Welcome Aboard, Mr. David Lynn!

We are honored to welcome David Lynn to our team. Dave left his post as Chief Counsel of the Division of Corporation Finance on Friday, after serving in that capacity for the past four years. This was his second tour of duty in Corp Fin, having spent some time at WilmerHale in between.

In addition to helping implement the record amount of rulemaking that occurred in the wake of Sarbanes-Oxley, Dave was one of the key point persons on the SEC’s proxy disclosure rules and, most recently, has been primarily responsible for the overhaul of the SEC’s Telephone Interpretations Manual. Dave and I worked together at the SEC a while back and I couldn't imagine a better partner to spend the next few decades churning out the news and analysis for you on this site.

The "Skinny" on Dave

So what will Dave be doing? Initially, Dave will be providing badly needed help on TheCorporateCounsel.net, serving as an Editor of the site along with me - and even splitting blogging duties starting next week. Dave actually ran an internal blog in Corp Fin so he is not afraid to stick his neck out. Dave also will be helping out on CompensationStandards.com, run our secret special project division and weigh in with his ten cents on some of our print publications, like The Corporate Counsel.

As evident from his biography, Dave is a man of multiple talents. Who else could come up a "going away" speech in the form of a CD&A (actually, several CD&As). And Dave will be able to help all of us decipher some of the more interesting comment letters that get filed with the SEC. Dave can be reached at dave@thecorporatecounsel.net. Let him know how much you want to love him...

The Rise of the "B's"

In our "Credit Ratings, Arrangements, & Facilities" Practice Area, we have posted a report on the rise in numbers of companies in the US with "B" credit rated debt. It notes the dramatic decline in percentage of companies with AAA/AA rated debt, as well as the percentage of companies with "B" rated debt that have filed for bankruptcy.

Recent Developments: The NYSE's "Broker Vote" Rulemaking

Recently there has been some movement in the NYSE's rulemaking to amend Rule 452 to eliminate broker non-votes in the director election context. First, there was some discussion on the topic during last week's proxy process roundtable at the SEC. Jim McRitchie does a good job of summarizing what the roundtable participants' positions have been, noting on CorpGov.net that the recommendations on broker voting appear to have broken into three categories:

- Stick with NYSE's proposal to eliminate broker voting for directors - One variation would only eliminate it where there is an active no-vote campaign.

- Proportional voting - Where the broker uses voting instructions given by other retail investors to determine how to vote uninstructed shares. There were several variations on this theme.

- Client-directed voting - Under this framework from American Express's Stephen Norman, retail investors would give general voting instructions to their broker when signing brokerage account agreements.

Second, as noted in this WSJ article, the mutual-fund industry got its wish and the NYSE has amended its proposal so that mutual funds would be excluded from any change in its rules (according to the article, after reviewing information supplied by the fund industry, the NYSE said its advisory panel concluded that mutual funds are different enough "that it was appropriate to treat such companies differently").

Finally, some investors are demanding that this rulemaking go forward. Below is an excerpt from the ISS "Corporate Governance Blog" on this topic:

A close director vote at CVS/Caremark is fueling investor demands for the Securities and Exchange Commission to approve a New York Stock Exchange rule change to bar brokers from casting uninstructed investor votes in board elections.

"I think this vote will be Exhibit A in the deliberations of the NYSE and the SEC in the coming weeks," said William Patterson, executive director of the CtW Investment Group, which has urged CVS/Caremark to request the resignation of director Roger Headrick. The Council of Institutional Investors (CII) plans to hold a conference call on May 29 to address the issue, Patterson said.

Headrick received 606.585 million "for" votes and 453.175 million "against" votes at company's May 9 meeting, CVS/Caremark said in a regulatory filing. Based on those numbers, Headrick received a 42.7 percent negative vote. However, the vote results for five other proxy items reveal that 264.762 million "broker non-votes" were cast. If those broker votes are subtracted from Headrick's "for" total, then the "against" votes would amount to 57 percent of the remaining votes.

The stakes are higher at CVS/Caremark, because the company, like scores of other large firms, now requires that board nominees receive a majority of votes cast in uncontested elections to be elected. "Before this proxy season, all of this was theoretical," Patterson told Governance Weekly. At CVS/Caremark, "the broker votes were decisive and that's clear."

CtW, which manages funds for the Change to Win labor federation, targeted Headrick and a second former Caremark Rx board member over their handling of the pharmacy benefits company's recent sale to CVS, the largest U.S. drug-store chain. In its regulatory filing, CVS/Caremark said "votes 'against' a director's election count as a vote cast, but 'abstentions' and 'broker non-votes' do not count as a vote cast with respect to that director's election."

However, the vote results suggest that some of those broker votes were counted in Headrick's election. The company's filing indicates that a total of 1,059.76 million shares were cast either "for" or "against" Headrick. CVS/Caremark also reported that the total votes cast at the meeting were 1,091.671 million, or 31.91 million more. The vote results for five other proxy items indicate that there were 264.762 million broker votes, so it appears that 232.852 million broker votes were counted in Headrick's election for his vote total to reach 1,059.76 million. Those 232.852 million votes exceed the 153.41 million difference between the "for" and "against" votes that the company reported that Headrick received.

Company spokeswoman Carolyn Castel told Dow Jones Newswires that the "broker votes were spread among the votes cast for and against the directors." However, Patterson and other investor advocates contend that broker votes are routinely cast in favor of management nominees in uncontested elections. The Council of Institutional Investors has said these votes "taint the integrity of the proxy voting process by stuffing ballot boxes for management."

Goldman Launches an Unregistered Stock Trading System

As noted in this recent WSJ article, Goldman Sachs has joined the ranks of those launching an unregistered securities trading exchange with its "GS TRue" platform. Here are one blogger's thoughts on this development - and here are two excerpts from the WSJ article:

"Goldman Sachs Group Inc. ranks as the most profitable securities firm on Wall Street -- reflecting its mastery of trading on the world's public markets. Now Goldman is turning that franchise on its head, creating its own private system to trade the stocks of companies that don't want the scrutiny and regulatory burdens of going public.

The new system, GS TRuE -- short for Goldman Sachs Tradable Unregistered Equity -- was announced two weeks ago and made its debut on Monday with an $880 million sale of a 15% stake in Oaktree Capital Management LLC, an alternative-investment manager. It is the first of several new, private exchanges like these being considered by Wall Street firms and others. Nasdaq is also planning its own new market for smaller, unregistered securities.

These markets will generally be closed to individual investors. For instance, Goldman's market is open only to large institutional investors with assets of more than $100 million. That is because the stocks traded on GS TRuE aren't registered with the Securities and Exchange Commission and issuers aren't subject to SEC regulations designed to protect individual investors.

It represents the latest step in the creeping exclusion of individual investors from a growing proportion of financial-market activity. For instance, giant private-equity firms are busy buying public companies and delisting them from stock exchanges. The growing importance of hedge funds -- which are generally limited to wealthy investors, institutions and endowments -- also excludes individuals."

"Bankers at rival firms -- many of which are developing similar systems -- predict that there will be consolidation among the different platforms. "History in other markets would indicate that this will converge into a single platform," said Daniel Simkowitz, a managing director in capital markets at Morgan Stanley, which advised Oaktree on the issue.

Indeed, Nasdaq Stock Market Inc. is in the home stretch of getting approval for a similar unregistered trading facility for smaller companies called Portal. Another securities firm, Friedman, Billings, Ramsey Group Inc., has sold unregistered stock for numerous companies in real estate, energy and lodging.

Goldman executives said one reason they launched their own system solo, without asking other rival securities firms to participate, was to insure control over the number of investors in any particular security. That is crucial, they said, because any company that goes over 499 investors must register as a public company.

That 499-investor limit, said one executive of a top private-equity firm, is one reason why such buyout firms aren't likely to rush pell-mell into this type of new issue for their portfolio companies. The buyout firms want to attract far more investors to make sure they get the best prices for their stock, he explained."

A Philosophy for Drafting Agreements

In our "Carl's Corner", we have posted the latest from Carl Schnider on "A Philosophy for Drafting Agreements." Great practical stuff from Carl!

The Evelyn Y. Davis Show

As expected, Evelyn Davis was all entertainment during the SEC's third proxy process roundtable on Friday. She is a "must see" on the video archive (her panel kicks off at the 1:22 mark; Evelyn starts at 1:27, but its worth hearing the calm voices of the other speakers before her for context). Note that the SEC upgraded the display of its open meetings from audio to video recently.

