June 30, 2008

Hang On! SEC Certifies "Reimbursement of Third-Party Solicitation Expenses" Binding Bylaw to Delaware Supreme Court

On Friday, the SEC Staff referred a shareholder proposal to the Delaware Supreme Court under a certification process we wrote about in the Nov-Dec 2007 issue of the The Corporate Counsel and discussed in this February podcast with a Delaware lawyer. The Delaware Constitution was amended last summer to create this process, allowing for greater cooperation between the SEC and Delaware Supreme Court on issues related to Delaware law. This is the first time that this new certification process is being used - the Delaware Supreme Court has the option to refuse the SEC's request, but is unlikely to do so.

Submitted to CA (formerly known as Computer Associates) by AFSCME, the shareholder proposal would require - yes, its a binding bylaw proposal - the company to pay for the expenses related to a successful election of a short slate of directors. Submitted to several companies in each of the past three years, this type of proposal is AFSCME's response to the stalled shareholder access debate; see this RiskMetric's blog where Professor Charles Elson calls it the "ultimate solution" - and here is a 2006 WSJ article that portrays VC Strine as supporting a similar type of proposal.

In its no-action request to Corp Fin (among other exclusion bases), CA argued that, under Rule 14a-8(i)(1), the proposal is an improper subject under Delaware law and, under (i)(2), it would cause the company to violate Delaware law because reimbursement of solicitation costs is a decision for the company and its board. Both of these exclusion bases has a legal opinion requirement and Richard Layton was hired to provide one to support the company's arguments.

AFSCME responded that its proposal doesn't violate state law and Grant & Eisenhofer supported this argument with a legal opinion. Faced with dueling legal opinions, Corp Fin refused the exclusion request since the Division doesn't resolve disputed questions of Delaware law - but also sent a request for certification to the SEC Commissioners, who approved certifying this question of law to the Delaware Supreme Court.

If the Delaware Supreme Court doesn't weigh in timely, it appears Corp Fin won't allow CA to exclude the proposal when it files and delivers its proxy materials on July 17th. Given the topic of the proposal, this is a huge development and one that may be resolved within a few weeks.

Here are the documents relating to this development:

- Corp Fin No-Action Response to CA

- SEC's Certification of Question of Law to Delaware Supreme Court

- Attachment A - Company's Initial Exclusion Request (copy of proposal is on page 11)

- Attachment B - Proponent's Letter in Support of Proposal

- Attachment C - Company's Response to Proponent

At the Society Conference on Saturday, I caught up with AFSCME's Rich Ferlauto and taped this interview with him about this development.

Last Day: Early Bird Discount for Our Conferences

Don't forget today is the last day to take advantage of the early bird discount for both the "16th Annual Naspp Conference" and the combined "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference." The deadline won't be extended.

Coming SEC Staff Review: On Friday, Corp Fin Director John White - who will keynote our Proxy Disclosure Conference, just like last year - said the SEC Staff will be conducting some form of executive compensation review – and a report of the Staff’s findings is likely sometime in the Fall. At this time, the Staff doesn’t know the form of either of these related projects. So executive compensation disclosure will continue to remain in the spotlight. [More notes from John's remarks at the Society's Annual Conference coming in tomorrow's blog.]

And remember that registration for attendance to these Conferences - either in New Orleans or by video webcast - entitles you to a discount for the upcoming Lynn and Romanek's "The Executive Compensation Disclosure Treatise & Reporting Guide." So there are two benefits to registering for one (or both) of these Conferences today.

Senate Confirms Three New SEC Commissioners

On Friday, the US Senate confirmed three new SEC Commissioners - Luis Aguilar, Elisse Walter and Troy Paredes - meaning that Paul Atkins will now depart and the Commission has a full five members. As I blogged about before, it's unprecedented to have three new Commissioners start at one time since the Commission was formed in '34. Here is a statement from SEC Chairman Cox about the three nominees.

- Broc Romanek

June 27, 2008

Corp Fin Issues Updated Section 16 and Form 8-K Guidance

Yesterday, Corp Fin issued:

- Updated Form 8-K Compliance & Disclosure Interpretations

- Updated Section 16 Compliance & Disclosure Interpretations

- Section 16 No-Action Letter to Society of Corporate Secretaries

Alan Dye has already blogged on these on his "Section16.net Blog," with more complete analysis coming up in "Section 16 Updates" in a week or so.

Society's Annual Conference: Twelve Videos Posted

So far, I am the only person contributing to the Society's FriendFeed room that I created - I'm not surprised given that it's an experiment - and I've posted these 12 videos (each of them is no longer than a minute):

- Carl Hagberg & His Lifetime Achievement Award
- Carolyn Coffey on Conference Pilates
- Geoff Loftus on Latest in Society's National Office
- Bob Woodward Luncheon Speech - Priceless
- Tom Kies & John Siemann: No Rap Song (Yet)
- John Truzzolino on Getting Involved in XBRL
- David Katz on Teaching the Youth
- Brian Lane on Meeting with SEC Staff
- Nicole Sanford on Technology Swat Team
- Jim Reda on Dealing with Advisors
- Welcome Reception - Society Conference
- Rapping with J&J's Doug Chia

Thanks to these brave souls for trying this out. More than one person refused to be interviewed and I can't say I blame them. But you only live once...

SEC Proposes to Amend Broker-Dealer Registration Requirements for Non-US B-Ds Working with US Investors

At Wednesday's SEC open meeting, the SEC proposed amendments to Rule 15a-6, which provides an exemption from broker/dealer registration for non-US broker/dealers that conduct business with US investors. The proposals are not overwhelming, give that they incorporate many of the liberalized positions taken in SEC Staff no-action letters. We have started posting memos on this development.

- Broc Romanek

June 26, 2008

Online Bartering of Voting Rights: My $1 Million Idea

How do you like that? I finally came up with a viable million dollar idea (probably many millions) and I've got too much on my plate to do something about it. So it's free for the first taker!

I got the idea when I was reading a white paper by Glyn Holton, founder of the Investor Suffrage Movement, that describes a system that would let people who own shares of a company transfer the voting rights of their stock to other shareholders so investors with similar goals could establish a bloc of votes. Glyn has already conducted proxy transfer trials (Thanks to CorpGov.net publisher, Jim McRitchie, for alerting me to isuffrage.org).

In the white paper, Glyn envisions a world where soccer moms donate the voting rights of their holdings to their favorite charities. It sounded interesting, but not earth-shattering. But my antenna got raised when I got to a paragraph on page 18 that says "For example, the purchase and sale of voting rights raises public policy issues, so an exchange should not facilitate such transactions."

Hmm, voting rights have been sold for decades, but typically in one-off transactions to facilitate a deal. What if someone created an online marketplace where voting rights could easily be bought and sold? It could even be in the form of an auction where management and a third-party bid up the price.

Taking it a step further: what if a retail holder checked a box when they opened a brokerage account indicating that their broker should routinely sell the voting rights of their holdings until they instruct otherwise. The proceeds from the annual sale of a particular batch of voting rights would be deposited in their account.

All of this would lead to exchanges listing the latest prices for voting rights for specific securities - and then derivatives could be created on top of that. This all sounds pretty crazy - but is it? It's potential impact dwarfs that of shareholder access.

I'm sure there are legal issues up and down the board that I'm not aware of. Let me know what you think. And if you take this idea and run with it - think of me from your yacht. Remember that I'm not saying whether something like this is good for the market and for boards or investors. I'm just throwing it out there as some possibility that could cause a whole lot of change...

Dissecting ProxyDemocracy.org

This one is about one of those things that I swear I've blogged about before - but it was all in my mind. When I've been out speaking about e-proxy, I point to ProxyDemocracy.org as an example about how the playing field is changing. Founded by Andy Eggers of Harvard's Department of Government, the site is a free resource where one can more easily analyze the voting track record of mutual funds. As you might recall, the SEC adopted rules a few years ago that requires mutual funds to report their votes for the year. However, the way the information is required to be reported is hard to decipher (eg. Fidelity files more than 100 of these forms). This site organizes the information from those Form N-PXs.

The site has other features, including alerts as to how the big institutional investors intend to vote (if those investors decide to announce what their intentions are, as they are permitted to do under the SEC's proxy rules - see note below). So the site makes it easy for anyone to vote, by reducing the time they need to spend on detailed analysis of issues and candidates. And this is just the start - you can easily envision a path where this site and others do much more to facilitate the information gathering process and present it in a much easier way than currently available in a way that may eventually impact the results of annual meetings.

Anyways, I waited so long to blog about this development that Andy has blogged about it himself on Harvard Law School's Corporate Governance Blog and in his own blog.

Under Rule 14a-l(1)(2)(iv), shareholders are permitted to publicize their voting intentions – as well as the reasons behind the intentions – without it being deemed a “solicitation.” Today, not many shareholders take advantage of this exemption to announce their intentions - CalPERS and a handful of others - so this feature doesn't hold much value. If more shareholders start making announcements, then it will become a more important aspect of the site.

SEC Proposes to Delete References to Credit Ratings

Yesterday, the SEC held an open Commission meeting to propose - jointly from three Divisions, Trading & Markets, Corporation Finance and Investment Management - changes that include replacing references to ratings by Nationally Recognized Statistical Rating Organizations (ie. NRSROs) with alternative qualitative standards. This follows another proposal from several weeks ago related to regulation of the ratings process. Here is a statement from the Corp Fin Staff and Chairman Cox's opening remarks from the open meeting (and a WSJ article). The SEC's related press release is not out yet - we will be covering this topic more in the coming weeks.

- Broc Romanek

June 25, 2008

McCain Joins "Say on Pay" Wagon

Recently, Senator John McCain has been speaking out against excessive executive compensation and has now joined Senator Obama in calling for mandatory "say on pay." Here is a Business Week article about this - and here is an excerpt from McCain's June 10th speech:

"Americans are right to be offended when the extravagant salaries and severance deals of CEOs ... bear no relation to the success of the company or the wishes of shareholders," says McCain, adding that some of those chief executives helped bring on the country's housing crisis and market troubles. "If I am elected president, I intend to see that wrongdoing of this kind is called to account by federal prosecutors. And under my reforms, all aspects of a CEO's pay, including any severance arrangements, must be approved by shareholders."

