On Friday, the SEC Staff referred a shareholder proposal to the Delaware Supreme Court under a certification process we wrote about in the Nov-Dec 2007 issue of the The Corporate Counsel and discussed in this February podcast with a Delaware lawyer. The Delaware Constitution was amended last summer to create this process, allowing for greater cooperation between the SEC and Delaware Supreme Court on issues related to Delaware law. This is the first time that this new certification process is being used – the Delaware Supreme Court has the option to refuse the SEC’s request, but is unlikely to do so.
Submitted to CA (formerly known as Computer Associates) by AFSCME, the shareholder proposal would require – yes, its a binding bylaw proposal – the company to pay for the expenses related to a successful election of a short slate of directors. Submitted to several companies in each of the past three years, this type of proposal is AFSCME’s response to the stalled shareholder access debate; see this RiskMetric’s blog where Professor Charles Elson calls it the “ultimate solution” – and here is a 2006 WSJ article that portrays VC Strine as supporting a similar type of proposal.
In its no-action request to Corp Fin (among other exclusion bases), CA argued that, under Rule 14a-8(i)(1), the proposal is an improper subject under Delaware law and, under (i)(2), it would cause the company to violate Delaware law because reimbursement of solicitation costs is a decision for the company and its board. Both of these exclusion bases has a legal opinion requirement and Richard Layton was hired to provide one to support the company’s arguments.
AFSCME responded that its proposal doesn’t violate state law and Grant & Eisenhofer supported this argument with a legal opinion. Faced with dueling legal opinions, Corp Fin refused the exclusion request since the Division doesn’t resolve disputed questions of Delaware law – but also sent a request for certification to the SEC Commissioners, who approved certifying this question of law to the Delaware Supreme Court.
If the Delaware Supreme Court doesn’t weigh in timely, it appears Corp Fin won’t allow CA to exclude the proposal when it files and delivers its proxy materials on July 17th. Given the topic of the proposal, this is a huge development and one that may be resolved within a few weeks.
Here are the documents relating to this development:
Coming SEC Staff Review: On Friday, Corp Fin Director John White – who will keynote our Proxy Disclosure Conference, just like last year – said the SEC Staff will be conducting some form of executive compensation review – and a report of the Staff’s findings is likely sometime in the Fall. At this time, the Staff doesn’t know the form of either of these related projects. So executive compensation disclosure will continue to remain in the spotlight. [More notes from John’s remarks at the Society’s Annual Conference coming in tomorrow’s blog.]
On Friday, the US Senate confirmed three new SEC Commissioners – Luis Aguilar, Elisse Walter and Troy Paredes – meaning that Paul Atkins will now depart and the Commission has a full five members. As I blogged about before, it’s unprecedented to have three new Commissioners start at one time since the Commission was formed in ’34. Here is a statement from SEC Chairman Cox about the three nominees.
So far, I am the only person contributing to the Society’s FriendFeed room that I created – I’m not surprised given that it’s an experiment – and I’ve posted these 12 videos (each of them is no longer than a minute):
– Carl Hagberg & His Lifetime Achievement Award
– Carolyn Coffey on Conference Pilates
– Geoff Loftus on Latest in Society’s National Office
– Bob Woodward Luncheon Speech – Priceless
– Tom Kies & John Siemann: No Rap Song (Yet)
– John Truzzolino on Getting Involved in XBRL
– David Katz on Teaching the Youth
– Brian Lane on Meeting with SEC Staff
– Nicole Sanford on Technology Swat Team
– Jim Reda on Dealing with Advisors
– Welcome Reception – Society Conference
– Rapping with J&J’s Doug Chia
Thanks to these brave souls for trying this out. More than one person refused to be interviewed and I can’t say I blame them. But you only live once…
SEC Proposes to Amend Broker-Dealer Registration Requirements for Non-US B-Ds Working with US Investors
At Wednesday’s SEC open meeting, the SEC proposed amendments to Rule 15a-6, which provides an exemption from broker/dealer registration for non-US broker/dealers that conduct business with US investors. The proposals are not overwhelming, give that they incorporate many of the liberalized positions taken in SEC Staff no-action letters. We have started posting memos on this development.
How do you like that? I finally came up with a viable million dollar idea (probably many millions) and I’ve got too much on my plate to do something about it. So it’s free for the first taker!
