Yesterday, the Treasury Department and IRS issued proposed regulations on deferred compensation under Section 409A of the American Jobs Creation Act. Section 409A governs plans and arrangements that provide nonqualified deferred compensation to employees, directors or other service providers and the proposed regulations provide a framework for implementing those.
The proposed regulations (which are 238 pages) identify which plans and arrangements are covered under Section 409A, outline operational requirements for deferral elections and permissible timing for deferred compensation payments made under the rules. The rules also extend the deadline for documentary compliance with the new rules for one year, to December 31, 2006.
In his Compensation Blog, Mike Melbinger will be providing his analysis on the proposed regulations in the days to come. His initial thoughts on the regs are:
“One of the areas of most interest to many readers will be the discussion of SARs. Recall that SARs issued by private companies and SARs that could be settled in cash came in for harsh treatment under the initial guidance on 409A.
Here the newly released proposed regulations bring good news. The regulations treat stock appreciation rights similarly to stock options, regardless of whether the stock appreciation right is settled in cash and regardless of whether the stock appreciation right is based upon service recipient stock that is not readily tradable on an established securities market. However, because the IRS remains concerned that manipulation of stock valuations, and manipulation of the characteristics of the underlying stock, may lead to abuses with respect to stock options and stock appreciation rights (collectively referred to as stock rights), the regulations contain more detailed provisions with respect to the identification of service recipient stock that may be used to determine the amount payable under stock rights excluded from the application of section 409A, and the valuation of such stock.”
Another great place to learn more about the proposed regs is at the upcoming NASPP Conference in Chicago November 1 – 3.
SEC Not so Free with Information for FOIA Requests
This article by Bloomberg discusses a recent report by the Coalition of Journalists for Open Government that found the SEC turns down more FOIA requests for non-public information than almost every other government agency, including the CIA and the Pentagon. Of the 25 U.S. departments and agencies in the report, only the Small Business Administration and the National Archives turned down more requests.
According to the report, the SEC granted only 34% of the 3,830 FOIA petitions it processed during the 2004 fiscal year and almost 20% of those denials that were appealed were overturned.
And the SEC’s backlog of 8,635 requests (at its 2004 year-end) was bigger than all but four agencies surveyed. The public filed 9,325 requests with the SEC from October 2003 to October 2004. All but 690 of the 3,830 FOIA petitions the SEC ruled on that year were holdovers from fiscal 2003, so when the SEC closed the books on 2004, it still faced 8,635 pending requests.
Like he has done over the past several years, in this text interview, Lou Hering of Morris Nichols covers how the Delaware legislature recently enacted a number of amendments to three of Delaware’s four “alternative entity” statutes in its latest legislative session.
Senator Frist and Insider Trading
Bound to be gobs and gobs of media coverage – some of it with questionable legal analysis – regarding the SEC’s probe into trades conducted by Senator Frist through some blind trusts. An article in today’s WSJ reported that the matter is now a formal investigation. Professor Bainbridge in his blog provides his own insights into the viability of a possible violation.
Survey Results from Shearman & Sterling
Recently, Shearman & Sterling released its annual survey on corporate governance practices of the 100 largest U.S. public companies (the survey is posted on GreatGovernance.com). Among the trends revealed by the survey:
– Poison pills and staggered boards are in decline. The number of companies with poison pills fell by 19%, and the number of companies with a staggered board fell by nearly 30%.
– A majority of companies continue to exceed the minimum independent director requirements of the NYSE and Nasdaq.
– Despite substantial attention to the issue, there has been little change in the number of companies at which different individuals serve as chairman of the board and chief executive officer (19%, up from 14% in 2003).
– Grants of stock options as a component of director compensation decreased to 55% from 70% in 2003.
– The number of shareholder proposals for majority voting in director elections has seen the largest increase, from no such proposals included in the proxy statements of the Top 100 companies in 2003 to 15 such proposals in 2005, fueled primarily by the demise of the SEC’s proxy access proposed rule.
When fiscal year 2006 starts on October 1st, the SEC will likely be operating under a continuing resolution as it normally does (under which fees remain at their current rates) – see last year’s blog as to why this is an annual rite. Once Congress approves the SEC’s ’06 budget, registration fees will go down to $107.00 per million from $117.70 per million.
Director Recruitment Developments
In this podcast, Dick McCallister, Managing Director of Boyden Global Executive Search, describes the latest trends in director search and recruitment, including:
– What is driving the need for international experience on boards?
– What industries are at the forefront of this movement?
