Monthly Archives: August 2006

August 14, 2006

Posted! The SEC’s Executive Compensation Disclosure Adopting Release

On Friday, the SEC posted the 436-page adopting release for its executive compensation disclosure rules. The compliance dates appear on page 2 – but you should also read pages 195-197 for more information about those important dates, including transition details. And thanks to Faegre & Benson for this useful Table of Contents to slap on your copy of the adopting release. Hours after its issuance, Mark Borges already had made his first stab at analyzing the adopting release in his “Proxy Disclosure Blog.”

With just a few weeks left, folks are registering in droves for our two-day Conference – “Implementing the SEC’s New Executive Compensation Disclosures: What You Need to Do Now!” – which will be held live in Washington DC at the Marriott Wardman Park on September 11-12. Rooms are filling up fast – here is how to obtain special room rates.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft – and review – disclosures during the proxy season. The Conference is still available by videoconference if you can’t make it to Washington DC on those days (and the Conference will be archived if those dates are conflicted for you).

If you haven’t yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

Sample Executive Compensation Disclosures

Even in advance of our comprehensive Conference coming up in a few weeks, many of you are – wisely – drafting mock disclosures to figure out how the SEC’s new rules impact your unique circumstances. To assist you, we have organized a horde of Mark Borge’s blogs from the past year – each of which provides analysis about how a particular company attempted to meet a component of the SEC’s then proposed rules – in these sample disclosures. These sample disclosures are posted in’s “The SEC’s New Rules” Practice Area.

As new proxy statements are filed, you can be sure that Mark will be analyzing how they stack up against the new SEC requirements in his “Proxy Disclosure Blog.”

Insider Trading Law Quirk?

A few bloggers are eating up the story about Dallas Mav’s owner Mark Cuban’s new site (which I blogged about pre-launch) and the revelation that Mark is selling short in some of the companies for which the site does investigative reporting to find a company’s warts. Gary Weiss does a juicy job – and has been battling Cuban – in his blog: see Round I, Round II and Round III. And Bruce Carton gives us the full-on legal analysis in his “Securities Litigation Watch” Blog.

August 11, 2006

Huey Lewis & The News to Play NASPP Annual Conference

Like last year’s blowout with Hootie & the Blowfish, this year’s NASPP Annual Conference – in Las Vegas – will include a special entertainment event. The NASPP, along with Fidelity Investments, is excited to announce that immediately after the Gala Opening Reception on October 10th, all Conference attendees are invited to join the NASPP and Fidelity on the beach at Mandalay Bay for an exclusive private concert featuring Huey Lewis & The News!

The concert is offered to NASPP Conference attendees only. There is no additional charge to attend – but space is limited and you must register with Fidelity in advance. Alas, major conferences will never be the same for me…

The Pension Protection Act of 2006

Last Thursday, the US Senate passed the Pension Protection Act of 2006, a pension reform bill approved by the House of Representatives on July 28th. The Act addresses a wide range of employee benefit-related issues, including the first change to the definition of “plan assets” under ERISA since 1986. Among many other changes, this Act will now permit managers of hedge funds, funds of funds and other investment vehicles that accept investments from public and private, non-US and US ERISA plans – that do not otherwise qualify for an exception or exemption from the plan asset rules – to accept significantly more capital from ERISA plans.

We have been posting law firm memos about the implications of the new Act in our “Pension Plans” Practice Area.

Former SEC Secretary Jack Katz on an “Overlawyered” SEC

Former long-time SEC Secretary Jonathan “Jack” Katz penned an editorial for Tuesday’s WSJ, following up on Harvey Pitt’s recent editorial about the SEC being over-lawyered. Jack agreed with Harvey’s identification of the problems at the SEC – but Jack doesn’t think that hiring more economists and fewer lawyers solves the problem.

Instead, Jack wants the SEC to play a more active role in monitoring rules once they’re adopted: “Over-lawyering is not merely a reflection of the personnel working at the SEC, it’s also a product of the institution’s definition of itself.” Jack’s thoughts are consistent with recently departed Commissioner Glassman’s emphasis on the need to discern the real-world implications that SEC rule-making initiatives will have before the so-called problem-solving is effectuated. It’s rather jolting to see Jack’s name on something other than an SEC order – and he certainly has a world of experience as he sat “in the room” for more than two decades at the SEC.

August 10, 2006

More Internal Controls Deadline Relief!

