It is a fact of life today that securities law violations are often investigated through parallel proceedings – in other words, independent investigations conducted by civil authorities and federal prosecutors relating to the same facts and circumstances. I can remember the days in the not too distant past (at least it seems not too distant) when it was nearly impossible to get the Justice Department interested in a federal securities law case, but Enron pretty much changed all of that.
Parallel proceedings present significant challenges, because the cooperation that is often so critical to a successful resolution of a civil proceeding brought by the SEC may very well increase a company’s (and its officers’ and directors’) exposure to criminal liability. While it is well settled that the government can conduct parallel proceedings, the latitude with which this can be done and the extent to which the SEC or another civil authority could “covertly” funnel evidence to a prosecutor was called into question a few years ago by the Federal District Court decision in U.S. v. Stringer, (408 F.Supp.2d 1083 (D. Or. Jan. 9, 2006). In that decision, the court found that prosecutors had engaged in misconduct by cloaking an ongoing criminal investigation with an SEC investigation, warranting dismissal of the indictment or suppression of the SEC-gathered evidence.
Recently, the Ninth Circuit reversed the District Court’s decision in U.S. v. Stringer, No. 06-30100 (9th Cir., April 4, 2008). The Court of Appeals found that no affirmative deception was involved, principally because the SEC had given each of the defendants a Form 1662 along with the request for evidence. Form 1662 (not to be confused with Form Catch-22) notes that the “Routine Uses of Information” gathered in an investigation include providing the information to state and federal law enforcement, self-regulating entities, foreign authorities, tax authorities, consumer reporting agencies, trustees and receivers, bar associations, and Congress. The form also provides a Fifth Amendment warning.
The Ninth Circuit relied heavily on the language of Form 1662 in finding that the defendants were adequately put on notice as to the potential parallel proceeding. Further, because the Form 1662 included a Fifth Amendment warning, the Court found a waiver of the defendants’ right against self-incrimination in the criminal case – given that the Fifth Amendment was not invoked in response to the SEC’s initial investigative request.
The Stringer decision reinforces the wide latitude that the SEC and prosecutors have in conducting their investigations – and highlights the perils of cooperation with the SEC. For more detailed analysis of the decision, take a look at the memos we recently posted in our “White Collar Crime” Practice Area.
Behind the scenes at the SEC, cooperation can also be a consideration when dealing with Corp Fin while an Enforcement investigation of a company is ongoing or contemplated. While Corp Fin is always sensitive to not being considered a “tool” for Enforcement to access information about the company and the conduct in question, it is still possible that information derived from the comment process, things said on conference calls, etc. could ultimately be shared with the Enforcement Division.
IFRS for U.S. Companies: On the Fast Track for Implementation?
Edith Orenstein noted yesterday in the FEI Financial Reporting Blog that an IFRS implementation plan for U.S. companies is moving along much faster than I would have ever expected. The blog notes: “In announcing the formation of the KPMG IFRS Institute, KPMG Chairman & CEO Tim Flynn stated: ‘The question about whether the world is going to global standards is no longer ‘if,’ but ‘when.’’ Flynn added, ‘The Securities and Exchange Commission (SEC) is expected to issue a rule proposal in the next few weeks outlining the manner, timing, and eligibility for some U.S. public companies to transition from U.S. Generally Accepted Accounting Principles (GAAP) to IFRS.'”
Given that the SEC already put out a concept release last Fall, it is likely that the rule proposals will be pretty well developed and there is probably a good chance that final rules will be adopted by this Fall. Perhaps this will give some larger US companies the joy of implementing IFRS and XBRL at the same time!
Farewell to Carol McGee
I want to send a “shout out” to my former Deputy Chief Counsel Carol McGee, who just left the SEC after 10 years in Corp Fin to become a Partner at Alston & Bird LLP. In my time at the SEC, Carol always provided me with truly wise counsel on every imaginable issue. I first met Carol when she was interviewing for a job in Corp Fin, and during the interview we began debating the relative merits of certain twentieth century philosophers – her preference being for Wittgenstein and mine for Sartre. Well, you can just imagine where that went…
From Alan Dye’s “Section16.net Blog“: The U.S. Court of Appeals for the Second Circuit has affirmed the holding of a judge in the Southern District of New York that a director by deputization, including one that also is a ten percent owner, may rely on Rule 16b-3 to exempt its transactions with the issuer in Roth v. Perseus. Here is the opinion (the facts of the Roth case are described in this blog.) The Ninth Circuit had previously held that Rule 16b-3 applies to a director by deputization in Dreiling v. American Express Co..
The SEC filed an amicus curiae brief with the court, just as it did in Dreiling, arguing that Rule 16b-3 is available to directors by deputization. The court agreed, holding that the Commission’s view is neither inconsistent with Section 16(b) nor plainly erroneous and therefore is entitled to deference under Chevron U.S.A Inc. v. Natural Resources Defense Council. The court also upheld the validity of Rule 16b-3, holding that the rule is not arbitrary, capricious, or manifestly contrary to the statute.
The court was persuaded that the SEC had a legitimate rationale for the rule: a director’s or officer’s transactions with the issuer are subject to the fiduciary duties of the insider and the gatekeeping function served by the board or committee of non-employee directors. The plaintiff-appellant had argued that a director by deputization doesn’t owe the same fiduciary duties to the corporation that an elected director does and therefore should not be protected by Rule 16b-3. The court declined to address the extent of the fiduciary duties of a director by deputization, holding instead that the SEC could reasonably have concluded that the fiduciary duties of the director(s) appointed by the director by deputization were sufficient to justify the SEC’s position.
Alan’s blog has a new functionality: you can now input your email address (it’s the second box on the left side of the blog) so that you will be notified as soon as Alan has posted something new. Members of Section16.net should sign up for this nifty service.
