Monthly Archives: August 2005

August 16, 2005

Whistleblower Hotlines: Conflicting Obligations in France; Confusion in Germany

Many members are asking about the recent decisions in France and Germany regarding whistleblower hotlines. In France, the French Data Protection Authority (aka “CNIL”) has rendered two decisions prohibiting a subsidiary and division of two US companies – McDonalds and Exide Technologies – from implementing anonymous reporting systems. These systems were developed in compliance with Rule 10A-3, which the SEC adopted to comply with Section 301 of Sarbanes Oxley. The CNIL believes these hotlines violate French privacy law due to the anonymous nature of the accusers permitted by the hotlines.

Meanwhile, a German authority has struck down Wal-Mart’s code of ethics, but not based on any kind of substantive rationale – rather, it appears to be due to a procedural snafu that turned on the failure of the company to consult with the German Works Council before implementing their code of ethics in Germany.

We have posted a number of law firm memos analyzing these overseas problems in our “Whistleblowers” Practice Area – and Tom White and Carrie Wofford of Wilmer Cutler Pickering Hale and Dorr have graciously provided copies of the two French CNIL opinions, including informal translations of them into English.

A number of groups, such as the Privacy Matters Committee of the World Law Group, have approached the French and German authorities – as well as the SEC and the NYSE – but right now, these issues are still lurking as there has not been any further word from any of these regulators. More inevitably to come…

New Form 144 Posted

One of our more popular sample documents is a Word version of Form 144. We have posted a new one that reflects changes in the form that the SEC has made (the SEC might have made these form changes a while ago; let me know if you ever see any outdated content on the site).

Speaking of Rule 144, don’t forget that we have a “Rule 144 Q&A Forum,” where members post Rule 144 questions – and long-time practitioners Bob Barron and Jesse Brill endeavor to provide some guidance. You can access this Forum on home page from the tool bar at the top.

Doing M&A Inhouse

Some of the younger lawyers out there might wonder if they could land a job in-house that would allow them to do M&A. In this podcast, George Villasana, Senior Counsel – Corporate Law of AutoNation (who has also worked in two different law firms and at the SEC), describes what it’s like to do M&A in-house, including:

– What types of M&A activities he undertakes?
– What is his daily life like?
– How he found his job?
– How being in-house compares to being in a firm?
– How being in-house compares to working at the SEC?

August 15, 2005

SEC Chair Cox Speaks on Executive Compensation Practices

Below is an excerpt from this transcript of an interview held last Wednesday with new SEC Chair Chris Cox on the PBS’ “Nightly Business Reports”:

DHUE: Runaway executive pay has long been criticized. Is that something that the agency is going to take out?

COX: Executive compensation is much in the news and there have been some very notorious cases of apparent excess. It should be, of course, in the main up to shareholders to discipline that kind of activity, but in order for shareholders to do that, they`ve got to have good information. I think you can look in the near future to the SEC for some improved rules on disclosure to make sure that, for example, shareholders can have one number, that the different kinds of executive compensation add up to a number that`s comparable executive to executive and company to company and at the same time that this information is provided in a timely way before rather than after the fact.

DHUE: Shareholder activists have also tried to rein in executive pay through the proxy process. Do shareholders need greater access to the proxy so they can be the watchdog on corporate management?

COX: Of course investors and particular equity owners own the company and it`s very much in shareholder interests to discipline executive compensation and make sure it`s in line with the market, making sure they`re getting full value and also to make sure that everything else about the company is running well and with a view to doing well and good at the same time. Shareholders, I think, will find it increasingly easy going forward to look after their interests because technology is making it possible for information to move so much more quickly. We can have better analysis, more cheaply in the hands of investors more quickly than ever before. And the SEC is going to look at every possible way of making sure that our disclosure requirements are up to date and providing investors what they truly need.

