We have posted notes from 6 panels of PLI’s Securities Law Institute in our “Conference Notes Practice Area,” including the popular Q&A Picnic with Corp Fin Director Alan Beller. Many of the questions answered by Alan deal with the new ’33 Act reform.
Controversial Executive Compensation Bill Introduced
As I blogged Thursday, the Democratic leaders of the House – led by Rep. Barney Frank – have introduced “The Protection Against Executive Compensation Abuse Act.” Here is a copy of the bill – and here is a summary (and here is a quasi-white paper issued by the House Democrats).
This Act would amend Section 16 of the ’34 Act that would require companies to:
1. Include an “Executive Compensation Plan” on the ballot for shareholder approval – This Executive Compensation Plan would to be included as part of the company’s proxy materials, which would disclose:
– Tally Sheets– Tally sheet-type information for top executives (the number of executives covered vary depending on the total assets of the company);
– Compensation Policies – Compensation policies for top executives, including the short- and long-term performance targets that are used to determine compensation (and whether such targets were met in the preceding year); and
– Clawback Policy – Company’s policy for clawing back compensation not disclosed in the company’s Executive Compensation Plan; incentive compensation or bonuses within 18 months of a negative restatement; or compensation if the executive was engaged in fraud.
2. Require shareholder approval of golden parachutes – As part of any merger or acquisition, companies would need to receive shareholder approval of any additional compensation for top executives that coincides with the sale or purchase of substantial company assets.
3. Require companies to include simple and clear disclosure of their compensation arrangements on their websites – “Rather than forcing shareholders to regularly monitor and decipher the SEC’s arcane “EDGAR” database.” That’s a Congressional zinger on EDGAR.
What Does This Executive Compensation Bill Really Mean?
First and foremost, this bill shows that predictions of CEO pay becoming a political football have been proven to be true. Even if this bill doesn’t go anywhere – and I don’t expect it to go far – we should expect more of the same from the Hill leading all the way up to 2008.
As for the confusing concept of having shareholders approve disclosure – but not the substance of compensation arrangements – we can look at what is happening in the United Kingdom. In the UK, for the past several years, shareholders have been able to vote on the disclosure made in compensation committee reports (interesting, the only time one has been voted down was due to the mere existence of a CEO employment contract – which is an unacceptable practice in the UK, but is fairly routine here in the US).
The shareholder votes on compensation disclosure in the UK are non-binding – but the message delivered by them can be ignored only at management’s peril. I believe this is the concept that the House Democrats are driving at by requiring shareholder approval of the disclosure regarding a company’s “Executive Compensation Plan.”
As for shareholder approval of severance arrangements and forcing companies to adopt policies on clawbacks – here the House Democrats target two areas where investors have been noticeably angry and the subject of quite a few shareholder proposals during the past few proxy season. Both of these areas were addressed by panels in the just-concluded “2nd Annual Executive Compensation Conference.”
The bottom line is that boards and managers should get their “house” in order regarding executive compensation or run the risk that Congress eventually will take action. And as you can see from this new bill, that is not something that many are gonna like.
In response to member inquiries, I recently polled my advisory board on several issues involving disclosure controls and how independent auditors were reacting to deficiencies – and have now posted some analysis of these issues in the “Disclosure Controls” Practice Area.
For example, when considering the interplay of internal controls and disclosure controls, here is one situation that should serve as a “cautionary note.” Mittal Steel (formerly known as International Steel Group) disclosed a material weakness in internal controls in Section 9A of its last Form 10-K – but yet the company concluded that its disclosure controls were effective. Notably, in its attestation, the company’s independent auditor stated that it disagreed with the company’s conclusions regarding the effectiveness of its disclosure controls. Ouch!
Let me know if you have any other 404 issues or anecdotes to share this proxy season.
“The Protection Against Executive Compensation Abuse Act”
I’m gonna try to make it down for the press conference today where the Democratic leaders of the House will introduce “The Protection Against Executive Compensation Abuse Act.” As this press release indicates, the proposed Congressional legislation appears to mainly focus on eliciting more disclosure about executive compensation practices in an effort to address the “problem of runaway executive compensation.”