And yes, this notification service is available for this blog too. We’ve had this functionality for quite some time and thousands get this blog pushed out to them every day. Simply input your email address in the box to the left of this very text…
Time to Tune-up Your Insider Trading Policy: The RSA 21(a) Report
Last month, the SEC issued an Exchange Act Section 21(a) Report regarding Enforcement’s investigation of the Retirement Systems of Alabama (RSA). The “message” of the Report is one that likely seems obvious to all of us: have the policies, procedures, training and personnel in place to ensure compliance with the federal securities laws, including insider trading prohibitions. This is apparently a message that the SEC thinks warrants repeating through the unusual venue of a Section 21(a) report, which is probably enough to prompt most responsible companies to take a hard at their insider trading policies and procedures – and more importantly the actual understanding of those policies and procedures by employees, directors, etc. – in order to make sure that everything is operating effectively.
The situation described in the 21(a) Report is somewhat astonishing. The RSA, with more than $30 billion in assets under management, had no policies, procedures, training or compliance officer in place to make sure that it was complying with the federal securities laws in general or insider trading prohibitions in particular. The activities of the RSA’s employees, including its CEO (who has held that position for 30 years), showed a profound lack of knowledge – or judgment for that matter – when purchasing the shares of an acquisition target of one of their portfolio companies while confidential negotiations regarding the acquisition were ongoing. These trades were unusual in that the CEO directed them even though he was rarely involved in equity trading decisions and the target’s market capitalization was well below the RSA’s investment guidelines.
I think this Report points out something that it is often easy to forget for securities law practitioners – issues that seem completely obvious to us like the potential for insider trading violations may never even occur to others, including experienced business people. This is why policies and procedures are important, but perhaps more important is the process of educating employees about the law, the policies and procedures – and the serious implications arising from insider trading and other securities law violations.
This Report should give everyone responsible for compliance – no matter how big or small a company – an excuse to dust off that insider trading policy manual (or create on if you don’t have one) and figure out a way to refresh everyone’s memory about insider trading issues. An annual training exercise and reminder memoranda are always a good baseline, but you may need to do more to really reach people within the organization and leave a lasting impression.
Section 21(a) Reports like the RSA report are a funny thing. It seems odd for the SEC to use a specific fact pattern – particularly where it did not feel it was appropriate to impose penalties – to communicate some broad policy statements, but that is usually what these reports are all about. In some instances, the purpose of the 21(a) Report is to put everyone on notice that the SEC is interested in pursuing Enforcement actions in a particular area in the future. There have only been a handful of 21(a) Reports over the past few years – you can see them all on this page at sec.gov.
In the RSA case, the SEC decided to not impose penalties because (1) RSA essentially sought to rescind the transactions with the sellers who sold RSA the stock while it was in possession of material nonpublic information; (2) any penalty would be paid out of the retirement system assets to the detriment of state and local employees; (3) a compliance program was established; (4) RSA and the CEO cooperated in the investigation; and (5) no individual profited from the conduct.
Instead, the 21(a) Report says that it seeks to “remind investment managers, public and private, of their obligation to comply with the federal securities laws and the risks they undertake by operating without an adequate compliance program.” But the lessons of the report should not be limited to investment managers, because just like RSA (which is not subject to SEC regulation as a broker-dealer or investment advisor), all public companies face the same risks – and potential liability under Exchange Act Section 21A – as a controlling person who fails to prevent insider trading. For this reason, I think that it is best to read the report broadly and use it as a catalyst for revisiting the effectiveness of insider trading compliance programs.
At yesterday’s hearing of the Senate Committee on Banking, Housing and Urban Affairs entitled “Turmoil in U.S. Credit Markets: The Role of the Credit Rating Agencies,” Chairman Cox defended the SEC’s implementation of the Credit Rating Agency Reform Act of 2006 and spelled out some possible new rulemaking efforts on the credit rating front.
In his testimony, Chairman Cox outlined the SEC Staff’s efforts in conducting ongoing examinations of the nationally recognized statistical rating organizations (NRSROs). Those efforts have included the review of thousands of pages of internal records and emails, public disclosures and rating histories by around 40 Staff members. While the examinations are not yet complete (a report is expected by early summer), Cox noted that the Staff has found so far that there was a substantial surge in ratings for structured finance deals from 2004 – 2006, with those deals involving increasingly complex products. The examination Staff’s preliminary observations have been that the “ratings process used to rate these products may have been less quantitatively developed, particularly as the products became more complicated and involved different types of loans, than was generally believed.” While the SEC is trying to avoid engaging in substantive regulation of the ratings process, it is interested in the adequacy of the NRSRO’s disclosure about their procedures and methodologies, and whether such factors as a desire to maintain or increase market share may have caused the NRSROs to be “less conservative” than their disclosed methodologies.
Now that the SEC’s NRSRO registration system is in place and other rules implementing the 2006 legislation are effective, the SEC is looking at other areas of rulemaking within its authority. Chairman Cox outlined the following possibilities:
1. Enhanced disclosure about ratings performance – this would include disclosures that allow market participants to better compare the ratings of one NRSRO with another.
2. Accountability for managing conflicts of interest – new rules might prohibit certain practices, as well as establish requirements that address potential conflicts that could impair the process for rating structured products (e.g., consulting services provided by NRSROs to issuers).
3. Annual reporting – new rules could required the NRSROs to furnish the SEC with annual reports describing internal reviews and how well the firms adhere to ratings procedures, manage conflicts of interest and comply with securities laws.
4. Enhanced disclosure of underlying assets – new rules may require disclosure of information about the assets underlying MBS, CDOs and other structured products so market participants could better analyze creditworthiness without the benefit of ratings (and to enhance the availability of data – and thus level the playing field – for subscriber-based NRSROs as compared to the “issuer pays” NRSROs).
