At the NACD Annual Conference today, PCAOB Chair William McDonough gave an excellent speech on “Restoring Trust” and explained how the number one topic on the Hill these days is not the Iraq occupation – but rather sheer rage over executive compensation. He noted how many in Congress were asking him if it would be feasible to pass a law regulating compensation.
Much to Chairman McDonough’s credit (my 1st time hearing him and he was simply great!), he recognizes that Congress’ last foray in this area probably played a role in where we have gotten today (i.e. Section 162(m)). However, he believes that companies are not acting fast enough to curb excessive compensation and warns that SOX II could very well happen and that it “would curl your hair.”
In addition, he noted that Wednesday is the deadline for audit firms to register with the Oversight Board, with just under 500 firms registering so far. As it will do every year, the PCAOB has begun investigating the Big 4 and have already moved from checking the “tone at the top” to an examination of individual audits (with next year promising to be more intrusive as the PCAOB grows from its 88 staffers to a much larger agency).
Ira Millstein, the Guru Speaks
The luncheon speaker was Ira Millstein, Senior Partner at Weil Gotshal, who was widely recognized at the NACD conference as the ultimate governance guru. A second edition of his book, “Recurrent Crisis in Corporate Governance” is due out in December (as an aside, Nell Minow was sporting the 3rd edition of her governance book that will be available soon – its a great book).
Ira pointed out that conceptually, two important events have occurred that outweigh the immediate impact of SOX and its related rules. First, he pointed out that the current governance revolution is a global one – not just localized here in the States. Second, he observed that governance has become a political issue – as governance undeniably impacts the company’s economic growth and plays a role in the integrity of our retirement system (i.e. most retirement funds are in equities).
Regarding shareholder access, Ira’s view is that the current system has not performed well – and that access clearly would be better (albeit perhaps not the best solution). Most of all, it would add to the other new incentives that should help ensure that directors are thinking about what they are doing, so that they would “be proud to tell their mother” about the decisions they have made.
At the NASPP conference, David Drake of Georgeson Shareholder and Art Meyers of Palmer & Dodge gave an excellent presentation on the impact of the new rules – and the NASPP might have a reprise of that panel on a special webcast soon. Also note that the Sept/Oct issue of The Corporate Counsel that just hit the streets covers the new shareholder approval rules in detail.
SFAS 123 Transition Deadline Looming
One point well made at the NASPP conference was the upcoming SFAS 123 transition deadline for companies looking to expense their outstanding options under the increasingly popular prospective method. As set forth in SFAS 148 – which amended SFAS 123 and establishes three alternative transition deadlines – the deadline for selecting the prospective method is December 15th.
Under the prospective method, the fair value expensing of options is applied only in the year of grant and subsequently. This initially results in a lower level of option expense in the income statement compared to the other two alternatives – which can make it appear that a company has a trend of increasing option expenses. However, this effect can be offset if the company intends to reduce the aggregate value of future grants – which is the case for many companies.
From Bear Stearns, here is a list of the 350 companies that have adopted – or announced that they intend to adopt – 123 as of early September.
Cert. Denied by Supreme Court in Section 16 Case
On October 14th, the U.S. Supreme Court denied the application for certiorari filed by the defendants (insiders) in Levy v. Sterling Holding Company LLC (Docket No.03-171).
This is the case with the troublesome decisions on Rule 16b-7 and Rule 16b-3. The SEC had filed an amicus brief in the rehearing before the entire Third Circuit arguing that the Court’s interpretation of the SEC rules was incorrect. As you may recall, the Third Circuit did not follow the SEC’s interpretation of the rules. Alan Dye – who was involved in the case – provides an analysis of this important case on Section16.net.
On Wednesday – on a teleconference program on my old website – David Lynn, Chief Counsel of Corp Fin, clarified that Section 404 of is not applicable to Forms 11-K. Section 404, and the SEC’s rules implementing it, requires each issuer that files
periodic reports with the SEC under the Securities Exchange Act of 1934 to (i) establish and maintain a system of internal control over financial reporting, (ii) include in its annual report a report by management on the system of internal controls, and (iii) accompany the report with an attestation report on the system of internal controls.
