One of the topics discussed several times at last week’s “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference” and the “5th Annual Executive Compensation Conference” was pledging of securities by executives, typically done under margin arrangements. A NY Times article from last week was among the latest media reports to note the rise in insider sales of securities necessary to satisfy margin requirements. The article notes the inadequacy of disclosure regarding pledged securities, despite the fact that the SEC specifically required disclosure of pledged shares in the Beneficial Ownership Table when it adopted the 2006 amendments to the executive compensation disclosure requirements.
Volatility in the stock market will continue to drive this trend – along with all of its potential pitfalls for executives and their companies. Because company stock may be pledged as collateral for margin on an account where an executive maintains a more diversified portfolio of securities, broad market swings can result in margin calls and the forced liquidation of company securities even in situations where the company’s share price remains relatively stable. Unfortunately, this issue may often be a “blind spot” in company policies on stock ownership, insider trading, codes of conduct, etc. As a result, many companies will need to re-examine this issue in light of the current turmoil – and before year-end – so that any necessary changes can be highlighted in the Compensation Discussion & Analysis for the 2009 proxy statement.
Look for more on this critical topic in the upcoming issue of The Corporate Executive. If you aren’t a subscriber to The Corporate Executive, take advantage of a “Rest of ’08 for Free” no-risk trial. If you are a current subscriber, be sure to renew for ’09 since all subscriptions are on a calendar-year basis.
A Banner Year for SEC Enforcement?
Last week, the SEC announced that the agency had the second highest number of enforcement actions take place in fiscal 2008, with 671 actions brought through the September 30, 2008 end of the fiscal year. The glowing press release notes that the SEC brought the highest number ever of insider trading cases during fiscal 2008, as well as a sharp increase in the number of market manipulation cases. The press release also notes the obvious uptick in Foreign Corrupt Practices Act cases, with 15 such cases filed in 2008 and a total of 38 FCPA cases brought since January 2006. Interestingly, the press release does not note how many cases the agency brought to suspend trading in and/or revoke the registration of delinquent filers, which has been a significant focus (in terms of the number of cases) over the past few years. The SEC notes that, for a second year in a row, more than $1 billion was returned to harmed investors through Fair Funds distributions.
The Division of Enforcement and the Commission’s attitude toward Enforcement matters have been under quite a lot of scrutiny recently, so it is good to still see these impressive numbers. While much might be made of the mix of cases that the SEC has brought (i.e., too much insider trading and not enough accounting fraud), it is important to keep in mind that priorities change over time and the agency always has to make due with its limited resources by focusing its enforcement efforts. Further, the Enforcement process – even with the many improvements made in recent years – remains relatively slow and will lag to a great extent the issues that are in the immediate public consciousness. All in all, these results should be taken as a positive sign that the SEC remains “on the beat.”
Unfortunately, the same might not be said for the FBI in its efforts to investigate financial fraud. This NY Times article notes that the FBI’s staff of white collar investigators shrank as the agency’s role shifted toward terrorism and intelligence. Most disturbing is the possibility that the shrinking ranks of white collar investigators may have thwarted efforts to investigate financial fraud occurring in the housing market in 2003 and 2004, when perhaps the criminal authorities could have made a real difference in how the financial crisis ultimately played out.
PCAOB Proposes Audit Risk Standards
Last week, the Public Company Accounting Oversight Board announced seven proposed auditing standards relating to “the auditor’s assessment of and responses to risk.” The PCAOB notes that these proposed standards would supersede the interim auditing standards related to audit risk and materiality, audit planning and supervision, consideration of internal control in an audit of financial statements, audit evidence, and performing tests of accounts and disclosures before year end. These new standards are all built around the concept of audit risk, which is the risk that an auditor will express an inappropriate opinion when financial statements are materially misstated. The titles of the proposed standards are:
– Audit Risk in an Audit of Financial Statements
– Audit Planning and Supervision
– Identifying and Assessing Risks of Material Misstatement
– The Auditor’s Responses to the Risks of Material Misstatement
– Evaluating Audit Results
– Consideration of Materiality in Planning and Performing an Audit
– Audit Evidence
The proposals are out for a generous 120-day comment period, ending February 18, 2009.
