We have posted a new nifty chart that analyzes what the SEC and NYSE rules, disclosure, lenders and D&O insurer issues are implicated under six different scenarios involving auditing crisises, including:
– Auditor gives SAS 71 letter with exceptions
– Auditor unable to perform SAS 71 review
– Failure to file Section 906 certification
– Failure fo file a Form 10-Q
– Unable to file clean 906 CEO/CFO certification in a timely manner
– Auditor pulls opinion
– Decision made to reaudit
CEO Turnover and Succession
In this podcast, Steve Wheeler of Booz Allen Hamilton analyzes the latest trends regarding CEO turnover and succession planning (as reflected in Booz Allen’s recent study), including:
– What are the most notable trends you found in your study?
– What do you see happen to most CEOs at targets in the wake of a merger?
– What do you see happen to CEOs at companies that are not performing well?
– What are the timeframes that companies are looking at for CEO performance?
– Are the trends different on a global scale?
– Your study talks about the end of the imperial CEO and the beginning the era of the inclusive leader – what does that mean for companies and CEOs?
It’s Just Human Nature: Playing “Fast and Loose” in the Credit Market
This WSJ article is one of those that you read and it gives you pause. This excerpt says it all:
“In a new report that assesses the status of the market, the Moody’s Corp. unit said it was passed over and not hired for 75% of the commercial mortgage-backed securities rating assignments issued in the past few months as a result of its requirement that issuers add an extra layer of credit enhancement. Moody’s said issuers are “rating shopping” — meaning they were hiring competitors that would hand out higher ratings on securities. Because Moody’s makes money rating the creditworthiness of bond issuances, blacklisting could potentially eat away at the firm’s bottom line if the trend continues.”
Brings back memories of why Congress forced the SEC to conduct a study back in 2003 regarding the role and function of rating agencies in the markets – which then led to the Credit Rating Agency Reform Act of 2006 (which gave the SEC more power over rating agencies). Learn more in our “Rating Agencies” Practice Area.
As the rumors predicted, the SEC will hold an open Commission meeting next Wednesday – July 25th – to propose some version of shareholder access; adopt a definition of “significant deficiency”; approve the PCAOB’s AS #5; and issue a concept release on IFRS.
Is the SEC Allowed to Float Drafts of Proposals?
As Dave blogged last week, the WSJ reports that a draft of the SECs’ shareholder access proposal has been making the rounds – but until we see what is announced at the open meeting, it is hard to know what version of it will actually be proposed.
Some members have asked whether the SEC is permitted to circulate a draft outside of the SEC before the Commission meets to formally propose a rule. I guess that depends on one’s interpretation of the Administrative Procedures Act (which is the Act that governs rulemaking by the federal government). I am far from an APA expert, but I think that the biggest issue is not so much that someone at the SEC gave a copy of a draft proposal rule to someone – the issue may be that the SEC did not process any comments received on a draft in accordance with the APA (ie. make them publicly available). Every so often, you will see a memo briefly summarizing a meeting between SEC Staffers and outside parties that is posted on the public comments section of the SEC’s website; this is done to comply with the APA.
On the other hand, some members have distinguished between talking about the general concepts with outside parties (as being generally okay) – from releasing specifics about a proposal even before the Commission has voted on it. One member points out that “leaks” are nothing new and occurred way back in the day when the tender offer rules were revised in the early ’80s – and that this resulted in some quasi-whistleblowing activity. I suspect that floating drafts goes on more than we know – but I would bet the final product probably is the better for it…
McGuire Woods put out this interesting client memo earlier this week:
“IRS officials continue to explain how the IRS will use FIN 48 Disclosures and SEC correspondence in examining taxpayers. As previously reported (see “IRS Releases Internal Memoranda on FIN 48“), the IRS is studying whether its policy of restraint on tax accrual workpapers remains sufficient in the new world of uncertain tax position disclosures. For now, the policy of restraint remains in effect with respect to FIN 48 workpapers. Nevertheless, the IRS is forging ahead with training examiners to more effectively audit taxpayers using FIN 48 Disclosures, as well as publicly available Securities and Exchange Commission (SEC) correspondence on those disclosures. In fact, FIN 48 Disclosures are the “centerpiece” of this year’s training for IRS agents, according to Robert D. Adams, Senior Industry Advisor to LMSB Division Commissioner Deborah Nolan.
