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."
In the corporate world, there are so many complex – and sometimes nonsensical – areas of law. Yet, one of the most convoluted areas underpin the SEC’s proposal regarding shareholder access. I am talking about the layers of intermediaries that must work together in order to cast votes for a shareholders’ meeting.
Companies ensure that all persons entitled to vote (both record holders and beneficial owners as of a record date) have an opportunity to vote after they have had an ample period of time to review proxy material and return proxy cards – and even revoke their votes if they desire. Companies solicit proxies through several layers of intermediaries – these intermediaries are involved because of the various different ways that securities can be owned. These layers of intermediaries makes it impossible for a company to directly communicate with all of its stockholders – since many stockholders remain anonymous to the company.
The voting process typically involves:
– Depositories provide an omnibus proxy to a company that states the number of shares held by “participants” in the depositories.
– “Participants” or “record holders” (primarily brokers and banks) hire proxy soliciting agents to obtain voting instructions from the beneficial owners who have bought stock through them (in “street name”).
– Tabulation agents tabulate voting instructions and facilitate providing these results to the company from the participants (or from beneficial owners who provided their voting instructions directly to the company).
The voting process is similar to the process for proxy solicitation – but there are some differences. Note that record holders vote by using “proxies” – beneficial owners vote by using “voting instructions.”
For TheCorporateCounsel.net subscribers, we have posted a PowerPoint presentation from ADP that explains this complicated proxy/voting process – this presentation might be useful to handout to directors so that they can better understand the SEC’s important proposal. [you will need a PowerPoint viewer on your computer to open the file under #7 in our “Shareholder Access Portal”; if you can’t – just shoot me an email and I will email the presentation directly to you.]
Directors By the Numbers
The WSJ has a special “Corporate Governance” section today, the most interesting of which is an interview with Peter Clapman of TIAA-CREF and David Farrell of Sun Microsystems. It also includes these factoids from The Corporate Library:
– average board size: 9.2 members
– largest board: 31 members; smallest board: 3 members
– independent outsiders: 66%
– average tenure on board: 8.4 years
– average age of directors: 58.9 years
– percentage of male directors: 90%
– total number of directors: 14,091; 9,369 served on one board and 7 served on nine boards
The Sushi Memo
From the “Ain’t the Internet Great” department, the so-called “Sushi” memo made the e-mail rounds over the past week. A junior corporate partner at [name of law firm omitted; but this could easily happen in any firm] asked the paralegal on a deal they were working on to order her sushi for dinner one evening. The dutiful paralegal did as instructed and went on the seamless web and made some selections for the partner. About 45 minutes later, the paralegal received a call from the irate partner who was very displeased with her evening meal. She ordered the paralegal to research and prepare a memo on sushi options in midtown Manhattan. A memo was produced.
The partner also instructed the paralegal to have the first year on the deal review the memo before forwarding it on to the partner. The partner was apparently quite satisfied with the memo. She was on the elevator one day with the senior partner on the deal when the paralegal entered the elevator. Junior partner asked senior partner if he knew the paralegal. He said of course he did. The junior partner then gushed that he should read this great memo the paralegal wrote for her. At least proper recognition was given!
In its FAQ No. 7 issued in June, the SEC staff reiterated that only the measure “funds from operations” – known as “FFO” – as defined by the industry association NAREIT could be used by companies as “funds from operations per share” in earnings releases and materials that are filed/furnished with the SEC. This exception for the real estate industry was first espoused in footnote 50 of Reg G’s adopting release.
The mixed blessing is that NAREIT’s definition was not universely applied by real estate companies – thus, the SEC’s exception did not really help those companies too much. In FAQ 7, the SEC staff made clear that use of a modified measure would be subject to all of the provisions of Item 10(e) of Regulation S-K.
Lately, NAREIT has been in discussions with the SEC staff over a disagreement regarding the exclusion of impairment charges from FFO – the staff ruled it can’t be excluded. As noted in a recent alert, NAREIT believes that this staff position is inconsistent with guidance it issued in July 2000, which indicated that impairment write-downs of depreciable real estate should be excluded from FFO. As I understand it, the theory for the NAREIT approach is that impairment charges should be treated like depreciation. The SEC staff appears to disagree. [it doesn’t appear that the NAREIT alert is available on their web site – if you want a copy of the alert, shoot me an email.]
Disclosure of Potential Environmental Liabilities
Investors consistently seek more disclosure about potential environmental liabilities; companies consistently are loathe to provide too much disclosure for fear of tipping their hand in litigation. Alan Beller has stated that if the SEC puts out an interpretative release on MD&A in time for the upcoming proxy season (a window that is now measured in weeks), it will address this tension.