The proposals that both Senators Obama and McCain support not only would provide shareholders an annual non-binding vote on executive pay, they would also provide shareholders with a separate non-binding vote when a company gives a golden parachute to executives while simultaneously negotiating to buy or sell the company.

With H&R Block joining the list, there are now nine companies that have agreed to a non-binding vote on pay.

Quick Survey: How R&D Intersects with Setting Bonus Amounts

On CompensationStandards.com, we have posted this quick survey to learn more about how research & development costs play a role when it comes time to set bonus levels for senior managers.

This survey was suggested by a doctoral student who is conducting research to gain additional insight into some of the practical issues and challenges faced by those in charge of setting and disclosing executive pay. If you ever have survey ideas, please drop me a line.

Board-Shareowner Communications on Executive Compensation

RiskMetrics is not the only entity seeking comments on a paper. Stephen Davis is looking for input on this Millstein Center paper: "Board-Shareowner Communications on Executive Compensation." The 17-page paper - which is an executive summary and initial findings - presents findings of a six-month research project that included interviews with directors, senior managers and investors on their views of dialouge regarding executive pay. A final paper will be published once more input is received.

Logically, the "say on pay" movement is addressed in the paper. Given that the media contains reports that some investors are now rethinking their views on "say on pay," some of the research might be dated already, even though it's not that old. I personally talked to some investors who now find themselves on the other side; and I find myself leaning against it for now (as I have blogged about). So please send Stephen your comments.

On pages 6-7 of the paper, there is this finding related to say on pay:

Compulsion, through crisis or other acute events, is the foundation under most current US corporate initiatives to foster governance dialogues with institutional owners.

Evidence suggests that scandals over executive compensation - whether payouts for failure or backdating stock options - were key contributors in 2007 in motivating certain boards to increase their interaction with shareowners. Exercises in board dialogue on governance have generally not come about in the United States as a product of proactive, long-term strategic outreach by untroubled corporations. This reality has contributed to growing investor conviction that regular dialogue will not spread widely in the absence of compulsion, even where companies are troubled. As a result, many funds back a UK-style annual advisory vote on executive pay policies, a measure that helped open channels of communication between UK boards and their equity owners.

The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices

Join Mike Kesner, Doug Friske and Fred Whittlesey tomorrow for this CompensationStandards.com webcast: "The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices." It should be pretty interesting to see if the tail is wagging the dog...

- Broc Romanek

June 24, 2008

My Ten Cents: The SEC's Coming Guidance on IR Web Pages

At the NIRI Annual Conference, as appropriate for his audience, Corp Fin Director John White devoted a fair portion of his remarks talking broadly about the SEC's upcoming guidance on the use of corporate websites (here are notes about John's remarks). The SEC intends to update its interpretive guidance - last issued in 2000 - sometime in the near future. This is a project recommended as part of the CIFiR report (see page 55).

After hearing John's remarks, I went back to refresh my memory of what the SEC said in 2000. I was pleasantly surprised in that I don't think much of that old guidance needs updating. The SEC was fairly flexible about what companies can do on their IR web pages; yet, the guidance was inflexible where there might be temptation for mischief. As a result, it's hard to see how the SEC's existing guidance has acted as a barrier that has prevented companies from leveraging their IR web pages to communicate with shareholders.

Clearly, companies can't blame their decisions to not provide shareholder-friendly proxy materials on their IR web pages on the SEC's existing guidance - since these online materials are not really impacted by the SEC's parameters much at all. Instead, the SEC's guidance relates to when companies get "fancy" and build out their IR web pages with other types of information and tools. Even creating annual meeting web pages that campaign are not limited by the SEC's current guidance.

So where does this leave me? I think the SEC's upcoming updated guidance should reinforce many of the principles that it already has set forth - along with filling in a few holes and making some tweaks - but the real need is to push companies to start treating their IR web pages as a place where shareholders want to visit to learn about the company and trust it. In fact, I think it makes sense for the SEC to engage in rulemaking that forces companies to post some minimum level of usable documents and other information on their IR web pages.

In recent rulemakings, the SEC has recognized IR web pages as a place for shareholders to go - the latest being the XBRL proposals, which would require companies to post XBRL documents on the same day as they are filed with the SEC - and this seems to be a logical next step. Below I delve more specifically into some of the SEC's options:

Corporate Website Use: Can the Industry Fix Itself?

I get worried about the recommendation in the CIFiR report that "industry participants" develop uniform best practices. Which industry participants have shown any leadership in this area? None that I can think of. What we do know is that many IR web pages are rudimentary in this country, with a fair number of companies outsourcing them to vendors who also show minimal vision.

In his IR Web Report, Dominic Jones recently provided startling statistics from this past proxy season: almost 90% of US companies chose formats for their online proxy materials that were essentially garbage; compare that to the large companies in the United Kingdom where 46% provided dynamic HTML documents.

US companies have a long road to hoe here - but it's easily fixable. Plough your e-proxy savings back into usable documents and the IR web page in general - listen to what Doug Stewart of Intel said on last week's e-proxy webcast. Make your IR web page a desired destination spot that investors are programmed to think of first when they want to conduct research about your company.

Corporate Website Use: What the SEC Should Do

With a hat tip to Dominic Jones, here are a few items that I hope to see the SEC tackle in its updated guidance:

1. Recognize Sufficient Internet Penetration for Regulation FD Purposes - Back in 2000, the SEC requested comments about what is considered sufficient Internet penetration to begin allowing companies to rely on the Web for delivery of information purposes. Some commentators noted way back then that surveys showed that there was sufficient support for the Web as an adequate disclosure medium. This is obviously much more true today and the SEC already has adopted rules that implicitly recognize this. The guidance should address whether information posted only on a corporate site meets Regulation FD's requirements, etc.

2. Give Smaller Companies a Break from Newswire Fees - The SEC should provide guidance on news releases per se. Can a company meet the requirements by issuing a summary and a link - or even just a notice - advising that it has posted it earnings release on its website and filed it on Edgar? Small companies are hurting from newswire fees. To cut costs, companies shouldn't have to use press releases to announce an upcoming earnings call or presentation because there are so many alternatives now that are just as good. Another way to cut costs is to allow companies to use summaries and links to reduce their word count in their press releases.

3. Liberalize the Link Liability Standard - One primary concern expressed by some is that the SEC's current liability approach for linking to other content is too restrictive. For linking to third-party content, in 2000, the SEC came up with a non-exclusive six-factor approach that is a principles-based regulation. When linking from one company document to another - in the delivery context - the SEC invoked the "envelope theory." [For more on the SEC's existing link regulatory framework, see these FAQs that I drafted long ago on my old site, but that are still relevant today.]

Even though the SEC's approach still seems reasonable today, it is too complex and companies uniformly don't provide access to outside perspectives as a result. Since one of the primary benefits of the Web is the ability to link to related content, I think the SEC should morph its approach and encourage companies to provide insights from multiple sources within certain reasonable limits.

Too often, companies use the existing regulatory framework as an excuse not to link to useful sources of information. Yet, it is hardly ever in an investors' best interests to have less information or fewer opinions about that topic. For example, companies should provide access to analyst research reports. I recogize that this brings risks - such as selectively linking to only favorable analyst reports - but there are many more ill-informed investors than there are crooked companies and dishonest analysts.

So we shouldn't punish all investors for the sake of a few bad apples. I believe we are better off allowing companies to leverage the Web and create comprehensive IR web pages - and the SEC can use its enforcement authority to chase the outliers who choose to abuse the freedom.

By the way, it's not just that the SEC needs to tweak its rules, the NYSE is in the dark ages as Dominic blogged about last year.

Corporate Website Use: What the SEC Should Not Do

In particular, there are two things that I think the SEC should not do when it issues its updated guidance:

1. Don't Impose Unnecessary "Hoops" on Links - I dislike the notion of using exit notices and click-through disclaimers in the linking context. I don't think they really warn shareholders and I doubt a court would give them much more weight than a standard disclaimer that sits at the bottom of the page and is not intrusive. And these "hoops" run counter to the purpose of links in the first place - getting folks easily from one place to the next. [And there is sparse caselaw so that its unclear if a court would really distinguish between these types of disclaimers anyways.]

If the SEC is really concerned about content "out of context," it should focus on the fact that under its XBRL proposal, numbers from the financials will be far removed from the all-important footnotes. And these footnotes will take on much greater importance under IFRS, a principles-based regulatory framework with a much greater level of discretion than under US GAAP.

2. Don't Try to Specifically Address Evolving Technology - So much of our technology today is still evolving that I don't think the SEC should try to set standards around specific online functionalities. For example, it's too early to tell how RSS feeds and IRO blogs will really evolve (I'll be blogging more about IROs as bloggers later this week). For these, it's best for the SEC to merely broadly state the obvious about not doing stupid things and allowing these technologies to continue to naturally evolve.

- Broc Romanek

June 23, 2008

SEC Approves One-Year Delay for Smaller Companies' Auditor Attestations

As proposed back in February, the SEC has approved another one-year extension of the compliance date for smaller companies to meet the Section 404(b) auditor attestation requirement of Sarbanes-Oxley. Smaller companies will now be required to provide the attestation reports in their annual reports for fiscal years ending on or after December 15, 2009.

In addition, the Office of Management and Budget is allowing the SEC to proceed with data collection for a study of the costs/benefits of Section 404, focusing on the consequences for smaller companies and the effects of the auditor attestation requirements.

FriendFeed: A New Way to Experience a Conference

Emboldened by my NIRI experience with FriendFeed a few weeks back, I have created a FriendFeed room for the Society of Corporate Secretaries & Governance Professional's Annual Conference - which starts this Thursday - at http://friendfeed.com/rooms/society08. A big "shout out" to Dominic Jones for leading the way here; FriendFeed only established its "rooms" capability in May, so this is truly cutting-edge.

1. Why Do You Care? - The FriendFeed experience is mind-blowing in that you can envision the future of conferences where the “speakers” are not just the lucky slobs up on the dais - it’s everyone in the room! It will be interesting to see how long it takes for this type of technology to live up to its potential.

