After SEC’s Chief Accountant Conrad Hewitt blessed the ESOARs arrangement proposed by Zions Bancorp, the Council of Institutional Investors wrote a letter to the SEC expressing concerns as to whether market instruments can appropriately value options, particularly given that Zions is activately marketing its valuation approach to other companies. Conrad recently sent this letter to CII noting that the SEC will continue to analyze – and accept input – on this issue.

In ISS’ “Corporate Governance Blog,” ISS has provided some analysis about the challenges that companies and investors face when determining the fair value of options. In addition, ISS recently held a webcast to discuss the complexities of option expensing as well as has begun publishing a regular “Options Expensing Alert” to help evaluate the accuracy and reliability of specific expense calculations.

Grumblings from investors about unfair option values seem to fall into a number of discrete categories, including questionable assumptions set forth by companies; auditors not challenging those assumptions; and wide lattitude from the SEC regarding what assumptions are acceptable.

Option Backdating Cases: Deadline Looming? Disclosure-Only Charges?

Like this recent Financial Times article notes, a number of commentators have been talking about whether SEC and other enforcement officials will beat applicable statute of limitations deadlines in the numerous option backdating investigations pending.

An Associate Director in the SEC’s Enforcement Division caused a stir a month ago when she said that she “wouldn’t be surprised” if the agency brings some backdating enforcement actions that do not involve fraud, but rather would allege misleading disclosures only. According to this related Reuters article, the SEC has established guidelines to determine which matters will be prosecuted. Those factors include the duration of the misconduct, the “quantitative materiality of the compensation charges,” the quality of the evidence and whether the company is filing a restatement.

Option Lies May Be Costly for Directors

Here is an interesting backdating column by the NY Times’ Floyd Norris from last month:

“For companies that played games with employee stock options, the possible penalties are growing. New rulings in Delaware indicate that directors will be personally liable if options were wrongly issued. And the Internal Revenue Service has decided that employees who innocently cashed in backdated options in 2006 face a soaring tax bill. The service has given companies two weeks to decide whether to pick up the tax for the workers. That means directors must decide whether to spend corporate assets on bailing out workers, possibly angering shareholders, or leave the workers to shoulder huge tax bills.

In two rulings issued this month, Chancellor William B. Chandler III of the Delaware Chancery Court made it clear that the backdating of options was illegal. That was no surprise, but he went on to say that the same applied to “spring loading,” the practice of issuing options just before the release of good news.

“It is difficult to conceive of an instance, consistent with the concept of loyalty and good faith, in which a fiduciary may declare that an option is granted at ‘market rate’ and simultaneously withhold that both the fiduciary and the recipient knew at the time that those options would quickly be worth much more,” Chancellor Chandler wrote.

That decision creates the possibility of significant liability for directors, particularly those on compensation committees. Issuing options is an area over which they had specific authority. And since the decisions came in suits filed by shareholders of Tyson Foods and Maxim Integrated Products, they open the way to similar suits by owners of other companies.

Chancellor Chandler’s opinions go well beyond anything that the Securities and Exchange Commission has said. The S.E.C. has denounced backdating, the practice of saying an option was issued earlier than it was, when the share price was lower. It has forced companies to restate financial results and pay penalties.

But on spring loading, the only official comments from the commission have come from its chief accountant, who said there was no need to revise accounting, and from one commissioner, Paul S. Atkins, who suggested that the practice was just fine with him. “Isn’t the grant a product of the exercise of business judgment by the board?” he asked in a speech last year. “For example, a board may approve an options grant for senior management ahead of what is expected to be a positive quarterly earnings report. In approving the grant, the directors may determine that they can grant fewer options to get the same economic effect because they anticipate that the share price will rise. Who are we to second-guess that decision? Why isn’t that decision in the best interests of the shareholders?”

Chancellor Chandler, without mentioning Mr. Atkins, had an answer for him. It is possible that a decision to issue spring-loaded options “would be within the rational exercise of business judgment,” he wrote. But, he added, that could be true only if the decision were “made honestly and disclosed in good faith.” No such disclosures were made by spring-loading companies.

Chancellor Chandler’s opinion counts because Delaware is where most major companies are incorporated. He cleared the way for a suit against Tyson directors who approved options that appear to have been spring loaded, although that has not been proved. He also ruled that companies could not use the statute of limitations to avoid such suits. Even if the options were issued years ago, the fact that the directors hid the practice means that they can be sued now, when the facts have come out.

