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Monthly Archives: October 2011

October 31, 2011

A Global Experiment: Integrated Reporting

Last week, the International Integrated Reporting Committee (IIRC) announced that over 40 leading companies from around the world – including some in the US – have been chosen as participants in the IIRC Pilot Programme initiative. The Pilot Programme will run for two years as companies network, exchange knowledge and share experiences to help develop the Framework, which ultimately is intended to result in innovative reporting and investor practices and drive convergence in international reporting guidance.

ISS has extended the comment period by a week for its ’12 policies, with a deadline of next Monday.

A Dodd-Frank Sleeper? Large Trader Reporting

Section 13(h) of the ’34 Act was amended by Dodd-Frank to include “large trader” reporting requirements, and persons who exercise investment discretion over an account are required to file certain reports with the SEC if they trade (i) two million shares or $20 million during any day or (ii) 20 million shares or $200 million during any month. Recently, the SEC finalized rules implementing this Section and there does not appear to be an exception for operating companies that trade as part of ordinary course balance sheet management activities – thus, this could be a sleeper for many. Learn more in our “Large Trader Reporting” Practice Area.

SEC Staff Guidance: SEC and DOL Advertising Rules Interpreted Similarly

Last week, the SEC’s Division of Investment Management issued this no-action letter, at the request of the Department of Labor, confirming that disclosures made in compliance the DOL’s regulation concerning investment-related disclosures to plan participants will be treated as being consistent with the SEC’s restrictions on advertising under Rule 482. The no-action letter resolves a number of potential inconsistencies between DOL and SEC rules. Thanks to Amy Moore of Covington & Burling for the heads up!

- Broc Romanek

October 28, 2011

Report: Corporate Disclosure of Political Spending Now Norm for Largest Companies

According to a report released this morning by the CPA-Zicklin Index of Corporate Political Disclosure and Accountability – a joint effort of the Center for Political Accountability and Wharton’s Zicklin Center for Business Ethics Research – the S&P 100 are voluntarily moving to disclose their corporate expenditures on politics. This report is important in the wake of calls upon the SEC to enhance disclosure requirements in this area in the wake of the controversial Citizens United decision. Among the report’s finding are:

- Disclosure & Board Oversight – 57 companies, or almost three-fifths, disclose on their websites their direct corporate political spending and have adopted board oversight, or they prohibit spending corporate cash on politics.

- Limits on Political Spending – Almost one-third place some limits on how they spend corporate dollars on politics. Nearly one in four companies declines to make independent political expenditures, which Citizens United permits. Colgate-Palmolive and IBM decline to spend corporate funds on political activity completely.

- Top 10 Best Disclosure Companies – Based on seven key indicators, the top 10 for political transparency and accountability: Colgate-Palmolive, Exelon, IBM, Merck, Johnson & Johnson, Pfizer, UPS, Dell, Wells Fargo and EMC.

- Indirect Spending – 43 companies disclose some information about their indirect spending through trade associations or other tax-exempt groups, including 501(c)(4)s.

- Independent Expenditures – 24 companies, or one-quarter, state on their websites that they will not make independent expenditures, as Citizens United allows.

Last month, a different Zicklin Center – the Robert Zicklin Center for Corporate Integrity – was behind this report based on “The Baruch Index,” which rates the S&P 100 companies from “transparent” to “opaque,” with a system of 57 items measuring corporate political activity at all levels and branches of government.

The Latest Anti-Corruption Developments (and Benchmarking)

In this podcast, Jeff Kaplan of Kaplan & Walker explains the latest developments in the anti-corruption area including the results of a benchmarking study conducted with the FCPA Blog, including:

- What’s new in anti-corruption enforcement?
- You’ve recently completed a benchmarking survey in this area. Why did you do it?
- What are some of the interesting findings from this survey?