Marty Dunn did a fair job of keeping Evelyn under control - but she did get a few good ones in, such as screaming that she is prettier than Nell Minow. The SEC has posted a transcript of the first roundtable as well as briefing papers and panel statements for all three.

Private Equity M&A Nuggets

We have posted a transcript from the popular DealLawyers.com webcast: "Private Equity M&A Nuggets."

Subprime Lending Developments

In this podcast, Stephen Ornstein of Thacher Proffitt & Wood provides some insight into what is happening in the subprime lending market, including:

- What are the latest developments in the subprime lending area?
- How bad is this market right now?
- For those companies that originate, purchase and underwrite securitizations with subprime loans, what is their respective primary exposure in today's markets and how do these parties mitigate risk?

PCAOB Adopts AS #5

Yesterday, the PCAOB adopted Auditing Std. No. 5 (and here is the PCAOB's press release). It is expected that the SEC will approve the PCAOB's new standard on an expedited basis.

Memos on the SEC's and PCAOB's guidance will be posted in our "Internal Controls" Practice Area. And I am putting the finishing touches on a July webcast to explain all the new internal controls guidance, featuring John Huber and some Big 4 experts...

Corp Fin Issues Section 16 Interps

Yesterday, Corp Fin issued these Section 16 interps. As he has already been doing, Alan Dye will be blogging about the nuances of these new interps on his Section16.net Blog – as well as writing about them in the upcoming issue of Section 16 Updates. Try a no-risk trial to Section16.net today - half-price for the rest of 2007!

A New Staffer Hang-Out?

Congrats to SEC Staffer Amy Starr for founding a groovy coffee shop in Northern Virginia (below is a related Washington Post article): "David A. Starr talks real fast, not because he's a lobbyist but because he is a professional coffee roaster on the side. He drinks about eight cups of his specialty brew a day.

Starr, a 48-year-old principal at the lobbying law firm Williams & Jensen, is an expert in tax and pension law. His clients include Brooks Brothers and the YWCA Pension Fund. But in recent years he and his wife, Amy Starr, a Securities and Exchange Commission lawyer, developed a passion for self-roasted coffee and this year they made it into a business, Beanetics Coffee Roasters in Annandale.

"We can roast 100 pounds of coffee -- from green bean to bag - in an hour," Starr said proudly. And yes, the beans, whether Costa Rican (his top seller) or Ethiopian, start off green before they are heated in the store's roaster, which patrons can see through a window.

Starr began 10 years ago with a tabletop roaster in his kitchen and progressed to a bigger roaster in his garage. But his friends wanted more coffee than his hobby could provide them, so in February he opened shop not far from his home. "I scoot over on the way into work to check in," Starr said, "and also have a great cup of coffee."

SEC Adopts Voluntary 404 Guidance and Much More

Yesterday, the SEC adopted new guidance for management's assessment of internal controls over financial reporting, which becomes effective 30 days after being published in the Federal Register. The new guidelines provide a principles-based framework, which is intended to promote a "healthy use of judgment" and provide companies with flexibility to establish an appropriate evaluation method. Here is Corp Fin Director John White's opening statement, Chief Accountant Hewitt's opening statement, Deputy Chief Accountant Zoe-Vonna Palmrose's opening statement and a press release. FEI's "Financial Reporting" Blog has more extensive notes about the meeting.

Although we don't have the text of the new guidance yet, the SEC Staff said that the proposed core principles remain unchanged in their final form - but the Staff stated that there are some changes, mainly to align the guidance with what the PCAOB will adopt today at their meeting. The core principles are that management should evaluate whether it has implemented controls that adequately address the risk that a material misstatement in the financials would not be prevented or detected in a timely manner - and that management's evaluation of evidence about the operation of its controls should be based on a risk assessment.

The SEC stated that its guidance makes clear that management can look to the principles-based guidance for carrying out its responsibilities. The new guidance doesn't include examples because the SEC wants to avoid the unintended consequence of creating a "one size fits all" box. The SEC Staff stated that many larger companies have developed acceptable procedures for Section 404 reporting that differ from the interpretive guidance and that such procedures may continue to be used.

The SEC amended Rule 12b-2 and Rule 1-02 of Regulation S-X to codify the term "material weakness" substantially as proposed (the Staff stated that the PCAOB will adopt the same definition) to "a deficiency, or combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility of leading to a material misstatement that will not be prevented or detected on a timely basis). The Staff explained that most of the material weakness situations seen so far involve accounting related issues within the areas of more complex accounting standards, such as taxes, revenue-recognition and the treatment of derivatives - and the new guidance addresses these areas.

The SEC amended Rules 13a-15(c) and 15d-15(c) to eliminate the requirement that auditors attest to management's process of evaluating internal controls. In addition, the SEC amended Rules 1-02(a)(2) and 2-02(f) of Regulation S-X to require the expression of a single opinion directly on the effectiveness of internal control over financial reporting by the auditor in its attestation report.

The SEC also proposed a new definition of the term "significant deficiency," which is intended to clarify those weaknesses that are considered to be less severe than a "material weakness." Unlike "material weakness," the proposed "significant deficiency" doesn't include a probability threshold.

What the SEC Didn't Do? Extend the Smaller Company Deadline Again

The SEC didn't extend the deadline for smaller companies (those with less than $75 million in market capitalization) to comply with Section 404 since the new guidance provides scalable and flexible ways for these companies to meet the December 31st deadline. So unless the SEC reverses itself - which is still possible since Commissioners Atkins and Casey said they are still considering it - three delays was the charm. Following the SEC meeting, Senators Kerry and Snowe issued a press release saying it was a mistake not to adopt a fourth delay.

By the way, the SEC has announced the agendas and panelists for today's and tomorrow's proxy process roundtables (Evelyn Davis is on the Friday agenda; that alone should make it worthwhile). And the SEC adopted rules yesterday related to the Credit Rating Agency Reform Act of 2006.

The SEC's Proposed Overhaul of Smaller Company Capital-Raising

Yesterday, the SEC also proposed a new framework for smaller company capital-raising. Here is an opening statement from the Corp Fin Staffers who shepparded this project. According to this press release, the proposals would include:

- A new system of securities regulation for smaller public companies that would make scaled regulation available to a much larger group of smaller companies (ie. up to $75 million in public float; up from $25 million), including killing the S-B system by integrating Regulation S-B into Regulation S-K and rescinding the SB Forms

- Modified eligibility requirements so companies with a public float below $75 million can use shelf registration

- A new Regulation D exemption from '33 Act registration requirements for sales of securities to a newly defined category of “Rule 507 qualified purchasers” for which limited advertising would be permitted

- Shortened holding periods under Rule 144 for restricted securities (ie. reduced from one year to six months, unless a short sale is involved) and a few changes to Rule 145

- Two new exemptions for compensatory employee stock options so '34 Act registration requirements would not be triggered solely by a company’s option granting practices

- Electronic filing of Form Ds

Hewlett-Packard's Boardroom Leak: SEC's Enforcement Brings a Form 8-K Case

So I guess filing those director resignation 8-Ks do matter after all. According to this press release, the SEC yesterday filed settled administrative charges with a cease and desist order (no fines or penalties) against Hewlett-Packard for failing to disclose the reasons for a director’s abrupt resignation in the midst of H-P’s controversial investigation into boardroom leaks.

The SEC found that several months before the public revelation of the company’s leak investigation, an H-P director objected to the company’s handling of the matter and resigned from the Board, yet H-P failed to disclose the reasons for his resignation as required under Item 5.02(b) of Form 8-K. Here is the SEC's administrative release.

The Independence of Compensation Consultants

A few weeks ago, Rep. Henry Waxman (Ca.-D) sent letters to a number of compensation consultants seeking information about potential conflicts, ahead of a likely hearing on the topic. Here is an excerpt from a recent NY Times article:

"Members of Congress are looking into the potential conflicts among executive compensation consulting firms that do other lucrative work for the companies whose pay they help devise. The chairman of the House Committee on Oversight and Government Reform has asked the largest companies in the industry for details on their client relationships and the revenues these ties have generated over the last five years.

The companies — Hewitt Associates; Mercer Consulting, which is a unit of Marsh & McLennan; Towers Perrin and Watson Wyatt Worldwide — confirmed yesterday that they had received a letter dated May 8 from Henry A. Waxman, the California Democrat who is chairman of the oversight committee.