The tax issue stems from a law that took effect in 2005 regarding deferred compensation. It was not aimed at backdated options, but the I.R.S. says it applies to them if they were vested — that is, if the employee got the right to exercise them — after the end of 2004. Options can vest up to five years after they are issued, so some old option grants are partly covered.

If a taxpayer exercised such an option in 2006, the effective tax rate rises from 35 percent of the profits to 55 percent, and interest penalties could make the figure even higher. The I.R.S. gave companies until Feb. 28 to notify it if the company would pay the excess taxes for employees who exercised such options last year, and said the employees must be notified by March 15.

Directors of companies that issued backdated or spring-loaded options may now try to shift the blame. One can imagine directors contending they were deceived by executives or by corporate counsel, and that they, not the directors, should pay. Personal liability, in other words, can concentrate a director’s mind.

In our “Conference Notes” Practice Area, we posted some notes from this weekend’s Spring Meeting of the ABA’s Business Law Section. This includes notes from the popular panel: “Dialogue with the Director of the SEC’s Division of Corporation Finance” – and notes from an executive compensation disclosure panel.

Corp Fin Review of Executive Compensation Disclosures

Here is an excerpt from the notes from the Corp Fin Director Dialogue panel regarding the Staff’s plans to review compensation disclosures:

“The Staff is gearing up for an organized review of the new executive compensation disclosures, which will include review of the disclosure provided pursuant to revised Item 404 of Regulation S-K and new Item 407 of S-K. Mr. White said the Staff will select a “critical mass” of companies for review (in the hundreds) and targeted reviews will be performed. Comment letters will not be issued immediately, but instead the Staff will wait until it has seen enough filings to ensure that the comments will be consistent when issued. Mr. White would not offer any assurance that companies would only receive futures comments, and that they may need to amend their Form 10-Ks because the Staff considers these disclosures to be “live.”

After this review, the Staff will issue a report of their observations regarding the new disclosures, similar to the Fortune 500 Report issued in 2003 (now available on Corp Fin’s Accounting and Financial Reporting webpage). The Staff may also issue new interpretations or even propose revisions to the rules based on this review. Mr. White expects these projects to be completed by the Fall (which in his view goes through December) so that any revisions will be completed in time for next proxy season.

Moreover, the Staff will be data tagging the executive compensation data from a select group of companies, probably the 500 largest or some such number of large companies, including their Summary Compensation Table. The Staff will not be tagging the footnote disclosure, but will provide links to the proxy statements where that information can be retrieved.

Mr. White also said that the data tagging will allow users to not only compare disclosure across companies, but will allow them to manipulate the data. For example, a user will be able to replace the FAS 123(R) numbers in the SCT with the fair value numbers and recalculate compensation based on those new values. This project is also expected to be completed by the Fall.”

By the way, the tagging of data was discussed during yesterday’s SEC Roundtable on XBRL – here are notes about that roundtable from FEI.

Latest Analysis of How Funds Vote

With each proxy season wilder than the last, keeping track of how funds vote becomes more important. The Corporate Library has now published their analysis of how mutual funds voted last year. The report analyzes the 2006 voting records of 29 large mutual fund families, which includes the voting records of 702 funds, amounting to more than 1.2 million voting decisions.

Here are some of the study’s findings:

– Funds supported 92% of management-sponsored proposals in 2006 on average, up from 89% in 2004. A small number of management resolutions propose reforms that shareholders have called for in the past, yet receive much higher support when proposed by management. For example: Dreyfus, which voted in favor of no shareholder resolutions to declassify the board in 2006, voted for 98% of management proposals to adopt the same reform.

– Putnam was the fund family least likely to support management-sponsored resolutions, with an average 79% support. American and Ameriprise had the highest levels of support for management resolutions, with average support of 97%.

– Funds voted in favor of 37% of shareholder-sponsored resolutions, on average. Governance-related resolutions, which comprised 76% of all shareholder-sponsored resolutions published in proxies in 2006, received 44% support from funds. This figure has increased over the three years spanned by this study for 14 of the largest fund families, from 37% in 2004.