I got the idea when I was reading a white paper by Glyn Holton, founder of the Investor Suffrage Movement, that describes a system that would let people who own shares of a company transfer the voting rights of their stock to other shareholders so investors with similar goals could establish a bloc of votes. Glyn has already conducted proxy transfer trials (Thanks to CorpGov.net publisher, Jim McRitchie, for alerting me to isuffrage.org).
In the white paper, Glyn envisions a world where soccer moms donate the voting rights of their holdings to their favorite charities. It sounded interesting, but not earth-shattering. But my antenna got raised when I got to a paragraph on page 18 that says “For example, the purchase and sale of voting rights raises public policy issues, so an exchange should not facilitate such transactions.”
Hmm, voting rights have been sold for decades, but typically in one-off transactions to facilitate a deal. What if someone created an online marketplace where voting rights could easily be bought and sold? It could even be in the form of an auction where management and a third-party bid up the price.
Taking it a step further: what if a retail holder checked a box when they opened a brokerage account indicating that their broker should routinely sell the voting rights of their holdings until they instruct otherwise. The proceeds from the annual sale of a particular batch of voting rights would be deposited in their account.
All of this would lead to exchanges listing the latest prices for voting rights for specific securities – and then derivatives could be created on top of that. This all sounds pretty crazy – but is it? It’s potential impact dwarfs that of shareholder access.
I’m sure there are legal issues up and down the board that I’m not aware of. Let me know what you think. And if you take this idea and run with it – think of me from your yacht. Remember that I’m not saying whether something like this is good for the market and for boards or investors. I’m just throwing it out there as some possibility that could cause a whole lot of change…
This one is about one of those things that I swear I’ve blogged about before – but it was all in my mind. When I’ve been out speaking about e-proxy, I point to ProxyDemocracy.org as an example about how the playing field is changing. Founded by Andy Eggers of Harvard’s Department of Government, the site is a free resource where one can more easily analyze the voting track record of mutual funds. As you might recall, the SEC adopted rules a few years ago that requires mutual funds to report their votes for the year. However, the way the information is required to be reported is hard to decipher (eg. Fidelity files more than 100 of these forms). This site organizes the information from those Form N-PXs.
The site has other features, including alerts as to how the big institutional investors intend to vote (if those investors decide to announce what their intentions are, as they are permitted to do under the SEC’s proxy rules – see note below). So the site makes it easy for anyone to vote, by reducing the time they need to spend on detailed analysis of issues and candidates. And this is just the start – you can easily envision a path where this site and others do much more to facilitate the information gathering process and present it in a much easier way than currently available in a way that may eventually impact the results of annual meetings.
Anyways, I waited so long to blog about this development that Andy has blogged about it himself on Harvard Law School’s Corporate Governance Blog and in his own blog.
Under Rule 14a-l(1)(2)(iv), shareholders are permitted to publicize their voting intentions – as well as the reasons behind the intentions – without it being deemed a “solicitation.” Today, not many shareholders take advantage of this exemption to announce their intentions – CalPERS and a handful of others – so this feature doesn’t hold much value. If more shareholders start making announcements, then it will become a more important aspect of the site.
SEC Proposes to Delete References to Credit Ratings
Yesterday, the SEC held an open Commission meeting to propose – jointly from three Divisions, Trading & Markets, Corporation Finance and Investment Management – changes that include replacing references to ratings by Nationally Recognized Statistical Rating Organizations (ie. NRSROs) with alternative qualitative standards. This follows another proposal from several weeks ago related to regulation of the ratings process. Here is a statement from the Corp Fin Staff and Chairman Cox’s opening remarks from the open meeting (and a WSJ article). The SEC’s related press release is not out yet – we will be covering this topic more in the coming weeks.
Recently, Senator John McCain has been speaking out against excessive executive compensation and has now joined Senator Obama in calling for mandatory “say on pay.” Here is a Business Week article about this – and here is an excerpt from McCain’s June 10th speech:
“Americans are right to be offended when the extravagant salaries and severance deals of CEOs … bear no relation to the success of the company or the wishes of shareholders,” says McCain, adding that some of those chief executives helped bring on the country’s housing crisis and market troubles. “If I am elected president, I intend to see that wrongdoing of this kind is called to account by federal prosecutors. And under my reforms, all aspects of a CEO’s pay, including any severance arrangements, must be approved by shareholders.”