Looks like Chairman Cox might be in favor of tally sheet use! We continue to post new sample tally sheets in the “Tallying Up Total Compensation” Practice Area of In addition, our “2nd Annual Executive Compensation Conference” includes a session entitled “How to Devise the Appropriate Tally Sheets” featuring Mike Kesner, who is head of Deloitte’s Exec Comp Practice and Pearl Meyer, who is the Chair of the firm that bears her name.

M&A Accounting Issues

On, the last leg of the popular M&A Boot Camp is available – Howard Dicker of Weil Gotshal does a great job parsing through accounting issues, both basic and those that relate to M&A.

It’s not too late to catch the entire 5-part series of the “M&A Boot Camp,” as all five are now up and available! If you are not a member, try a no-risk trial and take advantage of our half-price “Rest of 2005” rate – believe it or not, a license for a single user is only $100 and there are similar reduced rates for offices with more than one user! Among the many other resources, you can catch the upcoming webcast on September 21st – “Winning Strategies in Auctions” – featuring David Katz of Wachtell Lipton and Eileen Nugent of Skadden Arps.

Bueller? Anyone?

As a fan of the movie “Ferris Bueller’s Day Off” – I grew up in Chicago and attended Lane Tech HS before moving to Bethesda in 10th grade – I was taken aback to see a column blurb entitled “Bueller? Anyone?” in Friday’s WSJ (scroll down halfway through the column). Kudos to the WSJ for a light moment!

The article describes how a roll call of director nominees at a recent annual shareholders’ meeting semi-paralleled the movie’s sarcastic take on high school roll calls. I always thought I was cool because I answered “Yo” in response to the teacher’s call of my name – did I mention I never went on dates? That was a classic scene from the movie – here is a web site that provides a script, etc. from the movie…

August 12, 2005

FASB Issues “Milestone Draft” to Sort Out Financial Instruments

In late July, the FASB offered an advance preview of its project that will sort out the wide variety of financial instruments available in the market – which also will determine where these instruments belong on the balance sheet – by issuing a “milestone draft” that summarizes the FASB’s findings so far.

This is a comprehensive project that will define the differences for accounting purposes between liabilities, equities and assets. While the definitions of each used to be clear-cut in the accounting rules, the lines have blurred with the proliferation of complicated financial instruments – in many cases, new instruments hold characteristics consistent with more than one category on the balance sheet.

FASB Chair Bob Herz Lays Out Global Conceptual Framework

Earlier this week, FASB Chair Bob Herz addressed the 2005 Annual Meeting of the American Accounting Association and laid out an outline of the global conceptual framework that will help set international accounting standards – see this outline in a PowerPoint from Chair Herz. This global project is a joint effort with the IASB – in order to have common standards, it is necessary to have a common framework to base the standards on. The framework has not been revisited for several decades and is being looked at relative to creating consistency in when to use fair value vs. historical cost, and to address relevance vs. reliability, etc.

How to Handle Data Security Breaches

There has been a lot of press – and legislative activity – lately regarding companies that have had data stolen, particularly personal information of their customers. Obviously, this can have serious liability implications for companies.

In this podcast, Ben Wright, a well-recognized Internet lawyer, explains how companies can protect themselves in the face of growing breaches in security that lead to data theft, including:

– What has led to the rash of announced security breaches?

– What type of reactions are legislators having to these publicized

– How many of these breaches do you think go unannounced?

– What risks do companies face if they do not announce a breach?

– What type of policy changes can companies make to help protect themselves
from breaches?

August 11, 2005

More on the FASB’s Option Expensing Position on Grant Dates

A phenomenal number of members asked questions in the wake of Mike Melbinger’s blog two days ago on the FASB’s position on option grant dates. To clarify, the FASB’s position only applies under FAS 123(R), so it will not become relevant until a company makes its first grants after it adopts 123(R) and there should be no direct tax impact from the FASB’s actions. This article from the WSJ yesterday explains how the FASB’s grant date position emanates from overlooked language in 123(R).

