As companies fill out the new checkboxes on the cover of their Form 10-Ks, there appears to be a bit of understandable confusion regarding the checkbox that relates to “voluntary filer” status (eg. see #1569 in our Q&A Forum; in addition, a number of companies that have already filed checked the wrong box). This checkbox states:
“Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act. ___ Yes ____ No”
Rest assured that if “yes” is checked for this checkbox, that means the company is stating that it is a voluntary filer (and the EDGAR nest in the header should also be “yes”).
I can understand how the double negative in the checkbox causes some confusion; we probably would have been better off with a single box – like the Item 405 checkbox – rather than being faced with a “yes/no” set of boxes.
Comments on the SEC’s E-Proxy Proposal
The comment period closed on February 13th for the SEC’s E-Proxy proposal and final rules shouldn’t be expected anytime soon given that the new Corp Fin Director hasn’t started work yet. Scanning through the comment letters, it appears that the nature of the comments are all over the lot, with some fully supporting the idea and others not favoring it at all.
One of the more interesting comments came from AARP, which polled its members regarding their Internet use – 1500 retirees responded! – and found that 84% have access to the Internet at home (with 64% of those having high-speed access – we have posted the full survey results). Even despite the relatively high level of Internet use, it’s not too surprising that this group favors regular mail for their proxy materials.
In this podcast, Carl Hagberg provides his thoughts on the E-Proxy proposal (here is the comment letter that Carl submitted to the SEC), including:
– What are the primary issues that you see in the SEC’s e-proxy proposal?
– What should companies consider doing regarding these issues?
– What are your recommendations to tweak the SEC’s proposal?
– Does the SEC’s proposal change the playing field at all?
SEC Proposes PCAOB’s Independence and Ethics Standard
Last week, the SEC finally issued the PCAOB’s proposal – which was sent to the SEC last July! – that would prohibit auditors from engaging in aggressive and abusive tax services, among other matters. The SEC and PCAOB staff had a lot of interatction on this proposal before it was ever proposed by the PCOAB, so it is certainly due. Comments are due 35 days from publication in the Federal Register.
Yesterday, the US Chamber of Commerce issued a 44-page report on the SEC’s enforcement program. This Reuters’ article includes a reply from SEC Chairman Cox.
The Chamber seeks a special advisory committee to study – and possibly reform – the SEC’s Enforcement Division and its procedures. In addition, here are some of the report’s 15 recommendations noted on pages 7-8:
– review of whether the SEC is using its litigation and settlement positions to attempt to shift standards for civil liability, such as “materiality” and “scienter,” to an inappropriately low level
– refrain from interpreting or expanding the SEC’s regulatory reach through enforcement actions and clarify legal standards before initiating enforcement actions for violation of those standards
– greater SEC reliance on formal reprimands instead of enforcement actions to remedy inappropriate corporate behavior
– avoid blurring the line between civil actions and appropriate criminal prosecutions and ensure that SEC referrals to DOJ for securities violations are reserved for clearly egregious cases
– clarification that a waiver of attorney-client privilege or work product protection is not required to be viewed as cooperating with an SEC investigation
– refrain from imposing fines on companies entirely for lack of cooperation during investigations (because the SEC already has adequate tools through subpoena enforcement actions, threat of such actions, and rules on document maintenance to command cooperation)
– over the last several years, the investigative process has become more adversarial and less objective in finding the facts and determining whether a violation has occurred (so there should be more open dialogue and a reconsideration of the practice of industry sweeps due to overly broad requests for information)
What About Periodic Updates from Enforcement on Open Matters?
On a somewhat related note, on Tuesday’s webcast – “How to Handle a SEC Enforcement Inquiry Today” – Russ Ryan mentioned proposed legislation that would require the SEC to provide regular updates to companies under investigation. This would go a long way towards solving the dilemma discussed on the webcast – to quote Jay Dubow: “Do you want to call and get that confirmation or are you afraid you’re going to wake the sleeping dog; that it was on someone’s back burner and now they’re going to relook at the open matter?”
Howard Dicker sent me over to ExpectMore.gov to get a taste of what OMB is up to these days. By plugging “securities” and “exchange” into the search tool, I found that the SEC’s OCIE received a “moderately effective” grade in 2005. In 2004, Enforcement received a “not performing” – and Corp Fin received a “not performing” in 2003.
