Monthly Archives: October 2004

October 13, 2004

SEC Chair Donaldson Speaks Out on Executive Comp!

Got a jolt yesterday when I read the lead article in the Washington Post Business section, during which a reporter interviewed SEC Chair Donaldson about executive pay. Not only did it include some interesting comments about the significance of the GE disclosure settlement and the upcoming Tyson Foods action, but it referred to our conference and dealt with a number of other topics that we have been talking about (eg. tally sheets, “holy cow” moments).

Clearly, there is some momentum for change as reflected by our 1000th registration yesterday – combined webcast and in-person attendance – for the October 20th compensation conference.

How to Disclose Material Weaknesses in Internal Controls

Last week, SEC Chief Accountant Donald Nicolaisen gave a speech during which he urged companies to disclose material weaknesses in a manner that enables investors to carefully evaluate the circumstances underlying the material weakness. He also noted he has met with investors and urged them not to treat all material weaknesses as equally significant and encouraged them to consider issuing timely guidance on what impact the following scenarios may have on their investment decisions:

– Management fails to complete the work necessary to issue its report on a timely basis.
– The auditor fails to complete the work necessary to issue its report on a timely basis.
– The work is completed and the reports are issued timely, but they identify one or more material weaknesses.

The Chief Accountant said he was encouraged to learn during a recent meeting with Moody’s that they are considering these issues and are tentatively considering grouping material weaknesses into different categories. One category, for example, might include a material weakness whose effects are limited to a single account balance that an auditor could address by expanding audit procedures. Other categories might include an ineffective control environment, such as the tone at the top, an ineffective audit committee or an ineffective financial reporting process. In these cases it may be more difficult for the auditor to audit around the problem. Moody’s tentatively does not expect to take any rating action for some categories of material weaknesses; whereas it may for other categories.

Parsing the New Deferred Compensation Legislation

Parsing the new tax legislation is no easy task – and as with all legislation, there are bound to be some surprises. Consider Section 402 which contains a new SEC reporting requirement to disclose penalities incurred by the the JOBS Act:

(e) PENALTY REPORTED TO SEC- In the case of a person–
(1) which is required to file periodic reports under section 13 or 15(d) of the Securities Exchange Act of 1934 or is required to be consolidated with another person for purposes of such reports, and
(2) which–
(A) is required to pay a penalty under this section with respect to a listed transaction,
(B) is required to pay a penalty under section 6662A with respect to any reportable transaction at a rate prescribed under section 6662A(c), or
(C) is required to pay a penalty under section 6662B with respect to any noneconomic substance transaction, the requirement to pay such penalty shall be disclosed in such reports filed by such person for such periods as the Secretary shall specify. Failure to make a disclosure in accordance with the preceding sentence shall be treated as a failure to which the penalty under subsection (b)(2) applies.

October 12, 2004

Equivalent of Sarbanes-Oxley for Deferred Compensation

Yesterday, the Senate signed off on a massive $137 billion corporate tax overhaul that was passed by the House last Thursday. The legislation repeals the current tax regime that was ruled out of compliance by the World Trade Organization and replaces it with a system that brings the US into compliance – included in the legislation are some pretty dramatic nonqualified deferred compensation provisions that will require modification of virtually every nonqualified plan.

To be clear, this very significant legislation will require every employer in the US with a non-qualified retirement plan or a deferred compensation plan (which is virtually every employer, except small ones) to amend their plans, start a new plan or both.

Learn more about this legislation at next week’s upcoming NASPP annual conference, as it will be addressed by a number of the 45+ panels! Or learn more from the recent NASPP webcast – “The Coming Non-Qualified Deferred Compensation Legislation” and the NASPP Deferred Compensation Legislation portal.

More on Internal Checks

Last week, I blogged about the Council of Institutional Investors’ updated executive compensation policy. One item I neglected to mention is that CII endorses the internal check method – which we recommended as one way to bring CEO compensation back in line – by stating “The committee should also ensure that the structure of pay at different levels (CEO and others in the oversight group, other executives and non-executive employees) is fair and appropriate in the context of broader company policies and goals and fully justified and explained.”

Also notable is that CII not only recommends disclosure of a company’s compensation philosophy – but believes that best practices includes shareowner approval of the compensation philosophy. I agree with the recommendation to disclose, but I think that shareholder approval goes a little too far.

