Early Contender: Governance Poster Child of the Year

It was mind-boggling to read Joe Nocera's account of last week's Home Depot annual meeting in his column in Friday's NY Times (which followed this Wednesday article about CEO Nardelli's pay package). Talk about a domineering CEO! I find it hard to believe in this day and age that a board - not to mention a CEO - could be so deaf to shareholders and apparently blind to what's expected of them. It's a textbook example of how not to hold a shareholders' meeting.

I couldn't resist calling up Rich Ferlauto, who is Director of Pension Investment Policy for the American Federation of State, County and Municipal Employees, to discuss - in this podcast - what it was like to personally experience the Home Depot annual meeting, as well as ask Rich how AFSCME's shareholder proposals were received during this proxy season so far.

SEC Commissioner Campos Willing to Consider Notion of Shareholder Approval of Compensation Disclosure

If you listen to Rich's podcast, you will hear how AFSCME's proposals regarding shareholder approval of compensation disclosure have done quite well in their first year. As I blogged about yesterday, the House recently held a hearing on a bill that would require public companies to obtain such shareholder approval.

Earlier this month, SEC Commissioner Campos touched on this topic - and other issues related to executive pay- in this rousing speech. Here is an excerpt from that speech:

"Let me touch on a few of the comments that I found most interesting (although this is certainly not an exhaustive list):

Advisory Vote by Shareholders. A number of commenters have suggested that we require companies to put the compensation report to an advisory shareholder vote, or that we seek an amendment of exchange listing requirements to require such advisory votes. Alternatively, commenters have recommended that we codify a no-action position of the Staff that has allowed shareholders to include in proxies non-binding resolutions that ask for an advisory shareholder vote on the compensation report. As an aside, I'll also note that Congressman Barney Frank has introduced a bill that would, among other things, require shareholder approval of compensation plans.

These are definitely intriguing suggestions, and, if adopted, no doubt would provide shareholders the clearest and most direct voice in executive remuneration. Apparently, the United Kingdom and Australia have an advisory vote requirement on the compensation report, and there appears to be some evidence that this may have some effect in curbing excessive executive pay. For example, one study in the United Kingdom found that executive pay is declining, and another article noted that the typical British CEO makes only a little more than half of what the typical U.S. CEO makes. In any event, having the shareholders cast an advisory vote on this subject would very likely improve transparency in this area, and for this reason alone, I think it is a topic worthy of additional discussion. Of course, requiring shareholder votes, even advisory ones, is not something that the Commission has done frequently, and so I think that we'll need to look carefully at our powers in this regard.

Disclosure of Performance Targets. Another topic that comment letters touched upon is the fact that the proposal does not require the disclosure of specific quantitative or qualitative performance-related factors considered by the compensation committee or by the board in determining executive compensation. Apparently, the argument for not including such a requirement would be to avoid forcing companies to disclose confidential commercial or business information that would have an adverse effect on the company. This is certainly understandable.

On the other hand, without disclosure of these performance-related factors, it becomes difficult for shareholders to determine whether the targets are appropriate and whether executives have actually met the targets. Perhaps a middle alternative would be to require disclosure after the fact: that is, maybe it would be effective and appropriate to require companies to disclose the particular quantitative or qualitative performance-related factors after the time period for which the factors apply. Some commenters take the position that this would make the executive compensation process more transparent, yet alleviate concerns about disclosure of confidential information. However, companies might still be concerned that disclosure of specific targets even after the fact raises confidentiality issues that might ultimately harm the company. In any event, given the comment letters on the subject, this is an issue that we at the Commission should consider, and I intend to approach it with an open mind.

I could continue and recite at great length some of the insightful comments that have been submitted to us, but if I were to do so, I would surely eat up the time that has been set aside for questions. Rest assured that our Staff is carefully reviewing the comment letters right now, and all of us on the Commission will pay very close attention to the public's suggestions on this topic."

PCAOB Proposes Annual Reporting by Audit Firms

Last week, the PCAOB proposed rules that would require audit firms registered with the PCAOB to submit annual and special reports. These reports would be publicly available on the PCAOB's website, subject to confidential treatment requests. You might recall that Section 102(d) of Sarbanes-Oxley provides that each registered audit firm must submit an annual report to the Board (and may also be required to report more frequently to provide information specified by the Board or the SEC).

The reporting framework proposed by the Board includes two types of reporting obligations. First, the proposal would require each registered firm to provide basic information once a year about the firm and the firm's issuer-related practice over the most recent 12-month period. Second, the proposal identifies certain events that must be reported within 14 days.

The Board also proposed rules that, in certain circumstances, would allow a successor firm to succeed to the registration status of a predecessor firm following a merger or other change in the registered firm's legal form. In other circumstances, the proposed rules would allow for temporary succession for a transitional period of up to 90 days while the firm seeks registration.

At first blush, the concept of an audit firm filing annual reports seemed odd to me. But these annual reports would not really be akin to a company’s glossy annual report nor would they contain clearly objectionable information (like a firm's client list). Still, it will be interesting to read the comments on this one because auditors might have strong opinions here...

Section 404: The Need for Input

Corp Fin Director John White delivered this speech on Thursday regarding the need for input into internal control matters, for both large and small companies. In the speech, John emphasizes the need for a different type of input now that a small business exemption is off the table. John notes that most of the energy expended by the small business community so far has related to obtaining the exemption - now, the SEC, PCAOB and COSO need input into how to shape the guidance that was promised a week ago as part of the regulatory four-point plan.

In addition, John reminds us of the PCAOB's announcement a month ago about how this year's inspections of audit firms will include analysis about how those firms conduct AS 2 audits - and that the SEC will be involved in this process as "the SEC's inspectors will be inspecting the PCAOB inspectors." For those dealing with internal controls, this is an important speech as it asks a number of questions as if it were a proposing release.

Presidential Memo: National Intelligence Director's Power to Exempt Internal Controls, Etc.

Earlier this month, President Bush issued this memorandum that enables the Director of National Intelligence to exempt companies from the books and records and internal controls provisions of the Foreign Corrupt Practices Act. This shift in authority was accomplished without much fanfare and is only receiving coverage due to this article from Business Week. As noted in the article, the memo has the unrevealing title: "Assignment of Function Relating to Granting of Authority for Issuance of Certain Directives: Memorandum for the Director of National Intelligence." Here is a transcript of a NPR interview with the Business Week article author.

The hubbub involves a little known provision in the '34 Act. The Presidential Memo transfers the authority granted to the President under Section 13(b)(3)(A) of the '34 Act, which states:

"With respect to matters concerning the national security of the United States, no duty or liability under paragraph (2) of this subsection shall be imposed upon any person acting in cooperation with the head of any Federal department or agency responsible for such matters if such act in cooperation with such head of a department or agency was done upon the specific, written directive of the head of such department or agency pursuant to Presidential authority to issue such directives. Each directive issued under this paragraph shall set forth the specific facts and circumstances with respect to which the provisions of this paragraph are to be invoked. Each such directive shall, unless renewed in writing, expire one year after the date of issuance."

As someone who used to work at a defense contractor, I can imagine some - but not too many - scenarios where a company would want to bury the fact that it was working on a "black program" from its independent and internal auditors (as these programs are on a "need to know" basis). But the timing of this authority transfer is odd given the high profile of internal control exemptions today and in light of criticisms of this Administration being too secretive, etc.

The provocative thing is that there likely is at least one company out there that needs this relief now - otherwise, why would the President bother to sign the memo without a perceived need for it. We have posted a copy of the Presidential Memo in our "Foreign Corrupt Practices Act" Practice Area.

House Hearing Held on Executive Compensation

Last Thursday, the House Financial Services Committee finally held a hearing on Barney Frank's bill on executive compensation - Rep. Frank was forced to use a parliamentary rule to force the majority Republican leaders of the committee to convene the hearing. Here is the prepared testimony delivered at the hearing - and here is a LA Times article and an article from Business Week about the hearing.

Ding Dong, The Wicked Witches Are Convicted!

Yesterday's conviction of Enron's former CEO and CFO was greeted with the fanfare of The Wizard of Oz - and rightfully so given the symbol they have come to represent. I shudder to think if they had been found innocent as investors might have pushed Congress into creating Sarbanes-Oxley II. Of course, we still need to weather the appeals process for Skilling and Lay...

The NY Times has this nice count-by-count explanation of the verdicts. And FEI's "Section 404 Blog" has links to all the articles, charts and remarks that I would have done - including this cool USA Today chart about the verdicts - so I point you there if you have an unfathomable appetite for more news about the convictions.

More on Vonage's FWPs and Rule 134 Communications

After I blogged about Vonage's unique use of a blast voicemail on Tuesday, the company filed an amended registration statement with this new statement under "Directed Share Program" on page 140:

"Our initial email communication to prospective participants in the Vonage Customer Directed Share Program and the first page of the website identified above (from which a reader could access a detailed “frequently asked questions” section about the Vonage Customer Directed Share Program) did not include an active hyperlink to the prospectus contained in our most recently filed registration statement relating to this offering as required pursuant to Rule 433 under the Securities Act. The email communication and the information on the first page of the website therefore might be viewed as not having been preceded or accompanied by a prospectus meeting the requirements of the Securities Act. As a result, it is possible that the e-mail communication and the first page of the website could be determined to be an illegal offer in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price.

