Monthly Archives: September 2008

September 30, 2008

ACAP Report: Improving the Auditing Profession

Remember those halcyon days when Treasury Secretary Paulson was mostly concerned about the competitiveness of the US capital markets, rather than fighting 24/7 for the survival of the US capital markets? Well, back then when the Treasury Department’s time might have been better spent worrying about the systemic risks posed by credit default swaps or the looming mortgage crisis that was beginning to show its ugly face, the Treasury Department’s Advisory Committee on the Auditing Profession (ACAP) was established. In my view, it was always a little strange that the ACAP (which was headed by Arthur Levitt and Don Nicolaisen) was a Treasury Department creation, rather than a committee established by the SEC or the PCAOB, but then again I don’t think that Treasury has been too worried about stepping on the SEC’s toes.

On Friday, Treasury announced that the ACAP had adopted its Final Report. As noted in this Fact Sheet, the three principal areas of focus in the ACAP’s recommendations were human capital, firm structure and finances, and concentration and competition. A Draft Final Report has been posted, with the Final Report expected to be posted some time this week.

One of the areas that the ACAP studied which has garnered some attention over the past year is liability reform for accounting firms, however the Subcommittee on Firm Structure and Finances was unable to reach any consensus on recommendations in this area. Rather, the final report reflects the divergent views of the committee members on that topic.

Among the areas that the ACAP asks the SEC to consider are (1) amending Form 8-K disclosure requirements to characterize appropriately and report every public company auditor change, and (2) requiring disclosure by public companies of any provisions in agreements with third parties that limit auditor choice. The ACAP also asks the SEC and the PCAOB to undertake a number of other initiatives. The PCAOB issued a statement indicating that it welcomed the Committee’s recommendations, while the SEC issued no statement about the ACAP’s Final Report.

Back to the Drawing Board on Proposed FAS 5 Amendments

Last week, the FASB approved a recommendation from its Staff to reconsider the Exposure Draft issued last June that proposed significant changes to the reporting of loss contingencies under FAS 5. In deciding to reconsider the proposals, the FASB particularly noted comments that the proposed standard would compel defendants to waive their attorney-client privilege and disclose prejudicial information, as well as comments expressing implementation concerns with a potential effective date for fiscal years ending after December 15, 2008.

Now the FASB is seeking some volunteers to “field test” two alternative proposals using disclosure about already resolved lawsuits. A roundtable is also planned for the first quarter of 2009. The expectation is that a revised Exposure Draft will be considered in the first half of 2009, with a possible effective date for fiscal years ending after December 15, 2009.

No Change for SEC Filing Fees

Yesterday, the SEC issued a fee rate advisory indicating that when the new Federal fiscal year clicks over tomorrow, filing fees will remain at their current rates. I suspect the SEC will be operating under a continuing resolution for a while. It seems unlikely that Congress will be acting on budget legislation any time soon when the House can’t even pass the bailout bill.

Posted: The SEC’s Adopting Release for Cross-Border Deals

The SEC has finally posted its adopting release for cross-border deals. We have started to post memos on analyzing these rule changes.

– Dave Lynn

September 29, 2008

The Mother of All Bailouts: Off to a Vote

Based on the thankful press releases issued last night by the President and the Treasury Secretary, you would almost think that the Emergency Economic Stabilization Act of 2008 has actually been signed into law – but, in fact, it still faces a tough vote in the House today and a vote in the Senate on Wednesday. What did happen over the weekend were marathon negotiations that brought about the current bill, which Nancy Pelosi (D-CA) has described as “frozen” (as noted in this Washington Post article). As a result, we now have a clear picture of what the “TARP” program will look like if the bill is ultimately enacted.

Mark Borges has described the latest provisions of the bill directed at executive compensation and corporate governance matters in his blog. Needless to say, executive compensation limits were retained in the bill (and apparently remained a source of debate throughout the weekend), but whether these vague provisions will impose any real changes on compensation practices at participating institutions – or set a new standard for other companies to follow – remains to be seen. What does seem to be developing that may have more of a long-term impact on executive compensation is a groundswell of public outrage over executive pay in light of the financial crisis. All weekend long, I either read or watched “man on the street” type stories where people expressed disdain for a bailout of financial institutions and their executives while so many others are struggling.

Notably, the House bill also targets mark-to-market accounting, directing the SEC to conduct a study of Financial Accounting Standard No. 157, including as a minimum:

– the effects of FAS 157 on the balance sheets of financial institutions;

– the impacts of mark-to-market accounting on bank failures in 2008;

– the impact of such standards on the quality of financial information available to investors;

– the process used by the FASB in developing accounting standards;

– the advisability and feasibility of modifications to such standards; and

– alternative accounting standards to those provided in FAS 157.

The bill also restates the SEC’s authority to suspend the application of FAS 157 if the SEC determines that such a suspension is in the public interest and protects investors. I guess this goes to prove that when all else fails, blame the accounting.

