When the new Corp Fin “Compliance and Disclosure Interpretations” were launched back at the beginning of the year, the Staff promised more frequent updates to the Division’s interpretive material. The Staff delivered on that promise last week with some new and revised interpretations on Item 402 of Regulation S-K and Item 404 of Regulation S-K.
For the most part, these new and updated interpretations cover positions that are already pretty well known at this point, including some of the interpretations reflected in the notes that we posted from the 2007 JCEB meeting. As such, it does not appear that this update represents the more comprehensive guidance that everyone has been expecting in advance of the proxy season.
On the Item 404 front, the Staff indicated in new Interpretation 2.12 that, with respect to employment arrangements, the “amount involved in the transaction” would include all compensation paid to the employee, not just salary. This interpretation is consistent with the way the Staff had restated old Telephone Interpretation I.35 in Compliance and Disclosure Interpretation 2.07, where it changed a reference to a child’s “salary” to “compensation.” New Interpretation 2.13 deals with a relatively straightforward application of the rule to a situation where an executive officer’s compensation is not disclosed under Item 404 by operation of Instruction 5.a. to Item 404(a), yet the compensation paid to that executive officer’s immediate family member who works for the company must be disclosed, because the immediate family member does not have the benefit of Instruction 5.a. given that person’s non-executive officer status.
Mark Borges has already posted his analysis of some of the new and revised executive compensation interpretations on his CompensationStandards.com blog, with more to come. One of the notable new executive compensation interpretations is a definitive Staff position on the disclosure of negative numbers arising from amounts recognized for compensation from equity-based awards. For this significant interpretation, Mark notes:
“As you know, given the reporting requirements for equity awards in the Summary Compensation Table, it is possible that, in any given fiscal year, the amount reportable for an award may be a negative number (because the previously reported compensation expense has been reversed under SFAS 123(R), because the award was forfeited during the fiscal year, achievement of a performance-based condition has been determined to be no longer probable, or, in the case of an award accounted for as a liability accounting, the stock price has declined during the year. New Q&A 4.11 asks what portion of an award that was previously expensed and has been reversed under SFAS 123(R) may be deducted from the amount reported in, or shown as a negative number in, the Stock Awards or Option Awards column?
As expected the Staff has taken the position that only the previously expensed portions of awards that were previously reported in the Summary Compensation Table may be reversed in the Summary Compensation Table. As a result, an expensed amount relating to a period or periods before the new rules became effective or, perhaps more importantly, before a person became a named executive officer should not be deducted from the amount reported in, or shown as a negative number in, the Stock Awards or Option Awards column.
While everyone will not agree, this answer seems sensible to me, as it minimizes the distortive effect of negative numbers on the Total Compensation column in the table. In other words, a company gets to reverse an expense amount in the Stock Awards or Option Awards column (and, thus, affect an NEO’s total compensation for the fiscal year) only to the extent that the amount being reversed was previously reported in the SCT (and in total compensation) under the new rules.”
Farewell to Commissioner Campos
This has been a summer of many farewells at the SEC (including my own), and now the greener pastures fever has spread to the tenth floor of SEC headquarters. Last week, Commissioner Roel Campos announced that he will be leaving the Commission. I’ve got to say that Commissioner Campos is truly a class act – it was always a great pleasure to work with him and his very talented staff. His broad range of experience, including work as both a prosecutor and a business executive, was evident whenever he judiciously weighed the pros and cons of matters before the SEC. Investors will be losing a true friend on the Commission when Campos leaves for the private sector.
The departure of Commissioner Campos explains (in part?) a cryptic statement that Chairman Cox made while testifying last month before the Senate Committee on Banking, Housing and Urban Affairs. When pressed about his vote for two opposing approaches to shareholder access issue, Cox stated: “In order to put a rule in place, I’ve got to have a clear idea of what the Commissioners want to do and which Commissioners I’m voting with – which Commissioners by the way are members of the SEC – all of these things somewhat up in the air right now.” If you also consider Commissioner Nazareth’s continued service following an already expired term, there is no doubt that we will see a significant change in SEC dynamics as important rule changes come up for adoption this autumn and into next year.
Access Proposals: Should They Stay or Should They Go?
