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."
Last Thursday, SEC Chair Chris Cox delivered a speech on the future of IFRS – including a public policy oversight body that would oversee the IASB trustees (the speech notes that the IASC Foundation will consider a new monitor as part of its ’08 Constitution review). This is an important topic that I could literally blog about every day. But, to be honest, I’m not following it as closely as I probably should because I’m only human and there are still so many other developments to cover.
From reading comment letters, etc., I understand one considerable concern is the lack of a strong IFRS enforcement mechanism. The amazing circumstances of the fraud at Société Générale are often held up to illustrate the point of how easy it is for a company to break international accounting rules, get away with it, have its independent auditors bless it, with no major regulatory ramifications (read this Floyd Norris column and an Accounting Onion blog for more). Also held up is the fact that the IASB standards have not been enforced in the past. Finally, there have been concerns raised about how the FAF recently has managed the FASB.
So there are these – and many other – issues to deal with, but it’s clear that the globalization of accounting standards is something that is inevitable. We just need strong regulators – and ones that work together. This will be quite a feat to pull off since there are many cultural obstacles and regulatory differences among jurisdictions. But it is happening – here is a February statement from IOSCO urging companies to clarify which accounting standards they use. IOSCO is the organization whose members are comprised of securities regulators from around the world and who will be a key player in this movement.
Is IFRS Compatible with US-Style Corporate Governance?
This blog below from Tom Selling’s “The Accounting Onion” is several months old, but still interesting and relevant reading:
I just finished reading a brief, highly readable and interesting article by a Columbia Law School professor, John C. Coffee, Jr., entitled “A Theory of Corporate Scandals: Why the U.S. and Europe Differ.” The purpose of this post is to piggyback on his framework to also provide an explanation for the difference in basic approaches between U.S. GAAP and IFRS; and most importantly, why political pressure to trash U.S. GAAP and adopt IFRS should be resisted.
How and Why, According to Coffee, U.S. and European Scandals Differ
Coffee’s thesis is that corporate governance of majority-owned corporations (predominant in Europe) should be fundamentally different than corporate governance of corporations that lack a controlling shareholder group (predominant in the U.S.). It’s not necessarily because there are fewer incentives to rip off other shareholders, but the feasible means to do so will differ.
Scandals in Europe involving majority-owned corporations usually do not feature an accounting manipulation. First, financial reporting is less important to the majority owners because they rarely sell shares; and if they do, they usually receive a control premium that is uncorrelated with recent earnings (and generally larger than control premia in U.S. transactions). Second, fraud is more easily accomplished by misappropriation of the private benefits of control: authorization of related-party transactions at advantageous prices, below-market tender offers, are prime examples. Any trading that takes place between minority owners has less to do with recent earnings reports, and more to do with an assessment of how minority shareholders will be treated by controlling interests.
In dispersed-ownership corporations, managers do not possess private benefits of control. Moreover, a significant portion of manager’s compensation may be in the form of stock options or other forms of equity. Therefore, stock price can have a significant effect on a manager’s compensation, providing them with strong incentives to manipulate accounting earnings.
The Implications for Accounting
Professor Coffee’s thesis is that differences in ownership patterns have important implications for the selection of gatekeepers: auditors, analysts, independent directors, etc. His observations and recommendations are interesting, but I want to advance a related thesis, namely that different ownership patterns call for different types of accounting regimes.
It stands to reason that accounting should be difficult to manipulate, if it can be used to rip off shareholders. Thus, the evolution of U.S. GAAP can be seen as a response to the need for specific rules that minimized the role of management judgment because of their strong self-interest in the reported earnings and financial position. This has occurred in part because U.S. gatekeepers have shown themselves to often lack sufficient resolve or power to prevent management from under-reserving, overvaluing, or just plain ole making up numbers. U.S. managers effectively control the “independent” directors and auditors; and prior to Regulation FD, analysts bartered glowing assessment in exchange for tidbits inside information. Without empowered gatekeepers to prevent accounting fraud, we have had to place our hopes on very inflexible accounting rules, and sheriffs like the SEC and private attorneys to catch the cases where management has attempted to surreptitiously cross the bright line.
Thus, it should be self-evident that IFRS-style accounting, replete with gray areas, would be a gift to U.S. managers. Outright fraud would be replaced by more subtle means of “earnings management,” rendering the SEC and private attorneys much less potent. Is it any wonder why U.S. corporations and their auditors are practically begging to have IFRS available to them?
In short, it would be a grave mistake to adopt IFRS in the U.S. simply because it seems to work well elsewhere. As corporate ownership patterns in Europe change, it may well be that IFRS may evolve to look more like U.S. GAAP. Only after that occurs may it make more sense to have a single worldwide financial reporting regime.
Imagine if Enron Had Applied IFRS
One of the scapegoats of the Enron scandal was “rules-based” U.S. GAAP. The libel was that Andrew Fastow was a mad genius, capable of walking an accounting tightrope by creating complex special-purpose entities (SPEs). But, GAAP wasn’t the culprit in the Enron scandal. Frustrated Fastow was only able to get the accounting treatment he needed past the auditors by hiding from them side agreements that unwound critical provisions requiring the new investors to have a sufficient amount of capital at risk in the SPEs.
The enduring legacy of the libel is the erroneous conventional wisdom that GAAP is responsible for Enron; and what’s more, Enron et. al. might not have happened if our financial reporting system were more like IFRS. More likely, if IFRS had been the basis of accounting for Enron instead of GAAP, it might have taken longer to discover the fraud, or to pin the blame for the fraud where it belonged.
