As Broc noted in the blog last week, we posted an Advance Copy of our January-February 2008 Issue of The Corporate Executive to provide timely guidance for those currently drafting their CD&As. While many of the topics addressed in this issue relate to specific areas of concern raised by the Staff in its executive compensation review program, some of the model disclosures deal with areas where more analysis is necessary in your proxy statement even if not raised in the Staff’s review.
One of these areas is the discussion and analysis of stock ownership requirements, where compensation consultants are now expressing concerns that companies need to reassess their ownership guidelines because they are now too low, often dating back to a time when the value of equity grants was not as high and most equity awards were in the form of stock options. Our model disclosure highlights how a company might describe the compensation committee’s analysis (and adjustment) of the company’s stock ownership requirements.
Here is where you can access this Advance Copy now (you will need to renew for ’08 to receive it). Note that we will be mailing this issue to ’08 subscribers early in January. Feel free to let me or Broc know if you have any thoughts on the model disclosures in the Advance Copy. If you are not yet a subscriber, we encourage you to take advantage of a no-risk trial, which will give you immediate access to this important issue.
Changed Rule 144: Effective February 15th – Practical Guidance Coming
Yesterday, the SEC posted a conforming version of its Rule 144 adopting release to match what was just published in the Federal Register. Since the release has now been published, the effective date for the new rule is February 15th. The revised holding periods and other amendments are applicable to securities acquired before or after February 15th.
And since the new rule takes effect further out than expected, we have bumped back the date of our webconference – “New Rule 144: Everything You Need to Know – And Do NOW” – to Wednesday, January 30th. The conference will be archived in case that date doesn’t work for you.
Jesse Brill, Bob Barron and Alan Dye are busy working on the Key Conference Materials, which will provide the specific procedures, new memos, legends, representation letters, etc. that you will need to protect yourself. Some members have posted questions about the rule changes in our “Rule 144 Q&A Forum” and those will be answered during the conference.
Act Now: Protect your company (and your key executives and clients) and take advantage of reduced rates for those of you that use the TheCorporateCounsel.net and The Corporate Counsel by registering online or via this order form.
Yet Another SOX 404 Delay in the Works
In testimony before the House Committee on Small Business yesterday, Chairman Cox stated that he intends to propose that the SEC authorize a further one-year delay in implementation of the Section 404(b) audit requirement for non-accelerated filers. Without the delay, those issuers would have to comply with the audit requirement for fiscal years ending after December 15, 2008. Cox said that the delay is necessary so the Staff of the Office of Economic Analysis can complete a survey of the costs and benefits associated with implementing Section 404 requirements, which is expected to consist of a web-based survey and in-depth interviews with a subset of issuers.
I suspect that no delay for management’s assessment is warranted now that issuers have this “Section 404 Guide for Small Business.” The very happy people on the cover of this guide don’t seem to have a care in the world. They have obviously embraced the SEC’s new slogan for 404: “It doesn’t have to be a chore.”
At yesterday’s open meeting, the SEC adopted changes to Form S-3 that will allow eligible listed companies below $75 million in public float to register primary shelf offerings on Form S-3, provided that they do not sell more than the equivalent of one-third of their public float in primary offerings during any period of 12 calendar months. Here is the press release and Staff’s statement describing the changes to Form S-3 and Form F-3. The effective date for these amendments will be 30 days after their publication in the Federal Register.
The SEC raised the proposed 12-month offering limitation of 20 percent of public float to one-third of public float, reflecting commenters’ concerns that imposing a 20 percent cap on the amount of securities that could be sold over 12 months would prevent smaller issuers from satisfying their capital needs. Unfortunately for many potential issuers, along with the higher cap comes a new condition that eligible issuers must have at least one class of common equity securities listed and registered on a national securities exchange. As originally proposed, eligible smaller companies traded on the OTC Bulletin Board or the Pink Sheets would have been able to conduct limited primary shelf offerings off of Form S-3.
