Tuesday, July 27, 2010

“Public Company Advisory”

Goodwin Procter LLP

Dodd-Frank Wall Street Reform and Consumer Protection Act – Public Company Impact

On July 21, 2010, President Obama signed into law the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”). The Act is aimed in part at accountability and transparency in the financial system and represents the most comprehensive financial reform legislation since the Great Depression. The Act also includes a number of provisions relating to executive compensation, corporate governance, credit ratings agency reforms and other matters that generally apply to public companies. This Advisory describes these provisions of the Act and how they may impact publicly traded companies.

Executive Compensation

The Act includes several provisions relating to executive compensation, which are summarized below. These include provisions relating to “say on pay,” “say on golden parachute pay,” independence of compensation committee members, independence of compensation committee advisors, additional executive compensation disclosures (pay vs. performance and internal pay comparison), clawback of erroneously awarded compensation and disclosure regarding employee and director hedging.

Say on Pay [§ 951]

The Act provides for say on pay for shareholders of all public companies. Under the Act, each company must give its shareholders the opportunity to vote on the compensation of its executives at least once every three years. The vote will be non-binding and will take the form of a resolution submitted to shareholders to approve the compensation of the company’s executives as disclosed in the company’s proxy statement. The frequency of the say-on-pay vote (i.e., every one, two or three years) will be determined by a separate shareholder vote at least once every six years. The Act permits the SEC to exempt companies or classes of companies from these requirements, taking into account, among other factors, whether the requirements disproportionately burden small companies.

It is important to note that this provision of the Act does not modify the executive compensation disclosure required in companies’ proxy statements to require any additional disclosure of current or expected future compensation. Accordingly, as the say-on-pay vote will relate to the executive compensation that is disclosed in the proxy statement, it will primarily relate to historical compensation focusing on the compensation paid for or awarded during the prior year.

Effective Date: Companies must submit the say-on-pay vote and the vote to determine the frequency of future say-on-pay votes to their shareholders at the first annual meeting (or other shareholder meeting for which executive compensation disclosure is required in the proxy statement) occurring on or after January 21, 2011. As a result, most companies with a calendar year end will be required to submit these votes to their shareholders at their 2011 annual meetings.

Say on Golden Parachute Pay [§ 951]

In addition to the required say-on-pay votes, the Act also adds disclosure and voting requirements for golden parachute compensation that is payable to named executive officers in connection with sale transactions. These requirements apply to shareholder meetings at which shareholders are asked to approve a merger, consolidation, or sale of all or substantially all of the company’s assets. In the proxy materials for such a meeting, the company soliciting proxies will be required to disclose, in a clear and simple form in accordance with regulations to be adopted by the SEC, any agreements or understandings with any named executive officer concerning any type of compensation (whether present, deferred or contingent) that is based on or otherwise relates to the transaction and the aggregate total of all such compensation that may (and the conditions upon which it may) be paid or become payable to or on behalf of such executive officer. In addition, unless such agreements and understandings have already been subject to a say-on-pay vote, the company must give its shareholders a non-binding vote on such agreements and understandings and total compensation at the meeting for the transaction.

The Act permits the SEC to exempt companies or classes of companies from these requirements, taking into account, among other factors, whether the requirements disproportionately burden small companies.

Effective Date: These new requirements will apply to any meeting of shareholders at which shareholders are asked to approve a merger, consolidation, or sale of all or substantially all of the company’s assets occurring on or after January 21, 2011.

Independence of Compensation Committee Members [§ 952]

The Act provides that the SEC must issue rules directing the stock exchanges (i.e., national securities exchanges and associations) to prohibit listing classes of equity securities if the company’s compensation committee members are not independent. Under the Act, the SEC’s rules must require the stock exchanges to consider the following in defining independence for compensation committee members:  (i) sources of compensation for each compensation committee member, including any consulting, advisory or other compensatory fee paid by the company to the member, and (ii) whether the compensation committee member is affiliated with the company. This requirement is similar to the heightened independence standards that were placed on audit committee members by the Sarbanes-Oxley Act, except that the SEC rules to be adopted under the Act only require the stock exchanges to consider the factors described above in determining the independence standards for compensation committee members whereas the Sarbanes-Oxley Act effectively required the stock exchanges to prohibit persons from serving on the audit committee who (i) receive any consulting, advisory or other compensatory fee from the company or (ii) are affiliated with the company. However, if the stock exchanges adopt compensation committee independence rules that parallel current audit committee independence rules (which they might) then otherwise independent directors who are currently prohibited from serving on the audit committee will also be prohibited from serving on the compensation committee.

Once final SEC and stock exchange rules are adopted, companies will need to reevaluate the composition of their compensation committees to ensure that they meet whatever heightened independence standards are adopted.

These new requirements do not apply to controlled companies (i.e., companies where 50% of the voting power is held by an individual, a group or another company), foreign private issuers that provide annual disclosures to shareholders of the reasons they do not have an independent compensation committee or open-ended management investment companies that are registered under the Investment Company Act of 1940. In addition, the SEC rules must permit the stock exchanges to exempt categories of companies from these requirements and, in determining appropriate exemptions, the stock exchanges must take into account the potential impact of the requirements on smaller reporting companies.

Effective Date: The SEC is required to adopt rules by July 16, 2011 directing the stock exchanges to prohibit the listing of any securities of a company that is not in compliance with these requirements.

Independence of Compensation Committee Advisors [§ 952]

The Act provides that a company’s compensation committee may only select a compensation consultant, legal counsel or other advisor after taking into consideration factors to be identified by the SEC that affect the independence of a compensation consultant, legal counsel or other advisor. These will include the following five specific factors identified in the Act:

*The provision of other services to the company by the person that employs the compensation consultant, legal counsel or other advisor¹

*The amount of fees received from the company by the person that employs the compensation consultant, legal counsel or other advisor, as a percentage of the total revenue of the person that employs the compensation consultant, legal counsel or other advisor

*The policies and procedures of the person that employs the compensation consultant, legal counsel or other advisor that are designed to prevent conflicts of interest

*Any business or personal relationship of the compensation consultant, legal counsel or other advisor with a member of the compensation committee

*Any stock of the company owned by the compensation consultant, legal counsel or other advisor

The Act does not require companies’ compensation committees to make formal independence determinations with respect to any compensation consultant, legal counsel or other advisor that it engages, but it does require each company to disclose in its proxy materials for its annual meetings, in accordance with regulations of the SEC, whether its compensation committee retained or obtained the advice of a compensation consultant and whether the work of the compensation consultant raised any conflict of interest and, if so, the nature of the conflict and how it is being addressed. Under current rules, companies are already required in their proxy statements to identify any compensation consultants used in determining or recommending the amount or form of executive or director compensation and include some disclosure relating to potential conflicts of interest of such compensation consultants. However, as the current rules do not appear to squarely address all of the new disclosure requirements of the Act, we expect the SEC to adopt additional rules relating to the disclosure of conflicts of interest.

The Act also requires that (i) the compensation committee be directly responsible for the appointment, compensation and oversight of the work of a compensation consultant, independent legal counsel and any other advisor that it retains and (ii) companies provide appropriate funding as determined by the compensation committee for payment of reasonable compensation to a compensation consultant, independent legal counsel or any other advisor to the compensation committee. However, the Act does not require the compensation committee to retain a compensation consultant, independent legal counsel or any other advisor, and it does not prohibit the compensation committee from receiving advice from a compensation consultant, legal counsel or other advisor to the company that was not specifically selected or retained by the compensation committee.

These new requirements do not apply to controlled companies (i.e., companies where 50% of the voting power is held by an individual, a group or another company). In addition, the SEC rules must permit the stock exchanges to exempt categories of companies from these requirements and, in determining appropriate exemptions, the stock exchanges must take into account the potential impact of the requirements on smaller reporting companies.

Effective Date: The proxy disclosure requirements described above apply to proxy materials for annual meetings occurring on or after July 21, 2011, provided that no specific deadline is set for the additional SEC regulations that appear to be contemplated by the Act regarding these disclosure requirements. The SEC is required to adopt rules by July 16, 2011 directing the stock exchanges to prohibit the listing of any securities of a company that is not in compliance with these requirements.² Lastly, the SEC is directed to identify factors that affect the independence of a compensation consultant, legal counsel or other advisor, but there is no specific deadline placed on the SEC for the identification of such factors.

Additional Executive Compensation Disclosures (Pay vs. Performance and Internal Pay Comparison) [§ 953]

The SEC is required under the Act to issue rules obligating companies to disclose in proxy materials for annual meetings of shareholders information that shows the relationship between executive compensation actually paid to their named executive officers and their financial performance, taking into account any change in the value of the shares of the company’s stock and any dividends or distributions. The SEC is also required to amend Item 402 of Regulation S?K to require each company to disclose the median of total annual compensation for all employees of the company except the CEO, the total annual compensation of the CEO and the ratio of these two figures. Total compensation for the employees of a company will be calculated on the same basis as it is for purposes of the Summary Compensation Table required by Item 402 of Regulation S-K (i.e., including salary, bonus, grant date fair value of equity awards, perks, etc.). Depending on the number of employees a company has and the complexity of its compensation arrangements, among other things, determining the median of total annual compensation for all employees other than the CEO may impose a substantial additional administrative burden on the company.

Effective Date: Neither the date by which the SEC must adopt these rules nor the date by which any such rules must become effective is specified in the Act.

Clawback of Erroneously Awarded Compensation [§ 954]

The Act provides that the SEC must issue rules directing the stock exchanges to prohibit listing any security of a company unless the company develops and implements a policy providing (i) for disclosure of the policy of the company on incentive-based compensation that is based on financial information required to be reported under the securities laws and (ii) that, in the event that the company is required to prepare an accounting restatement due to the material noncompliance of the company with any financial reporting requirement under the securities laws, the company will recover from any current or former executive officer of the company who received incentive-based compensation (including stock options awarded as compensation) during the three-year period preceding the date on which the company is required to prepare the restatement based on the erroneous data, any excess compensation above what would have been paid under the restatement. This clawback requirement is significantly broader than the clawback contained in the Sarbanes-Oxley Act, which, among other things, only applied to restatements that resulted from misconduct and only applied to a company’s CEO and CFO.

Due to the draconian nature of the clawback required, this provision of the Act may lead companies to consider restructuring their incentive-based compensation to either (i) include a deferral feature to reduce the amount of compensation that is paid out prior to the expiration of the clawback period, (ii) move more towards discretionary incentive-based compensation programs or (iii) utilize non-financial metrics such as stock price appreciation or total return to shareholders.

Effective Date: Neither the date by which the SEC must adopt these rules nor the date by which the stock exchanges must have adopted rules addressing these requirements is specified in the Act.

Disclosure Regarding Employee and Director Hedging [§ 955]

The Act requires the SEC, by rule, to require that each company disclose in the proxy materials for its annual meetings whether any employee or board member is permitted to purchase financial instruments (including prepaid variable forward contracts, equity swaps, collars and exchange traded funds) designed to hedge or offset decreases in the market value of equity securities granted as compensation or otherwise held by the employee or board member. As a result, companies that do not already have a comprehensive policy addressing the use of hedging instruments, whether in their insider trading policies and procedures or elsewhere, may want to consider adopting one.

Effective Date: Neither the date by which the SEC must adopt these rules nor the date by which any such rules must become effective is specified in the Act.

Corporate Governance

The Act includes several provisions relating to corporate governance, which are summarized below. These include provisions relating to proxy access, disclosure of Chairman and CEO structure, and broker discretionary voting. However, in the area of general public company corporate governance, perhaps the most notable part of the Act is what is not included. The Act does not mandate majority voting in uncontested director elections, declassified boards or independent chairmen of the board, all of which had been in previously proposed legislation that was supplanted by the Act.

