Kara MacCullough and Laurie Green are Partners in our Fort Lauderdale office.

In this Issue...

  • Senate Passes Final Financial Reform Bill
  • SEC Proposes Amendments to NASDAQ Listing Rules
  • Thomson Reuters and NASDAQ OMX Embrace Web Disclosure
  • SEC's Chief Accountant Addresses Status of Accounting and Auditing Standards Projects
  • Court Holds That CFO Has No Duty to Correct Statements Made by Another Officer
  • Delaware Chancery Court Adopts Standard for Controlling Stockholder Going Private Transactions

SENATE PASSES FINAL FINANCIAL REFORM BILL

On May 20, 2010, the Senate passed the Restoring American Financial Stability Act of 2010 (the "Senate Bill"). The Senate Bill now must be reconciled with the Financial Stability Improvement Act of 2009 passed by the House in December 2009 (the "House Bill"). The House and Senate Conference Committee plans to submit a final bill to President Obama before July 4, 2010. Both bills attempt to regulate financial institutions and their products and also include the corporate governance and executive compensation provisions discussed below.

Both the Senate Bill and the House Bill provide:

  • Mandatory Proxy Access: The SEC would have the authority to adopt rules requiring companies that are subject to the SEC's proxy rules to include shareholder nominees for the board in the company's proxy statement on terms determined by the SEC.
  • Say on Pay: Companies would be required to have an annual advisory vote on executive compensation.
  • Compensation Committee Independence: Compensation committee members of listed companies would be required to satisfy heightened independence standards established by the national securities exchanges, including standards related to consulting, advisory or other fees to the issuer. In addition, the SEC would be required to adopt rules ensuring that any compensation consultant, legal counsel, or other advisor to the compensation committee was "independent" (as defined by the SEC).
  • Beneficial Ownership of Swaps: Section 13(d) would be amended to include beneficial ownership of security-based swaps.

The Senate Bill (but not the House Bill) provides:

  • Mandatory Majority Voting: Listed companies would be required to adopt a majority voting standard in uncontested elections. Any directors that do not receive a majority vote would be required to resign. The board must accept the resignation or vote unanimously to reject it and disclose the reasons for the rejection.
  • Enhanced Proxy Disclosure: Companies would be required to include proxy disclosure of the relationship between executive compensation and financial performance, taking into account any change in the value of stock and dividends and any distributions, which may, but is not required to, include a pictorial comparison. Companies would also be required to disclose the ratio between the CEO's compensation and the median compensation of all other employees.
  • Clawback Policy: Companies would need to develop and implement a clawback policy that would require recovery of all incentive-based compensation from all executive officers (both current and former) in the event of a financial restatement, for the three-year period preceding the restatement in excess of what they would have been paid under the restatement. This clawback provision strengthens Sarbanes-Oxley by requiring clawback even if no one engaged in misconduct.
  • Employee Hedging: Companies would be required to disclose whether their employees are permitted to engage in hedging activities that are designed to hedge or offset market declines affecting compensatory equity awards.
  • Broker Discretionary Voting: Brokers would be prohibited from exercising discretionary authority to vote in connection with the election of directors, executive compensation (including say-on-pay), or any other significant matter as determined by the SEC.
  • Disclosure of Separation of Chairman and CEO: Companies would be required to disclose in their annual proxy statements the reasons they have chosen to either have a single CEO and chairman, or why they have separated the CEO and chairman positions. SEC rules currently require this disclosure and it is unclear what additional disclosure would be required by the Senate Bill.

The House Bill (but not the Senate Bill) would require companies to have an advisory vote on golden parachutes relating to a merger, acquisition or other change of control.

Senate Bill: http://frwebgate.access.gpo.gov/cgi-bin/getdoc.cgi?dbname=111_cong_bills&docid=f:s3217as.txt.pdf

House Bill: http://docs.house.gov/rules/finserv/111_hr_finsrv.pdf

SEC PROPOSES AMENDMENTS TO NASDAQ LISTING RULES

On May 19, 2010, the SEC published a notice soliciting comments on amendments to NASDAQ's Listing Rules. NASDAQ filed the rule change with the SEC on May 14, 2010 and has designated the proposed rule change as constituting a non-controversial rule change, which renders the proposal effective upon filing with the SEC.

