– Why has Moody’s issued this new report?
– How can better disclosure of performance metrics targets enhance a creditworthiness evaluation?
– What type of peer group benchmarking disclosure is Moody’s looking for?
– How about for payments following a change in control?
SEC Amends Definition of “Eligible Portfolio Company” Under the ’40 Act
A while back, the SEC adopted amendments to the rule under the Investment Company Act of 1940 to more closely align the definition of eligible portfolio company – and the investment activities of business development companies – with the purpose that Congress intended by expanding the definition to include certain companies that list their securities on a national securities exchange, among other things. Here is the SEC’s press release. And here is an interview with Harry Pangas of Sutherland Asbill about business development companies in a nutshell…
Gatekeepers: The Professions and Corporate Governance
I haven’t done much in the way of book reviews, so I thought CorpGov.net’s Jim McRitchie’s review of the new book – “Gatekeepers: The Professions and Corporate Governance” – by well-known Columbia Professor John Coffee was worth repeating below given all the reforms currently on the table:
Although the book was written in the wake of Enron and WorldCom, it is equally applicable to the subprime debacle in its analysis of “gatekeeper failure.” In a personal note to me, Professor Coffee laments, “perhaps I should have waited a year longer to write this book.” Better he should have written it a couple of years earlier, with copies to Alan Greenspan and others charged with regulating and rating the mortgage industry.
However, the book’s timing could hardly be better, since substantive reform only seems to occur with a crisis. Implosion of the savings and Loan Industry brought us the Federal Institutions Reform, Recovery and Enforcement Act of 1989. Accounting scandals at Enron, WorldCom, etc. brought us the Public Company Accounting Reform and Investor Protection Act of 2002 (Sarbanes Oxley). The subprime debacle is likely to bring significant reform as well.
It would be great if those advising Presidential candidates would consult Gatekeepers in preparing such proposals. Coffee focuses on auditors, attorneys, securities analysts and credit-rating agencies who inform and advise corporate managers, boards and shareholders. After a brief introduction explaining the failure of gatekeepers and a comparative overview of their roles internationally, Coffee devotes a chapter to each of the four groups. He typically provides an informative history, a review of current issues such as conflicts of interests, and an evaluation. He wraps up the book with a thematic discussion of what’s gone wrong and how it might be fixed.
In general, gatekeepers act as “reputational intermediaries” by verifying corporate statements to investors. When trusted and successful, this lowers the cost of capital. However, as Coffee notes, “Watchdogs hired by those they are to watch typically turn into pets, not guardians,” especially in the euphoric environment typified by stock or housing bubbles, when the public is typically lulled into complacency.
As management incentives were aligned with shareholders through options, income smoothing gave way to robbing the future for earnings that could be recognized immediately. Coffee explains how Enron’s audit committee was blinded by professional advisers who fed it only the information senior management wanted them to have. Auditors were retrained and incentivized to sell consulting services. He explains why fund managers and gatekeepers tend to herd and why, until four days before Enron declared bankruptcy, its debt was rated “investment grade.’ Only those with a financial self-interest, the short-sellers, searched beyond the surface and predicted Enron’s accounting restatements. At WorldCom, “the limited due diligence that was conducted appears to have been constrained by the need not to offend the client” and the actual fraud was detected by the firm’s internal auditors.
Coffee helps the reader see from a different perspective. For example, while some studies have found that audit firms with high consulting revenues were more likely to acquiesce to questionable earnings management, others found no such correlation. Coffee points out that instead of looking what is already in hand, we should look to possibilities. “The real conflict lies not in the actual receipt of high fees, but in their expected receipt.” That explains why audits became a “loss leader” to obtain consulting services.
Similarly, disclosure of conflicts of interests often does not lead to expected results. Social psychologists find those on the receiving end often let down their guard, thinking because conflicts were disclosed they are being dealt with fairly. However, the conflicted party often feels that, having made the disclosure, they are now free to pursue their own interests aggressively. Gatekeepers is filled with such insights.
