Monthly Archives: June 2011

June 16, 2011

A Sixth Say-on-Pay Lawsuit

Last week, a sixth company that failed to garner majority support for their say-on-pay was sued – Hercules Offshore in a district court in Texas (here’s the complaint). We continue to post pleadings from these cases in’s “Say-on-Pay” Practice Area.

Yesterday, I traded tweets with someone regarding the probability that all companies that fail to earn majority support will be sued. I’m not convinced that will happen since these cases are brought in such diverse venues and by different plaintiff’s firms. Does anyone know of any guiding hand behind the scenes of these six lawsuits?

It’s also interesting to note that I haven’t seen a single law firm memo yet about these say-on-pay lawsuits even though it appears they are the talk of the town whenever I am out and about. Let me know if you see one…

Let the Wild Rumpus Begin! Competing Bills to Upsize ’34 Act Registration Threshold

Yesterday, I blogged about a new House bill (HR 2167) that would raise the ’34 Act registration threshold to 1000 shareholders (from 500) and exclude employees and accredited investors. In doing so, I neglected to mention another recent House bill (H.R. 1965) that would raise the threshold to 2000 shareholders and also raise the deregistration threshold from 300 to 1200 shareholders. As noted in Jim Hamilton’s blog, there also is a Senate companion bill (S 556) for this one.

For a view questioning the wisdom of raising the threshold, check out Suzanne Rothwell’s entry yesterday on “The Mentor Blog.”

SEC Enforcement Director Receives Delegated Power to Immunize Witnesses

A few days ago, the SEC Commissioners gave delegated authority to the agency’s Enforcement Director to immunize witnesses. I’m not certain that immunization happens all that happen at the SEC – since these are just civil cases – and in conjunction with 18 U.S.C. sections 6002 and 6004, I think this essentially allows Rob Khuzami to immunize any witness who is “pleading the Fifth” in an SEC investigation, thereby disallowing them to continue to assert the Fifth Amendment with the caveat that their testimony can’t be used against them in any criminal case.

– Broc Romanek

June 15, 2011

SEC Commissioner Nominations Blocked (Games Congress Plays)

Because he can, Senator Vitter temporarily blocked the nominations of Luis Aguilar and Dan Gallagher yesterday during a Senate Banking Committee hearing because he doesn’t like the pace of recovery for victims of Allen Stanford’s fraud. Strike that. I’m not sure it was “during” the hearing because Senator Vitter didn’t bother to show up to it, as noted in this Reuters article.

Yes, a single senator can hold up a nomination – but just temporarily as the Senate Banking Committee can still advance the nominations to the full Senate (so is that really a “hold”?). Doesn’t this make for some great gaming (last year, one Senator put an extraordinary “blanket hold” on at least 70 nominations)? I’m not sure what parliamentary procedure allows a nomination to be blocked when the Senator doesn’t even attend the hearing, but that surely compounds the waste of time that insincere holds are…

House Bill: Upsizing the 500 Shareholder ’34 Act Registration Threshold

During the past few months, I’ve blogged several times about the SEC’s upcoming capital-raising reform efforts, particularly in the area of pre-IPOs. Perhaps that’s not good enough for Congress as this Fortune article tells of a bill in the House that would boost the number of shareholders that trigger registration to 1000 shareholders, up from 500 – and would exclude exempt employees and accredited investors from counting towards the threshold. The bill was introduced yesterday and has six sponsors from both sides of the aisle. There is no corresponding Senate bill at this time.

Webcast: “Deals: The Latest Delaware Developments”

Tune in tomorrow for the webcast – “Deals: The Latest Delaware Developments” – to hear Rick Alexander of Morris Nichols, Stephen Bigler of Richards, Layton & Finger and Kevin Shannon of Potter Anderson discuss all the latest from the Delaware courts and legislature.

– Broc Romanek

June 14, 2011

Welcome to Suzanne Rothwell!

We’re very excited to announce the addition of Suzanne Rothwell to our editor staff. Suzanne brings a wealth of experience to our team. She recently retired from Skadden Arps after a decade of service here in DC. Previously, she served for 20 years in increasingly responsible positions with FINRA, including Associate Director and Chief Counsel of the Corporate Financing Department. At Nasdaq, she served as Special Counsel on the PORTAL Market and the development of trade reporting for debt securities. You’ll be seeing Suzanne on this blog – and our other blogs – as well as other parts of our sites.