If you don't attend, you can get a flavor of what is happening from those that are there - if you do attend, your fellow attendees can help enrich your experience. For example, at the NIRI conference, I was able to better identify which booths were to my liking by following the recommendations of someone else - and I enjoyed reading commentary about various panels as they happened. Also useful are tips about the conference hotel, nightlife, etc. Of course, all of this becomes more useful when more people contribute - the strength of numbers.

2. How Can You Participate? You can simply read, listen and watch the contributions of others - but of course, it's more fun if you actively participate. From what I have learned so far, here's a roadmap about how you can observe or participate (this is all very new and evolving, so some of these might not work for you depending on what technologies you are using):

a. Catch the Highlights at FriendFeed - As noted above, the contributions are - and will - mainly be found on this FriendFeed page. For this first year, it may well be the only postings come from me - but hopefully not. This is an experiment and I imagine it will grow in future years as the tools become more user-friendly and we all learn more about available technology.

To watch others contribute, just click on the room and browse. To actively participate, you simply need to "join the room" by creating a nickname and password for yourself (after first creating a free FriendFeed account). Then, you can participate in any one of several ways described below.

b. Adding a Link to FriendFeed - Here is a short video that explains how to post a link to FriendFeed. Once you register for FriendFeed and watch this one-minute video, you will find it takes mere seconds to add a link to something and write a short comment about it.

c. Commenting on Someone Else's Commentary on FriendFeed - This truly only takes seconds as you can click on the "comment" section underneath someone else's contribution and quickly add your ten cents.

d. Uploading Photos and Video on FriendFeed - Uploading multimedia is more time-consuming than adding links and mere text. I will be trying to play around with that during the Conference and we'll see how I do. It's fairly easy - with the hard part being uploading a video to YouTube (after first compressing it, which is dependent on the speed of your Net access). So we'll be at the mercy of the speed of the connections available at the Conference hotel.

e. Twitter, TwitterBerry and Twemes - Due to the "newness" of the technology, there might be Twittering during the Conference that isn't caught on the Society's FriendFeed page. Twemes allows you to follow Twitter posts that only relate to your conference (although that service is not perfect either and sometimes misses some Tweets). You can follow them by putting "society08" in the search box at the top of the Twemes home page - or simply go to this Society page.

If you carry a BlackBerry, you can twitter from that device by downloading free software called "TwitterBerry."

You might ask: what is Twitter? Twitter is a rapidly growing - free - service that allows you to text a message (or it can be done from any browser) that is no longer than 140 characters. Each of these messages is known as a "Tweet." (Fyi, Twitter is growing so fast that the people running it can't keep up and they keep having outages.) For Twemes and FriendFeed to capture Tweets about the Conference, you must use this as part of your 140 characters: #society08. Don't forget the pound sign.

Just like FriendFeed, you must first register for Twitter (at Twitter.com), which is free and easy to do.

f. Tag Everything with "#society08" - To contribute content, you will need to tag your Tweets, Flickr photos, YouTube videos, blog posts, public bookmarks, etc. with the "#society08" tag. That will just make it possible to get everything aggregated in the room.

3. Will I Get in Trouble? - Assuming you don't upload embarrassing pictures of yourself or give away trade secrets, it's hard to imagine you getting into trouble for participating. However, if you are paranoid, you can use screen names that won't identify you when you register for Twitter or FriendFeed (for example, one of my Twitter accounts is under "Captain XBRL"). That way you will feel unemcumbered and can join the "conversation." Have some fun and see ya in Boca!

Last Week: Early Bird Discount for Our Conferences

Don't forget it's the last week to take advantage of the early bird discount - which expires June 30th - for both the "16th Annual Naspp Conference" and the combined "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference."

And remember that registration for attendance to these Conferences - either in New Orleans or by video webcast - entitles you to a discount for the upcoming Lynn and Romanek's "The Executive Compensation Disclosure Treatise & Reporting Guide." So there are two benefits to registering for one (or both) of these Conferences today.

The Nasdaq Speaks '08: Latest Developments and Interpretations

Join us tomorrow for the webcast - "Nasdaq Speaks '08: Latest Developments and Interpretations" - to learn all the latest from the Nasdaq from these experts:

- Mike Emen, Senior Vice President, Nasdaq’s Listing Qualifications Department
- Arnold Golub, Associate General Counsel, Nasdaq’s Office of General Counsel
- Lanae Holbrook, Chief Counsel, Nasdaq’s Office of General Counsel/Hearings
- Suzanne Rothwell, Counsel, Skadden, Arps, Slate, Meagher & Flom LLP

- Broc Romanek

June 20, 2008

Commissioner Watch: The Washington Waiting Game Continues

With the first day of summer upon us tomorrow, the confirmation process for the three SEC nominees continues to drag on. Following the June 3rd hearing of the Senate Committee on Banking, Housing, and Urban Affairs, it seems likely that action on the nominations will proceed, although how quickly is anybody’s guess. At this point, there seems to be at least some expectation that the new Commissioners could be on board by the end of this month.

As discussed in this Bloomberg article by Jesse Westbrook, the nominees all indicated an interest in considering the issue of proxy access, and they also supported increased scrutiny of credit rating agencies.

Not everyone wants to see a speedy resolution to the appointment process. As noted in a recent issue of RiskMetrics’ Risk & Governance Weekly, AFSCME has been urging a delay in confirming the nominees so that the next president can select the Commissioners for the three open seats.

The Risk & Governance Weekly piece notes:

“The American Federation of State, County, and Municipal Employees (AFSCME) is calling on the Senate to hold off confirming the three nominees and allow the next president to fill those SEC vacancies.

‘It’s a five-year term [for SEC commissioners], and the next president should have the choice,’ said Richard Ferlauto, the union’s director of pension and benefit policy.

‘We don’t see any advantages’ to filling those vacancies now, said Ferlauto, who noted that the Republicans would still hold a majority on the commission. ‘That would give the green light to Chairman Cox to continue his deregulatory mission at the SEC.’

AFSCME also is specifically opposing Paredes’ bid to serve on the SEC. ‘He has a long track record of opposing the fundamental principles of investor protection . . . and shouldn’t serve on the commission,’ Ferlauto told Risk & Governance Weekly.

If presumptive Democratic presidential nominee Barack Obama is elected in November, he would be able to appoint a new SEC chairman, which would give Democrats a 3-2 majority on the commission."

More FASB Action: Accounting for Hedging Activity

Over the past 10 years, there has probably been no better course of action for financial statement preparers than to avoid hedge accounting like the plague. In terms of complexity, the hedge accounting model in FAS 133 has topped the charts since its adoption. The Standard includes many traps for the unwary, including the “shortcut method,” which is perhaps the accounting equivalent of skydiving without a parachute in terms of risk profile.

Earlier this month, the FASB issued an Exposure Draft of a proposed statement that would amend FAS 133 to completely revamp the hedge accounting model. Under the proposed Statement, a fair value approach to hedge accounting would be established, eliminating many of the complicated elements that exist under the Standard today, including bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting. While a fair value approach has its own issues, the proposed changes would likely substantially simplify the accounting for hedging activities.

On the convergence front, while the proposed Statement diverges from the hedge accounting requirements of IAS 39, Financial Instruments: Recognition and Measurement, the International Accounting Standards Board has taken up a project to revamp its own hedge accounting standards, including consideration of an alternative comparable to the FASB’s proposed approach.

The FASB intends to issue a final Statement by the end of this year, with the amendments becoming effective for financial statements issued for fiscal years beginning after June 15, 2009, and interim periods within those fiscal years. Comments on the proposed Statement are due by August 15, 2008.

Risk Factor Disclosure at Technology Companies

In this podcast, Doug Sirotta, a Partner in the Technology Practice at BDO Seidman, discusses BDO’s recently released report on the risk factor disclosure of the top 100 technology companies, including:

- Why was this study undertaken?
- What were the major findings?
- Were there any surprises?
- What practice pointers are there for companies in the wake of the study?

- Dave Lynn

June 19, 2008

Just Added! John White as "3rd Annual Proxy Disclosure Conference" Keynote

We're very excited to announce that Corp Fin Director John White will serve as the keynote speaker for our "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference." At last year's Conference, John delivered his important "Where's the Analysis?" speech.

So act now to take advantage of the early bird discount - which expires June 30th - for both the "16th Annual Naspp Conference" and the combined "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference."

Posted: Corp Fin’s Staff Legal Bulletin No. 3A

Yesterday, Corp Fin posted a revised Staff Legal Bulletin No. 3A, providing updated guidance on the exemption provided by Securities Act Section 3(a)(10). The SEC had noted that a revised SLB would be issued upon effectiveness of last year’s changes to Rule 145.

This SLB replaces the two prior Section 3(a)(10) bulletins – the one originally issued in 1997 and the revised version issued in 1999 (reflecting the enactment of SLUSA). In addition to the new guidance regarding the Rule 145 amendments, various tweaks and updates have been made throughout the SLB.

Schoon v. Troy: Denying Advancement Rights of Former Directors

A Delaware Chancery Court decision by Vice Chancellor Stephen Lamb from earlier this year may come as a quite a surprise to directors, who may be troubled to now learn that their rights to indemnification or advancement of legal fees and expenses could be eliminated after they leave a company’s board. In Schoon v. Troy Corporation, Vice Chancellor Lamb concluded that a bylaw amendment eliminating the company’s fairly typical legal fee advancement obligations for former directors could be enforced, even in a situation where a former director had served on the board when the pre-amendment bylaws provided for such advancement. Given that the time for appeal of the decision has now expired, it appears that Schoon will remain the law of Delaware for now.

All may not be lost for former directors, however. As Kevin LaCroix notes in The D&O Diary blog, former directors are typically included within the definition of “insured persons” under most D&O liability insurance policies, which means that in most situations the former directors could still get expense protection and indemnification under the policy – even if the company chooses to later change its bylaws to eliminate advancement and indemnification provisions. Kevin also points out the availability of former director and officer liability insurance policies that provide coverage exclusively to the individual director or officer, thus avoiding any potential for interference with the coverage by others (such as the company). That option sounds expensive, but it may be prudent depending on the circumstances.