During our Conferences, I announced that my co-blogger – Dave Lynn – would be taking on a new role as a Partner for Morrison & Foerster, working out of their DC office. We are happy for Dave, particularly because he also will continue to work with us. So you will continue to see him on our sites and print publications – just like Alan Dye splits time with Hogan & Hartson and us.
Not only is Dave a great guy, but he truly is a securities law genius. In my unique role setting up numerous conferences and panels over the years, I’ve worked with all the greats and I can honestly say I’ve never seen anyone quite like Dave. And I’m not the only one who thinks so, many of the greats regularly confer with Dave even though they have more experience. So seek Dave out in his new capacity if you need smart counsel.
Catch-Up Now: Register for Video Archive of the Executive Compensation Conferences
Not only was John White’s speech noteworthy, but every panel made an effort to provide practical implementation guidance for the challenges ahead of us. And given the likelihood that say-on-pay legislation will be adopted soon that will require shareholder votes on executive pay in 2010, the importance of your upcoming proxy disclosure can’t be overstated as investors will use that when they decide whether to include your company on a “watch list” and set your company on a path to not earn shareholder approval. You can still catch-up and register to watch the archived video of the Conferences (and obtain the critical Course Materials).
The Sights & Sounds of the Executive Compensation Conferences
Over 1800 Watch John Olson and Crew
The plenary session for the “5th Annual Executive Compensation Conference” was large (with several thousand more online):
The “We Want Heat” Chant
It got a little nippy during the “3rd Annual Proxy Disclosure Conference,” so I led the audience in a chant:
Baker & McKenzie’s Voodoo Dolls
Our Conference swag is always among the best; this year’s breakout hit was Baker & McKenzie’s voodoo dolls. Attendees were trading them like crazy:
Shiny Swag from Citi Smith Barney
Perfect for New Orleans – so shiny:
Merrill Lynch’s Photos
Many service providers took out clients after our receptions (one hired Howie Mandel for a private gig; another hired the singer Jewel). On Wednesday night, three different parades with marching bands left the hotel to private events. The hotel said that was two more than any other conference held there. Merrill Lynch provided keepsakes for their clients:
‘Living Room’ Exhibit Space
This exhibit booth from Stock & Options Solutions was the coolest I’ve seen in years:
Dude Singing ‘Time to Go’
My personal favorite moment was this dude telling the folks in the exhibit hall that the panels were back in session. Rather than ring a bell, he sang the schedule and more:
As I get on the plane to leave our Conferences in New Orleans, CNBC has this headline on its site: “Furious Stock Selloff Takes Historic Tone.” I believe we are just at the beginning of a dramatic restrucuring of our financial markets, particularly our regulatory framework. I know this is not going out on a limb at this point, but it bears repeating as we all think about our own career paths and immediate situations.
Yesterday’s US Senate Committee on Oversight and Government Reform hearing on the future of regulation was predictably sobering. Former Fed Reserve Alan Greenspan was grilled by angry Senators and Greenspan said he made a mistake for being too deregulatory. Here is the testimony from SEC Chair Chris Cox.
I know there is plenty to blog about regarding daily headline developments, but we are going to try to blog about the many other developments that impact the “bread and butter” of our members’ daily practices – partly to keep the tone from being so darn depressing…
Despite Conviction: Advancement Rights Continue Through Appeal
Travis Laster notes: In Sun Times Media Group v. Black, issued back on July 30th, Delaware Vice Chancellor Strine resolved a single question: Is a guilty verdict a “final disposition” for purposes of mandatory advancement rights, or do advancement rights continue through post-conviction proceedings and appeal? In a thorough 47-page opinion, the Vice Chancellor holds that advancement rights continue until the decision is truly final and not subject to potential reversal on appeal.
This decision resolves an issue that has arisen with increasing frequency in recent years, as corporations have bridled at providing advancements to individuals they believed had breached their fiduciary duties or engaged in bad or even criminal conduct. After a series of decisions from the Court of Chancery making clear that the corporation’s beliefs as to such matters were not a basis to cut off mandatory advancement rights, corporations began to focus on events that might otherwise provide a cutoff point, with guilty pleas and criminal convictions serving as the leading candidates.
