Reminiscent of the competing proposal approach that the Commission took a couple of years ago on shareholder access, yesterday the SEC voted to propose several alternative ways of addressing the widespread public nostalgia for the only recently abandoned uptick rule. As noted in the press release announcing the proposals, the SEC proposed either: (1) a market-wide permanent return of the uptick rule or a modified version of the uptick rule; or (2) a security specific circuit breaker approach, which could come in the form of: (i) an outright ban for the rest of the trading day when the price of a security drops precipitously; (ii) imposition of a modified uptick rule on the trading in a security for the rest of the day when there is a significant price decline; or (iii) imposition of an uptick rule on the trading in a security for the rest of the day following a big price drop. Got that? Commissioner Aguilar, Commissioner Parades and Chairman Schapiro each released their opening statements, providing more details.
I think that the competing proposal approach largely reflects the level of complexity and concern about unintended consequences arising with short sale regulation. The Commission has to walk a fine line here when seeking to perhaps reinstate a rule that was abandoned only a few years ago, and at the time based on extensive study and public comment. Much is often made of how different the market is today compared to when the tick test pilot was conducted, but it really seems that the principal differences are between a market trending up and a market trending down and the relatively obvious effects of government-induced panic, plus the attention of the public and Congress to an issue that was once largely relegated to the darker corners of the regulatory landscape.
With all of the pressure for SEC action, it is going to be a difficult task ahead for the Staff to weigh the responses to the over 200 questions included in the proposing release and narrow the field of potential rules down to just one approach. Further, they will have to do so under a new Director of the Division of Trading Markets, as yesterday’s Open Meeting marked Eric Sirri’s last as Director of the Division.
Comments will be due within 60 days of publication in the Federal Register. The roundtable on short selling is tentatively scheduled for May 5.
The “R” Word and Venture Capital Funds
An interesting opinion piece in today’s Wall Street Journal discusses the outrage that has erupted over the notion of having venture capital funds register with the SEC so that information about the funds can be passed on to the Great Systemic Regulator envisioned in the Administration’s recent regulatory reform proposals. As we tend to see time and time again, over-reaction to crises tends to sweep in things that probably don’t need the benefit of regulation or are in fact not systemically dangerous. I think that James Freeman makes a good case for why venture capital, which is vital to our capital-raising system, does not actually pose the sorts of systemic risks that we should all be concerned about.
Now that the “R” word – risk – is thrown around as being something that needs the closest attention from regulators, it is perhaps a good idea to step back and note that it was really the mispricing and mismanagement of risk (in particular with respect to financial instruments and trading strategies), as opposed to the taking of risk itself, which got us into this mess. For technology companies, for instance, who have benefited greatly from the risk tolerance of venture capital investors, every day in business is the riskiest of endeavors, which is typically reflected in their public or private valuations. But we wouldn’t want them – as a result of regulation arising from a financial crisis – to stop taking risk, or to discourage their management from pursuing risky new ideas, or discourage their venture capital backers from taking a flyer on their risky prospects, so long as those risks are all fully disclosed and properly reflected in the price of their securities.
A Bernanke Green Shoot?
For the first time in more than a year, confidence among venture capitalists has inched upward, according to a recent survey of 30 San Francisco Bay Area VC’s. The latest results show a confidence level of 3.03 on a 5-point scale during the first quarter of 2009, up from a 5-year low of 2.77 last quarter. Might a more positive outlook by traditionally optimistic VC’s be one of Ben Bernanke’s “green shoots” of economic recovery? There’s a long way to go yet – there were only 50 IPOs worldwide during the first quarter of 2009, down 80% from the first quarter of 2008. More significantly for venture capital, the first quarter of 2009 marked the second consecutive quarter with no venture-backed IPOs. As Broc noted in the blog towards the end of last year, IPOs are a traditional exit strategy for VCs – until the IPO market opens up, VC’s can’t deliver returns to their investors. So if the uptick in VC confidence is a green shoot, it’s an exceedingly small one – but at least it’s pointing up. Thanks go out to Linda DeMelis for these thoughts.
