Broc Romanek is Editor of CorporateAffairs.tv, TheCorporateCounsel.net, CompensationStandards.com & DealLawyers.com. He also serves as Editor for these print newsletters: Deal Lawyers; Compensation Standards & the Corporate Governance Advisor. He is Commissioner of TheCorporateCounsel.net's "Blue Justice League" & curator of its "Deal Cube Museum."
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…
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:
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.
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.
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.
As part of the Fall issue of InvestorRelationships.com, I got to spend some quality time with my good friend, the independent inspector Carl Hagberg to conduct an interview entitled, “An Insider’s Perspective: How to Avoid a Yahoo-Like Tabulation Nightmare.” In the interview, we get access to Carl’s many years of experience to better understand how the tabulation and inspection processes work. As borne out by the media attention to the voting result snafu at last month’s Yahoo annual meeting, this could be wisdom that saves you from a needless crisis at your own shareholder meeting. In Yahoo’s case, Carl explains how that snafu could have been easily avoided.
If you try a no-risk trial for InvestorRelationships.com for 2009, you get access to this Fall issue for free. Note that membership rates are very reasonable, starting at $295 for a single user through the end of ’09. And membership gets you free admission to the upcoming InvestorRelationships.com webconference: “The SEC’s New Corporate Website Guidance: Everything You Need to Know – And Do NOW.”
If you already have received an ID/password for InvestorRelationships.com this year, you can renew your membership for 2009 now (and get free access to this webconference, etc. for another year).
Survey Results: Disclosure Committees
Back in mid-2004, we conducted a survey on disclosure committees (here are those older results) – we recently canvassed folks again on this topic and here are the results:
1. Our company:
– has a disclosure committee – 97.8%
– doesn’t have a disclosure committee – 2.2%
2. Our disclosure committee has:
– more than 10 members – 37.2%
– between 8-9 members – 27.9%
– between 6-7 members – 27.9%
– between 4-5 members – 6.9%
– has less than 4 members – 0.0%
3. Our disclosure committee has the following types of members:
– CEO – 18.2%
– CFO – 70.5%
– Controller – 93.2%
– General Counsel – 75.0%
– Securities Counsel – 79.6%
– Compliance or Risk Management – 36.4%
– Investor Relations Officer – 77.3%
– Internal Auditor – 68.2%
– Officer from a Business Unit – 50.0%
– Other – 63.6%
Comparing the two surveys, it looks like the size of the disclosure committee has grown slightly (not surprising given the SEC’s 2006 exec comp rule changes that likely brought in some new members) – and more internal auditors joining the committee and some CEOs dropping off…
Please take a moment to take this “Quick Survey on CEO Succession Planning.”
I just wrapped up the Fall issue of InvestorRelationships.com, which includes an article entitled, “Our Roadmap: How to Comply with the SEC’s New Regulation FD Guidance.” The article doesn’t merely summarize what the SEC just issued – it goes far beyond that. It includes numerous specific examples of what you should – and should not – be doing to comply with the SEC’s new guidance.
In particular, the article provides detailed implementation guidance about how you can build a “recognized channel of distribution” and “broadly disseminate” under the SEC’s new guidance. Among other topics, I address:
– Website Marketing and Maintenance: The Disclosure Committee’s Role
– The IR Web Pages: Search, Design and Accessibility
– The Challenges of Media Awareness
– Web 2.0: Pushing It Out
If you try a no-risk trial for InvestorRelationships.com for 2009, you get access to this Fall issue for free. Note that membership rates are very reasonable, starting at $295 for a single user through the end of ’09. And membership gets you free admission to the upcoming InvestorRelationships.com webconference: “The SEC’s New Corporate Website Guidance: Everything You Need to Know – And Do NOW.”
If you already have received an ID/password for InvestorRelationships.com this year, you can renew your membership for 2009 now (and get free access to this webconference, etc. for another year).
Did Bill Gates Wiggle His Tush? That’s Some Nonverbal Communication
Not many marketing types think highly of the new Microsoft advertisement featuring Bill Gates and Jerry Seinfeld (see this WSJ article). Personally, I liked it – particularly when Jerry fitted Bill’s feet for shoes. A size ten!