Mr. Waxman asked the consulting firms to identify which companies among the nation’s 250 largest they had provided both executive pay consulting and other services for and to disclose total revenues received for each type of service. Mr. Waxman asked that the companies supply the information by May 29."

Personally, I'm not convinced that these consulting conflicts are "real" since the folks that advise on exec comp are not the same as those that consult on other HR stuff (ie. general workforce pay, retirement and health benefits) within these consulting firms - but perception often can be as important as real conflicts. Of course, as noted in the D&O Diary blog, there can be instances where a consultant can be implicated in some shenanigans...

Executive Compensation Disclosure Proposal: Et Tu, Canada?

Last month, Canadian regulators proposed an overhaul of their executive compensation disclosure rules, including a new CD&A and a total column in their Summary Compensation Table. Similar to last year's overhaul in the US, the Canadian proposal would be the first update of these rules since 1994. Learn more in CompensationStandards.com's "International" Practice Area.

Top Trends in Stock Plans for Overseas Employees

Tune in tomorrow for this NASPP webcast - "Top Trends in Stock Plans for Overseas Employees" - and learn:

- Trends in the design and usage of stock options, restricted stock, performance-based awards, and ESPPs for overseas employees
- Changes in stock compensation for overseas employees as a result of 123(R)
- Worldwide participation in ESPPs and changes in these plans post-123(R)
- Policies and procedures for tax withholding on both stock options and restricted stock
- Common practices for monitoring compliance with local laws, grant documentation and employee education, and compliance with data privacy laws and the EU prospectus directive

And just yesterday, the SEC announced a roundtable of five SEC Chairs that will take place today. Not too much in the way of advance notice for this program - and the announcement doesn't indicate what the topics will be (and this roundtable will convene at 5 pm, well after this morning's open Commission meeting that includes 8 agenda items). The CFO.com blog speculates as to what the topics might be...

Trouble for Glass Lewis

Glass Lewis suffered a blow when it was announced over the weekend that two of its key staffers - Lynn Turner and Jonathan Weil - have resigned (Jonathan has already left; Lynn leaves in two weeks). This article indicates the flap is over a dispute involving Glass Lewis' parent company, China-based Xinhua Finance Media Ltd. The dispute revolves around inadequate disclosures regarding the Chinese parent's CFO in the parent's IPO prospectus (which has led to a class action lawsuit). This WSJ article indicates the flap is generally over the parent's conduct (and the article raises questions about ISS' and Glass Lewis' new ownership; Glass Lewis' parent went public last year and ISS' parent may go public soon).

Lynn was the Managing Director of Research and a former SEC Chief Accountant and Jonathan was Managing Director and Editor of Financial Research and a former WSJ reporter who broke the Enron scandal wide open. I believe Barron's first reported on this development in this article.

Nasdaq Seeks to Reestablish PORTAL as a 144A Trading Market

Recently, Nasdaq has filed a proposal with the SEC seeking to reestablish PORTAL as a facility for broker-dealers to publish quotes for qualified Rule 144A securities and trade these securities, among themselves and with QIBs.

This is similar to how PORTAL was originally intended to operate when it was launched many years ago. PORTAL never thrived as a marketplace - and NASDAQ's current role with PORTAL (which it assumed when it separated from the NASD and commenced operations as a national securities exchange) is limited to the review of whether an issue of privately placed securities meets the eligibility requirements of Rule 144A. This role would change if the proposal is adopted.

Don't forget our upcoming June 5th webcast - "The Nasdaq Speaks: Latest Developments and Interpretations" - to hear key Nasdaq Staffers talk about all the latest...

UK's Securities Regulator May Act on IPO Concerns

A month ago, the Financial Times published this article: Financial regulators yesterday gave the first official recognition of intensifying City concern about the impact some overseas listings are having on the standards and reputation of London.

The Financial Services Authority said it will canvass opinions in the City about how to clarify the regulations to make clear whether companies have chosen light-touch listing methods, which can offer investors less protection. It said it was calling for formal debate about the balance between attracting new flotations and maintaining quality.

The decision comes a day after John Thain, chief executive head of the newly merged NYSE Euronext exchange group, took a thinly veiled swipe at the London Stock Exchange, criticising corporate governance and inadequate protection for minority investors offered by some Russian companies. There has been a steady flow of Russian and Kazakh companies seeking to raise capital in London.

The FSA's decision to formalise an already rumbling debate followed private pressure brought to bear by a group of large shareholders this year. There are widespread worries among institutional investors about the ability of companies with weak corporate governance standards to raise capital on the LSE. In February, a group of important investors, including Hermes, Fidelity, State Street, Royal London, Barclays Global Investors and M&G, warned the FSA the quality of the market was under threat. "In a less benign [economic] environment some decisions being taken now might come back to haunt the regulators," a fund manager told the FSA.

Hector Sants, managing director for wholesale business at the FSA, said new issues from non-traditional markets and European regulations designed to open up competition made it important to consider the balance: "This is a very important debate because of the changing nature of capital markets." Peter Montagnon, head of investment affairs at the Association of British Insurers, said investors were concerned about confusion between different types of London listings. These include primary, with traditional corporate governance standards; secondary, which need no primary listing elsewhere and have minimum regulation; and global depositary receipts, only available to professional investors.

The LSE also operates the Aim junior market with weaker regulation. "There's a risk of confusion here, and there's a risk that if we are not careful we could sacrifice some of London's reputation for quality and with it one of the reasons it is an attractive market," he said. Even some investment bankers - who make large fees from listings - are concerned. A senior industry figure said: "Has it gone too far? Not yet, but we're close."

The LSE has been successfully promoting itself in Russia but is keen to head off investor criticism, which surfaced last year when several big groups attacked the listing of Rosneft, Russian oil producer. The LSE welcomed the debate. "We are particularly keen to have clear labelling of the different forms of listing, giving investors the choice but making sure it is very clear exactly what they are being given," it said.

Google's Transferable Option Program

Google's transferable option program has gone "live" and it's readily apparent that Google and Morgan Stanley have put a great deal of thought into the program. The May-June 2007 issue of The Corporate Executive - which was just mailed - is dedicated to analyzing every aspect of this program, from the '33 Act registration issues to the insider trading blackout issues, and much more.

Take advantage of our "1/2 Off for the Rest of 2007" no-risk trial and obtain this valuable issue of The Corporate Executive. In addition, come watch a panel of those that put this transferable option program together as part of our “Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks.” You can catch this panel by video webcast or live in San Fran (either just for the day or as part of the 3-day NASPP conference).

Treasury Department Announces Accounting Industry Task Force

On Thursday, Treasury Secretary Hank Paulson announced the formation of a non-partisan task force, headed by former SEC Chair Arthur Levitt and former SEC Chief Accountant Donald Nicolaisen, to examine the world of auditing, including tackling key issues such as firm concentration and how to strengthen the industry's financial soundness and enhance its ability to attract and retain qualified personnel. It sounds like the task force's work won't be done for at least a year; they won't even begin deliberations until the Fall.

This task force serves as the first step in the Treasury Department's capital market plan to enhance the US markets competitiveness. Hank's plans were fleshed out in this Financial Times opinion column (which doubled as a Treasury press release).

A Mid-Season Proxy Review

If you're wondering how various types of shareholder proposals are faring at the polls this proxy season, check out ISS's "mid-season proxy review."

Audited vs. Unaudited

From Lyle Roberts' "10b-5 Daily" Blog: A recent decision by the U.S. Court of Appeals for the Second Circuit offers some interesting clarifications on the scope of accountant liability for securities fraud. In Lattanzio v. Deloitte & Touche LLP (2d Cir. Jan. 31, 2007), the court addressed whether Deloitte could be held liable for statements in audited and unaudited financial filings.

As to the company's unaudited financial filings, the court found that Deloitte's regulatory obligation to review the company's quarterly statements did not turn those statements into accountant's statements. Even if the public understood that Deloitte was engaging in these reviews, the accountant's "assurances were never communicated to the public." The court also rejected plaintiffs' argument that the reviews created a duty to correct the quarterly financial statements if false and that a breach of this duty amounted to a misstatement by Deloitte. The court noted that there is a distinct difference between the duties and liabilities created by a review of interim financial statements and those created by an audit of annual financials.