In addition, our initial voicemail communication to prospective Vonage Customer Directed Share Program participants, which communication may contain only limited information pursuant to Rule 134 under the Securities Act, included the Internet address at which prospective participants could obtain additional information about the Vonage Customer Directed Share Program, including a copy of the prospectus contained in our most recently filed registration statement relating to this offering. However, the voicemail did not include the name and address of a person from whom such a prospectus could be obtained. The inclusion of the Internet address in the voicemail might be viewed as incorporating into the voicemail information that is beyond the scope permissible under Rule 134. In addition, the omission of the name and address of a contact person means that the voice mail would not be entitled to the “safe-harbor” provided by Rule 134. As a result, it is possible that the voicemail could be determined to be an illegal offer in violation of Section 5 of the Securities Act, in which case recipients could seek to recover damages or seek to require us to repurchase their shares at the IPO price.

We believe we would have meritorious defenses to any legal actions based on claims of alleged defects in the email, website or voicemail. The website through which the Vonage Customer Directed Share Program is being conducted requires each prospective investor to open an electronic copy of a prospectus meeting the requirements of the Securities Act prior to making a conditional offer to purchase shares of our common stock. It is, therefore, impossible for someone to place an order (or to open an account to do so) in the Vonage Customer Directed Share Program without first having received a copy of the required prospectus. As a result, we believe that the risks to us relating to any such potential claims are not significant."

FASB's New Standard: Accounting For Uncertain Tax Deductions, Etc.

Recently, the FASB adopted a new standard that will require companies to disclose additional quantitative and qualitative information in their financials about uncertain tax positions. A final Interpretation reflecting these decisions are expected to be issued in June and would take effect in 2007.

As noted in this KPMG report (posted in our "Contingencies" Practice Area), the FASB initially proposed that a company would have to conclude it was "probable" (ie. likely to be able to sustain an uncertain tax position such as for an aggressive position on intercompany pricing or an aggressive tax deduction) if it was calculating its income taxes for its financial statements on that basis. At its May 10th meeting, the FASB has decided to lower the threshold required to recognize a financial statment benefit for a position taken for tax return purposes from 'probable' that the position will be sustained, as the exposure draft proposed, to a 'more-likely-than-not' that the position will be sustained.

This issue arose when two of the Big Four firms used the higher standard and the other two used the lower standard. The SEC Staff weighed in with a statement that the threshold under current accounting guidance should be the higher standard. The lower "more-likely'than-not" standard is effectively a standard that says there is a 51% or better chance the tax position will be sustained; the "probable" standard would have required companies to conclude it was a significantly higher chance they would be able to sustain an aggressive tax position before they could have used it to report their taxes for financial statement purposes.

Now all of the Big Four auditors, as well as other firms, will be using the new lower standard when it is officially issued. The FASB also decided to require further disclosure in connection with the relaxed threshold.

An Excellent Audit Committee Report

I'm excited about our new webcast series that deals with audit committees and their advisors. The first three of these webcasts are:

- The Evolving Relationship Between Lawyers and Auditors (6/15/06)
- Audit Committees in Action: The Latest Developments (6/22/06)
- How to Develop a Whistleblower Compliance Program Today (7/13/06)

Learn practice nuggets from the experts - such as why Home Depot's audit committee report contains more useful information for investors than do most other proxy statements (but curiously, Home Depot is under fire for making its financials less transparent by deciding to stop giving comparable-store sales numbers, a key retail-industry benchmark as noted in this recent WSJ article).

The US Post Office Weighs In on E-Proxy

In the analysis of e-Proxy comment letters submitted to the SEC from my blog a few months ago, I neglected to mention this hilarious 13-page comment letter from the US Postal Service.

The Post Office obviously has a vested interest in "keeping those proxy statements coming" - I imagine this is the first time they have ever submitted a comment letter to the SEC. For example, look at page 3 of their letter for a discussion of "consumer expectations and preferences." Consumers? Not investors? Maybe the SEC has a broader - double secret? - mandate than the one they have owned up to...

No-Holds-Barred Responses to Investor Queries

Continuing on the theme of something light for the 3-day holiday: Expeditors International is notorious for its no-holds-barred responses to investors' questions, which it publishes regularly on Form 8-K under Item 7.01. They can be pretty darn funny. Here are my favorite lines from the latest edition...

- "Sustainable?" Given enough time, the sun is not sustainable, however, we think it is a good bet that there will be daylight tomorrow.

- This was not an "open-ended, broad question" it was an interrogation that left us exhausted just reading it. We did not 'indulge" your question, we endured it.

- If you seriously are buying into this thinking, you have been sipping the integrator Kool-Aid. Hopefully you haven't swallowed, but just in case you have, let us attempt to provide some financial Ipecac here in hopes that we can induce vomiting before your investment psyche is permanently altered.

How to Handle Hedge Fund Activism

We have posted the transcript from the popular DealLawyers.com webcast: "How to Handle Hedge Fund Activism."

Chairman Cox's Interview

In the op-ed section of Saturday's WSJ, SEC Chairman Cox gave this interesting interview. Here are a few observations:

- As a former politician, the new Chairman sure knows how to make friends with the media. For example, the interviewer writes "My pen stops. This is not how regulators speak" when the Chairman uttered the same thought likely spoken by each of the 27 prior chairs of the SEC (ie. the SEC should arm investors with information to protect themselves).

- The Chairman hit the nail on the head when he focused on one of my pet peeves: the inane way that EDGAR displays forms, etc. How many investors do you think recognize "DEF 14A" as a proxy statement?

- I am not sure I agree that XBRL will "cut down on costly errors." I worry that it will create more new ones as companies (or vendors they hire) mistag their financial data. Tagging errors for XBRL will be more significant than EDGAR or HTML errors because it means that a number gets pushed to a different line item in the financials.

- While I completely agree that the SEC should not (and cannot, since it doesn't have the authority) to regulate executive compensation levels, I disagree with the statement that CEO pay is set by "market forces." As I flesh out in Realism #1 of my "Open Letter to All Journalists," that statement seems to be bandied about without careful thought as to what it really means.

Enron's Legacy

As long as I am blogging about the Saturday WSJ op-ed pages, I can't help but rebut this column about how we didn't need all this new regulation. I agree that Sarbanes-Oxley went overboard, but what do you expect from Congressional legislation? I read the op-ed as basically arguing that if Scrushy and all those fraudsters avoided jail, then there must not have been any widespread issues ripe for reform.

For those of us dealing with these issues on a daily basis, I think most of us would agree that numerous practices have changed "for the better." Put aside your anger about 404 and think about the bigger picture. [Although remember that in Year 1 after the implementation of Section 404, 17% of companies reported a material weakness. And that's just large companies - imagine how high that percentage would be if 404 was implemented across the board!]

Here is a list of recent changes that I think illustrate how most companies (and their advisors) are in much better shape today compared to before SOX:

1. Boards no longer conduct one-hour board meetings just several times per year.

2. Outside auditors will no longer do whatever it takes to keep the business.

3. CEOs and CFOs (and some directors) now actually read 10-Ks and 10-Qs before they are filed.

4. Outside lawyers are more careful about who they represent and what they advise.

5. Employees are more apt to blow the whistle on financial mischief and companies are more careful handling these complaints.

6. Investors are more active in keeping boards accountable.

Of course, some serious fine-tuning to the new rules are necessary, particularly as oversea listings of companies grows by leaps and bounds - and I am increasingly concerned about the balance of power shifting to shareholders, particularly those that are in it for the "greenmail." But I remain convinced that some reform was necessary and that there could be a much higher level of fraud being perpetuated today "but for" Sarbanes-Oxley and the related rulemaking that followed.

More on XBRL

Last week, Corey Booth, Chief Information Officer of the SEC, gave an enlightened speech on the SEC's efforts to implement XBRL reporting. Over the past year, Corey has noticed significant variation in how pilot companies translate their numbers into XBRL, even on relatively basic issues - and he notes that this variation suggests that significant subject matter knowledge is needed to effectively create an XBRL document (as the preparer must be comfortable with both the technological and accounting aspects of the standard). He also noted little growth in demand for XBRL information from investors - so he doubts that mandatory XBRL filing will be required before voluntary adoption has become widespread.

This all jibes nicely with my recommendation that the SEC go slow here. However, it still is apparent that the SEC will push this initiative - yesterday, it issued a press release announcing three more companies have joined the pilot program. And it's fascinating that yet another Brazilian-based company has signed up for the pilot program, continuing that country's very significant representation among the volunteers.

Next Tuesday, May 30th, you might want to check out AEI's XBRL Conference in Washington DC - it's free (but you need to pre-register).

Delaware Bar Association to Propose Majority Vote Bill

Last week, the annual legislation amending the Delaware General Corporation Law was introduced. Among other things, the bill addresses some of the majority voting issues raised recently by investors. As is customary, the Council of the Corporation Law Section of the Delaware Bar Association proposed the changes, which are expected to be approved.

