Monthly Archives: March 2008

March 17, 2008

Subprime Crisis: The PWG Weighs In

Last week, the President’s Working Group on Financial Markets issued a Policy Statement on Financial Market Developments, reflecting the collective views of the Treasury, the Federal Reserve, the SEC and the CFTC on how to deal with the current market turmoil.

The report does not appear to break any new ground in describing the underlying causes of the problems: sloppy mortgage underwriting; the “erosion of discipline” in the securitization process, including failures to provide adequate risk disclosure; flaws in the credit rating process; and weaknesses in risk management and failures in banking policies to mitigate those weaknesses. The recommendations in the report might best be characterized as a suggestive – and perhaps soft – in terms of getting at these identified issues. Much of what is suggested could take years to implement – such as getting all states to implement nationwide licensing standards for mortgage brokers (if all states need to do it might not a federal licensing standard be a better idea?), compelling institutional investors to seek better risk information and better ways to evaluate risk other than through credit ratings, reforming the credit rating process, and enhancing risk management practices and prudential regulatory policies for financial institutions.

The one issue that the report actively sidesteps is what sort of concrete steps must taken with respect to the enormous OTC derivatives market that remains the 800-pound (or maybe $500 trillion) gorilla in the room. It has been the common wisdom that regulators need to continue to steer clear of the OTC derivatives market, lest they snuff out the flames of financial innovation that everyone loves until someone (or everyone) gets burned. Now we have a north of $500 trillion in notional amount market that has virtually no oversight – other than industry “oversight” – and no way to get a handle on the systemic risks posed to the worldwide financial system. Instead of suggesting any radical reforms, the PWG says that financial institution regulators should insist that the industry promptly “set ambitious standards for accuracy and timeliness of trade data submissions and the timeliness of resolutions of trade matching errors for OTC derivatives,” urge the industry to amend credit derivative documentation to provide for cash settlement in the event of a credit event and ask the industry for a long terms plan for developing an integrated operational infrastructure. Whoa, some tough words on derivatives from the PWG!

The Bear Stearns Bailout: Is this the Big One?

Almost as if to underscore that the suggested fixes in the PWG report aren’t going to do anything to alleviate the current state of locked-up credit markets and rapidly deteriorating asset values, news began to break early Friday about the need for a Federal Reserve lifeline to the venerable Bear Stearns. The SEC put out this press release on Friday, noting that it was monitoring Bear’s capital adequacy in the light of the firm’s rapidly eroding liquidity. In a conference call on Friday – memorialized in this real time blog of the call – Bear Stearns executives said that the ability to borrow against the firm’s collateral from the Fed through JP Morgan was going to give them a chance to look at strategic alternatives – although they apparently weren’t thinking at the time that filing for bankruptcy or selling the firm at a fire sale price within 48 hours were among those alternatives.

As noted in this article from today’s WSJ, JP Morgan has agreed to purchase Bear Stearns for $236 million or $2 a share – quite a delta from the firm’s market value of $3.5 billion on Friday. The Bear Stearns board was apparently cajoled by government officials, who indicated that they might not be able to bail the firm out if it did not do a deal before markets opened again this week. Shareholders interests were of little concern, it seems, as the firm’s insolvency became imminent when counterparties continued to refuse to do business with Bear and prime brokerage customers ran for the exits. Apparently the Fed’s credit line on Friday was not enough to stave off the “run on the bank.”

The WSJ article notes that financial regulators are “scrambling to come up with new tools because the old ones aren’t suited for this 21st-century crisis, in which financial innovation has rendered many institutions not ‘too big too fail,’ but ‘too interconnected to be allowed to fail suddenly.'” Not too comforting by any stretch of the imagination.

Pro or Troll? Ten New Compensation Disclosure Games!

As you wind down from drafting your proxy disclosures, what better way to relax and take your mind off the turmoil on Wall Street than test your knowledge by challenging yourself with our “Pro or Troll?” games. We just posted ten new ones on

– Dave Lynn

March 14, 2008

Introducing eDelaware

If you’re a Delaware junkie, you need to check out this new – and free – resource that Potter Anderson & Corroon has developed: eDelaware™. It allows you to download all of the essential Delaware business statutes directly to your BlackBerry’s memory – and in addition to providing you with 24/7 access to a “carry” copy of the Delaware business statutes, it also provides brief summaries of recent key Delaware cases. Your BlackBerry will automatically update when there are new case summaries or changes to the Delaware statutes.

In this podcast, Scott Waxman of Potter Anderson (and the architect of eDelaware™) explains why – and how to – use eDelaware™, including:

– What is eDelaware™?
– What are the goals of eDelaware™?
– What is the process to subscribe for eDelaware™?
– What happens if I get a new BlackBerry and I want eDelaware™ on my new BlackBerry?
– Is eDelaware™ available for wireless devices other than BlackBerry?
– Are any enhancements on the horizon for eDelaware™?
– What type of information does Potter Anderson keep about subscribers?
– Have there been any surprises since you launched the service?

