Starting this Thursday, Google will begin providing pro forma numbers in their quarterly earnings releases. See their blog for the rather dumbed-down announcement (you might ask, how many companies have corporate blogs yet? answer is “not many”).
Google’s Chief Accountant indicates that the company will be providing a “non-GAAP, diluted earnings per share number” that excludes the effects of stock option expensing. (Google laid the groundwork for complying with Regulation G by mentioning that management reviews non-GAAP results when analyzing performance – but it will be interesting to see management explain how it uses the non-GAAP diluted EPS number in managing the business!)
Interestingly, Google notes that its non-GAAP numbers may nonetheless differ from the numbers that analysts present when they exclude the effects of expensing options – because Google will be presenting their non-GAAP calculation on an after-tax basis.
Another interesting aspect of Google’s “plain English” explanation of its non-GAAP adjustments is that the company did not address the fact that once a company is applying FAS 123(R), the number of shares outstanding on a fully diluted basis also will be different than the calculation pre-123(R). Thus, it will be interesting to see if Google’s disclosures do not fully back-out all of the effects of 123(R) – or whether they will be providing additional disclosure about how 123(R) affects the diluted share calculation.
The issue arises because under the treasury stock method of calculating fully diluted shares, the amount that is deemed to be applied to repurchase shares when all in-the-money options are exercised will have a different calculation for the assumed tax benefit from those deemed exercises – and will include an additional element not currently taken into account (ie. unamortized deferred stock compensation). This just further highlights Google’s point that any non-GAAP numbers given by companies will likely differ from what the analysts would give – not only would the analysts not have the tax effect numbers, but they may not have the fully diluted share effect numbers.
It just goes to show how this stuff is quite complex – and it reinforces why lawyers need to fully understand this dramatic new accounting change to be sure that disclosures are accurate. As I blogged last week, the upcoming NASPP conference will have 8 panels that will be addressing 123(R), including an address by FASB Chair Bob Herz on the topic. If you can’t make it to the Conference, you can now order a CD-Rom of the Stock Option Expensing Toolkit that includes an archive of all those panels and much more.
Binding Majority Vote Proposal Fails at Paychex
Last week, Paychex shareholders overwhelming – about 80% – voted against the first binding bylaw amendment proposal seeking a majority voting standard for director elections (see this background info). This AFSCME proposal received less shareholder support than the non-binding majority election proposals that appeared on ballots this year – at nearly the 60 meetings where this issue was considered so far this year, the average level of shareholder support averaged 44% of the votes cast. I don’t think this low level of support will deter more binding bylaw amendment proposals, but it likely won’t prompt a mad dash to submit more.
On September 30th, the NYSE filed a proposed change to the NYSE Listed Company Manual with the SEC that would eliminate Section 203.01’s requirement that listed companies physically distribute annual reports to shareholders – so long as they make the Form 10-Ks (or 20-Fs/40-Fs) available through their websites instead. Under the proposal, companies would have to offer – via a prominent plain English undertaking – to deliver paper copies, free of charge, to any shareholders who so request. [Check out footnote 1 of the proposal – the delivery requirement can be traced back to 1895!]
Standing alone, this proposal doesn’t mean much for US companies so long as the SEC’s Rule 14a-3(b) continues to require delivery of an annual report, along with the proxy statement, in advance of shareholder meetings. But the NYSE’s proposal is a big deal for foreign private issuers who are exempt from the proxy rules (and who now are often required to mail two annual reports each year – one to comply with home country rules and one to comply with the NYSE’s requirement).
Don’t be surprised if the SEC follows the NYSE’s lead here and moves to an access model for proxy delivery – those cost savings sure would be welcome for many companies to help offset their new 404 costs.
Getting Ready to Transition Your Shelf
I continue to highlight timely and useful law firm memos in the “Hot Box” on the home page – the latest is this 34-page memo from Sullivan & Cromwell that includes a healthy discussion about what you should be doing now with your existing shelf offerings. It’s a nice companion to the ’33 Act reform transition webcast we held recently – and the numerous other law firm memos we have posted on the topic.