The major problem is that gatekeepers have come to view corporate managers, not shareowners, as their principals. Their livelihood depends on being viewed as flexible, problem-solving and cooperative, rather than rigorous or principled. “If left to their own devices and subjected to a significant threat of private litigation, professionals will respond by defining GAAP and auditing standards in their own interest, rather than that of investors.” “Absent a litigation threat, professionals acquiesce in dubious and risky practices that their ‘client’ wants; but once subjected to an adequate litigation threat, professionals insist upon narrow duties, hopelessly specific safe harbors and a rule-base system that often seems devoid of meaningful principles.”
According to Coffee, “The challenge for the regulator is not to take discretion out of the system, but to preserve and expand it. But discretion must be accorded to the gatekeeper, not the client (whereas present-day GAAP does the reverse).” The gatekeeper must assess not simply whether GAAP contains a rule authorizing a given treatment, but whether discretion so exercised is reasonable. Pressure to reform must come from regulators, investors and the young that the profession hopes to recruit who would find that greater discretion enhances the professions’ image in their own eyes and those of the public.
Some of Coffee’s more interesting recommendations, at least as I read them:
– Break-up the major accounting firms to provide more competition.
– Establish an intermediary that receives payment from the issuer but then selects the analyst based on objective criteria, such as their record of predictions.
– Restore “aiding and abetting” liability for professionals instead of de facto immunity for knowingly or recklessly participating in fraud.
– Formalize the role of “disclosure counsel” by requiring audit committees to retain them to investigate and test corporate disclosures on an on-going basis.
I got quite a few responses to my blog on whether Apple should have handled its disclosure issues related to CEO’s Steve Jobs differently. In fact, NY Times’ reporter Joe Nocera wrote a great column on the topic the day after my blog.
Here are excerpts from several responses from members:
– The Jobs situation is a good illustration of the affirmative-duty-to-disclose question, which a lot of junior lawyers have a hard time grasping,
– Interestingly, some companies create problems for themselves when they throw in a risk factor about dependence on key management personnel, largely to stroke the ego of their CEO who could be replaced without much difficulty.
– The health disclosure question comes to a head when the CEO/CFO certifications must be filed. At what point is someone else effectively functioning as PEO or PFO? Let’s imagine a PEO/PFO is in a car accident or a coma, or just “out of sorts” for a couple weeks. Should companies start thinking about implementing procedures like the 25th Amendment to the US Constitution? That would be the logical extension of the Form 8-K Item 5.02 and certification issue.
I’ve done the analysis about whether a company could have an obligation to disclose health problems of its CEO and I normally would have agreed with your suggestion that Item 5.02(b) (retirement, resignation or termination) might be triggered if a CEO became so debilitated that he wasn’t truly functioning in that position. However, I keep coming back to the recent SEC Staff guidance that Item 5.02(b) is not even triggered when the CEO dies in office (see Interpretation 217.04 of Form 8-K CDIs)! How bizarre is that!
– One might consider whether information concerning Steve Jobs’ health something that a reasonable investor would want to know in making a buy/sell decision regarding Apple stock (and thus would be considered “material” under a TSC v. Northway analysis) as contrasted with mere intrigue surrounding a celebrity CEO (which is not particularly relevant to investors). If the former, one would think it is difficult for Apple not to disclose in connection with, say, a Form 10-K or 10-Q filing because its contains MD&A, which has broad materiality-based disclosure requirements. If the latter, there should be no disclosure obligation.
As a policy matter, query whether the investing public is better served by all companies including a risk factor stating that from time to time key personnel may have illnesses, which could be serious, might interrupt service to the company and that the interruption might be permanent. Further consider if anyone is served by a disclaimer of any duty to update info about the health of key personnel to the extent disclosure occurs.
Your Take: What Should Have Apple Done?
Here is a poll where you can anonymously provide your legal analysis:
Most large US public companies are incorporated in Delaware, but not all. You may ask: why did some blue chip companies choose to incorporate in New York rather than Delaware, which has long been favored because of its efficient corporate law structure and renowned courts whose justices are business savvy? Because these companies were formed long before Delaware earned its well-deserved reputation. Long-standing New York companies include General Electric (1892), International Paper (predecessor company incorporated in 1898), Xerox (1906) and IBM (1911).
In many areas, New York law and Delaware law are similar. In fact, New York recently passed two amendments to its business corporations law (signed into law by Gov. Patterson on July 22nd) that will put New York companies on equal footing with their Delaware counterparts in certain areas.