Pay for Performance

In addition, CII recommends that compensation of the executive oversight group should be driven predominantly by performance. Of course, the devil is in the details in this area.

To learn more about pay-for-performance – and how the lack of it has led to excessive compensation practices – I recommend the new book by Professors Lucian Bebchuk and Jesse Fried, “Pay without Performance: The Unfulfilled Promise of Executive Compensation.” We also will provide practice pointers in this area next week at the October 20th compensation conference.

October 11, 2004

Congress Has a “Holy Cow” Moment

During last week’s House hearing on Fannie Mae, Rep. Baker introduced a chart detailing the compensation received by the top 20 executives and also noted that the company awarded nearly $250 million in bonuses – bonuses, not option windfalls! – over the past five years. According to a NY Times article from last Thursday, this “figure stunned even the company’s strongest supporters.”

In The Corporate Counsel, we have written about how boards might be surprised when they tally up what might be paid out under pay elements that are not well understood. Learn how to understand them at the October 20th compensation conference during the panel on “What is the Appropriate Amount of Compensation for CEOS,” which will address:

– What responsible ways (and yardsticks) can be used to structure each component of top executives’ compensation, including cash compensation, bonuses, stock compensation, retirement plans, severance and more
– What types and levels of compensation are now appropriate for CEO pay – and how to identify them
– What should be the role of surveys regarding CEO pay; including how to overcome the problems of defining peer groups
– How to critically evaluate survey data and avoid the pitfalls of benchmarking – red flags and nuggets
– How to implement internal pay equity methodology

Is Chairman Donaldson a Short-Timer?

On Friday, I was in NYC to speak at IRRC’s annual proxy conference and didn’t think much of it when I heard SEC Commissioner Goldschmid give a speech on the 1st year anniversary of the shareholder access proposal railing against the Commission for not having adopted anything yet – because I already knew Goldschmid’s views and the fact that this proposal was still being debated behind closed doors on the 6th floor of the Commission as SEC Chairman Donaldson remains the swing vote.

So, I was a little surprised to read the Saturday NY Times that quoted Donaldson as stating that he was undecided if he would stay on if President Bush is re-elected – and there certainly were signs in the article that he might not stay for too long as Donaldson said that “he never sought the position” and “looked forward to other projects.” Perhaps Commissioner Goldschmid was pleading for action now as the future of this proposal could get quite murky once the November election passes.

Delay of Options Expensing?

In the same NY Times article, SEC Chair Donaldson also stated that he was considering a delay in the FASB’s option expensing proposal – even before he received a request to delay expensing from 51 US Senators last week (this request came in the form of 4 separate letters). The FASB meets this Wednesday to discuss the proposal’s status.

In July, the US House of Representatives voted overwhelmingly to stop the implementation of option expensing by passing a bill requiring instead that only a small portion of stock options – those given to a company’s top five executives – be expensed. This House-backed bill has been blocked in the Senate by Banking Committee Chair Richard Shelby – supporters are hoping to bypass his opposition by attaching the legislation as an amendment to a budget bill this week, but most action on the budget probably won’t happen until after the November elections.

Importance of Maintaining a Company-Wide Document Retention Policy

For the those of you involved with document retention, you should read this interview with Alan Yudkowsky and Peter Jazayeri on Frank Quattrone, Arthur Andersen, and the Importance of Maintaining a Company-Wide Document Retention Policy.

October 7, 2004

Updated PCAOB and SEC FAQs on Internal Controls

Yesterday, the PCAOB staff added three new FAQs on Auditing Standard No. 2 to the 26 FAQs that were issued in June. These FAQs are now in two separate PDFs on the PCAOB’s site.

In addition, the SEC’s Corp Fin updated its June FAQs on Section 404 management reports to clarify the answer to Question 3 to describe a Type 2 SAS 70 report and to address five new frequently asked questions (see Questions 19 through 23). The SEC’s changes were made to the June FAQs – so that all of their FAQs are in one document.

CII Updates Executive Compensation Policy

The Council of Institutional Investors has just updated its policy regarding executive compensation (the policy is not yet posted on their site) – and it includes many elements that we recommended in our 12 steps to responsible compensation practices (as written in the May-June and Sept-Oct issues of The Corporate Counsel). This is a significant development as CII doesn’t adopt or modify its policies without consensus among its 130 pension fund members (whose assets exceed $3 trillion).