The Council of Institutional Investors is seeking a straight answer on whether or not the SEC Staff will agree that access proposals may be excluded from company proxy materials under Rule 14a-8(i)(8) (the director election basis for exclusion). In this letter to Chairman Cox, the CII requests clarification on what the Staff intends to do with access proposals now that the SEC has published its release containing both an interpretation of Rule 14a-8(i)(8) and proposed changes to the text of the rule designed to implement that interpretation.
At the open meeting for the rule proposals, Commissioner Campos asked Corp Fin to explain how the Staff would respond to a no-action request seeking to exclude a shareholder access proposal. John White indicated that, based on their current thinking, the Staff would approach any such proposal the same was as they did last season, which apparently was a reference to the Staff’s “no view” response to HP. In his recent Senate testimony, Chairman Cox completely avoided the issue when asked about it by Senator Dodd. Then, in a speech a couple of weeks ago at the Federal Reserve Bank of Chicago, Commissioner Atkins indicated that the interpretive portion of the release “governs our administration of that provision, [and] will provide the necessary clarity and uniformity for both investors and companies alike until an amendment is adopted in the future.”
The CII wants some certainty on how things are going to proceed, which may be all the more important now as the departure of Commissioner Campos raises questions about where things are headed on the shareholder access front.
By the time you read this, this old dude will be off on vacation – so I can afford to be “preachy” and run. To me, the lesson for all of us in the Brocade CEO’s guilty verdict involving option backdating is to not always “go along with the crowd.” Just because “we’ve always done it this way” doesn’t mean it’s right.
I know this sounds obvious – but if you are lucky to live long enough, my bet is that you have at least a 50% shot at coming across circumstances in your professional life where you stop and think about whether you are in a grey area that feels a “little too grey.” It’s not worth your career – not to mention your personal life if it goes too far astray – to take big chances. I have a friend who has more integrity than most – yet, he fell into exactly this type of trap and just emerged from a year in prison (he didn’t concoct nor benefit from the scheme; rather, he found out about it and continued to sign sub-certifications). Sure, he’s happy to now be out, but his career is in tatters and his personal life has changed dramatically.
I think it’s just a matter of time before the next widespread scandal breaks. Will it be Rule 10b5-1 plans? I don’t know – but come hear SEC Enforcement Chief Linda Chatman Thomsen discuss how the SEC Staff is looking at these plans during the “Hot Topics and Practical Guidance Conference: The Corporate Counsel Speaks.” You can catch this Conference in San Francisco on October 10th – or watch it by video webcast on that date (or anytime thereafter). Or take advantage of the “Member Appreciation Package” discount to watch all three of our critical October Conferences online.
In our “Internal Controls” Practice Area, we have a list of filings reporting remediation of material weaknesses. Here is an interesting one that Bob Dow recently brought to my attention: 3d Systems Corp (Form 10-K/A filed 8/2/07). I have seen a couple of other long remediation disclosures, but this one is a lot more organized and includes more details about the company’s remediation plans.
Future of the Legal Profession
Our members asked for it. “Billy Broc” and Dave “The Animal” weigh in on the “Future of the Legal Profession.” The music at the end is appropriate for the mood…
In our “Q&A Forum,” we have reached query #3000 (which is really a higher number since many of these have follow-ups queries). I’m so happy Dave is on board; answering those sure can be stressful. You are reminded that we welcome your own input into any query you see. And remember there is no need to identify yourself if you are inclined to remain anonymous when you post a reply…
Posted: SEC’s IFRS Concept Release
Yesterday, the SEC posted a 42-page concept release relating to allowing US issuers to prepare their financials according to IFRS rather than US GAAP. This is a “biggie”…
Becoming a Blogger
The benefits of blogging yourself are many. Do you have what it takes? I’m always happy to discuss this with you if you are interested in trying. In this podcast, Kevin O’Keefe of LexBlog provides some insight into what you should consider if you decide to become a blogger, including:
– Why should corporate lawyers blog?
– How can a lawyer determine whether they have what it takes to blog?
– What are elements of a blog that will attract an audience?
– What are your favorite blogs – and why?