SOX Opens the Door for More O&D Bars
From Bruce Carton’s Securities Litigation Blog: For years, a threshold requirement for the SEC to obtain the equitable remedy of an officer and director bar against a defendant in one of its cases was an underlying fraud charge under Section 10(b). As stated in Section 21(d)(2) of the Exchange Act, a court has the authority to “prohibit, conditionally or unconditionally, and permanently or for such period of time as it shall determine, any person who violated section 10(b) or the rules or regulations thereunder…”
So historically, in a case like the recently settled enforcement action against David Michael, former director and chair of the audit committee of Del Global Technologies Corp., Inc., in which the SEC charged Michael only with violations of the books and records, internal controls, and lying-to-auditors provisions of Section 13 of the Exchange Act, no O&D bar would have been possible.
The Sarbanes-Oxley Act of 2002 changed this, however. Section 305 of SOX amends Section 21(d) by adding a new Section 21(d)(5): ” 5. Equitable Relief -In any action or proceeding brought or instituted by the Commission under any provision of the securities laws, the Commission may seek, and any Federal court may grant, any equitable relief that may be appropriate or necessary for the benefit of investors.”
The end result? Despite the absence of any fraud charge against David Michael, the SEC’s settlement provided for a final judgment that, among other things, permanently bars Michael, pursuant to Exchange Act Section 21(d)(5), from serving as an officer or director of a public company.
On the Lighter Side
Been a while since I showed my personal side. Excited about the White Sox! Grew up in Cubs country on the north side of Chicago but worked for the Sox in 1983 when I was in college. Part of my job was to ensure the network ran the right commercials and the announcers gave the appropriate plugs – so I never could go to the bathroom when watching a game unless a buddy watched with me. Talk about perils on the job! The Sox hosted the 50th anniversary all-star game that year and I met a bunch of Hall-of-Famers.
Recently saw the movie “In Her Shoes” – a very good flick. Reminded me a lot of “Terms of Endearment” and not just because Shirley MacLaine starred in both. Not that I see too many movies, but I am pretty selective and the only movie I saw this year that was better was little known “Off the Map” starring Joan Allen and Sam Elliott. That was a classic!
What might be the latest sleeper issue? Check out the just mailed Sept-Oct issue of The Corporate Executive – as well as this interview with Steve Quinlivan and Jeff Cotter on Option Expensing Disclosures. SAB 107 is gonna shake up MD&A soon enough, very soon for some companies.
Some folks are “on” this issue – many of them are attending this year’s NASPP Annual Conference in early November, as that conference includes 8 panels on expensing as well as an address by FASB Chair Bob Herz on the topic.
But who knows, maybe they are attending to catch the Hootie & the Blowfish show at the House of Blues that comes part and parcel with the conference – I sure could use a little fun and wish all legal conferences had some entertainment…
Want to Understand Hedge Fund Activism?
It seems like there is an article cada dia about hedge fund activism in the papers – here is yesterday’s WSJ article on the topic. Tuesday’s DealLawyers.com webcast on “The Convergence of Hedge Funds and Its Impact on M&A” was superb and went 15 minutes long (and it could have gone another two hours to be honest).
With MacKenzie Partners CEO Dan Burch joining the panel at the last minute – and Dan is involved with many of the hedge fund takeover battles raging these days – the panel imparted much knowledge about who the players are; what do they want – and what it means for companies that don’t want their boat to be rocked. I blogged more about this webcast on the DealLawyers.com Blog.
Get access to the audio archive of the webcast – and all the other content on DealLawyers – by entering a no-risk trial for 2006 today. A single license is only $195!
US Supreme Court Denies Certiorari in Gemstar Appeal
On Tuesday, the U.S. Supreme Court denied certiorari in the Gemstar-TV Guide appeal, thereby giving a boost to the SEC’s power to freeze payments to executives during investigations of possible securities law violations.
The decision confirms the SEC’s authority to prevent companies from paying extraordinary amounts to officers and directors who are under investigation by the SEC – and severance and indemnification arrangement should now come under greater scrutiny.
