Late yesterday, the SEC posted the hefty proposing release for ’33 Act Reform. Comment period ends 75 days after the release is published in the Federal Register (so the deadline likely will be sometime in mid-January).
Responding to Audit Inquiry Letters
As the nature of the auditor-issuer relationship evolves under the pressures of a new regulatory environment, there has been much discussion about what audit responses should look like – see this interview with Dean Hanley on Responding to Audit Inquiry Letters to learn more.
The Sale of Personal Intangible Assets
I’ve been trying to go light on compensation issues to give you – and me – a break from the madness, but I can’t help myself as I got riled up guest-teaching at Georgetown’s LLM corporate governance class last night. This past Sunday, Gretchen Morgenson wrote a column in the NY Times about how Audiovox sold some assets this summer, at which time their board revised the definition of “change of control” under an LTIP so that the asset sale would constitute a triggering event and pay two executives a million or two apiece. Here is the section of the proxy statement describing this action.
But the crazy thing is that the company also paid $16 million to one of these executives (who jumped over to the acquiror of the assets) in exchange for his “personally held intangibles,” which apparently consists of his personal contact information, personal and business relationships, “personal know-how” and trade names/patentable assets. Here is a filed copy of the Personally Held Intangibles Purchase Agreement.
I agree with Gretchen; I just don’t understand how all of these intangibles can accrue to an executive – who got paid quite nicely by the company while he acquired these intangibles – rather than the company. Are we all just independent contractors for the firm we work for? Someone please take me off the ledge and explain the way of the world to me…
Just reading over the FAQs that Market Reg issued yesterday about the Global Research Settlement – and can’t help but chuckle over the answers that address situations where a chaperone might be necessary. And you wonder why investors have lost confidence in our markets.
For example, FAQ 28 deals with “Can both Research and Investment Banking personnel participate in social and athletic events organized in connection with a conference?” and the answer gets into influencing of seating arrangements.
Friendly Advice on Nasdaq Staff Reviews
Over the past year or so, I have occasionally blogged when the Nasdaq has updated its PDF of formal interpretative letters (the Nasdaq keeps all of their interpretative letters combined into one PDF – an awkward format). The Nasdaq will issue a letter to issuers for a fee of at least $2,000. In August this year, Nasdaq posted a large number of helpful new interpretative letters that address a number of director independence and shareholder approval issues.
Suzanne Rothwell of Skadden Arps reminds us that it remains important that – regardless of whether a Nasdaq interpretative letter is on point and indicates that shareholder approval is not required in a situation – Nasdaq companies and their counsel should contact Nasdaq staff for at least an informal review of any situation involving an issuance of securities where it is believed that shareholder approval is unnecessary.
The same advice applies in the case of director independence issues. Since Nasdaq’s interpretative letters are entirely fact-specific, any change to the facts (some of which may not be reflected in the the applicable interpretative letter) may change the outcome.
The Passing of Milton Cohen
On October 30th, the legendary Milton Cohen passed away. Mr. Cohen was one of the seminal figures in the history of the SEC, from his start at the Commission in 1935 – just after its founding – to when he became Corp Fin Director in 1942.
He returned in 1961 to head a group that published a 6-volume set, which became the cornerstone for the integrated disclosure system that was eventually adopted. He then published one of the most influential law review pieces ever – “Truth in Securities Revisited” – which set forth the principles that underpin the ’33 Act reform that was proposed just last week. The SEC has posted a statement in his honor.
Each of the Big Four auditing firms is in the process of notifying a significant number of their clients that the auditor believes the company is significantly behind schedule on their 404 work, and unless appropriate action is taken promptly, the auditor believes management will not be able to complete its assessment before the reporting deadline, or if completed, management’s assessment will likely not be completed in sufficient time for the auditor to complete its assessment.