Currently, Rule 5625 of the NASDAQ Listing Rules requires that a listed company notify NASDAQ when an executive officer of the company becomes aware of any "material" noncompliance with NASDAQ's corporate governance requirements contained in the Rule 5600 series. As amended, Rule 5625 would now require notification of any noncompliance. According to the SEC release, NASDAQ has consistently interpreted this notification requirement such that any noncompliance with the corporate governance requirements contained in the Rule 5600 series would be considered material. The amendments also make conforming changes to Rule 5615(a)(3) and IM-5615-3, which, among other things, require a foreign private issuer to provide notice of noncompliance.

http://www.sec.gov/rules/sro/nasdaq/2010/34-62135.pdf

THOMSON REUTERS AND NASDAQ OMX EMBRACE WEB DISCLOSURE

Thomson Reuters and The NASDAQ OMX Group, Inc. are set to launch new one-stop web disclosure tools that give companies greater choice and direct control over how they meet their regulatory obligations and communicate with investors online. Both the Thomson Reuters and NASDAQ OMX products will enable companies to directly distribute their disclosure information in real time to their choice of disclosure points from a single web publishing tool. In addition, the Thomson Reuters and NASDAQ OMX products will allow clients to prepare and distribute press releases themselves with flat-rate pricing regardless of word count, in comparison to the standard PR Newswire practice of charging by the word.

On May 25, 2010, The NASDAQ OMX Group announced that GlobeNewswire (a NASDAQ OMX company) will debut its "do-it-yourself" news distribution and disclosure model at the National Investor Relations Institute Conference in San Diego from June 6-9, 2010.

http://ir.nasdaqomx.com/releasedetail.cfm?ReleaseID=473245

http://thomsonreuters.com/content/financial/pdf/i_and_a/web_disclosure.pdf

SEC'S CHIEF ACCOUNTANT ADDRESSES STATUS OF ACCOUNTING AND AUDITING STANDARDS PROJECTS

On May 21, 2010, the SEC's Chief Accountant, James Kroeker, testifying before a Subcommittee of the U.S. House Committee on Financial Services, addressed the status of various accounting and auditing standards matters that the SEC is working on in conjunction with the Financial Accounting Standards Board (FASB) and the Public Company Accounting Oversight Board (PCAOB). During the testimony, Mr. Kroeker provided an overview of the role and responsibilities of the Office of Chief Accountant (OCA) and the approximately 50 professionals that are employed by the Office. Mr. Kroeker stated that OCA oversees, on behalf of the Commission, the activities of the FASB and PCAOB and works closely with the other Offices and Divisions of the Commission, to:

  • monitor existing accounting and auditing standards in practice to determine areas where improvement or new standards may be warranted
  • increase standardization in the application of accounting and auditing standards and related interpretations – working closely with the FASB and PCAOB
  • coordinate enforcement efforts with the PCAOB

With respect to current SEC Accounting and Auditing projects, Mr. Kroeker highlighted the following:

  • Internal Control Over Financial Reporting: The final phase-in of the requirement under Sarbanes-Oxley Section 404 to have auditor attestation of internal control over financial reporting is proceeding on schedule. This requirement will be effective for registrants with less than $75 million of public float beginning for fiscal years ending on or after June 15, 2010.
  • Global Accounting Standards: As part of its ongoing project to promote the convergence of U.S. GAAP and International Financial Reporting Standards (IFRS), the SEC has launched a work plan to study the scope of, timing of and approach to changes necessary to effectively incorporate IFRS into the financial reporting system for U.S. issuers. There are also ongoing convergence projects between the FASB and IFRS involving financial instrument fair values, revenue recognition, leases, debt vs. equity, and financial statement presentation with the goal of developing high quality, common accounting standards.
  • Interactive Data (XBRL): XBRL, the SEC's interactive data system, pursuant to which registrants submit financial statements and notes to the financial statements to the SEC in an interactive format, is proceeding on schedule. The XBRL list of tags has been integrated into the FASB's Accounting Standards Codification, thereby making it possible to navigate from financial statements filed with the SEC to the underlying accounting standards, and to navigate from an accounting standard to where it has been applied in practice. The SEC believes that this will allow both it and the FASB to better monitor how standards are being applied in practice. Approximately 500 companies have submitted XBRL-encoded financial statements to date. Additional companies will begin complying with the XBRL rules with their Form 10-Qs for June 2010 and the remainder will begin submitting financial statements in XBRL format with their Form 10-Qs for June 2011.
  • Repo 105 Transactions: The SEC recently requested that 19 large public companies provide the SEC information about their use and accounting of "Repo 105" transactions (which are contracts to sell a security on a specific day and to repurchase that same security at a date in the future for a set price). Based on the responses, the SEC determined that inappropriate practices, such as those utilized by Lehman Brothers, of recording Repo 105 transactions as sales rather than secured borrowings are not widespread. However, the SEC has requested several companies to enhance disclosure regarding their accounting of Repo 105 transactions and expand disclosure of off-balance sheet arrangements beginning in their Form 10-Qs.