Earlier this month, PWC published is 13th annual evaluation of private securities class action lawsuits. PWC’s analysis found that federal securities class actions increased for a second year in a row, with the financial services industry unseating high-technology companies for the dubious distinction of most frequently sued. PWC also noted that, perhaps not surprisingly, accounting-related lawsuits declined as a percentage of total filings, while the number of settlements recorded declined to the lowest number this decade. The study also notes that CEOs and CFOs are most frequently named in lawsuits, and that plaintiffs are increasingly targeting Fortune 500 companies (also due to the financial services effect). Given these trends, 2009 could be shaping up to be a high water mark for private securities litigation.
Executive Compensation Litigation Heating Up Too
Kevin LaCroix provides an excellent overview of the latest developments in executive compensation litigation today in The D & O Diary blog. Kevin notes:
“Drawing on popular anger evidenced most recently in the outrage surrounding the AIG bonuses, these most recent compensation-related cases could represent an even more pronounced litigation threat than prior lawsuits over pay. The same forces driving the litigation have also produced a variety of other corporate and social responses, some of which may or may not fully serve the purposes of overall social utility.
Among other recently filed lawsuits involving executive compensation is the derivative complaint filed on April 1, 2009 in California (Los Angeles County) Superior Court against the current AIG CEO Edward Liddy and several other AIG directors and officers. The complaint (copy here) among other things alleges that ‘there was no rational business purpose or justification for these lucrative additional payments, particularly given AIG’s deteriorating financial condition and dismal financial performance,’ and described Liddy’s explanation of the bonus payments as ‘outrageous on its face’ and ‘absurd.’ The complaint seeks to recover damages for corporate waste, breach of fiduciary duty, abuse of control and unjust enrichment.
The bonuses paid to Merrill Lynch employees at year end just prior to the consummation of the company’s merger with Bank of America also features prominently in the shareholders’ litigation filed against Bank of America earlier this year, following the revelation of Merrill’s massive and previously unreported losses.”
The D&O Diary blog also notes the outcome in the recent Citigroup case in Delaware involving Charles O. Prince’s $68 million exit package, discussed in Broc’s blog on the topic from last month.
While shareholder-initiated litigation is taking off in the current anger-fueled environment, it seems that now may be the time when we will also see more SEC Enforcement focus on executive compensation. The “honeymoon” with the 2006 compensation rules is long over, and thus now may be the time when we will start to see Enforcement bring some high profile cases to demonstrate attention to the issue. A couple of roadblocks that could stand in the Enforcement Division’s way in bringing these sorts of cases is that the principles-based aspects of the rules might make it more difficult, in some circumstances, to bring fraud or reporting violation cases, given that the lack of bright lines gives companies a significant degree of latitude in deciding what is and is not material. Further, the heightened sensitivity to compensation issues, more engagement by compensation committees, and the voluminous disclosure that is now required may reduce the ability to hide or mischaracterize compensation that could give rise to Enforcement’s interest. Unlike shareholders, the SEC is limited to disclosure violations and can’t pursue claims such as corporate waste.
Goldman CEO’s Remarks on Wall Street Pay Reform
Earlier this week, at the same Council of Institutional Investors meeting where Chairman Schapiro laid out the SEC’s regulatory agenda, Goldman Sachs CEO Lloyd Blankfein called for changes to the compensation model on Wall Street. As noted in this story appearing in the LA Times, Blankfein faced some angry protestors while delivering his address – certainly a sign of these times of extraordinary public anger.
Blankfein noted that compensation decisions must be made in the context a multi-year evaluation of risk to get a full picture of an individual’s decisions, and that performance should not be judged in isolation. Among the specific guidelines that he suggested are:
1. Compensation should include salary and deferred compensation, which is “appropriately discretionary” because it is based on performance over the year.
2. The proportion of equity comprising and individual’s compensation should increase significantly as total compensation increases.
3. Senior employees should get most of their compensation in deferred equity, while junior people should get most of their compensation in cash.
4. Individual performance should be evaluated over time to avoid excessive risk taking and to allow for a clawback effect.
5. Equity awards should be subject to future delivery and/or deferred exercise over at least a three-year period.
6. Senior executive officers should retain the bulk of their equity until they retire, and equity should not be accelerated once someone leaves the firm.
