A few weeks ago, this Associated Press article about Ford Motor’s business in Syria and Sudan was spurred by a comment letter dated July 26th from Corp Fin – providing a nice reminder to all of us about being careful what we say in our response letters, given that they will be much more readily available to the public (and the media) than they were in the past. As I blogged about yesterday, the SEC has nearly caught up in its long-standing project to upload comment letters and related correspondence on EDGAR.
Recently, the Corp Fin Staff has begun issuing “no further comment” letters to companies once their comments have been cleared (here is a sample). However, since this practice is new, it might not happen in all instances and senior Staffers have publicly mentioned that you may need to call the Staff to ask for such a letter if you don’t get one and want one (I would think you would always want one; it’s suitable for framing even if you don’t want it for your file).
The date of this “no further comment” letter should be the date that kicks off the 45-day waiting period before all the comment letters and responses are uploaded on EDGAR. As you might recall when the SEC’s uploading project was announced a few years ago, the Staff adopted a policy that comment letters and responses would not be posted “no earlier than 45 days from when comments are cleared.”
The Evolving ‘Best Price’ Rule
Tomorrow, catch the head of the SEC’s Office of Mergers & Acquisitions (as well as two former SEC Staffers) in the DealLawyers.com webcast: “The Evolving ‘Best Price’ Rule.” Spurred by conflicting court decisions, the SEC recently adopted amendments to its “best price” rule. Join these experts as they explore the impact of this rulemaking on M&A activity:
– Brian Breheny, Chief, Office of Mergers & Acquisitions, SEC’s Division of Corporation Finance
– Dennis Garris, Partner, Alston & Bird LLP
– Jim Moloney, Partner, Gibson Dunn & Crutcher LLP
What this program will cover:
– What changes did the SEC make to the best price rule?
– What issues might still arise in the wake of the SEC’s changed rule?
– How might the SEC’s changes impact deal structures?
– How might the SEC’s changes impact compensation arrangements in transactions?
6.5 Degrees of Separation: Boards More Independent
A few months back, The Corporate Library conducted a study of board members and their interrelationships, suggesting that “Sarbanes-Oxley has had a lasting and far-reaching impact on the corporate board network in the US.” Key findings of the study, include:
– Among the 4,288 people who sat last year on S&P 500 boards, 261 sat on at least three boards, down 13 percent from 301 in 2002
– Among CEOs, 195 held outside directorships, the same as in 2002 – but only 57 held more than one outside directorship, down from 72
– 8% of S&P 500 companies’ boards are chaired by truly independent outsiders; up from 4% in 2002
– There has been a reduction in the average number of other S&P 500 boards that each board is linked to via shared directors, to 6.5 from 7.8
– 12 people held at least five S&P 500 directorships in 2005, down from 33 in 2002
– However, one finding deemed “surprising” was that the number of S&P 500 boards with no links at all to other S&P 500 boards declined to 40 from 51
At the ABA Fall Meeting held in Washington DC over the weekend, Corp Fin Director John White, Corp Fin Chief Accountant Carol Stacey and other senior Staffers spoke on various panels and provided these tidbits, among others:
– for the December 13th open Commission meeting, the e-Proxy initiative may (or may not) apply to the ’07 proxy season
– as the Commission has a draft final rule to review right now, it is possible that the “Katie Couric” rule could be added to the agenda and adopted at the December 13th meeting (and if adopted, could even apply to ’07 proxy season)
– we will know precisely what will be on the agenda of the December 13th meeting no later than this Wednesday, as that is when the Sunshine Act requires that the SEC post a notice
– a Corp Fin strategic plan for the near future is being worked on; new rulemaking and other projects to be identified
– some option backdating guidance will be forthcoming within a few weeks
– some executive compensation guidance might be forthcoming; estimated time unknown and “in what form” undecided
– a systematic review of executive compensation disclosures is expected to take place after the proxy season and a Staff report (and possible further rulemaking if deemed necessary) should result
– hiring freeze is finally off as Corp Fin has lost members through attrition (see the latest Staffers to leave in our December issue of Eminders)
– comment letters and related correspondence continues to be uploaded to the SEC’s website at a rapid clip; nearly up-to-date now
Note that today’s open Commission meeting has a revised agenda, which will not include the two hedge fund rulemakings: changing the definition of “accredited investors” and prohibiting advisers from making false or misleading statements to investors in certain pooled investment vehicles they manage, including hedge funds. According to this NY Times article, the SEC delayed considerations of these proposals to work out technical language; the proposals might be calendared for the already jam-packed December 13th open Commission meeting.