The proposals that both Senators Obama and McCain support not only would provide shareholders an annual non-binding vote on executive pay, they would also provide shareholders with a separate non-binding vote when a company gives a golden parachute to executives while simultaneously negotiating to buy or sell the company.
With H&R Block joining the list, there are now nine companies that have agreed to a non-binding vote on pay.
Quick Survey: How R&D Intersects with Setting Bonus Amounts
On CompensationStandards.com, we have posted this quick survey to learn more about how research & development costs play a role when it comes time to set bonus levels for senior managers.
This survey was suggested by a doctoral student who is conducting research to gain additional insight into some of the practical issues and challenges faced by those in charge of setting and disclosing executive pay. If you ever have survey ideas, please drop me a line.
Board-Shareowner Communications on Executive Compensation
RiskMetrics is not the only entity seeking comments on a paper. Stephen Davis is looking for input on this Millstein Center paper: “Board-Shareowner Communications on Executive Compensation.” The 17-page paper – which is an executive summary and initial findings – presents findings of a six-month research project that included interviews with directors, senior managers and investors on their views of dialouge regarding executive pay. A final paper will be published once more input is received.
Logically, the “say on pay” movement is addressed in the paper. Given that the media contains reports that some investors are now rethinking their views on “say on pay,” some of the research might be dated already, even though it’s not that old. I personally talked to some investors who now find themselves on the other side; and I find myself leaning against it for now (as I have blogged about). So please send Stephen your comments.
On pages 6-7 of the paper, there is this finding related to say on pay:
Compulsion, through crisis or other acute events, is the foundation under most current US corporate initiatives to foster governance dialogues with institutional owners.
Evidence suggests that scandals over executive compensation – whether payouts for failure or backdating stock options – were key contributors in 2007 in motivating certain boards to increase their interaction with shareowners. Exercises in board dialogue on governance have generally not come about in the United States as a product of proactive, long-term strategic outreach by untroubled corporations. This reality has contributed to growing investor conviction that regular dialogue will not spread widely in the absence of compulsion, even where companies are troubled. As a result, many funds back a UK-style annual advisory vote on executive pay policies, a measure that helped open channels of communication between UK boards and their equity owners.
The Consultants Speak: How the Latest Compensation Disclosures Impacted Practices
At the NIRI Annual Conference, as appropriate for his audience, Corp Fin Director John White devoted a fair portion of his remarks talking broadly about the SEC’s upcoming guidance on the use of corporate websites (here are notes about John’s remarks). The SEC intends to update its interpretive guidance – last issued in 2000 – sometime in the near future. This is a project recommended as part of the CIFiR report (see page 55).
After hearing John’s remarks, I went back to refresh my memory of what the SEC said in 2000. I was pleasantly surprised in that I don’t think much of that old guidance needs updating. The SEC was fairly flexible about what companies can do on their IR web pages; yet, the guidance was inflexible where there might be temptation for mischief. As a result, it’s hard to see how the SEC’s existing guidance has acted as a barrier that has prevented companies from leveraging their IR web pages to communicate with shareholders.
Clearly, companies can’t blame their decisions to not provide shareholder-friendly proxy materials on their IR web pages on the SEC’s existing guidance – since these online materials are not really impacted by the SEC’s parameters much at all. Instead, the SEC’s guidance relates to when companies get “fancy” and build out their IR web pages with other types of information and tools. Even creating annual meeting web pages that campaign are not limited by the SEC’s current guidance.
So where does this leave me? I think the SEC’s upcoming updated guidance should reinforce many of the principles that it already has set forth – along with filling in a few holes and making some tweaks – but the real need is to push companies to start treating their IR web pages as a place where shareholders want to visit to learn about the company and trust it. In fact, I think it makes sense for the SEC to engage in rulemaking that forces companies to post some minimum level of usable documents and other information on their IR web pages.
In recent rulemakings, the SEC has recognized IR web pages as a place for shareholders to go – the latest being the XBRL proposals, which would require companies to post XBRL documents on the same day as they are filed with the SEC – and this seems to be a logical next step. Below I delve more specifically into some of the SEC’s options:
Corporate Website Use: Can the Industry Fix Itself?
I get worried about the recommendation in the CIFiR report that “industry participants” develop uniform best practices. Which industry participants have shown any leadership in this area? None that I can think of. What we do know is that many IR web pages are rudimentary in this country, with a fair number of companies outsourcing them to vendors who also show minimal vision.