SEC Chairman Mary Schapiro laid out the agency’s upcoming regulatory agenda in a speech yesterday at the Spring Meeting of the Council of Institutional Investors. Now a few months into her new role, Chairman Schapiro has a vision for the SEC’s top priorities over the next several months, which will, not surprisingly, involve a lot of new rules for public companies. These rules will build on some common themes, including director accountability and enhanced disclosure about the role of risk in corporate decision-making.
The upcoming rulemaking agenda looks like this:
1. New rules designed to limit short sales in a down market will be considered at an open meeting tomorrow, followed by a roundtable.
2. In May, the SEC will consider a proxy access proposal, and in the process the Commission is considering the 2003 and 2007 proposals with “fresh eyes,” as well as proposed Delaware law changes.
3. In June, the SEC will consider whether to propose rules requiring enhanced disclosure about the experience, qualifications and skills of director nominees.
4. The SEC will also consider whether boards should disclose the reasons for selecting a particular leadership structure, such as an independent chair, a non-independent chair, or a combined CEO/chair.
5. Rule proposals are being developed to address how a company and its board of directors manage risks, both generally and in the context of compensation.
6. The SEC will consider new rules relating to compensation. The rules would be directed at making sure that shareholders fully understand how compensation structures and practices drive an executive’s risk taking. Further, the Commission will consider whether greater disclosure is needed about a company’s overall compensation approach – beyond decisions with respect to the highest paid officers – as well as enhanced disclosure about compensation consultant conflicts of interest.
Not mentioned in the speech, but certainly looming on the horizon, is the proposed change to the NYSE’s Rule 452, for which the comment period has now closed.
In addition to the proposals that are oriented toward public companies, Chairman Schapiro indicated the SEC is considering a number of other reform measures (some of which will require legislation) in the financial services area, including issues with respect to custody, the respective roles of brokers-dealers and investment advisers, registering hedge fund advisers (and potentially the hedge funds themselves), more disclosure about credit rating agencies, oversight of the credit default swap market, enhanced standards for money market funds, municipal securities disclosure and disclosure about asset-backed securities.
With these significant changes to executive compensation disclosure coming soon – and no doubt in time for next year’s proxy season – be sure to sign up now for the “4th Annual Proxy Disclosure Conference” and the “6th Annual Executive Compensation Conference.” The conferences will be live on November 9-10 in San Francisco and via webcast. You still have a few more weeks (until April 24th) to get “half off” early bird rates.
Blaming Mutual Funds for Pay Excesses
In this latest report sponsored by AFSCME, The Corporate Library and the Shareowner Education Network, the relationship between mutual fund voting patterns and excessive executive compensation is examined in detail. Dramatically named “Compensation Accomplices: Mutual Funds and the Overpaid American CEO,” the report outlines how, in 2007-2008, many mutual funds voted in favor of management proposals increasing executive compensation packages, while voting against shareholder proposals that seek to align pay with performance. I don’t know about you, but it doesn’t exactly knock me out of my chair with surprise to find out that mutual funds often vote with management. The report, however, notes that the level of support seems to continue unabated despite the level of public outrage over executive compensation.
The study does note a contrary trend that I think everyone has probably noticed in the past couple of years – mutual funds seem to be increasingly willing to withhold support or vote against directors serving on compensation committees of companies where pay practices are perceived as subpar.
One limiting aspect of the study is that the data only goes through June 2008, so the full impact of the recent “torches and pitchforks” attitude toward compensation is not fully reflected.
Raising Equity Capital in a Turbulent Market
We have posted the transcript for the recent webcast: “Raising Equity Capital in a Turbulent Market.” Also be sure to check out the excellent course materials posted for this webcast.
By all accounts, last week’s G-20 summit seemed to promote quite a bit of agreement on ways to move forward to turn around the global economy and reshape the financial regulatory framework. In many ways, the G-20 meeting served as an important “deadline” for member countries to get their regulatory reform proposals lined up so that they could be discussed with other world leaders. Last Thursday, the G-20 leaders issued this communiqué outlining, among other things, the key principles under which changes to financial regulation will be implemented. The leaders called for greater consistency and systematic cooperation among countries, which will be implemented through, among other initiatives:
– a newly established Financial Stability Board, as a stronger successor to the Financial Stability Forum (FSF), which will seek to provide early warnings of macroeconomic and financial risks;
– reshaped regulatory systems that will allow authorities to identify and take account of macro-prudential risks;
– extended regulation and oversight over systemically important financial institutions, instruments and markets, including systemically important hedge funds;
– standards for internationally consistent, high quality and sufficient bank capital (once the recovery is assured);
– high quality global audit standards, including improved standards for “valuation and provisioning;”
– an end to bank secrecy and tax havens; and
– oversight over credit rating agencies.
