Poor Home Depot. After its botched annual meeting last year and lavish executive pay – not to mention poor stock performance – it looks like it’s now easy game for the mass media on lesser issues. On Wednesday, the NY Times ran this article skewering the company’s board for waiving age limits for three of its directors. Given the apparent roles of these three directors in setting former CEO Nardelli’s lavish pay, there appears to be a basis for the attack.
But generally, I don’t believe in age limits for directors in all cases – some of the most productive directors can be those with the most age (and experience). In our “Board Composition” Practice Area, I have had a number of FAQs on age limits posted for some time including this one:
Should boards have age limits for their directors?
Most experts believe yes – unless the company truly believes it has a sound director evaluation process. If a board develops an effective process for evaluating individual directors, it may not need mandatory retirement guidelines – but if a board does not have a sound evaluation process, a mandatory retirement age should be considered.
Retirement ages vary between 70 and 75. Some companies allow the board to waive the retirement age for certain directors. Although a waiver may allow a company to keep a director who is quite valuable (and even become more valuable as more experience is garnered), this might be difficult to administer as some directors might wonder why they were not granted a waiver. Or even worse, a board may become divided over whether to grant a waiver to a particular director.
A possible solution is to grant limited waivers so that directors serve for just one more year. But this still could cause the problems noted above, without providing much in the way of a real benefit if the affected director is a true asset.
Proponents of mandatory retirement ages and term limits argue that they serve to bring fresh outlooks and perspectives to boards by periodically forcing a board to replace directors. Proponents also contend that directors who serve on a board for many years may be less independent from management and, as a result, less of an advocate for shareholders. In addition, retirement ages for directors can provide boards with a way of getting non-performing directors off the board without having to ask for a director’s resignation.
The bottom line is that most experts believe a bright line test can save boards from serious interpersonal issues that inevitably will cost a lot of invaluable time and energy and could cause permanent divisiveness on the board.
ISS generally recommends that investors oppose management and shareholder proposals to impose mandatory age limits or term limits on directors. ISS notes in its U.S. Voting Manual: “[A] mandatory retirement age sends the message that older directors cannot contribute to the oversight of the company. Although establishing a retirement age or limiting the number of times a director may be elected to the board provides a mechanical or ‘bloodless’ means for addressing a real or potential performance issue with a director, it does not take into consideration the fact that a board member’s effectiveness does not necessarily correlate with the length of his board service or his age. Time served is not a substitute for a thoughtful and rigorous board and director evaluation process, which is a better determinant of a director’s fitness for service.”
Carl’s Corner: Back in Business!
Finally got my act together and have started adding more wisdom from Carl Schenider of Wolf Block in “Carl’s Corner”. In this month’s installment, Carl tackles preferred stock features.
SEC’s Chief Accountant Backs Shielding Auditors From Lawsuits
Vineeta Anand of Bloomberg continues to do some great investigative reporting, including this story based on an interview with SEC Chief Accountant Conrad Hewitt:
“The U.S. Securities and Exchange Commission’s top accountant said he supports a proposal to shield public-company auditors from liability if they fail to detect fraud because shareholders won’t be protected should lawsuits force more accounting firms out of business. ‘We would like to see the remaining `Big Four’ firms remain as auditors for companies,” SEC Chief Accountant Conrad Hewitt said in an interview. ‘It helps investors. We would also like to see the second-tier and third-tier firms remain financially solvent.”
Most of the largest U.S. companies are audited by either PricewaterhouseCoopers LLP, Deloitte & Touche LLP, Ernst & Young LLP or KPMG International. Arthur Andersen LLP, formerly the world’s fifth-biggest accounting firm, shut down in 2002 after being convicted of obstruction of justice in the federal government’s investigation of fraud at Enron Corp.
Glenn Hubbard, a former White House economic adviser who’s dean of Columbia University’s business school, and former Goldman Sachs Group Inc. President John Thornton in November called for limits on auditor liability as part of a campaign to make U.S. financial markets more competitive. The group they lead, the Committee on Capital Markets Regulation, wants to ease provisions in the 2002 Sarbanes-Oxley Act that put more of an onus on auditors to detect accounting mistakes and fraud, making them more vulnerable to shareholder lawsuits in future Enron-like scandals. ‘We certainly don’t want to have another Arthur Andersen failure,” Hewitt said.
Mark Olson, chairman of the Public Company Accounting Oversight Board, said in a separate interview that Congress should set policy on protections for auditing firms. ‘Liability exposure is a significant management issue for firms,” he said. The six biggest accounting firms, which also include Grant Thornton LLP and BDO International, said in a Nov. 7 report that regulators should penalize individuals, rather than entire organizations, for faulty audits or misconduct.
