Monthly Archives: August 2003

August 29, 2003

The Occupational Safety and Health

The Occupational Safety and Health Administration has posted a compliance directive updating its Whistleblower Investigation Manual to cover two more statutes. The directive, DIS-0-0.9, adds two chapters and updates others to provide guidance on investigating whistleblower complaints under the Corporate and Criminal Fraud Accountability Act of 2002 (Title VIII of the Sarbanes-Oxley Act of 2002) and the Pipeline Safety Improvement Act of
2002. The manual is the primary vehicle for disseminating policy, procedures and information to whistleblower investigation staff.

For subscribers, we have posted a memo by Marty Lipton railing against the Breeden report as detailed in a blog yesterday by Mike O’Sullivan.

August 28, 2003

The battle over the executive

The battle over the executive compensation practices at Siebel Systems looks like its coming to an end with the settlement of a lawsuit brought by the Louisiana Teachers’ Retirement System – yet another sign of how far institutional investors will now go to rein in excessive compensation, particularly in Silicon Valley. Siebel in particular has been targeted for quite some time by a variety of investors, including the AFSCME.

One of the more curious governance reforms in the Siebel settlement is the committment to provide better disclosure about how the compensation committee makes its executive compensation determinations. Its not clear if this means that the committee will provide more details in its report than required under Item 402(k) of Regulation S-K – but a cursory review of Siebel’s 2003 Comp Committee Report shows that its current disclosure practices are not too far off the norm. So investors – and perhaps the SEC staff – may well be paying closer attention to these reports next proxy season.

August 27, 2003

With the SRO corporate governance

With the SRO corporate governance proposals likely to be adopted in the near future, we have started posting sample board committee evaluations on, starting with audit committee evaluations.

We have posted the 156-page Breeden MCI report, which I am labeling the “Grand Corporate Governance Experiment” as it recommends a number of mechanisms that have been debated but not tried. A prime example is the concept of the “town hall” website where shareholders can organize to present proposals to management. Here is Breeden’s recommended format:

“The Governance Committee should establish a website that will offer shareholders a “town meeting” forum for discussion of issues of concern. One or more shareholders representing at least 1% of the voting power of the Company should be entitled to place resolutions on the website for consideration of all shareholders, irrespective of whether such resolutions would be deemed appropriate for the Company’s proxy statement (based on considerations of whether such resolutions involve matters of ordinary business or otherwise). The Governance Committee should establish criteria for the times of submission of such resolutions, and the time and manner of recording votes of shareholders regarding any such proposals. Any such proposal that receives a minimum vote to be set by the Governance Committee (such as 20%) should be placed by the Company on its next proxy statement. It should be the general policy of the Company to solicit the views of shareholders on issues of concern to them on an active basis.”

As I recalled with Bill Morley yesterday, this concept is nothing new. The staff had debated over this concept back during the 1998 amendments to Rule 14a-8 and the staff’s July 15th report asks whether “solicitation should be facilitated by electronic means on one or more websites.” George Kobler floated this concept also in “Shareholder Voting over the Internet: A Proposal for Increasing Shareholder Participation in Corporate Governance,” 49 Ala. L.Rev. 673 (Winter 1998) – albeit without any real legal analysis.

As usual, the potential problems with this approach will be more evident once MCI flushes out – if they follow this recommendation – the details left unspoken by Breeden’s recommendation. This framework is potentially quite costly, both in terms of dollars and management’s time. First, there is the technology cost of setting up the website that contains mechanisms to allow voting, etc.

In fact, I believe only the largest companies could operate such a website as it will take quite a bit of time to qualify shareholders and keep tabs on what is being posted and prepare reports for senior management. This easily could lead to the corporate secretary’s department hiring an additional staffer and would burden inhouse securities lawyers with a heavier load.

