From Keith Bishop: A few weeks back, a reporter called me about “B” corporations; if you haven’t heard of them, here is an article about the subject. “B” stands for “beneficial.” Proponents hope that the “B corp.” logo will eventually become a well-known seal of approval for socially responsible businesses.
In California, the proponents of B corporations have introduced a bill – AB 2944 – that would explicitly permit directors to consider other constituencies in considering the best interests of the corporation. I found the bill analysis particularly interesting in its reference to the Chicago Cubs and Rutgers (I believe that the case referred to in the legislative analysis is Shlensky v. Wrigley, 95 Ill. App. 2d 173, 237 N.E. 2d 776 (1968)).
As noted in the article, the use of B corporations would have interesting implications in acquisitions since the board of a B corp. could weigh considerations other than financial ones to accept an offer. Learn more about B corps at BCorporation.net.
Back in February, we took a quick look at the scorecard in the options backdating litigation, tallying up the settlements and dismissals, among other things. In our earlier review, of the 36 options backdating cases that have been filed as securities class actions, 7 had settled and 3 had been dismissed.
Run the clock for a few months, and 9 of those cases have now been dismissed and 9 have now settled. The nine settlements total $255.58 million, for an average of $28.4 million. As noted earlier, these cases have settled much more quickly on average, than other cases. The nine cases have settled in an average of just 440 days. Removing the outlier, Mercury Interactive, which was filed earlier and added the options backdating allegations in a later
amended complaint, drops the average time from filing of initial complaint to tentative settlement for the remaining 8 cases to 397 days.
And the ratio of settlements to dismissals is somewhat out of line with historical averages as well. Most studies (and a quick check of our database) indicate that the percentage of new securities class actions that are dismissed is between 33-40 percent. With this group of cases, we can look at the data two ways. Dismissals as a percentage of total cases or dismissals as a percentage of cases that have reached a final, or quasi-final resolution.
Under the former analysis, exactly 25% of these cases have been dismissed. That number is artificially low, as not all of the cases have yet had a ruling on the motion to dismiss. Under the latter method, 50% of these cases have been dismissed. This number is artificially high, as a number of these cases have already survived a motion to dismiss. In any event, things remain interesting in the sometimes long-forgotten world of options backdating.
And law firm lawyers need to watch out. As noted in this article, some firms are being named as defendants in these backdating lawsuits.
We want to clarify that to obtain the “Conference Attendee” discount for the new Treatise, you need to register for one of the October Conferences before you order the Treatise. And since the early bird discount for the Conference expires on June 30th, you will want to register for those Conferences now:
This is worth repeating from Friday’s DealLawyers.com Blog: As the conclusion of one of the more closely-watched cases in recent years in the M&A area draws near (see this IR Magazine article for background; Alan Dye also riffed on this Friday in his Section16.net Blog), a number of amicus curiae filings were made available last week, including a letter from Corp Fin Deputy Director Brian Breheny (as transmitted by the SEC’s General Counsel; this is not a Commission amicus brief). We have posted them in the “M&A Litigation Portal” on DealLawyers.com, as follows:
Here is some analysis from Cliff Neimeth of Greenberg Traurig: In a pending litigation being watched closely by the public M&A bar, institutional activists and target issuers alike, this past Wednesday, in correspondence submitted by Corp Fin Deputy Director Brian Breheny to U.S. District Court (SDNY) Judge Lewis Kaplan, Brian endorsed the view of activist hedge funds – The Children’s Investment Fund (“TCIF”) and 3G Capital Partners (“3G”) – that they were not required under Regulations 13G or 14A to disclose their approximate 12% economic stake in Jacksonville, Florida-based railroad operator CSX Corp. until months after they entered into these arrangements. The hedge fund defendants previously announced their intention and presently intend to elect a short-slate of their five nominees at CSX’ annual meeting scheduled for later this month.
At issue, among many other aspects of the litigation, is the fact that TCIF and 3G were parties to elaborate “swap” and cash-settle derivative arrangements with investment bank counterparties, and that the nature of these contracts did (and do) not confer upon TCIF and 3G any shared or sole voting power over the underlying equity securities. Accordingly, in their view, such arrangements fall outside of the ambit of Section 13(d) and Regulation 13D thereunder until such time as these arrangements are converted into beneficial voting positions.
Although TCIF and 3G, on numerous occassions, announced to the investment community and to CSX directly that they were parties to the swaps and, in fact, made H-S-R (pre-merger notification) filings with the FTC, the absence of a detailed Schedule 13D filing (and subsequent amendments) allegedly enabled them to conduct (over a period of months) a broad range of “coordinating activities” with other institutional holders of CSX, to execute various plans, arrangements and understandings relating to control of CSX, and to otherwise engage in undisclosed “group” activities.