In addition to the FIN 48 Disclosures, IRS agents are being trained on reading SEC comment letters issued to taxpayers and the accompanying taxpayer responses. Some disclosure filings made to the SEC are selected for review. SEC staff may provide filers with comments on these filings in situations in which the SEC believes the filings could be improved or enhanced. Once the SEC reviews are completed, the comment letters and responses are made available online in 45 days. Although the purpose of SEC filings is to give investors the information they need to make informed decisions about the financial position of companies, including risks associated with tax positions, comment letters and responses with respect to these filings may provide ‘helpful’ tax information to IRS agents.”
Last Chance: Early Bird Discount Expires Tomorrow
For those watching via webcast, don’t forget that the Early Bird deadline expires tomorrow – Friday, July 20th. So this is your last chance to take advantage of a nice discount on the Member Appreciation Package to catch these October Conferences by video webcast:
We know that next proxy season will be as challenging as this past one, as the SEC continues to tweak its rules or interpretations of them – and as companies tweak what they disclosed after they see what emerging best practices are. So take advantage of this discount while you can.
We promise that these Conferences will be as practical as they were last year. These Conferences focus on developing practical skills with proven effectiveness. If you have questions, please contact me – or our HQ at info@thecorporatecounsel.net or 925.685.5111.
In this podcast, Peggy Foran of Pfizer explains the company’s new policy regarding board engagement, including:
– What does Pfizer’s new policy entail?
– How will the board’s activities under the new policy differ from what the Pfizer board has done in the past?
– Some commentators have urged that the Pfizer board’s “engagement” be webcast so that more shareholders can participate. Why won’t it be?
Management-Shareholder Engagement: The Results Are “In”
Speaking of “engagement,” did you catch this WSJ article on Monday that summarizes how the proxy season unfolded? This quote from ISS’ Pat McGurn encapsulates the piece: “We’ve never had a season that had so much activity going on in the wings and much less taking place center stage.”
What really struck me was that “24% of shareholder proposals for annual meetings were withdrawn this year, as of July 6.” Wow! That’s truly amazing, particularly given that there are many proponents with whom it’s a waste of time to even attempt to negotiate a proposal “out.” But clearly, more and more companies are realizing it’s worth the time to “engage” with those proponents who are willing to meet somewhere in the middle on the issues raised (and remember, those issues are not always those presented in a shareholder proposal – many proponents have ulterior motives, which they cannot include in a proposal because it might be excludable under the bases in Rule 14a-8).
Over the last few days, plenty has been written in the media about how the Whole Foods CEO John Mackey has been posting messages – anonymously – about his company and his competitor on this Yahoo! message board devoted to Whole Foods’ competitor Wild Oats (if you want to read some of the CEO’s posts related to Wild Oats, scroll down for the URLs in this blog). Wild Oats is now in the process of being bought by Whole Foods, but first needs anti-trust clearance from the Federal Trade Commission – and the FTC has sued to block the deal. The CEO’s postings came to light when they were mentioned in the FTC’s memo filed last week to support its motion for a preliminary injunction (and here is the FTC’s original complaint). According to this NY Times article regarding “sock puppets,” Mackey has been posting anonymously for 8 years.
Lord knows why Mackey has been doing this, particularly given that he is one of those rare CEOs that has his own blog, which he can use to express his views. For more on issues raised by employees that blog, see our “Employee-Blogger” Practice Area.
My take on the provocative story is that I didn’t realize that folks were still using message boards. That’s so ’90s! Back then, everyone was concerned about cybersmears and message boards – and how they could impact your stock price. It was such a big issue that I got halfway through writing a book on the topic, that I ended up scrapping because the issue dropped off the edge of a cliff, as everyone migrated away from message boards as “bigger and better” things to do on the Web emerged.
Apart from potential legal issues and liabilities, the biggest problem I have with this CEO’s activities is that it sets a poor example by the company’s leader. Back when I wrote on this topic, one area I would focus on is how companies should adopt policies to ensure employees didn’t post messages about their employer due to legal and other reasons. Here is a set of FAQs on Cybersmears and Message Boards that I wrote at least five years ago – note that it includes a section on “Potential Employer Obligations Arising from Employee Messages” that probably holds water even today. I didn’t think to include a statement that anonymous postings by a CEO could tank a merger…
The Whole Foods Fiasco: What are the Disclosure and Securities Laws Issues?
On his “The Race to the Bottom” Blog, Professor Jay Robert Brown does a great job of analyzing the securities law issues implicated by the Whole Foods anonymous posting incident as follows:
“The WSJ has reported that the Commission has opened an investigation into the activities of Whole Foods CEO John Mackey. It seems that Mackey over an eight year period made posts on an online stock forum run by Yahoo using a pseudonym. Mackey, according to the WSJ report, “lauded Whole Foods’ stock, cheered its financial results and bashed a company Whole Foods made a bid to acquire.” Some of the posts are here. The Journal speculated that the SEC might be looking into whether Mackey’s statements contradicted statements made by the company, were “were overly optimistic about the firm’s performance,” or violated Regulation FD.