In making its recommendation to the Commission on this point, the Staff noted that the addition of the exchange-listing requirement was necessary “because the stock exchanges’ listing rules and procedures, as well as other requirements, provide an additional measure of protection for investors by providing listed status to issuers with sufficient public float, investor base, and trading interest to evidence that the market for the issuer’s security has the depth and liquidity necessary to maintain fair and orderly markets.” The imposition of the exchange-listing requirement will substantially narrow the group of issuers that will eligible for expanded shelf-eligibility from approximately 4,900 issuers (as noted in the proposing release) to 1,400 issuers (as noted in yesterday’s press release). As a result, non-listed smaller issuers will likely continue accessing capital through PIPEs and equity lines.
At the same meeting, the SEC adopted electronic filing for Form D, along with some changes to the information requirements for Form D. As noted in the Staff’s statement, the Form D amendments will not be effective until September 15, 2008, and then electronic filing will be on a voluntary basis until March 16, 2009.
The SEC also voted yesterday to issue a concept release on oil and gas disclosure requirements. Here is the press release and the Staff’s statement regarding that concept release.
XBRL: Closer to Reality
Last week, the SEC announced that it was soliciting public comment on the XBRL taxonomy developed to date, as well as instructions on how to prepare financial statements using XBRL. The taxonomy is said cover “every U.S. GAAP accounting concept — virtually every fact that a company might want to report on its financial statements and in its footnotes.”
The “taxonomy review tool” is publicly available from XBRL US and the public comment period ends on April 4, 2008. Get started early if you are interested – it takes some effort to just get set up to use the taxonomy review tool, and then there is quite a lot of information to review.
Casey and SEC Staff Speak at the AICPA Conference
Commissioner Casey and members of the SEC Staff covered a lot of ground on the accounting, auditing and internal control fronts at the 35th Annual AICPA National Conference in Washington earlier this week. Commissioner Casey noted in her speech that she would like to examine more data about costs before implementing the audit requirement for internal controls of non-accelerated filers (and that issue will likely be covered today in more detail by Chairman Cox when he testifies before the House Small Business Committee). The other topics covered by the Staff at the AICPA Conference were:
Last week, the SEC announced the largest settlement to date in an options backdating case, which included the first use by the SEC of the “clawback” provision under Section 304 of the Sarbanes-Oxley Act. The $468 million settlement was with William W. McGuire, M.D., the former Chief Executive Officer and Chairman of the Board of UnitedHealth Group. The SEC alleged that over a 12-year period, McGuire had caused UnitedHealth to grant backdated options to him and other UnitedHealth officers and employees.
Section 304 of the Sarbanes-Oxley Act provides that if an issuer is required to restate its financials as a result of misconduct, the Chief Executive Officer and Chief Financial Officer must reimburse the issuer for bonuses or other incentive-based or equity-based compensation and trading profits received or realized in the 12 months after the financial information was first publicly issued or filed with the SEC. Section 304 was enacted in response to concerns that in many instances management was benefiting from misstated financial statements resulting from some form of misconduct.
There has been some confusion as to how exactly Section 304 is to operate. The provision itself does not specify an enforcement mechanism, which caused some to wonder whether it was the SEC or the issuer (either directly or through derivative action) that is authorized to seek relief. Further, in a number of cases, private litigants have asserted that they have a private right of action to recover on behalf of the company under Section 304, which the federal courts have generally rejected. Questions have also been raised about specific language of the provision, including whether the requirement that the restatement arise “as a result of misconduct” refers to misconduct by the particular CEO or CFO against whom a Section 304 action is being brought, by the issuer generally or by others.
Under the terms of the SEC’s settlement with McGuire, he is to pay $12.7 million in disgorgement (including interest) and a $7 million civil penalty, and he will reimburse UnitedHealth for all incentive- and equity-based compensation he received from 2003 through 2006, totaling approximately $448 million in cash bonuses, profits from the exercise and sale of UnitedHealth stock and unexercised UnitedHealth options. McGuire’s disgorgement and Section 304 reimbursement will be satisfied by his return of over $600 million in cash and options to the company in resolution of employment claims and shareholder derivative suits filed against McGuire. That has got to hurt.