The On-Going IPO Pricing Discussion: The Issuer’s Responsibility

And here’s a blog from Suzanne:

There has been quite a bit of commentary on the pricing of the LinkedIn IPO, which went public at $45 a share and closed at $94 on the first day of trading (including this entry in our “Mentor Blog”). The stock has traded as high as $122.69 and has since declined to close on June 7th at $77.82. One columnist questioned whether the underwriters of the LinkedIn IPO severely and intentionally underpriced the public offering in order to benefit customers who then immediately sold the stock to lock in the profit. (“Was LinkedIn Scammed?,” Joe Nocera, NY Times).

Another view was that possibly the IPO price for LinkedIn was too high as it resulted in a valuation of $8 billion for a company that made only $15.4 million in 2010. (“Why LinkedIn’s Price May Have Been Right,” Andrew Ross Sorkin, NY Times). Mr. Sorkin correctly points to the inherent conflict of IPO underwriters in meeting the interests of the company they are taking public and of their customers. He states that this is an “untenable position” and asks for a conversation on developing a better method. These statements reflect an on-going disagreement expressed over many years about the IPO pricing process.

The underwriters’ balancing of interests of the issuer and the need to price in some relation to the intrinsic value of the company in the interests of their customers has worked effectively for many years except when the underwriters have decided to game the distribution process or the aftermarket. In my experience, the regulation of IPO pricing is a difficult matter and it is better that the regulators limit their involvement to oversight for possible manipulation of the distribution process and the aftermarket as well as ensuring appropriate disclosures. FINRA’s predecessor, NASD, requested comment in 2003 on recommendations of the NYSE/NASD IPO Advisory Committee on three possible alternative approaches to promote transparency in pricing offerings, including whether to use an auction system–which is an oft-mentioned alternative.

What was not mentioned in the discussions of the LinkedIn IPO pricing was the responsibilities of the LinkedIn board of directors for that pricing, since the general view is that the issuer will accept the pricing determinations of the underwriters. However, this is where a new FINRA rule will likely make changes. Instead of proposing rules to adopt any of the alternative pricing methods, FINRA recently implemented new FINRA Rule 5131, which (among other things) requires that underwriters provide the IPO issuer’s pricing committee or board of directors with a regular report of indications of interest in order to assist the issuer to make an informed decision as to the pricing of the offering. As stated by the NASD in 2003, “. . . greater participation by issuers in pricing and allocation decisions would better ensure that those decisions are consistent with the fiduciary duty of directors and management, and would provide management with more information to evaluate the underwriter’s performance.” Clearly, it was FINRA’s intention to enhance the corporate governance responsibilities of issuers in the setting of the IPO price for the company.

We shall see whether the new rule, which became effective at the end of May, will have an impact on IPO pricing. In any event, any future discussions of the IPO pricing issue will have to take into account the fact that the issuer’s board of directors was part of an informed decision on the final pricing determination.

Supreme Court Rules Loss Causation Need Not Be Proven at Class Certification Stage

In the midst of my computer meltdown last week, the US Supreme Court held that securities fraud plaintiffs need not prove loss causation at the class certification stage in Erica P. John Fund v. Halliburton. We have been posting memos on this decision in our “Securities Litigation” Practice Area.

– Broc Romanek

June 13, 2011

Say-on-Pay: 32nd – 35th Failed Votes

We’ve now had four more companies file Form 8-Ks reporting failed say-on-pay votes: Nabors Industries (43%): Tutor Perini (49%); Cadiz (38%); and BioMed Realty Trust (46%) . I keep maintaining our list of Form 8-Ks for failed SOPs in’s “Say-on-Pay” Practice Area.

SEC Brings “Blue Ribbon” Enforcement Proceeding Against “Crowdsourcing” Offering

With thanks – and permission to blog – from the ABA’s State Regulation of Securities Committee:

This recent press release announcing the SEC’s entry into a cease and desist order with two individuals who attempted to raise $300 million via a website, a Facebook page and a Twitter account, to finance a company which would purchase the Pabst Brewing Company. While the respondents purportedly raised over $200 million in pledges from more than 5 million pledgors, they never collected any monies. A unique feature of the offering was the respondents’ promise that investors would not only receive a certificate of ownership in the acquisition company, but beer of a value equal to the amount invested (at least the SEC didn’t allege that the beer was a “security,” too – note, however, the old “whiskey warehouse receipt” cases).

