Monthly Archives: August 2007

August 30, 2007

Auditors Must Help Stem Subprime Defaults? A Rebuttal

Lynn Turner notes: The Honorable Senator Charles Schumer’s efforts described in this letter to the Big 4 are greatly misplaced (ed. note: the letter is posted in our “Credit Arrangements” Practice Area). Auditors did not make the problematic subprime loans, did not rate them or decide the terms on which the loans were made and certainly do not collect the loans. Now the Senator thinks auditors should fix the problem of subprime loans through greater obfusction and a lack of transparency by keeping these loans “off-balance sheet” in SPEs when the loans are restructured, as he pushes new accounting positions taken as a result of the credit and liquidity problems affecting the markets. He is also arguing auditors should get into the management of the loan portfolio and insist the loans be restructured. A unique role for independent auditors.

The Senator has jointly issued a report saying the US capital markets are not competitive. The current crisis also indicates they do not always act in a reasoned fashion, with appropriate pricing of risks. As a result, they are now requiring federal government intervention.

Unfortunately, some home owners and investors are both being hurt by the recent developments. Yet the reality of it is that borrowers will either have the ability to repay the required cash payments or some portion of the payments, or go into full default. If the borrowers can’t pay all the required payments, someone (the ultimate lendor/investor) has incurred a loss, which is less than transparent in these SPEs. If a home owner in default doesn’t make their payments, there is no way it doesn’t result in an economic loss for investors.

(Interestingly, it was Senator Schumer who inserted the language into Sarbanes-Oxley requiring a study of off-balance sheet financings and their magnitude so there would be increased transparency. He initially discussed language that would have required all the SPEs to be on the balance sheet, but ultimately went the study route.)

When it comes to contributing factors to the subprime credit and liquidity problems, it was the Senate Banking committee – of which the Senator is a member – that stood idly by, after being forewarned a year ago about the lax underwriting standards that existed and which have directly contributed to the problem. Unfortunately, it is perhaps worth remembering that USA Today reported that Senator Schumer took very substantial sums of money from Enron – and returned it after being embarrassed by the company’s scandal.

Perhaps even more important, on a going forward note, the banking regulators are considering a new regulation that will determine the amount of capital banks keep on hand, which provides them with a “cushion” of assets in the event of a financial crisis. This new regulation is called Basel II. However, the Chairman of the FDIC, which uses the backing of taxpayers to ensure deposits, has warned the new regulations if adopted without safeguards will INCREASE – not DECREASE – the susceptability of the financial system to a future crisis.

Will the Subprime Meltdown Affect the D&O Marketplace?

I feel like I could blog about the subprime meltdown continuously for weeks. Kevin LaCroix continues to do a great job as he analyzes how the meltdown might impact the D&O insurance market in his “D&O Diary” Blog.

Next Financial Crisis Starts Here

This Financial Times column by Clive Crook from last Thursday is worth reading:

“Washington is deserted in August, so demands for a political response to the financial-market debacle have been muted. Rest assured, this will change. The problem will not be dealt with by next month – things could easily get worse before they get better – and some appealing suspects are just asking for a regulatory beating. Enron and the other corporate scandals begat Sarbanes-Oxley. What will the subprime mortgage meltdown bring forth?

Observers of the subprime mortgage business (not counting those who work for it) had been predicting a breakdown for quite a while. Regulated banks do little if any such lending. Bank affiliates or independent mortgage companies have built the business – and they are, respectively, lightly regulated or virtually unregulated. They lent eagerly to borrowers of limited means, often on patently reckless terms (initially low “teaser” rates switching to expensive variable rates; interest-only loans; loans whose principal increased over time). Everything was premised on perpetually rising house prices.

The Federal Reserve was worried, but mainly on consumer-protection, not systemic-risk grounds. Lacking the will and the authority, it mostly failed to act and the business boomed. A lot of people who otherwise would have been unable to buy a house did so, which is good. How many of them hang on to their houses as this credit cycle unwinds, however, remains to be seen. Legislation will be needed to bring all mortgage lenders under the Fed’s supervision, so that basic standards of prudence can be enforced. This much seems likely to happen.

The harder question is whether new rules are needed for the wider financial system. On the face of it, the answer is Yes. One rationale for excluding non-bank lenders from Fed scrutiny is that they pose no systemic risk. So much for that. Wall Street financed the subprime boom by buying the loans – repackaged as securities, stamped AAA by the credit-rating agencies – and selling them on. This model, of course, made the original lenders even less attentive to loan quality. On the other hand, it spread the risk throughout the system, which was also thought to be a good thing – until the loans started to go bad. Then, it turned out, investors wanted to know where the risk was and nobody could say. Arriving as if from nowhere, that fear led to the freezing up of the credit system.