I still feel like I am missing something on the financial crisis. I don’t think I have yet heard a complete explanation of what has caused such an extreme level of apparent panic among the administration’s economic policymakers that would lead to, among other things, former Master of the Universe Hank Paulson begging on his knees to Nancy Pelosi, as reported in this NY Times article from Friday.

The Plight of Short Sellers

I have sympathy for those who have routinely employed short selling strategies to not only turn a profit, but also to hedge their positions, conduct market making activities, and exploit arbitrage opportunities. Short selling has, rightly or wrongly, become the SEC’s bogeyman in the financial crisis, and lots of unintended consequences are flowing from that status. Don’t get me wrong – I am no apologist for naked short sellers or those who engage in abusive short selling activities. Rather, I have spent an enormous amount of time thinking about short sale issues over the course of my career, and I am a firm believer in the power of short selling to maintain fair, orderly and liquid markets while helping to mitigate individual risks and market exposure.

The SEC’s ban on short sales of shares of financial firms (as amended) is now more than a week old, and is set to expire this Thursday, unless further extended. The likelihood that the ban will be extended seems high, as uncertainty reigns in the marketplace, particularly for the shares of financial institutions. But, as noted in this Wachtell Lipton memo, the ban has created confusion in the marketplace, particularly with respect to the convertible bond market. Further, as recently discussed on Q&A Forum, the short sale ban may be interfering with bona fide market-making activities, as market makers seek to widen the bid/ask spread by increasing the asked price so as to avoid going short and having a “fail to deliver.” Lastly, I fear the consequences if steps are not taken to prevent a massive market slide whenever the short sale ban is ultimately lifted, as “pent up” short selling has the potential to overwhelm an already shaky equity market.

Today is the day that Section 13(f) filers will need to file new Form S-H to report information about their short positions. Due to the SEC’s flip-flop on the public availability of this information, we won’t have access to these reports on Edgar for another two weeks. Last Friday, the SEC posted an updated submission template for Form S-H and some guidance on the disclosure required by the form.

Podcast: The Latest on the SEC’s Short Sale Actions

Last week, I spoke with Larry Bergmann, who is Special Counsel at Willkie Farr & Gallagher LLP and was Senior Associate Director in the SEC’s Division of Trading & Markets, about the emergency actions targeting short sellers and what the future might hold for short sale regulation. In this podcast, Larry discusses:

– What has the SEC done recently to target short sales?
– How are the SEC’s new rules being implemented on such short notice?
– What impact might the SEC’s recent actions have on the market?
– What else can the SEC do to address abusive short selling?

– Dave Lynn

September 26, 2008

The Senate’s “Agreement in Principles”

We’ve posted a copy of the US Senate’s “agreement in principles” that was reached yesterday for the bailout legislation (this WSJ article analyzes the odds of passage – and Dominic Jones explains the importance of retail investors for passage). Here is the very first principle:

Requires Treasury Secretary to set standards to prevent excessive or inappropriate executive compensation for participating companies.

The notion that a group of government staffers may be setting the parameters for a number of CEO pay packages is nearly incomprehensible. I’m glad it isn’t me.

What are “Appropriate Standards” for “Shareholder Disclosure”?

From Will Anderson of Bracewell & Giuliani: The draft language in the Senate bill released earlier this week contains what I view as a potentially significant “sleeper” issue that seems to have escaped the attention of the media, commentators and the Congress (although I confess that I have had trouble keeping up with the flow of information). The Senate draft provides that the Treasury Secretary require sellers to meet “appropriate standards” for “shareholder disclosure.” The draft from the House Financial Services Committee includes the same requirement for “corporate governance”.

It’s not clear to me what the Senate’s “shareholder disclosure” requirement means, but it could be read to grant very broad and virtually unlimited authority to Treasury to establish a disclosure system for participating financial institutions. Or perhaps this language is limited to only executive compensation disclosure, although that is not what the language says. Or maybe it means something entirely different – one lawyer I spoke with thought it could be read to mean disclosure of the identity of the shareholders of financial institutions, but I doubt that is the intent (but who knows).

Hopefully, the shareholder disclosure language will simply be deleted from the bill that comes out over the next few days – or at least add a “related thereto” after the words “shareholder disclosure” so that it is limited to executive compensation. Perhaps the House has it right and it will be replaced with “corporate governance”, although that requirement presents a host of issues that are better left for another day. Here is the Senate’s most recent text (emphasis added):


The Secretary shall require that all entities seeking to sell assets through a program established under this Act meet appropriate standards for executive compensation and shareholder disclosure in order to be eligible, which standards shall include—

Here is the House Financial Services Committee’s most recent text (emphasis added):


(a) IN GENERAL.—The Secretary shall require that all financial institutions seeking to sell assets through the program under this Act meet appropriate standards for executive compensation and corporate governance in order to be eligible.

