August 28, 2008

SEC Approves "Potential" IFRS Roadmap: D-Day Six Years Hence

Yesterday, the SEC adopted a proposed roadmap for the potential transition by US companies from US GAAP to IFRS at an open Commission meeting. The roadmap provides that the voluntary transition to IFRS for a limited category of US companies could start with reports filed for fiscal periods ending on - or after - December 15, 2009. To be allowed to do that, a company would have to be among the 20 largest companies within its industry in the world - and a large number of its competitors would have to already be using IFRS. The SEC estimates that about 110 companies would qualify for this voluntary movement.

The roapmap entails possibly mandating IFRS for large US companies for their 2014 financial statements, with somewhat smaller ones required to make the move in 2015 and then the smallest companies forced to use IFRS in 2016. The final decision on whether to implement this timetable would be made in 2011.

Here are the related SEC documents:

- Press Release
- Opening Remarks by Chief Accountant
- Videotaped Remarks from Chair Chris Cox
- Speech from Commissioner Elisse Walter

We'll provide more coverage of this big development over the next few weeks. Note that the Big 4 auditors and others will soon be holding webcasts - I've already seen announcements - so there will be "all you can handle" coverage of this topic. Here's more coverage from FEI's "Financial Reporting Blog."

SEC Adopts Tighter Form 20-F Deadline

At its open Commission meeting, the SEC also adopted amendments to the rules applicable to foreign private issuers that file reports with the SEC (here are opening remarks from the Corp Fin Staff; here is the press release). Here are extensive notes from Cleary Gottlieb:

The most important amendment is to accelerate the deadline for filing an annual report on Form 20-F to four months after the end of the fiscal year, an improvement compared to the 90-day deadline the SEC originally proposed for large issuers. Based on the discussion at the open meeting, the final rule will otherwise implement the amendments substantially as proposed in March 2008, with one exception (the full text of the release is not yet available).

Deadline for Filing Form 20-F

Currently an issuer's annual report on Form 20-F is due six months after the end of each fiscal year. The SEC shortened the deadline to four months for all FPIs. It had proposed 90 days for accelerated filers and 120 days for other filers. The change will take effect for fiscal years ending on or after December 15, 2011 – so for a calendar-year issuer, it will take effect for the 2011 annual report filed in 2012.

To justify the shorter deadline, the SEC pointed out that filing deadlines in other countries are generally not longer than four months and that a four-month deadline will ensure more timely disclosure for investors. The SEC apparently rejected the arguments of many commentators that an accelerated deadline will be burdensome for FPIs since their 20-F reports must include more and different information than the home-country report and are often prepared after the home-country report is substantially complete.

The accelerated deadline is particularly significant for FPIs that must reconcile their financial statements to U.S. generally accepted accounting principles, a complex and lengthy process that may be hard to complete within the new deadline. Companies that prepare financial statements under IFRS (as issued by the International Accounting Standards Board) are exempt from this requirement, and the tighter deadline may cause some companies to switch to IFRS, especially if they can use IFRS for home-country reporting. One reason for the three-year delay in effectiveness is to allow time for foreign issuers and regulators to adopt IFRS.

Other Changes Relating to Form 20-F

Most of the changes concern the disclosure requirements of Form 20-F, which FPIs use to file annual reports with the SEC and which forms the basis of the disclosures required for registered offerings.

- An FPI that must reconcile its financial statements to U.S. GAAP will no longer have the option to use the less demanding presentation under Item 17 of Form 20-F. Financial statements of a company other than the issuer – e.g., an acquired company or an equity-method investee – may still be prepared under Item 17.

- Form 20-F will require disclosure of significant differences between the issuer's corporate governance practices and the requirements of U.S. securities exchanges. The rules of the U.S. exchanges already require essentially the same information but permit it to be published on the website instead.

- Form 20-F will require disclosures about any fees and charges relating to an issuer's ADR programs, including payments made by a depositary to the issuer in connection with the programs.

- Form 20-F will require disclosures regarding changes in and disagreements with the issuer's auditors. The disclosures are substantially the same as those that apply to U.S. issuers under Form 8-K, except that under Form 20-F they will only be required annually.

The SEC specified that the change described in the first bullet above will take effect for fiscal years ending on or after December 15, 2011. It did not address the effectiveness of the other amendments, which will apparently be earlier.

The SEC did not adopt one related proposal, under which an annual report on Form 20-F would have had to include target financial statements and pro forma financial information for some large completed acquisitions. The proposal would have affected only a few companies each year, but the burden would have been significant, so the decision not to adopt this requirement provides significant relief.

Changes to "Going Private" Rules

The SEC amended its "going private" rules under Exchange Act Rule 13e-3 to cover share repurchases, tender offers and proxy solicitations that are intended, or would be reasonably likely, to render an FPI eligible to deregister its securities.

Changes to Determination of FPI Status

Under the new rules, an issuer will be required to determine its FPI status under the SEC's rules once a year on the last day of its second fiscal quarter, and the amendments will provide a transition period for a company that loses FPI status. Under current rules, a company must test its status continually and start reporting as a U.S. company immediately upon the loss of FPI status.

SEC Overhauls Registration Exemption for Foreign Companies

At the open Commission meeting, the SEC also voted to adopt amendments to Rule 12g3-2(b), which exempts certain foreign private issuers from registration with the SEC (here are opening remarks from the Corp Fin Staff; here is the press release). Here are extensive notes from Cleary Gottlieb:

Based on the SEC staff's comments at the open meeting, the SEC has accepted the most widely made comment on its original proposal, by eliminating the proposed 20% cap on U.S. trading volume. The final rule will otherwise be adopted substantially in the form proposed in the SEC's February 2008 proposing release (the full text of the release is not yet available).

Under Section 12(g) of the Securities Exchange Act of 1934 and related rules, a foreign private issuer (as defined under the Exchange Act) that has 300 or more U.S. resident holders of a class of equity securities at the end of its most recently completed fiscal year, and 500 or more worldwide holders of record (plus US$10 million or more in total assets), must register that class under the Exchange Act unless an exemption is available. Exchange Act registration requires a company to comply with SEC reporting requirements, and with the Sarbanes-Oxley Act of 2002.

Registration under Section 12(g) is theoretically required even if a company does not list or publicly offer its securities in the United States. However, an exemption is available under Rule 12g3-2(b). Rule 12g3-2(b) currently allows an FPI that has not listed or publicly offered securities in the United States to avoid registration by making an application under the Rule and furnishing the SEC with English-language versions of certain material information that the issuer makes public or is required to file in its home country. For most companies, the information must be submitted to the SEC in paper form.

The amendments will make the exemption automatically available to eligible FPIs, which will no longer have to make an application to the SEC. Under the amendments, in order to maintain the exemption, a company must publish electronically (either on its website or on a publicly available electronic system) English translations of certain key documents, such as annual and interim reports and financial statements, material press releases and certain other significant documents. Paper submission will no longer be required.

The amendments will include two eligibility requirements that an FPI must meet to benefit from the exemption:

- The issuer has no active Exchange Act reporting obligations under Section 13(a) or 15(d) (this means essentially that the issuer has not listed or publicly offered securities in the United States).

- The issuer maintains a listing of the subject securities on one or more non-U.S. exchanges that are its primary trading market (meaning one or two markets that represent at least 55% of its worldwide trading volume, at least one of which must have greater trading volume than the United States).

The amendments do not include the most controversial eligibility requirement from the SEC's February proposal, which would have made companies ineligible if trading in the United States represented more than 20% of the issuer's worldwide trading volume in the most recently completed year. In the open meeting, the SEC's staff indicated that most commenters had opposed the 20% trading volume test, in particular due to the dampening effect it could have had on sponsored ADR facilities and the inclusion of U.S. investors in exempt offerings such as private placements. As the issuer must still meet the primary trading market requirement described above in order to benefit from the exemption, U.S. trading must in any case represent no more than 45% of an issuer's worldwide trading volume.

The result of these amendments is that vast numbers of non-U.S. companies that regularly publish English-language documents will automatically become exempt, without any action (or even any knowledge of the exemption). As a result, their shares will become eligible for unsponsored ADR facilities and Rule 144A resales to qualified institutional buyers. At the same time, some companies, such as unlisted funds or acquisition targets that have delisted but have remaining U.S. shareholders, may be ineligible for the exemption.

