ON Securities : Securities Lawyer & Attorney for Corporate Governance & Executive Compensation Matters

There have been several recent articles on the SEC's proposed proxy access rule, Rule 14a-11. If adopted, this rule would allow large shareholders to nominate director candidates and have the candidates included in management's proxy statement for the company's annual meeting.

A Wall Street Journal article last week (subscription required for full article) reported that ". . . the measure looks like it will be passed by the Securities and Exchange Commission in November." The article describes efforts by the U.S. Chamber of Commerce and others to block the measure, but reports that ". . . most opponents expect the measure to pass." The article states that many corporate comment letters are suggesting a weakened version of the measure rather than opposing it altogether.

However, this post by Dave Lynn in the Corporate Counsel blog last Friday puts the proposal's status in perspective and raises doubts that shareholder access is a "done deal". Lynn refers to several interesting comment letters, including this comment letter from several prominent former SEC staff members, urging the Commission to focus on other, more pressing regulatory matters. The Corporate Counsel post points out that "this is a road that we have all been down before", basically stating that it's too soon to know where this will end up. We all need to stay tuned.

As always, you can refer to the ON Securities Cheat Sheet for information on this and other proposals before the SEC, as well as pending legislation.

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[Editor's Note: Apologies to those who tried to read this post based on the e-mail update sent on Monday - that e-mail was sent inadvertently, prior to some corrections on the post.]

A story in the Wall Street Journal last week (subscription required to read complete story) described an interesting recent academic study on stock options backdating. The study found that several hundred companies that improperly backdated options never were caught or confessed. In the study, out of the University of Houston's C.T. Bauer College of Business, the authors used computer models to determine companies that are highly likely to have committed backdating. These companies featured "lucky" officers, who received option grants at or near the low points for their stock prices.

Based on this sampling of companies the researchers found that only around one-third of these companies had ever disclosed evidence of backdating. The authors extrapolated that at least 500 companies engaged in backdating that was never disclosed.

We are reading very little about backdating these days, compared to how much the story dominated the business headlines in 2006 and 2007. It's hard to imagine that there will be a new wave of SEC enforcement actions against previously undisclosed companies that backdated options.

However, the legacy of the backdating scandal lives on in the SEC's compensation disclosure rules that became effective in 2006. The scandal caused the SEC to suspect that companies were unfairly manipulating the pricing of stock options through the timing of option grants - practices such as "springloading". The SEC's 2006 adopting release clarifies that a public company must disclose any plan or program to coordinate the timing of stock option grants with the release of material non-public information.

We recommend that public companies adopt a written stock option grant policy, if they have not already done so. Careful adherence to such a policy can make it easier to establish that options are not being granted in coordination with the release of material non-public information.

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As I've said before, some version of a requirement for shareholder advisory votes on compensation (Say-on-Pay) is likely to be adopted in the next few months. The Say-on-Pay requirement will probably be similar to the Corporate and Financial Institution Fairness Act of 2009, recently adopted by the House and described in the ON Securities Cheat Sheet. In other words, Say-on-Pay has become a political football lately.

[Editor's Note: You may have noticed veiled references to "football" in the title and the first paragraph of this post. The Editor of the ON Securities Blog categorically denies ANY relationship between these references and Brett Favre's announcement Tuesday that he signed a contract with the Minnesota Vikings.]

It looks like shareholder advisory votes will not be required until the 2011 proxy season. Still, it makes sense to keep track of the results of recent advisory votes to see how various companies have fared. Several hundred financial institutions that received TARP funds were required to hold advisory votes last spring, and their recently filed Form 10-Q reports disclose many of the results.

So, what does the scoreboard look like in Say-on-Pay season? Generally, the non-binding proposals to approve executive compensation did very well. Here is a sampling of the results from financial institutions with strong ties to the Twin Cities:

US Bancorp: 92.0% in favor
Wells Fargo Company: 92.8% in favor
TCF Financial Corporation: 69.5% in favor

If the SEC adopts its recent rule proposals, we will no longer have to wait several months to see the results of shareholder votes. Companies will generally have to report them on Form 8-K within four business days. It will practically be possible to follow the results on your BlackBerry, along with football scores.

[Editor's Further Note: Did I mention that Brett Favre is joining the Vikings? All right, maybe I did have football on my mind.]

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Occasionally, we will include guest columns with topics of interest to public companies and those that serve them. Here is a guest column by my colleague, Doug Holod. Doug is a partner in our Business and Securities Group and a member of Maslon's Governance Committee. Please let us know your thoughts about Doug's column - post a comment below or send me an e-mail. Doug's list will continue to be posted as one of the Resources on the home page of the Blog. - Marty Rosenbaum

One universal theme that has become more pronounced during the current (past?) recession is the demand by businesses for value; everyone wants more for less. On the legal front, in-house counsel are being pressured to: 1) reduce their reliance on outside counsel; 2) lower their own internal costs (which may include eliminating some in-house positions); and 3) minimize risk and exposure. Businesses without in-house counsel are also focusing on cutting costs while still minimizing risk and exposure.

In response, some law firms have become more resourceful with alternative billing arrangements such as fixed fees, including monthly retainers for corporate work, fixed prices for private placements, stock option and compensation plans and the like. Section 16 filings have become commoditized as well. Lawyers in firms will have to continue innovating in line with this trend, even after the recession subsides.

