I have received quite a few emails about my Tuesday blog from members that said they didn’t get the logic about the internal deficiencies disclosure in Progress Energy’s 10-Q. They asked if the process is substantially dependent on the “human performance” factor – and that performance proved deficient – why wouldn’t that be a “process deficiency”? If one’s disclosure process relies solely on the memory of an employee for compliance, and that employee forgets, gets sick, etc., isn’t that evidence of a weakness in the process – not just a human performance problem?
My guess is that the SEC might view “human factors” as contributing to a disclosure controls process deficiency – but perhaps not an internal controls deficiency. One member asked whether the term “financial reporting” in the context of management’s report on internal control over financial reporting and the related auditor attestation covers proxy statement disclosure (e.g., executive compensation and other non-financial statement stuff).
My two cents is that this term doesn’t include those types of matters – and language in the SEC’s 404 adopting release seems to say the same thing: “Our definition does not encompass the elements of the COSO Report definition that relate to effectiveness and efficiency of a company’s operations and a company’s compliance with applicable laws and regulations, with the exception of compliance with the applicable laws and regulations directly related to the preparation of financial statements, such as the Commission’s financial reporting requirements.” But disclosure controls obviously does cover proxy disclosure – that whole Venn diagram thing…
New GAO Study Targets Shareholder Access and More
The Government Accounting Office issued a new report this week that recommends 12 actions for the SROs to take. GAO had been was asked to discuss 3 matters: the status of the SEC recommendations to the three markets for improving their equity listing programs; the SEC’s oversight of Nasdaq’s moratorium on the enforcement of certain of its listing standards and the status of affected listed companies; and actions the three largest markets have taken to strengthen corporate governance.
Below are the recommended actions that are most relevant to corporate finance folks like us – some are moot or minor; some could be cause for concern:
– ensure that the Division of Corporation Finance place a high priority on establishing and meeting time frames for completing its rulemaking related to shareholder access to the director nomination process and reviewing issuers’ qualitative disclosure requirements related to potential director and director nominee conflicts of interest
– work with Nasdaq and Amex to ensure that the public receives early and ongoing notification of issuers’ noncompliance with their markets’ quantitative continued listing standards—using issuer’s receipt of the initial deficiency notice as the reference point for determining when public notification should begin or, if approved in a manner consistent with our following recommendation, the filing of the revised Form 8-K
– ensure that the SEC expeditiously finalizes the rule requiring that issuers file the Form 8-K after receiving notice of being deficient with their market’s listing standards and include a time frame for doing so that, consistent with its initial proposal, ensures early public notification of issuers’ noncompliant status
– work with Amex, Nasdaq, and NYSE to assess the feasibility of providing early and ongoing public notification of issuers’noncompliance with qualitative listing standards
– work with Amex to ensure that issuers disclose the names of those directors that they have designated as independent
– work with the SROs to further enhance board independence by giving serious consideration to requiring issuers, through listing standards, to establish a supermajority of independent directors and to separate the positions of CEO and chairman, recognizing that a reasonable period of time would be needed to make such changes effective
– work with the SROs to ensure that they have established effective processes for ensuring issuers’ compliance with corporate governance listing standards
NYC Legal Aid in Dire Trouble
One member asked that I use the power of the blog to highlight the troubles faced by the NYC Legal Aid Society that recently issued layoff notices to 254 staffers – more than 20% of their 759 staff attorneys – in a bid to close a $21 million budget shortfall forecast for its fiscal year starting July 1. It’s my pro bono announcement about a worthy pro bono organization.
I really like what Wells Fargo has posted on its website regarding shareholder/director communications and shareholder nominees. They have provided details of how communications might be vetted (including defining “ordinary business matter”) and by whom within the company, as instructed by the board. As you might recall, the NYSE laid out in FAQ D.1 how non-officer employees are allowed to filter shareholder communications, so long as non-management directors have provided instructions as to the nature of the filtering.
Lessons Learned from Lucent’s Non-Cooperation Enforcement Settlement
There are a host of lessons learned – and interesting questions – from Lucent’s settlement with the SEC on Monday which resulted in Lucent paying a $25 million penalty and 10 persons being charged with fraud (3 of the 10 have settled; the other 7 will go to court – one of the 10 had worked for Winstar). It is notable that earlier announcements of the settlement didn’t include a penalty against Lucent – so non-cooperation appears to have cost them $25 million.
The non-cooperative actions that led to the $25 million penalty were:
– “incomplete” and untimely document production
– comments from outside counsel, which according to the SEC “undermined both the spirit and letter of [Lucent’s] agreement in principle with the staff”;
– expanding the scope of employees that could be indemnified against the consequences of the SEC’s enforcement action without being required to do so by state law or corporate charter. The SEC’s press release labeled such conduct “contrary to the public interest.”