For more on the Schoon case - and the latest developments with D&O insurance and indemnification - check out our “D&O Insurance” Practice Area.

- Dave Lynn

June 18, 2008

SEC Staff Provides Some Auction Rate Securities Relief

The Investment Management and Corp Fin Staffs recently provided some no-action relief to Eaton Vance Management in one of the latest efforts to deal with the locked-up auction rate securities markets. There really seems to be no end in sight for the troubles in the auction rate market, so there is no doubt that the Eaton Vance’s plan to bail out its auction rate security holders will come as some welcome relief.

Several Eaton Vance funds have auction rate preferred securities outstanding, and Eaton Vance is seeking to enhance liquidity for the holders of the auction rate securities, given the inability to conduct auctions under current market conditions. Under the proposed transactions, the funds would issue “liquidity protected preferred shares” that would enable holders to sell their shares through a periodic remarketing or, in the event that the shares are not successfully remarketed, to a designated liquidity provider.

In addition to the requested Investment Company Act relief, Corp Fin said that, while offers to purchase the liquidity protected preferred shares in the event that they could not be remarketed may be a tender offer, the Staff would not recommend enforcement action if the offers are conducted without complying with Rule 13e-4 and Regulations 14D and 14E.

FASB Proposes an Expansion of FAS 5 Disclosures

Earlier this month, the FASB issued an Exposure Draft of a proposed Statement, Disclosure of Certain Loss Contingencies — an amendment of FASB Statements No. 5 and 141(R). The FASB is seeking to significantly expand the disclosures required about loss contingencies (including loss contingencies assumed in a business combination), such as pending or threatened litigation.

In issuing the Exposure Draft, the FASB is responding to concerns expressed by investors and others about the inadequacy of information currently available regarding the likelihood, timing and amount of future cash flows associated with loss contingencies. These changes could significantly impact the audit response letter process, given the potential increase in disclosure obligations concerning sensitive matters such as ongoing litigation and the operation of the proposed “prejudicial” exemption.

The proposal seeks to enhance current disclosure requirements by:

- expanding the types of loss contingencies to be disclosed to include specified remote loss contingencies;

- requiring that certain quantitative and qualitative information be disclosed;

- requiring a tabular reconciliation of changes in amounts recognized for loss contingencies; and

- providing an exemption from disclosing certain required information, if disclosing the information would be prejudicial to a company’s position in a dispute.

A significant aspect of the FASB’s proposal is the expansion of contingencies that are potentially reportable. Today, a company does not typically have to disclose loss contingencies for which the likelihood of a loss is remote. Under the proposed Statement, a company would be required to disclose remote loss contingencies if:

- the contingency (or contingencies) is expected to be resolved in the near term (within one year from the date of the financial statements); and

- the contingency (or contingencies) “could have a severe impact on the entity’s financial position, cash flows, or results of operations.”

Under the proposal, disclosure would also be required for all loss contingencies that stem from asserted claims or assessments (or those for which it is probable a claim will be asserted) and for which the likelihood of loss is deemed more than remote.

The FASB wants to “field-test” this proposal with preparers, and it also hopes to hold at least one roundtable on the topic. If adopted, the proposed Statement would be effective for fiscal years ending after December 15, 2008, and interim and annual periods in subsequent fiscal years. Comments are due by August 8, 2008.

E-Proxy Post-Mortem

Join us tomorrow for this important webcast - “E-Proxy's First Season: Lessons Learned” – and hear:

- Lyell Dampeer, President, Broadridge Financial Solutions
- Keir Gumbs, Associate, Covington & Burling LLP
- Helen Kaminski, Assistant General Counsel, Corporate & Securities, Sara Lee Corporation
- Jordan Kovler, Vice President, DF King & Co.
- John Seethoff, Vice President & Deputy General Counsel, Microsoft Corporation
- Doug Stewart, Senior Attorney, Legal and Corporate Affairs, Intel Corporation

For those of you that are not yet members of TheCorporateCounsel.net, take advantage of our "Half-Price for Rest of '08" no-risk trial to catch this program and more...

- Dave Lynn

June 17, 2008

More Rule 10b5-1 Plan Research

Last week, I was moderating a panel at the NIRI Annual Conference on SEC Enforcement developments, and the topic of 10b5-1 plans inevitably came up. Andrew Petillon, Associate Regional Director of the SEC’s Los Angeles Regional Office, confirmed that, while no SEC actions have been announced yet, Rule 10b5-1 remains an area of focus for the Staff.

Now, a new paper published by Stanford Business School Professor Alan Jagolinzer. Penn State Business School Professor Karl Muller and University of Chicago Law Professor Todd Henderson - entitled “Scienter Disclosure” - explores the relationship between voluntary disclosure regarding Rule 10b5-1 plans and the trading returns of the executives who have implemented the plans. (Professor Jagolinzer published the paper “Do insiders trade strategically within the SEC Rule 10b5-1 safe harbor?” which originally piqued the SEC Enforcement Staff's interest in potential 10b5-1 plan shenanigans.)

The concept of “scienter disclosure” from the title of this new study refers to "the voluntary disclosure of either information or the intention to act on the information in advance of acting on it." Through this, the authors are focusing on disclosure that attempts to mitigate litigation risks associated with any potential wrongdoing. The authors believe that disclosure of an insiders’ participation in a Rule 10b5-1 trading plan is an example of scienter disclosure, given that participation in a Rule 10b5-1 plan provides “clear, legal risk-reduction benefits.”

The study focuses on returns for executives participating in Rule 10b5-1 plans at firms that choose to disclose the existence of the plans and at firms that do not provide voluntary disclosure. The authors conclude from the study:

“Our evidence indicates that voluntary Rule 10b5-1 disclosure is associated with the level of firm legal risk and a proxy for insiders’ potential strategic trade. Our evidence also indicates that Rule 10b5-1 disclosure is associated with greater abnormal returns to insiders’ trades, especially for firms disclosing specific plan details. Finally, our evidence indicates that investors do not respond negatively to Rule 10b5-1 participation disclosure. Collectively, our work has three salient implications for voluntary disclosure: 1) litigation risk can play a key role in the propensity to disclose information prior to strategic trade; 2) Rule 10b5-1 participation disclosure does not fully reveal insiders’ private information; and 3) disclosure in this setting may actually enhance insiders’ strategic trade opportunities, which is seemingly inconsistent with the SEC’s intent for the Rule.”

Based on these findings, the authors suggest that courts might more carefully consider whether 10b5-1 disclosure mitigates scienter - given that strategic trading appears to be associated with enhanced disclosure - and that the SEC should also consider that if it were to require disclosure of Rule 10b5-1 plan participation, such disclosure might not mitigate strategic trading by those implementing Rule 10b5-1 plans. The SEC proposed, but never adopted, disclosure requirements concerning participation in Rule 10b5-1 plans, and the Staff has recently said that “asymmetric” voluntary disclosure around Rule 10b5-1 plans could be problematic.

Posted: Proposing Release on Credit Ratings

Yesterday, the SEC posted the proposing release for changes to the rules applicable to credit ratings and NRSOs, focusing particularly on structured products.

One of the interesting components of the proposed rule changes is the amendment to Rule 17g-5 that is designed to addressed the “issuer/underwriter pay” conflict by requiring that - as a condition to the NRSRO rating a structured finance product - the information provided to the NRSRO and used by the NRSRO in determining the credit rating would need to be disclosed through a means designed to provide reasonably broad dissemination of the information. The proposed amendment would require the disclosure of information provided to an NRSRO by the “issuer, underwriter, sponsor, depositor, or trustee.” The goal of this amendment is to purportedly level the playing field between the “issuer/underwriter pay” NRSROs and the subscription-based credit rating agencies, by giving all credit rating agencies equal access to information.

The release of this sort of loan level data (referred to as the “loan tape”) about a structured finance product could obviously create some complications under the Securities Act, for both registered and exempt transactions. The SEC has sought to address these concerns by issuing some proposed guidance. For registered deals, the SEC says that the information would need to be disclosed on the pricing date for the transaction. In offerings that are not registered under the Securities Act, the information would need to be disclosed to investors in the offering and credit rating agencies on the pricing date, and then disclosed publicly on the first business day after the transaction closes.

For registered deals, the SEC indicates that the loan tape information may constitute ABS informational and computational materials that need to be filed on Form 8-K, or as free writing prospectuses filed under Securities Act Rules 433 and 426. For private deals, the SEC says that general solicitation/general advertising concerns could be avoided by providing the information to investors, NRSROs, and credit rating agencies through posting on a password-protected website (as is often done today for investor access to the information), and then removing the password protection so the public may access the information after the offering closes. Similar guidance is provided for Reg. S offerings.

Conference Brochure: 16th Annual Naspp Conference

We just posted a brochure for the upcoming "16th Annual Naspp Conference," listing the 45-plus panels, etc. Take advantage of the early bird discount - which expires June 30th - by registering for the Naspp Conference (or the combined "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference") today.

- Dave Lynn

June 16, 2008

Survey Results: Earnings Guidance

Broc and I were at the National Investor Relations Institute Annual Conference in San Diego last week, and among the perennial topics for that group are the issues of how often companies should provide earnings guidance and whether companies should provide guidance at all. Here are the results of our recent survey on these topics:

1. Does your company:

- Provide monthly earnings guidance – 0.0%
- Provide quarterly earnings guidance – 18.3%
- Provide annual earnings guidance – 28.2%
- Provide quarterly and annual earnings guidance – 19.7%
- Provide earnings guidance selectively – 5.6%
- Not provide earnings guidance at all – 28.2%

2. If your company provides earnings guidance, have you considered (within the last 2 years):

- Reducing the frequency with which guidance is provided – 54.3%
- Increasing the frequency with which guidance is provided – 5.7%
- Discontinuing the practice of providing earnings guidance – 40.0%

3. If your company provides earnings guidance, have you considered (within the last 2 years):

- Increasing the detail of the guidance provided – 15.2%
- Decreasing the detail of the guidance provided – 37.0%
- Making no change to the detail of the guidance provided – 47.8%

4. If your company has discontinued earnings guidance, were the results:

- No changes can be attributed to discontinuing guidance – 43.7%
- Increased stock price volatility – 6.3%
- Reduction in analyst coverage – 6.3%
- Shift away from a short-term, quarter-to-quarter focus – 18.7%
- It is difficult to judge the impact of discontinuing guidance - 25.0%

New Survey: Audit Committees and Earnings Releases

We last conducted a survey on audit committees and earnings releases in August 2005 (here are those results). Practices appear to have changed since then; to determine the extent of change, we have repeated many of that survey’s questions in our new quick survey on "Audit Committees and Earnings Releases." Please take a moment to answer the five survey questions.