– Where are companies finding directors with global experience?
– What other skills are most in demand on boards today?
– How are searches for financial experts faring these days?
For Accounting Purposes, Katrina Considered “Ordinary”
According to this AccountingWeb.com article, the EITF of the FASB has reportedly determined that – for financial reporting purposes – the devastation wrought by Katrina does not meet these two criteria: “infrequent in occurrence” and “unusual in nature.”
Looks like Gretchen Morgenson of the NY Times and I have some of the same sources – she beat me to writing about the intriguing Form 8-K filed recently by Corinthian Colleges. This 8-K includes a 4-page letter from a resigning director that outlines the multiple problems he has witnessed during his tenure on the Corinthian board.
Rather than rehash the essence of Gretchen’s fine article, I thought I would provide some analysis as to the lay of the land regarding 8-Ks filed under new Item 5.02 when directors resign:
1. If there are no disagreements, disclose that fact. Most 8-Ks filed due to a director resigning disclose that there were no disagreements between the director and the company left behind. Many of these helpful 8-Ks go on to disclose the reason for the departure (egs. pursue other opportunities; health or age limitations; personal reasons).
2. Don’t raise questions in investors’ minds by not addressing the reason for departure (as required by Item 5.02(a)(1)(iii)) – such as “the resigning director did not give a reason for his decision in his letter” as noted in this Form 8-K filed by Monmouth REIT.
3. Train directors in the art of drafting resignation letters – providing reasons for the departure in the letter as well as the 8-K, including noting there were no disagreements that led to the departure, immensely help. Letters that raise questions by being silent as to “why” – such as this vague letter from a LitFunding director – don’t help, particularly if the 8-K itself doesn’t address the reasons for departure.
4. For me, the worst are 8-Ks that merely state that a director has resigned via a written communication – but the company fails to file the written communication as an exhibit to the 8-K as required by Item 5.02(a)(2) (and fails to disclose whether there were any disagreements). See the Form 8-Ks filed by Scan Optics and Power2Ship. Perhaps these companies had nothing to hide, but we don’t know from their scant disclosures.
5. The bottom line is that if there are disagreements between a resigning director and the rest of the board or management, don’t try to hide the disagreement – face it and explain it if you wish. So far, I have found about 10 8-Ks that fall in this category, including the Corinthian Colleges’ 8-K noted above and this one from Torvec that I blogged about a few months ago. I have posted a list of the 8-Ks that disclose disagreements in our “Director Recruitment” Practice Area.
“Stock Splits” Practice Area
We have created a new “Stock Split” Practice Area that includes a number of sample checklists that cover a timeline of required actions.
On Friday, PCAOB Chair William McDonough announced that he will resign his position November 30 or when his successor is in place, whichever is sooner. Here is the related press release. Even though I only heard him speak once, Chairman McDonough was one of the more charismatic speakers I have heard.
SEC Chair Cox has big shoes to fill when he selects a new PCAOB Chair. Here is Chairman Cox’s statement about Chairman McDonough’s departure. The process of selecting new PCAOB Board members is something quite new – it will be interesting to see if Chairman Cox renominates Kayla Gillan for another term, as I hear that she is more than willing to serve again.
On Friday, the SEC posted the adopting release related to delaying the 404 deadline for smaller companies – as well as the proposing release related to the new accelerated filer definitions and deadlines for such companies.
Go Figure! HealthSouth Whistleblower Receives Longest Sentence of Them All
Last Thursday, the primary whistleblower in the HealthSouth fraud case got a longer sentence than all the other HealthSouth executives that have been dragged through the criminal process so far. US District Judge Robert Propst sentenced former finance chief Weston Smith to 27 months in prison, ordered him to pay $1.5 million in forfeited assets and spend one year on probation after his release – the Judge acknowledged the disparate range of sentences that have been imposed and essentially invited Mr. Smith to appeal his sentence to the 11th US Circuit Court of Appeals.
Meanwhile, former HealthSouth CEO and Chair Richard Scrushy – acquitted for his role in the fraud and who still sits as a HealthSouth director – is angling to get back on the management team (and the company’s Chair recently resigned). Here is the company’s press release responding to Scrushy’s recent criticism of management over the company’s poor earnings. The SEC’s civil lawsuit against Scrushy has yet to come – and odds are he will be barred from serving as an officer or director of a public company once that lawsuit is finalized.