SEC Deputy Chief Accountant Zoe-Vonna Palmrose, before joining the agency, wrote in a 2005 academic paper that lawsuits by public-company shareholders “undermine the stability of even the largest audit firms.” She suggested establishing a new government office to review whether accountants should be culpable for securities violations.
Hubbard and Thornton’s committee, which is backed by U.S. Treasury Secretary Henry Paulson, said Nov. 30 that Congress can prevent ‘damage awards against audit firms and their employees at a level that could destroy a firm.’ The SEC in December proposed changing the provisions for business-practice audits under Sarbanes-Oxley to reduce costs for public companies.”
As I blogged about a few weeks ago, Corp Fin’s Office of Chief Accountant has updated its “Current Accounting and Disclosure Issues” Outline. Below is some excellent analysis from Davis Polk as to what Corp Fin changed in its Outline. I just love this piece; it surely is an early contender for memo of the year:
Part I of the Corp Fin’s Outline provides a summary of recent SEC rulemaking and written guidance (both proposed and adopted). Part II of the Outline discusses the SEC staff’s views on other accounting and disclosure issues. Although posted by the SEC in December 2006, the updated Outline has a date of November 30, 2006. As a result, the Outline does not reflect the significant rulemaking by the SEC in December 2006.
The new or updated disclosure items contained in the Outline include the following:
– Statement of Cash Flows – The SEC has added two new subcategories to Section II.C of the outline regarding the Statement of Cash Flows. One of the new subcategories addresses the treatment of Discontinued Operations and the other new subcategory addresses the treatment of Insurance Proceeds.
– Discontinued Operations – In the outline subcategory related to discontinued operations, II.C.1., the SEC staff notes that registrants who have discontinued operations should carefully consider how to present disclosures about the cash flows of the discontinued operations within the Liquidity and Capital Resources section of MD&A. According to the SEC staff, management should pay particular attention to describing how cash flows from discontinued operations are reflected in their cash flow statements, and, if material, they should quantify those cash flows if they are not separately identified in those statements. In addition, management should describe how it expects the absence of cash flows, or absence of negative cash flows, related to the discontinued operations to impact the company’s future liquidity and capital resources. Management should also discuss any significant past, present or upcoming cash uses as a result of discontinuing the operation.
– Insurance Proceeds – In the new outline subcategory related to insurance proceeds, II.C.2., the SEC staff notes that material cash insurance settlements should be discussed in MD&A. The discussion should inform investors of cash received and why it was received, what the company plans to do with the proceeds, how it is presented in the cash flow statement and the impact, if any, on reported earnings.
– Contingencies, Loss Reserves and Uncertain Tax Positions – The SEC has also updated Section II.I of the outline regarding Contingencies, Loss Reserves and Uncertain Tax Positions. As part of the update of this section, the SEC staff has added a new subsection entitled “Discussion in MD&A.” In this new outline subsection, the SEC staff notes that the requirement to discuss uncertainties in MD&A encompasses both financial and non-financial factors that may influence the business, either directly or indirectly. According to the SEC staff, the need to discuss such matters in MD&A will often precede any accounting recognition when the registrant becomes aware of information that creates a reasonable likelihood of a material effect on its financial condition or results of operations, or when such information is otherwise subject to disclosure in the financial statements, as occurs when the effect of a material loss contingency becomes reasonably possible. The outline provides that if a registrant is unable to estimate the reasonably likely impact, but a range of amounts are determinable based on the facts and circumstances surrounding the contingency, it should disclose those amounts.
The SEC staff also notes that MD&A should include a quantification of the related accruals and adjustments, costs of legal defense and reasonably likely exposure to additional loss, as well as the assumptions management has made concerning those amounts. According to the SEC staff, a company should articulate the reasons the assumptions it used best reflect its exposure and the extent to which the resulting estimates of loss are sensitive to changes in those assumptions. The SEC staff also indicates that it believes that the need to address the underlying assumptions is especially important when there is a material difference between the range of reasonably possible loss and the amount accrued.
– Segment Disclosure – The SEC staff has updated Section II.L.2. of the outline which discusses the aggregation of operating segments as permitted by FASB Statement No. 131, Disclosures about Segments of an Enterprise and Related Information (“SFAS 131”). The SEC staff has also added a new subsection, II.L.5, to discuss operating segments and goodwill impairment.
– Aggregation of Operating Segments – In Section II.L.2 of the outline, the SEC staff notes that it has seen improper aggregation of operating segments in situations involving a quantitatively immaterial segment. For example, the SEC staff has seen instances where a quantitatively immaterial segment is aggregated with a reportable segment because it does not meet the quantitative thresholds requiring separate presentation under SFAS 131. According to the SEC staff, if the quantitatively immaterial segment does not share a majority of the aggregation criteria with the reporting segment, aggregation is inappropriate. The outline provides that in this situation, the quantitatively immaterial operating segment would best be placed into the “other” category.