How are regulators to grapple with this? If the opacity of the system is the problem, then new scrutiny and disclosure requirements for secretive investors such as hedge funds and private-equity firms must be part of the remedy. But it could be that complexity, more than lack of transparency in its own right, is the issue. The accelerated pace of financial innovation and the ever-proliferating complication of modern financial instruments seem to defy the ability even of the products’ designers to fathom what is going on. And the new instruments are often thinly traded, if at all, so values are guessed by simulation or calculation, not in the market. Sophisticated investors are left poorly informed about the risks they are bearing; unsophisticated investors have not got a clue. Desirable as fuller disclosure by hedge funds and private equity firms may be, it is hard to believe that it will be enough.

In other words, financial innovation itself is the problem. This poses a dilemma. The benefits of modern finance are real: as its champions rightly say, it deserves much of the credit for the relative stability of the world economy in the past two decades. Stifling this innovation, or attempting to manage it, looks unpromising.

Part of the answer – and, along with fuller scrutiny, perhaps the best that can be done – is to create a climate where excessive risk-taking is more effectively discouraged, and punished when things go wrong. Here the role of the Fed is crucial, both in the boom phase of speculative cycles and in the bust. Fast-rising house and other asset prices have been buoyed by very low interest rates. It was enough for the Fed that consumer-price inflation was low; asset prices, in their own right, were not its concern. This set the scene for America’s remarkable debt-fuelled house-price surge – whose inevitable end was the proximate cause of the subprime collapse. The Fed’s long-maintained reluctance to weigh asset prices in its monetary policy calculations needs to go.

Then, when financial markets seize up, the Fed must take care, as far as possible, to avoid bailing out the culprits. As the economists, Willem Buiter and Anne Sibert, have argued, the Fed was wrong to cut the discount rate last week, and will compound the error if it soon cuts the more important Fed funds rate as many now expect – unless there is evidence of harm spreading to the real economy. Instead, honouring Walter Bagehot’s maxim, it should provide liquidity at a penalty rate (against conservatively valued collateral) to those so lacking in liquidity that they are willing to pay it. That memorably costly help should be available not just to banks, as now, but to hedge funds and other financial firms willing to accept the Fed’s terms.

It is a cliché, but nonetheless true, that the end of each financial crisis sows the seeds of the next. Better regulation has a place, but the Fed is the key to attacking that cycle.”

– Broc Romanek

August 29, 2007

Chancellor Chandler Refuses to Dismiss Options Springloading Lawsuit – Again

On August 15th, Delaware Chancellor Chandler again refused to dismiss a lawsuit against Tyson Foods directors over the alleged “spring-loading” of stock options. Kevin LaCroix notes in his “D&O Diary” Blog that the Tyson ruling is noteworthy because of Chancellor Chandler’s conclusion the directors may have failed to provide the disclosure required by their fiduciary duties. The Chancellor’s first refusal to dismiss came in February. Both court opinions are posted in our “Backdated Options” Practice Area on

More than 100 companies face lawsuits over option grant practices – and over 220 companies have disclosed that they are being investigated by regulators. Most lawsuits alleged backdating of option grants to coincide with share price declines; very few allege spring-loading. And, so far, all SEC Enforcement activity has challenged backdating, not spring-loading.

Backdating: Are the Lawyers to Blame?

Lately, the SEC has been charging quite a few lawyers over their roles in option backdating. In fact, the SEC charged one lawyer yesterday for her role in backdating at two different companies. Yesterday, ran this interesting article entitled “Backdating: Are the Lawyers to Blame?

Backdated Options: AFL-CIO Pressures Big 4 Directly

Here is a copy of the letter that I understand went to each of the heads of each of the Big 4 accounting firms from the AFL-CIO. It provides a view on what auditors should know about option procedures and processes – and steps auditors should be performing when auditing issues related to options.

– Broc Romanek

August 28, 2007

The Executive Compensation Comment Letters: Analysis & Guidance

Last week, the SEC Staff began sending the first wave of comment letters on proxy statements, as part of Phase One of its compensation disclosure review project. We thank the many of you that sent your comment letters to us on a confidential basis. We have read all of them and have been busy putting pen to paper.

You will not want to miss the upcoming Sept-Oct issue of The Corporate Executive. In this issue, we will be providing important analysis and guidance regarding the SEC’s comments and concerns – in other words, specific guidance about how to respond and what types of changes most companies will need to make to their disclosures. This critical issue will be mailed right after Labor Day.

