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

The Restoring American Financial Stability Act of 2010 (1,410 page PDF) (the “Dodd Bill”), which would reform regulation of financial institutions and the securities markets, has been introduced, and debate on the Senate floor has finally begun. It appears that the bill will probably be approved in the next few weeks in some form, followed by conference committee action to resolve differences with the Frank Bill that was approved by the House in December. The two bills include overlapping but differing governance and compensation reform provisions that apply to all public companies (or, in some cases, to all companies listed on a securities exchange). The ON Securities Cheat Sheet (PDF) has been updated, making it easier to compare these provisions in the two bills.

Both the Senate and House bills would require Say-on-Pay – an annual shareholder advisory "up or down" vote on compensation. Therefore, it is very likely that Say-on-Pay will be a reality by next year’s proxy season. Public companies should start planning for Say-on-Pay now, including considering what compensation practices might trigger a negative vote.

The Council of Institutional Investors (CII) just published “Top 10 Red Flags to Watch for When Casting an Advisory Vote on Executive Pay” (PDF), which provides rules of thumb to help institutional investors identify pay programs that might be objectionable. Whether you agree or disagree, the CII document makes interesting reading. Most of the red flags are pretty obvious, including option repricing. Others are more thought-provoking. For example, CII considers it a “problematic pay practice” to grant conventional (time-vested) stock options to the CEO. The CII document recommends:

To isolate management’s contribution to stock price performance, stock options should be indexed to a peer group or should have an exercise price higher than the market price of common stock on the grant date and/or vest on achievement of specific performance targets that are based on challenging quantitative goals.

"I’m Just a Bill"

Thinking about the committee process in Congress brought to mind the great "Schoolhouse Rock" series of animated shorts from the 1970s, and the episode called “I’m Just a Bill.” The song was written by the equally great Dave Frishberg (a songwriter who also wrote “My Attorney Bernie”), and it actually does a pretty good job of explaining the process by which Senate and House bills become laws.

Video: YouTube

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The SEC’s lawsuit against Goldman Sachs for securities fraud has been big news in the past few days. One interesting aspect of that lawsuit has implications for all public companies – should Goldman have disclosed the existence of the SEC investigation before the SEC announced the lawsuit last Friday? Whatever the answer, Goldman’s public disclosure practices are sure to generate a lot of commentary as the case proceeds.

In a Bloomberg story, “Goldman Sachs Said to Have Been Warned of SEC Suit”, Josha Gallu and David Scheer reported that Goldman received the Wells notice in the case in July 2009, and the company issued a lengthy response in September. Goldman did not mention the investigation in any of its public disclosures. Its 2009 Form 10-K filed on March 1, 2010 disclosed only that Goldman had received “requests for information from various governmental agencies and self-regulatory organizations” relating to CDOs and related instruments, and that the company and its affiliates were “cooperating with the requests.”

Given its size, Goldman might have been able to exclude the possible lawsuit from the 10-K – technically, there is a disclosure threshold of ten percent of current assets (see Instruction 2 to Item 103 of Regulation S-K). However, if it considered the possible lawsuit to be material to investors any time after it received the Wells notice, Goldman arguably should have made the disclosure anyway. In a footnoted.org blog post, “On Goldman and disclosure . . .”, Michelle Leder pointed out that, in contrast to Goldman’s silence, several other large financial companies have elected to disclose the existence of Wells notices. Leder asks, “If disclosing a Wells Notice was material enough for these companies, why was it not material enough for Goldman?”

The Goldman situation highlights one of the most difficult disclosure decisions for a public company. A public company arguably is not always required to make a disclosure as soon as an event becomes “material”, but then insiders must be restricted from trading until the information is disclosed. Goldman clearly based its non-disclosure on a conclusion that the information was not material. In a WSJ MarketBeat post, “Goldman Sachs Conference Call: Any Other Wells Notices?”, Matt Phillips reported that Goldman’s in-house counsel stated Tuesday, in Goldman's investor conference call:

Whether there is a wells or not a wells, if we consider it to be material we go ahead and we disclose it; and that is our policy. To get to your question, we do not disclose every wells we get simply because that just not — that wouldn’t make sense. Therefore we just disclose it if we consider it to be material.

Goldman’s advisors are certainly on the hot seat, given that, as Phillips points out, the announcement of the lawsuit “lopped some $12 billion [15 percent] in market capitalization off the stock on Friday”. And Goldman will continue to be under the microscope for some time, given the publicity that’s likely to accompany the Goldman case for months to come.

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In a post titled “Private Securities Litigation Continues to Fall”, Broc Romanek’s theCorporateCounsel.net Blog recently summarized the results of a report by Cornerstone Research, “Securities Class Action Filings – 2009: A Year in Review” (PDF):

The latest report from Cornerstone Research shows a sharp drop-off in federal securities fraud class action filing activity in 2009. Continuing a trend that we have seen over the past few years, the 169 federal securities fraud class action filings in 2009 were off 24% from 2008, and were well below the historical average over the past ten years. Included in this big decline was a sharp retreat in credit-crisis filings, down nearly 47% from 2008 levels.

