Yesterday, the Corp Fin Staff updated the Exchange Act Rules CDIs to include interpretations of Exchange Act Rule 10b5-1. Rule 10b5-1 interpretations had not been included in the Exchange Act Rules CDIs back when they were first published in September 2008, and were last addressed in the Fourth Supplement to the Manual of Publicly Available Interpretations from May 2001.
The new Exchange Act Rules CDIs largely repeat the Rule 10b5-1 interpretations from the Fourth Supplement without substantive change. There are, however, a few revised or new interpretations of note. In CDI 120.19 – which deals with the question of whether cancelling one or more plan transactions affects the availability of the affirmative defense in Rule 10b5-1(c) – the Staff notes that if a new contract, instruction or plan is put in place after the termination of a prior plan, then you would have to look at all of the facts and circumstances, including the period of time between termination of the old plan and establishment of the new plan, to determine whether a plan was established “in good faith and not as part of a plan or scheme to evade.” In order to address this concern, it has become relatively common to impose a significant waiting period before a new plan can be adopted (i.e., six months), as well as a cooling off period (i.e., 30 days) before any sales are made following a plan termination.
In CDI 120.20, the Staff notes that the Rule 10b5-1(c) affirmative defense is not available when a person establishes a 10b5-1 plan while aware of material nonpublic information but delays any plan transactions until after the material nonpublic information is made public. Further, CDI 220.01 provides guidance on how a 10b5-1 plan can be transferred to a new broker when the original broker goes out of business (something to think about these days), while CDI 220.02 indicates that an issuer contemplating a repurchase plan relying on Rule 10b5-1 and 10b-18 could not structure the plan so that the amount to be repurchased by the broker under the plan could be automatically reduced by publicly disclosed block purchases, given the potential for the issuer to effectively modify the plan through the block purchases.
Even though the Rule 10b5-1 CDIs don’t necessarily break new ground, it is a good time now to go back and review Rule 10b5-1 policies (or adopt such policies if none are in place). Some very useful resources are posted in our Rule 10b5-1 Practice Area. To date, we have not heard of any significant Rule 10b5-1 developments from the Division of Enforcement, but it is likely some of the cases that the Division began looking at a couple of years ago remain ongoing.
FASB Takes Quick Action on Fair Value and OTTI
Last week, the FASB took action to address fair value criticisms by issuing proposed FSP FAS 157-e, Determining Whether a Market is Not Active and a Transaction is Not Distressed, which clarifies when an issuer is dealing with an “inactive market” and a “distressed sale” under fair value standards. The FASB also released proposed FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, which would revise guidance on determining other-than-temporary impairments. As noted in this Morrison & Foerster memo, concern has already been expressed as to whether the FASB’s actions on these standards have gone far enough. The guidance is subject to a 15-day comment period and the FASB expects to finalize the guidance at its April 2 board meeting.
In testimony yesterday before the House Financial Services Committee, SEC Acting Chief Accountant Jim Kroeker commended the FASB for its quick action and called for guidance to be in place for the first quarter.
Earlier this week, the FASB and the IASB announced that, in order to help address issues arising from the financial crisis, “the two boards have agreed to work jointly and expeditiously towards common standards that deal with off balance sheet activity and the accounting for financial instruments. They will also work towards analysing loan loss accounting within the financial instruments project.”
A Washington Tradition Goes Nationwide
One of the more interesting (or perhaps odd is the better word) White House traditions is the annual Easter egg roll on the South Lawn. This tradition dates back to 1878, and the current financial crisis is by no means going to stop the eggs from rolling this year. In fact, the White House is taking steps to make the egg roll more open to the general public, by distributing tickets online to the nation rather than in person the weekend before the event. If you are interested in rolling some eggs on Monday, April 13 you can try to sign up today for tickets.
Nasdaq has filed with the SEC to extend the ongoing suspension of the bid price/market value of publicly held shares requirements until July 19, 2009. In support of the continued suspension, Nasdaq notes that market conditions have not improved since the suspension began last October, and that both the number of securities trading below $1 and the number of securities trading between $1 and $2 on Nasdaq has increased since the initial suspension. This is the second extension of the suspension, which would have otherwise expired on April 19, 2009. The NYSE recently filed with the SEC, on an immediately effective basis, a suspension of its $1 price requirement and an extension of the lowering of the market captialization requirement, lasting until June 30, 2009.
Nasdaq also recently re-filed its new listing rule book, which is now scheduled to become effective on April 13, 2009. In this project, the Nasdaq has sought to make the listed company rules more transparent and clear, without making substantive changes to the requirements.
More Extension News: The FDIC’s TLGP Debt Guarantee Program Extended
Just in case you are losing track of the alphabet soup of government programs, TLGP is the FDIC’s Temporary Liquidity Guarantee Program. The Debt Guarantee Program component of TLGP was set to expire at the end of June, but last week the FDIC board adopted an interim rule extending the program until October 31, 2009. Further, for any debt issued on or after April 1, the TLGP guarantee will extend until December 31, 2012. The interim rule also adopts new surcharges on guaranteed debt issuances that have a maturity of one year or more and are issued on or after April 1, 2009.