Management then would need to determine whether to run their own solicitation campaign against these proposals – and how to deal with false and misleading information posted on the website. Without the SEC staff to act as referees, its probably inevitable that proponents would make more false and misleading statements than they already do (and its unclear whether Rule 14a-9 would apply until more details are known). If the company’s website ends up hosting a “spitting match” between a group of proponents and management, this is sure to draw the media’s attention. More to come…

August 26, 2003

Whoa, the 78 suggestions filed

Whoa, the 78 suggestions filed by Richard Breeden, the court-appointed Corporate Monitor for MCI, with The United States District Court for the Southern District of New York to improve MCI’s corporate governance includes some real “doozys.” They surely will be fodder for much commentary in this blog and elsewhere for some time to come. Among them:

– placement of most of the board’s corporate governance guidelines within the company’s Articles of Incorporation, so that only shareholders can amend them

– establishment of a website “town hall” for shareholders to vote upon resolutions at any time of the year – and without the restrictions imposed by Rule 14a-8; with a mechanism to have certain of these resolutions then placed in the company’s proxy statement for a vote (i.e. so Rule 14a-8 restrictions can effectively be avoided)

– ban on stock options for 5 years; to be replaced by the use of restricted stock (see Microsoft)

– at least one new director elected each year, with a mechanism for shareholders to nominate and hold a contested election potentially each year

– mandatory rotation of independent auditors every 10 years

– 10 year term limits on directors

– maximum limits on executive compensation (any amounts in excess must be approved by shareholders) and elimination of most retention grants

For subscribers, we have posted an interview with Seth Aronson on Recent Developments under the Securities Litigation Uniform Standards Act .

August 25, 2003

Last week, Bloomberg ran an

Last week, Bloomberg ran an article about SEC proceedings involving Chancellor Corporation and its former officers, directors and auditors in which one director was sued in an injunctive proceeding and another director consented to an administrative settlement.

The interesting aspect of these proceedings is that they were based on alleged anti-fraud and reporting violations under the Securities Exchange Act of 1934 – even though there were no allegations that these directors participated in the fraud. Instead, the directors appear to have been targeted because they neglected to make proper inquiries when there were indications that management was engaged in fraudulent conduct.

As John Olson noted in an email to the ABA Corporate Governance subcommittee, the directors were alleged to have been “reckless” in their lack of due care when they signed SEC annual report filings – and that this is one of the few situations where the SEC has sought a federal scienter-based anti-fraud remedy for what amounts to an abdication of state law duties of care, attention and, possibly, good faith.

Marty Lipton came out with a client alert indicating that the business judgment rule is alive and well and is not affected by these SEC proceedings, even as explicated by SEC Director of Enforcement Stephen Cutler, due to the extreme circumstances of the facts in these proceedings.

For subscribers, we have created a new “Convertible Debt Offerings” practice area, with a September webcast on this topic to be announced soon.

August 20, 2003

Regarding the SEC staff’s recent

Regarding the SEC staff’s recent FAQs on auditor independence, Gibson Dunn just put out an alert regarding the need to tweak pre-approval policies of audit and non-audit services. The alert specifically addresses Questions 22 through 24 of the FAQs that contain guidance on whether, in the view of the SEC’s Office of the Chief Accountant, particular practices would satisfy the SEC’s pre-approval rules. Gibson Dunn’s analysis follows:

These rules, as set forth in Rule 2-01(c)(7) of Regulation S-K, provide that: (1) a pre-approval policy must be detailed as to the particular service to be provided; (2) the audit committee must be informed about each service; and (3) the policy must not delegate audit committee authority to management. The FAQs state that, although the level of detail that is appropriate in a pre-approval policy depends on a company’s facts and circumstances, the establishment of monetary limits alone is not sufficient because these limits do not, without more, provide sufficient detail or adequately inform the audit committee.

Similarly, policies that use “broad, categorical approvals” (the FAQs use “tax compliance services” as an example), or that call upon management to make judgments about whether proposed services fit within categories of services that the audit committee has pre-approved, are not sufficiently detailed as to the particular services to be provided. In general, a pre-approval policy must be “designed to ensure that the audit committee knows precisely what services it is being asked to pre-approve.”