5. Enhanced disclosure about ratings – new rules could also mandate enhanced disclosures about how the NRSROs determine their ratings for structured products, as well as ratings information that will make it possible for investors to distinguish between ratings for different types of securities.
6. Access to information – potential rules may seek to eliminate advantages (including access to information) that NRSROs following the “issuer pays” model may have over subscriber-based NRSROs.
7. SEC reliance on ratings – The SEC is revisiting its own reliance on ratings throughout its rules. This could be a big shift in the SEC’s rules, including those related to corporation finance.
These new rules could substantially change the ratings landscape, and most likely for the better. It certainly can’t get much worse.
For a great breakdown of the history behind securities ratings and what went wrong with the ratings on mortgage backed securities, check out Roger Lowenstein’s piece entitled “Triple-A Failure” which will be published in this Sunday’s New York Times Magazine.
PCAOB Adopts Audit Committee Communications and Tax Services Rule
Yesterday, the PCAOB announced that it had adopted new Rule 3526, Communication with Audit Committees Concerning Independence, and an amendment to Rule 3253, Tax Services for Persons in Financial Oversight Roles. The adopting release for these rules was posted shortly after the PCAOB’s open meeting. The rules changes are now off to the SEC for final action.
Rule 3526 will – if adopted by the SEC – supersede Independence Standards Board Standard No. 1, Independence Discussions with Audit Committees, and two related interpretations. The new rule will require registered audit firms – at the time of the initial engagement – to provide a detailed written description of all relationships between the firm and its affiliates and the issuer or persons in a financial reporting oversight role that may reasonably be thought to bear on independence. Registered audit firms will also be required to discuss the potential effects of these relationships with the audit committee. Similar communications will then be required annually.
The amendment to Rule 3523 will – if adopted by the SEC – exclude from the scope of that rule any tax services that are provided during the portion of the audit period that precedes the beginning of the professional engagement period. Under this change, tax services provided to persons in a financial reporting oversight role prior to the beginning of the professional engagement period would not necessarily impair a firm’s independence.
In other PCAOB news, earlier this week it was announced that Sharon Virag, Director of Technical Policy Implementation, will be leaving the PCAOB at the end of the month. Sharon was the project leader for the development of AS No. 5 and she recently participated in our webcast “The PCAOB Speaks: Latest Developments and Interpretations.” Best wishes for Sharon in her new position.
Options Backdating: Broadcom Settles
Last month the SEC settled an Enforcement action against Nancy Tullos, the former Vice President of Human Resources of Broadcom, for her involvement in the company’s five-year-long options backdating scheme – which resulted in Broadcom’s January 2007 restatement to include a whopping $2.22 billion of unreported compensation expense in its financials. I believe that was the largest restatement in the short and sordid history of options backdating.
Now the SEC has settled with Broadcom itself, and interestingly enough the SEC extracted only a $12 million civil penalty in addition to a permanent injunction. While this penalty is higher than the $7 million civil penalty paid by Brocade Communciations in its settlement of backdating charges, it is significantly lower than the $28 million civil penalty paid by Mercury Interactive. A number of the other companies charged with backdating-related violations paid no penalty whatsoever. It is still hard to say how the Commission arrives at these penalty amounts (even with the added transparency about the process issued a couple of years back), but certainly I think the Commissioners have not historically been big fans of imposing monetary penalties on corporations.
As noted in this CFO.com article, the former CFO of Mercury Interactive Corp., Sharlene Abrams, was indicted on charges related to Mercury’s options backdating scheme. Abrams was charged with one count of income tax evasion and two counts of aiding and assisting in the preparation of false tax returns for two other Mercury executives. This is the third time an executive has been charged with tax evasion arising from options backdating.
A persistent issue for auditors, public companies and their regulators in the wake of the 2002 collapse of Arthur Andersen is how do we prevent the Big 4 from becoming the Big 3 due to a catastrophic liability event? For some time now, auditors have called for the imposition of liability caps, and that approach has been debated by policymakers examining the issue. For instance, in 2006, the Treasury Department’s Committee on Capital Markets Regulation considered whether Congress should look into the possibility of protecting audit firms from catastrophic loss, either by creating a safe harbor for specified auditing practices or by setting a cap on auditor liability in some circumstances. Currently, the Treasury Department’s Advisory Committee on the Auditing Profession is considering the impact of auditor liability on the profession and whether any potential changes should be made to auditor liability regimes, with recommendations expected this summer. The European Union has also been studying the issue of auditor liability, and practices vary considerably among EU member states.
While the question of auditory liability protection is debated in the US and the EU, the UK has recently moved forward with changes to the Companies Act that permit auditor liability limitation agreements. As noted in this memo from Edwards Angell Palmer & Dodge, provisions effective earlier this month now permit auditors to enter into agreements with their clients that cap the auditor’s liability exposure to the company, so long as (1) the agreement does not limit the auditor’s liability to less than a “fair and reasonable” amount, and (2) the agreement is approved by the company’s shareholders. Under proposed guidance from the UK’s audit oversight body – the Financial Reporting Council – these types of agreements could be for a fixed limit based on a specified amount or formula, a proportionate share based on the auditor’s responsibility for a loss, or a mix of fixed and proportionate caps. The agreements may only cover one fiscal year, so they would be subject to shareholder approval on an annual basis.
While the UK approach is certainly interesting, I don’t think that it is likely to change the direction of the debate in the US. The first quarter of 2008 has come and gone without the roundtable on securities litigation reform that the SEC promised last summer, and it seems unlikely in the near term – particularly considering the ongoing sub-prime crisis and election year politics – that the issue will be taken up by Congress or the SEC.