Proxy Access [§ 971]

The Act clarifies that the SEC may, but is not required to, promulgate rules that would require that a company’s proxy materials include a nominee for the board of directors submitted by a shareholder. The Act also gives the SEC the authority to exempt companies or classes of companies from these requirements and specifically directs the SEC to consider whether the requirements would disproportionately burden small issuers. Prior versions of the Act (and its predecessors) had included limitations on the SEC’s ability to adopt proxy access (e.g., limiting the shareholders entitled to access to those who had held at least 1% of a company’s stock for at least two years). The most notable feature of this provision of the Act is that it does not include any such limitation and gave the SEC full flexibility to determine the parameters of proxy access. The SEC’s latest proposal regarding proxy access, from June 2009, was summarized in Goodwin Procter’s July 2, 2009 Public Company Advisory.

Effective Date: July 21, 2010.

Disclosure of Chairman and CEO Structure  [§ 972]

Pursuant to the Act, the SEC must issue rules requiring companies to disclose in their annual proxy sent to investors the reasons why the company has the same person serving as chairman of the board and CEO or has different individuals serving in those roles. Given that Item 407 of Regulation S-K already requires companies to disclose their board leadership structure along with an explanation of why the company selected the structure, it is unclear what additional steps will need to be taken, if any, in response to this provision.

Effective Date: The SEC is required to issue rules by January 17, 2011 regarding this disclosure requirement.

Broker Discretionary Voting [§ 957]

The Act requires stock exchanges to have rules prohibiting their members (i.e., brokers) from voting securities that they do not beneficially own (unless they have received voting instructions from the beneficial owner) with respect to the election of a member of the board of directors (other than an uncontested election of directors of an investment company registered under the Investment Company Act of 1940), executive compensation or any other significant matter, as determined by the SEC by rule. The potential impact of the restriction on discretionary voting for directors by brokers should have already been determined by most companies given the recent amendment to NYSE rules eliminating discretionary voting for director elections for annual meetings of shareholders held on or after January 1, 2010. NYSE rules have also prohibited discretionary voting by brokers on many of the most typical matters relating to executive compensation, such as the adoption or amendment of an equity compensation plan. As a result, for most companies, this provision of the Act should not have a significant impact on their shareholder voting.

Effective Date: July 21, 2010. The Act does not specify a date by which the SEC must adopt rules identifying any “other significant matters” with respect to which discretionary voting must be prohibited (or even if the SEC must adopt any such rules).

Credit Ratings Agency Reforms  [§§ 931 et seq.]

The Act includes a number of provisions that are targeted at improving the reliability of credit ratings. The precise impact of these reforms on companies and credit ratings agencies will not be fully known until the numerous additional rules the Act has charged the SEC with adopting and implementing have been promulgated. However, it does appear that these reforms could have a significant impact. Please note that the foregoing does not address the specific implications of the provisions of the Act relating to credit ratings agency reform as they apply to offerings of asset-backed securities.

One of the significant provision of the Act, in this respect, is the repeal of Rule 436(g) under the Securities Act of 1933, as amended (the “Securities Act”), which had provided that a credit rating disclosed in a registration statement (including any prospectus) was not considered an expertized portion of the registration statement requiring written consent of the applicable credit ratings agency for inclusion. In theory, this would require companies to either obtain the consent of the credit ratings agency or exclude the credit rating from the registration statement. However, because consenting to the inclusion of the credit rating would subject the ratings agency to potential liability under Section 11 of the Securities Act, the credit ratings agencies have indicated that they will not be willing to provide their consent. As a result, generally, companies will be required to exclude credit ratings from their registration statements (including any prospectuses) unless and until the credit ratings agencies change their positions. However, companies will still be permitted to refer to a credit rating orally, in a free writing prospectus or in communications complying with Rule 134 under the Securities Act, without obtaining the consent of the applicable credit rating agency and, therefore, the framework for offering rated debt securities as it currently exists (other than with respect to asset-backed securities) should not be effected materially by this change. In addition, the SEC has issued interpretive guidance confirming that companies (i) may still include disclosure of credit ratings if the disclosure is related only to changes to a credit rating, the liquidity of the company, the cost of funds for the company or the terms of agreements that refer to credit ratings³ and (ii) may continue to use registration statements that were declared effective before July 22, 2010 that included or incorporated by reference credit ratings without obtaining the consent of the applicable credit ratings agency until the next required amendment of the registration statement pursuant to Section 10(a)(3) of the Securities Act⁴, provided that no subsequently incorporated periodic or current report contains ratings information other than that described in clause (i) above.

The reforms also include several provisions that will change the type of information provided by credit ratings agencies and may change the type of information provided by public company issuers to credit ratings agencies. For example, the Act will require credit ratings agencies to publicly disclose additional information regarding the data relied upon to determine a credit rating and information on uncertainty of such credit rating (including information on the reliability, accuracy and quality of the data relied on in determining such credit rating and any limits on the accessibility to information that would have better informed such credit rating). Additionally, the SEC is directed to revise Regulation FD to remove the blanket exemption for a public company’s disclosure to entities whose primary business is the issuance of credit ratings. Therefore, a public company will have to determine whether a disclosure to a given credit ratings agency is a disclosure that is subject to Regulation FD, and if it is, whether another exemption, such as the exemption that permits material non-public information to be shared with a person who expressly agrees to maintain the disclosed information in confidence, may be relied upon.

The Act also requires the SEC, along with all other federal agencies, to modify all of its regulations to remove any reference to or requirement of reliance on credit ratings and to substitute an alternative standard of credit-worthiness that is deemed appropriate by the SEC. Among other things, this would require the SEC to replace the Form S-3 eligibility requirement relating to the issuance of non-convertible securities that are “investment grade securities.”  The SEC has previously proposed replacing this eligibility requirement with an alternative requirement that would be satisfied by companies that had issued at least $1 billion in aggregate principal amount of non-convertible securities, other than common equity, for cash (not exchange) in registered offerings in the prior three years. If this previously proposed standard is adopted, it would exclude a number of companies, such as operating partnerships of REITs that have not met this volume threshold, from using Form S-3 to publicly issue investment grade debt securities.

Effective Date: Generally, final regulations with respect to the credit ratings reforms are to be issued by the SEC by July 21, 2011. The SEC is required to revise Regulation FD by October 19, 2010. The repeal of Rule 436(g) is effective on July 21, 2010.

Various Other Provisions

The Act includes several other provisions that will impact public companies that are summarized below. These include provisions relating to a revised accredited investor standard, exemption for non-accelerated filers from Section 404(b) of the Sarbanes-Oxley Act, Section 13 and 16 reporting, reporting of short sales and certain votes by institutional investment managers and securities litigation matters.

Revised Accredited Investor Standard  [§ 413; § 926]

The Act directs the SEC to make certain adjustments to the accredited investor standard relating to a natural person’s net worth under the Securities Act, including for purposes of Regulation D. Regulation D provides a safe harbor for securities offerings that meet certain requirements from the registration requirements of the Securities Act. Under the most commonly used Regulation D exemption, offers and sales of securities are only exempt if, among other things, (i) there are no more than 35 purchasers in the offering who do not qualify as accredited investors and (ii) the company furnishes each purchaser in the offering who is not an accredited investor with detailed disclosure similar to that required in a registered offering. As a result, the definition of who qualifies as an accredited investor is very important, and companies routinely limit sales in private placements to investors who qualify as accredited investors.

The existing accredited investor standard relating to a natural person’s net worth, which is one of the ways a natural person may qualify as an accredited investor, provides that a natural person will qualify as an accredited investor if his or her net worth (or joint net worth with his or her spouse) at the time of purchase exceeds $1,000,000. The Act changes the net worth standard to “$1,000,000, excluding the value of the primary residence of such natural person” during the four-year period that begins on July 21, 2010, which is the date of enactment of the Act. Although this change was effective on the date of enactment, the Act also directs the SEC to adopt rules that will incorporate this change and permits the SEC to review and adjust other accredited investor standards for natural persons. The Act also directs the SEC to review and authorizes the SEC to adjust the definition of accredited investor in its entirety, as it applies to natural persons, at least once every four years to determine whether the definition should be adjusted or modified for the protection of investors and in light of the economy, provided that any adjustment to the net worth standard must be to an amount more than $1,000,000, excluding the value of the natural person’s primary residence.⁵ Companies intending to complete a private placement in reliance on this exemption after July 21, 2010 may need to take additional steps to ensure that this exemption will be available for offerings that were not closed before July 21, 2010.

In a separate provision, the Act also directs the SEC to issue rules to disqualify certain “bad actors” from participating in a private placement that is intended to satisfy the most commonly used Regulation D exemption (i.e., Rule 506 exemption).

Effective Date: The change in the accredited investor net worth standard is effective as of July 21, 2010. The SEC is required to issue rules by July 21, 2011 regarding the disqualification of “bad actors.”

Exemption for Non-Accelerated Filers from Section 404(b) of the Sarbanes-Oxley Act  [§ 989G]

The Act amends Section 404 of the Sarbanes-Oxley Act by exempting non-accelerated filers (i.e., generally, those companies with less than $75 million of non-affiliate common equity market capitalization) from the requirements to provide an independent auditor attestation of management’s assessment of the effectiveness of the company’s internal control over financial reporting. These companies will still be required to maintain internal control over financial reporting and assess the effectiveness of their internal controls on an annual basis. Previously, the SEC had temporarily delayed the application of this requirement to non-accelerated filers several times. This amendment will provide some much appreciated certainty on this issue for non-accelerated filers. The Act also requires the SEC to conduct a study to determine how it could reduce the burden of Section 404(b) of the Sarbanes-Oxley Act on companies with market capitalization between $75 million and $250 million.

Effective Date: July 21, 2010.

Section 13 and Section 16 Reporting  [§ 929R; § 766]

The Act eliminated the requirement under Section 13(d) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), for persons filing a Schedule 13D to send copies to the issuer and the exchanges on which such securities are listed and the requirement under Section 16 of the Exchange Act for reporting persons to file their Section 16 reports with any national securities exchange on which the underlying securities are registered. The Act also modified Section 13(d) and Section 16 to permit the SEC to require persons to make their initial filings under these sections (i.e., Schedule 13Ds or Form 3s, respectively) within less than 10 days of the triggering event (i.e., becoming a 5% or greater shareholder or becoming a director, officer or 10% shareholder).

The Act also amends Section 13 of the Exchange Act to provide that a person will be deemed to have acquired beneficial ownership of an equity security for the purposes of Section 13 or Section 16 based on the purchase or sale of a security?based swap only to the extent that the SEC by rule, after consultation with banking regulators and the Treasury, makes certain determinations regarding the security?based swap and its comparability to the underlying security. The Act then amends Section 13(d), Section 13(f) and Section 13(g) of the Exchange Act to provide that such deemed beneficial ownership will be considered beneficial ownership of the underlying equity securities for purposes of the reporting requirements contained in those subsections.

Effective Date: July 21, 2010.

Reporting of Short Sales and Certain Votes by Institutional Investment Managers [§ 929X; § 951]

The Act requires the SEC to prescribe rules providing for monthly or more frequent public disclosure of short sales by institutional investment managers who are currently subject to reporting under Section 13(f) of the Exchange Act. Additionally, the Act requires these institutional investment managers to disclose their votes on say on pay and say on golden parachute pay at least annually unless they are otherwise required to report such votes publicly. These rules may provide additional insight to companies regarding shorting of their securities and how certain institutional investors voted on the new say-on-pay votes.

Effective Date: The provision relating to the reporting of say-on-pay votes is effective on July 21, 2010; however, as it only relates to annual reporting of votes required under the Act (which are only required for meetings occurring on or after January 21, 2011), the first reporting may not occur until late 2011 or early 2012. With respect to the rules regarding the disclosure of short sales, the Act does not specify the date by which the SEC must adopt such rules or the date by which they must become effective.

Securities Litigation Matters

The Act also has a number of provisions designed to promote the SEC’s and private litigants’ litigation efforts, including, among others, the following:

*Establishing aiding and abetting liability for persons who knowingly or recklessly provide substantial assistance to another person in violation of the Securities Act with respect to civil actions brought by the SEC under certain provisions of Section 20 of the Securities Act

*Changing the liability standard for aiding and abetting liability with respect to civil actions brought by the SEC under certain provisions of Section 21(d) of the Exchange Act to includes persons who “recklessly” provide substantial assistance to another person in violation of the Exchange Act in addition to persons who do so “knowingly”

*Increasing whistleblower protections relating to violations of securities laws and allowing whistleblowers to collect a portion of monetary sanctions collected by the SEC relating to the matter the whistleblower provided information regarding

*The addition of specific anti-fraud prohibitions relating to short sales

*    *    *    *    *

Please note that this Advisory does not necessarily describe the specific impact of each of the provisions of the Act summarized above on voluntary filers, foreign private issuers, asset-backed issuers, registered investment companies and others subject to unique requirements.

