Yesterday, the SEC finally posted the 110-page adopting release regarding E-Proxy – or as it’s also called: “Internet availability of proxy materials.” These rules were adopted more than a month ago at a December 13 open meeting.
The new rules cannot be used before July 1, 2007 (which means a notice under the new rules cannot be sent to shareholders before then) – given that the notice period under the new rules is 40 days, this new notice and access model cannot be used for meetings scheduled before August 10th. As you may recall, these rules are optional and I bet it will take time for the proxy intermediaries to tweak their systems to allow for the new model. We will cover these new rules in a webcast – including what these tweaked systems look like – in a few months…
SEC Proposes Extension of E-Proxy to “Universal” Status
Yesterday, the SEC proposed amendments to E-Proxy that would require issuers and other soliciting persons to furnish proxy materials to shareholders by posting them on a web site and providing shareholders with notice of the Internet availability of the proxy materials. Comments are due 60 days after publication in the Federal Register.
Back in December at the open Commission meeting, this was referred to as “mandatory” e-Proxy, but that was a bit of a misnomer and I believe the proposing release doesn’t even mention the term “mandatory,” it’s coined “universal” instead – because compliance with the proposal would be so simple: merely posting proxy materials and providing notice of the URL. This change in terminology is helpful to understand what the SEC is proposing; I butchered my interpretation of what “mandatory” meant in a blog last month when the SEC first mentioned it. I can be a space cadet sometimes…
Corp Fin Expresses “No View” in Hewlett-Packard Shareholder Access Response
Yesterday, Corp Fin made public its highly anticipated no-action response letter staff to Hewlett-Packard regarding the AFSCME shareholder proposal seeking a by-law amendment that would allow for a form of shareholder access. It has been reported that this was the only shareholder access proposal submitted to an issuer this proxy season (although this Washington Post article intimates that two other companies have received this proposal). We have posted a copy of Corp Fin’s response in our “Majority Vote Movement” Practice Area.
Since the SEC is still grappling with how to respond to the Second Circuit’s decision regarding a similar proposal that AFSCME submitted last year to a handful of companies, the Staff decided not to express a view as to whether Hewlett-Packard can exclude the proposal from its upcoming shareholders’ meeting.
In deciding to pass on considering a proposal relating to this matter at a January 31st open Commission meeting as expected, SEC Chairman Cox said, “The SEC staff quite properly are following Commission precedent, expressing no view as to the eventual disposition of what is for the moment an unsettled legal question. Fortunately, during the current proxy season, the very small number of inquiries we have received have come solely from companies representing that they are not governed by the decision in the Second Circuit, so in the near term there is no risk of conflicting application of our rules. As a result, the Commission is taking advantage of this opportunity to consider more fully the questions raised by the court decision in their broader context, and to work on crafting a carefully considered proposal that will ensure there is one, clear rule to protect investors’ interests in all jurisdictions during the next proxy season.” So it looks like the SEC is still debating internally what it should do in this area…
What is a “No View” Response from the Staff?
It’s not surprising that the Staff decided to go with a “no view” response here, as the Staff has refused to take a position over the years when a close call is involved if the governing law is unclear.
Although a “no view” response may provide some comfort to a company that the SEC will not bring an enforcement action if it excludes the proposal, it is probably more likely that a court would compel inclusion since there is no Staff decision for a court to defer to – or consider – in making its decision…albeit the courts haven’t been following the SEC’s lead anyways in recent decisions, like the AFSCME one. Hewlett-Packard is expected to file its proxy materials within a few days and it will be interesting to see what appetite for risk they have after the pre-texting scandal.
A few weeks back, the PCAOB finally released its inspection reports for the two remaining auditors of the Big 4: E&Y and KPMG. As aptly covered in this CFO.com article, the reports reveal a number of issues at those firms.
Given that all four auditors did not receive rave reviews by the PCAOB during last year’s round of inspection reports, I’m not sure why the SEC’s Chief Accountant is supportive of giving auditors immunity for liability. Maybe setting the standard for negligence higher (or whatever the proper standard is for liability) is a better legislative/regulatory response?
By the way, Kevin LeCroix of the “D&O Diary” Blog provides us with the latest developments about auditor liability reform in Europe.
The SEC’s December Rule Changes: How They Impact You
We have posted the transcript from the popular CompensationStandards.com webcast: “The SEC’s December Rule Changes: How They Impact You.” Over 1300 members have listened to that webcast (either live or by audio archive) – and over 1400 caught last Thursday’s webcast: “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!” (for which there will be no transcript due to its length of over 3 hours, but the audio archive is available now).
On CompensationStandards.com, we continue to post numerous resources daily, including these recent gems:
– Posted in our “The SEC’s New Rules” Practice Area, Cleary Gottlieb has put together 52 FAQs regarding the new rules (helping us out until the SEC Staff’s FAQs come out sometime during the next week or two).