According to the FAQs, if the audit committee is presented with a schedule or cover sheet describing services to be pre-approved, that schedule or cover sheet must be accompanied by “detailed back-up documentation” regarding the specific services to be provided by the outside auditor. In light of the guidance in the FAQs, Gibson Dunn recommends that companies take a fresh look at their pre-approval policies and particularly, the categories and/or descriptions of pre-approved services included in their policies.

For subscribers, we have posted the transcript of last week’s webcast, “Designing Reporting-Up and Complaint Procedures.”

August 20, 2003

As evident from the number

As evident from the number of emails I received, it looks like yesterday’s blog struck a nerve; the one about a SEC staffer’s comment regarding exhibits listed under Item 7 and disclosed pursuant to Item 12 (i.e. earnings releases) being deemed “filed.” One community member noted that he got what was tantamount to contrary advice from a staffer – so this could be one of those areas where inconsistent guidance is being provided by different members of the staff.

However, I got quite a few emails from members who had gotten the same guidance from staffers that I blogged yesterday – and they were quick to point out the weaknesses of the staff’s approach, including:

1. As I pointed out, Item 7(c) says that “the exhibits shall be furnished in accordance with the provisions of Item 601 of Regulation S-K.”

2. Item 601(b)(99)(i) says that “any additional exhibits which the registrant may wish to file shall be so marked as to indicate clearly the subject matters to which they refer.” If the SEC recommends including the earnings release as an Exhibit 99, this language would question the conclusion that the release was merely “furnished” (under the SEC’s strict reading of the language used).

3. Instruction B.6. to Form 8-K indicates that “information in a report furnished pursuant to Item 12 shall not be deemed “filed” for purposes of Section 18 . . . unless the registrant specifically states that the information is to be considered “filed”under the Exchange Act . . . .” (the same language is used in Instruction B.2. for Item 9 disclosures) Surely the SEC couldn’t be implying that the introductory language in Item 7 alone deems the issuer to have “specifically stated” that the exhibits are to be considered “filed.”

4. All the language used in all of the above pre-dates the SEC’s use of the “furnished” vs. “filed” terminology that was introduced in its Regulation FD release, so the concept of liability for “filed” information existed earlier, but the language used in Item 7 when Form 8-K was adopted was clearly never intended to make these distinctions.

5. Item 601(a)(2) of Reg S-K and Rule 102 of Regulation S-T only contemplate the listing of exhibits “filed” in the exhibit index. So, based on the staff’s position, one would not list exhibits furnished in the exhibit list either.

One member noted that if the SEC is worried about being able to distinguish between “filed” and “furnished” exhibits in an 8-K that includes more than Item 9 and/or Item 12 disclosures, perhaps it could either clarify its position (and clean up the forms) or take its Instructions B.2. and B.6. as literally as it is taking the one use of the word “filed” in Item 7. He notes that the impact of this position is obviously troubling, given that most companies have been listing their Item 9 exhibits under Item 7 for years.

Another member grumbled about how does this staff position help transparency or help investors locate Item 12 information? Investors will pull up filings, look at the exhibit list, and then wonder why the issuer didn’t provide the information contemplated.

We hope that all of the SEC staff will get on the same page and accept something reasonable, like the practice of listing exhibits “furnished,” so long as the company expressly notes in the Item 7 exhibit list that they are furnished rather than filed.

Yesterday, the SEC’s enforcement division settled the first case that relies upon false CEO and CFO certifications provided under Section 302 of Sarbanes-Oxley.
According to the SEC’s Complaint, Rica Foods filed a Form 10-K containing a purported unqualified independent auditor’s report from Deloitte & Touche. The audit report represented that Rica Foods’ consolidated financial statements were presented fairly and in conformity with GAAP. At the time of the filing, however, Deloitte had not provided the company with a signed audit report, and the company’s financial statements contained material classification errors – yet the CEO and CFO included the standard 302 certifications in the 10-K.