In his IR Web Report, Dominic Jones recently provided startling statistics from this past proxy season: almost 90% of US companies chose formats for their online proxy materials that were essentially garbage; compare that to the large companies in the United Kingdom where 46% provided dynamic HTML documents.
US companies have a long road to hoe here – but it’s easily fixable. Plough your e-proxy savings back into usable documents and the IR web page in general – listen to what Doug Stewart of Intel said on last week’s e-proxy webcast. Make your IR web page a desired destination spot that investors are programmed to think of first when they want to conduct research about your company.
Corporate Website Use: What the SEC Should Do
With a hat tip to Dominic Jones, here are a few items that I hope to see the SEC tackle in its updated guidance:
1. Recognize Sufficient Internet Penetration for Regulation FD Purposes – Back in 2000, the SEC requested comments about what is considered sufficient Internet penetration to begin allowing companies to rely on the Web for delivery of information purposes. Some commentators noted way back then that surveys showed that there was sufficient support for the Web as an adequate disclosure medium. This is obviously much more true today and the SEC already has adopted rules that implicitly recognize this. The guidance should address whether information posted only on a corporate site meets Regulation FD’s requirements, etc.
2. Give Smaller Companies a Break from Newswire Fees – The SEC should provide guidance on news releases per se. Can a company meet the requirements by issuing a summary and a link – or even just a notice – advising that it has posted it earnings release on its website and filed it on Edgar? Small companies are hurting from newswire fees. To cut costs, companies shouldn’t have to use press releases to announce an upcoming earnings call or presentation because there are so many alternatives now that are just as good. Another way to cut costs is to allow companies to use summaries and links to reduce their word count in their press releases.
3. Liberalize the Link Liability Standard – One primary concern expressed by some is that the SEC’s current liability approach for linking to other content is too restrictive. For linking to third-party content, in 2000, the SEC came up with a non-exclusive six-factor approach that is a principles-based regulation. When linking from one company document to another – in the delivery context – the SEC invoked the “envelope theory.” [For more on the SEC’s existing link regulatory framework, see these FAQs that I drafted long ago on my old site, but that are still relevant today.]
Even though the SEC’s approach still seems reasonable today, it is too complex and companies uniformly don’t provide access to outside perspectives as a result. Since one of the primary benefits of the Web is the ability to link to related content, I think the SEC should morph its approach and encourage companies to provide insights from multiple sources within certain reasonable limits.
Too often, companies use the existing regulatory framework as an excuse not to link to useful sources of information. Yet, it is hardly ever in an investors’ best interests to have less information or fewer opinions about that topic. For example, companies should provide access to analyst research reports. I recogize that this brings risks – such as selectively linking to only favorable analyst reports – but there are many more ill-informed investors than there are crooked companies and dishonest analysts.
So we shouldn’t punish all investors for the sake of a few bad apples. I believe we are better off allowing companies to leverage the Web and create comprehensive IR web pages – and the SEC can use its enforcement authority to chase the outliers who choose to abuse the freedom.
By the way, it’s not just that the SEC needs to tweak its rules, the NYSE is in the dark ages as Dominic blogged about last year.
Corporate Website Use: What the SEC Should Not Do
In particular, there are two things that I think the SEC should not do when it issues its updated guidance:
1. Don’t Impose Unnecessary “Hoops” on Links – I dislike the notion of using exit notices and click-through disclaimers in the linking context. I don’t think they really warn shareholders and I doubt a court would give them much more weight than a standard disclaimer that sits at the bottom of the page and is not intrusive. And these “hoops” run counter to the purpose of links in the first place – getting folks easily from one place to the next. [And there is sparse caselaw so that its unclear if a court would really distinguish between these types of disclaimers anyways.]
If the SEC is really concerned about content “out of context,” it should focus on the fact that under its XBRL proposal, numbers from the financials will be far removed from the all-important footnotes. And these footnotes will take on much greater importance under IFRS, a principles-based regulatory framework with a much greater level of discretion than under US GAAP.
2. Don’t Try to Specifically Address Evolving Technology – So much of our technology today is still evolving that I don’t think the SEC should try to set standards around specific online functionalities. For example, it’s too early to tell how RSS feeds and IRO blogs will really evolve (I’ll be blogging more about IROs as bloggers later this week). For these, it’s best for the SEC to merely broadly state the obvious about not doing stupid things and allowing these technologies to continue to naturally evolve.
