract), it is unclear whether this practice is sanctioned by applicable regulations.

Nasdaq Acts on IFRS

Recently, Nasdaq made this proposal to amend its listing requirements to accept financials prepared in accordance with IFRS from foreign private issuers. It is anticipated that all stock exchanges will amend or interpret their listing standards to conform to the SEC’s acceptance of IFRS.

The Rise of “Social” Proposals

Over the past few years, shareholders have been supporting so-called “social” proposals more than ever before (also known as “ES&G” proposals). For a long time, the percentage of shareholders that supported these types of proposals remained in single digits. Given the growing support of them over the past few proxy seasons, it wouldn’t be surprising if they started to routinely receive majority support.

During our recent webcast with Pat McGurn of RiskMetrics (transcript here), Pat noted that “30% of the E&S proposals won at least 15% support last year. And more than 25 of their proposals won support in excess of 30%. And several, including one that was opposed by management, ended up winning.”

And as Pat noted, companies are more willing to settle on these types of these issues nowadays and have these proposals withdrawn. Some boards are concerned about reputational risk; some are worried about the long-term impact of issues like climate control. In fact, last Fall, Grant Thornton conducted a survey of more than 500 business executives and found that only a quarter of survey respondents agreed that profits needed to be sacrificed when dealing with these issues, while three quarters believed corporate responsibility could enhance profitability. As a result, 77% said they expected corporate responsibility initiatives to have a major impact on their business strategies over the next several years.

Other findings in the Grant Thornton survey include:

- 19% of the companies surveyed report having a single point person in charge of all their corporate responsibility programs.

- 68% say they expect environmental responsibility reporting to be mandatory within the next three to five years, yet 55 percent say they have no plans to do any kind of corporate responsibility reporting.

- The four greatest obstacles to successful execution of corporate responsibility programs are: focus on quarterly earnings or other short-term targets, cost of implementation, measuring and quantifying ROI, and a non-supportive corporate culture.

- The three greatest benefits of enacting corporate responsibility programs are: improves public opinion, improves customer relations and attracts/retains talent.

- 72% of respondents believe that government should regulate companies for their effect on the environment and 56 percent said companies should be regulated for their effect on human rights and labor practices.

- 70% of respondents foresee increased government regulation for environmental responsibility in five years or less.

- 62% believe that pressure to pursue corporate responsibility programs in the future will come chiefly from consumers (45%) and investors (21%).

- 64% believe that the human resources department should take on social programs, 50% say operations should be in charge of environmental initiatives and 57% say finance should be responsible for economic responsibility programs.

- Broc Romanek

March 26, 2008

Blockbuster Joins the “Say-on-Pay” Parade

Yesterday, Blockbuster became the 5th company to agree to a non-binding vote on executive compensation – it will place this topic on the ballot starting in 2009. Here is a list of companies that have agreed to “say-on-pay.”

The PCAOB Speaks: Latest Developments and Interpretations

Given that it’s still relatively young for a regulator, the PCAOB continues to change dramatically. Join us tomorrow for our 1st annual webcast – “The PCAOB Speaks: Latest Developments and Interpretations” – regarding what is happening at the PCAOB. During this webcast, senior PCAOB Staffers will provide a wide range of practical guidance, from what are the latest issues, like internal controls for smaller companies interpretations, to whom do you call to resolve an issue, and much more. Join these experts:

- Mary Sjoquist, Special Counsel to PCAOB Board Member Bill Gradison
- Sharon Virag, Director, Technical Policy Implementation, as part of Chairman Olson’s Staff
- Kayla Gillan, Chief Administrative Officer, RiskMetrics Group and former PCAOB Board Member

During the program, I will be spending some time interviewing Kayla about her experiences as one of the founding Board Members (following up on this blog).

Delaware Supreme Court Denies Director Standing To Sue

From Travis Laster: In Schoon v. Smith, the Delaware Supreme Court held that a director who was not also a stockholder lacked standing under Delaware law to assert derivative claims on behalf of the corporation he served. The Court held that derivative standing would be recognized only where necessary “to prevent a complete failure of justice.” The Court noted that although the director was not himself a stockholder, he was affiliated with a stockholder who had the ability to sue derivatively, and thus a “complete failure of justice” would not result.

The Court’s decision leaves open the possibility that a non-stockholder director, unaffiliated with any stockholder, might be able to sue derivatively if necessary “to prevent a complete failure of justice.” The opinion contains an extensive discussion of the history and purpose of the derivative action.