For subscribers, we have posted an interview with David Kaufman of Duane Morris with bulleted notes on what transpired at the Recent ABA Annual Meeting.

August 19, 2003

A member of the community

A member of the community brought this situation to my attention. In tandem with the Reg G rulemaking, the SEC adopted new rules earlier this year that require ’34 Act reporting companies to file an 8-K under new Item 12 to “furnish” any earnings releases as an exhibit to the Form 8-K. As a result, some companies have filed 8-K’s pursuant to the new Item 12 that list the earnings release as an exhibit under Item 7(c) (which is the Item that the Form 8-K suggests should be used to list exhibits).

In recent SEC comment letters, the staff indicates that their position is that listing the earnings release as an exhibit under Item 7(c) results in the earnings release being deemed “filed” as opposed to “furnished” for purposes of ’33 and ’34 Act liability. Recall that information that is “furnished” is not subject to ’33 and ’34 Act liability, but information that is “filed” is subject to such liability. The staff would prefer that the 8-K simply furnish the earnings release as an Exhibit 99 without reference to any Item number (other than Item 12).

Apparently, the staff wants to be able to easily distinguish between 8-K’s that were “furnished” and those that were “filed.” The end result doesn’t seem to make much sense, particularly in light of the fact that Item 7(c) of Form 8-K states that “the exhibits shall be furnished in accordance with the provisions of Item 601 of Regulation S-K” – but it may be wise to follow this guidance (and not list any 8-Ks that were previously “furnished” under Item 7(c) in the list of exhibits in a registration statement – so as to avoid them being deemed incorporated by reference). If you have your own interesting comments from the staff, please share them at

For members, we have posted interviews with Catherine Meeker, W. Scott Ortwein and Dennis Garris on the SEC’s Director Nomination Proposal and Kirk Maldonado on the Basics of Form 11-K.

August 18, 2003

As bad luck would have

As bad luck would have it, the power blackout affected the ability of some companies to file their 10-Qs on Thursday, and even Friday. The SEC staff has indicated its willing to adjust the filing date for these companies in certain circumstances – and has provided instructions on how to make a date adjustment request.

We continue to receive a number of questions about CEO/CFO certifications, including what to do with amended 10-Ks. It would appear that the certifications for an amended 10-K could follow the old certification rules if the original 10-K was not “due” on or after August 14th – because the amendment technically does not have a due date and the amendment relates to the original 10-K’s timeframe (when the new controls/procedures requirements were not imposed). So the amended 10-K should be able to use the old language regarding controls/procedures – and have the 302 certification following the signatures and the 906 certification as exhibit 99. However, if you decided to go this route, I recommend calling the SEC staff to confirm that it would be acceptable.

And remember that if you are filing an amendment that doesn’t affect the financial statements, the SEC staff informally has indicated that you only have to include paragraphs 1 and 2 of the certification.

Former SEC trial attorney Gary Goodenow has launched, which includes some interesting information about his perspective of how the SEC’s Miami office functions. We would be remiss if we did not point out that our own “SEC Enforcement” practice area has a wealth of information about the SEC’s enforcement process, including dozens of FAQs.

After a 9-month vacancy, the SEC finally hired a new Chief Accountant, long-time PricewaterhouseCoopers partner Donald Nicolaisen.

August 14, 2003

In this era of increased

In this era of increased pressure to cooperate with the SEC’s enforcement division, the WSJ reports today that RJR Reynolds has refused to provide certain documents underlying how the company aggregates legal and marketing expenses in its disclosure documents. The company states that it doesn’t want detailed information about its litigation costs to get into plaintiff’s lawyers hands for fear that the data could influence jurors in product-liability lawsuits – and notes that its competitors don’t break out this information. We will watch whether the SEC will sue to enforce the subpoena.

For subscribers, thanks to John Huber and Tom Kim of Latham & Watkins for providing an updated version of their helpful 216 page paper on SOX and SEC Rulemaking.