– There are 99 pending proposals on majority vote to elect directors versus 94 that came to a vote in 2006.
– There are 39 pending proposals on linking pay-to-performance versus 17 that came to a vote in 2006.
– There are 40 pending proposals to report on or disclose political contributions versus 28 that came to a vote in 2006.
Supreme Court to Review Pleading Standard in Private Securities Actions
From Wachtell Lipton: The US Supreme Court last week granted review in an important case that should resolve a split of authority concerning the pleading standard in private securities fraud actions. The standard was established by Congress in the Private Securities Litigation Reform Act of 1995 to combat abusive securities “strike suits,” and it requires that a securities complaint for damages “state with particularity facts giving rise to a strong inference”t hat the defendant acted with “scienter,” i.e., fraudulent intent. In virtually every securities fraud action, the defendants will likely move to discuss the complaint on the ground that the allegations doe not give rise to such an inference. If the court sustains the complaint, defendants must either settle or endure the massive expenses and risks of discovery and trial.
The case being reviewed by the Supreme Court is Makor Issues 7 Rights Ltd. V. Tellabs, 437 F.3d 588 (7th Cir. 2006), in which the United States Court of Appeals for the Seventh Circuit held that a securities fraud complaint should survive “if it alleges facts from which, if true, a reasonable person could infer that the defendant” acted with scienter. Id. at 602 (emphasis added). In making that determination, the court may not, according to Tellabs, evaluate inferences more consistent with innocence than with fraud. This approach is markedly more lenient for plaintiffs than the standards applied in other Circuits, which require the district court to consider all plausible inferences. The Seventh Circuit, however, reasoned that a district court could not consider competing inferences without potentially invading the constitutional role of the jury.
The Supreme Court decision promises to be a landmark in the federal securities laws. The “strong inference” standard is central to the congressional effort to eliminate abusive standards that prevailed prior to 1995. That effort has been frustrated by a multitude of approaches between and within the various circuits, and has led to forum-shopping, uncertainty, and inconsistent outcomes. From a defendant’s standpoint, the Seventh Circuit’s decision in Tellabs not only adds to this confusion, but takes a significant step backwards to the pre-PSLRA era. The Supreme Court has directed that briefing be completed by March 20, 2007, making it reasonably likely that a decision will be rendered this term.
We Live in a Complicated Society
The best part about working from home is that I don’t have to shave years off my life driving in rush hour traffic. I can leave my machete at home. I loved this WSJ article which laid out a number of websites where those without machetes can instead embarrass our fellow humans into behaving better, including:
To pay for certain small business tax relief, the Senate Finance Committee yesterday approved legislation that would severely limit nonqualified deferred compensation for executives. Specifically, the “Small Business and Work Opportunity Tax Act of 2007” would:
– Amend Section 409A to limit the annual accrual of nonqualified deferred compensation to $1 million (or if less, the executive’s average annual compensation determined over five years ). Going over the cap would trigger ordinary income tax plus a 20% additional tax.
– Amend Section 162(m) to treat any former executives as continuing to be covered by the Section 162(m) limits with the effect that payments made after termination of employment would no longer be deductible by the company.
From the FEI “Section 404″ Blog: At its board meeting yesterday, the FASB board voted unanimously (7-0) not to delay the effective date of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (FIN 48). However, FASB will consider potential implementation guidance to be drafted by its staff and presented for the board’s consideration at a future meeting, on one particular issue: the definition of “ultimate settlement.”
FASB received over 400 comment letters on FIN 48 in the past month. FASB staff said most of the letters were from preparers or organizations representing preparers, most were signed by tax executives, and many were form letters referencing an early letter sent by the Tax Executives Institute. FASB also received comment letters from users of financial statements who asked FASB not to delay FIN 48.
In reaching its decision not to delay the effective date of FIN 48 (effective fiscal years begininng after 12/15/06), FASB considered the 3 main calls for delay as summarized by the FASB staff:
– Implementation issues arising directly from provisions of FIN 48 (for which they decided to have staff draft guidance to be considered at future board meeting on the meaning of ‘ultimate settlement’)
– Other consequences not directly associated with FIN 48’s provisions (including documentation, internal control, timing constraints and available tools)
– Industry or other entity-specific concerns
As noted above, FASB decided the staff should draft implementation guidance for FASB to consider on the definition of ‘ultimate settlement’ but staff said other implementation issues raised in comment letters had been dealt with by staff or did not lend themselves to further general guidance because they were facts and circumstances based. Since FASB directed the staff to “burn the midnight oil” and work as quickly as possible on the “ultimate settlement” guidance, they did not believe a delay in the effective date of FIN 48 was required due to this particular implementation issue.