One-Time “Hall Pass” to Fix Cash Flow Classifications
One issue not discussed by the SEC Staff at PLI’s “SEC Speaks” is the SEC’s informal position that provides companies with an opportunity to fix erroneous cash flow classifications – in the discontinued operations context – without having to restate. This issue was first raised at the AICPA’s National Conference in December when Corp Fin Staffer Joel Levine stated that companies had better start paying attention to their cash flow classification. Joel also identified certain presentation formats that the Staff considers inconsistent with SFAS No. 95. Here is Joel’s speech and his PowerPoint from that conference.
Then, on February 15th, the AICPA issued CPCAF Alert #90, which notes which presentation formats are acceptable to the Staff – and that the Staff will allow companies to amend their classifications in their next Form 10-K or Form 10-Q without having to treat such amendments as a correction of an error. The Alert also states that any issues discovered and corrected in a later SEC filing will be treated as a correction of an error and require amendments of prior filings.
I don’t know why the SEC staff didn’t mention this position at the conference as I think it’s important for companies to know of this position if they have not been reporting cash flows relating to discontinued operations the way the SEC wants them to.
Talk About Having a Bad Day
As a former in-house lawyer, the thing that struck me about Google’s gaffe -that led to some internal projections being included in an “Analyst Day” presentation posted on the company’s IR web page – is that it might have cost some lawyer his or her job. Being in-house is tougher than you might imagine if you haven’t “been there, done that.” First, non-lawyers are your ultimate boss – and they often don’t like lawyers at all (since lawyers are the ones who say “no”). Second, one simple mistake like this and you can cost the company 5% of its market cap. Third, I often worked harder when I was in-house than when I worked in law firms – meetings all day, real work at night.
Now, we don’t know if a lawyer was to blame for Google’s gaffe (it depends on whether the unintended projections were included in a draft that the lawyer reviewed; I sure hope lawyers are involved in vetting analyst presentations!). In fact, the projections could have been added after it was reviewed and most in-house lawyers are absolved of any responsibility once a document leaves their hands. But this gaffe highlights the need to include double-checking on what is about to be filed with the SEC or posted on the company’s IR web page as part of a company’s disclosure controls and procedures. This mundane task clearly is as important as drafting the original disclosure since the end result is what really matters to investors. Here is Google’s Form 8-K that describes its gaffe.
According to this NY Times article, two large shareholders sued Hewlett-Packard on Tuesday, contending that a $21.4 million severance package for former CEO Carly Fiorina violated the company’s policy on executive compensation. The lawsuit was filed in US District Court in the Northern District of California; we have posted a copy of the complaint in the CompensationStandards.com “Litigation Portal” (remember there are two other compensation lawsuits heading to trial shortly!).
Here is an excerpt from the NY Times article:
“The suit says Ms. Fiorina’s severance pay exceeded a limit shareholders approved in 2003 that restricted such compensation to 2.99 times an executive’s base pay plus bonus. The lawsuit seeks to recover the money paid to Ms. Fiorina, who was forced to resign in February 2005.
A Hewlett-Packard spokesman said the company “believes the suit is without merit” and declined to comment further. A spokesman for Ms. Fiorina said she had not seen the suit and would not comment.
The lawsuit shows that executive compensation is of increasing concern to owners of public companies, said Gary Lutin, an investment banker at Lutin & Company in New York who advises institutional investors in corporate control battles. “The lawsuit indicates a growing sense of shareholder responsibility for controlling the diversion of corporate assets by the property managers,” he said, “especially by the ones who failed.”
In the most publicized case, Disney shareholders fought their company to rescind the $140 million severance package that was given to Michael S. Ovitz, who was fired after 14 months as president. Disney won that case last year when the judge ruled that the Disney board “fell significantly short of the best practices of ideal corporate governance,” but it did not violate its fiduciary duty.
It was shareholder outrage at the size of Hewlett-Packard’s award of about $17 million to Michael D. Capellas, who was Hewlett’s president for seven months, that prompted stockholders to approve the policy that limited future severance awards. The shareholder proposal was sponsored by the Service Employees International Union.