– Among shareholder resolutions, those proposing board declassification received the highest level of fund support – 87.7%, on average – in the 2006 proxy season. The largest category of shareholder resolution, those urging majority affirmative support for uncontested director elections, achieved 60% support from funds, on average, up significantly over the past three years.

Back at the end of January, at the Northwestern Conference in San Diego, Cisco’s general counsel, Mark Chandler, gave a provocative speech about how he sees the future of legal practice. Here is an excerpt from that speech that pretty nicely illustrates how Mark provides food for thought in his speech:

“First, how is technology driving change in knowledge-based industries? Second, what are the key areas of vulnerability in the legal services business to these technological changes? And third, what will it take to succeed in this changed environment?”

I think many of us would be more than happy to see the death of the billable hour. Aren’t you tired of reading articles like this one that implicitly makes a mockery of our profession?

Rethinking Your Legal Department

In this podcast, Rees Morrison of Hildebrandt International provides some insight into law department management issues, including:

– How do you help in-house legal departments?
– What do you see as the biggest challenges faced by those departments today?
– How do you see the practice of law changing?

Doing It “J-SOX” Style

Last year, the Japanese Diet passed a comprehensive governance reform to create the “Financial Instruments and Exchange Law.” Some commentators view this as a modified verison of the US’ Sarbanes-Oxley and have dubbed it “J-SOX.” This new law will impact all 4000 Japanese public companies when its implemented on March 31, 2009 (most Japanese companies have a 3/31 year-end). All of the details regarding what will be required have not yet been worked out.

There are some notable differences between J-SOX and what we have here in the US. For example, under J-SOX, an auditor attestation will not be required. Learn more in our “J-SOX” Practice Area.

A few days ago, Corp Fin issued this Beazer Homes USA interpretive letter that deals with the availability of Form S-8 for the exercise of stock appreciation rights and subsequent resale of underlying equity securities. General Instruction A.1(a)(5) of Form S-8 makes the Form available for the exercise of employee benefit plan options and the subsequent resale of the underlying securities by certain family members of an employee who acquired the options from the employee through a gift or domestic relations order.

The Staff was asked whether stock appreciation rights that may be settled in equity securities of the registrant may also be registered on Form S-8 in these situations. Given that the stock settlement of a stock appreciation right is economically equivalent to the cashless exercise of an option for the same number of shares, the Staff indicated that for purposes of General Instruction A.1(a)(5), in its view, the term “option” includes a stock appreciation right that may be settled in equity securities of the registrant.

Accordingly, when the other conditions of General Instruction A.1(a)(5) are satisfied, Form S-8 would be available for the exercise of stock appreciation rights and subsequent resale of underlying equity securities. This position is limited to stock appreciation rights that may be settled in equity securities of the registrant. All of this is not too much of a big deal as most practitioners haven’t questioned whether SSARs were covered under an S-8 – as we have written about in The Corporate Executive in the past – but it’s nice to have it clearly stated in an interpretive letter.

Tackling Global Warming: Even Corporate Lawyers Need to Take Heed

With climate control becoming an inevitable issue that we all will have to deal with – both in our personal and professional lives – we have launched a new website to help you navigate how global warming will impact the corporate & securities laws. Sponsored by TheCorporateCounsel.net and the National Council for Science and the Environment, this full-day June 12th webconference is free to all – and the agenda is listed on TacklingGlobalWarming.com. Here is a snapshot of that agenda:

– What the Studies Show: A Tutorial
– The Business Case for Tackling Global Warming
– The Board’s Perspective: Strategic Opportunities and Fiduciary Duties
– Why You Need to Re-Examine Your D&O Insurance Policy
– The Investor’s Perspective: What They Seek and Their Own Duties
– Disclosure Obligations under SEC and Other Regulatory Frameworks
– How (and Why) to Modify Your Contracts: Force Majeure and Much More
– Due Diligence Considerations When Doing Deals

It is notable that law firms are ramping up their climate control practices (see this recent NY Times article) and that an environment group recently hired an investment banker to help them negotiate their interests in an energy merger.