– Operating Segments and Goodwill Impairment – The SEC staff has added a new subsection, II.L.5, that discusses ramifications of FASB Statement No. 142, Goodwill and Other Intangible Assets, (“SFAS 142”) on segment reporting. Paragraph 18 of SFAS 142 requires that goodwill be tested for impairment at the reporting level. As part of this discussion, the SEC staff notes that given the impact the identification of reporting units can have on the determination of a goodwill impairment charge, registrants should consider providing disclosure in the critical accounting estimates section of MD&A. The SEC staff believes that this disclosure may be particularly important when the amount of goodwill is material. According to the SEC staff, the disclosure should address how the reporting units were identified, how goodwill is allocated to the reporting units and whether there have been any changes to the number of reporting units, or the manner in which goodwill was allocated. If such changes have taken place, they should be explained.
– Disclosure of Off-Balance Sheet Arrangements – The outline includes a new section, II.N., entitled “Disclosure of Off-Balance Sheet Arrangements.” In this section, the SEC staff discusses the Item 303 of Regulation S-K requirement to provide, within MD&A, a separately captioned section that discusses off-balance sheet arrangements that have or are reasonably likely to have, a material current or future effect. The SEC staff notes that they have found many registrants’ compliance with this requirement to be deficient. In particular, the SEC staff notes that registrants often provide the disclosure required by Item 303 throughout MD&A and in the footnotes to the financial statements rather than in a separate section as required. In addition, the SEC staff feels that the disclosure provided is often boiler-plate.
The SEC staff urges registrants to review whether any of their business activities may have off-balance sheet implications and present descriptions of these arrangements in their MD&A in one section that is clearly labeled. The nature and business purpose (i.e., why the transaction was structured as off-balance sheet) of off-balance sheet arrangements, as well as the exposure to risk that results from the arrangements, should be discussed. The SEC staff requests that, in order to increase transparency for investors, registrants should also consider disclosing that they have no material off-balance sheet arrangements, if that is the case.
More on Mark Cuban’s Investment Strategies
Cleaning out old emails and came across this gem from Bruce Dravis of Downey Brand, who waxes on my blogs about entrepreneur Mark Cuban’s investment strategies:
“I think the interesting question about Mark Cuban’s shorting/reporting business model is not the short positions that he establishes, but what will happen when he changes those positions. This is not Foster Winans taking a position ahead of the news without disclosing that fact, or the “scalping” case in SEC v. Capital Gains Research of the investment adviser taking positions without letting his newsletter recipients know.
Cuban advertises the fact he took a position ahead of the news. That is more honest than the hedge fund manager who shorts a stock and then leaks his negative investment thesis to CNBC or the Wall Street Journal—readers have a chance to consider the interested nature of the source of the news. However, what happens when Cuban unwinds the position? Once he takes this public position—and explicitly or implicitly invites other investors to follow him—I could envision circumstances in which his own investment plans could turn into material non-public information.
Even in that case, if he announced publicly before he changed his investment position, so that investors who followed him into the short position had a chance to get out first, it would be hard to claim that he manipulated other investors into generating trades that advantaged his investment. There is plenty that could go wrong with the business model: What if one of his own reporters misappropriates the information to establish a position ahead of Cuban? What if someone in his organization tips an outsider ahead of Cuban publishing his position?
Still, Cuban seems like an intelligent, careful businessman with a sense of business ethics. He bankrolled the excellent Enron documentary “The Smartest Guys in the Room.” If he had been advocating shorting Enron on the basis of Bethany McLean’s original Enron reporting, who knows what the alternative history of Enron—and consequently of the Sarbanes Oxley Act—might have been.”
According to this Reuters’ article, Chairman Cox talked about “why” the rules changes were made and the Chairman illustrated how the December rule changes to the SEC’s new executive compensation rules were not intended to hide pay levels at a Reuters summit on Monday. It’s unclear if the Chairman addressed “why now and not back in July” at the summit, but earlier media reports stated that the Chairman had believed at the time the original rules were adopted that a vesting approach for reporting option grants in the Summary Compensation Table was included as part of the new rule package.
Not quite sure I bite on that explanation. Below is something I received from a member following up on what the NY Times’ Floyd Norris wrote in his own blog last week:
“For what it’s worth, after digging around in the July 26th Open Meeting webcast archive, I found out that (i) Chairman Cox described the FAS 123R full grant value treatment in his opening remarks at the Open Meeting (ii) the SEC Staff described this as well in its opening remarks and (iii) the first Q&A exchange between Cox and Corp Fin Director John White (listen to the webcast archive at the 30:52 mark of the meeting) explicitly covered this issue. White, in response to Cox’s question about the treatment of options under the new rules, laid this out quite plainly, including the difference between FAS 123R for financial reporting purposes and for compensation disclosure purposes in the SCT (see 31:04 mark of the webcast archive).”