In his blog yesterday, Bruce Carton laid out a nice analysis of the non-cooperation aspect of this settlement. He noted that the third element of Lucent’s “lack of cooperation” should be a real eye-opener for public companies in similar situations. He noted that an SEC official was quoted as saying that with respect to Lucent’s offer to pick up the legal tab for employees who would not normally be covered by such benefits, “these people would basically be given a blank check to litigate with us, with no consequences” – and that the SEC has been reiterating in speeches “that to enhance deterrence and accountability, the Commission recently has adopted a policy requiring settling parties to forgo any rights they may have to indemnification, reimbursement by insurers, or favorable tax treatment of penalties.”
Bruce noted that the Lucent case takes that a step further, revealing the SEC’s apparent position that companies indemnifying employees that they are not required to indemnify are (a) outright failing to cooperate with the SEC, (b) acting contrary to the public interest, and (c) subject to stiff fines.
One interesting point is that the Monday article in the Wall Street Journal noted that indemnification of legal fees also was a factor in the non-cooperation – but the SEC’s complaint was silent on that point. More on that later.
Congrats to Barry Summer, Dennis Muse and Paul Belvin for being named new Associate Directors in Corp Fin yesterday. Barry (a lawyer) and Dennis (an accountant) are long-time – and well deserving – staffers. Paul is rejoining the staff for the third time from Akin Gump – Paul was in Corp Fin a few decades ago and also served as Counselor to Commissioner Norm Johnson in the late ’90s (Paul gives hope to guys like me who also would like to resurface on the SEC’s steps for a 3rd time someday).
It took the staff quite a while to find a replacement for Bill Tolbert – much less three replacements! Bill serves on tomorrow’s 8-K webcast panel. Speaking of which…
8-K Questions?
Tomorrow’s highly anticipated webcast – “Overcoming the Challenges of Real-Time Disclosure” – has elicited so many questions from members that we have extended the time allotted to it. Now, it will run from 4:00 until 5:15 pm eastern.
Join Ron Mueller of Gibson Dunn; David Martin of Covington & Burling, Bill Tolbert of Jenner & Block and Stacey Geer of BellSouth Corporation as they analyze a host of open interpretive issues – as well as how different disclosure determinations will be made going forward; what diligence, documentation and processes should be used when making these new determinations, and whether the new safe harbor is really “safe.”
If you have been grappling with an issue related to this rulemaking, please send me an email at broc.romanek@thecorporatecounsel.net – and I will try to have the panel address it.
“You Are the Weakest Link” Disclosure
If you handle SEC filings for your company, here is some internal control deficiency disclosure from Item 4 of the recent 10-Q filed by Progress Energy that should wake you up – the ole “human performance error”:
“Pursuant to Rule 13a-15(b) under the Securities Exchange Act of 1934, Progress Energy carried out an evaluation, with the participation of Progress Energy’s management, including Progress Energy’s President and Chief Executive Officer, and Chief Financial Officer, of the effectiveness of Progress Energy’s disclosure controls and procedures (as defined under Rule 13a-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based upon that evaluation, Progress Energy’s President and Chief Executive Officer, and Chief Financial Officer concluded that Progress Energy’s disclosure controls and procedures are effective in timely alerting them to material information relating to Progress Energy (including its consolidated subsidiaries) required to be included in Progress Energy’s periodic SEC filings.
These officers noted that after the end of the period covered by the report, Progress Energy was late in filing a Form 8-K pursuant to Item 11 of that Form (Temporary Suspension of Trading Under Registrant’s Employee Benefit Plans). The filing relates to notice to Section 16 insiders informing them of the prohibition of trading in the Company’s securities during an upcoming 401(k)blackout period. Notice was given to all Section 16 insiders regarding these trading restrictions well before the blackout period commenced. The President and Chief Executive Officer, and Chief Financial Officer have confirmed that procedures were in place identifying this filing requirement and allocating responsibility for notification to the appropriate personnel, and that this late filing was the result of a human performance error, not a process deficiency.
There has been no change in Progress Energy’s internal control over financial reporting during the quarter ended March 31, 2004 that has materially affected, or is reasonably likely to materially affect, Progress Energy’s internal control over financial reporting.”
Last week, the 9th Circuit – in SEC v. Gemstar-TV Guide Int’l, No. 03-56129 (9th Circuit, May 12, 2004) – overturned a district court in a 2-1 decision by holding that the SEC had not produced suffient evidence to prove that the termination payments to high-level corporate officials were “extraordinary” – and thus such payments should not be subject to involuntary retention in an escrow account under Section 1103 of Sarbanes-Oxley. This is the first court case to deal with Section 1103.