Yesterday, the SEC issued two releases to grant smaller companies and many foreign private issuers further relief from compliance with Section 404 of Sarbanes-Oxley. This relief reflects the “next steps for Sarbanes-Oxley implementation” announced in May and includes some new initiatives not previously announced. Here is the related press release – and below is a summary of the SEC’s actions:

Accelerated Foreign Private Issuers Get One More Year – In this adopting release, the SEC extended its Section 404(b) auditor attestation deadline for those foreign private issuers that also are accelerated filers (but not those that are large accelerated filers, who still must meet the earlier deadline of fiscal years ending on or after the July 15th that just passed) to fiscal years ending on or after July 15, 2007. Note that foreign private issuers still have to file their Section 404(a) management reports under the existing deadline of fiscal years ending on or after the July 15th that just passed.

Proposed Five-Month Deadline Extension for Non-Accelerated Filers – In this proposing release, the SEC proposed to extend the Section 404(a) management report deadline for non-accelerated filers (both US companies and foreign private issuers) to fiscal years ending on or after December 15, 2007 – and would extend the Section 404(b) auditor attestation deadline for non-accelerated filers to fiscal years ending on or after December 15, 2008. If this proposal is not adopted, non-accelerated filers would have to begin filing their Section 404 reports for fiscal years ending on or after July 15, 2007.

The SEC also proposed to deem the Section 404(a) management report included in a non-accelerated filer’s annual report (as well as for foreign private issuers that are accelerated filers (but not large accelerated filers)) during the first year of compliance to be “furnished” rather than “filed” for purposes of Section 18 of the ’34 Act, unless the filer specifically states that the report is to be considered “filed” or incorporates it by reference into another filing.

Proposed One-Year Relief for New Filers – In this proposing release, the SEC proposed a one-year stay for companies coming off IPOs (as well as those doing registered exchanges or any other first time filers with the SEC, regardless if they are US companies or foreign private issuers), so that they would not have to provide any Section 404 reports (ie. neither a management report nor an auditor attestation) in their first annual report. However, this relief would not be available if a company already had filed at least one Section 404 report.

More on Nasdaq’s Transition as an Exchange

In connection with Nasdaq’s transition to an exchange (see more in this blog), the SEC’s Market Reg and Corp Fin Staff issued this no-action letter that essentially permits companies and third-parties to satisfy, through EDGAR filings, their obligations to provide copies of most ’33 Act and ’34 Act filings to Nasdaq. Thanks to Alan Singer of Morgan Lewis for the heads up!

More on Blue Sky Issues and Nasdaq’s Exchange Transition

Recently, I blogged about possible blue sky issues related to Nasdaq’s transition to an exchange. Showing that I am indeed fallible, I overlooked Footnote 7 in Nasdaq’s amended rule filing which states that “The Nasdaq Global Market, including the Global Select segment, will be the successor to the National National Market. As such, Nasdaq believes that all securities listed on the Global Market, including those on the Global Select Market, will be “covered securities,” as that term is defined in Section 18(b) of the Securities Act of 1933, 15 U.S.C. 77r(b).”

Given that the SEC was silent on this point when it approved Nasdaq’s rule filing, practitioners can take some comfort that the position in this footnote holds some water.

By the way, we are still waiting for the SEC to approve Nasdaq’s rulemaking petition to designate securities listed on the Nasdaq Capital Market (f/k/a Small Cap) as “covered securities.” This rulemaking petition was made in February and I understand that the Nasdaq intends to file some changes to its Capital Market listing standards soon to address comments from the SEC Staff reviewing the petition, so some progress is being made…

August 9, 2006

John White Speaks at the ABA Annual Meeting

On Monday, Corp Fin Director John White addressed the ABA’s Business Law Section in Hawaii. I couldn’t swing that hall pass, but the program was available via teleconference. We have put together notes from John’s remarks and posted them in our “Conference Notes” Practice Area. John covered some ground on the new executive compensation disclosure rules – and he did say that the adopting release will be available this week, coming in at over 400 pages!

Now that the adopting release will be out soon, you need to act fast to reserve a hotel room for our Conference – “Implementing the SEC’s New Executive Compensation Disclosures: What You Need to Do Now!” – which will be held live in Washington DC at the Marriott Wardman Park on September 11-12. Rooms are filling up fast – here is how to obtain special room rates.

If you come to Washington DC to take in the conference, you still will get access to the video archive of the Conference, which will be important when you actually sit down to draft – and review – disclosures during the proxy season. The Conference is still available by videoconference if you can’t make it to Washington DC on those days.

If you haven’t yet, check out this detailed conference agenda to understand the types of challenges you should expect to face from the new rules.

Corp Fin Phone Interps: Regulation AB Interps Updated

Earlier this week, Corp Fin updated its Telephone Interpretations pertaining to Regulation AB, adding these items: 11.02 – 11.04, 15.02, and 17.03 – 17.05. Phone interp aficionados will recall that the Reg AB interps were the first new interps since Harvey Pitt became SEC Chair. No word on when the other interps will be updated…

How to Develop a Whistleblower Compliance Program Today

We have posted a transcript of our popular webcast: “How to Develop a Whistleblower Compliance Program Today.”