As to the company's audited financial filings, the court dismissed the relevant claims based on a failure to adequately plead loss causation. The court held that the "plaintiffs had to allege that Deloitte's misstatements [in the company's annual reports concerning accounts payable and inventories] concealed the risk of [the company's] bankruptcy." Given that Deloitte had issued a going concern warning - along with the disclosed (if understated) collapse in the company's value - the risk of bankruptcy was apparent. Accordingly, the court found that the plaintiffs had not alleged facts showing that Deloitte's misstatements were the "proximate cause of plaintiffs' loss; nor have they alleged facts that would allow a factfinder to ascribe some rough proportion of the whole loss to Deloitte's misstatements."

Holding: Dismissal affirmed.

Quote of note: "Public understanding that an accountant is at work behind the scenes does not create an exception to the requirement that an actionable misstatement be made by the accountant. Unless the public's understanding is based on the accountant's articulated statement, the source for that understanding - whether it be a regulation, an accounting practice, or something else - does not matter."

More on Auditor Liability

Recently, the Second Circuit reversed a lower court decision and held - in Overton v. Todman - that an auditor has a duty to correct prior certified opinions and may be held liable under Rule 10b-5 if it fails to do so. In other words, once an auditor knows their opinion is wrong, they ought to do something about it and tell people they should no longer rely on it. We have posted a copy of the opinion (and memos that analyze it) in our "Auditor Liability" Practice Area.

More specifically, the court holds that “an accountant violates the ‘duty to correct’ and becomes primarily liable under § 10(b) and Rule 10b-5 when it (1) makes a statement in its certified opinion that is false or misleading when made; (2) subsequently learns or was reckless in not learning that the earlier statement was false or misleading; (3) knows or should know that potential investors are relying on the opinion and financial statements; yet (4) fails to take reasonable steps to correct or withdraw its opinion and/or the financial statements; and (5) all the other requirements for liability are satisfied.”

This case appears to be the first in the Second Circuit to hold that an auditor has such a duty and may be primarily liable under the federal securities laws. The Second Circuit noted that its holding did not conflict with Central Bank of Denver v. First Interstate Bank of Denver, the 1994 Supreme Court case which held that there was no secondary aiding and abetting liability under Section 10(b), as the auditor in Overton had acted in a primary capacity.

PCAOB Report: The Auditors' Duty to Uncover Fraud

Way back in late January, the PCAOB issued a report that discusses auditors' implementation of PCAOB interim standards regarding the auditor's responsibility regarding fraud. The PCAOB issued the report to nudge auditors to be more diligent about their responsibilities vis a vis uncovering fraud and providing information that audit committees may find useful in working with auditors.

In the report, the PCAOB notes a number of deficiencies in the performance of audits, where audit procedures required to enhance the detection of fraud have not been performed, or have failed to measure up to professional standards, not unlike problematic audits of the past - and the report provides a list of areas for audit committees to probe the auditor on regarding how a particular audit is being conducted.

[I'm on the road for a few days so I took the liberty of posting some blogs I had drafted long ago but had never posted...plenty more of those in the cellar.]

Big Week: SEC Open Commission Meeting and More

In addition to hosting two more proxy process roundtables next week, the SEC will hold an open Commission meeting next Wednesday with lots of Corp Fin stuff going on, including whether to:

1. adopt interpretive guidance for management regarding its evaluation and assessment of internal control over financial reporting

2. adopt rule changes that would make it clear that an evaluation that complies with the Commission's interpretive guidance would satisfy the annual management evaluation required by those rules.

3. adopt rule changes to require the expression of a single opinion directly on the effectiveness of internal control over financial reporting by the auditor in its attestation report.

4. make rule proposals addressing the registration and disclosure requirements for smaller companies, as well as private offerings, including:

- increase the number of companies eligible for the scaled disclosure and reporting requirements for smaller reporting companies;

- expand the eligibility requirements of Form S-3 and Form F-3 to permit registration of primary offerings by companies with a public float of less than $75 million, subject to restrictions on the amount of securities sold in any one-year period;

- create exemptions from the registration requirements of the '34 Act for grants of compensatory employee stock options by non-reporting companies;

- create a new Regulation D exemption for offers and sales of securities to a newly defined subset of "accredited investors," as well as to propose revisions to the Regulation D definition of "accredited investor," disqualification provisions, and integration safe harbor and to provide interpretive guidance regarding integration;

- make revisions to Form D and mandate electronic filing of Form D; and

- amend Rule 144 to revise the holding period for the resale of restricted securities, simplify compliance for non-affiliates, revise the Form 144 filing thresholds, and codify certain staff interpretations, as well as to propose amendments to Rule 145.

5. adopt rules to implement provisions of the Credit Rating Agency Reform Act of 2006

And according to this Washington Post article, the House Financial Services Committee hearing with the five SEC Commissioners testifying on whether they are too soft on business is likely to be held during the week of June 25th.

Next Thursday: PCAOB to Act on Internal Controls

Next Thursday, the PCAOB will vote on a new standard - Auditing Standard No. 5 - that will supersede the Board’s existing internal controls standard, Auditing Standard No. 2. The PCAOB also will vote on two recommendations to amend the Board’s rules on the frequency of inspections - to remove the requirement that the Board regularly inspect each registered public accounting firm that plays a “substantial role” in audits but does not issue audit reports and whether to keep Rule 4003(d) in place beyond the June 30, 2007, tentative sunset date. Neither amendment would affect the annual inspection cycle for firms that audit more than 100 issuers.

Internal Controls Costs Down; Auditor Fees Unchanged

Yesterday, FEI published a summary of survey results showing that internal control costs for accelerated filers dropped 23% from 2005 to 2006 (and 35% since 2004, which was the first year of implementing Section 404). Audit fees were essentially unchanged between '05 and '06. This CFO.com article notes that audit fees could drop by 10% under new AS #5.

Posted: May-June issue of Deal Lawyers print newsletter

We have just sent our May-June issue of our new newsletter - Deal Lawyers – to the printer. Join the many others that have discovered how Deal Lawyers provides the same rewarding experience as reading The Corporate Counsel.

To illustrate this point, we have posted the May-June issue of the Deal Lawyers print newsletter for you to check out. This issue includes pieces on:

- Wake Up and Smell the E-proxy Coffee: Changes Ahead for Online Solicitations
- Lessons Learned: A Practical Look at the Caremark Trilogy
- Understanding the Real Meaning of Deal Certainty: Debunking a Few Myths and Suggesting a Few Solutions
- What's in a Choice of Law Clause?
- Unauthorized Management Buyout Proposals: It’s Time to Reevaluate Corporate Policies

Try a no-risk trial today; we have special "Rest of 2007" rates, which includes a 50% discount - and a further discount for those of you that already subscribe to The Corporate Counsel. If you have any questions, please contact us at info@deallawyers.com or 925.685.5111.

Exxon Mobil: Facilitating Questions for the Board

Interestingly, Exxon Mobil has a new web page that facilitates the ability of shareholders to e-mail questions in advance of its May 30th annual meeting. There is a May 15th cut-off for shareholders to send their questions in. I don't believe this is a first (IBM and BHP Billiton have done it before).

I'm not sure if many companies would be willing to encourage more questions, although it may be a way to get more diverse questions - or at least more questions related to the business of the company. But since Exxon Mobil doesn't promise to answer all questions submitted, it doesn't seem like there is too much potential for harm (from the corporate secretary's and senior management's perspective) and this type of web page provides another avenue to get potentially valuable shareholder feedback.

By the way, there is no mention in Exxon Mobil's proxy statement that shareholders can e-mail the board because this particular function was only added to the website after the proxy statement was mailed. However, the following paragraph can be found on page 9 under "Shareholder Communications":

"Electronic Communications: You may also send e-mail to individual non-employee directors or the non-employee directors as a group by using the form provided for that purpose on our Web site at exxonmobil.com/directors. These communications are sent directly to the specified director’s electronic mailbox. E-mail can be viewed by staff of the Office of the Secretary, but can only be deleted by the director to whom it is addressed. More information about our procedures for handling communications to non-employee directors is posted on the Corporate Governance section of our Web site."

AFL-CIO's Key Votes Survey

Last week, the AFL-CIO posted its 2007 AFL-CIO Key Votes Survey. This is a preliminary scorecard of how the AFL-CIO believes that shareholders should vote at selected shareholder meetings.

Paul Hodgson on the "Pay for Failure"

In this CompensationStandards.com podcast, Paul Hodgson, The Corporate Library’s Senior Research Associate, discusses his recent report on “Pay for Failure II — The Compensation Committees Responsible,” including:

- This is the second time you’ve produced this study. What made you revisit it and were you surprised to see some of the same companies reappear?
- Did you find any new problems within compensation structure and policy with the new companies or was it the same old issues?
- What do you think can be done to solve some of these problems?