We talk often about SOX, particularly in the context of investor confidence. Accurate disclosure is, in the end, at the core of investor confidence. But, while Mackey may have exercised very poor judgment, does that equate to a violation of the securities law?
There are two broad categories of possible violations. They include fraud (making materially incomplete or inaccurate statements) and selective disclosure (providing material information to select persons in the market). My book, The Regulation of Corporate Disclosure, examines these topics in detail.
Selective disclosure is not per se improper, a legacy of Chiarella. (We have criticized the awful reasoning of this case on my blog. Suffice it to say that it validated deliberate selective disclosure by corporate insiders in some cases). Regulation FD was a regulatory response to this case and the problem of selective disclosure. Regulation FD does not exactly prohibit selective disclosure. Instead, to the extent a company (through its agents) deliberately discloses material non-public information to certain investors/market professionals, it must simultaneously make public disclosure of the information. A company that accidentally disclosed material non-public information on a selective basis has 24 hours to disclose it to the entire market. See 17 CFR 243.100, et seq.
These provisions will be very difficult to apply to Mackey. First, with respect to Regulation FD, the SEC will have to show that Mackey disclosed material nonpublic information. Second, once disclosure occurs, it is not the disclosure of the information that violates Regulation FD but the failure to disclose the information to the entire market. This burden rests with Whole Foods. The SEC will need to show that Whole Foods knew about the disclosure and failed to meet the requirements of Regulation FD. While the CEO made the disclosure and he is an agent of Whole Foods, the SEC and courts may have a hard time attributing the information to the company given Mackey’s the possible stealth involved (indicated by the reported use of a pseudonym). Finally, Regulation FD only applies to disclosure to certain types of investors or market professionals such as analysts. It really was not intended to apply to disclosure that was arguably to the entire market. Disclosure in the Yahoo forum is arguably to the entire market (and, in any event, would arguably meet the defintion of “public dislcosure” for purposes of Regulation FD).
As for the antifraud provisions (primarily Rule 10b-5), there is no question that the prohibition on fraud applies to material disclosed on the Internet. Posting false information or making inaccurate statements in chat rooms or threaded discussions can be the basis of a fraud suit much the same was as false statements in press releases. The SEC will need to show that Mackey made materially false or incomplete statements. The problem here is materiality. Since he used a pseudonym, the market was arguably unaware that he was directly connected to Whole Foods. As a result, the market may have not treated his statements as material but instead viewed them no different than uninformed statements from ordinary investors.
This is not, however, the end of the story. Even without disclosing his identity or role in the company, the depth of the comments, the accuracy over time, and the uniqueness of the information, may well have alerted the market to the fact that he had unique information that could only come from an insider (either because he was an insider or because he was communicating with an insider). In those circumstances, those in the market may well have treated the statements as material. Analysts who follow Whole Foods in Yahoo could probably resolve this.
We shall see where this case goes. At a minimum, it suggests that top officers ought not to be communicating (perhaps at all but certainly not through pseudonyms) in chat rooms and investor forums.”
Romeo & Dye Analyze New Section 16 Interps
Recently, the SEC Staff issued long-awaited Staff interpretations on Section 16 issues. In the latest issue of Romeo & Dye Section 16 Updates – which was just mailed – Peter and Alan analyze the numerous new and modified interps, including a controversial one regarding aggregate reporting that will have a widespread impact on many Section 16 filings.
Act Now: To receive this critical guidance, take advantage of our “Half-Off for the Rest of 2007” No-Risk Trial for Romeo & Dye’s Section 16 Annual Service. Note that this Annual Service is a print service and this guidance is NOT available on Section16.net.
With voluntary E-Proxy now effective, many companies have been waiting to see what fees will be charged by Broadridge (formerly known as ADP) in order to run a cost-benefit analysis and determine whether cost savings would truly be realized by using E-Proxy (don’t forget our “Cost-Benefit Worksheet“). Broadridge’s fees have finally been announced – and I believe they work like this:
1. Existing fee rates remain in place for beneficial owner processing.
2. If an issuer decides to use voluntary E-Proxy, the following incremental/step-based fees apply for sending a notice, etc. to beneficial owners:
– First 10,000 accounts @ $0.25 per
– Next 10,001 – 100,000 accounts @ $0.20 per
– Next 100,001 – 200,000 accounts @ $0.15 per
– Next 200,001 – 500,000 accounts @ $0.10 per
– 500,001 + accounts @ $0.05 per
Regardless of the number of accounts that an issuer wants to “E-Proxy,” Broadridge will charge a minimum fee of $1500. In other words, if an issuer wants to E-Proxy to just a few accounts, the fee will be $1500 regardless of step-based fee formula above (but this floor is not a fee that is tacked onto the step-based fee).