Brian Breheny (expressing the Staff’s position of the appropriate interpretive legal standard and not the position of the SEC’s Commissioners) stated in his letter to Judge Kaplan that “the presence of economic or business incentives that the [swap counterparty] may have to vote the shares as the other party wishes” is insufficient to create the beneficial acquisition of voting power in respect of such shares.
If Judge Kaplan agrees with TCIF’s and 3G’s (and indirectly, Breheny’s amicus) interpretation of the legal standard for disclosure, this would have significant implications for hedge fund activist transaction planners and target companies. If he rules in this direction, it is not unlikely that this may prompt the SEC to accelerate its current assesment of whether Regulation 13D should be amended to broaden its reach to cover these cash-settled (synthetic) arrangements that have become more commonplace over the past several years.
Coupled with the SEC’s e-proxy regime, the current slowdown in traditional economic M&A activity, and the recent Delaware Supreme Court and Delaware Chancery Court decisions in Openwave-Harbinger Capital, Jana Partners-CNET, Levitt Corp.-Office Depot and TravelCenters-Brog (with respect to the efficacy of the advance notice by-laws in those cases), this continues to help fuel an unprecedented level of institutional activism and control contest activity for the forseeable future. This also underscores the need for corporate issuers to examine their “shark repellents” and defensive arsenal.
– 566 companies have used voluntary e-proxy so far (a big leap from 283 at the end of March – understandable since proxy season is in full swing)
– Size range of companies using e-proxy varies considerably; all shapes and sizes (eg. 30% had less than 10,000 shareholders)
– Bifurcation is being used more as the proxy season progresses (but still not all that much); of all shareholders for the companies using e-proxy, now over 10% received paper initially instead of the “notice only” (up from 5% at the end of February)
– 0.85% of shareholders requested paper after receiving a notice; this average is up from 0.45% at the end of March
– 57% of companies using e-proxy had routine matters on their meeting agenda; another 30% had non-routine matters proposed by management; and 13% had non-routine matters proposed by shareholders. None were contested elections.
– Retail vote goes down dramatically using e-proxy (based on 164 meeting results); number of retail accounts voting drops from 21.2% to 5.4% (a 75% drop) and number of retail shares voting drops from 34.3% to 15.8% (a 54% drop)
For the next few days, Dave and I are out speaking in San Diego at the NIRI Annual Conference. My panel deals with e-proxy and I’ll be doing my “usability” bit again – particularly regarding how the proxy card/VIF looks. Take a gander at how this sample (posted in our “E-Proxy” Practice Area) looks like for registered holders. Not too bad. And I’ll be discussing all the other e-proxy related developments that I haven’t yet had a chance to blog about…but will do so in the next few weeks.
And even though he can’t be there himself, Dominic Jones is helping collect Web 2.0 thoughts from conference attendees as it happens. Pretty wild.
Winning the World Series: Cubs Worth More? Or Less?
Friday’s Deal Journal from the WSJ.com included an interview with an economist about how much more the Chicago Cubs would be worth if they won the World Series this year (they are red hot and it’s been 100 years since they last won).
The interview is short and perhaps not complete – but in my opinion, the Cubs would be worth less in the long run if they won. Part of their national mystique is that they are perennial losers. “Maybe next year” is the fan mantra. As someone who grew up down the street from Wrigley Field at a time when they “had it in the bag” – the late ’60s/early ’70s – I personally don’t want to see the streak end…
Speaking of sports, I was bummed to discover in this WSJ article that “Gino” is dead. The “Gino dance” is all the rage at Boston Celtics games this year, based on a clip from a ’70s American Bandstand episode that shows a dancer wearing a “Gino” T-shirt. I went to a game in Boston this year to experience it for myself, but I had seen this clip on YouTube before I went. It’s a classic.
We’re excited that Dan Greenspan has left the SEC to join our staff! Dan spent five years at the SEC, spending the bulk of his time in Corp Fin, including a lengthy stint in the Office of Rulemaking. During the past six months, he toiled as Senior Special Counsel in the Office of the General Counsel. Dan was one of the key players during the SEC’s executive compensation disclosure rulemaking in ’06. He worked for seven years in private practice before his time at the SEC.
Dan nailed his interview when he showed up wearing an Elvis wig and holding a fake cigarette. A lesson for you kids out there. Dan is up and running in his new work clothes – and you can congratulate him at dan @thecorporatecounsel.net (remove the space after “dan” before sending).
The PCAOB’s Newest Board Member: A History Lesson
Several days ago, the SEC appointed Steven Harris to the PCAOB’s board. Steven was a former long-time Senate Banking Committee official, who more recently served as Senior Vice President and Special Counsel of APCO Worldwide.