2500! A Blistering Pace

In our “Q&A Forum,” we have blown right through query #2500 (and even #2600) – which is really a higher number since many of these have follow-ups queries. As the pace has been blistering, I’m not sure if we can keep up with the growing pace of questions – you are reminded that we welcome your own input into any query you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply…

Perhaps to the chagrin of those finalizing – or have finalized – their proxy disclosures, Corp Fin posted a bunch of new “phone interps” yesterday (they’re actually not called phone interps anymore; they are more formally known now as “Compliance and Disclosure Interpretations”). There four new sets of interps, including:

– Item 201 of Regulation S-K – Common Equity Information and Shareholder Matters

– Item 403 of Regulation S-K – Security Ownership

– Item 404 of Regulation S-K – Transactions with Related Persons

– Item 407 of Regulation S-K – Corporate Governance

SEC Plans to Adopt Foreign Private Issuer Termination Rules

The SEC announced an open Commission meeting for next Wednesday to consider adopting rules that would allow foreign private issuers to deregister more easily – and Chairman Cox gave a speech during which he said he opposes weakening Sarbanes-Oxley…

Pop Quiz! Proxy Season Reminders

A member sent over the following conference notes, which serve as a nice pop quiz to determine how well you are “informed” this proxy season. At the Corporate Counsel Institute held at Georgetown University Law Center last week, Corp Fin Deputy Director Marty Dunn provided 10 points to remember for this proxy season:

1. Companies should confirm that the certifications required in Form 10-K by Regulation S-K Item 601 are accurate. A number of companies have been found by the Staff to have not adhered to the precise language of the Item.

2. Companies should carefully follow Item 601(b)(10) of Regulation S-K regarding material contracts required as exhibits, particularly with respect to per se material agreements such as those involving named executive officers.

3. Companies are not required to deliver board committee charters to shareholders if such charters are made available via a web site link – but companies must reference the website link in its disclosure.

4. Pursuant to Item 407 of Regulation S-K, where a company adopts its own definition for “independence” of directors, it must disclose the web site link where the definition may be found or append the definition to the proxy statement every three years.

5. Regarding disclosure of related-party transactions under Item 404(b) of Regulation S-K, a company must disclose its related-party transactions policy even if it doesn’t have any related-party transactions required to be disclosed under Item 404(a).

6. The beneficial ownership table required under Item 403 of Regulation S-K was amended pursuant to the new executive compensation rules to require disclosure of shares beneficially owned by directors and officers that are pledged as security.

7. Companies should be aware of the expansion of the plain English requirement from prospectuses to include executive compensation-type disclosure required under Items 402, 403, 404 and 407 of Regulation S-K.

8. Remember the requirement imposed in the securities offering reform rules that companies must make certain disclosures in their Form 10-K regarding unresolved comments from the SEC Staff.

9. Under the new executive compensation rules, companies are not required to disclose precise numbers if the amounts of salary and bonuses through the last calculable date cannot yet be determined. However, where companies do not do so and the compensation later becomes calculable, they are required to file a Form 8-K report disclosing these amounts pursuant to 5.02(f) of Form 8-K.

10. The peer index performance graph is no longer a proxy statement requirement but has not disappeared entirely. It is still required to be included in the “glossy” annual report required to be filed under Rule 14a-3.

Both Sides Declare Victory at H-P

Hewlett-Packard investors voted down a proposal that would have allowed shareholders who have owned at least 3% of HP’s outstanding stock for at least two years proxy access to nominate two board candidates. About 1.61 billion shares, or 52% of the total shares voted, were against the proposal. More than 800 million shares, or 39% of the total shares voted, were in favor. The percentages were enough for both sides to declare victory. Learn more at CorpGov.net.

I started blogging about this executive compensation case way back in 2005 – and at long last, we have an opinion in Valeant Pharmaceuticals v. Panic & Jerney – a case that went all the way to trial in Delaware’s Chancery Court (just like Disney). In the CompensationStandards.com “Executive Compensation Litigation Portal,” we have posted a copy of the opinion.

Here is a recap of the decision from Travis Laster of Abrams & Laster: Vice Chancellor Stephen Lamb of the Delaware Court of Chancery held that a transaction bonus received by a former director and president of ICN Pharmaceuticals, Adam Jerney, was not entirely fair. The Vice Chancellor ordered Jerney to disgorge the entire $3 million bonus. He also held Jerney liable for (i) his 1/12 share (as one of 12 directors) of the costs of the special litigation committee investigation that led to the litigation and (ii) his 1/12 share of the bonuses paid by the board to non-director employees. The Vice Chancellor also ordered him to repay half of the $3.75 million in advancements that INC paid to Jerney and the primary defendant, ICN Chairman and CEO Milan Panic, to fund their defense. The Vice Chancellor granted pre-judgment interest at the legal rate, compounded monthly, on all amounts.