Halloran to Leave the SEC
Yesterday, the SEC announced that Chairman Cox’s Deputy Chief of Staff and Counselor Mike Halloran will be leaving the SEC in May to return to private practice. Mike has had quite a bit of influence on the regulatory agenda at the SEC over the last one and a half years, perhaps most notably on the Commission’s and the PCAOB’s efforts to revisit the implementation of Section 404 of the Sarbanes-Oxley Act.
New 3rd Edition: Romeo & Dye Treatise
Peter Romeo and Alan Dye just wrapped up the 3rd Edition of their “Section 16 Treatise” and we have been mailing this two-volume set with thousands of pages to the many of you that ordered it. For me, it felt kind of like Christmas in April when a copy of the Treatise arrived at my door yesterday!
If you didn’t order this essential body of work, you can still have it rushed to you – try a no-risk trial to the Treatise today.
Late last Friday, the SEC issued a notice postponing the Open Meeting previously scheduled for this morning. Now, the SEC will consider the use of interactive data in financial statements filed by public companies on May 14th at 10:00 a.m. Even with the postponement, the Staff will still meet its “Spring” deadline to have these proposals considered by the SEC, with expected adoption of implementing rules and a timetable still likely this Fall.
I can’t recall the last time an Open Meeting for a rule proposal was postponed on the business day before the meeting – generally I think that is a pretty extraordinary action. Perhaps the proposals were not quite “ready for prime time.”
Paulson Blueprint: An Orphaned Public Company Regulatory Function
One thing that struck me when reading the Treasury Department’s “Blueprint for a Modernized Financial Regulatory Structure” was that in the long term plans for financial regulation, the SEC’s current responsibilities over corporate disclosure, corporate governance, accounting and similar issues would be left behind in a “corporate finance regulator,” rather than being swallowed up into the Conduct of Business Regulatory Agency (“CBRA”) where most of the SEC’s other functions will go. [When naming this proposed new regulator, the drafters of the Blueprint obviously didn’t think too long and hard about the acronym they were creating, because usually reference to an undergarment in a new agency’s name is to be avoided.] This approach appears to be necessitated by the CBRA’s focus on financial services – the markets and financial intermediaries like brokers, investment advisers and mutual funds – rather than the reason for the existence of all those intermediaries, namely capital-raising for companies and liquidity for their shareholders. Under the Treasury proposals, the “legacy” SEC would continue to perform the function of corporate finance regulator in the optimal regulatory structure (perhaps just called the SC then, since exchanges would be regulated by the CBRA).
While the chances of these long-term proposals coming to fruition may be slim to none at this point, I still think that it is particularly troubling that corporate finance regulation is treated as an afterthought in the Blueprint, only five and half years after corporate governance, disclosure and accounting was front and center following enactment of the Sarbanes-Oxley Act. The proposals are short-sighted in that they largely ignore the fact that issues with respect to corporate finance are often integrally related to the financial services that the SEC regulates, and setting corporate finance regulation off in a tiny, orphaned agency that doesn’t have a “seat at the table” of the proposed “Big Three” regulators is doomed to failure.
To add further insult to injury, the proposals suggest that the Federal Reserve, in consultation with the corporate finance regulator, should be able to mandate additional public disclosures for federally chartered financial institutions that are publicly traded or part of a publicly traded company. The Treasury contemplates that such public disclosures could be included as a separate section of public reports, or embedded within an existing section such as Management’s Discussion and Analysis.
Hopefully, as the Treasury proposals and legislative proposals are hashed out over the next several years, the long term regulatory structure will be crafted around some solid principles of regulatory cooperation that focus on the “big picture,” rather than just regulating for the scandal du jour.
Securities Act Offering Integration
Test your skills with our new game – “Pro or Troll #8: Securities Act Offering Integration” – to see if you are up to speed on all of the lore and latest developments with every securities lawyer’s favorite topic – integration.
Last week, the NY Times ran this critical article about the growing use of deferred criminal prosecutions. It reminded me that I hadn’t yet blogged about the new Morford Memo, distributed internally by the Department of Justice a month ago. The Morford Memo provides guidance on corporate monitoring (eg. selection critieria, scope of responsibilities, terms). Here is the Morford Memo – and memos about it are posted in our “White Collar Crime” Practice Area.
In this 15-minute podcast, Gary DiBianco of Skadden, Arps provides some insight into the Morford Memo, including:
– What is the Morford Memo?
– What do the principles outlined in the Memo seek to address? What specific practices?
– What are the DOJ’s views on the duties of a monitor as expressed in the Memo?
– What does the Memo say about the monitor’s reporting obligations to the company and the government?
– What happens when a company disagrees with a monitor’s suggestions?
Congress remains skeptical of the DOJ’s unfettered discretion in this area. Rep. Frank Pallone (D-NJ) introduced legislation in January that would establish requirements for entry into deferred prosecution agreements.
The Treasury’s Restatement Study
Last week, Treasury Secretary Henry Paulson released a study on restatements that the Department commissioned last May when it began its look into reforming the capital markets. The study – “The Changing Nature and Consequences of Public Company Financial Restatements” – conducted by Professor Susan Scholz confirms what other studies have shown, that the number of restatements has soared over the past decade (although the restatements associated with fraud and revenue has declined since Sarbanes-Oxley was passed).
The numbers of restatements have dropped since the implementation of the requirement for an independent audit of internal controls of public companies, that provide reasonable assurance with respect to the accuracy of financial statements.
You can pluck out statistics from the Treasury’s study in this press release – and have a look-see at other studies about restatements in our “Restatements” Practice Area.
As noted in this CFO.com article, a key focus for the SEC’s Advisory Committee on Improvements to Financial Reporting is restatements – some changes are bound to be recommended and ultimately acted upon by the SEC.
I just put the finishing touches on our new newsletter – “InvestorRelationships.com” – which is a quarterly online publication. This newsletter is free, as well as all the issues for the rest of ’08. You simply sign-up online to be notified when the next issue is available (you also need to sign-up to be e-mailed an ID and password in order to access future issues).