¹ Presumably, where the compensation consultant, legal counsel or other advisor is a firm or other entity, the phrase “the person that employs the compensation consultant, legal counsel or other advisor” is intended to refer to such firm or other entity.

² Note that the Act does not explicitly limit the application of these provisions to companies listed on stock exchanges (or state that they don’t otherwise apply to all companies as of July 21, 2010). However, based on the provisions relating to the stock exchanges and their ability to exempt certain companies (among other things), we do not believe that the Act should be construed in this manner.

³ This position is consistent with the preliminary position that the SEC articulated in a concept release issued in 2009 relating to the potential repeal of 436(g).

⁴ For registration statements on Form S-3, a Section 10(a)(3) updating amendment will occur upon the filing of a company’s annual report on Form 10-K.

⁵ As written, this requirement only applies to the accredited investor definition under Rule 215 under the Securities Act and not the definition for purposes of Regulation D. However, we believe it is likely that the SEC will review and adjust both at the same time.

***

Wachtell, Lipton, Rosen & Katz

June 23, 2010

Lessons for Boards from the Deepwater Horizon Tragedy

Note: Martin Lipton is a founding partner of Wachtell, Lipton, Rosen & Katz, specializing in mergers and acquisition and matters affecting corporate policy and strategy. This post is based on a Wachtell Lipton firm memorandum by Mr. Lipton and Benjamin M. Roth.

There is no doubt the oil industry, corporate America, the United States and foreign governments and people across the globe will learn many lessons from the tragic events in the Gulf of Mexico. For boards of directors across many industries, these events highlight the critical importance of effective board oversight of risk management.

Most companies face numerous layers of risk in their daily business activities. As we have previously written (see, e.g. “Risk Management and the Board of Directors,” available on the Forum here), the board’s role is not to manage a company’s day to day risk management processes and procedures, but rather to properly oversee the risk management functions of the company by setting the right “tone at the top”. The board should satisfy itself that the company’s risk management processes are designed and implemented consistent with corporate strategy and the associated level of risk tolerance and are functioning properly. The board should also satisfy itself that the company fosters a culture of risk-aware and risk-adjustment decision making.

Recent events provide an opportunity for boards of directors to reassess the adequacy of risk management policies and procedures, in particular those related to health, safety and the environment (HSE). Although applicable risks vary greatly across companies, industries and jurisdictions, and there is no “one-size-fits-all” when it comes to risk management, many of the fundamental elements of a sound risk management exercise are applicable to numerous businesses. Attached is a series of questions that may be helpful to boards of directors and general counsel embarking on an assessment of HSE matters as well as a set of basic principles that form the basis of an effective risk management culture.

Virtually all business activities involve risk – it is extremely difficult, and if not impossible, commercially impractical, to eliminate all risk. Companies must constantly balance risk and reward and it falls on a company’s board of directors and senior management to foster a culture and environment that encourages proper risk assessment and mitigation into business decision-making.

Fundamental Questions Pertaining to Risk Assessment

Risk Identification

• What processes are employed to identify, on a continual basis, HSE risks?
• How are identified risks reported up through the organization?
• How, and to whom, are responsibilities allocated to manage these risks?

Response Preparedness

• Are response plans in place with respect to identified risks?
• How frequently are response plans reviewed? Are there “fire drills”?
• How are HSE incidents and near misses reported up through the organization?
• Does the senior officer(s) responsible for risk management have direct access to the CEO and the board of directors?
• What policies and procedures are in place to investigate HSE incidents or near-misses? How are findings memorialized and reported?
• What procedures are in place to incorporate findings from these investigations into practice as well as lessons learned from incidents with other companies, both within and outside of the company’s industry and peer companies?

Best Practices/Compliance

• What procedures are in place to continually monitor industry standards and regulatory compliance?
• In what circumstance would the company deviate from industry or company standards? How would this decision be reviewed and approved?
• What steps does the company take to monitor best practices? How is this reported?
• Are there circumstances when the company would deviate from best practices regarding HSE matters assuming applicable regulation would tolerate a lower standard? How would this decision be made and reviewed?
• How often are written manuals and procedures, including incident response plans, reviewed?

Basic Principles

• Set a proper “tone at the top” and reinforce the company’s commitment to HSE excellence through regular communications to the company’s workforce.
• Lead by example. Managers should not simply direct work and monitor compliance but should encourage suggestions, motive staff and engage the workforce to solve HSE problems.
• Rigorous HSE processes and procedures are not simply about legal compliance but make sound business sense and should be viewed as an integral part of productivity, competitiveness and profitability.
• Encourage personnel to be creative and take business initiative to drive competitiveness and profitability but do not tolerate cutting corners when it comes to HSE matters.
• Clearly define expectations, responsibilities and accountability for HSE compliance and failures.
• Foster a positive, trusting and open environment to facilitate communication of HSE problems and issues.
• Provide human and financial resources to ensure that safety procedures are effective and proper preventative measures can be taken.
• Make safety initiatives strong, clear and concise but do not overload personnel with duplicative or overwhelming policies or materials.
• Establish dynamic programs to continually monitor and evaluate hazards in systems to ensure prompt identification and rigorous analysis of such hazards.
• Ensure timely and thorough inspections and investigations of incidents and near misses.
• Conduct regular and rigorous safety process audits and fire drills and correct any deficiencies in a timely manner.
• Ensure appropriate aggregation and evaluation of information gathered regarding HSE issues and risks.
• Make clear throughout the organization that risk management is an ongoing and dynamic process – not one that is a finite project to be put to bed.
• Be vigilant for learning opportunities, across industries and jurisdictions.

***

May 27, 2010

Corporate Governance Update: Senate Bill Adversely Affects the Landscape

David A. Katz

and

Laura A. McIntosh*

From Wachtell, Lipton, Rosen & Katz

The final version of the financial reform bill1 adopted by the Senate last week included a number of corporate governance and executive compensation provisions that would apply to all U.S. public companies. The Senate bill will now need to be reconciled with the corresponding bill adopted late last year by the House of Representatives2, but it appears likely that most of these provisions will remain in the final legislation in some form. The House-Senate Conference Committee that intends to propose a final bill before July 4, 2010, will be led by Representative Barney Frank, the primary author of the House bill, and will include Senators Christopher Dodd, Blanche Lincoln, Richard Shelby and Saxby Chambliss3

Corporate Governance

The corporate governance provisions of the Senate bill primarily address four issues: mandatory proxy access, majority voting requirements, separation of the positions of chairman of the board and chief executive officer (CEO), and broker discretionary voting. Many of these provisions appear in similar form in the House bill. Importantly, the final version of the Senate bill does not include any limitation on public companies having staggered boards absent shareholder approval or ratification as had been proposed by Senator Charles Schumer in the Shareholder Bill of Rights Act of 20094. Similarly, the House bill has no limitation on staggered boards.

The Senate bill expressly authorizes the SEC to adopt mandatory proxy access rules under which shareholders would be able to nominate directors using the company’s proxy materials. While this is a change from the requirement that the SEC adopt proxy access rules, which was contained in Senator Schumer’s Shareholder Bill of Rights Act, the change may be a distinction that is irrelevant in light of the SEC’s continued stated commitment to implement mandatory proxy access.

Proxy access has the potential to wreak havoc with American business and we have previously expressed the view that the SEC’s adoption of proxy access rules is dangerous, unwise and unnecessary5. While the advocates of proxy access argue that it is designed to “help shift management’s focus from short-term profits to long-term growth and stability,”6 given the short-term outlook of many hedge funds and other institutions most likely to use proxy access, in our experience, it will do exactly the opposite. In our view, proxy access will only further empower activists who are focused on a short-term agenda and become another tool in the toolbox for corporate gadflies and special interest groups.

To the extent that the SEC moves forward with mandatory proxy access rules, the SEC should increase the eligibility thresholds and otherwise take steps to try to address the many risks that mandatory proxy access entails7. The SEC’s most recent proposal requires issuers to include in their proxy materials director nominees proposed by shareholders who satisfy ownership and other requirements. Any shareholder or group of shareholders that has held at least one percent of the stock of a public company (with larger thresholds for small-cap companies) for at least a year would be entitled to have their proposed nominees for up to 25 percent of the entire board included in the company’s proxy statement and on its proxy card, on a first-come, first-served basis. The one percent threshold is extremely low and will further empower activists to manipulate the corporate process in pursuit of their own agenda. The first-come, first-served procedure proposed by the SEC will give shareholders a perverse incentive to rush to nominate directors to ensure their place in line.

Moreover, the SEC proposed proxy access rule does not require a nominating shareholder to commit to hold stock in the company for any period of time if it succeeds in electing a nominee to the board. It would be detrimental to provide increased rights to shareholders who are free to seek short-term gain through the manipulation of board composition (and perhaps corresponding movements in stock price) without requiring such shareholders to continue to have an ongoing economic stake in the company. If the point of requiring a nominating shareholder to hold a substantial number of shares is to be sure that the shareholder has real “skin in the game,” that shareholder ought to be obliged to maintain its “skin” for some period should its nominee be elected to the board of directors.

The Senate version of the financial reform bill also requires that the stock exchanges implement majority voting in uncontested elections. The majority voting standard would apply only to uncontested elections (the plurality standard would still apply in contested elections) and would require that the number of shares voted “for” a director’s election exceed 50 percent of the votes cast with respect to that director’s election. Incumbent directors who are not reelected by a majority vote would be required to tender their resignation to the board of directors and the board would either have to accept the resignation or vote to reject it, in which case the company would have to publicly disclose the reasons for the rejection and why the rejection was in the best interests of the company and its shareholders. The House bill does not mandate majority voting.

The Senate bill would require the SEC to mandate disclosure of whether a company has separated its chairman of the board and CEO positions and its rationale for separating (or not separating) the positions. With respect to the separation of chairman of the board and CEO disclosure, it is not clear whether the Senate bill’s requirement would go beyond the rules that the SEC has already implemented. There are numerous justifications for having the same person hold the chairman of the board and CEO positions and we believe that so long as a board of directors has a majority of independent directors and an effective lead director, there is no real corporate governance benefit to separating the chairman and CEO positions8.

Finally, the Senate bill would require that the stock exchanges prohibit broker discretionary voting in connection with the election of directors, executive compensation or any other significant matter, as determined by the SEC. This prohibition would likely prevent brokers from being able to vote on most or all management proposals, such as management say-on-pay proposals that would also be mandated under the Senate bill. Effective in the 2010 proxy season, the SEC has already provided that brokers cannot vote on behalf of clients who fail to provide voting instructions in uncontested director elections at NYSE-listed companies. This is a significant change, as broker votes accounted for approximately 19 percent of votes cast with respect to directors during the 2009 proxy season9.

Although not strictly a corporate governance provision, the Senate bill, in its regulation of derivatives, would amend Sections 13(d), 13(f) and 13(g) of the Securities Exchange Act of 1934 to include within their beneficial ownership reporting requirements a market participant who “becomes or is deemed to become a beneficial owner [of an equity security] upon the purchase or sale of a security-based swap” under SEC rules. This is a change that should provide needed transparency to the markets, especially in the context of proxy contests and takeover battles, and is long overdue.

Executive Compensation

The executive compensation provisions of the Senate bill are largely unchanged from the initial version of the bill proposed by Senator Dodd. Unlike the House bill, the Senate bill does not require shareholder approval of golden parachutes.

The Senate bill requires an annual advisory vote on executive compensation (“say-on-pay”); this vote would not be binding on the company although a negative vote would be noticeable. For example, in 2009, no major U.S. public company lost a say-on-pay vote, but in the 2010 proxy season, where over 300 say-on-pay proposals are expected to be voted on, two significant companies have already lost the advisory vote10.