John White on FPI Deregistration and Other Global Issues
Earlier this week, Corp Fin Director John White delivered this speech at PLI’s 6th Annual European Securities Law Institute. John covered a number of international topics, including foreign private issuer deregistration and global accounting convergence.
Yesterday, Corp Fin’s Chief Accountant’s office posted guidance – in the form of a sample letter (ignore the header about oil & gas companies; that is a SEC webmaster snafu) – regarding restatements and option backdating. A little nerve-wracking that the Staff gives a lot of helpful guidance – but then adds the qualifier that even if you follow it, it doesn’t mean you can conclude you are current. So I imagine the Staff will continue to get a lot of calls from folks with backdating issues.
This Staff guidance was anticipated in the Nov-Dec 2006 issue of The Corporate Counsel, which was mailed last week – and will be dealt with more in the upcoming Jan-Feb issue which will be mailed by the end of the month. By the way, that Nov-Dec issue has a great – and lengthy – analysis of how to implement the SEC’s new related person rules.
The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!
Catch tomorrow’s blockbuster 3-hour webcast – “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!” – to hear the SEC’s Paula Dubberly, Mark Borges, Ron Mueller and Alan Dye discuss how companies are gearing up to provide their new executive compensation and related party transaction disclosures this proxy season.
Because this essential 2-Part Web Conference will be accessible only to those that are 2007 members of CompensationStandards.com (Part I on the SEC’s December rule changes was last week, audio archive now available), we urge those of you who have not yet renewed for 2007 to do so now (all memberships expired at year end; grace period for non-renewers has ended) – and anyone not a member should try a no-risk trial. If you need to renew, please renew online if you can as our HQ is overwhelmed right now.
Senate Panel May Limit Tax-Deferred Pay to $1 Million
According to this Bloomberg article, the Senate Finance Committee may consider a proposal setting a $1 million limit on the amount of compensation highly paid workers such as corporate executives, professional athletes and entertainers can defer tax-free each year. The provision was included in a preliminary draft of legislation that was posted yesterday (but then removed because it had been posted “prematurely”).
Rep. Barney Frank: CEO Pay Bill Vote By Mid-’07
Rep. Barney Frank, the new Chair of the House Financial Services Committee, continues to be outspoken on executive pay as he works towards resurrecting his Truth-in-Pay bill. On Thursday, Rep. Frank said he hopes to pass a bill by mid-2007 to give shareholders more say in setting corporate executive pay, according to this Reuters article.
Rep. Barney Frank: Speaking Frankly
Below is an excerpt from comments made by Rep. Frank at the National Press Club on January 3rd:
MODERATOR: You’ve said that you would support giving shareholders more power to constrain executive pay.
Will you provide some details, please, on how you would do this?
FRANK: We’re still working out the details. But, yes — I have to say, boards of directors, I didn’t know much about them before I got to be the senior member of our committee.
You read about boards — they’re supposed to be — I read about boards of directors in Enron and MCI and elsewhere, and they reminded me, I guess this is an appropriate journalistic forum to use this metaphor, the role of the boards of directors in all these crises remind me of something Murray Kempton once said, the great journalist from the New York Post, talking about editorial writers. He said the function of editorial writers is to come down from the hills after the battle is over and shoot the wounded.
(LAUGHTER)
And it seemed to me that’s what the boards of directors used to do.
Now, some of them have gotten more energetic, and I think Sarbanes-Oxley has helped them do that.
But there’s one area where the boards of directors do not appear to be much of a check, and it’s easy to understand why, because they don’t stand up to the CEO. They may stand up to the workers. People said, “Well, do you want to cut the bargaining agreements or the wages to go to shareholders?” You can count on the board of directors to want to depress what they pay the workers.
FRANK: But with regard to the CEO, in the first place, the CEO picked the board of directors; they picked the CEO. It’s a very collusive relationship.
And it’s clear that boards of directors do not provide any real check on CEOs. And it’s true, I guess, the board of directors of Home Depot finally decided that Mr. Nardelli had to go. And they put their foot down and gave him $210 million and asked him to please leave, at which point he apparently succeeded, for the first time, in raising the stock price, by leaving. But $210 million is an expensive thing for that.
So I plan to have some legislation by which we increase the ability of shareholders to vote. And we’re going to try to work out the details, including what happens if they were to vote no.
They have that in Britain, by the way. And Britain has become, recently, an example. And a lot of American corporate leaders have said, well, we like what they have in Britain. We think the Financial Services Authority is more flexible than the Securities and Exchange Commission, that Britain does it better.
But in Britain, shareholders have much more say. And particularly here, I do not think you can count on boards of directors to be adequate checks.
By the way, this compensation for CEOs — it’s not just a matter of envy. It has reached a point where it has some macroeconomic significance.