What’s the Word on Shareholder Access?
Yes, this is the question that everyone is asking. Alas, there still is no word on what we can expect regarding shareholder access on December 13th – as reflected in this recent article, the Commissioners are still debating what to do and Chairman Cox is striving for a consensus. Thanks to Jim McRitchie’s CorpGov.net for pointing out this interesting set of Directorship articles about where the Commission might be headed on this hotly contested issue.
December Eminders is Up!
The latest issue of our monthly email newsletter is now posted. And yes, we wuz robbed!
A while back, Floyd Norris of the NY Times wrote this article urging the SEC to tweak its rules to require companies to provide reasons why an audit firm resigned in all cases, rather than the limited circumstances currently triggered under Item 4.01 of Form 8-K. Here is an excerpt from the article:
“A new study by Glass Lewis & Co., a consulting firm, finds that 1,430 public companies in the United States changed auditors in 2005, a turnover rate of 11.3 percent. The turnover is biggest at small companies, and about 60 percent of the departures are characterized by the companies as firings, with the rest resignations.
Why the changes? In 72 percent of the cases, the companies chose not to give any reason when they notified the Securities and Exchange Commission of the departure. That was up from 58 percent in 2004, when 1,451 companies changed auditors. Companies audited by the Big Four accounting firms, generally the larger companies, are even less likely to give reasons, with 82 percent choosing to remain quiet.”
Director Resignations Intersecting with Auditor Resignations
Some companies have changed auditors after (1) in their 302 certifications, CEOs and CFOs said their company’s internal controls were effective, (2) the auditors came in, conducted their audit and said “no, they weren’t” and (3) restatements were made. Obviously, this type of situation can call management’s certifications into question.
Even worse are situations like Take Two’s, where this Form 8-K was filed in January 2006 to reflect the resignation of the audit committee chair – and then there is this Form 8-K filed in April where the auditor resigns and states they had no disagreements. The letter from the resigning audit committee chair’s lawyer below is fascinating – and certainly raises eyebrows about the auditor who claimed there were no disagreements.
“As you know, we have just been retained to represent Barbara Kaczynski. I write in response to your email of Friday, January 20, 2006, to Ms. Kaczynski, regarding her resignation from the board of directors of Take-Two Interactive Software, Inc. (“Take-Two”).
Your email seeks confirmation from Ms. Kaczynski that her resignation from Take-Two’s board was not due to a disagreement with management of the type requiring disclosure under Item 5.02(a) of S.E.C. Form 8-K. Your email further asks Ms. Kaczynski to approve draft language describing the circumstances surrounding her resignation, which language the company intends to include in its upcoming Form 8-K disclosure.
Ms. Kaczynski does not know whether her resignation is of a type requiring disclosure under SEC rules and she does not feel able to express a view with respect to the language the Company intends to include in its Form 8-K disclosure about the resignation.
However, she is able to express to you directly the reasons why she resigned. During Ms. Kaczynski’s tenure as a board member and chair of the audit committee, several matters requiring the board’s attention caused Ms. Kaczynski concern. These matters included Take Two’s discovery of illicit images depicted in its “Grand Theft Auto” videogame, the Federal Trade Commission’s investigation of Take-Two following that discovery, and various SEC inquiries directed at Take-Two and its employees.
More recently, in connection with preparation of the 10-K and its late filing, Ms. Kaczynski’s concerns have risen significantly because of what she views as an increasingly unhealthy relationship between senior management and the board of directors. In her experience, management’s interactions with the board were characterized by a lack of cooperation and respect. Moreover, Ms. Kaczynski felt that management failed to keep the board informed of important issues facing the company or failed to do so in a timely fashion. In these circumstances, Ms. Kaczynski decided to resign her position as a member of the board.”
Cell Phones Could Betray Former Users
Recently, Fox News ran this article about how sensitive information accumulated in your cell phone could be accessed by new users, even though you thought you had deleted the data. Resetting the phone may make it appear that confidential information was erased, but it actually can be recovered using inexpensive software that is readily available online.
