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 week, I blogged about the new lawsuit filed against the CEO, President, CFO and General Counsel – as well against each director – of Fairchild Corp. Following on the heels of an executive compenation lawsuit against Nortel, the WSJ correctly called this “one of the first of a new wave of Delaware lawsuits challenging excessive pay for corporate leaders.” Both the Fairchild and Nortel complaints are posted in CompensationStandard.com’s “Executive Compensation Litigation Portal.”
The complaint focuses on six areas:
– related-party transactions
– triggered change-of-control payments, without executives losing their jobs
– excessive salary and bonus – and huge advances on SERP payments
– reimbursement of legal fees
– interest-free loans
– nepotism
Interestingly, this complaint appears to be cobbled together from disclosures in SEC filings (can’t imagine what they might find that wasn’t disclosed) – which is a departure from the Cendant and Disney complaints that were replete with details taken from board minutes and other records that are not readily available.
Obviously, putting together the Fairchild complaint was easy to do in comparison. Given that the Wall Street Journal reported last year that three-quarters of the S&P 500 companies disclosed at least one related party transaction – the pool of potential defendants for this new breed of lawsuit appears to be quite large.
SEC Inquires Into How Much is Too Much
Further reflecting the SEC’s interest in executive compensation, check out this speech by the SEC’s Chief Economist into whether overall CEO pay is excessive – and not a proper allocation of resources. Some of Chester’s comments are too “economist” in nature for my tastes – but just the fact that the SEC’s Chief Economist is putting this issue out on the table is quite noteworthy.
NASD’s Shelf Offering Proposal
Yesterday, the SEC issued a proposing release seeking comment on the NASD proposed rule changes to its rules regarding the filing requirements and regulation of shelf offerings by NASD members – offerings of securities registered by issuers with the SEC pursuant to SEC Rule 415.
Thanks to Jonathan Wolfman of Wilmer, Cutler, Pickering, Hale and Dorr LLP for correcting my mistaken blurb that D&O Questionnaires for Nasdaq companies don’t need to be updated, as I forgot about the technical amendments that Nasdaq made to its listing standards over the summer.
As originally approved by the SEC in November 2003, Rule 4200(a)(15)(B) provided that a person cannot be an independent director if the person or a family member accepted any payments from the company (or any parent or subsidiary of the company) in excess of $60,000 during the current or any of the past three fiscal years. Under the revised rule – which took effect this summer – the look-back period is any period of twelve consecutive months within the three years preceding the date independence is to be determined. This change conforms to the approach used in the NYSE’s version of this rule (although the dollar thresholds and scope of included payments remain different between the Nasdaq and NYSE rules).
The exact wording of the new Nasdaq rule is as follows (underlining indicates new text; brackets indicate deleted text):
“(15) “Independent director” means a person other than an officer or employee of the company or its subsidiaries or any other individual having a relationship, which, in the opinion of the company’s board of directors, would interfere with the exercise of independent judgment in carrying out the responsibilities of a director. The following persons shall not be considered independent:
(B) a director who accepted or who has a Family Member who accepted any payments from the company or any parent or subsidiary of the company in excess of $60,000 during any period of twelve consecutive months within the three years preceding the determination of independence [deleted text: the current or any of the past three fiscal years], other than the following:”
Because the new definition implements a rolling 12 month testing period, rather than annual periods based on the company’s fiscal year, companies will need to re-examine the independence of directors who received any payments during the past three years.
Please note that a number of other minor changes have been made to the Nasdaq’s definition of independence, including (1) clarifications of the transition rules for companies emerging from bankruptcy, ceasing to be a controlled company or conducting an IPO and (2) an exclusion from the $60,000 test discussed above of certain standard, non-preferential transactions by financial institutions (such as banks) with their customers.
Glimpse into Congressional Mindset on Comp?
From yesterday’s Boston Globe (and NY Times ran a simliar blurb): “File this one under: Uh, thanks for coming, we think. In what attendees described as a fiery and lively keynote speech in New York City on Wednesday night, Congressman Barney Frank lit into a group of bankers on the subject of executive pay. “At the level of pay that those of you who run banks get, why the hell do you need bonuses to do the right thing? Most people in the world don’t get bonuses to do the right thing,” Frank told the 250 bank executives, regulators, and politicos gathered for the trade publication American Banker’s annual Banker of the Year Awards.
According to remarks provided from the evening, Frank said: “I mean, do we really have to bribe you to do your jobs? I’m serious. I don’t get it. I don’t get a bonus. Cops don’t get bonuses. . . . And the problem is not just the bonuses. Think what you’re telling the average worker, that you who are the most important people in the system and at the top, that your salary isn’t enough, that you need to be given an extra incentive to do your job.”