Neither GAAP nor IFRS are principles-based, but GAAP certainly has more rules and bright lines. At least there seems to be some method to the madness, but it would be nice if more of the rules were based on sound principles.
Peggy Foran: Moving On Up
Congrats to my good friend Peggy Foran, who is leaving Pfizer after a long stint to become General Counsel of Sara Lee (here is the press release). At Sara Lee, Peggy will be surrounded by friends – including Helen Kaminski, who will be speaking at our upcoming webcast: “E-Proxy’s First Season: Lessons Learned.”
As many of you know, Peggy is one of the most prolific persons in our profession. Besides being a very kind soul, Peggy has an incredible background, having worked a number of interesting jobs over the course of her long career. One of the reasons why Peggy is so knowledgeable is that she is a tireless networker. Being an avid networker myself, I am amazed at how much more Peggy is able to do – and Peggy uses her network, always asking probing questions to become even better at what she does. Now that Peggy is entering the executive suite, I hope we haven’t seen the last of her at the many events that she graces today!
As noted in this WSJ article last week, SEC Chairman Cox said in a speech that the four largest investment banks are being pushed by the agency to provide better disclosure about their “actual capital and liquidity positions…in terms that the market can readily understand and digest.” According to the article, these disclosures will begin after the second quarter, with additional information about concentrated exposures within the investment banks phased-in later.
Maybe all this Market Reg-type stuff is beyond me, but I don’t understand why the SEC Chairman has to twist arms to get this type of disclosure from the banks? Wouldn’t the banks provide this disclosure under MD&A – Item 303 of Regulation S-K – as part of their liquidity disclosures? This harkens back to my surprise about how the banks were not fully baking the impact of the credit crunch into their risk factors (see this blog). All of this baffles me as I always thought companies perceived their SEC filings as “liability” documents – meaning that they would disclose as much “bad stuff” as possible in them to avoid liability.
Anyways, I chalk up this entire incident as “Exhibit A” for why the prospect of principles-based regulation is scary. Looks like even line-item regulation doesn’t fully work…
Keith Bishop notes: The 11th Circuit recently rendered an interesting decision in US v. HUNT, (11th Cir. 5-5-2008). In that case, a police officer was convicted of making a false false entry into a police incident report with the intent to impede, obstruct, or influence an FBI investigation.
So what does that have to do with securities law? The statute in question is 18 U.S.C. Sec. 1519 which was amended by Section 802 of Sarbanes-Oxley to provide “Whoever knowingly alters, destroys, mutilates, conceals, covers up, falsifies, or makes a false entry in any record, document, or tangible object with the intent to impede, obstruct, or influence the investigation or proper administration of any matter within the jurisdiction of any department or agency of the United States or any case filed under title 11, or in relation to or contemplation of any such matter or case, shall be fined under this title, imprisoned not more than 20 years, or both.”
The case is noteworthy because the Court found that the statute was not: (1) limited to corporate fraud or malfeasance even though it was enacted as part of Sarbanes-Oxley and (2) unconstitutionally vague.
SEC Approves NYSE’s New SPAC Listing Standards
Last week, in this order, the SEC approved the NYSE’s rule changes to make it easier for SPACs to be listed on the exchange. In addition to SPAC listings, the rule changes will impact reverse mergers. Recently, DealBook reported on the first SPAC looking to jump from AMEX to NYSE.
Yesterday, the SEC held an open Commission meeting to propose mandatory XBRL. As expected, the SEC proposed a phase-in period for mandatory XBRL – starting with approximately the largest 500 companies (specifically, those with a public float of over $5 billion) filing in XBRL for fiscal periods ending on or after December 15, 2008. So they would start making XBRL-tagged filings as early as the spring of 2009! Umm, that’s not even a year away; the latest April tags can’t even be used for testing yet. Did someone wet their diaper?
Moving on, smaller companies and foreign private issuers would phase-in over a three-year period, with all filing in XBRL by 2011. Year 2 would bring in large accelerated filers (about another 1700 companies) and Year 3 would capture all remaining filers using US GAAP, which includes FPIs that file in IFRS. Here is the SEC’s press release, the Chairman’s opening statement (which quotes “Women’s Wear Daily”) and Corp Fin’s opening statement.
A few more items:
1. “Limited” liability – During the meeting, the SEC was coy about what the proposed liability scheme will be (and who might be on the hook for the tagging). It was mentioned that there would be “limited” liability, but no one mentioned if XBRL data would be considered “furnished” rather than “filed,” as is currently the case under the SEC’s pilot program. This is an issue that likely will be intensely debated during the comment period, regardless of what the SEC actually proposes (and in my opinion, limited liability for the accuracy of the financials is a huge mistake – if investors can’t rely on the numbers tagged in XBRL, what’s the real value of them?).
2. Grace period for first times – XBRL will be considered late if not provided to the SEC – as well as posted on corporate websites! – at the same time as the related report. There are two exceptions: a 30-day grace period would be permitted for a company’s first XBRL filing – and also for the first time they are required to include the footnotes and schedules tagged in detail.
3. Consequences of late filing – If not provided timely, the penalty is that the company would be deemed not current with their ’34 Act reports (hence, not eligible for short form registration or the resale exemption safe harbor under Rule 144).
4. Transition – In the first year, footnotes and schedules would be allowed to be filed in “blocked tags,” which means each item has its own tag and is much easier than the alternative.