The article made me wonder what kind of confidential information would be left on a Blackberry – or a computer hard drive for that matter – when it gets replaced on an upgrade. Lawyers have an ethical duty to protect client confidentiality, so lawyers disposing of smart phones, computers, PDAs, etc. should ensure that the data really gets deleted so that it cannot be recovered. That would also be a good practice for anyone seeking to protect their own personal data or to guard other confidential information.
So much has been written already about the Committee on Capital Markets Regulation Interim Report – which was released this morning – but there still should be plenty of fodder for academic-oriented blogs to chew on for months. For me, I focused first on a Committee recommendation that hits close to home for corporate finance lawyers: that the SEC adopt regulations that rely on principles-based rules and guidance.
In yesterday’s WSJ, Alan Murray scrutinized this recommendation in his column, which included an interview with someone who has tried to implement such a framework – the UK’s Financial Services Authority recently has been down this road with mixed results. The column also delved into the dominance of lawyers in the rulemaking process and how the SEC would have to hire more economists to implement this Committee recommendation. While it might be reasonable for the SEC’s Office of Economic Analysis to staff up and participate more in the rulemaking process, it could get dangerous if the OEA winds up dominating the process.
I fear that if there were a lack of specific and detailed rules (and guidance) from regulators, it would be too easy for companies to fall down the slippery slope of principles-based regulation. Not only are there plenty of executives out there not naturally inclined to implement sound practices (which is understandable because “compliance” is not a profit center), there are many companies that simply don’t have the resources to figure out what “everyone else is doing” – and figuring that out would become even more important under a pure principles-based regulatory framework.
I like a middle ground here, such as the path that Corp Fin followed in its executive compensation rulemaking. That set of rules is comprised of a mix of principles-based rules and very detailed line items. Corp Fin Director John White has been out speaking on what his principles-based approach means in a series of recent speeches. I am convinced that under an overly principles-based framework, more litigation would erupt over vast grey areas – thereby, paradoxically creating much more work for lawyers (although the Committee’s report has recommendations on how to neuter the plaintiff’s bar). Let me know your 10 cents.
Summary: Committee on Capital Markets Regulation Interim Report
– competitiveness/”loosen capital controls” (e.g. to make deregistration from U.S. market easier for foreign companies; providing them easier exit may reduce their hesitation to enter),
– reform the regulatory process (SEC and SROs must do more rigorous cost benefit analysis before and after rulemaking; focus on principles-based approach; federal and state enforcement should not be used for ad hoc rulemaking),
– enforcement (SEC should resolve uncertainties arising from conflicting court opinoins as to Rule 10b-5 liability, particularly regarding materiality, scienter and reliance; DOJ should revise Thompson memorandum to prohibit prosectors from seeking denial of legal fees and waiver of attorney-client privilege; Congress should consider liability cap for auditors/preventing catastrophic liability; regulators should not indict entire firm unless exceptional circumstances; SEC should reverese longstanding position that indemnification of directors is against public policy, and increase ability of directors to rely on auditors and company exec’s as part of due diligence),
– shareholder rights (e.g. supports majority voting over plurality voting; SEC should address shareholder access debate), and
– Sarbanes-Oxley Section 404 (Committee does not call for amendments to statute – Sarbanes-Oxley Act – but calls on SEC, PCAOB need to provide guidance to improve cost-benefit balance, such as revised definition of materiality, rotational testing in support of annual assessment, encourage more use of judgment. After these changes are in place, depending on result of updated cost-benefit assessment, Congress may need to consider if special treatment for smaller companies is necessary. However, Committee does not support one approach that has been suggested for smaller companies, to limit scope of auditors or management’s report to “design” of control).
Another good summary is in this WSJ opinion column, written by two of the Committee’s members.