The Short-Sleeve Culture: Celebrating Twenty Years

Twenty years ago, fresh off the bar exam, I started my professional career as a junior lawyer in Corp Fin. Five other lawyers started that day with me, including Bill Tolbert, Mark Coller and Larry Spaccasi (folks like Marty Dunn, Scott Freed, Celia Spiritos and Todd Schiffman started a few weeks before). Back then, more lawyers were hired right out of school – rather than the laterals that get into the SEC today – so a new batch always started in the Fall.

After a half-day of fingerprinting and general orientation, my branch chief, Steve Duvall, handed me a set of CCH books (ie. the rules) and told me to read them. That was my task for the week – a straight read of the rules. Ken Tabach was riding out his last week on the Staff before splitting for a law firm and he gave me some loose guidance about how to read a registration statement and write up comments.

Those comments that passed muster were read over the phone to an outside lawyer, who taped them and had them transcribed into a comment letter (eventually, we had a SEC secretary type the letter too – but that would take weeks as six or seven lawyers shared each secretary).

There were no computers and no voicemail for the phones. People could smoke in their offices if so inclined – and the old-timers followed an informal policy that they could wear short-sleeves if it was hotter than 90 degrees. And there were government-sponsored keg parties – or is that my vivid imagination playing tricks on me? Right after I started, Market Reg sponsored a party at a local bar to note the one-year anniversary of the ’87 “market break” (that was a day when the market crashed at record levels for a day).

When I returned for my second tour of duty in Corp Fin years later, Bill, Mark and I would grab a morning donut together every year on this date to commemorate our anniversary. For those guys, I’m having two today…

– Broc Romanek

September 25, 2008

Year Two for the CD&A: Our “3rd Annual Proxy Disclosure Conference”

With executive pay a key negotiation point in the bailout bill, rest assured that next year’s executive compensation disclosures will be more important than even. Last week, Mike Melbinger blogged three times about how the SEC Staff is now commenting on CD&A and other compensation disclosures as part of its Year Two review under the SEC’s new rules. Don’t forget that Corp Fin Director John White will serve as the keynote speaker for our upcoming “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference.” If you can’t make it to New Orleans on October 21st-22nd, you can still catch this important conference by video webcast.

So act now for both the “16th Annual Naspp Conference” and the combined “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference” & “5th Annual Executive Compensation Conference.”

Stock Repurchase Programs: Full Speed Ahead?

Last Friday, as part of its temporary emergency actions, the SEC issued an emergency order temporarily suspending the timing restrictions and significantly increasing the volume limitation for issuer repurchases under Rule 10b-18. Since then, I’ve seen a few announcement of stock repurchase programs from companies of all shapes and sizes, including Microsoft ($40 billion) and 3Com ($100 million). The SEC’s order expires next Thursday.

South Dakota’s Short-Selling Ballot Initiative

Below is an excerpt from a Morrison & Foerster memo on short-selling:

Some contend that the SEC’s actions are too little, too late. This November, voters in South Dakota will consider a ballot initiative called Measure 9 that could impact short selling across the United States. Promoted by American Entrepreneurs for Securities Reform, or ESR, a non-profit organization backed by small businesses, Measure 9 would amend sections of the South Dakota Uniform Securities Act of 2002.

The initiative is cast by ESR as a consumer protection measure that will protect South Dakota’s small investors by curbing naked short selling. Opponents of Measure 9 argue that the initiative is unnecessary, impractical, poorly drafted and unconstitutional, with the potential to halt all legitimate short selling activity in the U.S.

Several commentators oppose Measure 9 on the grounds that, as written, the ballot measure would effectively ban short selling altogether. The proposed law would permit the state to take action against a seller of stock in a publicly traded company if that seller engaged in a pattern of commercially unreasonable delay in the delivery of securities sold, or “has sold securities that the person did not own or have a bona fide contract to purchase.” This language tracks the definition of a short sale in Regulation SHO. The law would apply to any brokerage registered in South Dakota even if it does not have an office there.

If interpreted to ban short sales altogether, a broker that transacts short sales with investors in South Dakota would violate the law, regardless of where the transaction takes place or whether the transaction takes place or whether the transaction complies with federal law. Because a broker-dealer’s South Dakota registration is all that would be required to trigger liability under the law, some have predicted that Measure 9 would result in broker-dealers leaving the state or, alternatively, ceasing all short selling activities.

ESR and its supporters contend that the SEC’s efforts to restrict naked shorting have been ineffective and support additional regulation at the state level. From their perspective, the purpose of Measure 9 is to ban naked short selling by permitting South Dakota regulators to take action against broker-dealers engaged in a pattern of fails-to-deliver. Opponents of Measure 9 argue that the trading of securities occurs on a national market and accordingly, should be regulated solely by federal law to preserve consistency, making additional state regulation both unnecessary and impractical.

They predict that the introduction of additional legislation in various states will result in a confusing patchwork of inconsistent and contradictory rules, choking the very markets they are designed to protect. Additionally, they contend that proposed law would be preempted by the National Securities Market Improvement Act (and thus would be unconstitutional). These opponents point out that litigation over the law after it has been adopted (on preemption grounds) would be costly and time-consuming for the parties opposing it, as well as for South Dakota taxpayers.