Act Now: If you are not currently a subscriber to The Corporate Executive, just take advantage of the no-risk trial—which will enable you to receive the balance of this year’s issues at no charge as part of the 2008 no-risk trial. You may also now renew your subscription to The Corporate Executive for 2008.

Introducing the “New” Herb Scholl

In Corp Fin, Patti Dennis is taking over Herb Scholl’s old job as Chief of the Office of Disclosure Support (formerly known as the “Office of EDGAR and Information Analysis”). Patti had been serving as one of the Special Counsels in Corp Fin’s Office of Enforcement Liaison.

Wanna New Client? Take Your Law Firm Public

Bruce MacEwen’s “Adam Smith” Blog contains an interview with the Managing Partner of Australia’s Slater & Gordon, the first law firm to do an IPO.

[Fyi, if you are interested in lawyers that blog, this annual free BlawgWorld guide contains representative samples from 77 leading law-related blogs, including yours truly.]

– Broc Romanek

August 27, 2007

Almost Half of Directors Serve on Only One Board: A Trend to Watch?

According to a PricewaterhouseCoopers/Corporate Board Member Study from earlier this year, 47% of directors sit on only one public company board – and a total of 78% sit on either one or two. Clearly, the issue of “overboarding” has come to director’s attention (although a more likely factor is the growing time commitment of serving on a board). But this trend poses a new dilemma: is there now sufficient cross-fertilization on boards?

Although it’s too early to tell, I think this trend is not problematic if most of those directors serving on only one board have sat on other boards previously (which I think will likely be the case). This trend could become a problem a decade or so in the future as it becomes less likely that directors have extensive board experience. And of course, it all depends on the individual – seem people are willing to ask the hard questions right off the bat. But most need to sit in a boardroom for a while to understand the boardroom dynamic and learn the mindset of what it means to be a director.

A Dust-Up over a Ditty

Recently, the “Above the Law” Blog has had a spat with Nixon Peabody over a song that celebrates the firm’s “Best Places to Work” recognition. Apparently, the song was not supposed to be released to the public. Unfortunately, the firm appears to be making a stink out of the song posting and there are dozens of critical comments posted on the blog’s site, including someone who went to the trouble of transcribing the text of the song. Here is a follow-up blog.

I did find the song somewhat funny (you know, “funny” in that nerdy way that lawyers can sometimes get), but not offensive in any way. In fact, if the song had been used for marketing purposes, I would have applauded the firm for doing something novel to set it apart. Law firms should be leveraging the Web for its multi-media abilities.

I first heard the song because it was e-mailed to me and I went to their home page to confirm they are an innovator – and indeed, it seems they are: they have posted an ad campaign and branded their practice as being “Legally Green.” Pretty forward-thinking stuff, as I think the legal profession should stop pretending that it’s not a business and start marketing like one…

Delaware Gloss on Advancement of Legal Fees

From Travis Laster: The scope of an individual’s advancement rights is an issue frequently implicated by criminal, regulatory or internal investigations, particularly where a company is concerned about advancing expenses to someone believed to be a wrongdoer. Delaware case law traditionally has dealt with mandatory advancement rights and has consistently held that mandatory provisions must be enforced according to their terms. A recent Delaware decision, Thompson v. The Williams Companies, Inc., C.A. No. 2716 (July 31, 2007), sheds light on the types of conditions a board of directors can place on permissive, i.e. non-mandatory, advancement rights. This case is an under-the-radar decision that offers particularized guidance to practitioners.

The Thompson case involved an employee who was first investigated and later indicted for participating in a conspiracy to manipulate the price of natural gas. The corporation’s bylaws provided for permissive advancement to directors and officers. For employees, the bylaw stated, “Such expenses incurred by other employees and agents shall be paid upon such terms and conditions, if any, as the Board of Directors deems appropriate.” Vice Chancellor Strine had no difficulty holding that this was a permissive grant of advancements and that the stray use of “shall” did not convert the provision into a mandatory right.

The board of directors in Thompson conditioned its willingness to grant advancements on (i) financial statements or other evidence from Thompson substantiating his ability to repay the funds if he were not indemnified, (ii) dollar for dollar security for the funds, in the form of a bond, letter of credit, or similar arrangement, and (iii) a certification by the employee that he believed himself entitled to indemnification. The employee challenged each of these conditions as unreasonable.

VC Strine held that in determining whether to grant advancements, the board could impose any condition that was not “arbitrary” and was “rationally related to a proper corporate interest.” As examples of arbitrary conditions, the Court offered “a requirement that Thompson walk a tight-rope between skyscrapers … or … post security worth five times the amount advanced.” The decision to impose conditions on a permissive advancement right is thus a matter of business judgment.