The SEC had frozen $37.6 million in termination pay and bonuses negotiated by two top officials of Gemstar while they were under suspicion of cooking the company’s books. These officers are awaiting trial, set for August, on civil fraud charges of overstating revenue by $223 million.
From the decision, it looks like the two judges that overturned the district court wanted more evidence that $37.6 million was extraordinary for severance payments – basically perpetuating the survey/benchmarking practices that helped send compensation levels into the strasophere over the past decade.
As a result of the 9th Circuit’s decision, the outstanding escrow order was vacated and the case was remanded to allow the SEC to produce more evidence. The SEC is examining its options; it could ask the full appeals court for a rehearing or appeal to the U.S. Supreme Court.
Updated Internal Controls Proposed for Financial Institutions
On Friday, the SEC and all the federal bank regulators (Fed Reserve, FDIC, Comptroller and OTS) put out a proposed statement describing updated internal controls and risk management procedures for financial institutions with complex structured finance transactions.
The interagency statement refers to risks to a financial institution where a customer uses a complex structured finance transaction to “circumvent regulatory or financial reporting requirements, evade tax liabilities, or further other illegal or improper behavior.” The Statement emphasizes the critical role of the board and senior management in establishing a corporate-wide culture that fosters integrity, compliance with law and overall good business ethics. The Statement would represent a policy statement for institutions supervised by the SEC, and supervisory guidance for institutions supervised by the four banking agencies.
Just as I was blogging a set of rumors on Tuesday, The Daily Deal was reporting that the SEC may expand its shareholder access proposal to give shareholder groups with a 15% stake in a company the right to nominate a director on the company’s proxy card in any given year. Allegedly, such nominations would have to be made at least 90 to 120 days before an annual meeting. Obviously, this would give shareholders the power to take action more quickly and not have to worry about triggers.
My question is – how are all of these rumors leaking out of the SEC? I doubt anyone at the SEC staff level would take the chance and provide info to the press – it could be someone who has met with the staff (or maybe a Commissioner)…but I’m still convinced that the SEC won’t take action on this proposal anytime in the very near future.
Nifty 8-K Chart
Thanks to my good friend Larry Spirgel of Morrison & Foerster for this chart that can serve as a bedside resource for remembering the SEC’s new regs on 8-Ks.
We have added the chart to our memos – some of which also contain charts – on this topic (now numbering over 50) in Section B.26 of the Sarbanes-Oxley Law Firm Memos – as well as our “Real-Time Disclosure” Practice Area (which will be growing quite rapidly).
On pages 4-8 of the March/April issue of The Corporate Counsel, there is a discussion about how the SEC staff might interpret the crucial definition of “material definitive agreement” under the new 8-K regulations. Included in that analysis are notes about comments made by Alan Beller at the ABA meeting in Seattle, particularly in the area of compensation arrangements.
In noting Alan’s comments, we took pains to point out that Alan qualified his comments by stating they didn’t reflect the staff’s final positions. And from what I hear transpired at the ABA-JCEB meeting last week with the staff, we were wise to include that disclaimer. For example, it appears that the staff is now leaning towards requiring an 8-K for each grant to a NEO, even under previously filed plans (contrary to what Alan stated in Seattle).
Learn more about the staff’s latest thinking from our webcast next Wednesday – “Overcoming the Challenges of Real-Time Disclosure” – during which the panel will discuss grey areas and provide practical guidance in those areas that might not be grey, but still will be challenging.
California Dreaming
We have developed a Practice Area devoted to issues raised by California Corporations, including links to the corporate governance web pages of some of the more prominent companies incorporated in California.
The mainstream media continues to run articles containing rumors of where the SEC is heading with its shareholder access proposal. On Friday, the NY Times ran a controversial Floyd Norris column indicating, among other rumors, that the withheld vote trigger would be racheted up to 50% in exchange for not counting broker non-votes.
And yesterday, the WSJ ran an article indicating that the SEC was going to drop its 1% opt-in trigger in exchange for speeding up the ability for investors to force a contested election (but didn’t provide details as to what this latter trade-off really was). The article also noted that the SEC was considering the BRT’s suggestion to allow companies to implement a “cure” after a triggering event (i.e. remove one or more directors that received high withheld votes).
Despite these media musings, I would wager that the SEC is at least a few months from adopting their final rules in this area (hey, the World Series of Poker started last night, I gotta bet something…).