Another Delaware Bullet-Dodging Case

Recently, VC Lamb of the Delaware Court of Chancery rejected a motion to dismiss a derivative complaint challenging option grants made pursuant to stockholder-approved option plans in Weiss v. Swanson et al., C.A. No. 2828 (Del. Ch. Mar. 7, 2008). Here is a case summary from Potter Anderson:

The plaintiff alleged in his complaint that stock option grants made by the board of Linear Technology Corporation (“Linear”) were strategically timed in order to take advantage of stock prices favorable to the defendants: when the Company anticipated issuing favorable quarterly earnings releases, the director defendants “spring-loaded” the options by granting them just before they were released, and when the releases contained negative information, options were granted just after the release of the information – “bullet-dodging.”

In its decision, the Court rejected the defendants’ motion to dismiss for demand excusal and for failure to state a claim upon which relief may be granted. The Court also rejected the claim that plaintiff’s complaint was barred by the statute of limitations. The Court first addressed whether the plaintiff was obligated to make a pre-suit demand on the board under Delaware Court of Chancery Rule 23.1. The Court found that the plaintiff alleged particularized facts sufficient to raise reasonable doubt under both prongs of Aronson v. Lewis.

First, plaintiff raised reasonable doubt that the decisions authorizing the option grants and failing to disclose the grants to Linear’s stockholders were a valid exercise of the board’s business judgment. Plaintiff’s particularized claims sufficiently alleged that the director defendants had access to the quarterly earnings releases before they became public and knew that the releases materially affected Linear’s stock price, that the releases actually did affect the stock price, and that, in 22 out of 28 option grants made in conjunction with quarterly earnings releases, the option grants were approved before positive releases or after negative releases. The complaint further alleged that the director defendants had failed to disclose this information to Linear’s stockholders.

Second, plaintiff raised reasonable doubt that the directors were disinterested and independent. Citing Conrad v. Blank, the Court found that the board was interested and demand was excused because the directors received the challenged options and thus “they have a strong financial incentive to maintain the status quo by not authorizing any corrective action that would devalue their current holdings or cause them to disgorge improperly obtained profits.” The Court next addressed the defendants’ motion to dismiss for failure to state a claim. The Court rejected this motion, finding that because the plaintiff had alleged particularized facts sufficient to prove demand futility under the second prong of Aronson, he had rebutted the business judgment rule for the purposes of surviving a motion to dismiss. The Court further found that the plaintiff had stated claims for breach of fiduciary duty, for unjust enrichment, and for waste.

Finally, the Court rejected the argument that the complaint was barred by the statute of limitations because the statute was tolled by the fraudulent concealment by the defendants of the spring-loading and bullet-dodging plan, and because it was equitably tolled.

March-April Issue: Deal Lawyers Print Newsletter

This March-April issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:

– 2008: The Year of the Activist Hedge Fund
– How to Settle Insurgencies and Secure Stockholder Votes Without Creating New Exposures
– Engagement Letters: Their Role in Limiting Investment Banker Liability
– The Obligations of Financial Advisors – New Decision Upholds Contractual and Other Limitations
– Buyers Beware: Tennessee Chancery Court Tries to Get Genesco to The Finish Line
– Items to Consider When Negotiating a MAC Claim

Try a 2008 no-risk trial to get a non-blurred version of this issue for free.

Spring Break ’08: Heading out on a week vaca and thought I would leave you with this funny clip from Sarah Silverman regarding her, ahem, “relationship” with Matt Damon. More than a bit profane – but hilarious. And here is the follow-up clip

– Broc Romanek

March 13, 2008

Canada’s New “Material Contract” Disclosure Obligations

On Monday, Canada’s disclosure rules – National Instrument 51-102 (go to Appendix H) – will be amended to expand the number and types of agreements that issuers must disclose and file as “material contracts.” In many cases, the amended rules will now require filing of certain types of material contracts even if they were entered into in the ordinary course of business.

Provisions within a contract can be striked only if they would be “seriously prejudicial to the interests” of the company or violate confidentiality provisions – except this isn’t allowed under certain circumstances (eg. debt covenants or ratios in credit agreements that are required to be filed). This standard appears pretty high (e.g. Tory’s memo notes that “this drafting suggests that it is not enough that the business would be adversely affected, or even materially harmed, by the loss or absence of the contract”). If a provision is struck, the company must provide a brief one-sentence description of the type of information redacted.

We have posted memos regarding this development in our “Canadian Law” Practice Area. And listen to this podcast with Raman Grewal of Stikeman Elliott who explains:

– What was the old standard for Canadian companies to file their “material contracts”?
– What is the new standard? What are the key differences?
– Under what circumstances can Canadian companies seek to exclude provisions that they want to remain confidential?
– How are confidential treatment requests processed in Canada?