Judge Rakoff Questions the Citigroup-SEC Settlement: Hearing Scheduled

As covered well by Kevin LaCroix today in his “D&O Diary Blog,” Southern District of New York Judge Jed Rakoff has scheduled a November 9th hearing at which the SEC and Citigroup are directed to be prepared to answer 9 specific questions about the settlement that they reached a few days ago. Yes, this is the same judge who refused to accept a prior settlement of the SEC”s action against BofA a few years back…

- Broc Romanek

October 27, 2011

A “Wow”: CEO Pushes Reg FD Limits on Twitter

This blog from Dominic Jones of IR Web Report is a “must” read. I’m going to tease it out by excerpting the first few paragraphs below:

ALAN Meckler, CEO of WebMediaBrands Inc. (NASDAQ: WEBM), may be single-handedly redefining how corporate executives in the buttoned-down world of public companies communicate with their investors. The 64-year-old media entrepreneur, whose company owns interests in a number of online businesses and blogs, has been using Twitter to talk about his micro-cap company in ways that have stunned some observers and even drawn questions from the SEC.

While some in the conservative world of corporate disclosure have speculated about how Twitter might meet the SEC’s Reg FD requirements, Meckler appears to have made up his mind that Twitter is as good a channel as any to break news about everything from pending acquisitions to his next quarter’s results. The result is that investors in WEBM are being treated to a new level of access to their chief executive and board chairman, as well as unprecedented commentary and news about the company’s business in a real-time, abbreviated format that was previously unheard of.

It’s worth noting that Dominic just helped launch a free online IR ranking service – Investis Online IR Rankings – that should help companies gauge how they are doing with their online presence in investor relations. The initial launch includes the S&P 100, as well as a bunch of European companies. The US companies do not do well…

Time to Vote: Vote for This Blog Today

I’m excited to note that this blog was selected by LexisNexis yesterday as a “Top 25 Business Law Blog” – and that there is a voting contest among the 25 that ends on November 5th (we won the voting contest last year!) Here is the announcement – and more importantly, here’s where you can vote. Simply scroll down and click on the circle to the left of “TheCorporateCounsel.net” (it’s the 3rd bullet from the bottom) – then click “Vote” at the bottom of the page. I’m also excited that my DealLawyers.com Blog made the Top 25…

Mailed: September-October Issue of “The Corporate Executive”

We just mailed the September-October Issue of The Corporate Executive and it includes pieces on:

- What’s in Store for Say-on-Pay in 2012?
- Modifying Awards in Response to Say-on-Pay
- Trap for Unwary Executives: Cost-Basis Reporting Going Into Effect in 2012
- Tax Deposits for RS/RSUs

Act Now: Get this issue for free when you try a 2012 No-Risk Trial today.

- Broc Romanek

October 26, 2011

The SEC-Citi Settlement: A Cautionary Tale for Corporate Lawyers

Below are some interesting thoughts from Vince Pisano of Troutman Sanders:

Last week, the SEC announced the settlement with Citigroup Capital Markets of an action related to the formation and marketing of a largely synthetic collateralized debt obligation, with the collateral consisting primarily of credit default swaps referencing other collateralized debt obligations, themselves collateralized by subprime residential mortgage backed securities. Similar to the case of the SEC’s earlier action against Goldman Sachs involving the same general allegations, Citi, as the arranging bank, selected many of the assets underlying the CDO with, according to the SEC, misleading disclosure.

Also as in the case of the earlier action against Goldman Sachs, the SEC brought an individual action against the senior banker on the transaction, which has not been settled. Without delving into the intricacies of these transactions, which are very clearly designed for extremely sophisticated investors, all securities and other lawyers should take note of some important points highlighted by these actions.

The first is that we have an obligation to our clients to understand their transactions completely and to assure that the details of which we are aware are disclosed properly. We are the ones who are entrusted with understanding and explaining the details and risks of any securities transaction in which participate. We are advisors to market participants and not just deal execution assistants. It is a principle that applies to everything we do as corporate lawyers.

Second, we need to more actively help our clients engage in risk management, whether we are in house or outside counsel. There are deals that probably should not be done. When a transaction has no obvious connection to any corporate purpose, when it raises no capital or at least serves as an aide to the production of capital, we should at least make sure the proper people at our client appreciate the risks and rewards. We are not simply in place to help minimize risk in any transaction, but to help the institution understand whether any level of risk is acceptable. It is one of the things that separates the great corporate lawyers from the field.