The first amendment – S.7350 / A.10824 – allows companies to move from the default plurality standard for director elections to majority election via a bylaws amendment. Until now, New York companies could only change from a plurality to a majority standard by amending their charters, which requires shareholder approval (and under the SEC’s rules, the filing of preliminary proxy materials). Delaware companies have always been able to easily make this change through a bylaws amendment, which does not require shareholder approval.
The other amendment – S.7349 / A.10825 – allows New York companies to pay dividends out of either surplus or net profits, which is consistent with Delaware law. Previously, New York companies could only pay dividends out of surplus.
I imagine that New York companies are happy that their state legislature is staying on top of issues like this – and these moves are seen as friendly to both companies and their shareholders.
Now Available: RiskMetrics’ Annual Policy Survey
RiskMetrics has opened its annual policy survey to corporate issuers in the United States as well as global institutional investor clients. This year, they desire to gather corporate views earlier in the policy formulation process. The survey questions are nearly identical for both the institutional and issuer surveys – both seeking a broad perspective on the policy topics they’re investigating for the 2009 proxy season, including compensation, board elections, director independence and more.
As in recent years, RiskMetrics will also hold an open comment period in the Fall to solicit specific feedback on their proposed policy changes.
How to Handle Hedge Fund Activism
On DealLawyers.com, we have posted the transcript from our recent popular webcast: “How to Handle Hedge Fund Activism.”
When Will Michael Phelps Be Swimming for His Eight Medals?
Both my boys are competitive swimmers (and my wife used to be) and Kate Ziegler grew up swimming in our neighborhood, so we’re pretty excited about Michael Phelps and Katie Hoff’s upcoming events at the 2008 Beijing Olympics.
However, I had a hard time figuring out when Michael would be swimming when we are on vacation next week – here is what I figured out from this complex NBC Olympic schedule (all gold medal swimming events will be shown live and at night Eastern Time; but it’s unknown when at night they will be swimming):
– 653 companies have used voluntary e-proxy so far (this pretty much is the head count for this proxy season)
– Size range of companies using e-proxy varies considerably; all shapes and sizes (eg. 32% had less than 10,000 shareholders)
– Bifurcation is being used more as the proxy season progresses (but still not all that much); of all shareholders for the companies using e-proxy, now over 10% received paper initially instead of the “notice only” (up from 5% a few months ago)
– 1.1% of shareholders requested paper after receiving a notice; this average is about double what the trend was a few months ago
– 57% of companies using e-proxy had routine matters on their meeting agenda; another 31% had non-routine matters proposed by management; and 12% had non-routine matters proposed by shareholders. None were contested elections.
– Retail vote goes down dramatically using e-proxy (based on 586 meeting results); number of retail accounts voting drops from 20.6% to 5.5% (over a 73% drop) and number of retail shares voting drops from 34.8% to 16.7% (a 52% drop)
A Note on Bifurcation
A number of members whose companies bifurcated have told me that a primary reason they did so was because Broadridge maintains a database of investors who prefer paper. So far 2.5 million investors have asked to be in this database.
Many companies have a fair number of their shareholders in this database – often over double digits in terms of percentages – and these companies recognized that it would be challenging to do a notice-only delivery and risk fulfillment issues (egs. not printing enough to meet demand; service provider botching the fulfillment, etc.). For these companies, it was better to bifurcate and keep the number of shareholders who requested paper much lower than it otherwise would have been the case.
In other words, the relative level of shareholders that requested paper would be a bit higher than the 1.1% experienced if these companies had not bifurcated (if I comprehend the Broadridge stats correctly). But this all still begs the question of why so many companies didn’t bother to bifurcate? I imagine they will next year to reap the cost savings available…
The Yahoo Annual Meeting: My, My, How Things Change
I got a chuckle out of the Washington Post’s headline for the Yahoo annual shareholders’ meeting this Saturday: “Shareholders Give Yahoo a Vote of Confidence.” It’s funny because each director received over 75% of the vote – meaning that nearly 25% of shareholders “withheld” their votes from these directors, who ran unopposed and without a major “just vote no” campaign. [You may recall that Carl Icahn had initially challenged management by running an opposing short slate, but he was appeased and placed on the board – so he withdrew his campaign.]