I was able to catch up with a member of the Council that worked on the draft bill, John Grossbauer of Potter Anderson & Corroon, to discuss this development in this podcast, including:

- What does the Delaware bill say?
- How does it compare to the ABA's recommendations for the Model Business Corporation Act?
- When is the Delaware legislature expected to act?

Clarifying the SEC's Latest Section 404 Deadlines

In last week's press release on Section 404, the SEC stated that there will be a new short postponement of the effective date for the rules implementing Section 404 for non-accelerated filers - this statement noted that all filers will nonetheless be required to comply with the Section 404(a) management assessment for fiscal years beginning on or after December 16, 2006. Quite a few members were confused because under the existing deadline - emanating from Release 33-8618 from September 2005 - non-accelerated filers are not required to comply with the rules under 404 until the first fiscal year ending on or after July 15, 2007.

As Alan Dye was quick to point out to me, the key difference between the SEC's two statements is that the new one refers to the beginning of a fiscal year and the older one refers to the end of a fiscal year. However, the upshot of the SEC's latest announcement is that there is no real change for companies with fiscal years that coincide with the calendar year.

Remember that the SEC's September 2005 release established two extended deadlines: fiscal years ending on or after July 15, 2006 for foreign private issuers meeting the accelerated filer deadline and a July 15, 2007 for non-accelerated filers. Under its latest announcement, the SEC does not intend to extend both deadlines as the upcoming extension will be limited only to non-accelerated filers (but of course any foreign private issuers that also happen to be non-accelerated filers will get the benefit of that extension).

Fielding Those Option Back-Dating Phone Calls

I'm being told that institutional investors and investment bankers are calling the investor relations departments at companies and giving them the third degree about whether those companies have any "backdating" issues. Hopefully, the IR folks remember Regulation FD because I would love to know which companies are going to confirm they have backdating issues too - I could sell short and retire. A lot of fishing going on. And of course, the IR folks need to be sure that their companies don't have the problem before they say they don't...

In my blog last week on this topic, I forgot to mention that the most recent issue - March/April - of The Corporate Counsel contains extensive analysis of issues posed by options-backdating. In addition, in the "Timing of Stock Option Grants" Practice Area on CompensationStandards.com, we have now added some research reports and an article analyzing the issues as well as several complaints filed in lawsuits against some of the companies accused of backdating.

Kathy Casey Nominated for SEC Commissioner

On Thursday, it was announced that President Bush nominated Kathleen Casey to serve as an SEC Commissioner - she currently serves as the Staff Director and Counsel for the Senate Banking Committee, having previously worked as Chief of Staff and Legislative Director for the Committee's chairman, Senator Richard Shelby (R-Al.). Ms. Casey will replace Commissioner Cynthia Glassman, who announced earlier this week that she will not serve a second term and would leave the agency after her term expires next month.

Ms. Casey, whose term would extend to the middle of 2011, is subject to confirmation by the Senate. I doubt she will have any problem securing confirmation, but I thought it would be useful to provide an overview of the confirmation process (and here is Senate Rule XXXI, which governs confirmation hearings) for those that want to learn about what's involved in a confirmation.

The First Blast Voicemail Free Writing Prospectus?

In our "Free Writing Prospectuses" Practice Area, we have uploaded this interesting voicemail recording (give it a few seconds to load) from Vonage that appears to solicit interest from its customers in its upcoming IPO (more specifically, the Directed Share Program that will receive an allotment in the IPO). Perhaps the first blast voicemail free writing prospectus? I found this letter to customers filed as a FWP, but I'm not sure if that FWP (or any of the other FWPs filed by Vonage) relate to this v-mail. Perhaps this one?

Per Rule 405 - and footnote 97 of the adopting release for the Securities Act reform - “written communications” includes broadly disseminated or “blast” voice mail messages. So it would seem like a blast voicemail FWP would be required to be filed (and since Vonage is an unseasoned issuer, the blast email would need to be accompanied or preceded by a prospectus pursuant to Rule 433(b)(2) if it were an FWP) - however, since the voicemail and the customer letter are essentially word-for-word, perhaps this FWP is intended to cover both forms of communication. Remember that Rule 433(d)(3) essentially says you don’t need to file if the “FWP does not contain substantive changes from or additions to a FWP previously filed.”

Or perhaps the blast voicemail is intended to be a Rule 134 communication, which now permits more procedural information about directed share programs (note the voicemail includes the statement required by Rule 134(b)(1)). It's a brand new ballgame and the rules certainly have changed.

Don't forget to take our new survey on how many pieces typically constitute the "disclosure package" as well as the largest disclosure package you have worked on to date - and which one of six FWPs filed to date is the most interesting.

Vonage's Directed Share Program

Looking at Vonage's Amendment No. 5 to the Form S-1, I see that up to 13.5% of the IPO shares are reserved for a "Directed Share Program." This level seems a tad high, as 5-10% is the normal range (although there were deals in the '90s with programs over 15% if I recall correctly). And the angle to offer shares through a program to customers is novel, although not unheard of as Boston Beer and Annie's Homegrown come readily to mind.

I wonder whether this high level is due to (i) a calculation by the underwriters that VOIP subscribers tend to be more affluent and tech-savvy and therefore this is a good way to attract some new high-end retail clients to their private bank or (ii) they are worried that the deal is too large and this is a good way to soak up demand by going out to the true-believers. Based on my conversations with folks that have tried Vonage's service, my guess is that it's the latter (which is supported by this recent WSJ article which describes a high level of customer complaints).

The Widening Option-Backdating Scandal

This WSJ article from last week notes that the SEC has ramped up its examination of options timing and is now conducting reviews of about 20 companies. 20 companies! This truly has been shocking to me as I had assumed it would be a half a dozen bad apples at the most. It's a good reminder to push back if you ever are placed in the position of doing something that "doesn't feel right."

Some companies are claiming their processes legally involved backdating. For example, in this Form 12b-25 filed by Affiliated Computer Services, the company notes "the Company has granted stock options principally utilizing a process whereby its compensation committee or special compensation committee, as applicable, would approve stock option grants through unanimous written consents with specified effective dates that generally preceded the date on which the consents had been executed by all members of the applicable compensation committee. In connection with option grants to senior executives, the historical practice was for the Company’s chairman, who during periods prior to September 2003 was also a member of the Company’s compensation committee, to engage, on a relatively contemporaneous basis with the effective date specified in the written consent, in individual telephonic discussions with each of the members of the applicable compensation committee, during which the committee member would indicate his approval of the option grants in question." It will be interesting to see if the company's Chair can prove he made all these phone calls for each grant.

It's breathtaking to look at the scope of some of the restatements announced so far - UnitedHealth might restate three years worth of financials due to option back-dating, trimming off $286 million of net income! This is precisely why we included a panel on how to design internal controls for compensation matters in our "1st Annual Executive Compensation" Conference (video archive of that panel and more are in the "Internal Controls" Practice Area of CompensationStandards.com). I would imagine that auditors are paying closer attention to compensation items now.

Remember that these CEOs and CFOs had to sign a certification saying their financial statements were correct (and if backdating did occur, the financials could well have been incorrect). They also would have signed representation letters to the auditors. My guess is it will be tough for executives to argue they knew nothing about the backdating, if in fact things had been backdated. Perhaps this is why a federal prosecutor is looking into all of this.

In the "Timing of Stock Option Grants" Practice Area on CompensationStandards.com, we have posted a host of resources, including links to a number of Form 8-Ks filed by companies under investigation and the complaints filed in two lawsuits against UnitedHealth. Also some good stuff today in Jack Ciesielski's "AAO Weblog."

XBRL Alternatives

Following up on my blog about XBRL alternatives a few weeks ago, in this podcast, Michael Becker, Director, Global Disclosure & Financial Reporting Services of Business Wire, talks about "EarningsDirect," an XBRL templated service being offered by Business Wire in conjunction with CoreFiling, including:

- What is the difference between what services you offer and what the SEC is trying to accomplish in its pilot programs so far?
- How have your clients found your offerings? What questions do they ask?
- How about analysts? Do they seem to be interested in using the data that your clients provide through your services?

Pre-Emptive Press Releases

From the "Lies, Damn Lies & Forward-Looking Statements" Blog: "They don't appear often enough to call them a trend, yet.

A number of law firms (and their clients) have begun putting out press releases in advance of the deadline for filing a lead plaintiff motion, often indicating their intention to file a lead plaintiff motion.

Last week, Bernstein Litowitz Berger & Grossmann LLP and the Police and Fire Retirement System of the City of Detroit put out this release regarding the securities class actions pending against Bausch & Lomb Inc. in the United States District Court for the Southern District of New York. The release indicated the Police & Fire Retirement System's intention to both file an expanded complaint and a lead plaintiff motion.

The previous week, Kahn Gauthier Swick, LLC and WestEnd Capital Management, LLC put out this release regarding the securities class actions pending against Pixelplus Co., Ltd., also in the Southern District of New York. This release simply noted that WestEnd had retained Kahn Gauthier to pursue claims, with no mention of lead plaintiff issues."