More insight on this case is available from Steven Haas on the “Harvard Law Corporate Governance Blog.”

- Broc Romanek

March 25, 2008

The Section 162(m) Workshop

Tune in today for this CompensationStandards.com webcast: “The Section 162(m) Workshop.” This webcast will be held in a “workshop” style, where experts provide analysis of the numerous issues raised for specific types of employment arrangements, including guidance on what well-designed plans should look like under the IRS’ latest guidance. Join these experts:

- Christine Daly, Partner, Holme Roberts & Owen LLP
- Elizabeth Drigotas, Principal, Washington National Tax, Deloitte Tax LLP
- Jeremy Goldstein, Partner, Wachtell Lipton Rosen & Katz
- Mike Kesner, Head of Deloitte Consulting’s Executive Compensation Practice
- Paula Todd, Managing Principal, Towers Perrin

You may want to print out these “Course Materials,” which consist of notes regarding hypothetical 162(m) scenarios (courtesy of Regina Olshan of Skadden Arps).

What We Got Here is a Failure to Communicate…

If a company doesn’t respond timely to an SEC comment letter, it likely is more than a failure to communicate (I just love using that line from “Cool Hand Luke”). Since the end of 2006, the SEC Staff has sent more than 50 threatening letters that tell companies to respond to outstanding comments now – or else the Staff will post the correspondence relating to the Staff’s review. Not meaning to pick on any particular company, but here is a sample of these letters.

A Focus on Swaps and 13D Reporting in CSX Litigation

For the past year, CSX Corp. has been locked in a battle with an activist investor – The Children’s Investment Fund (TCI) and its affiliates – over governance reforms and now that battle has gone to court over the issue of swaps and Section 13(d) reporting.

Last fall, TCI called on the CSX Board to undertake a number of initiatives, including separating the Chairman and CEO roles, adding new independent directors, allowing shareholders to call special meetings, aligning management compensation with shareholder interests, presenting a detailed operating plan with specific long-term operational and cost targets to address under-performance, justifying the capital spending plan, and improving relations with labor, shippers and shareholders.

By the end of 2007, TCI had formed a group with 3G Capital Partners and filed a Schedule 13D indicating that they intended to nominate five directors for election at CSX’s 2008 annual meeting scheduled for June 25th – and in a subsequent Schedule 13D/A, the group indicated plans to present a proposal to amend the company’s bylaws to permit 15% or greater shareholders to call a special meeting.

Last week, CSX filed a complaint in the Southern District of New York seeking injunctive and declaratory relief against the group based on allegations that the funds are seeking to change or influence control of CSX through the use of swaps and secretly coordinated efforts while failing to comply with the Schedule 13D and Schedule 14A reporting requirements.

The complaint alleges that 37 million shares of CSX common stock were transferred to financial institutions that were counterparties to swaps referencing shares of CSX common stock in anticipation of the company’s February 28, 2008 record date, indicating the existence of understandings that those counterparties would vote the shares in accordance with TCI’s and 3G’s wishes, or alternatively indicating that the counterparties would vote with TCI and 3G because of their relationships with those funds.

CSX also challenges, among other things. the funds’ disclaimer of beneficial ownership of shares referenced in swap arrangements, the timely filing of their initial Schedule 13D and the adequacy of their disclosure regarding their intentions and arrangements, understandings or relationships. CSX wants the court to order, among other relief, that the funds divest their interests and terminate their swap arrangements, or that the funds be prohibited from voting their shares (or be subject to proportional voting) at the annual meeting.

The funds filed a Schedule 13D/A indicating that the allegations in the complaint are without merit and that they intend to defend themselves vigorously.

In this case, CSX is taking on one of the most vexing problems that is faced today with respect to beneficial ownership reporting and contests for control – that swaps and other similar instruments which provide investors solely with economic exposure (and arguably without any voting or investment power) for the most part fall outside of today’s Section 13(d) reporting requirements. Thanks to Jonathan Levy of Lindquist & Vennum for pointing this case out!

- Broc Romanek

March 24, 2008

Delaware: Advanced Notice Bylaw Limited to Rule 14a-8 Proposals

From Travis Laster: A few weeks ago – in Jana Master Fund Ltd. v. CNET Networks – Chancellor Chandler holds that an advanced notice bylaw applies only to Rule 14a-8 precatory proposals and not to all stockholder proposals to conduct business at an annual meeting. Given that the ruling clears the way for a proxy contest for control over a Delaware corporation, the decision is likely to be appealed. If it holds up, I predict that a lot of Delaware corporations will be amending their advanced notice bylaws.

