July 11, 2003
In anger over comments made
In anger over comments made about classification of non-audit services at HealthSouth, the SEC has sent a letter to E&Y. The letter states that not all attestation services can be treated as “audit-related” for purposes of the audit/non-audit fee table in the proxy statement. See the letter at http://www.sec.gov/info/accountants/staffletters/e-y070803.htm.
The PCAOB has announced a roundtable on internal controls to be held on July 29th – an all day affair which will be webcast. See http://www.pcaobus.org/pcaob_news_7-10-03.htm.
Thanks to John Jenkins at Calfee, Halter & Griswold for the following insightful analysis regarding the questions I posed on Wednesday regarding Microsoft’s underwater option arrangement with JP Morgan:
It’s hard to predict what Microsoft is going to do, but I’ll bet that from a 1933 Act standpoint, they’ll do something similar to what they did for their directors and executive committee members’ stock options back in December 1997, which is use the discretion provided under the plans to allow them to transfer the options, and then register the primary shares underlying them on an S-3 – http://www.sec.gov/Archives/edgar/data/789019/0001047469-97-009148.txt.
By doing it this way – instead of through the the re-offer prospectus approach contemplated by General Instruction C to Form S-8 – I guess Microsoft concluded that it could avoid having to name the transferors or transferees of the options as selling shareholders. I don’t think that works with whatever they’re doing here. If the transferees are JP Morgan or other identified investment banks and they’re purchasing the securities, I would imagine that the S-3 would have to identify the relevant investment banks in the plan of distribution section or in a prospectus supplement and that those folks would likely be subject to Section 11 liability.
The issue of shareholder approval came up when the SEC eliminated the restrictions on transferability back in the mid-1990s. I know that back then, the staff took an interpretive position that eliminating the transferability restrictions wasn’t a material modification requiring shareholder approval. It looks like Microsoft acted on that advice, like I think most people did. In the 1997 S-3, there’s language indicating that the option plans generally prohibit transfers by plan participants, but as with many of the plans put in place after transferability was first permitted, they allow the Board to “extend such transferability rules, on a general or specific basis, in its sole discretion.” I think most post-1995 plans have similar language, so even if Microsoft is dealing with newer plans than the ones covered here, my guess is that the ability of the board to allow transfer won’t be an issue under the plans or the agreements.
The transcript of Steve Ballmer’s press conference sheds some light on the accounting treatment Microsoft expects (the bottom line is that they’re going to expense all of their outstanding options and reflect that treatment in prior periods as well):
“Given that we are going to account for this under FAS 123, which is also the rule under which stock options must be expensed, it means we will also be expensing stock options that have been granted previously. For best comparability of our results going back and forward, we will reflect FAS 123 in our basic results for prior years in addition to our go forward results.”
Ballmer’s comments provide a few more details on how this is going to work (I’ve got no idea how they’re going to implement this, but it sort of sounds like a combination of a standby underwriting arrangement and some of the restricted stock hedging strategies that brokerages have been peddling for quite some time). It also looks like they’re trying to get some interpretative advice from the Commission (perhaps on the tender offer issue):
“The other thing which we are announcing to our employees today is the work that we are doing to implement a program that will allow them or give them the option, I should say, the choice, to sell their options that are, let’s say, quite a bit underwater, to a third party or a set of third parties. We are working through the details of that now, both with the Securities and Exchange Commission, who needs to review this kind of an offer, as well as with third parties. The goal here would be to allow the employees to make a sale of their underwater options, and to receive the proceeds from a third party on that sale on some schedule which vests into the future.”
Here’s the link to the whole press conference –http://www.microsoft.com/presspass/exec/steve/2003/07-08compensation.asp .
As to the tender offer issue, Microsoft probably is arguing this isn’t like a repricing exchange offer, in that it involves the facilitation of the exercise of an option, which is best regarded as a compensation decision, and not an investment decision. Ballmer’s comment that the optionees are going to be paid “on some schedule which vests into the future” undercuts that argument, and also suggests to me that in addition to any Williams Act issues are associated with the deal, there may also be some 1933 Act issues associated with what the employees are receiving from JP Morgan (or whomever).