The lawsuit notes that Ms. Fiorina’s severance package of $21.4 million was 3.75 times her $5.6 million salary and bonus. The suit contends that her severance package could be worth as much as $42 million when the potential value of her stock and options and her pension are factored in. Under the company policy, any award that exceeds the limit must be approved by shareholders.
The crux of the case depends on how one defines the bonus that Ms. Fiorina received under what Hewlett calls the long-term performance cash program. The three-year incentive plan, approved by shareholders in May 2003, provided bonuses to executives if certain financial targets were met. However, the plan stated that executives who were fired would not receive the bonuses.
The board gave Ms. Fiorina $14 million, which was 2.5 times her salary and regular bonus, and an additional $7.38 million from the long-term bonus plan. “It is a severance payment no matter what they call it,” said Michael Barry, a partner at Grant & Eisenhofer, which filed the lawsuit on behalf of the unions.
The company changed the terms of that plan to apply to fired executives after Ms. Fiorina received her severance in February 2005. The suit says the plan was amended secretly.”
House Representatives Oxley and Baker Support SEC Authority
On Monday, following the request for comment on the SEC’s Advisory Committee on Smaller Public Companies Final Report, House Financial Services Committee Chairman Michael Oxley (OH) and Capital Markets Subcommittee Chairman Richard Baker (LA) wrote a letter to SEC Chairman Cox to express their view that the SEC holds the necessary authority to act on the Committee’s recommendations should it choose to do so.
The letter likely was in response to Committee member Kurt Schacht, Director of the CFA Center for Financial Market Integrity, who wrote in dissent that “it is unclear to many whether the broad exempting recommendations of this subcommittee are even within the commission’s legal authority.”
Nasdaq Seeks “Covered Securities” Relief for Listed Companies
Last week, Nasdaq filed a rulemaking petition with the SEC so that securities listed on the Nasdaq Capital Market are considered “covered securities” for purposes of Section 18 of the ’33 Act (and hence be preempted from the reach of blue sky laws).
Particularly since NASAA doesn’t oppose Nasdaq’s request, it certainly seems like a “no-brainer” that the SEC would make this rulemaking, which is why I found it unusual that Nasdaq filed a rulemaking petition rather than informally ask the SEC to act. But since Nasdaq is allowed to file these petitions by statute, it’s not a bad move to provide people with an opportunity to comment (and voice their support, which perhaps might spur the SEC to take faster action).
Last week, Jesse Brill submitted a comment letter to the SEC regarding the executive compensation disclosure proposals. Jesse’s comments are embedded in the Jan-Feb 2006 issue of The Corporate Counsel, which was mailed over the weekend (and a copy of this issue is posted on CompensationStandards.com). We hope you will read these 8 pages as “food for thought” as you consider what issues you intend to comment upon.
Meet Our Compensation Consultants: Ratchet, Ratchet and Bingo
In this year’s 23-page letter to shareholders, Warren Buffett takes his annual swing at excessive CEO pay. My three favorite quotes from this year’s letter:
1. “The deck is stacked against investors when it comes to the CEO’s pay. Outlandish ‘goodies’ are showered upon CEOs simply because of a corporate version of the argument we all used when children: ‘But, Mom, all the other kids have one.'”
2. “The upshot is that a mediocre-or-worse CEO – aided by his handpicked VP of human relations and a consultant from the ever-accommodating firm of Ratchet, Ratchet and Bingo – all too often receives gobs of money from an ill-designed compensation arrangement.”
3. “Comp committees should adopt the attitude of Hank Greenberg, the Detroit slugger and a boyhood hero of mine. Hank’s son, Steve, at one time was a player’s agent. Representing an outfielder in negotiations with a major league club, Steve sounded out his dad about the size of the signing bonus he should ask for. Hank, a true pay-for-performance guy, got straight to the point, ‘What did he hit last year?’ When Steve answered ‘.246,’ Hank’s comeback was immediate: ‘Ask for a uniform.'”
New Disclosure Requirement? How Much You Got Paid to Draft Those Compensation Disclosures
Got a chuckle reading Evelyn Y. Davis’ comment letter to the SEC regarding the executive compensation disclosure proposals. If you don’t know about Evelyn, here is some background information.