Steven is the first Hill person to be named to the Board. However, that is not a foreign concept for SEC Commissioners. Current SEC Commissioner Kathy Casey was Staff Director and Counsel for the Senate Banking Committee when she was appointed last year. And the Commissioner I worked for a decade ago – Laura Unger – also came directly from the Senate Banking Committee.
Going back further, Rick Roberts was a former Hill staffer (although technically he left Senator Shelby’s office and went to a law firm for a short while before becoming a Commissioner in the early ’90s). In the ’80s, Lindy Marinaccio was an aide to Senator Proxmire when he was appointed by Reagan. In the ’70s and early ’80s, John Evans served two terms after coming from the Senate.
Then there are the Commisioners who were White House aides when appointed: Joe Grundfest, Richard Breeden and Paul Carey. Given Congress’ intense interest in the markets lately, any of this is not a bad background to have, as navigating Capitol Hill can be tricky. Thanks to Jack Katz for his endless knowledge of SEC history!
Closing Time: When the Founder is Ready to Sell
We have posted the transcript for the DealLawyers.com webcast: “Closing Time: When the Founder is Ready to Sell.”
Okay, you now know why Dave and I haven’t been making silly videos lately – we have been busy jamming on a comprehensive treatise of executive compensation disclosures – Lynn & Romanek’s “The Executive Compensation Disclosure Treatise & Reporting Guide” – so that we can get it into your hands by Labor Day. This thing will be massive: over 1000 pages and is full of explanations, annotated sample disclosures, analysis of possible situations that you may find yourself in, etc.
After you order the Treatise, you will also receive quarterly Update newsletters – so that we can give you the latest practice tips at the crucial moments you need them. And once the Treatise is done, those that order the hard copy also get access to an online version of the Treatise (and newsletters). We haven’t yet figured out the URL for the online version – suggestions are welcome. Here are FAQs about the Treatise.
Order your Treatise now so we can rush it to you right after Labor Day; there is a reduced rate if you are attending any of our Conferences. Order online – or here is an order form if you want to order by fax/mail. If at any time you are not completely satisfied with the Treatise, simply return it and we will refund the entire cost.
Completed the Set: The SEC Staff’s Executive Compensation Comment Letters
As the Corp Fin Staff has nearly finished uploading the 350 comment letters from its executive compensation review project last Fall, we have put the finishing touches on providing links to all the comment letters and responses in the CompensationStandards.com “SEC Comments” Practice Area. Thanks to Dave for the heavy lifting on this one. Note that it might be missing one or two…
RiskMetrics’ “Explorations in Executive Compensation”
Recently, RiskMetrics has put out a draft – and lengthy – set of white papers entitled “Explorations in Executive Compensation.” The project is intended to spark constructive dialogue about executive pay issues and I really encourage you to read their papers and provide comments.
The first white paper – “Considerations” – defines and puts into context the basic elements of U.S. executives’ pay packages, with special attention paid to emerging key considerations for investors in evaluating pay and equity plans in particular. The second one – “Innovations” – offers a pair of new methods of looking at critical issues in executive pay: peer group benchmarking and and the degree of alignment between the risks borne by investors and by shareholders.
SEC Petition: Disclosure about Consultant Conflicts
As I prepare to speak at a director’s college next week on executive pay, I read this recent petition from a group of 21 large institutional investors to the SEC that seeks to require companies to disclose all fees associated with consultant engagements for a single company and any ownership interest a consultant working for the compensation committee may have in the parent consulting firm. This disclosure would be made in proxy statements.
I’m still not convinced that consultant conflicts routinely impact CEO pay levels – and I definitely believe there are many other areas in the CEO pay process that are in greater need of fixing, with a much higher priority. Here is some food for thought – a recent study that concludes that potential conflicts of interest between companies and consultants are not a primary driver of excessive CEO pay (note there are studies that have opposite findings).
Back in March, I blogged about Corp Fin’s new position on health care proposals. Now, the NY Times has caught up with this development in this recent article. The article is pretty good and discusses the Staff’s willingness to allow these types of proposals in the proxies this year, but it neglects to mention the instances where the staff granted no-action relief and allowed their exclusion.
The AFL-CIO has been one of the primary proponents in the health care area. In this podcast, Rob McGarrah of the AFL-CIO’s Office of Investment explains the evolution of shareholder proposals related to health care, including:
– Why did the AFL-CIO choose this topic for its proposals?
– What was the SEC Staff’s historical position for this type of proposal?
– What happened this proxy season regarding these proposals?