The chart on page 4 of the Cornerstone Research report shows an especially sharp decline when special cases, such as credit crisis filings and Ponzi schemes, are excluded.

Counterbalancing the drop-off in securities class action filings are the continued reports of the SEC’s efforts to beef up its enforcement efforts. In a Washington Post article, “SEC faces setbacks, skepticism in trying to reform its enforcement image”, Zachary A. Goldfarb outlines the SEC’s increased enforcement activity. He reports that SEC investigations more than doubled, from 233 in 2008 to 496 in 2009, and financial penalties increased from $1.03 billion in 2008 to $2.86 billion in 2009.

Comment: Goldfarb’s article focuses on the setbacks the SEC has encountered in beefing up its enforcement activities, which makes for interesting reading. However, the point remains that the SEC is more anxious than ever to bring enforcement proceedings. Compliance officers at public companies must continue to be vigilant to minimize exposure to disclosure-related liability. I included some tips in my previous post, “Don’t Get Caught Cheating”, and I will provide more tips in future posts.

Image: Wikimedia Commons
 

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Many public companies have recently filed their proxy statements including a description of executive compensation in 2009, and we are starting to see some analyses in the media of trends in executive compensation. In an article in the St. Paul Pioneer Press on April 8, “For Target's CEO, bonuses are back”, Christopher Snowbeck reported on Target Corporation’s disclosure of its CEO’s compensation in 2009 compared to 2008. Snowbeck reported that, like many companies, Target’s executives received much higher incentive compensation in 2009 than in 2008. In fact, a number of financial services firms, such as U.S. Bancorp and TCF Financial, paid hefty bonuses in 2009, compared to no bonuses in 2008.

Snowbeck asked for my opinion on whether this shift suggested that public companies are moving  toward greater emphasis on bonuses or other short term incentives. He quoted me as attributing the higher bonuses mainly to a different factor, which I called the "under-promise and over-deliver" principle:

For 2008, the year started out with high expectations, which were dashed by the end of the year. . . In 2009, compensation committees were careful to set realistic goals and [performance] targets to give executives a real incentive to turn things around, and many were able to meet or exceed more modest expectations.

By using the term "under-promise and over-deliver,” I wasn’t suggesting that executives or compensation committees are deliberately suppressing goals to boost bonuses. Instead, I just wanted to make the point that financial expectations at the beginning of the year (or other performance period) are a huge factor in ultimately determining bonuses.

In addition to the levels of incentives discussed in Snowbeck's article, there was another interesting aspect of the Target executives’ incentive compensation. Those incentives were actually based on two performance periods – for the first six months and last six months of the year. In an article in the Wall Street Journal on March 15, “Semiannual Bonuses Gain Traction”, Joann S. Lublin reported that many retail and high-tech companies have tried these semiannual bonuses, to help “. . . retain key players by dangling the carrot of two targets a year, while giving boards a chance to raise those goals quickly if economic conditions improve.” The article noted that at least 50 companies have recently disclosed plans to pay semiannual bonuses. [Note: a subscription may be required to read the entire Journal article.]

In his Advisors’ Blog (subscription required), Broc Romanek reported this feedback from his expert consultants about semiannual bonuses:

Semi-annual bonuses were adopted by a small fraction of companies due to those companies' inability (or unwillingness) to set 12 month financial targets due to the uncertainty of the economy. I've seen companies adopt the semi-annual approach and they seem to only pay the bonus when the calendar year is over. I imagine the compensation committees made sure the goals were stretch-based on the best available information at the time the goals were set. Some of these same companies retained the discretion to reduce bonuses prior to payment after taking stock of the year as a whole.

. . . This too shall pass, as compensation committees hate negotiating bonus targets two times per year (or even four times if you count the end-of-the-period negotiations on what to include - or exclude - in the final performance calculations).

SEC Accounting, Compliance & Legal Issues Conference Announced

Bowne of Minnesota has announced the 2010 SEC Accounting, Compliance & Legal Issues Conference, which will be held on Thursday, May 27, 2010 in the IDS Center in Minneapolis. The Conference is always a great way to get timely guidance and practical insights into the latest developments in corporate governance and SEC rules, regulations and initiatives. The faculty always includes experts from top Minnesota law firms and accounting firms, and the program is always well received.

I am one of the co-chairs of the Conference, as I have been for the past several years. I will be leading the Disclosure Update panel discussion, in which my partner Paul Chestovich will also participate. In that panel, we will provide information on new SEC disclosure requirements (including guidance on climate change disclosure), an update on securities litigation and SEC enforcement activity and practical tips on how to avoid liability. As the Conference approaches, I will be blogging about these topics further. Other panels will provide helpful updates on proxy statement disclosures, M&A developments and great information on accounting requirements.

To make it even better, the Conference is free! You are welcome to register here. Also, feel free to e-mail this post to anyone else you know who might be interested – use the “Send to a Friend” feature below or click on the envelope icon.

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