5. Costs – In his “IR Web Report,” Dominic Jones blogs some good stuff about the projected costs of XBRL for companies. Put me down as leery of the SEC’s estimate that the average price for an XBRL conversion will be under $30,000 and require less than 40 hours of work.
There is a 60-day comment period that commences once the proposing release is published in the Federal Registrar – meaning that the deadline will land about a week after our July 16th webcast: “XBRL: Understanding the New Frontier.”
It’s a good time to pick up your free book “XBRL for Dummies” from Hitachi – although I haven’t seen it myself, so I can’t vouch for its real-life usefulness…
XBRL and Third-Party Assurance
One issue that wasn’t discussed at the open meeting yesterday, but bound to be commented upon – and considered by the groups that are in the process of making reform recommendations like the SEC’s Advisory Committee on Improvements to Financial Reporting – is third-party assurance. Here is an article by two accounting professors (who were Academic Accounting Fellows at the SEC not long ago) discussing the challenges that XBRL presents for third-party assurance, raising interesting questions like: what to do about “bad” tagging that may be invisible when looked at through a viewer or other rendering tool, but can create errors when end-users try to slice and dice the data?
Although the article doesn’t really provide much in the way of answers – in sum, the authors suggest that software may be able to help automate the assurance process at some point and that academics have a lot to offer – it’s a good capsule of the state of XBRL and some of the conceptual difficulties that it presents for auditors (and lawyers).
The Myth: XBRL is Just Another Edgar
It’s a bummer that Chairman Cox kicked off his opening statement comparing XBRL to Edgar, as I think it will serve to perpetuate the myth that XBRL is essentially another Edgar project. He would have been better served dispelling the myth if he wants to keep us corporate types as part of his audience on this topic. Otherwise, most folks I know will simply roll their eyes and assume this is something that they can pass off to financial printers, etc. and not bother to understand what it’s about.
Simply put, Edgar is about tagging so that a document will be received by the SEC; XBRL is about tagging so that numbers have meaning. An Edgar tagging error is not a big deal compared to an XBRL tagging error, which might cause a company’s stock to drop 20% in the course of an hour.
I’m not saying that printers and others won’t be helpful; you will need them – it’s just that XBRL is much more than the conversion of documents. I’ve blogged about this myth before…
And no, I’m not being critical just because I haven’t been invited to one of the SEC’s “XBRL blogger lovefests.” Although it is a tad strange – plug “XBRL” and “blog” any-which-way into Google and this blog consistently comes up in the Top Ten. Compare the “hard-hitting” analytical reporting from some of the bloggers that did get an invite: ShopYield.com and Cara Community.
FASB’s New House of GAAP
I haven’t mentioned Jack Ciesielski’s “AAO Weblog” much since he limited parts of his fine blog to paying subscribers (I do understand that the man has to make a living), but here is one available to the public:
Statement No. 162, “The Hierarchy of Generally Accepted Accounting Principles,” was issued last week. It’s not a standard that will drive investment decisions – but if you’re an investor who’s in a conversation with a CFO and the subject comes up, it might help to understand what the of “GAAP hierarchy” comes up, it might help to know a little bit about it.
Here’s the background. The American Institute of CPAs had long decided what constituted the strength in various “levels” of generally accepted accounting principles because their constituents – auditors – needed a consistent policy on how to handle conflicts in accounting literature when more than one standard might be found on a single topic. Hence, there were “levels” with in the “house of GAAP,” as it’s frequently called. When the AICPA dictated auditing standards, it mattered that they be the ones to establish the hierarchy – but that right was removed with the establishment of the Public Company Accounting Oversight Board in 2003. The right to set accounting principles was also removed from the AICPA by the Sarbanes-Oxley Act: it required the SEC to appoint a single accounting standard setter for the establishment of accounting standards. And it picked the FASB, not the AICPA.
The FASB has now revised the standards hierarchy; it’s absorbed many AICPA standards into its own domain. They didn’t simply vanish along with the AICPA’s authority. Here’s how the new hierarchy of generally accepted accounting principles shapes up, in descending order of authority:
– FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, FASB Staff Positions, and American Institute of Certified Public Accountants (AICPA) Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by actions of the FASB
– FASB Technical Bulletins and, if cleared, by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position
– AICPA Accounting Standards Executive Committee Practice Bulletins that have been cleared by the FASB, consensus positions of the FASB Emerging Issues Task Force (EITF), and the Topics discussed in Appendix D of EITF Abstracts
– Implementation guides (Q&As) published by the FASB staff, AICPA Accounting Interpretations, AICPA Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB, and practices that are widely recognized and prevalent either generally or in the industry.
The hierarchy still needs to be approved by the PCAOB to be completely effective on the auditing community. When you look at how many sources of accounting principles still exist after the clean-up, you can appreciate the calls for simplicity and the arguments made in favor of International Financial Reporting Standards. Make no mistake however: the more popular they become, the more interpretation and guidance they’ll require. It wouldn’t be surprising to IFRS principles grow at a rapid clip over the next few years.
We all know about globalization in accounting standards, IFRS, etc. We know that the accounting industry is being closely studied for reform, with a series of changes (eg. limiting liability) being kicked around by the SEC’s Advisory Committee on Improvements to Financial Reporting and the Treasury Secretary’s “Blueprint” for a modernized regulatory structure.