As proposed back in February, the SEC has approved another one-year extension of the compliance date for smaller companies to meet the Section 404(b) auditor attestation requirement of Sarbanes-Oxley. Smaller companies will now be required to provide the attestation reports in their annual reports for fiscal years ending on or after December 15, 2009.
In addition, the Office of Management and Budget is allowing the SEC to proceed with data collection for a study of the costs/benefits of Section 404, focusing on the consequences for smaller companies and the effects of the auditor attestation requirements.
FriendFeed: A New Way to Experience a Conference
Emboldened by my NIRI experience with FriendFeed a few weeks back, I have created a FriendFeed room for the Society of Corporate Secretaries & Governance Professional’s Annual Conference – which starts this Thursday – at http://friendfeed.com/rooms/society08. A big “shout out” to Dominic Jones for leading the way here; FriendFeed only established its “rooms” capability in May, so this is truly cutting-edge.
1. Why Do You Care? – The FriendFeed experience is mind-blowing in that you can envision the future of conferences where the “speakers” are not just the lucky slobs up on the dais – it’s everyone in the room! It will be interesting to see how long it takes for this type of technology to live up to its potential.
If you don’t attend, you can get a flavor of what is happening from those that are there – if you do attend, your fellow attendees can help enrich your experience. For example, at the NIRI conference, I was able to better identify which booths were to my liking by following the recommendations of someone else – and I enjoyed reading commentary about various panels as they happened. Also useful are tips about the conference hotel, nightlife, etc. Of course, all of this becomes more useful when more people contribute – the strength of numbers.
2. How Can You Participate? You can simply read, listen and watch the contributions of others – but of course, it’s more fun if you actively participate. From what I have learned so far, here’s a roadmap about how you can observe or participate (this is all very new and evolving, so some of these might not work for you depending on what technologies you are using):
a. Catch the Highlights at FriendFeed – As noted above, the contributions are – and will – mainly be found on this FriendFeed page. For this first year, it may well be the only postings come from me – but hopefully not. This is an experiment and I imagine it will grow in future years as the tools become more user-friendly and we all learn more about available technology.
To watch others contribute, just click on the room and browse. To actively participate, you simply need to “join the room” by creating a nickname and password for yourself (after first creating a free FriendFeed account). Then, you can participate in any one of several ways described below.
b. Adding a Link to FriendFeed – Here is a short video that explains how to post a link to FriendFeed. Once you register for FriendFeed and watch this one-minute video, you will find it takes mere seconds to add a link to something and write a short comment about it.
c. Commenting on Someone Else’s Commentary on FriendFeed – This truly only takes seconds as you can click on the “comment” section underneath someone else’s contribution and quickly add your ten cents.
d. Uploading Photos and Video on FriendFeed – Uploading multimedia is more time-consuming than adding links and mere text. I will be trying to play around with that during the Conference and we’ll see how I do. It’s fairly easy – with the hard part being uploading a video to YouTube (after first compressing it, which is dependent on the speed of your Net access). So we’ll be at the mercy of the speed of the connections available at the Conference hotel.
e. Twitter, TwitterBerry and Twemes – Due to the “newness” of the technology, there might be Twittering during the Conference that isn’t caught on the Society’s FriendFeed page. Twemes allows you to follow Twitter posts that only relate to your conference (although that service is not perfect either and sometimes misses some Tweets). You can follow them by putting “society08” in the search box at the top of the Twemes home page – or simply go to this Society page.
If you carry a BlackBerry, you can twitter from that device by downloading free software called “TwitterBerry.”
You might ask: what is Twitter? Twitter is a rapidly growing – free – service that allows you to text a message (or it can be done from any browser) that is no longer than 140 characters. Each of these messages is known as a “Tweet.” (Fyi, Twitter is growing so fast that the people running it can’t keep up and they keep having outages.) For Twemes and FriendFeed to capture Tweets about the Conference, you must use this as part of your 140 characters: #society08. Don’t forget the pound sign.
Just like FriendFeed, you must first register for Twitter (at Twitter.com), which is free and easy to do.
f. Tag Everything with “#society08” – To contribute content, you will need to tag your Tweets, Flickr photos, YouTube videos, blog posts, public bookmarks, etc. with the “#society08” tag. That will just make it possible to get everything aggregated in the room.