This fact finding seems to cut across the grain that the Commission really didn’t know what standard it originally adopted and hopefully will put an end to such musings, such as done in yesterday’s WSJ op-ed. The op-ed states: “The SEC’s mistake is regrettable, but the agency might be forgiven for overlooking what was a relatively minor point in its gigantic 450-page July rule.” I think anyone closely following the rulemaking during the proposal stage would argue that this was not a “relatively minor point”; this was a hotly debated issue as reflected in the comment letters submitted last summer by many major organizations.
What to Do Now: How to Implement the December Rule Changes
Regardless of the “why,” what’s done is done and we turn to what we practitioners care about most: the “how to implement” aspect of the December rule changes. Don’t forget to tune into tomorrow’s CompensationStandards.com webcast: “The SEC’s December Rule Changes: How They Impact You.”
That webcast will be followed by another (and much longer) one next Thursday: “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!.” Because this essential 2-Part Web Conference will be accessible only to those that are 2007 members of CompensationStandards.com, we urge those of you who have not yet renewed for 2007 to do so now (all memberships expired at year end; grace period for non-renewers ended last week) – and anyone not a member should try a no-risk trial. If you need to renew, please renew online if you can as our HQ is overwhelmed right now.
Whining about Semantics
I can’t help but whine about last week’s WSJ opinion column that did some whining of its own about Home Depot’s former CEO ‘severance’ package. The WSJ claimed that most of Nardelli’s $210 million payout wasn’t really severance at all because the terms for much of that package were set when he was hired years ago.
I got news for whomever wrote that piece: just because severance arrangements are negotiated well in advance of a termination doesn’t change the fact that they are indeed severance arrangements. In other words, don’t bother writing that others are not properly using terminology until you master it yourself!
And One More Wake-Up Call
This statement in the WSJ opinion column”>op-ed should serve as one more wake-up call to boards and advisors: “That contract can’t be abrogated now simply because the board has concluded it made a mistake.” The statement might be true for Nardelli because he is gone – but it certainly isn’t true for every other CEO who still holds their job today.
As we have written about numerous times, boards get an opportunity each year to revisit their past mistakes when they are set pay levels for the following year. Remember that’s one of the primary purposes of going through the exercise of creating a tally sheet – it enables boards to find out if excesses have been created and then the board has an action item to try to rectify them.
One of the first steps a board can take is to ensure properly worded clawback provisions are added to outstanding contracts – see more in our “Clawback Provisions” Practice Area on CompensationStandards.com.
Boards really need to take action here. It seems hardly a day goes by without another example of a senior manager getting fired and still taking millions of dollars home with them despite poor performance. Who wouldn’t want $10 million in severance for six months on the job? That’s what the just-fired COO of JC Penney walked away with; seems like managers are incentivized to perform badly with some of these poorly negotiated employment arrangements…
The New York City Bar Association has put together a pretty fascinating report – through a task force – on what role lawyers should play in corporate governance. The 298-page report – “Lawyer’s Role in Corporate Governance” – was just released a few weeks ago.
In this podcast, Tom Moreland of Kramer Levin – and the Chair of the NYC Bar’s Task Force that prepared the report – tells us more, including:
– Why did the NYC Bar Association decide to prepare this Report?
– What were you able to determine about the involvement of lawyers in those scandals?
– Did this conclusion lead the Task Force to make any recommendations for the future?
– What other recommendations in this Report would you like to highlight?
– What should lawyers do in light of this Report?
Mad as Heck and Not Going to Take It Anymore
Shutterfly Chairman Jim Clark, founder of Netscape, resigned from the company’s board (even though he is a 30% shareholder) complaining that Sarbanes-Oxley overly restricts the ability of large shareholders to participate in board functions, as noted in this resignation letter filed as an exhibit to a Form 8-K filed yesterday.
FIN 48: Slouching Toward Implementation
Here’s some great stuff from Jack Ciesielski’s AAO Weblog: “Last June, the FASB released an interpretation of Statement No. 109, which deals with income tax accounting. It was called Interpretation No. 48 (catchy, eh?), “Accounting for Uncertainty in Income Taxes” and quickly picked up the moniker “FIN 48.” Or, if you work in the tax department of a publicly-traded company, it became known by other, more colorful nicknames. I won’t go into those here; family publication and all that.