In the “Legal Proceedings” section of its 10-K filed Tuesday, Analog Devices disclosed that the SEC’s Enforcement Division was conducting an investigation into the timing of certain option grants: “We have received notice that the SEC is conducting an inquiry into our granting of stock options over the last five years to officers and directors. We believe that other companies have received similar inquiries. Each year, we grant stock options to a broad base of employees (including officers and directors), and in some years those grants have occurred shortly before our issuance of favorable annual financial results.”
Back in March, the Wall Street Journal reported that the SEC was looking into the practice at a number of companies, especially those in technology industry, of granting options shortly before announced positive news.
Combining the SEC’s interest in excessive comp with the recent lawsuit against Fairchild Corp. – in which not only the CEO, but the GC was named in the suit, and which the WSJ called “one of the first of a new wave of Delaware lawsuits challenging excessive pay for corporate leaders” (I will blog more on this suit next week) – you can see why so many are still taking advantage of our “Catch Up” offer to hear all the practical guidance from the video webcast archive of our October 20th conference and all the other practice pointers on CompensationStandards.com. It is refreshing to see so many companies signing up their comp committees – catch up today!
On Wednesday, the SEC instituted public administrative proceedings against 15 companies to determine whether to revoke the registration of their securities under the ’34 Act (the SEC also temporarily suspended trading in the securities of 26 companies). This is the second time the SEC has done this – last time was back in June, so perhaps its a semi-annual housecleaning.
California Department of Corporations Wants Comments
On Wednesday, the California Department of Corporations announced that it is requesting public comment for a study on the effectiveness of the California Corporate Disclosure Act aimed at providing investor protection. In September, Governor Arnold Schwarzenegger directed that the Department to review the efficacy of the Act and make recommendations to eliminate duplicative reporting requirements and further align its provisions with federal reporting requirements.
Comments can be sent to Kathy Womak, Office of Law at regulations@corp.ca.gov. Thanks to Keith Bishop for the heads up!
Yesterday’s blog on this topic resulted in a flood of emails – so here is another attempt to make sense of it all. If you look at Telephone Interp A.78, it states: “For purposes of Rule 401(b), the updating of a Form S-3 registration statement through the incorporation of a Form 10-K is the equivalent of filing a post-effective amendment pursuant to Section 10(a)(3). This means that if the registrant were not eligible to use Form S-3 at the time of such updating, it would be required to file a post-effective amendment on whatever other Form would be available at the time.”
As I understand it, since accelerated filers that rely on the SEC’s exemptive order will not be S-3 eligible until they file their 10-K amendment (per the terms of the SEC’s order), they are not able to draw down off a shelf under this Telephone Interp. This is because companies would remeasure their eligibility to use their shelf at the time of their 10(a)(3) update – which is the date of filing the 10-K – and the SEC’s order operates to render the company S-3 ineligible until the date of filing the 10-K amendment, at which time the order operates to restore the company’s S-3 eligibility.
As a practical matter, information regarding management’s assessment of the company’s internal controls and the auditor’s ability to give a “clean” attestation might be material anyways – effectively precluding a takedown since this information would be non-public until the 10-K amendment is filed. Similarly, a company’s auditor isn’t likely to allow incorporation of its opinion into a takedown until a 10-K amendment is filed that includes the management report and attestation. Thanks to Mark McElreath of Alston & Bird for these two nuggets!
Also note that the use of Rule 144 and Form S-8 are fine before the 10-K amendment is filed by an accelerated filer that relies on the SEC’s order – their use is not impacted like S-3/S-2 eligibility by the SEC’s order.
Here are some open issues identified in a Weil Gotshal memo that came out last night:
· Under what circumstances may an auditor provide an unqualified audit report on a company’s financial statements if it has concluded that the company’s internal control over financial reporting is ineffective as of the 10-K filing date?
· What are the consequences to a company relying on the Order if its auditor determines that it is unable to provide an audit report on the financial statements until it concludes the internal control audit, despite the latitude afforded by the SEC and PCAOB?
· What should management do about the SOXA Section 906 certifications under the bifurcated filing procedure contemplated by the Order? Can appropriate qualifying language be added to the body of the 10-K (e.g., in the Item 9A disclosure)?
8-K Trends: Part II
I have seen a lot of 1.01 and 2.03 8-K filings accompanied by exhibit filings – including material definitive agreements, even though this is not required by the items. In some cases, I hear that companies have filed the exhibits to get them out of the way (and not worry about forgetting to file them in the next Q or K) – but in other cases, I hear that companies have filed them because they were concerned about whether the summary description (particularly in the 2.03 context) was sufficient, so they wanted to file it and incorporate them by reference.
