United States: Securities Update, September 2010

SEC RELEASES TENTATIVE RULEMAKING SCHEDULE

By Troy Calkins

In September 2010, the SEC posted a proposed schedule for considering rules to implement various provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act. This schedule can be found at http://www.sec.gov/spotlight/dodd-frank/dfactivity-upcoming.shtml. The schedule for rulemaking to implement Dodd-Frank provisions related to compensation, corporate governance and securities offerings is as follows:

October‑December 2010 (planned)

• §413 – Propose rules to revise the "accredited investor" standard, with a goal of adoption by April‑July 2011
• §926 – Propose rules disqualifying the offer or sale of securities in certain exempt offerings by certain felons and others similarly situated, with a goal of adoption by April‑July 2011
• §951 – Propose rules regarding shareholder votes on executive compensation and golden parachutes, with a goal of adoption by January‑March 2011
• §951 – Propose rules regarding disclosure by investment advisers of votes on executive compensation, with a goal of adoption by January‑March 2011
• §952 – Propose exchange listing standards regarding compensation committee independence and factors affecting compensation adviser independence; propose disclosure rules regarding compensation consultant conflicts, with a goal of adoption by April‑July 2011

April‑July 2011 (planned)

• §§953 and 955 – Propose rules regarding disclosure of pay-for-performance, pay ratios and hedging by employees and directors
• §954 – Propose rules regarding recovery of executive compensation
• §957 – Propose rules defining "other significant matters" for purposes of exchange standards regarding broker voting of uninstructed shares

FASB PROPOSES CHANGES TO LOSS CONTINGENCIES DISCLOSURE REQUIREMENTS

By F. Douglas Raymond III and Elizabeth A. Diffley

The Financial Accounting Standards Board (FASB) has once again waded into the sensitive subject of disclosure of loss contingencies by proposing new standards for required disclosures of possible losses and liabilities (the 2010 Exposure Draft). The Exposure Draft, Proposed Accounting Standards Update, Contingencies (Topic 450), Disclosure of Certain Loss Contingencies, is available at http://tinyurl.com/FAS450. As we discussed in an earlier memorandum (available at http://tinyurl.com/DBR-LossContingencies), the longstanding accounting guidance for loss contingencies, ASC 450-20 (formerly FAS 5), has been challenged by investor groups and others as requiring disclosure about potential liabilities that is often inadequate. FASB's previous attempt in 2008 to expand disclosure elicited controversy and significant resistance from commenters. In general, the 2008 Exposure Draft was broadly criticized for requiring disclosure that relied on information that may not be readily available or reliable, was irreconcilable with the litigious U.S. legal environment and constituted an assault on the attorney-client privilege. As a result, FASB conducted extensive re-deliberations before releasing the 2010 Exposure Draft, which it has indicated was designed to address both investor needs for information and the practical concerns raised about the 2008 Exposure Draft.

The proposed amendments do not have a direct balance sheet impact, but would both expand the types of loss contingencies required to be disclosed and mandate the disclosure of specific quantitative and qualitative information about loss contingencies. FASB solicited comments to the 2010 Exposure Draft and extended the due date for comments from August 20 to September 20, 2010. If adopted in its current form, the disclosure requirements would be applicable to public companies for fiscal years ending on or after December 15, 2010, and to private companies for fiscal years beginning on or after December 15, 2011.

Current Requirements under ASC 450 (Contingencies)

Currently, ASC 450 requires that a company book a loss contingency on its balance sheet if both the probability of the contingency occurring is "probable" (likely to occur) and the loss is reasonably estimable. If, however, the loss contingency does not meet both of these conditions, but is "reasonably possible" (meaning more than remote but less than likely), the company does not book the loss, but must disclose the loss contingency in the footnotes to the financial statements. The footnote disclosure must include the nature of the contingency and an estimate of the possible loss, or a statement that an estimate cannot be made. No footnote disclosure is required if the probability of loss is "remote" (slight).

Under current standards, when public companies disclose information about litigation loss contingencies that are not required to be reserved for on the balance sheet, they usually do not disclose an estimate of their loss exposure, and they often limit the discussion of material litigation to basic facts, procedural history and status. FASB has said that its objective for the 2010 Exposure Draft is to provide users of financial statements with information that helps them assess various possible outcomes of a loss contingency before it is settled. Furthermore, FASB has stated that it has been motivated by investor concerns that disclosures under the current guidance do not provide adequate and timely information to assist users in assessing the likelihood, timing and magnitude of future cash outflows associated with contingencies.