Finally, two individual bankers, one at Goldman and one at Citi, have been charged by the SEC individually for disclosure issues. We as lawyers cannot lose sight of the fact that we must intercede to protect our clients, even over the objections of our clients. We cannot afford not to challenge and question and counsel those with whom we work. It’s what makes us part of a profession.

Chinese Regulators Battle SEC Over Document Production

According to this Reuters article, China’s Ministry of Finance and Securities Regulatory Commission have asked auditors to review their US-listed company work and provide details of any information the China-based offices may have given to foreign regulators in an effort to reminding them of Chinese confidentiality laws in the face of the SEC’s efforts to compel document production by the Shanghai office of Deloitte Touche Tohmatsu concerning a Chinese company audit.

How to Conduct Stock Repurchase Programs

In this podcast, Rachel Smydo of Thorp Reed & Armstrong discusses what to consider when conducting a stock repurchase program, including:

- Which action items should be considered ahead of a stock repurchase program?
- Through whom can a company execute actual repurchases? Does it have to be a third party?
- What type of documentation (eg. SEC filings) is the company required to prepare every time there is an actual repurchase?
- Is any documentation required when repurchases are completed?

Coming early next year is an entire webcast devoted to this topic: “Company Buybacks: Best Practices.”

- Broc Romanek

October 25, 2011

Two More Failed Say-on-Pays: Up to 43 For the Year

Last week, two more companies failed to gain majority support for their say-on-pay, although one of the companies failed for the second time this year – further obscuring how to count how many failures there have been so far. In this Form 8-K, Synaptics reports that it received 44% in support. And then there’s this news from Ted Allen of ISS:

Hemispherx Biopharma, a micro-cap biotech firm based in Philadelphia, has failed to win majority support (based on votes present) for its executive compensation practices for the second time. The company, which restated its 2009 results, conducted its 2011 annual meeting on Oct. 13 after holding its 2010 meeting in March 2011. Hemispherx is the first issuer with a failed Dodd-Frank Act advisory vote to face shareholders again.

At the most recent meeting, as reported in this Form 8-K, the company said it received 44.1 percent support for its pay practices, while there was 37 percent opposition and 18.9 percent in abstentions. The company pointed out that there was “very little stockholder voting on this resolution, with only 20.7% of the outstanding shares eligible voted.”

The company’s CEO, William A. Carter, received a 72 percent base salary increase in 2012, according to the proxy statement, while the company has posted negative one-, three-, and five-year total shareholder returns. In its proxy statement, the company pointed out that the CEO agreed to a 50 percent reduction in base salary during the first five months of 2009. At the same time, the CEO’s 2010 salary and fees still represent a significant increase from the 2008 level, according to the ISS report on the company.

The company also said that its compensation committee had acted “to better align the compensation options with our stockholders’ interests in supporting long-term value creation.” Hemispherx pointed out that it renewed expired stock option grants for a 10-year term at the same exercise price of the original option grants, rather than at current market price, and the company said that future non-executive employee compensation could include company stock.

While Hemispherx shareholders used the advisory vote again to express concerns over pay, most of them did not withhold support from directors. The directors all were reelected by more than a 8-1 margin. Some institutional investors have said they may take a “red card/yellow card” approach and withhold support from directors in 2012 if companies fail to adequately address significant opposition during 2011 advisory votes.

A list of the Form 8-Ks filed by the “failed” companies is posted in CompensationStandards.com’s “Say-on-Pay” Practice Area.

Course Materials Now Available: Over 50 Sets of Talking Points!

For the many of you that have registered for our Conferences coming up in just one week, we have posted the Course Materials (attendees will receive a special ID/PW later today via email to access them; but copies will be available in San Fran). The Course Materials are better than ever before – with over 50 sets of freshly written talking points comprising 200 pages of practical guidance. Our expert speakers certainly have gone the extra mile this year!