I asked NASPP Executive Director Barbara Baksa for her views on what companies might do now – here is Barbara’s insight on the two alternatives posed in Mike’s blog (and two new alternatives):

“I believe alternative #2 could be problematic under 409A, but we don’t know for certain yet as the IRS and Treasury are still developing their interpretations. The grant date for tax purposes most likely will still be the date the board approved the grant. Thus, if the market value declines before the option price is set, you’ll have a discounted stock option under 409A. I think a discounted option under 409A is probably a much worse result than the differential in fair value. Also, this alternative creates a lot of administrative work without really accomplishing much. For these reasons (and more in this NASPP alert), I don’t expect #2 to be popular.

There is a third alternative, which is to simply try to minimize the amount of time between when the board approves the grant and when the terms are communicated to employees. Unless the market value moves dramatically during this time period, this isn’t likely to have a significant impact on the option fair value. For these reasons – and more in this NASPP alert – I expect that this third alternative is the approach most companies will take. With the emergence of online grant communication, many companies have already begun tightening up their practices in this area and this will probably just further that trend.

And there is a fourth alternative, which is to communicate the material terms (except for the option price) of the grant to employees in advance. For example, in a new hire situation, I would expect that it isn’t completely uncommon for the material terms of the grant to be included in the employee’s offer letter (the company would probably still have to follow-up with employees to let them know that the grant was approved, but this could be a relatively short and simple communication). For annual grants, the company might communicate the terms in advance or have managers review with employees the grants that will be recommended for them, then just send out a global communication that grants were approved at X price on the date the board approved them.”

More on this is available in the NASPP’s “Option Expensing Portal,” including a number of firm memos and the NASPP alert on this topic.

Office Depot Amends Corporate Governance Guidelines Ala Pfizer

Last week, Office Depot amended their corporate governance guidelines so that any director who receives a majority withheld vote is required to tender their resignation, just like Pfizer did a few weeks ago. Here is an excerpt from the latest ISS Friday Report: “Heeding a 52 percent shareholder vote, Office Depot Inc. announced this week that it had adopted a modified majority standard for director elections. The company joins Pfizer Inc. and more than 20 other U.S. companies that have some form of majority voting.

While Office Depot’s new policy is not, strictly speaking, a majority election standard, the company’s move adds to the growing shift from the plurality system that most U.S. companies use to elect directors. So far this year, a majority of investors in at least 14 U.S. companies, including Dell Inc. and Supervalu Inc., have supported shareholder proposals on the issue.

In another recent development, the American Federation of State, County and Municipal Employees (AFSCME) has submitted the first binding resolutions seeking majority elections. Those proposals were filed at Sysco Corp. and Paychex Inc.

Office Depot’s policy change is also noteworthy because company CEO and Chairman Steve Odland also chairs the Business Roundtable’s corporate governance task force. The BRT is an influential trade association that has urged “careful consideration of the complications any new standard would present.”

Another Blow to SEC’s Mutual Fund Governance Rules

Late yesterday, the US Court of Appeals in DC unanimously granted an emergency motion for a stay pending court review of the latest lawsuit filed by the Chamber of Commerce. This stay puts on hold the SEC’s new mutual fund governance rules that require mutual fund boards to be comprised of 75% independent directors and have independent chairs. As you might recall, the SEC re-adopted these rules on June 29th, just before former SEC Chair Donaldson left office.

These new rules were to take effect January 16, 2006. The Court directed the parties to provide briefs on the issue of whether the SEC had the authority to adopt the rules, in light of the fact that the Court had not yet issued its mandate sending the case back to the SEC. The Chamber of Commerce is asking the Court to order the SEC to put the modified rule out for public comment, which could force the SEC to hold yet a third vote.

August 10, 2005

Sigh of Relief in the Boardroom: Disney Directors Absolved of Personal Liability

Yesterday, Delaware Chancery Court Chancellor William Chandler delivered his long-awaited opinion in the Disney case by holding that the Disney directors didn’t violate their duties by ratifying Eisner’s decision to fire Ovitz in a way that entitled Ovitz to a huge severance package.