Half-Price for “Rest of 2008”
As our site memberships and print publications are on a calendar-year basis, we have reduced our prices for all of our websites and most of our print publications so that they are half price for the rest of this year. Take advantage of these reduced rates in our “No-Risk Trial Center.”
Two New Deputy Directors for SEC’s Enforcement Division
Congrats to Scott Friestad and George Curtis for their promotions to Deputy Director in the Division of Enforcement (and Chief Counsel Joan McKown, who gained additional responsibilities). I dig the related press release, which includes an embedded video from the news conference.
Scott and George replace Peter Bresnan, who left last year, and Walter Ricciardi who “retires” at the end of this month (I put retires in quotes because Walter only served on the Staff for four years and starts at Paul Weiss when he leaves the Commission).
Nasdaq Proposes Change to Continued Listing Standards
From Davis Polk: The SEC has published a Nasdaq proposed rule change that would require listed companies to maintain a certain amount of “public shareholders” rather than a certain amount of “round lot holders” as is currently required for continued listing. According to the Nasdaq, for a variety reasons, it is often difficult to determine compliance with the current round lot holder requirements.
If the SEC approves the proposal, Nasdaq would generally require 300 public shareholders for continued listing on the Nasdaq Capital Market, and 400 public holders for continued listing on the Nasdaq Global and Global Select Markets. In the case of preferred stock and secondary classes of common stock, 100 public shareholders would be required for continued listing on the Nasdaq Capital, Global and Global Select Markets. As proposed, the definition of public holder would include both beneficial holders and holders of record, but would not include any holder who is, either directly or indirectly, an executive officer, director, or the beneficial holder of more than 10% of the total shares outstanding. Under this definition, Nasdaq would consider immediate family members of an executive officer, director, or 10% holder to not be public holders to the extent the shares held by such individuals are considered beneficially owned by the executive officer, director or 10% holder under Exchange Act Rule 16a-1.
No change is proposed to the Nasdaq’s initial listing requirements that also require a certain number of round lot holders because the majority of initial listings are IPOs, where a certain number of round lot holders is already required by SEC rules in order to avoid being subject to the penny stock rules and the number of round lot shareholders can be easily determined by the underwriter when distributing the offering. Nasdaq does propose, however, to clarify that the definition of round lot holders includes beneficial holders in addition to holders of record, consistent with current practice.
Late on Friday, the SEC posted a 143-page proposing release for its mandatory XBRL rulemaking. Based on a quick glance, here are some additional thoughts to the ones I blogged a few weeks ago based on what was said at the open Commission meeting:
1. The Proposed Liability Framework – During the open Commission meeting, it was unclear what liabilities might attached to filing in XBRL – giving the impression that this important issue had not been fully worked out yet. Now that we have the proposing release, we can see on page 60 that the SEC is proposing two very different standards – (i) that the interactive data be considered “furnished” as it is under the pilot program versus (ii) that it be considered “filed” as the “viewable interactive data as displayed through software available on the Commission’s Web site… would be subject to the same liability under the federal securities laws as the corresponding portions of the traditional format filing.” I guess this was a compromise to get the proposal out of the building.
Some of you may be asking – what did he just say? I know that this is confusing. The SEC’s proposal has different liability standards for the XBRL data itself and for the “viewable” data. The former is what the machines read; the latter is what humans read (yes, there is a difference – a big difference; more on this later). So, in other words, the raw XBRL data (the “non-viewable” XBRL data) would essentially carry forward the pilot program’s liability regime (but note that no liability for Section 12 has been added – the voluntary filers program didn’t have this immunity) – and the “viewable XBRL data” would have the same type of liability as the official HTML or ASCII filings have today (and so viewable data would be considered “filed”).
2. Late Filers and “Springback” of Current Status – Under the proposal, the financials in XBRL would be filed as an exhibit under Item 601 of Regulation S-K and be considered part of the company’s “official” filing, rather than as a supplement as is the case in the pilot program. Even though a company would lose its Form S-3, etc. eligibilty if it was late in filing its XBRL data, it could regain its current status once the XBRL information was filed. This is a new concept under the SEC’s regulatory framework. (And there is a proposed pair of 30-day grace periods for the first two years.)
3. Possible Alternative Regulatory Frameworks – As with most SEC proposing releases, the Staff does a great job of posing questions to help solicit comments. In the proposing release, I particularly like the list of questions beginning on page 26. Read them to help you better understand what XBRL is all about.
4. Costs – As Dominic Jones notes in his “IR Web Report,” costs are expected to go up significantly in Years 2 and 3 (when “deep-tagging” will be required) and then will decrease rapidly as each company develops its own customized templates that can be re-used.
