We have posted the March-April 2007 issue of The Corporate Counsel since it contains practical guidance that pertains to proxy season issues that you may be grappling with. We are making an exception to our subscription license to allow you to forward this issue of The Corporate Counsel to whomever you think it will benefit (and tell them to try a no-risk trial to The Corporate Counsel print newsletter).
SFAS 159: More Fair Value Accounting
A few weeks ago, the FASB issued SFAS 159, which is a new standard that provides companies with the opportunity to report selected financial assets and liabilities at fair value. In other words, SFAS 159 allows companies to measure specified financial instruments and warranty and insurance contracts at fair value on a contract-by-contract basis, with changes in fair value recognized in earnings each reporting period.
The election, called the “fair value option,” will enable some companies to reduce the volatility in reported earnings caused by measuring related assets and liabilities differently, and it is simpler than using the complex hedge-accounting requirements in Statement 133 to achieve similar results.
Another Internal Controls Delay for Smaller Companies?
According to this article, Senators John Kerry (D-Mass.) and Olympia Snowe (R-Maine) have sent a letter to the SEC and PCAOB seeking another one-year delay in requiring small U.S. public companies to evaluate their internal controls of financial reporting.
Meanwhile, COSO announced that Grant Thornton has been commissioned to develop guidance designed to help organizations monitor the quality of their internal control systems.
A few months ago, Google announced a “Transferable Stock Option Program” that would allow employees to auction off vested options, as managed by Morgan Stanley. Last week, Google filed a Form S-3ASR that fleshs out what they intend to do. Now, Google is test driving the auction process using 20 pre-selected employees, with a full roll-out to other employees expected in April.
– Testing Phase – This prospectus supplement explains how Google’s “test launch” works. The test-driving employees receive 5 transferable options with different exercise prices, each with a strike price higher than Google’s stock price on the date on which the option is issued. During the testing phase, only one institution is able to bid on the options (in comparison, when the auction is “live,” there will has to be at least two competing bids before an auction is deemed complete).
– Full Roll-Out – Here’s an excerpt from the prospectus explaining how the auction likely will work:
“Options will be sold under the TSO program through an auction process in which a designated broker dealer will serve as auction manager. Currently, we have selected Morgan Stanley & Co. Incorporated to act as the auction manager. The auction will be operated through a secure internal online tool (the “TSO system”), which is accessible by participating employees. All participating financial institutions must be able to provide automated bids for all options in the TSO program on a continuous basis, updated approximately every 30 seconds while the TSO market is open.
Employees will use the TSO system to see the current highest bid price offered by the participating financial institutions for their vested options. During regular TSO market hours, the TSO system will continuously update to display the highest current bid price for each eligible option. All participating financial institutions will be required to bid on all of the options eligible for sale as a condition of participation in the TSO program, although the participating financial institutions may place zero dollar bids. A bid will be valid, at the time submitted by the participating financial institution, for at least 1,000 shares underlying options. A bid will remain in force until either the total available size of the bid is purchased at the bid price or a revised bid is submitted by the auction manager or a participating financial institution. Employees will receive the highest bid price at the time their market order is received, which may not be the same as the latest quote provided through the TSO system. No order may exceed 1,000 shares.”
President’s Working Group: Hedge Fund Regulatory Approach of Market Discipline
Last week, the President’s Working Group on Financial Markets issued guidelines on hedge funds that are intended to guide regulators as they address issues associated with private pools of capital, including hedge funds. The President’s Working Group is chaired by the Treasury Secretary and composed of the Chairs of the Federal Reserve, SEC and CFTC. As noted in this press release, the guidelines reflect an agreement between the Working Group and the regulators to use an approach of market discipline to protect investors rather than an approach of regulator’s doing more inspections or requiring more disclosure.
Wanna Buy a Hedge Fund – Cheap?
Search for “hedge fund” on Ebay. Bidding ends tomorrow and minimum bid is $70,000 (no bids made yet). This hedge fund – located in Switzerland – didn’t receive any bids the first time it was offered a couple of weeks ago. If you don’t want to buy a hedge fund, but would rather grow your own – you can find plenty of “How To” books on how to form a hedge fund. You too can have your own hedgie!