In Sun Times, Vice Chancellor Strine holds that advancement rights continue through appeal based on the plain language of Section 145, Delaware public policy, and the unworkable regime that would result from advancement rights that started or stopped at each phase of a proceeding. Prior to this opinion, practitioners had only the language of Section 145 and two transcript rulings from scheduling conferences for guidance. Although these authorities pointed strongly in favor of the outcome reached in Sun Times, the issue has now been definitively resolved.
As I noted in discussing the recent CA decision, the next round on mandatory advancement rights likely will involve a board arguing that a mandatory advancement bylaw cannot compel the directors to provide advancements if they believe that by doing so they would breach their fiduciary duties. This argument was not viable under prior advancement decisions, but it could be asserted in good faith after the Supreme Court’s broad language against mandatory bylaw provisions set forth in CA. The argument also could be made to challenge a contract-based advancement right, but in my view remains non-viable against charter-based advancement rights.
Introducing the Lead Director Network
In this podcast, Jeff Stein of King & Spalding discusses a new group for lead directors, presiding directors and non-executive board chairs, called the “Lead Director Network” (see the LDN’s first issue of Viewpoints) including:
– What is the Lead Director Network?
– What is the exact purpose of the Network? For example, will the Network engage in advocacy on behalf of corporate directors or boards? Why do members choose to participate in the Network?
– So who are the initial members of the Network?
– How does the Lead Director Network differ from other director organizations (for example, NACD and the Millstein Center’s independent chair’s group)?
– What topics did the members of the Network cover in their first meeting, held this past July?
– What are the some of the topics that may be addressed by the Lead Director Network in the future? What do you see on the horizon for the Lead Director Network?
In the September-October issue of The Corporate Counsel – which was just mailed – the primary focus is on issues you need to consider for your upcoming Forms 10-Q and 10-K. It’s a great issue, which includes pieces on:
– Economic Crisis Impacts: Disclosure in 1934 Act Reports
– More Meltdown Fallout—Falling Share Prices Can Affect S-3 Eligibility, WKSI Status, Listing
– SEC Regulation of Investment Banking—R.I.P.
– Legal Opinions in Rule 14a-8 No-Action Letter Requests
– Rule 701 Heads-Ups—Measurement Date(s) for Restricted Stock/RSUs
– New 1934 Act CDIs—Staff Confirms 10-K Delinquency Date Where Issuer Doesn’t File Proxy Statement Within 120 Days After Yearend
– The Recent Short Sale Ban—Impact on Counterparty Transactions
– A Few More Meltdown Thoughts
– It’s Here! Lynn, Romanek & Borges’ Executive Compensation Treatise
If you aren’t a subscriber yet, take advantage of a “Rest of ’08 for Free” no-risk trial to have this issue sent to you immediately. Current subscribers will want to start renewing for ’09 since all subscriptions are on a calendar-year basis.
Trends: Retail Ownership Continues to Drop
Not a big surprise that the concentration of ownership of US companies among institutional investors continues to grow, but it’s nice to get confirmation of this trend via this Conference Board press release with plenty of statistics, including that retail ownership of US stocks has fallen to a record low of 34% of all shares and 24% for the top 1,000 companies at the end of 2006.
Fallout from the Market Dip: Preferred Shareholders Sue
In his “D&O Diary” Blog, Kevin LaCroix notes how preferred shareholders have begun securities class action lawsuits for the first time.
At our “3rd Annual Proxy Disclosure Conference” yesterday, Corp Fin Director John White delivered an important speech – entitled “Executive Compensation Disclosure: Observations on Year Two and a Look Forward to the Changing Landscape for 2009” – during which John talked briefly about how the TARP’s executive compensation provisions could potentially spill-over and impact the many companies not directly subject to TARP. Specifically, John addressed the TARP provision that requires participating financial institution’s compensation committees to meet with the senior risk officers of the institution to ensure that the incentive compensation arrangements do not encourage the senior executive officers to take “unnecessary and excessive risks that threaten the value of the financial institution.” Here is an excerpt from John’s remarks on this topic:
Most of you are not from financial institutions, so let’s talk for a moment about non-participating companies. This new Congressionally-mandated limitation on having compensation arrangements that could lead a financial institution’s senior executive officers to take unnecessary and excessive risks that could threaten the value of the financial institution obviously applies on its face only to participants in the TARP.