5. Foreign Private Issuers – As Dominic notes, the proposed rules would not require foreign private issuers that prepare their financial statements in accordance with a variation of IFRS as issued by the IASB to provide XBRL. Foreign private issuers that provide financial information on Form 6-K or any financial information prepared with non-US GAAP that must be reconciled to US GAAP in the foreign private issuer’s ’34 Act reports will not have to be provided in XBRL.
Just added! We are excited that David Blaszkowsky, Chief of the SEC’s Office of Interactive Disclosure, has joined the panel for our July 16th webcast: “XBRL: Understanding the New Frontier.”
By the way, I’ve learned that the Bush Administration’s moratorium on rulemaking doesn’t apply to the SEC because the agency is considered “independent.” So it shouldn’t impact the SEC’s ability to propose and adopt rules whenever it sees fit (although the SEC may voluntarily decide to abide by the Administration’s edict).
XBRL: A New Enforcement Tool?
This recent Reuters article claims XBRL will help uncover suspicious trading and accounting patterns. The example in the article is the option backdating scandal which was based on a study of the information filed in Form 4s (note that Section 16 forms are not being proposed by the SEC to be tagged in XBRL; they already are tagged in XML). If you recall, uncovering backdating practices gathered steam after Professors Randall Heron and Erik Lie’s study, which gathered Form 4 data starting in ’96 – well before Section 16 reports were required to be electronically filed. The professors relied on the Thomson Financial Insider Trading database to obtain the datapoints necessary for their study (and Thomson filled its database manually until Section 16 reports were required to be filed electronically after SOX).
But if memory serves, the SEC’s Enforcement Staff has to work hard to break open a financial fraud case; it’s not typical that the Staff can discern that numbers are “funny” on their face – rather, the fraud is uncovered by digging beyond the information in the SEC filings. So I don’t think that just running the numbers in XBRL is gonna help much. Most analysts (and I presume the SEC Staff) have long had the technology to crunch numbers using computers. In fact, you can access 10 years worth of financials tagged in XBRL right now for all public companies on TryXBRL.com.
Anyways, I worry that this type of promise about XBRL benefits adds to the boatload of misinformation already swirling around XBRL – but maybe someone can give me some concrete examples to show otherwise? I am certainly not an XBRL expert.
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Last Thursday, SEC Chair Chris Cox delivered a speech on the future of IFRS – including a public policy oversight body that would oversee the IASB trustees (the speech notes that the IASC Foundation will consider a new monitor as part of its ’08 Constitution review). This is an important topic that I could literally blog about every day. But, to be honest, I’m not following it as closely as I probably should because I’m only human and there are still so many other developments to cover.
From reading comment letters, etc., I understand one considerable concern is the lack of a strong IFRS enforcement mechanism. The amazing circumstances of the fraud at Société Générale are often held up to illustrate the point of how easy it is for a company to break international accounting rules, get away with it, have its independent auditors bless it, with no major regulatory ramifications (read this Floyd Norris column and an Accounting Onion blog for more). Also held up is the fact that the IASB standards have not been enforced in the past. Finally, there have been concerns raised about how the FAF recently has managed the FASB.
So there are these – and many other – issues to deal with, but it’s clear that the globalization of accounting standards is something that is inevitable. We just need strong regulators – and ones that work together. This will be quite a feat to pull off since there are many cultural obstacles and regulatory differences among jurisdictions. But it is happening – here is a February statement from IOSCO urging companies to clarify which accounting standards they use. IOSCO is the organization whose members are comprised of securities regulators from around the world and who will be a key player in this movement.
Is IFRS Compatible with US-Style Corporate Governance?
This blog below from Tom Selling’s “The Accounting Onion” is several months old, but still interesting and relevant reading:
I just finished reading a brief, highly readable and interesting article by a Columbia Law School professor, John C. Coffee, Jr., entitled “A Theory of Corporate Scandals: Why the U.S. and Europe Differ.” The purpose of this post is to piggyback on his framework to also provide an explanation for the difference in basic approaches between U.S. GAAP and IFRS; and most importantly, why political pressure to trash U.S. GAAP and adopt IFRS should be resisted.
How and Why, According to Coffee, U.S. and European Scandals Differ
Coffee’s thesis is that corporate governance of majority-owned corporations (predominant in Europe) should be fundamentally different than corporate governance of corporations that lack a controlling shareholder group (predominant in the U.S.). It’s not necessarily because there are fewer incentives to rip off other shareholders, but the feasible means to do so will differ.
Scandals in Europe involving majority-owned corporations usually do not feature an accounting manipulation. First, financial reporting is less important to the majority owners because they rarely sell shares; and if they do, they usually receive a control premium that is uncorrelated with recent earnings (and generally larger than control premia in U.S. transactions). Second, fraud is more easily accomplished by misappropriation of the private benefits of control: authorization of related-party transactions at advantageous prices, below-market tender offers, are prime examples. Any trading that takes place between minority owners has less to do with recent earnings reports, and more to do with an assessment of how minority shareholders will be treated by controlling interests.