Litigation Update: How the Courts are Ruling on Stock Compensation

Tune in tomorrow for the NASPP webcast – “Litigation Update: How the Courts Are Ruling on Stock Compensation” – which can help provide guidance about:

– What the courts are saying about contract ambiguities and other employment disputes
– Tips on how to stay out of court
– What the IRS is saying about equity compensation tax shelters
– How to keep abreast of recent legal and regulatory developments

August 8, 2006

Whether Silence is Golden for Anti-Dilution Provisions of Equity Plans

A handful of members dropped me a line responding to my query last week regarding silence in anti-dilution provisions of stock option plans and FAS 123: the question of whether as a matter of contract construction, an option plan (or warrant) that was silent about adjustment could be adjusted if the stock was split.

For example, Professor David Yermack of New York University noted that a seven-year old Delaware case – Sanders v. Wang, 1999 Del. Ch. Lexis 203 (11/8/99) – considered the very issue of a Computer Associates equity compensation plan that was silent about what to do in the event of a stock split. A very large restricted stock award to the CEO and several top managers was split in line with the company’s stock splits. A shareholder sued, alleging waste of corporate assets, since the plan had no provision for such an adjustment to a share award. The court agreed and ordered the top three executives to return the extra shares – 9.5 million shares since their restricted stock plan had no provision for increasing the inventory of shares when the stock split – which cost them close to $600 million on paper. Interestingly, Dick Grasso was one of the outside directors/defendants in the suit.

And Ken Stuart of Holland & Knight noted that in December 2001 – in Reiss v. Financial Performance Corporation, 97 N.Y.2d 195, 764 N.Y.S. 2d 658 (2001) – the New York Court of Appeals held that where a warrant was issued without any provisions for adjustment in the event of a stock split (or a reverse stock split), the Court would not read such provisions into the warrant in the case of a one-for-five reverse split. Thus, the holder could exercise for the full number of shares stated in the Warrant and not the after-split amount. The lower court had relied on a First Circuit case – Cofman v. Acton Corp., 958 F2d 494 (1992) – which had held that the parties there had not given any thought to dilution and that an essential term of the contract was missing, so it could be given effect by the court. However, the N.Y. Court noted in dicta that if they were dealing with a forward stock split, they might give effect to dilution on the theory that the holder did not intend to acquire nothing.

Is It Time to Merge the SEC and CFTC?

In Saturday’s WSJ, former SEC Chairman Arthur Levitt opines that the SEC and CFTC should be merged into one in this editorial. I’m not sure many would disagree since the two agencies have overlapping constituencies to some extent. But why stop there? There are a number of federal agencies that should be merged out of existence – but the “gov” is so tough to downsize. That’s why we have six federal agencies to regulate financial institutions (Fed Reserve, OCC, OTS, FDIC, OTS, NCUA)…

Spinning Off: ADP’s Proxy Delivery & Voting Business

Last week, ADP announced plans to spin off a combination of its brokerage, securities clearing and outsourcing divisions – which includes the proxy delivery and voting services that it offers to its broker clients (which result in services offered to beneficial owners). The spin-off is expected to be in the form of a tax-free dividend, paid by the middle of next year.

Since mother ADP is not expected to control the new spun-off entity, it should give more freedom to the folks running the proxy delivery/voting services to be innovative, etc. – and it shouldn’t adversely impact companies or their shareholders.

August 7, 2006

Securities Litigation Continues Downward Trend

This recent study on class action securities litigation – “2006 Mid-Year Securities Fraud Class Action Filings Report” – from Stanford Law/Cornerstone Research shows that securities litigation continues to trend downwards with a 45% decline in the number of securities class actions filed during the first half of 2006 compared to the same period of the prior year. We have posted a copy of the study, along with other securities litigation studies, in our “Securities Litigation” Practice Area. Can you believe that only one new securities class action was brought against an audit firm in the first half of 2006?

The Study posits some reasons for this trend, including the dissipation of the ill effects from the boom and bust period of the late ’90s, the cleansing effects of Sarbanes Oxley, and the absence of stock market volatility. Kevin LaCroix of the “D&O Diary” is a bit more cynical and believes that this downward trend is partially due to Milberg Weiss’ troubles and the disappearance of the paid plaintiff.

