A few weeks back, I attended a very informative ALI-ABA conference devoted to corporate governance – here are some notes from a great panel on investor expectations. These notes are posted in Section F of our Sarbanes-Oxley Law Firm Memos.
One tale worth repeating relates to how a few companies still are willing to waive their code of ethics. Apparently, one particular company’s CEO conducted a related party transaction without bothering to get board approval. When the company’s independent auditor found this out and brought it to the board’s attention, the company waived its code of ethics and the independent auditor was fired. At least, that is the story that I heard – when I went to verify it, none of the company’s SEC disclosure stream matched up with the story. Scary!
Late 10-Q Filings
Perhaps the most fascinating anecdote in this Business Week article about late 10-Q filings – which theorizes that 404 is causing the delays – is that the number of late filings was so high last year, even without 404! The article states: “In just one week in early November, 61 companies with a market cap of $100 million or more announced they would be late with their filings, including info-tech giant Electronic Data Systems, General Motors, and Suntrust Banks. That was up 25% from the same period a year ago, according to Glass, Lewis & Co., an independent researcher.”
As the number of Canadian companies registered with the SEC is far higher than any other country (other than the US obviously), we have created a “Canadian Law Practice Area.” For those practicing in this area, please let me know if you have any content to contribute!
Recently, there have been several news accounts about how the SEC is threatening a first-ever lawsuit against a lawyer hired to help with a company’s internal accounting probe. Below is some paraphrasing from a Bloomberg article on this topic:
Exactly what the lawyer did to provoke the SEC isn’t clear. The company issued a press release last year saying the probe the lawyer conducted found no “intentional wrongdoing by management.” About a month later, Endocare said it was under investigation by the Justice Department and the SEC, which has since threatened to sue the company and its former managers.
The SEC has encouraged corporate boards to hire outside legal advisers, saying their findings help the agency root out fraud quickly. If the SEC brings a suit against the lawyer in question, it may define how far lawyers have to go to police a company after assuming the role of investigator, according to former SEC officials, who said the agency has never sued a lawyer for mishandling a corporate probe.
If the SEC proceeds against the lawyer in this case, other lawyers may balk at taking on company investigations. “This looks like an expansion of the government’s crackdown on gatekeepers, particularly accountants or lawyers who bless a company’s prior conduct,” said William McLucas, a former SEC enforcement chief, who conducted the internal investigation at Enron. “It ratchets up the risk for lawyers doing inquiries that are held out to the public as independent.”
Guidance for Proxy Compensation Tables
We have posted an updated version of the popular chapter regarding the proxy comp tables written by Alan Kailer of Jenkens & Gilchrist in Section II.C.3 of our 2005 Proxy Season Resource Center (and also posted on CompensationStandards.com).
I know that you wouldn’t forget about Festivus – my kids still whine about the aluminum pole by our hearth – but this is just a reminder in case you are Seinfeld-challenged (you know, the tradition of Festivus begins with the airing of grievances). Send a loved one an e-card reminding them of the Festivus holiday – and if you want to amp up your celebration this year, check out this Festivus Blog!
Of course, I am still mad at Ben & Jerry for their renaming their Festivus ice cream. Now I just add an asterik to “Gingerbread Cookie*” to indicate that its the flavor formally known as “Festivus.”
Laura Thatcher of Alston & Bird – a CompensationStandards.com Task Force member – notes a silver lining in Merck’s broad-based (and in my mind, not very responsibile) COC arrangements announced a few weeks back. Laura notes that the arrangements follow the movement towards tightening up of the definition of “Good Reason” in the sense that Merck limits the more hair-trigger change-in-status provision to Management Committee members and provides a somewhat harder Good Reason trigger for others.
For example, for Management Committee members, Good Reason includes the typical “significant adverse change” in the executive’s authority, duties, responsibilities or position (including title, reporting level and status as a Section 16 officer). For others, Good Reason does not include a change in the person’s title or status as a Section 16 officer, or a change of less than two levels in the position to which the person reports.