Just Announced! Proxy Disclosure/Exec Comp/"The Corporate Counsel Speaks" Conferences

Come join us in San Francisco or via Nationwide Video Webcast for three special Conferences in mid-October:

- “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference” (10/9)
- “Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks” (10/10)
- “4th Annual Executive Compensation Conference” (10/11)

Among many other luminaries, the SEC's John White, Linda Chatman Thomsen and Paula Dubberly will be speaking. Here is a combined agenda for the three conferences – and here is a brochure.

“Member Appreciation Package”: Three Conference Bonus for those Attending by Video Webcast - Early Bird Rate Thru June 30th

If you plan to attend by video webcast, take advantage of our special “Member Appreciation Package” to get access to all three of these Key Conferences for a single reduced rate for our members. And if you act by June 30th for this Member Appreciation Package, you will get $300 off as an Early Bird Discount.

And a Bonus for those Attending in San Francisco

Those who come to San Francisco to attend live in person are able to take advantage of a special reduced rate to attend the three-day NASPP 15th Annual Conference (with over 40 panels!) from October 10-12, which includes the “4th Annual Executive Compensation Conference” and the "Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks." With over 2000 attendees year after year, many advisors find this to be the most practical conference available all year.

Act Now: You can register online by clicking any of the links above – or use this order form. If you wish to register for the “Member Appreciation Package,” you merely have to go to the online registration form for any of the three conferences or use this order form.

If you need help, please contact us at info@thecorporatecounsel.net or 925.685.5111 (8 am - 4 pm West Coast time).

Radical Changes to Financials Underfoot?

Saturday's WSJ included a cover story about how the FASB and IASB are considering radical changes to how financials are cobbled together as part of its joint Financial Statement Presentation project. The article's title says it all: "Profit as We Know It Could Be Lost With New Accounting Statements."

Here is an example of what financials might look like in the future. And here is an excerpt from the article:

"Pretty soon the bottom line may not be, well, the bottom line. In coming months, accounting-rule makers are planning to unveil a draft plan to rework financial statements, the bedrock data that millions of investors use every day when deciding whether to buy or sell stocks, bonds and other financial instruments. One possible result: the elimination of what today is known as net income or net profit, the bottom-line figure showing what is left after expenses have been met and taxes paid.

It is the item many investors look to as a key gauge of corporate performance and one measure used to determine executive compensation. In its place, investors might find a number of profit figures that correspond to different corporate activities such as business operations, financing and investing.

Another possible radical change in the works: assets and liabilities may no longer be separate categories on the balance sheet, or fall to the left and right side in the classic format taught in introductory accounting classes.

The overhaul could mark one of the most drastic changes to accounting and financial reporting since the start of the Industrial Revolution in the 19th century, when companies began publishing financial information as they sought outside capital. The move is being undertaken by accounting-rule makers in the U.S. and internationally, and ultimately could affect companies and investors around the world.

The project is aimed at providing investors with more telling information and has come about as rule makers work to one day come up with a common, global set of accounting standards. If adopted, the changes will likely force every accounting textbook to be rewritten and anyone who uses accounting - from clerks to chief executives - to relearn how to compile and analyze information that shows what is happening in a business."

SEC's Filing Fees: Demystifying How They Are Set

Have you ever wondered how the SEC's filing fees are set every year? I have - and finally did a little research. I always knew that the SEC has no discretion over how much it collects in registration fees - but beyond that, it has been a black box for me. And I erroneously mused in this blog last week that the higher rates for 2008 might have something to do with funding the war.

The reality is that the fees are determined by a law passed by Congress a few years ago, the "Investor and Capital Markets Fee Relief Act of 2002." Under that law, the SEC must adjust the fee rate each year to a rate that is reasonably likely to produce a target fee collection amount set in the statute. The SEC must determine the new fee rate by dividing the target fee collection amount by an estimate of the aggregate offering prices for securities registrations during the year.

Significantly, the target collection amounts set in the statute vary by year; thus, witness the sharp swing in rates the past few years. The targets in the law fell substantially between 2006 and 2007 (from $689 million to $214 million), but then they rose modestly for 2008 (to $234 million) and will continue to do so in the near future.

The new fee rate reflects the fact that the target for 2008 is $20 million higher than the target for 2007. But, even at this increased level, total fee collections in 2008 will still be dramatically reduced compared to just two years ago, when they were nearly three times larger...

Proposed Amendments to the Delaware General Corporation Law

On Harvard Law School's "Corporate Governance Blog," Professor Lawrence Hamermesh of Widener University School of Law made the following entry last week:

This year’s round of proposed amendments to the Delaware General Corporation Law, introduced on May 8, unquestionably falls a little short in the excitement department, at least compared to last year’s amendments (particularly those relating to director elections and retirement policies).

In the current crop, the most notable changes are to the appraisal statute. Under these proposed amendments:

- Petitions for appraisal can be filed by beneficial owners, rather than only by stockholders of record (although demands for appraisal must still be made by record owners). The Depository Trust Company will surely be relieved not to have to serve as a nominal petitioner in every public company appraisal suit.

- Reference to a “national market system security on an interdealer quotation system by the National Association of Securities Dealers, Inc.” has been deleted from the so-called “market out,” in light of last year’s reorganization of the NASDAQ stock markets.

- Most notably, there is to be a presumptive approach to awarding interest in appraisal proceedings. Ordinarily, interest is to “be compounded quarterly and shall accrue at 5% over the Federal Reserve discount rate (including any surcharge) as established from time to time during the period between the effective date of the merger and the date of payment of the judgment.” This has been Delaware’s default legal rate of interest for some time, and has frequently been the basis for awards of interest in recent appraisal cases. By making it the presumptive approach to awards of interest in such cases, however, it is hoped that unproductive litigation efforts on the interest issue can be avoided. Under the proposal, however, the Court of Chancery still retains discretion, for “good cause,” to choose a different approach in awarding interest.

These amendments to the appraisal statute are to apply only with respect to transactions consummated pursuant to agreements entered into after August 1, 2007.

Two other proposed amendments would clarify voting rights in two specialized situations, as described in the synopsis accompanying the legislation:

- An amendment to Section 141(d) clarifies that when a provision of the certificate of incorporation endows some directors with greater or lesser voting power than other directors, that differentiation of voting power applies both in voting by the board of directors and in voting by committees and subcommittees of the board, unless otherwise provided in the certificate of incorporation or bylaws.

- An amendment to Section 216(4) clarifies that, unless otherwise provided in the certificate of incorporation or the bylaws, a plurality vote (and not a majority of the quorum) is the vote required to elect directors where one or more classes or series of stock votes as a separate class or series on the election of directors. Last year’s amendments relating to the ability to provide in the bylaws for majority voting in the election of directors remain unaffected.

Is This Commission Pro-Business or Pro-Investor?

I have to chuckle. The following scenario reminds me of my youth in Chicago, when Cubs fans wore one of two buttons: "Leo Must Go!" or "Leo Must Stay!" Leo Durocher was the embattled manager at the time; I still have one of each button somewhere in a box. Leo coined the phrase, "nice guys finish last."

1. Pro-Investor? This article states that the White House thinks that SEC Chairman Cox sides with investors too much. Here is an excerpt:

“Of course, even if such a resolution were to finally force Bush to dump Gonzales, it could not require him to choose a successor worthy of the job. But the president is so weak politically, and the supply of plausible nominees with "loyal Bushie" credentials is so small, that he might be forced to choose a person of stature, such as Securities and Exchange Commission Chairman Christopher Cox. After all, Bush did replace the hapless Harriet Miers as White House counsel with Washington wise man Fred Fielding, and the discredited Donald Rumsfeld as Defense secretary with Robert Gates. Other signs are not encouraging, however. In response to suggestions that Cox would be a good nominee, for example, an unidentified White House source told The Washington Times: "Cox has been a disappointment at the SEC." The reason? "He's shown too much of a willingness to work with the Democratic members of the Commission."

Of course, we cannot presume that the Democrats are always in favor of investors though, which clearly may not always be the case.

2. Pro-Business? A Bloomberg article from yesterday notes that Rep. Barney Frank, the House Financial Services Committee Chair, will hold a hearing next month to hear from each of the five SEC Commissioners, in response to criticism that SEC policies are increasingly favoring companies over investors. Here is an excerpt:

"'There have been concerns that various people have voiced,'' Frank, 67, said in an interview yesterday. "There is no point in prejudging, but obviously there are enough questions in the air that we are holding a hearing.' He cited complaints that recent SEC actions have muzzled the agency's enforcement division and may make it harder for investors to sue companies.''