These articles come on the heels of the MBNA Corp. annual meeting last week at which a TIAA-CREF shareholder proposal received a majority vote regarding the appointment of additional directors without personal or financial ties to senior management/founders. Two MBNA directors received more than a 40% withheld vote due to their ties to management. Interestingly, both of those directors are lawyers – and MBNA just appointed two other lawyers to vacant seats on the board, Mary Boies and former SEC Commissioner Laura Unger (my old boss racking up her third board seat) – so that nearly half of MBNA’s directors are lawyers (4 out of 9)!
The SEC’s Shell Company Proposal
The SEC has been jawboning about perceived abuses of shell companies for some time. So last month’s proposal to prohibit the use of Form S-8 by shell companies should not be a surprise. Still, some of us represent clients that engage in these transactions and the question remains, what now? Learn more in my interview with David Kaufman on the SEC’s Shell Company Proposal.
Last Wednesday, I attended PLI’s 1st Annual “PCAOB Speaks” held in Washington DC. I was surprised that live attendees numbered over 200 (although a significant percentage of that were PCAOB and SEC staffers)- because the “SEC Speaks” audience always consists of a handsome number of SEC alumni and the PCAOB doesn’t yet have alumni.
One point brought home during the conference is that, under Auditing Standard No. 2 (which is awaiting final SEC approval), audit committees must pre-approve all services related to internal controls if these services are performed by the same firm that conducts the company’s audit. Audit committees cannot pre-approve these services by categorical standards. As a result, in this area, Auditing Standard No. 2 effectively trumps the SEC’s auditor independence rules adopted in January 2003 to implement Section 201 of Sarbanes-Oxley.
The rationale is that auditor independence is not viewed as a simple compliance matter; it is much more important than that. So audit committees are required to scrutinize each possible internal controls engagement to ensure that the auditor can be impartial and objective. By the way, the grandfathering of some non-audit services ended last Thursday.
We have posted more PCAOB Speaks notes on our home page and in Section F of our Sarbanes-Oxley Law Firm Memos portal.
Late Breaking 703 Developments
In case you missed this blog that I posted Friday afternoon: I understand that the SEC staff has reached an agreement on the treatment of restricted stock that is forfeited for purposes of the 703 stock repurchase table. The key determinant here is whether the company pays any consideration when the stock is returned – even a de minimis amount is sufficient consideration so that the returned stock must be included in the table. If there is no consideration given for the forfeited stock at all – it need not be included in the table.
By the way, at the ABA-JCEB meeting this week, the SEC staff apparently stated that stock repurchases by a 401(k) plan or other employee benefit plan may be required to be reported when the plan is an “affiliated purchaser” within the meaning of Rule 10b-18(a)(3). This could be a real problem in cases where a benefit plan is administered in-house, instead of being handled by a brokerage firm, transfer agent or other outside party. I would wait until the staff has a position in writing on this one before taking any drastic actions, such as hiring a third-party administrator.
Under Rule 10b-18, an “affiliated purchaser” is:
(i) A person acting, directly or indirectly, in concert with the issuer for the purpose of acquiring the issuer’s securities; or
(ii) An affiliate who, directly or indirectly, controls the issuer’s purchases of such securities, whose purchases are controlled by the issuer, or whose purchases are under common control with those of the issuer; Provided, however, that “affiliated purchaser “shall not include a broker, dealer, or other person solely by reason of such broker, dealer, or other person effecting Rule 10b-18 purchases on behalf of the issuer or for its account, and shall not include an officer or director of the issuer solely by reason of that officer or director’s participation in the decision to authorize Rule 10b-18 purchases by or on behalf of the issuer.
I understand that the SEC staff has reached an agreement on the treatment of restricted stock that is forfeited for purposes of the 703 stock repurchase table. The key determinant here is whether the company pays any consideration when the stock is returned – even a de minimis amount is sufficient consideration so that the returned stock must be included in the table. If there is no consideration given for the forfeited stock at all – it need not be included in the table.
By the way, at the ABA-JCEB meeting this week, the SEC staff apparently stated that stock repurchases by a 401(k) plan or other employee benefit plan may be required to be reported when the plan is an “affiliated purchaser” within the meaning of Rule 10b-18(a)(3). This could be a real problem in cases where a benefit plan is administered in-house, instead of being handled by a brokerage firm, transfer agent or other outside party. I would wait until the staff has a position in writing on this one before taking any drastic actions, such as hiring a third-party administrator.