In dispersed-ownership corporations, managers do not possess private benefits of control. Moreover, a significant portion of manager’s compensation may be in the form of stock options or other forms of equity. Therefore, stock price can have a significant effect on a manager’s compensation, providing them with strong incentives to manipulate accounting earnings.
The Implications for Accounting
Professor Coffee’s thesis is that differences in ownership patterns have important implications for the selection of gatekeepers: auditors, analysts, independent directors, etc. His observations and recommendations are interesting, but I want to advance a related thesis, namely that different ownership patterns call for different types of accounting regimes.
It stands to reason that accounting should be difficult to manipulate, if it can be used to rip off shareholders. Thus, the evolution of U.S. GAAP can be seen as a response to the need for specific rules that minimized the role of management judgment because of their strong self-interest in the reported earnings and financial position. This has occurred in part because U.S. gatekeepers have shown themselves to often lack sufficient resolve or power to prevent management from under-reserving, overvaluing, or just plain ole making up numbers. U.S. managers effectively control the “independent” directors and auditors; and prior to Regulation FD, analysts bartered glowing assessment in exchange for tidbits inside information. Without empowered gatekeepers to prevent accounting fraud, we have had to place our hopes on very inflexible accounting rules, and sheriffs like the SEC and private attorneys to catch the cases where management has attempted to surreptitiously cross the bright line.
Thus, it should be self-evident that IFRS-style accounting, replete with gray areas, would be a gift to U.S. managers. Outright fraud would be replaced by more subtle means of “earnings management,” rendering the SEC and private attorneys much less potent. Is it any wonder why U.S. corporations and their auditors are practically begging to have IFRS available to them?
In short, it would be a grave mistake to adopt IFRS in the U.S. simply because it seems to work well elsewhere. As corporate ownership patterns in Europe change, it may well be that IFRS may evolve to look more like U.S. GAAP. Only after that occurs may it make more sense to have a single worldwide financial reporting regime.
Imagine if Enron Had Applied IFRS
One of the scapegoats of the Enron scandal was “rules-based” U.S. GAAP. The libel was that Andrew Fastow was a mad genius, capable of walking an accounting tightrope by creating complex special-purpose entities (SPEs). But, GAAP wasn’t the culprit in the Enron scandal. Frustrated Fastow was only able to get the accounting treatment he needed past the auditors by hiding from them side agreements that unwound critical provisions requiring the new investors to have a sufficient amount of capital at risk in the SPEs.
The enduring legacy of the libel is the erroneous conventional wisdom that GAAP is responsible for Enron; and what’s more, Enron et. al. might not have happened if our financial reporting system were more like IFRS. More likely, if IFRS had been the basis of accounting for Enron instead of GAAP, it might have taken longer to discover the fraud, or to pin the blame for the fraud where it belonged.
Neither GAAP nor IFRS are principles-based, but GAAP certainly has more rules and bright lines. At least there seems to be some method to the madness, but it would be nice if more of the rules were based on sound principles.
Peggy Foran: Moving On Up
Congrats to my good friend Peggy Foran, who is leaving Pfizer after a long stint to become General Counsel of Sara Lee (here is the press release). At Sara Lee, Peggy will be surrounded by friends – including Helen Kaminski, who will be speaking at our upcoming webcast: “E-Proxy’s First Season: Lessons Learned.”
As many of you know, Peggy is one of the most prolific persons in our profession. Besides being a very kind soul, Peggy has an incredible background, having worked a number of interesting jobs over the course of her long career. One of the reasons why Peggy is so knowledgeable is that she is a tireless networker. Being an avid networker myself, I am amazed at how much more Peggy is able to do – and Peggy uses her network, always asking probing questions to become even better at what she does. Now that Peggy is entering the executive suite, I hope we haven’t seen the last of her at the many events that she graces today!
Last month, a three judge panel of the DC Circuit Court of Appeals heard oral arguments in Free Enterprise Fund, et al. v. Public Company Accounting Oversight Board, et al.. The lawsuit, originally filed in February 2006, alleges that the provisions of the Sarbanes-Oxley Act establishing the PCAOB are unconstitutional because those provisions violate separation of powers principles. With no separability clause in the Sarbanes-Oxley Act, a finding that one provision of the law is unconstitutional could bring down the whole Act. The pending appeal is from a March 2007 District Court ruling in favor of the PCAOB.