Your Friday "Make a Million" business idea? Make some buttons...

Blockbuster Shareholders Vote 57% 'For' Say-On-Pay Proposal

As noted in this article, Blockbuster has become the first company to receive the support from a majority of shareholders on a "say on pay" proposal. Most of these other proposals have received significant support from shareholders, as recorded in ISS' "Say on Pay" Information Center (scroll down on that page).

Foreign Corrupt Practices Act: Recent Developments

There have been a number of recent Foreign Corrupt Practices Act settlements entered into by the Department of Justice and the SEC that are quite meaningful, as they illustrate the government's continued focus on enforcement of the FCPA, including when there is a change in ownership. The most recent settlement involved Baker Hughes, which paid a record $11 million criminal fine.

In our "Foreign Corrupt Practices Act" Practice Area, we have posted a number of memos on these recent settlements.

Corp Fin's Review of Compensation Disclosures: Results Due This Fall

Last Friday, Corp Fin Director John White gave this speech at Northwestern's "27th Annual Ray Garrett Jr. Corporate & Securities Law Institute" about the compensation disclosures made during this proxy season. In his speech, John White noted that the Staff's compensation disclosures review project has begun and would be done in the Fall. I believe the Staff intends to finish its review and then announce its final results, rather than commenting on what it finds in a piecemeal fashion.

Executive Compensation Disclosures: Parsing John White's Speech

There is quite a bit of information in Corp Fin Director John White's speech. It's a "must read" speech if you deal with proxy disclosures at all. Here are some highlights:

1. CD&A and Analysis - First and foremost, John spoke about "Analysis (or lack thereof)," a topic we started writing about in The Corporate Counsel even before disclosures were filed. This will continue to be an area of focus during our October 9th event: “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference.” The agenda for that Conference will be available next week (and includes John, among other Staffers).

2. Performance Targets and CT Treatment - John also discussed several specific areas that the Staff is focusing on. One area involves performance targets, such as whether companies have properly omitted specific target information (ie. whether they meet the competitive harm standard) as well as looking at the adequacy of the disclosures required if performance target metrics are omitted, i.e. how difficult it will be for the officer - or how likely it will be for the company - to achieve an undisclosed performance level or other factors. John also discussed the problem of negative numbers, disclosure about the CEO's role in setting compensation and perk disclosure.

3. Disclosure Length - John also weighed in about the length of the compensation disclosures, something I have blogged about several times in the wake of a recent Chairman Cox speech that flagged this issue. Taking the risk that excerpts don't place the statements in proper context, here are some excerpts from John's speech on this topic:

- "I also think that criticisms of the length and language of the new disclosures can go too far. One of the primary drivers of length of the disclosure in proxy statements is that executive compensation itself tends to be very complicated and varies significantly in form and function, in spirit and letter, from company to company. Even if plain English principles are faithfully applied, under the new rules there may very well be substantially more disclosure required overall."

- "Criticisms of the length and language of executive compensation disclosures tend to be fairly amorphous complaints. It is also not necessarily clear—if you agree with those criticisms on their merits—whether the problems or weaknesses leading to those complaints are rooted in the rules themselves, or in companies' failure to comply with the rules. I would urge people to keep in mind, though, that the Commission was seeking to establish a "layered" disclosure approach, with CD&A as the top layer."

SEC's Chief Accountant: No Meddling With FASB

Jack Ciesielski notes in his "AAO Weblog": According to this article on CFO.com, Chief Accountant Conrad Hewitt appeared to deny that the budget actions were linked to any further SEC gains in control over FASB, saying "The budget coincidentally came at the same time as we were [evaluating] candidates," adding that the SEC's role over FASB is outlined in a 2003 agreement between the two organizations." He also said that "FASB is independent as far as we are concerned.We do not appoint board members." The remarks took place at a financial reporting conference at Baruch College in New York.

The next big scheduled test of how involved the SEC will be in FASB member selection will come up in less than a year. Next July 1, current board member Mike Crooch will trudge into the sunset, and the machinery behind his replacement will click into action around the beginning of 2008. In addition to the usual guessing games about who will be chosen, there'll be an added element of suspense surrounding the SEC's involvement - or laissez-faire."

Conrad's remarks come after FASB Chairman Bob Herz admitted to concerns about "control" issues with the SEC - as noted in this CFO.com article, Bob pledges to guard FASB's independence.

SEC Staff Answers JCEB Disclosure Questions

Yesterday was another "gold star" day for Mark Borges, as he recapped some of the happenings from the annual meeting between the ABA's Joint Committee on Employee Benefits and key members of the Corp Fin Staff in his CompensationStandards.com blog - just a few hours after the meeting ended! Mark promises to blog more about this meeting soon, but yesterday he analyzed the discussions about: (1) Prior Year Information for a New NEO and (2) A Perquisite's "Total Cost."

Once the official meeting notes are available (which often takes several months), we will post them in our "JCEB Meeting with SEC Staff Notes" Practice Area," which remains a real treasure trove for informal Staff guidance regarding issues where the securities law intersects with compensation-related arrangements. Thanks to Gloria Nusbacher of Hughes Hubbard & Reed for her scribing all these years!

SEC Filing Fees: Going Up

In Monday's fee rate advisory, the SEC announced that filing fees will be going up after October 1st (or whenever Congress approves the SEC's budget, which historically is significantly later than October 1st) to $39.30 per million from $30.70 per million of securities registered with the SEC.

This is a 28% hike - and the first increase in the filing fee rate in quite some time. Not sure why there is an increase (remember how Chairman Cox was quite proud of the steep drop last year, that was quite a drop - over 70%). The SEC's fee rates aren't related to the amount of funding available to the SEC; instead, the money goes to the US Treasury - so my guess is that the rate is going up to indirectly fund the Iraqi war.

Inside/Outside CEOs: The Cost of Poor Succession Planning

Paul Hodgson of The Corporate Library has been issuing a score of research reports this proxy season. Below is a summary of a recent report from Paul on succession planning:

It has long been a contention of pay experts – even Jack Welch agreed – that one of the many ingredients ratcheting up CEO compensation is the ‘golden hello’ that is often paid to a candidate recruited to the position from outside the company. Mr. Welch claimed that both Robert Nardelli and James McNerney – each of whom lost out to Jeffrey Immelt for the top job at GE – ended up being paid more than he.

Initial impressions would certainly back that up, with both Mr. Nardelli and Mr. McNerney in receipt of very generous golden hellos. Indeed, in Mr. McNerney’s case, these turned out to be serial golden hellos as he has had two new jobs since leaving GE.

However, as a detailed analysis shows, Mr. Welch’s impressions were wrong in this instance. Taking the last six years of available compensation data, starting with Mr. Nardelli’s and Mr. McNerney’s first years in their new roles, and with Mr. Immelt working as chairman elect at GE, the positioning is:

1. Nardelli
2. Immelt
3. McNerney

Mr. Nardelli leads even without the inclusion of his termination package at the same time as having done, arguably, the worst job of the three in returning value to stockholders. While this example is illustrative of the experience of three CEOs and the actions of four compensation committees, it cannot provide a reliable generalization or conclusion.

In order to come to a more general conclusion, an analysis was conducted of the compensation of 52 S&P 500 CEOs who joined their companies at some point in 2005 (still the last year for which there are compensation details). Of these 52 CEOS, there were 32 inside appointments and 20 outside. No adjustments for industry or size were made to the sample, as each group contained a wide mix of market capitalization levels and industries and this mix on both sides of the sample is likely to have cancelled out any effects on pay levels.

The findings of this study clearly show that – in the first year of employment at least – CEOs recruited from outside the organization are more expensive. As can be seen, the biggest differential lies in total target compensation, which includes the grant date value of equity awards such as stock options and restricted stock, including the hefty up front awards that make up most golden hellos. Particularly at the median, the differential for outside appointees is considerable. They earn almost 2.6 times the target compensation of their inside appointee peers in their first year of employment.

Moody's: How to Analyze Compensation Disclosures

One of my more popular blogs lately was one about how the Associated Press reports on total compensation numbers. Now, Moody's explains how they look at what has been disclosed in the new batch of proxy statements filed this proxy season.