3. Will I Get in Trouble? – Assuming you don’t upload embarrassing pictures of yourself or give away trade secrets, it’s hard to imagine you getting into trouble for participating. However, if you are paranoid, you can use screen names that won’t identify you when you register for Twitter or FriendFeed (for example, one of my Twitter accounts is under “Captain XBRL”). That way you will feel unemcumbered and can join the “conversation.” Have some fun and see ya in Boca!
Last Week: Early Bird Discount for Our Conferences
With the first day of summer upon us tomorrow, the confirmation process for the three SEC nominees continues to drag on. Following the June 3rd hearing of the Senate Committee on Banking, Housing, and Urban Affairs, it seems likely that action on the nominations will proceed, although how quickly is anybody’s guess. At this point, there seems to be at least some expectation that the new Commissioners could be on board by the end of this month.
As discussed in this Bloomberg article by Jesse Westbrook, the nominees all indicated an interest in considering the issue of proxy access, and they also supported increased scrutiny of credit rating agencies.
Not everyone wants to see a speedy resolution to the appointment process. As noted in a recent issue of RiskMetrics’ Risk & Governance Weekly, AFSCME has been urging a delay in confirming the nominees so that the next president can select the Commissioners for the three open seats.
The Risk & Governance Weekly piece notes:
“The American Federation of State, County, and Municipal Employees (AFSCME) is calling on the Senate to hold off confirming the three nominees and allow the next president to fill those SEC vacancies.
‘It’s a five-year term [for SEC commissioners], and the next president should have the choice,’ said Richard Ferlauto, the union’s director of pension and benefit policy.
‘We don’t see any advantages’ to filling those vacancies now, said Ferlauto, who noted that the Republicans would still hold a majority on the commission. ‘That would give the green light to Chairman Cox to continue his deregulatory mission at the SEC.’
AFSCME also is specifically opposing Paredes’ bid to serve on the SEC. ‘He has a long track record of opposing the fundamental principles of investor protection . . . and shouldn’t serve on the commission,’ Ferlauto told Risk & Governance Weekly.
If presumptive Democratic presidential nominee Barack Obama is elected in November, he would be able to appoint a new SEC chairman, which would give Democrats a 3-2 majority on the commission.”
More FASB Action: Accounting for Hedging Activity
Over the past 10 years, there has probably been no better course of action for financial statement preparers than to avoid hedge accounting like the plague. In terms of complexity, the hedge accounting model in FAS 133 has topped the charts since its adoption. The Standard includes many traps for the unwary, including the “shortcut method,” which is perhaps the accounting equivalent of skydiving without a parachute in terms of risk profile.
Earlier this month, the FASB issued an Exposure Draft of a proposed statement that would amend FAS 133 to completely revamp the hedge accounting model. Under the proposed Statement, a fair value approach to hedge accounting would be established, eliminating many of the complicated elements that exist under the Standard today, including bifurcation-by-risk, the shortcut method, critical terms match, and the requirement to quantitatively assess effectiveness in order to qualify for hedge accounting. While a fair value approach has its own issues, the proposed changes would likely substantially simplify the accounting for hedging activities.
On the convergence front, while the proposed Statement diverges from the hedge accounting requirements of IAS 39, Financial Instruments: Recognition and Measurement, the International Accounting Standards Board has taken up a project to revamp its own hedge accounting standards, including consideration of an alternative comparable to the FASB’s proposed approach.
The FASB intends to issue a final Statement by the end of this year, with the amendments becoming effective for financial statements issued for fiscal years beginning after June 15, 2009, and interim periods within those fiscal years. Comments on the proposed Statement are due by August 15, 2008.
Risk Factor Disclosure at Technology Companies
In this podcast, Doug Sirotta, a Partner in the Technology Practice at BDO Seidman, discusses BDO’s recently released report on the risk factor disclosure of the top 100 technology companies, including:
– Why was this study undertaken?
– What were the major findings?
– Were there any surprises?
– What practice pointers are there for companies in the wake of the study?
Yesterday, Corp Fin posted a revised Staff Legal Bulletin No. 3A, providing updated guidance on the exemption provided by Securities Act Section 3(a)(10). The SEC had noted that a revised SLB would be issued upon effectiveness of last year’s changes to Rule 145.
This SLB replaces the two prior Section 3(a)(10) bulletins – the one originally issued in 1997 and the revised version issued in 1999 (reflecting the enactment of SLUSA). In addition to the new guidance regarding the Rule 145 amendments, various tweaks and updates have been made throughout the SLB.