More analysis to come soon as there is an interesting discussion on good faith in the opinion. It’s important to remember that Chancellor Chandler was applying existing law to the facts in this case – the standard for personal liability was created last year in this Chancellor Chandler opinion when the case first survived a motion to dismiss.

We have posted a copy of the new 174-page opinion in the “Compensation Litigation Portal” on In addition, don’t forget that our “2nd Annual Executive Compensation Conference” will open with a panel on director duties featuring Delaware Supreme Court Chief Justice Myron Steele; Delaware Vice Chancellor Stephen Lamb; and Professor Charles Elson, Director of the U. of Delaware Center for Corporate Governance.

Tweaks to D&O Questionnaire for E&Y Independence

My good friend Linda Wackwitz of Quovadx informs me that she has learned that in connection with their settlement, E&Y is now required to scrutinize independence more closely than previously – so E&Y was going to require the Quovadx directors to complete a detailed E&Y independence questionnaire. Instead, Linda convinced E&Y to leverage off of the company’s existing D&O questionnaire by having the company add the following question to it:

“Do you or any member of your immediate family have any business relationships with Ernst & Young LLP or any of its affiliates or have an ownership interest in, or serve as an officer, director, or substantial stockholder of, any company (public or private) that has any business relationships with Ernst & Young LLP or any of its affiliates? If so, please specify the name of the person or entity that has the business relationship, a description of the business relationship, and the dollar amounts involved.”

Lessons Learned from WorldCom Mid-Manager Sentencing

Last week, Bruce Carton had the following interesting observations in his Securities Litigation Watch: Betty Vinson, a former WorldCom mid-level accounting manager who pleaded guilty in October 2002 to participating in the financial fraud at the company, was sentenced to five months in prison and five months of house arrest. Although her sentence won’t get even one-thousandth of the press coverage that Martha Stewart’s sentence did, it is far more important in terms of the impact it may have on deterring fraud in the future.

Vinson represents the typical “pawn” in a financial fraud–a lower or mid-level accounting person who by all accounts had no interest and no desire to commit fraud. Nonetheless, the fraud came to her. She was instructed by her boss, former CFO Scott Sullivan, to make improper accounting entries to make WorldCom’s numbers appear better than they really were, supposedly at the ultimate direction of CEO Bernie Ebbers. Vinson testified that “I felt like if I didn’t make the entries, I wouldn’t be working there.”

Vinson was deeply troubled by this instruction and went so far as to draft a letter of resignation in protest. But at this key juncture in her life, she did not quit. Instead, she stayed with the company and made many of the fraudulent accounting entries that enabled the financial fraud at WorldCom. She apparently did so for personal financial reasons and because of the personal appeals from Sullivan “not to jump out of the plane . . . [to] hang in there and help him get through the situation for the third quarter.” Vinson chose to believe Sullivan that this was a “one-time thing” that he would correct.

People placed in the excruciating position that Vinson found herself in need to know that the issue is not merely whether they should quit their job. They need to know that the consequences for participating in and enabling a financial fraud are severe–you may well go to prison as a convicted felon. As Judge Barbara Jones who sentenced her correctly observed,

“Ms. Vinson was among the least culpable members of the conspiracy at WorldCom,” Jones said. Still, she said, “Had Ms. Vinson refused to do what she was asked, it’s possible this conspiracy might have been nipped in the bud.”

Prison time for Betty Vinson was the right outcome, and public companies should be training their employees that prison is a realistic outcome for anyone–not just the ringleaders–who would betray the integrity of the company’s financial reporting.

August 9, 2005

The FASB Speaks: Confirming the Worst on Option Expensing

Following up on a coupla of recent blogs, Mike Melbinger blogged yesterday on as follows: Confirming our worst fears, we are told that during a Friday conference call with the Big 4 accounting firms, the FASB confirmed its view that companies cannot fix the equity grant date at which expensing would begin until the material terms of the award have been communicated to employees.