The ICN decision is a must-read for any practitioner who advises boards of directors or compensation committees on compensation issues. It contains a number of key holdings and comments. Here are some highlights:

1. Vice Chancellor Lamb found that all of the members of the board were interested in the bonuses paid in connection with an IPO of ICN, because even the outside directors on the compensation committee received a minimum of $330,500 per director. The Vice Chancellor viewed this compensation as making the compensation committee members “clearly and substantially interested in the transaction they were asked to consider.”

2. The Vice Chancellor was highly critical of the process followed by the compensation committee and its reliance on a compensation report prepared by Towers Perrin. The Vice Chancellor found that Towers Perrin was initially selected by management, was hired to justify a plan developed by management, initially criticized the amounts of the bonuses and then only supported them after further meetings with management, and opined in favor of the plan despite being unable to find any comparable transactions.

3. The Vice Chancellor rejected an argument that the Company’s senior officers merited bonuses comparable to those paid by outside restructuring experts. “Overseeing the IPO and spin-off were clearly part of the job of the executives at the company. This is in clear contrast to an outside restructuring expert…”

4. The Vice Chancellor held that reliance on the Towers Perrin report did not provide Jerney with a defense under Section 141(e) of the General Corporation Law, which provides that a director will be “fully protected” in relying on experts chosen with reasonable care. “To hold otherwise would replace this court’s role in determining entire fairness under 8 Del. C. sec. 144 with that of various experts hired to give advice….” The Vice Chancellor also held separately that Towers Perrin’s work did not meet the standard for Section 141(e) reliance.

5. The Vice Chancellor held that doctrines of common law and statutory contribution would not apply to a disgorgement remedy for a transaction that was void under Section 144. Hence Jerney was required to disgorge the entirety of his bonus without any ability to seek contribution from other defendants or a reduction in the amount of the remedy because of the settlements executed by the other defendants.

As an aside, it bears noting that this case is one of the rare situations in which a special litigation committee has realigned the company as plaintiff and pursued the claims originally brought by a stockholder plaintiff as a derivative action.

The ICN opinion shows the significant risks that directors face when entire fairness is the standard of review. The opinion also shows the dangers of transactions that confer material benefits on outside directors, thereby resulting in the loss of business judgment rule protection. Although compensation decisions made by independent boards are subject to great deference, that deference disappears when entire fairness is the standard. “Where the self-compensation involves directors or officers paying themselves bonuses, the court is particularly cognizant to the need for careful scrutiny.” Contrast, for example, the outcome in ICN, involving an interested board, and the quite different outcome in Disney, involving an independent board.

[Broc’s Final Four Picks: Georgetown over Florida in the final, with Texas A&M and Kansas also making the last weekend; it was tough not to take Texas over Georgetown. I correctly picked Florida to win it all last year, so I can rest on those laurels for at least a decade, right?]

Backdated Options and ERISA Claims

In this CompensationStandards.com podcast, John Gamble of Fisher & Phillips provides some insight into how ERISA claims will be brought in the options backdating lawsuits, including:

– For what we can tell, what were the backdating circumstances at Mercury Interactive?
– What role do you think human resource professionals played in backdating (compared to other employees)?
– How do ERISA claims come into play regarding backdating?

International Investors Endorse Say-on-Pay

From ISS’ “Corporate Governance Blog“: An international coalition of 13 institutional investors has endorsed the right of U.S. shareholders to have an annual advisory vote on executive compensation practices.

In a letter to Securities and Exchange Commission Chairman Christopher Cox, the investor group argued that advisory votes on executive pay would “improve communication between shareholders and directors; encourage pay-for-performance practices; increase focus on individual company circumstances and strategic goals in the development and evaluation of executive compensation plans; and provide a counter-weight to upward pressure on executive compensation from enhanced disclosure requirements.”

The group urged the SEC to take action to establish shareholder votes on pay through regulatory action or through exchange listing standard changes. The investors also said they would support legislation to provide such a right. U.S. Rep. Barney Frank, the chairman of the House Financial Services Committee, introduced a bill in 2005 that called for votes on pay plans, but the measure stalled in Congress, which was then controlled by Republicans.