If you haven’t seen it, the TV commercial ends with Jerry soliciting nonpublic material information from Bill regarding whether Microsoft will be launching edible personal computers that are moist and chewy in the future. He asks Bill to give him a “sign” if something big is on the horizon, something like adjusting his shorts. And then Bill wiggles his tush.
This presents a perfect example of the type of nonverbal communication that Regulation FD applies to. I’m sure some of you remember the SEC’s 2003 enforcement case against Schering-Plough which focused on nonverbal cues. In that case, the company’s then-CEO disclosed “negative and material, nonpublic information regarding the company’s earnings prospects” at private meetings “through a combination of spoken language, tone, emphasis, and demeanor.” Bill, keep those hips in check!
The Impact of Regulation FD on the Flow of Information
A while back, CFO.com ran this article that described a 2007 study on Regulation FD, which concluded that investors received less information after the adoption of the disclosure rule compared to before it. Given that growing numbers of companies are foregoing earnings forecasts, I can believe the report’s findings.
Back when the SEC announced its new “21st Century Disclosure Initiative” at the end of June, Chairman Cox credited former SEC Commissioner Joe Grundfest and former Corp Fin Director Alan Beller with originating the idea (which was named “Project Alpha” back in the day). Now, Joe and Alan have published a brief 8-page summary of their model for reinventing the SEC’s disclosure system (they plan to expand it into a more extensive article later).
With a somewhat dramatic flourish, Grundfest and Beller suggest that the SEC should abandon “all vestiges of the world of paper-based filings” in favor of a Web-based questionnaire. This questionnaire would replace the forms-based filing framework that currently exists (and could be accomplished without any legislative action or change to liability standards). Here is a summary of their summary:
– On-line questionnaire would be comprised of a combination of yes/no responses, pull-down menus, predefined fields and narrative responses; many of the questions would require “free form” narrative disclosure (e.g. MD&A).
– Going forward, companies would only need to update any items that have changed since the last reporting period – there would no longer be a need to repeat unchanged information.
– When a change occurs, this would be highlighted – so period-to-period comparisons would be possible.
– All exhibits would be centralized in a single location.
– Companies wouldn’t need to file their questionnaire responses directly with the SEC – rather they would post the responses either on an SEC website or on their own websites, with a ‘hash’ that authenticates the document as well as the date and time of posting.
The notion of “company-based disclosure” rather than periodic or current reporting is not a new one. It’s been battered around for quite a while. But with the Web facilitating things, it’s exciting to see that the SEC is seriously considering such a radical change. The SEC will be holding its first roundtable on the “21st Century Disclosure Initiative” in October.
My Ten Cents: “21st Century Disclosure Initiative”
Here are a few of my thoughts on the general notion of reforming the periodic/current reporting regime (note these do not relate to the Grundfest/Beller model specifically):
1. Don’t Overpromise Savings – Whatever ideas are floated to change the reporting regime, don’t sell it as a cost-saver. Even if you cut out the financial printers, etc., there will be new vendors that will have to be paid. And the time that lawyers haggle over language will continue to exist in bountiful numbers.
2. Don’t Underestimate Technological Challenges – If my memory serves, some of these ideas were kicked around back in the mid-90s when I was at the SEC. One hurdle that continued to pose insurmountable problems was how to enable companies to avoid filing all of their disclosure with the SEC. One of these concerns was security – can companies (or their vendors) post information on their own websites in a manner that couldn’t be hacked? Another type of example – Dominic Jones recently wrote about a possible tech snafu with the SEC’s XBRL proposal.
3. The Tricky Issue of Duty to Update – If a new regime requires companies to post their disclosure on their IR web pages rather than in the form of a Form 10-K and Form 10-Q, consider what investors will expect? Even if the SEC adopts rules clearly stating that this disclosure is not subject to a duty to update except on a quarterly basis (or more frequently for Form 8-K-like items), investors won’t necessarily know – or care – about that – particularly retail investors. They will be expecting the information they read on a company’s site to be current.
4. Cut to the Chase for Investors – This point really is the bottom line. If the SEC is gonna bother to rework their reporting regime, I think the focus should first be on delivering the type of information that investors covet most – i.e. forward-looking information, what is the company’s strategy going-forward, how is employee morale, a sense of what management is really like, do the directors really kick the tires, etc.