I believe Kevin’s hunch is correct – but also agree with the Study’s theory that the downward trend probably has been helped along by the morass of regulatory changes wrought by Sarbanes-Oxley, which has provided ample incentive for executives and boards to improve their governance practices. Another factor I would add is the spate of recent court decisions that have raised the benchmarks that must be met for successful cases, such as last year’s US Supreme Court decision of Dura Pharaceuticals.

Given that there were a record number of restatements in 2005 – and I understand that restatements in 2006 are ahead of that pace so far – I would hazard to guess that this downward trend will continue (except perhaps the option backdating lawsuits that are now being filed in droves will reverse the trend).

The Art of Predicting the Securities Law Class Action

In related news, The Corporate Library released an update to its continuing study of the correlation between its corporate governance ratings and the risk of securities class action lawsuits. The findings include:

– Companies rated “D” or “F” are more than 3x as likely to be hit with a securities class action lawsuit than those rated “A,” “B” or “C”
– Excessive CEO compensation is the single most predictive factor of being sued
– Other predictive factors include director age, tenure, over-commitment and lack of independence
– Takeover defenses are less important as a predictive factor
– Nearly all securities class action lawsuits are filed against companies with more than $485 million in market capitalization

A “Stolen” Parachute

What struck me as offensive about the article below from Sunday’s NY Times is not the political angle – but that a CEO got a $28 million severance package when he voluntarily quit his job to run for the US Senate (here is a related LA Times article – and here is the complaint amid other materials from the plaintiff):

“Someone has finally made executive compensation an explicit campaign issue. Emma Schwartzman, who says she is a great-great-granddaughter of a founder of what later became the Safeco Insurance Company, has sued the company’s recently departed C.E.O., Michael S. McGavick — now the Republican candidate for the United States Senate from Washington state — over his $28 million severance package. In her suit, filed in Federal District Court in Seattle, Ms. Schwartzman, 27, said Mr. McGavick was entitled only to his last paycheck and that he had forfeited all other compensation, including bonuses and stock options, when he resigned.

According to the suit, the board agreed to let Mr. McGavick remain on the payroll for an extra four months and then to provide freelance “transition services” for two more months. That agreement, she contends, let Mr. McGavick keep stock options and other compensation that he otherwise would have had to forsake, under the terms of his original employment contract.

Mr. McGavick, who is trying to unseat Maria E. Cantwell, a Democrat, said in a statement that the allegations were ‘without merit and politically inspired.’” Safeco described the departure package as ‘reasonable.’

Ms. Schwartzman’s lawyer, Knoll D. Lowney, said the case was about “corporate corruption, not partisan politics.’ But he also insisted that Mr. McGavick return the money to Safeco and not spend it on his campaign.”

What in the world was the Safeco board thinking when they allowed this severance payment to be made (not to mention keeping him on the payroll, etc.)? Particularly with the SEC’s new executive compensation rules requiring more disclosure about a board’s pay strategies, boards and their advisors should heed the responsible pay wisdom that will be imparted during the “3rd Annual Executive Compensation Conference,” available live in Las Vegas or by nationwide video webcast. Register today!

August 4, 2006

Nasdaq Proposes to Amend “Director Independence” Definition

Last week, Nasdaq filed a proposal with the SEC to modify its definition of “independent director” with the result that the Nasdaq rules would be more consistent with the NYSE’s definition of independent director. This is different than the Nasdaq’s outstanding proposal to modify the independence cure period that I blogged about a month ago.

If adopted, the changes could result in sitting directors no longer meeting the revised Nasdaq independence requirements – so Nasdaq also proposed a 90-day transition period after rule approval for compliance with the new standards. The next step is for the SEC to publish the Nasdaq’s proposal for public comment – seems like 90 days for a transition could be a little short since an average director search takes nearly six months these days…

The Stock Market: 1950s Style!

For Friday fun, how about enjoying this cartoon from 1952 from the NYSE – “What Makes Us Tick.” This is a “cartoon promoting the stock market as the engine of America’s prosperity.” Thanks to Howard Dicker for pointing me to this antique video!

Delaware First

Here is a nice piece from Jim McRitchie’s ““: Delaware, the first state, is also the most important state for corporate governance, since more than half of America’s publicly traded businesses are incorporated there and must live by its statutes. Additionally, states that want to keep up, frequently adopt Delaware rules. The Delaware Court of Chancery produced a 180-page tome with the legal opinion it rendered last year in the Disney case.

An article entitled Delaware Rules in (8/1/06) gives us a glimpse of what Chancellor William B. Chandler III sees as questions the court will face in upcoming cases. For example, can shareholders adopt bylaws that trump board decisions? If they do, can the board then turnaround and negate their decision? “That issue has never been directly faced or answered in Delaware,” says Chandler, “but I think it’s inevitable that it will be decided.”