2010 Exposure Draft – Proposed Amendments to ASC 450

Disclosure Threshold

The 2010 Exposure Draft would not change the standard for recording a liability in connection with a loss contingency and, for the most part, would retain a similar disclosure threshold. A company must disclose information about a contingency if there is at least a reasonable possibility (more than a remote possibility) that a loss may be incurred, regardless of whether the company has accrued a reserve for the loss. FASB would also retain the current standard for unasserted claims. Generally, a company is not required to disclose a loss contingency involving an unasserted claim if there has been no manifestation by a potential claimant of an awareness of a potential claim, but disclosure is required if it is both probable that a claim will be asserted and there is a reasonable possibility that the outcome will be unfavorable.

The Exposure Draft would, however, expand required disclosures to include even remote loss contingencies that "due to their nature, potential magnitude or potential timing" could have a "severe impact." FASB defines "severe impact" as a significant financially disruptive effect on the normal functioning of a company. It intends that this would be a higher threshold than "material" but would include matters that are less than catastrophic. Though some events are material to an investor because they affect the company's stock price, a change in the stock price alone, without a corresponding impact on the company itself, would not necessitate disclosure under this standard. A company would not be permitted to consider the availability of insurance or other indemnification arrangements when assessing the materiality of a loss contingency, which many commenters expect to lead to an increase in the number of contingencies companies are required to disclose.

Quantitative and Qualitative Information Requiring Disclosure

When the standards of the 2010 Exposure Draft require disclosure of a contingency, a company must disclose information in the notes to the financial statements sufficient to enable readers to understand the nature of the loss contingency, its potential magnitude and, if known, its potential timing. The 2008 Exposure Draft was criticized because it called for management to predict the outcome of a disclosure contingency, so in the 2010 Exposure Draft, FASB attempted to address this issue by instead requiring enhanced disclosure of the known facts and the contentions of the parties. For example, in the early stages of litigation, the company must disclose, at a minimum, the contentions of the parties, including the basis of the plaintiff's claim, the damages claimed by the plaintiff and the basis for the company's defense or a statement that it has not yet formulated its defense. As the matter progresses and the information becomes available, the company would be required to disclose publicly available quantitative information, such as the amount of damages indicated by expert witness testimony and, for individually material contingencies, sufficiently detailed information to enable the reader to obtain additional information from publicly available sources such as court records. If the possible loss or range of losses can be estimated, disclosure of the estimate would be required, and if it cannot be estimated, the company would be required not only to state that it cannot be estimated but also the reasons it cannot be estimated. If known, the company would be required to disclose the anticipated timing of the resolution of the contingency or other next steps.

The 2010 Exposure Draft would also require the disclosure of other nonprivileged information that would be "relevant" to understanding the "potential magnitude of the possible loss." Information about possible recoveries from insurance and other sources must be disclosed if discoverable by the litigation plaintiff or by a regulatory agency, or if the recovery is related to a recognized receivable. A company would further be required to disclose if an insurer has denied, contested or reserved its rights related to the company's claim for recovery.

Public (though not private) companies would also be required, during each financial reporting period, to provide a table that reconciles the carrying amounts of accruals for loss contingencies as of the beginning and end of the period, the amount accrued for new loss contingencies during the period, changes in the estimates for prior period loss contingencies and decreases for payments or other forms of settlement. The tabular disclosure could be presented on an aggregated basis for loss contingencies of the same class or type. In deciding how to aggregate the accruals, the company would be required to exercise judgment to strike a balance between obscuring important information and overburdening financial statement users with excessive detail.

No Exemption for Prejudicial Information

The 2008 Exposure Draft included a limited exemption from disclosure of information that may be prejudicial to the company, but the 2010 Exposure Draft does not include such an exemption. FASB has specifically, through the public comment process, requested that interested parties provide feedback as to whether a prejudicial information exemption is necessary, but noted that it did not include an exemption in its proposal because it believed that it had eliminated the need for such an exemption by changing the disclosure requirements to focus on publicly available and discoverable information.

Concerns with Proposed Amendments

FASB has demonstrated a commitment to change the loss contingency disclosure requirements in its effort to help users of financial statements make more informed assessments about the possible outcomes of loss contingencies and has made an obvious effort to address and resolve many of the serious concerns expressed about its 2008 Exposure Draft. Nevertheless, the 2010 Exposure Draft has raised renewed concerns about its potentially prejudicial impact, waivers of privilege and the usefulness of the information disclosed.