To listen to this webcast series, renew your CompensationStandards.com membership today – or if you are not a member, try a no-risk trial (and also get access to the recently completed “2nd Annual Executive Compensation Conference” at reduced rates).
With the December 1st effective date approaching, many of us are ramping up for the many changes that will take place. I just posted a helpful Davis Polk memo about issuer preparedness in our “Hot Box” on the home page; a nice companion to the Sullivan & Cromwell memo that I posted earlier. Soon I will announcing additional webcasts on what deals actually look like under the new regime.
Heads Up: ’33 Act Reform and EDGAR Coding
Last Friday, the SEC adopted the updated EDGAR Filer Manual that includes numerous changes in response to the ’33 Act reform rules that become effective December 1st.
Some of the changes in the updated EDGAR Filer Manual can be confusing, because even though the new rules aren’t effective until December 1st, the headers for Form 10-Ks and 20-Fs must now include a checkbox as to whether the filer is a WKSI or voluntary filer (which is further odd because the voluntary filer checkbox doesn’t appear to be required for Form 10-SBs; but it is required for 10-Ks), as well as include a checkbox as to whether the filer is a shell company.
On the other hand, a filing will be suspended if it includes certain ’33 reform coding before December 1st, such as coding for free-writing prospectuses (i.e. the new Form FWP).
The revised Volume II of the EDGAR Filer Manual also updates the Form 8-K to include Item 5.06 for changes in shell company status.
In addition, the SEC Staff has issued this statement, which includes Q&As about EDGAR programming and Regulation AB for asset-backed issuers.
FOIA Litigation Against the SEC
Last week, a Federal judge concluded that the SEC failed to follow proper procedure in responding to litigation brought by SEC Insight in 2004, an independent and private investment research firm. According to this press release, starting under former Chairman Harvey Pitt, the SEC began to simply “refuse to confirm or deny” the existence of records in response to many of SEC Insight’s FOIA requests. SEC records show that this type of denial, commonly referred to as a “Glomar response,” was asserted by the SEC only three times in the entire decade prior to 2002 – but was used 99 times in 2003 alone, with 66 of those instances specifically targeted at blocking SEC Insight’s requests.
The court declined to issue an injunction against the SEC’s future use of the Glomar. However, the SEC has not issued a Glomar response against SEC Insight since the lawsuit was filed. Here is a copy of the court’s order, which we have posted in the “Confidential Treatment Requests” Practice Area.
To keep you satisfied until we will post notes from last week’s PLI Securities Law Institute, here are some noteworthy points from the SEC Staff panelists at the conference:
– Corp Fin’s Chief Accountant’s Office intends to issue a new version of the “Current Issues Accounting Outline” by the end of November
– Corp Fin is planning on issuing additional ’33 Act Reform FAQs sometime during the next few weeks – these will not deal with transitional issues, but will rather focus more on the substance of the new rules
– Corp Fin’s Office of Mergers & Acquistions has come to the conclusion that an interpretation of 14d-10, the all-holders rule, will not suffice to solve the problem created by the split in the circuit courts – thus, it is working hard to provide a proposal to amend the rule. The proposed amendment will not be a brightline test, but will be broad enough to provide the Staff with the ability to interpret. As a reminder, the Staff noted that the SEC has consistently taken the view that bona fide compensation arrangements should not raise 14d-10 issues.
As you can see, there weren’t too many newsbreaking developments at this year’s conference – likely because the new SEC Chair has not set his full agenda yet. Heard a few attendees bemoan the fact that fan favorite Marty Dunn was used for little more than “eye candy” on the ’33 Act reform panel – but that’s what happens when someone is a last minute addition to the panel (which Marty was).
[Not sure why, but my wife just sent me this video – maybe she’s a closet Milli Vanilli fan? Anyways, it reminded me how cool Google Video will be once it has matured…]
Implementing Ombudsman Programs
In this podcast, Arlene Redmond and Randy Williams, Founders of Redmond, Williams & Associates, provide their experiences on what makes a sound ombudsman program work, including:
– What is an organizational ombuds? And what role does one have in helping to protect a company’s reputation and assets?