As noted by Gibson Dunn in a recent client alert, “this guidance addresses a significant question that was left open in the release adopting the Section 404 internal control requirements. Although most employee benefit plans would not have been viewed as “accelerated filers,” and thus would not have been required to comply with the Section 404 rules until filing the Form 11-K report for the fiscal year ending on or after April 15, 2005 (whereas public companies that qualify as “accelerated filers” must comply with the 404 rules for fiscal years ending after June 15, 2004), there was substantial uncertainty as to how the 404 rules would
apply in the context of employee benefit plans. Accordingly, the SEC staff’s interpretation provides reasonable and welcome relief.”
After my blog last night, the SEC posted its no-action response to a request from Microsoft that sought exemptive relief from certain tender offer provisions to conduct its option exchange program. The relief granted includes exemptions from:
– Rule 13e-4(f)(2)(ii) to permit Microsoft to terminate withdrawal rights for tendered options at the end of the Election Period.
– Rule 13e-4(f)(8)(i) to permit Microsoft to exclude certain options and certain option holders from the program.
– Rule 13e-4(f)(8)(ii) to permit Microsoft (i) to pay holders of Multi-year Grant Options less for those options than other options with similar terms, (ii) to pay option holders, who are entitled to a total payment in excess of $20,000, a portion of the payment on a deferred and contingent basis, (iii) to further defer the contingent payment portion due to senior management, and (iv) to calculate the initial payment due to senior management holders in certain foreign jurisdictions with adverse tax regimes based on the relevant increased tax imposed.
In addition, the SEC staff noted that it would not object nor take enforcement action if:
– the pricing structure has a final price that will be neither known nor paid until after the Averaging Period ends.
– the total payment for transferred options is determined after the Election Period and during the Averaging Period (i.e. Rules 13e-4(f)(1)(ii) and 14e-1(b)).
– the total payment for options is determined after the Election Period and pays holders for transferred options (i.e. Rules 13e-4(f)(5) and 14e-1(c)).
Another day of hectic travel, so I borrow liberally from Mike O’Sullivan’s blog to inform you that Microsoft has filed tender offer documents divulging the details of its novel stock option transfer program, which is designed to permit its employees to sell their underwater options to J.P. Morgan.
GMI Study Shows Link Between Good Governance & Financial Performance
GovernanceMetrics International – one of the governance rating services – recently completed a study that demonstrated a positive link between strong governance practices and a company’s financial performance. Among other things, GMI found that overall, average annual total returns are higher as the percentage of independent directors increases.
For TheCorporateCounsel.net subscribers, we have posted an interview with Howard Sherman, the Chief Operating Officer of GMI, on the results of that study and the relationship between corporate governance and a company’s financial performance.
8-Ks and 906 Certifications
I have received a few clarifying questions on what Paula Dubberly stated at the ACCA conference last week regarding the SEC/DOJ joint position on 906 certs (see my10/8 blog). The most common question relates to 8-Ks – its should be noted that the joint position applies to no 8-K, even ones with financial statements.
On Wednesday, the NYSE filed a second amendment to its proposed corporate governance listing standards with the SEC. The NYSE had made its original filing last August and filed the first amendment back in April. The current amendment (which reflects the Exchange’s response to 64 comment letters from the public as well as from the SEC) is expected to be the NYSE’s final filing with the SEC – as the NYSE sent an email to issuers indicating that the SEC might approve these standards as early as next week.
Markets Appear to Appreciate Director Independence
The executive search firm Christian & Timbers recently released results of a study it did on 15 large public companies that had each elected new, independent directors to their boards. That study found that the value of the company’s stocks rose at an annualized rate of 91.5% during the period beginning with the election of the new directors.
Analysis of Shareholder Access Proposal
As the community knows, the SEC’s new proxy access rules will hinge on a couple of triggering events — one of which will be the receipt of 35% or more “withhold” votes for any given director or directors. (For a good recap of the rules based on the little we’ve gotten from the press release and the open meeting, see Mike O’Sullivan’s blog summarizing the proposal. We’re still hoping to see the SEC’s release later today.)
Floyd Norris reported in the New York Times yesterday that Calpers will be withholding its votes from members of any audit committee who vote to allow the company’s independent auditor to perform any tax advisory services. This is really not anything new as CalPERS had announced this policy during the past proxy season – and actually might withhold votes if an independent auditor provides any type of non-audit services this season.