As an example of how this works, an issuer using E-Proxy for 100,000 beneficial owner accounts would incur fees as follows:
– First 10,000 accounts @ $0.25 = $2,500
– Next 90,000 accounts @ $0.20 = $18,000
Total Cost = $20,500
3. Rather than have separate fees for various services, Broadridge will provide the following services as part of the step-based fees above (ie. they are “inclusive”): print and fulfillment (ie. mail) services for the notice; fulfillment and fulfillment support for hard copy requests; 800# set up; Internet and 800# voting, support two work flows (sending notices and hard copy proxy materials), and will also provide a standard landing web page (ie. where shareowner inputs control number) and standard shareowner portal (ie. where shareowner arrives once the control number is recognized; this is where proxy materials, voting platform and place to request hard copy is located).
Issuers can upgrade and have a customized landing page and shareowner portal, where the fee will vary depending on what features an issuer wants. Annual storage fees for hard copies are approximately $1,000 per document (so storage is cheaper if you have a combined proxy and annual report vs. two separate documents) for the first 5,000 copies and $800 for every 5,000 after that.
4. Note that same rates in #2 above apply if Broadridge is hired to send notice, etc. to registered owners. However, when calculating costs, the registered accounts are not combined with beneficial accounts. In other words, when making your registered owners calculation, you start at the top of the step-based fee ladder.
5. Broadridge’s suppression fees remain in place for large issuers (>200,000 positions) at $0.25 per suppression, and changes slightly for small issuers (<200,000 positions) to $0.40 per suppression for householding, etc. The e-delivery suppression fee, however, remains at $0.50 for small issuers.
The NYSE’s and SEC’s (Lack of) Role in Broadridge’s E-Proxy Fee-Setting
Note that the NYSE and SEC aren’t directly involved in Broadridge’s fee-setting process regarding E-Proxy. In contrast, the SEC requires issuers, brokers and banks to ensure that proxy materials are distributed to beneficial owners – and NYSE Rule 465 governs the fees paid by listed companies to brokers and banks for their distribution of proxy materials and other communications to the shareholders. Nearly every broker and bank have contracted with Broadridge to perform the functions related to these beneficial ownership obligations, including distribution of proxy materials, proxy tabulation and responses to requests for shareholder lists; resulting in a near-monopoly.
Under Rule 465, the NYSE and SEC are required to bless how much Broadridge charges brokers and banks to forward proxy materials to shareholders (issuers reimburse these brokers and banks – in practice, issuers directly get billed by Broadridge). This rate-setting exercise occurs every few years, with the last rate-setting transpiring in 2002. As part of this fee-setting process, the public is allowed to comment.
Under E-Proxy, Rule 465 comes into play only to the extent an issuer continues to rely on affirmative consents to e-delivery – or chooses to send paper to some beneficial owners. So, the SEC and NYSE largely remain uninvolved in setting Broadridge’s E-Proxy fees – something that has a number of issuers concerned, judging by the e-mails I recently have been receiving from some in-house members.
E-Proxy: The Issue of “Usability”
When E-Proxy was proposed, one fear expressed by commentators was that companies aren’t sufficiently prepared to provide proxy materials and a voting platform that enables shareholders to easily access the materials and vote. By looking at the first handful of companies that have revealed that they are trying E-Proxy, this fear may not have been far off the mark.
Here is one thought from an anonymous member: “What gets me about these initial E-Proxy companies is that everyone is following the prevailing vendors’ (some say manipulative) leads – in requiring people to enter their voting codes in order to view the proxy materials. The voting code should only be required to execute a proxy – not to view or print.
To my eyes, the SEC rule plainly states that the url/link provided to shareholders needs to link directly to the materials, no navigation required. I’d venture that the fact that a code is required to view could be interpreted by some as not being “public” in the general understanding of the word, as well. This technique is likely to make the first shareholder experiences less palatable and chase people back to paper. All those people who try to go to a site without the code in hand will bail and opt for paper. We have nanosecond tolerances these days on the web.”
If you read the transcript from our recent E-Proxy webcast (or listen to the audio archive), Dominic Jones did a great job talking about usability. Here are three recent blogs from Dominic that delve more into the usability of the first E-Proxy volunteers:
Let the games begin! Our new game is called “Executive Compensation Disclosures: 51 Tips.” Our goal is to generate a bunch of practical tips that can increase the effectiveness of the processes for – and content of – your company’s executive compensation disclosures.