It is also uncertain whether the amended Rule will require that issuers publish full English translations of documents or whether English versions that cover all material information will be sufficient. We had noted in our comment letter that many companies include information in their home country reports (due either to local regulations or to local practices) that is not of interest for U.S. investors, and that some of these companies omit this information from the English versions of these reports.

The amendments will provide for a three-year transition period for FPIs that lose their Rule 12g3-2(b) exemption because they are unable to meet the Rule's new substantive requirements. In addition, the Rule will include a three-month transition period following effectiveness to enable issuers to comply with the Rule's substantive requirements, in particular the electronic publication of English-language documents.

- Broc Romanek

August 27, 2008

A Sleeper? The SEC's Proposal Limiting the Ability of Subsidiaries to Issue Shelf Debt

Back in early July, the SEC snuck in a proposal - amidst a host of proposals directed at the rating agencies - that has the potential to limit the number of companies that can currently issue debt securities using a shelf registration statement, while at the same time expanding shelf eligibility to less creditworthy issuers. As proposed, the investment grade non-convertible debt securities transaction requirements in General Instruction I.B.2 of Form S-3 would be replaced with essentially the WKSI debt issuer standard - that the company has issued more than $1 billion for cash in registered offerings of non-convertible securites over the prior three years. The comment period for this proposal ends next week, on September 5.

This potentially could be a huge deal. For instance, junk bonds could be offered on Form S-3 under the proposed eligibility criteria, so long as the issuing company meets the $1 billion issuance standard. Further, a company could use S-3 if it met the $1 billion standard, even if some or all of the outstanding debt is in default. The SEC also asked questions about making disclosure concerning ratings mandatory (now it is permissive under Item 10(c) of S-K), including whether ratings and changes in ratings should be disclosed on Form 8-K. Further, in an unusual move, the eligibility standard for issuing asset-backed securities off of Form S-3 would look to, among other things, the status of the investors - namely whether they are QIBs. In its proposing release, the SEC says that only six corporate debt issuers would be kicked off of S-3 if they switched to the $1 billion issuance standard, but it is unclear at this point whether that estimate captures the full impact of the proposed rule change.

Unfortunately, this proposal appears to represent a purely facial change - pulling references to credit ratings out of all of the SEC's rules because it supposedly gives the ratings (and the ratings process) an SEC "stamp of approval" - that could have some far-reaching ramifications for the markets at a time when issuers of asset-backed securities, hybrid instruments and corporate debt are most in need of the quick access to capital afforded by Form S-3 and shelf registration.

- Dave Lynn

August 26, 2008

Delaware Chancery Court Forces Director Compensation Disgorgement

Good to see more securities law blogs emerge. Joe Wallin's new "Corp Fin Blog" recently ran this item:

In Julian v. Eastern States Construction Service, Inc. (Del. Ch. July 8, 2008), the Delaware Chancery Court ordered the disgorgement of director compensation bonuses after its determination that the bonuses did not pass the entire fairness standard.

"Self-interested directorial compensation decisions made without independent protections, like other interested transactions, are subject to entire fairness review. Directors of a Delaware corporation who stand on both sides of a transaction have “the burden of establishing its entire fairness, sufficient to pass the test of careful scrutiny by the courts.” They “are required to demonstrate their utmost good faith and the most scrupulous inherent fairness of the bargain.” The two components of entire fairness are fair dealing and fair price. Fair dealing “embraces questions of when the transaction was timed, how it was initiated, structured, negotiated, disclosed to the directors, and how the approvals of the directors and the stockholders were obtained.” Fair price “assures the transaction was substantively fair by examining ‘the economic and financial considerations.'

SEC Approves PCAOB's "Communication with Audit Committee re: Independence" Proposal

Yesterday, the SEC issued this order approving the PCAOB's proposal regarding communications with audit committees regarding independence.

- Broc Romanek

August 25, 2008

The PCAOB (and Sarbanes-Oxley) Lives!

Despite indications that the holding would be the opposite, the DC Circuit Court of Appeals delivered an opinion in Free Enterprise v. PCAOB which upheld - by a 2-1 vote - the constitutionality of the Public Company Accounting Oversight Board on Friday. Here is a statement from SEC Chairman Cox - and here is a PCAOB statement.

The Court of Appeals decision upholds a lower court decision from eighteen months ago. The WSJ reports in this article that the plaintiffs intend to appeal either for a rehearing before the full DC Appeals court or to the US Supreme Court.

In eighteen parts, Professor Jay Brown has some analysis of the decision in his "Race to the Bottom" Blog. And here is an excerpt from a Washington Post article:

"Writing for the appeals court panel's majority, Judge Judith W. Rogers said the plaintiffs lost the bulk of their case more than 70 years ago when the Supreme Court upheld the constitutionality of independent agencies. In addition, the SEC, whose members are nominated by the president and confirmed by the Senate, has broad authority over the board, including the power to change its rules, limit its operations and block any sanctions it proposes against auditors, she said.

The Sarbanes-Oxley Act "vests a broad range of duties" in the accounting oversight board, but the board's "exercise of those duties is subject to check" by the SEC "at every significant step," Rogers wrote. She was joined in the majority by Judge Janice Rogers Brown.

In an impassioned dissent, Judge Brett M. Kavanaugh wrote that the Sarbanes-Oxley Act renders the PCAOB "unaccountable and divorced from Presidential control to a degree not previously countenanced in our constitutional structure." The majority sided with U.S. District Judge James Robertson, who threw out the suit last year, asserting that its legal theories did not merit a trial."

The SEC's Big "End of Summer" Rulemaking Binge

On Wednesday, the SEC will hold an open Commission meeting to consider:

- proposing an IFRS roadmap

- adopting rule amendments regarding the circumstances under which a foreign private issuer is required to register equity securities under Section 12(g)

- adopting amendments to foreign private issuer form/rules that are intended to enhance the information that is available to investors

- adopting an expansion of the cross-border business combination transactions and rights offerings exemptions and adopting changes to the beneficial ownership reporting rules to permit certain foreign institutions to file reports on a shorter form (as well as issuing interpretive guidance related to cross-border transactions)

- Broc Romanek

August 22, 2008

Analyst "Quiet Period Practices Survey

It's gonna be light blogging from here until Labor Day. To amuse yourself, take a moment and participate in this Quick Survey on Analyst "Quiet Period Practices. This will help us all gauge how analyst quiet periods differ from insider trading blackout policies as well as Regulation FD policies.

And also take a moment to fill out this Quick Survey on CEO Succession Planning.

Harvey Pitt and His Naked Short Selling Compliance Role

On the heels of the news that former SEC Chairman Harvey Pitt is one of the forces behind a new web-based electronic stock lending and location service, the State of Alabama tapped Harvey to become a Deputy Attorney General so that he can investigate naked short selling activities that impact companies in the state. Here is a column from NY Times' Floyd Norris.

I have all the respect in the world for Harvey (I believe his work as SEC Chair in the wake of SOX and 9/11 is unparalleled in the history of the SEC) - so I hope he isn't getting in over his head here. Criticism for his role in short selling (as well as the identity of one of his partners in his new venture) has started and may not abate. Here is a blog about possible conflicts from DealBreaker.

- Broc Romanek

August 21, 2008

Connecticut Treasurer Obtains Better Internal Pay Equity Disclosure

Recently, the Connecticut Treasurer - through the Connecticut Retirement Plans and Trust Funds - issued this press release to announce that it has withdrawn shareholder proposals at Abercrombie & Fitch and Supervalu after the companies pledged to disclose information relating to pay differences among top executives. Although it's unknown whether these two companies will adopt all of the requested elements sought by the withdrawn shareholder proposals (their proxy statements have vague statements about use of internal pay equity), here are the four pieces of the internal pay equity policy that the Connecticut Treasurer proposed:

- The Committee should receive data on internal pay equity at peer group companies at least annually.
- The Committee should consider internal pay equity in (a) the establishment, modification and termination of senior executive pay plans and programs and (b) making specific awards under those plans and programs.
- The Committee should provide the internal pay equity data it receives, as well as any analysis performed by it or its outside advisors, to the board as a whole (or an appropriate Board committee) at least annually to assist in evaluating succession planning.
- The Company should disclose to stockholders on its website or in its proxy statement the role of internal pay equity considerations in the process of setting compensation for the CEO and other NEOs.