Perhaps the most interesting focus of the G-20 for me was their pledge to deal with compensation issues at financial institutions. In this Declaration, which provides more details on the broad G-20 principles, the leaders appeared to recognize compensation issues as a global problem and endorsed FSF principles on dealing with compensation at significant financial institutions. The principles require that:
1. Boards of directors of firms play an active role in the design, operation and evaluation of compensation schemes;
2. Compensation arrangements, including bonuses, properly reflect risk, and that the timing of compensation payments be sensitive to the time horizon of risks (i.e., payments should not be made in the short term when the risks occur over the long term); and
3. Firms publicly disclose clear, comprehensive and timely information about compensation, so that stakeholders (including shareholders) are timely informed and can “exercise effective oversight.”
The EU’s Role in Financial Regulation
In anticipation of the G-20 meeting, the European Council rolled out a plan to significantly expand the European Union’s role in regulating the financial system across Europe. As discussed in this memo from Cleary Gottlieb, a new European financial supervisory body could be up and running by the end of 2010, helping to coordinate the regulatory efforts of member states. Further, the EU’s plans call for legislative proposals that will help fill gaps in the regulatory structure and create a framework for regulating retail financial services. Echoing efforts in the US, the EU will direct efforts toward regulating hedge funds and credit rating agencies, revisiting capital requirements, addressing compensation issues and providing for centralized clearing of derivatives. All of these efforts appear to be on a very fast track, with further recommendations on a number of these principles expected over the next couple of months.
Skirting the EESA/ARRA Exec Comp Limitations?
This Washington Post article from over the weekend notes how the Administration has been “engineering its new bailout initiatives,” so that participating firms can avoid limitations imposed on executive compensation contemplated by the Emergency Economic Stabilization Act of 2008 and the American Recovery and Reinvestment Act of 2009. The article notes that a number of programs through which bailout funds are distributed are using special entities, so that funds are provided only indirectly from the government. Also noted is the Obama Administration’s decision to reverse the Bush Administration’s efforts to apply the executive pay limits to the originators of the assets participating in the TALF program (which was finally launched at the beginning of March).
Efforts to craft programs around the executive compensation limits reflect what appears to me to be a legitimate concern that the imposition of the pay limits may, in some circumstances, undermine bailout efforts by discouraging participation. While executive pay reform is important and we can’t ignore the level of public anger over the topic, it seems that there should be some flexibility in applying the limitations outside of a direct investment context. My hope is that Congress doesn’t try to reverse these decisions for the purpose of achieving short-term political gains, because we are still in a time where some level of regulatory flexibility is needed on these issues.
Yesterday, the FASB conducted a meeting that mainly focused on changing fair market value accounting and voted to issue three final Staff Positions (FSPs) dealing with fair value for inactive markets; other-than-temporary-impairment (OTTI), and changing annual disclosures of fair value to quarterly. Here’s the FASB’s summary of what happened at the meeting.
Given that I’m heading out on vacation, I’m providing a list of analyses by others on this big development:
We have posted the transcript of our popular DealLawyers.com webcast: “The SEC Staff on M&A.”
Boards Today: The Spencer Stuart Board Index
A few months ago, Spencer Stuart issued this study of S&P 500 companies that shows how board composition and structure have changed over the past decade. Among the findings are:
– Shorter terms – On average, boards are older and directors serve shorter terms than 10 years ago. There are also fewer active CEOs and more first-time directors joining boards.
– Younger directors – A total of 26% of boards have an average age of 64 or older, up from 14% 10 years ago, even though 74% now have mandatory retirement ages.
– One-year terms – As of 2008, 66% of boards have one-year terms, up from 40 percent just five years ago and 39% 10 years ago.