The Latest Compensation Disclosures: A Proxy Season Post-Mortem

Join me, Mark Borges and Ron Mueller tomorrow for this CompensationStandards.com webcast - "The Latest Compensation Disclosures: A Proxy Season Post-Mortem" - to hear all the latest about the proxy disclosures filed with the SEC over the past few months. Then, a week later, catch the companion webcast: "The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices."

- Dave Lynn

June 13, 2008

The CSX Opinion is In!

From the DealLawyers.com blog: On Wednesday, in CSX Corp. v. The Children's Investment Fund Management, Judge Lewis Kaplan of US District Court (SDNY) delivered his anxiously awaited opinion finding that the two plaintiff activist funds violated the securities laws by not disclosing their positions and intentions many months before they did.

However, Judge Kaplan also ruled that there was nothing effective that he could do and he didn't bar the funds from voting their shares at CSX's upcoming annual meeting. And in his fine analysis, Professor Steven Davidoff notes that it is unlikely the SEC will pursue an enforcement action given the letter submitted to the court from Corp Fin. Here is a NY Times article - and here is a WSJ article.

Here is an additional tidbit - the NY Times' Andrew Ross Sorkin wrote his column Tuesday about how CSX is a case study in how not to respond to a proxy fight...

COSO Releases Exposure Draft on Internal Control Monitoring

Just in case you haven't received enough internal control guidance, last week the Committee of Sponsoring Organizations of the Treadway Commission announced the release its exposure draft: Guidance on Monitoring Internal Control Systems. The purpose of this new guidance is to more fully develop the monitoring component of the guidance in COSO’s Internal Control - Integrated Framework.

COSO initiated this project “based on observations that many organizations were not fully utilizing the monitoring component of internal control” - which became much more noticeable as requirements for internal control assessments were implemented around the world. COSO had issued a discussion paper on the ongoing monitoring of internal controls in September 2007, and feedback on that paper was used to develop the concepts in this exposure draft.

The guidance is built around the concept that monitoring involves the key elements of:

- establishing a foundation for monitoring;
- designing and executing monitoring procedures that are prioritized based on risk; and
- assessing and reporting the results, including following up on corrective action where necessary.

The comment period for the exposure draft ends on August 15, 2008.

May-June Issue of The Corporate Executive

We have just mailed the May-June issue of The Corporate Executive, which includes a bunch of follow-up pieces regarding net exercises and analysis of the SEC Staff's ongoing commenting on executive compensation disclosures. Specifically, the issue includes articles on:

- Your Questions on Net Exercises Answered
- Follow-Up on Net Exercises: Voluntary or Mandatory?
- Cash Flow Issues from Net Exercises
- Technical Questions Related to Exercise Transactions
- ISOs and Net Exercises
- Modifying Stock Options After Termination
- What to Expect from the SEC After the 2008 Proxy Season
- More Comments on the Way: Key Executive Compensation Disclosure Issues

Take advantage of a "Half Price for Rest of '08" no-risk trial to have this issue sent to you immediately.

- Dave Lynn

June 12, 2008

SEC Proposes Credit Rating Reforms

As I noted in this blog from back in April, some major changes have been under consideration for credit ratings. Yesterday, the SEC proposed the first two parts of a three part package of proposals targeted at reforming the credit ratings business. Here is the press release announcing the proposal, Chairman Cox’s opening statement, and the statement of Commission Atkins. The third set of proposals is slated for consideration on June 25th.

One set of recommendations is focused on regulating some troubling practices of the NRSROs, including rules that would:

- prohibit the issuance of ratings on structured products unless information about the assets underlying the products is available;

- prohibit credit rating agencies from structuring the same products that they rate;

- require that credit ratings (and subsequent rating actions) be made publicly available;

- prohibit anyone who participates in determining a credit rating from negotiating the fee that the issuer pays for it;

- ban gifts from those who receive ratings to those who rate them in any amount over $25 (that is a pretty low threshold!);

- require publication of performance statistics over 1, 3, and 10 year periods within each rating category in order to facilitate competitive comparisons across NRSROs;

- require disclosure about reliance on due diligence of others in order to verify the assets underlying structured products;

- require disclosure of how frequently credit ratings are reviewed, whether different models are used for ratings surveillance than for initial ratings, and whether changes made to models are applied retroactively to existing ratings;

- require an annual report of the number of ratings actions, along with an XBRL database of all rating actions maintained on the agency's website;

- require public disclosure of the information a credit rating agency uses to determine a rating on a structured product, including information on the underlying assets; and

- require documentation of the rationale for any significant “out-of-model” adjustments.

The second set of proposals (approved by a 2-1 vote, with Commissioner Atkins dissenting) is focused on differentiating ratings issued on structured products from those issued on bonds. The SEC proposed that such differentiation might occur either through the use of different symbols - such as attaching an identifier to the rating (maybe they should adopt the “skull and crossbones” approach used by the Pink Sheets) - or by issuing a report that discloses the differences between ratings of structured products and other securities.

The proposals scheduled for consideration on June 25th will focus on revising the broad range of SEC rules that look to credit ratings. The concern expressed by some is that, by referencing the credit ratings in the SEC’s rules, the government’s imprimatur is somehow implied. On the Corp Fin side, this would of course mean looking at things like the use of credit ratings in determining eligibility to use Form S-3.

This first round of proposals is out for a very short comment period – only 30 days – perhaps reflecting the accelerated pace of SEC rulemaking as we rapidly move through 2008. It is hard to imagine that the SEC will be able to get really thoughtful comments on these major proposals within such a short timeframe.

Corp Fin Guidance on the Filing Review Process

The Corp Fin Staff recently posted some helpful guidance detailing its process for reviewing filings, including information about the structure of the Operations offices and how to “appeal” a Staff determination.

You can refer to our SEC Staff Organization Chart for more information on the line-up of Corp Fin’s Staff, as well as the telephone numbers for each of the Offices.

On The Way: Romeo & Dye Section 16 Deskbook

For those of you that subscribe to the popular Romeo & Dye Section 16 Annual Service, you will be happy to hear that Peter and Alan have finished the 2008 edition of the Section 16 Deskbook - and it will be dropped in the mail shortly. If you are not yet a subscriber, try a no-risk trial now (or if you haven't renewed, it's time to do so).

- Dave Lynn

June 11, 2008

The Latest Developments for Special Litigation Committee Practice

As Travis Laster notes, a recent decision has significant implications for special litigation committee practice:

In Sutherland v. Sutherland, C.A. No. 2399 (Del. Ch. May 5, 2008), Vice Chancellor Lamb denied a motion to terminate filed by a single-member SLC, despite finding that the SLC member was disinterested and independent, on the grounds that the SLC did not conduct an adequate investigation. By my count, this is only the fourth Delaware decision to reject an SLC's motion to terminate and only the second to do so on the basis of an inadequate investigation, as opposed to on the basis of lack of independence.

Key practice points include:

1. Vice Chancellor Lamb rejected the argument that the SLC member was not independent because he was paid his hourly rate for conducting the investigation. Questions about SLC member compensation frequently arise, and the Sutherland decision indicates that paying an hourly rate should be acceptable.

2. Vice Chancellor Lamb was not troubled by the fact that the SLC's counsel and the SLC did not retain their notes from witness interviews. Prior SLC rulings differed on whether notes of interviews should be retained and whether they would be subject to production during discovery, although at least one decision supported the general practice of not retaining notes. The Sutherland case upholds the general practice in this area. However, because the failure to retain interview notes potentially implicates spoliation issues, practitioners should continue to be cautious, particularly if their actions will be reviewed by courts in jurisdictions other than Delaware.

3. Despite his ruling on the underlying interview notes, Vice Chancellor Lamb appeared quite troubled by the cursory nature of the interview memoranda prepared by the SLC's counsel. The Court noted that the summaries were "perfunctory" and typically recorded only the questions or topics of discussion, but not the interviewee's answers. The Court remarked that "Without this information, the Court is unable to ascertain the reasonableness of the SLC's investigation."

4. Vice Chancellor Lamb reiterated his concern, expressed in an earlier opinion, that the SLC's report was "wholly devoid of citations to key documents or interview summaries." (18 n.34). The Court also noted that "the SLC did not enter any of the underlying documents, interview summaries, affidavits, or deposition transcripts into the record until it filed its reply [brief]. ... Needless to say, these facts do not enhance the court's confidence in the SLC. Not only does the lack of a record hinder the court's, and the plaintiff's ability to scrutinize the SLC's good faith, independence, and reasonableness, it also suggests that the SLC has not taken its obligation seriously and has not acted in
good faith."

5. Vice Chancellor Lamb expressed concern that the SLC report referred to exculpatory evidence for certain expenses that were the subject of the investigation but did not mention other, problematic evidence. The Vice Chancellor noted that the SLC member and SLC counsel both stated that they were aware of the expenses, yet they were not addressed in the report. In the Court's words, "[t]he incongruity between omitting analysis of the large, possibly suspicious payments, yet referencing the innocent, generally available discount, raises significant questions as to the good faith of the SLC's work."

Practitioners advising or considering the use of an SLC should pay careful attention to the Sutherland case. Most significantly, the opinion indicates that interview summaries should contain significant detail and that the SLC report should cite to evidence and underlying documents, and not merely provide an unsupported narrative.

Even More on Special Litigation Committee Practice

More from Travis Laster:

In the wake of Vice Chancellor Lamb's Sutherland decision rejecting a special litigation committee's motion to terminate a derivative action, the SLC moved for reconsideration, and the Vice Chancellor denied the motion in this new decision.