It appears that two firms are providing warnings orally (and then tracking them internally) and two firms are providing warnings in writing. The most severe warning described above is known as a “red letter” or a “category 3 letter,” depending on the firm’s nomenclature. Based on anecdotal evidence, my guess is that 20-30% of companies are receiving red letters.
I hear that a much greater number of companies are receiving a “yellow letter” or “category 2 letter,” which still is a warning but less severe than a red letter. (Unfortunately, I have even heard from a few companies that they have been dropped by their Big 4 auditor due to “staffing issues” related to 404; another fallout for smaller companies as a result of Sarbanes-Oxley – see this press release from one company that got dropped.)
For the most part, those companies not receiving notification apparently are deemed to be on “green letter” or “category 1 letter” status – however, at least one of the Big 4 is providing letters to companies with this status. These companies have been determined to be “on track” to complete their 404 work on time.
With so many companies receiving written warnings from their auditor, the question remains – “what do I need to disclose if I receive a letter?” The possible answers – and sample disclosures – are in this new Disclosure about Internal Controls Status page that I have posted in our “Internal Controls Practice Area.”
New Competition for ISS and Glass Lewis
As we gear up for tomorrow’s webcast – “Another Wild Proxy Season? Forecast for 2005” – featuring Pat McGurn of ISS, Greg Taxin of Glass Lewis and David Drake of Georgeson – you should be aware that a new proxy advice service has been born. (Don’t forget to print off the Course Materials before tomorrow’s webcast!)
We have posted the long-awaited transcript from our webcast, “Reality Bites: More on the New 8-K Rules.” All of the information from this webcast is still relevant as there has been no written guidance from the SEC Staff since then.
NYSE Posts Amendments to Its Corporate Governance Standards
In early September, the SEC proposed changes to the NYSE governance listing standards. On Thursday, the NYSE posted an amendment to its standards after receiving comments – including some from members of Congress.
In the revised standards, the NYSE has withdrawn its proposed changes to the definition of immediate family member relating to a a company’s auditor that would have been part of the bright line independence test – but it has kept the other proposed changes to the bright line test that focus on specific relationships which would impair the independence of a director, such as individuals who formerly were affiliated with the auditor only if those individuals actually worked on the company’s audit.
The SEC still needs to adopt these revised standards before they are applicable to listed companies, which adoption is expected this week. The NYSE is giving companies until their first annual meeting after January 1, 2005 to replace a director who was independent under the existing standards, but isn’t under the revised standard.
In a controversial 3-2 vote on Tuesday, the SEC adopted new Rule 230(b)(3)-2 of the Advisers Act, which will require hedge fund advisers to register with the SEC. Such registration will permit the SEC to conduct examinations of advisers, require compliance controls, regulate disclosure to investors and prevent certain individuals (such as felons) from managing hedge funds.
The rule eliminates the ability of advisers to rely on an exemption from adviser registration designed for advisers providing advice only to a small number of clients. The new rule also contains provisions for advisers located outside the United States to limit the extraterritorial application. Hedge fund advisers must register with the SEC by February 1, 2006.
More on Changes to the Form 10-Q
Following up on the interview that was blogged about yesterday, the SEC release adopting the new Form 8-K rules also included revisions to Form 10-Q. In our Form 10-Q Practice Area, we have posted a redlined version of the changes to Part II of Form 10-Q.
Yesterday, the SEC proposed its long-awaited ’33 Act reform at an open Commission meeting. “Well-Known Seasoned Issuer” (“WKSI,” pronounced “WICK-SEE”?) is a new term of art to define a category of issuers to which the most significant proposed revisions apply. A WKSI is an S-3 eligible issuer that has $700M in float, or in limited circumstances, has issued $1B of registered debt in the last three years.