For those seeking CLE credit, here’s a list of states in which credit is available for watching the Conferences live in San Francisco and by video webcast. Note that the list is broken out for each of the Conferences – and note two states are listed as “pending” (check back to determine if the Conferences are approved in those states).

Act Now: As happens so often, there is now a mad rush for folks to register for these Conferences that begin on Tuesday, November 1st. With an aggregate of over 50 panels (including the “19th Annual NASPP Conference“), if these Conferences don’t help get you prepared for the upcoming proxy season, nothing will. You can either register for the three days of the “19th Annual NASPP Conference” (in San Francisco) – or the two days of the “6th Annual Proxy Disclosure Conference” & “8th Annual Executive Compensation Conference” (in San Francisco or by video webcast, or a combination of both). Register Now.

Say-on-Pay in the UK

In this CompensationStandards.com podcast, Euan Fergusson of White & Case and Tony Gilbert of the Hay Group discuss how say-on-pay has fared in the United Kingdom, including:

- How did say-on-pay start in the UK?
- How does the UK say-on-pay regime differ in the UK compared to the US?
- What have been the most recent say-on-pay developments in the UK?

- Broc Romanek

October 24, 2011

Senate Confirms Luis Aguilar and Dan Gallagher as SEC Commissioners

As noted in this Bloomberg article, on Friday, the Senate finally confirmed SEC Commissioner Luis Aguilar’s reappointment and Dan Gallagher’s initial appointment; both unanimously despite the six-month delay from when President Obama nominated them. Here’s Chair Schapiro’s statement.

SEC to Hold Revenue Recognition Roundtable

On Friday, the SEC announced it will hold a roundtable to consider financial statement measurements (and associated disclosures) that incorporate judgments about future events on November 8th, with comments being collected from the public until December 8th. This is the inaugural roundtable in the SEC Chief Accountant’s Financial Reporting Series. Here’s the roundtable’s briefing paper – and here’s more info about what the Financial Reporting Series is all about…

ETFs: Under the SEC Spotlight

It’s worth reading this testimony by SEC IM Director Eileen Rominger – she testified before a Senate Banking subcommittee last week – about ETFs as the SEC engages in a general review of these financial products. ETFs have been widely criticized as turning the stock markets into more of a casino than they already were…

- Broc Romanek

October 21, 2011

Yikes! Hacking of Nasdaq’s Board Portal Database Worse Than Thought

Back in February, I blogged about how Nasdaq’s Directors Desk database had been hacked. In this Reuters article, it is reported that an ongoing investigation has found that the hacking was worse than originally reported. Here is an excerpt from that article:

Hackers who infiltrated the Nasdaq’s computer systems last year installed malicious software that allowed them to spy on the directors of publicly held companies, according to two people familiar with an investigation into the matter. The new details showed the cyber attack was more serious than previously thought, as Nasdaq OMX Group had said in February that there was no evidence the hackers accessed customer information.

It was not known what information the hackers might have stolen. The investigation into the attack, involving the FBI and National Security Agency, is ongoing. “God knows exactly what they have done. The long term impact of such attack is still unknown,” said Tom Kellermann, a well-known cyber security expert with years of experience protecting central banks and other high-profile financial institutions from attack.

Smaller Companies: House Financial Services Subcommittee Passes Five Bills

As noted in this press release, the House Financial Services Capital Markets and Government Sponsored Enterprises Subcommittee passed five bills recently to ease the regulatory burden on smaller companies. The bills are:

- HR 2167, the Private Company Flexibility and Growth Act, introduced by Rep. David Schweikert
- HR 2940, the Access to Capital for Job Creators Act, introduced by Rep. Kevin McCarthy
- HR 2930, the Entrepreneur Access to Capital Act, introduced by Rep. Patrick McHenry
- The Small Company Job Growth and Regulatory Relief Act, introduced by Rep. Stephen Fincher
- HR 1965, introduced by Rep. Jim Himes

Recently, the American Bankers Association posted this Dodd-Frank tracker and calendar.