Schoon v. Troy: Denying Advancement Rights of Former Directors
A Delaware Chancery Court decision by Vice Chancellor Stephen Lamb from earlier this year may come as a quite a surprise to directors, who may be troubled to now learn that their rights to indemnification or advancement of legal fees and expenses could be eliminated after they leave a company’s board. In Schoon v. Troy Corporation, Vice Chancellor Lamb concluded that a bylaw amendment eliminating the company’s fairly typical legal fee advancement obligations for former directors could be enforced, even in a situation where a former director had served on the board when the pre-amendment bylaws provided for such advancement. Given that the time for appeal of the decision has now expired, it appears that Schoon will remain the law of Delaware for now.
All may not be lost for former directors, however. As Kevin LaCroix notes in The D&O Diary blog, former directors are typically included within the definition of “insured persons” under most D&O liability insurance policies, which means that in most situations the former directors could still get expense protection and indemnification under the policy – even if the company chooses to later change its bylaws to eliminate advancement and indemnification provisions. Kevin also points out the availability of former director and officer liability insurance policies that provide coverage exclusively to the individual director or officer, thus avoiding any potential for interference with the coverage by others (such as the company). That option sounds expensive, but it may be prudent depending on the circumstances.
The Investment Management and Corp Fin Staffs recently provided some no-action relief to Eaton Vance Management in one of the latest efforts to deal with the locked-up auction rate securities markets. There really seems to be no end in sight for the troubles in the auction rate market, so there is no doubt that the Eaton Vance’s plan to bail out its auction rate security holders will come as some welcome relief.
Several Eaton Vance funds have auction rate preferred securities outstanding, and Eaton Vance is seeking to enhance liquidity for the holders of the auction rate securities, given the inability to conduct auctions under current market conditions. Under the proposed transactions, the funds would issue “liquidity protected preferred shares” that would enable holders to sell their shares through a periodic remarketing or, in the event that the shares are not successfully remarketed, to a designated liquidity provider.
In addition to the requested Investment Company Act relief, Corp Fin said that, while offers to purchase the liquidity protected preferred shares in the event that they could not be remarketed may be a tender offer, the Staff would not recommend enforcement action if the offers are conducted without complying with Rule 13e-4 and Regulations 14D and 14E.
In issuing the Exposure Draft, the FASB is responding to concerns expressed by investors and others about the inadequacy of information currently available regarding the likelihood, timing and amount of future cash flows associated with loss contingencies. These changes could significantly impact the audit response letter process, given the potential increase in disclosure obligations concerning sensitive matters such as ongoing litigation and the operation of the proposed “prejudicial” exemption.
The proposal seeks to enhance current disclosure requirements by:
– expanding the types of loss contingencies to be disclosed to include specified remote loss contingencies;
– requiring that certain quantitative and qualitative information be disclosed;
– requiring a tabular reconciliation of changes in amounts recognized for loss contingencies; and
– providing an exemption from disclosing certain required information, if disclosing the information would be prejudicial to a company’s position in a dispute.
A significant aspect of the FASB’s proposal is the expansion of contingencies that are potentially reportable. Today, a company does not typically have to disclose loss contingencies for which the likelihood of a loss is remote. Under the proposed Statement, a company would be required to disclose remote loss contingencies if:
– the contingency (or contingencies) is expected to be resolved in the near term (within one year from the date of the financial statements); and
– the contingency (or contingencies) “could have a severe impact on the entity’s financial position, cash flows, or results of operations.”
Under the proposal, disclosure would also be required for all loss contingencies that stem from asserted claims or assessments (or those for which it is probable a claim will be asserted) and for which the likelihood of loss is deemed more than remote.
The FASB wants to “field-test” this proposal with preparers, and it also hopes to hold at least one roundtable on the topic. If adopted, the proposed Statement would be effective for fiscal years ending after December 15, 2008, and interim and annual periods in subsequent fiscal years. Comments are due by August 8, 2008.
Last week, I was moderating a panel at the NIRI Annual Conference on SEC Enforcement developments, and the topic of 10b5-1 plans inevitably came up. Andrew Petillon, Associate Regional Director of the SEC’s Los Angeles Regional Office, confirmed that, while no SEC actions have been announced yet, Rule 10b5-1 remains an area of focus for the Staff.