What’s In It For You? Four things:
1. You participate in a fun game.
2. You learn practical tips to improve your compensation disclosure skills.
3. You share some practical tips with an eager audience.
4. You achieve fame (if you want). You get points and – if you are one of the five top scorers – get your name placed in the Hall of Fame. If you wish to remain anonymous, that is fine too. No one will be acknowledged publicly unless they consent.
How to Play: Send us some practice tips on how to best navigate or improve the compensation disclosure drafting process or draft better disclosures, including things that you have seen a lot of companies do wrong this proxy season. Keep your tips brief (three or four sentences and not more than 50 words). Send us at least one tip and not more than five tips before the deadline.
How to Win: Any tip earns you 10 points. The best tips receive a bonus score of 50 points, the second-best ones earn 30 points, and the third-best ones earn 15 points. If you are among the top five scorers, your name is added to our Hall of Fame (if you consent to being named). All participants will be sent an email with their point total.
How to “Cheat”: Reflect on your own experience and derive important tips. We also encourage you to borrow ideas from your friends and coworkers. This really isn’t cheating – but my kids are always looking for the “game cheats,” so I felt compelled to act like there might be “cheats” involved.
How to Send Your Tips: Just email them to broc@naspp.com. Remember the limit of five tips. The deadline is close of business on Wednesday, August 1, 2007.
The Latest Compensation Disclosures: A Proxy Season Post-Mortem
We have posted the transcript from our recent CompensationStandards.com webcast: “The Latest Compensation Disclosures: A Proxy Season Post-Mortem.”
It’s a Wrap! California’s Stock Option Proposal
A few weeks ago I blogged about the status of the proposed changes to the California Department of Corporations’ proposed stock option regulations. These regulations are now final – and we have posted related memos in our “Rule 701″ Practice Area. Below is an excerpt from a Fenwick & West memo (which contains a nice chart):
“Effective July 9, 2007, California liberalized its regulations concerning the permissible provisions of stock option plans. Practically every stock option plan of a privately-held company that has employees in California that participate in the plan can take advantage of this liberalization.
For decades, California was unique among the 50 states in the stringency of its regulation of the scope of permissible provisions that a stock option plan or restricted stock plan could contain. For example, only California required that stock options granted to non-officer employees in California must “vest” (meaning that the shares could not be repurchased on termination of employment by refunding the purchase price) at an annual rate of at least 20% of the shares subject to the stock option.
Non-compliance with even one of the regulatory requirements meant that rather than the company being able to file a simple notice, and pay a small fee to, California, the company would have to submit a pages-long application to the California Dept. of Corporations, which could easily cost $10,000 or more to prepare. The liberalization of the regulations means this is far less likely to occur.”
Congress Tightens “National Security” Reviews of Foreign Investment in the US
On Wednesday, Congress passed the “Foreign Investment and National Security Act of 2007” to formalize and tighten the process for reviews of foreign acquisitions of businesses in the US that raise potential national security concerns. The new Act amends the “Exon-Florio Amendment to the Defense Production Act” and codifies – as well as extends – recent trends toward more stringent review of foreign acquisitions by the Committee on Foreign Investment (CFIUS), which is an interagency committee chaired by the Treasury Secretary and composed of various representatives of the executive branch. There are also enhanced Congressional reporting requirements.
The new Act cleans up many of the provisions of earlier proposals considered problematic by the business community. We have posted memos regarding this development in our “National Security” Practice Area.
Friday the 13th: Be Scared
Did you know that thieves can steal your checks, etc. by having the ink “wash” off the payee and amount (with acetone), leaving your signature, write in any amount, and cash it? Check out this video to understand more (it may take a while to load as its 6 minutes long). Apparently, the Uniball 207 is the only pen whose ink chemically bonds to the paper so it won’t wash off…
An article in yesterday’s WSJ previewed the SEC’s plans for providing shareholder access to the proxy statement. The near-term timing of this proposal should come as no surprise, given that Chairman Cox committed to an aggressive timetable during his appearance before the House Committee on Financial Services last month. Unfortunately, the SEC is already generating controversy around the proposal because it is apparently considering a 5% ownership threshold for those seeking to propose a shareholder access bylaw amendment.