Two points are worth noting for practitioners who advise SLCs:

First, the Court stated that "the touchstone of good faith in the context of a special litigation committee report is its demonstrated willingness to deal openly and honestly with all relevant information." The Court found that the destruction of interview notes by the SLC, after using the notes to prepare cursory and incomplete interview summaries, undermined the Court's confidence in the SLC's actions.

In his prior decision, Vice Chancellor Lamb held that it was not improper to destroy interview notes. Nevertheless, the clear lesson is that if an SLC decides not to retain interview notes, the interview summaries should be considerably more detailed than might otherwise be required if notes are retained and produced. This ruling dovetails with Chancellor Chandler's holding in Ryan v. Gifford, where he required an investigative committee to produce its interview summaries, notes, and communications with counsel where the committee had not prepared a report and there was no other factual record of what the committee did.

Second, the Court stated that "the SLC was required to investigate the claims in the case, not merely the specific allegations [the plaintiff] made in her complaint." This is significant because it makes clear that an SLC investigation cannot stop with the allegations of the complaint, but must explore more broadly into the merits of the underlying claims. This may require the SLC to investigate issues that the plaintiff did not identify. Although parsing the complaint can be a way to sidestep difficult issues, the Sutherland decision indicates that the Court of Chancery will not look kindly on such an approach.

The fact that an SLC will have a duty to explore beyond the narrow allegations of the complaint reinforces the need for a board of directors to think carefully before creating an SLC. Put simply, it is not always clear when an SLC is created where its investigation will lead or end. While an SLC can be a powerful device to address derivative litigation, it should not be the knee-jerk response to the denial of a motion to dismiss.

The Perils of Naked Short Selling

As Dave recently blogged, the SEC proposed an anti-fraud rule for naked short selling a few months ago. In this podcast, Dave Patch, Founder of InvestigatetheSEC.com, discusses naked short selling, including:

- What do you see as the most important short issues that we face today?
- How is the SEC addressing those issues?
- What do you think the SEC should be doing?

- Broc Romanek

June 10, 2008

The "B" Corporation: Duties to Constitutiencies Beyond Shareholders

From Keith Bishop: A few weeks back, a reporter called me about "B" corporations; if you haven't heard of them, here is an article about the subject. "B" stands for "beneficial." Proponents hope that the "B corp." logo will eventually become a well-known seal of approval for socially responsible businesses.

In California, the proponents of B corporations have introduced a bill - AB 2944 - that would explicitly permit directors to consider other constituencies in considering the best interests of the corporation. I found the bill analysis particularly interesting in its reference to the Chicago Cubs and Rutgers (I believe that the case referred to in the legislative analysis is Shlensky v. Wrigley, 95 Ill. App. 2d 173, 237 N.E. 2d 776 (1968)).

As noted in the article, the use of B corporations would have interesting implications in acquisitions since the board of a B corp. could weigh considerations other than financial ones to accept an offer. Learn more about B corps at BCorporation.net.

Options Backdating: Cases Now Proceeding

From Adam Savett in the RiskMetric's "Governance Blog":

Back in February, we took a quick look at the scorecard in the options backdating litigation, tallying up the settlements and dismissals, among other things. In our earlier review, of the 36 options backdating cases that have been filed as securities class actions, 7 had settled and 3 had been dismissed.

Run the clock for a few months, and 9 of those cases have now been dismissed and 9 have now settled. The nine settlements total $255.58 million, for an average of $28.4 million. As noted earlier, these cases have settled much more quickly on average, than other cases. The nine cases have settled in an average of just 440 days. Removing the outlier, Mercury Interactive, which was filed earlier and added the options backdating allegations in a later
amended complaint, drops the average time from filing of initial complaint to tentative settlement for the remaining 8 cases to 397 days.

And the ratio of settlements to dismissals is somewhat out of line with historical averages as well. Most studies (and a quick check of our database) indicate that the percentage of new securities class actions that are dismissed is between 33-40 percent. With this group of cases, we can look at the data two ways. Dismissals as a percentage of total cases or dismissals as a percentage of cases that have reached a final, or quasi-final resolution.

Under the former analysis, exactly 25% of these cases have been dismissed. That number is artificially low, as not all of the cases have yet had a ruling on the motion to dismiss. Under the latter method, 50% of these cases have been dismissed. This number is artificially high, as a number of these cases have already survived a motion to dismiss. In any event, things remain interesting in the sometimes long-forgotten world of options backdating.

And law firm lawyers need to watch out. As noted in this article, some firms are being named as defendants in these backdating lawsuits.

An Overwhelming Response

Last week, we announced our new upcoming comprehensive treatise of executive compensation disclosures - Lynn & Romanek's "The Executive Compensation Disclosure Treatise & Reporting Guide" – and the response was overwhelming.

We want to clarify that to obtain the “Conference Attendee” discount for the new Treatise, you need to register for one of the October Conferences before you order the Treatise. And since the early bird discount for the Conference expires on June 30th, you will want to register for those Conferences now:

- "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference" & "5th Annual Executive Compensation Conference" (10/21-22 in New Orleans or via Nationwide Video Webcast)

- "16th Annual NASPP Conference" (10/22-24 in New Orleans)

- Broc Romanek

June 9, 2008

Disclosing Swaps: SEC Staff Takes a Position in CSX Lawsuit

This is worth repeating from Friday's DealLawyers.com Blog: As the conclusion of one of the more closely-watched cases in recent years in the M&A area draws near (see this IR Magazine article for background; Alan Dye also riffed on this Friday in his Section16.net Blog), a number of amicus curiae filings were made available last week, including a letter from Corp Fin Deputy Director Brian Breheny (as transmitted by the SEC's General Counsel; this is not a Commission amicus brief). We have posted them in the "M&A Litigation Portal" on DealLawyers.com, as follows:

- SEC General Counsel's Brian Cartwright Transmittal Letter
- SEC Corp Fin Deputy Director's Brian Breheny Letter
- Prof. Bernard Black's Response to SEC Staff Letter
- ISDA/SIFMA Amicus Curiae Brief

Here is some analysis from Cliff Neimeth of Greenberg Traurig: In a pending litigation being watched closely by the public M&A bar, institutional activists and target issuers alike, this past Wednesday, in correspondence submitted by Corp Fin Deputy Director Brian Breheny to U.S. District Court (SDNY) Judge Lewis Kaplan, Brian endorsed the view of activist hedge funds - The Children's Investment Fund ("TCIF") and 3G Capital Partners ("3G") - that they were not required under Regulations 13G or 14A to disclose their approximate 12% economic stake in Jacksonville, Florida-based railroad operator CSX Corp. until months after they entered into these arrangements. The hedge fund defendants previously announced their intention and presently intend to elect a short-slate of their five nominees at CSX' annual meeting scheduled for later this month.

At issue, among many other aspects of the litigation, is the fact that TCIF and 3G were parties to elaborate "swap" and cash-settle derivative arrangements with investment bank counterparties, and that the nature of these contracts did (and do) not confer upon TCIF and 3G any shared or sole voting power over the underlying equity securities. Accordingly, in their view, such arrangements fall outside of the ambit of Section 13(d) and Regulation 13D thereunder until such time as these arrangements are converted into beneficial voting positions.

Although TCIF and 3G, on numerous occassions, announced to the investment community and to CSX directly that they were parties to the swaps and, in fact, made H-S-R (pre-merger notification) filings with the FTC, the absence of a detailed Schedule 13D filing (and subsequent amendments) allegedly enabled them to conduct (over a period of months) a broad range of "coordinating activities" with other institutional holders of CSX, to execute various plans, arrangements and understandings relating to control of CSX, and to otherwise engage in undisclosed "group" activities.

Brian Breheny (expressing the Staff's position of the appropriate interpretive legal standard and not the position of the SEC's Commissioners) stated in his letter to Judge Kaplan that "the presence of economic or business incentives that the [swap counterparty] may have to vote the shares as the other party wishes" is insufficient to create the beneficial acquisition of voting power in respect of such shares.

If Judge Kaplan agrees with TCIF's and 3G's (and indirectly, Breheny's amicus) interpretation of the legal standard for disclosure, this would have significant implications for hedge fund activist transaction planners and target companies. If he rules in this direction, it is not unlikely that this may prompt the SEC to accelerate its current assesment of whether Regulation 13D should be amended to broaden its reach to cover these cash-settled (synthetic) arrangements that have become more commonplace over the past several years.

Coupled with the SEC's e-proxy regime, the current slowdown in traditional economic M&A activity, and the recent Delaware Supreme Court and Delaware Chancery Court decisions in Openwave-Harbinger Capital, Jana Partners-CNET, Levitt Corp.-Office Depot and TravelCenters-Brog (with respect to the efficacy of the advance notice by-laws in those cases), this continues to help fuel an unprecedented level of institutional activism and control contest activity for the forseeable future. This also underscores the need for corporate issuers to examine their "shark repellents" and defensive arsenal.

Broadridge's Latest E-Proxy Stats

In our "E-Proxy" Practice Area, we have posted the latest e-proxy statistics from Broadridge. As of April 30th:

- 566 companies have used voluntary e-proxy so far (a big leap from 283 at the end of March - understandable since proxy season is in full swing)

- Size range of companies using e-proxy varies considerably; all shapes and sizes (eg. 30% had less than 10,000 shareholders)

- Bifurcation is being used more as the proxy season progresses (but still not all that much); of all shareholders for the companies using e-proxy, now over 10% received paper initially instead of the "notice only" (up from 5% at the end of February)

- 0.85% of shareholders requested paper after receiving a notice; this average is up from 0.45% at the end of March

- 57% of companies using e-proxy had routine matters on their meeting agenda; another 30% had non-routine matters proposed by management; and 13% had non-routine matters proposed by shareholders. None were contested elections.

- Retail vote goes down dramatically using e-proxy (based on 164 meeting results); number of retail accounts voting drops from 21.2% to 5.4% (a 75% drop) and number of retail shares voting drops from 34.3% to 15.8% (a 54% drop)

For the next few days, Dave and I are out speaking in San Diego at the NIRI Annual Conference. My panel deals with e-proxy and I'll be doing my "usability" bit again - particularly regarding how the proxy card/VIF looks. Take a gander at how this sample (posted in our "E-Proxy" Practice Area) looks like for registered holders. Not too bad. And I'll be discussing all the other e-proxy related developments that I haven't yet had a chance to blog about...but will do so in the next few weeks.