Laura also notes that Merck moves in the right direction by providing less stringent procedural hurdles for a finding of “Cause” for executives other than Management Committee members (i.e. no need to get Board action to fire such a person for Cause). Finally, the excise tax gross-up is limited to the Management Committee members, with a modified cut-back approach for others.
However, these are small favors in Merck’s scheme – particularly given that there will likely be a diminution of duty in any deal that Merck doesn’t lead, so these might as well be single triggers. I tried to be positive. Learn more about responsible provisions in executive contracts in the CompensationStandards.com Employment Agreements Practice Area.
Best Practice Guidelines Governing Analyst/Corporate Issuer Relations
– Information Flow between Analysts and Corporate Issuers
– Analyst Conduct
– Corporate Communication and Providing Analysts with Access to Management
– Reviewing Sell-Side Analyst Reports by Corporate Issuers
– Issuer Paid Research
New SEC Filing Fees
As noted in the SEC’s 6th Fee Advisory, President Bush finally signed the omnibus appropriations bill that includes the SEC’s funding for fiscal year 2005. Accordingly, effective this upcoming Monday – the 13th – the Section 6(b) fee rate applicable to the registration of securities and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions will decrease to $117.70 per million.
SEC’s Asset-Backed Proposal to Be Considered
Next Wednesday, the SEC is holding an open Commission meeting to consider adopting the far-reaching asset-backed proposal.
On DealLawyers.com, I am excited to announce that three new bloggers are slaving away. As blogging is the highlight of my day (ain’t that sick!), I am always glad to see others express themselves. Former SEC Staffer Jim Moloney and Rob Bujarski of Gibson Dunn are manning “Moloney’s M&A Scoop” – and Scott Sher of Wilson Sonsini is running with “Trust & Antitrust – The Antitrust Blog.”
Here is a recent blog from Jim and Rob:
The SEC Speaks at the ABA Fall Meeting
On Friday, November 19th the ABA Subcommittee on Proxy Statements and Business Combinations chaired by Dennis Garris (partner at Alston & Bird), met in Washington DC. At this meeting senior members of the SEC staff, including Brian Breheny, Chief of the Office of Mergers & Acquisitions (OM&A), and Nick Panos, Special Counsel in OM&A, addressed several topics of interest to M&A practitioners.
One issue that may come as a surprise to many is the staff’s position that materials prepared by an investment bank as “pitch materials” and provided to a company that is considering a potential transaction may be deemed a “report, opinion or appraisal” under Item 1015 of Reg MA (formerly known as Item 9 reports), that must be summarized in the company’s SEC filings relating to such transaction, even where the investment bank is not retained by the company to advise on the transaction and does not receive any fees or other compensation in connection with the transaction.
The key to the staff’s decision rests with the degree to which the materials contain substantive analysis and the extent to which the Company’s Board considers and relies upon the materials in its deliberations with respect to the proposed transaction. In the situation discussed by the staff, although the bankers argued that the materials were “pitch materials,” the staff deemed the materials a report since the materials consisted of multiple presentations to the Board over an extended period of time and included specific analyses and recommendations that contributed valuable information used to structure the transaction presented to security holders. The staff also reminded the audience that when there are material differences between preliminary and final versions of an Item 1015 report, each version will be viewed as a separate report that must be summarized in the company’s SEC filings.
Also of interest is the staff’s continued position that insurgents who solicit proxies by sending management’s proxy card to security holders and request that such cards be returned to management may continue to rely on the exemption in Rule 14a-2(b)(1) under the Securities Exchange Act despite the Second Circuit’s recent decision to the contrary in MONY Group, Inc. v. Highfields Capital Management, 368 F.3rd 138 (2nd Cir. 2004). While staff is adhering to its long-standing position that such activities are exempt solicitations and insurgents need not file their own proxy statements, they are advising callers who seek guidance on this issue that the Second Circuit takes a different view.