But, consider the broader implications and ask yourself this question: Would it be prudent for compensation committees, when establishing targets and creating incentives, not only to discuss how hard or how easy it is to meet the incentives, but also to consider the particular risks an executive might be incentivized to take to meet the target — with risk, in this case, being viewed in the context of the enterprise as a whole? I’ll let you think about what Congress might want. We know what our rules require. That is, to the extent that such considerations are or become a material part of a company’s compensation policies or decisions, a company would be required to discuss them as part of its CD&A. So please consider this carefully as you prepare your next CD&A.
Also, more broadly speaking, I expect that current market events are already affecting many companies’ compensation decisions and thus should be affecting the drafting of their upcoming CD&A’s. Regardless of whether your company participates in the TARP and consequently finds itself having to make new material disclosures, you should not merely be marking up last year’s disclosure. Instead, you should be carefully considering if and how recent economic and financial events affect your company’s compensation program.
For example, have you modified outstanding awards or plans, or implemented new ones? Have you reconsidered the structure of your program, or the relative weighting of various compensation elements? Have you waived any performance conditions, or set new ones using different standards? Have you changed your processes and procedures for determining executive and director pay, triggering disclosure under Item 407? These questions and more should be addressed as you consider disclosure for 2008.
Corp Fin’s ’09 Narrowly Selected Review of Executive Compensation Disclosures
Regarding Corp Fin’s review of compensation disclosures filed during the upcoming proxy season, John said this during his speech:
We also are looking at how we will shape our Corporation Finance review program for 2009 in light of recent market events, including the new executive compensation provisions in TARP and continued investor interest in executive compensation. As you know, our selective review program is guided by Section 408 of Sarbanes-Oxley, which requires that we review all public companies on a regular and systematic basis, but in no event less frequently than once every three years. The Act also sets out criteria for us to consider in scheduling these regular and systematic reviews, including considering companies that “experience significant volatility in their stock price,” companies “with the largest market capitalizations,” and companies “whose operations affect any material sector of the economy.” As you also will recall, in 2007 we did a targeted review of the executive compensation disclosure under our then-new rules for 350 companies of all sizes.
Our plan for 2009 will be responsive to current conditions. In 2009 we will select for review and review the annual reports of all of the very largest financial institutions in the U.S. that are public companies. This group will include the nine large financial institutions that have already agreed to participate in the Treasury’s capital purchase program. Our reviews will include both the financial statements and the executive compensation disclosures of these companies. We also intend to monitor the quarterly filings on Form 10-Q and current reports on Form 8-K of these companies.
Today is the “5th Annual Executive Compensation Conference.” Note you can still register to watch online – and note that the archived video for yesterday’s “3rd Annual Proxy Disclosure Conference” is now available.
– How to Attend by Video Webcast: If you are registered to attend online, just log in to TheCorporateCounsel.net or CompensationStandards.com to watch it live or by archive (note that it will take about a day to post the video archives after it’s shown live). A prominent link called “Enter the Conference” on the home pages of those sites will take you directly to today’s Conference.
Remember to use the ID and password that you received for the Conferences (which may not be your normal ID/password for TheCorporateCounsel.net or CompensationStandards.com). If you are experiencing technical problems, follow these webcast troubleshooting tips. Here is the Conference Agenda; times are Central.
– How to Earn CLE Online: Please read these FAQs about Earning CLE carefully to see if that is possible for you to earn CLE for watching online – and if so, how to accomplish that. Remember you will first need to input your bar number(s) and that you will need to click on the periodic “prompts” all throughout each Conference to earn credit. Both Conferences will be available for CLE credit in all states except Pennsylvania (but hours for each state vary; see the list for each Conference in the FAQs).