For TheCorporateCounsel.net subscribers, we have posted an interview with Greg Rogers on Environmental Liabilities Risks and Disclosure.
Like collecting baseball cards, we have completed a set of sample audit committee evaluations by obtaining one from each of the Big 4. Subscribers of TheCorporateCounsel.net can review these samples in our “Audit Committee Portal.”
When putting together a committee evaluation, I believe its important to not overwhelm directors with too many questions. Quality over quantity. Its also important to have company-specific questions, particularly questions that probe into the committee’s performance for handling critical matters that arose over the past year. The principal purpose of the evaluation process is continuous improvement.
Two different sets of directors should evaluate the committee, those on the committee and those not on the committee – although questions for those not on the committee often are part of the overall board evaluation. Note that under the PCAOB’s proposal regarding internal control attestations, the independent auditor would be required to evaluate the audit committee’s performance (see paragraphs 56-59 of the proposed standard)! [I find it odd that I haven’t seen a single client memo on this proposal yet, arguably the most important rulemaking of the year.]
Forced and Sudden Auditor Rotation
One of the side effects of the absolute prohibition of certain non-audit services in Section 301 of Sarbanes-Oxley is that a company might suddenly find itself without an auditor with little warning. There is no materiality standard or safe harbor in Section 301 for these prohibitions. Changing an auditor is expensive as the new auditor has to exert a lot of effort to get up to speed and – more often than not – a change results in a restatement.
The first example of this dilemma comes from the Royal Bank of Canada, which had one of its two auditors (Canadian companies often have two auditors, a practice that is now changing) because it performed $200k (Canadian dollars) of non-audit services at a foreign subsidiary.
Audit committees are responsible for ensuring they don’t have this messy – and expensive – situation on their hands. This can be quite a challenge for multinational companies with dozens of audit firms to oversee in far flung places (the Big 4 have loose affiliations with audit firms all over the world that share the same brand name, but really have separate operations – one of the issues implicated by the PCAOB trying to regulate the Big 4 as if they were really only 4 firms).
For TheCorporateCounsel.net subscribers – thanks to Marilyn Mooney of Fulbright & Jaworski – we have posted a nifty chart that audit committees can use to keep track of the various types of audit/non-audit services performed by the independent auditor (its at the bottom of the memo which resides in our “Audit Committee Portal”).
SEC Adopts Amendments to Rule 10b-18 Safe Harbor
At its open Commission meeting yesterday, the SEC adopted changes to the Rule 10b-18 safe harbor. Rule 10b-18 provides a safe harbor from certain market manipulation violations under Rule 10b-5 for issuer repurchases of its common stock that meet certain conditions regarding the manner, timing, volume and price of repurchases.
Thanks to Mike Holliday, based on the oral comments made at the meeting, it appears that the changes include:
– elimination of the exclusion of block purchases from the volume limitation of 25% of the average daily trading volume (ADTV) so that block purchases will now have to be included in the 25% test; block purchases will also be included in the ADTV determination. The modifications adopted will provide a limited block purchase exception that would permit one block trade per week (probably of greatest value to small issuers).
– exclusion of repurchases from the safe harbor during the period from the time of public announcement of a merger, acquisition or similar transaction involving a recapitalization until the completion of such transaction. This would appear to expand the present wording which excludes from the safe harbor a purchase made “pursuant to a merger, acquisition, or similar transaction involving a recapitalization.”
– expansion of merger exclusion from the safe harbor, but the SEC said it was also adopting a limited exception (e.g. whatever activity the issuer had during the 3 months prior to announcement of a merger would be permitted after announcement of the merger. In other words, the issuer could mirror the activity during the 3 prior months. It will be necessary to see exactly how this exception is worded in the adopting release.
– adoption of new disclosure requirements that will require a tabular presentation of information on all purchases of any class of registered equity securities by the issuer or any “affiliated purchaser” as defined in Rule 10b-18, whether public or private purchases, and whether or not the purchases were made under the Rule 10b-18 safe harbor conditions. The table and related footnote information are required in Forms 10-Q and 10-K. The purchase information is required to be presented on a monthly basis for each quarter. The 10-K would report information for the fourth quarter. In addition to information about purchases, certain information about publicly announced repurchase plans or programs is required, including whether the issuer still intends to purchase under the plan or program. This latter point on future intent was opposed by some commenters, but it appears it was retained in the new requirements as adopted.