The Court found that each of the proposed conditions was one that “rational directors might believe necessary to protect [the corporation’s] legitimate interests” and therefore represented an appropriate business judgment. The board did not have any duty to offer the employee “terms and conditions that permit him to receive advancements.” Nor did the board have a duty to treat all persons receiving advancements equally. VC Strine declined to “read 14th
Amendment-like protections against unequal treatment into discretionary contracts governing the relationship of corporations and their executives.” VC Strine upheld each of the conditions imposed by the corporation.

Given the lack of precedent on permissive advancement rights, the Thompson decision provides a helpful guide for both the types of conditions that are appropriate and the standard by which conditions will be judged. Note, however, that the case involved a disinterested board addressing advancements for an employee. The case did not involve a board granting discretionary advancements to itself, which remains a self-interested decision to which entire fairness applies under Havens v. Attar, C.A. No. 15134 (Jan. 30, 1997).

– Broc Romanek

August 24, 2007

Five Majorities for “Say on Pay” So Far

Over the past few weeks, five separate shareholder proposals asking for an annual advisory vote on executive pay have received a majority vote. According to ISS’ “Corporate Governance” Blog, a majority vote has been achieved at Valero Energy, Ingersoll-Rand, Motorola, Blockbuster and Verizon Communications.

So far this year, “say on pay” proposals have averaged 42.4% across 37 meetings in the first half of 2007 where results are known. In 2006 – the first year the proposals appeared on US ballots – seven proposals went to a vote and averaged 40% support.

Divining “The Future of the World”

Come and enjoy the latest installment of “The Sarbanes-Oxley Report” entitled “The Future of the World.” There’s a nod to “The Graduate” hidden in it…

Governance Posterchild of the Year: The Smithsonian

It’s early, but I doubt any institution will trip up on governance this year as much as the Smithsonian. The fascinating 112-page internal investigation report provides shocking details regarding a cover up of expenses of the Smithsonian’s former top executive. It also highlights severe weaknesses in governance, internal controls and financial reporting that existed for an extended period of time.

Part of the Report’s “shock and awe” is that the Smithsonian Board includes the Chief Justice of the Supreme Court, the Vice President of the United States (who I understand never attended a meeting) as well as other notable US Senators and Representatives. We have posted a copy of the Smithsonian report in our “Internal Investigations” Practice Area.

August 23, 2007

Looming 409A Deadline: Large Group of Law Firms Plead for Postponement

Quite a few law firms have been sending memos to clients in recent days warning of the pitfalls of the upcoming 409A deadlines, which will require many companies to make changes to their deferred compensation arrangements. A few days ago, 92 of America’s most prominent law firms sent a letter to the IRS and Treasury asking that the 409A deadline get pushed back to the end of 2008. We have posted this letter in the “Deferred Compensation Arrangements” Practice Area on

The New “Billable Hour” Gold Standard: $1,000 Per

Yesterday, the WSJ ran this article about the growing number of attorneys that now charge $1,000 per hour. Certainly makes our humble websites seem like a bargain…

A Second Night of Music

The NASPP is excited to announce a second night of music and dancing at the 2007 NASPP Annual Conference. On Thursday, October 11th, Merrill Lynch is sponsoring a gala reception featuring the band “Café R&B.” We hope you will join the NASPP for this high-energy rhythm and blues band, which promises to be an exciting evening of entertainment. Note that the concert is offered to NASPP Conference session attendees only; advance registration is not required.

Register Now for the 2007 NASPP Annual Conference: Don’t miss this year’s keynote presentation by the SEC’s Division of Enforcement Director Linda Chatman Thomsen, catch the latest on Section 409A from current and former IRS and Treasury staff, and learn about best practices and developments in 123(R) and stock plan accounting. The NASPP Conference features a full two and a half day program of critical updates and practical guidance; read the “Top Ten Reasons You Need to Attend.” As a bonus, the Conference includes’s “4th Annual Executive Compensation Conference.”

– Broc Romanek

August 22, 2007

They’re Here! Corp Fin Comments on Executive Compensation Disclosures

It appears that the SEC Staff has begun sending its first wave of comment letters on proxy statements, as part of Phase One of its compensation disclosure review project (Phase Two will involve a Staff report that summarizes what the Staff has seen overall – and more importantly, what the Staff expects next year). Often, Corp Fin Staffers are calling in advance to warn of a comment letter being faxed. A few members have already forwarded a few of these letters to me – and I hear that the flood gates are about to open.