And I won’t go into details about the nuances of FIN 48, either; suffice it to say, it provides a framework for evaluating “uncertain tax positions” that companies take from time to time, that might either create/increase a tax asset or reduce a tax burden. Sometimes those tax positions are solidly defensible, and there’s little question that any tax assets recognized in the financial statements are going to be realized; sometimes the positions taken on tax returns are done so with fingers crossed in the hope that the taxing authorities are going to miss them. Any effect that “fingers crossed” positions may have on the financial statements – creation/increase in assets or reduction in liabilities – might be different from what shareholders (after it’s been asserted in the financial statements that these things are so.)
In studying balance sheets, investors want to see what is – not what managers wish for. And that’s what the effect of applying FIN 48 does: it forces managers to look at the odds of open tax positions being sustained under review by tax authorities. The standard might wring some water out of assets on balance sheets … IF it’s actually implemented. It’s supposed to be effective in years beginning after December 15, 2006. For calendar year companies, that’s right now.
Recently, the FASB has started receiving unsolicited letters about the interpretation, insisting that the standard-setter push back the implementation date – for example, this one from Tax Executives International. This is a standard that has gestated for over two years, has been exposed for comment, and issued in final form six months before implementation – and now firms decide that it’s too soon to implement it? Even more ironic, the IRS had even offered expedited reviews of issues with FIN 48 importance in order to enable them to meet the implementation deadline.
I’ve written a letter of my own to the FASB, urging them to stand pat on the implementation date. Feel free to send one of your own to FASB chairman Robert Herz, using this link. Tell him that you support their standard as it stands.”
And Paula Dubberly, Associate Director of the SEC’s Division of Corporation Finance, has joined the panel for the Thursday, January 18th webcast: “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!.” Both Paula and David played key roles in writing the new executive compensation rules and will continue to do so in interpreting them.
Because this essential 2-Part Web Conference will be accessible only to those that are 2007 members of CompensationStandards.com, we urge those of you who have not yet renewed for 2007 to do so now (all memberships expired at year end; grace period for non-renewers ended on Friday) – and anyone not a member should try a no-risk trial. If you need to renew, please renew online if you can as our HQ is overwhelmed right now.
NYSE Proposes Automatic Suspension of Significantly Delinquent Filers
A few weeks back, the NYSE proposed a rule change to eliminate the NYSE’s discretion to allow a company to continue to be listed on the NYSE if it is over 12 months delinquent in filing an annual report. The NYSe proposed that its revised rules would become effective December 31, 2007. Comments are due by January 18th and the proposal is subject to SEC approval.
Under the NYSE’s proposal, if a company has not filed its annual report within 12 months of the required date, the NYSE will begin suspension and delisting procedures. Under current rules, the NYSE has the discretion to not commence such procedures in specified circumstances (egs. if delisting would result in investor harm or be significantly contrary to the national interest).
Recently, the NYSE has been criticized for using this discretion to allow Fannie Mae to continue to be listed for a long period of time without being current in its reporting. Last month, the NYSE gave Fannie Mae a deadline of the end of 2007 to file its 2005 reports.
Accounting Reform: How the Latest Developments Impact You
We have posted the transcript from our webcast: “Accounting Reform: How the Latest Developments Impact You.” Among other topics, the webcast covered FIN 48, which continues to be an issue for lawyers – read more about that in our “Tax Uncertainties” Practice Area.
In the “Compensation Committee” Practice Areas on both CompensationStandards.com and TheCorporateCounsel.net, we have posted a number of recently amended compensation committee charters, tweaked by companies to adapt to the SEC’s new rules as well as other considerations.
Look at First Disclosures under the SEC’s New Executive Compensation Rules
Yesterday, the SEC posted the federal register version of its December amendments (comments are due January 29th for these “interim final” rules). In addition, we posted the January supplement of Mark Borges’ latest blogs on executive compensation disclosures, which include several analyses of the SEC’s December rulemaking as well as a look at the first disclosures made under the new rules.
We have wrapped up our latest survey; this one on compensation and disclosure committee meetings – and the results are repeated below (and don’t forget to take our latest survey on related party transaction policies):
1. In the wake of the SEC’s new compensation disclosure rules, our compensation committee has the following people attend their meetings:
– General counsel – 57.6%
– Securities law counsel – 33.7%
– Employee benefits law counsel – 8.5%
– Head of Human Resources department – 59.4%
– Other member of Human Resources department – 24.5%
– Corporate secretary or assistant corporate secretary – 50.0%
2. Does someone from your independent auditor attend your disclosure committee meetings:
– No; no one from the independent auditor attends any disclosure committee meetings – 66.3%
– Some; someone from the independent auditor attends some of the disclosure committee meetings (e.g. just selected meetings such as those relating to financial reports or earnings releases) – 18.4%
– All of them; someone from the independent auditor attends all of the disclosure committee meetings – 15.3%
3. If someone from your independent auditor attends some or all of your disclosure committee meetings, the:
– Independent auditor requested the right to attend – 29.0%
– Company requested that someone from the independent auditor attend – 71.0%
4. If someone from your independent auditor attends some or all of your disclosure committee meetings, what is the purpose for attendance:
– To function as an active participant in the deliberations of the disclosure committee – 32.4%
– To serve in an advisory capacity and answer questions if asked – 35.3%
– To monitor and record the activities of the disclosure committee – 20.6%
– Other – 11.8%
As I blogged about a few months back, a group of institutional investors sent letters to major companies seeking to elicit more disclosure about how those companies utilize compensaiton consultants. The disclosure sought exceeds the requirements adopted by the SEC last August.