GOP Candidates Seek to Kill Dodd-Frank (and Even Sarbanes-Oxley in Some Cases)

A member sent this in: Republican presidential candidates have been calling for a repeal of the entire Dodd-Frank Act. Former Massachusetts Gov. Mitt Romney and Texas Gov. Rick Perry both have called for repeal, according to The New York Times. Rep. Michele Bachmann of Minnesota regularly points out that she introduced the first Dodd-Frank repeal bill this year. Former Gov. Jon Huntsman of Utah said he would go one step further and repeal the entire Sarbanes-Oxley Act, the NY Times reported.

Meanwhile, this “Globe & Mail” article is entitled “A desperate Obama kicks Sarbanes-Oxley halfway to the curb.”

Senate Legislation Would Expand Unfunded Mandates Reform Act to Bring SEC and CFTC Within Its Embrace

As Jim Hamilton blogged back in August: “Legislation introduced by Senator Rob Portman (R-OH) would strengthen the Unfunded Mandates Reform Act of 1995 by bringing the SEC, CFTC and other independent federal agencies within its mandate. UMRA was a bipartisan effort to prevent Congress and federal regulators from blindly imposing major economic burdens on the private sector and on state, local and tribal governments without weighing the costs and benefits, said Senator Portman. Signed by President Bill Clinton in 1995, the Unfunded Mandates Reform Act was bipartisan legislation that basically says that regulators have to evaluate a regulation’s cost and find less costly alternatives before adopting a major rule.”

- Broc Romanek

October 20, 2011

Coming Soon: #Occupy [Name of Your Company Here]

As we all begin to plan for another wild proxy season, I wonder how many are planning for the potential of major disruptions at their annual shareholder meetings as Occupy Wall Street-type protests quickly spread to avenues that we never dreamed of. Are you planning for protests at your annual meeting? How about one of your board meetings? Your CEO’s house? Your CEO’s golf game? Or when your CEO lands in the corporate jet at the airport? Or any of these for one – or more – of your directors?

I truly believe that some of these things could happen this proxy season. Here are a few stories that lend credence to my belief:

1. Protestors in general are getting bolder and fairly savvy. Earlier this week, a trio posed as golfers to allow themselves to approach House Speaker John Boehner during his golf game at California’s Pelican Hill Resort. Here’s a video of that confrontation.

2. Protestors already have targeted the homes and offices of those they want to make a statement about during the “Billionaires Walking Tour” in Manhattan a few weeks ago, as noted in this article.

3. A friend recently described to me how he attended a bankers conference in Newport Beach last month where protestors actually spent the night at the ritzy conference hotel and then stormed through the doors of the conference the following day, carrying signs, etc. Here’s the only media mention of this episode that I could find.

4. Check out this new site – OccupytheBoardRoom.org – which lists 200 CEOs and asks the public to send in their personal horror stories (loss of job, etc.) so they can be hand-delivered to the executive. All the messages, videos, etc. received will eventually be posted according to the site.

The Coming Protests: What You Should Be Doing Now

Yes, these risks mean that you should revisit your security plans. But it also is a red flag that should prompt you to start thinking about what all this anger towards the Top 1% really means (see this Bloomberg article about income inequality and its meaning for the economy). It looks like the protests have staying power even if there are no well-defined unifying goals. As the upcoming proxy season forces pay packages back into the limelight, the growing anger likely will turn to CEOs and those that pay them.

What can you do? For starters, compensation committees and their advisors should be doing an internal look to counterbalance the heavy use of peer group benchmarking. Peer group benchmarking is a practice that continues to be a primary cause of runaway CEO pay levels – and one that continues to be the crutch for many directors who don’t want to have the hard conversation with CEOs about the Lake Wobegon excesses that boards have inadvertently caused over the past two decades.

Conducting this exercise now is particularly important with the SEC’s pay disparity ratio rulemaking on the horizon. If a company’s board hasn’t even bothered to see what types of ratios they might need to disclose in the not-so-distant future – and determine if any adjustments to pay levels are warranted now ahead of forced disclosure – it only has itself to blame when the SEC’s rulemaking takes effect and shareholders, stakeholders and the general public have a negative reaction to what it ultimately discloses.