Evelyn asks the SEC to require disclosure of “all outside legal fees.” Not sure how that would work within the SEC’s proposed framework nor am I sure what that would accomplish (do shareholders really want to know how much companies pay each vendor they work with?). She appears incensed that one company paid $800 million in legal fees in a one year period – I agree that sounds more than a tad bit high.
Why Rules Can’t Stop Executive Greed
This NY Times article from Sunday is among the best I have seen on the complexities of pay-for-performance metrics. It also addresses the importance of boards taking charge to tackle the perils of excessive executive compensation. I recognize that shareholders have a role here, but the burden truly does rest on the board’s shoulders.
As many WKSIs will soon be filing 10-Ks that forward incorporate Part III information from a proxy statement, be aware that an automatic shelf registration statement may not be available if the WKSI has not already made the Part III information publicly available. The issue relates to the filing of an automatic shelf registration statement by a WKSI registrant after filing a Form 10-K (that forward incorporates by reference the Part III information) and before filing the proxy statement.
Historically, the Staff had the policy (as set forth in the Telephone Interpretations Manual H.6) that they would not declare effective a registration statement on Form S-3 until the company either amended its 10-K to include the Part III information or filed its proxy. Informally, however, the Staff did allow registrants to do shelf takedown offerings from a shelf registration statement that had been declared effective prior to the filing of a Form 10-K.
At PLI’s “SEC Speaks” on Saturday, Corp Fin Chief Counsel David Lynn fleshed out this issue as follows. The Staff says that an automatic shelf registration statement filed during this period will continue to be automatically effective as set forth in the new rules. However, the Staff believes that the prospectus contained in the registration statement does not satisfy the requirements of Section 10(a) of the Securities Act and therefore cannot be used by a WKSI until: it files either an amendment to its 10-K or its proxy statement to include Part III information – or unless it includes the Part III information in a prospectus supplement to the automatic shelf.
The bottom line: while a WKSI technically can file an automatic shelf registration statement after filing its Form 10-K and before filing its proxy, it cannot conduct an offering under that newly-filed automatic shelf registration statement until such time as the Part III information is filed (via 10-K/A, proxy statement or prospectus supplement). We will be posting more notes from “SEC Speaks” soon…
SEC Chair Cox Discusses Disclosure of SEC Investigations
This Reuters article from last week quotes SEC Chairman Cox on the issue of when companies should disclose the existence of an investigation or the offer of a settlement. For Chairman Cox, the disclosure threshold is that “material” disclosures should be made – but he confessed that determining what constitutes “materiality” is difficult. The article notes a recent speech by Commissioner Atkins during which he expressed frustration with companies that disclose tentative SEC settlement agreements before the Commissioners had an opportunity to vote on whether to further pursue the Enforcement action. Here is an interesting excerpt from Commissioner Atkin’s speech:
“Often in the SEC enforcement process, public companies, or sometimes their regulated subsidiaries such as broker-dealers, decide to pursue a settlement with the Commission. In the settlement process, the settling party deals directly with our enforcement staff, but the staff does not have the authority to bind the Commission to the terms of a settlement. Simply put, the settling party is offering to the enforcement staff to settle the matter based on certain violations of the securities laws, with certain remedies such as bars, penalties, or disgorgement, and in return the enforcement staff is agreeing to recommend to the Commissioners that they approve the settlement as offered.
At this stage nothing is final, and because of that lack of finality I find it hard to believe that the agreement by the staff to recommend settlement to the Commission is, by itself, necessarily an event that must be reported to shareholders. Although we Commissioners have deep respect for the work of enforcement staff, I can assure you that the next step in the process is not a rubber stamp approval by the Commission.”
Request for Comments on Small Business Advisory Committee Draft
On Thursday, the SEC released a draft of the Final Report of the Advisory Committee on Smaller Public Companies and seeks comment by April 3rd. This draft isn’t much different that the draft report released before the Committee’s last meeting – the recommendations are the same, but some of the language has been fleshed out. Since the Advisory Committee is required to unwind in April, the Final Report is expected no later than April 23rd.