If you receive a comment letter, please share it with us. I promise we will not post it nor forward it (nor publicize it or the company in any way); we just want to observe the comment letter trends since we will be providing guidance regarding how you should be drafting executive compensation disclosures going forward in the upcoming Sept-Oct issues of The Corporate Executive and The Corporate Counsel. Both of these special issues will be mailed sometime after Labor Day. To receive these issues, try a “No-Risk Trial” at 1/2 price for the rest of the year.

And of course, join John White and Paula Dubberly of Corp Fin – as well as a host of other exec comp disclosure experts – for our upcoming Conference: “Tackling Your 2008 Compensation Disclosures: The 2nd Annual Proxy Disclosure Conference.” You can attend either live in San Francisco or by nationwide video webcast. Register today!

Now Available: SEC’s Comment Letters on Blackstone’s IPO

Speaking of comment letters, I note that the Staff has posted its comments on the Blackstone IPO prospectus. The SEC’s database can be a bit hard to navigate, so here are direct links to the comment letters:

Form S-1

Amendment No. 1

Amendment No. 2

Amendment No. 3 (accounting comments)

Amendment No. 3 (tax opinion comment)

Amendment No. 4

The responses are embedded in the cover letter of the amended filings (we wrote about the practice of burying responses within filings on page 6 of our Nov-Dec 2005 issue of The Corporate Counsel) as follows:

Response to comments on Form S-1

Response to comments on Amendment No 1

Response to comments on Amendment No. 2

Response to comments on Amendment No. 3

Response to comments on Amendment No. 4

If you’re wondering when comments are typically made public, you might recall that the Staff’s informal policy is that comments and responses will be posted “no earlier than 45 days from when comments are cleared.”

Improving the Public Comment Process

Here’s an entry from Professor Bainbridge’s Blog that I have been meaning to share for quite some time: “The US PTO has come up with a very interesting idea: The Patent and Trademark Office is starting a pilot project that will not only post patent applications on the Web and invite comments but also use a community rating system designed to push the most respected comments to the top of the file, for serious consideration by the agency’s examiners.

Why not do the same thing for other administrative actions? For example, like all other federal agencies, the SEC currently invites public comments on rulemaking prceedings, but lacks the community rating system. Given the widely available technology for creating such a system, however, there’s no reason why the SEC couldn’t follow in the PTO’s footsteps. Comments by respected securities law academics (ahem) presumably would get pushed up, while duplicate astroturf comments presumably get pushed down. Or maybe not, as we might see astroturf campaigns to affect the ratings. Yet, it seems a worthwhile experiment.

If adopted, an area of particular interest will be the possible intersection with judicial review. Suppose the most respected commenters propose A, but the agency adopts B. Should a reviewing court give less deference to the agency in such cases?”

– Broc Romanek

August 21, 2007

Activism on the Rise: CalPERS Doubles Shareholder Proposals

Recently, the California Public Employees’ Retirement System announced that it had doubled the number of shareholder proposals submitted to companies in fiscal 2007, bringing the number of proposals to 33. CalPERS reports that only six out of the 33 proposals actually appeared in proxy materials, with several proposals withdrawn “mostly in response to companies’ agreement to adopt the proposed corporate governance practices.” CalPERS also noted that all six of its proposals appearing in proxy ballots received investor votes averaging over 60 percent.

CalPERS increased its proxy solicitor pool from one to three in order to campaign for more votes. Further, CalPERS reports that it stepped up “policy reform engagements” with the SEC, the NYSE, the European Union and the Tokyo Stock Exchange.

One interesting trend is that while activism by organizations such as CalPERs has certainly increased, the workload for the SEC on shareholder proposals has steadily declined over the past few years. In a speech last week, John White indicated that the Staff has received and responded to 356 no-action letter requests seeking to exclude shareholder proposals this fiscal year, compared to 370 for the same period last year. These numbers are down sharply from roughly 450 no-action requests in 2005 and 2004. Less no-action requests at the SEC no doubt signals more success on the negotiation front, and perhaps more instances of companies running shareholder proposals rather than going through the process of seeking to exclude them.

Carol Stacey Speaks on Interaction with the SEC Staff and Current Accounting Issues

Former Corp Fin Chief Accountant Carol Stacey has been on the interview circuit these days in her new role as a Vice President at the SEC Institute. In this interview with, Carol talks about such things as her perspective on communications with the SEC Staff, complexity, and the future of IFRS and convergence.