In other words, only a few discrete pieces of Reg S-K have been updated since the movement to integrated disclosure thirty years ago. Why not focus on whether the required information is still material in this day and age and whether the information is what investors truly want, rather than keep tinkering around with how the information gets delivered?
These are really tough issues to parse and have been tackled before. But this should be the starting point for the discussion and debate. I fear that the SEC may focus on “form” rather than “substance”…
A few weeks ago, I blogged about how lawyers were not happy about the FASB’s proposal to reform FAS 5. Now that the comment period has expired, the views of the auditors and investors are available – some of which side with lawyers (and management) and most of which that don’t. For example, CFO.com ran this article that summarized some of the objections.
Former SEC Chief Accountant Lynn Turner tells me: “The comments from the investor community are solidly in the camp favoring complete and timely information on loss contingencies. Now it is the unenviable task of the FASB to decide which camp they are in as their proposed statement was strongly supported by investors, and is consistent with their own conceptual framework. The question is whether the FASB will now water down what they have proposed.
As several of the investor comment letters note, it appears some companies are not currently complying with the current standards which raise the question of where is the enforcement. This issue also highlights that is probably not correct to say that there is an “expectation gap” difference between companies and their auditors and those in the investment community, as much as there is an out right ideological difference on what management of companies should have to report and disclose to the owners of the business.
And in the past, when on statements addressing such issues as off balance sheet SPEs, derivatives (No. 133), stock options (No. 123) and leasing, and the FASB chose to give companies what they asked for, it always seemed to come back to kick them on the backside when those standards had significant shortcomings or outright failures as a result of the compromises made.”
Getting lots of great feedback on the new “The Advisors’ Blog” on CompensationStandards.com, with new content from the 30-plus experts being posted daily. Yesterday, Gregory Schick of Sheppard Mullin blogged a great piece on the intersection of Rule 701 and Section 409A. Below is an excerpt from that blog:
The potential securities law compliance issue that is the source of my musings relates to Rule 701 of the Securities Act of 1933. Rule 701 is the easiest and primary way that companies obtain exemption from the registration requirements of the Act with respect to their compensatory stock options. Rule 701 imposes numerical limitations on the magnitude of equity securities that can be issued in reliance on Rule 701 in a twelve month period.
In particular, the aggregate sales price or amount of securities sold in a twelve month period cannot exceed the greater of: (i) $1 million, (ii) 15% of total assets or (iii) 15% of outstanding securities. Moreover, if relying on either (ii) or (iii) and the aggregate sales price of Rule 701-issued securities exceeds $5 million, then Rule 701 requires that additional disclosures (in essence, a prospectus) be provided to grantees. Such additional disclosures need to have been provided to grantees before they exercised their Rule 701 options and acquired shares.
The sales price for stock options awarded for purposes of these numerical tests is computed at the time of option grant and is calculated by multiplying the number of option shares by the per share exercise price. The SEC’s April 1999 adopting release of amendments to Rule 701 provides that “In the event that exercise prices are later changed or repriced, a recalculation will have to be made under Rule 701.”
Normally, such a recalculation would be performed (with favorable results) when there is an option repricing to lower the exercise price to equal a share fair market value that has declined since the grant date. But, what about if the option is repriced upwards in order to accommodate 409A? Presumably, options whose exercise price is increased to avoid being treated as a discounted option under 409A must also be recalculated for purposes of Rule 701 using the higher option exercise price. Would the recalculation be retroactively performed for the period when the initial grant was made or would the value of the amended option be included in Rule 701 numerical analysis as of the date of the amendment?
In either case, the effect of such an upward adjustment could result in the aggregate sales price exceeding the $1 million and/or total assets thresholds of Rule 701 whereas computations applying the pre-adjusted exercise prices did not. And, perhaps even more troubling, if the Rule 701 $5 million threshold was breached as a result of the recalculation, it could be problematic or even impossible for the company to comply with the additional disclosure requirements imposed by Rule 701 since it is quite possible that some grantees may have already exercised their stock options absent the benefit of the requisite additional disclosure.