This dramatic reversal of the accounting rules under APB 25, FAS 123 (and common sense), seemingly made wholly outside the regular review and comment process, means that companies will have to completely revise the way they have made equity awards for the last 50 years or risk negative accounting and tax consequences.

Inasmuch as the exercise price for a stock option (and expense date for other awards) will need to be set as of the date the material terms of the award are communicated to optionee, at this point according to Mike, companies would seem to have a few choices:

1. Prepare option award agreements in advance so that they may be sent to optionees on the same date as approved by the Board (or Compensation Committee), or

2. Have the Board resolution specify an option award date sufficiently in the future to give the plan administrator time to prepare and send the award agreements, with the exercise price for the option award determined only on that future date.

On the NASPP’s site, there is more info on this issue, including this Q&A. More to come on this…

SEC Staff to Issue Transitional Guidance on ’33 Act Reform

Yesterday at the ABA’s Annual Meeting, Corp Fin Director Alan Beller noted that the Staff was putting together transition guidance regarding ’33 Act reform. A number of transition issues remain open, such as how to deal with open shelfs. No timetable was given for the upcoming guidance, but it likely will be well before the December 1st effective date.

PUHCA Repealed!

If you don’t work with utility holding companies, you might not be aware of PUHCA (pronounced “puke-ah”) – this odd moniker relates to legislation enacted in 1935 that regulates holding companies for utilities and was controversial from day one. A small group of folks in the SEC’s Division of Investment Management work primarily on PUHCA issues.

Yesterday, PUHCA was repealed as part of President Bush signing the new energy bill – and replaced with a less onerous Public Utility Holding Company Act of 2005. Learn more in this memo from McGuire Woods.

August 8, 2005

SEC Chair Cox Already Gives First Speech

Upon my return from vacation, I was surprised to see that new SEC Chair Chris Cox already had delivered his first speech – in the form of a welcoming statement to the SEC Staff.

In this Washington Post article, Chairman Cox’s speech was characterized as “gently chiding analysts and media reports that predicted he would take a less investor-friendly approach than Donaldson, who frequently cast his vote with the agency’s two Democrats to impose new regulations on industry.”

An interesting sidenote from the article was “The agency also faces an October deadline for naming a candidate to the Public Company Accounting Oversight Board. Kayla J. Gillan, a former lawyer at the California Public Employees’ Retirement System and a favorite of investor advocates, has expressed interest in being reappointed to her slot on the accounting board. In a telephone interview yesterday, Cox said he would be “careful and deliberate” about the appointment process. “It’s going to take a few weeks to determine an approach to those issues,” he said.” Looks like the PCAOB member appointment process could become a little dicey for SEC-PCAOB relations; the bond among the members of the PCAOB’s Board is quite strong even though they have differing backgrounds.

As a former Staffer, I can tell you that the mere fact that Cox addressed the SEC Staff early on in his tenure will boost employee morale; not that morale suffered under former Chair Donaldson. I don’t recall a new Chair addressing the Staff on his first day in office – and it definitely is the first address from a Chair to the Staff that was simultaneously webcast to the world.

[Beach note – my sole purchase during vaca was a T-Shirt that says “The Beatings Will Continue…Until Morale Improves.” My kids love it!]

Thomson Financial Buys LivEdgar

Recently, Thomson Financial continued its buying spree in the legal market by acquiring Global Information, which operates the popular LivEdgar service. Before the days of EDGAR, some of us will remember when the three founders of LivEdgar rode their bikes to pull copies of Schedule 13Ds from the SEC’s Public Reference Room. Those founders decided to stay on and are now Thomson Financial employees.

Registration Statement Review: Old School Style

For the first vacation in some time, I fended off the urge to work and didn’t check email, etc. Gotta do that more often. During the week, I read a fascinating biography of William Randolph Hearst called “The Chief” – and was intrigued about the description of how Hearst hired Joe Kennedy in 1936-37 (after Kennedy had served as the first SEC Chair) to help him reorganize his embattled media empire.