But we haven’t heard much about how the Big 4 might be taking action itself. In this podcast, Francine McKenna, CEO of McKenna Partners (and a fellow blogger on re:theauditors.com) discusses some of the new structural developments, including analying Ernst & Young’s announcement to merge its European partnerships and integrate a further 42 countries into a single unit. This is a bold shift by a Big Four firm to overcome the country-level legal and regulatory restrictions that have limited the Big 4 national partnerships and frustrated their efforts to mirror the global reach of their multinational clients.
Auditors’ Access to Board Minutes: Results of Our Quick Poll
A few weeks ago, I blogged a poll about auditors asking to review board minutes. The poll results indicated:
– 40% allowed auditors to read them, but not copy them
– 18% provided auditors with a copy to take, with privileged parts redacted
– 36% provided auditors with a full copy to take
– 7% don’t allow auditors to review minutes
On her blog, Francine McKenna discussed these results:
I have answered the poll as I believe one of my former clients would have. This former client, still completing several years of restatements, having made a fairly recent change in auditors, subject of internal and SEC investigations, defendant in more than a few lawsuits, and the recipient of assorted Sarbanes-Oxley material weakness and significant deficiencies, has no choice but to do whatever their new auditor asks. I believe their auditor has them by the short-hairs.
However, it looks like there are more than a few companies, more than 65% of the respondents to the poll, that believe that keeping information from their external auditors, perhaps under the guise of privilege, is ok and good policy. Who, in heck’s name, are their auditors?
Advance Notice Bylaws: Delaware Supreme Court Affirms Jana Partners
Yesterday, the Delaware Supreme Court issued this Order affirming the decision of the Court of Chancery in the CNET/Jana matter.
JPMorgan Chase/Bear Stearns: Splicing the Delaware Issues
Today, join DealLawyers.com for the rescheduled webcast – “JPMorgan Chase/Bear Stearns: Splicing the Delaware Issues” – as Professors Elson, Davidoff and Cunningham analyze a host of novel provisions in the JPMorgan Chase/Bear Stearns merger agreement.
On his “Proxy Disclosure Blog” on CompensationStandards.com, Mark Borges continues to report on proxy disclosures as well as other items. For example, here is a recent entry from him:
I was doing some research on “Say on Pay” today when I stumbled across a piece of legislation that was introduced in the US Senate earlier this month that has potential implications for, among other things, executive compensation disclosure.
S. 2866, the “Corporate Executive Compensation Accountability and Transparency Act,” was introduced by Senator Hillary Clinton (D-NY) on April 15th and referred to the Senate Committee on Finance for consideration. The bill aggregates a number of pay-related proposals and ideas that were in the news last year and consolidates them under a single executive compensation heading. Among other things, the bill would:
– Amend Section 409A of the Internal Revenue Code to impose a $1 million cap on the amount of compensation that can be deferred each year
– Amend Section 304 of the Sarbanes-Oxley Act of 2002 (the provision providing that, where a company is required to restate its financial statements as a result of misconduct, the CEO and CFO must reimburse the company for bonus or other incentive or equity-based compensation, or any trading profits, received during the 12-month period following the filing of the financial statements) to extend the 12 month period to 36 months and define what constitutes “misconduct” for purposes of the statute
– Add a provision to the Securities Exchange Act of 1934 mandating that reporting companies give their shareholders an annual advisory vote on their executive compensation programs (a provision that essentially mirrors the bill that passed the House of Representatives in 2007)
– Require the Securities and Exchange Commission to promulgate rules “clarifying and strengthening” the disclosure requirements concerning the compensation paid to compensation consultants and other advisors to the board compensation committee. Further, these rules would be required to (i) prohibit compensation consultants to the compensation committee from performing any other work for the company if its presents a conflict of interest or otherwise compromises the consultant’s independence and (ii) contain an independence standard that would preclude a consultant from working with a compensation committee if it had a noncompensation-related business or financial relationship with the company during the previous 18 months
Finally, in an area that’s close to my heart, the bill directs the SEC to promulgate rules requiring the disclosure of the full grant date fair value of equity awards in the Summary Compensation Table. While this provision wouldn’t require the Commission to scrap its December 2006 interim final rules on the reporting of equity awards, that is essentially what it’s intended to do.
At this point, it’s difficult to know whether Senator Clinton is serious about advancing this bill, or whether it’s just a campaign tactic. (Earlier this month, when the excessive executive compensation issue reared its head on the campaign trail, Senator Obama urged the Senate to take up his Say on Pay bill.) Either way, it’s a strong indication of the type of legislation that may be coming next year when a new Administration is installed in Washington.
Our New “Compensation Consultant’s Blog”: A Baker’s Dozen Now Blogging!
We’re pretty excited that thirteen compensation consultants have agreed to contribute to “The Consultant’s Blog” on CompensationStandards.com. If you’re a member of the site, input your email address on the blog to get new entries pushed out to you.
Only One Week Left! Early Bird Discount for Compensation Conferences
Like last year’s blockbuster conferences, an archive of the entire video for both conferences will be right there at your desktop to refer to – and refresh your memory – when you are actually grappling with drafting the disclosures or reviewing/approving pay packages. Here are FAQs about the Conferences.
For those choosing to attend by coming to New Orleans, I encourage you to also register for the “16th Annual NASPP Conference,” where over 2000 folks attend 45+ panels. And if you attend the NASPP Conference, you can take advantage of a special reduced rate for the Exec Comp Conferences.
Register by May 20th for Early-Bird Rates: Whether you attend in New Orleans or by video webcast, take advantage of early-bird rates by registering by May 20th. You can register online or use this order form to register by mail/fax.