Private companies that have increased their option exercise prices in order to comply with 409A may want to also re-examine their compliance with the numerical limitations of Rule 701 particularly if they are considering going public or being acquired since their historical securities law compliance will come under closer scrutiny. While it is possible that the company may be able to avail itself of another exemption under the Act (e.g., Regulation D for certain qualifying option grants), will these recurring 409A-related headaches never end?
The Battle Over Online Ratings
A while back, I blogged about the initial unhappiness over Avvo’s rating system – that service has evolved since then and seems to be doing well with consumers (and the litigation has been dropped). Now, the “Wired GC” Blog describes the latest dust-up regarding ratings involving TheFunded, a site that purports to offer information on VC firms and deal terms from anonymous entrepreneurs. This dispute involves anonymous online feedback…
I’m pretty excited about our upcoming webconference for InvestorRelationships.com: “The SEC’s New Corporate Website Guidance: Everything You Need to Know – And Do NOW.” The agenda is jam-packed, ranging from the SEC’s Corp Fin Chief Counsel Tom Kim – to online experts Dominic Jones and Ryan Lejbak – to legal wunderkinds John Huber and Stan Keller, and many more.
This webconference will not just parrot the SEC’s new guidance (as most firm memos have done). Instead, all of the panels will provide detailed analysis and guidance about how to implement the SEC’s new positions. They will explore what the possibilities now are for companies – and how you can (and should) leverage them.
If you try a no-risk trial for InvestorRelationships.com for 2009, you get access to this webconference for free (including the upcoming Fall issue of our quarterly newsletter, in which I provide a detailed roadmap of how you can comply with Regulation FD under the SEC’s new guidance). Note that membership rates are very reasonable, starting at $295 for a single user through the end of ’09 (this gets you this webconference as well as the quarterly newsletter, and more to come on the site).
If you already have received an ID/password for InvestorRelationships.com this year, you can renew your membership for 2009 now (and get free access to this webconference, etc. for another year).
Here Come the E-Forums!
It appears that some companies intend to take advantage of the SEC’s new rules clarifying how to apply the securities laws to e-forums. This will be surprising to many who predicted that only investors would be sponsoring e-forums.
For example, Amerco has used an e-forum for its annual shareholders’ meeting the past two proxy seasons (see this description from the first year). And Michael O’Brien of iMiners (who will be speaking at our webconference) notes in his blog that Oxygen Biotherapeutics will soon be launching an e-forum via iMiners’ turnkey eShareholderForum solution. Looks like the smaller companies will be leading the way here.
Broadridge’s New Social Network?
Kudos to Dominic Jones of IR Web Report for catching Broadridge’s announcement about a proposed social network/e-forum called “Investor Network” during the company’s August analyst conference call. Chuck Callan of Broadridge will be explaining what this is all about at our upcoming InvestorRelationships.com webconference.
Below is an excerpt from an unofficial transcript of the conference call; scroll down for the portion that deals with the social network since I included additional comments at the top because they seemed interesting as well:
Rich Daly (CEO of Broadridge): Now, let’s move on to the business segment overview. I’ll start with our largest segment, Investor Communication Solutions. As I mentioned earlier, the ICS segment represents over 70% of Broadridge’s revenue and operating profits. We anticipate fee revenue growth for this segment in a range of 5% to 9% which feels great. Overall revenue growth will be in a range of 2% to 4%, but that’s just given the decline in postage.
We are anticipating close sales in a range of $100 million to $110 million, of which 50% is expected to be recurring and 50% is expected to be event-driven. Event-driven sales will primarily be related to mutual fund proxies. For the second year in a row, we’re expecting solid sales for both registered equity proxy and transaction reporting, which we expect will drive our recurring sales activity.
Our strategic leadership around Notice & Access in the core communications business has increased the chasm between Broadridge and our competitors. Our leadership in Notice & Access has resulted in industry-wide savings of an additional $140 million. The 600 or so companies that took advantage of the program realized significant savings in postage and print costs. Our industry leading Notice & Access solution gave us entre to sell our registered proxy services to over 350 new companies increasing our client count by 45% to approximately 1,200 public companies.