Specifically, the investors sought disclosure about whether the companies hire compensation consultants that provide services to the company beyond advising on CEO pay and whether the companies have a policy prohibiting such perceived conflicts. So far, 18 of the 25 companies that received the request have responded – and most of them said they have taken steps to ensure the independence of consultants who advise their boards on executive pay. Here are the response letters from the 18 companies – and a January 2nd press release from the investor group.
On pages 49-50 of its proxy statement last year, Pfizer was the first company to provide such disclosure by naming their compensation consultant, discussing what they are engaged for, noting other work done for the company and the dollar amount of the fees, pointing out that it is the compensation committee that has engaged the consultant, and describing the consultant’s involvement with compensation committee meetings.
Now, Vineeta Anand of Bloomberg reports in this article that General Electric will provide similar disclosure to Pfizer’s in this year’s proxy statement. I imagine that many – if not all – of the 18 other companies that responded to the institutional investors will do the same…
January Eminders is Up!
The January issue of our monthly email newsletter is now available.
SEC Releases Two Economic Studies on Mutual Fund Governance
As part of the re-proposal of the SEC’s mutual fund governance rulemaking, the SEC’s Chief Economist has issued two reports – here and here – that outline the difficulties in evaluating the benefits of a rule requiring 75% of mutual-fund directors to be independent. The 60-day comment period commenced from the release of these reports on December 29th. Here is an article from today’s WSJ describing the two reports.
As we know that executive compensation is foremost on director’s minds these days, we have posted the Winter 2007 issue of our new practical print newsletter for you to read and share with your directors about executive compensation practices – at no charge!
The new newsletter – Compensation Standards – will help keep directors abreast of the latest executive compensation practices and to help them glean practical pointers that can assist them in performing their challenging duties. Try a no-risk trial to Compensation Standards today. You have our permission to forward as many copies of the Winter 2007 issue as you like to directors and CEOs and others that might benefit from it.
The SEC’s December Executive Compensation Rule Changes: Help is on the Way!
To help all those trying to sort out the SEC’s surprise December amendments to its executive compensation rules, we just announced a new Part 1 of our January Web Conference to address how you should implement the amendments in a webcast to be held next Thursday, January 11th: “The SEC’s December Rule Changes: How They Impact You.” [And if you can’t wait til next Thursday for guidance, Mark Borges already has blogged four different times providing analysis on the amendments in his “Proxy Disclosure” Blog.]
And then, following up where our September two-day executive compensation disclosure conference left off, catch the rest of our critical 2-Part Web Conference on Thursday, January 18th – “The Latest Developments: Your Upcoming Proxy Disclosures—What You Need to Do Now!“- which will provide you with all the latest guidance about how to overhaul your upcoming disclosures in response to the SEC’s most recent positions on the new executive compensation rules as well as the latest thinking on how to face the most difficult issues, such as how to deal with airplane and other perks and what to include in the CD&A.
Because this essential 2-Part Web Conference will be accessible only to those that are 2007 members of CompensationStandards.com, we urge those of you who have not yet renewed for 2007 to do so now (all memberships expired at year end; grace period for non-renewers ends this Friday) – and anyone not a member should try a no-risk trial. If you need to renew, please renew online if you can as our HQ is overwhelmed right now.
Floyd Norris: A Little More on the SEC’s Forgetful Chairman
The NY Times columnist, Floyd Norris, has really been going after the SEC for adopting changes to its executive compensation rules so soon before the proxy season and without asking for public comment. In addition to a couple of scathing columns, Floyd has posted additional thoughts on his blog, including this one (he has others, including this one):
“My column today points out that the staff of the Securities and Exchange Commission knew — and told the public — things that Christopher Cox, the commission chairman, now says were unknown to him. It also points out that those things were discussed in January by him at the S.E.C. public meeting when the rules were proposed. The column has links to documents, but may make readers work too hard to find them. The explanatory documents, which the S.E.C. put out in August, a month after the commission voted, can be reached here. The relevant part is on pages 56 to 58.