The ruling interprets an advanced notice bylaw that many practitioners will likely view as industry standard and non-controversial. The bylaw does not say that it is limited to Rule 14a-8 proposals. It instead says that any stockholder who wishes to propose business to be conducted at a meeting of stockholders must (i) own at least $1000 of stock for at least a year, (ii) propose the business 120 days before the one year anniversary of the mailing of the prior year’s proxy statement, and (iii) include with the proposal the information required by the federal securities laws.

Jana, which had held the requisite stock for only 8 months, made proposals to pack the CNET board. CNET responded that the proposals were not validly made under its bylaw. Jana then filed suit in the Court of Chancery. Rather than taking on the fiduciary duty issues implicated by a bylaw that limits the right to make director nominations to a stockholder owning a certain amount of stock, the Court of Chancery construed the bylaw as applying only to Rule 14a-8 proposals. The Court identified three reasons for its interpretation.

First, the Court cited the language of the bylaw which referred to a stockholder who “may seek to transact other corporate business” at the meeting. The Court held that this language must refer to a Rule 14a-8 proposal, since stockholders generally do not need to “seek” permission “to transact … business” at an annual meeting. This holding would seem to beg the question of whether a corporation can enact an advance notice bylaw in the first place. Since Delaware courts have previously answered that question “yes,” it follows that for a stockholder to comply with an advance notice bylaw, it must “seek to transact” business in compliance with the bylaw. If a stockholder fails to comply with the bylaw, it logically may not “transact business” at the meeting. It is thus not clear that anything necessarily follows from the “may seek” language, which seems rather standard.

Second, the Court focused on the timing requirement of 120 days before the one year anniversary of the prior year’s proxy statement. The Court viewed this language as consistent with the timing of a Rule 14a-8 proposal that would go in management’s proxy statement rather than a proposal that would be made at the meeting and be the subject of a stockholder’s own solicitation. Having been on both sides of arguments about the 120 day anniversary issue, I have traditionally viewed the fighting issue there as the length of the advance notice period (which typically works out to about 200 to 230 days). I have not previously seen anyone argue that this language was a constructive limitation to Rule 14a-8 proposals.

Third, the Court cited the requirement that “such notice must also comply with any applicable federal securities laws establishing the circumstances under which the Corporation is required to include the proposal in its proxy statement,” finding that this language silently incorporated Rule 14a-8. This also strikes me as relatively typical language designed to make sure the corporation has access to at least the same types of information about any proposal that it would be entitled to under a Rule 14a-8 proposal.

Based on these three factors, the Court concluded that the CNET bylaw only applied to Rule 14a-8 proposals. As a result, JANA or any other stockholder would be free to make proposals at the annual meeting without any advance notice requirement, including proposals made from the floor of the meeting.

As you can tell from my commentary, I would not have bet on this outcome. I thought the case might go either way under a fiduciary duty analysis, a reasonableness analysis, or a statutory interpretation of Section 109 of the DGCL. The Rule 14a-8 interpretation surprises me.

I suspect that many Delaware corporations will find that their advance notice bylaws contain each of the three features cited by the Court, or language closely paralleling them. I also suspect that many Delaware corporations do not believe that their advance notice bylaws are limited to Rule 14a-8 proposals. Under the Jana ruling, however, assuming it holds up on appeal, these Delaware corporations may find themselves vulnerable to an argument that they really have no advance notice bylaw protection at all. This in turn renders them vulnerable to proposals made for the first time from the floor of a meeting, particularly if a majority of their outstanding voting power is highly concentrated among a few holders.

Bottom line: Unless the Delaware Supreme Court goes in a different direction, it’s time for a new generation of advance notice bylaws that (i) explicitly apply to all stockholder proposals, (ii) return to a reasonable 60-120 day advance notice period before the meeting date, rather than a date keyed off the prior year’s proxy mailing, and (iii) specify the information that must be provided without incorporating federal securities requirements by reference.

