Today is our webcast on novel features of recent convert offerings – subscribers of TheCorporateCounsel.net should check it out live – or by audio archive or transcript!
Reporting Out Next?
The ABA Task Force on Corporate Responsibility has released its final report that was approved at the ABA Annual Meeting back in August. Still no word whether the SEC will act on its outstanding proposal regarding reporting out. Hopefully, the Commission will take some time to observe the impact of its reporting up rules and the ABA’s recommendations before it acts.
By the way, did you notice how I blogged yesterday about the SEC’s tardiness on the PCAOB’s ethic rules – and a few hours later they appeared! Maybe I should wish for 402 guidance from the SEC…
An Accountant’s Perspective of SOX Surprises
Rick Telberg, Editor of Online Content for The CPA Letter, offers his Top 10 Surprises of SOX:
1. There’s new caution in mergers and acquisitions, as public companies fret over uncertain financial liability for the private companies they acquire. Due diligence is costing more and taking longer for both sides in a deal, and some deals aren’t getting done or even being considered because of it. And the law is unclear on whether the public company’s executives will be held accountable for the private company’s history. Deals are taking months instead of weeks.
2. Annual reports, quarterlies and proxies are getting heavier and thicker with detail. But it’s not clear investors, who had a hard time staying awake through the turgid prose before SOX, are absorbing all the new footnotes. General Electric’s latest annual report, for example, weighs in at 160 pages, twice the size of last year’s. Wal-Mart, the superstore, has put out a superstore-sized annual report, three times the size of the previous year’s.
3. After years of stagnation in a flat economy, Sarbanes-Oxley is reportedly fueling salary increases of about 6 percent across the finance function. Cash managers saw the most significant salary increase in 2003, receiving a 10 percent increase.
4. Outside auditors were hit by insult as well as injury through the financial traumas of the post-bubble era. But today the Final Four are bigger and busier than ever. And corporate clients are paying up to 30 to 40 percent more in fees to get up to speed with the new rules and regulations.
5. Financial software companies are enjoying a new bounty of business. Some information technology types are saying this is the best thing that’s happened to their industry since the Year 200 bug was supposed to crash the world’s computers
6. Private companies, supposedly exempt from SOX, are feeling a trickle-down effect. There are few signs that lenders and investors are embracing separate standards for private firms, forcing even smaller companies to ramp up their controls and reporting.
7. Talk about trickle-down. The law was designed to make top executives take personal responsibility, but many are reportedly strong-arming middle-level and lower-level managers to sign off on their reports before sending them upstairs.
8. Second-tier CPA firms were expected to get bypassed in the bonanza of new work sparked by Sarbanes-Oxley. But in the turmoil of more client switches than at any time in the history of public audits, large local firms are picking up a surprising amount of business. Even more surprising: They’ve learned to be careful and are passing up a lot of opportunities if they don’t like the client.
9. After years of declines, many colleges are reporting surges of interest in accounting courses and careers. Suddenly CPAs are sexy again. And whatever happened to the 1990’s panic over a labor shortage? Firms are hiring.
10. And, contrary to worries within the profession that new government involvement and oversight of the profession would usurp the profession’s traditional roles in self-determination, state and national professional associations appear to be as vibrant, active and well-supported by their members as ever before.
Late last week, Microsoft filed its definitive proxy statement. It contains a brief description of its pre-approval policy for audit/non-audit services on page 12 and an updated calendar of audit committee activities at the back.
More importantly, as Mike O’Sullivan notes, while Microsoft does seek approval for certain changes to its 2001 Stock Plan – principally to eliminate a sublimit on the amount of restricted stock it can grant – Microsoft does not seek approval for the changes it expects to make to its underwater employee options once they are sold to JP Morgan.
If Microsoft still plans to complete its Stock Option Transfer Program in 2003, it can be assumed that Microsoft would seek whatever stockholder approvals it needs in this proxy statement. Therefore, it’s fair to assume that Microsoft will not be seeking stockholder approval, even under the new Nasdaq rule, for its planned amendments to the options acquired by JP Morgan.
Change in Accountants to Be Scrutinized by PCAOB
At the PLI Director’s Institute yesterday, PCAOB Board Member Charles Niemeier stated that the PCAOB will closely scrutinze any instances of a company firing auditors. This is not necessarily anything new as the SEC’s Enforcement staff routinely reviews any Form 8-Ks filed under Item 4. But its noteworthy because the PCAOB staff might have more motivation, time and resources to delve further than the SEC staff.