A few weeks back, the New York Supreme Court sided with Eliot Spitzer by partially denying summary judgment and finding the former CEO of McLeodUSA liable for “spinning” (i.e. accepting IPO shares from the same brokerage firm that his company used as an investment banker). Here is a copy of the court’s decision – and a copy of the complaint.
Here is an excerpt from a related WSJ article: “A New York state court recently found former telecommunications executive Clark E. McLeod liable for receiving hot new stocks in his personal brokerage account. The rationale: His company was sending business to the same securities firm, Citigroup Inc.’s Salomon Smith Barney, that doled him the new stocks.
That is a big change. Previously, “spinning” of initial public offerings of stock involved a direct quid pro quo. In a common form, securities firms allocated IPOs to the personal accounts of corporate executives, so the shares could then be sold, or “spun,” for quick profits — in exchange for business from the executives’ companies.
IPO shares are coveted because they often surge on their first trading day. Spinning has raised concerns among investors that the IPO market is rigged.
Bottom line: Senior executives now could skate on thin legal ice if they receive IPO shares from a Wall Street firm with which their company at some point does business, and don’t disclose it to their board or shareholders.”
We have posted the March issue of our popular email newsletter. I’m heading to “SEC Speaks” tomorrow and unlikely to blog. Ugh, the Corp Fin panel is not until early Saturday morning…
On Monday, the FASB and IASB issued a memorandum of understanding in which they laid out a detailed work plan to narrow differences between their standards – with a goal of substantially completing this process in eleven specified areas by 2008 (and take a hard look at ten other areas).
For those following this important development closely, you know that the SEC’s willingness to downsize its requirement that non-US issuers fully reconcile their financials when registering securities in the US is conditioned on this convergence effort. Reconciliation is unpopular in the European Union – but convergence hasn’t been widely popular either as there are concerns that it could lead to the creation of overly theoretical accounting standards. Learn more in our “Globalization of Accounting Standards” Practice Area.
How to Find a Company’s CGQ
Occasionally I get asked how someone can check a company’s corporate governance rating, as assigned by ISS (ie. the “CGQ”). You can obtain a company’s CGQ by going to Yahoo Finance, entering the company’s stock symbol in the “Get Quotes” search tool – and then hit “company profile” on the bottom right side of the page.
Then, you will see the CGQ on the right side under a “Corporate Governance” header. Two separate ratings are generated for each company; one compared with other companies in the same index and within the company’s industry group. Oddly, I don’t believe you can obtain these ratings on ISS’ own site. Learn more about how CGQ ratings are compiled in our “Governance Ratings” Practice Area.
ISS’ New “Corporate Governance” Blog
ISS has launched a new “Corporate Governance Blog” and it looks quite promising. I wonder what the average shelf life of a blogger is these days. It seems that many blogs start off with a bang amid much enthusiasm – and then they trail off within a few months.
Much like the typical New Year’s resolution (here is a history lesson on why we even bother to make those resolutions every year). How you doing on your resolutions? Did you hoard a box of Tamiflu like you promised yourself?
Marty Dunn, the Deputy Director (Legal) of Corp Fin, has deservedly been named Acting Director to head up Corp Fin now that Alan Beller has left and before John White assumes the directorship on March 20th. Marty has been with Corp Fin since 1988.
Notes from the SEC’s Small Business Advisory Committee Meeting
I blogged last week briefly about the SEC’s Small Business Advisory Committee latest meeting. Here are more extensive notes about the meeting from FEI’s “Section 404 Blog,” which are partially repeated below:
“The SEC Advisory Committee on Smaller Public Companies (SEC ACSPC) voted unamimously at its public meeting to release for public comment its Exposure Draft (ED) of what will ultimately be its “Final Report” to the SEC. The ED contains over 30 recommendations regarding improving regulation of smaller public companies, and and is expected to be formally released for public comment by Feb. 24 or shortly therafter. There will be a 30 day comment period on the ED. A summary of what is expected to be in the ED, based on a “draft of the ED” posted on the SEC’s website for informational purposes as of Feb. 14, 2006, is available here.
Among the most controversial, if not the most controversial, of the SEC ACSPC’s recommendations, concerns its recommendation to exempt microcaps and smallcaps from certain provisions of Section 404. The size threshholds the SEC ACSPC proposes to use to define “microcap” and “smallcap” companies generally are :
– under $128 million market cap for microcaps, and
– between $128 million and $787 million for “smallcaps”.