Practice Pointers in the Wake of Jana Master Fund

Here is some guidance from Cleary Gottlieb:

What action should companies take in response to this decision? The advance notice deadline specified by the by-laws of most companies about to host a 2008 shareholders’ meeting has likely already passed. For such a company, unless it has reason to believe there is a specific risk of a last-minute proxy contest, we would not recommend a rush to amend the advance notice by-law. This controversial decision may be reversed on appeal or not followed where different by-law language exists or specific additional or different facts can be presented to the court.

Accordingly, in the absence of concern about a potential proxy contest, we recommend that companies whose advance notice deadlines have passed not take any action now, but watch to see if yesterday’s decision is appealed and, if so, whether the Chancellor’s opinion is reversed or clarified on appeal. Then the board can decide whether an amendment would be appropriate. At the same time, however the appeal is decided, the board may wish to consider other amendments to the advance notice provision, including a requirement that a shareholder proponent make appropriate disclosure regarding short positions or other derivative positions relating to the company’s shares, and to update that information as well as beneficial ownership information through the time of the annual meeting.

A company, whose advance notice deadline has passed and has reason to believe a last minute proxy contest is possible, should of course immediately review its specific situation with counsel and its proxy solicitor – including the language of the by-law, prior disclosure regarding the by-law, the timing of the meeting, the extent and nature of the proxy contest risk, and its shareholder profile – before deciding how best to proceed.

Finally, companies whose advance notice deadlines have not yet passed should consider a by-law change to eliminate the risk that their advance notice provisions would be interpreted as in this decision.

We are posting memos about this case in our “Annual Stockholders’ Meetings” Practice Area.

Wow! What a Difference a Week Makes…

I go on a week-long vacation without email access for the first time in years and wow, the world goes topsy-turvy. The Fed pushes JPMorgan Chase to bail out Bear Stearns in a mind-blowing deal that isn’t yet done and whose consideration may now be quintupled. This wouldn’t be the first time the government has pushed a company into a deal that went sour (eg. the Department of Defense “encouraged” Lockheed Martin to buy Northrop Grumman a few years before I went to work for Lockheed; after the deal was inked, the Department of Justice stopped the deal on anti-trust grounds – go figure, right?).

The deal’s initial consideration was 6% of what Bear Stearn’s market cap was – and the deal was struck just days after Bear Stearn’s CEO said that liquidity was not an issue. There are loads of other crazy stuff on this deal in my in-box and posted on numerous blogs, etc. I’m in the process of catching up and possibly setting up these future webcasts:

- Risk management and the responsibilities of various parties (ie. boards, internal auditors, outside auditors)
- How the credit crunch is impacting debt covenants and other financing arrangements
- Analyzing the novel Delaware law aspects of the Bear Stearns deal

Let me know if you (or someone you know) might fit on one of these panels.

Jamie Dimon: CEO Extraordinaire?

Then there is the whole Jamie Dimon angle to the Bear Stearns story. Who will play Jamie in the movie? George Clooney? Russell Crowe? Or Will Ferrell? Here is a poll to express your opinion:

Opinion Polls & Market Research

- Broc Romanek

March 21, 2008

Is Fair-Value Accounting the Problem?

In the search for causes of the recent market turmoil, it was inevitable that a finger would eventually be pointed at fair-value accounting. FASB’s Statement No. 157, Fair Value Measurements, which defines fair value and establishes the framework for measuring fair value under GAAP, is under attack as financial institutions take enormous write-downs of the fair values of their financial assets. The developing debate was noted in this recent CFO.com article:

In recent weeks, financial services firms have blamed their financial troubles on the use of fair value. Perhaps the most vocal has been Martin Sullivan, CEO of American International Group. The insurer recently reported $11 billion in write-downs, and has called for changes in the accounting rules.

“We are trying, as are many others, to value very complex instruments,” Sullivan told investors during a conference call in February. “These valuations are not mechanical. They involve difficult estimates and judgments. I can tell you that we have, at all times, brought our best judgment to bear in making these valuations.”

To be sure, critics of fair value say that it can distort market realities by giving management too much discretion and room for abuse. But the proponents say it actually creates transparency by reflecting the up-to-date reality of an asset’s or liability’s worth.

Corporations that have made poor decisions lately are using fair value as a “scapegoat,” according to the CFA Institute Centre for Financial Market Integrity, a research and policy organization. “Fair value accounting and disclosures, which provide investors with information about market conditions as well as forward-looking analyses, does not create losses but rather reflects a firm’s present condition,” says Georgene Palacky, director of the CFA’s financial reporting group.