Payments to Terrorists: Chiquita Brands and the Role of the Board of Directors
In his “The Race to the Bottom” Blog, Professor J. Robert Brown recently posted this interesting analysis regarding a troublesome situation involving a former SEC Chairman:
“There was an interesting article in the WSJ last week about Chiquita Brands International Inc. and payments made to a violent group in Colombia designated by the Department of State as terrorists. According to the article, Roderick M. Hills, the former Chairman of the SEC, went to the Justice Department in his capacity as chair of the audit committee to disclose the payments. Despite having self reported, a criminal prosecution resulted with Chiquita ultimately agreeing to a plea of one count of engaging in transactions with a specially-designated global terrorist and topay a fine of $25 million. A grand jury is now apparently weighing a possible indictment of Hills.
The implication of the article was that companies confront heightened risk if they self report their own misdeeds. As the article noted: “The investigation illustrates the recent posture taken by U.S. authorities to prosecute aggressively even when companies turn themselves in for breaking the law.”
But in fact it illustrates no such thing. This is not the usual case of a company discovering improper behavior, putting a stop to it, and self reporting to the government. This is a case that involves a fundamental breakdown in the system of corporate governance.
First, this was not the only payment problem incurred by Chiquita’s Colombian subsidiary. It had already been found to have made improper payments to government officials by the SEC, with Chiquita subjected to a $100,000 fine. See SEC v. Chiquita Brands International, Inc., Litigation Release No. 17169 (D DC Oct. 2. 2001). In other words, the board and management was on notice that there were problems with this particular subsidiary, specifically in connection with the making of improper payments.
Second, the payments in Colombia were made to Autodefensas Unidas de Colombia (AUC), an organization described in the factual proffer as “a violent, right-wing organization” (a copy of the Proffer is posted on the DU Corporate Governance web site). As one US Attorney described in the WSJ article:
“I regarded this as a murder investigation,” from the start, says Roscoe Howard Jr., former U.S. Attorney for Washington, D.C., who helped lead the Chiquita prosecution before he left his position in 2004. “Even though Chiquita didn’t murder anyone, that’s what the money was used for — to buy weapons.”
Moreover, the role of the AUC was not lost on the US Government. It was designated as a foreign terrorist organization in September 2001.
Third, the payments had been discussed and apparently approved by persons in the highest echelons of management. Again, according to the Proffer:
“Defendant CHIQUITA’S payments ot the AUC were reviewed and approved by senior executives of the corporation, to include high-ranking officers, directors, and employees. . . An in-house attorney for CHIQUITA conducted an internal investigation into the payments and provided Individual C [listed only as a high ranking official] with a memorandum detailing that investigation. The results of the internal investigation were discussed at a meeting of the then-Audit Committee of the then-Board of Directors in defendant CHIQUITA’S Cincinnati headquarters in or about September 2000.”
In other words, this was not a case where a company’s management discovered improper behavior and went right to the authorities. This behavior was apparently widely known among top management and allowed to continue.
Fourth, as the WSJ Article indicated, Hills joined the board in 2002 and almost immediately learned about the payments. Nonetheless, it took a year before he reported them to the Justice Department. Moreover, the decision to self report only occurred after the matter was brought to the attention of outside counsel and the entire board. Outside counsel (apparently Kirkland & Ellis), according to the Proffer, indicated that the company “must stop [the] payments.” A report was made to the full board and at least one member “objected to the payments.” It was after that meeting that officials met with officilas at the Department of Justice.
Fifth, Justice Department officials, according to the Proffer, informed Chiquita officials (including, apparently, Hills) that the payments to the AUC “were illegal and could not continue.” Moreover, several months later, officials at Chiquita were told by outside counsel that DOJ officials “have been unwilling to give assurances or guarantees of non-persecution; in fact, officials have repeatedly that they view the circumstances presented as a technical violation and cannot endorse current or future payments.” Nonetheless, the payments continued until February 2004.
Finally, the WSJ left the impression that Chiquita and Hills were being treated harshly. Compare that to an article in the LA Times which suggested that some in the US Attorneys Office wanted more rigorous prosecution at an earlier date and were possibly stymied by higher ups in the Justice Department. That Article indicated that Congress was conducting an investigation. Id. (“As part of an inquiry into corporate payments to violent groups in Colombia, a group of congressmen wants more details about the Justice Department’s handling of the Chiquita Brands International Inc. case, including whether the department was too lenient and why it took four years to file criminal charges after the banana company admitted making payoffs.”).