On the Way: Romeo & Dye Section 16 Deskbook
Peter Romeo and Alan Dye just completed the 2009 edition of the Section 16 Deskbook and it’s now at the printers. In addition, they are in the process of wrapping up their latest version of the popular “Forms & Filings Handbook,” with numerous new – and critical – sample forms included. To receive these critical Section 16 resources, try a ’09 no-risk trial to the “Section 16 Annual Service” (or renew).
To the roaring approval of the stock market (even though details are fairly scarce and it’s been known for a week that this was coming), the Treasury Department provided more details about it’s plans to bailout banks and handle their toxic assets by providing a fact sheet and white paper about its new “Public-Private Partnership Investment Program.”
Boiling down the PPIP, it will use a combination of public and private capital, managed by private sector managers to purchase toxic (now known as “legacy”) assets from banks and investors. The PPIP proposes to use $75-100 billion of TARP funding along with with private investor capital and FDIC-guaranteed debt to generate an initial $500 billion in purchasing power, which could grow to $1 trillion over time.
The PPIP has multiple components, including a Legacy Loans Program and a Legacy Securities Program. Since more details are needed, the government will need to create regulations to get these programs off the ground. We are posting memos in our “Credit Crunch” Practice Area.
SEC Commissioners Speak Out on Enforcement Policy
Last week, in this speech, Commissioner Luis Aguilar predicted the SEC will impose more fines on companies going forward – and expressed a desire to rescind the SEC’s policy statement that guides the Enforcement Division on how to determine financial penalties because he believes it doesn’t deter misconduct. As you may recall, the SEC issued the policy statement back in early 2006 amid a fight among the five Commissioners that existed at the time over the level of fines levied against public companies.
Commissioner Troy Paredes also got into the act, delivering this speech regarding the Enforcement Division, its jurisdiction and available resources – and the methods used to select cases for investigation, among other topics.
Finally, Commissioner Elise Walter gave this testimony to Congress about the SEC’s enforcement efforts in response to the financial crisis. She noted that possible areas of investigations include possible insider trading at subprime lenders; misleading, inadequate or non-existent disclosures regarding subprime exposure by investment banks; abusive short selling; and improper valuations of illiquid assets.
How Boards Should Manage Risk
We have posted the transcript from our recent webcast: “How Boards Should Manage Risk.”
Just a few days after I weighed in on the problems caused by naked short selling, the SEC’s Inspector General issued a report noting that the SEC received 5,000 complaints over a year and a half period about aggressive short selling (of which, 2.5% of those were investigated) and the SEC’s failure to bring any enforcement cases in this area (and Congress may consider legislation restricting short selling ahead of the SEC adopting a new uptick rule). Here is a Bloomberg article.
According to this WSJ article: “In a written response, the SEC’s enforcement staff played down the likelihood of naked short-selling abuses. It noted that most trades settle on time. The SEC staff said the agency needs to “intelligently leverage” its resources and a large number of complaints provide “no support for the allegations.” The SEC said it is looking to improve its handling of tips.”
While I agree that a large number of complaints doesn’t prove anything – and the Staff certainly needs more resources to do it’s job – I sure hope the SEC is taking the problems caused by naked shorts seriously and realize that adopting an uptick rule alone doesn’t do the trick. I strongly urge folks to read Carl Hagberg’s clear explanation of how naked short selling damages the markets and his suggestion for an easy fix.
Another Ten Cents: The Problems of Share Lending
Thanks to the many members who sent me emails last week, agreeing with the sentiments in my naked short selling blog. Below is one of those emails; this one highlights another issue that the SEC should consider:
Thanks for publishing the blog on naked short selling. I completely agree that rules against failing to deliver should be more aggressively enforced. I have had some clients in the past that have come under attacks from shorts, with their issues being listed on the “Reg SHO Threshold List” for months, while being unable to get any regulatory attention through the SEC or FINRA.
Another – admittedly less pressing – issue that needs to be considered is changing the rules governing when brokers are allowed to lend shares held in their accounts. As I understand the current system, brokers can lend shares unless the account holder has specifically asked that this not be allowed. I imagine most people who take a long position in a stock are under the belief that once they’ve bought the shares, they’ve essentially taken those shares out of circulation, which would normally be expected to reduce supply and help push the price up.
By allowing brokerages to lend shares without affirmative consent (e.g., though an “opt in”), these shares remain available to be traded many times over without the consent or even knowledge of the “holder.” By requiring affirmative consent, brokerage firms may also end up choosing to share part of their stock loan revenues with the account holders, which may provide for some modest hedge and result in better pricing for share lending and more accurate price information in the market for short selling in general.