Measure 9 is not the first proposal of its kind. Measures seeking to limit shorting have popped up in other states such as Virginia and Arizona, where legislation was introduced and quickly withdrawn, and Utah, where such a measure was overturned. Despite setbacks for these similar proposals, ESR plans to lobby for similar legislation in 19 additional states. Opponents of Measure 9 are concerned that the initiative, which addresses relatively sophisticated matters of securities law, will pass due to a lack of voter understanding, leading to unintended consequences in the national markets. Even if Measure 9 is not approved by South Dakota voters or is subsequently overturned, it, and similar proposals, as well as continuing market pressures, will place additional pressure on the SEC to demonstrate that it is proactive in its efforts to curb abusive short-selling practices. The impact of the SEC’s newest regulations on shorting activities, legitimate or otherwise, and whether the results will satisfy activist groups like ESR remains to be seen.

– Broc Romanek

September 24, 2008

What We Really Need from a Bailout Bill: 58 Trillion Reasons

Predictably, the bare-boned Treasury proposal for a bailout bill – fraught with Constitutional problems – is receiving backlash on the Hill. Also predictable – given that elections are coming up – many key Republicans have come around to the notion that the bailout bill should include limits on executive pay (see this Washington Post article and NY Times’ article).

However, the bailout plan is missing a strategy to fix the problems that caused all the problems that the market faces. Without a going-forward plan, I don’t see an end to shoveling money to the bailout. Simply banning short sales ain’t gonna do it. Yesterday, SEC Chairman Cox testified about some of these problems before the Senate Banking Committee – here is an excerpt:

The failure of the Gramm-Leach-Bliley Act to give regulatory authority over investment bank holding companies to any agency of government was, based on the experience of the last several months, a costly mistake. There is another similar regulatory hole that must be immediately addressed to avoid similar consequences. The $58 trillion notional market in credit default swaps – double the amount outstanding in 2006 – is regulated by no one. Neither the SEC nor any regulator has authority over the CDS market, even to require minimal disclosure to the market.

Economically, a CDS buyer is tantamount to a short seller of the bond underlying the CDS. Whereas a person who owns a bond profits when its issuer is in a position to repay the bond, a short seller profits when, among other things, the bond goes into default. Importantly, CDS buyers do not have to own the bond or other debt instrument upon which a CDS contract is based. This means CDS buyers can “naked short” the debt of companies without restriction. This potential for unfettered naked shorting and the lack of regulation in this market are cause for great concern. As the Congress considers fundamental reform of the financial system, I urge you to provide in statute the authority to regulate these products to enhance investor protection and ensure the operation of fair and orderly markets.

What Companies are Disclosing: Form 8-Ks Filed in Response to the Crisis

With the market in crisis, it would be expected that some companies would be be filing Form 8-Ks to disclose material developments. Here are just a few of the many Form 8-Ks filed regarding potential fallout due to exposure from Lehman Brothers and/or AIG:

Primus Guaranty

Ambac Financial Group

Protective Life Insurance Company


Ford Motor


Magellan Health Services

Portland General Electric

Commonwealth Edison


New York Community Bancorp

A Classic Cousin of the “Nigerian Loan Scam”

I received this classic email yesterday:

Dear American:

I need to ask you to support an urgent secret business relationship with a transfer of funds of great magnitude.

I am Ministry of the Treasury of the Republic of America. My country has had crisis that has caused the need for large transfer of funds of 800 billion dollars US. If you would assist me in this transfer, it would be most profitable to you.

I am working with Mr. Phil Gram, lobbyist for UBS, who will be my replacement as Ministry of the Treasury in January. As a Senator, you may know him as the leader of the American banking deregulation movement in the 1990s. This transactin is 100% safe.

This is a matter of great urgency. We need a blank check. We need the funds as quickly as possible. We cannot directly transfer these funds in the names of our close friends because we are constantly under surveillance. My family lawyer advised me that I should look for a reliable and trustworthy person who will act as a next of kin so the funds can be transferred.

Please reply with all of your bank account, IRA and college fund account numbers and those of your children and grandchildren to so that we may transfer your commission for this transaction. After I receive that information, I will respond with detailed information about safeguards that will be used to protect the funds.

Yours Faithfully Minister of Treasury Paulson

– Broc Romanek

September 23, 2008

Draft House Version of Bailout Bill: Includes “Say on Pay” and Shareholder Access

The latest version of the House “bailout” legislation includes provisions for a “say on pay” vote, limits on severance, clawbacks and shareholder access to the proxy for those companies involved in the bailout. See Section 9 on pages 11-13. The Senate version of a bailout bill contains the executive compensation provisions (see Section 17 on pages 30-31), but not the shareholder access one.

Bear in mind that both of these are just drafts and that they likely are just the Democratic versions of a bill. Media reports indicate that the bailout plans changes from hour to hour. In fact, I can’t even be sure I have linked to the latest drafts…

The World is Changing: Why Can’t CEO Pay?