The Senate bill also sets enhanced independence requirements for compensation committee members and consultants/advisers and requires enhanced disclosure regarding the compensation committee and its operation. The Senate bill also requires enhanced disclosure on the relationship between pay and performance as well as disclosure with respect to director and employee hedging activities.

Unlike the House bill, the Senate bill would require a mechanism for recovering incentive compensation from current or former executive officers in the event of specified accounting restatements. The amount of compensation “clawed back” would be determined by what would have been payable under the restated results.

Another provision that is in the Senate bill but not the House bill would require public companies to disclose in their Form 10-Ks or proxy statements the ratio between the CEO’s compensation and the median compensation of all other employees (other than the CEO). While it may be important for compensation committees to consider internal pay equity analyses, it is unclear how comparing the ratio of the CEO’s compensation to the median compensation of all other employees will be useful to investors; yet this disclosure requirement appears to be politically popular.

Conclusion

There remain a number of differences between the financial reform bill adopted by the Senate and the corresponding version adopted by the House of Representatives late last year, but it appears likely that most of the corporate governance and executive compensation provisions will be part of the final legislation as the House–Senate Conference Committee led by Representative Frank fashions a compromise bill.

While a number of public companies, academics and commentators are advocating the elimination or substantial revision of the corporate governance provisions of the Senate bill, the growing likelihood is that they will be enacted largely in their current form and that public companies will have to address them in their proxy and compensation program planning in the near future. In our view, this will serve only special interests and investors with a short-term focus without enhancing the competitiveness of American companies in the global marketplace.

As we have said before, many of these reform proposals represent misguided attempts to assert federal control over areas that have traditionally, and successfully, been governed by state law11. The benefits of the state law model have been demonstrated time and again by states’ useful regulatory innovations, timely responsive actions and individualized regimes that help companies to maximize efficiency and minimize unnecessary burdens. Especially with respect to the details of corporate governance, a one-size-fits-all, top-down approach would have the effect of forcing conformity where it does not belong and serves no useful purpose. SEC Commissioner Troy A. Paredes recently spoke about the benefits of private ordering versus mandatory legislative initiatives:

Mandatory corporate law forces a universal governance scheme on all firms without permitting an enterprise to adapt its approach to governance and corporate accountability to its distinct circumstances. Recognizing that one-size-fits-all mandates are inappropriate for many businesses, the enabling approach defers to private ordering, spurred on by market discipline and competition, to determine how each firm should be organized to advance its interests most effectively. The enabling approach permits the internal affairs of each corporation to be tailored to its own attributes and qualities, including the company’s personnel, culture, maturity as a business, and governance practices.

The virtue of private ordering, in sum, is that it does not force all corporations into the same governance box. Instead, in yielding to the unique features of different companies, enabling corporate law expects firms to follow different paths to achieve the best results for the enterprise.

. . . .

Simply put, the countless characteristics that differentiate thousands of public companies in the U.S. from each other suggest that a one-size-fits-all approach to corporate governance is ill-advised12.

Early in his presidency, Barack Obama decried the “reckless culture and quarter-by- quarter mentality that in turn have wrought havoc in our financial system.”13 Unfortunately, it appears that the federal legislation that he currently supports will further that destructive culture instead of dismantling it.

Notes and Footnotes:

* David A. Katz is a partner and Laura A. McIntosh a consulting attorney at Wachtell, Lipton, Rosen &

Katz.Steven A. Rosenblum, a partner at the firm, assisted in the preparation of this article. The views expressed are the authors’ and do not necessarily represent the views of the partners of Wachtell, Lipton, Rosen & Katz or the firm as a whole.

1 “Restoring American Financial Stability Act of 2010,” H.R. 4173 (adopted by the Senate on May 20, 2010 by a vote of 59 to 39), available at

frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:h4173eas.txt.pdf.

2 “The Wall Street Report and Consumer Protection Act of 2009,” H.R. 4173 (adopted by the House on Dec. 11, 2010 by a vote of 222 to 202), available at

financialservices.house.gov/Key_Issues/Financial_Regulatory_Reform/FinancialRegulatoryReform/hr4173eh.pdf.

The House bill is 1279 pages and the Senate bill is 1616 pages, as it regulates derivatives and other matters not covered by the House bill.

3 Rachelle Younglai and Kevin Drawbaugh ,“Wall Street critic Frank to shepherd final reform bill” Reuters, May 24, 2010, available at http://www.reuters.com/article/idUSTRE64I5JQ20100524. Other Senators expected to be included on the Conference Committee are Tim Johnson, Charles Schumer, Tom Harkin, Patrick Leahy, Jack Reed, Mike Crapo, Judd Gregg and Bob Corker. Id.

4 Shareholder Bill of Rights Act of 2009 (S. 1074), available at frwebgate.access.gpo.gov/cgibin/

getdoc.cgi?dbname=111_cong_bills&docid=f:s1074is.txt.pdf.

5 See David A. Katz and Laura A. McIntosh, “Corporate Governance Update: Populists’ Wish Lists Offer

Legislative Parade of Horribles” NYLJ, July 23, 2009; see also David A. Katz and Laura A. McIntosh, “Corporate Governance Update: SEC Revisits Shareholder Access to Director Nominations,” NYLJ, Aug. 30, 2007; David A. Katz and Laura A. McIntosh, “Corporate Governance Update: Proxy Access—Not Then, Not Now,” NYLJ, Sept. 28, 2006.

6 Senate Committee on Banking, Housing, and Urban Affairs, “Summary: Restoring American Financial Stability, available at banking.senate.gov/public/_files/FinancialReformSummaryAsFiled.pdf

7 See Wachtell, Lipton, Rosen & Katz, “Comments on the SEC’s Proxy Access Proposals” (Aug. 17, 2009) available at http://www.wlrk.com/webdocs/wlrknew/WLRKMemos/WLRK/WLRK.16917.09.pdf.

8 See, e.g., PricewaterhouseCoopers “Lead Directors: A study of their growing influence and importance,” April2010, available at www.pwc.com/en_US/us/forensic-services/assets/lead-director-survey.pdf.

9 For an in-depth discussion of the issues raised by this rule, see David A. Katz and Laura A. McIntosh, “Corporate Governance Update: Activist Shareholders Would Gain Power from Proposed Rule Change,” NYLJ, Mar. 27, 2009.

10 See Erin White, “Investors Start to Make Their Voices Heard on Pay,” Wall Street Journal Online (May 10, 2010).

11 For a thorough discussion of this issue and other related points, see Martin Lipton, JayW. Lorsch and Theodore N. Mirvis, “A Crisis Is a Terrible Thing To Waste: The Proposed ‘Shareholder Bill of Rights Act of 2009’ Is a Serious Mistake,” May 12, 2009.

12 Commissioner Troy A Paredes, “Remarks at the 22nd Annual Tulane Corporate Law Institute” (April 15, 2010, available at sec.gov/news/speech/2010/spch041510tap.htm.

13 President Barack Obama, Speech on Executive Compensation, Feb. 4, 2009.

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From Wachtell, Lipton, Rosen & Katz

March 16, 2010

The Real Risks in Riskmetrics’ GRIds

By Trevor S. Norwitz

This week, Riskmetrics Group retires its signature governance ratings product, the Corporate Governance Quotient (or CGQ), and unveils its successor, Governance Risk Indicators (or GRIds). Many companies will be pleased to see the back of the CGQ, a blunt instrument used to pressure corporations into conforming to one-size-fits-all corporate governance “best practices”. But GRIds will not give them much reason to cheer, being largely a sharpened version of the CGQ skillfully repackaged to take advantage of the elevated power of the word “RISK” (also the company’s new ticker symbol). Predictably, in explaining the need for its new product Riskmetrics points to the financial crisis and the collapse of “storied financial houses,” even though governance failures were not a primary cause of the crisis (many of those storied houses had boasted stellar CGQ scores) and even though, as we have previously noted, academic research does not support the value of governance ratings.

It does appear that GRIds will avoid some of the CGQ’s more egregious flaws, like its mysterious “black-box” methodology and the conflict created by giving ratings credit for attending director education programs. Riskmetrics also says that GRIds will be more comprehensive and more granular than CGQ because, instead of providing a single relative governance “score” for each issuer, the take-away will be an absolute “level of concern” indicator (low, medium or high) in each of four dimensions: Board, Audit, Shareholder Rights and Compensation/Remuneration. This change will provide more information than the unitary CGQ, but will likely also mean greater pressure on areas where a company fails to live up to the Riskmetrics ideal. Although the GRIds process will be more transparent, it is still just a mechanical formula-based application (using criteria and weightings established by Riskmetrics) that does not take into account a company’s specific circumstances. Indeed, not only does GRIds not address serious real-world risks like the risk of failing to attract and retain top management talent, or the risk of being subject to a destabilizing hostile takeover bid at an opportunistic time, but blind adherence to its dictates could greatly exacerbate such risks.

Among the most serious risks to corporate effectiveness are the risk that managements and directors are distracted from the real threats and opportunities in their businesses by grading systems and “best practices” that are little more than “check-the-box” exercises, and the risk that the experienced business leaders needed to guide our corporations as directors decline to serve because the director’s role is being downgraded by the “good governance” industry.

Given Riskmetrics’ virtual monopoly in proxy advising, boards and their advisors will not be able to ignore GRIds and will likely have to spend considerable time understanding and responding to it. However, it should be seen for what it is, a data-point and an artfully marketed product, not a model to be embraced to earn governance “brownie points”. We continue to recommend that corporations and boards consider their own unique circumstances and needs in establishing their governance and compensation policies, and their takeover defenses.

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From Wachtell, Lipton, Rosen & Katz

April 20, 2010

UK Passes Strict New Bribery Act

Earlier this year, we noted that other countries, in addition to the United States, are increasing their efforts to combat international bribery and corruption. (See Increasing International Cooperation and Other Key Trends in Anti-Corruption Investigations – February 11, 2010). In a further reflection of this trend, on April 8, 2010, the United Kingdom passed the Bribery Act 2010 (http://www.opsi.gov.uk/acts/acts2010/ukpga 20100023 en 1). The Act is in many respects even broader in scope than the U.S. Foreign Corrupt Practices Act, including in its extraterritorial application. Thus, every company with ties to the U.K. should become familiar with the Bribery Act’s provisions.

The Bribery Act criminalizes several different types of domestic and foreign bribery including: (i) offering, promising or giving a bribe (section 1); (ii) requesting, agreeing to receive or accepting a bribe (section 2); and (iii) bribing a foreign public official (section 6). However, section 7, which sanctions any failure by commercial organizations to prevent bribery, may be the most significant provision. Under that section, a corporation will be liable when a person “associated” with that company (defined in section 8 as a person who “performs services for or on behalf” of the company) pays a bribe for the purpose of obtaining or retaining business or to obtain or retain a business advantage. The company can defend itself only if it can establish that it “had in place adequate procedures designed to prevent persons associated with [the company] from undertaking such conduct.” Thus, unlike in the U.S., where prosecutors apply their discretion in evaluating a company’s compliance policies and procedures in the context of weighing charging decisions and potential leniency, the statute establishes strict liability in the case of a bribe being paid for companies that failed to implement adequate compliance policies and procedures.

The Bribery Act itself does not specify what procedures will be considered adequate. Pursuant to section 9, the U.K.’s Secretary of State is required to publish guidance “about procedures that relevant commercial organisations can put in place.” However, we expect that such guidance will not be written in a vacuum. The U.S. Sentencing Guidelines for Organizations (section 8B2.1) and DOJ’s Principles of Federal Prosecution of Business Organizations (United States Attorneys’ Manual 9-28.800) have for several years provided a framework for U.S. companies designing and implementing effective policies.