Recently, a number of members have asked about NYSE Rule 203.01, as they wonder why companies listed on the New York Stock Exchange haven’t been issuing press releases when they’ve filed their Form 10-K with the SEC (indicating that the 10-K is available from their website, etc).
As you might recall, last August, the NYSE amended its rules – to facilitate the SEC’s e-proxy initiative – that repealed the requirement that listed companies distribute a copy of the annual report containing financial statements to shareholders. As part of the rule changes, the NYSE amended Rule 203.01 to provide that listed companies must (1) post its Form 10-K on or through the company’s website, (2) state on its website that paper copies of the audited financial statements are available upon request and free of charge, and (3) simultaneously issue a press release announcing the filing with the SEC of the Form 10-K and stating that the Form 10-K is available on the company’s website.
However, the NYSE recently stated in its annual corporate governance letter to listed companies that a listed company will be deemed to satisfy Rule 203.01 if it distributes its audited financial statements in compliance with the SEC’s proxy rules (ie. “The Exchange will deem a domestic company that distributes its audited financial statements to shareholders in compliance with SEC proxy rules to be in compliance with the requirements of Section 203.01”). In other words, the NYSE clarified that a press release is not necessary if the company delivers a glossy annual report with financials to shareholders.
So most listed companies will not have to issue press releases when they file their Form 10-Ks. By the way, several companies have issued such a press release: Ryder Systems, Quicksilver, Krispy Kreme Doughnuts; Aspen Insurance Holdings Limited; Deere & Company; Building Materials Holding Corporation; and Pioneer Natural Resources Company. Thanks to Beth Ising of Gibson Dunn for helping to sort this quagmire out…
Last Minute Planning for the Proxy Season
We have posted the transcript for our webcast: “Last Minute Planning for the Proxy Season.”
The Promise of Transparency — Corp Fin in 2007
On Friday, Corp Fin Director John White delivered this speech entitled “The Promise of Transparency — Corporation Finance in 2007,” which covers a bunch of rulemakings, etc. that are in the Division’s “kitty” for the year.
My blogs on the Direct Registration System continue to generate a healthy dose of member feedback. Michael Kaplan of Davis Polk notes that there are some states (and countries) that don’t allow issuance of uncertificated securities – and some companies actually have charter provisions about this. For these companies, it seems that the exchanges will not require charter amendments – which would require a vote during this year’s shareholder meeting so long as the securities are DTC eligible. Michael also points out that IPO issuers should bear this in mind as they already are subject to the DRS eligible requirements of the exchanges.
Some members took the analysis a step further and asked why the exchanges were even bothering sending notices about uncertificated securities at all, as they view street name holders as essentially being in the same position vis a vis the company’s shareholder records. In their view, all that should matter is that the company has securities that are DTC eligible.
Highlighting that each state has a law that can be read differently, one member noted that I mentioned the language “each shareholder is entitled to a certificate” as potentially requiring certificates under a common sense reading. He notes that, under Ohio law, there is that specific “entitled to” language in the statute itself, which many companies repeat in their code of regulations (the Ohio equivalent of bylaws), yet language further in the statute specifically provides that, unless provided otherwise in their articles or regulations, a company can have uncertificated shares. So at least under Ohio law, the “entitled to” language shouldn’t be read to require certificated shares.
And Jane Whitt Sellers of McGuireWoods points out that Section 13.1-648 of the Virginia Code provides that, unless the articles or bylaws provide otherwise, the board may authorize the issuance of some or all shares without certificates. Jane believes that if you have a statute like Virginia’s that operates “subject to” whatever the bylaws or articles say, you must amend any existing provisions in bylaws or articles that require certificates before going to an uncertificated approach. And in our “Direct Registration” Practice Area, we have posted another sample by-law provision for those that may need to amend their by-laws.
An M&A Conversation with Chief Justice Myron Steele
We have posted the transcript from the DealLawyers.com webcast: “An M&A Conversation with Chief Justice Myron Steele.”
Chancellor Chandler Enjoins Caremark Special Meeting: Mailing Supplemental Disclosures
Last week, Chancellor Chandler of the Delaware Court of Chancery enjoined a stockholder vote on the pending merger between Caremark and Express Scripts until not earlier than March 9th. The Chancellor issued his decision because of the materiality of supplemental disclosures made by Caremark on February 12th, just 8 days before the stockholder vote scheduled for February 20th. We have posted a copy of the opinion in the DealLawyers.com “M&A Litigation” Portal.