Lastly, it was noted that Mara Ransom, Special Counsel in OM&A, is currently working on a rulemaking project that will hopefully resolve some of the conflicting case law on the “best-price” provisions in Rule 14d-10 under the Securities Exchange Act. As many of you know the Seventh and Ninth Circuits have split, with each adopting different tests as to when severance payments, golden parachutes and similar compensation arrangements in business combination transactions run afoul of the best-price rule. Brian Breheny expects to have something published by early next year. We are hopeful!
Join the hordes that are taking advantage of our introductory pricing for DealLawyers.com – and try a no-risk trial!
My Chinese Delegation Experience
It’s my b-day today, so I thought I would take liberties with another personal anecdote. A few weeks back, I was asked to address a delegation from China – consisting of legislative and regulatory members – on how they can develop their own version of Sarbanes-Oxley. Having spoken to other international groups in the past – such as IOSCO – I thought I knew what to expect.
But I was wrong. There were separate translators for what I said – and what members of the delegation replied – and it took an hour just to cover the basics of independent boards. It will be interesting (and perhaps scary) to see what they come up with if they adopt something. Proud to say that a translation of my joke about my baldness went through just fine. For my b-day party, I gotta try that 6th Annual Santa Stumble, put together by some former SEC Staffers.
404 Trends Emerging for Next Year
Here is some interesting info from last week’s AccountingWeb.com newsletter: “As public companies strive to meet compliance deadlines for Section 404 of the Sarbanes-Oxley Act, trends related to how companies will implement an efficient and effective process beyond the initial year of compliance are beginning to emerge, according to the results of a new survey released by Ernst & Young.
The survey, the third in a series (and oddly enough, not yet posted in E&Y’s Internal Controls Library), is part of an ongoing study from Ernst & Young’s Business Risk Services practice entitled “Emerging Trends in Internal Controls.” The study takes an in-depth look at emerging trends in Section 404 compliance, and polls nearly 100 large, public companies
representing a diverse cross-section of industries. This survey provides an update on the progress large public companies are making in 404 compliance and addresses key issues such as the level of effort involved; the amount of testing being done; key areas of remediation; and the extent and frequency of executive and audit committee oversight and communications.
The survey shows a sharp increase in the urgency of public company first-year efforts to meet compliance deadlines, with 46 percent of companies expecting largely to complete evaluation and testing of 404-related controls only one to two months before their fiscal year end, compared to only 13 percent in the previous survey. In addition, 30 percent of companies reported the time they expect to spend complying with Section 404 has increased by nearly 50 percent, due in large part to the increased number of controls identified for testing.
With 404-related controls testing comprising the largest portion of ongoing effort beyond the first year of compliance, trends for addressing this important area are beginning to emerge. In Year 2, companies anticipate that their testing resources will continue to be primarily those dedicated to 404 testing, as well as resources supplied by Internal Audit functions. In many cases, third-party resources are expected to be used to support these functions, in addressing the unique skills and cyclical demands for testing.
Some companies are also using or exploring the potential to use control self assessment (80 percent), continuous controls monitoring and analytics (48 percent), and, to a lesser extent, management self testing to support their Year 2 efforts.
“After dedicating an extraordinary level of effort to meet 404 compliance deadlines, companies are starting to look ahead in towards 404 sustainability while containing costs and finding value in the process,” said Tom Bussa, Global Director of Ernst & Young’s Business Risk Services.
“Although most are still primarily focused upon first-year compliance, there is increasing recognition that a long-term view and plan are required.”
In fact, most companies are now beginning to build the infrastructures and embed the technologies needed to sustain 404 compliance for the long term. In addition, many are also recognizing additional benefits from investments. For example, nearly two-thirds of companies expect to benefit from improved financial processes. Approximately 40 percent expect to extend risk coverage beyond financial reporting, and more than one-third are anticipating benefits stemming from systems enhancements.”
In our “Internal Controls” Practice Area, I have posted samples from companies that have disclosed the fact that they have received “red letters” and “yellow letters” from their independent auditors, courtesy of Mark Adams of Cleary Gottlieb.
At an ALI-ABA corporate governance conference last week, I heard Lynn Turner, former SEC Chief Accountant, state his belief that companies should get “dinged” by investors if they receive this type of letter – but don’t timely disclose their existence.