The Bribery Act contains other significant differences from the FCPA in addition to the new “failure to prevent bribery” offense. Unlike the FCPA, it applies to bribery transactions that do not involve public officials and applies to the recipient of a bribe. In addition, there is no exemption for “facilitating payments”—small payments made for the purpose of expediting the performance of a routine governmental action. Moreover, the “failure to prevent bribery” offense applies, by its terms, to any foreign corporate entity “which carries on a business, or part of a business, in any part of the United Kingdom.” And section 12 of the Act specifies that a company may violate section 7 “irrespective of whether the acts or omissions which form part of the offence take place in the United Kingdom or elsewhere.” This broad jurisdictional reach of the Act thus creates potential liability for any U.S. company with ties to the U.K. regardless of where a covered act of bribery takes place.

While DOJ’s recent emphasis on the FCPA has made global compliance a high priority for companies doing business internationally, those companies must now consider more than the FCPA when they assess the adequacy of their policies and procedures. The passage of the Bribery Act underscores the importance for companies of taking affirmative steps to establish an effective anti-corruption compliance infrastructure, set an appropriate tone at the top to reinforce senior management’s commitment to compliance, and give employees and supervisors adequate tools to understand and comply with applicable rules and regulations.

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From The Harvard Law School Forum on Corporate Governance and Financial Regulation

April 8, 2010

A Cautionary Tale for Audit Committee Chairs?

Posted by Keith F. Higgins, Ropes & Gray LLP, on Thursday April 8, 2010 at 9:11 am
Editor’s Note: Keith F. Higgins is a partner at Ropes & Gray LLP specializing in securities offerings, mergers and acquisitions and corporate governance.

The SEC announced on March 15, 2010 that it had charged the former CEO, CFOs, and Audit Committee Chair of infoGroup Inc. with securities fraud and other securities law violations in connection with almost $9.5 million of undisclosed perquisites paid to the CEO and $9.3 million of undisclosed related party transactions with entities the CEO controlled. The CEO and the Audit Committee Chair agreed to settle the matter, without admitting or denying the allegations.

The Audit Committee Chair, Vasant Raval, consented to an injunction against future violations, agreed to pay a $50,000 civil money penalty, and agreed to be barred from serving as an officer or director of a public company for five years.

Bad facts, it is frequently said, make bad law. It is difficult to know whether this case represents a measured response to a set of egregious facts or whether it sets a new standard to which audit committee chairs should be held. At the very least, it provides audit committee chairs with a roadmap of what not to do when confronted with allegations of improper conduct.

The infoGroup CEO, who was also its largest shareholder, appears to have utterly missed the distinction between appropriate corporate and personal expenses. He also appears to have engaged in multiple related party transactions through entities he controlled that were never disclosed in infoGroup’s SEC filings. In January 2005, a list of related party transactions was brought to the attention of the board of directors, which tasked Raval, as chair of the audit committee, with investigating the issues. The following ensued:

* Raval conducted an investigation on his own, without the assistance of independent counsel, which revealed insufficient documentation and explanations for various reimbursements and transactions.

* During the investigation, Raval received an unsolicited communication from the company’s internal auditor questioning various amounts reimbursed to the CEO. Raval was the only director who appears to have received this communication. He assured the internal auditor that he would address the concerns with the CEO, but did not.

* A mere 12 days after being tasked with looking into the related party transactions, Raval prepared a report he characterized as the product of an “in-depth investigation” of the matter. He did not, according to the SEC, inform the board that he was aware of insufficient documentation or that he had not, in fact, investigated the CEO’s expenses.

* Raval received subsequent communications from internal audit and from outside disclosure counsel questioning various transactions but failed to inform the board or take appropriate action.

The SEC asserted that Raval knew, or was reckless in not knowing, that infoGroup was making false and misleading disclosures about the payments to and transactions with the CEO. These false and misleading statements were made in SEC filings that Raval signed as a director. The SEC asserted further that Raval “had a duty to take steps to ensure the accuracy and completeness of statements contained in the company’s Commission filings.” Had he investigated the red flags, hired outside counsel to do so, or brought the red flags to the attention of others on the audit committee or the board, the fraud could have been uncovered sooner. That was the basis for the complaint against him.

What does this proceeding mean for audit committee chairs? Notwithstanding the broad language of the SEC’s complaint, it would be an overreaction to conclude that the audit committee chair must “fact check” a company’s SEC filings. The SEC’s statement that Raval had a duty to ensure the accuracy of a company’s filings must be read in the context of a director who was aware of red flags but failed to take reasonable steps under the circumstances to investigate.

What it does mean, however, is that when presented with credible allegations of improper conduct, a director should perform a vigorous and thorough investigation. That investigation should, at the very least, involve others on the audit committee, and consideration should be given to retaining outside counsel to conduct, or assist with, the investigation. It is worth noting as well that under state corporate statutes, such as Sec. 141(e) of the Delaware General Corporation Law, directors are fully protected in relying in good faith upon experts selected with reasonable care.

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RiskMetrics, March 9, 2010

SEC Allows Two Banks to Omit Bonus Banking Proposal

By Ted Allen

The SEC has ruled that Bank of America and JPMorgan Chase may omit the American Federation of State, County, and Municipal Employees’ new “bonus banking plus” proposal, which seeks changes in how the banks compensate their 100 most highly paid employees.

The agency staff concluded that the AFSCME resolution did not focus on the relationship between executive compensation and excessive risk-taking. The staff found that the proposal related to general employee compensation, which traditionally has been viewed as an “ordinary business” matter, and thus is not a proper subject for a shareholder resolution.

“We are disappointed by the SEC’s ruling,” said John Keenan, a strategic analyst with AFSCME. “On one hand, Pay Czar Ken Feinberg has the authority to regulate pay of the top 100 paid employees at the big seven TARP firms, and the Federal Reserve is reviewing the link between compensation and risk at the largest 25 banks, and yet the SEC is allowing Bank of America and JPMorgan to omit our bonus banking proposals on ordinary business grounds. As the financial crisis plainly shows, compensation practices for traders, brokers, and investment bankers, and not just the senior executives, can [incentivize] unnecessary and excessive risk.”

AFSCME has submitted similar proposals at Wells Fargo and Goldman Sachs, which also have filed no-action requests. They both argue that the resolution relates to “ordinary business” and is “misleading.”

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February 1, 2010

Executive Compensation Trends in the Current Economic Climate

DolmatConnell & Partners of Boston conducted a survey in the fourth quarter of 2009 to complement the Company’s Spring 2009 survey on changes in executive compensation practices and structure in response to the economic downturn. This release highlights the trends and issues facing Compensation Committees and executive teams as they respond to the continually challenging economic climate.

Base Salaries

• 73% of respondents plan to increase base salaries for 2010, up significantly from the 16% in the spring survey, and 52% of respondents plan to increase base salaries by between 2.0% and 4.0%.
• Larger companies are more likely to be increasing base salaries in 2010 than their smaller counterparts. 95% of firms over $1B in revenue are planning to increase base salaries, while only 63% of firms under $1B in revenue plan to increase base salaries.

Short–Term Incentives / Bonus Plans

• While a majority of responding companies anticipate paying out bonuses for fiscal 2009, the majority of those making payments expect to do so below target. Only 15% of respondents reported expectations of paying bonuses above target, while 18% of firms expect no bonus payout at all given continued financial troubles. Unlike projected base salary increases, projected bonus payout ranges do not correlate with company size, and small and large firms alike reported payments across the scale.
• 45% of respondents do not anticipate any adjustments to their short–term incentive plans, similar with findings in the spring survey. The two most commonly reported adjustments were placing an increased emphasis on financial performance and allowing for Board discretion of short–term incentive payouts. A large number of firms additionally noted expanding the performance range given financial instability and difficulty in predicting accurate metrics.

Long–Term Incentives

• 23% of respondents indicated that they plan on modifying their equity instrument mix in 2010, as compared to 44% of in the spring survey, indicating that the pace of change in LTI plan design may be beginning to slow as companies are now fine–tuning their plans and the market has somewhat recovered.
• Though not a sea change in equity instrument usage, the most notable trend in instrument mix change was the decline in the number of companies using only stock options. While in 2009, 24% of survey respondents granted only stock options, companies indicate that in 2010 only 15% plan on granting stock options alone, as many companies seek to balance the upside leverage of options with the retention of full–value awards.
• As shown in the chart below, survey respondents are slightly decreasing the use of stock options, and placing more of a focus on other equity instruments, including time–based restricted shares / units, and performance–based equity. Likely in response to significant share pool constraints, 26% of participants also reported granting long–term cash awards in 2010, a substantial increase over the 18% of firms granting long–term cash awards in 2009.

• While approximately 75% of respondents provide annual equity awards to C–suite officers and SVP / VP level executives, participation begins to fall off below that point as many companies face equity and budgetary constraints. 61% of respondents grant equity to the director level, while this decreases to only 48% at the manager level, and approximately a third provide grants to individual contributor level employees. This follows a trend seen in recent years of companies reserving equity for upper–level management and executives as equity pools shrink due to increased pressure caused by FAS 123(R) and from scrutiny on burn rates from shareholder watchdogs such as RiskMetrics Group.

Emerging Governance Best–Practices

• 42% of respondents indicated that their firms have an incentive or severance clawback policy, increasing dramatically from our Spring 2009 survey, which indicated only 16% of those surveyed had clawback policies. In addition, 29% of companies are considering implementing an incentive or clawback policy, indicating that the increasing prevalence of clawback policies is likely to continue in 2010.
• While a majority of companies surveyed do not mandate a stock ownership policy, 43% of companies have executive stock ownership programs, while 36% mandate Board of Director’s stock ownership. While the most prevalent ownership policy is stock ownership guidelines, several companies have enhanced their ownership guidelines with holding requirements.
• Augmenting ownership guidelines with holding requirements is gaining prevalence in the broader market, as holding requirements ensure executives with longer tenure do not begin selling once they have reached the ownership guideline threshold.

• We anticipate that the number of firms implementing ownership policies will continue to increase; however, given current markets, many companies are rethinking how to set requirements, as a dollar?based approach (i.e. 3x base salary for CEO) may no longer be reasonable given low stock prices.

• While risk has become a major focal point for the government, regulators, and shareholder advocates, only 35% of survey respondents assert that risk has become a factor in designing compensation plans. When segmented by the size of respondents, it is interesting to note that while the vast majority of companies greater than $3B in revenues are factoring risk into plan design, the next most concerned group is those companies with revenues less than $50M.

• Furthermore, 30% of companies surveyed have addressed risk in compensation plans by conducting Compensation Committee risk assessments. Risk assessments are certainly the most popular way to tackle the risk issue; however, a small percentage of companies (<10%) are also addressing risk through a risk committee, including risk as a metric in the annual bonus plan, and utilizing excessive–risk triggered clawbacks.
• Continuing the governance discussion, it is highly anticipated that Say–on–Pay will be legislated in the near future. While this cloud is hanging over the head of those planning the executive compensation disclosure in their annual proxy statements, no companies surveyed plan on willingly adopting Say–on–Pay at this time, and only 39% are even considering doing so.

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DolmatConnell & Partners is a privately held compensation consulting firm dedicated to providing independent, insightful, and innovative advice in all areas of executive compensation and Board of Directors remuneration.

At a time of unprecedented scrutiny of executive compensation programs, DolmatConnell & Partners delivers the independent advice required in today’s demanding governance environment. Our consultants draw on their significant consulting and corporate experience to provide insightful advice to a wide range of clients, including venture–backed startups and Fortune 500 companies.

If you would like to discuss this survey and how it relates to your firm, please contact Jack Dolmat–Connell at dcinfo@dolmatconnell.com or (781) 392–3600.

***

Goodwin Proctor LLP

Public Company Advisory, December 21, 2009

SEC Adopts Final Rules Requiring Additional Proxy Statement Disclosures and Earlier Disclosure of Voting Results from Stockholder Meetings

On December 16, 2009, the Securities and Exchange Commission (“SEC”) adopted rules requiring companies to make additional disclosures in proxy statements about (i) their board of directors and executive officers, including director and director nominee qualifications, legal actions involving directors, director nominees or executive officers, board leadership structure and risk oversight; (ii) compensation policies and practices that relate to risk management practices and risk-taking incentives; and (iii) potential conflicts of interest of compensation consultants that advise companies and their boards of directors. In addition, the new rules change how companies must report awards of stock and options in the Summary Compensation Table and Director Compensation Table and when companies must report voting results from stockholder meetings.