– More board independence – In 1998, the CEO was the only insider on 23% of boards. Today the CEO is the only insider on 44%. A total of 36% of boards reported lead or presiding directors in 2003, compared with 95% today.
· Average board size convergence – Very large and very small boards are less common. Nearly 75% of boards have between nine and 13 directors, up from 66% in 1998. A decade ago, 23% of boards had 14 or more directors; today only 11% do.
Our April Eminders is Posted!
We have posted the April issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
For each of the seven years I’ve been on this job, I’ve conducted an average of one survey on some aspect of insider trading policies (here is a list of them from our “Blackout Periods/Insider Trading” Practice Area). Recently, we wrapped up our latest one – this “Quick Survey” related to hedging and other trading prohibitions in insider trading policies. Below are the results:
1. Our company’s insider trading policy prohibits insiders from trading in any of the following:
– Exchange-traded options – 41.1%
– Hedging/monetization transactions (e.g., zero cost collars, forward sale contracts) – 36.7%
– Puts and calls – 45.6%
– Margin accounts – 25.6%
– Pledges – 23.3%
– None of the above – 10.0%
– We don’t have an insider trading policy – 1.1%
2. Our company discourages – but still permits – the following:
– Exchange-traded options – 18.2%
– Hedging/monetization transactions (e.g., zero cost collars, forward sale contracts) – 25.0%
– Puts and calls – 13.6%
– Margin accounts – 47.7%
– Pledges – 52.3%
– None of the above – 29.6%
Please take a moment to participate in our new “Quick Survey on D&O Questionnaires.”
Shelley Parratt: Longest-Serving Interim Corp Fin Director?
Although my memory is limited to the modern era, I believe Shelley Parratt is the longest-serving interim Corp Fin Director in SEC history with three months under her belt so far. Marty Dunn served as an interim for a few weeks before John White started – and Meredith Cross had a brief turn before Brian Lane moved over from Chairman Levitt’s office.
In fact, it’s not uncommon that there be no period of time between one Director leaving and another starting – particularly when the new Director is being promoted from within the building. For example, when John Huber left the SEC in ’86, Linda Quinn started that afternoon.
Not that any of this matters at all. Just some curious facts before I kick off my spring break vacation. I imagine we’ll see an announcement about a new permanent Corp Fin Director in the near future.
NYSE Clarifies Shareholder Approval Requirement for Convertible Debt Exchange Offers
Below is an excerpt from this recent Gibson Dunn memo (note this reflects an update from when blog was originally posted):
In the context of an exchange offer of new convertible debt for previously outstanding convertible debt, the NYSE staff has taken the position that the 20% Test only applies to any increase in the number of shares issuable under the new debt as compared to the old debt; the calculation is not made on the total number of shares issuable under the new debt. In other words, the NYSE only looks at the net increase in the number of shares potentially issuable upon conversion as a result of the exchange.
The NYSE staff had previously provided guidance that, when calculating whether an issuance of securities meets the 20% Test, the NYSE would take into account the number of shares issuable upon the original convertible debt, in addition to the actual amount outstanding, for purposes of calculating the number of shares outstanding on the date of measurement. The NYSE, however, has since corrected that guidance and has advised us that, pursuant to NYSE Rule 312.04, when calculating whether the 20% limit has been reached, the net increase in shares issuable upon conversion (the numerator in the calculation) will be compared only to the number of shares actually outstanding on the date of the listing application without giving effect to the number of shares then issuable upon conversion of the old convertible debt.
Yesterday, the Chicago Tribune ran this article about a lawsuit brought against McDonald’s by a former Senior Director of Compensation who balked against signing a subcertification related to the company’s disclosure of executive compensation. The company denies the allegations. I’m pretty sure this is the first whistleblower suit related to executive compensation disclosure.
The complaint was filed in US District Court for Northern Illinois – and includes allegations of (as noted in this blog):
– Setting up a reimbursement/repayment scheme to avoid disclosing golf club memberships for the regional President stationed in Hong Kong;
– Mislabeling the outgoing CEO as a “transitional officer” so he could keep his health and other benefits, and so the millions paid to him after his last day of work for McDonald’s could be called salary and incentive pay, rather than severance; and
– Implementing a shareholder-mandated 2.99X cap on executive severance agreements with loopholes large enough to render the cap meaningless.