Now, a new paper published by Stanford Business School Professor Alan Jagolinzer. Penn State Business School Professor Karl Muller and University of Chicago Law Professor Todd Henderson – entitled “Scienter Disclosure” – explores the relationship between voluntary disclosure regarding Rule 10b5-1 plans and the trading returns of the executives who have implemented the plans. (Professor Jagolinzer published the paper “Do insiders trade strategically within the SEC Rule 10b5-1 safe harbor?” which originally piqued the SEC Enforcement Staff’s interest in potential 10b5-1 plan shenanigans.)
The concept of “scienter disclosure” from the title of this new study refers to “the voluntary disclosure of either information or the intention to act on the information in advance of acting on it.” Through this, the authors are focusing on disclosure that attempts to mitigate litigation risks associated with any potential wrongdoing. The authors believe that disclosure of an insiders’ participation in a Rule 10b5-1 trading plan is an example of scienter disclosure, given that participation in a Rule 10b5-1 plan provides “clear, legal risk-reduction benefits.”
The study focuses on returns for executives participating in Rule 10b5-1 plans at firms that choose to disclose the existence of the plans and at firms that do not provide voluntary disclosure. The authors conclude from the study:
“Our evidence indicates that voluntary Rule 10b5-1 disclosure is associated with the level of firm legal risk and a proxy for insiders’ potential strategic trade. Our evidence also indicates that Rule 10b5-1 disclosure is associated with greater abnormal returns to insiders’ trades, especially for firms disclosing specific plan details. Finally, our evidence indicates that investors do not respond negatively to Rule 10b5-1 participation disclosure. Collectively, our work has three salient implications for voluntary disclosure: 1) litigation risk can play a key role in the propensity to disclose information prior to strategic trade; 2) Rule 10b5-1 participation disclosure does not fully reveal insiders’ private information; and 3) disclosure in this setting may actually enhance insiders’ strategic trade opportunities, which is seemingly inconsistent with the SEC’s intent for the Rule.”
Based on these findings, the authors suggest that courts might more carefully consider whether 10b5-1 disclosure mitigates scienter – given that strategic trading appears to be associated with enhanced disclosure – and that the SEC should also consider that if it were to require disclosure of Rule 10b5-1 plan participation, such disclosure might not mitigate strategic trading by those implementing Rule 10b5-1 plans. The SEC proposed, but never adopted, disclosure requirements concerning participation in Rule 10b5-1 plans, and the Staff has recently said that “asymmetric” voluntary disclosure around Rule 10b5-1 plans could be problematic.
Posted: Proposing Release on Credit Ratings
Yesterday, the SEC posted the proposing release for changes to the rules applicable to credit ratings and NRSOs, focusing particularly on structured products.
One of the interesting components of the proposed rule changes is the amendment to Rule 17g-5 that is designed to addressed the “issuer/underwriter pay” conflict by requiring that – as a condition to the NRSRO rating a structured finance product – the information provided to the NRSRO and used by the NRSRO in determining the credit rating would need to be disclosed through a means designed to provide reasonably broad dissemination of the information. The proposed amendment would require the disclosure of information provided to an NRSRO by the “issuer, underwriter, sponsor, depositor, or trustee.” The goal of this amendment is to purportedly level the playing field between the “issuer/underwriter pay” NRSROs and the subscription-based credit rating agencies, by giving all credit rating agencies equal access to information.
The release of this sort of loan level data (referred to as the “loan tape”) about a structured finance product could obviously create some complications under the Securities Act, for both registered and exempt transactions. The SEC has sought to address these concerns by issuing some proposed guidance. For registered deals, the SEC says that the information would need to be disclosed on the pricing date for the transaction. In offerings that are not registered under the Securities Act, the information would need to be disclosed to investors in the offering and credit rating agencies on the pricing date, and then disclosed publicly on the first business day after the transaction closes.
For registered deals, the SEC indicates that the loan tape information may constitute ABS informational and computational materials that need to be filed on Form 8-K, or as free writing prospectuses filed under Securities Act Rules 433 and 426. For private deals, the SEC says that general solicitation/general advertising concerns could be avoided by providing the information to investors, NRSROs, and credit rating agencies through posting on a password-protected website (as is often done today for investor access to the information), and then removing the password protection so the public may access the information after the offering closes. Similar guidance is provided for Reg. S offerings.