With the very real possibility of executive compensation constraints being part of the Congressional bailout legislation, it seems like a good time to examine why executive compensation practices haven’t changed – even though 99% of this country believes they should. With Wall Street and our financial markets undergoing a complete transformation and the regulatory framework certain to be reformed in ways we never imagined, why does CEO pay remain “untouchable” for many boards and their advisors?

Here are a few of my thoughts:

1. Lots of Lip Service – Personally, I am tired of having conversations with colleagues who tell me that compensation committee meetings really have changed. I believe that. The problem is it’s just the committee processes that have changed – to pass judicial muster after Disney – but the committee’s actions remain the same. When I have these conversations, it’s telling how perfunctory committee meetings used to be!

2. When There is Responsible Change, It’s Driven by the CEO – Most often when I talk to someone who regularly advises boards, I hear that the few companies that really make responsible changes are the ones where the CEO speaks up and voluntarily asks for the change. Sadly, boards and compensation committees are not the ones driving responsible change.

3. Debunking “Everyone Else is Doing It” – How often has this justification lead us down the garden path? Just because everyone is using peer group benchmarking instead of alternative benchmarking – like internal pay equity – doesn’t make it right. In fact, some plaintiff lawyers may argue that it’s now widely known that 15 years of broken peer group benchmarking has made that methodology unreliable – and that boards that continue to heavily rely on that broken database are not fulfilling their fiduciary duty to be reasonably informed. (And remember that today’s excessive CEO pay packages are a relatively new phenomenon, only about 15 years old as I’ve explained before).

4. You Won’t Lose Your CEO If You Trim $10 Million – Probably the most frequent justification to maintain the status quo is that the CEO will walk if the pay package is cut from $20 million to $10 million. I find this an empty argument in most cases (and for the many really hurting in today’s economy, even the $10 million produces anger). Sure, the grass is always greener – but the reality is the grass is brown all over right now.

I realize that having a pay-cutting conversation is hard – but there are baby steps that can be taken to bring executive compensation back in line. Start with implementing a clawback provision with teeth, eliminate severance arrangements that have no purpose and require executives to hold-til-retirement. Use better tools to ensure a fairer process, like internal pay equity and wealth accumulation analyses.

5. Congressional Solution Not Preferred, But Perhaps Inevitable – I don’t believe Congressional intervention into pay practices is a sound idea, but the failure of boards to fix pay practices on their own has brought us to where we are today. And it shouldn’t be a surprise that Congress is now focusing on this topic – the House has held hearings on CEO pay repeatedly this year and both Presidential candidates have stated their intention to pass “say on pay” legislation next year. I believe we are at a “last chance” stage for boards to truly get their act together or else we will wind up with laws that do it for them.

What Can You Do? You can be informed and learn as much about responsible practices as possible. Our upcoming “5th Annual Executive Compensation Conference” can help you get started by providing a roadmap of practical tools and processes that you – and your board – can use to make things right. If you can’t make it to New Orleans on October 21st-22nd, you can still catch this important conference by video webcast.

If times are tight and your company doesn’t have the budget to cover the full cost of registration, send me an email and we’ll accommodate you. We are far more interested in getting CEO practices back on the right track than making money from the Conference. Note that when you register for the “5th Annual Executive Compensation Conference,” you also get access to the “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference” as these two practical Conferences are bundled together. The two Conferences are being held on successive dates.

Fixing the “No Short List”: The SEC Punts to Stock Exchanges

In my rush to blog before I left for a speaking engagement yesterday morning, I had missed the part of the SEC’s revised emergency order that now requires each stock exchange to post a list of the financial institutions that should be covered by the SEC’s temporary short-selling ban. Last night, the exchanges posted their lists with additional companies on them (here is the NYSE list and Nasdaq list), which are subject to further refinement.

This is probably a wise move given the snafus made by the SEC so far – but pretty embarrassing given that the SEC went through the exercise of creating a “No Short List” for financial institutions just a month ago (read some of the quotes at the end of this WSJ article). As a SEC Staff alumni, this Bloomberg article makes me cringe and I worry that the SEC will be made a scapegoat for the ongoing crisis and that Congress will fold it into another federal agency…

– Broc Romanek

September 22, 2008

Dear Treasury: Will $700 Billion Cover It?

The US Treasury’s initial draft of Congressional legislation to provide Treasury with authority to purchase up to $700 billion in mortgage-related assets is unbelievably simple, providing broad authority for the Treasury to set their own guidelines about how to spend the money. So simple that I think it was drafted on the back of a napkin. However, there is much Congressional haggling to be done over the next few days and the final product likely will look much different.

Here is a Davis Polk memo that summarizes the legislation pretty nicely – and here are some articles on the proposed legislation:

WSJ’s “Lawmakers Battle Over Rescue Plan

NY Times’ “Democrats Set Terms as Bailout Debate Begins

Washington Post’s “As Hill Debates Bailout, Wall St. Shifts Continue”

WSJ’s “Paulson Presses Congress to Act On $700 Billion Bailout Plan

NY Times’ “A Bailout Plan, but Will It All Work?