Why this new newsletter? As you can see from the article titles in the Spring ’08 issue listed below, I felt there was a dearth of practical guidance on the cutting-edge – as well as the “bread ‘n butter” – issues confronted by those involved in investor relations, shareholder services and corporate governance today. Take a look and let me know what you think:
– The E-Proxy Experience: Practice Pointers and Pitfalls to Avoid
– The Coming Online IR Campaigns: The Future of Director Elections
– The Regulation FD Corner
– Ten Steps to a Clawback Provision with “Teeth”
– Notables: All the Latest
Washington Mutual: Case In Point
The jaw-dropping results from the Washington Mutual annual meeting this week are timely in that they bolster my argument that companies need to learn how to “campaign” during the proxy season cycle. These arguments – and specific recommendations about how to campaign – are in my piece entitled “The Coming Online IR Campaigns: The Future of Director Elections” (sign-up to obtain your free copy).
So what happened at the WaMu meeting? Here is what has been reported so far:
– One director resigned, Mary Pugh, who was the Chair of the company’s Finance Committee.
– Some reports state that all director nominees received majority support (eg. see this article); others are reporting that three nominees failed to reach a majority. Change to Win’s press release states that one director had 51.2% withheld, another had 50.9% withheld and Ms. Pugh had 61.9% withheld.
– Change to Win called on the WaMu board to immediately release full election results and demand the resignation of any directors who failed to win majority shareholder votes. WaMu then issued this press release that contains preliminary results – notice the paragraph at the bottom that leads one to believe that the difference in the three challenged nominees getting majority support was the presence of broker non-votes.
– With a vote of 51%, shareholders supported a precatory proposal to appoint an independent director as chair.
– In February, WaMu revised its incentive program in a way so that mortgage-related credit losses and foreclosure costs could have been cast aside when awarding management’s performance bonuses. Shareholders were not pleased – and WaMu’s CEO announced at the annual meeting that the board would soon revise the pay program to hold management more accountable for credit-related losses.
The campaign against WaMu has been intense during the past month, fueled by plenty of online tactics. For example, Change to Win launched this blog that targeted the company. Yes, the future is now. Read the Spring ’08 issue of InvestorRelationships.com today to learn how to protect yourself. ] I also recommend reading this new memo from Davis Polk about how the ’08 proxy season is faring so far.]
Corp Fin’s New M&A Chief: Michele Anderson
Congrats to Michele Anderson, who was promoted to Corp Fin’s new Chief of the Office of Mergers & Acquisitions. Most recently, Michele served as a Legal Branch Chief in the Office of Telecommunications – but she spent time in OM&A a few years back. She replaces Brian Breheny, who was promoted to Deputy Director a few months ago.
On Monday, the SEC will hold an open Commission meeting to vote on a proposal to mandate XBRL. Given that this has been one of Chairman Cox’s top priorities since he took office – and the Chairman and SEC Staff have not been shy about their timeframe to kick-start mandatory XBRL – this is no surprise.
We just announced a May 15th webcast – “XBRL: Understanding the New Frontier” – to help you understand the signficance of what these means for you (and your CPA brethren). As a warm-up for this program, here are three quickie “foods for thought”:
1. This Ain’t Edgar – You’ll note that the webcast panel is populated by reps from the major financial printers. Don’t let this fool you into thinking that XBRL is just another version of Edgar, with tasks that can be contracted out. This is much more than that – and I believe entails a new skill set that all the finance and auditing folks are gonna have to know. It’s gonna be a huge education effort. As with most new things, there is plenty of misinformation out there. One article I just read called XBRL the “new Edgar.” The only rationale I can conceive for that statement is that XBRL will increase public access to information filed via Edgar.
Let’s see if I can make this clearer: Edgar tagging just involves placing tags on a disclosure document to enable it to be filed on the SEC’s system. In comparison, XBRL will likely affect how companies approach their financial disclosure. Information coded in XBRL will likely used – and abused – in ways that companies don’t worry about today. Similar to the many speeches that Chairman Cox has delivered over the years, SEC General Counsel Brian Cartwright gave this speech on Saturday at the ABA Spring Meeting.
2. We Need Time to Learn – I can appreciate that Brian was trying lay out the simplicity of the concept of XBRL because many of us still have not grasped what it really is – but I worry about the speed by which it will be implemented. I hope there will be a fairly long phase-in period before it becomes mandatory (and I think that will be the case since the SEC’s meeting notice refers to a “near- and long term-schedule”). As noted in this CFO.com article, others have similar concerns – for example, the SEC’s Advisory Committee on Improvements to Financial Reporting urged the SEC to wait three years. The Advisory Committee also wants to phase-in the legal liability of XBRL documents, starting with them being considered “furnished” rather than “filed,” as it’s currently done in the SEC’s Pilot Program.
3. XBRL Will Provide “Bennies” – For me, there certainly is an upside to XBRL. The most fascinating aspect is not the enhancement to disclosure through “conversion” of financials into a XBRL format simply by adding tags. Rather, the value-creation occurs when XBRL becomes embedded into a company’s enterprise resource management system, so that data can be extracted and analyzed to drive business decisions with greater speed and precision. Public financial reporting simply is an ancillary by-product of embedded XBRL. Thanks to Jim Brashear for allowing me to “borrow liberally” from some of his ideas…
Delaware Court of Chancery Permits Insurgent To Nominate Short Slate
On Monday, the Delaware Court of Chancery ruled on another advance by-law case (here is a blog about the other case). Here is some analysis from Travis Laster: If the recent JANA Partners v. CNET decision (currently on expedited appeal) wasn’t enough to make corporations review and update their advanced notice bylaws, the attached opinion should do the trick. In Levitt Corp. v. Office Depot, Inc.,, Vice Chancellor Noble holds that (i) a bylaw requiring advanced notice of “business” to be proposed at an annual meeting extends to director elections and director nominations, but that (ii) the advanced notice bylaw was not applicable because the corporation had given notice that the election of directors would be an item of business at the meeting. In light of the second holding, the Court concluded that the stockholder did not have to give advance notice of its intent to run a short slate. As with CNET, this is a decision that will likely prompt an appeal.