Now that Section 304 has been used successfully in the McGuire settlement, it is likely to be showing up in many more Enforcement cases involving restatements. I know that recovery of compensation under Section 304 is being sought in at least one other options backdating case against the former CEO and CFO of Mercury Interactive.
The PCAOB announced that it settled an enforcement proceeding against Deloitte & Touche and one of its former audit partners for violations of interim auditing standards in connection with D&T’s 2003 audit of Ligand Pharmaceuticals. Under the terms of the settlement, D&T must pay a $1 million civil penalty and will undertake certain documentation practices relating to quality control policies and procedures that the firm has implemented.
As noted in this Washington Post article, “[w]hile the PCAOB has taken action against 10 accounting firms during its lifespan, yesterday’s case marks the first among the industry’s biggest players as well as the first financial penalty. Christopher M. Cutler, who has worked at the Securities and Exchange Commission and the audit board, said the Deloitte case is a milestone. ‘It shows that the PCAOB’s Enforcement Division is fully mature and also that we should expect to see within a short period of time additional cases against not only other Big Four firms, but against the so-called second four firms as well,’ Cutler said.”
FASB to Codify GAAP
Recently, the FASB announced that it plans to release its FASB Accounting Standards Codification in late 2007 or early 2008. The codification, which will be subject to a one-year comment or “verification” period, will reorganize thousands of authoritative U.S. accounting pronouncements issued by multiple standard-setters, including those of the FASB, the American Institute of Certified Public Accountants (AICPA), and the Emerging Issues Task Force (EITF) into a single source with a consistent structure. Once approved by the FASB, the codification will become the single source of authoritative U.S. GAAP, and will supersede existing FASB, AICPA, EITF and related literature. Also to be included is relevant SEC guidance.
Last week, Representative Henry Waxman (D-CA), Chairman of the House Committee on Oversight and Government Reform, convened a hearing on the topic of conflicts of interest among compensation consultants. As Broc noted in the blog earlier this year, Waxman had sent letters to a number of compensation consultants seeking information about potential conflicts.
The report released by the Committee’s Majority Staff indicates that over 100 large publicly traded companies hired compensation consultants with “substantial conflicts of interest” in 2006. Further, the Majority Staff reports that over two-thirds of the Fortune 250 companies that hired compensation consultants with conflicts of interest did not disclose the conflicts in their SEC filings (even though no such disclosure requirement exists), and in 30 instances a compensation consultant was identified as independent while being paid to provide other services to the company. The data also shows that consultants were paid nearly 11 times more for providing other services than they were paid for providing executive compensation advice. Finally, the report indicates that there “appears to be” a correlation between the extent of a consultant’s conflict of interest and the level of CEO compensation.
At the hearing, James Reda, Managing Director of James F. Reda & Associates (who submitted this comment letter on the SEC’s 2006 executive compensation amendments calling for disclosure about compensation consultant independence), recommended to the Committee that all fees paid to compensation consultants be disclosed. Representative Waxman echoed this sentiment, indicating that companies should be willing to disclose the full scope of compensation consultant relationships when the consultant is recommending executive pay.
The Corporate Library Reports on Compensation Consultants
As further evidence that compensation consultants can’t seem to stay out of the spotlight these days, The Corporate Library released a study finding that companies using compensation consultants tend to pay higher CEO compensation, and such compensation levels do not necessarily relate to increased shareholder returns.
– Why did The Corporate Library conduct this study? What type of data was collected?
– What were the study’s findings regarding boards that used compensation consultants and those that didn’t?
– How about the study’s findings regarding use of consultants and shareholder returns?
– How did the study’s findings vary depending on which consultant was used?
Annual Reports: How to Create Them for an Online World
We have posted a copy of the transcript from our recent webcast: “Annual Reports: How to Create Them for an Online World.”
Yesterday, we posted an Advance Copy of our January-February 2008 Issue of The Corporate Executive because we know that so many of you are grappling with drafting your CD&A disclosures now. Drafting model disclosures is no easy task – and everyone obviously has to customize for their own circumstances – but David Lynn and Jesse Brill worked hard to put together these examples of “best practice” CD&A disclosures to help you get a head start on what the SEC Staff will be looking for in your CD&As next year.