One interesting point not mentioned in the press release – but raised in the actual Order – is that the SEC describes the offering as being effected “via crowdsourcing” (see paragraphs 3 and 5). Query whether this is the first enforcement proceeding by any securities regulator against a “crowdsource” offering? In any event, it sounds like the respondents never consulted with a reputable securities (or any?) attorney before commencing their offering; I would hope that any member of our Committee would have dissuaded them from attempting this venture in the chosen manner.

Here is a pun related to this case that I received: “I understand that the SEC went after the respondents when they heard that this offering was brewing on the Internet. Unfortunately for the SEC staff, they were only able to bottle up the respondents with their cease-and-desist order, the Justice Department decided the case wasn’t worth throwing them in the can with a criminal action.”

And another member noted: My foggy memory thinks that the Boston Beer Company tried to do something that was the then-equivalent of that back in the (maybe?) early 1990s when it was organized. I think they had “solicitation” language on their labels or something goofy like that…

Senator Grassley: How Does the SEC Treat Enforcement Referrals from Fellow Agencies?

As noted in this Reuters article, Senator Grassley’s recent investigation of SAC Capital Advisors is not really about the private investment firm but rather is a look into how the SEC treats referrals from other agencies. Here’s a letter from Grassley to reporters about how he believes that this response from the SEC into questions about how the SEC handled a referral from FINRA about suspicious trades by SAC Capital.

There are two Congressional hearings this week related to the SEC. Tomorrow, the Senate Banking Committee takes up the Commissioner nominations of Luis Aguilar and Dan Gallagher.

And then on Thursday, the House Transportation Committee hearing is holding a hearing entitled “The SEC’s $500 Million Fleecing of America” regarding the SEC leasing a building after it was directed to hire many more Staffers under Dodd-Frank – and then Congress reversed ship on the SEC’s budget (and is now blaming the SEC for thinking it was staffing up). This briefing memo relies heavily on the SEC Inspector General report about the lease that has been mentioned in the mass media lately. Note that it’s pretty rare that this House Committee gets involved with SEC affairs…

– Broc Romanek

June 10, 2011

The SEC’s New Whistleblower Rules: Should You Amend Your Whistleblower Policy?

In the wake of the SEC’s new whistleblower rules, we are posting dozens of memos analyzing them in our “Whistleblowers” Practice Area. We also are addressing some questions on the new rules in our “Q&A Forum,” including this one:

Question #6531: As a result of the SEC adopting final rules implementing the whistleblower provisions of Dodd-Frank, does anyone find it necessary or prudent to amend an issuer’s Whistleblower Policy accordingly? Because the final rules will not be effective until probably later this summer, figure it isn’t too early to start thinking about this.

Steve Pearlman of Seyfarth Shaw noted: I’m not aware of any publicly available. But my knee-jerk is that the potential down-sides of amending a whistleblower policy to take changes in the legal landscape into consideration are not readily apparent and likely well outweighed by the advantages. For example, it generally would be unreasonable for an employee to argue that a change in the policy amounts to an admission that the prior policy was ineffective or not legally sufficient and thus yields liability. Plus, it is worth noting that subsequent remedial measures generally are not appropriate evidence of liability.

Caveat: any revision to the policy needs to be carefully crafted so that it does not inadvertently invite or condone any sort of retaliation or otherwise run afoul of the new law (or any other laws for that matter).

By the way, you may want to see Keith Bishop’s blog entitled “SEC’s Whistleblower Release Misapprehends California Ethics Laws And Rules” – and this recent memo analyzing the latest Sarbanes-Oxley whistleblower case.

Which In-House Department Should Handle Whistleblower Complaints?

In this podcast, Steve Pearlman of Seyfarth Shaw describes how companies are grabbling with who handles whistleblower complaints under the new Dodd-Frank framework adopted recently by the SEC, including:

– Historically, which departments within a company handled whistleblower complaints?
– Is that changing and how?
– Can you give a specific example of how a company may create a hybrid model involving multiple departments?
– What factors should companies consider to determine what is the best model for them?