Webcast: “Compensation Arrangements in a Down Market”
Tune in tomorrow for the CompensationStandards.com webcast – “Compensation Arrangements in a Down Market” – to hear Blair Jones of Semler Brossy, Mike Kesner of Deloitte Consulting and James Kim of Frederic W. Cook & Co. discuss how boards are rethinking compensation practices in the wake of the down market.
Below are a dozen pearls of wisdom from former SEC Chief Accountant Lynn Turner:
I am taken aback when people like President Obama say our problem is we had an outdated regulatory system. I beg to disagree. It was a regulatory system that in the past two decades had not become out-of-date, but rather had been almost entirely dismantled by Congress and the various Administrations as they:
1. Passed Gramm-Leach-Bliley guaranteeing large financial supermarkets that can only be too big to fail, while prohibiting the SEC from being able to require regulation of investment bank holding companies. When legislation was passed saying one could put all these businesses under one roof, without a single word in the law requiring regulation of the inherent conflicts, it was sealed in stone that there would be huge institutions the government would HAVE to bail out if they failed. And this legislation was specifically passed to permit the merger of CitiBank and Travelers to form CitiGroup, now one of the largest institutions requiring a bailout.
2. Cutting budgets at CFTC and SEC year-after-year dismantling those agencies block-by-block. They sent these agencies to do a gunfight with an empty gun all too often.
3. As new products such as credit derivatives were created and introduced to the credit markets, Congress and the Administrations took action to ensure those products could not be regulated. Companies such as Enron and AIG used the law to avoid regulation of these products. And history now has another chapter on how these products became financial weapons of mass destruction.
4. As hedge and private equity funds grew exponentially in the past two decades, Congress again exempted them from any regulatory oversight, even as they took in increasing amounts of retail money.
5. The banking regulators became “Prudential Supervisors” and not regulators, as they allowed the banks to engage in unsound lending practices, notwithstanding the 1994 legislation giving the Fed the power to stop such destructive business practices. Congress passed legislation that even allowed the Federal Home Loan Banks to expand their lending and compete with one another for the same bank’s business, with significantly increased risk.
As a result, today they have balance sheets loaded up with lousy mortgage securities and loans to the like of Citi, WaMU, Countrywide and Wachovia. It use to be they were simply in the business of making loans to local community and regional banks. And when Congress passed this legislation, they also allowed the compensation for the executives of these banks, whose business is guaranteed in the same manner as Freddie and Fannie were, to jump significantly.
6. Congress failed to provide authority, tools and resources for OFHEO, the regulator of Fannie and Freddie, blocking attempts to provide for effective oversight and regulation. These agencies watched as their assets and guarantees grew to trillions of dollars without effective oversight, while the government backed them up with the guarantee of taxpayer dollars. These agencies were allowed to grow their balance sheets unchecked, and with insufficient capital in light of the risks they were taking on and imposing on the taxpayer.
7. The credit rating agencies were granted exemption from accountability by the investing public it turns out they were misleading as well as by the securities regulators. Yet it was mandated that their ratings be used. To this day, the SEC must judge the work of these credit rating agencies by the policies and procedures the rating agencies themselves decide are sufficient, even if the rating results in a bad rating. That is quite simply still the law today.
8. Congress interceded to block attempts to bring greater transparency to financial reporting of equity compensation that grew to hundreds of millions of dollars in some cases, as the use of stock options became a drug many executives and their boards became addicted to.
9. The courts and Congress stepped in to prevent investors from getting justice through legitimate legal actions. It ultimately led to the Supreme Court of this land ruling it was legal and quite fine for people to assist others in the commission of a securities fraud – in essence drive the get away car – and there would be no justice or legal course of action for those who had been their victims.
10. Shareholders were stripped of their rights, as we saw the SEC first in 1992, and then again in 2007, denying them the right to have the same access as the management who work for them, to the proxy of the companies they owned. While Congress was well aware of compensation abuses, they failed to pass legislation that would have reined in such abuses. While two to three years ago, the House passed such legislation, it went no where in the Senate.
11. We now have Congress stepping in to put undue pressure to undo transparent accounting practices. The FASB has become most accommodating as the new rules they are proposing, with only a two week comment period, will effectively become a moratorium on fair value accounting for banks.
They will no longer have to report the effect of their bad investment decisions in their income statements – much like suspended disbelief occurs at the movies. We are now going back to accounting that the GAO in 1991, in a report titled “Failed Banks,” said raised the cost to taxpayers of the S&L bailout.
12. And finally, people were put in charge of the key agencies who did not believe in regulation. Inspector General reports on the OTS, OCC and SEC cite serious lapses in regulation. From Greenspan at the Fed who failed to act on the 1994 Hoepa legislation, to Dugan and Hawke at the OCC who opposed state regulators attempts to rein in predatory lending practices, to the SEC’s Chris Cox, these were all regulators who publicly opposed regulation and engaged in the dismantling of the regulatory system we once had.