The January conversation can be linked to here. A reader then has to go to the Jan. 17 meeting, and watch a video. The important part starts at about 24 minutes and 50 seconds into the video, when Mr. Cox engages in a conversation with Alan Beller, who was then the director of the commission’s division of corporation finance.
‘If I might turn next to stock options,’ Mr. Cox stated, ‘the proposal today would require the disclosure of the fair value of stock option awards as of the date that the option is granted to an executive officer. That distinguishes it in some respects from the reporting otherwise for financial reporting purposes.’ This point is the one that Mr. Cox now says he did not know was in the rule when the commission approved it in July. The commision changed the rule just before Christmas.
Mr. Cox told me tonight that he had remembered the January conversation, and that I misunderstood him if I thought he had not. But he repeated that he wrongly believed that section had been changed by July, and blamed the error on miscommunication amid staff changes at the commission. In January, Mr. Beller said the S.E.C. had tried timing conformity in the past, only to reject it because it was viewed as less informative and ‘excessively confusing.’ That is not a bad description of the rule the commission came up with in December.”
As we recently wrote about in the November-December issue of The Corporate Executive, increasing the strike price – or even fixing the exercise date – ordinarily cannot be effected without the consent/agreement of option holders (except, possibly, where there is a strong plan provision allowing the board/administering committee to unilaterally amend outstanding options), even to increase the exercise price, as deemed necessary or advisable to comply with applicable (e.g., tax) laws.
In an apparent effort to offset the foregone compensation, some companies are offering additional new options, restricted stock, or even cash bonuses in exchange for the consent. Under these circumstances, companies, in effect, are offering to buy existing stock options in exchange for materially amended options, etc. and/or cash. The Staff generally takes the position that option holders are presented with an economic investment decision, and not “merely a compensation decision,” if they are asked to consent to an increase in the exercise price of options – or even just adjust the exercise date.
The company’s presentation of the investment decision to the option holder implicates the SEC’s issuer tender offer Rule 13e-4 and requires the company to file a Schedule TO in advance of the offer being presented to the option holders. (Companies contemplating financial restatement may face another problem as tender offers for employee stock options filed on Schedule TO generally must be accompanied by current financial statements.)
It appears some companies might liberally interpret Corp Fin’s limited class 2001 exemptive order on repriced options as authorizing them to “fix” backdated options for (1) previous employees and (2) defer any cash consideration and/or substitute non-cash consideration into a subsequent year in order to avoid the ill tax consequences presented by §409A. These companies should think again because the exemptive order doesn’t say a thing about extending the offer to former employees or relief from “prompt payment.” Nor should these companies necessarily rely on the Clorox’s issuer tender offer that was recently conducted.
Availability of the SEC’s 2001 Exemptive Order
Back in 2001, the SEC adopted a limited class exemptive order to address issues implicated by exchange offers for repriced options. Reliance on the SEC’s exemptive order was conditioned on, among other things:
– the issuer being eligible to use Form S-8;
– the options subject to the exchange offer being issued under an employee benefit plan as defined in Rule 405 under the Securities Act; and
– any substitute securities offered in exchange for existing options being issued under such an employee benefit plan.
The availability of Form S-8 when issuing an option to a former employee of the issuer is based on that employee receiving the option while employed by the issuer and then exercising the option on S-8 after leaving. If the Form S-8 is not available (e.g. because the person is no longer an employee when a replacement option is issued), issuers will need to rely on another exception from the ’33 Act or register the issuance of the new options.
An issue also exists in construing the Rule 405 definition of employee benefit plan, which “means any written purchase, savings, option, bonus, appreciation, profit sharing, thrift, incentive, pension or similar plan or written compensation contract solely for employees, directors, general partners, trustees (where the registrant is a business trust), officers, or consultants […]” If former employees are being issued new options but do not fall into one of the other enumerated categories, new options issued to former employees will not be options issued under an employee benefit plan. Note that when Microsoft employees transferred their options to JP Morgan in late 2003, Microsoft amended its plan to remove the transferred options so that Microsoft would not rupture the 405 definition based on the “solely” requirement.
Prompt Payment Issues
When the exemptive order was issued in 2001, the scope of the order’s relief was limited to Rule 13e-4(f)(8)(i) and (ii), the all-holders and best-price provisions. The repricing offers that gave rise to this exemptive order, however, were generally structured to award substitute options on a deferred 6-month and one day payment schedule if certain conditions were met. This payment schedule was driven by the accounting policies in existence at that time. This payment schedule was also technically in conflict with the prompt payment rules. Based on the accounting requirements, however, the Corp Fin Staff generally did not raise objections to the payment schedule.