We will be mailing the issue to ’08 subscribers early in January, perhaps with a few tweaks to the advance copy – so please send any thoughts you might have on what we drafted to Dave or myself. Here is where you can access this Advance Copy now (you will need to renew for ’08 to receive it).
Note that Dave will be writing the lead piece in each issue of The Corporate Executive this coming year. If you are not yet a subscriber, we encourage you to take advantage of a no-risk trial, which will give you immediate access to this important issue.
Posted: SEC’s Adopting Releases for Shareholder Access and Rule 144
With many of the executive compensation comment letters likely to be posted by Corp Fin on Edgar sometime in the next month or so, it’s a good time to test your knowledge about the SEC comment letter process. Thanks to David Mittelman of Reed Smith – who served as a Corp Fin Branch Chief until last year – we have posted our 3rd quiz in a series: “Pro or Troll #3: SEC Comment Letter Process.”
In this podcast, Maria Pizzoli, Assistant General Counsel of Sun Microsystems, discusses how e-proxy went for Sun the first time around, including:
– Why did Sun decide to adopt the Notice and Access model?
– What were the company’s major concerns about adopting the Notice and Access model?
– Did Sun adopt the model with respect to 100% of your stockholders or did it follow a hybrid approach?
– Were there any follow-up mailings?
– Did you send out a press release or add language to your website to explain the Notice and Access model?
– How many requests for printed materials did the company receive and was this in keeping with your expectations?
– What was the quorum attained at Sun’s meeting? How did it compare with prior years?
– How did you handle the web site posting of your proxy materials?
– How did the company’s investors react to your adoption of the Notice and Access model? Did you receive complaints?
– What were the biggest surprises you encountered with adopting the Notice and Access model?
Kicking the Tires: The Year-End Governance Check
In this podcast, Kris Veaco of the Veaco Group runs down some governance action items to consider for year-end, including:
– What were your responsibilities at McKesson?
– What does the Veaco Group do?
– What is an example of what you can do for a company?
– What are some year-end corporate governance tips that our listeners should consider?
The FASB/IASB Convergence Begins: New FAS Nos. 141(R) and 160
As I blogged yesterday on DealLawyers.com, the FASB issued FAS No. 141(R), Business Combinations (as well as FAS No. 160 regarding noncontrolling interests in consolidated financials). Here is an excerpt from the FASB’s press release:
“The new standards represent the completion of the FASB’s first major joint project with the International Accounting Standards Board (IASB), as well as a significant convergence milestone,” states FASB member G. Michael Crooch. “These standards and the counterpart standards issued by the IASB will improve reporting while eliminating a source of some of the most significant and pervasive differences between International Financial Reporting Standards (IFRS) and U.S. Generally Accepted Accounting Principles (GAAP).” The IASB plans to issue its counterpart standards IFRS 3 (revised), Business Combinations, and IAS 27 (as revised in 2007), Consolidated and Separate Financial Statements, early next year.
Statement 141(R) improves reporting by creating greater consistency in the accounting and financial reporting of business combinations, resulting in more complete, comparable, and relevant information for investors and other users of financial statements. To achieve this goal, the new standard requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.
Statement 141(R) also will reduce the complexity of existing GAAP. The newly issued standard includes both core principles and pertinent application guidance, eliminating the need for numerous EITF issues and other interpretative guidance.”
Yesterday, the SEC sued Maxim Integrated Products (and its CEO and CFO) for filing false financial information by improperly backdating options. The CEO agreed to pay $800k; the company didn’t pay a fine. Meanwhile, a second Brocade backdating case went to jury. And there’s more to report…
The following analysis is from Travis Laster: Now, there is a third important decision from Chancellor Chandler in the Maxim option backdating case: Ryan v. Gifford, C.A. No. 2213 (Nov. 30, 2007). It comes in the guise of a discovery decision, but it has major implications for special committee practice. [We have posted this opinion, as well as the other ones from this case, in our “Backdated Options” Practice Area on CompensationStandards.com.]