Note that we have combined both of our popular Conferences – one focusing on proxy disclosures and the other on compensation practices – into one package to simplify registration.
If you have questions or need help registering, please contact our headquarters at info@thecorporatecounsel.net or 925.685.5111 (they are on West Coast, open 8 am – 4 pm).
As I’ve mused before, I believe the day will come when more of you will be either a contributor to a blog or otherwise participating in some form of “expressing yourself online” activity. A perfect example is an IRO who gets the word out about a company’s investor relations through a blog.
In this podcast, Lynn Tyson, VP-Investor Relations of Dell and a co-blogger of “Dell Shares,” provides tips and insights into how investor relations officers can blog for their companies, including:
– What was the genesis for launching the “Dell Shares” blog?
– What types of internal approval did you need to obtain?
– Have there been any surprises from blogging?
– What changes have you made to your blogging style since you started?
Fyi, since I blogged about my pet peeve regarding the use of a click-through disclaimer on the “Dell Shares” blog, it has been removed. Bravo!
More on the SEC’s Staffing Levels
Last week, SEC Chair Chris Cox gave this testimony regarding the SEC’s ’09 budget before the US Senate’s Appropriations Subcommittee on Financial Services. On the same day, ten Senators sent this letter to the head of that subcommittee requesting more funding for the SEC – in the amount of $50 million – than the Bush Administration is seeking.
This Bloomberg article from last week – entitled “SEC’s Bear Stearns Oversight Points to Fund Shortage” – argues that more money is necessary for the SEC to adequately do its job. Here is an excerpt:
SEC staffing levels peaked in 2005 at 3,851 full-time employees, including 1,232 in its enforcement division, which investigates fraud. The agency had 3,465 full-time employees in the fiscal year ended last September and staffing in the enforcement unit dropped to 1,111.
“Staffing levels haven’t kept pace with the urgent work needing to be done,” Arthur Levitt, a former chairman of the SEC, said today in a Bloomberg Television interview. “We need more people in enforcement and more people at the commission. Those budget cuts have got to be restored.”
Under Cox, who became chairman in August 2005, the SEC has left money on the table. The 2007 budget included $14 million in “available balances from prior years,” according to the SEC’s 2009 funding request. The $906 million Congress granted the SEC in 2008 includes $63.3 million in unspent money from earlier years.
“This is akin to the fire department laying off people as the house burns down,” said Lynn Turner, a former SEC chief accountant. Nester said more than 90 percent of the money carried over to the 2008 budget from earlier years can’t be used for staff salaries. Most of the $63.3 million represents funding intended
for contract work such as technology upgrades that wasn’t spent, he said.
In re infoUSA: Special Litigation Committee Stay Granted In Backdating Case
Lots still going on with options backdating. For example, the SEC has settled/brought several actions during the past month, like this action brought against Marvell Technology and its COO last Thursday.
And there is this Delaware development from Travis Laster: In Ryan v.
Gifford, Delaware Chancellor Chandler held that an investigatory board committee (but not a formal SLC) had waived the attorney-client privilege in connection with an investigation into stock option backdating by reporting on its
findings to the full board. That opinion and the Chancellor’s subsequent denial of the application for interlocutory appeal have attracted well-deserved practitioner attention. Some have expressed concern that Delaware’s traditional deference to the SLC process may have ebbed, particularly in the stock option backdating context.
In this opinion, issued in the option backdating case involving infoUSA, Chancellor Chandler applied traditional Delaware deference to an application by an SLC to stay the derivative litigation to investigate the underlying allegations and claims. The opinion confirms that traditional principles of Delaware law continue to apply to SLCs, even in the sensitive area of stock option backdating.
Here are a few highlights:
1. The Chancellor granted the stay even though the defendants previously had moved to dismiss the complaint under Rule 23.1 and the Court had found demand was futile. The Court rejected the argument that the SLC was formed “too late,” noting specifically that under Delaware law, even a conflicted board has the power to appoint an SLC: “The fact that I have already determined demand is excused demonstrates why the board must act by means of a committee; it does not in any way explain why it cannot act through an SLC.” (Page 3).
2. The Chancellor granted a stay of 150 days, towards the high end of the traditional 3-6 month range routinely granted by Delaware courts.
3. The Chancellor rejected an argument, based on Ryan, that the Committee was not sufficiently empowered to address the litigation.
4. The Chancellor held that any challenge to the independence of the SLC was premature and would be addressed at the same time the Court considered the bases for the SLC’s conclusion.
Note that the infoUSA SLC was comprised of 5 directors, three newly appointed directors and 2 whom the Court previously had deemed disinterested.
Yesterday, the SEC posted a 194-page proposing release related to the amendments of its cross-border rules, the first proposed changes to the rules since they were initially adopted in 1999. A departure from recent practice, these proposals were approved by the Commission seriatim rather than in an open Commission meeting.