Today is the “Tackling Your 2009 Compensation Disclosures: The 3rd Annual Proxy Disclosure Conference”; tomorrow is the “5th Annual Executive Compensation Conference.” Note you can still register to watch online by using your credit card and getting an ID/pw kicked out automatically to you without having to interface with our Staff (but you can still interface with them if you need to).
– How to Attend by Video Webcast: If you are registered to attend online, just log in to TheCorporateCounsel.net or CompensationStandards.com to watch it live or by archive (note that it will take about a day to post the video archives after it’s shown live). A prominent link called “Enter the Conference” on the home pages of those sites will take you directly to today’s Conference.
Remember to use the ID and password that you received for the Conferences (which may not be your normal ID/password for TheCorporateCounsel.net or CompensationStandards.com). If you are experiencing technical problems, follow these webcast troubleshooting tips. Here is the Conference Agenda; times are Central.
– How to Earn CLE Online: Please read these FAQs about Earning CLE carefully to see if that is possible for you to earn CLE for watching online – and if so, how to accomplish that. Remember you will first need to input your bar number(s) and that you will need to click on the periodic “prompts” all throughout each Conference to earn credit. Both Conferences will be available for CLE credit in all states except Pennsylvania (but hours for each state vary; see the list for each Conference in the FAQs).
– How Directors Can Earn ISS Credit: For those directors attending by video webcast, you should sign-up for ISS director education credit using this form. This is meant to facilitate providing information to ISS; they are the ones in charge of accreditation and any disputes will need to be taken up with them.
Soliciting Queries for Our “Compensation Consultants Speaks” Panel
Among the more popular panels during Wednesday’s “5th Annual Executive Compensation Conference” will be the panel entitled “The Consultants Speak: Straight Talk from the Top Experts.” I am soliciting issues or questions to be addressed by the panel if you want to shoot me an email beforehand (they will be posed anonymously).
Moral Hazard and Executive Compensation
Setting the tone for our big executive compensation conferences, we have posted an important new alert on CompensationStandards.com from Fred Cook, founder of Frederic W. Cook & Co. In his piece – “Moral Hazard and Executive Compensation” – Fred addresses what moral hazard means and lays out a number of steps that you can take to mitigate it. We strongly urge you to read this piece and show it to your CEO and directors.
In response to a no-action request, the SEC’s Corp Fin Staff recently decided that Hain Celestial could not exclude a shareholder proposal calling for the company to reincorporate to North Dakota from its proxy statement (the company had hoped to exclude the proposal on procedural grounds; there don’t appear to be substantive grounds to argue for exclusion). Hain Celestial is incorporated in Delaware; the other two companies with this proposal so far – Oshkosh and Whole Foods – are incorporated in Wisconsin and Texas, respectively. Here is a copy of the proposal.
More companies can expect this type of proposal this proxy season as proponents attempt to leverage the North Dakota Publicly Traded Corporations Act, enacted in mid-’07 to provide for a host of shareholder-friendly measures (as noted in this blog).
As noted in this Reuters article, hold-til-retirement and say-on-pay will be two popular shareholder proposals topics during this proxy season as investors turn their attention to pay practices that encourage excessive risk-taking.
An Opportunity to Comment on RiskMetric’s ’09 Proxy Policies
Last week, RiskMetrics’ ISS Division put up a “Request for Comment” for a number of potential modifications to its policies for 2009. Take advantage of this opportunity to influence these important proxy voting policies through an easy-to-use online form. This year, the topics include:
– Poor Accounting Practices (U.S.)
– Discharge of Directors (Europe)
– Independent Chair (U.S.)
– Names of Director Nominees Not Disclosed (Global)
– Net Operating Loss Poison Pills (U.S.)
– Peer Group Selection for Executive Compensation Comparisons (U.S.)
– Poor Pay Practices (U.S.) Pay for Performance (U.S.)
– Corporate Social Responsibility Compensation Related Proposals (U.S.)
– Share Buyback Proposals (Global)
This Gibson Dunn memo summarizes RiskMetrics’ proposed policy changes. In addition, RiskMetrics has made these survey results from institutional investors available.