The author of the article, Roy Harris, believes that “what Chancery rulings say in the near future could establish standards that rival anything that Sarbanes-Oxley and the Securities and Exchange Commission have offered.” To back that up, he quotes Charles Elson. While the court must wait for cases to be brought before it — “ultimately the Delaware Chancery Court will have a significant role in changing governance,” he says. Elson adds, “Traditionally, the court’s view was that shareholders were not sophisticated and needed to be protected from their own foolishness,” he says. “Today what they need to be protected from is managerial overreaching.” Signs of new directions:

– director independence – Beth I. Z. Boland, a partner in the Boston law firm of Bingham McCutchen LLP, believes the court will now “look beyond quantifiable measures to go into soft issues” in determining who is independent.”

– liability – Chandler says, “my view is that our law doesn’t expect different standards to be applied to different directors based on their expertise, their skill, or their training.”

– directors are agents – Chandler argues that it “would be a strange thing to invoke your fiduciary duties as a sword to break a contract that you had made with shareholders.”

– compensation – “The board is ultimately going to have to decide compensation for executives,” Chandler says, “but could shareholders adopt bylaws that place limitations or constraints in either the scope or magnitude of that compensation, or on the procedures that boards must follow before it awards compensation to a particular executive?”

Charles Elson provides insight into the way the Court of Chancery works. “Delaware doesn’t get its jollies holding people liable,” he says. “Its message is that ‘the next time I see this conduct, I’m likely to rule differently.’ It’s a delayed impact that defines the parameters of behavior.” Good discussion of the issues plus one sentence summaries of two decades of important cases.

August 3, 2006

More on Anti-Dilution Provisions and FAS 123(R)

Following up on my blog from a few weeks ago, in this podcast, Jon Lewis of Fried Frank Harris, Shriver & Jacobson analyzes the issues raised by applying FAS 123(R) to anti-dilution provisions in equity plans, including:

– What are the Big 4 saying about anti-dilution provisions in equity plans?
– What are examples of situations, such as changes in capitalization and restructurings, that might cause problems?
– Will the FASB weigh in on this issue?
– What should companies do now to determine if they have an issue? And if they do have a problem, how can they fix it?

And the impact of this problem is starting to be felt – as noted in this Form 8-K, Core Labatories recently cancelled a planned stock-split after being alerted to the accounting problems raised by this issue.

As an aside, a member e-mailed me wondering if anyone would feel that an option plan that was silent about adjustment for stock splits would be allowed to adjust as a matter of contract construction, at least in the context or warrants or other contractual rights to receive stock. Has anyone yet dealt with that? Shoot me an e-mail if you have (and I will keep your identity hidden if you wish).

ISS on “Does Cumulative Voting Complement Majority Voting?”

As a result of the ongoing debate festering on this blog, ISS weighed in with its voting policy regarding cumulative voting and majority vote on the “Corporate Governance Blog“: “An interesting post ran last week on Broc Romanek’s Blog. If one agrees, as mentioned in the piece, that cumulative voting helps protect shareholder rights–which ISS policy does–then majority vote standard and cumulative voting compliment each other. Without majority vote standard, cumulative voting in an uncontested election has no teeth because then a director could still be elected if he/she receives one single vote.

As for cases of contested elections, it is a non-issue because plurality voting standard would remain the election standard maintaining the status quo. Having majority vote standard in an uncontested situation would actually serve as a takeover defense. Therefore, in evaluating shareholder proposals requesting majority vote standard, ISS looks for such carve-out for contested elections in the language of the resolution.

Regarding ISS’ policy on cumulative voting with respect to majority vote standard, we would not support a cumulative voting shareholder proposal if the company has majority vote standard in place. This is not because the two are incompatible, as many companies have been arguing. Rather, the rationale behind this policy is to provide an incentive mechanism (the carrot) for companies to move toward a majority voting standard for electing its directors.

It is true that cumulative voting can be viewed as a vehicle to allow special interest shareholders to make their voice heard in that, in theory, it makes it easier for a minority holder to get at least one director elected. However, many would say this isn’t necessarily a negative byproduct. ISS’ current policy is willing to “trade off” a cumulative voting provision if the company is willing to adopt a majority vote standard.”

New Treasury Secretary Doesn’t Like Sarbanes-Oxley’s Impact

From a Dorsey & Whitney alert: “Hank Paulson, the former head of Goldman Sachs worldwide who left that position last month to become the new US Secretary of the Treasury, has used the occasion of his first public address as Secretary to suggest that the US Sarbanes-Oxley Act of 2002 has caused too much damage to US competitiveness internationally and should be revised.