– If a company has effective formal channels, such as the Corporate Secretary or legal department, why would it need an ombuds?
– How do the role of whistleblower hotlines compare to the role of an ombuds?
– How can a company assess the effectiveness of an Ombuds program?
– What are examples of companies that have Ombuds programs?
Governance Posterchild: Sovereign Bancorp?
Last week, much was reported about how Sovereign Bancorp’s CEO botched his communication of some deals that the company was negotiating. Boy, the news reports regarding investor reaction to the CEO’s comments at an analyst conference sure don’t seem to jibe with tenor of this press release released by the company.
But that is just the tip of the iceberg for Relational Investors, who owns the largest stake in the company and has filed preliminary proxy materials with the SEC to elect a short slate to the company’s board. The short slate consists of two members of Relational. (For those of you unfamiliar with Relational Investors, this is how they typically invest – they target poor performers and buy a stake; then take an active role in reforming the company. They are quite successful with this investment strategy.)
If you read Relational Investor’s preliminary proxy materials, it will blow you away. For example, here is a snapshot of how Relational Investors describes the company’s director compensation practices:
– Directors are paid over $300,000 annually, more than any other financial institution in the country, including global banks like Citigroup and Bank of America and more than 5x the peer group (which means that it will be easier for a plaintiff to show that the company’s directors are not independent since they set their own pay)
– Directors have the opportunity to earn “special bonuses” if the company meets certain cash targets – and the targets were set below guidance put out by management and could even be paid if the targets weren’t met (not to mention using this type of incentive pay for directors is dangerous since this could incentivize directors to be in cahoots with a management team that wanted to manipulate the numbers)
– Until recently, the company paid directors under a two-tiered compensatory structure so that newer directors were only paid about $60,000 annually (compared to the $300,000 paid to more senior directors) – even though all directors had the same obligations, liabilities, responsibilities and workload (arguably calling into question the board’s business judgment and sense of fairness)
Last week, it was widely reported that the CEO, CFO and General Counsel of Mercury Interactive Corp. resigned involuntarily after an internal investigation revealed that some of the company’s stock option grants had been manipulated over the past decade. The company’s internal investigation was prompted by an inquiry from the SEC; then SEC Enforcement Director Stephen Cutler gave a speech about the Staff looking into granting practices well over a year ago and this is the first publicly known result from that sweep.
According to the company’s Form 8-K, in 49 instances, the stated grant date of the stock options differed from the actual grant date – and in almost every case, the price of Mercury’s stock was higher on the actual grant date than on the stated grant date.
Interestingly, the misdating occurred with respect to grants to all levels of employees – not just the senior managers who were forced to resign. Also interesting was that the CEO, CFO and GC were each aware of and, to varying degrees, participated in the practices (and of course, benefited personally from the practices). At most companies, I would think that the legal department and stock plan administrator’s office would handle dating practices – and that the CEO and CFO would have no clue as to what they were.
It didn’t help that the CEO misreported, on at least three occasions, exercise dates which had the effect of reducing his income (and exposing the company to possible penalties for failure to pay withholding taxes) – and that a $1 million loan to the CEO did not appear to have been approved in advance by the board and was not clearly disclosed.
On the subject of the culpability of the company’s compensation committee – here is what is disclosed in the 8-K: “The Special Committee believes that questions should have been raised in the minds of the Compensation Committee members from 1995 through 2002 (who included present directors Igal Kohavi, Yair Shamir and Dr. Yaron) whether six grants that they approved by unanimous written consent were properly dated. It appears that the Compensation Committee members reasonably, but mistakenly, relied on management to draft the proper documentation for the option grants and to account for the options properly. The Special Committee believes that changes in Board procedures made in recent years will prevent similar oversights occurring in the future.”
It will be interesting to see how many other actions the SEC has in the pipeline over this type of behavior…
Judge Alito and the Securities Law
For those wondering how the Supreme Court nominee has ruled on securities law issues to date, check out this website, where the University of Michigan Law Library has posted an extensive collection of Judge Alito’s opinions. Here is a blogger’s analysis of Judge Alito and the securities law.