Nasdaq has made a rule filing with the SEC seeking to temporarily suspend the exchange’s bid price and market value of publicly held securities continued listing requirements until January 16, 2009, given the current state of the market. The last time the Nasdaq imposed an across-the-board, three-month moratorium on the application of its minimum bid and public float requirements for continued listing was during the market turmoil following September 11, 2001.
In its filing, Nasdaq notes that, as of September 30, 2007, there were only 64 securities trading below $1 on Nasdaq, while by September 30, 2008 that number had jumped to 227, and by last Thursday, the number of securities trading below a $1 was 344. Nasdaq further notes that “during this time there was no fundamental change in the underlying business model or prospects for many of these companies, but the decline in general investor confidence has resulted in depressed pricing for companies that otherwise remain suitable for continued listing. These same conditions make it difficult for companies to successfully implement a plan to regain compliance with the price or market value of publicly held shares tests.”
Nasdaq is requesting that the SEC waive the 30-day operative delay period so that the rule change can be put in place immediately.
I think that this is a very positive step to help both issuers and investors at a time when neither can afford to experience unnecessary delistings.
Time to Choose Prime over LIBOR?
Earlier this year, I blogged about the troubles with LIBOR, that ubiquitous short-term rate used in so many lending arrangements. Now, with the extraordinary conditions in the credit markets (including a near collapse of inter-bank lending – yikes!), LIBOR has shot up, hitting new highs in recent weeks.
In an alert issued earlier this week, Foley Hoag LLP discussed the impact of the inversion of LIBOR relative to the US Prime Rate and the potential impact on credit agreements:
“U.S. Companies that borrow under bank credit facilities that provide for the borrower to elect payment of interest at either a LIBOR-based rate (sometimes called a “Eurodollar” loan) or a Prime Rate-based rate (sometimes called a “Base Rate” loan) need to be aware of a significant development resulting from the recent turmoil in the world’s credit markets.
Under normal market conditions, the Prime Rate generally exceeds LIBOR rates. Given this, borrowers generally elect to pay interest at a LIBOR-based rate on loans that will be outstanding for more than a short time.
However, in recent days, certain LIBOR rates have at times exceeded the Prime Rate quoted by most major U.S. banks. Because of this, chief financial officers and treasurers need to carefully monitor their LIBOR/Eurodollar interest periods and consider whether to elect the Prime Rate/Base Rate when those interest periods next roll over. Furthermore, borrowers may wish to consider whether to “break funding” on some or all of their existing LIBOR/Eurodollar contracts and convert their outstanding loans to Prime Rate/Base Rate loans – depending on how LIBOR rates have moved since the beginning of the current interest period for an outstanding LIBOR/Eurodollar loan, borrowers may have to pay minimal or no “breakage costs” for doing so. The ability to “break funds” on an outstanding LIBOR/Eurodollar loan and convert it to a Prime Rate-based loan will depend on, among other factors, the language of the relevant loan agreement and whether the relevant loan is a revolver loan or a term loan, and borrowers should discuss this option with their lender before doing so.
It’s impossible to predict how long this anomalous situation will last, but the savings to alert companies could be substantial. When and if this rate inversion is reversed and more normal conditions prevail, borrowers under typical loan agreements should again be able to elect LIBOR on short notice and resume their normal interest rate strategies.”
Walk-in Registration for New Orleans
For our big executive compensation conferences next week, online registration for New Orleans attendance closed last night. However, you can walk-in and register in New Orleans with a check or credit card. In light of current economic conditions, we are waiving the standard walk-in fee this year.
Note that you will still be able to register for the video webconference at any time as this deadline doesn’t apply to that method of attendance.
I look forward to seeing you either in New Orleans or on the web!
This week, the Treasury Department and the IRS rushed out guidance and rulemaking on the executive compensation provisions included in the Emergency Economic Stabilization Act. The guidance comes out as Treasury seeks to implement the $250 billion Capital Purchase Program (CPP), as well as other programs under the Troubled Asset Relief Program (TARP). The new rules and guidance are included in:
– An IRS notice regarding the Section 162(m) and 280G provisions of the EESA.