From a member regarding the SEC’s 404 delay: “I read your entry today and have a small point that makes a big difference for at least one client. When you refer to the extension for non-accelerated filers, you indicate that an issuer who is not an accelerated filer will benefit from the extension. I think the extension will only apply to issuers who are not accelerated filers now and don’t exceed the $75 million public float test at the end of their next second quarter.
I have a client whose public float has been hovering around $75 million for the past year. When the SEC last extended the 404 deadline for nonaccelerated filers, the client had to wait until the end of its second quarter to see whether they qualified for the extension or would have only 6 months to comply with 404. After listening to yesterday’s meeting, it doesn’t seem that the SEC is taking a different approach with this extension – in other words, they won’t grandfather issuers who aren’t accelerated filers at the time the extension was granted. I realize this affects a very small number of issuers and our client intends to publicly comment on the latest extension.”
Read: Just like the last time 404 was delayed, if you become an accelerated filer during the extension period, you get no relief – unless the SEC changes something when it adopts new final rules.
We have posted our own notes from Wednesday’s open Commission meeting as well as a number of law firm memos regarding the meeting. In addition, I answered a query in the Q&A Forum yesterday (#1195) that fleshes out the proposed definition of “accelerated filer.”
Transcript for IPO Webcast Posted!
We have posted the transcript from last week’s webcast: “Drilling Down: Doing an IPO After the ’33 Act Reform.”
AICPA’s 2nd Exposure Draft re: Communication of Internal Control Matters
The exposure draft contains guidance beyond what the PCAOB has provided on control deficiency assessment – and in certain areas, the draft is not consistent with the direction of the SEC and PCAOB from their May 16th statements. Not sure why the ASB is providing guidance on the same topics as PCAOB, especially without indicating it only applies to non-issuers. The comment period for the revised exposure draft ends on October 31, 2005.
How to Frame Arguments in Post-Acquisition Disputes
In this DealLawyers.com podcast, in light of the fact that more and more accountants are being used to serve as independent arbitrators in post-acquisition disputes, Jeffrey Katz, a director in the BDO Seidman Litigation and Fraud Investigation Practice, provides guidance on how attorneys might pose their arguments based on the accounting principles underlying a transaction, including:
– Why are generally accepted accounting principles (GAAP) so often at the center of post-acquisition disputes?
– What is the key to presenting persuasive evidence to an accounting arbitrator?
– What is the distinction between an arguable position and a position that is compelling to accounting principles?
– How can changes in GAAP be used to plant doubt in the mind of the arbitrator?
In the “Hot Box” on the home page of TheCorporateCounsel.net, we promptly posted notes shortly after yesterday’s SEC’s open Commission meeting (Chair Cox’s 1st meeting – a 3 hour doozy) – these notes are more extensive than the following bullet points:
– Smaller Companies – A company that is not an “accelerated filer” can now wait to comply with the internal control over financial reporting requirements until their first fiscal year ending on or after July 15, 2007.
– Foreign Private Issuers – The delay above includes foreign private issuers that don’t meet the definition of “accelerated filer.” Note that a foreign private issuer that is an “accelerated filer – a concept never before applied to FPIs – will stay on its current course to comply with 404 for fiscal years after July 15, 2006.
– Large Accelerated Filers – A new category of issuers was proposed: “Large Accelerated Filers,” who would be issuers that meet the current definition of “accelerated filer,” except that their public float is $700 million or more. As proposed, Large Accelerated Filers would need to file their 10-Ks within 60 days after fiscal year-end and their 10-Qs within 40 days after quarter end, for year-ends after December 15, 2005. See the notes for a discussion of the overlap between WKSIs and LAFs.
– Accelerated Filers – Companies that meet the traditional definition of “accelerated filer” will still need to comply with 404, but it is proposed to give them 75 days as the deadline for their 10-Ks and 40 days for their 10-Qs (and to modify exiting of accelerated filer status by permitting an accelerated filer whose public float has dropped below $25 million to file an annual report on a non-accelerated basis for the same fiscal year that the determination of public float is made).
Here is the SEC’s press release regarding its actions. There is a short 30-day comment period for the proposals.
Correction About the NASD’s “New Issue” Rule Amendments
Last Thursday, I blogged that the amendments to Rule 2790 would become effective Monday, September 19th – I was wrong! I forgot about the SEC’s Release No. 34-52209A issued August 22nd that made the Rule 2790 amendments effective upon announcement by the NASD in a Notice to Members to be published no later than 60 days following SEC approval. The effective date will be not more than 30 days following publication of the Notice to Members according to the amended order. It doesn’t appear that a Notice to Members has yet been issued, which means the old rule is still in effect at this time. Thanks to Eric Graham of Goodwin Procter for the heads up!