It will be interesting to see how more shareholders demand changes in board's benchmarking practices in the near future. We have posted copies of the internal pay equity shareholder proposals in our "Internal Pay Equity" Practice Area on

Study: Leadership Pay Disparities

While we're on the topic of internal pay equity, here is an interesting excerpt from Professor Lisa Fairfax posted on the "Conglomerate Blog":

I recently ran across a 2007 study conducted by the Institute for Policy Studies, a progressive research center, which published figures on the pay disparities of various people in leadership positions. Based on 2005 and 2006 data, the study focused on the median salaries for the twenty highest paid individuals in various sectors. It found the following:

- Congress members: $171,720
- Military leaders: $178,542
- Federal executive branch: $198,369
- Heads of non-profit organizations: $968,698
- Heads of publicly held companies: $36.4 million

Recently, I posted this same blurb on "The Advisor's Blog" on and received quite a variety of responses. Some criticized the way the study was prepared - some had a visceral reaction to the stats...

CEO Pay Remains in the News

Warning signs over excessive pay and those who won't stand for it anymore continue to pop up all around us. For example, recently - as noted in this Washington Post article - the Maryland Insurance Commissioner cut in half the $18 million severance package paid to a former CareFirst BlueCross BlueShield CEO, saying the CareFirst board failed to restrain his compensation.

It's also noteworthy that UnitedHealth Group has settled the two class action lawsuits over its options backdating for the unbelievable amount of $912 million (this is on top of the more than $600 million the former CEO has proposed to repay to settle the lawsuit against him). Shortly afterwards, the company announced it was laying off 6% of its workforce.

- Broc Romanek

August 20, 2008

Alas, EDGAR R.I.P.

As Dave gave us the heads up yesterday in this blog, the SEC held a press conference yesterday to announce that EDGAR will be succeeded by a new filing platform called "IDEA," which is short for "Interactive Data Electronic Applications." As noted in this press release, this new platform is based on the SEC's XBRL initiative and IDEA will at first supplement and then replace EDGAR.

In his "IR Web Report," Dominic Jones reports that SEC Chairman Cox said that IDEA won't be fully mature for five years - and he noted that the press conference didn't reveal anything all that newsworthy. The thing that struck me when I read Dominic's blog is he notes the likely motivation for the SEC to hold a press conference with nothing really new to report: an attempt to wake up companies to the fact that XBRL is coming. Dominic notes: "I guess I’m just not attuned to the idea of regulators as marketers."

The big news out of the press conference is that the SEC intends to kill off its most valuable brand by choosing to rename EDGAR. In my opinion, it's a horrible marketing move for the SEC even if the underlying architecture is being completely replaced. If there is one thing that all investors - large and small - know about the SEC, it's that they can find information about public companies on "EDGAR." Everyone knows what the term means; it has a twenty-year plus history and the term is unique. "IDEA" will need to be branded anew and my guess is that this term is so common in our language that folks will come up with a nickname for it (or simply continue to call it "EDGAR") to distinguish it from the common use of the term "idea."

Note that I'm not being critical because Dave and I were once again left out of the group of bloggers invited to the SEC's press conference. We already had another party to go to. Besides I would have moaned that I’m really getting sick of the incredibly poor animation and voice-over at the top of the SEC's home page - and it’s only been one day! I'm surprised that there isn't an IDEA mascot, maybe a duck or a bear - something preferably with an extra large head...

Our "3rd Annual Proxy Disclosure" Conference: Hotel Nearly Full

All of our Conferences - "Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference"; "5th Annual Executive Compensation Conference" and "16th Annual NASPP Conference" - will be held during the week of October 20-24th at the Hilton New Orleans Riverside.

Note that the Hilton New Orleans Riverside is almost sold out - so act today by registering for the hotel online or call them at 504.561.0500. If you are unable to secure a room at the Hilton New Orleans Riverside, we have secured additional rooms at the Loews New Orleans Hotel (which is two blocks away from the Hilton), which you can obtain by calling 866.211.6411. We also have secured rooms at the Embassy Suites New Orleans - Convention Center, where you can register online or by calling 800.362.2779.

At any of these hotels, be sure to mention the "NASPP Annual/Executive Compensation Conference" to obtain the special Conference rate. If you have difficulty securing a room, please contact our HQ at or 925.685.9271.

FindLaw: Not Playing By Google's Rules? And Law Firms Pay...

Some pretty interesting stuff from Kevin O'Keefe's LexBlog in this blog - FindLaw appears to have been caught gaming Google by selling links to lawyer websites and, in the words of one blogger, possibly scamming their lawyer customers. Here is Kevin's follow-up blog expressing disbelief that FindLaw and its parent, Thomson Reuters, has not done anything in the way of damage control with its law firm clients.

- Broc Romanek

August 19, 2008

Help for Short Sellers

In the wake of the recent SEC focus on naked short selling, former SEC Chairman Harvey Pitt is teaming up with the CEOs of two existing services to launch, a new web-based electronic stock lending and location service. As noted in this Washington Post article, the website will provide access to, a lending-borrow marketplace focused on hard-to-borrow stocks, and, which identifies demand for borrowed stocks and provides a historical database of short sale transactions. joins others providing similar services, such as,, ICAP and Quadriserv. If a pre-borrow requirement similar to the recent emergency order goes into effect for the entire market (as I discussed in the blog last week), these services are likely to see quite a boost in business.

A George Jetson Disclosure System?

The SEC has announced a news conference for today at 11:00 am eastern time with the tagline “SEC Chairman Cox to Unveil Futuristic Information Disclosure System for Investors and Markets.” While the term “futuristic” evokes images of hovercraft and floating treadmills to walk the dog on for me, perhaps what the news conference is really about is scrapping our old friend EDGAR. An article in this morning’s Washington Post notes that the SEC’s plans to replace EDGAR with IDEA, which stands for "Interactive Data Electronic Applications." I have not heard of this IDEA platform before, but apparently its implementation will coincide with the phase-in of XBRL and will involve a move away from the “document” based approach of EDGAR. Tune in at 11:00 to learn more.

For some reason the notice for today’s press conference also reminded me of one of my all-time favorite John Prine songs, “Living in the Future.” The chorus goes:

We are living in the future
I’ll tell you how I know
I read it in the paper
Fifteen years ago
We’re all driving rocket ships
And talking with our minds
And wearing turquoise jewelry
And standing in soup lines
We are standing in soup lines

The Birth of a New National Securities Exchange

Yesterday, the SEC approved the application of BATS Exchange, Inc. for registration as a national securities exchange. As noted in this article from today’s WSJ, BATS stands for “Better Alternative Trading System” and the exchange expects to be up and running in about two months. The BATS electronic trading network was established in 2006 and already trades about 10% of the share activity on NYSE and Nasdaq-listed stocks. The firm’s goal as an exchange is to up its market share to 25%, potentially posing more of a competitive threat to the established exchanges.

- Dave Lynn

August 18, 2008

Director Independence Standards Revisited

Just in time for tweaking your D&O Questionnaires, the NYSE and the Nasdaq have revised their bright-line director independence tests. As noted in this Sullivan & Cromwell memo, the NYSE is changing the direct compensation test in Section 303A.02(b)(ii) of the NYSE Listed Company Manual from $100,000 to $120,000, consistent with the SEC’s 2006 increase of the disclosure threshold in Item 404(a) of Regulation S-K. In addition, the NYSE’s standards for determining if a majority of the board is independent will now permit a director to have an immediate family member serving as an employee (not a partner) of the company’s auditor, provided that the immediate family member does not personally work on the company’s audit (see Section 303A.02(b)(iii)). This auditor affiliation tweak brings the NYSE’s standards closer to the standards of the AMEX and Nasdaq on this point. Both of these changes apply to NYSE-listed companies beginning September 11, 2008.