Here is some analysis from Travis Laster of Abrams & Laster: The 8 days provided by Caremark was definitely towards the short end of the spectrum for supplemental disclosures, but it was not unprecedented. The Chancellor instead appears to have been influenced by the combination of the brief time period and the his view of the significance of the disclosures, which included “the revelation that Caremark has considered, on at least three separate occasions, potential transactions with Express Scripts.”
The Chancellor juxtaposed this disclosure with the Caremark board’s “present protestations that antitrust difficulties loom so large as to prevent the board of directors from even discussing an offer with an admittedly higher dollar value.” (Emphasis in original). The Chancellor also noted the materiality of Caremark’s disclosure that the CVS merger would extinguish stockholder standing to pursue derivative litigation regarding claims for stock option backdating. This statement comes on the heals of the Chancellor’s two recent and quite strong decisions criticizing stock option practices.
At 2 typed pages, the opinion is quite short and worth a first-hand read, particularly for deal counsel and litigators who frequently must consider whether – and when – to make supplemental disclosures.
After facing a shareholder proposal on the topic, Aflac has agreed to become the first major company in the US to give shareholders an advisory vote on executive compensation packages beginning in 2009 (the first year the company will have three years of comp data under the SEC’s new exec comp rules). Boston Common Asset Management had submitted the proposal last year. Here is a related Washington Post article.
At least 60 companies have shareholder proposals regarding “say-on-pay” for their shareholder meetings this year, up from seven last year. As Pat McGurn of ISS noted during our recent webcast on the proxy season (here is the transcript), these proposals are expected to average a majority level of support from shareholders this year.
Rep. Barney Frank (D-Mass.), Chairman of the House Committee on Financial Services, has been pushing a bill that would allow for advisory votes on executive compensation and he intends to hold a hearing on March 8th regarding strengthening the role of shareholders in setting executive compensation. Advisory shareholder votes on executive compensation are currently required in the United Kingdom, Australia, Sweden and the Netherlands.
More on Delaware Chancery Court’s Backdating Decisions
A few weeks back, I blogged about Delaware Chancellor Chandler two opinions in declining to dismiss complaints alleging backdating of options (in Ryan v. Gifford) and spring-loading of option grants (in Tyson Foods). In this CompensationStandards.com podcast, Megan McIntyre of Grant & Eisenhofer (the firm that is bringing some of these backdating suits) provides some insight into these decisions, including:
– What did Chancellor Chandler hold in these cases?
– What does this mean for companies with backdating issues?
– Do you think these two opinions portend that more executive compensation related lawsuits will be filed in Delaware?
Survey Results: Stock Option Grant Procedures
The NASPP recently wrapped up a very popular survey regarding option grant procedures. Below is an excerpt from the survey results, along with the other questions posed to NASPP members:
1. Who approves option grants to non-executives?
– Board of Directors – 18.1%
– Compensation Committee – 47.6%
– Committee of officers – 6.0%
– CEO – 20.5%
– CFO – 0%
– Other – 7.8%
2. When are grants to new hires (non-executives) approved?
– Once a week (at the same time every week) – 3.6%
– Once a month (at the same time every month) – 23.1%
– Once a quarter (at the same time every quarter) – 10.9%
– After earnings are released – 5.3%
– Before earnings are released – 1.0%
– Only during open window periods – 4.9%
– When the board meets – 13.0%
– When the compensation committee meets – 28.9%
– Other – 16.4%
– No set scheduled – 16.8%
3. When are other (not hire-related) grants to non-executives approved?
4. How have you changed (or are planning to change) your grant procedures in light of the back-dating scandal?
5. If you conducted an investigation of historical grant dates, what was the extent of your investigation?
6. For new-hire grants (where the grant date is not the hire date), what date is vesting based on?
7. Did your external auditors apply additional procedures to validate the income statement impact of option grants?
A few days ago, I was quoted in this Indy Star article as saying that “outside directors should devote 200 hours or more a year to adequately do their jobs.” For those following governance, this shouldn’t be a bombshell as others have thrown around 200 hours as the post-SOX time commitment for quite a while (e.g. ABA’s Corporate Directors Handbook).