Indeed, Tweedie [David Tweedie, chairman of the International Accounting Standards Board] deflects the current fair-value criticisms as ignoring the true roots of the current problems in the financial marketplace. “The real problem in the current crisis is a lack of trust and lack of transparency,” he says.

The IASB further defends the use of fair value in a discussion paper about reducing complexity in reporting financial instruments, released on Wednesday. The 98-page document was in the works long before the credit crisis hit; however it comes at an opportune time for the supporters of mark-to-market accounting.

In it, the IASB says fair value “seems to be the only measure that is appropriate for all types of financial instruments.” Still, the board acknowledges that “there are issues and concerns that have to be addressed before [rule-makers] can require general fair value measurement.”

It seems to me that it is highly unlikely the SEC or Congress would bow to this pressure and seek to suspend FAS 157 at a time when up-to-date financial information is more important than ever to investors. The days of book value accounting for financial instruments are long gone – and probably for the best.

Some Legislative Developments

Congress has left town for its Spring recess (which I hope to do next week as well), but before it left town some members dropped a couple of securities-related bills that are worth noting.

Earlier this month, Senator Elizabeth Dole (R-NC) introduced the “Regulatory Relief and Fairness Act” (S. 2703), a bill seeking to exempt certain financial institutions from the requirement to provide SOX Section 302 certifications and Section 404 internal control assessments. Recall that when adopting the internal control and certification requirements in the Sarbanes-Oxley Act, Congress (and the SEC when adopting the rules) considered the example of similar requirements that were already in place for banks and similar financial institutions.

In February, Representative Jeb Hensarling (R-TX) and Representative Ed Royce (R-CA) introduced the “Securities Litigation Attorney Accountability and Transparency Act” (H.R. 5463). The bill seeks to amend the federal securities laws to target frivolous securities suits by awarding reasonable fees and expenses to a defendant in the event the suit is adjudicated in the defendant’s favor based on a motion to dismiss, a motion for summary judgment or a trial on the merits and, among other conditions, “the position of the plaintiff was not substantially justified.” The bill would also attempt to get at some of the “Milberg Weiss” problems by requiring sworn certifications from plaintiffs and their counsel concerning payments, the nature of their legal representation, political contributions and other conflicts of interest. The bill would also provide for a competitive bidding process in the selection of lead counsel in securities class action litigation.

Yesterday, Representative Barney Frank (D-MA) gave a speech in Boston where he called for either the Federal Reserve or a new regulator to oversee systemic risks in the financial system posed by banks, securities firms or hedge funds. As noted in the NY Times article, this concept – if enacted – could change the landscape for the financial regulators, given that the oversight duties are currently spread across the Treasury, the Fed and the SEC.

Developing Future Securities Lawyers?

Last week I spoke at “Career Day” at my kids’ school, and my rather daunting challenge was how to make securities law fun and exciting for second and fourth graders. It is always tough as a lawyer to compete with the firemen, policemen, air force pilots, etc. in terms of capturing the kids’ imagination.

In my presentation, the students went to an abbreviated version of law school where they learned about the securities laws. I boiled them down as follows:

- Always tell the truth – and don’t lie or make stuff up
- Don’t trick anybody
- Tell the whole story
- Tell people all of the risks involved.

The kids then counseled me in raising capital for my “big idea” – turning their school into an amusement park. They nixed me saying things like “this amusement park will be so big you can see it from the moon” and reviewed this prospectus with some critical comments. With regard to the statement in the prospectus – “This is our roller coaster. We think that it will be the best roller coaster around” – one of the second graders said “I think you should say that it is ‘one of the best’ roller coasters around.” I think that young man has a future as an examiner in Corp Fin!

I hope that I got through to the kids with some good investing tips and a positive take on lawyers. One wrote to me in a thank you note: “I learned that you have to be careful with money and not just give it to someone.” Another kid said “Your job sounds more like a hobby to me than a job – you are lucky to do that all day!” Perhaps I was guilty of not telling the whole story…

- Dave Lynn

March 20, 2008

FASB Issues New Derivatives and Hedging Standard

Yesterday, the FASB announced the issuance of Statement No. 161, Disclosures about Derivative Instruments and Hedging Activities. The new standard amends FASB Statement No. 133, and seeks to enhance disclosure about how and why a company uses derivative and hedging activities, how derivative instruments and related hedged items are accounted for under FAS 133 (and the interpretations of that standard) and how derivatives and hedging activities affect a company’s financial position, financial performance and cash flows.