As noted on our “Nasdaq Speaks ‘08” webcast earlier this summer, the Nasdaq has also been seeking to revise its corporate governance listing standards so that a director may receive compensation from the company of up to $120,000 per year (rather than $100,000) and still be deemed independent for the majority of independent directors standard (of course audit committee independence is subject to a different standard). The SEC approved the Nasdaq’s change to Rule 4200(a)(15)(B) on August 8. In approving the rule change, the SEC noted that “even if a director (or a family member) received less than $120,000 in compensation from the listed company, the company’s board still would have to make an affirmative determination that the director has no relationship with the listed company that, in the board’s opinion, would interfere with the exercise of his or her independent judgment in carrying out the responsibilities of a director.”

As noted recently in our Q&A Forum, one important difference that remains between the NYSE and Nasdaq listing standards mandating a majority of independent directors is that the NYSE — unlike Nasdaq — does not provide for a cure period. As a result, when an independent director resigns and causes the company to no longer meet the standard specified in Section 303A.01 of the NYSE Listed Company Manual, the company must file a Section 303A Interim Written Affirmation notifying the NYSE that it fails to meet the continued listing standard. In addition, the company must file an Item 3.01 Form 8-K disclosing the failure to satisfy a continued listing standard. An example of this is the Form 8-K filed by CBS Corp. on December 15, 2006.

Options Backdating: Uptick in Rule 102(e) Proceedings Against Lawyers

When I started working on Rule 102(e) proceedings at the SEC in the mid-‘90s, cases seeking to bar lawyers from practicing before the Commission were almost unheard of. The focus was almost exclusively on proceedings involving accountants. Since at least the Carter & Johnson case of the early 1980s, there has been a healthy debate about the extent to which the SEC should seek to censure, suspend or bar lawyers from practicing before it. The SEC has generally taken the position that Rule 102(e) is not meant to be an enforcement tool in and of itself, but rather a means to protect the process of SEC practice, particularly once a lawyer or accountant is found to be responsible for a violation of the federal securities laws.

Now with the advent of options backdating cases, a disproportionate number of lawyers are settling to primary and secondary anti-fraud, reporting and other violations, and Rule 102(e) proceedings are showing up with increasing frequency as one of the “collateral consequences” of settling to those other violations. Typically, attorneys are barred from appearing or practicing before the SEC as an attorney, with a right to reapply after a specified number of years, or suspended altogether. Some examples of recent settled Rule 102(e) proceedings in options backdating cases are:

- Christopher Martin (HCC Insurance) - barred with a right to reapply in five years;

- Frances Jewels (Sycamore Networks) – barred as both an attorney and accountant with a right to reapply in five years;

- Robin Friedman (Sycamore Networks) – barred with a right to reapply in five years;

- William Sorin (Comverse Technology) – suspended from appearing before the SEC; and

- Leonard Goldner (Symbol Technology) – suspended from appearing before the SEC

It Must be Tough to Find Attentive Plaintiffs These Days

A court recently rejected a plaintiff seeking to serve as a class representative based on the plaintiff’s lack of familiarity with or concern for the case. Apparently, it is not good enough to just have your name listed on the complaint to serve as a class representative – you actually have to know who you are suing and have a passing knowledge of the matters involved in the litigation.

From the Alston & Bird Securities Litigation Blog:

The court in In re Monster Worldwide, Inc. Securities Litigation, No. 07 Civ. 2237, 2008 WL 2721806 (S.D.N.Y. July 14, 2008), rejected as insufficient a proposed class representative due to “inadequate familiarity with, and concern for, the litigation.” Id. at *3. Plaintiffs had filed a putative securities fraud class action against Monster Worldwide based on alleged stock option backdating practices and related accounting issues. In the course of ruling on plaintiffs’ motion to certify a class of investors for this case, the District Court for the Southern District of New York examined whether the two named plaintiffs satisfied the basic requirements of Rule 23 of the Federal Rules of Civil Procedure, including whether they would be adequate representatives for the class. Id. at *2.

The defendants had deposed the co-chairman of the Steamship Trade Association-International Longshoremen’s Association Pension Fund (the “Fund”), one of the named plaintiffs in the case. During that deposition, the witness testified that he was the person at the Fund with the most knowledge about the lawsuit. Upon reviewing the deposition transcript, the court found that the witness “did not know the name of the stock at issue in this case, did not know the name of either individual defendant, did not know whether [the Fund] ever owned Monster stock, . . . did not know whether he had ever seen any complaint in the action,” and was ignorant of various other matters pertinent to the litigation. Id. at *4. Even the second witness designated by the Fund supposedly to ‘mitigate the damage’ of the first witness’s “appalling testimony” admitted that he had only learned about the litigation a week before his deposition. Id.

In a strongly worded opinion, the court rejected the Fund as a class representative, declaring that it refused to be “a party to this sham.” Id. It was clear to the court that this plaintiff had “no interest in, genuine knowledge of, and/or meaningful involvement in [the] case” and was in effect a “willing pawn of counsel.” Id. Ultimately, the court concluded that the other proposed representative did not suffer from these same deficiencies and certified the class. Id. at*4, *8.

- Dave Lynn

August 15, 2008

FASB Proposes Changes to the EPS Standard

Last week, the FASB issued an Exposure Draft proposing amendments to FASB Statement No. 128, Earnings per Share. As with other recent proposals, the EPS changes are issued in conjunction with similar proposals of the IASB, which simultaneously issued its Exposure Draft on proposed amendments to IAS 33, Earnings per Share. The proposals reflect an effort to converge – to the extent possible – EPS guidance under US GAAP and IFRS.

Given that it is somewhat of a lost cause to attempt convergence on the calculation of earnings under US GAAP and IFRS, the FASB and the IASB have focused their efforts on clarifying the instruments that must be included in computing the “per share” amounts. The FASB is now proposing that when computing basic EPS, a company should only include the company’s current common shareholders, instruments that can currently become common shares with “little or no cost” to the holder of the instrument, or instruments that can currently participate in earnings along with the common shareholders. Under this proposed guidance, instruments such as mandatorily convertible securities would not be included in calculating basic EPS prior to conversion, unless the holders participate in current-period earnings along with the common shareholders.

Under FAS 128 today, when a company computes diluted EPS, it is to presume that any instruments which may be settled in either cash or stock will be settled in stock, except that the presumption can be overcome if the company demonstrates a past practice or policy that the instruments are settled in cash. Under the proposals, this exception is removed, forcing companies to always assume that cash or stock settled instruments will be settled in stock (except for instruments that can only be settled in stock in the event of bankruptcy but are otherwise settled in cash). The proposals also call for some changes to the treasury stock method and the reverse treasury stock method, provide some guidance on handling participating securities when computing diluted EPS and would provide that companies consider each quarter and year-to-date period as discrete when computing the number of incremental shares to include in the EPS denominator.

The comment period for both the FASB and the IASB proposals closes on December 5, 2008.

Consolidating SRO Insider Trading Surveillance

The one thing that always fascinates me about insider trading cases is that the perpetrators, who are typically smart, successful people, somehow think that they won’t get caught. I don’t think that these people realize the level of sophistication involved with the SEC’s and the exchange’s surveillance efforts, which are constantly on the lookout for unusual trading activity or trends.

Earlier this week, the SEC announced an effort to rationalize the insider trading surveillance efforts at the some of the SROs, with a proposal that FINRA will cover surveillance, investigation and enforcement with respect to insider trading for Amex and NASDAQ-listed securities (and securities listed solely on the Chicago Stock Exchange), while NYSE Regulation will maintain responsibility for the New York Stock Exchange and NYSE Arca. It appears that the remaining equity exchanges will retain their own responsibilities for surveillance, investigation and enforcement with respect to actions involving their own members.

Overall, this consolidation of regulatory authority over the major exchanges will mean less likelihood for transactions slipping between the cracks, and perhaps stonger investigative and enforcement efforts at the SRO level.

The proposed plan is out for comment for 21 days after publication in the Federal Register.