Fraud Prevention and Management
In this podcast, Jim Persing, a former lawyer who is now a life coach, delves into how to deal with an employee engaged in fraudulent conduct, including:
– Are companies seeing more cases of fraud and questionable ethics?
– When discovered, how do companies typically deal with the employee and the related issues, particularly if the employee is valued and productive?
– What are the pros and cons to these actions from the company’s perspective?
– Could the company turn to an unbiased outsider to help? How?
– What monitoring would be needed? What if it doesn’t work – then what?
Today’s WSJ tackles a topic dear to our hearts with this article – “New SEC Chief Tackles A Big One: CEO Pay.” Here is how that article kicks off: “Chris Cox isn’t starting out as the capitalists’ tool his critics made him out to be. The new head of the Securities and Exchange Commission is smart. He’s got good political instincts. And those instincts have led him to the biggest piece of unfinished business on the corporate reform agenda: CEO pay.”
In addition, the title above and the following excerpt is from yesterday’s Times of London: “Christopher Cox, the new chairman of the Securities and Exchange Commission, has declared war against excessive executive pay amid claims that many American companies try to hide big remuneration deals from investors.
Mr Cox, who has been in the job for little more than a month, has set a specialist team of SEC investigators to the task of discovering how American companies disguise executive pay or special bonuses. “This is one of the first things he (Cox) has prioritised,” a spokesman for the SEC said. “Executive compensation can be opaque and this is what the commission aims to find out about.”
The September-October Issue of The Corporate Counsel
In our effort to encourage more responsible behavior in the area of executive compensation, we have made the Sept-Oct 2005 issue of The Corporate Counsel freely available on CompensationStandards.com. This issue follows up on our 12-Step Roadmap to Responsible Pay Practices, laid out in two issues from last year (those two issues are also freely available on CompensationStandards.com at the right side of the home page).
Hurricane Katrina Delays Guidance on Deferred Compensation Plans
From a recent Mullin Consulting alert: “Speaking to the Bureau of National Affairs on September 14, IRS Chief Counsel Donald Korb stated that the agency’s effort to provide hurricane relief has further delayed guidance on deferred compensation plans.
While there was speculation that guidance would be released in time for the mid-September meeting of the American Bar Association Section of Taxation, the devastation caused by Katrina put the agency’s release on hold. Immediate tax relief to Katrina victims has included lifting restrictions on low-income housing nationwide and extending tax-filing deadlines along the Gulf Coast. Korb said additional tax relief for hurricane victims will be forthcoming.
In a telephone call, Daniel Hogans, an Attorney-Advisor in the Office of Benefits Tax Counsel, told Mullin that Section 409A guidance “is in the clearance process right now. It comes down to when the people who sign off will have time to look at it. I’m hoping we’ll see it in the next few weeks, but something like Katrina takes a lot more time than people realize.”
Last week, California State Treasurer Phil Angelides called for the state’s two big pension funds – CalPERS and CalSTRS – to oppose the proposed acquisition of Pacificare by UnitedHealth Group unless certain payments to executives were rescinded. Angelides (who recently announced he is running for California Governor) claims that $315 million in payouts to the top tier of management is excessive. I agree that it sounds excessive – but some of this amount reflects acceleration of vesting of stock options (in which case perhaps the option grants were excessive but not the severance arrangements – without knowing more, my hunch is that both were more than enough as I intimated in this article).
Even though no Form S-4 has yet been filed, a regulatory hearing was held last week by the Department of Managed Health Care – but the Department doesn’t have the authority to regulate executive compensation levels. The transaction will also require approvals from the U.S. and California Departments of Justice, the California Department of Insurance and nine other states, including Texas, Nevada and Colorado.
The Treasurer’s move does illustrate the fact that executive pay can become a political football – particularly when it involves a controversial industry such as health care. The transaction will have an effect on about 3.5 million California enrollees. Thanks to Keith Bishop for helping to sort this one out!
We have posted the transcript of our popular webcast: “Drilling Down: Doing a WKSI Offering After the ’33 Act Reform.”
Winning Strategies in Auctions
Don’t forget tomorrow’s webcast on DealLawyers.com – “Winning Strategies in Auctions” – featuring Mark Gordon of Wachtell Lipton, Eileen Nugent of Skadden Arps, John Grossbauer of Potter Anderson – and for the banker’s perspective, Jill Goodman of Lazard. Learn steps to reduce the impact of the “Winner’s Curse” and more, including analysis of the recent Toys ‘R Us decision.