For puposes of the Section 404 exemptions specifically, the SEC ACSPC adds an additonal metric relating to revenue to determine which companies would be exempted under Section 404:
– microcaps (as defined above) with less than $125 million revenue, and
– smallcaps (as defined above) with less than $10 million revenue.
Additionally, smallcaps (as defined above) with more than $10 million in revenue, but less than $250 million in revenue, would be exempt from the auditor attestation portion of Section 404 only [Section 404(b)] but not from the management report requirment under Section 404 [Section 404(a)].
Further, the SEC ACSPC recommends that if the SEC decides not to offer such exemptions, that the SEC ask the PCAOB to issue a more “cost-effective” version of an auditing standard, referred to generically as “ASX,” which the SEC ACSPC recommends to be scoped more narrowly than the current auditing standard (AS2). ASX is proposed to encompass: “an audit of the design and implementation of internal control over financial reporting.”
Also, the SEC ACSPC recommends that the SEC and PCAOB provide additional guidance “to help clarify and encourage greater cost-effectiveness in the implementation of AS2.”
Although the SEC ACSPC voted unanimously to release the ED for public comment, some dissenting views were voiced, particularly with respect to the Section 404 related recommendations, and dissenting views submited by SEC ACSPC members prior to Feb. 23 will be included in the ED, said SEC ACSPC co-chair Herb Wander at the Feb. 21 meeting. Among those expressing dissenting views on the Section 404 exemptions were Mark Jensen of Deloitte, John Veihmeyer of KPMG, and Kurt Schacht of CFA Institute. (Info on members of the SEC ACSPC is available here.)
One SEC ACSPC member from a smaller bank expressed frustration at the dissent of the members of Big 4 accounting firms, noting the perception that Big 4 firms had abandoned smaller companies under the pressure to complete 404 audits for larger companies, noting some referred to the Sarbanes-Oxley Act as the ‘full employment act for auditors.'”
The “Sith Lord” Analyst Conference Call
I’m just loosely following the battle between Overstock.com’s CEO Patrick Byrne and those that he alleges are conspiring against the company (a short-selling hedge fund, an independent research firm and others – here are the pleadings in that lawsuit), but I found this Joe Nocera column in Saturday’s NY Times about the “Sith Lord” analyst conference call to be quite amusing (you need to provide your email address to access an archive of that call). Here is an excerpt from that column:
“If you know anything about Patrick Byrne, it’s probably his famous “Sith Lord” conference call. Held last summer, it was an hourlong monologue during which Mr. Byrne laid out a vast, overarching conspiracy, made up of dozens of Wall Street players — including the New York attorney general, Eliot Spitzer! — all under the thumb of an mysterious puppet master, whom Mr. Byrne labeled the Sith Lord. He titled the conspiracy “The Miscreants’ Ball,” an obvious reference to Michael Milken’s old Predators’ Ball.
Although Mr. Byrne told me that his Sith Lord speech ranked among “the 10 proudest moments of my life,” most people, including me, thought it was loony beyond belief. Roddy Boyd of The New York Post recalled hearing about it from someone on Wall Street. “When he described it, I thought he was embellishing,” Mr. Boyd said. But when he listened to the replay, ‘my jaw dropped — you cannot make up what occurred on that phone call.'”
On Friday, Nasdaq filed a proposed rule change which sets forth a proposed process of how Nasdaq issuers would transition the registration of their securities from Section 12(g) to Section 12(b) as Nasdaq officially becomes a national securities exchange (which likely will occur in early April). This is an issue that I blogged about last week in the context of which Section 12 box to check on the cover page of the upcoming Form 10-Ks.
The Nasdaq’s proposed rule would allow an easy transition of the registration of the securities for its 3200 companies from Section 12(g) to Section 12(b) without each company having to file their own Form 8-A. Each Nasdaq company would have a 10-day window to “opt out” of this process – but I can’t imagine any company would want to do that as they then would either have to file their own Form 8-A or be kicked down to the Pink Sheets or the OTC Bulletin Board.