As Delphi Corporation prepared to file for bankruptcy last week, the company first increased the severance pay for 21 of its top executives from 12 months of pay to 18 months, plus variances in the severance formula – see this Form 8-K (yesterday’s WSJ also discussed how executives were offered as much as 10% of the restructured company and $90 million in bonuses – but I’m not sure where those details emanate from). All in all, it seems like a textbook example of pay-for-nonperformance!
At the same time it increased the potential severance payouts to its senior managers, the company was telling employees that it needed to cut their pay by more than 60% as well as reduce their health care and retirement benefits.
Here is an excerpt from a Detroit Free Press article: “Patrick Keenan, a law professor at the University of Detroit Mercy, said rich severance packages are difficult for workers to swallow when they are being asked to sacrifice for the company. “The idea is to keep the company’s top executives, but there’s something borderline immoral about these golden parachutes,” he said.” An even stronger statement came from the United Auto Workers union – and here is an interesting editorial.
Here is an answer to a trivia question – according to one study, Nevada ranks fourth among the states when it comes to the number of publicly traded companies (after Delaware, California and New York) and third in all companies going public from 1996-2000. Who would have thunk it?
Thus, I was surprised to recently learn that the Toronto Stock Exchange has decided that corporations incorporated in Nevada are not eligible for listing on the Exchange. The only other jurisdictions that have landed on this proscribed list are the British Virgin Islands and Turks & Cacaos. Look for a full court press from Nevada to get itself taken off this short list.
CII’s New Policy on Director Compensation
One item arising out of the recent annual Council of Institutional Investors conference was a new director compensation policy. Here are some key components of this new policy:
– Only Two Components of Director Pay – director pay should include only cash and equity with some noteworthy exclusions.
– Meeting Fees – CII opposes meeting attendance fees because meeting attendance is the most basic expectation of a director.
– More Pay for More Responsibilities – CII believes retainer fees may be differentiated to recognize that independent board chairs, independent lead directors, committee chairs or members of certain committees are expected to spend more time on board duties than others.
– Equity Holding Periods and Ownership Guidelines – CII believes equity pay should include an ownership requirement (at least 3-5x annual comp) and a minimum hold-til-retirement requirement (at least 80% of equity grants).
– No Perks and No Pay-for-Performance – CII’s policies specify directors should not receive performance-based compensation nor any perks (aside from meeting-related expenses such as airfare, hotel accommodations and modest travel/accident insurance) or change-in-control or severance payments.
– Disgorgement for Malfeasance – CII’s policies support disgorgement, saying directors should be required to repay compensation to the company in the event of malfeasance or a breach of fiduciary duty involving the director.
– Comp Committee’s Role in Setting Director Pay – CII believes the comp committee should understand and value each component of the compensation and annually review the sum potentially payable to each director and be allowed to retain an independent compensation consultant to assist in the evaluation of director pay packages (with a summary of the consultant’s advice disclosed in the proxy statement).
– Proxy Disclosure about Director Pay – Companies should include a table with columns valuing each component of compensation paid to each director during the previous year; another column in the table should show an estimate of the total value, including the present value of equity awards, of each director’s annual pay package and other relevant information; and a third column should indicate the number of board meetings and committee meetings attended by each director. In addition, philosophy for director pay and the processes for setting pay levels should be disclosed (including fleshing out peer group comparisons) – as well as how many committee meetings involved discussions about director pay, and any reasons for changes in director compensation programs.
In addition, the CII recently updated this “spectrum of activism” white paper, which lists 22 actions that investors can take to “reduce risk in their portfolio and enhance performance.” And here is CII’s new 2005 Focus List.
Ever have one of those career highlight moments and fully recognize it at the time? Last week, I had one of those moments when I met Ed Woolard – former DuPont CEO and current Chair of the NYSE comp committee – and witnessed the taping of his remarks on executive pay. Hey, you gotta love anyone that says “double bull”!
On CompensationStandards.com, we have posted the 10-minute video of Mr. Woolard’s remarks – for free – to keep the momentum going for implementing internal pay equity and tackling the other issues addressed by Mr. Woolard. The video might take a minute to download – please urge any others you know, including directors, to watch this inspiring commentary.