The Statement is strictly focused on disclosure – it doesn’t revisit any of the thorny issues from FAS 133 such as how to deal with embedded derivatives or the application of the always perilous “shortcut” method of hedge accounting. A central part of the new disclosure will be tables highlighting the location and fair values of derivative instruments in the statement of financial position and the location and amounts of gains and losses on derivative instruments in the statement of financial performance. The two tables (one relating to the statement of financial position and relating to the statement of financial performance) will distinguish between derivative instruments that are designated as hedging instruments under FAS 133 and those that are not. In addition, the information in the tables will require presentation of each major type of derivative instrument – interest rate contracts, foreign exchange contracts, equity contracts, commodity contracts, credit contracts and other types of contracts. The FASB provides illustrations of these new tables in paragraph 3(d) of FAS 161.

The new tables will be accompanied by additional qualitative disclosure about derivative instruments, focusing on how and why the derivatives are used, how they are accounted for and their impact on the company’s finances. The disclosure will be organized around particular risk exposures (interest rate, credit, foreign exchange, etc.), and must distinguish between instruments used for risk management purposes and those used for other purposes.

FAS 161 is effective for financial statements issued for fiscal years and interim periods beginning after November 15, 2008. Early application of the standard is encouraged, as well as comparative disclosures for earlier periods at initial adoption (although such comparative information is not required).

Corporate Hijacking: Something New Under the Sun?

Last week, the SEC announced that it had suspended trading in 26 companies that were involved in “hijacking” the identity of defunct or inactive publicly-traded corporations. Coming out of Enforcement’s microcap fraud working group, these cases are targeted at what Enforcement Director Linda Chatman Thomsen called “a burgeoning problem.”

The modus operandi of the alleged hijackers was relatively simple – they incorporated a new company with the same name as a defunct or inactive publicly-traded company, and then obtained a new CUSIP number and ticker symbol for the securities of the new company by claiming to be officers, director or agents of the inactive or defunct company. One of the companies was traded on the AMEX, while the rest were quoted on the Pink Sheets. Exchange Act Section 12(k) was used to suspend the trading in the companies until March 27th, based on claims that there is a lack of current and accurate information concerning the securities of the companies and trading in the securities of the companies was predicated on apparent misstatements. The identities of the alleged hijackers have not yet been revealed.

While on the topic of fraud: As an aficionado of the classic American genre of entertainment known as the “infomercial,” I have spent many a sleepless night trying to learn the intricacies of real estate flipping, commodity trading and internet-based sales businesses from those always entertaining and informative shows. Therefore, I couldn’t help but notice when the SEC announced a crack-down on a couple of “stars” of the investment infomercial world in a case involving the program called “Teach Me to Trade.” I especially liked how, along with the press release announcing the action, the SEC embedded clips from the TMTT infomercials. My favorite parts of these clips are shots of a guy sitting with his feet up on a table and trading in his socks and the shots of an obviously contrived live studio audience trying to look fascinated about this program. You’ve got to love this stuff!

Pro or Troll #6: Developments with PIPEs

When markets are choppy, PIPE transactions can be an attractive alternative for raising capital. In fact, some large financial institutions have recently obtained capital through PIPE deals, even though they don’t typically call them “PIPEs.”

Test your knowledge of PIPEs with our newest Pro or Troll game.

- Dave Lynn

March 19, 2008

Bear Stearns FAQs

You know a crisis is bad when it warrants its very own set of SEC FAQs. The Staff took the relatively unusual step of putting out some FAQs on the Bear Stearns fiasco yesterday, covering a wide range of topics. These FAQs include a few tidbits that are worth noting.

In describing the Staff’s role in “advancing” the Bear Stearns/JP Morgan transaction, the Staff from each of the SEC’s Divisions provided letters to the parties clarifying Staff positions with respect to the transaction. Among these letters was one from the Enforcement Staff, indicating that while they were declining to provide any assurances about possible future Enforcement actions because reaching such conclusions would be premature:

In the letter, the Division confirmed that, consistent with prior statements and guidance by the SEC, the staff would favorably take into account the circumstances of the JPMorgan acquisition of Bear Stearns when considering whether to recommend enforcement action against JPMorgan arising out of statements made by Bear Stearns in the 60 days before the public announcement of the merger.