The SEC's and PCAOB's Four-Point Plan on Internal Controls

Yesterday, the SEC and PCAOB announced a four-point plan to tackle Section 404 issues. The big news is that the SEC will not exempt small companies from Section 404, which really is not much of a surprise given comments from some of the Commissioners leading up to the Advisory Committee's report. The Plan consists of:

1. Guidance for Companies - including issuing a Concept Release covering a variety of issues (such as the management assessment process and the appropriate role of outside auditors in connection with the management assessment and on the manner in which outside auditors provide the attestation required by Section 404(b)); consideration of additional guidance from COSO; and guidance to management to assist in its performance of a top-down, risk-based assessment of internal control over financial reporting (timing and form of this guidance not yet determined)

2. Revisions to Auditing Standard No. 2 - the PCAOB announced yesterday that it intends to propose revisions to its Auditing Standard No. 2, which overall would:

- Seek to ensure that auditors focus during integrated audits on areas that pose higher risk of fraud or material error;

- Incorporate key concepts contained in the guidance issued by the PCAOB on May 16, 2005; and

- Revisit and clarify what, if any, role the auditor should play in evaluating the company's process of assessing internal control effectiveness.

3. SEC Oversight of PCAOB Inspection Program - the PCAOB will focus its 2006 inspections on whether auditors have achieved cost-saving efficiencies in the audits they have performed under AS No. 2, and on whether auditors have followed the guidance that the PCAOB issued in May and November 2005.

4. Extension of Compliance for Non-Accelerated Filers - the SEC expects to announce another short postponement of the effective date - five months according to this WSJ article - for the rules implementing Section 404 for non-accelerated filers (but will still require filers to comply with the Section 404(a) management assessment required for fiscal years beginning on or after December 16, 2006).

Introducing the COMPETE Act

Some in Congress still want smaller businesses exempt from Section 404. Yesterday, Senator Jim DeMint (R-SC) and House Representative Tom Feeney (R-FL) led a group of other supporters to introduce legislation entitled the "Competitive and Open Markets that Protect and Enhance the Treatment of Entrepreneurs [COMPETE] Act." Here is a related press release.

According a copy of the bill posted on CFO.com, it is designed "to reduce the burdens of implementation of Section 404 of the Sarbanes-Oxley Act..." by creating an exemption for small companies, recommending "random" rather than annual internal control audits, creating a "de minimis" standard for materiality of 5% of net profits, recommends SEC and PCAOB issue guidance for measuring the terms "reasonable," "significant" and "sufficient," defining other terms, and that SEC/PCAOB conduct a study to compare and contrast the U.K.'s "Turnbull" guidance vs. the implementation of Section 404, and submit the results of that study to Congress within one year of the date of enactment of the COMPETE Act. Thanks to FEI's "Section 404" Blog for the heads up and language above.

According to this WSJ article, the bill is unlikely to get before Congress for a vote this year.

What the Top Compensation Consultants Are NOW Telling Compensation Committees!

We have posted the transcript from the popular CompensationStandards.com webcast: "What the Top Compensation Consultants Are NOW Telling Compensation Committees!"

2nd Annual "M&A Nuggets" Webcast

We have posted the transcript from the popular DealLawyers.com webcast: "2nd Annual "M&A Nuggets."

Congressional Republicans Plan to Introduce Bill to Soften Sarbanes-Oxley

Yesterday, according to this Reuters article, a group of Republican members of the House announced they will introduce a bill that would exempt smaller companies from Section 404; a similar Senate bill is also planned.

And I continued yesterday to add sets of notes to my blog about the SEC's and PCAOB's Section 404 roundtable - and the SEC posted a full transcript of the roundtable (which will help you appreciate how much effort we put into cleaning up the transcripts of our webcasts before we post them).

A Historical Rambling

Finally got off my duff to manually upload all my blogs from 2002 that comprise my first blog musings from when I founded RealCorporateLawyer.com (and from when I was one of the first lawyers to try this very new thing called a "blog"). Reviewing these old blogs is amusing for two reasons. First - and admittedly personal - is to see how I've come along as a home-grown journalist. I would argue that I have more of a "voice" now, partly a function of blogging more frequently and in much greater length. I'm always open to criticism if you think my style can be improved.

Far more interesting is to follow the developments leading up to the passage of Sarbanes-Oxley and the incredible rash of rulemaking that quickly followed. Unbelievably, I used the term "Sarbanes" only twice before the Act was signed into law (see May 13th and May 28th). That is how quickly the Act came into being (and how unprepared we all were when it did). The Sarbanes bill languished from the first day it was drafted and was essentially dead until the WorldCom scandal came to light in July 2002 and then poof - it was a done deal within several weeks.

It's also interesting to recall what the top issues initially were - in August 2002, the biggest concern involved CEO and CFO certifications and the mechanics of how those newfangled things worked, which really wasn't fully ironed out for several months. With a smile, I remember the chaos as I put together a last minute teleconference regarding certifications (just two days notice) and we had an incredible turnout as the first batch of certs were due to be filed the next week. It was wild, man. Better than Woodstock...

Can you imagine that internal controls was nowhere on the radar screen at the time? In fact, my March 2003 webcast on the topic (which I appropriately labeled then as a "sleeper," thanks to a memorable conversation with John Huber) remains the most sparsely attended webcast I have held in my 5 years of hosting them. Look back at the law firm memos drafted right after SOX was passed and you will not find anyone predicting that Section 404 was something formidable. That was because we only had the bandwidth to tackle only the numerous new requirements that were applicable immediately - and Section 404's implementation seemed so far away.

A lot of surprises looking back - who remembers that four SEC Commissioners were confirmed by Congress on the same day that they passed SOX? It's true. And what about the fact that John Biggs was quasi-announced as the first PCAOB Chairman, just before the William Webster debacle. Hard to believe this now all comes under the category of "history." Time flies...

Sentencing Commission Finalizes Amendment to Eliminate Mandated Waiver of Attorney-Client/Work Product Protections

Two weeks ago, the final amendments to the Sentencing Guidelines were submitted to Congress from the US Sentencing Commission. As I blogged about last month, these amendments include the deletion of the provision on waiver of the attorney-client privilege and work product protections. These changes become effective on November 1st, unless Congress takes affirmative action.

In addition to deleting the provision on privilege, a number of commenters had urged the Sentencing Commission to also include an express statement that such waivers are not to be considered in evaluating the level of cooperation or determining the appropriate sentence. The Sentencing Commission didn't add the requested statement, but did add a reason for the amendment on pages 29-30. We have posted law firm memos on this development in our "Sentencing Guidelines" and "Attorney-Client Privilege" Practice Areas.

SEC Commissioner Glassman Declines to Seek Second Term

Yesterday, SEC Commissioner Cynthia Glassman issued this letter indicating that she would not seek a second term when her current term expires next month as she is ready to tackle new challenges. The Commissioner agreed to stay in office until a successor is found, which can take up to 18 months as noted in the SEC's press release - however, this article predicts a successor will be named within a few days.

With a background as an economist, Commissioner Glassman hasn't been afraid to assert herself and joined fellow Republican Commissioner Paul Atkins in a stand against a number of measures passed by former Chair Donaldson and the two Democratic Commissioners. It will be interesting to see who is selected as her replacement - among the names being circulated is Kathy Casey, majority staff director for the Senate Banking Committee's chairman, Sen. Richard Shelby (R-Ala.).

Nasdaq's FAQs re: Transition to an Exchange

Yesterday, the Nasdaq issued a set of FAQs about its transition to a stock exchange. The timing of the Nasdaq becoming an exchange is still noted as the "2nd quarter of 2006," but the FAQs also note that this might be delayed.

Yesterday, the Nasdaq also sent this bulletin to listed companies, which states much of what I have blogged about before regarding the Nasdaq taking care of the transition from a 12(g) to a 12(b) reporting company for all listed companies that don't exercise their right to "opt out" by May 30th. The bulletin also notes that listed companies will keep the same '34 Act filing number for purposes of their SEC filings (ie. they will keep their numbers beginning with a "0-" despite the fact that listed companies will now be registered under Section 12(b)).

Notes from the May 10th Internal Controls Roundtable

These notes from last week's 404 Roundtable, hosted by the SEC and the PCAOB, are available from the FEI's "Section 404 Blog" - and here are notes from the NACD and notes from CFO.com. This is the SEC's related briefing paper.

The timing of any "next steps" was not discussed during the roundtable - but according to this Reuters article, Chairman Cox told reporters immediately afterwards that the SEC and PCAOB plan to issue "statements" within the "next few weeks."

Court Questions Prosecutor's Opposition to Corporate Payment of Employees' Attorney Fees

Last Tuesday, the NY Times ran this article about the testimony given at a hearing into whether federal prosecutors improperly pressured KPMG to cease paying the legal fees of former employees indicted for selling illegal tax shelters. The hearing before Judge Lewis Kaplan of the US District Court of New York focused on the so-called "Thompson Memorandum," written by then US Deputy Attorney General Larry Thompson. The Thompson Memorandum contains nine factors that prosecutors could consider when determining whether to indict a company - one factor was whether the company advanced legal fees to employees caught up in an investigation. [This Memorandum is discussed within some of the law firm memos posted in the "Attorney-Client Privilege" Practice Area].