This is not, therefore, a case where a company learns about a bad practice and immediately coming clean. It is the story of illegal payments that were known at the top levels of management, continued for seven years, went to a violent terrorist group, and were self reported only when the entire board and outside counsel learned about them. Indeed, the history of payments apparently went back beyond 1997. As the WSJ article noted, “Chiquita had previously paid another violent group until it was declared a terrorist organization in 1997.”
There were no doubt moments when Chiquita was truly in a difficult spot. The articles indicate that the payments were made to ensure the security of employees in Columbia. But that might explain the payments for the time it took to either provide adequate security or exit the country. In fact, the payments to AUC continued for seven years, from 1997 to 2004.
Whatever happens to Hills, as a director with fiduciary obligations to shareholders, he (and the entire board) should, once they knew, have put an end to these payments. That they did not is a remarkable failure of governance.”
Here are the results from a recent survey on earnings releases and earnings calls:
1. Regarding the archiving of earnings calls on our corporate web site:
– We archive them for one quarter – 30.8%
– We archive them for six months – 1.5%
– We archive them for between 6 and 12 months – 6.2%
– We archive them for 12 months – 41.5%
– We archive them for over one year – 7.7%
– We don’t archive our earnings calls – 12.3%
2. When we make/provide our earnings calls and related materials timely by a broadly available webcast and/or teleconference:
– We always file (or “furnish”) the transcript and related materials on a Form 8-K – 5.8%
– We sometimes file (or “furnish”) the transcript and related materials on a Form 8-K – 4.4%
– We never file (or “furnish”) a transcript and related materials on a Form 8-K (unless material information was disclosed during the earnings call that was not disclosed in the earnings release) – 89.9%
3. During the past few years:
– We have changed our earnings release practices, so that such releases coincide with our 10-Q filings – 12.9%
– We have kept our earnings release practices the same, and they get released a few weeks before our 10-Q filings – 40.0%
– We have kept our earnings release practices the same, and they get released a few days before our 10-Q filings – 24.3%
– We have changed our earnings release practices, so that they get released closer to the time of our 10-Q filings – 14.3%
– Our earnings releases have always been released at the same time as the 10-Q filings – 8.6%
– We decided to no longer provide earnings releases at all – 0.0%
4. In the near future:
– We definitely intend to revise the timing of our earnings releases so that they coincide with our 10-Q filings (or no longer provide earnings releases at all) – 3.2%
– We might revise the timing of our earnings releases so that they coincide with our 10-Q filings (or no longer provide earnings releases at all) – 11.1%
– We don’t need to change our earnings release practices because we recently did so – 23.8%
– We are comfortable with our earnings releases being issued before our 10-Q filings and don’t need to review those practices – 61.9%
– We already no longer provide earnings releases at all – 0.0%
5. We issue our earnings releases:
– Immediately before the start of the earnings calls – 23.2%
– Two hours before start of the earnings calls – 37.7%
– More than two hours before the start of the earnings calls – 37.7%
– During or immediately after earnings calls – 1.5%
– After, but within four business days of the earnings calls – 0.0%
6. We disclose earnings guidance:
– In the text of the earnings release – 16.9%
– During the earnings call, but not in the text of the earnings release – 8.5%
– On a Form 8-K filing, but not in the text of the earnings release – 4.2%
– In the text of the earnings release as well as during the earnings call – 31.0%
– On a Form 8-K filing and in the text of the earnings release – 2.8%
– During the earnings call, on a Form 8-K filing and in the text of the earnings release – 14.1%
– We do not give earnings guidance – 22.5%
7. We provide archives of our earnings calls (eg. calling them “podcasts”; here is an example):
– On our website only – 85.3%
– On iTunes only – 0.0%
– On both our website and iTunes – 1.5%
– We do not provide audio archives of our earnings calls – 13.2%
New Survey: Lead/Presiding Directors
Please take a moment to take part in our new Quick Survey on Lead/Presiding Directors, which asks these queries:
– Does your board have a lead or presiding director?