This 60-day “safe harbor” for an acquiror – while certainly nothing new from a Staff policy perspective – will no doubt be something that others can point to in similar merger situations, now that the policy has been so explicitly referenced in this context.

The FAQs also note that the Corp Fin Staff provided relief in this no-action letter, which gives broad Securities Act Section 5 and Rule 144 relief that enables JP Morgan and its advisory affiliates to sell securities issued by Bear Stearns and its affiliates that were held in client accounts prior to executing the merger agreement, and enables Bear Stearns and its advisory affiliates to sell JPMorgan securities held in client accounts prior to the execution of the merger agreement. As noted in the FAQs and in the incoming letter, this relief was necessary given the control relationship created by the merger agreement. The relief is only available for 15 business days following the date of the merger agreement, and is limited to securities that were otherwise freely transferable and securities that are not held for the account of a person that was an affiliate of the particular issuer prior to execution of the merger agreement. Further, the relief only applies to sales of securities which may be required in order for advisory affiliates of the firms to satisfy their fiduciary obligations to their clients. It is not likely that this letter will serve as precedent for many others.

The FAQs note generally that Enforcement may investigate possible violations of the securities laws in situations such as this, including “potential indications of insider trading or manipulation of markets through the dissemination of false or misleading information to investors by companies or other market participants.” This Bloomberg article indicates that sources are saying the SEC and the NYSE are investigating whether traders illegally sought to force Bear Stearns shares down last week by intentionally spreading false information about the firm’s financial situation, focusing in particular on transactions in options and short sales.

What’s Driving Restatements?

In a recent study of the reasons behind 3,744 restatements by Associate Professor Marlene Plumlee of the University of Utah and Associate Professor Teri Lombardi Yohn of Indiana University, the authors found that restatements were most often caused by basic internal company errors unrelated to accounting standards – rather than due to the complexity of accounting standards as many have suggested. For those restatements that related specifically to some characteristic of the accounting standards, the authors found that the primary contributing factor for restatement was “the lack of clarity in applying the standards and/or the proliferation of the literature due to the lack of clarity in the original standard.” The study also demonstrates that the materiality threshold that has been applied in decisions to restate seems to have decreased over the period 2003 – 2006.

The study indicates that companies with Big Four auditors were more likely to have a restatement caused by characteristics of the accounting standards. Further, the data suggests that the use of judgment in applying standards is a significant factor in driving restatements, although maybe not as significant as others have suggested.

Some good news from the study is that intentional manipulation accounted for a very small percentage of restatements during the sample period. Instead, restatements related to accounting standards and internal errors accounted for 94 percent of all restatement filings over the four year period covered by the study.

Concerns Over Well-Timed Stock Gifts by Executives

Some recent press – including this NY Times article – highlighted research by NYU Professor David Yermack on the timing of large gifts of stock by CEOs and chairmen of companies to their family foundations, with the implication that gifts made before significant price drops would maximize the tax benefits to the executives and allow them to avoid capital gains taxes. The NY Times article also notes “[t]he research … also found patterns to suggest that some gifts of stock might have been backdated to enhance their value, in much the same way that some companies backdated stock options.”

These sorts of academic studies have certainly sparked interest at the SEC – for example with options backdating and Rule 10b5-1 plans – so the obvious question is whether there is anything wrong with these practices and will the SEC or others start investigating them?

As this recent client memo from Proskauer Rose notes, “there is absolutely nothing wrong with corporate insiders donating their companies’ stock to charity when the share price is high; indeed, it is smart financial planning.” The NY Times article notes that while Professor Yermack emphasized that there was nothing illegal from a securities law perspective about these gifts, he said that given the impact on taxpayers and charities, this is perhaps something the Congress should consider.

- Dave Lynn

March 18, 2008

Spring Cleaning for Some Corp Fin Rules: No E-Proxy for Business Combinations

Yesterday, the SEC posted a “technical amendments” release correcting several rules and forms – including some adopted or amended many moons ago. The SEC can make these sorts of immediately effective corrections without going through the whole notice and comment process when they are conforming the rules to the express intent of the Commission, fixing typos and cross-references, and making other types of “technical” changes.