People at Harvard, Lucian Bebchuk and others, have shown the percentage of the profit of these top 1,500 corporations that goes to compensation for the top three officials has reached almost 10 percent. We’re talking, now, about significant numbers. When Lee Raymond gets $400 million when he leaves ExxonMobil, and the pension is shorted, the pension fund, we’re not just talking about envy.
So yes, we are going to be working on this, and when it gets to committee, we’ll be dealing with it. The SEC — I have one small difference with what they did, but the SEC has made some real gains in requiring corporations to be more open about what kind of compensations there are. And that’s all compensation. It’s stock options, and it’s retirement, and what happens if there’s a change in the corporation.
And by the way, one of the things that we don’t do enough of in this business of ours and yours is to talk about the predictions of doom that didn’t happen. We’re often beating our breast because something bad happened, and we didn’t predict it. What about all the bad things that we predicted that didn’t happen?
Two that come to mind, to me, are same-sex marriage in Massachusetts and expensing stock options. In both cases, enormous negative consequences were predicted and, of course, none have materialized.
I do think it’s time to have a hearing. When we voted on preventing the accounting officials from requiring that stock options be expensed, we heard terrible predictions about the negative effects this would have on the valuation, particularly, of technology companies. It has not happened.
FRANK: And I got to say — and I voted against that bill. So yes, I am saying I told you so.
One of the most common lies in human existence is when people say, “Oh, I don’t like to say ‘I told you so.'”
I do not know anyone who doesn’t like to say “I told you so.”
(LAUGHTER)
And I have personally found that as one of the few pleasures that improves with age.
(LAUGHTER)
I can say I told you so and enjoy it without taking a pill before, during or after the operation.
And we told them so about this. So I think that — again, there’s a lot less fragility in this economy than people think.
But, yes, we have got to find some way to give shareholders — maybe it’s automatic or maybe it’s whatever shareholders want to — but shareholders have to be the check.
By the way, the shareholders we’re talking about now — we’re not talking about this or that individual somewhere off in the country. You’re talking about a very sophisticated set of institutional investors. You’re talking about CalPERS. You’re talking about other pension funds run by public officials or by unions.
There are entities out there representing groups of shareholders who are sophisticated and thoughtful, and I believe corporations would benefit greatly by their increased participation.
In response to so many requests for a practical M&A print newsletter about deal practices, we have created a new newsletter: Deal Lawyers. Just like its sister publication, The Corporate Counsel, Deal Lawyers is tailored for the busy dealmaker, bi-monthly issues that do not overload you with useless information – rather, this newsletter will provide precisely the type of information that you desire: practical and right-to-the-point. As in all our publications, this newsletter will include analysis of timeless “bread and butter” issues that you confront time and again.
To illustrate how Deal Lawyers will provide the same rewarding experience as reading The Corporate Counsel, we have posted the Jan-Feb issue of Deal Lawyers for you to check out at no charge. Feel free to share it with your deal-minded brethren. This issue includes pieces on:
– What the New “Best Price” Rule Means for You
– The New “Best Price” Rule: Financing Issues and Answers
– The New – and Tricky – SEC “Change-in-Control” Disclosures
– What Private Equity Firms Want in a Lender
– The “Sample Language” Corner: Acquiring the California Corporation
Try a no-risk trial today; we have special introductory rates and a further discount for those of you that already subscribe to The Corporate Counsel.
The Evolving ‘Best Price’ Rule
We have posted the transcript of our DealLawyers.com webcast: “The Evolving ‘Best Price’ Rule.”
NYSE and NASD Propose Changes to Research Analyst Rules
On Thursday, the SEC posted a proposing release that would amend NASD and NYSE rules regarding research analysts’ conflicts of interest. The proposed amendments would implement certain recommendations from a Joint Report issued a year ago by the NYSE and NASD.
Among other things, the proposals would change rules regarding disclosure of conflicts; quiet periods; restrictions on review of research reports by non-research personnel; and restrictions on personal trading by research analysts. The proposing release identifies those instances where the NYSE and NASD proposals are different.
Poor Home Depot. After its botched annual meeting last year and lavish executive pay – not to mention poor stock performance – it looks like it’s now easy game for the mass media on lesser issues. On Wednesday, the NY Times ran this article skewering the company’s board for waiving age limits for three of its directors. Given the apparent roles of these three directors in setting former CEO Nardelli’s lavish pay, there appears to be a basis for the attack.
But generally, I don’t believe in age limits for directors in all cases – some of the most productive directors can be those with the most age (and experience). In our “Board Composition” Practice Area, I have had a number of FAQs on age limits posted for some time including this one:
Should boards have age limits for their directors?
Most experts believe yes – unless the company truly believes it has a sound director evaluation process. If a board develops an effective process for evaluating individual directors, it may not need mandatory retirement guidelines – but if a board does not have a sound evaluation process, a mandatory retirement age should be considered.