SOX Upheld in Court
On Monday, former HealthSouth CEO Richard Scrushy’s claims that Sarbanes-Oxley is unconstitutionally vague were rejected by a federal judge in Birmingham, Ala. In the first court test of the Sarbanes-Oxley’s constitutionality, U.S. District Judge Karon Bowdre said jurors, not a judge, should decide key questions raised in Scrushy’s fraud case. No big surprise here…
I’m pretty excited to hear today’s webcast – “The Overhaul: ’33 Act Reform” – featuring SEC Staffer Amy Starr, who wrote much of the proposing release and three lawyers that I admire much from my days working with them on the Staff: Abbie Arms of Shearman & Sterling; Meredith Cross of Wilmer, Cutler, Pickering, Hale and Dorr; and our own Julie Hoffman. Spend an hour learning from the best rather than try to wade thru 350+ pages.
We continue to post law firm memos on the ’33 Act reform in Section A.17 of our “Sarbanes-Oxley Law Firm Memos” – including a 75-page gem from Sullivan & Cromwell that has some nifty charts at the back.
The Nasdaq D&O Questionnaire that is posted doesn’t appear to need updating – and contributors are busy updating the Independence Questionnaires that are posted on that page.
Flushing Out the Internal Controls Delay for Certain Accelerated Filers
One interesting aspect of the SEC’s exemption order that I blogged about yesterday – which delays the internal controls deadline by 45 days for certain accelerated filers – is that it doesn’t delay the requirements of Item 307 of Regulation S-K because the exemptive order states that it applies to 308(a) and (b). So the remainder of Item 9A of 10-K must be provided, which means you must still disclose management’s conclusions about disclosure controls and procedures as required by Item 307 of Reg S-K as of the year end.
So even though some accelerated filers get more time to conduct testing, management’s assessment must still be conducted as of the same time as applied before the order. Thanks to Will Anderson of Bracewell Paterson for being the first to point out this tidbit!
Another interesting aspect of the SEC’s order is that for purposes of the Form S-3/S-2 eligibility requirements, a company that relies on this special exemption will not be considered to have timely filed its 10-K until it has filed an amendment that contains the internal controls information that had been omitted per the order.
In other words, a company that relies on the 45-day exemption can’t sell securities that already are registered on a shelf until the company files an amendment to complete its 10-K by including the management report and auditor’s attestation. And once the 10-K amendment is filed, it can continue drawing off the shelf.
Today’s NY Times quotes SEC Chief Accountant Donald Nicolaisen as saying that one open issue is “whether auditors would be allowed to certify that material weaknesses identified in this year’s audit were fixed after the audit is completed – or whether certification would not be possible until a new audit was conducted a year later.”
Today, the SEC issued an exemptive order to grant certain accelerated filers an additional 45 days to include their 404 report (and the related auditor attestation). The exemptive order applies to an accelerated filer that has a fiscal year ending between and including November 15, 2004 and February 28, 2005, and that had a public equity float of less than $700 million at the end of its second fiscal quarter in 2004.
The PCAOB also met today to adopt a temporary rule, subject to SEC approval, that would permit the delayed filing of the auditor’s attestation consistent with the SEC’s exemptive order.
Securities Act Reform Practice Area
In preparation for tomorrow’s webcast – “The Overhaul: ’33 Act Reform” – we have developed a Securities Act Reform Practice Area devoted to the ’33 Act reform proposal – including a Table of Contents from Shearman & Sterling that helps navigate the 389-page proposing release. In the Practice Area, we also have posted the 97-page copy of the release from the Federal Register.
The New SEC Phone Book is Here!
We have just posted the new edition of the “SEC Phone Directory” – not available anywhere else on the Web! The “SEC Phone Directory” is available from TheCorporateCounsel.net home page under the “SEC Rules/Guidance” button.
Moody’s Ratings of Internal Control Disclosures
In the wake of SEC Chief Accountant’s Donald Nicolaisen’s speech in early October about internal controls – during which the Chief Accountant noted that Moody’s would be analyzing internal control disclosures – a number of members have asked me about how Moody’s intends to divide material weaknesses into two degrees of severity.
The first category – “Category A” – of material weaknesses concern control problems with specific transaction-level processes such as tax accrual, bad-debt reserves, and impairment charges. These require attention, but external auditors can effectively “audit around” them and still deliver an unqualified opinion of the financial statements.