On the topic of further SEC guidance on materiality, Carol notes: “I think the staff of the SEC and potentially the commission itself will look at some other areas of materiality, as the staff has already talked publicly about doing. There are some areas that people struggle with all the time, like if you find an error in a quarter, what’s material to a quarter versus a year? That’s one area the staff is looking seriously at and they’re talking to some groups from the outside to get their views. I wouldn’t be surprised to see the staff come out with something along those lines. So far it’s been staff-level guidance in the form of staff accounting bulletins, and I wonder if the commissioners are thinking at some point about whether they need to provide guidance themselves. There have been so many calls for them to do something.”

In terms of what this sort of SEC materiality guidance might look like, Carol states: “The qualitative factors in, for instance, SAB 99, suggest to investors that if you somehow trip one of these qualitative factors, it’s material. A lot of people have struggled with that because the qualitative factors are mainly geared toward a small error being qualitatively material. And there are other situations where you could have a quantitatively larger error that’s immaterial and it could be for various reasons, such as it’s a break-even year. But there are no good quantitative factors that address that in SAB 99, so the SEC could step back and say they need more robust materiality guidance that really covers a lot more fact patterns that the one that SAB 99 covers. Maybe they won’t issue a new definition per se but more helpful guidance to help people in different situations.”

FCPA Legislation Introduced

Two members of the House of Representatives are interested in significantly raising the stakes for violations of the Foreign Corrupt Practices Act. Earlier this month, Congressman Gene Green (D-TX) and Congressman Tim Ryan (D-OH) introduced a bill that would require persons and entities to certify that they have not violated foreign corrupt practices statutes before being awarded government contracts. The bill has been referred to the House Committee on Oversight and Government Reform. The recent high profile of FCPA cases has no doubt attracted this Congressional interest, and the business implications of this legislation would be severe for the multinational companies that you typically see as the subjects of FCPA investigations.

Reputation and Communications Implications of the Whole Foods Message Board Fiasco

While the Whole Foods Markets takeover of Wild Oats Markets was put on ice yesterday by the U.S. Court of Appeals for the DC Circuit, perhaps the most notable thing to date arising from that transaction has been the revelation last month that Whole Foods CEO John Mackey had been posting anonymous messages about his company and Wild Oats Markets on a Yahoo message board.

In this podcast, Rhoda Weiss, the National Chair and CEO of the Public Relations Society of America (PRSA), provides insight on the corporate reputation and communications issues arising in the Whole Foods situation, including:

– What is the PRSA?
– How important are ethical considerations to public relations professionals in their day-to-day work and in the way they advise clients and senior management?
– What does PRSA’s Code of Ethics basically say, and how does it apply to an executive’s misuse of Internet-drive communications and social media?
– From PRSA’s standpoint, what are the ethical implications of corporate executives engaging in online discussion forums under an assumed name – particularly in discussing anything of material significance about their own companies?
– What should the recent Whole Foods situation in general tell CEOs and other corporate executives about the do’s and don’ts of using social media?
– What about the trust factor – what is the impact on the level of trust that people have in a company when a key executive is accused of wrongdoing?
– How might a company best respond when faced with “white-collar” crises that are management driven?

– Dave Lynn

August 20, 2007

Earnings Guidance: Beginning to Take the Long View?

Broc recently blogged about efforts to move away from the quarterly earnings guidance grind, including the desire by many CFOs to see the practice of quarterly earnings guidance go the way of the dinosaur. A recent NIRI survey suggests that while there are some encouraging developments on the earning guidance front, radical change in this practice is certainly not going to happen overnight.

Of the companies responding to the NIRI survey, 34% indicated that they had discontinued guidance within the past 5 years. Those who discontinued guidance reported a relatively indifferent reaction from the investor community (62% reported indifference from the sell side while 47% reported indifference from the buy side), along with a generally positive reaction from senior management (88% reported a positive management reaction). For those survey respondents discontinuing guidance, most reported either a neutral impact on the company’s stock valuation (45%), or no opinion about the impact on stock valuation (42%).

Among those companies that continue to provide guidance, the vast majority reported providing guidance on earnings per share and revenue. Of the survey respondents providing guidance, 82% cited the need to ensure sell-side consensus and that market expectations are reasonable as the reasons for continuing to provide guidance on quantifiable financial measurements. Only 27% of the companies reported providing guidance for quarterly estimates, with 58% reporting that they provide annual estimates. 82% of the companies providing guidance indicate that they were not considering changing the frequency with which they provide that guidance. Unfortunately for all of those CFOs out there who would like to see an end to earnings guidance, a surprising 90% of the survey respondents indicated that their company was not considering any change to the policy of providing earnings guidance.