The article focused on the current President of Purdue University – Dr. Martin Jischke – who serves on three boards. The President is quoted in the article as saying that my 200 hour estimate “sounded high.” Probably proving that I take blogging too seriously, I decided to analyze his three directorships:
– Wabash National – According to the company’s 2006 proxy statement, the Board meet 5x during 2005 – and Dr. Jischke served on the board’s governance and compensation committees, which met 4x and 6x during 2005, respectively.
– Duke Realty – According to the company’s 2006 proxy statement, the Board meet 6x during 2005 (including 4 executive sessions for independent directors) – and Dr. Jischke served on the board’s compensation committee, which met 4x during 2005.
– Kerr-McGee (which was acquired last August; Dr. Jischke recently joined Vectren’s board) – According to the company’s 2006 proxy statement, the Board meet 14x during 2005 – and Dr. Jischke served on the board’s governance and compensation committees, which met 4x and 4x during 2005, respectively.
So, during 2005, assuming that Dr. Jischke attended all of the board meetings for these three companies (he did attend at least 75% for each company; otherwise there would be proxy disclosure that he hadn’t), he attended 25 board meetings and 22 committee meetings (not counting executive sessions, etc.).
Being generous in my calculations, let’s assume Dr. Jischke spent 8 hours per board meeting (which includes the time spent at a companion committee meeting, travel time, etc.). Based on this assumption, I figure Dr. Jischke spent 200 hours alone just sitting in board-related meetings (i.e. 25 x 8 hours).
Now, I recognize that one of Dr. Jischke’s companies was pondering a merger during 2005 and thus held an unusually large number of meetings – but if you sit on three boards, odds are that one of them will be in crisis mode or considering extraordinary events at any given time. But even if I was to presume “normal times” for each company on which he serves – and cut the number of board meetings for the mergerd company in half – I still come up with Dr. Jischke spending 150 hours for board-related meetings each year.
And in this age of close director scrutiny when it comes to the duty of care, I don’t see how a director doesn’t spend at least one hour doing board-related reading and research for each hour of meeting. Putting my “final answer” of 150 hours meeting plus 150 hours preparing = 300 hours per year. So I think I have room to argue that my estimate of 200 hours was even conservative if you’re doing the job properly.
Apparently, my blog on Friday about the Direct Registration System – as it relates to amending by-laws to ensure companies are DRS-eligible – hit a nerve as I received quite a few emails in response. There appears to be a debate regarding whether – and under what circumstances – companies need to amend their bylaws to permit uncertificated shares.
Section 158 of the Delaware General Corporation Law permits shares of stock to be either certificated or uncertificated, in the discretion of a company’s board – the 2005 amendments to Section 158 went further, removing the statutory entitlement for holders of uncertificated shares to request an executed certificate for their shares. Many other states – including both Georgia and New York – followed Delaware’s lead and now permit the issuance of uncertificated shares (Section 14-2-626 of Georgia Business Corporation Code and Section 508 of the New York General Business Law).
The Debate Under Delaware Law
Section 158 permits companies to issue uncertificated shares if authorized by board resolution. However, many companies have by-laws that expressly provide that “all stockholders shall be entitled to receive certificates,” or, in even stronger language, that “all shares shall be represented by certificates.” Based on a common-sense reading of such bylaw provisions, one could view them as stand-alone requirements that are not overridden by Section 158. In comparison, by-laws that merely provide that “shareholders are entitled
to certificates” are less likely to be viewed as a stand-alone requirement.
What’s Happening in Practice (So Far)
It appears that there are different views among (and even within) Delaware law firms as to whether – and under which circumstances – one can interpret Section 158 as authorizing companies to issue uncertificated shares under the various permutations of certificate requirements that exist in the bylaws that exist today. This division is reflected in practice out there so far. For example, Paul Blumenstein of DLA Piper notes that he looked up the bylaws of a dozen or so “name brand” companies included in the list of DRS-eligible companies set forth in the SIA Dematerialization Guide – and in only two of them was he able to find language permitting the board to authorize uncertificated shares.
In describing Watts Water Technologies Form 8-K with their amended bylaws, I stated that they “needed” to amend there bylaws to provide for noncertificated shares to become DRS eligible. I retract that thought in the wake of receiving member input.