Your IR Officer’s Greatest Fear: “Clever and Pernicious” Hacking
From Bruce Carton’s “Securities Litigation Watch Blog“: “According to this SEC press release, the SEC filed an emergency action against an Estonian financial services firm and two of its employees for conducting an alleged fraudulent scheme “involving the electronic theft and trading in advance of more than 360 confidential press releases issued by more than 200 U.S. public companies,” resulting in at least $7.8 million in illegal trading profits.
How did they supposedly steal 360 confidential press releases? How did they earn the “clever and pernicious” description from the SEC?
According to the SEC, ” in June 2004, [the Estonian firm] became a client of Business Wire for the sole purpose of gaining access to Business Wire’s secure client website. Once defendants had access, they surreptitiously utilized a software program, a so-called “spider” program, which provided unauthorized access to confidential information contained in impending nonpublic press releases of other Business Wire clients, including the expected time of issuance.”
The complaint further alleges that the information fraudulently stolen by the defendants has allowed them to strategically time their trades around the public release of news involving, among other things, mergers, earnings, and regulatory actions. Using several U.S. brokerage accounts, the defendants have bought long or sold short the stocks of the companies whose confidential press release information they have stolen, and purchased options to increase their profits.”
Note that Business Wire has issued a press release stating that none of their client’s press releases were accessed before the public saw them.
With such a focus on majority voting and tendering of director resignations these days, I thought it would be a good time to conduct a new survey on director retirement ages. Please take a moment and provide your input!
Here are the survey results from our last survey on disclosure controls and committees:
1. Does your company have a formalized, written set of “Disclosure Controls & Procedures”?
– Yes – 57%
– No, but the appropriate personnel know what these procedures are – 10%
– No, but the appropriate personnel know what these procedures are, and there are some written documents or checklists that are utilized – 32%
2. Have your company’s Disclosure Controls & Procedures been formally updated and revised in the last year?
– Yes – 56%
– No formal changes, but there have been some informal changes during the last year – 21%
– No, there have been no changes in the last year – 22%
3. Does your company have a Disclosure Committee Charter?
– Yes – 59%
– No – 39%
– We don’t have a formal Disclosure Committee – 2%
4. If there is a formal Disclosure Committee, who is the chairman of the Disclosure Committee?
– General Counsel – 11%
– Securities Counsel – 11%
– CFO – 20%
– COO – 1%
– Controller – 30%
– Corporate Secretary – 1%
– Other – 25%
PIPE Transactions Remain Under Scrutiny
According to this CFO.com article, the SEC has announced another Enforcement action in a PIPEs transaction. From what has been reported for a while, a number of market players have been dealing with the SEC’s Enforcement Division in connection with alleged fraudulent trading and reporting of private investments in public equities. These SEC actions will be among the many topics addressed in our upcoming webcast: “The Latest on PIPEs.” The webcast primarily will focus on the latest developments in PIPE mechanics and strategies.
2nd Circuit: Former Target Stockholder Can’t Bring Action for Lost Merger Premium
From the DealLawyers.com Blog: Some of you will recall the 2004 decision in Consolidated Edison v. Northeast Utilities by the US District Court for the SDNY holding that former shareholders of the target could bring an action for a lost merger premium as a result of the buyer’s wrongful repudiation of the merger agreement. Because such claim was vested in shareholders as of the date of the repudiation – and not the target or transferees of their shares – the target could not settle such claims (e.g., by amending or revising the terms of the original merger agreement).
Thankfully, the 2nd Circuit has overturned the decision on appeal concluding that, under the terms of the merger agreement between Consolidated Edison and Northeast Utilities, target stockholders become third party beneficiaries – with the right to enforce the buyer’s obligation to pay the contracted merger consideration, only upon consummation of the merger.
This important decision confirms that claims of wrongful repudiation of a typically constructed merger agreement will not deprive the principal parties of the ability to amend – or otherwise settle disputes – by vesting claims in the hands of target shareholders at the time of the breach. Thanks to Kevin Miller of Alston & Bird for the heads up!
[Iffy if I will be able to blog from the PLI Conference the next coupla days – should be a ringdinger. Last night at the NASPP Conference, Hootie & the Blowfish was a huge hit – should be mandatory for every major conference to have live music!]