It wasn’t that we didn’t have an effective system as much as it was the system we had was dismantled during the past two decades. And now tens of millions of Americans are paying for this with their jobs, the loss of their retirement, having to work for many more years when they have grown old, and kids having to leave college, no longer able to afford it. It is no wonder the public is so outraged by what they see going on with Congress and at companies such as AIG.
More on Notorious A.I.G. – and B.A.D. Congress
Rightfully so, many of the folks I know have as equal disdain for the House of Representatives as for AIG itself, due to the silly – and potentially harmful – legislation which passed yesterday that imposes a huge tax on bonuses to anyone earning over $250,000, who happens to work for a TARP company that received $5 billion or more in funds. Those same people also show disdain for the Treasury’s bait and switch, wherein some companies were forced to accept TARP money. The processes of the bailout from start to finish so far have been the stuff of comedy (except unfortunately this is all reality).
Even though I believe changes in the way senior executives get paid need to happen, I don’t think that Congress should be dictating them. As I’ve said before, until boards want change, they will find a way around any artificial restrictions. And those work-arounds typically end up being more excessive than the pay arrangements that would have originally been implemented.
My blog about AIG a few days ago resulted in a record level of member correspondence. Here are just a few from the many I received:
1. This letter from a former AIG Financial Product unit executive has been in the hands of Congress since October. After the fact, it is clear that AIG mispriced the risk on the credit default swaps – they took in a lot less premium than they should have, given the scope of risk. I don’t know if the board has gone back and determined if the mispricing was error, or done deliberately to make a commission-generating and bonus-generating product more attractive. I would want to know that before paying out any bonuses, particularly in light of the red flag raised in that letter.
2. Congress will do something stupid and penalize AIG – which is realizing penalizing taxpayers given that we own the thing – rather than just try to get the money back from the rouges.
3. No first-year corporate lawyer would ever let her or his client invest billions in a company without doing, apparently, ANY DUE DILIGENCE.
4. As I read the news stories, these severance agreements have been in place for a very long time, perhaps before the first government advance.
5. The recipients are not to blame. Whoever approved these agreements is to blame, if, and only if, their actions are not protected by the business judgment rule (as things existed at the time; not with the benefit of 20-20 hindsight). I’ve seen nothing to indicate that to be the case (see the recent Citigroup case).
6. Be very careful, my friend, whatever the government concocts to punish these recipients, they can also do to you. Trust me, my friend, you really do not want to start meandering down that path.
7. I think the board could only be justified in paying bonuses to those employees whose services directly related to the winddown, and presumably those bonuses were only earned in the last few months so its hard to see how they got to be 165mm; anything else smacks of gross negligence. Further, the bonuses clearly didn’t need to be at the same rate as they were before the meltdown – are there that many jobs available to these employees.
Finally, it seem likely that at least some of these employees violated fiduciary or other duties to the corporation – so the only bonus should be that “if you get the corporation successfully out of the mess you got it into, the corporation won’t sue you for breach of those duties”. In this environment, how successful do you think a claim for a bonus would be when matched up against a counterclaim by the corporation?
8. It’s obviously a very complicated legal issue totally swamped by the idiocy of the players. You certainly can’t blame the public for being outraged.
9. With all the layoffs, there is plenty of talent available (and having created the mess, its hard to see that the talent that AIG has is all that talented or irreplaceable).
10. People must be held accountable for their actions, and inactions – in this case, the directors. A few lawsuits will bring a new sense of vitality to them, and given the failures revealed by the recent past, I don’t think the argument that current boards are irreplaceable and no one will serve is sufficient – certainly a better balance needs to be struck.
Back in January, I blogged about Broadridge’s new e-proxy notice for beneficial owners. It looks like they have gone back to the drawing board and improved their Notice some more in an effort to better educate shareholders and boost their willingness to vote. [Personally, I think this process would have gone smoother had Broadridge posted a draft Notice for public comment, both last year – and this year. And I don’t mean to single Broadridge out here. All the providers with Notices should post drafts for comment – so they can get input into enhancing usability.]
Although there has been no statement from the SEC Staff, Broadridge informs us that the Staff has reviewed these changes in this Notice. This is important to know since the new notice fails to satisfy a few of the requirements of Rule 14a-16(d). For example, the new notice doesn’t seem to have a place for directions to the meeting (Rule 14a-16(d)(8)). And although the requisite text for the legend required by Rule 14a-16(d)(1) seems to be included in one form or another, it doesn’t track the exact wording from the Rule.
We have received a number of inquiries from members nervous about relying on Broadridge’s representation that the Staff has blessed this departure. Hopefully, the Staff can make some type of public statement to alleviate the fears of those that want to be in compliance.
To help educated shareholders learn more about Notice & Access, Broadridge has created this Resource Center. Originally, it seemed like they would use the simple URL of ShareholderEducation.com for this new portal. But now that simple URL routes folks to Broadridge’s home page – and they’re using a long complicated URL for this new page. The original idea seemed more shareholder-friendly…
Pension Assets: Another Shoe to Drop?