1. Holding: Waiver of Privilege – In the most significant of several holdings, the Chancellor ruled that a Special Committee created by the Maxim board to investigate concerns about stock option backdating waived the attorney client privilege as to all of the communications between the Special Committee and its lawyers and therefore had to produce all communications relating to the investigation and report. The waiver arose because the Special Committee and its counsel made a presentation to the full board regarding the outcome of the investigation at which the individual board members who were alleged to have been involved in the option scheme and their counsel were present.
According to the Chancellor, “The presentation of the report constitutes a waiver of privilege because the client, the Special Committee, disclosed its communications concerning the investigation and final report to third parties – the individual director defendants and [their counsel] Quinn Emmanuel – whose interests are not common with the client, precluding application of the common interest exception to protect the disclosed communications. …The Special Committee was formed to investigate wrongdoing and in response to litigation in which certain directors were named as individual defendants. This describes a relationship more akin to one adversarial in nature.” (page 7). The Court found that the waiver as to the presentation of the report was a “partial waiver” which “operates as a complete waiver for all communications regarding this subject matter.” (pages 6-7).
The Chancellor also held that in the absence of a waiver, the materials would be ordered produced under the “good cause” exception to the attorney client privilege – also known as the Garner doctrine – which can be invoked in stockholder litigation against fiduciaries.
As a result, the Chancellor ordered Maxim to produce “all communications between [Special Committee counsel] and the Special Committee and [Special Committee counsel] and Maxim.” This included all of the communications that occurred “during the course of the investigation” and during the board presentations.
The Special Committee asserted work product doctrine as to notes of witness interviews, arguing that they necessarily contained attorney mental impressions. The Chancellor ordered these documents provided to the Court for in camera inspection.
Although the application of Garner to these facts is consistent with Delaware precedent, the waiver rationale appears novel. There is considerable tension between the ruling and typical special committee practice, in which committees frequently render a final report and make a presentation to the full board. Historically such a report and presentation have not resulted in a complete privilege waiver. Instead, there has been case-by-case analysis under Zapata as to what materials a plaintiff can obtain, with special committees largely being able to maintain the attorney-client privilege. In footnote 2, the Chancellor notes that the Maxim committee was not a special litigation committee and implies that the privilege analysis might have been different for a formal SLC, citing Moore Business Forms v. Cordant Holdings Corp.
Moore Business Forms, however, contemplated a special committee that would negotiate with and oversee litigation against a major stockholder; it did not involve a traditional special litigation committee. It is thus not clear that a meaningful distinction with respect to the privilege can be drawn between formal special litigation committees and other board committees, or that Ryan‘s holding can readily be cabined from extending to other committee contexts.
2. Risk of No Privilege Going Forward – In the aftermath of Ryan, there is a significant risk that the attorney-client privilege will not be available for a special committee and its counsel when conducting an internal investigation, particularly in the area of stock option backdating, if the special committee chooses to give a report and presentation to the full board with named defendants in attendance. Excluding named defendants and their counsel from the presentation of the report would provide a basis to distinguish Ryan and avoid waiver, but such a course may not be practical. Future committees and their counsel may also attempt to document clearly that they are not intending to waive any privilege and to distinguish between the Committee’s substantive report and mid-investigation communications.
There is support in Delaware law, primarily in the takeover context, for permitting discovery into what a board was told by counsel but barring discovery into underlying lawyer communications. Given the broad waiver rationale in Ryan, it is not clear how such an approach would fare. It does seem likely, however, that future decisions will cabin the expansive scope of the waiver ruling.
3. Producing in Native File Format – In a second noteworthy holding, the Chancellor ordered Maxim to produce documents in native file format, with original metadata. This is the first Delaware Chancery opinion to address native format and metadata issues. The Chancellor held that “metadata may be especially relevant in a case such as this where the integrity of dates entered facially on documents authorizing the award of stock options is at the heart of the dispute.” (page 3). The Chancellor also noted that the Special Committee and its advisors had analyzed the metadata as part of their investigation. The opinion also addresses a handful of other issues, mainly involving discovery and claims by the company that production of certain documents would be burdensome.
Next Tuesday, the SEC will hold an open Commission meeting to adopt its Form D and S-3 proposals, as well as approve the PCAOB’s budget and issue an oil & gas concept release.