On CompensationStandards.com, in this podcast, Mark Watson, Managing Director, Corporate Governance Specialist Team of Moody’s Investors Service, explains the “in’s” and “out’s” of "Moody’s User Guide to Compensation Disclosures" (which is posted in CompensationStandards.com's "Investor Demands for Reasonable Pay" Practice Area), including:

- What is the purpose of Moody’s new user guide for compensation disclosures? Why did Moody’s put one together?
- In your staff’s review of the disclosures made so far, which areas do you think are being adequately disclosed? Which areas need improvement?
- What do you recommend that companies do for next year?

More on the "Readability" of Compensation Disclosures

I'm still getting plenty of feedback from my blog about the SEC Chairman's recent comments on the lack of plain English in compensation disclosures. One of the themes in these responses is how - after a decade since the SEC's plain English initiative began - practitioners had never heard of the metrics used in the Chairman's speech. These commentors point out that the Gunning-Fog and Flesch-Kincaid tests are not mentioned a single time during any of the SEC's plain English rulemaking or commentary over the years.

In the wake of the Chairman's speech, a group of compensation consultants conducted this follow-on readability study that is pretty interesting, looking at more disclosures, the SEC's rules themselves and even Dr. Seuss' "Green Eggs & Ham" for comparison purposes.

The upshot is that I think the SEC will have to revisit the plain English requirements if it is going to insist on using the metrics that the Chairman mentioned in his speech, because it doesn’t look like any company is coming anywhere close to what has been targeted as a “good” score. And I would bet that would be true for disclosure in any SEC filing, whether it be a proxy statement, prospectus, etc. This situation might be saying as much about these metrics as they do about disclosures generally; I think the metrics have to be examined more carefully before being applied as the litmus test of whether it is "good disclosure."

Meanwhile, I imagine it won’t take long for shareholder activists to grab onto this issue - particularly since Microsoft Word has a tool that allows anyone to easily gauge the "readability" of a document. So my advice is for all companies to run the numbers and find out the readability of their CD&As (and other disclosures) now before someone comes calling. And of course, we wouldn't be surprised to see Corp Fin get back into the business of issuing plain English comments. Should be fun...

Implementing the SEC's Compensation Rules: Companies Start Providing Feedback

Even nine months after the SEC adopted its final executive compensation rules, it is still receiving comment letters on them. The first company to weigh in on the new rules after filing its initial proxy statement under them is Leggett & Platt, with this comment letter that focuses on confusion in the media in reading the disclosures as well as the impact of the sudden December rule change made by the SEC.

Leggett & Platt is not the only company frustrated by the SEC's December change in the rules. As Marc Trevino and Joseph Hearn of Sullivan & Cromwell noted in their survey of compensation disclosure trends by the Fortune 50, Citigroup decided to include multiple pages in its proxy statement regarding the meaning of retirement-eligible accounting under FAS 123R, including this excerpt:

"In the view of the committee and Citigroup, the December 2006 SEC release regarding reporting of equity compensation in the Summary Compensation Table does not reflect the way the committee and Citigroup analyze and make equity awards. Under the new rules, the treatment in the Summary Compensation Table of awards with the same terms for all the named executive officers may differ depending on age and length of service with Citigroup, and accordingly, may make it difficult to discern the committee’s judgments about executive performance for 2006. The purpose of the foregoing discussion and disclosure is to make it clear that the committee made incentive awards for 2006 and in prior years based on the fair value of the awards and not on the accounting treatment of those or prior awards on Citigroup’s financial statements under SFAS 123(R) or other applicable accounting standards."

Rule 10b5-1 Plan Developments

As I have blogged about before, academics - and now the SEC Staff - have been scrutinizing transactions made under Rule 10b5-1 plans to see if the "next" scandal is afoot (Kevin LaCroix has a nice recap about this in his D&O Diary Blog).

In this podcast, Barrett Howell of Haynes and Boone delves into some of the latest Rule 10b5-1 plan developments, including:

- Why have 10b5-1 plans come under scrutiny by the SEC Staff recently?
- How are such plans relevant in securities law class actions?
- What can companies and insiders do to protect themselves from allegations in these class actions?

Today's "Federal Proxy Rules and State Corporation Law" Roundtable: Agenda and Briefing Paper

Today is the first of three SEC roundtables on the proxy process scheduled for this month; today's roundtable is focused on how the federal proxy rules intersect with state corporate law.

Here is today's roundtable agenda - along with its all-star line-up (albeit a tad heavy in the academic department for my tastes) - as well as a briefing paper.

NASD: Change in Proposed Rules for Real Estate Underwriting Arrangements

Recently, the NASD posted Amendment No. 2 to its proposed rules regarding the underwriting terms and arrangements of public offerings of direct participation program securities ("DPPs"), i.e., limited partnershps and other pass-through entities, and REITs. The amendments are significant, responding to comments from last July's proposal. Since the rule filing includes a draft Federal Register notice, it is hoped that the SEC will republish the proposal for comment.

For folks in the real estate industry, this is a long-awaited SEC filing because it sets out the procedures that the NASD will use to allocate compensation of dual-employees of broker/dealers that sell DPPs and REITs (and amends what many viewed as a highly problematic proposal). The revised structure, if implemented with some discretion by the NASD Staff, should work and make reviews of DPP and REIT offerings less problematic in the future. Nonetheless, there remains areas of uncertainty about the practical application of certain of the amendments and republication of the amended proposal appears necessary to help resolve these areas.

Happy Anniversary to Me!

Believe it or not, today marks five years that I have been blogging. To toot my own horn, I believe I was the first lawyer to blog on substantive law issues. When I started back in 2002, a handful of lawyers were blogging about the marketing aspects of blogs, but not about the law itself. For the first year or so, whenever I told someone that I was blogging, I had to explain what it was. Only 25 more years to go until retirement!

Do me a "solid" and take this brief survey on my blogging...

[Your Friday "Moment of Happiness": Here is a hilarious "don't mess with this blogger dude" saga].

Answers About "Readability" of My Push-Out Blogs

Many of you have inputted your e-mail address in the box to the left of this blog, which enables you to receive an e-mail notification when I blog each morning. This notice includes the text of that day's blog entry - but it's not in the easiest-to-read format.

Unfortunately, there is nothing that I can do about this problem, as it's a function of the blogging software (ie. Movable Type). Moving to another piece of software would be a killer because I have five years worth of archived blogs on this page that I would need to import.

The easy fix for you: most people just click on the link at the top of the e-mail when they get the blog sent to them and that sends them to the blog itself which is much easier to read...

Holy Sherlock Holmes! SEC's Enforcement Staff Finds the Pipe Bomber

As noted in this article, there were over 150 law enforcement officials (including over 100 postal inspectors) trying to figure out who sent pipe bombs to a number of mutual fund companies. It was the SEC Staff who found him using trading records - and only 3-4 staffers were involved. As many of you know, it's very unusual for the SEC to be tracking down this type of criminal - normally they are investigating those involved in problematic PIPEs...

John White on the Foreign Private Issuer Community in 2007

On Wednesday, Corp Fin Director John White delivered this speech on "Corporation Finance and the Foreign Private Issuer Community in 2007."

The SEC's Inspector General Comments on the Staff's Interpretive Guidance

The SEC's Office of Inspector General has been busy, issuing no fewer than four reports this week (even though some are dated March). The most important one is "Audit of Full Disclosure Program's Staff Interpretive Guidance Process," given that it is a topic frequently criticized by SEC Commissioner Atkins and something that is a lifeblood for many of us.