Early in his speech, Paulson noted that the US had taken “corrective measures to address corporate scandals and increase investor confidence” following the Enron and WorldCom failures. But, he added, “often the pendulum swings too far”. He said that the US now needed to follow its initial corrective measures with “a period of readjustment”, and that “the challenge” facing the US is “to achieve the right regulatory balance to allow us to be competitive in today’s world”.

The Secretary of the Treasury has no authority to amend SOX or the rules that have been promulgated under it, and he has no authority over the US SEC or the PCAOB (Public Company Accounting Oversight Board), the new agency that drafts SOX auditing rules. Changes to SOX must be made principally by the US Congress, which itself wrote most of the detail in SOX about which non-US companies complain.

Nevertheless, the person serving as Treasury Secretary is usually listened to carefully by US legislators and regulators when speaking on broad policy issues. And, this particular Treasury Secretary will likely be listened to even more closely, due to his personal background as a top international financier and his position as a late entry in the Bush cabinet charged with finding solutions to a number of economic issues that are currently worrying Washington.

Paulson’s swipe at SOX is part of a general concern in the US that may soon lead to real efforts to change the law. The US has its next Congressional elections in November 2006, at which time both Senator Paul Sarbanes and Representative Mike Oxley, the sponsors of the law, plan to retire from office. The Congress that meets following this election will likely be more open to amending the statute, which at that time will be over four years old and will have generated a substantial track record that should help SOX critics argue for meaningful revisions. And, at that time, Hank Paulson should still be Treasury Secretary.” Here is more commentary about Paulson’s speech at

August 2, 2006

Nasdaq Emerges as an “Exchange”

On Monday, the SEC issued this press release announcing that companies listed on the Nasdaq Stock Market will transition to registration under Section 12(b) of the Securities Exchange Act of 1934 effective as of Monday. The Nasdaq Stock Market commenced operation as a national securities exchange yesterday.

As I have indicated would happen in prior blogs, under an order issued by the SEC, all Nasdaq companies became Section 12(b) registrants instead of 12(g). Among other consequences, this means that these companies will need to indicate such on the front of their Form 10-Ks (listing common stock under the 12(b) line, instead of 12(g)) – and that companies de-registering will need to file a Form 25 with Nasdaq in addition to a Form 15 with the SEC, and that deregistration will not be based solely on the number of stockholders (see our Q&A Forum for a recent question regarding a company de-registering right now, which poses really tricky transition issues). Other consequences of this transition were covered in recent issues of The Corporate Counsel.

In addition, the SEC issued an exemptive order allowing Nasdaq members, brokers and dealers to execute trades until August 1, 2009, in 13 Nasdaq-listed firms that were previously exempted from SEC registrations. Nasdaq sought the relief saying an immediate registration requirement could prompt the firms – four insurance companies and nine non-U.S. firms – to withdraw from Nasdaq trading altogether.

Congrats to Nasdaq after wading through a prolonged regulatory process. In fact, outgoing SEC Commissioner Glassman alluded to how long it took for Nasdaq to obtain regulatory approval of its exchange application – which I believe is in the 6-7 year range – in her outgoing speech

Nasdaq as an Exchange: Blue Sky Implications?

Nasdaq’s transition to an exchange and its related name changes may give rise to some blue sky interpretive questions. As you may recall, the National Securities Markets Improvement Act of 1996 (known as “NSMIA”) preempted state qualification/registration requirements for “covered securities” which include a security that is listed on the “National Market System of the Nasdaq Stock Market (or any successor to such entities)”. The bifurcation of the National Market System into the Global National Market and the Global Select Market as proposed by the Nasdaq proposed rule change creates some ambiguity as to whether both markets will be considered as successors.

A further wrinkle is added by the continuing value of state level exemptions for options or warrants to acquire listed securities. The NSMIA did not clearly preempt state qualification requirements for options or warrants to acquire covered securities, as discussed in May-June 2003 issue of The Corporate Counsel. This “gap” is filled by exemptions that continue under some state blue sky laws.

For example, California Corporations Code Section 25100(o) exempts a security listed or approved for listing on the National Market System (or any successor) as well as any warrant or right to purchase or subscribe to the security. California also requires that offers or sales of any security in a nonissuer transaction must be qualified or exempt from qualification. Corporations Code Section 25101(a) exempts from this qualification requirement any security (i.e, not just a covered security) that is issued by a person that is the issuer of any security listed on a national securities exchange or the National Market System (or any successor).

Finally, California has an exemption from its constitutional usury provisions for evidences of indebtedness if the issuer has any security listed or approved for listing upon notice of issuance on a national securities exchange or on the National Market System (or any successor). In each of these cases, the National Market System must be certified by rule or order of the California Commissioner of Corporations. See, e.g., Release 87-C (revised) and Release 88-C. All this is to explain that the move to exchange status and the name changes should give rise to some interpretive questions under state law. Thanks to Keith Bishop for his input here.