The proposing release includes many proposed rule changes that would codify existing Staff interpretive positions and exemptive orders – although there are some areas that are proposed to change – as well as some Staff interpretive guidance that the SEC seeks comment on. The SEC’s proposals include:
1. Refinement of the tests for calculating U.S. ownership of the target company for purposes of determining eligibility to rely on the cross-border exemptions in both negotiated and hostile transactions, including changes to:
– Use the date of public announcement of the business combination as the reference point for calculating U.S. ownership;
– Permit the offeror to calculate U.S. ownership as of a date within a 60 day range before announcement;
– Specify when the offeror has reason to know certain information about U.S. ownership that may affect its ability to rely on the presumption of eligibility in non-negotiated tender offers;
2. Expanding relief under Tier I for affiliated transactions subject to Rule 13e-3 for transaction structures not covered under our current cross-border exemptions, such as schemes of arrangement, cash mergers, or compulsory acquisitions for cash;
3. Extending the specific relief afforded under Tier II to tender offers not subject to Sections 13(e) or 14(d) of the Exchange Act;
4. Expanding the relief afforded under Tier II in several ways to eliminate recurring conflicts between U.S. and foreign law and practice, including:
– Allowing more than one offer to be made abroad in conjunction with a U.S. offer;
– Permitting bidders to include foreign security holders in the U.S. offer and U.S. holders in the foreign offer(s);
– Allowing bidders to suspend back-end withdrawal rights while tendered securities are counted;
– Allowing subsequent offering periods to extend beyond 20 U.S. business days;
– Allowing securities tendered during the subsequent offering period to be purchased within 14 business days from the date of tender;
– Allowing bidders to pay interest on securities tendered during a subsequent offering period;
– Allowing separate offset and proration pools for securities tendered during the initial and subsequent offering periods;
5. Codifying existing exemptive orders with respect to the application of Rule 14e-5 for Tier II tender offers;
6. Expanding the availability of early commencement to offers not subject to Section 13(e) or 14(d) of the Exchange Act;
7. Requiring that all Form CBs and the Form F-Xs that accompany them be filed electronically;
8. Modifying the cover pages of certain tender offer schedules and registration statements to list any cross-border exemptions relied upon in conducting the relevant transactions; and
9. Permitting foreign institutions to report on Schedule 13G to the same extent as their U.S. counterparts, without individual no-action relief.
In addition to those proposed rule changes, the Corp Fin Staff provides interpretive guidance or solicit commenters’ views on the following issues:
1. The ability of bidders to terminate an initial offering period or any voluntary extension of that period before a scheduled expiration date;
2. The ability of bidders in tender offers to waive or reduce the minimum tender condition without providing withdrawal rights;
3. The application of the all-holders provisions of our tender offer rules to foreign target security holders;
4. The ability of bidders to exclude U.S. target security holders in cross-border tender offers; and
5. The ability of bidders to use the vendor placement procedure for exchange offers subject to Section 13(e) or 14(d) of the Exchange Act.
If you’re wondering if the lack of an open Commission meeting means that this rulemaking is less important to the SEC, the answer would be “no.” Until a few Chairman ago, most rulemakings were approved seriatim and only the ones that the SEC wanted to get the attention of the mass media were approved at an open meeting. “Seriatim” simply means that each Commissioner signs an order indicating whether they vote in favor of a particular proposing or adopting release.
That trend started to change when Harvey Pitt became Chair and it is my hunch that since the open meetings are more “open” now due to the Web, that trend has continued to today. Plus, the SEC likes the publicity. But it’s a production to hold an open meeting, so some rulemakings have to go seriatim to keep the rulemaking machine humming.
More on Short Sellers and Rumors
My favorite part about blogging is reactions from members, particularly those that add more value to our experiences here. Here is another excellent addition from Keith Bishop following up on my recent blog about the SEC acting on short selling and rumors: There have been two recent cases involving challenges under California law to short selling:
1. Remember Broc’s “Lord Sith” blog about Overstock.com’s analyst call from about two years ago? Overstock.com did file suit. Among other things, Overstock alleged that the knowing and intentional dissemination of negative reports on Overstock.com containing false and/or misleading statements concerning Overstock constituted unlawful, unfair, or fraudulent business acts or practices by the defendants . . ., in violation of California Business and Professions Code § 17200. The Court of Appeal found California’s unfair competition statutes do not exclude securities claims. Overstock.com also alleged violations of California’s Corporate Securities Law. In a victory for Overstock.com, the Court of Appeal affirmed the trial court’s denial of the defendants motion to strike the entire complaint under California’s anti-SLAPP statute (Strategic Lawsuit Against Public Participation, Cal. Code of Civil Procedure § 425.16). Overstock.com, Inc. v. Gradient, 151 Cal. App. 4th 688 (2007).
2. Remember ZZZZ Best Co. and Barry Minkow (See In re ZZZZ Best Securities Litigation, 864 F. Supp. 960, 963 (C.D. Cal. 1994))? In Usana Health Sciences, Inc. v. Minkow (D. Utah, March 3, 2008), a company sued Barry Minkow and the Fraud Discovery Institute alleging that they engaged in a scheme of illegal market manipulation involving a lengthy and uncomplimentary report about the Company. In contrast to the decision in Overstock.com, the Court dismissed the state claims under California’s anti-SLAPP statute.
For years, some issuers have been complaining about the short sellers and rumors. To some extent, Wall Street has dismissed these complaints. See Joe Nocera . “New Crusade for Master of Overstock”, The New York Times, (June 10, 2006) (“Except for a few fellow-traveling Web sites, where Mr. Byrne is viewed as a heroic figure, most people who understand the issue or have looked into it think it’s pretty bogus.”). Overstock.com teaches that it may be possible to pursue these complaints under California’s Unfair Competition Law as well as its securities law. The differing conclusions of the courts in the Overstock and Usana cases make it clear that success in the face of free speech challenges is not assured. Finally, it is important to keep in mind that Overstock.com has not yet won its case – it has only survived a motion to strike. Nonetheless, the SEC’s recent settlement and the Overstock.com decision may burnish the credibility of those who are complaining about short selling and rumor mongering and encourage more litigation in this area.