Relaunch of CompensationStandards.com
Now that CompensationStandards.com is more than just “course materials,” we have uploaded much more content – and built two special sections in the left column of the home page: one for those involved with proxy disclosure and one for those involved with setting pay levels.
Last week, I blogged about the new lawsuit filed against the CEO, President, CFO and General Counsel – as well against each director – of Fairchild Corp. Following on the heels of an executive compenation lawsuit against Nortel, the WSJ correctly called this “one of the first of a new wave of Delaware lawsuits challenging excessive pay for corporate leaders.” Both the Fairchild and Nortel complaints are posted in CompensationStandard.com’s “Executive Compensation Litigation Portal.”
The complaint focuses on six areas:
– related-party transactions
– triggered change-of-control payments, without executives losing their jobs
– excessive salary and bonus – and huge advances on SERP payments
– reimbursement of legal fees
– interest-free loans
Interestingly, this complaint appears to be cobbled together from disclosures in SEC filings (can’t imagine what they might find that wasn’t disclosed) – which is a departure from the Cendant and Disney complaints that were replete with details taken from board minutes and other records that are not readily available.
Obviously, putting together the Fairchild complaint was easy to do in comparison. Given that the Wall Street Journal reported last year that three-quarters of the S&P 500 companies disclosed at least one related party transaction – the pool of potential defendants for this new breed of lawsuit appears to be quite large.
SEC Inquires Into How Much is Too Much
Further reflecting the SEC’s interest in executive compensation, check out this speech by the SEC’s Chief Economist into whether overall CEO pay is excessive – and not a proper allocation of resources. Some of Chester’s comments are too “economist” in nature for my tastes – but just the fact that the SEC’s Chief Economist is putting this issue out on the table is quite noteworthy.
NASD’s Shelf Offering Proposal
Yesterday, the SEC issued a proposing release seeking comment on the NASD proposed rule changes to its rules regarding the filing requirements and regulation of shelf offerings by NASD members – offerings of securities registered by issuers with the SEC pursuant to SEC Rule 415.
Thanks to Jonathan Wolfman of Wilmer, Cutler, Pickering, Hale and Dorr LLP for correcting my mistaken blurb that D&O Questionnaires for Nasdaq companies don’t need to be updated, as I forgot about the technical amendments that Nasdaq made to its listing standards over the summer.
As originally approved by the SEC in November 2003, Rule 4200(a)(15)(B) provided that a person cannot be an independent director if the person or a family member accepted any payments from the company (or any parent or subsidiary of the company) in excess of $60,000 during the current or any of the past three fiscal years. Under the revised rule – which took effect this summer – the look-back period is any period of twelve consecutive months within the three years preceding the date independence is to be determined. This change conforms to the approach used in the NYSE’s version of this rule (although the dollar thresholds and scope of included payments remain different between the Nasdaq and NYSE rules).
The exact wording of the new Nasdaq rule is as follows (underlining indicates new text; brackets indicate deleted text):
“(15) “Independent director” means a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The following persons shall not be considered independent:
(B) a director who accepted or who has a Family Member who accepted any payments from the company or any parent or subsidiary of the company in excess of $60,000 during any period of twelve consecutive months within the three years preceding the determination of independence [deleted text: the current or any of the past three fiscal years], other than the following:”
Because the new definition implements a rolling 12 month testing period, rather than annual periods based on the company’s fiscal year, companies will need to re-examine the independence of directors who received any payments during the past three years.
Please note that a number of other minor changes have been made to the Nasdaq’s definition of independence, including (1) clarifications of the transition rules for companies emerging from bankruptcy, ceasing to be a controlled company or conducting an IPO and (2) an exclusion from the $60,000 test discussed above of certain standard, non-preferential transactions by financial institutions (such as banks) with their customers.
Glimpse into Congressional Mindset on Comp?