Here are my "Top Notables" about this 18-page report (listed in order of where they are mentioned in the report):

1. It took the Inspector General's office 10 months to draft its report. (pg. 2)

2. The report states that most interpretive guidance comes from four groups of the Staff (Corp Fin’s Office of Chief Counsel and Office of Chief Accoutant and two offices in the SEC's Office of Chief Accountant). I'm stumped why the report doesn't include three of Corp Fin's other specialized offices, which provide plenty of guidance: Office of Mergers & Acquistions; Office of International Corporation Finance and Office of Edgar and Information Analysis. (pg. 3)

3. Corp Fin as a whole answered 32,500 phone calls during 2005 - ouch! (pg. 4)

4. The report notes that Corp Fin's Office of Chief Accountant provided advice on 340 referrals to Enforcement during 2005 - but oddly doesn't mention Corp Fin's Office of Enforcement Liaison, whose main function is to provide advice to Enforcement. (pg. 4)

5. Corp Fin/OCA runs its SABs through the Commissioner's legal counselsors typically. The Inspector General recommends that the Office of General Counsel look into compliance with the Administrative Procedures Act relating to the processes involved in the SEC issuing SABs, as well as interpretive guidance from the Staff generally. In my view, this is the report's bombshell as it has the potential to really gum up the works. (pg. 4-5)

6. Corp Fin doesn't post shareholder proposal no-action responses on its website due to resource limits; it is recommended that Corp Fin post these responses. (pg. 5)

7. The Inspector General is looking for confirmation that Corp Fin's Shareholder Proposal Task Force does indeed take mailing deadlines into consideration when processing no-action requests. I haven't heard any company complain about Corp Fin not being conscientious of this need. (pg. 7)

8. Corp Fin issues comments on non-shareholder proposal no-action letters within 30 days of filing - its stated goal - about 50% of the time. (pg. 7)

9. Corp Fin may be updating its 25-year old interpretive release on how to submit no-action letters, including the format they should take. (pg. 11)

10. The report includes esoteric commentary about "uploading" internal documents. This is a process that commenced near the end of my last tour of duty in Corp Fin and luckily I never had to upload a single document. (pgs. 11-12)

The SEC's IG also issued these reports on Enforcement Peformance Management and Backlog of FOIA Requests for Comment Letters. Before these, the last Inspector General report involving Corp Fin was issued last summer; it dealt with continuous surveillance of larger companies and lifted the curtain a little bit on Corp Fin's screening process.

Resume Indiscretions Possible at the SEC?

Another new report from the SEC's Inspector General deals with verification of bar memberships. Not only is it interesting that the SEC hasn't been verifying bar memberships in light of the highly publicized cases of resume indiscretions in the news lately, it's interesting because - not so long ago - it was a big deal for a SEC lawyer to pass a bar.

During my first tour of duty in Corp Fin, the SEC didn't have the luxury of so many lateral hires like it does now. Back in the "day," most new lawyers came right out of law school. Our new jobs weren't "official" until we passed the bar and when you did, you were promoted from "law clerk" to "lawyer." There was a one-year probation period during which you had to pass the bar; so if you failed the bar twice, your probation period will likely have run and you were booted out of the SEC!

The IG's report does note that lawyers fresh out of school do indeed still have their bars checked; it's the horde of lateral hires that apparently have not been verified. I'm surprised the SEC fell down on this because it's pretty easy these days to go online to a state bar website and verify membership. If there was one area I could see falling through the cracks, it would be verifying that Staffers remain members of the bar (eg. someone doesn't pay their bar dues). It's easy to forget about - or ignore - state bar requirements.

No mention in the report about whether the SEC checks the CPA licenses of the accountants...

The NYSE Speaks: Latest Developments and Interpretations

We have posted a copy of the transcript from our popular webcast: "The NYSE Speaks: Latest Developments and Interpretations."

Option Backdating: The Apple Saga - To Be Continued?

There has been quite a bit of commentary about what the SEC did - and didn't do - in the Apple option backdating case last week. As this SEC press release notes, the SEC brought charges against Apple's former General Counsel and former CFO Fred Anderson, but didn't seek a bar against them as an executive or director of another public company (nor has the SEC brought any action against the company itself). The former CFO currently serves as the head of eBay's audit committee.

From the complaint filed in US District Court by the SEC, it appears that Apple's CEO Steve Jobs was fully aware of the implications of what was going on with the backdating. It is interesting that the CFO discussed backdating with the CEO, then did it and apparently did not inform the auditors about it - but some argue he did not do it "intentionally"; it seems pretty clear to me from the complaint that the CFO did mean to backdate the options.

And right after the SEC announced what it intended to do in the Apple case, former CFO Anderson spoke up in this WSJ article to claim that Jobs misled him. And then this Joe Nocera column from Saturday's NY Times gives this story another twist, providing details about why certain mega-grants of options were awarded to Jobs in the first place.

Lawsuit Dismissed: Backdating Alone Not Sufficient to Prove Fraud - But Not Over?

A few weeks ago, Judge Alsup of the US District Court for the Northern District of California granted the defendants’ motion to dismiss the consolidated shareholders’ derivative complaint filed in the connection with alleged backdating at CNET Networks, based on plaintiffs’ failure “to plead with particularity that demand on the board was excused as futile.”

But then, on Monday, Judge Alsup issued a follow-up order to his CNET dismissal, after receiving briefing from the parties. The Judge is allowing the plaintiffs to amend (noting in particular that they should be more specific about whether the company's compensation committee was allowed to delegate its authority), though he's denied them discovery. He's also opened up the possibility of staying the action while plaintiffs pursue discovery through Section 220 of the Delaware General Corporation Law.

So although the original order might end up being useful to those of you mired in backdating litigation - as it shows that plaintiffs will have to allege more than merely that options grant dates differed from the measurement date, or even that the directors received backdated options - there could be future developments. We have posted copies of the order of dismissal dismissal and the follow-up order in the "Backdated Options/Grant Policies" Practice Area on CompensationStandards.com.

Much thanks to Kevin Muck and Felix Lee of Fenwick & West for keeping us apprised of the developments in this potentially important case - here is their memo on the dismissal (and here is a CFO.com article - and a D&O Diary Blog on it). And on a somewhat related note, Kevin LaCroix has a blog about the first settlement of a backdating-related class action lawsuit.

Chairman Cox: SEC Will Resolve Option Backdating Cases Soon

Last Wednesday, in this Reuters article, SEC Chairman Cox apparently stated that the SEC's investigation into improper awards of options at many of the 130 companies under examination will be resolved within the next few weeks...

Just Posted: Spring Issue of Compensation Standards Print Newsletter

Because the response to the first few issues of Compensation Standards has been so positive – with many companies asking for permission to provide additional copies to all their directors – we have decided to provide complimentary subscriptions to the popular Compensation Standards print newsletter to all our friends for the rest of this year. Hot off the press, here is the latest issue: Spring 2007.

Act Now: To receive these complimentary issues, you can do so in one of three ways:

(1) you can sign-up online for you and your directors.

(2) you can email us a list of all the contact information for you and your directors to info@compensationstandards.com (for the directors, we just need their mailing information, company and title; for you, we would also need your email address, phone number and fax number).

(3) you can email us at info@compensationstandards.com with your contact information (including title, company, mailing address, email address, phone number and fax number) and the number of copies you need (which you would then forward to your directors).

If you need assistance, contact our HQ at info@compensationstandards.com or 925.685.5111. Note our HQ is on the West Coast with hours of 8am - 4pm.

Senate Takes Up "Say on Pay" Bill

From ISS' "Corporate Governance Blog": After the passage of the "Shareholder Vote on Executive Compensation Act" by the U.S. House of Representatives, Senate Democrats are making it known that they, too, want shareholders to have a vote on executive pay.

A bill seeking to amend the Securities and Exchange Act of 1934 to give shareholders at public companies an advisory vote on executive compensation--or "say on pay"--was introduced April 20 in the U.S. Senate as a companion to the House bill approved the same day. The House legislation passed by a vote of 269-134, indicating that it got some Republican support.

Senate Bill 1181, which was introduced by Sen. Barack Obama of Illinois, proposes an annual vote on the executive compensation disclosed in proxy statements under the new Securities and Exchange Commission's standards. Companies would be required to allow a non-binding vote on the compensation disclosure and analysis (CD&A), summary compensation tables, and related material, starting in 2009.

Like the House measure, the Senate bill would give shareholders the opportunity to vote on any severance agreements that are reached while a company is considering a takeover offer or merger.

S. 1181 has been referred to the Senate Committee on Banking, Housing, and Urban Affairs, and has attracted co-sponsorships from at least four of Obama's fellow Democrats, including Sen. Sherrod Brown of Ohio, Sen. Tom Harkin of Iowa, Sen. John Kerry of Massachusetts, and Sen. Richard Durbin, also of Illinois.

In his invitation to co-sponsors on April 24, Obama wrote, "It's time that we not only make executive compensation packages more transparent, but that we also allow shareholders to express and debate their views on those packages."

The Bush administration has expressed opposition to the House legislation, saying it "does not believe that Congress should mandate the process by which executive compensation is approved."

Understanding What "Say on Pay" Means

To review a new ISS 18-page white paper on pay votes in international markets, please go to the ISS' "Say on Pay" Information Center. Note that, in this Center, you can track the results of how shareholders voted on "Say on Pay" proposals as they happen.

Our May Eminders is Posted!

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