We’ll be closely following this development since the topic is “near and dear” to many of our members…
Are Credit Default Swaps Enforceable?
In a recent presentation, Brink Dickerson of Troutman Sanders questioned whether credit default swaps are enforceable, at least in certain circumstances. Hedge funds, large banks and other financial institutions routinely control, either as a result of holding the underlying security or under contractual arrangements, the voting rights with respect to bonds and other indebtedness. At the same time, however, these institutions have hedged their economic interest in the CDS market, in some cases so much so that they are “over-hedged” and would benefit more from the failure of the underlying business than they do from its survival.
This in turn can lead to their opposing – if not blocking – otherwise rational consent solicitations, exchange offers and other restructurings. Brink speculated that to the extent that an institution has an over hedged position that leads to an irrational action as a holder (or former holder) of indebtedness, the underlying CDS may be void (or, if misused, voidable) as a matter of public policy (see Restatement Second of Contracts § 178). He also speculated on whether the misuse of an over hedged position might lead to liability.
The law is not there yet on this issue, but the extremeness of the facts in some of the current restructurings – where in one case the CDS positions were a substantial multiple of the outstanding indebtedness – could lead to the courts striking out in a new direction. Professors Henry Hu and Bernard Black have written widely on this and related issues – which they call “debt decoupling” and “equity decoupling” – and this clearly is a topic that would get significant focus should a major company fail just because of irrational actions by a holder (or former holder).
Help Me! Researching Fake SEC Filings
On footnoted.org, Michelle Leder recently wrote about a fake Form 8-K purportedly filed by a penny stock company. That reminded me of a fake Form S-1 (or Form SB-2) filed a few years back that listed a bunch of celebrities as officers and it maybe even included the US President. I erroneously thought I blogged about it – but now I can’t find any mention of it on the Web.
Does anyone remember it too? And if so, do you recall the name? Please help me prove I’m not losing my marbles and jog my memory. It’s not this amended Form SB-2 filed by Toks. Although that filing included a ton of lies (and resulted in a rare stop order from the SEC), it lists the fraudster as the sole officer – so that’s not the one I’m thinking of…
Speaking of “fake” on April Fools’ Day, Michelle reminded me yesterday of the SEC’s own bogus press release from ’07. Although that fake release was never posted on the SEC’s site (it was just sent to reporters), it was mentioned in our blog and captured verbatim by the Financial Times.
We just posted the registration form for our popular conferences – “Tackling Your 2010 Compensation Disclosures: The 4th Annual Proxy Disclosure Conference” & “6th Annual Executive Compensation Conference” – to be held November 9-10th in San Francisco and via Live Nationwide Video Webcast. Here is the agenda for the Proxy Disclosure Conference (we’ll be posting the agenda for the Executive Compensation Conference in the near future).
Special “Half-Off” Early Bird Rates – Act by April 24th: We know that many of you are hurting in ways that we all never dreamed of – and going to a Conference is the last thing on your mind. But with huge changes afoot for executive compensation and the related disclosures, we are doing our part to help you address all these critical changes—and avoid costly pitfalls—by offering a “half-off” early bird discount rate so that you can attend these critical conferences (both of the Conferences are bundled together with a single price). So register by April 24th to obtain 50% off.
Rolling In: Rule 452 Comments
With comments due last Friday on the NYSE’s broker non-vote proposal as noted in this blog, below are links to comment letters submitted by notable groups so far (here is a link to all the comment letters):
There are a surprising number of comment letters submitted by companies, including one from GM’s now-former CEO Wagoner submitted Friday. I guess they realize the significance of this proposal and have overcome their traditional reluctance to voice an opinion directly (as opposed to through an industry group).
In terms of analysis of voting returns, this comment letter from Broadridge covers how broker non-votes impacted shareholder meetings during 2007.
The Latest Proxy Season Developments
If you haven’t signed up to get our new “Proxy Season Blog” pushed out to you, here are a few of the items you’ve missed in the last week:
A few weeks back, Moody’s Investor Service published its list called the “Bottom Rung,” which represents the roughly 20% of the companies that it tracks that are in most danger of defaulting on their debt. As noted in this Wall Street Journal article, Moody’s is estimating that approximately 45% of the Bottom Rung companies will default in the next year, and the number of companies falling into this category is rapidly increasing. Moody’s has been separately calling out these bottom tier credits for the last several months, and plans to update the Bottom Rung list on a monthly basis.