On March 14, 2008, Office Depot sent out its notice of annual meeting. Item 1 on the list of items of business was “To elect twelve (12) members of the Board of Directors for the term described in this Proxy Statement.” The proxy statement contained standard Rule 14(a) disclosures regarding how votes would be tabulated in an uncontested versus a contested election. On March 17, 2008, Levitt filed its own proxy statement seeking to nominate two candidates for director.
Office Depot had a relatively standard advanced notice bylaw which provided that “business” could be brought before the annual meeting if (i) specified in the notice, (ii) otherwise properly brought before the meeting by the board, or (iii) proposed by a stockholder in compliance with advanced notice requirements. The time period for advanced notice was “not less than 120 calendar days before the date of the Company’s proxy statement released to shareholders in connection with the previous year’s annual meeting.” The bylaw required the stockholder proposing business to provide standard information, including basic stockholder information and a brief description of the business to be conducted.
Levitt did not try to comply with the advance notice bylaw. Office Depot rejected Levitt’s nominations for failure to comply.
In granting judgment on the pleadings for Levitt, Vice Chancellor Noble first held that the scope of “business” under the Office Depot advanced notice bylaw extended to director nominations by stockholders. The Court construed the plain meaning of the term “business” broadly to include all “affairs” or “matters” that could be considered at an annual meeting. This included director elections. (11-12). The Court also relied on Section 211(b) of the DGCL, which provides for an annual meeting to elect directors “and other business.” As a matter of plain language, the Court held that this section indicated that electing directors was “business.” (13)
This holding makes sense as a matter of contractual interpretation, but it conflicts with widespread corporate practice. Many corporations have separate advance notice bylaw requirements, one for “nominations” and another for “business.” The information requested for the former is typically different than the latter. The advance notice windows are also often different, with the former including additional windows for issues such as an increase in the size of the board. The Levitt decision could render the bylaws of companies with dual structures ambiguous, as nominations now arguably will be covered by two competing sections. It would be prudent to clarify when “business” means “all business, including nominations of candidates for and the election of directors” versus “all business other than nominations of candidates for and the election of directors.” Interestingly, the opinion indicates that Office Depot previously had a dual structure, but eliminated its “nomination” bylaw. The Court declined to give significance to the amendment.
Based on this first holding, one would think that the Office Depot advanced notice bylaw would apply to Levitt’s nominations. But the Court then went in a different direction. The Court instead agreed with Levitt that because Office Depot had sent out a notice of meeting saying that the business of the meeting would include the election of directors, that item of business was properly before the meeting under the advanced notice bylaw and the stockholder did not have to separately give advance notice. (15-16). The Court rejected the argument that the notice of meeting contemplated only a vote on the corporation’s nominees for directors, finding that it was not supported by the text of the notice (which referred generally to “elections of directors”). In support of its interpretation that the notice also contemplated a contested election, the Court cited the standard Rule 14(a) language on contested elections that appeared in the Office Depot proxy statement.
As in JANA, the Levitt decision effectively left the corporation without any advance notice protection whatsoever for director nominations. This, of course, is an odd result for a company that nominally has an advance notice structure in place. In support of this outcome, the Court observed that “neither Subchapter VII of the [DGCL] nor any provision of Office Depot’s Bylaws discusses or imposes limitations on the nomination process.” The Court did not explain how it reached this conclusion given its prior holding that the term “business” in Office Depot’s advanced notice bylaw included director elections and nominations.
In light of the Levitt decision, corporations should make sure that their bylaws explicitly discuss “nominations.” Corporations also may wish to consider changing the historic and ubiquitous language that appears in notices of annual meetings and identifies the first item of business as “election of directors.” One alternative to avoid the Levitt problem would be to say “election of the Board of Directors’ nominees.” Because all candidates are voted on as a single item of business, however, the better route is likely to be to maintain the historic language in the notice of meeting and instead make sure that the bylaws have a specific advance notice structure for stockholder nominations.
As noted in this WSJ article, both Senator Barack Obama and Senator John McCain attacked executive compensation last week. You may recall that Senator Obama introduced a bill on “say on pay” in the Senate after it passed in the House last year. Below is an excerpt from Sen. Obama’s Friday speech (and here is a video and full text of the speech):
We all believe in that fundamental, American value that if you do good work, if you’re successful, you should be rewarded. But if you’re a Wall Street CEO today, it doesn’t seem to matter whether you’re doing a good job or a bad job for your shareholders and workers: You’ll be rewarded either way.
Take the home building company, KB Home. They lost nearly $1 billion last year. But their CEO walked away with a $6 million cash bonus, and that’s on top of his $1 million base salary. And just the other week, we learned that when Countrywide Financial was sold a few months ago, its top two executives got a combined $19 million. Nevermind that Countrywide is as responsible as anyone for the scandalous mortgage crisis we’ve got today – a crisis that’s the source of many of our other economic problems.
This is an outrage. But as I said in a recent speech at the Cooper Union in New York City, this isn’t an accident. It’s because of decisions made, not just in boardrooms or trading floors, but in Washington. Under Republican and Democratic Administrations, we failed to guard against practices that all too often rewarded financial manipulation instead of productivity and sound business practices. We let the special interests put their thumbs on the economic scales, using their clout to rig the game against everyday Americans.
So what we need to do is restore balance to our economy and put in place rules of the road to make competition fair, and open, and honest. One place we can start is by restoring common sense to executive pay.