It appears that Judge Kaplan has questioned the constitutionality of the prosecutor's policy regarding advancement of fees. According to this article, "When a prosecutor, Marc Weinstein, said the document written in 2003 by Larry D. Thompson, a former deputy attorney general, did not advise companies that they risk indictment by paying the legal fees for all employees, the judge cut him off. Kaplan said if what Weinstein said was accurate, then the Department of Justice in Washington chose poor wording of the document and ''it's time they start all over again because that's sure not what they've said to the defense bar.''

The defendant's pre-hearing brief in this case - US v. Stein - gives some pretty interesting (albeit one-sided) insights into how potential criminal defendants may be pressured by the U.S. Attorney's Office into cutting off the advancement of legal fees to employees. And here is an amicus curie brief filed on behalf of the SIA, Bond Market Associationn, Associaton of Corporate Counsel and the US Chamber of Commerce which questions the legality of the DOJ's position in the Thompson Memo that companies under investigation should deny legal fee advances to "culpable" individuals. Both of these pre-hearing briefs are posted in the "Indemnification Arrangements" Practice Area.

There often is tension in situations like this - where companies can be put under a lot of pressure to deny protections to individuals who have not been convicted (at least, not yet). Just review some of the recent cases like Homestore in Delaware, where the court dismissed efforts by a company to avoid paying the fees of an executive who really was "culpable." And then there are the very valid concerns about the massive legal fees incurred by indicted executives who "eat up" the D&O coverage of other directors and officers who are less culpable (for example, as noted in the WSJ Law Blog, check out how large the Hollinger legal bills were: well over $4 million each for Conrad Black and Richard Pearle!).

This is why companies need to address these tricky situations before they arise, within employment agreements and the like. Get some negotiating and drafting tips in the "Clawback Provisions" Practice Area on CompensationStandards.com.

Understanding the EU Prospectus Directive

Tune in tomorrow for the NASPP's webcast - "Understanding the EU Prospectus Directive" - to learn, among other topics:

- Which stock plans are most likely to be subject to the directive and what exemptions are available
- How to comply with the directive, including how to file a prospectus in your home member state and passport it to other EU countries
- How the directive intersects with local laws and the EU countries where compliance is most problematic
- What to do if you discover that your stock plans are in violation of the directive

A Refresher on CEO/CFO Certifications

We are still getting plenty of queries on CEO/CFO certifications, so I thought it was a good time for a refresher with this podcast with Andy Thorpe of Morrison & Foerster (and a former SEC Staffer who worked on the 302 rulemaking), who provides some insight into how to handle CEO/CFO certifications, including:

- Can a CEO/CFO vary the language at all in a 302 certification?
- What about a 906 certification?
- What happens if a CEO/CFO is hired after a period end? Can they skip the certification until they are on the job longer?
- What other questions are being asked about CEO/CFO certifications?

New Life for House's Truth-in-Pay Bill

Cheryl Hall of the Dallas Morning-News devoted her Wednesday column to providing an update on the progress of the House bill on executive pay (here is a blog from November when bill was introduced). Here is an excerpt from Cheryl's column:

"U.S. Rep. Barney Frank owes Exxon Mobil Corp.'s Lee Raymond a thank-you note. In November, the Democratic congressman from Massachusetts introduced a bill that would force public corporations to give easy-to-read, fully detailed reports on their top executives' pay, retirement, perks and golden parachutes.

But it was going nowhere fast until last week, when all 33 Democrats on the Republican-dominated House Financial Services Committee forced hearings in the near future on the bill. Mr. Raymond's stupefying retirement package and high gasoline prices created this solidarity, says Mr. Frank, who sees executive compensation escalation as corporate America's arms race.

"It's not simply that these guys are getting large amounts of money," says Mr. Frank. "But they're getting large amounts of money at the same time that large numbers of workers are seeing their pensions jeopardized, their wages frozen in real terms, their jobs abolished."

Not since Enron Corp. and Ken Lay have public angst and outrage seemed so unified. As a result, the winds of change are blowing from various directions at once. Regulators, stockholder groups and now perhaps Congress are saying enough is way too much. Charles Peck, a compensation specialist at the Conference Board in New York, has watched packages spiral upward for decades. "If you do the abnormal enough times, it becomes the norm," he says. "Shareholders are waking up to the fact that there's a whole lot of stuff going on underneath."

Under Mr. Frank's bill, companies would have to 'fess up to the private jets, limos, vacations, maids and special considerations that otherwise might have been buried in incomprehensible verbiage. The Protection Against Executive Compensation Abuse Act is similar in many respects to new rules the Securities and Exchange Commission is about to hand down. These mandate a plain-English, single-page tally of top executives' compensation – present and future. These tough disclosure regulations should be in place for the next proxy season.

So why doesn't Mr. Frank just wait for the SEC rules to take hold? "Excuse me," Mr. Frank says incredulously. "You must have a different version of the Constitution than I do. You must have one that says, 'Article 1: The SEC shall ...' "

And there is one critical difference. His bill would give shareholders the right to vote on whether the execs deserve the bounty. "CEOs pick the boards of directors, and the boards of directors pick the CEOs," says Mr. Frank. "They scratch each other's back. So there is no market mechanism for controlling CEO salaries. The only way to do that is to give stockholders a chance to vote." This is something the SEC cannot mandate because companies are incorporated under state laws. "We have no jurisdiction," says a commission spokesman. "All that Frank wants to achieve is unachievable by us."

Former CEO Ordered to Pay $22 Million in Disgorgement

On Wednesday, the SEC announced that Gemstar-TV Guide International's former CEO was ordered by the US District Court for the Central District of California to pay $22 million in disgorgement (including interest and penalties) for his role in a fraudulent scheme to inflate the company's revenues. Now that is a clawback - one of the largest fines ever handed down for an individual charged with accounting fraud! [The SEC had sought $60.9 million but the court did not rule on a $29.5 million severance payment because the former CEO didn't have access to it.]

If you remember back to the end of last year, this was the situation in which the Justice Department - responsible for criminal prosecution - agreed to a plea bargain in which the former CEO was given 6 months home detention, a $250,000 fine, and an order to make a $1 million charitable contribution. The judge threw out the plea bargain due to its leniency, which the SEC Staff appropriately opposed at the time (as noted in this blog).

Searching for Hidden Treasure

I found the following piece interesting in Susan Mangiero's Pension Risk Matters Blog: "I've spent the last few weeks trying to uncover information about the retirement plan decision-makers at various companies. I'm willing to pay money for this information. Why?

Simply put, I want to know who has responsibility for making multi-million dollar decisions that affect thousands of employees and retirees. Once identified, I'd like to read their bios, understand how they were selected, read about how they are evaluated and identify to whom they report.

Unfortunately, my quest has provided scant results. Here is a summary of what I know. (I welcome comments about possible data sources.)

1. There is no universally accepted organizational structure to determine who is in charge of recommending and deciding on what retirement benefits to offer those outside the executive suite.

2. When a retirement benefits committee exists, it goes by different names, some of which are listed below.

(a) Master Retirement Committee
(b) Trust Selection Committee
(c) Saving and Investment Plan Committee
(d) Pension Committee
(e) Retirement Board
(f) Fiduciary Committee
(g) Benefits Committee
(h) Deferred Compensation Board
(i) Compensation and Employee Benefits Committee

3. Titles of benefits-related decision-makers vary. Some examples follow.

(a) 401K Board Chairperson
(b) Benefits Director
(c) Benefits and Compensation Director
(d) Benefits Administrator
(e) Head of Human Resources
(f) Compensation Committee Chairperson

4. The SEC has proposed a significant overhaul of reporting rules as relates to executive compensation and compensation committees. It appears to be silent with respect to the compensation decision-making process for employees below C-level.

5. Page 1 of Form 5500 requires the identification of the plan sponsor and plan administrator, respectively. Schedule P to Form 5500 requires the signature of a fiduciary and the name of a trustee or custodian. (According to the U.S. Department of Labor website: "Each year, pension and welfare benefit plans generally are required to file an annual return/report regarding their financial condition, investments, and operations. The annual reporting requirement is generally satisfied by filing the Form 5500 Annual Return/Report of Employee Benefit Plan and any required attachments.")

6. ERISA mandates the distribution of a Summary Plan Description (SPD) to each plan participant and beneficiary currently receiving benefits. Required information includes "the name, title and address of the principal place of business of each trustee of the plan". Education and experience are not mandatory disclosure items.

The bottom line is that a systematic identification of who does what and why with respect to employee benefits is simply not a reality as things stand today. This makes it difficult (perhaps impossible) to effect change. Hunting for treasure shouldn't be this hard!"

Executives Take Company Planes as if Their Own

Looks like the executive pay issue is growing in prominence for the mainstream press as the NY Times ran this article attacking personal airplane use by executives on the front page of yesterday's paper. That's right - page A1.

The article's statistics about a 45% increase in amounts billed as personal use from the 100 largest companies - from 2004 to 2005 - could have been easily predicted. In the article, the rise is explained by the IRS cutting back on what companies could deduct when they pay for their executive's personal travel - thus increasing the burden on companies.