Delaware: Strine Nominated as New Chancellor; Glasscock as New Vice Chancellor

Yesterday’s breaking news that I blogged on the Blog: Delaware Chancery Court VC Leo Strine tapped as the new Chancellor and Sam Glasscock, a long-time court master, nominated for Strine’s VC slot. They now need to be confirmed by the Delaware State Senate. Here’s articles from:

Delaware Online


WSJ Law Blog

NY Times Dealbook

– Broc Romanek

June 9, 2011

Senators Ask SEC for Guidance on Information Security Risk Disclosure

While my computer recovers from a meltdown, here is a guest blog courtesy of Jim Brashear, General Counsel, Zix Corporation:

Spate of Data Security Incidents

The news media recently have reported many high-profile breaches of corporate data security. These incidents should prompt securities lawyers to focus on the potential materiality of public companies’ risks concerning data security, data privacy and data breaches and the necessary disclosures when those risks are material.

Most of the recent data breach reports have focused on incidents in which consumers’ personal information was exposed. In perhaps the most egregious example, Sony Corporation experienced multiple instances of hackers breaching several of its databases, potentially exposing the personal information of more than 100 million users, some of it in unencrypted plain text files. In another recent example, hackers targeting marketing services company Epsilon accessed email addresses for customers of dozens of major consumer brands.

Other data breaches indicate that hackers were looking for trade secrets or other valuable corporate information. Earlier this year, hackers targeted five multinational oil companies, apparently seeking proprietary data about global oil discoveries. Data security firm RSA was hacked, putting at risk the SecurID token security used by the firm’s clients. That incident apparently allowed hackers to attempt to penetrate networks at Lockheed. Moreover, Google reported this month that hackers accessed personal email accounts of senior White House officials, which was likely an attempt to penetrate sensitive U.S. Administration systems.

Confidential information is not only at risk on companies’ own internal networks. Companies and government agencies are increasingly storing confidential data with third party “cloud” services providers. A recent Trend Micro survey reportedly shows that nearly half of IT executives have reported a security lapse or issue with their cloud services provider in the last year. There are also indications that law firms are becoming targets for hackers, because those firms hold confidential data of many clients and may use relatively less-sophisticated data security procedures – potentially making them a weak link in the cybersecurity chain. The same may be true of other corporate advisors and business partners. So, companies evaluating data security risks need to consider “Who else has our confidential data and where is it?”

Potential Materiality of Data Security

Why are data breaches potentially material? As the Inside Investor Relations blog points out, “hackers can bring down your networks – and your stock price.” A data breach can remove an competitive advantage, through the loss of proprietary information. A data breach can seriously impair a company’s brand and reputation. If consumers or business partners lose confidence in the ability of a company to protect information, they may move their data and business elsewhere.

A data privacy breach can expose companies to significant disclosure and remediation costs, averaging over $7 million per incident and over $200 per individual whose personal data is compromised. A data breach can subject companies to fines and penalties, such as the $4.3 million HIPAA fine imposed on Cignet Healthcare. Last month, the White House issued its U.S. cybersecurity legislative proposal, which promotes a federal standard for data breach notification to individuals.

Letter Seeks SEC Guidance on Cybersecurity Disclosure

In a May 11th letter to SEC Chair Mary Schapiro, five Democrat members of the Senate Committee on Commerce, Science & Transportation asked the SEC to “issue guidance regarding disclosure of information security risk, including material network breaches.” The letter opines that “Federal securities law obligates the disclosure of any material network breach, including breaches involving sensitive corporate information that could be used by an adversary to gain competitive advantage in the marketplace, affect corporate earnings, and potentially reduce market share.” [Original emphasis]

The letter cites a 2009 survey by Hiscox which concluded that 38% of Fortune 500 companies made a “significant oversight” by not mentioning privacy or data security exposures in their public filings. The letter criticizes the lack of disclosure about steps being taken by companies to reduce those risk exposures.

One might expect the SEC Staff to be particularly sensitive to the adverse impacts of a data breach that exposes consumers’ personal information. After all, the SEC’s own employees were recently affected by a data breach when the Department of the Interior’s National Business Center sent out SEC employees’ social security numbers and other payroll information in unencrypted emails. In response to the Senators’ request, an SEC spokesperson reportedly said “companies do have a disclosure obligation when it comes to events such as cyber security or cyber vulnerabilities just like any other events that face a company in the normal course of business.”