We will continue to update our “Earnings Releases” Practice Area with information on the latest earnings guidance developments.

Options Backdating: Former Brocade CFO Charged With Turning a Blind Eye to Misconduct

On Friday, the SEC announced charges against the former CFO and COO of Brocade Communications Systems for his involvement in the company’s options backdating efforts. These charges come shortly after the criminal conviction of former Brocade CEO Gregory Reyes, which Broc blogged about earlier this month.

According to the SEC’s complaint, Michael J. Byrd was allegedly involved in the backdating practices in his role as CFO and later as COO of Brocade. The allegations point out Byrd’s involvement with backdated grants to new employees through the company’s so-called “part-time” program, where, in order to establish a tortured basis for meeting an accounting interpretation of the definition of an “employee,” new hires were to be paid for “four hours a week until they start.” It is alleged that option grants were made through offer letters dated well in advance of the actual hiring decision, along with directives to treat the employees as part-time from the date the options were granted. Byrd is also alleged to have been involved with interviewing and hiring candidates – thus fully aware of the timing of these events – while at the same time signing minutes of purported Committee meetings designating earlier (and advantageous) hiring dates. The complaint alleges that Byrd received one backdated grant, and he is charged with filing a false Form 5 reporting that grant.

As noted in this article, Byrd was originally expected to testify at the criminal trial for Reyes, but for unknown reasons the prosecution never called him as a witness. The article states: “In a follow-up interview with, Potter [Byrd’s attorney] said he did not know why Byrd was never called, but said his client had cooperated fully with both the SEC and the DoJ as a witness, and that at no point in the investigation had his client assumed status as a target of federal prosecutors. ‘He never entered into a cooperation agreement,’ Potter told ‘He volunteered his cooperation as a witness.’”

Interestingly, despite Linda Chatman Thomsen’s statement in the press release that “[t]his case confirms the Commission’s commitment to pursuing not just those who perpetrate financial fraud, but the corporate gatekeepers who allow it to happen on their watch,” no officer and director bar is sought for Byrd. The SEC is seeking only disgorgement and civil money penalties in this particular case, raising the question: “what does it take to get an O&D bar these days?”

Hewlett-Packard Sued by CNET Reporters over Spying Fiasco

Nearly a year has gone by since the details of Hewlett-Packard’s investigation into a boardroom leak began to surface, and there is no doubt that at this point H-P would like to move on from this scandal. Now, as reported last week in this CNET article, three reporters at CNET and members of two of the reporters’ families have decided to sue H-P in California state court. The plaintiffs seek unspecified damages for invasion of privacy, intentional infliction of emotional distress and violations of a state law prohibition against “unfair, fraudulent and deceptive practices.” Former H-P board of directors chair Patricia Dunn and former H-P attorney Kevin Hunsaker are also named as defendants in the lawsuit suit.

Prior to this lawsuit, justice had been relatively swift for H-P. The company had settled civil charges with California’s Attorney General, and also settled SEC disclosure charges earlier this year. Criminal charges against Dunn, Hunsaker and two others were dismissed. The practice of “pretexting” was also addressed in a surprisingly quick manner by Congress with the enactment of the Telephone Records and Privacy Protection Act of 2006, which was signed into law by the President back in January of this year.

– Dave Lynn

August 17, 2007

Update on Corp Fin Developments

At the American Bar Association meeting earlier this week, John White delivered this speech entitled “Corporation Finance in 2007 – An Interim Report.” The speech provides an update on the status of a number of projects that are happening in Corp Fin. Here are some highlights:

1. There are no plans for any further extensions for Section 404 compliance by non-accelerated filers.

2. The Staff is interested in hearing about experiences with implementing E-proxy so that they can make any changes necessary to maximize benefits while minimizing problems associated with the process.

3. On the executive compensation front, no rule changes are anticipated for this year. The Staff is getting ready to issue the first round of comment letters coming out of its exec comp review program. No letters have yet been issued, as the Staff has been holding on to them in order to ensure consistency. The Staff’s report on the first year of disclosures under the new rules will be out in time for next year’s proxy season. The big things that the Staff has been looking at in the course of its reviews are:

– analysis of the different components of compensation and change of control and termination payments;

– the adequacy of disclosure about performance targets;

– the justification for not disclosing performance targets, and the adequacy of the “degree of difficulty” disclosure provided instead;

– disclosure about benchmarking; and

– who makes the compensation decisions, including the role of the CEO and others in the process.