The second category – “Category B” – of material weaknesses, however, cannot be circumvented by auditors because they represent “company level” control problems, such as ineffective control environments, audit committees, and financial reporting processes, encompassing everything from a lax code of conduct, to feeble fraud-prevention guidelines, to poor attempts at assigning executive responsibility.
Moody’s does not intend to publicize the categorization of internal control disclosures for any particular company. However, Moody’s has made clear the process it will be using (which is described in this Special Comment in our Internal Controls Practice Area) – and if a company’s rating is adjusted due to material weakness disclosures, the rationale for the downgrade would be disclosed at that time.
In a vaguely worded announcement, the PCAOB will meet tomorrow morning on internal controls. My guess is they will vote on delaying implementation for smaller companies – a topic covered in a feature article in Saturday’s Washington Post.
8-K Trends: Part I
With last Tuesday’s release of FAQs by the SEC Staff, it might be a good time to take stock in how many 8-Ks are being filed. The SEC predicted each company would, on average, file an additional five 8-Ks per year – resulting in 59,000 additional 8-K filings from the nearly 12,000 companies that file them, which prediction is about double the rate of filings before the new rules were adopted. Notably, the SEC originally estimated that the new rules would cause two new 8-Ks per year in the proposing release – but bumped this number up substantially in the adopting release.
But the SEC probably didn’t bump up their estimate enough. I don’t have actual statistics – but I have looked at quite a few companies that appear to be averaging the filing of an 8-K per week. And it doesn’t appear to depend on the size of the company – plenty of smaller companies are filing 8-Ks at this clip. For example, look at this filing stream for the Williams Companies – I count 14 8-Ks filed since August 23rd. Of course, many companies are not filing at this rate and actual stats might prove closer to the SEC’s final estimate.
The New Obstruction of Justice
Here is a rehash of an interesting blog from Bruce Carton of the Securities Litigation Watch: Prosecutors requested a fall 2005 trial date yesterday for Sanjay Kumar, former CEO of Computer Associates International, who is charged with obstruction of justice, conspiracy and lying to law enforcement officers in a multibillion-dollar financial fraud. The obstruction of justice charge is particularly notable, and perhaps novel, because it relates to statements Kumar made not to any government official but rather to the company’s outside counsel (Wachtell Lipton), which was conducting an internal investigation of the matter.
According to paragraph 53 of the indictment filed against Kumar:
“Shortly after being retained in February 2002, the Company’s Law Firm met with the defendant SANJAY KUMAR and other CA executives in order to inquire into their knowledge of the practices that were the subject of the Government Investigations. During these meetings, KUMAR and others did not disclose, falsely denied and otherwise concealed the existence of the 35-day month practice. Moreover, KUMAR and others concocted and presented to the Company’s Law Firm an assortment of false justifications, the purpose of which was to support their false denials of the 35-day month practice. KUMAR and others knew, and in fact intended, that the Company’s Law Firm would present these false justifications to the United States Attorney’s Office, the SEC and the FBI so as to obstruct and impeded the Government Investigations.”
Four former executives of the company, including its chief financial officer and general counsel, have reportedly already pleaded guilty to the charge of obstructing justice by lying to the lawyers from Wachtell. According to this article in the National Post, this new form of obstruction was the subject of discussion recently by defense attorneys John Keker and Theodore Wells, Jr. at PLI’s Securities Institute conference:
“You better understand how broad these obstruction statutes are — and how risky for both you and your clients,” Mr. Keker told the audience of securities lawyers.
He pointed to the case against Computer Associates International, in which the three executives — including the general counsel — pleaded guilty to obstruction of justice for lying to their own lawyers at Wachtell Lipton Rosen & Katz, who were conducting an internal investigation.
Government prosecutors said the general counsel hid some information and gave incorrect information to Wachtell, even though he knew the findings were being passed along to the government.
“What’s really scary here is some prosecutors are now taking the position that if an employee makes a false statement to the outside lawyer doing the internal investigation, that can constitute obstruction based on the theory that the outside lawyer is doing the investigation with the purpose of giving that information to the government,” said Mr. Wells, who, like Mr. Keker, is consistently ranked as one of America’s leading white-collar defence lawyers.
“So now we’ve moved from a situation where you’re not supposed to make false statements to government agents, which at least people understand, to a world where if you make a false statement to the lawyer from Skadden Arps or Cravath, that in and of itself may constitute an act of obstruction.”
The SEC Staff has issued the long-awaited 8-K FAQs! There are 30 FAQs – plus an interesting introduction about the purpose of the 8-K rules and a warning to ensure that companies have implemented appropriate disclosure controls and procedures to handle the new rules.