I believe an even more significant reason for the increase is that the SEC Staff had been providing warnings about perk valuations long before the SEC proposed the use of the incremental valuation method a few months ago (see Alan Beller's speech at our "1st Annual Executive Compensation Conference" in October 2004 and we analyzed this issue way back in the May-June 2004 issue of The Corporate Counsel). I believe some companies took this message to heart and moved away from some of the more egregious valuation methods, such as SIFL.

Unfortunately, valuation methodologies - as well as how companies determine what is "personal" versus "business" use - continue to vary greatly from company to company, as we recently highlighted on pages 8-9 of the September-October 2005 issue of The Corporate Counsel.

So no one should be surprised when these numbers go up significantly when 2005 is compared to 2006 - and even more so when 2006 is compared to 2007, as this is when the "rubber meets the road" as the SEC new rules take effect and hopefully the result is more uniformity in practice. I say "hopefully" because the SEC's proposed rules lack a clear definition of what costs should be included in the incremental calculation, as noted on pages 5-8 of this comment letter (which also argues that the valuation should be made from the perspective of the executive; not the company). More guidance in this area is necessary to ensure that companies don't continue to abuse "loopholes" to hide the true costs of personal airplane use.

How to Go Public on the London Stock Exchange’s AIM

Check out today's webcast - "How to Go Public on the London Stock Exchange’s AIM" - to learn how the London Stock Exchange's Alternative Investment Market (AIM) increasingly has become an option for companies seeking to go public.

The Impact of Stock Trading Plans on Potential Liability

From Lyle Robert's "The 10b-5 Daily": Whether selling company stock under a Rule 10b5-1 trading plan can help shield corporate executives from securities fraud liability is an open question. Although some courts have considered the existence of a trading plan in finding that an executive's stock sales did not create a strong inference of scienter (i.e., fraudulent intent), a recent decision goes the other way. In In re Cardinal Health Inc. Sec. Litig., 2006 WL 932017 (S.D. Ohio April 12, 2006), the court held that it was "premature" to evaluate the impact of a trading plan at the motion to dismiss stage because it is an affirmative defense to insider trading allegations.

Some Final Thoughts on Form 10-Q Risk Factor Disclosure

Brink Dickerson responds to some of the comments made on his thoughts on risk factors in 10-Qs by noting: “Commentators are absolutely correct that the SEC is hostile to disclaimers of duties to update. However, I include one in any event – usually with the qualifier “except as required by law” – because of Winick and some similar authority.

I have received comments from the SEC on this language – and they usually comment on the companion language as well that provides that the risk factors are the ones that the company currently considers to be material, but may not necessarily every material risk factor – and usually am able to convince them that some middle ground is appropriate. In Winick vs. Pacific Gateway Exchange, Inc., 73 Fed. Appx. 250 (9th Cir. 2003), the court said that ‘The company repeatedly disclaimed any duty to update its forecasts; thus, the company’s predictions regarding its ability to meet future obligations could not have remained “alive” in the minds of reasonable investors.’

A disclaimer of an obligation to update – or the general absence of a duty to update – is consistent with case law in the other circuits as well, and it is unfortunate that the SEC does not recognize that in its comments.”

Whole Lotta Internal Control Commenting Going On

Just ahead of today's SEC and PCAOB Section 404 Roundtable, there have been three recent notable commentaries:

1. On Monday, the GAO issued a report entitled "Consideration of Key Principles Needed in Addressing Implementation for Smaller Public Companies," which found that there is a disproportionate cost of compliance for smaller public companies to implement Section 404 but expresses concern over the Small Business Advisory Committee's recommendation that smaller companies be exempt from Section 404.

2. On Monday, SEC Commissioner Cynthia Glassman gave a speech entitled "Internal Controls Over Financial Reporting - Putting Sarbanes-Oxley Section 404 in Perspective."

3. Last Thursday, PCAOB Board Member Charlie Niemeier gave a speech entitled “Confronting the Challenges of Change in the World of Financial Reporting,” which includes comments on the rise in cost of capital when a company fails to have adequate internal controls as well as some interesting stats on foreign listings by US companies.

The FEI's "Section 404 Blog" describes comment letters submitted to the SEC for the purposes of today's roundtable. And yesterday, the SEC and four banking regulators issued a revised draft policy statement on complex structured finance activities of financial institutions - which includes internal controls and risk management procedures - to make it more principle-based, among other changes.

NYSE Proposes to Eliminate Treasury Share Exception

Last Friday, the NYSE submitted a proposal to the SEC that would eliminate the "treasury share exception" from the requirement for shareholder approval under Section 312.03 of the NYSE Listed Company Manual. From reading this blog, it's clear what the history is on this. The proposal has not yet been published for comment by the SEC and could still be changed.

Although Section 312.03 requires that companies obtain shareholder approval before issuing stock in certain situations or in significant amounts, the calculation of whether the amount of shares issued triggers the shareholder approval requirement doesn't apply to the reissuance of treasury stock in some cases (i.e., previously issued and listed shares that previously were reacquired by the company). In particular, the NYSE proposal would:

- Eliminate the treasury share exception entirely
- Require that companies notify the NYSE regarding issuances of treasury shares; and
- Clarify that the shareholder approval requirements for issuances to related parties cover a "series of related transactions"

In its proposal, the NYSE clarifies that companies may continue to rely on the treasury share exception until the SEC approves the rule change. But note on page 5 of the proposal: "Issuances effective on or after that date will be unable to utilize the treasury share exception, even if the issuer had contracted for the issuance prior to that effective date." In other words, the NYSE states that once the SEC approves the rule change, the treasury share exception is not available for any transaction - even if contracted for prior to the rule change.

This could hurt those companies that may have contacted the NYSE and obtained their blessing that shareholder approval isn't necessary, contracted for the arrangement, and then the arrangement is effected after the SEC approves the rule proposal; in this situation, shareholder approval would still be necessary despite the NYSE's prior acquiescence.

Developments for LLCs Doing Business in New York

Significant developments for any LLC that does any business in New York. In this podcast, Monica Lord of Kramer Levin provides analysis of changes in the laws – that are effective on June 1st - impacting limited liability companies doing business in New York (here is more information on these new laws), including:

- What are the latest developments for LLCs doing business in New York?
- What are the consequences of noncompliance?
- Can you tell us more about the new requirement to disclose the identity of the top ten members?
- Are there any exemptions?
- What should LLCs do now in anticipation of these changes?
- I hear that a revision to the law is being considered in Albany. Might all this change?

Even More on Form 10-Q Risk Factor Disclosure

Many members reacted to yesterday's blog, here is one from an anonymous member: "The last 2 sentences of the Coke disclosure is disclosure that I have seen the SEC Staff object to - in my mind, as long as the forward-looking cautionary statement is there, you don't need all the stuff they did and simply say "there are no material changes." Given there is now a specific form requirement that requires disclosure of material changes to risk factors, I believe that, regardless of what one discloses, if there are no new risks included, one is saying there are no material changes. I believe that is okay if true."

And Stan Keller noted: "Keep in mind that MD&A sometimes is used on a standalone basis, e.g., in the glossy annual report. Thus, a discrete safe harbor statement within MD&A may make sense. Often the safe harbor statement used in the earnings press release will serve the purpose for the MD&A. Also, I counsel against use of "disclaim any obligation" language because of Staff sensitivity and suggest another formulation, such as 'we do not intend to update.' But our advice has been consistent with Coke's - if there is no updating, and the company is comfortable not repeating the risk factors in the 10-Q, to refer to the 10-K risk factors without any statement that there have been no changes."

Some Progress on the NASD's Shelf Offering Proposal

Last week, the NASD proposed an amendment to its long-standing shelf offering proposal (it was originally published for comment by the SEC at the beginning of 2004! This is the 4th amendment.). The proposal is intended to clarify the application of the NASD's filing and substantive underwriting requirements to shelf takedowns - the NASD has revised a number of aspects of the original proposal, including no longer proposing to amend the definition of "underwriter and related person." Any rule change would not be effective until an approval order is issued by the SEC.

No More Broker Non-Votes? NYSE Advisory Panel Consensus

Somehow I missed this interesting piece a few weeks ago from Phyllis Plitch that ran on the Dow Jones newswire:

"In what would represent a major change in current shareholder voting rights, a committee formed last year by the New York Stock Exchange has reached a consensus that brokers should no longer vote for investors in director elections.

According to a person familiar with the situation, the panel stopped short of scrapping the controversial broker vote altogether, but has reached agreement that such votes shouldn't be counted in board elections.

A recommendation on the broker voting issue is contained in a draft report circulated to members of the committee Wednesday. Once the report is finalized it is expected to go to the NYSE for approval in June. The recommendation isn't likely to change as it is supported by most members of the committee, said the person, who requested anonymity.

The NYSE rule, which lets brokers cast votes in place of shareholders who don't return voting instructions, has been long maligned by some activist investors as a "ballot-stuffing" device. Consideration of the thorny issue was part of the panel's mandate to undertake a broad review of shareholder communications and proxy voting. The proxy working group's chairman, Palo Alto, Calif., attorney Larry Sonsini declined comment on the substance of the report, but cautioned that the committee's work is not yet complete. "There are a number of moving pieces that have to be rationalized," he said.