Tackling Systemic Risk: The CRMPG III Report

I think that one of the positive things to note about the financial crisis over the past year is that we have not yet seen any massive systemic failures within the financial world. Certainly there have been some major disruptions – such as the freezing of the auction rate securities market, the near-failure of Bear Stearns and some large bank failures – but we have not been faced with any sort of system-wide failures such as a massive inability to settle derivatives or widespread defaults spreading from institution to institution.

The Counterparty Risk Management Policy Group III – which is led by former New York Fed President (and current Goldman Sachs Managing Director) Gerald Corrigan and HSBC’s Douglas Flint, and includes senior management from a number of major financial institutions – released its report last week on how financial institutions can seek to contain systemic risks. The report is built around five precepts that organizations must adhere to when implementing the group’s detailed recommendations:

- a corporate governance culture balancing commercial success with disciplined behavior;
- effective risk monitoring of all positions on a real time basis;
- estimating the firm’s risk appetite;
- focusing on potential contagion risks; and
- enhancing oversight.

As with the group’s prior reports, this report should be useful for firms seeking to apply what has been learned from this latest financial crisis to make progress toward reducing the unprecedented level of systemic risk.

- Dave Lynn

August 14, 2008

What’s Next for Short Sellers?

Earlier this week, the SEC’s emergency order (as amended) targeting naked short selling in the stocks of 19 financial institutions expired. In the coming weeks, the SEC is likely to propose rule changes that could extend the requirement to borrow or arrange to borrow securities prior to effecting a short sale to a broader range of companies, or to the market as a whole. In addition, last month the SEC reopened the comment period on proposed amendments to Regulation SHO (the SEC rules governing short sales). These developments set the stage for some revamping of the short sale rules this Fall, although it remains unclear just how much can actually be accomplished on this controversial topic as the election approaches.

Whether the emergency order helped or hurt Fannie Mae, Freddie Mac and the seventeen primary dealers that were covered by the order is the subject of some debate. In this New York Times piece, Floyd Norris notes mixed results. A recent WSJ article indicated that a majority of stocks covered by the emergency order saw fewer shares shorted in the latter half of July, although it is unclear how much of that is attributable to the actual (or psychological) effects of the order, or to broader market trends. A study released by Professor Arturo Bris at IMD in Switzerland notes that market quality deteriorated for the shares of the 19 companies covered by the order. Professor Bris states “Our preliminary findings show that the impetus for the SEC’s emergency order – that short selling was adversely affecting the performance of the 19 financial stocks – is groundless.” The study goes on to note that between July 21 and August 4, the shares of the 19 companies that were the subject of the order lost 3.83% of their value, or $60 billion.

So far, over 460 comment letters have been submitted in response to a comment request included in the Staff’s guidance on the emergency order, with a vast majority of those comments coming from individuals. This is a pretty amazing number of comments, given that the order was effective for only 23 days and the comments don’t appear to reflect any sort of form letter campaign (although a few commenters were apparently inspired to write in by CNBC’s Jim Kramer).

One thing is for certain when looking through these comment letters: short selling – and in particular naked short selling – inspires a great deal of investor anger and frustration. Many commenters expressed concern that the SEC has not adequately enforced the existing short sale rules, and many call for extending the emergency order to all stocks. Naked short selling has been a “populist” cause for some time now among smaller companies (and their investors), who have felt that they have been unfairly targeted – and in some cases destroyed – by naked short sellers while the SEC has done little to stop the practice. It now appears that the emergency order has raised the issue’s profile, grabbing the attention of a much broader cross-section of investors.

I think the SEC’s internet comment form has been a great innovation for soliciting comments from a broader range of interested persons, but the comments on the emergency order sometimes seem like they are better suited for a Yahoo Finance Message Board. One commenter remarks “[p]ersonally, I think that the entire SEC should be tarred and feathered for the job they have done over the years,” while this comment letter can be best described as a tirade and ends with the question: “And what's the deal with not allowing exclamation points to be used in these comments??”

Nostalgia for the Uptick Rule

Many of those submitting comments on the naked short selling emergency order asked the SEC to bring back the “uptick” rule, which was eliminated last summer after a 70-year run. The rule was originally adopted out of concern about “bear raids” and their contribution to the 1937 market break (sound familiar?). While perhaps more of a symbolic gesture than an actual means of deterring short selling abuses, Rule 10a-1 had provided that, subject to some exceptions, a listed security could only be sold short at a price above the price at which the immediately preceding sale was effected (a plus-tick) or at the last sale price if it was higher than the last different price (a zero-plus tick). Short sales were not permitted on minus ticks or zero-minus ticks, subject to some limited exceptions. (Nasdaq had adopted similar restrictions via a bid test, since it was not an exchange at the time.)

Of course, last summer, when the uptick rule was abandoned, times were good – you could still get a mortgage without any income and you could fill up your SUV for under $3.00 per gallon – and the possibility of a prolonged bear market seemed remote. At the time, the SEC had concluded that the uptick test had modestly reduced market liquidity and did not appear to be necessary to prevent manipulation.

Today, a groundswell of support for bringing back the uptick test seems to be developing. Last month, Representative Gary Ackerman (D-NY), a member of the House Financial Services Committee, introduced legislation that would reinstate the uptick rule. Further, Chairman Cox has talked about the possibility of revisiting the rule. While bringing back the uptick rule is not part of the package of proposed amendments to Regulation SHO for which the comment period was recently reopened, the SEC will no doubt feel pressure to take another look at its decision on Rule 10a-1 as it delves into broader short selling issues over the next few months.

Are Covered Bonds the Answer to Mortgage Financing Woes?

Recently, Treasury Secretary Paulson stated that covered bonds “have the potential to increase mortgage financing, improve underwriting standards, and strengthen U.S. financial institutions by providing a new funding source that will diversify their overall portfolio.” Covered bonds are a special category of debt instruments that provide for recourse to the issuer or a “cover pool” of collateral that is segregated from the issuer’s assets. Covered bonds make up a $3 trillion market in Europe, and are now being looked out as a major financing alternative in the US.

In this podcast, Anna Pinedo of Morrison & Foerster discusses covered bonds, including:

- What is a covered bond?
- Why has the covered bond market in the United States lagged behind other markets?
- How do covered bonds differ from securitizations?
- What assets can be used to constitute a cover pool?
- What are the latest regulatory changes in the United States regarding covered bonds?
- What does the FDIC Policy Statement on Covered Bonds do for the market? What about the Treasury Best Practices?
- How have the covered bond markets responded to these regulatory changes?

- Dave Lynn

August 13, 2008

Rush for the Exits: Why Foreign Firms Leave the US

In a new study, G. Andrew Karolyi and René Stulz of Ohio State and Craig Doidge of the University of Toronto looked at 59 companies that took advantage of Exchange Act Rule 12h-6 (adopted in March 2007) to deregister and leave the US market. This study appears to be the first look at the hard data following the SEC’s efforts to ease deregistration for foreign firms, and offers some glimpses into the arguments about US competitiveness in the capital markets.

The authors found that the firms deregistering in the first six months after Rule 12h-6 was adopted generally exhibited poor growth opportunities, come from more economically developed countries and experienced poor stock price performance in the years prior to deregistration. Of the 59 firms studied, 19% were from Europe, 12% were from Australia and 10% were from Canada.

Upon announcing their delisting, the firms experienced either no or a negative stock price reaction, although those firms with greater growth opportunities experienced a significantly worse stock price reaction. The authors of the study were not able to definitively establish the extent to which the Sarbanes-Oxley Act adversely affected the firms that deregistered.

The authors admit that some of the tests performed may have been limited by the small sample size of only 59 firms. Perhaps it may be too early to tell what the long term effects of Rule 12h-6 will be, but certainly the study supports the notion that no great “pop” can be expected in a firm’s value from leaving the US. Further, with the movement toward global accounting standards and mutual recognition occuring in the US while other developed countries implement Sarbanes-Oxley-like reforms, it could be expected that any loss of competitiveness arguments (and perceived benefits of dropping a US listing) will continue to lose steam.

For more on Rule 12h-6 and foreign issuer deregistration, check out our “Deregistration & Modified Reporting” Practice Area.

Auction Rate Settlements (In Principle)

Last week, the Division of Enforcement announced preliminary settlements in principle with Citigroup and UBS in cases arising from the collapse of the auction rate securities market, and more such settlements are likely on the way. Merrill Lynch announced that it was voluntarily buying back auction rate securities from retail customers beginning in January 2009.