– A Treasury notice describing golden parachute restrictions applicable to institutions participating in the Troubled Asset Auction Program (TAAP).
– A Treasury notice describing (much tougher) golden parachute restrictions applicable to institutions participating in the Programs for Systematically Significant Failed Institutions (PSSFI).
For an excellent summary of the rulemaking and guidance, see Mark Borges’ Proxy Disclosure blog and Mike Melbinger’s Compensation blog, both on CompensationStandards.com.
These provisions are only applicable to a relatively narrow group of financial institutions. While this NY Times article notes some doubt about the real impact of the provisions on executive pay at financial institutions – much less on other companies – I think that it is starting to feel like we are at a broader tipping point with the recognition of some pay excesses in this federal legislation. Now it is up to all boards to take the public and shareholder anger to heart when making compensation decisions. This will certainly be a topic that we will discuss in more detail at next week’s “3rd Annual Proxy Disclosure Conference” & “5th Annual Executive Compensation Conference.” Don’t miss them!
Accounting Guidance: It Keeps on Flowing
The accounting guidance for fair value and other financial meltdown issues continues to flow at a rapid pace:
1. Last Friday, the FASB issued FASB Staff Position No. 157-3, Determining the Fair Value of a Financial Asset When the Market for That Asset Is Not Active. This FSP amends FAS 157 by incorporating “an example to illustrate key considerations in determining the fair value of a financial asset” in an inactive market. FSP No. 157-3 is effective upon issuance, and should be applied to prior periods for which financial statements have not been issued – including in upcoming third quarter 10-Qs. The FSP notes that the guidance included in the Statement is consistent with the guidance provided by the SEC’s Office of Chief Accountant and the FASB Staff in last month’s press release. The FSP’s example illustrates how a company can determine the fair value of an investment in a collateralized debt obligation security that is no longer quoted in an active market, emphasizing that approaches other than the market value may be appropriate for determining fair value.
2. On Tuesday, under intense political pressure, the IASB amended IAS 39, Financial Instruments: Recognition and Measurement. The amendment, which is effective immediately and to be applied retrospectively to July 1, 2008, will permit financial instruments that had been measured at fair value through profit or loss to be reclassified to a different accounting basis (to, i.e., held-to-maturity). The restrictions on reclassification had been in place to stop companies from gaming the system by, e.g., marking to market in the good times and then ceasing to mark to market in the bad times. The IASB shift may tilt the playing field in favor of international standards, because, under US GAAP, reclassifications among trading, available for sale and held-to-maturity are only permitted (under FAS 115) in rare circumstances. So much for “convergence” when the going gets tough.
3. Also on Tuesday, SEC Chief Accountant Conrad Hewitt sent a letter to FASB Chairman Robert Herz on interpretive issues arising in how to assess declines in fair value for perpetual preferred securities under the existing other-than-temporary impairment model in FAS No. 115, Accounting for Certain Investments in Debt and Equity Securities. In the letter, Hewitt states that for perpetual preferred securities, which are treated like equity securities under FAS 115, the Staff (in consultation with the FASB Staff), “would not object to an issuer, for impairment tests in filings subsequent to the date of this letter, applying an impairment model (including an anticipated recovery period) similar to a debt security. OCA would not object to this treatment provided there has been no evidence of a deterioration in credit of the issuer (for example, a decline in the cash flows from holding the investment or a downgrade of the rating of the security below investment grade) until this matter can be addressed further by the FASB.” The Staff expects sufficient disclosure about the impairment analysis, so that investors can understand all of the information considered in determining that the impairment is other than temporary and what was considered in determining that there was no evidence of credit deterioration in the perpetual preferred securities.
Short Sale Disclosure (Only to the SEC) Now In Place
Yesterday the SEC adopted an interim final temporary rule requiring specified institutional investment managers to file information on Form SH concerning their short sales and positions of Section 13(f) securities, other than options. The rule is effective on October 18 and will continue in place until August 1, 2009.