[News coverage did not disclose the identity of the of the contractor whose software failed to encrypt the Interior Department’s email, but we can confirm that it was not Zix Corporation, which provides automated email encryption for SEC staff.]

Considerations in Improving Cybersecurity Disclosure

In light of the potential materiality of these issues, forward-thinking securities counsel have already been advising clients about the need to include in their public disclosure discussions about material data security, privacy and data breach risks. See, for example, the client advisory by Sullivan & Worcester, which provides several examples of SEC rules applicable to data security, privacy and data breach risk disclosure. We expect that more firms will begin advising public company clients to focus on the potential materiality of their risks concerning data security, data privacy and data breaches and to craft necessary disclosures when those risks are material.

Last year, the SEC Staff issued interpretive guidance regarding disclosure related to climate change. Based on the approach taken in that guidance, the SEC Staff may now suggest that companies must consider in their disclosure:

– The impacts of compliance with privacy and data security legislation and regulation, including federal, state, foreign and international rules,
– The indirect consequences of data privacy regulations or business trends (e.g., the implications of Do Not Track on web marketing),
– The impacts of mitigating data security, privacy and data breach risks, such as systems costs and training,
– The potential impacts of data breaches on the company’s business,
– The steps that the company is taking to identify and mitigate those risks.

June 8, 2011

How is Morale at the SEC? A 2010 Job Satisfaction Survey

Last year, I blogged about the results of a biannual government-wide “Federal Human Capital Survey” as it pertained to the SEC. Now, a new government-wide survey is out – and here is the SEC’s 2010 Federal Employee Viewpoint Survey. Overall, the SEC did not fare well compared to the other 36 federal agencies included in the survey – coming in 35th on Job Satisfaction; 33rd on Talent Management; 33rd on Results-Oriented Performance Culture and 26th on Leadership & Knowledge Management.

There are a lot of interesting items in this new Survey – enough to dribble out blogs for weeks – but I take it all with a grain of salt. Case in point: in the “Private Sector Comparison” on page 16, 86% of the respondents in the private sector replied that they like the work they do. That’s certainly not the case when I talk to people. Talk someone out of going to law school today!

Webcast: “Yes, It’s Time to Update Your Insider Trading Policy”

Tune in tomorrow for the webcast – “Yes, It’s Time to Update Your Insider Trading Policy” – to hear Alan Dye of Hogan Lovells and, Sean Dempsey of Sealed Air, Keith Higgins of Ropes & Gray, Isobel Jones of Del Monte Foods and Dave Lynn of and Morrison & Foerster provide practical guidance on revisiting your insider trading policy, as well as your insider trading training program for officers, employees and directors.

Trading Blackouts: Not Taken Seriously in Australia?

I recently received this from a member:

I pass this item on just for its “that’s unbelievable” factor. The Australian government has asked a private sector advisory group to look into assorted matters that they think detract from the integrity of their market. One item is director trading during black-out periods. See Section 2.4 of this report, which indicates that there is a lot of trading by directors during blackout periods in that country, some approved by the CEO and some not – directors just ignoring the blackout period. Can you imagine that happening in the US? Just hang out a sign that says “Sue me, please.”

– Broc Romanek

June 7, 2011

Where Are They Now? Corp Fin’s Bill Morley

Over a 30-year career at the SEC, Bill Morley served as Corp Fin’s Chief Counsel for many years and hired many generations of Staffers in the Division before he retired in ’99. In this podcast, Bill provides some insight into what it was like to work in the Division of Corporation Finance, including:

– How did you wind up at the SEC?
– How do you recall the shareholder proposal process?
– Did you enjoy recruiting and hiring?
– What are among your fondest memories?
– What are you doing now?

IPOs: Rare Case of Poison Pill for Newly Public Company

John Laide of FactSet notes that “Lone Pine Resources went public recently. Lone Pine is a subsidiary of Forest Oil Corp. that is based in Canada but is incorporated in Delaware. Lone Pine is the first U.S. incorporated company to IPO with a poison pill in place since 2007. It used to not be uncommon for companies to go public with a pre-adopted poison pill – but no company had done so since Ulta Salon, Cosmetics & Fragrance in October 2007.”

Federal Debt Ceiling & Another Government Shutdown? Securities Law Considerations

Here’s analysis from this Holland & Knight memo:

We’ve seen it before. Our team is out of time outs. There’s very little time left on the clock, and, absent a miraculous play, the home team is going down in defeat.