Food for Thought: The Canadian confidential treatment standard is interesting – particularly the notion of tying it to a confidentiality agreement. If they had that in the US, I imagine some companies would add a clause to their agreements saying the thing is confidential so they would disclose nothing…or am I just a pessimist?

Practical Guidance on Conducting CEO Evaluations

One of the most challenging tasks that boards face is properly conducting a CEO evaluation. There is not much guidance out there on this topic. In this podcast, Mike Haefner, President & Founder of Perform for Life, explains how to perform CEO evaluations, including:

– Should boards use a written CEO evaluation?
– What is the typical CEO evaluation process?
– What areas should be evaluated in conducting a CEO evaluation?

Form 10-Q Filing Establishes Venue in SEC’s Offices

Several months ago, the Fourth Circuit – in US v. Benyo – reversed the District Court’s dismissal for lack of venue of the government’s charges that a defendant allegedly committed accounting fraud by filing a false Form 10-Q. The Fourth Circuit held that causing the transmission of the allegedly false Form 10-Q established venue in Northern Virginia, which is where the SEC’s servers that operate Edgar are located. (Bet you thought the servers were in the SEC’s DC headquarters! Also bet you didn’t care.) We have posted the opinion in our “Securities Litigation” Practice Area.

– Broc Romanek

March 12, 2008

Aflac’s Proxy Disclosure: Say-on-Pay

On the heels of my blogging about Aflac’s upcoming say-on-pay vote yesterday, the company filed its preliminary proxy statement, which sets forth the text of its say-on-pay proposal. A relevant excerpt is set forth below:

In November 2006, an interest was expressed by a shareholder in casting a non-binding advisory vote on the overall executive pay-for-performance compensation policies and procedures employed by the Company, as described in the CD&A and the tabular disclosure regarding named executive officer compensation together with the accompanying narrative disclosure) in this Proxy Statement. We believe that our compensation policies and procedures are centered on a pay-for-performance culture and are strongly aligned with the long-term interests of our shareholders.

We also believe that both the Company and shareholders benefit from responsive corporate governance policies and constructive and consistent dialogue. Thus, with Board approval, the Company announced in February 2007 that the Company would voluntarily provide shareholders with the right to cast an advisory vote on our compensation program at the annual meeting of shareholders in 2009 when our disclosure could reflect three years of compensation data under the newly adopted SEC disclosure guidelines.

Subsequently, we concluded that the expanded disclosure of compensation information to be provided in this Proxy Statement would already provide our shareholders the information they need to make an informed decision as they weigh the pay of our executive officers in relation to the Company’s performance. As a result, on November 14, 2007, the Company announced that its Board of Directors accelerated to 2008 an advisory shareholder vote on the Company’s executive compensation disclosures. This proposal, commonly known as a “Say-on-Pay” proposal, gives you as a shareholder the opportunity to endorse or not endorse our executive pay program and policies through the following resolution:

“Resolved, that the shareholders approve the overall executive pay-for-performance compensation policies and procedures employed by the Company, as described in the Compensation Discussion and Analysis and the tabular disclosure regarding named executive officer compensation (together with the accompanying narrative disclosure) in this Proxy Statement.”

Because your vote is advisory, it will not be binding upon the Board. However, the Compensation Committee will take into account the outcome of the vote when considering future executive compensation arrangements.

While we believe this “Say-on-Pay” proposal demonstrates our commitment to our shareholders, that commitment extends beyond adopting innovative corporate governance practices. We also are committed to achieving a high level of total return for our shareholders.

Since August 1990, when Mr. Daniel Amos was appointed as our Chief Executive Officer through December 2007, our Company’s total return to shareholders, including reinvested cash dividends, has exceeded 3,867% compared with 660% for the Dow Jones Industrial Average and 549% for the S&P 500. During the same period, the company’s market capitalization has grown from $1.2 billion to over $30 billion.

NYSE Files Proposal to Allow Listing of SPACs

From Davis Polk: “Following a similar move by the Nasdaq Stock Market last week, the NYSE has filed a proposed rule change with the Securities and Exchange Commission that contains a new listing standard specifically for special purpose acquisition companies, commonly referred to as “SPACs.” SPACs are companies with little or no operations that conduct a public offering with the intention of using the proceeds to acquire or merge with an operating company. Until now, the American Stock Exchange has been the only national securities exchange to list SPACs.

The NYSE’s current financial listing standards for operating companies require some period of operations prior to listing. Because SPACs have no operating history, they do not qualify for listing under the NYSE’s current standards. Under the proposed new standard, a SPAC seeking to list would need to demonstrate a total market value of at least $250 million and a market value of publicly held shares of at least $200 million (excluding shares held by directors, officers or their immediate families and other concentrated holdings of 10% or more). In addition, SPACs would have to meet the same distribution criteria applicable to all other IPOs. All of the NYSE’s corporate governance requirements applicable to operating companies would apply to SPACs.