No word yet on how – and if – ’34 Act filing numbers for each Nasdaq company would change…
The Latest Pfizer Proxy Statement
Always striving to be a disclosure leader, Pfizer’s latest proxy statement filed Friday is no exception. As I am sure Mark Borges will be blogging about shortly in his “Proxy Disclosure Blog,” Pfizer voluntarily makes quite a few of the new disclosures that are discussed in the SEC’s recent executive compensation proposals.
Here is a quote from me in a Dow Jones article about Pfizer’s disclosure, “Given that investors are demanding the types of disclosures that the SEC has proposed, it makes sense that companies would voluntarily make them this year rather than wait for the SEC to adopt final rules.”
FEI’s Staff Notes from the PCAOB’s SAG Meeting: Auditor Liability Limits
A few weeks back, I asked if anyone had taken notes during the PCAOB’s Standing Advisory Group February 9th meeting, during which auditor liability clauses were debated.
– Some members of PCAOB staff and members of SAG have heard anecdotally that litigation related clauses have become widespread; others said there is a lack of data on this and suggested the PCAOB gather facts to present subsequently to SAG.
– Specific types of litigation related clauses which auditors are putting in engagement letters with clients include:
1. Indemnification – which virtually everyone agreed, for public company audits, would clearly be violation of SEC independence rules; nothing to debate here.
2. Alternative dispute resolution (ADR) – many not troubled by this as a commercial agreement between two business parties like any other vendor agreement, some think its cheaper than going to jury trial, consumer rep says recent studies say ADR is not much cheaper, investor reps said the problem with these clauses is they are out of the sunshine, unlike in court system, where even if ultimately settled out of court, a complaint is filed which public has access to, without such filing, investors have no way of knowing if certain firms are being subject to a lot of these ADR private proceedings, etc,. companies do not seem to be disclosing such agreements (with noted exceptions of Sun Microsystems and another company); how can shareholders ratify auditors if they don’t have this info, etc.
3. Limitation of liability – punitive damages , or actual damages, some of the same investor concerns as stated for ADRs above, also, debate about whether limitation of liability clauses with auditors pose an independence issue per se, and even if not, doesn’t it effect auditors performance, wouldn’t they put their best resources on their riskiest clients (i.e.., the ones that don’t sign of f on limitation of liability); term “actual damages” is undefined, subjective, unknown.
– Some believe there is distinction in how “permissible” some of these clauses should be and were troubled by PCAOB staff seeming to blend or group some of these diff types of clauses together for discussion; others troubled by all the clauses; some said it was problematic to ask SAG to discuss this without providing any data as to how prevalent these clauses are.
– Nick Cyprus (who is a member of FEI’s Committee on Corporate Reporting (CCR) provided overall statistics from an informal survey CCR recently conducted: 22 companies responded, 64% percent have ADR clauses;, 100 percent% did not disclose them. Cyprus added that his view was, having heard the SAG’s discussion, “if you have this language in your agreements with auditors, you should be disclosing it.”
– Some pointed out they might not object to ADR clauses generally, but they would if it prohibited discovery of documents or ability to call on witnesses.
– Some also pointed out they would not necessarily object to certain litigation related clauses like ADR if it was a matter of negotiation between auditor and client, but some understand there are instances in which auditors have given client no choice: to either sign the engagement letter with such a clause, or the auditor would resign.
– Some believe audit committees and board members are not fully aware of such clauses being asked of them; others believe it puts audit committee member at increased risk in their fiduciary role by signing engagement letters that limit the liability of their auditors vis a vis the company, or that could potentially put company at disadvantage vs. the auditors; a PCAOB board member asked that research be done as to whether a company could still sue its auditor in a derivative suit (even for negligence) if such clauses were signed.
– There was discussion as to whether there should be any requirement for auditors’ communication with audit committees as to any such proposed clauses, as well as whether there should be any requirement for companies to disclose any such litigation related clauses entered into with its auditors.
– It was noted that the AICPA proposed standard (applicable to audits of non-issuers; PCAOB standards apply to audits of issuers – “issuers” generally meaning public companies or companies subject to Sarbanes-Oxley Act) in September 2005 on this topic; AICPA currently is reviewing comment letters filed.