The disclosures about short positions will not be available to the public, only to the SEC. The SEC stated that Form SH “will provide useful information to the staff to analyze the effects of our rulemakings relating to short sales and in evaluating whether our current rules are working as intended, particularly in times of financial stress in our markets. The reports will supply the Commission with important information about the size and changes in short sales of particular issuers by particular investors. That information will be available to the Commission to consider when questions about the propriety of certain short selling occur.”
Note that you will need your Conference ID and password to access the course materials (if you’ll be in New Orleans, a set will be handed out to you). It’s not too late to register!
Instructions for Those Watching Online Next Week: Come to the home page on the day of the Conference and click the prominent link that will be posted that day. Watch the Conference live by clicking a video link that will be on the Conference page that matches the type of player installed on your computer (ie. Windows Media Player or Flash) and the speed of the connection that you have. Panels will be archived a day after they are shown live.
Short Sale Tuesday
Yesterday, the SEC issued three separate releases taking action on short sale rules. All of these rule changes are effective this Friday, October 17. The changes include:
1. In Release 34-58773, the SEC adopted Rule 204T of Regulation SHO as an “interim final temporary rule” (I think that is a whole new flavor of rule). Rule 204T was first adopted in a September 17 Emergency Order and was set to expire on Friday, October 17. Now, a revised version Rule 204T will be effective until July 31, 2009, and the SEC will consider comments on the rule and respond to those comments “in a subsequent release.” The new version of Rule 204T includes some tweaks from the version adopted in the September 17 Emergency Order to address operational and technical concerns. The rule generally requires that securities be purchased or borrowed to close out any fail to deliver position in an equity security by no later than the beginning of regular trading hours on the settlement day following the date on which the fail to deliver position occurred, as a means for discouraging potentially abusive “naked” short selling.
2. In Release 34-58774, the SEC adopted Exchange Act Rule 10b-21, the naked short selling antifraud rule. This rule is actually being adopted in the “normal” way – it was proposed back in March and comment was solicited on the rule. In the September 17 Emergency Order, the SEC had adopted Rule 10b-21, but only through this Friday. New Rule 10b-21 is aimed specifically at short sellers (including broker-dealers acting for their own accounts) “who deceive specified persons, such as a broker or dealer, about their intention or ability to deliver securities in time for settlement and that fail to deliver securities by settlement date.” Such deception could include lying to a broker about the source of the borrowable securities under the locate requirement of Regulation SHO, or lying about whether the short seller owns the securities to be sold short.
3. In Release 34-58775, the SEC adopted previously proposed changes that eliminate the options market maker exception to the close-out requirement of Regulation SHO. With these amendments, fails to deliver in threshold securities resulting from hedging activities by options market makers will no longer be excepted from Regulation SHO’s close-out requirement. In the September 17 Emergency Order, the SEC had adopted and made immediately effective the elimination of the options market maker exception to Regulation SHO’s close-out requirement, which was also set to expire this Friday. The Release also provides some interpretive guidance on activities that constitute bona fide market making activities.
These rule changes are by and large targeted at naked short selling, and may finally go a long way toward stamping out the shady side of the short sale business. However, these changes may not be the last word on short selling regulation – calls for reviving the uptick rule will continue, as will perhaps the overall mistrust of short selling that the SEC has contributed to with its emergency short sale ban. Also, the SEC should be publishing interim final rules in the next day or so to implement the new Form SH filing requirement (for the SEC’s eyes only) on a permanent basis.
What’s Next for the SEC’s Emergency Actions?
With the markets’ big comeback on Monday and the rally cries of “capitulation” emerging, is the SEC going to ban long purchases next? I think not, but that would make about as much sense as banning short sales, in my opinion. What the SEC could do now is adopt some interim final temporary rule changes to continue the relaxation of the Rule 10b-18 volume and timing conditions to facilitate long purchasers by issuers. The timing of the SEC’s Emergency Order relaxing the 10b-18 requirements was not particularly good, since many issuers were in possession of material nonpublic information as a result of being so close to the end of the quarter, and thus had concerns about implementing any new repurchase plans or doing any sort of one-off repurchases. The potential benefits of encouraging issuers into the market to support their shares could actually be realized soon, as earnings get announced and issuers get back into windows where they could be in a position to repurchase their own securities.