– What is the term of the lead/presiding director?
– Are there “term limits” for the lead/presiding director?
– What are the responsibilities of the lead/presiding director?
– Does the lead/presiding director receive extra compensation for these additional responsibilities?
SEC Staff Adds a Few More Auditor Independence FAQs
The SEC’s Office of the Chief Accountant has added a few more auditor independence FAQs (look for the ones marked with a “2007” date). The last update of these FAQs was in 2004.
Early Bird Extended One More Week: 3rd Edition of Romeo & Dye Section 16 Treatise
Peter Romeo and Alan Dye are hard at work updating their two-volume Section 16 Treatise. The Treatise is the definitive work in this area with thousands of pages of reference material.
Order your set by August 15th to receive a pre-publication discount now – you can order online or by fax/mail with this order form. The Treatise will be completed and delivered to you in the Fall.
After two decades of service, Corp Fin Deputy Director Marty Dunn is leaving the SEC at the end of August and will join the DC office of O’Melveny & Myers. During his tenure, Marty probably has worked on every standing Corp Fin-related rule in the book. Not only is Marty a superb securities lawyer, he is a great guy and I’m sure he will be sorely missed in the Division. Here is the related press release.
With the Chief Accountant and Chief Counsel jobs still vacant, Corp Fin now has its hands full with all of these empty big shoes…
Today is our webcast – “Broadridge Speaks: Demystifying E-Proxy’s Implementation” – where senior Broadridge executives explain the nitty gritty about how they will help implement e-proxy. I ended up pre-recording this webcast – so you can listen to it at your leisure and not necessarily wait until 2 pm eastern. Note that there won’t be a transcript for this particular webcast.
Broadridge (formerly known as ADP) is driving the e-proxy process and has addressed all the items on this detailed agenda during the webcast. This is a great companion program for our popular June 2-hour webcast on e-proxy (audio archive and transcript now available).
Twist on California E-Proxy Conflict? Delaware Slant
Here is a recent question posted in our Q&A Forum: “Following up on Broc’s recent blog on a California conflict of e-proxy, has the issue of how the “notice only option” under the final e-proxy rules will jive with Delaware General Corporation law section 232, Notice by Electronic Transmission? Specifically, DGCL 232 permits notice by “electronic transmission consented to by the stockholder to whom to whom notice is given.” Query whether such consent may be implied by receipt of the prescribed form of notice under the “notice only option” or whether consent must be obtained in some other way prior to that?”
John Grossbauer of Potter Anderson helped me craft an answer here (as he often does on Delaware law issues): “Our understanding of the rules is that you need to send out a 1 page document – in hard copy – that notifies shareholders that the proxy statement is available on the Web. Our thinking is that 1 page notice could be drafted (which might be postcard-sized) to satisfy the Delaware notice of meeting requirements, which are very minimal: time, place, date, and, if a special meeting or if required by the bylaws, notice of what’s to be voted upon.”
Posted: Adopting Release for Regulation M Amendments
Yesterday, the SEC posted this adopting release relating to short selling in connection with a public offering by amending Rule 105 of Regulation M, etc.
Companies with converts beware! A soon-to-be released proposed FASB Staff Position would require companies with convertible debt that may be settled in cash to account for the debt and equity components separately. The proposal would require separate accounting to be applied retrospectively to both new and existing convertible instruments – and would thereby affect net income and earnings per share reported by many issuers of these convertible instruments. Learn more in our “Convertible Debt Offerings” Practice Area.
Also, the FASB has proposed guidance that would require companies to evaluate previous and new hedges of interest rate risk, with fewer of them qualifying to use the simplified “shortcut method” of hedge accounting under Statement 133’s requirements. More companies may therefore need additional systems to track the data and the evaluations for far more demanding hedge accounting. Learn more in our “Derivates” Practice Area.