What are issuers doing that find themselves on the Bottom Rung list? Based on the WSJ article, Eastman Kodak came out swinging, noting in an e-mail statement that “Any speculation, however informed, suggesting that Kodak is less than financially sound, is irresponsible.” Similarly, Univision issued a statement stating that it “has more than ample liquidity to operate the business in the current environment.” But other companies contacted declined to comment, or didn’t respond, which after all is probably for the best.
I don’t think that a Bottom Rung designation necessarily changes anything that these companies are or should be disclosing in their SEC filings. Item 10(c) of Regulation S-K does not mandate disclosure of security ratings, but rather calls for additional disclosure concerning ratings and changes in ratings when a company voluntarily elects to include any security rating disclosure. (See our summary of the topic in the “Credit Ratings” Practice Area.) Many companies these days will include in their MD&A the actual ratings from the big rating agencies, along with disclosure of the rating agencies’ views that are expressed in addition to the ratings themselves. I would say that this practice is not ubiquitous, however, in that some companies may still resist including the rating information with a view that it is otherwise available to investors and can be difficult going forward to keep up to date.
In the SEC’s credit rating proposals from last summer, which sought to eliminate credit rating references from the SEC’s rules, the Commission proposed to keep this voluntary disclosure scheme, but solicited comment on whether that approach should be reconsidered in favor of specified mandatory disclosure. The SEC has not moved forward on those proposals, and it is unclear whether they will be revisited.
What’s Left to Do on Credit Ratings?
Credit ratings still remain at the forefront of the SEC’s agenda, as Chairman Schapiro noted in her testimony last week before the Senate Committee on Banking, Housing and Urban Affairs. Proposals are currently outstanding (in addition to the proposals referenced above) to require NRSROs (and possibly subscriber-based ratings services) to disclose ratings actions histories for all credit ratings issued on or after June 26, 2007 at the request of the obligor being rated or the issuer, underwriter or sponsor of the security being rated, no later than 12 months after ratings action is taken, and in an XBRL format.
The SEC also re-proposed rule changes that would make it a prohibited conflict of interest for an NRSRO to rate a structured finance product whose rating is being paid for by the product’s issuer, sponsor or underwriter, unless information about the product provided to the NRSRO to determine and monitor the rating is made available to the NRSROs not retained to issue a credit rating. In addition, the re-proposed rule changes would amend Regulation FD to permit disclosure of material non-public information to NRSROs, whether or not the NRSROs make their ratings publicly available.
Further, a roundtable is schedule for April 15 to examine the SEC’s oversight of credit rating agencies. As Chairman Schapiro mentioned in her testimony, further reforms may be considered based on what is discussed at the roundtable.
SEC IG Focuses on Senior Executive Officer Bonuses
Last Friday, the Office of Inspector General released a report on its 2008 Audit of Sensitive Payments. “Sensitive payments” are described as things such as “executive compensation, travel, official entertainment funds, unvouchered expenditures, consulting services, speaking honoraria and gifts, an executive perquisites.” On the executive compensation front, the SEC’s Inspector General did not find any fraud or payments that went over the established limits or budgeted amounts, but did question the lack of justification for seemingly large merit pay increases and bonuses for some SEC executives who worked directly for the Chairman.
As noted on page 10 of the report, the seven SEC senior officers studied who worked directly for former Chairman Cox received merit pay increases ranging from $24,657 to $65,082 for the performance year ending September 30, 2007 and bonuses of $20,000 each. The SEC’s Executive Director noted in his response to the report that these merit increases were unique and unlikely to recur, arising essentially as “catch-up” payments when then-Chairman Cox lifted a cap on the salaries of his direct reports, which had kept them all in line with his own salary of $152,000.
Suffice it to say that as a non-executive SEC Staffer, you are unlikely to see those sorts of increases or bonuses over the course of your career, much less in one year. It is perhaps most notable that the IG had the same question that many Corp Fin Staffers have when reviewing CD&As: “Where’s the analysis?”