Retirement ages vary between 70 and 75. Some companies allow the board to waive the retirement age for certain directors. Although a waiver may allow a company to keep a director who is quite valuable (and even become more valuable as more experience is garnered), this might be difficult to administer as some directors might wonder why they were not granted a waiver. Or even worse, a board may become divided over whether to grant a waiver to a particular director.
A possible solution is to grant limited waivers so that directors serve for just one more year. But this still could cause the problems noted above, without providing much in the way of a real benefit if the affected director is a true asset.
Proponents of mandatory retirement ages and term limits argue that they serve to bring fresh outlooks and perspectives to boards by periodically forcing a board to replace directors. Proponents also contend that directors who serve on a board for many years may be less independent from management and, as a result, less of an advocate for shareholders. In addition, retirement ages for directors can provide boards with a way of getting non-performing directors off the board without having to ask for a director’s resignation.
The bottom line is that most experts believe a bright line test can save boards from serious interpersonal issues that inevitably will cost a lot of invaluable time and energy and could cause permanent divisiveness on the board.
ISS generally recommends that investors oppose management and shareholder proposals to impose mandatory age limits or term limits on directors. ISS notes in its U.S. Voting Manual: “[A] mandatory retirement age sends the message that older directors cannot contribute to the oversight of the company. Although establishing a retirement age or limiting the number of times a director may be elected to the board provides a mechanical or ‘bloodless’ means for addressing a real or potential performance issue with a director, it does not take into consideration the fact that a board member’s effectiveness does not necessarily correlate with the length of his board service or his age. Time served is not a substitute for a thoughtful and rigorous board and director evaluation process, which is a better determinant of a director’s fitness for service.”
Carl’s Corner: Back in Business!
Finally got my act together and have started adding more wisdom from Carl Schenider of Wolf Block in “Carl’s Corner”. In this month’s installment, Carl tackles preferred stock features.
SEC’s Chief Accountant Backs Shielding Auditors From Lawsuits
Vineeta Anand of Bloomberg continues to do some great investigative reporting, including this story based on an interview with SEC Chief Accountant Conrad Hewitt:
“The U.S. Securities and Exchange Commission’s top accountant said he supports a proposal to shield public-company auditors from liability if they fail to detect fraud because shareholders won’t be protected should lawsuits force more accounting firms out of business. ‘We would like to see the remaining `Big Four’ firms remain as auditors for companies,” SEC Chief Accountant Conrad Hewitt said in an interview. ‘It helps investors. We would also like to see the second-tier and third-tier firms remain financially solvent.”
Most of the largest U.S. companies are audited by either PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP or KPMG International. Arthur Andersen LLP, formerly the world’s fifth-biggest accounting firm, shut down in 2002 after being convicted of obstruction of justice in the federal government’s investigation of fraud at Enron Corp.
Glenn Hubbard, a former White House economic adviser who’s dean of Columbia University’s business school, and former Goldman Sachs Group Inc. President John Thornton in November called for limits on auditor liability as part of a campaign to make U.S. financial markets more competitive. The group they lead, the Committee on Capital Markets Regulation, wants to ease provisions in the 2002 Sarbanes-Oxley Act that put more of an onus on auditors to detect accounting mistakes and fraud, making them more vulnerable to shareholder lawsuits in future Enron-like scandals. ‘We certainly don’t want to have another Arthur Andersen failure,” Hewitt said.
Mark Olson, chairman of the Public Company Accounting Oversight Board, said in a separate interview that Congress should set policy on protections for auditing firms. ‘Liability exposure is a significant management issue for firms,” he said. The six biggest accounting firms, which also include Grant Thornton LLP and BDO International, said in a Nov. 7 report that regulators should penalize individuals, rather than entire organizations, for faulty audits or misconduct.
SEC Deputy Chief Accountant Zoe-Vonna Palmrose, before joining the agency, wrote in a 2005 academic paper that lawsuits by public-company shareholders “undermine the stability of even the largest audit firms.” She suggested establishing a new government office to review whether accountants should be culpable for securities violations.
Hubbard and Thornton’s committee, which is backed by U.S. Treasury Secretary Henry Paulson, said Nov. 30 that Congress can prevent ‘damage awards against audit firms and their employees at a level that could destroy a firm.’ The SEC in December proposed changing the provisions for business-practice audits under Sarbanes-Oxley to reduce costs for public companies.”
As I blogged about a few weeks ago, Corp Fin’s Office of Chief Accountant has updated its “Current Accounting and Disclosure Issues” Outline. Below is some excellent analysis from Davis Polk as to what Corp Fin changed in its Outline. I just love this piece; it surely is an early contender for memo of the year:
Part I of the Corp Fin’s Outline provides a summary of recent SEC rulemaking and written guidance (both proposed and adopted). Part II of the Outline discusses the SEC staff’s views on other accounting and disclosure issues. Although posted by the SEC in December 2006, the updated Outline has a date of November 30, 2006. As a result, the Outline does not reflect the significant rulemaking by the SEC in December 2006.