Congressional Report Released: Aguirre Firing and Hedge Fund Investigation
On Friday, the Senate Finance and Judiciary Committees issued a joint report (108 pages, 711 pages with exhibits) regarding the investigation into the SEC’s firing of former Enforcement Staffer Gary Aguirre, who had been investigating suspicious trading at Pequot Capital Management, a hedge fund. Among other criticisms of the SEC, the report notes that the SEC had unnecessary delays in the Pequot investigation, high-level Staffers disclosed sensitive case information to lawyers that represented those under scrutiny and the appearance of “undue deference” to a prominent Wall Street executive that resulted in the postponement of his interview until after the case’s statute of limitations had expired. This is all not too far from the findings of the interim report issued six months ago.
Saturday’s NY Times included this lengthy article on the final joint report.
SEC Posts Trio of Releases
On Friday, the SEC posted these three releases:
– proposing release for revision of Regulation D limited offering exemptions
At a Senate Banking Committee hearing on Tuesday, Committee Chair Christopher Dodd (D-Ct.) warned SEC Chairman Cox that he will consider legislation to resolve the question of proxy access if the SEC doesn’t adopt access rules. Here is Chairman Cox’s statement from the hearing.
ISS’ “Corporate Governance Blog” notes: “Cox, a former Republican Congressman from southern California, was questioned by Dodd on the likelihood that investors would be able to file a proposal calling for access, given the threshold of 5 percent could keep ‘even large institutional investors such as Calpers’ from filing.
Cox defended the threshold, noting it aligns with the commission’s existing 13D/G regime, which requires investors to disclose holdings above the 5 percent level and whether or not they intend to exert control. Cox also noted that groups could pool holdings to meet the threshold and questioned whether a group unable to meet the 5 percent requirement could muster 50% support to pass an access bylaw.
Echoing past assurances, Cox told committee members that the issue of access would be resolved, one way or another, within months. ‘There will be a rule in place this fall … so [investors filing proposals for the 2008 proxy season] will know how to conform their conduct to the law,’ Cox said.”
Last Sunday, the Washington Post ran this article that nicely describes how the Pink Sheets have evolved over the past decade – including the new categorization system to alert investors about the ability and willingness of individual issuers to provide adequate public disclosure in a timely manner. Beware the skulls and cross-bones!
A few months ago in our Q&A Forum, we received a question regarding the attorney letter requirement for the new Pink Sheets tiers. The Attorney Letter Agreement is now available. Learn more in our “Pink Sheets” Practice Area.
Mailed: July-August Issue of The Corporate Counsel
We just mailed the July-August 2007 issue of The Corporate Counsel. Try a no-risk trial for half-price for the rest of the year.
The July-August issue includes analysis of:
– Fixing The Rule 144 Proposals
– Majority Voting—Uncontested Elections Only?
– Section 13 Reporting of Short Positions
– Revised 8-K Items 5.02 (and 1.01)
– Accessing on Edgar Exhibits That are Incorporated by Reference—No Hyperlinking!
– Non-Voting Shares—Proxy/Information Statement Required?
– S-K Item 404—Is the Spouse of a Stepchild a Related Person?
– More Item 404—Calculating the “Amount Involved” When a Family Member is an Employee of the Issuer
– S-K Item 402—Options Assumed In Merger—Which Compensation Tables Do They Go In?
– When to Include Post-FYE Deferred Bonus in Non-Qualified Deferred Compensation Table
– Not Filing the Proxy Statement Within 120 Days After Yearend—Follow-Up on Delinquent 1934 Act Reports and S-3 Use/Eligibility
We have just posted a complimentary copy of our “Summer 2007″ issue of Compensation Standards. This issue includes articles on:
– The Debate Over “Say on Pay”
– Independence of Compensation Consultants: A Growing Issue
– Severance and Termination Payouts: A Whole New Ballgame
– Respected Consultant Calls Severance and CIC “Huge Embarrassment for Corporate America”
– The True “Walk Away Number”
– Leading By Example: The True Leaders Speak Up
You might ask: Why do we give this newsletter away for free? Because we believe in responsible compensation practices. Learn more about how to implement responsible practices by registering for our upcoming “4th Annual Executive Compensation Conference.” This Conference provides practical “how to implement” guidance – unlike any other conference.