The proposed rule establishes a number of requirements applicable only to SPACs, including:

– a minimum of 90% of the IPO proceeds, together with the proceeds of any other concurrent sales of equity securities, must be placed in a trust account;

– the SPAC’s business combination must be with one or more businesses or assets with a fair market value equal to at least 80% of the net assets held in trust (however, unlike the rule proposed by Nasdaq, there is no requirement that 80% of the consideration for the initial business combination be in cash); and

– the business combination must be consummated within three years.

The NYSE would have significant discretion under the proposed rule. The NYSE indicates in the rule filing that it intends to consider proposed SPAC listings on a case-by-case basis and does not necessarily intend to list every SPAC that meets the minimum requirements for listing. In addition, after shareholder approval of a business combination, the NYSE will assess the continued listing of the SPAC and will have the discretion to delist the SPAC prior to consummation of the business combination. Upon consummation of the business combination, the NYSE will consider whether the transaction constitutes an acquisition of the SPAC by an unlisted company (a “back door listing”), and if so, the resulting company must meet the standards for original listing or be delisted.

The NYSE proposal is subject to publication and approval by the SEC.”

IR Gate! My Joke Goes Awry

A few weeks ago, I recorded a podcast where I played both the role of interviewer and interviewee. The topic was about someone impersonating analysts to gain access to managers to ask questions during earning calls. I impersonated the impersonator as a joke as part of my new brand of “gonzo journalism.” Here is a new podcast that extends that nutty concept even further.

Unfortunately, a magazine ran this article entitled “Earnings call imposter gives interview” because the interview seemed all too real. Dominic Jones blogged about this snafu in his “IR Web Report.” One member asked if I have also interviewed DB Cooper?

– Broc Romanek

March 11, 2008

Up Close and Personal: House Hearing on CEO Pay and the Mortgage Crisis

Dave wandered down to the House Hearing on severance pay last Friday and wrote up these thoughts (you could see Dave sitting in the background if you watched CNN; he didn’t phone this one in – compare the WSJ article and NY Times article):

“The hearing of the House Committee Oversight and Government Reform on CEO pay was a little disappointing. It had all of the potential to be the sort of public spectacle that the same Committee’s hearings on steroid use in baseball had become, but instead it was a relatively straightforward identification of some CEO pay abuses, juxtaposed to the people that are unfortunately losing their houses to foreclosure in the midst of the mortgage mess.

In addition to testimony from some experts on the state of the mortgage crisis and issues with executive pay (which was covered by Nell Minow of The Corporate Library), the hearing featured Angelo Mozilo from Countrywide, E. Stanley O’Neal formerly at Merrill Lynch, and Charles Prince formerly at Citigroup. The respective compensation committee chairmen from those organizations also appeared, including Richard Parsons, Chairman of Time Warner.

The questioning was relatively light – both in volume and in tone – given the sparse turnout from Committee members on an unusual Friday hearing (the day when many members are heading home to their district). Much of the questioning focused on issues outlined in the Committee’s majority Staff memorandum, which outlined a number of issues that tend to be wrong with the CEO pay process – “confusion” about for who a compensation consultant is working (i.e. the CEO, the comp committee or the company), questionable use of 10b5-1 plans, awards that don’t seem to make sense in light of the circumstances or the rationale, extraordinary low performance targets, and payment of performance bonuses and the awarding of retirement and severance benefits even in a year as bad as 2007.

The battle lines were clearly drawn, with Chairman Waxman (D-CA) and his colleagues in the majority pointing out the financial distress that many Americans face while these three executives reaped rich rewards. Meanwhile, Representative Tom Davis (R-VA) repeatedly drew the old sports and entertainment analogy for executive pay – saying that no one expected Ben Affleck and Jennifer Lopez to pay reparations for Gigli.

Both sides were careful not to sully the reputations of the three CEOs who all represented classic American success stories, and clearly the CEOs (particularly Mozilo) seemed to be emboldened as the hearing went on and the “light” touch was evident. The only thing that tripped up Mozilo were questions concerning a threatening email that he sent seeking reimbursement of taxes for his wife’s travel on company aircraft – he apologized, noting that he was an “emotional person” – but Representative Issa (R-CA) was quick to jump to his defense and note that many of his colleagues in Congress fly their spouses all over the world on government aircraft because they need to have their spouse with them when conducting business.

One of the particular areas of questioning was on Mr. Mozilo’s sales of substantial amounts of stock under Rule 10b5-1 plans while Countrywide was conducting an accelerated share repurchase program. Mr. Mozilo asserted that all of his stock sales were done pursuant to a plan to diversify his holdings in anticipation of retirement and were unrelated to the stock repurchase program. The Chairmen of the Merrill Lynch and Citigroup compensation committees noted that these kinds of sales were unlikely at their companies, given their very high stock ownership and retention requirements.