For example, Eric Handler of Dewey Ballantine notes that Watts Water’s by-laws, prior to being amended, neither prohibited the issuance of noncertificated shares nor required the issuance of certificated shares only. Rather, they simply stated that the holders of stock shall be entitled to a certificate (which language was left in the bylaw even after the amendment). Eric notes that other large company’s such as McDonalds and Staples have DRS issues (according to Appendix 4.1 of the SIA Dematerialization Guide) and yet their by-laws contain no language expressly authorizing the issuance of noncertificated shares – in fact, the bylaws of those two companies contain the same “shall be entitled to a certificate” language as that found in Watts Water Technologies.
As Brink Dickerson and Curry Woods of Troutman Sanders have shared with me: Although there’s seems some ground to stand on that companies can rely on Section 158 without having to amend their by-laws, the safe thing to do would be to amend the bylaws – for those companies with by-laws that did not anticipate uncertificated share issuances – to provide clarity and transparent compliance with the new SRO rules. This just seems like the smart thing to do even though I understand that some companies prefer not to trigger an 8-K event if it can be avoided. At the end of the day, I don’t think companies should feel ashamed to file this type of an 8-K as I don’t think it reflects poorly on them.
After a longer delay than usual (as I blogged about recently), President Bush signed a continuing resolution on Thursday that allows the federal government to operate for the remainder of fiscal year ’07 (instead of the regular appropriations bill that Congress normally passes; Congress can’t get their act together this go around) – which triggered the filing fees cuts determined by the SEC last year (but which doesn’t go into effect until Congress acts).
These are significant cuts as SEC Chairman Cox notes in this press release. Starting today, registration fees are down to $30.70 per million, a 71% drop from the prior filing fee rate of $107.00 per million! The extended delay cost companies some real change this time around…
Recently, Nasdaq sent out a notice reminding listed companies that they must be using a transfer agent and have governing documents that enable them to participate in the Direct Registration Program, even if they don’t intend to actually participate in the Program. To be DRS-eligible, a company must allow for investors to hold their securities in book entry-only form (aka “uncertificated shares”).
All the exchanges adopted similar rules regarding the Direct Registration Program last summer, with a long phase-in period to enable companies to find new transfer agents or make changes to their by-laws if they needed to do so (eg. see the NYSE’s approval at page 3 and the SIA dematerialization guide on page 26).
There is a standard section in most by-laws about certificates that addresses form and it’s possible that some companies have a section that doesn’t provide for uncertificated securities. In this case, a by-law amendment would be in order (and I guess it’s also possible some by-laws that don’t permit uncertificated certificates and would require shareholder approval for such an amendment, but most by-laws have a provisions that permit the board to amend the by-laws).
However, few companies have needed to make by-law changes, since many companies already allow for uncertificated shares through ESOPs or DRIP programs, etc. Here is an example of one company that needed to make a by-law amendment recently to comply with the new DRS-eligible requirement: Watts Water Technologies filed a Form 8-K under Item 5.03.
IT Forensic Audits
In this podcast, Don Cox of Cyber-Tech Forensics explains how to protect a company’s assets, including:
– What should companies do to protect themselves against employees misusing computers?
– If someone deletes a document, is it really gone?
– What is involved with an IT computer audit?
Yes, blogs can live on even when their founders move on…meaning this blog may very well live well past my own lifetime and my mortality fades. Anyways, Bruce Carton has left ISS to join claims administrator Garden City Group and just started up the new “Best in Class” Blog.
[Kidnapping redux, don’t let it happen to you! Another round of airplanes sitting on the ground for 10 hours with no food, etc. Sign the petition today and support the “Stranded Passengers Bill of Rights”!]