NY Times’ “Bipartisan Support for Wall St. Rescue Plan Emerges”

Bloomberg’s “Treasury Seeks Authority to Buy Mortgages Unchecked by Courts”

Between the time I drafted this blog last night and this morning, things were already changing. Things are moving so fast. One of the key bones of contention regarding the legislation is whether there should be limits on CEO pay – including severance pay – at those companies that benefit from the legislation. Last night, Mark Borges covered this story in his “Proxy Disclosure” Blog.

Patching Up the SEC’s Temporary Emergency Actions

Wow, what a wild week last week was. And I imagine this week will be more of the same as Congress seeks to act. In the SEC’s haste to take action, its temporary emergency actions had holes in them, some of which were addressed by clean-up amendments adopted on Sunday – see this SEC press release. In addition to making technical amendments, the SEC’s revised order provides that the information disclosed by investment managers on new Form SH will be nonpublic initially, but will publicly available on Edgar two weeks after it is filed with the SEC (see footnote 8 of the revised order).

Here is a WSJ article describing some of the holes and below is an excerpt from a Davis Polk alert:

“Unlike a similar action taken by the U.K. Financial Services Authority on September 18th, the prohibition is not limited to the active creation or increase of net short positions. Without this exception, it would appear that financial institutions (including those the SEC is trying to protect) and other market participants who hold convertible securities, options and other equity derivatives, cannot adjust their delta hedge positions in the underlying common stock that hedge their risk of owning the equity derivatives. Therefore, contrary to its intent, the SEC action may significantly limit the ability of the indentified financial institutions to access the convertible and equity derivative markets.

The SEC has been addressing a number of specific questions and concerns that have been noted. For example, we understand that the SEC staff has informally advised market participants that, despite the reference to ‘publicly traded security’ in the order, the order is not intended to cover debt securities.”

A few members were not happy with my dig against McCain on Friday, about his jab against SEC Chairman Cox. I just want the record to show that I had written that piece before I had read this op-ed entitled “McCain’s Scapegoat” in Friday’s WSJ, which expressed a similar sentiment. Don’t worry, I’m not gonna start blogging about politics – but that one was too hard to resist.

The Importance of Your SIC Code

On Friday morning, the SEC took temporary emergency action to prohibit short selling in 799 financial companies. These actions were effective immediately and will expire at the end of the day on October 2nd (unless extended by the SEC). For its “No Short List” (see Appendix A for the list), the SEC selected the 799 companies based on their Standard Industrial Classification code (known as a “SIC” code; these codes are a US government system for classifying industries by assigning a four-digit code to each company). A total of 31 SIC codes were included in the list.

I received a number of emails from panicky members whose financial service companies were not part on the SEC’s list. Some of these companies have SIC codes covered by the SEC’s emergency order, but they were not listed by name in the SEC’s order. For example, this situation applies to AllianceBernstein Holding, Invesco and Legg Mason. They’ve all filed Form 8-Ks stating that they believe they should be on the list since they were covered by the SIC code used by the SEC (eg. Legg Mason’s 8-K).

Others believe their companies are financial services companies and should be on the list, but their companies don’t have SIC codes – at least, as they show up in the SEC’s database (however, EDGAR shows their SIC code) – that correspond to the range of SIC codes covered by the SEC’s “No Short List.” To illustrate, CNBC reported that several companies – like General Electric – may be added to the list because their financial services businesses are substantial. GE’s SIC code in the EDGAR database shows up as “SIC: 3600 – Electronic & Other Electrical Equipment (No Computer Equip).” CNBC mentioned several other financial service companies not on the SEC’s list, including CIT Group and American Express. Watch this CNBC video, which points out the problems and quirks with the list (egs. there aren’t 799 names on the list and at least four non-trading companies were inadvertently included).

Note in the SEC’s order, the SEC took pains to say that its list was prepared on a “best efforts basis.” I’ve heard that the SEC expects to post an amended list soon.

Lesson learned? Re-consider your company’s SIC code to ensure it properly fits your company. Remember that companies pick their own SIC code when they file their Form S-1 to go public – there is a spot on the facing page – and the SEC has no input (although in theory, the Staff could question your choice). The SIC code also is submitted as part of the header when the filing is Edgarized (note a SIC code isn’t solicited on the Form ID).

Note that the SEC is one of the few – if not the only – government agency that still uses SIC codes (probably because those codes are so hard-wired into much of the SEC’s disclosure framework). The more recent – and widely used – identification system is the North American Industry Classification System (NAICS), which has largely replaced SIC codes in other contexts.

– Broc Romanek

September 19, 2008

McCain vs. Cox

Yesterday, Senator John McCain stated that he would fire SEC Chairman Cox if he were President. In response, Cox issued this press release in his defense.