At the Annual ACCA Conference, I just came off a panel with Paula Dubberly, Corp Fin’s Associate Director – Legal, who announced that she (and other members of the staff) just completed discussions with the Department of Justice – as well as members of the President’s Corporate Fraud Task Force – and they have jointly concluded that Section 906 of Sarbanes-Oxley does not apply to 8-Ks, 6-Ks and 11-Ks.
Of course, this would have been more welcome news back in June when most plans were filing their 11-Ks – but Senator Biden’s unexpected remarks on the topics put considerable pressure on the SEC staff to not take a position at that time. So those plans that filed the 906 certification in June seemingly are stuck with a cert in that filing – but can rest easy with the knowledge that the DOJ doesn’t believe that 906 applies. And don’t file the 906 cert next year…
Although the SEC has not yet issued a rulemaking release (expected Friday) – but there is a press release – about its meeting this morning, the Commission did vote unanimously to propose rules allowing for shareholder access to corporate proxies. At the meeting today, Commissioner Harvey Goldschmid raised the question — addressed in summary fashion by the SEC’s General Counsel — of the Commission’s authority to regulate in this area. Commissioner Paul Atkins also appeared highly engaged with this issue. The SEC seems to be expecting a legal challenge on authority grounds to any access proposal it adopts, and we look forward to more on this angle of the rulemaking.
The SEC has put the proposal out for a 60-day comment period (following its official publication in the Federal Register).
Ethical Accountants
With the PCAOB, among others, continuing to spotlight the importance of accountants’ professional standards, at least one state has also stepped in to make it clear that the stakes have indeed been raised. The New York State Society of Certified Public Accountants announced on September 25 that it has adopted a bylaw amendment that requires its professional ethics committee (PEC) to share ethics violations with state and federal regulatory authorities. The PEC may even inform regulatory authorities about its investigations before a final determination is made about the alleged ethics violations. The new bylaw also requires the PEC to turn over all statements and other materials relating to the investigation, or copies thereof, requested by the regulatory authorities. New York is the first state society to adopt such an extensive referral process.
EC Adopts International Accounting Standards
On September 29, the European Commission adopted a regulation endorsing International Accounting Standards (IASs), including related interpretations, thereby confirming their compulsory use starting in 2005 under the terms of the general IAS Regulation adopted by the European Parliament and the Council in 2002. The regulation requires listed companies, including banks and insurance companies, to prepare their consolidated accounts in accordance with International Accounting Standards from 2005 onwards.
PCAOB Likely to Rebuff European Plea for Auditor Equality
As reported in the Financial Times today, Chairman William McDonough of the PCAOB is meeting next week with representatives from the European Union. McDonough has indicated that the PCAOB is unlikely to stand down on inspections of European audit firms in the near term. Chairman McDonough also indicated to the FT that the PCAOB was planning to review the independence implications raised by accountants providing tax services to their audit clients, although the Board has not set any specific time table for that review.
Although the proposed attestation standards are not yet posted, the PCAOB has posted a briefing paper. Here are my ten cents on the proposed standards:
– Overall, the bulk of the proposed attestation standards were not a surprise, particularly the PCAOB’s “one-size-does-not-fit-all” philosophy.
– However, the devil is in the details of a bevy of novel definitions. In the proposal, the most critical definitions are that of “significant deficiency” (if it results in more than a remote likelihood of a misstatement of the company’s annual or interim financial statements that is more than inconsequential in amount) and “material weakness” (if, by itself or in combination with other internal control deficiencies, it results in more than a remote likelihood of a material misstatement in the company’s annual or interim financial statements). Hopefully, the proposing release will clarify terms such as “more than remote” and “inconsequential.”
– From the issuers’ perspective, the proposal would allow companies to be able to rely on others, which is a positive development – but the discretion given to auditors as to how much documentation is considered adequate might be considered a negative one from the corporate viewpoint (ie. more expensive).
– The concept of mandatory “walk-throughs” arguably brings the involvement of auditors to new heights. A “walk-through” is when auditors kick the tires to ensure that the controls actually were implemented and operate as they were designed to operate.
– The bottom line is how will auditors “evaluate the results and form an opinion” when they consider whether a particular deficiency is “significant” or “material.” Considering the fact that the Big 4 still are being sued for the misdeeds of their clients (for which they bear some responsibility, of course), they likely will remain quite conservative – which could result in a long road to hoe for companies.
Okay, I am back to the Annual ACCA Conference and I will let Kimberley take it from here…