MD&A Risk Factors (Nelson Rocks Preserve-Style)
As Bruce Carton shutters his “Securities Litigation Watch” Blog (he is moving on to a new job), I thought I would pay tribute by repeating the following blurb he penned a few months back:
Courtesy of Overlawyered.com, I found this inspiring Disclaimer on the Nelson Rocks Preserve website. Nelson Rocks Preserve is an outdoor recreation area located in West Virginia that is apparently tired of people suing them when they fall off cliffs, get bit by snakes, etc. They are responding with a disclaimer that reminds would-be users of the preserve of important things like “a whole rock formation might collapse on you and squash you like a bug” or
…climbing is extremely dangerous. If you don’t like it, stay at home. You really shouldn’t be doing it anyway. We do not provide supervision or instruction. We are not responsible for, and do not inspect or maintain, climbing anchors (including bolts, pitons, slings, trees, etc.) As far as we know, any of them can and will fail and send you plunging to your death. There are countless tons of loose rock ready to be dislodged and fall on you or someone else. There are any number of extremely and unusually dangerous conditions existing on and around the rocks, and elsewhere on the property. We may or may not know about any specific hazard, but even if we do, don’t expect us to try to warn you. You’re on your own.
Inspired by Nelson Rocks, I have come up with a securities disclosure version of their disclaimer, designed to meet all of the MD&A “Risk Factors” needs of your favorite public company. It looks like this:
ITEM 1A: RISK FACTORS
Risks Related to our Business and Ownership of our Securities
Our business is unpredictable and unsafe. The stock market, including the market for our securities, is dangerous. Many books have been written about these dangers, and there’s no way we can list them all here. Read the books.
The path to success for our business is littered with land mines. Seriously-anything could happen. Our competitors try their best every day to crush us, and they could succeed. We could get rich and complacent following our IPO and fail to innovate. Our customers could abandon us. Key members of our management team could quit to sail their yachts around the world for a decade. We could grow so fast that our business spirals out of control. Any or all of these could occur and our business would go down the toilet, along with your investment.
Real dangers are present even if none of the above occurs. New technologies may be developed that will render ours obsolete. A patent troll could come along who claims to own the intellectual property rights to our technology, costing us tens of millions of dollars in defense costs (best case) or destroying our entire business (worst case). Third parties such as malicious hackers could emerge to undercut our business. Even the government could torpedo us by passing new laws that hurt our business. The bottom line is that our business and the stock market are unsafe, period. Live with it or stay away.
Totally unforeseen things can happen. There could be a SARS epidemic. There could be a terrorist attack. There could be a natural disaster, such as a hurricane. A herd of elephants could escape from the zoo and trample our headquarters, squashing our business and your investment you like a bug. Don’t think it can’t happen.
Even if none of these things happen, the stock market could go down for no reason whatsoever. That is to say, you may make a wise investment, we may work our tails off, our business may thrive, and you may still lose all of your money. It happens all the time.
If you engage in particularly dangerous trading such as uncovered options or naked short selling, you may lose everything you own. This is true whether you are experienced or not, trained or not, educated or not, or intelligent or not. It’s a fact, such trading is extremely dangerous. If you don’t like that, don’t do it. You really shouldn’t be doing it anyway. We do not provide supervision or instruction. We are not responsible for the financial ruin that may result. As far as we know, any of these types of trades can and will fail and send you plunging to your financial death. You’re on your own.
Financial bail-out services are not provided by our company. If you lose your shirt investing in our company after reading all this, don’t come running to us (or your class action lawyers). We assume no responsibility.
By investing in our business, you are agreeing that we owe you no duty of care other than not being crooks. We promise you nothing else. This is no joke. We won’t even try to warn you about any dangerous or hazardous conditions not required of us by the SEC, whether we know about it or not. If we do decide to warn you about something, that doesn’t mean we will try to warn you about anything else. We and our employees or agents may do things that are unwise and dangerous. In fact, we probably will. Sorry, we’re not responsible. We may make bad decisions or give out mistaken guidance. Don’t listen to us. In short, INVEST IN OUR COMPANY AT YOUR OWN RISK. And have fun!
As been bandied about for some time, the NASD and NYSE announced yesterday the signing of a letter of intent to consolidate their broker-dealer regulatory operations into a new self-regulatory organization. The new SRO will be named later and is expected to begin operations in the second quarter of 2007, and will operate from Washington DC; New York; and 18 District and Dispute Resolution office locations around the country. Here is a statement from SEC Chair Cox.
NYSE Regulation’s CEO Richard Ketchum will serve as the non-executive Chairman of the organization’s Board of Governors during a three-year transition period and remain CEO of NYSE Regulation; NASD Chairman and CEO Mary Schapiro will serve as CEO of the new SRO. According to this article, it is estimated that a single regulator could save the brokerage industry at least $100 million a year.