One item to be closely watched in the annual reports being filed now is how the pension liabilities of companies are faring. For example, this recent report states that among the 100 largest corporate pensions, they suffered asset losses of $49 billion – partially offset by declines of $26 billion in liabilities due to changing the discount rates used to calculate the amount of the liabilities. The report notes that the funded status of these plans has fallen by 22% over the past twelve months, a decrease in funded status of $308 billion. Learn more about this development from the memos posted in our “Pension Plan” Practice Area.
It’s Tournament Time, with both my alma maters – Michigan and Maryland – representing! Go down memory lane and recall the miracle run by Michigan 20 years ago when their coach quit/got fired just before the tourney commenced.
March-April Issue: Deal Lawyers Print Newsletter
This March-April issue of the Deal Lawyers print newsletter was just sent to the printer and includes articles on:
– Lessons from the Meltdown: Remedies
– Poison in a Pen: Recent Trends in Drafting Shareholder Rights Plans
– The Ultimate Takeover Defense? RiskMetrics’ New View on Net Operating Loss Poison Pills
– Delaware Upholds Private Equity Deal Structures
– Recent Developments under the Delaware Short-Form Merger Statute
– Section 13(d): The Challenges of “Group Membership”
If you’re not yet a subscriber, try a 2009 no-risk trial to get a non-blurred version of this issue for free.
Yes, I’m angry too. I drafted a profanity-laced blog on Sunday, but held it back to calm down (you can get the profanity if you need it at “Daily Kos” – and the extremism at “Zero Hedge“). Even though I can understand why paying $165 million in guaranteed bonuses (plus another $239 million later) to wind down $2.7 trillion in risky derivatives (now wound down to 1.7 trillion) could make sense to a board (as Andrew Ross Sorkin argues), I’m still having trouble buying into the arguments made in this letter from AIG’s CEO Edward Liddy and AIG’s White Paper for these reasons:
1. Why Did the Government Wait So Long? – One maddening thing is the lost opportunity in dealing with these problems last Fall when the government started to shell out big bucks. The Obama Administration says it just learned about this bonus program, but ignorance is not an excuse when you own 80% of the company.
In any pre-bankruptcy workout, employees can be forced to make compensation concessions as a condition to the restructuring. The employees are given a reality check, based on the compensation they would receive if the company goes into Chapter 11. In the case of AIG, you and I were the lenders – but no one represented our interests to ensure the right people gave the right things up before the company was “saved.” Paulson, et al. screwed us from the start. As noted in this Washington Post column, the same negotiation tactics could be used today.
And what’s the response now that this fiasco has come to light? All sorts of “innovative” solutions are being promised from newly enlightened politicians (or some not so innovative: Geithner is talking about withholding $165 million from a $30 billion payment due to AIG now – as if that is a real solution). As one member told me: I’m from Iowa, so I understand the process of closing the barn door after the horse has bolted.
2. Avoiding a Lawsuit? – One of the primary reasons that the government – which controls just under 80% of AIG – allowed these bonuses to get paid was that it didn’t want to “risk a lawsuit” in paying out the bonuses. Risk a lawsuit? That was your worst case scenario in deciding not to challenge these bonuses? [Prof. Cunningham provides some examples of ways payment might have been avoided under the bonus plan; here is analysis from others.]
How many times in your life have people broken a contract to drive you to a better deal? This is “Business 101” stuff. Real business people realize that breaking contracts is an acceptable way to renegotiate terms – for starters, look at all the broken merger deals over the past year. The government is probably right to be wary of unilaterally abrogating employment contracts willy-nilly. But a little renegotiation could have gotten a lot of results here.
For example, I don’t understand why they didn’t offer to swap cash for equity (e.g., restricted stock that doesn’t get paid back until after AIG gets back on its feet.) That approach would recognize market realities and still provide a decent incentive for current employees. It’s done all the time by Silicon Valley companies that have fallen on hard times. I suppose a disgruntled employee could still file a wage claim, but it’s hard to see a court ruling in favor of a well-compensated employee that refused a reasonable settlement.
3. Feels Like Blackmail – One of AIG’s arguments is that “retention” bonuses were necessary to retain the employees of their Financial Products unit because they are the only ones who could understand AIG’s complicated mess (note when the bonus plan was created last year, the stated purpose was not retention!). It sure sounds like blackmail on the part of the quants who control AIG’s derivatives book. There have been a lot of layoffs on Wall Street lately – would hiring talented individuals to work for AIG really be so difficult?
My personal favorite is Liddy’s claim that these bonuses were necessary to prevent the competition from stealing these outstanding employees. Some reports say that some of these employees are indeed being courted because knowledge of counterparty strategies can be lucrative; others claim that the employees getting paid the biggest bonuses no longer have any relevance to AIG since that unit is no longer soliciting new business. I imagine both of these thoughts might be correct, but there are bigger issues at stake here (not to mention that a total of 52 bonus recipients are not even employed by AIG anymore, including one who received over $4 million).