While the Democrats on the Committee may not have been able to establish these CEOs as suitable scapegoats, the majority was certainly able to put some questionable pay practices under the microscope at a time when most people are worried about paying for their house – as opposed to paying for taxes on spousal travel on the company jet.”

My Ten Cents: It’s too bad the committee members did such a poor job of questioning the hearing’s compensation committee members. Had they simply followed the path of the Committee staff’s memo, they could have called for an explanation of each of the actions by the compensation committees (although some of the meaty issues were addressed, like why did Prince got a bonus for 2007).

My primary “take-away” is that when a successful CEO throws a temper tantrum over pay – even if the demands are unreasonable – the board caves in. My guess is that all too often boards are told the consultant is hard to work with – or is not responsive or does not understand the company – and has to go. Boards comply – and there is typically no explanation other than “the board thought it was time for a change.”

I can’t resist addressing the mistaken comparison between CEO pay and the pay levels in the sports & entertainment industry. Putting aside the fact that only the top 1% of athletes and actors get paid astronomically – remember all those starving actors and baseball players buried in the minor leagues – it’s apple and oranges because the processes by which the relative amounts are established are completely different. I recently addressed this point by posting a comment on this compensation consultant’s blog. I guess the argument that public company CEOs will be flocking to hedge funds doesn’t hold much water anymore…

Aflac’s CEO Speaks

Take a moment to read this interview in Friday’s WSJ with Aflac CEO Daniel Amos (there is a video of him linked from the article). Aflac will be the first company in the US to have shareholders vote on “say on pay” at their May annual meeting.

During the interview, Mr. Amos says: “I want to be paid what I am worth” and “compensation is the way the scorecard is kept.” There are many CEOs who feel that way. But there are many others (like GE’s Jeff Immelt and others who have taken significant steps) that realize that CEOs’ total compensation and accumulated wealth generally are out of whack – particularly when it comes to equity grants and post-employment arrangements. Here’s where compensation committees need to be doing a better job. And just as importantly. where stand-up CEOs need to take the lead.

For many CEOs, the real scorecard is their legacy and what others will remember them for. The typical CEO will not want to be remembered as caring more about squeezing the last nickel for themselves than the well-being of the company’s employees, shareholders, customers and communities. Instead, there are a growing number of CEOs and directors who feel an obligation to do something to restore trust in our leaders and the integrity of our markets. (Who can forget former DuPont CEO Ed Woolard’s candid remarks that we taped a few years back.)

So cheer up, we do believe that there is a sea change coming as more CEOs and boards start to make significant changes (we’ll continue to update our list of responsible actions on But as reflected from the House severance hearing, we still have a loooong way to go (particularly if there are more CEOs like the one described in this article).

Exec Comp Comment Letter Highlights

On, Mark Borges continues to blog regularly on the latest compensation disclosures in the proxy statements as they are filed with the SEC. He also recently waxed on the highlights in the publicly available comment letters in this blog.

And we continue to maintain our list of links to the SEC’s comment letters as they are posted – here is the latest list.

Here is some sad news – my good friend Maria Pizzoli of Sun Microsystems recently passed away. Maria was well known in the Bay Area legal coummunity and this notice describes her beautifully. A memorial service was held last week; donations in lieu of flowers can be sent for an educational fund for her very young son Nate.

– Broc Romanek

March 10, 2008

Shareholder Proposals: The SEC Staff’s New Health Care Position?

As usual, a number of shareholder proposals requesting companies to adopt healthcare policy principles were submitted to companies this proxy season. Unlike prior years, it appears that Corp Fin is permitting the inclusion of some of these proposals – in past years, they were universally viewed as “ordinary business” and exclusion was permitted. In fact, it appears that the SEC Staff generally has lightened up on social proposals this season.

We have posted some of these health care proposals (and SEC Staff responses) in our “Shareholder Proposals” Practice Area. Note that the CVS proposal was permitted to be excluded – the distinction likely is that the CVS proposal asks the company to report on its implementation of the proposal; the other proposals do not.

The New Business Combination Accounting

As I learn more about the impact the FASB’s new business combination rules on deals, I truly believe that this is the “sleeper” of the year. Did you know that lawyers won’t be able to capitalize their fees in deals anymore (and what that means for documentation of hours billed)? Learn more during tomorrow’s webcast – “The New Business Combination Accounting” – and hear from these experts:

John Formica, Partner, PricewaterhouseCoopers LLP in the National Professional Services Group
Michael Holliday, Securities Counsel (retired), Lucent Technologies
Brenna Wist, Partner, KPMG in National Department of Professional Practice

Forfeiture Provisions in Stock Purchase Plans

From Keith Bishop: Recently, the California Court of Appeal upheld Citigroup’s restricted stock purchase plan against a challenge that it violated California’s Labor Code (here is a copy of the opinion). Under the plan, an employee could elect to use a portion of their annual earnings to purchase shares in the company’s stock at a price below the stock’s price. If the participating employee resigns or is terminated for cause within a two-year vesting period, the employee forfeits the stock as well as the money used to purchase it.