For TheCorporateCounsel.net subscribers, we have provided analysis/disclosure samples for companies to consider when they change auditors.
SEC and PCAOB Ethics – What’s Up With That…
Have you noticed that the SEC hasn’t approved any PCAOB rules since August 1, or even noticed any. For example, the PCAOB Code of Ethics was adopted as a final rule by the PCAOB on June 30 – but it hasn’t even been noticed yet (and neither organization lets you know if the PCAOB has filed them with the SEC either). Let alone approved or rejected. What’s up with that? It is interesting that the SEC would let the PCAOB meander along without an ethics code given what’s going on at the NYSE and all the attention that situation is getting.
Last week, I was on a panel with representatives from the NYSE and Nasdaq. They indicated that final standards should be blessed by the SEC within six weeks. On September 10th, the Nasdaq filed an amendment to its proposal.
Regarding interpretative advice, the NYSE should be posting FAQs about shareholder approval of equity compensation plans sometime in the next month – and the Nasdaq will be posting more interpretation on their “Legal & Compliance” page soon (they posted a handful back in the spring). Interestingly, the Nasdaq will be charging companies a fee for putting any interpretative guidance in writing – the NYSE has decided not to charge.
Restatements Galore
For 2003, expect more than the approximately 330 restatements that were made during 2002. This is due to a number of factors, including enhanced internal controls and more frequent changes in auditors.
And if Bob Herz, head of the FASB, is successful in aligning US accounting standards with international standards, there will be a general requirement to apply accounting changes retroactively. This undoubtably would result in an explosion of restatements each year.
Isabel packed a wallop and knocked this blogger for a loop. Noteworthy is that even though the SEC was closed here in DC – EDGAR was open and accepting filings. Coming back to the blog, its amazing how much there is to report. Miss a few days and you have a dozen items worthy of mention. However, I will stick by my guns and not overwhelm the community by limiting myself to rolling out no more than a few tidbits per day.
Microsoft Announces New Details Re: Option Transfer Program
In his blog, good ole Mike O’Sullivan (safely ensconced on the West Coast) was able to nicely outline more details about Microsoft’s option exchange program as revealed in a recent S-3 filing. The shelf registration statement will be used to facilitate sales of Microsoft (including short sales) by JP Morgan to hedge their risk under the option transfer program.
As indicated in the S-3, Microsoft’s program contemplates that employees with options and SARs will have a 20 day period to elect to transfer their stock options or SARs to JP Morgan. In exchange for the options, JP Morgan will pay a cash amount to Microsoft. Microsoft will then pay 33% of the amount to the employees who transferred their options/SARs by 12/31/03 and the remaining amount over a period of time contingent on the optionee’s continued employment.
There are still a number of open questions about how the program will work, such as how the stock options/SARs became “transferable.” More might be gleaned when Microsoft files its proxy statement, which should occur any day now. Mike also notes that Microsoft has submitted two no-action letters confidentially on paper (and they likely relate to the terms of how the program will work).
GE Grants Performance Shares to CEO – and No Options
Picking up on a growing trend, General Electric announced that it will not grant options to its CEO. Instead, the CEO will receive performance shares, based on measures such as cash flow (which is harder to manipulate compared to earnings or revenue measures). This year, the CEO received a grant of 250,000 performance share units presently valued at $7.5 million (if the performance criteria are met). By comparison, his annual equity grant last year was 1 million stock options, with a present value of $8.4 million.
Here are some details of the CEO’s performance share units:
– half of the performance share units convert to shares of GE stock only if the company’s cash flow from operating activities has grown an average of 10 % or more per year over the period.
– the remaining half convert only if GE’s total shareholder return meets or exceeds the broader market.
– performance share units will be canceled if GE doesn’t meet the performance criteria.
– during the performance period, the CEO receives quarterly cash payments on each performance share unit equal to GE’s quarterly per-share dividend.
As I mentioned on Monday, in the July-August issue of The Corporate Counsel (at pg 2), there was a discussion of the exception from the 8-K filing/furnishing requirement for oral presentations (e.g., the post-earnings release conference call) made within 48 hours after the earnings release is issued, and noted that the exception is available only where the earnings release 8-K is filed “prior to” the oral presentation.
The point intended to be made was that, where an issuer plans to hold an early morning conference call, the “prior to” requirement may mean the earnings release 8-K has to be filed the preceding day, to assure that it is publicly available prior to the conference call. Unfortunately, The Corporate Counsel wasn’t as clear as it should have been, and some readers thought it was a suggestion that the earnings release must in all cases be filed a day in advance of the conference call, regardless of the time of day the call is held.