It wasn’t that long ago that directors routinely received 98% of the vote – so I really wouldn’t call 75% a “vote of confidence.” And now a major shareholder is questioning the results and asking for a recount of its votes…
On Friday, the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR) issued its final 172-page report.
The final report has 25 recommendations for implementation by the SEC, FASB and PCAOB. Although the report is probably most important for accountants, it certainly has implications for lawyers and IROs/corporate communications. And these recommendations are likely to be taken seriously – the SEC already has acted on two of the recommendations: mandatory XBRL and guidance on company websites.
Posted: SEC’s Interpretive Release on Corporate Use of Websites
On Friday, the SEC posted its interpretive release on corporate use of websites. I’m off on vacation soon – and Dave is already floundering on a beach – so it’s gonna be a while before we dribble out some original thoughts…
Last SEC Commissioner Sworn In
On Friday, Troy Paredes was sworn in as a SEC Commissioner. The gang’s all there now – and I imagine the shareholder access debate will resume as Chairman Cox has promised. By my count, there is a total of twelve Commissioners that have served in that capacity during the access debate…
Our August Eminders is Posted!
We have posted the August issue of our complimentary monthly email newsletter. Sign up today to receive it by simply inputting your email address!
Kudos to Francis Pileggi and his “Delaware Corporate and Commercial Litigation Blog” for highlighting a new Delaware Chancery Court case that exposed independent directors of a public company to personal liability in a M&A context; a topic that always gets people’s attention.
In Ryan v. Lyondell Chemical Company, (Del. Ch. Ct., 7/29/08), the Delaware Chancery Court found that at the procedural stage of a summary judgment motion, the issue of whether independent directors should be exposed to personal liability for their role in the sale of the company can proceed to trial – despite selling the company to the only known buyer for a substantial premium. We have posted the opinion in DealLawyers.com’s “Litigation” Portal.
Earlier this week, the SEC approved Nasdaq’s proposal to adopt new listing standards for SPACs. The approved listing standards are slightly different from what was originally proposed including:
– reduced amount of gross proceeds that must be deposited from 100% to 90%
– clarified period in which SPAC must complete one or more business combinations
– required all listed SPACs contain provisions allowing shareholders to convert shares into cash if they vote against a business combination
Another SEC Commissioner Sworn In
Yesterday, Luis Aguilar was sworn in as a SEC Commissioner. Only one more to go…
Yesterday, the SEC adopted updated interpretive guidance regarding how companies can use their websites. Here is Corp Fin’s opening statement – and here is the press release (which includes a video from SEC Chair Chris Cox). The interpretive release is not yet available.
Based on comments made during the open Commission meeting and the press release, we know the SEC’s guidance is principles-based that relies on a facts-and-circumstances analysis and is divided into four parts as follows:
1. Reg FD Guidance – How information posted on a company’s site can be considered “public” and provides guidance to help companies comply with Regulation FD. The upcoming release contains factors to help determine whether online information is considered “public” so that subsequent communications would not constitute disclosure of material non-public information, including whether:
(i) a company site is a recognized channel of distribution
(ii) online information is considered broadly disseminated
(iii) information has been posted for a sufficiently long period of time so that it has been absorbed by investors
In addition, the release addresses when disclosure of information on a site is considered adequate to make such information “public” for purposes of the alternative public disclosure prong of Regulation FD (the default prong is furnishing a Form 8-K). At the open Commission meeting, it was predicted that fewer Form 8-Ks will be filed under this guidance.
2. How Liability Standards Work Online – What the liability framework is for electronic disclosure, including how companies can provide access to archived data without it being considered reissued or republished; how companies can link to third party information; appropriate use of summary information; how antifraud provisions apply to statements made by the company in blogs and electronic shareholder forums, and more.
3. No Disclosure Controls Necessary for Website – How information posted on company sites would not be subject to rules relating to disclosure controls and procedures (unless the information is the type to satisfy a ’34 Act obligation). This information remains subject to Rule 10b-5 liability.
4. Printer-Friendly Functionality Not Required – How information need not satisfy a “printer-friendly” standard, unless other rules explicitly require it.