Last Word: Cumulative Voting and Majority Voting

Yesterday’s blog contained a rebuttal from CalPERS on the topic of cumulative voting and majority voting. Here is a counterpoint from Keith Bishop: “There is a very sound reason for not allowing majority voting when a corporation has cumulative voting available to stockholders. At its core, majority voting establishes a significantly less burdensome way to remove directors without cause. California Corporations Code Section 303 protects directors from removal when those directors were elected by cumulative voting. This is true even when a majority of the outstanding shares has voted for removal. There is a very sound reason for this.

If removal could be effected by a majority of the shareholders, then the right to elect directors cumulatively would be largely meaningless. While SB 1207 does not amend Section 303, it creates a total end-run on the minority protections of Section 303 and cumulative voting rights in general. Delaware and Nevada provide similar (but not exactly the same) protections to for cumulative voting in DGCL Section 141(k)(2) and NRS 78.335 (Note that Nevada requires a 2/3 vote for removal).

The implications of SB 1207 are illustrated by the following example. A corporation has 7 directors and 1000 outstanding shares. If a meeting is held to elect all 7 directors and all 1000 shares are voted, a minority group holding 126 shares could elect a director under cumulative voting. Without Section 303(a)(1), the holders of 501 (a majority of the outstanding shares) could take action to remove this director without cause. Obviously, electing a director only to have her removed would be pointless. Under Section 303(a)(1), however, cumulative voting is protected.

For example, assume that the majority shareholders seek removal at a meeting. If 800 shares are present and voting at the removal meeting, the holders of 101 shares could block removal of the director. Note that Section 303(a)(1) implicitly assumes that abstentions and other shares that are note voted should not be counted as supporting removal. If SB 1207 is enacted, removal in the above example could be effected by as few as 251 shares! This is far less than the 501 votes that would be required for removal even without the special cumulative voting rule in Section 303(a)(1). SB 1207 can thus have the effect of turning majority rule into minority rule – especially if the minority is held by a few shareholders and the majority is widely dispersed.

I believe that my views regarding the incompatibility of cumulative voting and majority voting are very much in the mainstream. The ABA’s amendments to the Model Business Corporation Act do not allow majority voting if a corporation has cumulative voting.”

August 1, 2006

New Compensation Rules Raise Many Complexities

Mark Borges continues to work wonders on his “Compensation Disclosure Blog” on Here is one of his latest: “Although we won’t see the final rules for several more days, it hasn’t stopped me from attempting to parse the SEC’s eight-page press release and related materials to try to figure out what they will look like. Here are a couple of items that I’ve identified that seem a little, shall we say, curious.

NQDC Earnings

It appears that final rules will only require disclosure of above-market or preferential earnings on nonqualified deferred compensation in the Summary Compensation Table. So far, so good. It didn’t seem to me (and many others) appropriate to treat all earnings on NQDC as compensatory and subject to disclosure. The final rules go on, however, to exclude these above-market earnings (along with changes in the actuarial present value of accumulated pension benefits) from total compensation when determining a company’s most highly-compensated executive officers.

That seemed to be the right result when all earnings were being included in total compensation; I’m not sure it’s still necessary when only the above-market portions are considered. After all, everyone agrees these amounts are compensatory. I think companies may have caught a break here.

Earnings on Equity Awards

The final rules do not require disclosure of earnings (such as dividends and dividend equivalents) on outstanding equity-based awards where the earnings are already factored into the grant date fair value of the awards. This result is likely to be controversial. In fact, I’ve already heard some observers suggest that this could lead to underreporting and, perhaps, even encourage the use of this benefit.

The concern stems from the belief that the incremental portion of a stock award’s fair value representing the future dividend stream is relatively small compared to the actual dividends that an NEO will receive during the award’s vesting period. The change in the final rules appears to be in response to commenters who pointed out that, by requiring dividends to be reported in the SCT, these amounts were being included twice – once as part of the fair value calculation and then again when the dividends were paid. The SEC made a policy choice to eliminate the doublecounting. This covers one issue, but leads to other nuances.

For example, what happens where a company issues an award on dividend-paying shares, but the recipient is not entitled to dividends (or equivalents) during the vesting period? SFAS 123(R) seems to say that the fair value of a share that does not participate in dividends during the vesting period is less than that of a share that fully participates in dividends. Will a company be able to reduce the value disclosed in the SCT in this instance? SFAS 123(R) says yes – you reduce the share price of the award by the discounted present value of the dividends expected to be paid on the shares during the vesting period to determine fair value. Presumably, companies would be permitted to make this adjustment.