The decades-old NYSE rule gives brokers the right to vote shares held in investors' accounts - so-called street-name shares - on "routine" matters, when shareholders don't provide voting instructions. What has been particularly vexing to some investor activists is that the NYSE considers director elections a routine matter. To their minds, adding insult to injury, brokers cast their votes with management, under long-time industry practice.

In some cases, without the broker vote being added to management's tally, the outcome of dissident campaigns could have looked very different. In the high-profile election of Disney board members in 2004, 45% of the votes were cast against, or "withheld," from the election of former Chairman and Chief Executive Michael Eisner. But hundreds of millions of shares were cast in favor of Eisner, even though the true stockholders never returned their broker-supplied proxies. If the broker vote wasn't included in the tally, a majority of votes cast would have been withheld.

If the draft report doesn't change, other shareholder voting issues would still be considered routine for purposes of the broker vote, such as auditor ratifications. The panel is throwing the question of whether the broker vote is needed at all back to the NYSE for further evaluation. A key argument heard from the NYSE and supporters of the rule over the years is that without the broker vote thrown into the mix, it would be harder for companies to reach an annual meeting quorum.

Any rule change would have to be approved by the Securities and Exchange Commission. An NYSE spokesman had no immediate comment."

Tomorrow's Webcast on Hedge Fund Activism

With so much going on with hedge funds these days, I am pretty excited about tomorrow's DealLawyers.com webcast - "How to Handle Hedge Fund Activism" - where Craig Wasserman and Marc Wolinsky just joined a panel of their fellow Wachtell Lipton partners: Marty Lipton, David Katz, Josh Cammaker and Mark Gordon. Talk about an all-star line-up!

To catch this program, try a no-risk trial to DealLawyers.com, where a license for a single user only costs $195. This webcast alone is well worth the price of a license...

House Approves Tying Senior Manager Pensions to Funding Status

Last Wednesday, the US House of Representatives passed a motion - with a vote of 299-125 - that would restrict the pension benefits of senior managers whose companies' pension plans are less than 80% funded. The bill primarily is aimed at companies switching to cash balance plans.

Rep. George Miller's (D-Calif.) motion instructs conferees seeking to reconcile differing House and Senate pension reform legislation (H.R. 2830) to adopt provisions that would:

- restrict executive compensation, including nonqualified plans - in companies with pension plans that are less than 80% funded - equal to restrictions that would be imposed on benefits for workers and retirees in those plans, and

- insist that the definition of ''covered employee'' include the CEO of the plan sponsor, any other employee of the plan sponsor who is a ''covered employee,'' within the meaning of such term specified in the provisions contained in the Senate pension bill, and any other individual who is an officer or employee of the plan sponsor

This press release provides more information. Progress on reconciling the House motion with the Senate has been limited so far.

More on Form 10-Q Risk Factor Disclosure

One of the primary benefits of having an advisory board is receiving their sound counsel, even when they do not fully agree with you. Brink Dickerson of Troutman Sanders was kind enough to send along his thoughts on Coke’s approach to risk factors – which shows that he favors a different approach to the one I favored in this blog from last Monday:

"A well written MD&A will always contain forward-looking statements. They might be triggered by the requirement to discuss “known trends” and “uncertainties,” but they certainly will be triggered by the liquidity disclosure, which is required to address how companies expect to meet future liquidity needs. The safe harbor, as it applies to written statements, requires three things: Identification of the forward-looking statements (which, hopefully, is something more than the verb-to-be buzzword approach), the magic language that “actual results may differ materially,” and, most relevantly, accompaniment by “meaningful cautionary language.”

There now are hundreds of forward-looking statement cases. Few have focused intently on what it means to “accompany.” Two have come up with odd answers on this issue – one suggesting a “truth on the market” approach to counter the judge’s apparent distaste for the “fraud on the market” theory that might suggest that anything in the public domain that is cautionary would qualify (Judge Easterbrook, what were you thinking?) and another who dismissed based upon a safe harbor argument where the cautionary language was in a separate document.

However, the overwhelming majority of the cases involve situations where the meaningful cautionary language was in the same document and the issue did not have to be addressed, but dictum in a number of those cases suggests that is what the law requires. To me, “accompany” means “in the same document, appropriately captioned and not obscure.” Until a court holds clearly otherwise, that certainly is the best practice, if not the only practice that counsel could responsibly advocate.

Thus, a well written From 10-Q is going to contain forward-looking statements and should contain a safe harbor. But remember, safe-harbor disclosure is not required (and the SEC still appears reluctant to admit that the Reform Act is law).

“Risk factors” require the disclosure of risks that make a security “speculative or risky.” See Reg. S-K, Item 503(c). “Meaningful cautionary language” requires a discussion of the most likely reasons, but not necessarily all know reasons, that actual results may differ materially form those suggested by the forward-looking statements. See, e.g., Harris v. Ivax Corp, 182 F.3d 799 (11th Cir. 1999). These requirements are not the same, and good risk factor disclosure probably is a bit more robust than good safe-harbor disclosure.

Technically, a registrant could include Coke-like risk factor language in Item 1A of Part II of their Form 10-Q, i.e., a cross-reference to the Form 10-K risk factors and a statement that there have been no material changes and be fully compliant with their Form 10-Q obligations. But, the MD&A should be accompanied by a good safe harbor, and probably the most common practice is to put the safe harbor at the end of the MD&A section.

But, why not move the safe harbor introductory language – the “identification” plus “magic language” – to the beginning of Part II, Item 1A of the Form 10-Q and then follow it by traditional risk factor language? (And then follow that with language that expressly states that “We disclaim any obligation to update . . . except as required by law.”) This puts the safe harbor language in a readily findable spot and utilizes the, hopefully, good risk factors, and adds only minimal length to the document. We also know that meaningful cautionary language is supposed to be “alive” and change over time (common sense plus Judge Easterbrook, at least if you want him to uphold your motion to dismiss), and risk factor language should as well. So, republishing updated risk factors on a quarterly basis has other value.

I believe that this is the best approach, although I expect it to be the minority approach given the wording of the Item 1A and the fact that most registrants will not focus on the opportunity to combine their safe harbor and risk factors."

Big Drop in Filing Fee Rates Planned for '07

On Wednesday, in the midst of providing testimony on the Hill, Chairman Cox announced that the SEC would drop fee rates considerably for the next fiscal year - the registration filing fee rate will be reduced by 71.3%! The rate would decrease to $30.70 per $1 million worth of securities registered from the current rate of $107.00.

This new rate will be effective at the beginning of the SEC's next fiscal year, October 1, 2006 or 5 days after the date on which the SEC receives its regular appropriation, whichever date comes later (and based on past experience, as evidenced by my blogs from prior years, it's always the latter as Congress inevitably drags its feet in approving the federal budget).

An Open Letter to All Journalists

On CompensationStandards.com, I have posted my "Open Letter to All Journalists," which is an indirect response to the Holman Jenkins op-ed in Wednesday's WSJ entitled: “Surprise! CEOs are Still Highly Paid!”

I characterize my response as "indirect" because it is difficult to take Mr. Jenkins too seriously because I believe he will hold onto his views despite his lack of command over the subject matter. For example, Mr. Jenkins blasts pay-for-performance because Mr. Jenkins contends: "Pay for performance" is paying for the past, not the future, which is what stock prices care about."

As far as I know, that's not anyone else's definition of "pay-for-performance." In fact, pay-for-performance is precisely the opposite of what Mr. Jenkins believes it to be. A company enters into a CEO pay arrangement today with specified future performance targets that need to be triggered in order to earn the pay. But I thought posting my response could be useful to other journalists who need to get up-to-speed on responsible pay practices in the midst of so much misinformation out there on the topic.

Analysis: Comment Letters on the SEC's Executive Compensation Disclosure Proposal

Last week, Jesse Brill submitted his second comment letter on the SEC's executive compensation disclosure proposal. This second letter contains analysis of other interesting comment letters and reiterates some of the points made in his first comment letter. Check them out!

Free Writing Prospectuses: The Survey

Since the December 1st effective date of Securities Act reform, lawyers have been more careful about what constitutes the "disclosure package" as more writings are being considered a potential offer and filed as a free writing prospectus. Take our new survey on how many pieces typically constitute the "disclosure package" as well as the largest disclosure package you have worked on to date.

Free Writing Prospectuses: The Fun Stuff

As noted in our "Analysis of Free Writing Prospectuses" - which includes samples of the various types of FWPs filed so far - approximately 3000 FWPs have been filed with the SEC since December 1st. As part of the survey noted above, we have included a question asking which of six notable FWPs you find the most interesting. Check it out and have some fun.

If you are aware of other interesting FWPs not on this list, please drop me an email and let me know.

Survey Results: Trading Policies for Outside Directors

Our June 2005 survey on blackout practices ended with a question as to whether outside directors were subject to restrictions. Our most recent survey followed up on that theme with the following results:

1. Are outside directors at your company subject to restrictions on trading in company securities?

- Yes - 100%
- No - 0%

2. If yes, are they subject to the same restrictions as senior management?

- Yes - 93.7%
- No - 6.3%

3. Are outside directors free to trade at any time when there are no restrictions or must they also preclear their trades (eg. with the compliance or legal department)?