Based on the transcript of the oral argument, the focus of the Court was on the uniqueness of the PCAOB’s structure as essentially a government entity for constitutional purposes, but not a government entity for statutory purposes. While the appellants conceded the SEC’s role in overseeing the PCAOB’s rulemaking, they targeted their attack on the PCAOB’s allegedly unchecked enforcement and inspection function. In addition, the Court focused its questioning on the “for cause” requirement for removal of PCAOB Board members (as opposed to an at will removal standard), which is likewise the standard for removal of SEC Commissioners and thus puts the PCAOB’s leadership two “for cause” steps away from the President. While the government argued that the PCAOB was built around the self-regulatory organization model, the appellants (and the Court) pointed out the significant distinctions with the PCAOB, principally in that its board is appointed by the SEC and board members are only removable by the SEC for cause.
While it is certainly difficult to tell solely from the oral argument, this case may not be a slam dunk for the PCAOB and the government. Certainly the consequences of a ruling against the PCAOB are difficult to imagine – reopening the PCAOB and all of Sarbanes-Oxley at this point would undoubtedly be a bad idea.
In this commentary, Jonathan Weil of Bloomberg points out the views expressed during the oral argument by Judge Kavanaugh, who was by far the most vocal of the three judges on the panel.
LIBOR on Shaky Ground
I can’t think of anything more ubiquitous as a benchmark in financings and derivatives than the London Interbank Offered Rate (LIBOR), which has come under attack in the last few months for being out of synch with market developments. Yesterday’s WSJ featured an interesting article on the problems with LIBOR and some data suggesting how far out of whack LIBOR has become. Later today, the British Bankers Association will announce plans to make the first changes to LIBOR in over ten years.
Before becoming a lawyer, I managed assets and liabilities for a bank, and I can recall anxiously awaiting for the moment shortly after 11:00 a.m. London time when the BBA would post the day’s LIBOR and it would pop up on my Telerate screen. I always envisioned a bunch of guys in bowler hats (kind of like the bankers in Mary Poppins) drinking tea and setting the daily rates, but in reality, the BBA surveys its 16 member banks on how much it would cost them to borrow from each other for 15 periods ranging from overnight to one year (in currencies including dollars, euros and yen), and then averages the results of that survey data. Always taking the numbers as gospel, it never occurred to me that LIBOR’s reliability could ever be called into question, given the tendency of any survey and average to potentially distort reality. Notably, the WSJ article indicates that during times of market turmoil like we have faced in the past several months, banks have an incentive to avoid submitting rates to the survey that are higher than those submitted by their peers, lest they signal financial problems or desperation. This incentive tends to force the rates used to compute LIBOR to cluster together. This trend is perhaps confirmed by the fact that when the BBA threatened a month ago to ban from the survey any banks that misquoted their rates, the three month rate shot up 18 basis points over the next two days.
I doubt that the current troubles with LIBOR will push too many players to other benchmarks, particularly given how entrenched LIBOR is in the US and abroad. There are of course other alternatives for benchmarking short-term rates, such as the US Fed Funds rate. The principal difference between LIBOR and the Fed Funds rate is that while LIBOR is based on survey data, the Fed Funds rate is a target interest rate fixed by the Federal Open Market Committee and implemented through the open market operations carried out by the New York Federal Reserve.
2008: The Year of the Hedge Fund Activist
We have just posted the transcript for the DealLawyers.com webcast: “2008: The Year of the Hedge Fund Activist.” Catch the companion webcast – “How to Handle Hedge Fund Activism” – on July 15th.
Like last year’s blockbuster conferences, an archive of the entire video for both conferences will be right there at your desktop to refer to – and refresh your memory – when you are actually grappling with drafting the disclosures or reviewing/approving pay packages. Here are FAQs about the Conferences.
For those choosing to attend by coming to New Orleans, I encourage you to also register for the “16th Annual NASPP Conference,” where over 2000 folks attend 45+ panels. And if you attend the NASPP Conference, you can take advantage of a special reduced rate for the Exec Comp Conferences.
If you have questions or need help registering, please contact our headquarters at info@thecorporatecounsel.net or 925.685.5111 (they are on West Coast, open 8 am – 4 pm).
SEC Nominations Move Forward
A Senate Banking, Housing and Urban Affairs Committee hearing is now scheduled for Tuesday, June 3rd to consider the nominations of Luis Aguilar, Elisse Walter and Troy Paredes. The hearing will include a number of other nominees for open positions at various federal agencies, including the Treasury Department, HUD, GNMA, the National Credit Union Administration Board and the President’s Council of Economic Advisors. Once the Senate Banking Committee has considered the nominations, it remains to be seen whether the SEC nominees will be fast-tracked for a vote by the full Senate.