Among the clarifications in this release are some fixes to the language in the e-proxy requirements (Exchange Act Rules 14a-3(a)(3) and 14a-16(m)) which clarify that the notice and access model regarding internet availability of proxy materials is not available with respect to business combination transactions, which is now expressly defined to include transactions covered by Securities Act Rule 165 and transactions involving cash consideration for which disclosure under Item 14 of Schedule 14A is required. While the SEC had intended that business combination transactions for cash consideration be excluded from the application of the e-proxy rules, the final rules did not specifically include the necessary language referencing cash transactions for which Item 14 disclosure is required. The SEC also fixed the language of Rules 14b-1 and 14b-2 to refer to the correct legends (Legends 1 and 3, rather than Legends 1 and 2) in the part of those rules addressing the legends that are not required in the Notice of Internet Availability of Proxy Materials.

The SEC also adopted changes to the tender offer rules and related forms to correct several cross references, to reflect the repeal of the Public Utility Holding Company Act, to fix some typos and to correct cross references to Rule 10b-13, which was redesignated as Rule 14e-5 with the adoption of Regulation M-A. In addition, the titles referencing “Regulation 13D” have been changed to “Regulation 13D-G,” the number of copies of Form CB was reduced, references to paper submissions of Schedule 14D-9 have been eliminated, and references to the SEC’s new address have been added to some rules and forms.

The technical amendments release also contemplates shifting the authority to grant exemptions from the issuer tender offer rules and to determine the applicability of the issuer tender offer rules from the Division of Trading and Markets to Corp Fin.

SEC Proposes Anti-Fraud Rule for Naked Short Selling

Naked short selling – when a short seller fails to borrow or arrange to borrow securities for delivery to buyers within the T+3 settlement cycle – has proven to be an intractable problem and the bane of some smaller public companies that claim to be under “attack” by naked short sellers. The SEC sought to directly address concerns about abusive naked short selling with the adoption of Regulation SHO (effective in 2005), by establishing a uniform “locate” requirement – where before executing a short sale order a broker-dealer must have a reasonable grounds to believe that the subject security can be borrowed so that it can be delivered on time – and “close out” requirements that force participants to close-out open failures to deliver for certain securities. In connection with adoption of Reg. SHO, the SEC Staff notably expressed the view that “[n]aked short selling is not necessarily a violation of the federal securities laws or the Commission’s rules. Indeed, in certain circumstances, naked short selling contributes to market liquidity.”

But apparently even with all of those efforts, the SEC continues to perceive problems with abusive naked short selling (as opposed to “good” naked short selling). Last fall, the SEC adopted amendments to Reg. SHO’s close-out requirements, grandfathering provisions and options market maker exception to address lingering concerns. Earlier this month, the SEC proposed a new rule to target the practice. In the proposing release that was posted yesterday for this new anti-fraud rule – Rule 10b-21 – the SEC cites continuing Enforcement actions (see, e.g., Sandell Asset Management Corp.) as part of the reason for taking yet another stab at abusive naked shorts.

With proposed Rule 10b-21, the SEC seeks to “highlight” something that it acknowledges is already illegal under Section 10(b) and Rule 10b-5 – it would be unlawful for a short seller to intentionally deceive a broker-dealer, clearing agency participant or purchaser regarding its intention or ability to deliver the security on the date delivery is due when the short seller in fact fails to deliver the security on or before the date delivery is due. The proposed rule would cover situations where a short seller misrepresents its ability to locate the security in time for delivery, as well as situations where the short seller causes the broker-dealer to mark its order to sell the security as “long” when the seller knows or recklessly disregards that it is not “deemed to own” the security being sold. While targeted at naked short sellers (typically funds that do this sort of thing for a living), the rule would also apply to broker-dealers trading for their own account, and broker-dealers could be liable for aiding and abetting a customer’s fraud under the proposed rule.

The SEC is seeking comment on the proposed rule for 60 days following publication in the Federal Register.

Say-on-Pay: Popular with CFOs?

BDO Seidman recently conducted a survey of the opinions of 100 CFOs at leading technology companies located throughout the U.S., and found that a majority of those CFOs thought that shareholders should have a say on executive compensation plans. Not surprisingly, two-thirds of the CFOs also indicated that the compensation plans at their companies have been impacted by such regulatory developments as FAS 123R and Section 409A. Despite these changes, however, over 80 percent of the CFOs surveyed felt that there was little impact on the ability to attract and retain talent – and they cited restricted stock and stock option grants as the most effective tools for recruiting employees in the technology industry.

The CFOs that BDO surveyed also expressed support for Sarbanes-Oxley Section 404, with a majority indicating that it has led to improved processes while not curtailing risk-taking by companies.

- Dave Lynn