And even though he can't be there himself, Dominic Jones is helping collect Web 2.0 thoughts from conference attendees as it happens. Pretty wild.

Winning the World Series: Cubs Worth More? Or Less?

Friday's Deal Journal from the WSJ.com included an interview with an economist about how much more the Chicago Cubs would be worth if they won the World Series this year (they are red hot and it's been 100 years since they last won).

The interview is short and perhaps not complete - but in my opinion, the Cubs would be worth less in the long run if they won. Part of their national mystique is that they are perennial losers. "Maybe next year" is the fan mantra. As someone who grew up down the street from Wrigley Field at a time when they "had it in the bag" - the late '60s/early '70s - I personally don't want to see the streak end...

Speaking of sports, I was bummed to discover in this WSJ article that "Gino" is dead. The "Gino dance" is all the rage at Boston Celtics games this year, based on a clip from a '70s American Bandstand episode that shows a dancer wearing a "Gino" T-shirt. I went to a game in Boston this year to experience it for myself, but I had seen this clip on YouTube before I went. It's a classic.

- Broc Romanek

June 6, 2008

Welcome to Dan Greenspan!

We're excited that Dan Greenspan has left the SEC to join our staff! Dan spent five years at the SEC, spending the bulk of his time in Corp Fin, including a lengthy stint in the Office of Rulemaking. During the past six months, he toiled as Senior Special Counsel in the Office of the General Counsel. Dan was one of the key players during the SEC's executive compensation disclosure rulemaking in '06. He worked for seven years in private practice before his time at the SEC.

Dan nailed his interview when he showed up wearing an Elvis wig and holding a fake cigarette. A lesson for you kids out there. Dan is up and running in his new work clothes - and you can congratulate him at dan @thecorporatecounsel.net (remove the space after "dan" before sending).

The PCAOB's Newest Board Member: A History Lesson

Several days ago, the SEC appointed Steven Harris to the PCAOB's board. Steven was a former long-time Senate Banking Committee official, who more recently served as Senior Vice President and Special Counsel of APCO Worldwide.

Steven is the first Hill person to be named to the Board. However, that is not a foreign concept for SEC Commissioners. Current SEC Commissioner Kathy Casey was Staff Director and Counsel for the Senate Banking Committee when she was appointed last year. And the Commissioner I worked for a decade ago - Laura Unger - also came directly from the Senate Banking Committee.

Going back further, Rick Roberts was a former Hill staffer (although technically he left Senator Shelby's office and went to a law firm for a short while before becoming a Commissioner in the early '90s). In the '80s, Lindy Marinaccio was an aide to Senator Proxmire when he was appointed by Reagan. In the '70s and early '80s, John Evans served two terms after coming from the Senate.

Then there are the Commisioners who were White House aides when appointed: Joe Grundfest, Richard Breeden and Paul Carey. Given Congress' intense interest in the markets lately, any of this is not a bad background to have, as navigating Capitol Hill can be tricky. Thanks to Jack Katz for his endless knowledge of SEC history!

Closing Time: When the Founder is Ready to Sell

We have posted the transcript for the DealLawyers.com webcast: "Closing Time: When the Founder is Ready to Sell."

- Broc Romanek

June 5, 2008

Lynn & Romanek's "The Executive Compensation Disclosure Treatise & Reporting Guide"

Okay, you now know why Dave and I haven't been making silly videos lately - we have been busy jamming on a comprehensive treatise of executive compensation disclosures - Lynn & Romanek's "The Executive Compensation Disclosure Treatise & Reporting Guide" - so that we can get it into your hands by Labor Day. This thing will be massive: over 1000 pages and is full of explanations, annotated sample disclosures, analysis of possible situations that you may find yourself in, etc.

After you order the Treatise, you will also receive quarterly Update newsletters - so that we can give you the latest practice tips at the crucial moments you need them. And once the Treatise is done, those that order the hard copy also get access to an online version of the Treatise (and newsletters). We haven't yet figured out the URL for the online version - suggestions are welcome. Here are FAQs about the Treatise.

Order your Treatise now so we can rush it to you right after Labor Day; there is a reduced rate if you are attending any of our Conferences. Order online - or here is an order form if you want to order by fax/mail. If at any time you are not completely satisfied with the Treatise, simply return it and we will refund the entire cost.

Completed the Set: The SEC Staff's Executive Compensation Comment Letters

As the Corp Fin Staff has nearly finished uploading the 350 comment letters from its executive compensation review project last Fall, we have put the finishing touches on providing links to all the comment letters and responses in the CompensationStandards.com "SEC Comments" Practice Area. Thanks to Dave for the heavy lifting on this one. Note that it might be missing one or two...

RiskMetrics' "Explorations in Executive Compensation"

Recently, RiskMetrics has put out a draft - and lengthy - set of white papers entitled "Explorations in Executive Compensation." The project is intended to spark constructive dialogue about executive pay issues and I really encourage you to read their papers and provide comments.

The first white paper - "Considerations" - defines and puts into context the basic elements of U.S. executives' pay packages, with special attention paid to emerging key considerations for investors in evaluating pay and equity plans in particular. The second one - "Innovations" - offers a pair of new methods of looking at critical issues in executive pay: peer group benchmarking and and the degree of alignment between the risks borne by investors and by shareholders.

SEC Petition: Disclosure about Consultant Conflicts

As I prepare to speak at a director's college next week on executive pay, I read this recent petition from a group of 21 large institutional investors to the SEC that seeks to require companies to disclose all fees associated with consultant engagements for a single company and any ownership interest a consultant working for the compensation committee may have in the parent consulting firm. This disclosure would be made in proxy statements.

I'm still not convinced that consultant conflicts routinely impact CEO pay levels - and I definitely believe there are many other areas in the CEO pay process that are in greater need of fixing, with a much higher priority. Here is some food for thought - a recent study that concludes that potential conflicts of interest between companies and consultants are not a primary driver of excessive CEO pay (note there are studies that have opposite findings).

- Broc Romanek

June 4, 2008

More on Healthcare Shareholder Proposals

Back in March, I blogged about Corp Fin's new position on health care proposals. Now, the NY Times has caught up with this development in this recent article. The article is pretty good and discusses the Staff's willingness to allow these types of proposals in the proxies this year, but it neglects to mention the instances where the staff granted no-action relief and allowed their exclusion.

The AFL-CIO has been one of the primary proponents in the health care area. In this podcast, Rob McGarrah of the AFL-CIO’s Office of Investment explains the evolution of shareholder proposals related to health care, including:

- Why did the AFL-CIO choose this topic for its proposals?
- What was the SEC Staff's historical position for this type of proposal?
- What happened this proxy season regarding these proposals?

Half-Price for "Rest of 2008"

As our site memberships and print publications are on a calendar-year basis, we have reduced our prices for all of our websites and most of our print publications so that they are half price for the rest of this year. Take advantage of these reduced rates in our "No-Risk Trial Center."

Two New Deputy Directors for SEC's Enforcement Division

Congrats to Scott Friestad and George Curtis for their promotions to Deputy Director in the Division of Enforcement (and Chief Counsel Joan McKown, who gained additional responsibilities). I dig the related press release, which includes an embedded video from the news conference.

Scott and George replace Peter Bresnan, who left last year, and Walter Ricciardi who "retires" at the end of this month (I put retires in quotes because Walter only served on the Staff for four years and starts at Paul Weiss when he leaves the Commission).

Nasdaq Proposes Change to Continued Listing Standards

From Davis Polk: The SEC has published a Nasdaq proposed rule change that would require listed companies to maintain a certain amount of "public shareholders" rather than a certain amount of "round lot holders" as is currently required for continued listing. According to the Nasdaq, for a variety reasons, it is often difficult to determine compliance with the current round lot holder requirements.

If the SEC approves the proposal, Nasdaq would generally require 300 public shareholders for continued listing on the Nasdaq Capital Market, and 400 public holders for continued listing on the Nasdaq Global and Global Select Markets. In the case of preferred stock and secondary classes of common stock, 100 public shareholders would be required for continued listing on the Nasdaq Capital, Global and Global Select Markets. As proposed, the definition of public holder would include both beneficial holders and holders of record, but would not include any holder who is, either directly or indirectly, an executive officer, director, or the beneficial holder of more than 10% of the total shares outstanding. Under this definition, Nasdaq would consider immediate family members of an executive officer, director, or 10% holder to not be public holders to the extent the shares held by such individuals are considered beneficially owned by the executive officer, director or 10% holder under Exchange Act Rule 16a-1.

No change is proposed to the Nasdaq's initial listing requirements that also require a certain number of round lot holders because the majority of initial listings are IPOs, where a certain number of round lot holders is already required by SEC rules in order to avoid being subject to the penny stock rules and the number of round lot shareholders can be easily determined by the underwriter when distributing the offering. Nasdaq does propose, however, to clarify that the definition of round lot holders includes beneficial holders in addition to holders of record, consistent with current practice.

- Broc Romanek

June 3, 2008

Parsing the SEC's XBRL Proposing Release: Two Liability Standards and More

Late on Friday, the SEC posted a 143-page proposing release for its mandatory XBRL rulemaking. Based on a quick glance, here are some additional thoughts to the ones I blogged a few weeks ago based on what was said at the open Commission meeting:

1. The Proposed Liability Framework - During the open Commission meeting, it was unclear what liabilities might attached to filing in XBRL - giving the impression that this important issue had not been fully worked out yet. Now that we have the proposing release, we can see on page 60 that the SEC is proposing two very different standards - (i) that the interactive data be considered "furnished" as it is under the pilot program versus (ii) that it be considered "filed" as the “viewable interactive data as displayed through software available on the Commission’s Web site… would be subject to the same liability under the federal securities laws as the corresponding portions of the traditional format filing.” I guess this was a compromise to get the proposal out of the building.