Despite the industry’s financial success from Notice & Access, the reduced rate of voter participation by retail shareholders that resulted remains an industry challenge, but it’s an opportunity for Broadridge to once again provide industry leadership. Notice & Access has had a slightly better financial impact on Broadridge than we originally anticipated. This was primarily due to winning new clients for our registered proxy services as well as selling a greater percentage of the ancillary services that are required to support Notice & Access.
Although other vendors offer these ancillary services, we believe we had a higher win ratio because of our strong one-stop shop value proposition and our subject matter expertise. In fiscal year 2009, we’re anticipating a 40% adoption rate for Notice & Access. The fact that we ended a full year with an adoption rate of 28% and we had an adoption rate during our fourth quarter proxy season of 31%, lead us to believe that 40% is a reasonable estimate.
Event-driven revenues are anticipated to be virtually flat to slightly down this year given the current economic environment we’re still in. Although we’re in a down market, we don’t expect to see the fall off in event-driven revenues that we experienced in fiscal year 2003, when it was down 30%. In fiscal year 2008, we did see a decline in proxy contest and M&A activity. However, the changes in mutual fund regulatory focus requiring more activity, our market share gains and our new products in the mutual fund space lead us to believe that there will be less volatility than we experienced in the past. As we exit this down market, we anticipate we’ll get back to realizing the greater than 10% CAGRs and event-driven revenue we experienced before in the past.
Now, I’ll talk about a few other product opportunities in this segment. Summary prospectus is a pending regulatory change related to how investment companies communicate with investors. It could result in mutual fund prospectuses going from 20 plus pages today down to, say, five or so pages. Although the regulatory change would most likely have a negative impact on our pick-and-pack fulfillment business, the change could drive opportunities for our print-on-demand business. Directionally, we view it similarly to the way we saw the Notice & Access regulatory change.
Our Investor Mailbox product which is part of our e-delivery solution is designed to streamline multiple delivery channels into a single visit financial portal that investors find on their broker’s Web site. This product is having a positive impact by converting investors from traditional hard copy delivery to electronic delivery. Investor Mailbox has been the primary driver for increasing our electronic delivery rate for proxies from 47% to 52% this fiscal year.
I believe one of the new and exciting opportunities is around what we’re calling the Investor Network. It’s really unusual for us to be talking about something so early in its development, but the range of this opportunity could be anything from negligible to a unique and meaningful financial social network which could be really big. The Investor Network is an online electronic form that will facilitate shareholder to shareholder communications with a unique feature that will differentiate it from the chat rooms in existence today. Investors who use our Investor Network will be validated as real shareholders. This feature will not only enhance shareholder to shareholder communications, but it will provide a new channel of communication between shareholders and companies.
When the SEC expressed a desire to enable better communications between shareholders using today’s online technology, Broadridge stepped up to help provide a workable solution by leveraging our unique capabilities. The Investor Network will validate shareholders through the core plumbing of the Investor Communications segment while allowing institutional, retail and professional investors to remain anonymous. We are uniquely positioned to create a vibrant social network that validates real shareholders while allowing both anonymity and accountability for any statements made online.
Through providing industry-wide technology-based solutions for Notice & Access, summary prospectus and the new Investor Networks, we continue to demonstrate that we are in the communications solution business and it’s so much more than merely an ink on paper or physical distribution business.
Operator: Our next question will come from Leo Schmidt with the Chubb Corp.
Leo Schmidt – Chubb Corp: First of all, very good quarter gentlemen. Could you give us a little more insight into this new product you’ve been talking about? I know you’ve been talking about growing sales through acquisitions and then through products you invest to networks. Could you give us some insight how big that you think you could grow that? Could you explain a little bit how that works? Would that be something that investors would pay for, companies would pay for, would this be mandated by the SEC? Would you page your goal or could you give us a little sense of how that works and I’m assuming the incremental cost would not be that much bigger additive to revenues? Could you give us some sense to that?
Rich Daly: Okay. Well, the first thing I’m going to give you the sense of, is really hard to say this early. I took the unusual step and we actually talked about it internally here, but I took the step of talking about it now since we will be meeting with so many new entities out there on this topic. I really had a need to make it public completely. So far, the experts we are working with view it as on a range as – some of them think, well, maybe it will work, maybe it won’t, maybe it will just be another social network. To some of them, their eyes bulge open and say, wow, this could really be a game changer.