An employee challenged the program as violating California Labor Code Sections 201 and 202. These statutes require an employer to pay its employee all earned but unpaid compensation following the employee’s discharge or his or her voluntary termination of employment. The Court of Appeal upheld the plan, stating: “As a matter of economic reality, employees who elect to participate in the plan’s stock-purchase program are paid all the wages they designate to invest in company stock. Thus, the plan’s forfeiture provisions do not violate the Labor Code; and the trial court in this case properly granted summary judgment in favor of the brokerage company.”

My Ten Cents: Citigroup’s plan is pretty unique – and there are few companies that have a plan or forfeiture provisions like this. Also, this is a situation where legally you might be able to have this sort of provision – but does it really make sense? Having this kind of provision in their plan must significantly impact their participation rate: I’d be surprised if it is higher than 5% to 10%.

Stock is already a risky investment, then Citigroup has increased the risk further by requiring employees to forfeit their entire investment if for some reason they have to leave their jobs before the vesting requirements are met. Unless the discount is substantial enough to mitigate the risk of a loss in the stock (and if the discount is too high, at some point you start to run into constructive receipt issues), it seems “out there” to even think about participating in a plan like this.

– Broc Romanek

March 7, 2008

WaMu’s Compensation Whammy: Performance Targets That Ignore Mortgage Fallout

This WSJ article from earlier this week noted how the board of Washington Mutual Inc. had set performance targets for top executives that “will exclude some costs tied to mortgage losses and foreclosures when cash bonuses are calculated this year.” As noted in a Form 8-K filed by Washington Mutual on Monday, the 2008 targets selected by the compensation committee included “net operating profit” which is to be calculated by excluding loan loss provisions other than related to the credit card business and expenses related to foreclosed real estate assets, as well as 2008 “noninterest expense,” which is to be calculated to exclude expenses related to business resizing or restructuring and foreclosed real estate assets. The Form 8-K notes that “in light of the challenging business environment,” when awarding 2008 bonuses the company’s compensation committee will consider the targets, then review other appropriate factors – such as subjectively evaluating credit risk management and other strategic actions – and individual performance.

The WSJ article notes:

“In a statement late yesterday, WaMu said, ‘The success with which credit costs are managed will unequivocally continue to be a major part of the Board’s final deliberations.’ The company added that it will include further information on the company’s compensation philosophy in its proxy statement later this month.

The new formula angered some WaMu investors, who have seen the value of their holdings shrivel as the thrift’s mortgage troubles worsened. In the past year, WaMu’s share price has tumbled about 70% – to where it was about 12 years ago. The shares fell 26 cents, or 1.9%, to $13.39 in New York Stock Exchange composite trading. ‘They’ve cost their shareholders a lot of money,’ said David Dreman, chairman of Dreman Value Management LLC, which holds 27.9 million WaMu shares. ‘Bonuses should be given to the executives who enhance shareholder value, not destroy it.’

In a research report, Frederick Cannon, an analyst with Keefe, Bruyette & Woods, expressed concern that the cash-bonus formula “could result in executive focus away from issues, particularly credit management, that we feel are critical to the success” of WaMu. Mr. Cannon, who is forecasting a steep loss by WaMu this year largely because of housing woes, called on the company’s directors to ‘revisit the 2008 compensation plan and make managing credit a top priority of senior management with objective rather than subjective measurements.'”

WaMu’s CD&A will no doubt be an interesting read in the coming weeks, and we will likely soon see whether any other companies stricken by the mortgage turmoil and the overall credit crunch will come up with new ways to “creatively” address 2008 compensation levels for their highest paid executives.

Plenty of issues on CEO pay and the mortgage crisis will be aired today at the rescheduled House Committee on Oversight and Government Reform hearing that Broc blogged about last week.

Senate Acts on an Attorney-Client Privilege Bill

Last week, the Senate passed a bill that would change the federal rules of evidence to provide some limited attorney-client privilege protection when, in the course of waiving the privilege for specific information in a federal proceeding or communications with a federal agency, there is an undisclosed communication or information or an inadvertent disclosure.

In the case of an undisclosed communication or information, the new rule would provide that when disclosure is made in a federal proceeding or to a federal agency that waives the attorney-client privilege or work-product protection, the waiver would only extend (in a federal or state proceeding) to an undisclosed communication or information if (1) the waiver is intentional; (2) the disclosed and undisclosed communication or information concern the same subject matter; and (3) the disclosed and undisclosed communication should – in fairness – be considered together. With respect to an inadvertent disclosure in a federal proceeding or to a federal agency, the rule would provide that the disclosure doesn’t operate as a waiver in a federal or state proceeding if the disclosure is inadvertent, the holder of the information took reasonable steps to prevent disclosure and the holder took steps to rectify the error.