And as we’ve repeatedly warned, it’s just a matter of time before the plaintiff’s bar successfully challenges boards who continue to rely heavily on peer surveys given the widespread evidence that they have been tainted when so many boards strive to pay their CEOs in the top quartile, year in and year out. When the excesses caused by peer group surveys is front page news – as it was a few weeks ago in the Washington Post – the cat clearly is out of the bag on this one! We have resources about how to conduct an internal pay look in our “Internal Pay Equity” Practice Area on CompensationStandards.com.

The SEC’s Conflict Minerals Roundtable

On Tuesday, the SEC held its conflict minerals roundtable – and then extended the comment period for its related proposal through November 1st to obtain any additional comments that the roundtable provoked. Here’s archived video from the roundtable – and a Shearman & Sterling memo, Cooley alert and Gibson Dunn memo capturing some notes from the proceedings.

Meanwhile, a group of 11 Senators wrote a letter to the SEC, urging the agency to quickly adopt rules, as noted in this Reuters article. Also see this Cooley alert for other interesting views on this topic…

- Broc Romanek

October 19, 2011

Corp Fin Issues a New “Shareholder Proposals” Staff Legal Bulletin

As it often has in recent years, Corp Fin issued a Staff Legal Bulletin relating to shareholder proposals. This year’s installment covers these topics:

1. Guidance on introducing brokers and who constitutes a “record” holder under Rule 14a-8(b)(2)(i) for purposes of verifying whether a beneficial owner is eligible to submit a proposal under Rule 14a-8 (reversing the Staff’s prior position in Hain Celestial back in ’08 – going forward, for purposes of Rule 14a-8(b)(2)(i), only DTC participants will be considered record holders)

2. Tips for proponents so they can avoid common errors when submitting proof of ownership

3. Guidance on how to submit revised proposals

4. Guidance on how to withdraw no-action requests when there are multiple proponents

In addition, the Staff Legal Bulletin announces Corp Fin’s new process for transmitting their Rule 14a-8 no-action responses. Going forward, Corp Fin is sending those by email rather than paper – so it’s important that you include email addresses in any correspondence so the Staff knows where to send their response. If you don’t include email contact information, the Staff will send its response by snail mail, which is not good for you during the compressed time-frames that exist during the proxy season…

As posted on Corp Fin’s incoming Rule 14a-8 no-action requests page, the first requests for this proxy season have already dribbled in…

Time to Comment on ISS’s ’12 Policies: Time to Speak Up

Yesterday, as noted in this blog, ISS opened the comment period for it’s 2012 policies, as it has for the past several years. Here is their policy gateway where you can input your views – and here are the draft policies. The comment period is short – ending on October 31st. Given the importance of this proxy season, this would be a good time to get involved if you haven’t before.

Come hear from ISS and Glass Lewis about their policies during our upcoming pair of say-on-pay conferences (one regarding disclosure and one regarding pay practices – both combined for one price) that takes place in less than 2 weeks. You can attend online or in San Francisco. Register now.

Webcast Transcript: “Materiality: The Hardest Determination”

We have posted the transcript of our popular webcast: “Materiality: The Hardest Determination.”

- Broc Romanek

October 18, 2011

A First: PCAOB Releases a Part II Inspection Report for a Big 4 Auditor

Here’s news from Lynn Turner: Yesterday, the PCAOB issued its first ever Part II of an inspection report on a Big 4 audit firm to the public – it relates to Deloitte & Touche. Here’s the PCAOB’s related statement. Such reports do not become public unless the auditor fails to address and remediate the deficiencies noted in the report. One would think a firm would be incented to do so. The report notes a number of deficiencies and questions the judgments of Deloitte. This is important as auditors have been clamoring for greater latitude in their ability to make judgments – the PCAOB’s report seriously calls that into question.

The report notes deficiencies in Deloitte’s internal systems for monitoring independence on a global basis. In the spring of 2001, the then SEC Chief Accountant called each of the auditing firms down to the SEC to discuss weaknesses in controls that the SEC had identified. That meeting was subsequent to a 1998 letter sent to the CEOs of each of the Big 5 firms. Yet 8 years later, Deloitte still has not addressed and remedied the identified weaknesses. Tough to figure out an excuse for that.