The rules are effective for filings made on or after February 28, 2010. The text of the SEC release is available on the SEC’s website here. The additional disclosures will be required in companies’ proxy statements and certain other filings for which disclosure regarding corporate governance, directors and executive officers and compensation is required, which may include Form 10-K annual reports and registration statements under the Securities Exchange Act of 1934 and registration statements under the Securities Act of 1933 and Investment Company Act of 1940.

Board of Directors and Executive Officers

The rules require companies to make additional disclosures about their board of directors and executive officers, including:

• Director Qualifications. For each director and director nominee, a discussion of the specific experience, qualifications, attributes and skills that led to the board’s conclusion that the person should serve as a director in light of the company’s business and structure. If material, this disclosure is required to cover more than the past five years, including information about the person’s particular areas of expertise or other relevant qualifications.
• “Bad Boy” Disclosures. An expanded list of legal proceedings involving a director, director nominee or executive officer that must be disclosed, which includes (i) orders, judgments, decrees or findings relating to alleged violations of securities or commodities laws, laws respecting financial institutions or insurance companies or laws prohibiting fraud and (ii) sanctions or orders of any self-regulatory organization, such as the stock exchanges, or other similar organizations. In addition, the look-back period for disclosing these legal proceedings, as well as the other “bad boy” legal proceedings previously required to be disclosed, has been increased from five years to 10 years.
• Other Directorships. Any other public company or registered investment company directorships held by directors and director nominees during the past five years, as opposed to just current directorships, which are required to be disclosed by existing rules.
• Leadership Structure. The leadership structure of the board of directors, including whether the same person serves as both chief executive officer and chairman of the board and, if so, whether the company has a lead independent director and the specific role the lead independent director plays in the leadership of the board. The disclosure must indicate why the company has determined that its leadership structure is appropriate given the specific characteristics or circumstances of the company.
• Risk Oversight.The board’s role in the oversight of risk, such as how the board administers its oversight function, and the effect that this has on the board’s leadership structure.
• Diversity. Whether, and if so how, the nominating committee or the board considers diversity in identifying nominees for director. If the nominating committee or the board has a policy with regard to the consideration of diversity in identifying director nominees, the company must describe how this policy is implemented as well as how it assesses the effectiveness of its policy.

Action Items:

• Update directors’ biographical information to include the expanded discussion required by the new rules regarding each director’s specific experience, qualifications, attributes and skills that led to the board’s conclusion that the person should serve as a director in light of the company’s business and structure and any other additional disclosure required by the new rules. Circulate the updated disclosure concerning directors’ and nominees’ experience, qualifications, attributes and skills for internal review.
• Update director and officer questionnaires to gather additional information about director and nominee qualifications, legal actions and other public company or registered investment company directorships. Our 2009 Year-End Toolkit will contain questionnaires that have been updated to gather this additional information.
• Consider whether any changes to the board leadership structure, such as the appointment of an independent chairman or lead independent director, are desired in light of the new disclosure requirements. Update the description of the board’s leadership and risk oversight and related matters and circulate for internal review.
• Consider adopting a formal policy addressing the consideration of diversity in identifying director nominees. Note that the new rules do not define diversity, citing a wide range of factors that companies may wish to consider, including differences in viewpoint, professional experience, education, skill, race, gender and national origin.

Compensation Policies and Practices Relating to Risk Management

Under the new rules, if risks arising from a company’s compensation policies and practices for its employees are reasonably likely to have a material adverse effect on the company, then the company is required to include a discussion of these compensation policies and practices as they relate to risk management practices and risk-taking incentives. The SEC has indicated that situations that may trigger disclosure include, among others, compensation policies and practices:

• At a business unit that carries a significant portion of the company’s risk profile;
• At a business unit with compensation structured significantly differently than other units within the company;
• At a business unit that is significantly more profitable than others within the company;
• At a business unit where the compensation expense is a significant percentage of the unit’s revenues; and
• That vary significantly from the overall risk and reward structure of the company, such as when bonuses are awarded upon accomplishment of a task, while the income and risk to the company from the task extend over a significantly longer period of time.

If a company determines that disclosure is required, the SEC has provided the following examples of issues that the company may need to address for the business units or employees:

• General design philosophy of compensation policies and practices for employees whose behavior is most affected by the incentives established by the policies and practices, and the manner of their implementation;
• Risk assessment or incentive considerations, if any, in structuring compensation policies and practices or in awarding and paying compensation;
• How compensation policies and practices relate to the realization of risks resulting from the actions of employees in both the short term and the long term, including policies requiring claw backs or imposing holding periods;
• Policies regarding adjustments to compensation policies and practices to address changes in risk profile, and material adjustments made as a result of any such changes; and
• Monitoring of compensation policies and practices to determine whether its risk management objectives are being met with respect to incentivizing its employees.

Important note: smaller reporting companies will not be subject to these new rules.

Action Items:

• Evaluate compensation policies and practices at all levels within the company to determine whether there are risks arising from these compensation policies and practices that are reasonably likely to have a material adverse effect on the company. Companies should specifically consider different compensation policies and practices that apply to different groups of employees. To the extent that all employees are subject to substantially similar policies and practices, this discussion may be consolidated. To the extent that companies have significantly different compensation structures for certain groups of employees, such as compensation that is heavily weighted towards transaction-based incentives, a separate discussion of such compensation structures may be required. Each public company will have a different risk profile, and as a result there is no “one-size-fits all” approach. Both quantitative and qualitative analysis of compensation policies and procedures may, and likely will, be appropriate.

Potential Conflicts of Interest of Compensation Consultants

The rules also require disclosure of the fees paid to compensation consultants in the following circumstances:

• Compensation Consultant Engaged by Compensation Committee. If a compensation consultant is engaged by the compensation committee to provide advice or recommendations on the amount or form of executive and director compensation and the compensation consultant or its affiliates also provided additional services to the company or its affiliates in an amount in excess of $120,000 during the company’s last fiscal year, then the company must disclose (i) the aggregate fees for determining or recommending the amount or form of executive and director compensation and (ii) the aggregate fees for such additional services. In addition, the company must disclose whether the decision to engage the consultant for the other services was made or recommended by management and whether the compensation committee or the board approved such other services.
• Compensation Consultant Engaged by Management. If the compensation committee has not engaged a compensation consultant, but management has engaged a compensation consultant to provide advice or recommendations on the amount or form of executive and director compensation and the compensation consultant or its affiliates also provided additional services to the company in an amount in excess of $120,000 during the company’s last fiscal year, then the company must disclose (i) the aggregate fees for determining or recommending the amount or form of executive and director compensation and (ii) the aggregate fees for such additional services. Note: For companies where the compensation committee and management have separate compensation consultants, no disclosure requirement is triggered for services provided by management’s compensation consultant, regardless of whether those services relate to executive or director compensation or other matters.

Action Items:

• Review the use of compensation consultants by the compensation committee and/or management of the company, and determine whether any disclosure will be required.
• Consider using separate consultants for executive and director compensation and for all other matters.

Summary Compensation Table and Director Compensation Table Changes

Under the new rules, in the Summary Compensation Table and Director Compensation Table, companies must disclose the aggregate grant date fair value of stock and option awards in the year in which the grant was made. Previously, companies were required to report the amount recognized during the year for accounting purposes for all stock and option awards, regardless of when they were granted. This will be a significant change in how total compensation will be calculated for directors and named executive officers. For example, if a company granted one of its named executive officers an equity award on December 31, 2009 with a grant date fair value of $500,000 that vested over five years, under the new rules, the company would be required to report the entire $500,000 as 2009 compensation. Under the old rules, the grant date fair value would have been incorporated into the executive’s compensation over five years (approximately $100,000 per year).

For equity awards that are subject to performance conditions, the value that is to be reported is to be based on the probable outcome of such conditions, which should be consistent with the estimate of the aggregate compensation cost to be recognized under applicable accounting rules, excluding the effect of estimated forfeitures. However, companies must also disclose in footnotes to the tables the value of the award at the grant date assuming that the highest level of performance conditions will be achieved.

In adopting the new rule, the SEC specifically considered whether the grant date fair value for stock and option awards should be included for the year in which the grant occurred for accounting purposes or the year to which the grant related. The SEC concluded that the amount should be included for the year in which the grant date occurred, stating that “because it appears that multiple subjective factors, which could vary significantly from company to company, influence equity awards granted after fiscal year end, we are concerned that changing the approach to reporting [away from the requirement to report awards in the year granted] could result in inconsistencies that would erode comparability.”

This rule change is also significant because it influences the total compensation number that is used to determine which executive officers are “named executive officers” whose compensation information must be disclosed in the proxy statement. Under SEC rules, “named executive officers” generally includes the CEO and CFO as well as the three other most highly compensated executive officers based on their total compensation as reported in the Summary Compensation Table. As a result, if an executive officer who would not ordinarily be a named executive officer receives a large one-time grant in a particular year, that executive officer could become a named executive officer for that year. In the adopting release, the SEC specifically acknowledged this consequence and indicated that in such situations the company can consider including compensation disclosure for the executive officer who ordinarily would have been a named executive officer to supplement the required disclosures.

Under the new rules, data for prior years, if included in the table, must be recalculated in accordance with the new rules.

Action Items:

• Assess how this change will impact the identity of the company’s “named executive officers,” and consider whether it will be appropriate to include supplemental compensation disclosure for executives who, but for large grants of stock, would be “named executive officers.”
• Consider how this change will impact the company’s reported total compensation for its named executive officers and directors, in particular in connection with the reporting year for year-end grants which may be made just prior to the end of the current year or in the beginning of the new year.

Early Disclosure of Stockholder Votes on Form 8-K

The rules create a new Item 5.07 of Form 8-K pursuant to which companies are required to disclose the results of stockholder votes within four business days of a stockholder meeting or written consent in lieu of a stockholder meeting. In the event that final voting results are not available, companies must file preliminary voting results within four business days of the vote, and file the final voting results within four business days after they become available. This item replaces the previous Form 10-Q and Form 10?K requirement to report these voting results for stockholder meetings or consents that occurred during the quarterly period to which the report related (or the fourth quarter for Form 10?Ks).

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RiskMetrics

December 10, 2009

Proxy Disclosure Rules on the SEC’s Agenda

Submitted by: Ted Allen, Publications

The Securities and Exchange Commission has scheduled a Dec. 16 open meeting where it will consider whether to finalize a new set of proxy disclosure rules.

The final regulations have not been released, but the rules have not generated significant controversy since the five-member commission unanimously voted in July to propose them. The SEC has not disclosed the effective date for these requirements, but agency officials have said they hope to approve the rules in time for the 2010 proxy season. The proposed rules include the following:

* The relationship of a company’s overall compensation policies to risk. SEC officials said companies would only be required to address “material” risks.

* The qualifications of director nominees and how their skills would help them to serve on the board and perform their specific committee assignments. In addition, companies would have to provide details on outside directorships held during the past five years, instead of only current board memberships. SEC staffers have said that issuers should welcome a chance to expound on the qualifications of their nominees.

* Board leadership structure. Companies would have to explain why they decided to appoint a non-executive chairman or chose to combine the roles of board chair and CEO.

* Potential conflicts of interests of compensation consultants. Companies would have to provide details on other services performed by pay advisers and the fees paid for that work.

The proposals also included a revised proxy solicitation rule to allow short-slate dissident groups to round out their slates with candidates from other dissident groups. Under current rules, dissidents may only supplement short slates with management nominees.

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Wachtell, Lipton, Rosen & Katz

November 12, 2009

A Principles-Based Model for Regulating Compensation

The Swiss Financial Market Supervisory Authority (FINMA) recently issued regulations addressing executive compensation at Swiss financial institutions. Notably, the regulations provide significant guidance on appropriate compensation incentives and structures, but emphatically decline to regulate pay directly.