That’s why last year, I proposed legislation that would give shareholders a say on what CEOs are getting paid, and help ensure that companies are disclosing the rationale for the salary and benefits that CEOs are getting. This isn’t just about expressing outrage. It’s about changing a system where bad behavior is rewarded – so that we can hold CEOs accountable, and make sure they’re acting in a way that’s good for their company, good for our economy, and good for America, not just good for themselves.
We’ve seen what happens when CEOs are paid for doing a job no matter how bad a job they’re doing. We can’t afford to postpone reform any longer. That’s why Washington needs to act immediately to pass this legislation.
And here are some tidbits from the WSJ article:
– Obama on his “say on pay” bill: “Washington needs to act immediately to pass this legislation” and change “a system where bad behavior is rewarded.”
– If the “say-on-pay” bill doesn’t pass this year, it “will be a priority for Sen. Obama as president,” campaign policy director Heather Higginbottom says. A spokesman for New York Sen. Clinton’s Senate office says she also favors additional federal rules on executive-pay disclosures.
– Sen. McCain hasn’t taken a stance on the say-on-pay bill, and opposes legislative or regulatory cures for executive-pay problems, says senior policy adviser Douglas Holtz-Eakin.
– In a campaign appearance Friday, Sen. McCain said he strongly endorsed Aflac Inc.’s voluntary decision to become the first public U.S. company to give investors a say on pay; the vote is to occur at Aflac’s May 5 annual meeting.
– An Obama commercial that has aired in 14 states assails chief executives “who are making more in 10 minutes than ordinary workers are making in a year.”
– Sen. McCain recently blasted what he called the “outrageous” and “unconscionable” rewards received by leaders of Bear Stearns Cos. and Countrywide Financial Corp. despite the credit crisis
My Ten Cents: Say on Pay
For what its worth, here is my current thinking on “say on pay.” And maybe it’s a cop-out, but I would say that I’m torn at this moment in time. On the one hand, I find the arguments that it’s a slippery slope to have shareholders vote on a matter that is supposed to be a board task (ie. that shareholders will eventually be voting on all sorts of board tasks) and that shareholders won’t have the requisite knowledge to vote on a complex pay package convincing.
On the last point, I worry that say on pay will provide RiskMetrics with even more clout given that most investors will need help deciphering 30 pages of pay disclosure across the many companies in which they invest (although a partial fix for this is for boards to simplify their pay packages so that CEOs aren’t getting paid in a dozen different ways – why is there a need for such complex pay packages?).
I also worry that most shareholders will blindly vote in favor of pay packages, thereby arguably providing directors a shield from liability for the poorly designed pay packages they give a CEO (a theory espoused by the wise Professor Charles Elson, who points out how ironic it is that most directors oppose say on pay). And there are more convincing arguments, including those espoused by some investors who would rather just vote against/withhold directors than participate in a non-binding vote. Or those who say a simple “thumbs down” doesn’t help the board understand which aspects of a pay package are objectionable.
On the other hand, I am at my wit’s end to understand why CEO pay packages aren’t changing. I hear a lot about how the behavior of directors has dramatically changed in the boardroom over the past five years. But I really don’t see much evidence of that when reviewing proxy disclosures. Some commentators claim that the stories in the mainstream media about CEOs getting paid for non-performance are only outliers – but then I look for a CEO whose compensation I can point to as a model and I come up fairly empty.
So maybe “say on pay” is necessary to shake up the boardrooms of this country so that directors truly understand that the excesses of the past need to be reversed. That the 15 years of being paid in the top quartile have added up to a batch of inflated data in peer group benchmarks – and the sole cure is to wind back the clock and take a huge pay cut. Boards may need to be pushed by “say on pay” to see daylight on this issue, because nothing else seems to work.
So I’m personally at a crossroads regarding this issue. There was a “Say on Pay Roundtable” organized by the Working Group on Advisory Votes on Compensation last week; Carol Bowie of RiskMetrics reports on what happened there in this article (scroll down) – and check out the many resources we have on this topic posted in our “Say on Pay” Practice Area on CompensationStandards.com. And then there is this hopeful article from yesterday’s WSJ. Maybe this information can help you make up your own mind. It’s a challenging issue and an important one that needs to be addressed before it’s legislated for us…
Last Tuesday, I attended a roundtable in New York City on the advisory vote on executive compensation (otherwise known as “Say on Pay”). I was sitting through a panel discussion featuring representatives of the various proxy advisory firms, listening to them talk about the criteria that they would use to analyze a Compensation Discussion and Analysis when formulating a voting recommendation on a Say on Pay proposal when it occurred to me that one of them, RiskMetrics Group (which acquired ISS last year), is itself a reporting company that has to comply with Item 402. I was immediately curious about what was in its executive compensation disclosure.
So yesterday, I took a look at the RiskMetrics’ information. Although the company just filed its first annual report on Form 10-K, it won’t file its first proxy statement until later this month. Consequently, I had to go back to the Form S-1 registration statement from its initial public offering earlier this year.
Like many other newly public companies, the Form S-1 disclosure is on the light side. At 10 pages, it features a Compensation Discussion and Analysis (which clocks in at 2,871 words), a Summary Compensation Table, and four of the other required disclosure tables (a Grants of Plan-Based Awards Table, an Outstanding Equity Awards at Fiscal Year-End Table, an Option Exercises and Stock Vested Table, and a Director Compensation Table).There’s no Pension Benefits Table or Nonqualified Deferred Compensation Table, which isn’t too surprising, and no severance and change in control disclosure (it doesn’t appear that the company has any such arrangements in place).