Some of you may be asking - what did he just say? I know that this is confusing. The SEC's proposal has different liability standards for the XBRL data itself and for the "viewable" data. The former is what the machines read; the latter is what humans read (yes, there is a difference - a big difference; more on this later). So, in other words, the raw XBRL data (the "non-viewable" XBRL data) would essentially carry forward the pilot program's liability regime (but note that no liability for Section 12 has been added - the voluntary filers program didn't have this immunity) - and the "viewable XBRL data" would have the same type of liability as the official HTML or ASCII filings have today (and so viewable data would be considered "filed").

2. Late Filers and "Springback" of Current Status - Under the proposal, the financials in XBRL would be filed as an exhibit under Item 601 of Regulation S-K and be considered part of the company's "official" filing, rather than as a supplement as is the case in the pilot program. Even though a company would lose its Form S-3, etc. eligibilty if it was late in filing its XBRL data, it could regain its current status once the XBRL information was filed. This is a new concept under the SEC's regulatory framework. (And there is a proposed pair of 30-day grace periods for the first two years.)

3. Possible Alternative Regulatory Frameworks - As with most SEC proposing releases, the Staff does a great job of posing questions to help solicit comments. In the proposing release, I particularly like the list of questions beginning on page 26. Read them to help you better understand what XBRL is all about.

4. Costs - As Dominic Jones notes in his "IR Web Report," costs are expected to go up significantly in Years 2 and 3 (when "deep-tagging" will be required) and then will decrease rapidly as each company develops its own customized templates that can be re-used.

5. Foreign Private Issuers - As Dominic notes, the proposed rules would not require foreign private issuers that prepare their financial statements in accordance with a variation of IFRS as issued by the IASB to provide XBRL. Foreign private issuers that provide financial information on Form 6-K or any financial information prepared with non-US GAAP that must be reconciled to US GAAP in the foreign private issuer’s '34 Act reports will not have to be provided in XBRL.

Just added! We are excited that David Blaszkowsky, Chief of the SEC's Office of Interactive Disclosure, has joined the panel for our July 16th webcast: "XBRL: Understanding the New Frontier."

By the way, I've learned that the Bush Administration's moratorium on rulemaking doesn't apply to the SEC because the agency is considered "independent." So it shouldn't impact the SEC's ability to propose and adopt rules whenever it sees fit (although the SEC may voluntarily decide to abide by the Administration's edict).

XBRL: A New Enforcement Tool?

This recent Reuters article claims XBRL will help uncover suspicious trading and accounting patterns. The example in the article is the option backdating scandal which was based on a study of the information filed in Form 4s (note that Section 16 forms are not being proposed by the SEC to be tagged in XBRL; they already are tagged in XML). If you recall, uncovering backdating practices gathered steam after Professors Randall Heron and Erik Lie's study, which gathered Form 4 data starting in '96 - well before Section 16 reports were required to be electronically filed. The professors relied on the Thomson Financial Insider Trading database to obtain the datapoints necessary for their study (and Thomson filled its database manually until Section 16 reports were required to be filed electronically after SOX).

But if memory serves, the SEC's Enforcement Staff has to work hard to break open a financial fraud case; it's not typical that the Staff can discern that numbers are "funny" on their face - rather, the fraud is uncovered by digging beyond the information in the SEC filings. So I don't think that just running the numbers in XBRL is gonna help much. Most analysts (and I presume the SEC Staff) have long had the technology to crunch numbers using computers. In fact, you can access 10 years worth of financials tagged in XBRL right now for all public companies on TryXBRL.com.

Anyways, I worry that this type of promise about XBRL benefits adds to the boatload of misinformation already swirling around XBRL - but maybe someone can give me some concrete examples to show otherwise? I am certainly not an XBRL expert.

Our June Eminders is Posted!

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

- Broc Romanek

June 2, 2008

IFRS: A Lot of Debate, But Inevitable

Last Thursday, SEC Chair Chris Cox delivered a speech on the future of IFRS - including a public policy oversight body that would oversee the IASB trustees (the speech notes that the IASC Foundation will consider a new monitor as part of its '08 Constitution review). This is an important topic that I could literally blog about every day. But, to be honest, I'm not following it as closely as I probably should because I'm only human and there are still so many other developments to cover.

From reading comment letters, etc., I understand one considerable concern is the lack of a strong IFRS enforcement mechanism. The amazing circumstances of the fraud at Société Générale are often held up to illustrate the point of how easy it is for a company to break international accounting rules, get away with it, have its independent auditors bless it, with no major regulatory ramifications (read this Floyd Norris column and an Accounting Onion blog for more). Also held up is the fact that the IASB standards have not been enforced in the past. Finally, there have been concerns raised about how the FAF recently has managed the FASB.

So there are these - and many other - issues to deal with, but it's clear that the globalization of accounting standards is something that is inevitable. We just need strong regulators - and ones that work together. This will be quite a feat to pull off since there are many cultural obstacles and regulatory differences among jurisdictions. But it is happening - here is a February statement from IOSCO urging companies to clarify which accounting standards they use. IOSCO is the organization whose members are comprised of securities regulators from around the world and who will be a key player in this movement.

Is IFRS Compatible with US-Style Corporate Governance?

This blog below from Tom Selling's "The Accounting Onion" is several months old, but still interesting and relevant reading:

I just finished reading a brief, highly readable and interesting article by a Columbia Law School professor, John C. Coffee, Jr., entitled "A Theory of Corporate Scandals: Why the U.S. and Europe Differ." The purpose of this post is to piggyback on his framework to also provide an explanation for the difference in basic approaches between U.S. GAAP and IFRS; and most importantly, why political pressure to trash U.S. GAAP and adopt IFRS should be resisted.

How and Why, According to Coffee, U.S. and European Scandals Differ

Coffee's thesis is that corporate governance of majority-owned corporations (predominant in Europe) should be fundamentally different than corporate governance of corporations that lack a controlling shareholder group (predominant in the U.S.). It's not necessarily because there are fewer incentives to rip off other shareholders, but the feasible means to do so will differ.

Scandals in Europe involving majority-owned corporations usually do not feature an accounting manipulation. First, financial reporting is less important to the majority owners because they rarely sell shares; and if they do, they usually receive a control premium that is uncorrelated with recent earnings (and generally larger than control premia in U.S. transactions). Second, fraud is more easily accomplished by misappropriation of the private benefits of control: authorization of related-party transactions at advantageous prices, below-market tender offers, are prime examples. Any trading that takes place between minority owners has less to do with recent earnings reports, and more to do with an assessment of how minority shareholders will be treated by controlling interests.

In dispersed-ownership corporations, managers do not possess private benefits of control. Moreover, a significant portion of manager's compensation may be in the form of stock options or other forms of equity. Therefore, stock price can have a significant effect on a manager's compensation, providing them with strong incentives to manipulate accounting earnings.

The Implications for Accounting

Professor Coffee's thesis is that differences in ownership patterns have important implications for the selection of gatekeepers: auditors, analysts, independent directors, etc. His observations and recommendations are interesting, but I want to advance a related thesis, namely that different ownership patterns call for different types of accounting regimes.

It stands to reason that accounting should be difficult to manipulate, if it can be used to rip off shareholders. Thus, the evolution of U.S. GAAP can be seen as a response to the need for specific rules that minimized the role of management judgment because of their strong self-interest in the reported earnings and financial position. This has occurred in part because U.S. gatekeepers have shown themselves to often lack sufficient resolve or power to prevent management from under-reserving, overvaluing, or just plain ole making up numbers. U.S. managers effectively control the "independent" directors and auditors; and prior to Regulation FD, analysts bartered glowing assessment in exchange for tidbits inside information. Without empowered gatekeepers to prevent accounting fraud, we have had to place our hopes on very inflexible accounting rules, and sheriffs like the SEC and private attorneys to catch the cases where management has attempted to surreptitiously cross the bright line.

Thus, it should be self-evident that IFRS-style accounting, replete with gray areas, would be a gift to U.S. managers. Outright fraud would be replaced by more subtle means of "earnings management," rendering the SEC and private attorneys much less potent. Is it any wonder why U.S. corporations and their auditors are practically begging to have IFRS available to them?

In short, it would be a grave mistake to adopt IFRS in the U.S. simply because it seems to work well elsewhere. As corporate ownership patterns in Europe change, it may well be that IFRS may evolve to look more like U.S. GAAP. Only after that occurs may it make more sense to have a single worldwide financial reporting regime.

Imagine if Enron Had Applied IFRS

One of the scapegoats of the Enron scandal was "rules-based" U.S. GAAP. The libel was that Andrew Fastow was a mad genius, capable of walking an accounting tightrope by creating complex special-purpose entities (SPEs). But, GAAP wasn't the culprit in the Enron scandal. Frustrated Fastow was only able to get the accounting treatment he needed past the auditors by hiding from them side agreements that unwound critical provisions requiring the new investors to have a sufficient amount of capital at risk in the SPEs.

The enduring legacy of the libel is the erroneous conventional wisdom that GAAP is responsible for Enron; and what's more, Enron et. al. might not have happened if our financial reporting system were more like IFRS. More likely, if IFRS had been the basis of accounting for Enron instead of GAAP, it might have taken longer to discover the fraud, or to pin the blame for the fraud where it belonged.

Neither GAAP nor IFRS are principles-based, but GAAP certainly has more rules and bright lines. At least there seems to be some method to the madness, but it would be nice if more of the rules were based on sound principles.

Peggy Foran: Moving On Up

Congrats to my good friend Peggy Foran, who is leaving Pfizer after a long stint to become General Counsel of Sara Lee (here is the press release). At Sara Lee, Peggy will be surrounded by friends - including Helen Kaminski, who will be speaking at our upcoming webcast: "E-Proxy's First Season: Lessons Learned."

As many of you know, Peggy is one of the most prolific persons in our profession. Besides being a very kind soul, Peggy has an incredible background, having worked a number of interesting jobs over the course of her long career. One of the reasons why Peggy is so knowledgeable is that she is a tireless networker. Being an avid networker myself, I am amazed at how much more Peggy is able to do - and Peggy uses her network, always asking probing questions to become even better at what she does. Now that Peggy is entering the executive suite, I hope we haven't seen the last of her at the many events that she graces today!

- Broc Romanek