To be clear, it appears that the Staff’s position is that, to avoid filing a second 8-K, the earnings release 8-K must be “accepted for filing” by EDGAR prior to the conference call (even if only by a nanosecond). Since EDGAR filings made after 5:30 p.m. eastern time are accepted for filing (and available on the SEC’s website) at 8:00 a.m. (6:00 a.m. during the current six-month pilot program that started July 28), issuers who file their earnings release 8-K after 5:30 p.m. – but before 10:00 p.m. – the day before the conference call should be able to conduct their conference call any time after 8:00 a.m. the following morning (6:00 a.m. during the pilot program).
Similarly, an issuer should be able to file an earnings release 8-K on the day of the conference call, so long as the 8-K is accepted for filing before the call. There will be further discussion of this in the next issue of The Corporate Counsel, which should be out in a few weeks.
FASB Issues Exposure Draft on Pension Plans
Yesterday, the FASB issued an exposure draft – Employers’ Disclosures about Pensions and Other Postretirement Benefits – that would improve financial statement
disclosures for defined benefit plans. This new statement would amend SFAS 87, 88, 106 and replace 132.
Under the exposure draft, the FASB would require companies to provide
more disclosure about their plan assets, benefit obligations, cash flows, benefit costs, as well as other relevant information (e.g. companies would be required for the first time to
provide financial statement users with a breakdown of plan assets by category, such as equity, debt, or real estate). In addition, companies would have to provide more information in 10-Qs about their pension costs.
If adopted, the proposal would be effective for fiscal years ending after December 15, 2003 and for the first fiscal quarter of the year following initial application of the annual
disclosure requirements.
It looks like California has joined the jurisdictional flap over the SEC’s new “reporting up” rule. In response to the SEC’s General Counsel’s letter to the State of Washington, the Corporations Committee of the State Bar’s Business Law Section has sent a letter to the SEC notifying it that new Rule 205.3(d)(2) conflicts with California law.
The Corporations Committee also notified the SEC that – in the absence of an appellate judgment in favor of the SEC’s pre-emption claim – the California State Bar may not refuse to enforce Section 6068(e) of the California Business and Professions Code. Under Section 6068(e), California attorneys have an ethical obligation to maintain client confidences “at every peril to himself or herself.”
As you may recall, back on July 23, the SEC’s General Counsel publicly released a letter stating that state bar associations were pre-empted from disciplining an attorney who made voluntary disclosure of client confidences to the SEC in reliance on its rules. This letter was in response to a proposed action by the Washington State Bar Association Board of Governors. On July 26, the Washington State Bar Association Board of Governors took its action notwithstanding the SEC’s position.
Next, the California State Bar Board of Governors Standing Committee on Professional Responsibility and Conduct (COPRAC) will prepare and issue an educational Ethics Alert on this matter and the Executive Committee of the California Business Law Section and the Corporations Committee will work together with COPRAC to study these issues and draft the Alert.
The PCAOB is holding an open meeting to adopt investigation, disciplinary and registration withdrawal rules this Friday at noon. On September 29, the PCAOB is holding a roundtable on audit documentation.
The SEC has posted its proposed rules regarding the foreign bank exemption under Section 402 and the unavailability of Form F-6 for unsponsored American depositary receipts if a foreign issuer separately lists deposited securities on a registered national securities exchange.
Regarding filing fees, the SEC already has adopted a continuing resolution in the event that Congress does not act on the SEC’s 2004 fiscal budget by the end of September 30th, which is the end of the SEC’s fiscal year. I don’t recall Congress ever acting timely – and last year, it dragged approval of the SEC’s budget all the way to Christmas I believe. This rate change is quite significant as the fee for all registrations under the 1933 Act (including proxy contest solicitations) will go up over 50%.
We have fielded a lot of questions on the July-August 2003 edition of The Corporate Counsel, in which there is a statement on page 2 that, in order to avoid having to file a second Form 8-K with respect to any non-public material information that is released in an analyst conference call, a company is required “to release their earnings and furnish the first Form 8-K [with the earnings release] by the end of the EDGAR filing day on the day preceding the analyst call, not the next morning before the market (or EDGAR) opens.” As many readers have noted, this prior-day filing does not seem to be required by the SEC rule release or the FAQs issued by the SEC on June 13. This indeed is true and I intend to post a clarification/correction very soon (and thankfully, I was not the author of that statement).
For TheCorporateCounsel.net subscribers, we have posted an interview with Andrea Robinson of Hale & Dorr about Parallel Criminal and SEC Prosecution Risks, a topic that is increasingly becoming important.