The FINMA regulations will apply on a mandatory basis to the largest Swiss banks and insurance companies and will serve as a guideline for all other firms that FINMA supervises. Most significantly, the regulations require (1) alignment of compensation structures with risk management and promotion of long-term sustainable business objectives, (2) imposition of stock holding periods and compensation deferral arrangements under certain circumstances, (3) integration of compensation decisions with capital and liquidity planning, (4) company-established limits on sign-on bonuses and severance payments that a company may exceed only by obtaining approval from the board of directors, and (5) increased disclosure and transparency, including a comprehensive annual remuneration report from the board of directors.

FINMA rejected calls for a total ban on variable compensation, and the regulations avoid provisions that would directly regulate pay levels or that would mandate or prohibit particular compensation design structures. FINMA notes that it does not regard “a total ban or severe restrictions on variable pay” as a “useful approach” and that direct restrictions on compensation do not represent a “sensible option.” Rejecting a one-size-fits-all framework, FINMA further notes the impracticality of determining a “single appropriate arrangement” for all regulated firms within the Swiss financial sector.

FINMA’s new rules represent a sound approach from a regulator in a jurisdiction that houses a significant number of global financial institutions. The regulations establish core principles designed to ensure that compensation does not create incentives to take inappropriate risks, and impose on boards key oversight and disclosure responsibilities. At the same time, the rules recognize that long-term economic growth requires that individual institutions have the flexibility to implement programs specific to their needs and the ability to attract and retain management talent. A universal principles-based approach would place all financial institutions on a level playing field.

Adam J. Shapiro

David E. Kahan

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RiskMetrics November 4, 2009

House Panel Approves Proxy Access Provision

Submitted by Ted Allen, Publications/Governance Institute

The U.S. House Financial Services Committee voted 41-28 today to approve a wide-ranging investor protection bill that affirms the authority of the Securities and Exchange Commission to issue a rule on proxy access.

The legislation, the “Investor Protection Act of 2009,” also would double the SEC’s budget over five years, authorize the commission to bar mandatory arbitration clauses in investor contracts, require all financial intermediaries to have a fiduciary duty to their investor clients, expand whistleblower bounties, and address some of the enforcement failures and regulatory loopholes illustrated by the Madoff scandal.

However, the bill also includes an amendment that would permanently exempt companies with less than $75 million in market capitalization from the auditor attestation requirements of Section 404 (b) of the Sarbanes-Oxley Act of 2002. That amendment, which was sponsored by Reps. Scott Garrett and John Adler of New Jersey, was narrowly approved by a 37-32 vote, with nine Democrats joining panel Republicans in support. That measure, which was opposed by SEC chair Mary Schapiro and investor advocates, also directs the SEC and the Comptroller General to study how to reduce compliance burdens for companies with less than $250 million in market capitalization.

Supporters of the Garrett-Adler amendment said the measure was backed by the Treasury Department and White House officials. The SEC previously extended the Section 404(b) compliance deadline for small issuers until 2010, while looking into ways to lessen compliance burdens. Rep. Adler argued that Sarbanes-Oxley’s higher-than-expected compliance costs had dissuaded some companies from going public and prompted others to list their shares overseas. He and Garrett said the amendment would help preserve jobs while maintaining the status quo.

Rep. Paul Kanjorski, a Democrat from Pennsylvania, opposed the permanent exemption, noting that 43 percent of restatements occur at firms with less than $75 million in market capitalization. “This is exactly the wrong time to lessen reporting and the information that investors can get,” he warned.

The proxy access amendment, which was offered Rep. Maxine Waters of California and Rep. Gary Peters of Minnesota, was approved by a 39-30 vote, with 28 Republicans and two Democrats opposing the measure. The amendment, which doesn’t set any specific ownership standards for access, was offered to provide legal support to the SEC in the event that the U.S. Chamber of Commerce or other corporate groups file a lawsuit to block the rule. Corporate advocates and some governance observers have warned that the SEC doesn’t have the authority currently to set minimum federal standards for permitting shareholders to nominate directors to appear on management proxy statements. Schapiro and other SEC officials have said they hope to approve a final access rule in early 2010.

The California Public Employees’ Retirement System, the nation’s largest public pension fund, hailed the approval of the proxy access amendment. “This legislative effort strongly led by Rep. Maxine Waters supports the single most powerful thing we can do to improve corporate governance in America’s boardrooms by giving shareowners a way to hold directors more accountable,” Rob Feckner, CalPERS’ board president, said in a press release.

The House committee also voted 41-27 to reject an amendment by Rep. Christopher Lee of New York that would have prohibited certain contingency fee arrangements for lawyers suing broker-dealers and investment advisers under contracts that predate the legislation.

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Recent Executive Summaries of legislation impacting Boards of Directors. Latest Major Action may not be current.

H.R.3269
Title: To amend the Securities Exchange Act of 1934 to provide shareholders with an advisory vote on executive compensation and to prevent perverse incentives in the compensation practices of financial institutions.
Sponsor: Rep Frank, Barney [MA-4] (introduced 7/21/2009) Cosponsors (11)
Related Bills: H.RES.697
Latest Major Action: 8/3/2009 Referred to Senate committee. Status: Received in the Senate and Read twice and referred to the Committee on Banking, Housing, and Urban Affairs.
House Reports: 111-236

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SUMMARY AS OF:

7/31/2009–Passed House amended. (There are 2 other summaries)

Corporate and Financial Institution Compensation Fairness Act of 2009 – (Sec. 2) Amends the Securities Exchange Act of 1934 to require that any proxy or consent or authorization for an annual shareholders meeting provide for a separate shareholder vote to approve executive compensation for named executive officers as disclosed pursuant to rules of the Securities and Exchange Commission (SEC).

States that the shareholder vote shall not be: (1) binding on the corporation or the board of directors; (2) construed as overruling a board decision, or as creating or implying any additional fiduciary duty by the board; or (3) construed as restricting or limiting shareholder ability to place executive compensation proposals within proxy materials.

Requires solicitations that seek shareholder approval of an acquisition, merger, consolidation, or proposed sale or other disposition of assets to disclose clearly and simply in the proxy or consent solicitation material any agreements or understandings with named executive officers of the disposing or the acquiring issuer concerning (golden parachute) compensation (present, deferred, or contingent) that is based upon or relates to such asset disposition, including the aggregate total compensation to or on behalf of such executive officer.

Requires separate shareholder approval of such golden parachute agreements or understandings and compensation, as disclosed, unless already subject to a shareholder vote at an annual shareholders meeting. States that a separate shareholder vote on golden parachute compensation shall not be: (1) binding on the issuer or its board of directors or the person making the solicitation; or (2) construed as overruling a decision by such person or issuer, or as creating or implying any additional fiduciary duty by any such person or issuer.

Requires certain institutional investment managers to report annually how they voted on any shareholder vote.

Authorizes the SEC, after taking into account the potential impact on smaller reporting issuers, to exempt certain categories of issuers from the requirements of this Act.

(Sec. 3) Directs the SEC to direct the national securities exchanges and national securities associations to prohibit the listing of any class of equity security of an issuer that does not comply with specified requirements for compensation committees (or equivalent bodies) established by and amongst an issuer’s board of directors for the purpose of determining and approving the compensation arrangements for the issuer’s executive officers.

Requires each member of the compensation committee of the issuer’s board of directors to be independent. Prohibits any compensation committee member from accepting any consulting, advisory, or other compensatory fee from the issuer. Allows for SEC exemptions from such requirements for particular relationships.

Requires a compensation consultant, legal counsel, or other adviser to an issuer’s compensation committee to meet SEC independence standards.

Grants the compensation committee of each issuer discretionary authority to retain and obtain the advice of a compensation consultant meeting SEC independence standards. Requires any proxy or consent solicitation material for an annual shareholder meeting to disclose whether the issuer’s compensation committee retained and obtained the advice of an independent compensation consultant.

Authorizes a compensation committee to retain and obtain the advice of independent counsel and other independent advisers.

Directs the SEC to study and report to Congress on the use of independent compensation consultants.

(Sec. 4) Directs federal regulators to prescribe jointly regulations requiring each covered financial institution to disclose the structures of all incentive-based compensation arrangements sufficient to determine whether the compensation structure: (1) is aligned with sound risk management; (2) is structured to account for the time horizon of risks; and (3) meets other criteria appropriate to reduce unreasonable incentives offered by such institutions for employees to take undue risks.

Requires such regulators to prescribe jointly regulations that prohibit any compensation structure or incentive-based payment arrangement that encourages inappropriate risks by financial institutions that could: (1) threaten the safety and soundness of covered financial institutions; or (2) present serious adverse effects upon economic conditions or financial stability.

Exempts covered financial institutions with assets of less than $1 billion from these compensation arrangement disclosure requirements.

Prohibits any such regulation from requiring the recovery (clawback) of incentive-based compensation under compensation arrangements in effect on the date of enactment of this Act if such an agreement is for a period of no more than 24 months. Declares that this Act shall neither prevent nor limit the recovery of incentive-based compensation under any other applicable law.

Directs the Comptroller General to study and report to Congress on whether there is a correlation between compensation structures and excessive risk taking. Requires the study, in determining whether a company failed, or nearly failed but for government assistance, to focus on: (1) companies that received exceptional assistance under the Troubled Asset Relief Program (TARP) under the Emergency Economic Stabilization Act of 2009 (EESA) or other forms of significant government assistance, including under the Automotive Industry Financing Program, the Targeted Investment Program, the Asset Guarantee Program, and the Systemically Significant Failing Institutions Program; (2) the Federal National Mortgage Association (Fannie Mae); (3) the Federal Home Loan Mortgage Corporation (Freddie Mac); and (4) companies that participated in the SEC’s Consolidated Supervised Entities Program as of January 2008.

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H.R.2861
Title: To amend the Securities Exchange Act of 1934 to provide for rules and standards relating to the election of boards of directors and certain requirements relating to compensation of executives.
Sponsor: Rep Peters, Gary C. [MI-9] (introduced 6/12/2009) Cosponsors (11)
Latest Major Action: 6/12/2009 Referred to House committee. Status: Referred to the House Committee on Financial Services.

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SUMMARY AS OF:
6/12/2009–Introduced.

Shareholder Empowerment Act of 2009 – Amends the Securities Exchange Act of 1934 to direct the Securities and Exchange Commission (SEC) to prohibit national securities exchanges and associations from listing the securities of any issuer unless, to the extent permitted by state law, such issuer requires: (1) the election of directors who receive the majority of votes in uncontested elections or a plurality of votes in contested elections; and (2) directors who are not reelected to offer to tender their resignations.

Directs the SEC to: (1) require issuers to identify and provide security holders with an opportunity to vote on director candidates who have been nominated by holders of at least 1% of the issuer’s voting securities for at least two years, provided security holders have nominated fewer than a majority of the directors then authorized to serve; (2) prohibit brokers from voting securities on an uncontested election to the board of directors without having received specific instructions from the securities’ beneficial owners; and (3) requires listed issuers, to the extent possible, to have an independent chairman of their board of directors who has not served as an executive of the issuer.

Requires any proxy or consent or authorization for an annual or other meeting of a securities issuer to permit a separate shareholder vote on executive compensation, though such vote shall not be binding on its board of directors.

Directs the SEC to direct the national securities exchanges and national securities associations to prohibit: (1) issuers from retaining advisors in negotiating executive employment or compensation agreements that are not independent or are protected from liability by such issuers; (2) the listing of issuers that do not have a (clawback) policy of recovering executive payments that were unearned due to fraud, faulty financial statements, or some other cause; and (3) the listing of issuers that provide severance payments to senior executives who are terminated for poor performance.

Directs the SEC to require additional disclosure of specific performance targets issuers use in determining a senior executive’s eligibility for bonuses, equity, and incentive compensation.

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S.1074
Title: A bill to provide shareholders with enhanced authority over the nomination, election, and compensation of public company executives.
Sponsor: Sen Schumer, Charles E. [NY] (introduced 5/19/2009) Cosponsors (1)
Latest Major Action: 5/19/2009 Referred to Senate committee. Status: Read twice and referred to the Committee on Banking, Housing, and Urban Affairs.

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SUMMARY AS OF:
5/19/2009–Introduced.