The new or updated disclosure items contained in the Outline include the following:
– Statement of Cash Flows – The SEC has added two new subcategories to Section II.C of the outline regarding the Statement of Cash Flows. One of the new subcategories addresses the treatment of Discontinued Operations and the other new subcategory addresses the treatment of Insurance Proceeds.
– Discontinued Operations – In the outline subcategory related to discontinued operations, II.C.1., the SEC staff notes that registrants who have discontinued operations should carefully consider how to present disclosures about the cash flows of the discontinued operations within the Liquidity and Capital Resources section of MD&A. According to the SEC staff, management should pay particular attention to describing how cash flows from discontinued operations are reflected in their cash flow statements, and, if material, they should quantify those cash flows if they are not separately identified in those statements. In addition, management should describe how it expects the absence of cash flows, or absence of negative cash flows, related to the discontinued operations to impact the company’s future liquidity and capital resources. Management should also discuss any significant past, present or upcoming cash uses as a result of discontinuing the operation.
– Insurance Proceeds – In the new outline subcategory related to insurance proceeds, II.C.2., the SEC staff notes that material cash insurance settlements should be discussed in MD&A. The discussion should inform investors of cash received and why it was received, what the company plans to do with the proceeds, how it is presented in the cash flow statement and the impact, if any, on reported earnings.
– Contingencies, Loss Reserves and Uncertain Tax Positions – The SEC has also updated Section II.I of the outline regarding Contingencies, Loss Reserves and Uncertain Tax Positions. As part of the update of this section, the SEC staff has added a new subsection entitled “Discussion in MD&A.” In this new outline subsection, the SEC staff notes that the requirement to discuss uncertainties in MD&A encompasses both financial and non-financial factors that may influence the business, either directly or indirectly. According to the SEC staff, the need to discuss such matters in MD&A will often precede any accounting recognition when the registrant becomes aware of information that creates a reasonable likelihood of a material effect on its financial condition or results of operations, or when such information is otherwise subject to disclosure in the financial statements, as occurs when the effect of a material loss contingency becomes reasonably possible. The outline provides that if a registrant is unable to estimate the reasonably likely impact, but a range of amounts are determinable based on the facts and circumstances surrounding the contingency, it should disclose those amounts.
The SEC staff also notes that MD&A should include a quantification of the related accruals and adjustments, costs of legal defense and reasonably likely exposure to additional loss, as well as the assumptions management has made concerning those amounts. According to the SEC staff, a company should articulate the reasons the assumptions it used best reflect its exposure and the extent to which the resulting estimates of loss are sensitive to changes in those assumptions. The SEC staff also indicates that it believes that the need to address the underlying assumptions is especially important when there is a material difference between the range of reasonably possible loss and the amount accrued.
– Segment Disclosure – The SEC staff has updated Section II.L.2. of the outline which discusses the aggregation of operating segments as permitted by FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”). The SEC staff has also added a new subsection, II.L.5, to discuss operating segments and goodwill impairment.
– Aggregation of Operating Segments – In Section II.L.2 of the outline, the SEC staff notes that it has seen improper aggregation of operating segments in situations involving a quantitatively immaterial segment. For example, the SEC staff has seen instances where a quantitatively immaterial segment is aggregated with a reportable segment because it does not meet the quantitative thresholds requiring separate presentation under SFAS 131. According to the SEC staff, if the quantitatively immaterial segment does not share a majority of the aggregation criteria with the reporting segment, aggregation is inappropriate. The outline provides that in this situation, the quantitatively immaterial operating segment would best be placed into the “other” category.
– Operating Segments and Goodwill Impairment – The SEC staff has added a new subsection, II.L.5, that discusses ramifications of FASB Statement No. 142, Goodwill and Other Intangible Assets, (“SFAS 142”) on segment reporting. Paragraph 18 of SFAS 142 requires that goodwill be tested for impairment at the reporting level. As part of this discussion, the SEC staff notes that given the impact the identification of reporting units can have on the determination of a goodwill impairment charge, registrants should consider providing disclosure in the critical accounting estimates section of MD&A. The SEC staff believes that this disclosure may be particularly important when the amount of goodwill is material. According to the SEC staff, the disclosure should address how the reporting units were identified, how goodwill is allocated to the reporting units and whether there have been any changes to the number of reporting units, or the manner in which goodwill was allocated. If such changes have taken place, they should be explained.