It will interesting to see how the state boards of accountancy react to this – and what, if any, action they take. It also raises a question as to inspections of private audits being performed by the AICPA.

This report – relating to inspections conducted in 2007 about 2006 audits, with Part I released in May 2008 – raises a serious public policy issue of why is such a Part II report citing such serious deficiencies in audit work permitted to remain confidential until almost five years after those audits were performed. And even with the release of this report, investors are not told which companies received deficient audit reports and which partner led those audits. Presumably, Deloitte told the audit committee chairs which audits were determined to be deficient – and yet that information was not provided by audit committees to investors.

Here’s a list of all the Part II reports that the PCAOB has issued over the years – you can see how they are mostly unheard of firms other than Deloitte. Here’s today’s NY Times article about this development.

Webcast Transcript: “”How to Handle Contested Deals”

We have posted the transcript of our DealLawyers.com webcast: “How to Handle Contested Deals.”

EU to Break Up the Big 4 Auditors?

Some pretty wild stuff from this article from “The Economist” that is repeated below:

HOW to improve the work of audit firms, on which investors in public companies depend? Should clients be forced to change them every so often, so auditors and management will not get too cosy? Should two auditors be appointed to especially important companies, so they can check each others’ work? Should, perhaps, auditors even be forbidden from offering any other services, to force them to stick to the knitting so important to investor confidence?

“All of the above” is the answer from the European Commission, according to a leaked proposal from the directorate-general for the European Union’s single market. Michel Barnier, the commissioner in charge, is due to unveil a formal set of proposals for the audit industry in November. The leaked document suggests that he thinks the industry is overdue for reform from top to bottom.

The proposal for mandatory rotation of audit firms has been floating around for the better part of a year. There is little evidence to suggest that it will improve audits, and some weak evidence (based on national experiences in countries like Italy) that it will not help, or make things slightly worse. The big audit firms say that their work improves as they get to know their clients over the years. Their critics say that these years stretch into decades, with auditors forgetting that they serve investors, not company management.

But by far the most radical proposal would be to forbid audit firms from providing non-audit services, even to clients that they are not auditing. In America, providing most non-audit services to audit clients is already forbidden under the Sarbanes-Oxley financial reform passed in the wake of the meltdown of Enron, an energy-trading company. In some European jurisdictions, selling both audit and, say, consulting to a client is still permissible. Mr Barnier’s leaked proposal would not just go down the route of Sarbanes-Oxley and forbid this, but force the creation of pure audit firms.

This would be a huge change to the business model of the “big four” audit firms: PricewaterhouseCoopers, Deloitte Touche Tohmatsu, Ernst & Young and KPMG. These are technically networks of firms, rather than single global entities. All have seen robust growth in their consulting business in recent years, which now accounts for around a third of total revenues for most of them, whereas the mature audit business has grown more modestly. Forcing the break-out of pure audit firms would separate an exciting and growing business from a plodding but vital one, in Europe at least.

Would that force the big four to split elsewhere? Joe Echevarria, the new head of Deloitte in America, merely says that policy pendulums will swing, sometimes overshooting their ideal mark. Well might his parent network, Deloitte Touche Tohmatsu, not want to lose its consulting work. In the year ending in May 2011, the consulting business grew by 14.9%, against 4.7% for the audit business, a result in line with recent years. If such a trend continued for another decade, Deloitte (like its rivals) would go from being an audit business with a consulting arm to a consulting business with an audit arm.

Mr Barnier’s proposals are still in draft, and may change before formal unveiling. After that, the EU’s Council of Ministers (representing national interests) as well as the European Parliament will take a crack at modifying it. It is unlikely that the leaked draft will become final law in its entirety. But it does represent a marker: the mood in Europe (reflected elsewhere) that auditors have a crucial function that is being weakened by distractions like consulting, and even by over-long audit engagements.

- Broc Romanek