Third Circuit Court Weighs In: The Attorney-Client Privilege in the Parent-Sub Context
A few weeks back, the U.S. Court of Appeals for the Third Circuit issued a noteworthy opinion – In re Teleglobe Comm’cns Corp., No. 06-2915, (3rd Cir. 7/17/07) – regarding the attorney-client privilege under Delaware law in the context of a parent-subsidiary joint representation. The case involved claims by subsidiaries against their former parent for abandoning them after they started faltering.
The Third Circuit held that a parent could not be compelled to produce documents on the ground that the parent and subsidiary were jointly represented. The Court reasoned that the sub cannot unilaterally waive a joint privilege with its parent – and that the parent’s consent would also be required to waive the joint privilege. We have posted a copy of the opinion and related memos in our “Attorney-Client Privilege” Practice Area.
Rule 3500? Ah, That Rule 3500…
In this recent installment of “The Sarbanes-Oxley Report” – entitled “Rule 3500 is a Crock” – Billy Broc provides some critical analysis of Rule 3500. If you don’t recall Rule 3500, this is an important rule and I recommend that you have a summer associate look it up immediately. (And it’s coincidental that “3500” is the Office of Chief Counsel’s voicemail extension.)
Internal Controls Update: AS #5, Management Reports and All that Jazz
We have posted the transcript from our recent webcast: “Internal Controls Update: AS #5, Management Reports and All that Jazz.”
I know a lot of people have been waiting a long time for the Government Accountability Office’s report on the state of the proxy advisor industry. The GAO report – which had been requested by two members of Congress – was finally released to the public on Monday.
I guess the big surprise from the report is that there really was not much in the way of surprise. It appears that the primary purpose of the report was to hone in on ISS’ conflicts of interest (ie. taking on both investors and issuers as clients). But since ISS fully discloses its conflicts – and investors told GAO that it was comfortable with these conflicts – this proved to not be much of an issue for the report.
Here are some of the GAO’s reports “notables”:
1. There are over 28,000 public companies worldwide that send out proxy statements with over 250,000 separate issues. Nice stats to know. (pg. 6)
2. Most institutional investors report conducting due diligence to obtain reasonable assurance that ISS is independent and free from conflicts. But in many cases, this consists of just reading ISS’ conflict policy. (pg. 11)
3. Other potential conflicts consist of owners that do other business to issuers and investors (and the owners of advisory firms serving on boards of other companies). To me, this is the real conflict risk that exists in the industry. (pg. 11-12)
4. A chart shows how dominant ISS is within the industry, with more clients than the other 4 proxy advisory firms combined. I have to admit I had not heard of Marco Consulting Group before – and its been around nearly 20 years. (pg. 13)
5. Many of the investors that GAO contacted said that they do not vote their proxies; they hire asset managers to do that for them. (pg. 21)
So What Did the GAO’s Proxy Advisor Report Miss?
I would not place much stock in commentary that the GAO report means that ISS’ influence is overblown; if you have any actual experience with shareholder meetings, you know that ISS’ recommendation often is the difference between a controversial matter being approved by shareholders or not. So as many members e-mailed me yesterday, when it comes to ISS’ influence on votes, the report does not ring completely true.
Here are some “beefs” that members have sent me regarding the report:
1. Failure to interview impacted constituents – It appears that the GAO failed to talk to anyone other than investors and regulators. What about other key players? The issuer community? The proxy solicitors? Investor relations personnel?
2. Flying at a “1000 foot” level – One gets a sense that the GAO investigators didn’t really learn much. For example, the report mentions that issuers feel the need to get help from ISS to get a favorable recommendation – but then leaves it at that – without exploring what that means. The report should have clarified that this isn’t a “pay to play” (ie. vote buying) situation – and it also should have explained that the bulk of ISS’ corporate consulting money comes from equity plan design; not helping with governance rating (ie. CGQ) scores.
Given the influence that ISS has on institutional shareholders – coupled with the proprietary equity plan methodology that ISS uses – many issuers feel pressure to sign-up for ISS’ consulting services to make sure their plan will be approved by shareholders.
3. Understating the extent of ISS’ influence – In footnote 14, the GAO cites a recent study that examined the extent to which recommendations can influence vote outcomes and stock prices. But the report didn’t delve further into that important topic. Any proxy solicitor will tell you that ISS’s influence on voting issues can often be as high as 25% of the shares outstanding.