Trust me that the 2004 proxy season will be wild. On top of the changes wrought by the NYSE/Nasdaq new rules regarding shareholder approval of equity comp plans (including the loss of broker non-votes), investors appear ready to cooperate more than ever. And the SEC staff likely will allow shareholder nomination proposals – so long as they reference the SEC’s proposed 14a-11 rule – so that “triggerable” circumstances will exist by the time the SEC adopts some form of shareholder access for 2005.
Last season, similar proposals were deemed excludable by the staff, such as the Citigroup no-action letter (that essentially was part of the motivation for the SEC to embark on this initiative) that the SEC staff has informally indicated is still excludable.
Tommorrow, on a TheCorporateCounsel.net webcast, join Pat McGurn of ISS as he dissects what trends are shaping up for next proxy season. In addition, Professor Charles Elson will spend some time discussing the Breeden report. I will be posting a PowerPoint from Pat sometime in the early afternoon and will link to it here and on the home page. Sign up for a “no-risk” trial to access this timely webcast.
PCAOB Registration of European Auditors
According to AccountingWeb.com, U.S. and European Union regulators are nearing agreement over the controversial matter of European firms registering with the PCAOB. U.S. firms have until tommorrow to register; EU firms have until April 2004.
Last year, E.U. Commissioner of Internal Markets objected to the suggestion that EU firms need to register with the PCAOB, indicating that their own controls are sufficient and a required U.S. registration would subject EU audit firms to “a double regulatory regime which would be excessive, inefficient and disproportionate.” Now, PCAOB Chairman McDonough says that a final agreement was imminent that would require EU firms to “joint register” with their local regulators and the PCAOB.
One open issue is how much information firms will have to provide when registering. In addition, the compromise will require EU legislative changes, so that the EU registration requirements match those of the PCAOB. EU legislation can take up to 18 months – making it unlikely they could occur before the PCAOB registration deadline of April 2004.
At the NACD Annual Conference today, PCAOB Chair William McDonough gave an excellent speech on “Restoring Trust” and explained how the number one topic on the Hill these days is not the Iraq occupation – but rather sheer rage over executive compensation. He noted how many in Congress were asking him if it would be feasible to pass a law regulating compensation.
Much to Chairman McDonough’s credit (my 1st time hearing him and he was simply great!), he recognizes that Congress’ last foray in this area probably played a role in where we have gotten today (i.e. Section 162(m)). However, he believes that companies are not acting fast enough to curb excessive compensation and warns that SOX II could very well happen and that it “would curl your hair.”
In addition, he noted that Wednesday is the deadline for audit firms to register with the Oversight Board, with just under 500 firms registering so far. As it will do every year, the PCAOB has begun investigating the Big 4 and have already moved from checking the “tone at the top” to an examination of individual audits (with next year promising to be more intrusive as the PCAOB grows from its 88 staffers to a much larger agency).
Ira Millstein, the Guru Speaks
The luncheon speaker was Ira Millstein, Senior Partner at Weil Gotshal, who was widely recognized at the NACD conference as the ultimate governance guru. A second edition of his book, “Recurrent Crisis in Corporate Governance” is due out in December (as an aside, Nell Minow was sporting the 3rd edition of her governance book that will be available soon – its a great book).
Ira pointed out that conceptually, two important events have occurred that outweigh the immediate impact of SOX and its related rules. First, he pointed out that the current governance revolution is a global one – not just localized here in the States. Second, he observed that governance has become a political issue – as governance undeniably impacts the company’s economic growth and plays a role in the integrity of our retirement system (i.e. most retirement funds are in equities).
Regarding shareholder access, Ira’s view is that the current system has not performed well – and that access clearly would be better (albeit perhaps not the best solution). Most of all, it would add to the other new incentives that should help ensure that directors are thinking about what they are doing, so that they would “be proud to tell their mother” about the decisions they have made.
At the NASPP conference, David Drake of Georgeson Shareholder and Art Meyers of Palmer & Dodge gave an excellent presentation on the impact of the new rules – and the NASPP might have a reprise of that panel on a special webcast soon. Also note that the Sept/Oct issue of The Corporate Counsel that just hit the streets covers the new shareholder approval rules in detail.
SFAS 123 Transition Deadline Looming
One point well made at the NASPP conference was the upcoming SFAS 123 transition deadline for companies looking to expense their outstanding options under the increasingly popular prospective method. As set forth in SFAS 148 – which amended SFAS 123 and establishes three alternative transition deadlines – the deadline for selecting the prospective method is December 15th.