The Latest Privacy Policy Developments
In this podcast, Andy Serwin of Foley & Lardner talks about the latest privacy policy developments, including:
– What are the latest developments regarding companies losing their private data?
– Any state or federal legislative reactions?
– How can drafting policies and procedures protect a company?
– What do you recommend should be in a policy to protect social security numbers and other private employee or customer data?
– What should be in a policy to provide notification to affected parties in the event of a breach?
Patentability of Tax Advice and Tax Strategies
Mike Holliday notes a developing issue involving the patentability of tax advice and tax strategies which may be of interest, as noted in this article by the AICPA on “Patenting Tax Strategies.” In August, the NYSBA Tax Section sent a letter to Congressional leaders on difficult policy and practical issues raised by the patenting of tax advice and tax strategies. In addition, a House Subcommittee held hearings on this issue in July.
The AICPA article and the NYSBA letter both refer to a pending case (Wealth Transfer Group LLC v. Rowe) filed in the US District Court in Conn. in January, claiming infringement of a patented tax strategy by a corporate executive-director. Apparently the alleged infringement was the defendant’s transfer of nonqualified stock options to fund a Grantor Retained Annuity Trust (GRAT). The letter points out that although tax strategies in many cases may be embodied in confidential documents – e.g., a tax return and/or legal advice – tax strategies for publicly offered securities are disclosed in SEC filings. In addition, in the pending infringement case, the alleged infringement of transferring nonqualified stock options to a GRAT was reported in Forms 4 filed with the SEC. It has been suggested that the plaintiff apparently found out about the transfer through the SEC filing.
With the highly anticipated December 13th open Commission meeting looming, the SEC announced yesterday that it will hold an open Commission meeting next Monday, December 4th, to consider whether to, among other actions:
– propose a new rule under the ’33 Act to revise the criteria for natural persons to be considered “accredited investors” for purposes of investing in certain privately offered investment vehicles;
– propose a new rule under the ’40 Act to prohibit advisers from making false or misleading statements to investors in certain pooled investment vehicles they manage, including hedge funds;
– propose amendments to Rule 105 of Regulation M that would further safeguard the integrity of the capital raising process and protect issuers from manipulative activity that can reduce issuers’ offering proceeds and dilute security holder value; and
– propose an amendment to the short sale price test of Rule 10a-1. In addition, the Commission will consider whether to propose an amendment to the “short exempt” marking requirement of Regulation SHO.
Coming Soon: Shorter Form 10-K Filing Deadline for Accelerated Filers
With a 60-day deadline coming up for accelerated filers, we have posted a new Time & Responsibility Schedule – courtesy of one of our advisory board members – in our “Proxy Season” Practice Area. Recently, CFO.com ran this article about the shorter deadline, which notes that many expect that a number of companies will need to utilize Rule 12b-25 to meet the new 60-day deadline.
The stock option backdating scandal has now touched more companies than any other single scandal, except for the one involving illegal payments and bribes during the Watergate era (which incidentally led to the initial Congressional mandate – in the form of the Foreign Corrupt Practices Act – that companies maintain adequate internal controls; interestingly, internal controls over financial reporting of stock options include some basic controls for which some are now pushing to not be included as part of Section 404 testing).
As noted in the latest Glass Lewis study, the number of implicated companies has grown to over 200 companies – that is up over 70 companies since the Senate last heard testimony about backdating in September – which is when many believed that the worst was over.
Last week, the NY Times ran this article about a new study of backdated stock options conducted by professors from Harvard, Cornell, and the University of Chicago. The study finds that stock option grants were more likely to be backdated at companies where independent directors were a minority – and the study concludes that “old-economy” firms were more likely to engage in backdating compared to technology companies. Learn more about this study from the “D&O Diary” Blog.
The Art of Boardroom Etiquette and Confidentiality
We have posted the transcript from our popular webcast: “The Art of Boardroom Etiquette and Confidentiality.”
Warren Buffett’s “Tone at the Top”
A few months ago, Warren Buffett sent this memo to managers at Berkshire Hathaway:
To: Berkshire Hathaway Managers (“The All-Stars”)
From: Warren E. Buffett
Date: September 27, 2006
The five most dangerous words in business may be “Everybody else is doing it.” A lot of banks and insurance companies have suffered earnings disasters after relying on that rationale.