From yesterday’s Boston Globe (and NY Times ran a simliar blurb): “File this one under: Uh, thanks for coming, we think. In what attendees described as a fiery and lively keynote speech in New York City on Wednesday night, Congressman Barney Frank lit into a group of bankers on the subject of executive pay. “At the level of pay that those of you who run banks get, why the hell do you need bonuses to do the right thing? Most people in the world don’t get bonuses to do the right thing,” Frank told the 250 bank executives, regulators, and politicos gathered for the trade publication American Banker’s annual Banker of the Year Awards.
According to remarks provided from the evening, Frank said: “I mean, do we really have to bribe you to do your jobs? I’m serious. I don’t get it. I don’t get a bonus. Cops don’t get bonuses. . . . And the problem is not just the bonuses. Think what you’re telling the average worker, that you who are the most important people in the system and at the top, that your salary isn’t enough, that you need to be given an extra incentive to do your job.”
In the “Legal Proceedings” section of its 10-K filed Tuesday, Analog Devices disclosed that the SEC’s Enforcement Division was conducting an investigation into the timing of certain option grants: “We have received notice that the SEC is conducting an inquiry into our granting of stock options over the last five years to officers and directors. We believe that other companies have received similar inquiries. Each year, we grant stock options to a broad base of employees (including officers and directors), and in some years those grants have occurred shortly before our issuance of favorable annual financial results.”
Back in March, the Wall Street Journal reported that the SEC was looking into the practice at a number of companies, especially those in technology industry, of granting options shortly before announced positive news.
Combining the SEC’s interest in excessive comp with the recent lawsuit against Fairchild Corp. – in which not only the CEO, but the GC was named in the suit, and which the WSJ called “one of the first of a new wave of Delaware lawsuits challenging excessive pay for corporate leaders” (I will blog more on this suit next week) – you can see why so many are still taking advantage of our “Catch Up” offer to hear all the practical guidance from the video webcast archive of our October 20th conference and all the other practice pointers on CompensationStandards.com. It is refreshing to see so many companies signing up their comp committees – catch up today!
On Wednesday, the SEC instituted public administrative proceedings against 15 companies to determine whether to revoke the registration of their securities under the ’34 Act (the SEC also temporarily suspended trading in the securities of 26 companies). This is the second time the SEC has done this – last time was back in June, so perhaps its a semi-annual housecleaning.
California Department of Corporations Wants Comments
On Wednesday, the California Department of Corporations announced that it is requesting public comment for a study on the effectiveness of the California Corporate Disclosure Act aimed at providing investor protection. In September, Governor Arnold Schwarzenegger directed that the Department to review the efficacy of the Act and make recommendations to eliminate duplicative reporting requirements and further align its provisions with federal reporting requirements.
Comments can be sent to Kathy Womak, Office of Law at email@example.com. Thanks to Keith Bishop for the heads up!
Yesterday’s blog on this topic resulted in a flood of emails – so here is another attempt to make sense of it all. If you look at Telephone Interp A.78, it states: “For purposes of Rule 401(b), the updating of a Form S-3 registration statement through the incorporation of a Form 10-K is the equivalent of filing a post-effective amendment pursuant to Section 10(a)(3). This means that if the registrant were not eligible to use Form S-3 at the time of such updating, it would be required to file a post-effective amendment on whatever other Form would be available at the time.”
As I understand it, since accelerated filers that rely on the SEC’s exemptive order will not be S-3 eligible until they file their 10-K amendment (per the terms of the SEC’s order), they are not able to draw down off a shelf under this Telephone Interp. This is because companies would remeasure their eligibility to use their shelf at the time of their 10(a)(3) update – which is the date of filing the 10-K – and the SEC’s order operates to render the company S-3 ineligible until the date of filing the 10-K amendment, at which time the order operates to restore the company’s S-3 eligibility.
As a practical matter, information regarding management’s assessment of the company’s internal controls and the auditor’s ability to give a “clean” attestation might be material anyways – effectively precluding a takedown since this information would be non-public until the 10-K amendment is filed. Similarly, a company’s auditor isn’t likely to allow incorporation of its opinion into a takedown until a 10-K amendment is filed that includes the management report and attestation. Thanks to Mark McElreath of Alston & Bird for these two nuggets!