By the way, internal pay equity was addressed in the Sunday NY Times’ column, “Companies Not Behaving Badly.” We have many more examples of responsible pay practices in “CEOs That Have Set An Example” on CompensationStandards.com.
NYSE’s Factors in Determining Enforcement Sanctions
Yesterday, the NYSE posted this Information Memo which lists factors considered when the NYSE decides to levy sanctions in an enforcement proceeding. I have added this memo to the “SEC Enforcement” Practice Area.
No registration is necessary – and there is no cost – for DealLawyers.com members. So try a no-risk trial to DealLawyers.com today! And if you subscribe for 2006, you will receive the rest of this year at no charge, including the webcast noted above as well as two that will be held in November and December. A license for a single user is only $195 through the end of 2006 – and there are similar reduced rates for offices with more than one user!
PCAOB Issues 2004 Deloitte Inspection Report
Dribbling them out one at a time, the PCAOB issued its 2004 inspection report for Deloitte & Touche on Thursday (KPMG’s report was issued last week, as noted in this blog). The inspection covered 125 Deloitte audits from May to November 2004 and the report points out deficiencies in eight of those audits – and 4 Deloitte clients restated their financials as an indirect result of the inspection.
Can the PCAOB Require a Company to Restate Financials?
Both of the Big 4 inspection reports released by the PCAOB recently highlighted the fact that a number of auditor clients restated their financials in the wake of the PCAOB Staff’s inspection. One member posted a question a few weeks ago wondering if the PCAOB had the power to force a company to restate.
Here is that question (Q&A #1163):
Company’s auditor has informed Company that the PCAOB insists that Company must restate its balance sheet. This is in connection with the PCAOB’s inspection of the auditor and the PCAOB’s review of representative audits of the auditor. Earlier this year Company completed an exhaustive six-month long review by the SEC in connection with a registration statement, and the issue raised by the PCAOB was not raised by the SEC. The registration statement was finally declared effective. Company continues to believe that its treatment of the issue is correct. Is the PCAOB’s authority over Company merely indirect in that Company will need auditor’s opinion next year, which the auditor can’t/won’t give in light of the PCAOB’s decision? And is there a mechanism by which Company may talk to the PCAOB directly or appeal the PCAOB’s decision in this matter? Thank you.
Here is my answer:
The PCAOB does not tell an audit firm that a company must restate its financial statements. (If the auditor tells the client that the PCAOB “insists” that the financial statements must be restated, I suspect that this is a CYA on the part of the auditor.) Rather, the PCAOB tells the auditor what it has found in the course of its inspection. It is then up to the auditor and its client to determine what steps to take based on materiality, etc.
In the course of inspecting the conduct of a specific audit engagement, the PCAOB may conclude, based upon the work papers, that there is a violation of GAAP. (Remember, a primary purpose of the PCAOB’s inspection is to determine if the audit has been conducted appropriately. One of the side effects may be that the PCAOB finds a violation of GAAP.)
Whether or not the auditor agrees with the PCAOB, it has an obligation to discuss the issue with the client – one of the AUs requires them to do so. Once the client is aware of the matter, it can go to the SEC if it still believes that the accounting treatment was correct. The SEC is the final arbiter regarding issuer questions, not the PCAOB. In other words, there is no appeal process with the PCAOB for the issuer.
In your scenario, it sounds as though the auditor agrees with the PCAOB. If the auditor doesn’t agree with the PCAOB, it shouldn’t be advising the client to restate. As for the full review by the SEC Staff, that review is not the same as a PCAOB inspection because the SEC Staff typically doesn’t look at the auditor’s work papers and doesn’t delve into the same level of detail as the PCAOB does when it does its inspection.
All of this goes back to what I have been urging companies to do: the PCAOB issues comments to the auditor following a field review and long before a draft inspection report is issued. The company can require its auditor, in the engagement letter or a side agreement, to inform it if its financial statements have been selected for review by the PCAOB. Once the company has been advised by the auditor that its financial statements are being reviewed by the PCAOB, they can also ask to receive from the auditor any comments that are issued by the PCAOB regarding the company. If I were on the audit committee, I would make sure to ask for this kind of information.