Even worse have been the consequences from using that phrase to justify the morality of proposed actions. More than 100 companies so far have been drawn into the stock option backdating scandal and the number is sure to go higher. My guess is that a great many of the people involved would not have behaved in the manner they did except for the fact that they felt others were doing so as well. The same goes for all of the accounting gimmicks to manipulate earnings – and deceive investors – that has taken place in recent years.
You would have been happy to have as an executor of your will or your son-in-law most of the people who engaged in these ill-conceived activities. But somewhere along the line they picked up the notion – perhaps suggested to them by their auditor or consultant – that a number of well-respected managers were engaging in such practices and therefore it must be OK to do so. It’s a seductive argument.
But it couldn’t be more wrong. In fact, every time you hear the phrase “Everybody else is doing it” it should raise a huge red flag. Why would somebody offer such a rationale for an act if there were a good reason available? Clearly the advocate harbors at least a small doubt about the act if he utilizes this verbal crutch.
So, at Berkshire, let’s start with what is legal, but always go on to what we would feel comfortable about being printed on the front page of our local paper, and never proceed forward simply on the basis of the fact that other people are doing it.
A final note: Somebody is doing something today at Berkshire that you and I would be unhappy about if we knew of it. That’s inevitable: We now employ well over 200,000 people and the chances of that number getting through the day without any bad behavior occurring is nil. But we can have a huge effect in minimizing such activities by jumping on anything immediately when there is the slightest odor of impropriety. Your attitude on such matters, expressed by behavior as well as words, will be the most important factor in how the culture of your business develops. And culture, more than rule books, determines how an organization behaves. Thanks for your help on this. Berkshire’s reputation is in your hands.
In February, the Article 29 Working Party of the European Commission adopted a pan-European approach to Sarbanes-Oxley whistleblowing. Recently, the Article 29 Working Group and the SEC’s Office of International Affairs exchanged a total of four letters (although the SEC’s letters are dated September, they were just recently posted). This is the first time we’ve seen the SEC Staff’s views in writing on what the Europeans are doing in – and should dispel some of the confusion about how to implement whistleblower procedures taking into account multiple regulatory frameworks. We have posted this set of letters in our “Whistleblowers” Practice Area.
In this podcast, Mark Schreiber of Edwards Angell Palmer & Dodge discusses this latest development. Once you hear this podcast, you will realize that companies should now be creating whistleblower policies and procedures that comply with both Sarbanes-Oxley and EU data protection laws, which a number of companies are now doing.
Proposal: Nasdaq Listed Securities as “Covered Securities”
Last week, the SEC issued this proposal, based on a petition from Nasdaq, so that Nasdaq’s listed securities would be considered “covered securities” under Section 18 of the ’33 Act and thus exempt from state law registration. This proposal covers what used to be known at the Nasdaq SmallCap market and is now known as the Nasdaq Capital Market. The top two tiers of Nasdaq (which were all formerly Nasdaq National Market) are already covered securities.
I note that as part of getting the more favorable “covered securities” treatment for the Capital Market, Nasdaq has proposed raising the NCM listing standards. (See SR-NASDAQ-2006-032, filed 8/23/06). Sort of a “cod liver oil” feature. Getting covered securities treatment for NCM securities would be a big help for NCM-listed companies, who sometimes have trouble getting blue sky exemptions. The trade-off is that it will probably become harder to get on NCM. Thanks to Linda DeMelis for prodding my memory on some of this stuff…
In Polygon Global Opportunities Master Fund v. West Corp., (Del. Ch., October 12, 2006), the Delaware Chancery Court addressed another request for books and records under DGCL Section 220 by a hedge fund and found it wanting, as explained in this thoroughly reasoned opinion. For another recent Chancery decision, Highland Select, denying a Section 220 request by an equity fund, due at least in part to the request being overly burdensome in scope, see the summary on this blog here. In that Highland case, trial was held about 6 weeks after the complaint was filed.
This case involved a trial that took place about 2 months after the complaint was filed. To state the obvious, the limited scope of the trial was for the purpose of determining entitlement to the documents sought–something that in the ordinary case one would obtain in routine discovery.
The court noted that the plaintiff hedge fund often invested in arbitrage situations and in this case heavily invested in the defendant corporation following the announcement of a going private transaction. The stated purpose of the demand under 220 was to: (i) value their stock; (ii) determine whether to seek appraisal; (iii) investigate breaches of duty; and (iv) communicate with other stockholders.