The bill is now being considered by the House Judiciary Committee.

MAC Clauses: All the Rage

We have posted the transcript from our recent webcast: “MAC Clauses: All the Rage.”

– Dave Lynn

March 6, 2008

Corp Fin Posts Smaller Reporting Company Interpretations

Yesterday, Corp Fin posted answers to some of the most frequently asked questions concerning implementation of the new smaller reporting company disclosure rules. These new Compliance and Disclosure Interpretations include definitive answers to some of the queries posted recently in our Q&A Forum.

Among the notable interpretations are:

1. Given the application of the transition rules for accelerated filers, a company can be both an accelerated filer and a smaller reporting company simultaneously (such as when it has a public float of $60 million on the last business day of its second fiscal quarter of 2007), in which case the company may use the scaled disclosure rules in its annual report on Form 10-K, but the report is due 75 days after the end of the its fiscal year and the company must include the auditor attestation report required by Item 308(b) of Regulation S-K. (See Interpretation 2)

2. All smaller reporting companies must provide the audit committee report required by Item 407(d)(3) of Regulation S-K. Smaller reporting companies are not required to provide the audit committee financial expert disclosure required in paragraph (d)(5) of Item 407 until their first annual report after their initial Securities Act or Exchange Act registration statement becomes effective. A corrected adopting release has been posted to clarify this point. (See Interpretation 4)

3. In its proxy statement, a smaller reporting company must provide all of the disclosure required by Item 404(d)(1) of Regulation S-K – rather than just the disclosure required by Item 404(a) of Regulation S-K – even though Item 7(b) of Schedule 14A refers specifically to Item 404(a). In addition, smaller reporting companies need not furnish the disclosure required by Item 404(b) of Regulation S-K – regarding the review, approval or ratification of related person transactions – even if a form or schedule (like Schedule 14A) specifically calls for Item 404(b) disclosure. (See Interpretations 5 and 6)

The SEC’s Foreign Private Issuer Reporting Proposals

The SEC has posted the proposing release for its foreign private issuer initiatives. In addition to shortening the filings deadline for accelerated filer and large accelerated filer FPIs to within 90 days of an issuer’s fiscal year-end, the SEC proposes to change the testing for FPI status to once a year, rather than the continuous testing scheme that is currently in place. The SEC also proposes to change the requirements regarding segment data in the Form 20-F and to clarify the applicability of Exchange Act Rule 13e-3 when an FPI deregisters under the Exchange Act. The SEC is soliciting comment on some other potential changes to the disclosure required of FPIs in registration statements and annual reports.

These proposals are out for a 60 day comment period.

The Latest FCPA Developments

At the end of last year, I noted how in 2007 we saw a significant uptick in Foreign Corrupt Practices Act enforcement activity. Now, the SEC and DOJ have kicked off 2008 with two more high profile FCPA cases. Flowserve was recently charged with violating the books and records and internal controls provisions of the FCPA in connection with kickbacks made during the company’s participation in the UN’s Oil for Food Program, while Westinghouse Air Brake Technologies was charged with FCPA violations in connection with improper payments that the company’s Indian subsidiary made to employees of the government of India.

These trends should put FCPA compliance on the front burner for any company with operations abroad. In this podcast, Ellen Zimiles and Joseph Spinelli of Daylight Forensic and Advisory LLC discuss the latest developments in FCPA enforcement, including:

– What is the current “lay of the land” regarding FCPA enforcement?
– What do you see as the principal areas of focus for regulators and prosecutors?
– What are the potential consequences of failure to comply with the FCPA?
– How can companies protect themselves?

– Dave Lynn

March 5, 2008

Déjà vu All Over Again – SOX 404 Experiences of Non-Accelerated Filers

Bob Dow of Arnall Golden Gregory has been tracking the progress of non-accelerated filers who – for the first time this year – are required to furnish their management’s assessment of internal control over financial reporting. Bob says that about half of the Form 10-KSBs that he has seen filed so far don’t include management’s assessment and don’t have any required explanation for excluding it, such as if a company fits under the new public company exception (see, e.g., this filing by Infinera Corporation). [Most of those now filing on Form 10-K under the new smaller company reporting requirements seem to include the required management report.]

Here are some examples that Bob noted where companies more or less got it right with respect to the disclosure about management’s assessment:

Sensata Technologies
Netlist, Inc.
International Cellular Accessories
OrganiTech USA, Inc.
Znomics, Inc. (doesn’t reference the exclusion of the audit report)
Pet Express Supply, Inc.
SteelCloud, Inc. (complying early)

It will be interesting to see how the SEC reacts to those smaller issuers that don’t include the required report. In the first year of implementation for the Section 404 rules, the Staff tried to be pretty flexible with issuers who – for one reason or another – omitted the report or filed with a qualified auditor’s attestation. For the most part, the Staff tried to work with the issuers to remedy the situation. It is possible that the Staff will take the same approach again with the non-accelerated filers, particularly given that the report is only “furnished” this year as opposed to “filed” – we will have to just wait and see.