This article from yesterday’s Washington Post notes the government-wide exodus of senior officials as the current administration winds down, as well as the difficulties faced in moving nominees forward. I agree with some of the experts cited in the article that the process of changeover in agencies is exceptionally difficult for the staff and tends to go on for way too long these days. Even for agencies like the SEC, which doesn’t have any political appointees beyond the Commissioners, the unwritten rule is that directors and perhaps other senior Staffers can expect to be replaced when a new Chairman comes aboard. Even in the best of circumstances, this makes for at least a couple of years of uncertainty about the direction of SEC policy and a lot of Staff distraction.
SEC Settles an Auction Rate Securities Case
The SEC recently settled an administrative proceeding instituted against First Southwest Company for its role as an underwriter of and agent for auction rate securities. The auction rate securities market has seen some significant disruptions throughout the credit crisis, and the activities of market participants in connection with recent auctions may receive more attention from Enforcement in the coming months. Back in 2006, the SEC had reached a $13 million settlement with 15 investment banks, and the industry agreed to impose a voluntary code of conduct for the auction-rate market.
The SEC’s Order in the First Southwest case indicates that, without adequate disclosure, the broker-dealer intervened in the auctions that served to reset the interest rate on the securities by bidding for its own account in order to prevent failed auctions and to prevent “all hold” auctions (when a below market rate is set because no securities are for sale in the auction). In some of these interventions, First Southwest’s activity had an effect on the clearing rate derived from the auction, which is the rate that determines the interest rate or yield that the issuer must pay to investors until the next auction. The only charge brought by the SEC on this conduct was for violation of Securities Act Section 17(a)(2), based on the misstatements and omissions about the potential for such intervention in the auctions.
In determining the penalty assessed on First Southwest, the SEC noted the firm’s cooperation, but also noted that First Southwest had not self-reported the potential violations to the SEC. The SEC noted that it “aims to promote voluntary disclosures in industry-wide investigations and to encourage firms to provide comprehensive information to the staff in such investigations.”
We just put the finishing touches and mailed the May-June ’08 issue of The Corporate Counsel, which includes analysis of:
– More on Obtaining Staff Guidance
– Amended Rule 144—Impact on Pledgees and Donees
– More on the New 8-K CDIs
– Parsing the Integration Safe Harbors
– Corp Fin’s Mini Re-Org
– S-3 Eligibility Waivers—8-K Latitude?
– Staff Says No Non-GAAP Financial Statements
– Use of Company Stock to Make Matching Contribution to 401(k) Plan—NYSE Notice and Shareholder Approval Requirements
– 8-K Reporting of JPMorgan Chase’s CEO Option/SAR Grant
– Bebchuk Status Report
If you are not a subscriber to The Corporate Counsel, try a no-risk trial today. If you still need to renew your subscription for this year, do so today so you won’t miss this critical guidance.
Using SOX 302 Certifications to Plead Scienter
Since the enactment of the Sarbanes-Oxley Act, courts have been split on the extent to which CEO/CFO certifications may be used by private plaintiffs to satisfy the requirement for pleading scienter under Section 10(b) and Rule 10b-5.
In this podcast, Howard Suskin and Jennifer Lawson of Jenner & Block provide insight into the use of SOX Section 302 certifications to plead scienter, including:
– How are Section 302 certifications being used by plaintiff’s lawyers in lawsuits?
– What are the courts’ reactions so far? Are they drawing an inference of scienter?
– What do you advise companies to do now to minimize the risk of scienter being found?
If International Financial Reporting Standards (IFRS) is really going to come to pass for US issuers in the next five years or so, then some radical changes will need to be made to our US GAAP-based system – and soon. One of the most important areas where this change needs to occur is in the accounting departments of our colleges and universities, on the theory that accounting majors should not be wasting their time learning the intricacies of US GAAP, if what they will have to apply in four years is IFRS as established by the IASB.
This CFO.com article notes that the Big Four accounting firms are moving forward with efforts to help develop IFRS-focused curricula and to provide other resources that may be used by academia. These efforts are encouraging, but perhaps may not be enough to accomplish the real sea change that is needed to make IFRS a reality on such a relatively short timetable. Ultimately, perhaps the ideal would be for graduating students to have a better handle on IFRS than the partners that they go to work for at accounting firms!
The SEC announced that it signed protocols with financial regulators in Belgium, Bulgaria, Norway and Portugal to share information on the application of IFRS. These protocols, which are based on a model protocol developed between the SEC and the Committee of European Securities Regulators, provide for the confidential exchange of issuer-specific information that will be relevant toward implementing IFRS. The SEC has a similar arrangement with the UK Financial Reporting Council and the UK Financial Services Authority.