A Personal Note: 20-Year Law School Reunion
I recently missed my twenty-year law school reunion. Yes, I had a bad attitude since I didn’t “dig” law school – but I was out-of-town anyways. My primary reason for disliking law school was the style – way too serious and not much in the way of “real life.” Isn’t that true of most educational platforms? Anyways, I pose the question to you:
As the end of his term nears – and after six years in office – Republican SEC Commissioner Paul Atkins announced that he intends to leave the Commission “once a successor is appointed and takes office.” Well that may be soon since President Bush has already nominated Professor Troy Paredes as Atkin’s successor (as noted in this article). Given the speed of this nomination, the confirmation hearings may be upon us shortly.
So it looks like the Senate will consider the confirmation of three SEC Commissioners at once – Troy and the two Democratic candidates, Luis Aguilar and Elisse Walter. Three new Commissioners at once is beyond rare; according to this chart, it would be the first time it has happened since the Commission was formed in 1934.
By the way, Peter Schwartz recently wrote a pretty nice piece about Commissioner Atkins in his “Soap Box” (scroll down to April 28th entry).
I think it will be cool to have someone named “Troy” as a Commissioner. You may recall that was Fred Flintstone’s nickname in Episode 140 when Fred became a surfer hipster dude and kept saying “Yeah, yeah, I’m hip, I’m hip.” My friends made me a “Troy” T-shirt in college…
CorpGov.net: The First Governance Site
I’ve been a long-time reader of Jim McRitchie, who is Editor of CorpGov.net, a site that has been up over a decade and where Jim essentially has been blogging that entire time on his “News” page (even before there was blogging software available).
In this podcast
, Jim provides insights into what it’s like to be a long-standing reporter on corporate governance issues, including:
– What led you to create CorpGov.net a decade ago?
– How has the site evolved over time?
– What have been the biggest surprises in managing the site?
The Future of Corporate Law: Symposium Notes
Below is a great example of the useful types of information that Jim McRitchie provides on CorpGov.net:
In the current issue of The Delaware Lawyer, a variety of practitioners and academics (including Lucian Bebchuk, Robert Thompson, Michael Dooley and Charles Elson) present brief appeals for reform of Delaware’s corporate statutes. Many of them, joined by professors Jennifer Hill, Brett McDonnell, Faith Kahn, Elizabeth Nowicki, and Ann Conaway, discussed their proposals for reform at the Delaware General Corporation Law for the 21st Century Symposium on May 5th at the Widener University School of Law in Wilmington.
Most Americans have become “forced capitalists” as companies have moved from traditional defined benefit pensions to 401(k) plans for employees, said Vice Chancellor Leo Strine Jr., a judge in Delaware’s Court of Chancery, at the lunch address. These forced capitalists invest in the market through intermediaries or money managers, Strine said. He calls it “separation of ownership from ownership.” (Experts look at corporate law statute, Delawareonline.com, 5/6/08)
Robert Thompson noted that “self-help” measures are important for shareholders. Delaware statutes have gaps with regard to that need. If Delaware doesn’t address the need directly, it will likely lead to a patchwork of Federal provisions. Shareholders must be able to check directors when they are conflicted or entrenched. There has to be an effective way to exercise their franchise which cannot be redirected by the board. Delaware should write statutes which make Federal preemption less likely.
Charles Elson said that times change. As great as the Delaware corporate law scheme is, we need changes to better protect investors. Forty years ago, we were in a different era. Now, stock is aggregated and held by largely by institutional investors who are more sophisticated. They don’t need protected by management. Shareholders need a way to replace directors, not just vote them down. Shareholders don’t have the right to direct day to day operations and shouldn’t. However, for directors to be accountable to shareholders, we need the threat of a real election. Make the election a vibrant process by allowing reimbursement for short slate contests instead of the current asymmetry where corporations only pay for one side. I get nervous when managers view themselves as the corporation. Elson has proposed a statute that would reimburse shareholders for the cost of putting forth a competing slate of directors if they are successful or nearly successful in getting people on the board.
Rick Alexander argued that five mergers were shot down by shareholders recently. The market is doing its job. Directors have a lot of information that isn’t publicly available. There are legitimate differences. We’re not going to maximize the economy by going with what 51% of stockholders think. What about the rights of the other 49%? Directors take their jobs very seriously. They know that failure to adopt resolutions that get a majority may cost them their jobs because ISS will recommend voting against them.
Jennifer Hill said the US hasn’t looked much to developments in other countries. The federalist system provides competition for corporate charters in the US. Common law may be better than civil law. However, the idea that the US operates similarly to other common law countries is a misconception. In the UK and Australia changes happens much more frequently. SOX didn’t give shareholders participatory rights, only some additional protection of their rights through disclosure and liability. In Australia and the UK a raft of recent laws have strengthened rights with provisions such as “say on pay.” Bainbridge and Stout argue shareholders don’t want rights. However, for Hill, News Corporation’s move from Adelaide was instructive. Institutional investors wanted charter provisions to render inapplicable certain Delaware laws in order to maintain Australian rights where corporate constitutions can be changed by shareholders, meetings can be convened by 100 members, and no poison pills are allowed.