A prime example of ISS’ influence is the bumps felt by recent private equity deals when ISS recommended voting against them (egs. Clear Channel, Biomet). Not that that is a bad thing for shareholders, but it illustrates ISS’ influence.
4. Lack of investigative research – A big flaw in the report was taking at face value that many of these institutional investors said they make independent decisions. Yes, some do. But how many of them, when asked, would be expected to say: “Yep, most of the time I just vote the way they tell me.” Not any of the smart ones, because they have a fiduciary duty to vote.
Remember that most of these investors hold positions in thousands of companies; it would be a monumental task to conduct independent research about each item for each issuer’s ballot. To do so, an investor would have to have a staff along the lines of a proxy advisor to adequately do the job. The reality is that investors are trying to keep their expense ratios down – and even the larger investors typically have only a few employees dedicated to vetting voting issues.
5. Misses the “real” barrier to entry – Although the report talks about barriers to competition, it ignores the real issue connected with that topic: vote execution. No sane institutional investor is going to assume the risk inherent in moving thousands of accounts and ballots from ISS to another provider. The chance that accounts would be lost, not voted, or voted incorrectly is far too great. An ISS competitor has a rough road to try to duplicate the sophisticated vote execution platform that ISS has built over the years.
6. Short shrift to looming conflict issue – One wonders if the conclusions of the GAO report change if the rumors are true that ISS’ parent company, RiskMetrics, goes public?
I don’t blame the GAO for missing the boat; this is a complex area to tackle if you don’t have any “hands on” experience. They did better than the Washington Post, which ran an article yesterday on the GAO report with a picture of the ISS executive team from about six years ago -including Ram Kumar, who was infamously ousted because he had represented himself as a law school graduate to ISS, a degree he did not possess…
PCAOB Inspection: KPMG Not Up to Snuff on Testing
Last week, the PCAOB released its report related to a 2006 inspection of KPMG and cited the firm for 14 audit deficiencies, which occurred at seven clients. The deficiences included the failure to identify accounting errors and material weaknesses in internal controls. As noted in this CFO.com article, the firm had not identified and reported in material weaknesses on audits as it fell behind in its testing. Perhaps the pressure that Congress and the SEC has brought to bear on audit firms to reduce testing could have a systemic impact?
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!
Since we continue to get so many questions about voluntary e-proxy, I have decided to hold an emergency webcast – “Broadridge Speaks: Demystifying E-Proxy’s Implementation” – next Tuesday, August 7th, so that senior Broadridge executives can explain the nitty gritty about how they will help implement e-proxy.
Broadridge (formerly known as ADP) is driving the e-proxy process and will address all the items on this detailed agenda during the webcast. This is a great companion program for our popular June 2-hour webcast on e-proxy (audio archive and transcript now available).
Posted: “Mandatory” E-Proxy Adopting Release
Last Thursday, the SEC finally posted its adopting release regarding universal e-proxy. You may recall the Staff has been avoiding using the term “mandatory” with this rulemaking because that term implies that a company would have to deliver electronically. This is not true, companies can still deliver in paper under universal e-proxy – the only thing mandatory about it really is that companies will have to post their proxy materials on their website. And most companies already do that. The other change wrought by universal e-proxy is that the proxy materials would have to include another half-page worth of content, the “Notice of Internet Availability of Proxy Materials.”
There continues to be a lot of misinformation out there about what mandatory e-proxy really means. In fact, there even is a bit of misinformation out there about voluntary e-proxy. I hear that some folks are recommending that companies sit out the first couple of years to see how things shake out. Remember that significant cost savings are available – although the calculations can be complex – and that a bi-furcated approach is allowable (ie. you can deliver paper and use access for different shareholders). Tune in to next Tuesday’s webcast to learn more about how to conduct your e-proxy cost-benefit analysis.
Last Call: Executive Compensation Disclosure Tips
Don’t forget that the deadline for our new game – “Executive Compensation Disclosures: 51 Tips” – is this Wednesday, August 1st (we will accept stragglers). We have had many great tips submitted so far, as well as some funny and curious ones. But we know a lot of you out there have more.
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.