More on the Most Bizarre Registration Statement of All-Time
Following up on last week’s blog about the bogus Apollo Publication Corp. registration statement, one member asked how EDGAR accepted the filing if there wasn’t a filing fee? This question presumed the prankster wasn’t willing to pay something for the publicity the scheme has generated.
I believe that a fee – albeit a small one – was paid through Mellon for this filing. David Copenhafer of Bowne explains that the SEC Staff double checks to ensure that the system-approved fee is what was actually due, and that was one of the things that triggered the SEC’s identification of a problem in this case.
David notes this “filer” went to a lot of trouble to light up EDGAR functions. He took a quick look at the HTML of the filing and thinks the fraudster made an effort to see what was possible and how things work within the EDGAR system. So this might be the handicraft of a fraudster with “skills.” [Finally saw Napoleon Dynamite – my favorite scene is where Pedro and Napoleon are conspiring to blend their “skills” in Pedro’s pursuit of the class presidency.]
Survey Results: Audit Committees and Earnings Releases
Here are the results from last month’s quick survey on audit committees and earnings releases:
1. Does your Audit Committee review your company’s earnings releases prior to their release to the media? Yes – 90%; No – 10%
2. If the answer to #1 is “Yes,” how many days prior to public issuance of the earnings release is a draft typically sent to the Audit Committee?
– One day or less – 15%
– Two days – 31%
– Three days – 25%
– Four days or more – 29%
3. If the answer to #1 is “Yes,” does the Audit Committee hold a meeting for the purpose of discussing each earnings release?
– Yes, and mostly (or all) by telephone meetings – 81%
– Yes, and mostly (or all) by face-to-face meetings – 13%
– No – 6%
4. If the answer to #3 is “No,” is the Audit Committee informed about issues that will be discussed in the related earnings release?
– Yes, in writing – 7%
– Yes, at a meeting – 72%
– No – 21%
5. Does your Audit Committee hold a separate meeting to review draft Forms 10-Q and 10-K (and at the same meeting, review the CEO’s and CFO’s certification of the Forms 10-Q and 10-K)? Yes – 68%; No – 32%
The Executive Compensation Revolution
Below is an interesting excerpt from my interview with Paul Hodgson of The Corporate Library. Paul says: “In the U.K. there was a real groundswell of protest against excessive executive pay during the early 1990s. This was primarily caused by the government privatizing utilities at a price well below their market value. Stock prices for these utilities exploded once they hit the market, and the executives – who had all been awarded substantial stock option awards in line with typical practice – were millionaires overnight. And these were people who had been public servants up until this point.
Well, the press just had a field day. There were pictures of pigs dressed up in pin striped suits, headlines like “Snouts in the trough”. You know what the British press is like. Anyway, it was a disaster for corporate Britain.
In response to the protest, there was a corporate governance revolution. The government set up a series of corporate governance committees, and put them in charge of solving the crisis in executive compensation. These committees did not look to the institutions or to the regulators for what should be done. They looked to those companies which they felt had already introduced best practices.
More important, they looked to those companies that had already introduced best practice compensation policies without any negative impact on their ability to recruit talented executives or any negative impact on the performance and commitment of their existing executives. These best practices were then enshrined in a series of corporate governance codes. But the inspiration for these codes came from business, not regulators.”
As expected, the shakeout in the governance rating industry continues as S&P has dropped out. S&P’s “pay-to-play” model never made sense (ie. companies had to pay in order for S&P to rate them) and it didn’t help that S&P’s marketing efforts centered on its voluntary rating of Fannie Mae (to which it gave a high rating before Fannie’s bottom fell out).
S&P remains active in providing ratings in other markets around the world -primarily emerging markets – where governance concerns remain strong and where stand alone governance analysis continues to have merit.
In the US (and elsewhere), S&P also remains focused on applying corporate governance analytics in the context of their credit ratings. Specific feedback from investors was that S&P needs to continue to monitor corporate governance as a risk factor, but investor preference is to factor this into credit ratings rather than provide it as a separate service. This is what Moody’s does also.
SEC Posts New Periodic Report Forms
To add in the new shell company disclosure items, the SEC posted this new Form 8-K, Form 10-K and Form 10-Q on its website last week. Besides shell company changes, the Form 8-K changes relate to Item 6 for extensive asset-backed issuer disclosure provisions (previously Item 6 was “reserved”).
You can tell they are new by the date in the lower left corner of the first page – check those against the forms you might be using.