Also note that the use of Rule 144 and Form S-8 are fine before the 10-K amendment is filed by an accelerated filer that relies on the SEC’s order – their use is not impacted like S-3/S-2 eligibility by the SEC’s order.
Here are some open issues identified in a Weil Gotshal memo that came out last night:
· Under what circumstances may an auditor provide an unqualified audit report on a company’s financial statements if it has concluded that the company’s internal control over financial reporting is ineffective as of the 10-K filing date?
· What are the consequences to a company relying on the Order if its auditor determines that it is unable to provide an audit report on the financial statements until it concludes the internal control audit, despite the latitude afforded by the SEC and PCAOB?
· What should management do about the SOXA Section 906 certifications under the bifurcated filing procedure contemplated by the Order? Can appropriate qualifying language be added to the body of the 10-K (e.g., in the Item 9A disclosure)?
8-K Trends: Part II
I have seen a lot of 1.01 and 2.03 8-K filings accompanied by exhibit filings – including material definitive agreements, even though this is not required by the items. In some cases, I hear that companies have filed the exhibits to get them out of the way (and not worry about forgetting to file them in the next Q or K) – but in other cases, I hear that companies have filed them because they were concerned about whether the summary description (particularly in the 2.03 context) was sufficient, so they wanted to file it and incorporate them by reference.
SOX Upheld in Court
On Monday, former HealthSouth CEO Richard Scrushy’s claims that Sarbanes-Oxley is unconstitutionally vague were rejected by a federal judge in Birmingham, Ala. In the first court test of the Sarbanes-Oxley’s constitutionality, U.S. District Judge Karon Bowdre said jurors, not a judge, should decide key questions raised in Scrushy’s fraud case. No big surprise here…
I’m pretty excited to hear today’s webcast – “The Overhaul: ’33 Act Reform” – featuring SEC Staffer Amy Starr, who wrote much of the proposing release and three lawyers that I admire much from my days working with them on the Staff: Abbie Arms of Shearman & Sterling; Meredith Cross of Wilmer, Cutler, Pickering, Hale and Dorr; and our own Julie Hoffman. Spend an hour learning from the best rather than try to wade thru 350+ pages.
We continue to post law firm memos on the ’33 Act reform in Section A.17 of our “Sarbanes-Oxley Law Firm Memos” – including a 75-page gem from Sullivan & Cromwell that has some nifty charts at the back.
The Nasdaq D&O Questionnaire that is posted doesn’t appear to need updating – and contributors are busy updating the Independence Questionnaires that are posted on that page.
Flushing Out the Internal Controls Delay for Certain Accelerated Filers
One interesting aspect of the SEC’s exemption order that I blogged about yesterday – which delays the internal controls deadline by 45 days for certain accelerated filers – is that it doesn’t delay the requirements of Item 307 of Regulation S-K because the exemptive order states that it applies to 308(a) and (b). So the remainder of Item 9A of 10-K must be provided, which means you must still disclose management’s conclusions about disclosure controls and procedures as required by Item 307 of Reg S-K as of the year end.
So even though some accelerated filers get more time to conduct testing, management’s assessment must still be conducted as of the same time as applied before the order. Thanks to Will Anderson of Bracewell Paterson for being the first to point out this tidbit!
Another interesting aspect of the SEC’s order is that for purposes of the Form S-3/S-2 eligibility requirements, a company that relies on this special exemption will not be considered to have timely filed its 10-K until it has filed an amendment that contains the internal controls information that had been omitted per the order.
In other words, a company that relies on the 45-day exemption can’t sell securities that already are registered on a shelf until the company files an amendment to complete its 10-K by including the management report and auditor’s attestation. And once the 10-K amendment is filed, it can continue drawing off the shelf.
Today’s NY Times quotes SEC Chief Accountant Donald Nicolaisen as saying that one open issue is “whether auditors would be allowed to certify that material weaknesses identified in this year’s audit were fixed after the audit is completed – or whether certification would not be possible until a new audit was conducted a year later.”