The Citigroup and UBS settlements, if ultimately approved by the SEC, would provide for the extreme result of obligating the firms to repurchase the securities at par from smaller investors and making those investors whole in some instances, while liquidating auction rate securities from institutional investor accounts by the end of next year. The firms would be prohibited from selling their own inventory of these securities before the customers’ holdings are liquidated. The firms also would be obligated to provide no-cost loans to customers that will remain outstanding until all auction rate securities are repurchased. The firms face the possibility of penalties, depending on whether they adequately perform on their obligations under the terms of the settlement.

I have spoken with a number of people harmed in the auction rate securities meltdown, and I am encouraged to see that these settlements focus on very direct ways at helping investors, particularly the smaller investors that suffered the most as a result of the collapse of liquidity in the market.

It remains to be seen what relief – if any – these firms will get from the tender offer rules or other requirements when complying with the terms of the settlement, although there is some talk that relief might be forthcoming.

It is pretty rare to see the Staff announce a settlement agreement in principle (that is to say, still subject to Commission approval) in an Enforcement investigation. The last time I can recall it happening was with the global settlement in the research analyst cases, which like these auction rate cases involved joint settlements with state regulators. I suspect that the Commissioners may have been involved in the formulation of these auction rate securities settlements, given the enormity of this matter, and perhaps now there is less hostility at the Commission level to the Staff negotiating and reaching settlements that are subject to Commission approval.

Marty Dunn’s Second “Pro or Troll” on Shareholder Proposals

Test your skills with our new game courtesy of Marty Dunn of O'Melveny & Myers – “Pro or Troll #10: Shareholder Proposal Subject Matter.” This game delves into the Staff’s positions on several notable shareholder proposals.

- Dave Lynn

August 12, 2008

Midyear Corp Fin Update

Yesterday, at the ABA meeting in New York, John White provided his mid-year update on Corp Fin’s 2008 activities and priorities. There is no doubt from his speech that Corp Fin will remain very busy well into 2009, with projects spanning a wide range of topics. Here is the complete text of the speech, which includes details on all of Corp Fin's big projects and comments on the shareholder proposal season.

With respect to accounting and financial reporting, Corp Fin will be working to implement some of the final recommendations of the Advisory Committee on Improvements to Financial Reporting. With the guidance on use of company websites already done, the Staff is working on Commission-level guidance concerning other issues raised by the Committee, such as materiality and the correction of errors. In addition, the Committee’s recommendation to require an executive summary in Exchange Act reports is under serious consideration, given how such an approach could tie into the SEC’s website guidance, the 21st century disclosure initiative, and XBRL. IFRS continues to be a high priority, with a recommendation expected soon on the anticipated roadmap for IFRS implementation, which will ultimately be in the form of some Commission action. Finally, accounting guidance from Corp Fin’s Chief Accountant’s Office – in a format that is comparable to the new Compliance and Disclosure Interpretations – is expected by the end of the summer.

On the international front, the Staff is considering the comments received on the proposals dealing with foreign issuer registration and reporting, as well as the cross-border tender offer rules.

Obviously XBRL remains on the front burner, and John indicated a high likelihood of completion of the first steps in implementing XBRL. The Staff is considering all of the comments (76 comment letters have been submitted so far), including those comments seeking to delay the effective dates.

In terms of other projects, John noted that the much-anticipated Regulation D amendments are still on his list, and that he hopes to see something coming out on those proposals. The proposals dealing with NRSRO references in SEC rules will clearly get done this year in John’s view, given the urgency associated with those proposals. John also indicated that there is a Commission-wide effort to look at adjusting dollar amount thresholds in the SEC’s rules for inflation, both now and in the future. (See the July-August issue of The Corporate Counsel for a discussion of how the SEC backed off of a proposed inflation adjustment provision in the smaller reporting company rules.) On the e-proxy front, the Staff has been monitoring all of the issues that have come to light with the first year of implementation, and is considering ways to address them. John indicated a preference to do some sort of clean-up rulemaking this Fall to have in place for next proxy season – but if that timing does not work out, then something would be done next year.

In terms of longer-term projects, John referenced the 21st century disclosure initiative, which he described as a refinement of integrated disclosure while factoring in current technology. The goal for this project remains to have blueprint developed by the end of this year, followed by the formation of an advisory committee. Further, the Staff intends to take up a project looking at beneficial ownership reporting.

Apparently among the things not on the list of priorities are (1) the previously discussed possibility of voluntary filer guidance, and (2) any effort to address the uncertainty created by the three federal district courts that have dismissed Section 5 actions against investors that shorted PIPE shares.

Lawyers in the Crosshairs in Subprime Cases?

More from the ABA Meeting this past weekend: In a panel discussion of SEC Enforcement activities, the possibility was raised that lawyers could be targeted for their role in the subprime fiasco. This article from the ABA Journal notes:

“This time the Securities and Exchange Commission may be the plaintiff in civil complaints that target lawyers for their role advising lenders and securitizing loans for sale to investors.

Reid Muoio, assistant director of the SEC’s division of enforcement, isn’t foreclosing the possibility. While private securities plaintiffs aren't permitted to bring aiding and abetting claims, the SEC has congressional authorization to do so.

‘It can be expected that if we can identify problems, we will then ask, Where were the lawyers?’ he said in an interview after the discussion. A typical aiding-and-abetting scenario might be a law firm that aids misrepresentation in a prospectus for a mortgage-backed security, he said. He cautioned that he was speaking for himself and not the SEC.

During the panel discussion, Muoio said the SEC has opened 48 investigations in the subprime mortgage mess and assigned more than 100 lawyers to the cases. The possibility of aiding-and-abetting actions – against lawyers and others – won’t be considered until the probes are further along, he said.”

Corruption or Compliance: Ernst & Young’s Global Fraud Survey

The DOJ and SEC have significantly stepped up FCPA enforcement efforts, focusing attention on the fact that corruption remains pervasive around the world. In this podcast, Brian Loughman discusses Ernst & Young’s 10th Global Fraud Survey, which focuses on anti-corruption efforts and compliance, including:

- What is the background of E&Y’s Global Fraud Survey?
- What were the major findings of this year’s Survey?
- Were any findings surprising?
- What advice do you have for companies in light of the Survey findings?

- Dave Lynn

August 11, 2008

The FAS 5 Proposal Controversy

One of the hot topics at this weekend's ABA Annual Meeting was the early June proposal by the FASB that would require companies to disclosure more about their litigation risks (here is Dave's blog outlining the proposal). Here is the ABA's comment letter that was just submitted; comments are due now. Here are the rest of the comment letters.

One member called the proposal a "Summertime Submarine" as many lawyers feel that the accountants are mounting a major attack on the attorney-client privilege and a disturbance on the ABA's Accord regarding lawyers' responses to auditor inquiries adopted back in 1975. Many lawyers also see that the proposal's change in FAS 5's disclosure requirements as inevitably increasing auditor demands for information and that auditors also will seek greater justification for what is disclosed. I don't remember seeing such strong opinions expressed by law firms in their client memos on any other topic - see these memos posted in our "Contingencies" Practice Area.

California Court of Appeal: Coerced Disclosure Doesn't Waive Privilege

From Keith Bishop: Here is a significant decision - UC Regents v. Superior Court - issued a few weeks ago by the California Court of Appeal. I think the following quotation from the case pretty much sums up the holding:

"Although no California cases have considered this issue directly, the cases which have discussed waiver of the privileges have found that the holder of a privilege need only take "reasonable steps" to protect privileged communications. No case has required that the holder of a privilege take extraordinary or heroic measures to preserve the confidentiality of such communications. Here, the threat of regulatory action and indictment posed the risk of significant costs and consequences to the corporations such that they could cooperate with the Department of Justice's investigation without waiving the privilege."

While this holding may seem protective of the privilege, I think that it may well have the effect of eroding it. Ultimately the attorney-client privilege may be weakened by allowing selective disclosure without waiver. Another thing to keep in mind is that this decision relates to the California Evidence Code. I always tell my clients that there is no one attorney-client privilege as it depends upon the court in which the question arises.