http://sec.gov/news/testimony/2010/ts052110jlk.htm

COURT HOLDS THAT CFO HAS NO DUTY TO CORRECT STATEMENTS MADE BY ANOTHER OFFICER

The Third Circuit Court of Appeals recently held that "the plain language of § 10(b) and corresponding Rule 10b-5 do not contemplate the general failure to rectify misstatements of others." The Court also rejected the federal government's argument that the defendant's position as a "high corporate executive" imposed a general fiduciary duty requiring disclosure.

The defendant was the former CFO of a business unit of a pharmaceutical company. He was criminally indicted on conspiracy and securities fraud charges related to statements and alleged omissions concerning the company's business practice of incentivizing its wholesalers to purchase and inventory more products than were needed based on actual demand. The government maintained that this practice fraudulently inflated corporate sales in the short term, and was covered up in public pronouncements to analysts and in the company's filed financials.

On appeal was the district court's dismissal of a government theory that the CFO could be convicted for failing to correct misleading statements as to wholesale inventory levels made by another officer on analyst calls. The Court of Appeals affirmed the lower court's rejection of any duty to speak in order to correct another's statements, confirming that in only three scenarios does a duty to disclose arise: (1) insider trading; (2) a statutory requirement of disclosure; and (3) an inaccurate, incomplete, or misleading prior disclosure by the same individual. The court rejected the Government's theory that "high corporate officers" have a fiduciary duty to correct the omissions or inaccuracies of others.

United States v. Schiff, 2010 WL 1338141 (3d Cir., Apr. 7, 2010)

http://www.ca3.uscourts.gov/opinarch/081903p.pdf

DELAWARE CHANCERY COURT ADOPTS STANDARD FOR CONTROLLING STOCKHOLDER GOING PRIVATE TRANSACTIONS

The Delaware Court of Chancery held that the "entire fairness" standard of review applies to a going private transaction (tender offers and mergers) initiated by a controlling stockholder unless the transaction is both (i) negotiated and affirmatively recommended by a special committee of independent directors and (ii) conditioned on the affirmative tender or approval of a majority of the minority stockholders. However, if these two prongs are met, then the less burdensome "business judgment" standard of review would apply.

The Court applied the entire fairness standard since neither prong was satisfied. The first prong fell short as (i) the special committee of the board of directors did not recommend the transaction (it remained neutral) and (ii) the special committee of the board of directors did not have the proper authority to negotiate with the controlling stockholder. The second prong was not met because the effectiveness of the majority of the minority tender or approval condition remained in question.

The Court's decision also focused on the requirement that the special committee of the board of directors must have decision making power similar to the board's in a third-party transaction, including the ability to adopt a stockholder rights plan. In addition, the Court stated that the effectiveness of a majority of the minority condition may be undermined by the inclusion of stockholders whose economic incentives materially differ from those of the other minority stockholders. Specifically, the largest minority stockholder held a slightly larger percentage of shares in the controlling stockholder.

In re CNX Gas Corp. Shareholders Litigation, C.A. No. 5377-VCL (Del Ch. May 25, 2010)

http://www.delawarelitigation.com/uploads/file/int2B(3).pdf

The editors would like to thank the following contributors for their assistance with this issue of Securities & Financial News to Note: David A. Kahn and Alexandra P. Lumpkin

www.hklaw.com

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.