As part of Hearst’s bailout, Kennedy’s staff filed two registration statements to sell bonds which Time magazine called “two of the most remarkable registration statements ever filed” which were filled with “many a Hearst publishing secret, many a Hearst business oddity…”

The review process back then was to allow the public to file their own comments on registration statements (and the Commissioners themselves would review the disclosures themselves and issue comments!) – and apparently that was done in droves as Hearst was widely disliked at the time. Not only that, but Hearst never kept his personal funds separate from those of his various corporations and was a monumental spender. Today, he would be considered more of a crook than Bernie Ebbers – but commingling was fairly common in those days.

Although not entirely clear, “The Chief” intimates that the registration statements were amended to add disclosures based on public comments – and according to this information that I found on the Web when I got home, the registration statements were ultimately withdrawn (“The Chief” merely said there was a lack of investor interest in the bond offerings, but didn’t indicate whether the offerings were ever completed).

To learn more about the beginnings of the SEC, check out this interesting transcript from the SEC Historical Society about the legacy of the second SEC Chair, James Landis. Note that first Chair Joe Kennedy didn’t stay at the SEC for much more than a year, but his appointment was absolutely critical to help gain Wall Street acceptance of the notion of being regulated, as Kennedy was among the foremost movers and shakers on the Street before his appointment.

August 4, 2005

Cox’s First Day

Christopher Cox became the 28th Chairman of the SEC yesterday when he was sworn in by Federal Reserve Chairman Alan Greenspan. Since its inception in 1934, the SEC’s Chairs have been pretty evenly split between the two major political parties, with 15 Republicans versus 13 Democrats. Here’s a list of all past Chairmen and Commissioners.

Chairman Cox’s first official day is today. He is scheduled to address the Staff in the Commission’s auditorium at 10:30 eastern, which appears will be accessible to non-Staffers by webcast. I like the transparency already!

New Section 16 Adopting Release

The SEC took care of some Section 16 business yesterday, adopting amendments to Rules 16b-3 and 16b-7 in response to the Third Circuit’s ongoing Levy v. Sterling Holding Company case. For the background and current status of the Levy case, check out Alan Dye’s blogs on – most recently in June 2005 and July 2005.

As you know, Rules 16b-3 and 16b-7 are exemptive rules, which provide that transactions that satisfy their conditions will not be subject to Section 16(b) short-swing profit recovery. The amendments clarify the regulatory conditions that must be present for the exemptions to apply – and do not represent substantive interpretive changes in the application of the rules.

Additionally, the SEC amended S-K Item 405 to delete the ability, on the part of the issuer, to presume that a Section 16 form it receives within three calendar days of the required filing date was filed with the SEC by the required filing date. The SEC thought that in light of the two-business day due date generally applicable to Form 4 and the requirements of mandatory EDGAR filing (and website posting), this presumption no longer is appropriate.

For more insight into this release and other updates on Section 16 – be sure to check out

Settlement Pipeline Grows

As Broc pointed out in his July 18th blog, class action settlements have soared over the last year. Yesterday, Time Warner said it had agreed to settle its class-action litigation with shareholders for $2.4 billion and Arthur Andersen agreed to pay $25 million to settle a lawsuit brought by investors over its role in the collapse of Global Crossing Ltd. On Tuesday, CIBC agreed to pay $2.4 billion to settle fraud claims by investors who lost money in Enron Corp.

But perhaps even more astounding than these settlements (if that’s possible) was when former Cendant vice chairman E. Kirk Shelton was sentenced yesterday to 10 years in prison and ordered to pay full restitution for his role in an accounting scandal in the amount of $3.27 billion. The $3.27 billion would cover what Cendant spent to settle shareholder litigation, pay its legal fees and conduct audits. The payment schedule will be $15 million by October 2005 and then monthly payments of $2,000 per month once he is out of prison. That will make him approximately 135,685 years old before the debt is paid off (excluding interest).