– Disclosure of Off-Balance Sheet Arrangements – The outline includes a new section, II.N., entitled “Disclosure of Off-Balance Sheet Arrangements.” In this section, the SEC staff discusses the Item 303 of Regulation S-K requirement to provide, within MD&A, a separately captioned section that discusses off-balance sheet arrangements that have or are reasonably likely to have, a material current or future effect. The SEC staff notes that they have found many registrants’ compliance with this requirement to be deficient. In particular, the SEC staff notes that registrants often provide the disclosure required by Item 303 throughout MD&A and in the footnotes to the financial statements rather than in a separate section as required. In addition, the SEC staff feels that the disclosure provided is often boiler-plate.
The SEC staff urges registrants to review whether any of their business activities may have off-balance sheet implications and present descriptions of these arrangements in their MD&A in one section that is clearly labeled. The nature and business purpose (i.e., why the transaction was structured as off-balance sheet) of off-balance sheet arrangements, as well as the exposure to risk that results from the arrangements, should be discussed. The SEC staff requests that, in order to increase transparency for investors, registrants should also consider disclosing that they have no material off-balance sheet arrangements, if that is the case.
More on Mark Cuban’s Investment Strategies
Cleaning out old emails and came across this gem from Bruce Dravis of Downey Brand, who waxes on my blogs about entrepreneur Mark Cuban’s investment strategies:
“I think the interesting question about Mark Cuban’s shorting/reporting business model is not the short positions that he establishes, but what will happen when he changes those positions. This is not Foster Winans taking a position ahead of the news without disclosing that fact, or the “scalping” case in SEC v. Capital Gains Research of the investment adviser taking positions without letting his newsletter recipients know.
Cuban advertises the fact he took a position ahead of the news. That is more honest than the hedge fund manager who shorts a stock and then leaks his negative investment thesis to CNBC or the Wall Street Journal—readers have a chance to consider the interested nature of the source of the news. However, what happens when Cuban unwinds the position? Once he takes this public position—and explicitly or implicitly invites other investors to follow him—I could envision circumstances in which his own investment plans could turn into material non-public information.
Even in that case, if he announced publicly before he changed his investment position, so that investors who followed him into the short position had a chance to get out first, it would be hard to claim that he manipulated other investors into generating trades that advantaged his investment. There is plenty that could go wrong with the business model: What if one of his own reporters misappropriates the information to establish a position ahead of Cuban? What if someone in his organization tips an outsider ahead of Cuban publishing his position?
Still, Cuban seems like an intelligent, careful businessman with a sense of business ethics. He bankrolled the excellent Enron documentary “The Smartest Guys in the Room.” If he had been advocating shorting Enron on the basis of Bethany McLean’s original Enron reporting, who knows what the alternative history of Enron—and consequently of the Sarbanes Oxley Act—might have been.”
According to this Reuters’ article, Chairman Cox talked about “why” the rules changes were made and the Chairman illustrated how the December rule changes to the SEC’s new executive compensation rules were not intended to hide pay levels at a Reuters summit on Monday. It’s unclear if the Chairman addressed “why now and not back in July” at the summit, but earlier media reports stated that the Chairman had believed at the time the original rules were adopted that a vesting approach for reporting option grants in the Summary Compensation Table was included as part of the new rule package.
Not quite sure I bite on that explanation. Below is something I received from a member following up on what the NY Times’ Floyd Norris wrote in his own blog last week:
“For what it’s worth, after digging around in the July 26th Open Meeting webcast archive, I found out that (i) Chairman Cox described the FAS 123R full grant value treatment in his opening remarks at the Open Meeting (ii) the SEC Staff described this as well in its opening remarks and (iii) the first Q&A exchange between Cox and Corp Fin Director John White (listen to the webcast archive at the 30:52 mark of the meeting) explicitly covered this issue. White, in response to Cox’s question about the treatment of options under the new rules, laid this out quite plainly, including the difference between FAS 123R for financial reporting purposes and for compensation disclosure purposes in the SCT (see 31:04 mark of the webcast archive).”
This fact finding seems to cut across the grain that the Commission really didn’t know what standard it originally adopted and hopefully will put an end to such musings, such as done in yesterday’s WSJ op-ed. The op-ed states: “The SEC’s mistake is regrettable, but the agency might be forgiven for overlooking what was a relatively minor point in its gigantic 450-page July rule.” I think anyone closely following the rulemaking during the proposal stage would argue that this was not a “relatively minor point”; this was a hotly debated issue as reflected in the comment letters submitted last summer by many major organizations.
What to Do Now: How to Implement the December Rule Changes
Regardless of the “why,” what’s done is done and we turn to what we practitioners care about most: the “how to implement” aspect of the December rule changes. Don’t forget to tune into tomorrow’s CompensationStandards.com webcast: “The SEC’s December Rule Changes: How They Impact You.”
That webcast will be followed by another (and much longer) one next Thursday: “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!.” Because this essential 2-Part Web Conference will be accessible only to those that are 2007 members of CompensationStandards.com, we urge those of you who have not yet renewed for 2007 to do so now (all memberships expired at year end; grace period for non-renewers ended last week) – and anyone not a member should try a no-risk trial. If you need to renew, please renew online if you can as our HQ is overwhelmed right now.