That’s where the nation was on April 8, 2011. Many went home late that Friday night fully expecting to wake up Saturday morning to the first federal government shutdown since 1996 and wondering what would happen next. We all know what happened. Very late that evening – at literally the 11th hour – congressional leaders and the Obama Administration forged an agreement that prevented a federal government shutdown.

In March 2011, many government contractors were preparing their businesses, employees, subcontractors and team members for the looming shutdown. Even though the nation has a budget for fiscal year 2011, that doesn’t mean that government contractors can put those contingency plans away until next September. The reality is that we may face another shutdown sooner than expected.

May 16, 2011, came and went without much fanfare, but it was nonetheless an important day. The Treasury issued about $72 billion in securities that day which would have eclipsed the federal debt ceiling – a statutorily imposed maximum amount the government may borrow at any one time – absent some maneuvers by the Treasury to suspend certain federal retirement fund payments to use that money to finance the nation’s general obligations.

Trick plays sometimes work, but Administration officials will have exhausted their play book by the time the clock expires on August 2, 2011, which is when Treasury Department officials believe they no longer can suspend those payments. Absent an agreement to raise the federal debt ceiling by then, the United States would begin to default on its interest payments for the first time in our nation’s history. The consequences could include an initial slow down in payments to federal government contractors. Delayed payments to government contractors could expose the government to interest charges under the Prompt Payment Act or other statutes. Government agencies may then need to refrain from making new contract awards or ordering additional work under existing contracts and, at some point, the government may need to terminate or significantly downsize some of its existing contracts. A slow trickle eventually could lead to turning the faucet off completely, and the nation could again face a government shutdown – even during a budget year.

In light of another looming federal government shutdown, public company government contractors need to examine their businesses and their disclosure and consider whether, and to what extent, they need to include disclosure about a government shutdown in filings they make with the Securities and Exchange Commission (SEC). Reporting companies should consider whether (i) as a result of a shutdown they should file new disclosure in order to correct material misstatements or to make what they said not misleading, and (ii) the government shutdown will trigger any new disclosure required by federal securities law.

– Broc Romanek

June 6, 2011

More on the “CEO as a Team Job?”

A while back, I conducted a poll on this blog asking whether people thought companies that allow the CEO to be held by multiple persons at once was a good idea. In response, 3% said “yes”; 18% said maybe in certain circumstances; and 77% said no (3% said “what me worry?).

I agree with the folks that said “no” – but maybe the poll awoke the CEO gods as articles came out right around when the poll was posted on this topic. First, there was this news about Warner Bros. creating a team-approach to the President role. They have three people sharing the “Office of the President.” Possible issues to ponder: Do they share a single office? Do they take turns depending the day of the week? Perhaps they need a marital relations lawyer rather than a corporate lawyer to work out the schedule? Just having fun here.

Then, a few weeks later, this WSJ article described how UniCredit SpA’s board is considering splitting the CEO position in two, with a general manager in charge of managing the bank’s operations and a chief executive in charge of strategy.

The Bizarre Filing Cabinet: Lawyer Acts Without Company’s Knowledge

Once in a while you come across a strange SEC filing that makes you chuckle (eg. the classic is the fake Form F-1 filed by Apollo Corporation; more recent is this fake Form 8-K filing). Here’s a Form RW filed by American Restaurant Concepts a few weeks ago seeking the withdrawal of a post-effective amendment filed by the company’s lawyer – one that was not authorized by the company. Here’s an excerpt from the request:

The Amendment was not filed at the direction of the Company. It was filed without our knowledge or consent by an attorney previously retained by the Company.

More on our “Proxy Season Blog”

With the proxy season in full swing, we are posting new items regularly on our “Proxy Season Blog” for members. Members can sign up to get that blog pushed out to them via email whenever there is a new entry by simply inputting their email address on the left side of that blog. Here are some of the latest entries:

– Annual Meetings: The Use of Floor Proposals
– Notes from the Council of Institutional Investors’ Spring Meeting
– Diverse Director “DataSource” Announced, Dogged by Questions
– Environmental Proposals and Proponents: More Than Nuns in Tennis Shoes
– Annual Meeting Survey Results: Part II