More Fraud Reported Through Tips Than Audits

This SmartPros article - that contains stats from a survey - about how more fraud is caught through tips than the auditing process caught my eye. It's interesting that despite increased focus on anti-fraud controls in the wake of Sarbanes-Oxley - and mandated consideration of fraud in financial audits due to SAS 99 - the latest data shows that occupational frauds are much more likely to be detected by a tip than by audits, controls or any other means.

I'm a little surprised, although I guess I shouldn't be - Section 16 is probably the best enforced provision of the securities laws and it's mainly due to the enforcement mechanism is driven by greed...

- Broc Romanek

August 8, 2008

Impact of Executive Compensation Disclosures on Creditors

In this podcast, Chris Plath of Moody's Investors Service discusses Moody's new report entitled "Expanded Disclosure On U.S. Executive Compensation Offers New Clues For Creditors," including:

- Why has Moody's issued this new report?
- How can better disclosure of performance metrics targets enhance a creditworthiness evaluation?
- What type of peer group benchmarking disclosure is Moody's looking for?
- How about for payments following a change in control?

SEC Amends Definition of "Eligible Portfolio Company" Under the '40 Act

A while back, the SEC adopted amendments to the rule under the Investment Company Act of 1940 to more closely align the definition of eligible portfolio company - and the investment activities of business development companies - with the purpose that Congress intended by expanding the definition to include certain companies that list their securities on a national securities exchange, among other things. Here is the SEC's press release. And here is an interview with Harry Pangas of Sutherland Asbill about business development companies in a nutshell...

Gatekeepers: The Professions and Corporate Governance

I haven't done much in the way of book reviews, so I thought's Jim McRitchie's review of the new book - "Gatekeepers: The Professions and Corporate Governance" - by well-known Columbia Professor John Coffee was worth repeating below given all the reforms currently on the table:

Although the book was written in the wake of Enron and WorldCom, it is equally applicable to the subprime debacle in its analysis of “gatekeeper failure.” In a personal note to me, Professor Coffee laments, “perhaps I should have waited a year longer to write this book.” Better he should have written it a couple of years earlier, with copies to Alan Greenspan and others charged with regulating and rating the mortgage industry.

However, the book's timing could hardly be better, since substantive reform only seems to occur with a crisis. Implosion of the savings and Loan Industry brought us the Federal Institutions Reform, Recovery and Enforcement Act of 1989. Accounting scandals at Enron, WorldCom, etc. brought us the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes Oxley). The subprime debacle is likely to bring significant reform as well.

It would be great if those advising Presidential candidates would consult Gatekeepers in preparing such proposals. Coffee focuses on auditors, attorneys, securities analysts and credit-rating agencies who inform and advise corporate managers, boards and shareholders. After a brief introduction explaining the failure of gatekeepers and a comparative overview of their roles internationally, Coffee devotes a chapter to each of the four groups. He typically provides an informative history, a review of current issues such as conflicts of interests, and an evaluation. He wraps up the book with a thematic discussion of what's gone wrong and how it might be fixed.

In general, gatekeepers act as “reputational intermediaries” by verifying corporate statements to investors. When trusted and successful, this lowers the cost of capital. However, as Coffee notes, “Watchdogs hired by those they are to watch typically turn into pets, not guardians,” especially in the euphoric environment typified by stock or housing bubbles, when the public is typically lulled into complacency.

As management incentives were aligned with shareholders through options, income smoothing gave way to robbing the future for earnings that could be recognized immediately. Coffee explains how Enron's audit committee was blinded by professional advisers who fed it only the information senior management wanted them to have. Auditors were retrained and incentivized to sell consulting services. He explains why fund managers and gatekeepers tend to herd and why, until four days before Enron declared bankruptcy, its debt was rated “investment grade.' Only those with a financial self-interest, the short-sellers, searched beyond the surface and predicted Enron's accounting restatements. At WorldCom, “the limited due diligence that was conducted appears to have been constrained by the need not to offend the client” and the actual fraud was detected by the firm's internal auditors.

Coffee helps the reader see from a different perspective. For example, while some studies have found that audit firms with high consulting revenues were more likely to acquiesce to questionable earnings management, others found no such correlation. Coffee points out that instead of looking what is already in hand, we should look to possibilities. “The real conflict lies not in the actual receipt of high fees, but in their expected receipt.” That explains why audits became a “loss leader” to obtain consulting services.

Similarly, disclosure of conflicts of interests often does not lead to expected results. Social psychologists find those on the receiving end often let down their guard, thinking because conflicts were disclosed they are being dealt with fairly. However, the conflicted party often feels that, having made the disclosure, they are now free to pursue their own interests aggressively. Gatekeepers is filled with such insights.

The major problem is that gatekeepers have come to view corporate managers, not shareowners, as their principals. Their livelihood depends on being viewed as flexible, problem-solving and cooperative, rather than rigorous or principled. “If left to their own devices and subjected to a significant threat of private litigation, professionals will respond by defining GAAP and auditing standards in their own interest, rather than that of investors.” “Absent a litigation threat, professionals acquiesce in dubious and risky practices that their 'client' wants; but once subjected to an adequate litigation threat, professionals insist upon narrow duties, hopelessly specific safe harbors and a rule-base system that often seems devoid of meaningful principles.”

According to Coffee, “The challenge for the regulator is not to take discretion out of the system, but to preserve and expand it. But discretion must be accorded to the gatekeeper, not the client (whereas present-day GAAP does the reverse).” The gatekeeper must assess not simply whether GAAP contains a rule authorizing a given treatment, but whether discretion so exercised is reasonable. Pressure to reform must come from regulators, investors and the young that the profession hopes to recruit who would find that greater discretion enhances the professions' image in their own eyes and those of the public.

Some of Coffee's more interesting recommendations, at least as I read them:

- Break-up the major accounting firms to provide more competition.
- Establish an intermediary that receives payment from the issuer but then selects the analyst based on objective criteria, such as their record of predictions.
- Restore “aiding and abetting” liability for professionals instead of de facto immunity for knowingly or recklessly participating in fraud.
- Formalize the role of “disclosure counsel” by requiring audit committees to retain them to investigate and test corporate disclosures on an on-going basis.

- Broc Romanek

August 7, 2008

More on Steve Jobs and Disclosure of Health Issues

I got quite a few responses to my blog on whether Apple should have handled its disclosure issues related to CEO's Steve Jobs differently. In fact, NY Times' reporter Joe Nocera wrote a great column on the topic the day after my blog.

Here are excerpts from several responses from members:

- The Jobs situation is a good illustration of the affirmative-duty-to-disclose question, which a lot of junior lawyers have a hard time grasping,

- Interestingly, some companies create problems for themselves when they throw in a risk factor about dependence on key management personnel, largely to stroke the ego of their CEO who could be replaced without much difficulty.

- The health disclosure question comes to a head when the CEO/CFO certifications must be filed. At what point is someone else effectively functioning as PEO or PFO? Let's imagine a PEO/PFO is in a car accident or a coma, or just "out of sorts" for a couple weeks. Should companies start thinking about implementing procedures like the 25th Amendment to the US Constitution? That would be the logical extension of the Form 8-K Item 5.02 and certification issue.

I've done the analysis about whether a company could have an obligation to disclose health problems of its CEO and I normally would have agreed with your suggestion that Item 5.02(b) (retirement, resignation or termination) might be triggered if a CEO became so debilitated that he wasn't truly functioning in that position. However, I keep coming back to the recent SEC Staff guidance that Item 5.02(b) is not even triggered when the CEO dies in office (see Interpretation 217.04 of Form 8-K CDIs)! How bizarre is that!

- One might consider whether information concerning Steve Jobs' health something that a reasonable investor would want to know in making a buy/sell decision regarding Apple stock (and thus would be considered "material" under a TSC v. Northway analysis) as contrasted with mere intrigue surrounding a celebrity CEO (which is not particularly relevant to investors). If the former, one would think it is difficult for Apple not to disclose in connection with, say, a Form 10-K or 10-Q filing because its contains MD&A, which has broad materiality-based disclosure requirements. If the latter, there should be no disclosure obligation.