So far this proxy season, labor pension funds and other U.S. investors have filed more than 60 proposals seeking advisory votes on pay practices.

The Jan. 25 letter, which was orchestrated by the Universities Superannuation Scheme of the United Kingdom, was signed by eight other U.K. institutions, two from the Netherlands, one from Australia, and the Connecticut Retirement Plans and Trust Funds. Among the other signatories are ABP Investments from the Netherlands; Hermes Equity Ownership Services, F&C Asset Management, the Local Authority Pension Fund Forum, and Shell Pensions Management Services, all from the U.K.; and UniSuper Management from Australia.

Such advisory votes are required in the United Kingdom, Australia, and Sweden, while Dutch firms must submit pay policies to a binding shareholder vote. According to the international investor group, the votes in these markets have made companies more receptive to shareholders on compensation issues. The investors cited the example of British drugmaker GlaxoSmithKline, which adjusted its remuneration plan after a 51 percent negative vote in 2003. In Australia, shareholder opposition prompted gaming company Tabcorp to withdraw an options plan for its CEO last year, while packaging firm Amcor agreed to increase performance hurdles and extend vesting schedules, according to the investor group. Other firms in these markets now are using longer-term performance targets in incentive plans and have improved their pay disclosure.

Yesterday, the US Chamber of Commerce released a 179-page Report from a Commission it formed that makes a series of reform recommendations (here is an executive summary of the Report). This Report comes on the heels of a number of other reports urging reform, all of which are posted in our “Sarbanes-Oxley Reform” Practice Area; also noteworthy is today’s NY Times article on CEOs mingling with Congress leaders and Bush adminstration officials over reform efforts.

Here are the six “primary recommendations” from the Report:

1. Modernize the SEC – Reform and modernize the federal government’s regulatory approach to financial markets and market participants, including realigning its organizational structure (by forming a few new Divisions, including promoting a few offices to a Division such as the Office of International Affairs).

2. Give the SEC More Exemptive Authority – Congress should pass a law to provide the SEC with the flexibility to address issues relating to the implementation of the Sarbanes-Oxley, including folding SOX into the Securities Exchange Act of 1934.

3. Minimize Earnings Guidance – Companies should stop issuing earnings guidance altogether or move away from quarterly earnings guidance with a single earnings per share number to just providing annual guidance with a range of projected EPS numbers.

4. Protect Auditors – Policymakers should consider proposals to reduce the significant risks faced by auditors raised by litigation and criminal prosecution; consider the notion that auditors be allowed to raise capital from private shareholders rather than just audit partners.

5. More Retirement Savings Plans – Retirement savings plans should be multiplied by connecting all businesses with 21 or more employees which lack these plans to financial institutions that will provide such a plan.

6. Encourage More to Save for Retirement – Employers should sponsor retirement plans and enhance the portability of retirement accounts through the introduction of a simpler, consolidated 401(k)-like plan.

There are quite a few recommendations in the Report beyond these six primiary ones. For example, in the accounting area, the Report encourages continued of convergence of international and US accounting and auditing standards and seeks a change to the SEC’s existing approach to reconciliation (the Report recommends deciding whether to eliminate should be made on a country-by-country basis, with mutual recognition). The Report also would have the SEC’s Chief Accountant conduct rulemaking about when a restatement of financials is required.

In the enforcement area, the Report believes the SEC should implement – with Congressional support via targeted legislation – an enhanced “prudential” role over financial intermediaries and recommends that the DOJ and SEC should not consider the waiver of privilege as a factor in determining whether there was cooperation in an investigation. The Report also urges the SEC to study whether its enforcement program is effective (as well as the PSLRA’s impact on the effectiveness of the federal securities laws).

The Report tackled the thorny issue of formal vs. informal guidance from the SEC Staff – although informal guidance from the SEC is encouraged in the Report, “all parts of the SEC – including the Office of Chief Accountant – should adhere to the notice and comment procedures of the Administrative Procedures Act for significant changes in policy.” That sounds fine in principle but I get worried that all Staff guidance will be shut down (and the queries in our Q&A Forums will triple).