PCAOB Issues More Internal Control FAQs
Yesterday, the PCAOB issued FAQs 30-36 to assist in the implementation of PCAOB Auditing Standard No. 2. Among the topics addressed in the new FAQs are audits of multi-national companies that involve the work of more than one auditor; audits of federally insured financial institutions; the timing of auditors’ communications to management and audit committees regarding material weaknesses or significant deficiencies in internal control; evaluations of deficiencies in information technology general controls; and the ability of outside auditors to use internal auditors to provide direct assistance in the audit of internal control over financial reporting.
Amendment of California’s Corporation Disclosure Act
The original California Corporate Disclosure Act was adopted in the aftermath of Sarbanes-Oxley and required public companies doing business in California to file various corporate data with the California Secretary of State’s office. The intent of the Act was to provide people with access to key public information without having to scour voluminous SEC filings. Unfortunately, the original Act’s disclosure requirements exceeded those required by the SEC and required the expenditure of additional resources by companies complying with the Act.
Governor Schwarzenegger recently approved a law amending California’s Corporation Disclosure Act. Regrettably, this Act continues to diverge from SEC disclosure requirements in some material respects and California remains the only state in the nation to impose such a duplicative and burdensome filing requirement upon its businesses – and the Act still applies both to public companies incorporated in California and to companies that are simply qualified to do business in California. Learn how the Act has changed in my interview with Jason Slater on Changes to California’s Corporate Disclosure Act.
And Even More Notes from the PLI Securities Law Institute
Here is our last batch of notes from PLI’s Securities Law Institute from the “SEC Review Developments” and “Follow-Up On Recent Disclosure Initiatives” panels.
On Saturday, at a panel from the ABA’s Committee of Federal Regulation of Securities’ Fall Meeting, Corp Fin Director Alan Beller stated that the SEC Staff is considering taking action regarding the ability of accelerated filers to comply with the internal controls deadline – and is thinking of whether a category of smaller accelerated filers should be given more time.
Alan expressed the view that to the extent that a company has financials that the company stands behind – but the company cannot complete its 404 report timely to include in the 10-K – he would prefer that the company file the 10-K without the 404 report and auditor’s attestation, so at least there is the 10-K information available to investors (but the 10-K would nonetheless be considered deficient). Alan stated that SEC Staff is considering whether such a company would be deemed deficient in its filing obligations for purposes of Form S-3 eligibility. We should hear relatively shortly from the SEC Staff whether they will take such action.
More PLI Notes
Speaking of internal controls, we have posted notes from PLI’s Securities Law Institute from the internal controls panel as well as the popular Q&A Picnic with Alan Beller.
Reporting Up and Shopping Around for Legal Advice
Our February e-minders described an example of reporting up at TV Azteca (because the company’s Chair didn’t want to disclose one of his related party transactions) – yesterday, Pat McGheehan wrote a column in the NY Times with many more details, illustrating how TV Azteca continued to shop around for the specific legal advice that they desired.
[Personal note– took the kids to SpongeBob Squarepants this weekend; took a pass on “Seed of Chucky.” On the NBA brawl, I agree completely with Michael Wilbon’s column.]
Yesterday, the SEC adopted its proposed release to postpone the final phase-in period for acceleration of periodic report deadlines that apply to “accelerated filers.” Under the amended rules, the deadline for accelerated filers will remain at 75 days after year end for annual reports and at 40 days after quarter end for quarterly reports. The accelerated filing phase-in will resume for reports filed for fiscal years ending on or after Dec. 15, 2005, when an accelerated filer will have to file its annual report within 60 days after year end and file its quarterly reports within 35 days after quarter end.
The SEC said that the primary purpose of the postponement is to allow additional time and opportunity for accelerated filers and their auditors to focus their efforts on complying with new requirements regarding internal control over financial reporting that were mandated by Section 404 of SOX.
The PCAOB is Making Its List
At its meeting with its Standing Advisory Group yesterday, the PCAOB revealed an ambitious agenda for developing auditing standards in 2005.
The topics include:
• Auditor independence and tax services.
• Detection of and reporting on financial fraud.
• The relative authority of auditing guidance in the Board’s interim auditing standards.
• Communications with audit committees.
• Engagement quality review, also known as concurring or second partner review.
• Auditing related-party transactions.
• Consistency of application of generally accepted accounting principles.
• Use of confirmations in an audit.
• Auditing fair value measurements and disclosures.
• Elements of quality control for registered firms.
• Assessing audit risk.
The Staff of the PCAOB acknowledged that it may not be possible to address all of the above issues in 2005, so it may need to focus on the topics with the highest priority.