Under the prospective method, the fair value expensing of options is applied only in the year of grant and subsequently. This initially results in a lower level of option expense in the income statement compared to the other two alternatives – which can make it appear that a company has a trend of increasing option expenses. However, this effect can be offset if the company intends to reduce the aggregate value of future grants – which is the case for many companies.
From Bear Stearns, here is a list of the 350 companies that have adopted – or announced that they intend to adopt – 123 as of early September.
Cert. Denied by Supreme Court in Section 16 Case
On October 14th, the U.S. Supreme Court denied the application for certiorari filed by the defendants (insiders) in Levy v. Sterling Holding Company LLC (Docket No.03-171).
This is the case with the troublesome decisions on Rule 16b-7 and Rule 16b-3. The SEC had filed an amicus brief in the rehearing before the entire Third Circuit arguing that the Court’s interpretation of the SEC rules was incorrect. As you may recall, the Third Circuit did not follow the SEC’s interpretation of the rules. Alan Dye – who was involved in the case – provides an analysis of this important case on Section16.net.
On Wednesday – on a teleconference program on my old website – David Lynn, Chief Counsel of Corp Fin, clarified that Section 404 of is not applicable to Forms 11-K. Section 404, and the SEC’s rules implementing it, requires each issuer that files
periodic reports with the SEC under the Securities Exchange Act of 1934 to (i) establish and maintain a system of internal control over financial reporting, (ii) include in its annual report a report by management on the system of internal controls, and (iii) accompany the report with an attestation report on the system of internal controls.
As noted by Gibson Dunn in a recent client alert, “this guidance addresses a significant question that was left open in the release adopting the Section 404 internal control requirements. Although most employee benefit plans would not have been viewed as “accelerated filers,” and thus would not have been required to comply with the Section 404 rules until filing the Form 11-K report for the fiscal year ending on or after April 15, 2005 (whereas public companies that qualify as “accelerated filers” must comply with the 404 rules for fiscal years ending after June 15, 2004), there was substantial uncertainty as to how the 404 rules would
apply in the context of employee benefit plans. Accordingly, the SEC staff’s interpretation provides reasonable and welcome relief.”
After my blog last night, the SEC posted its no-action response to a request from Microsoft that sought exemptive relief from certain tender offer provisions to conduct its option exchange program. The relief granted includes exemptions from:
– Rule 13e-4(f)(2)(ii) to permit Microsoft to terminate withdrawal rights for tendered options at the end of the Election Period.
– Rule 13e-4(f)(8)(i) to permit Microsoft to exclude certain options and certain option holders from the program.
– Rule 13e-4(f)(8)(ii) to permit Microsoft (i) to pay holders of Multi-year Grant Options less for those options than other options with similar terms, (ii) to pay option holders, who are entitled to a total payment in excess of $20,000, a portion of the payment on a deferred and contingent basis, (iii) to further defer the contingent payment portion due to senior management, and (iv) to calculate the initial payment due to senior management holders in certain foreign jurisdictions with adverse tax regimes based on the relevant increased tax imposed.
In addition, the SEC staff noted that it would not object nor take enforcement action if:
– the pricing structure has a final price that will be neither known nor paid until after the Averaging Period ends.
– the total payment for transferred options is determined after the Election Period and during the Averaging Period (i.e. Rules 13e-4(f)(1)(ii) and 14e-1(b)).
– the total payment for options is determined after the Election Period and pays holders for transferred options (i.e. Rules 13e-4(f)(5) and 14e-1(c)).
Another day of hectic travel, so I borrow liberally from Mike O’Sullivan’s blog to inform you that Microsoft has filed tender offer documents divulging the details of its novel stock option transfer program, which is designed to permit its employees to sell their underwater options to J.P. Morgan.
GMI Study Shows Link Between Good Governance & Financial Performance
GovernanceMetrics International – one of the governance rating services – recently completed a study that demonstrated a positive link between strong governance practices and a company’s financial performance. Among other things, GMI found that overall, average annual total returns are higher as the percentage of independent directors increases.
For TheCorporateCounsel.net subscribers, we have posted an interview with Howard Sherman, the Chief Operating Officer of GMI, on the results of that study and the relationship between corporate governance and a company’s financial performance.
8-Ks and 906 Certifications
I have received a few clarifying questions on what Paula Dubberly stated at the ACCA conference last week regarding the SEC/DOJ joint position on 906 certs (see my10/8 blog). The most common question relates to 8-Ks – its should be noted that the joint position applies to no 8-K, even ones with financial statements.