As a policy matter, query whether the investing public is better served by all companies including a risk factor stating that from time to time key personnel may have illnesses, which could be serious, might interrupt service to the company and that the interruption might be permanent. Further consider if anyone is served by a disclaimer of any duty to update info about the health of key personnel to the extent disclosure occurs.

Your Take: What Should Have Apple Done?

Here is a poll where you can anonymously provide your legal analysis:

- Broc Romanek

August 6, 2008

I Love New York (Companies)

Most large US public companies are incorporated in Delaware, but not all. You may ask: why did some blue chip companies choose to incorporate in New York rather than Delaware, which has long been favored because of its efficient corporate law structure and renowned courts whose justices are business savvy? Because these companies were formed long before Delaware earned its well-deserved reputation. Long-standing New York companies include General Electric (1892), International Paper (predecessor company incorporated in 1898), Xerox (1906) and IBM (1911).

In many areas, New York law and Delaware law are similar. In fact, New York recently passed two amendments to its business corporations law (signed into law by Gov. Patterson on July 22nd) that will put New York companies on equal footing with their Delaware counterparts in certain areas.

The first amendment - S.7350 / A.10824 - allows companies to move from the default plurality standard for director elections to majority election via a bylaws amendment. Until now, New York companies could only change from a plurality to a majority standard by amending their charters, which requires shareholder approval (and under the SEC's rules, the filing of preliminary proxy materials). Delaware companies have always been able to easily make this change through a bylaws amendment, which does not require shareholder approval.

The other amendment - S.7349 / A.10825 - allows New York companies to pay dividends out of either surplus or net profits, which is consistent with Delaware law. Previously, New York companies could only pay dividends out of surplus.

I imagine that New York companies are happy that their state legislature is staying on top of issues like this - and these moves are seen as friendly to both companies and their shareholders.

Now Available: RiskMetrics' Annual Policy Survey

RiskMetrics has opened its annual policy survey to corporate issuers in the United States as well as global institutional investor clients. This year, they desire to gather corporate views earlier in the policy formulation process. The survey questions are nearly identical for both the institutional and issuer surveys - both seeking a broad perspective on the policy topics they're investigating for the 2009 proxy season, including compensation, board elections, director independence and more.

As in recent years, RiskMetrics will also hold an open comment period in the Fall to solicit specific feedback on their proposed policy changes.

How to Handle Hedge Fund Activism

On, we have posted the transcript from our recent popular webcast: "How to Handle Hedge Fund Activism."

When Will Michael Phelps Be Swimming for His Eight Medals?

Both my boys are competitive swimmers (and my wife used to be) and Kate Ziegler grew up swimming in our neighborhood, so we're pretty excited about Michael Phelps and Katie Hoff's upcoming events at the 2008 Beijing Olympics.

However, I had a hard time figuring out when Michael would be swimming when we are on vacation next week - here is what I figured out from this complex NBC Olympic schedule (all gold medal swimming events will be shown live and at night Eastern Time; but it's unknown when at night they will be swimming):

1. 400 IM - Saturday, 8/9

2. 100 Free Relay - Sunday, 8/10

3. 200 Free - Monday, 8/11

4. 200 Fly - Tuesday, 8/12

5. 200 Free Relay - Tuesday, 8/12

6. 200 IM - Thursday, 8/14

7. 100 Fly - Friday, 8/15

8. 100 Medley Relay - Saturday, 8/16

- Broc Romanek

August 5, 2008

Broadridge's "Final" E-Proxy Stats for the Proxy Season

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

- 653 companies have used voluntary e-proxy so far (this pretty much is the head count for this proxy season)

- Size range of companies using e-proxy varies considerably; all shapes and sizes (eg. 32% 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% a few months ago)

- 1.1% of shareholders requested paper after receiving a notice; this average is about double what the trend was a few months ago

- 57% of companies using e-proxy had routine matters on their meeting agenda; another 31% had non-routine matters proposed by management; and 12% had non-routine matters proposed by shareholders. None were contested elections.

- Retail vote goes down dramatically using e-proxy (based on 586 meeting results); number of retail accounts voting drops from 20.6% to 5.5% (over a 73% drop) and number of retail shares voting drops from 34.8% to 16.7% (a 52% drop)

A Note on Bifurcation

A number of members whose companies bifurcated have told me that a primary reason they did so was because Broadridge maintains a database of investors who prefer paper. So far 2.5 million investors have asked to be in this database.

Many companies have a fair number of their shareholders in this database - often over double digits in terms of percentages - and these companies recognized that it would be challenging to do a notice-only delivery and risk fulfillment issues (egs. not printing enough to meet demand; service provider botching the fulfillment, etc.). For these companies, it was better to bifurcate and keep the number of shareholders who requested paper much lower than it otherwise would have been the case.

In other words, the relative level of shareholders that requested paper would be a bit higher than the 1.1% experienced if these companies had not bifurcated (if I comprehend the Broadridge stats correctly). But this all still begs the question of why so many companies didn't bother to bifurcate? I imagine they will next year to reap the cost savings available...

The Yahoo Annual Meeting: My, My, How Things Change

I got a chuckle out of the Washington Post's headline for the Yahoo annual shareholders' meeting this Saturday: "Shareholders Give Yahoo a Vote of Confidence." It's funny because each director received over 75% of the vote - meaning that nearly 25% of shareholders "withheld" their votes from these directors, who ran unopposed and without a major "just vote no" campaign. [You may recall that Carl Icahn had initially challenged management by running an opposing short slate, but he was appeased and placed on the board - so he withdrew his campaign.]

It wasn't that long ago that directors routinely received 98% of the vote - so I really wouldn't call 75% a "vote of confidence." And now a major shareholder is questioning the results and asking for a recount of its votes...

- Broc Romanek

August 4, 2008

Now Available: CIFiR's Final Report

On Friday, the SEC's Advisory Committee on Improvements to Financial Reporting (CIFiR) issued its final 172-page report.

The final report has 25 recommendations for implementation by the SEC, FASB and PCAOB. Although the report is probably most important for accountants, it certainly has implications for lawyers and IROs/corporate communications. And these recommendations are likely to be taken seriously - the SEC already has acted on two of the recommendations: mandatory XBRL and guidance on company websites.

Posted: SEC's Interpretive Release on Corporate Use of Websites

On Friday, the SEC posted its interpretive release on corporate use of websites. I'm off on vacation soon - and Dave is already floundering on a beach - so it's gonna be a while before we dribble out some original thoughts...

Last SEC Commissioner Sworn In

On Friday, Troy Paredes was sworn in as a SEC Commissioner. The gang's all there now - and I imagine the shareholder access debate will resume as Chairman Cox has promised. By my count, there is a total of twelve Commissioners that have served in that capacity during the access debate...

Our August Eminders is Posted!

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

- Broc Romanek

August 1, 2008

Potential Personal Liability for Directors: Selling the Company

Kudos to Francis Pileggi and his "Delaware Corporate and Commercial Litigation Blog" for highlighting a new Delaware Chancery Court case that exposed independent directors of a public company to personal liability in a M&A context; a topic that always gets people's attention.

In Ryan v. Lyondell Chemical Company, (Del. Ch. Ct., 7/29/08), the Delaware Chancery Court found that at the procedural stage of a summary judgment motion, the issue of whether independent directors should be exposed to personal liability for their role in the sale of the company can proceed to trial - despite selling the company to the only known buyer for a substantial premium. We have posted the opinion in's "Litigation" Portal.

Here is more from Francis in his blog - and some analysis from Ideoblog and Legal Profession Blog.

SEC Approves Nasdaq's Revised SPAC Listing Standards

Earlier this week, the SEC approved Nasdaq's proposal to adopt new listing standards for SPACs. The approved listing standards are slightly different from what was originally proposed including:

- reduced amount of gross proceeds that must be deposited from 100% to 90%
- clarified period in which SPAC must complete one or more business combinations
- required all listed SPACs contain provisions allowing shareholders to convert shares into cash if they vote against a business combination

Another SEC Commissioner Sworn In

Yesterday, Luis Aguilar was sworn in as a SEC Commissioner. Only one more to go...

- Broc Romanek