With new Item 404(b) requiring that the proxy statement describe a company’s “policies and procedures for the review, approval, or ratification of any transaction required to be reported” by Item 404(a), our latest survey on these policies and procedures was popular. Below are the results from that survey (and please participate in our new survey on director resignations!):
1. Indicate which of the following you have in place (or are proposing) to implement for approval of related party transactions:
– A stand-alone policy statement regarding related person transactions – 42.5%
– Approval procedures regarding related person transactions covered in one or more board committee charters – 20.4%
– Approval procedures regarding related person transactions covered in our Code of Conduct – 19.5%
– Approval procedures regarding related person transactions covered in our corporate governance guidelines – 14.2%
– Approval procedures not included as part of any of the documents noted above – 10.6%
2. Indicate what process do you use (or are proposing) to use for approval of related party transactions:
– Pre-approval or pre-clearance of related person transactions – 61.8%
– Monthly review of related person transactions after-the-fact – 0%
– Quarterly review of related person transactions after-the-fact – 5.6%
– Annual review of related person transactions after-the-fact – 12.4%
– Periodic review of related person transactions, with timing tied to board/board committee meetings after-the-fact – 14.6%
– Other – 5.6%
3. If someone is responsible for reviewing related person transactions, which of the following will undertake that task:
– Full board – 12.2%
– Board committee – 76.7%
– Board committee chair – 8.9%
– General counsel – 35.6%
– Securities counsel – 23.3%
– Other type of inhouse lawyer – 1.1%
– Head of human resources – 2.2%
– Chief compliance officer – 7.8%
– CFO or controller – 11.1%
– Other – 2.2%
SAB 108 Disclosure Trends
As we were reminded by Corp Fin Chief Accountant Carol Stacey during “SEC Speaks,” the one-time relief granted in connection with restatements under SAB 108 is not a general amnesty for prior period restatements. The Staff expects companies to restate prior period financial statements for material errors if management failed previously to appropriately apply either the iron curtain or rollover method (whichever method it had previously selected to use) including the proper consideration of all relevant quantitative and qualitative factors.
Recently, the SEC and the DOJ jointly filed an amicus curie brief in the Tellabs case pending on writ of certiorari before the US Supreme Court, in which the agencies urge the Court to adopt a restrictive test that plaintiffs must satisfy in order to meet the heightened pleading standard under the Private Securities Litigation Reform Act. Kevin LeCroix does a great job exploring what this means in his “D&O Diary” Blog – and here is a related article from Business Week and an article from NY Times.
In our “Conference Notes” Practice Area, we have posted notes from the Accounting panel and workshop from the PLI “SEC Speaks” Conference. No big surprise for those avidly following this blog, SEC Chief Accountant Conrad Hewitt spoke about how he wants to add liability limits for audit firms to AS #5 at the Conference.
By the way, following up on the global accounting “roadmap” announced back in the spring of 2005, the SEC has announced it will hold a Roundtable on this topic on March 6th.
The SEC’s 8-K Rule Changes: How They Impact You
Join SEC Staffer David Lynn, Alan Dye and Ron Mueller tomorrow for the CompensationStandards.com webcast: “The SEC’s 8-K Rule Changes: How They Impact You.” This is Part III of our Web Conference regarding the SEC’s new executive compensation rules.
As an aside, following up on my blog yesterday about the ability to file preliminary proxy statements without exec comp disclosures, Corp Fin tweaked Interp 1.04 of the newly minted Item 402 FAQs (ie. 1.04 relating to FAQs of “General Applicability”; the numbering system for the new interps can be a little confusing) yesterday to reflect what was said at SEC Speaks. Of course, companies can choose to file preliminary proxy statements with the exec comp disclosure as Baker Hughes recently did…
Backdated Options: IRS’ New “Tax Reprieve” Program
Last week, the IRS launched a new initiative for rank and file employees that unwittingly received backdated stock options. Here is the IRS announcement – and here is the related IRS press release.
Under the voluntary initiative, companies are allowed to pay the 20% penalty plus interest tax owed by employees – but they are not allowed to pay for the taxes on backdated options for Section 16 officers and other insiders and directors. This relief is available only for options that vested in 2005 and 2006 and were exercised last year – and the amounts paid to cover these additional taxes will be treated as compensation income for those employees in 2007 tax year.
For companies that plan to participate in the program, they must notify the IRS by February 28th and notify the affected employees by March 15. If they do decide to participate, companies will be expected to provide detailed information about the backdated options, including the tax calculation sufficient to allow the IRS to determine that the Treasury received all taxes owed.
Given the February 28th deadline, this 20-minute podcast on “IRS’ Voluntary Initiative for Backdated Options” on CompensationStandards.com with “Handy” Hevener of Baker & McKenzie is timely and should be very useful for those companies with backdating issues. Handy is one of the more experienced practitioners out there when it comes to dealing with the IRS. The podcast is a big audio file so give it a minute to download…