Then, next Tursday and the following Monday, the SEC will hold IFRS roundtables. The SEC also has posted the adopting release regarding the ’34 Act registration exemption for employee options.
The Latest on Fairness Opinions
With new rules from FINRA impacting fairness opinion practices (and a host of new cases addressing management conflicts), the dynamics – and processes – of preparing fairness opinions have been changing. Join these experts tomorrow on DealLawyers.com as they explore the latest trends and developments in this webcast: “The Latest on Fairness Opinions” (print out these “Course Materials” in advance):
– Kevin Miller, Partner, Alston & Bird LLP
– Dan Schleifman, Managing Director and Chairman of the Investment Banking Committee – Advisory, Credit Suisse Securities (USA) LLC
– Ben Buettell, Managing Director and Co-Head Fairness Opinion Practice, Houlihan Lokey Howard & Zukin
– Denise Cerasani, Partner, Dewey & LeBoeuf LLP
This program will cover:
– Recently approved FINRA Rule 2290 – what impact will it have on fairness opinion practices?
– Fairness Opinions: Their Uses and Abuses – How should (and do) boards use fairness opinions?
– What are the implications of recent case law developments regarding investment banking conflicts, including the disclosure of fees (Caremark) and discovery regarding material relationships (Orstman)
– What are the latest issues raised by SEC Staff comments regarding fairness opinion disclosure
– What changes should companies make to their timetable?
– What areas should companies be particularly mindful of this year? In other words, what are the areas where companies often find that they miss a deadline?
Yesterday, the Treasury and IRS jointly issued this notice allowing 409A corrections. I know this transitional guidance is something that many had been waiting on…
Key Executive Compensation Takeaways from Our Conferences
The Nov-Dec 2007 issue of The Corporate Executive – which has just been sent to the printer – includes important analysis and guidance regarding fixes companies will need to make to their compensation practices and disclosures next year – and much more. We have posted this blurred issue so that non-subscribers can get a sense of it before trying a 2008 no-risk trial, under which you can get this issue and the rest of 2007 for free. The issue includes pieces on:
– Key Executive Compensation Takeaways from Our Conferences
– Google’s Transferable Stock Options—Follow-Up
– ESOARS—Staff Reaffirms Use to Value Options Under 123(R) (But, Other Accounting Uncertainties)
– The New Requirement to File a Section 6039 Return with the IRS—For 2007?
– Does Anyone Really Care About the FAS 123(R) Earnings Charge? Deep Thoughts II (and Some Shallow Ones, Too)
– The New Rule 144 Amendments—Our Upcoming Video Conference
A number of members e-mailed me after my recent blog about D&O questionnaires to point out a few items that I had missed (eg. Nasdaq’s independence threshold has risen). In this podcast, Craig Mordock of Morrison & Foerster discusses areas where D&O questionnaires may need to be updated for this proxy season, including:
– What changes do you recommend that companies make to their D&O questionnaires for the ’08 proxy season?
– What areas of D&O questionnaires often need tweaking each year?
– What processes of reviewing D&O questionnaires before they are sent to D&Os might need a change?
– How about the process of reviewing the responses received from D&Os?
2nd Round: Corp Fin Compensation Disclosure Comments
I’m hearing from some members that the second round of comments emanating out of Corp Fin’s executive compensation disclosure review project are starting to trickle out. Quite a few of the 350 companies that were initially sent comment letters are likely to receive notification from the Staff that their review is complete and that there are no further comments.
For these companies, the 45 calendar day (or more if the Staff decides to take longer) countdown begins until the Staff makes the company’s responses (as well as the comments they received) public. You may recall the Staff confirmed this 45 day or greater timeline in the Staff’s Report on compensation disclosures.
Rightsizing Compliance Programs for Smaller Companies
Tune in for tomorrow’s webcast – “Rightsizing Compliance Programs for Smaller Companies” – to learn how to master the challenges (ie. resource, culture and other) of developing and implementing compliance programs for small companies. The program also will review emerging best practices and recent legal developments relating to compliance programs for businesses of all size. Please print these Course Materials in advance.