Both of these actions are breathtaking. McCain obviously is looking for a scapegoat in his efforts to win the Presidency. And Cox looks wildly paranoid – and stooping low to engage in politics when he is supposed to be managing an independent federal agency in the midst of the biggest financial crisis of our lifetime.

I’ve blogged over six years and haven’t blogged a single item that could be considered partisan politics. But with McCain’s unbelievable flip-flopping of late, I can’t help it. I guess that means next week McCain will say that Cox will be named Treasurer if he gets elected. On Wednesday, McCain was saying that the government should let AIG fail – but by Thursday, he was touting the opposite (see this video).

Meanwhile, Paulson continues to socialize our economy. The US Treasury just set aside $50 billion to guarantee money market funds (see this press release). I could sit here and blog all day about the unbelievable string of events this week – by the end of next week, it looks likely that our entire financial system will be completely revamped before our very eyes. I’m sure glad people are taking their time to debate the course of action and closely consider all the long-term ramifications of these actions…

I do believe Cox could have done a whole lot more during this financial crisis – for starters, he should have been on the bully pulpit trying to maintain calm. I’m not the only one who thinks more could have been done: check out this blog that criticizes Cox for demoralizing the Enforcement staff – and listen to this story from Chicago public radio’s This American Life called “Now You SEC Me, Now You Don’t,” which talks about how noticeably absent SEC Chair Cox has been in the midst of the meltdown. This podcast is just free for this week – and the story starts at 36 minutes into the program. Minute 54 is particularly amusing.

Parsing the SEC’s Authority to Adopt Its Short-Selling Emergency Order

Yesterday, I noted in passing that Professor Jay Brown had analyzed in his “Race to the Bottom” blog, whether the SEC’s emergency order violates the Administrative Procedures Act.

Jack Katz, the SEC’s long-time former Secretary, saw that and noted there was something weird at first glance. Under Section 12(k)(2)(C), when the SEC takes emergency action, it’s exempt from the APA, including the Section 553 notice and comment period as well as the 30-day waiting period for effectiveness. However, the SEC’s press release explicitly says that the action is taken under the APA. In comparison, the SEC’s emergency order is silent on the APA.

For example, under the APA, a federal agency can skip both the notice and comment period and 30-day waiting period for effectiveness if it makes a finding that the action is unnecessary, impracticable or contrary to the public interest (for notice and comment) and a finding of good cause (30-day period for effectiveness). You may recall that the December 2006 executive compensation amendments were adopted under that standard as interim final rules.

I think the discrepancy can be explained – there likely was a shift in the SEC’s thinking between the time of issuance of the press release and the later issuance of the emergency order, when the SEC decided to issue its new rules in the form of an emergency order from interim final rules, probably due to the fact that they just didn’t have the time to crank out a full-blown release. The whole thing happened very quickly.

By the way, the SEC just banned all short selling in financial companies, similar to what the United Kingdom did yesterday.

The SEC’s Investor Education Efforts During the Crisis: Ummmm

On Tuesday – the day that AIG was being bought by the government and the world felt like it was ending – the SEC retooled its home page to provide much more information directed towards the retail investor. I got excited because I had already fielded four calls from my mom and several of her friends about the annuities they had bought from AIG. Naturally, they were freaking out. A quick search online showed that the same question was being asked by millions around the country. No surprise there.

So what does the SEC do? It devotes the top half of its home page to market its “3rd Annual Senior Summit,” an event to help seniors spot fraud (note that on Wednesday, nearly half of the SEC’s home page was devoted to this summit; now, it’s much less but it still is the top item). Normally that wouldn’t even give me pause. I wondered to myself – this is what the SEC focuses on in the face of the gravest financial crisis of our lifetime?

But wait, maybe I’m saved as I spot this link on the right side of the home page: “What to Know About Equity-Indexed Annuities.” You can read it for yourself to see if it would truly answer the types of questions being asked by those in distress right now. I guess this is what they mean by deregulation.

– Broc Romanek

September 18, 2008

The SEC Acts: Short-Selling and Rumor-Mongering

Yesterday, facing a cry to adopt a market-wide rule on naked short sales and rumor-mongering (see this Wachtell Lipton memo entitled “Today the SEC Must Step Up” from Tuesday), the SEC took several coordinated actions against “naked” short selling. This came in the form of an emergency order, thereby avoiding the typical notice and comment period of government rulemakings. The SEC’s new actions became effective at midnight. Here is a statement from Chairman Cox and Enforcement Director Thomsen.

These actions apply to the securities of all public companies; compared to the SEC’s temporary Emergency Order (that lapsed a month ago) which only applied to companies in the financial sector. Wachtell’s new memo? “Too Little, Too Late.”