4. Who’s In Charge Here? – I guess owning 80% doesn’t get you much when you’re the government – not even the courtesy of transparency when you repeatedly request it. Now under heavy fire, AIG has started to disclose counterparties that received some of the bailout money. I can’t imagine any other situation where a 80% owner appeared to have so little clout.
5. Some Will Be Connecting Dots – It’s already being reported that bonuses were paid out to some executives at some of the institutions who received money from AIG. Brace yourself as this story has “legs” and I imagine is just the first in what will be a long series of pieces about misuse of taxpayer money. The cycle will be the government rushing to bail someone out (sometimes against the recipient’s will!), abuse of the bailout money, Congressional outrage, repeat.
6. Can Everyone Stop Treating Us Like Children? – I’m so sick of the corporate executives and the government feeding us a bunch of bull. I’m having trouble trusting anyone. I imagine this is a widely-held belief. It doesn’t help when so many lies are thrown at us to explain the latest foul-up.
Executive Pay: Once Again, Where Do We Go From Here?
I sure hope the furor over these AIG bonuses is yet again a wake-up call for the pay apologists among us. As I recently wrote, it’s time for all board advisors – lawyers and consultants – to start providing responsible advice and get their head out of the sand. Times have changed and it’s not going back. The days of arguing that excessive pay is necessary to retain an executive who might jump ship are over. Excessive pay is never justifiable. It’s just excessive.
Unless – and until – boards and their advisors take charge of their own destiny and fix all that is broken, all the legislative and regulatory fixes in the world won’t stop them from finding loopholes and continuing the excesses. When boards recognize that the causes of these excesses are a relatively recent phenomenon (for starters, read this) – and that excessive pay arrangements aren’t some type of birthright for CEOs – it’s easy to go back two decades and recreate what was a more reasonable way of doing things in the executive compensation area.
A board with the proper mindset can employ the few simple tools we have identified to fix CEO pay and save themselves a lot of heartache easily. They just need the will to do so, along with advisors with the backbone to speak full truths.
I’m the kind of guy who likes to think in terms of T-shirts. For this AIG debacle, my idea of a cool T-shirt would look like this:
– Front – “AIG, I love you even more today than yesterday…”
– Back – “…Yesterday, you really pissed me off.”
The SEC Staff on M&A
Tune in tomorrow for this DealLawyers.com webcast – “The SEC Staff on M&A” – to hear all the latest from:
– Michele Anderson, Chief, SEC’s Office of Mergers & Acquisitions
– Dennis Garris, Partner, Alston & Bird LLP and former Chief, SEC’s Office of Mergers & Acquisitions
– Jim Moloney, Partner, Gibson Dunn & Crutcher LLP and former Special Counsel, SEC’s Office of Mergers & Acquisitions
Recently, Bank of America filed preliminary proxy statement that includes BOTH a management proposal on say-on-pay and a shareholder proposal on say-on-pay (from Kenneth Steiner, whose agent is John Chevedden). The management proposal is an actual vote, while the shareholder proposal is merely a non-binding vote regarding whether the company should have a policy requiring an annual pay vote.
BofA had tried to exclude this proposal through the no-action letter process, arguing that it (1) conflicts with management’s proposal and (2) the company has substantially implemented the shareholder proposal by including the management proposal. The proponent won the day with his argument that the two proposals are not the same because management’s proposal is limited to the period of time that the company is in TARP, while his proposal is unlimited as to duration. Yesterday, Corp Fin posted its response, not permitting BofA to exclude the proposal on either ground (they did waive the 80-day advance requirement).
I think dueling “say-on-pay” proposals will be confusing to shareholders – and I certainly hope this won’t be a new trend. Over the past month, most proponents withdrew their “say-on-pay” proposals once management included their own; this position by the Staff may cause them to reconsider going forward…
Transcript Posted: “Say-on-Pay: A Primer for TARP Companies”
Due to popular demand, we decided to prepare a cleaned-up transcript of the recent CompensationStandards.com webcast – “Say-on-Pay: A Primer for TARP Companies” – and have posted it in our “Say-on-Pay” Practice Area.
Tune in tomorrow for our webcast – “Raising Equity Capital in a Turbulent Market” – to hear Dave Lynn, John Newell of Goodwin Procter and Lora Blum of Jones Day discuss how companies are using alternative methods to raise capital these days (egs. registered directs, “at-the-market,” etc.).
Thanks to Jay Brown for his note about the passing of the SEC’s Associate General Counsel Diane Sanger. She was truly unique and will be sorely missed.