4. The Staff is committed to putting together a rule this fall from the two competing shareholder access proposals. The Staff is continuing to consider what to do about other issues that came up during the May proxy roundtables, including NYSE Rule 452, empty voting, over-voting, and shareholder communications.

5. With regard to interactive data, the Staff is working on a second prototype XBRL tool, which it hopes to release soon. This prototype will feature enhanced graphics and an easy search function. Expanded taxonomies are expected to be released for public testing and comment this fall. The much anticipated “Executive Compensation Disclosure Viewer” (it has a catchy name now) is still anticipated, and will be available some time this year. More progress on implementation of interactive data is expected in the near future.

6. On the PIPEs front, the Staff hopes that the pending proposal for opening up primary offerings on Form S-3 to smaller issuers and the proposal to shorten the holding period for Rule 144 will help give smaller issuers some alternatives to PIPEs financing.

7. The Staff still has the topic of “stealth restatements” and disclosure under Item 4.02 of Form 8-K on its agenda, although no proposals are ready on these issues.

8. The Staff is still considering possible rule proposals or guidance dealing with voluntary filers.

The Rise of Alternative Trading Platforms

This seems to be the summer of alternative trading platforms for unregistered securities. As Broc noted in the blog back in May, Goldman Sachs launched its new system called GS TRuE – short for Goldman Sachs Tradable Unregistered Equity. Earlier this week, Nasdaq rolled out its new and improved PORTAL trading platform, which is described as a centralized trading and negotiation system for Rule 144A securities. Now Citigroup, Lehman Brothers Holdings, Merrill Lynch, Morgan Stanley and Bank of New York Mellon announced that they are pulling together their considerable resources to launch OPUS-5, which is short for Open Platform for Unregistered Securities (I love the name on this one). OPUS-5 is expected to begin operations next month.

These trading platforms are popping up in an environment where there is an unprecedented amount of private money sloshing around the financial system. As noted in this Washington Post article on the PORTAL Market “[f]or the first time last year, corporate America raised more money – $162 billion – from private investors than from initial public offerings, which raised $154 billion from the three major U.S. stock markets – Nasdaq, the New York Stock Exchange and the American Stock Exchange.”

The SEC Staff recently issued an interpretive letter facilitating trading of the securities of foreign private issuers on the Nasdaq PORTAL Market. In the letter, the Staff indicated its view that a foreign private issuer would continue to be eligible to claim the exemption from SEC registration under Exchange Act Rule 12g3-2(b), notwithstanding the fact that the securities would be traded through the PORTAL market, because PORTAL would not be deemed an “automated inter-dealer quotation system” under Rule 12g3-2(d)(3).

There is no doubt that one thing we need right now is more liquidity in the markets, and that seems to be what these new trading platforms are all about.

Credit Rating Agencies Face Scrutiny

It has been a wild ride in the markets over the last few weeks, and that has got to mean somebody, somewhere is at fault. It is time once again to look for some gatekeepers who were not manning their gates, and it looks like the credit rating agencies are one of the prime targets this time around. A page one article in Wednesday’s WSJ noted:

“It was lenders that made the lenient loans, it was home buyers who sought out easy mortgages, and it was Wall Street underwriters that turned them into securities. But credit-rating firms also played a role in the subprime-mortgage boom that is now troubling financial markets. S&P, Moody’s Investors Service and Fitch Ratings gave top ratings to many securities built on the questionable loans, making the securities seem as safe as a Treasury bond.

Also helping spur the boom was a less-recognized role of the rating companies: their collaboration, behind the scenes, with the underwriters that were putting those securities together. Underwriters don’t just assemble a security out of home loans and ship it off to the credit raters to see what grade it gets. Instead, they work with rating companies while designing a mortgage bond or other security, making sure it gets high-enough ratings to be marketable.

The result of the rating firms’ collaboration and generally benign ratings of securities based on subprime mortgages was that more got marketed. And that meant additional leeway for lenient lenders making these loans to offer more of them.”

This is by no means the first time that the credit rating agencies have to take the heat for market troubles. This time around, however, they will be facing scrutiny as SEC-regulated entities. Back in June, final rules implementing the Credit Rating Agency Reform Act of 2006 and certain provisions of that Act went into effect, and the rating agencies filed their registrations with the SEC. The SEC’s new rules regarding rating agencies are outlined in this press release and in this adopting release. Check out our “Rating Agencies” Practice Area for more information.

While on the topic of the choppy markets, check out this timely music video from “Merle Hazard.” Thanks to Jack Ciesielski’s AAO Weblog for pointing out this gem. With this kind of competition, Billy Broc and Dave “the Animal” are going to have to tune up their crooning voices!

– Dave Lynn