Yesterday marked what I think was the big kick-off of several months of debate about the future shape of financial regulation. Treasury Secretary Geithner outlined the Administration’s framework in testimony before the House Committee on Financial Services and, as noted in this Treasury Department outline, yesterday’s remarks focused particularly on addressing systemic risk.
Not surprisingly, the Administration’s proposals echo much of the conceptual framework that has been floated over the last several months by some legislators, academics and groups such as the Group of Thirty. In particular, the four focal points of the regulatory reform are: (1) addressing systemic risk; (2) protecting investors and consumers; (3) eliminating regulatory gaps; and (4) fostering international coordination. The Administration’s systemic risk proposals contemplate one “independent” regulator who is responsible for overseeing “systemically important firms” (i.e., too big to fail firms) as well as the payment and settlement systems. Systemically important firms would be subject to heightened capital requirements, strict liquidity, counterparty and credit risk management requirements and would be subject to an FDIC-like “corrective action regime.” These special firms could be any type of financial business: banks, brokers, insurance companies, etc.
The SEC figures prominently in the proposed systemic risk efforts, not as the systemic risk regulator of course but rather as the regulator of hedge funds and money market funds. The Administration envisions that advisers of hedge funds meeting as yet unspecified size requirements would be compelled to register with the SEC, and the funds would be subject to mandatory disclosure and reporting requirements, with the details of their reports to be shared with the systemic risk regulator. The proposals also call on the SEC to “strengthen the regulatory framework” around money market funds to make them less susceptible to a run on the funds and to reduce the credit risk and liquidity risk profile.
It is not clear from the proposals what role the SEC would play in a proposed new regulation of credit default swaps and OTC derivatives. The Administration calls for a “strong regulatory and supervisory regime” over OTC derivative markets, focused on central clearing of standardized OTC derivatives, encouragement of more exchange traded instruments, mandated standards for non-standardized contracts, transparency around trading volumes and positions, and robust eligibility requirements for market participants.
Chairman Schapiro’s Remarks on the SEC’s Role
At the same time the Treasury Secretary was outlining the regulatory reform proposals in the House committee room, SEC Chairman Schapiro was at a hearing before the Senate Committee on Banking, Housing and Urban Affairs focused on the regulation of the securities markets. In her testimony, Chairman Schapiro called for maintaining the independence of a capital markets regulator, consistent with preserving the Commission’s role as the investor’s advocate. The Chairman noted that, as an independent capital markets regulator, the SEC would be integral to dealing with the overarching concerns about systemic risks and serve to help the systemic risk regulator in evaluating risks. It seems clear from this testimony that, as the battle lines are being drawn, the SEC is going to fight to preserve its independence within the overall financial regulatory structure.
The Views of the Former SEC Chairmen
Among the many folks testifying at the Senate hearing yesterday were former SEC Chairmen Richard Breeden and Arthur Levitt. Breeden and Levitt both supported Chairman Schapiro’s call for maintaining a strong SEC as a separate capital markets regulator – and not subsuming the agency into some larger financial regulator. In his testimony, Levitt stated:
“The proper role of a securities regulator is to be the guardian of capital markets. There is an inherent tension at times between securities regulators and banking supervisors. That tension is to be expected and even desired. But under no circumstance should the securities regulator be subsumed – if your goal is to restore investor confidence, you must embolden those who protect capital markets from abuse. You must fund them appropriately, give them the legal tools they need to protect investors, and, most of all, hold them accountable, so that they enforce the laws you write.”
Breeden’s testimony called for merging the SEC, CFTC and PCAOB into a single regulator charged with overseeing trading in securities, futures, commodities and hybrid instruments. In this role Breeden would envision that the combined agency would also set disclosure standards for issuers and the related accounting and auditing standards.
Levitt didn’t mince words on his views about the SEC in an interview with the Washington Times, noting in this article that “The SEC has been grievously hurt over the past eight years” and that “It’s lost its best people. It’s been demoralized. It’s been humiliated [to the] point it is no longer the pride of government agencies.” As for the Congress’s oversight of the SEC, Levitt said it “is a function of perfectly terrible oversight of the SEC on the part of Congress. It’s neither a Democratic nor a Republican issue. It’s a national disgrace.”