August 3, 2005

More 123R Valuation Challenges

Following up on Broc’s July 25 blog on the challenges of option valuation under FAS 123R for expensing purposes, Mike Melbinger blogged the following on his blog, which has been getting a lot of attention:

“Apparently one of the Big Four accounting firms is taking the position that under FAS 123R the stock option grant date does not take place when the Board of Directors approves the size of the grant and the grant price, but only when a letter describing grant price, size of the award, and the terms and conditions is received by the employee.

If this extraordinary interpretation holds up, many companies will need to reconsider their current process for making stock option grants, or face negative accounting and tax implications Code Section 409A.

For example, if the Board or Compensation Committee makes a stock option award on day 1 when the price of the stock is $25, but the terms of the award are not reduced to writing and delivered to optionees until day 8 when the price is $27, then for accounting purposes the company will be deemed to have issued a discounted option, according to this Big Four firm – exercise price is $25 but FMV at the date of grant is $27.”

As Mike noted, companies may well want to contact their outside audit firm to determine the audit firm’s view on this issue.

Smaller Public Companies Ask for Comments

The SEC’s Advisory Committee on Smaller Public Companies published a series of 29 questions yesterday to solicit input from investors and companies on ways to improve the current regulatory system for smaller companies.

The questions are categorized in the following areas: general impact of SOX; SOX 404/Internal Controls; Accounting/Auditing; Corporate Governance/Listing Requirements; and the Disclosure System. Comments are due by August 31, 2005. The Advisory Committee will use the responses as it prepares its recommendations to the Commission, to be delivered by April 2006. Next up for the committee is its meeting on August 9-10 in Chicago, which will be webcast on the SEC’s website.

For more on the Committee’s work to date, check out our July-August 2005 issue of The Corporate Counsel.

Securities Act Reform in Federal Register

Today, the Securities Act Reform Release (33-8501, July 19, 2005) was published in the Federal Register, making December 1, 2005 official as the effective date. For those of you who have been carrying around the release in your briefcase waiting for a chance to read it, you may want to print out the Federal Register PDF version. If you can live without the Cost-Benefit Analysis, Regulatory Flexibility Analysis, etc., you can get the release down to 102 pages (print pages 1-68 and 78-111), unlike the 468 pages from the SEC’s pdf version.

August 2, 2005

Bigger Compensation Equals Bigger Credit Risk

This article discusses a new study (posted on issued by Moody’s that examines the empirical relationship between executive compensation and credit risk. Moody’s took three components of CEO compensation – salary, bonus, and stock option awards – to discover compensation that deviates substantially from expected pay based on firm size, past performance, etc. (described as “unexplained” compensation). They then took the “unexplained” compensation and related it to the risk of default and large rating downgrades between 1993 and 2003.

Ultimately, Moody’s found that large, positive, unexplained bonus and option awards are predictive of both default and large rating downgrades. Variations in salaries, however, do not appear to be predictive of credit risk. Moody’s concludes that high levels of unexplained compensation may indicate that board oversight is lax and, as a result, management has insufficient pressure to deliver good financial performance. Large performance-based compensation packages, in particular, may induce managers to: deliver strong short-term financial results and obscure longer-term structural problems, and pursue high risk strategies with very strong positive, but also very adverse, potential payoffs.

Shooting Fish in a Barrel ….

Last week, the SEC filed a complaint against two stock promoters in an alleged scam designed to mislead investors into believing they had inadvertently received a confidential stock tip faxed from a stockbroker to his client. The handwritten fax (available here) had the appearance of an urgent message from a financial planner intended only for his client, urging the purchase of a stock that was about to “tripple” in price. The fax was sent to more than one million recipients across the country – including the SEC’s San Francisco Office! – by stock promoters who made over half a million dollars unloading their shares on duped investors.

Inside Track with Broc Posted

Check out Broc’s interview on the return of the IPO market with M. Ridgway Barke, Chair of the Corporate Finance and Securities Practice Group at Kelley Drye & Warren, and Randi-Jean G. Hedi, Partner in the Corporate Finance and Securities Practice Group at Kelley Drye & Warren.