The policy calls for quite a number of dramatic changes in compensation practices. Just in the disclosure area alone, consider these points to see how CII seeks to advance the ball well beyond what is required by S-K:

· Overview – Compensation committee is responsible for ensuring that all aspects of executive compensation are clearly, comprehensively and promptly disclosed, in plain English, in the proxy statement – regardless of whether such disclosure is required by current rules and regulations.

· Benchmarking – If benchmarking is used, disclose the peer group companies – and if the peer group is different from that used to compare overall performance, describe the differences between the groups and the rationale for choosing between them. Also disclose targets for each compensation element relative to the peer/benchmarking group and year-to-year changes in companies composing peer/benchmark groups.

· Salary – Disclose rationale for paying salaries above median of the peer group.

· Annual Incentive Compensation – Fully describe qualitative and quantitative performance measures and benchmarks used to determine annual incentive compensation, including the weightings of each measure. At the beginning of a period, disclose the maximum compensation payable if all performance-related targets are met – and at the end of the performance cycle, disclose actual targets and details on the determination of final payouts.

· Long-Term Incentive Compensation – Fully and clearly disclose a well-articulated philosophy and strategy for long-term incentive compensation – including size, distribution, vesting requirements, other performance criteria and grant timing of each type of long-term incentive award granted to the executive oversight group and how each component contributes to the company’s long-term performance objectives. Disclose whether and how long-term incentive compensation may be used to satisfy meaningful stock ownership requirements – and whether the committee imposes post-exercise holding periods or other requirements.

· Dilution – Disclose the philosophy regarding dilution including definitions of dilution, peer group comparisons and specific targets for annual awards and total potential dilution represented by equity compensation programs for the current year and expected for the subsequent four years – including a table detailing the overhang represented by unexercised options and shares available for award and a discussion of the impact of the awards on earnings per share.

· Stock Option Awards – Fully describe the qualitative/quantitative performance measures and benchmarks used and the weightings of each component – and whenever possible, include details of performance targets.

· Perquisites – Total perquisites should be described, disclosed and valued.

· Employment Contracts, Severance and Change-of-Control Payments – Fully and clearly describe the terms and conditions of employment contracts and other agreements/arrangements and reasons why the committee believes the agreements are in the best interests of shareowners – including tabular disclosure of the dollar value payable, including gross-ups and all related taxes payable by the company under each scenario covered by the contracts/agreements/arrangements.

· Retirement Arrangements – Disclose the terms of any deferred compensation, retirement, SERP or other similar plans, along with a description of any additional perquisites or benefits payable to executives after retirement – including a single table that details the expected dollar value payable to each executive under any deferred compensation, retirement, SERP or similar plan, along with a dollar value of any additional perquisites of benefits payable after retirement.

· Stock Ownership – Disclose stock ownership requirements and whether any members of the executive oversight group are not in compliance.

Learn how to handle these new disclosure demands during the panel – “What Now Needs to Be Disclosed in the Proxy Statement” – of our October 20th compensation conference.

October 6, 2004

Former Dupont Chair Jack Krol Talks About Internal Pay Equity

Yesterday, I was pretty excited to be in Delaware to videotape the critical panel for the October 20th executive compensation conference with Delaware Chief Justice Myron Steele, former Chief Justice Norman Veasey and Professor Charles Elson. That panel – “Director Liability and Responsibilities: The Changing Face of Delaware Law” – will be played on a delay basis as the first panel on October 20th.

But the real bonus was having Jack Krol – former Dupont CEO/Chair, who sits on a number of boards today – come in for a brief videotaped session. Jack urgently wanted to participate live on the panel “What Compensation Committees Should Be Doing Now” to urge others to consider the novel methodology implemented under his watch at Dupont – but he has a date conflict.

As we outlined in the Sept-Oct issue of The Corporate Counsel, one corrective approach to rolling back excessive pay is the “the internal check” – checking for “internal pay equity” at various levels within a company to ensure that the CEO’s compensation has not gotten out of line within the company. So now those of you that have registered for the conference – in person or by webcast – will be able to hear Jack explain how he accomplished this at Dupont as part of the panel for which he originally was slotted!

Is CEO Pay Really Changing?