Other bloggers have analyzed this Report, including the D&O Diary and FEI’s Financial Reporting Blog.

Fixing CEO Pay From “Within”

Congrats to our own Jesse Brill for being profiled in today’s front-page WSJ article for his efforts to rein in CEO pay. Working with Jesse for these past 4-plus years has taught me a lot – including how important it is for us lawyers to speak up and say what we think, regardless of how unpopular the message might be. Somewhere over the past few decades, the legal profession changed and has tended to look more and more like a pack of sheep. Jesse has a lot of backbone and isn’t afraid to use it.

All I Ever Wanted Was a Human…

Thanks to Jim McRitchie of CorpGov.net for pointing us to GetHuman.com, a site that blissfully lists how to get ahold of a human on the phone rather than the automated mazes we encounter too often in our daily life. Of course, the human you get may very well be far away in India or some exotic locale…

On Friday, I blogged about Chairman Cox’s speech during which he noted that some explanations of executive compensation in proxy statements are running more than 40 pages and yet are not telling investors enough about how the bosses are being paid. He also noted that there is a lack of plain English in some CD&As. And he used the term “overlawyered.”

I received quite a bit of feedback from members that have been working long hours on these disclosures and took offense to the Chairman’s “overlawyered” comment. First, they noted that no one should be surprised that compensation disclosures are running more than 30 pages. This was the page count predicted by most when the new rules were adopted – and this was the length of Pfizer’s compensation disclosure last year when that company made proxy disclosures that roughly complied with the proposed rules that existed at the time.

Some members noted that the new rules are very extensive and companies are concerned about being sued by the SEC or the plaintiffs’ bar if they have not completely described everything. For many companies, there is a need for lengthy narrative disclosure explaining the numbers in the Summary Compensation Table as well as the other tables (eg. yesterday’s NY Times’ column cites an example of a negative “total” number in a a recently filed SCT; that circumstance surely requires some narrative explaining). In fact, as I noted on Friday, I believe that some companies have not provided enough disclosure as it’s hard to follow the dots in their compensation story.

More importantly, quite a few members note that it is the lawyers who are helping to cut through the HR department’s attempt to put boilerplate in the proxy statement. They worry that the Chairman’s comments may backfire as people now have a basis for rejecting the lawyer’s comments, for example: “We don’t really have to disclose the performance goals; you’re just overlawyering this.”

“Say-on-Pay”: What Would Disclosures Look Like?

If Congress passes a law requiring companies to put their compensation arrangements to a non-binding vote by shareholders, what would the disclosures look like? In my mind, that really is the key issue in the debate over whether “say-on-pay” is a good idea. If this issue is resolved, I don’t have a beef with the concept of “say-on-pay” since it would not be Congress attempting to dictate the level of CEO pay through the tax code. Rather, a “say-on-pay” law would merely be Congress allowing shareholders to have a clearer voice on executive compensation arrangements. The risk of unintended consequences is much lower for this type of law compared to tax code shenanigans.

Looking at what other countries that already require “say-on-pay” can help. In the United Kingdom, there are two provisions that make up their law: companies prepare an annual “remuneration report” as required by Chapter 46, Part 15, Chapter 6, Sections 420-422 (ie. the Companies Act 2006) – and companies are required to put the report to an advisory vote by Chapter 9: Section 439.

Here is an old renumeration report from GlaxoSmithKline. This 2003 renumeration report is perhaps the most cited example of such a report because it had just over 50% of the company’s shareholders disapprove of it – and the law then was in its first year of existence. Fyi, in late 2006, the UK adopted the Companies Act 2006 to amend and restate almost every facet of English law that applies to companies – “say -on-pay” was already on the books and restated in the Companies Act 2006. Looking at what UK companies disclose, I think the SEC’s new rules – if properly complied with – elicit the type of disclosure that should allow investors to make an informed voting decision.

How to Find Those CD&As

Some members asked how to find those hundreds of new proxies with CD&As now on file at the SEC. The easiest way is to go to the SEC’s free-text search tool and plug in the search term of: “compensation discussion & analysis” (include the quotation marks).

Yesterday, SEC Chairman Cox gave a speech during which he said that incoming executive compensation disclosures are in some cases suffering from “overlawyering” and need to be written in plain English – and that some explanations of executive compensation in proxy statements are running more than 40 pages, yet not telling investors enough about how the bosses are being paid. Having read a few CD&As myself so far this proxy season, I agree that some feel like they have considerable gaps when it comes to describing the company’s compensation arrangements.