- Must always preclear- 88.8%
- Only needs to preclear in limited circumstances - 6.3%
- Never needs to preclear - 5.0%

4. If preclearance is required, how long is the preclearance valid?

- Less than 3 trading days - 35.5%
- 3-5 trading days - 28.9%
- 5-10 trading days - 18.4%
- More than 10 trading days - 17.1%

The SEC's Virtual Workforce Pilot Program

During his testimony last week before the US House Appropriations Subcommittee regarding the SEC's budget, Chairman Cox discussed how the SEC has made "great strides in increasing participation" by Staffers in the Commission's telework program. He noted that "during the first half of this year, we increased our telework participation to more than 1,100 employees. This represents an increase of 532 over the level at the start of fiscal 2005."

He also noted that "our evaluation to date of our Virtual Workforce pilot program within the Division of Corporation Finance, we are considering options for expanding the program to other divisions and offices within the agency." This pilot program consists of Staffers who work from home 100% of the time; whereas the telework program consists of Staffers who work from home one or two days per week. Both efforts are part of an overall initiative within the federal government to encourage more teleworking (which saves $ on office space, etc.). I'm sure there are lots of ex-Staffers out there wishing they had never left...

Comments from Corp Fin's Office of Global Security Risk

During his testimony, Chairman Cox noted that the Office of Global Security Risk issued comments to 137 companies over the past year. I believe these comments often come in this form:

"We note the several references to your operations in ___. Please identify for us the __countries in which you have operations. If any of these operations are in a country identified by the U.S. State Department as state sponsor of terrorism, or if you have other contacts with any such country, identify each such country for us. Advise us also whether your __subsidiary is in __, a country identified by the U.S. State Department as a state sponsor of terrorism.

If any of your operations or other contacts is with a country identified as a state sponsor of terrorism, please advise us of the materiality of those contacts to the Company, and give us your views as to whether those contacts constitute a material investment risk for your security holders.

If you have contacts with more than one such country, provide the requested information with respect to your contacts with the countries individually and in the aggregate. In preparing your response, please consider that evaluations of materiality should not be based solely on quantitative factors, but should include consideration of all factors, including the potential impact of corporate activities upon a company's reputation and share value, that a reasonable investor would deem important in making an investment decision."

On a related note, last Thursday, the SEC jointly released this special study with the Federal Reserve and Office of the Comptroller regarding sound practices to strengthen the resilience of the US financial system.

Grasso Pay Package 'Shocked' Board

Couldn't resist this short article from Friday's WSJ describing the NYSE Board's "Holy Cow" moment: "A newly surfaced document calls into question whether the board of the New York Stock Exchange fully understood the scope of the pay package being offered to former Big Board boss Dick Grasso. That $188 million pay package is the subject of a lawsuit against Mr. Grasso by New York state's attorney general, Eliot Spitzer, whose case argues that such compensation was inappropriate for the head of a what was then a nonprofit organization.

The NYSE's board "did not receive detailed information from the compensation committee," according to internal notes prepared by former New York Stock Exchange Compensation Committee Chairman H. Carl McCall and his assistant in 2003. Mr. McCall's notes said he realized that the board was in the dark when he started chairing the NYSE's compensation committee in June 2003. The NYSE is now part of publicly listed NYSE Group Inc.

The notes became public by court order Wednesday after they came up during Mr. Spitzer's deposition of Linda Scott, Mr. McCall's assistant. They indicate that many board members were "shocked" when Mr. McCall gave them a "heads up" on the size of Mr. Grasso's pay package."

da Vinci Code Judge Embeds Own Code in Ruling

Who says that lawyers don't have a sense of humor? UK Judge Peter Smith, who decided the case brought against Dan Brown involving "The Da Vinci Code," embedded a coded message in his ruling: smithcodeJaeiextostpsacgreamqwfkadpmqz. This coded message has now been cracked. Judge Smith's clerk confirmed that the judge is a "humorous type of person."

Coke's Form 10-Q Risk Factor Disclosure

Last Monday, I blogged about the new risk factor disclosure requirement to consider for the 10-Qs being filed over the next few days. A subsequent question was asked in our "Q&A Forum" about what to do if a company has no material changes to the risk factors described in its last Form 10-K (see #1712 in the Forum).

I like the approach that Coke took to this issue. As reflected in its Form 10-Q filed recently, Coke directs readers to its 10-K without expressly stating that there was "no material change." This is the best approach I've seen so far. Here is what Coke disclosed:

"In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2005, which could materially affect our business, financial condition or future results. The risks described in our Annual Report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results."

More from the PCAOB on Inspections and Internal Controls

Possibly in response to the rising internal control audit costs, the PCAOB issued a statement yesterday on the approach it intends to take with regard to inspections of internal control audits during this year's inspection cycle, which commences this month. The key emphasis will be on the efficiency of the auditors’ performance of internal control audits and the inspectors will be delving into whether the auditors have achieved the objectives of Standard No. 2 with the least expenditure of effort and resources. This will include an examination of how well auditors implemented the PCAOB’s guidance from last May (which was supplemented by the November 30, 2005 Report on the Initial Implementation of PCAOB Auditing Standard No. 2.)

This year's inspection cycle will include the annual inspections of the nine firms – eight U.S. and one Canadian – that audit more than 100 public companies (as required per SOX Section 104). Additionally, the PCAOB will continue its three-year cycle of inspections of firms that audit 100 or less public companies.

Also yesterday, the SEC and PCAOB announced the panels for their May 10th joint roundtable on the second year of internal control reporting. A related briefing paper and agenda were also issued by the SEC.

Also, last Thursday, the PCAOB issued an "Overview of Auditing Standard 4 - Reporting on Whether a Previously Reported Material Weakness Continues to Exist," which summarizes key points from PCAOB’s previously issued AS4. As you might recall, this overview was requested by the SEC when it finally approved Standard No. 4 in February.

NYSE Updates Its Affirmations and Certifications

Last Friday, the NYSE updated its Section 303A Annual and Interim Written Affirmations and Section 303A Annual CEO Certification for domestic companies. The changes appear to be minor, and include adding the company’s ticker symbol, eliminating references to the transition period for classified boards that expired last year and simplifying text.

Here is a full comparison of the 2006 forms to the 2005 forms. Note that if your company has already submitted its 2006 Section 303A Annual Written Affirmation, a new submission is not required.

Progress on Delaware Bar Association's Consideration of Majority Vote Standard

According to ISS' "Corporate Governance Blog," the Executive Council of the Delaware State Bar Association's Corporate Law Section has endorsed draft legislation to amend the Delaware General Corporation Law to enable shareholders to introduce an irrevocable change of bylaws on director elections, as well as provide for an irrevocable resignation of directors who fail to get a requisite number of votes. The proposal does not modify the default plurality standard.

The proposal would amend paragraph 216 of Section 5 of the DGCL to provide that a company bylaw adopted by a vote of stockholders that prescribes a required vote for director elections cannot be altered by the board without shareholder consent.

Another proposed revision seeks to get around the restrictions of Delaware's "holdover" rule by adding a new provision that a director resignation may be made effective upon the occurrence of a future event or events, coupled with authority granted in the same section to make certain resignations irrevocable.

The proposed bill will be submitted to the Delaware legislature in the next week or two - and then it must be endorsed by the full Bar Association and then passed by the Delaware legislature before becoming law.

49% Support for Binding Majority Vote Proposal

Here is another item from ISS' "Corporate Governance Blog": This season's first binding proposal seeking majority voting received more than 49% of votes cast at Honeywell this week, according to the proponent, AFSCME.

That showing was significantly higher than the 20% vote received by a binding AFSCME proposal at Paychex in October. The Honeywell vote is also noteworthy, because the company had adopted a director resignation policy. Before the April 24 vote, the best showing for a majority vote resolution at a company with a resignation policy was the 45% support at Hewlett-Packard in March for a non-binding proposal by the United Brotherhood of Carpenters and Joiners.

Majority Vote Standards in Articles of Incorporation?

And one last item from ISS' "Corporate Governance Blog": "Progress Energy filed in its proxy materials what is believed to be the first management proposal to change a company's articles of incorporation to require a majority vote for the election of directors. Management is also proposing a resolution to hold annual board elections. The North Carolina utility's annual meeting is May 10.

More than 20 companies have adopted a majority vote standard this year, primarily by revising their bylaws. Progress Energy appears to be the first to seek to make the change in its articles of incorporation. In North Carolina, as in most jurisdictions, articles of incorporation can only be amended if the change is proposed by the board and endorsed by shareholders, whereas bylaws can generally be revised by the board alone.

The Progress Energy proposal requires a majority of votes cast to pass, and abstentions and broker non-votes will not count as votes cast or against, the proxy statement notes. If approved, the new standard would apply for the company's 2007 annual meeting. To overcome the North Carolina "holdover rule" which requires a director to serve until his or her successor is elected, the company adopted a director resignation policy in its corporate governance guidelines, which would become effective upon filing of the amended articles of incorporation.

Action on the resignation is left up to the governance committee, but if its members fail to gain majority support, the independent directors who did get elected can appoint a committee of independent directors to make a recommendation on the tendered resignation."

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