Shareholder Bill of Rights Act of 2009 – Amends the Securities Exchange Act of 1934 to require any proxy or consent or authorization for an annual or other meeting for which the proxy solicitation rules of the Securities Exchange Commission (SEC) require shareholder compensation disclosure to include a separate resolution subject to shareholder vote to approve the compensation of executives.

Requires any person making a proxy solicitation concerning an acquisition, merger, consolidation, or proposed sale or other disposition of substantially all of the assets of an issuer (transaction) to disclose in the proxy solicitation material, in a clear and simple form, any agreements or understandings of that person with any of the issuer’s principal executive officers concerning any type of (golden parachute) compensation based on or otherwise related to the transaction that have not been subject to a shareholder vote.

Requires the proxy solicitation material for a golden parachute to require a separate shareholder vote to approve it.

Directs the SEC to establish rules for the use by shareholders of issuer proxy solicitation materials for the purpose of nominating individuals to membership on the issuer’s board of directors. Prohibits such rules from providing for such use, however, unless the shareholder, or a group of shareholders acting by agreement, has beneficially owned, directly or indirectly, an aggregate of at least 1% of the issuer’s voting securities for at least the two-year period preceding the date of the issuer’s next scheduled annual meeting.

Requires the SEC to direct the national securities exchanges and national securities associations to prohibit the listing of any security of an issuer that is not in compliance with any specified requirements pertaining to director independence, mandatory annual elections, SEC rules on elections, and mandatory establishment of a risk committee to establish and evaluate the issuer’s risk management practices.

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RiskMetrics Group U.S. Policy – Repricing of Stock Options

Option Exchange Programs/Repricing Options:

Vote CASE-by-CASE on management proposals seeking approval to exchange/reprice options taking into consideration:

• Historic trading patterns–the stock price should not be so volatile that the options are likely to be back “in-the-money” over the near term;
• Rationale for the re-pricing–was the stock price decline beyond management’s control*
• Is this a value-for-value exchange*
• Are surrendered stock options added back to the plan reserve*
• Option vesting–does the new option vest immediately or is there a black-out period*
• Term of the option–the term should remain the same as that of the replaced option
• Exercise price–should be set at fair market or a premium to market
• Participants–executive officers and directors should be excluded.

If the surrendered options are added back to the equity plans for re-issuance, then also take into consideration the company’s three-year average burn rate. In addition to the above considerations, evaluate the intent, rationale, and timing of the repricing proposal. The proposal should clearly articulate why the board is choosing to conduct an exchange program at this point in time. Repricing underwater options after a recent precipitous drop in the company’s stock price demonstrates poor timing. Repricing after a recent decline in stock price triggers additional scrutiny and a potential AGAINST vote on the proposal. At a minimum, the decline should not have happened within the past year. Also, consider the terms of the surrendered options, such as the grant date, exercise price and vesting schedule. Grant dates of surrendered options should be far enough back (two to three years) so as not to suggest that repricings are being done to take advantage of short-term downward price movements. Similarly, the exercise price of surrendered options should be above the 52-week high for the stock price.

Vote FOR shareholder proposals to put option repricings to a shareholder vote.

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RiskMetrics

Monday, September 21, 2009

“Microsoft Agrees to Hold a Triennial Pay Vote”
Submitted by: Ted Allen, Publications

Microsoft has become the first U.S. company to agree to hold a triennial advisory vote on executive compensation. The software giant’s example, if followed by other issuers, could put significant pressure on U.S. lawmakers to allow firms to hold triennial rather than annual “say on pay” votes.

In a Sept. 18 blog posting, Brad Smith, Microsoft’s general counsel, and deputy general counsel John Seethoff said the company’s board decided to conduct a triennial vote at the next annual meeting on Nov. 19 after receiving a triennial vote proposal from the United Brotherhood of Carpenters and a request for an annual advisory vote from Walden Asset Management and the Calvert Group.

The company lawyers said the board considered the merits of both resolutions and concluded that a triennial pay vote was preferable. Among the reasons cited by the Redmond, Washington-based company were:

• Our compensation program is designed to induce and reward performance over a multi-year period. Say-on-Pay votes should occur over a similar timeframe.
• A three-year cycle will provide investors sufficient time to evaluate the effectiveness of our short- and long-term compensation strategies and related business outcomes.
• Most compensation programs can’t be changed overnight. Triennial votes give the Board and the Compensation Committee sufficient time to thoughtfully respond to shareholders’ sentiments and implement any necessary policy changes.
• Pre-existing Board requirements to seek shareholder approval of employee stock plans and other compensation-related matters give our shareholders an opportunity to provide feedback even in years when Say-on-Pay votes do not occur.

In late July, the Democratic-controlled House of Representatives approved legislation to require U.S. issuers to hold annual pay votes, although some Republicans argued that triennial votes would be less burdensome on issuers. The Senate likely will consider the issue, along with other governance reforms, in the coming months. The Carpenters union, which had filed more than 20 triennial proposals, has withdrawn the resolutions and plans to focus on lobbying lawmakers.

Two dozen U.S. companies, including Intel and Occidental Petroleum, have agreed to hold annual votes on compensation, according to RiskMetrics Group data.

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KPMG LLP

M&A Spotlight, August 19, 2009

“Global Acquirers Should Include FCPA Due Diligence to Limit Liability”

A challenging deal environment and a rigorous regulatory enforcement environment are increasing the importance of due diligence. Acquirers involved in cross-border deals need to pay particular attention to the Foreign Corrupt Practices Act (FCPA) to limit their potential liability. The FCPA, in essence, prohibits U.S. companies and issuers from bribing foreign entities or officials in order to obtain business. U.S. regulatory agencies have stepped up their already aggressive enforcement efforts in prosecuting companies for alleged violations of the statute. For example, this year, a leading global engineering, construction, and services company agreed to pay a record fine of $579 million in a case involving the bribery of Nigerian officials. Another global engineering company in December 2008 pled guilty to FCPA violations involving kickbacks to Iraqi officials and paid $450 million in criminal fines and $350 million in civil penalties. And in July, a U.S. executive was convicted of FCPA charges arising out of inadequate due diligence concerning an investment involving the privatization of the State Oil Company of the Azerbaijan Republic. There were at least 120 companies at the end of May 2009 under investigation by the Department of Justice, up from 100 at the end of last year, according to the Wall Street Journal.

There currently is at least one high-profile investigation with mergers and acquisition (M&A) implications. A large public information technology company, which may be acquired by a competitor, stated in its recent 10-Q that “[d]uring fiscal year 2009, we identified activities in a certain foreign country that may have violated the Foreign Corrupt Practices Act.” It is not uncommon for FCPA issues to first come to light during the M&A due diligence process.

Discovering Problems

According to a recent KPMG LLP survey of over 100 U.S. executives operating abroad, 84 percent reported having implemented FCPA anti-corruption policies, while 75 percent reported having implemented whistleblower mechanisms; 67 percent stated that their companies provided FCPA-related communications and training programs to at least a segment of their employees. Only 36 percent, however, felt that their company’s level of FCPA due diligence in a merger, acquisition, or other transaction in the past five years was “adequate,” while 27 percent described FCPA due diligence efforts as “minimal.”

A recent criminal prosecution illustrates the cost of failing to undertake adequate pre-deal due diligence. In April, a recently acquired telecommunications company pled guilty to violating the FCPA’s anti-bribery provision. The acquiring company did not discover the violations until after the closing. The acquiring company self-reported the violation to the Department of Justice, paid a $2 million fine and fired the acquired company’s management team. The acquiring company also wrote off $20 million of its $26 million investment, as a direct result of the discovery of the FCPA violation, costs associated with the company’s resulting internal investigation and its cancellation of various contracts and business lines. Finally, the acquiring company agreed to conduct pre-deal due diligence on all future acquisitions. Clearly the acquiring company would have been in a far better position had it uncovered the FCPA violation prior to closing.

Adding to the due diligence challenges is the fact that there is not a great deal of legal precedent in this area. Therefore, new regulatory enforcement actions and legal settlements can alter established interpretations of the FCPA, thereby requiring companies to continuously recalculate FCPA-related risk assessments, especially in regard to due diligence and internal audit work plans.

Those involved in overseas acquisitions should always consider including FCPA issues during due diligence. These issues need to be uncovered early in the process because if a problem is found, resources need to be mobilized quickly to assess the impact of that problem on the overall acquisition and the acquirer needs to determine the steps that should be taken either before or immediately after an acquisition closes. It should be noted, however, that the discovery of FCPA violations does not have to be a deal breaker. A deal may be able to be completed if the improper business practices and the legal issues are promptly and appropriately addressed.

In addition to the risk of potentially large financial liabilities, companies associated with FCPA violations may also experience a loss of investor confidence, loss of revenue generated through improper or illegal conduct, and, in some instances, indictments or convictions that put the acquirer at risk of being barred from doing business with government agencies. “While purchasers may not be aware of all of the target’s inappropriate historical practices, they are nevertheless legally liable in most cases for those practices that continue after the transaction is closed,” according to KPMG’s Rocco deGrasse, a principal in the firm’s Forensic practice who performs FCPA-focused due diligence. “Federal regulators are less inclined to consider reducing penalties for an acquirer who fails to discover a target’s improper practices before the closing of an acquisition if the government believes that inadequate due diligence played a role in causing that oversight,” he says.

FCPA violations may also impact the target’s valuation, says KPMG’s Rob Coble, who has worked on numerous cross-border deals. If an acquirer discovers that the target has obtained business partially through payments of bribes, then the buyer needs to understand how the absence of bribe payments would affect future revenue. Depending on the situation, the acquirer may decide to lower its purchase price or possibly walk away from the transaction. The company may also want to request guidance from federal regulators through a formal process offered by the Department of Justice. The acquirer’s degree of leverage also is an important consideration in planning FCPA-related preacquisition due diligence, according to Coble. “It is much more challenging to perform FCPA-related due diligence in an auction context, as opposed to a deal environment in which the potential acquirer has an exclusive right to acquire for at least a set period of time,” he says.

Understanding the Risk Factors

FCPA-focused due diligence is most relevant in deals that share certain types of high-risk characteristics. The target’s geographic location and the nature of a target’s business operations are the two most significant factors to consider in undertaking an FCPA risk assessment. Organizations such as Transparency International rank countries based on corruption and propensity to demand bribes. According to a recent Transparency International report, the least corrupt countries were Denmark, New Zealand, and Sweden; the most corrupt countries included Somalia, Myanmar, Iraq, and Haiti.

The target’s industry and business operations is a significant consideration because the nature of those operations define the areas in which the target’s operations interact with foreign entities or foreign officials. Companies that provide goods and services to state-owned entities (SOEs) or government agencies create a different FCPA risk profile from targets that do not sell to SOEs but are heavily regulated by foreign governments. For example, industries with significant contacts to SOEs as both customers and regulators will merit even greater scrutiny, such as target associated with the oil and gas, pharmaceutical, and aerospace and defense industries, according to KPMG’s deGrasse. In short, any acquisition that may require some sort of governmental approval or involvement beyond something standard such as an antitrust evaluation may indicate a possible vulnerability.

“When reviewing financial records of targets that have added risk factors, acquirers should look for unexplained commissions, suspicious ‘charitable’ donations, and suspect invoices,” says KPMG’s Coble. Complicating the due diligence process, however, is the fact that the types of deals and jurisdictions that are most vulnerable to potential FCPA problems are also those that are likely to pose the most challenging due diligence environments. According to the KPMG study, 73 percent found that it was either “very” challenging or “somewhat” challenging to conduct FCPA due diligence during M&A activities.

Conclusion

Targets with business practices that may constitute FCPA infractions may create significant legal liabilities for an acquirer that can result in fines, penalties and termination of business lines that generate significant revenue. It is therefore crucial for acquirers, especially those involved with targets that have a relatively high FCPA risk profile to include a forensic FCPA component in the due diligence process. Early discovery will help an acquirer to determine if a deal should proceed and also provide it with the information needed to address the relevant legal and business issues if the deal does proceed.

(underlining by The Directors Letter)

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