At a Wednesday meeting, the FASB decided to delay rulemaking to expense options by six to nine months and hinted that it might use a model other than Black-Scholes. Board members argued over whether the valuation of stock options should be based on the contractual life of the option or the time period until the option expires.
Originally, the FASB hoped to propose rules by the end of 2003, but have now pushed back the target date to the first quarter of 2004. It hopes to adopt rules now in the third quarter of 2004. So far, over 350 companies have voluntarily stated that they will – or are – expensing stock options (albeit using different methodologies).
More evidence that some CEOs still don’t quite get it. For $10 million, AIG settled an enforcement action with the SEC yesterday for marketing and selling an “income smoothing” insurance product to a public company. The SEC staff blasted AIG for not initially cooperating and sure enough, AIG’s CEO criticized post-Enron regulatory initiatives as going too far in his acceptance speech for “CEO of the Year” back in July (see page A3 of today’s WSJ). AIG is the largest provider of D&O insurance by far.
And don’t get me started about the NYSE’s governance structure. True, its not a public company but it does have all the earmarkings of a poster child for bad governance. A CEO who handpicks the board – and the compensation committee. A compensation committee who approves CEO compensation arrangements that it doesn’t understand. A compensation committee comprised principally of CEOs from companies that have inherent conflicts of interest with the CEO by virtue of him being their regulator.
And finally, as noted by Nell Minow at the Business Roundtable panel on governance two days ago, the worst compensation committees are those that include CEOs from other companies. This is because these CEOs have an interest in perpetuating the cycle of mindblowing levels of compensation as compensation consultants primarily use benchmarking to advise about CEO compensation levels. The NYSE’s compensation committee appears to solely consist of CEOs – and quite a few at that (6 or 7 as compared to 3-4 comp committee members at a typical public company; this is because the NYSE board has dozens of members, a governance “no-no” itself).
Last week, at an ALI-ABA conference, I heard Dan Goelzer, PCAOB Board Member, speak and he noted that the PCAOB had received slightly over 200 registrations from audit firms so far. Audit firms need to register in order to be eligible to audit public companies. The deadline for registration is effectively now – even though October 22 is the deadline – because SOX provides the Board with a period of 45 days to review registration applications. And the PCAOB has specifically stated “U.S. firms that submit their applications after the first week of September might not receive approval by the Oct. 22 deadline.” [Non-U.S. firms must register by April 19, 2004.]
What does this mean? It means that it is quite likely that numerous audit firms have decided to get out of the business of auditing public companies. Last year, over 700 audit firms had at least one public company client. Of this number, the Big 4 firms had over 95% of the market and the vast majority of these firms had only one or two public clients.
The cost of registering with the PCAOB is immense. The registration application is quite burdensome (over 100 hours to complete for a small audit firm) and the risk of getting slapped by a rapidly growing PCAOB staff and losing your reputation – all for one or two public clients – is is too high for these smaller audit firms. [At some point, the applications will be made public. I hear that a typical Big 4 application contains over one terabyte of data – you won’t be able to download that over the Web.]
The upshot is that many small public companies are going to suffer and be forced to switch auditors. That is, if they can find one – at this conference, two panelists from the Big 4 mentioned that each of the Big 4 had shed “dozens” of clients recently as part of their quality control and due to higher fees that the client refused to pay. Now, this is a true cost of SOX.
Okay, the SEC’s Reg FD enforcement proceedings are getting more serious – Schering-Plough paid a $1 million fine and the former CEO/Chair paid $50k himself (with injunctions levied against both). This is the first Reg FD settlement with an individual.
The facts appear straight-forward on their face, private meetings with analysts who then downgrade and sell immediately. An interesting aspect of the SEC’s press release is that the company executives conveyed their selective disclosure through a “combination of spoken language, tone, emphasis, and demeanor.”
Before the Senate Banking Committee yesterday, SEC Chair Donaldson testified that state regulators endanger enforcement of securities laws when they fail to coordinate cases with federal prosecutors or his agency. He specifically cited Oklahoma prosecutors who filed an action against WorldCom two weeks ago – and before he testified, Donaldson noted that he wished Elliott Spitzer had given the SEC more notice regarding his mutual fund investigation.
Our first survey on “Reporting Up/QLCCs” was quite successful with over 175 responses, so we urge everyone to participate in our new Quick Survey on Individual Director Evaluations.
Thanks to Warren de Wied of Fried Frank for his excellent (and lengthy) analysis of the Breeden report, which is now available on GreatGovernance.com.