The court found no entitlement in this case under Section 220 because the plaintiff: (i) had already obtained “all necessary, essential and sufficient” data to determine whether to seek appraisal; (ii) did not have a proper purpose to investigate wrongdoing; and (iii) did not seek a stockholder list for a proper purpose.
Notably, after suit was filed, the court asked the plaintiff to “prepare a chart” linking :(i) the documents sought with (ii) the proper purpose for each document sought, as asserted in the demand for records (resulting in a pared-down list prior to trial).
The court made clear that valuation of shares is a proper purpose for a Section 220 demand, especially in the context of determining whether to pursue an appraisal–but if the data is already available in the public domain (e.g., in an SEC filing) the Section 220 claim may be obviated. It was also made clear that SEC Rule 13e-3 requires, as here, more data about valuation in a going private transaction than would otherwise be available. This highlights the different lens through which a demand involving a public company will be viewed as opposed to a closely-held one. Although there is no per se rule that a Section 220 claim for valuation purposes may be mooted in a squeeze-out merger subject to disclosures under SEC Rule 13e-3, in this case that was the result.
It was also made clear (as stated in many cases) that a Section 220 case is not a substitute for normal discovery in a regular lawsuit, nor will it be allowed as a substitute for discovery in a subsequent appraisal action. The scope of documents available in regular discovery under Rule 34 is much different than the scope of documents available under Section 220 (citations omitted).
Referring to DGCL Section 327 and related cases, the court emphasized the important public policy against “the evil of purchasing stock in order to attack a transaction which occurred prior to the purchase of the stock” (citations omitted)(i.e., purchasing a basis for litigation). Due to the claim here that the investigation into wrongdoing related to an event prior to the purchase of stock, the court observed that the plaintiff did not have standing for a derivative claim; nor did it have standing to make allegations based on entire fairness.
Regarding its alleged interest in communication with other stockholders, though the burden is on the corporation in this type of request to establish an improper purpose for the request of a stockholder list, and is rarely denied, here the reason for the request was based on the 2 prior reasons which were rejected by the court. (e.g., the list was not requested for a proxy solicitation but merely to “share” what it got from the Section 220 case and to inquire about anyone else who might be seeking appraisals.) In sum, on this point, the court said that simply because a stockholder may communicate with other stockholders based on Federal Securities Laws, that fact in and of itself does not support a proper purpose under Section 220.
Though it might be tempting to do so, I don’t think this case can be read as imposing a higher hurdle for hedge funds making a Section 220 demand. Rather, the relevant background of the stockholder, to the extent it provides insight into the stockholder’s intent in buying the stock, and its “end-game”, will be part of the court’s analysis of whether the requirement of a “proper purpose” has been satisfied.
On Friday, ISS released its US, Canadian and international 2007 proxy voting policy updates. ISS analysts will begin applying the new policies for all companies with shareholder meeting dates on – or after – February 1, 2007. As apart of its comprehensive policy formulation process, ISS collected more feedback this year compared to the past.
Here are some of the more noteworthy changes:
– ISS will generally support precatory proposals and binding by-law amendments related to majority voting for directors (provided it doesn’t conflict with state law in the state where a company is incorporated and there is a carve-out for plurality voting in contested elections).
– ISS recommends that shareholders withhold their vote from the CEO, or even the entire board, of companies with “poor compensation practices”; last year, ISS recommended withheld votes in such circumstances only for directors sitting on the compensation committee. A non-exhaustive list of sample poor compensation practices is on pages 17-18 of the revised guidelines, which includes internal pay disparity, overly generous hire packages and excessive severance arrangements.
– ISS has tightened its guidelines on corporate performance, recommending withheld votes for directors of companies that significantly underperform their sector in both financial and share price terms for two years in a row.
The SEC’s New Online Search Tool
Last week, the SEC launched a new full-text search tool that enables searches of the contents of any disclosure documents filed electronically on EDGAR, including same day filings and any others made sometime during the past four years. Here is the SEC’s related press release.
Here are some reactions from David Copenhafer of Bowne:
– The SEC’s new tool seems to work pretty well.
– Rather amazing that filings are indexed for text search on the same day as they are filed.
– The “hit list” doesn’t always show you the “hit.”