At our “2nd Annual Executive Compensation Conference,” John Reed opened with some stirring remarks. Among other things, Mr. Reed said “That’s a cop out” when directors grant equity awards and don’t then make adjustments to future grants when the amounts actually realized/accumulated exceed what was anticipated.
Here is more from Mr. Reed, excerpted from a Dow Jones article published yesterday: Calling stock based compensation a “blunt” and even “dangerous” instrument, Reed suggested that compensation can easily be skewed by market forces, resulting in executives being significantly overpaid.
Reed issued his warning about stock grants in a pretaped Webcast delivered to a compensation conference, offering up himself and his former company in his frank assessment. According to Reed, some Citigroup employees were ultimately paid at least four times more than initially targeted because of options.
“I’ve had personal experience when I was at Citibank where we gave out stock to individuals expecting it to represent a certain value, and it turned out to represent four or five times more than we had anticipated at the time we gave out the stock,” he said. “This really meant that we had paid the people substantially more than we felt was appropriate to pay them.”
Jamie Dimon Speaks Out
Equally impressive was the passion and candor from luncheon speaker JPMorgan Chase CEO Jamie Dimon – he started by noting the widespread “anger” out there – shareholders, employees and the general public – and how we all need to get our house in order before Congress does it for us. He then went on to discuss many specific compensation topics at length, an amazing display of knowledge about this important area. The guy was truly dynamic; I am ready to buy JP Morgan stock…
We had over 100 walk-up registrations at the last minute, with a final count of well over 600 in Chicago and more than 3000 by video (surprising considering it was Halloween and PLI’s big event is later this week). We heard nothing but glowing reports from everyone here (an exhausting pace with so many panels back-to-back, but we felt a one-day conference was preferable to a two-dayer). I welcome any feedback you may have.
Update on Conflict of French Law and SOX’s Whistleblower Provisions
There have been some recent developments on the whistleblowing/French data protection rulings issues, as the French data protection agency – the CNIL – had a conference call with the World Law Privacy Group data protection committee on the issues faced by companies seeking to comply with SOX and deal with EU data protection laws at the same time. Subsequent to that call, CNIL produced draft guidelines with a comment period that ends November 10th (the draft CNIL guidelines are posted in our “Whistleblowers” Practice Area).
Unfortunately, the draft guidelines have some problematic provisions – any comments should be sent to Mark Schreider at “MSchreiber@palmerdodge.com,” who co-chairs the World Law Privacy Group data protection committee (and is a Partner with Edwards Angell Palmer & Dodge LLP). Obviously, the CNIL comment process is different than submitting comments to the SEC or the exchanges; they need to go in through specific channels.
In this podcast, Mark discusses these latest developments with the French CNIL, including:
– What does he make of the new draft CNIL guidelines on whistleblower schemes in France?
– What are the deficits or problems in the draft CNIL guidelines?
– How can US companies or their in-house or outside counsel provide input to the CNIL on these guidelines?
Nasdaq Proposes Clarification of Director Independence Standards
A while back, the Nasdaq filed proposed rule changes with the SEC to clarify its rules regarding director independence. Under the existing rules, a director’s independence is evaluated based on payments accepted from the company or its affiliates – the definition of independent director in Nasdaq Rule 4200(a)(15)(B) is proposed to be modified to provide that a finding of independence is precluded if a director accepts any compensation from the company or its affiliates in excess of $60k during any consecutive twelve month period within the three years prior to the independence determination.
The Nasdaq also proposed to change a Rule 4200(a)(15) interpretation to provide that a director that serves as a compensated officer of a company on an interim basis is not precluded from being considered independent after that service – the service as an interim officer is limited to not more than one year. The board would also still have an obligation to consider this interim service in making its overall independence determination.
The proposals would also clarify that references to “the company” in Nasdaq Rule 4200(a)(15)(D) includes any parent or subsidiary of the listed company.
Also, the proposals would clarify that the Rule 10A-3(c)(2) exception to the audit committee requirements for certain issuers that have a listed parent is also applicable to the Nasdaq’s audit committee requirements.