Under Rule 10b-18, an “affiliated purchaser” is:
(i) A person acting, directly or indirectly, in concert with the issuer for the purpose of acquiring the issuer’s securities; or
(ii) An affiliate who, directly or indirectly, controls the issuer’s purchases of such securities, whose purchases are controlled by the issuer, or whose purchases are under common control with those of the issuer; Provided, however, that “affiliated purchaser “shall not include a broker, dealer, or other person solely by reason of such broker, dealer, or other person effecting Rule 10b-18 purchases on behalf of the issuer or for its account, and shall not include an officer or director of the issuer solely by reason of that officer or director’s participation in the decision to authorize Rule 10b-18 purchases by or on behalf of the issuer.
“Please Disregard The Attached Document”
After attending 3 conferences in 3 days (more on that next week), I need a light moment – and what better than repeating this great 4/29 blog from Bruce Carton of the SecuritiesLitigationWatch Blog:
“What would you do if a secretary in your publicly-traded company accidentally e-mailed a sensitive internal document showing weaker-than-expected profits to 50 of your investors? Would you immediately post the internal document on the front page of your company website with a request that “no reliance whatever should be placed on the estimates, forecasts or opinions expressed therein” and that the company “would be grateful if you disregard this information”?
That’s what Amvescap did on Tuesday on the front page of its website, after a secretary in London inadvertently e-mailed this “Presentation to the Executive Management Committee” to a group of investors. Amvescap added on its website that the presentation was sent out “in error,” was “in the course of preparation” and was “incomplete in a number of important respects.”
Under the SEC’s Regulation FD, Amvescap probably had no other real choice. Reg FD requires an issuer that inadvertently discloses material nonpublic information regarding itself to promptly make a public disclosure of that information, as well. This can be done either by filing a Form 8-K with the SEC or through some other method that is “reasonably designed to provide broad, non-exclusionary distribution of the information to the public.” Amvescap’s posting of the document on its website was presumably done to provide the “broad, non-exclusionary distribution” of the information required under Reg FD (as long as it was combined with a press release).
The inadvertent disclosure had several other ripple effects. First, many analysts media speculated that a $300 million “exceptional item” mentioned in the document was its estimate of costs to resolve an SEC investigation into alleged improper mutual fund trading, which was reportedly three times analysts’ estimates. Amvescap, however, denies that it made any such estimate in that document.
In addition, the investors’ receipt of the report presented compliance and insider trading landmines at those investors’ companies. According to this article, for example, some compliance officers prohibited investment bankers receiving the document from talking to investors or the trading desk after it became clear that they were in possession of confidential documents. One investment banker stated that “we effectively had inside information for two hours, so we took legal counsel and I had to stay incommunicado.”
According to the Financial Times, however, not all the proscriptions against insider dealing were effective. On Tuesday of this week, over $40 million shares changed hands – nearly four times the daily average – and Amvescap ADRs fell 3.5% to $14.08.” Thanks Bruce!
It doesn’t appear that any more certainty on the finer points of the 703 table can be derived from the staff’s Tuesday meeting with the ABA’s JCEB – as many of the open issues are rather complicated and the staff likely wants to ensure its interps are appropriate before they are issued in “final.” My guess is that the staff will put out written guidance on these open issues, but will not be able to do so before Monday’s 10-Q deadline for accelerated filers.
The issues that appear to be soundly resolved are the ones noted in my Tuesday blog, such as net withholding/exercises of options don’t need to be included in the table – but stock-for-stock exchanges should be included.
Beyond that, bear in mind that the staff’s general view is that the table is supposed to provide a broad and comprehensive picture of the repurchase activity going on within a company (i.e. more inclusive than what Rule 10b-18 covers). So it might be better to err on the conservative side until written guidance is available.
Once firm guidance is available, the question then is whether you need to amend this 10-Q if the numbers in the table would have been different under the guidance (note that it’s only a 3-month table, so there would be no natural opportunity to correct what you included in the last 10-Q). My bet is that, in most cases, there will be an argument that the changes are not material – but that argument likely would be bolstered if you provide too much disclosure now, rather than too little.
Our Spring Cleaning
I often get asked why there is no search engine on TheCorporateCounsel.net. The reason is that I was never satisfied with the quality of results from the engines we have tried.
However, to facilitate your ability to find useful information on the site, I have significantly increased the number of “Practice Areas” on the site – with over 100 of them now! I believe this indexing approach is the best search solution for the site. Our Practice Areas can be accessed by hitting the button with that name at the top of every page on the site.
Scrushy’s Attempt to Render SOX Unconstitutional
As I blogged a while back, HealthSouth’s former CEO, Richard Scrushy argues that Sarbanes-Oxley – particularly Section 906 – is unconstitutional in this recent motion to dismiss criminal charges. It is hard to tell what the Judge’s response is, due to many of the Judge’s orders being sealed (see the N.D. Alabama web page for notable cases).