In his “Race to the Bottom” blog, Professor Jay Brown provides some nice analysis of whether the SEC’s emergency order violates the Administrative Procedures Act…

AIG to Be Renamed “NOSLAUP II, LLC”? Hint: “Paulson” Spelled Backwards

Some members wonder why the Federal Reserve only purchased 79.9% of AIG – was there any magic to it not going over 80%? As noted in this DealBook blog by Prof. Davidoff, the government can’t purchase more than 80% of a company “because if it goes over the magical number of 80 percent, the company’s debts are then required to be consolidated onto the federal government’s balance sheet. Keeping it at 79.9 percent allows the government to maintain the fiction that it is still not responsible for the company’s solvency.” Thanks to Tom Conaghan of McDermott Will for tracking this down.

A nice off-balance sheet play by the Feds. I guess they are trying to be like Enron. Maybe they should rename Fannie Mae “Raptor 6” and AIG “NOSLAUP II, LLC” (ie. “Paulson” spelled backwards).

Anyways, I can’t wait to see the Fed file their Schedule 13D and all of their Section 16 reports.

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– Broc Romanek

September 17, 2008

Completed! Lynn, Romanek and Borges’ “The Executive Compensation Disclosure Treatise & Reporting Guide”

Broc and I are more than excited to be finally done with our comprehensive treatise of executive compensation disclosures: Lynn, Romanek and Borges’ “The Executive Compensation Disclosure Treatise & Reporting Guide”. This thing is massive, over 1000 pages long and it wouldn’t have been possible without the help of our new co-author Mark Borges and our two co-editors, Julie Hoffman and Dan Greenspan.

It’s great to have Mr. Borges as part of our Treatise team since he was able to lend his well-known experience and wisdom to the project. And of course, we thank the many of you that have sent us encouraging words (and ordered a copy).

We hope to have the online version of the Treatise up over the next week or so and it will take about a month to typeset and print the hard copy of the book. Remember that when you order the Treatise, you not only get the hard copy of the book – but you also get access to an online version of the Treatise. We’ll let you know when the Treatise is online – as well as when we mail. Here are FAQs about the Treatise.

Order your Treatise now so we can rush it to you right after it’s printed; remember there is a reduced rate if you are attending any of our Conferences.

Order online – or here is an order form if you want to order by fax/mail. If at any time you are not completely satisfied with the Treatise, simply return it and we will refund the entire cost.

Is it Friday Already? The AIG Bailout

Apparently AIG couldn’t wait around for the typical flurry of weekend meetings at the New York Federal Reserve and had to be bailed out on, of all days, a Tuesday. It just doesn’t seem to have quite the same dramatic flair as when the announcements are made on Sunday. But the bailout of AIG is quite dramatic, involving an $85 billion bridge loan and the nationalization of one of the largest insurance companies in the world. Under the terms announced last night, AIG has access to up to $85 billion through a Fed liquidity facility with a 24-month term. Interest will accrue on the outstanding balance at a rate of three-month Libor plus 850 basis points. The government will receive a 79.9 percent equity interest in AIG and has the right to veto the payment of dividends to common and preferred shareholders. Not the best of terms for AIG or its shareholders, but I guess beggars can’t be choosers. I note that $85 billion is more than twice the amount that AIG was seeking over weekend.

Why backstop AIG but not Lehman? It is certainly hard to say, other than apparently it was thought that Lehman could be unwound in an orderly fashion under Chapter 11, while AIG was at risk for a “disorderly failure.” At this point, there doesn’t seem to be a whole lot of consistency in the government’s approach, which could only spell more uncertainty for those institutions still standing.

Kevin LaCroix has provided a great summary of what we know so far in The D&O Diary blog. Kevin notes: “The problem for AIG is that sale of its non-core subsidiaries alone may not be sufficient to pay back even half of $85 billion. The Deal Journal blog estimates (here) that sales of AIG’s non-core subsidiaries and minority interests might raise ‘as much as $42 billion’ – and that, I might add, is before taxes. (I think Uncle Sam will insist on the payment of all applicable taxes.) Which raises the question whether the sale of ‘businesses’ specifically contemplates the sale of some or all of AIG’s core insurance operations?

Left unanswered in the Fed press release is the question of what this development means for AIG’s continuing business operations. The primary goal of the Fed facility is the orderly sale (as opposed to the ‘disorderly failure,’ as the Fed statement put it) of AIG’s businesses. What does this imply about the future of AIG’s operating companies? And what will be left of AIG after the ‘orderly sale’?”

Kevin raises a number of excellent questions that we will only know the answers to as the situation unfolds. Chief among the questions for me is why is the government now the majority owner of a major insurance company and what does it intend to do with its ownership interest?

Shell Companies and Rule 144

New paragraph (i) of Rule 144 has provided a framework for Rule 144 sales of shell company securities, but it has raised a number of questions and concerns for practitioners.

In this podcast, David Feldman of Feldman Weinstein & Smith discusses the latest developments with Rule 144(i), including:

– What are the principal concerns that have come up so far in implementing Rule 144(i)?
– What guidance did you seek from the SEC Staff and what did they say?
– What are some practical considerations for issuers now?
– What further adjustments to Rule 144(i) might be possible at this point?

– Dave Lynn