Once the interpretive release itself is available, I’ll blog more including how it stacks up against my ten cents. Dominic Jones has more on yesterday’s open Commission meeting in his IR Web Report blog.
Gulp! The SEC’s View on Lawyer Negligence
A few weeks ago, the SEC issued an order – regarding “In the Matter of Scott G. Monson” – dismissing an enforcement action against the former in-house lawyer of a broker-dealer (this action related to an appeal by the SEC from an administrative law judge’s dismissal of cease-and-desist proceedings). The lawyer had a background in family and real estate law, etc. and took this job without any securities law background; he drafted an agreement based on a sample – and botched the job.
Although the issues in this action are fact-specific, the SEC’s order has some interesting things to say about enforcement actions against lawyers in general. In the order, the SEC acknowledges that “as far as we are aware, we have not sanctioned attorneys in litigated enforcement proceedings based on alleged negligent acts or omissions they may have committed in providing non-public legal advice to clients.”
But then the SEC’s order goes on to list the types of cases that the SEC will pursue against lawyers – and notes that this case doesn’t require the SEC to address the appropriate parameters of lawyer liability in administrative enforcement proceedings because the record didn’t show that the in-house lawyer acted negligently by a preponderance of the evidence. Keith Bishop (who is now at his new firm Allen Matkins) served as an expert for Monson.
All the Latest: Two New Blogs to Check Out
Long-time blogger Bruce Carton – a former SEC Enforcement Staffer – is back with his UnusualActivity.com blog; check out his piece on the death of ShareSleuth.com.
And a former SEC Corp Fin accountant – John Feeney – who has been advising the CFO & audit committee community on strategic financial reporting issues for past ten years has launched his “StreetDisclosure.com Blog“; John provides his first-hand account working with IFRS in this entry.
Over the past six months or so, sovereign wealth funds have increasingly been the subject of debate – in the media and in Congress – for taking stakes in distressed companies in the US and Europe. This debate has taken on many forms (eg. Boeing’s loss of a $40 billion contract to a joint venture that includes AirBus) and arguments (eg. Warren Buffett’s take from his annual letter).
As noted by RiskMetrics a while back, European Union regulators proposed guidance to member states to align policies on sovereign wealth fund investments and to aid international bodies in their efforts to craft a voluntary code of conduct to oversee these practices. Last Fall, the International Monetary Fund began to develop a code of conduct to address these issues, a project which continues – and the Organization for Economic Cooperation and Development is developing best practices guidance for countries receiving these types of investment.
During this upcoming DealLawyers.com webcast – “The Rise of Sovereign Fund Investing” – an expert panel will analyze the issues that should be considered for a sovereign wealth fund investment.
Sovereign Wealth Funds: The SEC’s Perspective
Several months ago, John Olson posted this blog on Harvard Law School’s “Corporate Governance Blog”: “I’m posting a too little noticed speech by SEC Chairman Cox, delivered a month ago in Washington, in which he discusses the growing concerns with the role of sovereign wealth funds and government-affiliated public companies in global securities markets and the impact of such government-related concentrations of capital, and related market influence, on corporate ethics and policy, transparency and the integrity of financial reporting. What about the values of corporate governance, and shareholder power, when the controlling interest or “golden share” is held by a government, particularly a government that itself does not practice transparency or tolerate democracy as we know it?”
In addition, there is this Congressional testimony:
A member recently asked how many companies participate in taking environmental and social surveys, ratings, etc., such as the Carbon
Disclosure Project, Dow Jones Sustainability Index, etc. Please take a moment for this survey:
Recently, I blogged about an interesting new website that has the potential to empower investors more. In this podcast, Andy Eggers discusses his website “ProxyDemocracy.org,” including:
– Where did you get the idea for the site? How long did it take to launch?
– What features does ProxyDemocracy.org currently have?
– Any plans to tweak things going forward?
– What have been the biggest surprises in how the site is used so far?