Mark Borges blogged yesterday about the long-awaited Reg S-K 402 revisions, noting that this article in Wednesday’s St. Louis Post-Dispatch suggests that the disclosure project is back on the front burner and could be expected soon.
The Washington University Law School in St. Louis held a corporate governance conference last week at which Commissioner Roel Campos and Corp Fin Director Alan Beller spoke, indicating that possible areas for revision include pension disclosure, board compensation committee reports and requiring disclosure of a “total compensation” figure. Additionally, as Broc has blogged on September 21 and August 15, Chairman Cox has been voicing his opinion in the last few weeks about the need for change in the executive compensation disclosure area.
Is it possible that the Commission can move quickly enough to update the rules before next proxy season? It’s possible, but it would be very tight. However, as Mark points out, if the Commission proposes changes before the end of the year, the proposals could very well influence companies’ 2006 disclosures, even if they are not yet adopted or in effect.
“New Issue” Rules in Effect Nov. 2
The NASD issued a notice to members this week advising that the “new issue” rules will go into effect November 2, 2005. As Broc previously has blogged about on September 22 and September 19, Rule 2790 replaces the Free-Riding and Withholding Interpretation (IM-2110-1), and is “designed to protect the integrity of the public offering process.” It requires that: (1) NASD members make bona fide public offerings of securities at the offering price; (2) members do not withhold securities in a public offering for their own benefit or use such securities to reward persons who are in a position to direct future business to members; and (3) industry insiders, including NASD members and their associated persons, do not take advantage of their insider position to purchase “new issues” for their own benefit at the expense of public customers.
Likely to happen even before the Disney case’s appeal is decided by the Delaware Supreme Court, another executive compensation lawsuit is headed to trial in the Delaware Court of Chancery. This trial is calendared for February 2006 before Vice Chancellor Lamb – and results from the former CEO and COO of Valeant Pharmaceuticals receiving cash bonuses upon spinning off a subsidiary of the company.
The company is alleging that the two men breached their fiduciary duties of loyalty and good faith and unjustly enriched themselves, among other charges, by granting and paying themselves and other directors and officers approximately $48 million as a cash bonus at the completion of an IPO of a minority interest in one of the company’s subsidiaries.
More information, including a copy of the Second Amended Complaint filed against the company’s former Chairman/CEO and its former COO/Director, is posted on CompensationStandards.com in the “Hot Box” on the home page.
In addition, don’t forget that our “2nd Annual Executive Compensation Conference” will open with a panel on director duties and liabilities 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.
Updated Majority Vote Chart
Fyi, we continue to update our “majority vote chart,” which lists those companies that have adopted some form of voluntary corporate governance guideline regarding the tendering of a director resignation in the event a majority of votes are withheld from that director. Companies that recently have taken the step of adopting some version of this guideline include Microsoft, Wells Fargo, Avnet, Gap and United Technologies.
Last week, the ABA Director Voting Task Force issued a press release indicating it has received 36 comment letters and that its next meeting is set for early December (and that companies adopting voluntary guidelines is a positive development). The press release claims the comment letters are posted and provides a URL – but it doesn’t work.
I am speaking on this topic today at the Society’s Chicago Annual Chapter Meeting. Next week, I will be providing analysis about the legal consequences of adopting voluntary guidelines regarding director resignations.
Webcast Transcript on ’33 Act Reform and Seasoned/Unseasoned Issuers is Up!
We have posted the transcript for the webcast: “Drilling Down: Seasoned/Unseasoned Issuers and Voluntary Filers Doing Offerings After the ’33 Act Reform.”
One of our members said it better than I could about this recent Chief Executive article: “I work in the law department at a public company in the midwest. Although this Chief Executive article isn’t about stock options, restricted stock or a perk awarded to directors or executive officers, I still think it is rather heinous that a publication “flaunts” the fact that executives are, in effect, using shareholder money to buy their cars. I find this article in strict contrast to “CEOs Who Have Set an Example” on Compensation Standards.com and just thought it might be of interest for one of your more succinct words of wisdom and insight.”