The reform proposal can loosely be grouped into the following 5 categories (which are all summaries based on meeting notes and subject to certain conditions):
1. Easier Communications Around Registered Offerings
• WKSIs would be permitted to communicate orally or in writing at any time
• All issuers/offering participants would be permitted to use a free writing prospectus after filing the registration statement
• Communications more than 30 days prior to filing a registration statement would not be an offer (so long as they don’t mention an offering)
• Definition of “prospectus” would be narrowed
• Exemptions for research reports would be expanded
2. Liability Issues
• Would interpret 12(a)(2) and 17(a)(2) disclosure liability to be assessed against the information conveyed to an investor at the time of its investment decision
• Would provide that the application of Section 11 liability in shelf offerings would be similar to non-shelf offerings
3. Registration Procedures
• WKSIs would be permitted to use “automatic shelf registration,” which would involve automatic effectiveness, pay-as-you-go fees and maximum flexibility in the offering process
• The shelf system would be modernized to: include a single rule detailing the information permitted to be omitted from a base prospectus; require a new registration statement every three years; permit immediate takedowns; permit at-the-market offerings and permit material changes to plan of distribution in a prospectus supplement
• S-3 eligible companies would be permitted to identify selling security holders in the prospectus supplement where the securities are outstanding at the time the registration statement is filed
• Form S-1/F-1 would permit incorporation by reference, and therefore, S-2/F-2 would be eliminated
4. Prospectus Delivery Reform
• Would move to an “access equals delivery” model for final prospectuses, but would require notification to investors that they purchased securities in a registered offering
5. Changes to Exchange Act Reports
• Risk factors would be required in 10-Ks
• Voluntary filers would be required to disclose their filing status as such
• Accelerated Filers would be required to disclose material, unresolved Staff comments
Deferred Compensation Legislation Become Law
Last Friday, President Bush signed the tax overhaul legislation that includes the deferred compensation provisions – so the Treasury Department now has 60 days to adopt regulations under the law to flush out how the deferred compensation provisions work. (Unlike other tax bills, there was no ceremony for this legislation-signing – Bush signed it on Air Force One on his way to a campaign stop.)
For those waiting for the 8-K webcast transcript, thanks for your patience as posting it is beyond my control – hopefully it will be ready soon.
SEC Flushes Out Qualitative Materiality in Enforcement Action
Last week, the SEC settled charges with KPMG LLP, two former partners, and a current partner and senior manager for “improper professional conduct” as auditors for Gemstar-TV Guide International. KPMG was not fined by the SEC – but it did agree to compensate Gemstar shareholders in the amount of $10 million, the largest payment ever made by an accounting firm in an SEC action.
According to a Floyd Norris column in Thursday’s NY Times, “The standard is what is important to investors,” said Kelley Bowers, an assistant regional director of enforcement in the Los Angeles office of the S.E.C. “A growing part of the business can be important to investors even though it is a small part of the business.” Audit firms have long taken the position that they did not need to challenge errors in company accounts if the amounts involved were “immaterial,” often defined as being perhaps 5 or 10 percent of a company’s revenues or profits.
From 1999 through 2002, Gemstar-TV Guide was promoting to analysts the prospects of its interactive program guide, which customers could navigate through and select television programs. Because the guide provided a small part of the company’s total business, the SEC said, the auditors considered the amounts of some questionable transactions involving it to be immaterial, including transactions where advertisers in the print edition were given an equal amount of free advertising in the interactive guide. The revenues were then attributed to the interactive division, helping it to show rapid growth.
The auditors should have considered “qualitative materiality,” the SEC said in its administrative order, saying the revenue in question “related to business lines that were closely watched by securities analysts and had a material effect on the valuation of Gemstar stock.”
According to the settlement, KPMG has agreed to conduct additional training for its partners and managers on qualitative materiality – and adopt a policy that requires more-effective consultation between audit engagement teams and KPMG’s national office in connection with possible restatements.
If you haven’t heard Alan Beller’s speech last week – noted in this NY Times article yesterday – it is MUST viewing as it is very significant for those involved with drafting proxy disclosures – and the video contains Q&A following his speech that includes important clarifications to his remarks.
Due to the incredible demand, we have decided to maintain CompensationStandards.com next year – and have posted a special offer for those that renew by December 15th.