– Broc Romanek

June 3, 2011

Thundershock! PCAOB’s New Chair Floats Mandatory Auditor Rotation

Yesterday, new PCAOB Chair Jim Doty delivered this speech that should be considered the most profound public policy speech ever made by a PCAOB Chair. Jim talks about cultural challenges that still impede auditor independence and skepticism – and then calls for a broad public policy debate to repair the credibility and transparency of the audit. Jim lays out four areas that this debate should touch – auditor’s reporting model, auditor independence, more context for audit committees and audit transparency – all of which have several items within them. But the one item that surely will get people talking is this excerpt from his speech:

The PCAOB’s efforts to address these problems through inspections and enforcement are ongoing. But considering the disturbing lack of skepticism we continue to see, and because of the fundamental importance of independence to the performance of quality audit work, the Board is prepared to consider all possible methods of addressing the problem of audit quality — including whether mandatory audit firm rotation would help address the inherent conflict created because the auditor is paid by the client.

The idea of a regulatory limit on auditor tenure is not new. Over the years, it has been considered by a variety of commentators and organizations. Through this public debate, the basic arguments both for and against mandatory term limits have been fairly well described.

I won’t revisit all the history now. But most recently, in 2002, Congress considered requiring firm term limits during the debates that led to the Sarbanes-Oxley Act. It ultimately decided that the idea required more study and directed the GAO to prepare a report. That report, issued in 2003, noted that the SEC and the Board would need several years to evaluate whether the Sarbanes-Oxley reforms — including audit partner rotation — were sufficient, or whether further independence measures are necessary to protect investors.

The PCAOB has now conducted annual inspections of the largest audit firms for eight years. Our inspectors have reviewed more than 2,800 engagements of such firms and discovered and analyzed hundreds of cases involving what they determined to be audit failures. We have conducted more than 1,500 inspections of smaller domestic firms and of non-U.S. firms. These include multiple inspections of hundreds of those firms. And our inspectors have identified hundreds more cases involving what they determined to be audit failures.

Based on this work, I believe it is incumbent on the PCAOB to take up the debate about firm tenure and examine it, with rigorous analysis and the weight of evidence in support and against. I don’t have a predetermined idea as to whether the PCAOB ultimately should adopt term limits. My only predilection is that the PCAOB deepen the analysis of how we can better insulate auditors from client pressure and shift their mindset to protecting the investing public.

As such, the Board plans to issue another concept release to explore whether there are other approaches we could take that could more systematically insulate auditors from the forces that pull them away from the necessary mindset. We expect to issue this concept release around the same time that we issue the concept release on the auditor’s reporting model, in order that they can be considered together in a holistic manner.

Proxy Access: What If the SEC Loses the Lawsuit?

As we breathlessly wait for a decision in the proxy access lawsuit brought by the Chamber of Commerce and Business Roundtable in the US Court of Appeals for the DC Circuit, it is fair to consider what might happen in the wake of the decision – which is expected sometime over the next few months. As I blogged last month, the SEC was questioned pretty hard during oral argument by the three judges – giving some indication that the SEC may lose the case.

If the SEC loses, Brian Breheny of Skadden Arps notes that the agency’s three options are:

1. Reapprove the Rule 14a-11 provisions and then have the 14a-11 rules and 14a-8 amendments become effective at the same time;

2. Lift the stay on Rule 14a-8 and allow those amendments to go into effect for the ’12 proxy season and then approve the Rule 14a-11 amendments later; and

3. Do nothing.

It’s possible that the SEC could hold off on lifting the stay on Rule 14a-8 at any time because the SEC imposed the stay on those amendments even though they were not the subject of the lawsuit. They could lift this part of the stay regardless if they win or lose. Meaning, if they lose, they could say “we are letting the 14a-8 amendments become effective while we consider what, if anything, we will do with the 14a-11 rules after the decision.”

But they could also lift the 14a-8 stay if they win because of the timing of the decision. For instance, if the decision is issued after the deadlines for filing the Schedule 14N or other 14a-11 deadlines, the SEC may think it would be better to wait until next year. This scenario is highly unlikely – but anything is possible…

Poll: When Will the Proxy Access Lawsuit Be Decided?

It’s expected that the US Court of Appeals for the DC Circuit will deliver its decision sometime this summer, but we don’t know if that indeed will happen – or when within the summer it will take place. Take a moment for this anonymous poll to provide your own input on this hot topic:

Online Surveys & Market Research

– Broc Romanek