Attached you will find a list that I prepared for businesses to reduce legal costs and maximize value. Much of it is common sense (e.g avoid lawsuits) . . . but some of it shakes the foundation of the way corporate law firms have traditionally practiced over the past few decades (give clients standardized forms for them to customize). By applying some principles from this list, a business should be able to reduce legal costs and maximize the value of the services it receives.

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The SEC's recent clawback action against Maynard Jenkins, the former CEO of auto supplier CSK Auto Corporation, has gotten more commentary than just about any other recent enforcement proceeding I can think of. The SEC is seeking reimbursement of $4 million in Jenkins' bonuses and profits from his stock sales during years when CSK's financial results were inflated by accounting fraud. What's getting all the attention? The SEC has not charged Jenkins individually with any wrongdoing.

The SEC is seeking the clawback under Section 304(a) of the Sarbanes-Oxley Act of 2002, which allows recovery of incentive compensation following a financial restatement "as a result of misconduct." Section 304 doesn't specify that the misconduct be tied directly to the individual from whom the recovery is sought. However, the SEC, in its press release announcing the action, reported:

It is the first action seeking reimbursement under the SOX 'clawback' provision . . . from an individual who is not alleged to have otherwise violated the securities laws. . . . . 'Jenkins was captain of the ship and profited during the time that CSK was misleading investors about the company's financial health,' said Rosalind R. Tyson, Director of the SEC's Los Angeles Regional Office. 'The law requires Jenkins to return those proceeds to CSK.'

Much of the negative commentary accuses the SEC of overreaching, in a situation where it could not state an accounting fraud case directly against Jenkins. However, this case is an extreme one - Jenkins collected $4 million in bonuses and stock profits at a time when the company was committing massive accounting fraud. The COO, CFO, controller and another responsible officer were all indicted, and the latter two individuals have already pled guilty. Even if the SEC couldn't make a direct case against Jenkins for the fraud, this is the perfect test case for the extension of a Section 304 clawback beyond the responsible individuals to the "captain of the ship".

Regardless of the result in the case, the SEC has sent another signal that it is "loaded for bear" - as we reported in this post, the agency has a beefed-up enforcement staff and new energy. Regardless of the result in the Jenkins "no fault clawback" case, the SEC will be putting more heat on executives in the coming months.

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On Friday, the House of Representatives passed the Corporate and Financial Institution Fairness Act of 2009. The Senate still needs to consider similar legislation, and any differences will need to be resolved.

For most public companies, the bill will (1) require an annual advisory vote on executive compensation ("Say-on-Pay") and (2) for exchange-traded companies, increase the independence requirements for compensation committee members. The bill also would, if enacted, regulate pay at the largest financial institutions. TheCorporateCounsel.net Blog in its August 3, 2009 post contains an excellent summary of the bill. As that blog points out, Say-on-Pay almost certainly will not be a reality during the 2010 proxy season.

The bill allows the SEC to exempt certain companies from both the Say-on-Pay requirement and the compensation committee requirements. Therefore, the SEC might exempt smaller companies from either or both provisions.

We have updated the ON Securities Cheat Sheet to include the revised status and content of this bill. As you can see, there are still several other bills making their way through the Senate and the House, as well as several proposed regulations that would impact governance and compensation. These bills and rules continue to jockey for position, like the toy arcade horses in the video that amuses me so much.

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I've been working on my outline for an upcoming continuing legal education program on how in-house practitioners can avoid or minimize securities fraud liability. I talked to Maslon's securities litigation partner extraordinaire, Rich Wilson, about the topic, and we came up with the following tips:

The simple rule is to disclose material information in a way that's not misleading. However, Rich cautions that a higher standard of disclosure may be required now. As Rich puts it, "There is a growing public skepticism that will make its way into the jury pool and even into the judiciary. In a dispute, a tie may no longer go to the company." SEC enforcement also poses new dangers, because the agency has a beefed-up enforcement staff and new energy. In other words, business as usual may not be the best course in the current atmosphere.

Also, in the current climate, process and consistency become increasingly important. Companies should take a fresh look at their disclosure controls and procedures. The CEO and CFO have to certify the adequacy of these procedures every quarter in the 10-K and 10-Qs, but now is the time to make sure the procedures still make sense and are being followed consistently. This increased emphasis on compliance has to be maintained, even at a time when a lot of companies are cutting back on their in-house legal and compliance staffs due to economic considerations.

It is also important to minimize the possibility of inconsistent disclosures by multiple individuals, and leaks of material non-public information. The company should have a clear written communications policy to ensure that corporate disclosures are made consistently by authorized spokespersons, and to prevent leaks. Again, the company should monitor and enforce consistent compliance with the policy.

It is also very important to consistently monitor and enforce compliance with the company's insider trading policy. If insiders appear to be trading in the company's stock before allegedly material information is disclosed, this will greatly increase the risk of a lawsuit or SEC enforcement proceeding, compared to a disclosure-based claim alone.

All good tips. Although, maybe not as good as the tip my law school buddy used to give me: "Don't get caught cheating". Yes, he was kidding. Or maybe not - he ended up getting elected to Congress.

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