The Chairman also said the SEC Staff would be electronically tagging the executive compensation data in proxy statements and posting the interactive data around June, which would allow the public to compare compensation data for several hundred of the largest companies.

Shareholder Access in ’08?

According to this WSJ article, SEC Chairman Cox indicated that the Commission has made progress towards proposing a shareholder access rule and is hopeful to have something adopted in time for next year’s proxy season.

Executive Compensation: House’s Financial Services Committee Hearing

As reflected in this WSJ article, there were no real surprises during yesterday’s House Financial Services Committee hearing on Rep. Barney Frank’s “say-on-pay” bill. Here is the prepared testimonies of the hearing witnesses – and here is a related Reuters’ article.

Internal Pay Equity Legislation: Another Angle for Legislators to Cap Pay

For those following our musings on CompensationStandards.com, you hopefully know that we have been touting internal pay equity as a simple balancing methodology to help handle the challenges of utilizing peer group benchmarking to set CEO pay levels.

Recently, two Maryland state senators, Paul Pinsky and Richard Madaleno Jr., have sponsored a bill to prohibt Maryland corporations from deducting executive pay as a business expense if it exceeds 30 times what the lowest-paid worker earns. I doubt this bill will go anywhere – and I don’t think legislating pay levels is the way to go – but it illustrates that pay practices need to change voluntarily before they are changed for you…

As nicely laid out in this CFO.com article, restatements reached a new high last year – not too surprising given option backdating, etc. In our “Restatements” Practice Area, we have posted copies of several recent studies.

Here is an excerpt from the CFO.com article: “Companies with U.S.-listed securities filed 1,538 financial restatements in 2006, up 13 percent from what had been a record number in 2005, according to an annual study by Glass, Lewis. Out of that total, 118 restatements were made by foreign issuers.

All told, the number of companies that restated last year—1,244 U.S. companies and 112 foreign companies—filed 1,538 financial restatements to correct errors represent 9.8 percent of all U.S. public companies. In 2005, only one in 12 companies restated their financial results. More interesting, in 2006, there was a 14 percent decrease in the number of restatements from companies that were mandated to comply with Section 404 of the Sarbanes-Oxley Act, “a sign that larger companies are making progress on cleaning up their books,” the proxy research firm asserted. However, restatements rose a whopping 40 percent among companies that haven’t yet been required to comply with Sarbox 404—smaller companies.”

Not that it matters, a different study noted in this WSJ article found even greater numbers of restatements last year…

US and EU Will Accept Global Financial Reporting Rules

At Wednesday’s Roundtable on International Financial Reporting Standards, SEC Chairman Cox announced that he and EU Internal Markets Commissioner Charlie McCreevy have struck an agreement that would eliminate the reconciliation to U.S. GAAP by 2009. In other words, US and European regulators pledged to recognize each other’s rules by 2009 for how companies report financial data, a move that may facilitate more international investing and reducing corporate compliance costs. Here is a related Washington Post article – and here are FEI’s notes on the Roundtable.

This development was a long time in the making, here is a timeline:

– 1996 – Congress passes the “National Capital Markets Efficiency Act, which directs the SEC to respond to the growing internationalization of securities markets by giving “vigorous support” to the development of “high-quality international accounting standards as soon as practicable.”

– 2000 – SEC issues a Concept Release that solicits comment on whether we should consider accepting International Financial Reporting Standards in the US.

– 2002 – FASB and IASB began in earnest to achieve short-term convergence between their respective sets of accounting standards after signing the “Norwalk Agreement.”

– 2002 – European Parliament and the Council of the European Union determine that all listed European Union companies have to prepare their consolidated financial reporting using IFRS, beginning in 2005.

– 2005 – SEC lays out International Financial Reporting Standards “Roadmap.”

Proposed Tweaks to FASB’s FIN 48

Last week, the FASB proposed guidance for FIN 48, the new standard that requires companies to state the value and risks of uncertain tax positions more clearly. Proposed FSP FIN 48-a provides guidance regarding when a position is “settled” and thus no longer is in need of a FIN 48 review. Comments are due by March 28th.