According to the WSJ article (written by Judith Burns):
“Critics of the SEC’s proposal say a 5% ownership stake is so high that it would make the plan usable only by hedge funds. Mr. [Richard] Ferlauto [director of pension investment policy at AFSCME] called that ‘totally irresponsible,’ and predicted that if the SEC sticks with such an approach, it would ‘create a field day for hedge funds.’ Some think the 5% level is meant to be a starting point for discussion and could be lowered to 3%, a level that would still be seen as too high by some pension fund groups and might be viewed as too low by business groups. … Mr. Cox is aiming to have the five-member commission consider floating a proxy-access proposal at a public meeting on July 25, according to individuals familiar with the matter. Final adoption of any changes would require a second vote by the SEC. Even many large institutional investors would have to band together in order to meet a 5% threshold. The SEC proposal calls for such groups to comply with the current disclosure requirements for individual owners holding 5% or more of a company’s shares. Such an approach would require groups seeking to propose proxy-access plans to file reports on their finances, an annual process for passive investors. Requiring shareholders who individually hold less than 5% of a company’s shares to file such reports may be a deterrent to some activists, including hedge funds, say those familiar with the proposal.”
Of course, the SEC’s last attempt at proxy access never made it past the comment stage, as the Commissioners divided over the best approach. Whether the current proxy access efforts devolve into a numbers game remains to be seen, but there is no doubt that – as with 2003 proposals – the SEC is going to have a hard time satisfying the various sides in this debate.
[By the way, whatever happened to the good old “Sunshine Act Notice” for announcing the date of SEC open meetings?]
XBRL for Mutual Fund Risk/Return Summaries
The SEC published an adopting release for rules extending its interactive data voluntary reporting program to the risk/return summary section of mutual fund prospectuses. Under these rules, mutual funds will now be able to voluntarily tag the information included in the risk/return summary. The release notes the SEC’s accomplishments so far in realizing the potential of XBRL, including notable progress toward developing standard taxonomies.
The risk/return summary section of a mutual fund prospectus is largely presented in a narrative format, so the voluntary participants will be breaking some new ground when tagging that type of data. The SEC is relying on a taxonomy developed for this purpose by the Investment Company Institute. The final rules include generous protections from liability for the tagged exhibits, including express protection from liability under Section 11 of the Securities Act.
Now all the SEC needs to do is to sign up some volunteers for the program, and mutual fund investors can start to see XBRL’s potential for disclosures beyond just financial schedules. That potential could be realized for operating companies as well, if interactive data concepts are ultimately deployed to narrative portions of prospectuses, proxy statements and 10-Ks.
SEC Speaks on Recent Private Equity Fund IPOs
Andrew Donohue, Director of the SEC’s Division of Investment Management, provided testimony yesterday to both the House Domestic Policy Subcommittee of the Oversight and Government Reform Committee and the Senate Committee on Finance. Those Committees are considering issues around the recent IPOs of private equity titans Fortress Investment Group and Blackstone Group. In his testimony, Donohue provided very specific information about the SEC Staff’s consideration of whether Fortress and Blackstone are investment companies.
The testimony notes that Corp Fin Staff referred the Fortress and Blackstone registration statements to Investment Management, following the normal procedures when Corp Fin is reviewing a filing. My experience has been that the Corp Fin Staff is always on the lookout for investment company issues, particularly in IPO reviews.
Donohue provides a great primer on what the Staff looks at when determining whether an entity is actually an “orthodox” investment company or an “inadvertent” investment company. In the case of Fortress and Blackstone, Donohue indicated that they do not meet the orthodox investment company test because they “are engaged primarily (and hold themselves out as being engaged primarily) in the business of providing asset management and financial advisory services to others and not primarily in the business of investing in securities with their own assets.” With respect to inadvertent investment company status, the Staff’s analysis apparently turned on the predominance of Fortress’s and Blackstone’s investments in general partnership interests that would not be deemed investment securities for the purposes of the ’40 Act.
The latest study from Stanford’s Securities Class Action Clearinghouse and Cornerstone Research finds that securities class action filings remain at historically low levels in the first six months of 2007, with only 59 filings made in courts nationwide. We have posted a copy of this study, along with other securities litigation studies, in our “Securities Litigation” Practice Area.
While the study notes that filing activity was up slightly compared to 53 filings in the same period last year, the overall trend for the past two years has been surprisingly low filing rates when compared to historical averages. The types of allegations made in the filings for the first half of 2007 remained relatively steady, with 92% of cases alleging misrepresentations in financial documents (unchanged from 2006), and a slight drop-off in the number of cases alleging false forward looking statements at 64% of all cases (down from 72% in 2006). Among the new developments noted in the study is that there have been at least 3 filings so far this year with allegations relating to the meltdown in the subprime mortgage market.