In addition, for those that waited and missed the 10/20 conference, you can still subscribe this year and obtain a special rate if you also subscribe for next year at the same time.
More Than a Pet Peeve – It’s Theft
True story: As the 10/20 conference is about to commence, frantic call from IT person at a major law firm saying “I have 50 irate lawyers over here that have tried using the ID and password you have provided and it won’t work.” A quick check of our records reveal that a license for only one user was purchased.
Unfortunately, this is not an isolated incident for any of our online services. I’m not sure why lawyers (of all people) think they are entitled to steal from us – but last time I checked, theft is still a crime in most states. But its the ethics that bothers me, we work hard and I believe we provide full value for the prices we charge. So why cheat us?
By the way, a few years back, Legg Mason was hit with a $20 million dollar judgment because its employees were sharing IDs/passwords for an online service.
A Preview of the Disney Trial?
With lots of attention being paid to the Disney trial, it is probably taking a look at the recent opinion of Vice Chancellor Noble of the Delaware Court of Chauncery in Integrated Health Services v. Elgin.
This opinion was discussed during my videotaped panel with current and former Delaware Supreme Court Chief Justices Steele and Veasey – and it is the first case that interprets the “good faith” standard enunciated in the May 2003 Disney decision arising out of the Ovitz severance payment.
Today, the SEC approved the Nasdaq amendments that amend Rule 4350 and related interpretative material to provide time frames for foreign issuers and foreign private issuers to disclose certain code of conduct waivers. The amendments provide that:
1. Foreign issuers, other than foreign private issuers, are required to disclose any waivers of the code of conduct by the board of directors for directors and executive officers in the same time frame as domestic issuers, i.e., via a Form 8-K within five business days.
2. Foreign private issuers are required to disclose waivers of the code of conduct by the board of directors for directors and executive officers either on the issuer’s next Form 20-F or 40-F, or on a Form 6-K.
How Closely Are Mutual Funds Following Their Voting Guidelines?
As you may recall, mutual funds began reporting their voting records at the end of August for the first time. Because mutual funds hold about a quarter of the domestic stockholdings, their votes can be decisive.
The report ranked the 10 funds by the percentage of how often the fund met the AFL-CIO’s guidelines – and their was quite a variance as the scores ranged from a high of 100% for American Century to a low of 20% for Putnam. Fidelity, the nation’s largest fund family (and who was very opposed to disclosing its voting record during that debate) ranked 9th with a 25% score.
Charities Get Their Own Sarbanes-Oxley
Sarbanes-Oxley continues to ripple through other areas of the law. A week ago, Governor Schwarzenegger signed a California bill – SB 1262 – which will impose some SOX-like requirements on charities, including requirements that charities with gross revenues of more than $2 million prepare financial statements in accordance with GAAP that are audited by independent auditors.
Corporate charities meeting this threshold will have to have an audit committee with responsibilities similar to those under SOx. The boards of all charities will be required to review and approve the compensation and benefits of the President or CEO and the Treasurer or CFO to assure that it is “just and reasonable.”
Keith Bishop notes that there probably are more charities affected by this law than issuers affected by SOX. According the California Attorney General, there were over 80,000 charitable organizations registered in California as of January 2001.
At our compensation conference today – its actually is still going on right now – Corp Fin Director Alan Beller gave a memorable 45 minute speech on executive compensation that is bound to raise the eyebrows – and sharpen the pencils – of those of you that are responsible for compensation disclosure. Kudos to Alan for speaking out and doing the responsible thing!
Alan mentioned that his speech will be posted on the SEC site in a day or so – you can review the archived video of it on CompensationStandards.com whenever you wish.
There are an overwhelming number of attendees, both here and on the web – and a palatable buzz in the audience here in San Francisco. Very gratifying for six months of hard work and navigating an experiment in video conferencing. Tonight, I drink heavy…or go right to sleep.