The larger lesson here is that options may not be the only instrument where computing fair value is going to involve some work. In talking about the proposals over the past few months, I frequently said that, for most equity-based awards (other than options), the amount to be reported in the SCT would equate to the award’s market value on the grant date. I’m starting to see that this may not always be the case.

These rules are getting complicated, and they aren’t even out yet.”

Act Today!
Mark is a key speaker at our two-day conference: “Implementing the SEC’s New Executive Compensation Disclosures: What You Need to Do Now!” He will participate on four separate panels dealing with the new CD&A, retirement pay disclosures, the revised Summary Compensation Table and the tricky world of perks.

August E-Minders is Up!

The August issue of our monthly newsletter is available.

Cumulative Voting and California’s Majority Vote Bill: CalPERS’ Perspective

Below is a rebuttal from CalPERS to last week’s blog from Keith Bishop:

CalPERS appreciates the opportunity to respond to Keith Bishop’s analysis of SB 1207, currently being considered by the California Legislature. SB 1207 does not weaken the cumulative voting provisions currently contained in California’s General Corporation Law or conflict in any way with Government Code Section 6900. In fact, SB 1207 supports the ability of all companies to adopt or preserve cumulative voting, including those companies that opt into a majority voting rule. SB 1207 does this by allowing a company to utilize majority voting for uncontested elections and cumulative voting for contested elections. There is no “fundamental incompatibility” in a system that accords a corporation the opportunity to choose between majority voting for one kind of election and cumulative voting for another.

SB 1207, as currently drafted, changes only one aspect of director elections: it provides a listed corporation with the ability to implement majority voting in “uncontested” elections. The bill does not change the existing process for contested elections (i.e. directors who receive the highest number of votes are elected; if a shareholder has elected cumulative voting, each shareholder may multiply the number of votes to which the shareholder’s shares are entitled by the number of directors to be elected, and distribute the votes among the candidates as the shareholder sees fit; subject to the ability of a listed corporation to eliminate cumulative voting under Section 301.5(a)). This approach provides corporations with maximum flexibility in addressing director elections, while also preserving to the fullest extent possible California’s tradition of cumulative voting.

Those who propound a “fundamental incompatibility” argument would require a corporation to make an “either/or” choice between majority and cumulative voting. In other words, they would permit California corporations to adopt majority voting in uncontested elections only if they were willing to eliminate cumulative voting in all elections, whether contested or uncontested. We think that choice is best left to each corporation and its shareholders. Corporations already have the ability under Corporations Code Section 301.5 to opt-out of cumulative voting if they wish to do so. There is no reason to force a choice.

Put another way, is there a reasonable justification as to why the Corporations Code should, as a matter of law, prevent a corporation from selecting a majority voting system for uncontested elections and a cumulative voting system for contested elections? We think the answer is “no.” Each system serves different purposes, and both can co-exist quite well. The policy goal of majority voting is to provide a means for shareholders to vote against incumbent directors. The purpose of cumulative voting is to ensure minority representation on a board.

While the policy purposes may overlap, they don’t necessarily conflict. Given California’s historic policy and the current practice of most California corporations favoring cumulative voting, we believe that the approach of letting each corporation and its shareholders determine whether to adopt majority voting for uncontested elections (as opposed to an “either/or” choice between majority voting and cumulative voting) represents a strong reason to support SB 1207. Delaware has adopted such an approach, and we believe this approach is in the best interest of California corporations and their shareholders.

With regard to the removal issues raised by Mr. Bishop, we believe that his concerns are overstated. SB 1207 does not amend Corporations Code Section 303 relating to removal. Thus, the protections afforded directors elected or supported by a group of minority shareholders remain intact: no director may be removed without cause if the votes cast against the director’s removal would be sufficient to elect the director if voted cumulatively at an election at which the same number of votes were cast.

Further, candidates in contested elections would not be impacted by majority voting since majority voting does not apply in contested elections. Only candidates in an uncontested election must achieve the affirmative vote of a majority of votes cast. In such an election, a minority shareholder whose candidate would not gain a majority of votes cast may be required to force a contested election in order to maintain a board seat. However, as a practical matter, when a company knows that a minority shareholder is assured a board seat through cumulative voting, it often nominates that shareholder’s candidate to avoid the contest.

Thus, while it is possible that a scenario could arise where a minority shareholder is required to force a contested election, we think this would be rare. In our view, Mr. Bishop’s concern with the removal of cumulatively-elected directors is not so significant to prevent corporations from being given the option to select majority voting, and does not further the argument that SB 1207 either is inconsistent with or undermines cumulative voting.