The obvious question is: are we living in a brave new world where directors and executive officers of public companies have less to fear from securities class action lawsuits? The Securities Class Action Clearinghouse/Cornerstone Research study examines two possible hypotheses for explaining the recent trends, citing the stepped-up SEC and Justice Department as deterring fraud and the overall strength and low volatility of the stock market as providing little reason to sue. Professor Joseph Grundfest of Stanford states his opinion that “increased enforcement activity and a heightened awareness among corporate insiders may have led to a permanent shift in the incidence of securities fraud litigation.” On the other hand, John Gould of Cornerstone Research notes in the study that he “would not be surprised to see filings move back to the 200 per year level if the stock market were to weaken.” I suspect that the market hypothesis may be the stronger of the two for explaining the most recent trends – any observer of the federal securities laws could attest to the fact that the regulatory zeal of the government and the litigiousness of investors each swing with the overall strength or weakness of the markets and the broader economy.
Further, class actions only tell part of the story. As noted in this recent PricewaterhouseCoopers 2006 Securities Litigation Study, the recent options backdating scandal demonstrates that even when federal securities class actions may not be attractive because there is little in the way of potential damages to recover, shareholders still opt to express their disapproval in court by filing state derivative actions. Further, while the number of securities class action cases remains relatively low, the PwC study notes that settlement costs remained high at a whopping $6.17 billion in 2006, which was down 20% from $7.67 billion in 2005.
Is There a Milberg Weiss Effect?
In the Securities Class Action Clearinghouse/Cornerstone Research study, Professor Grundfest rejects the notion that the recent downtick in securities class action filings is attributable to a chilling effect from the indictment of legendary plaintiffs’ firm Milberg Weiss & Bershad. I guess that remains to be seen, as the controversy around the practices of Milberg Weiss and its principals continues to play out. Earlier this week, the US Attorney for the Central District of California announced that name partner David Bershad agreed to plead guilty to a federal conspiracy charge. Under the plea deal, Bershad will forfeit $7.75 million, pay a fine of $250,000 and cooperate with the government’s efforts to prosecute the other participants in the alleged conspiracy. Along with Bershad, one of the former Milberg Weiss named plaintiffs Steven Cooperman also agreed to plead guilty to a conspiracy charge.
The allegations concerning kickbacks to named plaintiffs came into sharper focus with the Bershad plea, as the details of scheme start to sound more like an episode of the Sopranos than a day in a life of your typical plaintiff’s attorney. As Kevin LaCroix notes in his D&O Diary Blog: “Another interesting feature of the Statement of Facts is its description of the personal cash pool that Bershad and other Milberg partners supposedly formed to be ‘used by the Conspiring Partners to supply cash for secret payments to paid plaintiffs and others.’ The contributions to the pool, which was maintained in Bershad’s office, were proportionate to the contributing partners’ respective partnership interests. The contributing partners then ‘caused Milberg Weiss to award “bonuses” to them’ to reimburse them for the cash contributions to the pool. Among the partners alleged to have contributed to and made cash payments out of the fund are the pseudononymous ‘Partner A’ and ‘Partner B’ whom some commentators (refer here and here) believe to refer to Melvyn Weiss and Bill Lerach, respectively. Neither Weiss nor Lerach has been charged with any crime, nor even mentioned by name in any of the government documents in the criminal matter.”
There is no doubt that this case has the attention of other class action firms, although there seems to be nothing yet to suggest that the practices at Milberg Weiss were more widespread.
Latest Developments about the European Union Whistleblower Laws
In this podcast, Mark Schreiber of Edwards Angell Palmer & Dodge discusses the latest developments as several more countries have issued whistleblower guidelines in recent months, including:
– What are the latest whistleblower developments in the European Union?
– What are the new German guidelines?
– What should companies with operations in the EU be doing in response?
The summer reading just keeps on coming from the SEC, with last week bringing two more releases geared toward reducing regulatory burdens for smaller companies. Under proposed changes to rules and forms outlined in last Friday’s proposing release, a significantly expanded category of “smaller reporting companies” could benefit from reduced disclosure and reporting requirements that would be integrated into the big company rules and forms. Regulation S-B as we know it today, along with the associated S-B forms, would be eliminated under these proposals.
The SEC’s proposed changes to the reporting requirements for smaller public companies come out of specific recommendations from the Advisory Committee on Smaller Public Companies. The Advisory Committee had raised concerns that, among other things, the current definition of “small business issuer” picks up only the smallest companies, and that Regulation S-B and the S-B forms carry with them a stigma making life difficult for small business issuers using the system. The SEC did not fully embrace the Advisory Committee’s recommendation to establish a tiered disclosure regime for microcap and smallcap companies, opting instead to extend scaled-back disclosure and reporting requirements to essentially those companies that fall under the definition of “non-accelerated filer.” A new proposed term “smaller reporting company” will be defined to include companies with a public float of less than $75 million, or revenues below $50 million if the issuer cannot calculate its public float. As with some other recent SEC proposals, the dollar thresholds in the definition will be automatically adjusted for inflation on a 5-year timetable.