– Hits are not highlighted when you go to the filing; you have to use the browser to find the location of the hit(s).
– If you have several hits in one document, they seem to be “together” – in that they each line up under the previous hit. Good services collect all the hits from one filing and allow you to see more easily the context of each.
– Not sure about accuracy or completeness. For example, “exxon capital exchange” shows up with 2 hits in filings made this year using the SEC’s tool, but 5 hits on a commercial service – the commercial service found hits in SEC comment letters, so the SEC’s search may not be vetting those.
– No apparent “help” screen, although it looks like standard Internet techniques work (e.g., quotes around several words performs search on that string). The Boolean operator “AND” seems to work. I didn’t try “NOT” or “OR.”
UK Regulator Rejects Adoption of XBRL Due to Cost
According to this article, the United Kingdom’s securities regulator, the Financial Services Authority, has decided against using extensible business reporting language (XBRL) for companies to file their regulatory returns on the grounds of cost. The FSA’s decision to abandon XBRL means that UK regulators do not have to commit to backing XBRL for the foreseeable future.
Personal note – As a Michigan alumni, I am among those that demand a rematch at a neutral site! Go Blue!
Recently, a member asked whether most companies pay their annual board retainers in monthly or quarterly installments or in a single lump payment? My sense is that for meeting fees, they are paid following each meeting (often as part of the next check) – and companies often pay the annual retainer in quarterly installments, but sometimes in an annual installment (sometimes in advance, but often in arrears). Many companies utilize a “compensation year” for director fee purposes that begins after each annual shareholders meeting. Essentially, there is no standard practice and companies often make changes to their fee payment schedule without regard to their fiscal year.
Also, most companies “1099” the fees, while others W-2 them. The difference impacts whether the company withholds taxes on option exercises; “1099” means no withholding on option exercises or restricted stock vesting.
So you ask, “why should we care when we pay directors?” Or more specifically, “does the timing of director fees impact what – and when – we need to disclose under the SEC’s new compensation rules?”
The answer from Brink Dickerson of Troutman Sanders: Sort of. Let’s say that a company in 2005 decided to pay an annual retainer of $60,000 based upon a compensation year that began in April at the annual meeting and continued until the annual meeting in April 2006, at which they decided to pay $72,000. Under the old rules the 2007 proxy statement would report that directors receive an annual retainer of $72,000 (and under the new rules it may say that too). But the table is going to reflect what actually was paid.
Let’s say that the practice is to pay the retainer based upon fiscal quarters in arrears. So, in 2006 a director would have received $15,000 in January, $15,000 in April, $18,000 in July and $18,000 in October, for a total of $76,000. Let’s say that it is paid in six installments at the actual board meetings. That will result in an even different number. Let’s say it is paid in advance…
Former Directors – Subject to Disclosure?
On CompensationStandards.com, Mark Borges continues to blog about interpretations of the SEC’s new executive compensation rules. For example, here is a recent entry: “Last month, I blogged about whether the compensation of a director who resigns or otherwise leaves the board of directors of a company before the end of the fiscal year needed to be included in the Director Compensation Table. At the time, I said I simply wasn’t sure, as I could read the new rules both ways.
At a recent conference, I was on a panel with Corp Fin Staffer Anne Krauskopf who confirmed that these individuals are subject to disclosure, even though they may not be members of the board at the end of the last fiscal year. Essentially, she agreed with my analysis that Item 402(k)(1) places the focus on the total compensation paid to the board for the year, rather than on the individual amounts received by the current board members. Thus, each person serving as a director at any time during the last completed fiscal year should be included in the table.”
Institutional Investors Seek Disclosure of Compensation Consultant Conflicts
Under the SEC’s new executive compensation rules, companies are required to identify the use of any compensation consultants and describe their compensation-related work. A group of large institutional investors, which control nearly $850 billion in assets, have sent a letter to the 25 largest US companies asking them to disclose more about their compensation consultants than required under the SEC’s new rules. In particular, these investors want to know:
– Does their compensation consultant provide other services?
– Do they have a policy prohibiting this?
This request is akin to what this group of investors (and a few others) commented upon earlier this year, as noted in footnote 495 of the SEC’s adopting release. It will be interesting to see how many companies comply with the request. We have posted a copy of the letter from these investors in our “Outside Advisor Use” Practice Area on CompensationStandards.com.