Whining about Semantics
I can’t help but whine about last week’s WSJ opinion column that did some whining of its own about Home Depot’s former CEO ‘severance’ package. The WSJ claimed that most of Nardelli’s $210 million payout wasn’t really severance at all because the terms for much of that package were set when he was hired years ago.
I got news for whomever wrote that piece: just because severance arrangements are negotiated well in advance of a termination doesn’t change the fact that they are indeed severance arrangements. In other words, don’t bother writing that others are not properly using terminology until you master it yourself!
And One More Wake-Up Call
This statement in the WSJ opinion column”>op-ed should serve as one more wake-up call to boards and advisors: “That contract can’t be abrogated now simply because the board has concluded it made a mistake.” The statement might be true for Nardelli because he is gone – but it certainly isn’t true for every other CEO who still holds their job today.
As we have written about numerous times, boards get an opportunity each year to revisit their past mistakes when they are set pay levels for the following year. Remember that’s one of the primary purposes of going through the exercise of creating a tally sheet – it enables boards to find out if excesses have been created and then the board has an action item to try to rectify them.
One of the first steps a board can take is to ensure properly worded clawback provisions are added to outstanding contracts – see more in our “Clawback Provisions” Practice Area on CompensationStandards.com.
Boards really need to take action here. It seems hardly a day goes by without another example of a senior manager getting fired and still taking millions of dollars home with them despite poor performance. Who wouldn’t want $10 million in severance for six months on the job? That’s what the just-fired COO of JC Penney walked away with; seems like managers are incentivized to perform badly with some of these poorly negotiated employment arrangements…
The New York City Bar Association has put together a pretty fascinating report – through a task force – on what role lawyers should play in corporate governance. The 298-page report – “Lawyer’s Role in Corporate Governance” – was just released a few weeks ago.
In this podcast, Tom Moreland of Kramer Levin – and the Chair of the NYC Bar’s Task Force that prepared the report – tells us more, including:
– Why did the NYC Bar Association decide to prepare this Report?
– What were you able to determine about the involvement of lawyers in those scandals?
– Did this conclusion lead the Task Force to make any recommendations for the future?
– What other recommendations in this Report would you like to highlight?
– What should lawyers do in light of this Report?
Mad as Heck and Not Going to Take It Anymore
Shutterfly Chairman Jim Clark, founder of Netscape, resigned from the company’s board (even though he is a 30% shareholder) complaining that Sarbanes-Oxley overly restricts the ability of large shareholders to participate in board functions, as noted in this resignation letter filed as an exhibit to a Form 8-K filed yesterday.
FIN 48: Slouching Toward Implementation
Here’s some great stuff from Jack Ciesielski’s AAO Weblog: “Last June, the FASB released an interpretation of Statement No. 109, which deals with income tax accounting. It was called Interpretation No. 48 (catchy, eh?), “Accounting for Uncertainty in Income Taxes” and quickly picked up the moniker “FIN 48.” Or, if you work in the tax department of a publicly-traded company, it became known by other, more colorful nicknames. I won’t go into those here; family publication and all that.
And I won’t go into details about the nuances of FIN 48, either; suffice it to say, it provides a framework for evaluating “uncertain tax positions” that companies take from time to time, that might either create/increase a tax asset or reduce a tax burden. Sometimes those tax positions are solidly defensible, and there’s little question that any tax assets recognized in the financial statements are going to be realized; sometimes the positions taken on tax returns are done so with fingers crossed in the hope that the taxing authorities are going to miss them. Any effect that “fingers crossed” positions may have on the financial statements – creation/increase in assets or reduction in liabilities – might be different from what shareholders (after it’s been asserted in the financial statements that these things are so.)
In studying balance sheets, investors want to see what is – not what managers wish for. And that’s what the effect of applying FIN 48 does: it forces managers to look at the odds of open tax positions being sustained under review by tax authorities. The standard might wring some water out of assets on balance sheets … IF it’s actually implemented. It’s supposed to be effective in years beginning after December 15, 2006. For calendar year companies, that’s right now.
Recently, the FASB has started receiving unsolicited letters about the interpretation, insisting that the standard-setter push back the implementation date – for example, this one from Tax Executives International. This is a standard that has gestated for over two years, has been exposed for comment, and issued in final form six months before implementation – and now firms decide that it’s too soon to implement it? Even more ironic, the IRS had even offered expedited reviews of issues with FIN 48 importance in order to enable them to meet the implementation deadline.
I’ve written a letter of my own to the FASB, urging them to stand pat on the implementation date. Feel free to send one of your own to FASB chairman Robert Herz, using this link. Tell him that you support their standard as it stands.”