Just Mailed: July-August Issue of The Corporate Counsel
We have just wrapped up the July-August issue of The Corporate Counsel, which includes pieces on:
– Correcting CEO/CFO Certifications—New S-K Interps
– De-Mystifying the 135-Day Rule on the Age of Financial Statements When 1933 Act Registration Statement is Effected
– “No View” on Bebchuk Proposal
– Disclosing Pending Government Investigation—Qui Tam Actions
– Recent Uptick of Software Revenue Recognition Accounting Problems
– SEC Backs Off Inflation Adjustment
– PCAOB Inspection Tidbits
– Staff’s Non-Use of E-Mail–A Few Insights
– Clarifying California’s Updated Stock Option Regs—Expansion by Regulation of Its Rule 701-Like Statutory Exemption
– North Dakota’s New Corporation Law—Now, We Get It!
Wanna Feel Good? Remember You Aren’t Taking the Bar Exam
A member sent this in: It’s that time of year when graduating law school students find out what pain is really about – studying for the bar exam (I’ll spare you my nutty bar exam experience). A member just sent me this: In this recent decision, the Delaware Supreme Court affirmed the decision of the Delaware Board of Bar Examiners refusing denying Papdima’s request for partial certification of her qualifications to take the Delaware Bar Examination.
Papadima studied civil law for four years at the law schools of the University of Bucharest in Romania and the University of Paris receiving a joint degree in 2003 and received an LLM from the University of Paris in 2004 and an LLM from Harvard Law in 2006.
Unfortunately, the Delaware Board of Bar Examiners determined that Papadima failed to satisfy the qualifications to take the Delaware Bar examine because neither the University of Bucharest nor the University of Paris, from which she received undergraduate law degrees, is approved by the American Bar Association and the LLM. she received from Harvard Law School is not the equivalent of a juris doctor degree from an ABA approved law school.
What made this case particularly interesting was that Papadima has been a member of the Bucharest Bar since 2004, a member of the Paris Bar since 2006, and a member of the New York Bar since 2007 and is currently a member in good standing of all three Bars. In addition, Papadima spent several months in 2004-2005 practicing Romanian law with Linklaters in its Romanian office and after receiving her LL.M. from Harvard Law School in 2006, worked at Latham & Watkins in New York for approximately a year. Best of all, Papadima is currently employed for a one-year clerkship in the Delaware Supreme Court, assigned to Justice Jack B. Jacobs (who disqualified himself sua sponte).
We just put the finishing touches on the Summer issue of our new newsletter, InvestorRelationships.com. This newsletter is complimentary, as well as all the issues for the remainder of ’08. You simply sign-up online to gain free access to it (and be notified when the next issue is available).
– Non-Deal Roadshows: Latest Developments and Trends
– Lessons Learned: How Funds Vote on Proxy Proposals
– Hedge Fund Attacks: Eight Lessons Learned from the In-House Perspective
– How Blogging Can Enhance Your Investor Relationships (and Your Career)
– My Ten Cents: The SEC’s Coming Guidance on IR Web Pages
– SEC Staff Says “No” to Non-GAAP Financial Statements
Earning Trust: The Mantra of Bloggers
At the NIRI Annual Conference last month, one of the panels I served on was “Is Your Company or IR Dept Ready for a Blog? Innovative Communication Methods for the 21st Century.” In describing why I think blogging is important for IROs, I discussed how effective a vehicle a blog can be to get people to trust you – if you do it right – because they can get a window into who you are. This allows IROs to get outside the staid press release environment that they typically live in to show their constituents – investors, analysts, employees and potential investors – that they can be trusted. And “trust” is the name of the game in investing (and also in life, but that is a different story.)
For the Summer issue of InvestorRelationships.com – the one noted above – I wrote a piece that persuasively argues why you should blog – and three considersations to determine if you have an inner blogger in you. The article will be relevant for lawyers as well as IROs. You can get this article for free if you provide us with your contact information.
More on Investor Relations and Blogs
Recently, I did a podcast with Lynn Tyson of Dell about the “DellShares” blog. Rob Williams, one of Lynn’s co-bloggers, was on the panel mentioned above and was great. Learn what transpired during the panel from several others who covered some of our roundtabling in these blogs:
– Ryan Lejbak’s blog (and here is a follow-up video with IRO blogger Rob Williams from Dell)
By the way, Ryan also uploaded this interview with me on YouTube if you want to see what I really look like. It’s pretty daunting to have a camera stuck in your face. I enjoyed doing the same thing to others during the Society’s Annual Conference…