The activity here is really going to be driven by, is the SEC going to deem that this is something that shareholders need to have the right to. And if that was the case, then I can’t imagine at getting done any other way than through the plumbing we have in place, and again that’s a chasm between us and any one else, no one else is close to connecting every investor to every public company.
If this is going to be something where it’s on a shareholder opt-in basis only, then the validation process becomes a little more complicated, but again we are uniquely positioned to create that validation. And that would be, I’ll called it, a more evolutionary process where we take longer for the network to gain hold.
Now, depending on which way it happens is depending on who will pay and what the model will be. If it’s an opt-in model, I expect it’s going to be probably similar to an eyeball model where there is going to be advertising, et cetera. If it’s a right of shareholders, then it could be a combination of fees and banner advertising or other related activities. We have a significant number of people internally and externally working on this. We are looking to use the best mind on this activity outside of here. But let me be very clear. I think it’s upside, I think there’s very little downside, but we’re certainly not putting anything in any numbers we are representing to you to related to the future as it relates to this activity. But it is meaningful enough that if it was to become a real deal, we would be uniquely positioned with a high quality social network with real investors who are validated accountable and have an amenity, and I will call it a place where serious people could have serious conversations about their investments.
Leo Schmidt – Chubb Corp: I am assuming that some regulator somewhere has made noise about how making this happen and this is part of the reason why you have interest in this. This is not — is that a fair assumption?
Rich Daly: I have had meetings with the SEC staff and the chairman of the SEC on this topic.
Now that the Delaware Supreme Court has affirmed the Chancery Court’s decision in Jana Partners (as well as the holdings in the Office Depot and CSX cases), as noted in this article, a number of companies are now crafting bylaws designed to flush out the actual size of activist stakes.
In the article, Professor Charles Elson notes that he wouldn’t be surprised if more than half of all US companies revise their advance notice bylaws in time for the 2009 proxy season. Tune in on Thursday for this DealLawyers.com webcast – “How to Change Your Advance Notice Bylaws” – so that you will be able to fully evaluate what you should be doing now.
This webcast is important because advance bylaw provisions are not boilerplate. Even if two companies have identical language in their advance notice bylaws, they may operate differently because companies in their shark repellent arsenal may (or may not) allow shareholders to call special meetings or act by written consent, etc., and because many companies have adopted a majority voting standard.
Here are a dozen questions that the panelists will be addressing during the webcast:
– Should companies that have their bylaws tied to the mailing of the prior year’s proxy statement consider revising their bylaws?
– What do the Delaware cases say about how long the advance notice period can be?
– How should companies deal with the interplay between Rule 14a-8 and their advance notice bylaws?
– In the wake of the CNET and CSX cases, are companies starting to incorporate the concept of “cash-settle only” and similar derivative instruments into their advance notice bylaw provisions?
– If so, how broadly are such concepts applied in their bylaws?
– Are you seeing companies incorporate the swap and derivatives concept into their poison pills?
– Are there any loopholes in these organic shark repellent provisions that the courts have not addressed?
– Are you seeing hedge funds and their investment banking and other institutional counterparties starting to shy away from total return swaps and similar derivatives arrangements in view of the CSX case?
– Apart from the recent judicial decisions, what mistakes do targets sometimes make with respect to their advance notice bylaws?
– What are the SEC Staff’s views on what is happening?
– At the end of the day, are the decisions in Openwave, C-Net and Office Depot contract construction and drafting error cases – or do they speak more broadly to Delaware corporate policy?
– Are folks over-reacting to all of this?
How Common are Rule 10b5-1 Plans that Buy?
In Bruce Carton’s new “Securities Docket,” he carries this item about a founder and chair of a company that has set up a 10b5-1 plan to buy his company’s stock because he believes it’s undervalued.
It’s not uncommon for companies to set up 10b5-1 plans to buy, but it is for executives. In talking this over with Alan Dye and Dave, this certainly isn’t a “first of its kind,” but it is rare. Slightly more common are 10b5-1 plans for directors to help them meet their stock ownership guidelines.
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