§Section 409A appears to require that any cash amounts paid in connection with an option repricing be paid in the year after the option repricing (i.e. offers completed in 2007 would require payment in 2008). If true, this payment schedule could contravene the SEC’s prompt payment rules. In the absence of any Staff relief, therefore, issuer tender offers conducted in accordance with IRS §409A are required to comply with the SEC’s prompt payment rules. Although issuers may have legitimate compensation concerns as to why they may wish to defer payment of tender offer consideration for an extended period, issuers should first consult with the Staff before tender offer payments are deferred.
Today is a National Holiday: SEC is Closed
Remember that today’s national day of mourning for former President Gerald Ford means that the SEC is closed and that any filings otherwise required to be made today will be due instead on January 3rd – as the SEC will treat today just like yesterday (ie. New Year’s Day) for 8-K purposes (ie. not a business day). EDGAR is closed too. And remember this old blog regarding counting days for tender offer purposes…
The “League Tables”: Battle for the Top
I always love this stuff. On Saturday, the WSJ ran this article about the battle to obtain top ranking for Thomson Financial’s all-important league tables regarding deal advisors (and here’s an article from today’s WSJ about the top deals of ’06):
“Citigroup lost a bid Tuesday to win credit for arranging a $30 billion deal in Norway that might have vaulted it to the top of one closely watched list of busiest advisers on European merger-and-acquisition deals. After days of wrangling, Thomson Financial declined to give the banking titan “league table” credit for writing a fairness opinion – a relatively minor role in the merger process – that endorsed Norsk Hydro’s planned $30 billion sale of energy assets to Statoil.
Citigroup was appointed by Norsk Hydro on Dec. 18, the same day the deal was announced. Thomson, whose league tables are cited by investment banks to validate their deal prowess, requires banks to prove they were hired before deals are announced to be granted credit. A Citigroup spokeswoman declined to comment.
Dealogic, a rival to Thomson Financial, on Thursday gave Citigroup credit for the Norsk Hydro assignment. It and Thomson rank the banking titan second behind Goldman Sachs Group Inc. as the top global adviser on mergers.
Citigroup lobbied hard for the Norsk Hydro credit, people close to the company said, because it would have given it dominance in the European league tables. According to Dealogic, the deal vaults Citigroup one notch up in the European rankings to third place. But in Thomson’s rankings, the Norwegian deal would have let Citigroup leapfrog Morgan Stanley to first place as adviser on European deals. Morgan Stanley is credited in the Thomson table with $482 billion of deals, a hair’s breadth ahead of Citigroup’s $473 billion.”
With Sarbanes-Oxley in the rear-view mirror for 4 years now, one would think that this would have been a quiet year for corporate governance developments. To the contrary, it was arguably the most dramatic year of change in recent history. Here is a snapshot of some of the more significant developments:
– The majority-vote movement matured at an incredible pace. Within the span of a single year, over half of the Fortune 500 adopted some form of policy or standard to move away from pure plurality voting for director elections. This trend is likely to continue as it’s the governance change that investors seek the most.
– An area not touched by Sarbanes-Oxley – executive compensation – continued to be inspected under a microscope by both investors and regulators. The SEC adopted sweeping changes to its compensation disclosure rules and investors became more willing to challenge companies that continue outlandish compensation policies. And House Democrats intend to consider executive compensation legislation early in 2007. [Today’s WSJ and Washington Post contain articles in which Rep. Barney Frank expresses displeasure over the SEC’s recent change in its exec comp rules – and we have announced a January 11th webcast just on these new changes. More on all this next week.]
– More and more hedge funds and private equity funds found “value” in using governance as an entree into forcing management to alter strategic course or to put a company into “play.” The recent hiring of Ken Bertsch, a former TIAA-CREF governance analyst who had been working for Moody’s, by Morgan Stanley is an indicator that using governance as a “big stick” is likely to continue.
– The recent sale of the two primary proxy advisory services – ISS and Glass Lewis – at handsome premiums is a pretty good indicator that governance as a skill set can be quite profitable.
– The re-opening of the SEC’s “shareholder access” proposal – spurred by a recent 2nd Circuit decision – was unthinkable a year ago. But it’s now reality.
– The proposed elimination of broker votes in 2008 – via a rulemaking from the NYSE – means that the 2008 proxy season promises to be the wildest yet. But 2007 surely will be wild enough.
One thing we know for sure – we can’t predict what the New Year will bring! Happy Holidays!
Some Thoughts from Professor John Coffee
In an interview with the Corporate Crime Reporter, Professor John Coffee waxes on problems with the McNulty Memo and the Paulson Committee Report.
A Conservative Year for Holiday Cheer
Fried Frank took it easy in this year’s annual festive message. Each year, the firm issues an alert at the end of the year which focuses on a true – and zany – government prosecutorial act. No food fraud to report on this year…