Under the proposals, Regulation S-B would be folded into Regulation S-K by expanding the relevant S-K items to include a scaled down version for smaller reporting companies, with some slight tweaking of the current S-B requirements along the way. The reduced financial statement requirements under Item 310 of Regulation S-B would remain intact and would be extended to the broader group of smaller reporting companies. If adopted, these proposed changes could result in a very long, and perhaps a little more complicated, version of Regulation S-K. An interesting component of the proposed changes is that smaller reporting companies could choose, on an “a la carte” basis, whether to comply with regular or modified S-K requirements. As a result, a company could choose in a particular filing to comply with the full-blown Item 101 of S-K requirement for its description of business, while in the same filing providing executive compensation disclosure under the stripped-down smaller reporting company requirement. Transitioning into and out of smaller reporting company status would be easier to determine than under current small business requirements, by essentially following the current model for accelerated filer status. The proposed rule and form changes will be out for a 60-day comment period.
Proposed Registration Relief for Employee Stock Options
The SEC also published its proposing release for two new Exchange Act registration exemptions for compensatory employee stock options. As with the S-B proposals, this idea also comes out of the Advisory Committee report. I think that these proposals should be welcome news for companies that are not yet public (and don’t want to be public just yet, or ever for that matter) and that use stock options as a means of compensating employees. It can be quite a shock to find out that you are all of the sudden a public company just because you granted options to 500 or more employees. I know from experience that it can be even more of a shock to try to get a no-action letter from the Staff in order to avoid the registration requirements.
Under the proposed exemptions, the SEC would eliminate the need for companies faced with this uncomfortable situation to either avoid crossing the 500 holder threshold or seek individual no-action relief. An exemption for companies that are not already reporting would be conditioned on the compensatory nature of options that are granted to eligible Rule 701 option plan participants, restrictions on transferability, and the delivery of risk and financial information required by Rule 701 when the $5 million threshold is exceeded. For reporting companies, a proposed exemption would be available so that the compensatory employee stock options would not give rise to an independent obligation to register those securities under the Exchange Act. The SEC notes in the proposing release that public reporting companies may be “unclear” regarding the need to comply with Exchange Act Section 12(g) for compensatory employee stock options, so the exemption would provide some welcome relief for a problem that many quite possibly did not know that they have.
The SEC is soliciting comments for 60 days on these proposals, so hopefully they could be in place before the next round of mandatory Exchange Act registrations surface for companies with a fiscal year ending on December 31.
Reverse Mergers: Latest Developments
Join us tomorrow for a DealLawyers.com webcast – “Reverse Mergers: Latest Developments” – to hear David Feldman of Feldman, Weinstein & Smith, Tim Keating of Keating Investments and Nanette Heide and Michael Dunn of Seyfarth Shaw discuss the latest issues in the area of reverse mergers.
With the effective date of voluntary E-Proxy just a week old, a few companies have already filed proxy materials indicating that they will be the first to “give it a go.” In our “E-Proxy” Practice Area, we have begun a list of those companies, complete with a link to their proxy materials.
Interestingly, one company’s proxy statement even has a statement from the company’s President in the “Letter to Stockholders” touting the use of E-Proxy:
“I am also pleased that we are one of the first companies to take advantage of the new Securities and Exchange Commission rules allowing issuers to furnish proxy materials over the Internet. Please read the proxy statement for more information on this alternative, which we believe will allow us to provide our stockholders with the information they need while lowering the costs of delivery and reducing the environmental impact of our annual meeting.”
This particular company also includes a FAQ about E-Proxy on its IR web page. I would expect many companies that utilize voluntary E-Proxy to include a note on their IR web page to explain what they are doing this year – and I understand that some companies have already posted explanations (even though I haven’t seen any others; if you do, let me know). Remember that the more complete – and clearer – an explanation about what the company is doing on your website, the fewer the number of calls to your IR department…
Note that the SEC’s new rules require the Notice & Access to inform shareholders that they have an option to request a paper copy, but there is no requirement for companies to make that statement on their IR web page.
How to Implement E-Proxy: Avoiding the Surprises and Making the Calculations
We have posted the transcript from our recent two-hour webcast: “How to Implement E-Proxy: Avoiding the Surprises and Making the Calculations.” It was a great webcast and the panelists fleshed out a lot of issues that I believe many companies have not yet considered. And the course materials are superb. Hats off to our fine panelists on this one!