Read this interesting interview with Josh Lurie on Whether CEO Pay Is Really Changing to read the interesting results of a CEO pay survey of 2400 companies over a three-year period.

8-K Webcast Transcript Coming Soon

Due to its length, it has taken the September 23rd panel a little longer than usual to clean up the webcast transcript – it will be up soon. Sorry for the delay! The audio archive is available now.

October 5, 2004

October E-Minders is Up!

Here is our October E-Minders – tomorrow, it will be emailed to all that signed up for it.

Enforcement Director Speaks on Gatekeepers

In probably his most significant speech to date, Enforcement Director Steve Cutler gave this riveting speech about gatekeeper responsibilities at UCLA a few weeks back. The speech is entitled “The Themes of Sarbanes-Oxley as Reflected in the Commission’s Enforcement Program.” The three themes identified were: fundamental significance of gatekeepers in maintaining fair and honest markets; importance of maintaining integrity in the investigative process aimed at ferreting out securities law violations; and need for greater personal accountability and deterrence at the top of the corporate world.

Here are some notable snippets that might be close to home for the lawyers out there:

– we named lawyers as respondents or defendants in more than 30 of our enforcement actions in the past two years

– close to half the Commission’s actions against lawyers during the past two years involved outside counsel

– we are also considering actions against lawyers, both in-house and outside counsel, who assisted their companies or clients in covering up evidence of fraud, or prepared, or signed off on, misleading disclosures regarding the company’s condition

– one area of particular focus for us is the role of lawyers in internal investigations of their clients or companies, as we are concerned that, in some instances, lawyers may have conducted investigations in such a manner as to help hide ongoing fraud, or may have taken actions to actively obstruct such investigations

– but what we want to do is focus their [gatekeepers’] minds, to have them think, when they wake up in the morning, if I fail to live up to my legal and fiduciary obligations, if I don’t hold the line with my corporate client and resist pressure to acquiesce in wrongdoing, the consequences will be swift and severe.

October 4, 2004

SEC Brings First “Up-The-Ladder” Case

Without much fanfare, the SEC Enforcement Division recently brought what could be considered the first “up-the-ladder” case, a settlement with John Isselmann.

As proof that Enforcement Director Steve Cutler was serious in his recent gatekeeper speech that the SEC is setting a high bar for attorneys that represent public companies – and expects to be bringing more actions against lawyers – this case was brought against a general counsel, even though he was the one that blew the whistle against wrongdoing within the company! However, the Staff believed he didn’t blow it soon enough.

Also notable is that the conduct in question occurred in December 2002 – before Part 205 was adopted – so it is a more traditional “causing” violation and not really a true “reporting up” case. This is important because it shows that – with respect in-house counsel who have a direct role in preparing and approving public statements and filings – that the SEC believes that the pre-SOX securities laws have the practical effect of requiring “reporting up.” (I imagine that when – and if – the SEC sues an associate at a company’s outside law firm under Part 205, there’ll be some commotion!)

The bottom line is that this case indicates that the SEC is prepared to seek additional penalties against counsel who do not promptly notify the audit committee upon learning that their client is about to violate the federal securities laws. Thanks to Ken Winer and Tom Kuczajda for the heads-up!

Dilbert Enters Into Excessive Compensation Fray!

During the past few days, Scott Adams has challenged excessive compensation practices through his famous Dilbert comic strips. Here are two from the weekend:


dilbert 2.bmp

October 1, 2004

E-Communications in California

A few weeks back, I blogged about several states that had amended their laws to allow for electronic-only shareholder meetings. Now, California has changed its laws to be more e-communications friendly. Join Keith Bishop, a former California Commissioner of Corporations, who dissects this development in this interview on Taking Care of Business Using Electronic Communications in California.

Filing Fees – It’s That Time of Year Again…

Yesterday, the SEC released Fee Advisory #3 stating that the SEC will operate under a continuing resolution that will extend through November 20th – meaning filing fees remain at their current rates until that time (and at that time, there likely will be another extension). Today is the first day of the SEC’s fiscal year – and it has become an annual tradition for Congress to drag their feet passing the federal budget, which forces the SEC to issue multiple fee advisories to reflect its “continuing resolution” status.

Five days from whenever Congress passes the budget, the SEC will lower registration fees from the current rate of $126.70 per million to $117.70 per million, a 7% decrease. We have experienced lower rates each year for quite a while now.