With Aflac’s annual meeting results now in, “say on pay” is in the news. Here are five items to consider:
1. Aflac’s Pay Package Gets 93% Support – As noted in this NY Times article, Aflac’s meeting on Monday was uneventful with the company’s executive pay package getting overwhelming support.
2. RiskMetrics’ Aflac Report – ISS kindly has given us permission to post its analysis of Aflac’s “say on proposal.” It is interesting comparing that to the PIRC report that I posted last week.
3. Shareholders Not Supporting “Say on Pay” As Much This Year – As noted in this Washington Post article, the level of support for “say on pay” proposals is down this year compared to last year (bearing in mind that last year’s levels were remarkable for a “first year” type of proposal). So far, only proposals at Apple and Lexmark have garnered majority support.
Compare the Washington Post’s conclusions with those of ISS from this article. Here is an excerpt: “This year, pay vote proposals have averaged 42.1 percent support at 21 companies so far. That is in line with results for calendar 2007, when 52 such proposals received 42.5 percent average support. Surprisingly, however, the measure received less support at a number of financial companies this season, including Citigroup, Morgan Stanley, Wachovia and Merrill Lynch, where many observers expected the measure would fare better than last year given investor anger over subprime-related losses.”
As noted in the ISS piece, I’m also hearing that levels of support for proposals generally are down. I’m not sure of the reason, although some claim it’s partly due to the lower level of retail holders voting under e-proxy (I’m not sure I buy that given that relatively few companies are doing e-proxy).
4. Two More Companies Agree to “Say on Pay” – Littlefield and MBIA have joined the group of companies that have agreed to allow their shareholders to vote on executive pay, bringing the total number to seven. MBIA’s vote will occur in 2009 and Littlefield’s vote is in a few weeks, where its shareholders will vote on two management resolutions that ask shareholders whether the total compensation received by the CEO, president, and directors in 2007 “is within 20 percent of an acceptable amount,” according to its proxy statement. Hat tip to this ISS article for uncovering these two!
5. RiskMetrics’ Own “Say on Pay” Proposals – A few weeks ago, RiskMetrics Group filed its first proxy statement and it includes three separate resolutions for shareholder approval, which may become the model for future “say on pay” proposals. These three proposals are: (1) the company’s overall executive compensation philosophy; (2) whether the board executed these principles appropriately in making its 2007 compensation decisions; and (3) the board’s application of its compensation philosophy and policies to the company’s 2008 performance objectives.
Canada Revises Its Executive Compensation Proposals
Recently, the Canadian Securities Adminstrators re-published their executive compensation disclosure proposals. The original proposals were made a year ago – and interestingly, many Canadian companies have already voluntarily changed their disclosures to match the proposals. Here is a memo explaining how the proposals have changed.
The PCAOB Speaks: Latest Developments and Interpretations
We have posted the transcript from our recent webcast: “The PCAOB Speaks: Latest Developments and Interpretations.”
In the wake of the two recent Delaware Chancery Court cases (Levitt Corp. v Office Depot; JANA Partners v. CNET) regarding advance by-laws, some companies are taking the memos posted in our “Advance By-Laws” Practice Area to heart. Essentially, the memos urge companies to specify in their Notice that the agenda item on director elections applies only to the election of director candidates described in the company’s proxy statement; not to nominations generally. For example, when Wal-Mart filed its proxy statement recently, it limited its state law notice to only those nominees “named in the attached proxy statement.” Compare Wal-Mart’s notice from last year.
Another example is the proxy statement filed by the Canadian company, Storm Cat Energy Corp. Interestingly, Storm Cat is incorporated in British Columbia, so it’s not directly impacted by the recent Delaware decisions. (By the way, it’s a cool name for a company, although I have a beef with them – when you click on “Annual Reports” on their IR web page, the 2005 glossy is the latest!)
J-SOX is On!
A few years in the making, Japan now has it’s own version of the Sarbanes-Oxley Act. The J-SOX rules became effective on April 1st and they apply to about 3,800 Japanese listed firms, their large subsidiaries and affiliates. The new rules are bound to have their own challenges. Learn more in our “J-SOX” Practice Area.
2008: The Year of the Hedge Fund Activist
Join DealLawyers.com tomorrow for the webcast – “2008: The Year of the Hedge Fund Activist” – to learn about the latest strategies and tactics used by hedge fund activists, as well as latest planning tips employed by those that seek to stave off these attacks. The panel includes:
– David Katz, Partner, Wachtell Lipton Rosen & Katz
– Ron Orol, Senior Writer, The Deal and The Daily Deal
– Damien Park, President & CEO, Hedge Fund Solutions, LLC
– Veronica Rendon, Partner, Arnold & Porter LLP
– Professor Randall Thomas, Vanderbilt University Law School
– Christopher Young, Director of M&A Research, RiskMetrics Group
The Williams Act – 40 Years Later!
On May 21st and 22nd, Georgetown University Law Center will be hosting a conference to commemorate the 40th anniversary of the adoption of the Williams Act takeover regulations. The speakers and panelists will include members of the SEC staff, academics, financial journalists, international takeover regulators, practitioners, bankers, and Delaware judges. It’s free – but you still need to register (here is the agenda). If you have questions, contact Larry Center at center@law.georgetown.edu.
Earlier that week, Corp Fin will be hosting a meeting of international takeover regulators at the Commission’s headquarters – so representatives from the UK, Germany, France, Hong Kong, Australia and Japan will likely be at the Georgetown conference, lunch and reception if you want to rub elbows with a group of regulators.