When the market surged 6% last Tuesday, it was allegedly due to the rumor that the SEC would bring back the “uptick” rule (on Friday, the SEC announced it will hold an April 8th Commission meeting to propose a new uptick rule). The use of short selling by hedgies to move markets for their own gain was discussed during the conversation between Jon Stewart and Jim Cramer on Thursday. Add us to the chorus that something has to be done about short-selling. And something different than the SEC’s emergency short-selling restrictions implemented last Fall, which some argue had no impact.
We’ve always believed that naked short selling is a form of manipulation, particularly when it occurs near the market’s opening and close (even if it’s part of a hedging strategy, it’s often still manipulative). There now have been a number of stories revealing what short sellers have been doing over the past few years and it’s clear that this is destructive behavior.
It’s time that the SEC and other regulators step up. Otherwise, this is one more aspect of “deregulation” that will continue to allow some to artificially manipulate stock prices – and feed the widespread belief that the markets aren’t safe.
How to Fix It: Totally Eliminate Naked Short Selling
Many thanks to Carl Hagberg, for allowing us to reproduce his fine article below from the most recent issue of his “Shareholder Service Optimizer“:
Here’s the simple fix: We still can’t figure why smart people haven’t been able to understand exactly how naked short sales cheat investors – and how they can and do create cascades of sales to spook legitimate investors into panic selling – so the shorts can lock-in their profits, guaranteed – AND how simple the “fix” to the naked short-selling scandal really is:
Every single trade must be settled on T+3, or a mandatory buy-in must be executed by the seller’s agent…no excuses or exceptions allowed. Something the SEC is still – shockingly and wrongly allowing.
We’ve been equally surprised by the large number of very smart people who think that restoring the “uptick rule” is the solution to the problem. It isn’t – especially since with trades now moving in one-cent increments, any crook in town can create an uptick to sell on – but still fail to deliver, sale after sale, after sale, etc.
How the markets are supposed to work: Let’s patiently review what should really be simple logic, about the way securities markets are supposed to work – and also about the inexorable, but basically simple law of supply and demand:
– First, let’s remember that one of the main reasons the SEC was formed in the first place – and the main reason that SEC registration of all publicly tradable shares was (and is) required – is to prevent fraudulent “over-issuances” of securities. In other words, if 100 shares of Company-A are registered, and I own 10 of them, the SEC rules and regs are meant to assure that I own one-tenth of the company, regardless of whether the shares are $1 each or $10 each.
– Second, let’s note than when shares are “sold short” there is always, by definition, a buyer. That buyer is entitled to have possession of his shares, and all the rights pertaining thereto, on T+3. And, under the present system, the buyer’s agent automatically credits the buyer with the ownership.
– But thus, please note, it is not enough for a seller to simply “locate shares” or to simply “ascertain that shares are available for lending” as current SEC rules seem to say is sufficient: the “short seller” must literally “borrow” the shares – and literally deliver them to the buyer for cancellation and re-registration; otherwise the issuer is “over-issued.”
Let’s review: For every single day a short-seller is allowed to go “naked” – i.e., the seller or his agent has failed to deliver the shares sold for cancellation – the issue is literally “over-issued” by that number of shares.
– In other words, if I sell 10 shares and the buyer has taken ownership of ten shares … but I haven’t delivered 10 shares for cancellation… there are now 110 shares “floating” out there in our little example. And, most important to note, in economic terms, this represents a 10% dilution of the SEC-registered shares.
– Theoretically, the 10% dilution – and the accompanying economic distortion of the true “equilibrium price” of the stock – is supposed to be immediately corrected by a forced “buy-in” of the undelivered shares, which will automatically bring the price back to a market-based “equilibrium” price.
– But when the buy-in rule is not strictly enforced, as is presently the case, “smart” naked-short-sellers will make as many more naked-short-sales as they possibly can – since allowing shorters to go naked almost guarantees that the shares will continue to fall – which will allow them to “cover” at even lower market prices than if they’d been covered on time.
– Please note carefully that allowing “naked shorts” to go uncovered by T+3 creates a “double whammy” in terms of market dynamics and in terms of the economics: Not only is there a frightening drumbeat or repeated sales – that tends to encourage a barrage of covered-sales too – each “naked sale” dilutes the number of shares they’ve bought, but no shares have been presented for cancellation.
– Please note too, that if a mandatory buy-in takes place, the “outstanding shares” are immediately brought back to the registered number of shares – and the market purchase automatically assures that the price is brought to a market-based “equilibrium number”…which, of course, is the correct number from a market-based perspective.
Let’s review the math again: If I make a short sale of 10 shares of the 100 shares outstanding on Monday, and don’t deliver on Thursday – and I am not automatically bought-in – as theoretically required, Company-A is over-issued by 10%. If I decide to make another naked short sale of 10 shares – and once again fail to deliver and fail to get bought-in, Company-A is now over-issued by 20%. Make no mistake about it: the SEC is allowing this to happen every single day!