Trading Restricted Stock on an Exchange?
Last Wednesday, this NY Times article analyzed the new Restricted Securities Trading Network, a platform that has been built to trade “restricted stock.” I don’t know about you, but the article seemed a little off.
Sounds like the reporter is confusing restricted securities (a la Rule 144) with restricted stock, which may be registered on S-8 but nevertheless is illiquid. I don’t see how there could be a market for restricted stock, so the issue must be whether there’s a market for restricted securities that are not yet eligible for resale under Rule 144, like the market for Rule 144A stock that’s open only to QIBs. If that’s the case, I would think that any user of this new service should be asking a number of questions, such as what’s the applicable ’33 Act exemption (Section 4(1 1/2)?) – and what practical hurdles must be overcome (eg. will the transfer agent require a legal opinion for each trade, since the shares will be legended?). Thanks to Alan Dye for his insight here.
Some Thoughts on Why We Need Option Expensing
Yesterday, I posted this rebuttal by Lynn Turner, Managing Director of Research for Glass Lewis and a former SEC Chief Accountant, to the points made by former US Senators Bob Dole and Tom Daschle in this WSJ opinion editorial. Lynn provides strong support for the FASB’s move to require options expensing.
Next Wednesday, Paychex shareholders will vote on a binding shareholder proposal from ASFCME which would require the board to change the company’s bylaws, stipulating, “directors shall be elected by a majority of the shares present in person or represented by proxy, provided a quorum is present at the meeting.” In Sunday’s NY Times, this mandatory bylaw proposal was discussed in this article.
As noted in ISS’s Friday Report, ISS has supported non-binding majority elections proposals this proxy season, but recommended against AFSCME’s binding proposal at Paychex on the grounds that it does not differentiate between contested and uncontested elections. As ISS noted in its analysis: “Dissidents in a contested election would be subject to the same majority standard as management nominees. The majority vote standard becomes more difficult to achieve because of the complicating impact of withhold votes, as well as the division of votes between two candidates for the same seat. In a case where no candidates win a majority of the votes cast, the holdover rule would favor the incumbent directors, thus creating a form of takeover defense for the management nominees. While the risks of these types of scenarios are small, they do exist.”
“ISS, which applies stricter scrutiny to binding proposals, would have supported the AFSCME resolution had it stated that plurality voting would apply in contested elections,” said Martha Carter, senior vice president and director of U.S. research at ISS. ISS’ position could have profound implications for the majority vote movement.
Court Rules that There is No Private Right to Sue Under Section 304
More than a handful of members emailed me this recent article from Law.com – the article is about the recent opinion of Neer v. Pelino from U.S. District Judge Stewart Dalzell, who became the first judge to address the question of whether §304 creates an implied private right of action.
Judge Dalzell ruled that §304 – which calls for disgorgement of profits and bonuses from top corporate executives in the wake of an alleged accounting fraud – does not provide a private right of action for shareholders to file a derivative suit. Rather, the Judge found that Congress clearly intended for §304 to be enforced only by the SEC. We have posted the 23-page opinion in our “SEC Enforcement” Practice Area.
Changing Relationships Between Auditors and Their Clients
In this podcast, Nils Okeson, a Partner of Alston & Bird, explains how auditor/client relationships have changed as there is a greater emphasis on the independence of outside auditors in the wake of Sarbanes-Oxley, including:
– How has all of this affected the relationship between issuers and their auditors (or, from the other point of view, between auditors and their “clients”)?
– Both the SEC Staff and the PCAOB have issued public statements addressing some of these concerns, including the “chilling effect” on communications between auditors and issuers that has reportedly occurred. What impact will these public statements have?
– Looking ahead then, what do you see going forward? Will relationships return to what they used to be, or is this simply the new reality?
– Some companies observe that changing auditors in a quest to get better service (whatever that might be) or to find a more cooperative relationship is not a realistic alternative. What can companies do to improve the situation? How can they be proactive about it?