Non-Accelerated Filers: Watch Your Section 302 Certification Language!

A number of the filings referenced above did not include the complete Section 302 certification language required under Item 601(b)(31) of Regulation S-K. Remember that under the transition rules for non-accelerated filers, the introductory language in paragraph 4 and the language in paragraph 4(b) of the certification referring to internal control over financial reporting may only be omitted until the company files its first annual report required to contain management’s internal control report – the full certification is required in that report and in all periodic reports filed thereafter.

Typically, when officers have mistakenly omitted this language from their certification after the end of the transition period, the Staff has permitted the company to file a stripped-down amendment to the periodic report including just a cover page, an explanatory note about the purpose of the amendment, a signature page and the required Section 302 certifications – including the complete text of paragraphs 1, 2, 4, and 5 (paragraph 3 may be omitted because no financial statements are included in the amendment).

Turning Around Troubled Companies

Jim Thornton, CEO of Provo Craft and Novelty, saved this company from bankruptcy by growing revenue to $200 million, a 38% increase in two years with an improvement of 227% in EBITDA. For example, he turned over the entire original management team and took over the roles of CEO, CFO and COO personally, until he discovered the company’s bugs. He then personally recruited five Fortune 50 executives to come to come join the company.

In this podcast, Jim provides some insight into how to handle turning around a company, including:

– How is your turnaround style unique?
– What do you find to be the greatest challenges in a typical turnaround situation?
– What are your feelings about incumbent managers who seek retention bonuses after they have caused a company to become troubled?

– Dave Lynn

March 4, 2008

Disclosure of Political Contributions on the Rise

There is nothing like an election year to focus attention on the staggering amounts of money sloshing around in our political system. Inevitably, questions arise as to the role of large companies in political giving. Answers to those questions aren’t likely to be found in the 10-Ks, proxy statements or websites of most public companies, because the SEC has never adopted an item requirement calling for specific disclosure of political contributions. That hasn’t stopped groups from seeking such disclosure (and related policies on political giving), principally through the shareholder proposal process – and generally support for these efforts has been on the rise over the past few years.

As noted in the article from last week, five more large US companies – American Express, Xerox, Washington Mutual, Capital One and Texas Instruments – have agreed to publicly disclose amounts spent for political purposes. The Center for Political Accountability, one of the groups that is seeking more disclosure in this area, lists 38 other companies that have adopted a policy geared toward transparency about political spending. Here are recent political contribution reports from some of these companies:

American Express
General Motors
Johnson & Johnson

For more information on this topic, check out our “Political Contributions” Practice Area.

PCAOB Proposes New Auditing Standard on Engagement Quality Review

Amazingly enough, Sarbanes-Oxley directed rulemaking/standard-setting continues to this day. The PCAOB announced last week that it has now proposed standards under Section 103 of the Sarbanes-Oxley Act, which directed the Board to adopt standards requiring each registered public accounting firm to provide a concurring or second partner review and approval of each audit report (and other related information), as well as concurring approval in its issuance.

The PCAOB had previously adopted – as an interim quality control standard – SECPS Requirements of Membership Section 1000.08(f), which was the concurring partner review requirement imposed by the SEC Practice Section of the AICPA.

As noted in this proposing release, the PCAOB’s proposed standard takes a risk-based approach to the second level review. The standard would require the engagement quality reviewer to “assess whether there are areas within the engagement that pose a higher risk that the engagement team failed (1) to obtain sufficient competent evidence or (2) to reach an appropriate conclusion.” In making these assessments, the reviewer would evaluate whether the engagement team responded appropriately to risks, whether the judgments made were reasonable, and whether the engagement team’s overall conclusions were supported by the results of the procedures performed. This review would be required for all engagements performed in accordance with PCAOB standards, including integrated audits of financial statements and reviews of interim financial information, and it would need to be obtained before the firm could grant the client permission to use the engagement report (or communicate a conclusion in the absence of a report).

The PCAOB proposes that the engagement quality reviewer be an associated person of a registered public accounting firm that is independent of the client. The reviewer must also be “competent, perform assigned procedures with integrity and maintain objectivity with respect to the engagement and the engagement team.” The reviewer could be a partner or other person within a firm, or someone from outside of the firm.

The proposed standard is out for public comment until May 12th.

Finding the Right Law Firm: Improving Your RFP Process

In this podcast, Rees Morrison of Hildebrandt International provides some insight into law department requests for proposal issues, including:

– What are the common mistakes in-house counsel make?
– Ten nuggets for improving the request for proposal process

– Dave Lynn