Let’s review the consequences again: The market – and the market price of the stock – are being inexorably distorted…because in reality, sellers are being allowed to sell something they do not have…or ever plan to have and for every day they are allowed to go naked they have been allowed to sell shares that should no longer truly exist under the charter and bylaws of the company – or under SEC rules.
So let’s sum up: There is absolutely nothing wrong with short selling…as long as one ponies-up the shares on settlement date…regardless of whether one owns them outright or borrows them. (If one bets the wrong way, as very often happens, and the shares go up – and pass the point where the seller “sold short” legitimate short sellers will, of course, have to “cover their bet” at some point and repay the borrowed shares – either by delivering shares they may now own or buying them at the market price, which keeps the price of said shares at the market-based “equilibrium price”).
But note: There is something that is both immoral and illegal about selling something you don’t own – or where you haven’t actually borrowed the goods to make delivery…and made delivery, pursuant to the normal terms of the sale. (And if you sold short with no intention of ever delivering the goods…that’s fraud.)
If one allows the supply of shares to multiply by 5% or 10% or more – as naked short sellers actually have done…while the “demand” to buy shares is constant, other things being equal, the price of said shares will definitely fall. (This is the first law of economics by the way). And if one adds to the normal desire to sell – by initiating a panic, fueled by sales of shares that one doesn’t own, and doesn’t intend to lay claim to and deliver try the agreed upon date…(i.e. an artificially induced ‘disequilibrium’ between real supply and real demand)…the price will fall even more!
Yesterday’s House hearing on mark-to-market issues seemed to light a fire under the SEC and FASB, prompting commitments from FASB Chairman Robert Herz and the SEC’s Acting Chief Accountant Jim Kroeker to provide guidance on fair value accounting within three weeks.
As Edith Orenstein notes in the FEI Financial Reporting Blog, the members of the Committee pressed for immediate action:
“Rep. Paul Kanjorski (D-PA), chair of the Capital Markets Subcommittee of the House Financial Services Committee, noted in his opening remarks, “Mark-to-market accounting did not create our economic crisis, and altering it will not end the crisis. But improving the application of a fundamentally sound principle that is having profound adverse implications in a time of global financial distress is imperative. Therefore, our hearing today is about getting Financial Accounting Standards Board and the Securities and Exchange Commission to do the jobs they are required to do.” He added, “Emergency situations require expeditious action, not academic treatises. They must act quickly.”
“There are three pieces of legislation presently pending in Congress,” noted Kanjorski, with respect to mark-to-market accounting or accounting standard-setting generally (e.g. HR 1349 co-sponsored by Rep. Ed Perlmutter (D-CO) and Rep. Frank Lucas (R-OK) which would create a Federal Accounting Oversight Board). Kanjorski added, “I guarantee you one of those pieces of legislation is going to become law before early April.
Rep. Gary Ackerman (D-NY) responded to FASB’s current timetable, ‘If you are going to act, you’ve got to do it real quick.’”
The FASB Chairman ultimately responded, “We could have the guidance in three weeks; whether it will fix things, I don’t know.”
Also on the fast track are efforts to reinstate the “uptick rule” applicable to short selling. As noted in this Business Week article, SEC Chairman Mary Schapiro indicated in her testimony before the House appropriations committee earlier this week that the SEC hopes to propose reinstatement of the uptick rule some time in April.
SEC Filing Fees Increase on Monday
With the signing of the fiscal 2009 appropriations bill earlier this week, the SEC announced that is now set to raise the fees due for Securities Act registration statements and other filings. On Monday, March 16th, the Section 6(b) fee rate applicable to Securities Act registration statements, the Section 13(e) fee rate applicable to the repurchase of securities, and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions all increase to $55.80 per million dollars. Filings that get in today by 5:30 p.m. eastern time (except for short-form Rule 462 registration statements which get until 10:00 p.m.) will pay the old fee of $39.30 per million dollars.
The Alaska Air Letter and Beneficial Ownership
As noted in this O’Melveny & Myers memo, a Rule 14a-8 no-action letter granted to Alaska Air Group by Corp Fin last week delved into the specific proxy authority granted with respect three shareholder proposals, and whether the breadth of that proxy actually caused the person designated as proxy to be a beneficial owner of all of the nominal proponents’ shares – and thus unable to submit more than one proposal under Rule 14a-8(c). The particular proxy language in question specified that the designee could “act on my behalf in all shareholder matters, including this Rule 14a-8 proposal for the forthcoming shareholder meeting before, during and after the forthcoming shareholder meeting.”
This language appears to differ from proxies in circulation among other shareholder proponents, which often are not as broad in that they don’t grant authority with respect to “all shareholder matters.” As is always the case, the Staff’s decisions on shareholder proposal no-action letters are based on the specific circumstances of each proposal and the arguments raised by issuers in seeking to exclude the proposal. Certainly, the result in the Alaska Air letter will focus attention – both for issuers and proponents – on the specific language used in granting proxy authority with respect to a proposal.