I noted two interesting features in the disclosure. First, in the CD&A (which starts on page 105) the company describes the five corporate objectives used in determining its 2007 bonus compensation, but doesn’t give the performance target levels. Instead, the company provides the following statement:
“Our corporate objectives for 2007, particularly the specific financial targets for revenues, EBITDA and cash flow, which we used for purposes of determining our 2007 bonus and equity compensation for our executive officers, were set at levels which our board of directors intended to be challenging and which provided an incentive for our executive officers to meet our corporate objectives, including increasing our revenues, earnings and cash flow. However, our corporate objectives were (and are) also intended to be attainable if we have what we considered to be a successful year. We believe that a senior management team that is providing strong performance should be able to achieve our corporate objectives in most, but not all, years.”
I interpret this as a “degree of difficulty” statement as specified by Instruction 4 to Item 402(b). It’s a statement that may come in handy if you run into an issue with this type of disclosure down the road.
Also, the company provides an alternative summary compensation table (at page 114), which adds the anticipated grant date fair value of the equity awards it intended to grant to its named executive officers for fiscal 2007 to the other compensation elements reported in the required Summary Compensation Table (these awards had not been granted at the time of the IPO). I guess this is a pretty strong endorsement of these alternative tables and another not-so-subtle criticism of the current equity award reporting requirements.
RiskMetrics status as a reporting company puts the ISS business in a unique position. Its executive pay disclosure is going to be closely scrutinized each year; particularly given its new policy on evaluating executive pay disclosures to make voting recommendations on Say on Pay proposals. (By the way, RiskMetrics has announced that it intends to give its shareholders an annual advisory vote at each annual meeting to approve its executive compensation policies and practices.) I’m probably not the only one who is looking forward to taking a look at its proxy statement in a couple of weeks.
The Section 162(m) Workshop
We have posted the transcript from our recent CompensationStandards.com webcast: “The Section 162(m) Workshop.”
Ah, Cracker Barrel. A decade ago, the biggest Corp Fin-related controversy was the shareholder proposal’s “ordinary business” exclusion basis and the SEC Staff’s Cracker Barrel no-action letter under Rule 14a-8(c)(7) (the basis has since been renumbered to 14a-8(i)(7)). Those were much simpler times. Back then, the SEC’s dealings in corporate governance matters were pretty much limited to the shareholder proposal rule.
The Cracker Barrel saga arose due to a ’92 no-action letter under which Corp Fin allowed that company to exclude a anti-sexual orientation discrimination proposal by stating that all employment-related proposals raising social issues were excludable. Enough fuss was raised so that the Commission specifically overruled its Staff’s position in a ’98 rulemaking and returned the agency’s position on social issues to a “case-by-case analytical approach.” Corp Fin has been making this case-by-case determination when deliberating on social proposals ever since.
Now, a similar case has been brought in the US District Court, Southern District of Texas, by Apache Corporation, which is seeking a declaratory judgment supporting its exclusion of a shareholder proposal submitted by the New York City Employees’ Retirement System. This case seeks to enjoin a lawsuit brought by NYCERS in the Southern District of New York. The facts are as follows:
– For the last two years, NYCERS has submitted proposals to companies in a campaign designed to fight discrimination against gays/lesbians and transgendered people (eg. asking companies to amend their EEO statements a la Cracker Barrel).
– This proxy season, NYCERS submits a proposal to Apache asking for the implementation of a program based on “equality principles” that include additional steps to avoid discrimination against this group of people.
– On March 5th, Corp Fin provides no-action relief allowing Apache to omit the proposal on ordinary business grounds, noting that some of the principles in the proposal relate to ordinary business.
– On April 8th, Apache filed for a temporary restraining order to try to prevent NYCERS from delaying its annual meeting and mailing supplemental materials.
– On April 9th, NYCERS files a lawsuit in SDNY, arguing – among other things – that Corp Fin had denied no-action relief for similar proposals in the past (specifically citing these no-action responses: Armor Holdings ((i)(7) denied on burden grounds) (4/3/07) and Aquila ((i)(10) denied)(3/2/06)) and that the Court doesn’t owe deference to Corp Fin’s positions anyways.
– After it filed its lawsuit, NYCERS subsequently filed for a temporary restraining order, but then quickly changed its request to an affirmative/mandatory injunction to force Apache to deliver supplemental proxy materials ahead of its May 8th annual meeting.
This is where this battle stands today, although it promises to move quickly. We have posted all of the documents filed in the SDTX and SDNY so far in our “Shareholder Proposals” Practice Area.
Corp Fin Tweaks Form 8-K Interps Again
For the second time since their issuance, Corp Fin has tweaked its new Form 8-K Interps to fix a conflict. As had been addressed in our “Q&A Forum” last week, new Interp 202.01 seemingly conflicted with Item 601 of Regulation S-K – with the Staff’s fix, that is no longer so.
John Newell has updated his three sets of redlined 8-K Interps against the old guidance that the Interps updated. John has also provided this redlined version of the new Form 8-K Interps against what the Staff originally issued on April 2nd – which will help those of you that printed them out back then to see what was changed on April 3rd and April 10th.
Closing Time: When the Founder is Ready to Sell
Tomorrow, catch the DealLawyers.com webcast – “Closing Time: When the Founder is Ready to Sell” – to hear about the special issues that come into play when the founders of a privately-held company want to sell out to a private equity firm or a professional roll-up operator. Join these experts:
– Brad Finkelstein, Partner, Wilson Sonsoni Goodrich & Rosati LLP
– Don Harrison, Senior Counsel, Google
– Armand Della Monica, Partner, Kirkland & Ellis LLP
– Geoffrey Parnass, Partner, Parnass Law
– Sam Valenzisi, Vice President, Lincoln International LLC
SEC Tweaks Form S-11 to Permit Incorporation By Reference
Last week, the SEC issued this adopting release indicating it had adopted the amendments to Form S-11 to permit companies using this form to incorporate by reference previously filed ’34 Act reports.