Legal Environment

The expanded disclosure requirements may have been motivated by a desire for transparency, but the consequences of that disclosure demonstrate a significant conflict with a company's interest as a party to a dispute. By requiring detailed disclosure about a dispute, including anticipated timing of developments and a tabular reconciliation of changes in accruals from period to period, the 2010 Exposure Draft could force a company to provide a roadmap of its litigation strategy to the benefit of the company's adversaries. Disclosure of specific quantitative information, such as amounts accrued, estimates of loss and potential insurance recoveries, is widely expected to set a floor for plaintiffs in settlement negotiations. It may additionally encourage plaintiffs to press claims with very limited merit, particularly if companies become required to disclose loss contingencies that are considered "remote," both because companies may feel pressure to settle cases before being required to disclose them and because the amounts disclosed may encourage other plaintiffs to assert similar claims.

Motivated by concerns about the prejudicial impact of disclosure of individual contingencies, FASB would allow companies to present quantitative information about accruals on an aggregated basis. Aggregation will be of limited value in mitigating the potential prejudice for many companies, however. For instance, a company may have only a few significant litigation matters, may not have a sufficient basis for aggregating multiple claims, or may have one or a few large claims that dominate the others. In these cases, quantitative disclosure could reveal information about individual accruals, which may be most useful to the company's adversary, whereas the shareholders may be more interested in the overall impact of all loss contingencies and accruals on the company's financial results.

In response to earlier criticisms that the 2008 Exposure Draft would require the disclosure of information that was not readily available and may be speculative and unreliable, FASB's approach in the 2010 Exposure Draft is to require disclosure of known facts and information that are otherwise publicly available. As currently drafted, however, disclosure of "discoverable" insurance coverage or indemnification agreements would be required. In addition to setting a floor for settlement negotiations, disclosing potential sources of recovery in the financial statement footnotes may provide a company's adversary with access to this information earlier in the process than it would otherwise be obtained or require public disclosure of information that might otherwise only be discoverable in court subject to strict confidentiality restrictions. As a result, disclosure would provide an advantage to plaintiffs to the prejudice of defendants, which may encourage plaintiffs to file lawsuits with the goal of recovering insurance proceeds and could also increase the cost of insurance coverage.

As currently drafted, the lack of any exemption from disclosing information that would be prejudicial to a company makes these concerns all the more troubling.

Potential Waivers of Privilege

Companies generally look to their lawyers to help draft disclosures relating to pending or threatened litigation contingencies, including the factors likely to affect the outcome of the contingency and the assessment of the most likely outcome. The information and analysis needed to prepare this disclosure is generally kept confidential and is subject to attorney-client privilege or work-product privilege. In light of this, the American Bar Association (ABA) and the American Institute of CPAs (AICPA) have agreed to The ABA Statement of Policy Regulating Lawyers' Responses to Auditors' Requests for Information. This "treaty" addresses the information lawyers can share with their clients' auditors without waiving the privilege. The 2010 Exposure Draft would require more extensive disclosure, for which auditors would typically turn to the company's lawyer for corroboration and an assessment of the need for disclosure, such as whether certain remote contingencies meet the disclosure threshold, whether relevant information is or is not privileged, and whether insurance recoveries are "discoverable." This type of information is beyond the scope of the treaty because it requires more than facts and procedural status about a matter and instead calls for legal determinations and a legal evaluation of the case. Requiring this disclosure will increase the tension between the need to maintain the confidentiality of information so as not to waive privilege and the need to provide sufficient audit evidence and may chill open communication between lawyers and clients.

In the 2010 Exposure Draft, FASB stated that it will continue to work with the ABA, the AICPA and the Public Company Accounting Oversight Board to identify and address the potential implications of the new disclosure standards on the treaty. On the other hand, FASB has not indicated that it is willing to delay effectiveness of the amendments until agreement is reached on modified guidelines.

Usefulness of Quantitative Disclosure

The 2010 Exposure Draft would also require the disclosure of certain information that many believe will be of limited usefulness to investors. For example, the amount of a plaintiff's claim or the amount of damages supported by expert testimony (of one or more parties) may bear limited relation to a company's actual loss exposure. Additionally, certain disclosure items, such as an estimate of loss, are inherently uncertain and rely on complex judgments. Other new requirements may lead to inconsistent disclosure approaches. For example, discovery standards vary across jurisdictions, so discoverable information that is required to be disclosed will vary from company to company and may even vary among different matters for the same company. As a result of the increased and potentially confusing disclosure requirements, companies may also feel pressure to expand their disclosure, for example, to discredit expert testimony or to explain why the amount claimed by the plaintiff is not an appropriate reflection of an expected loss. It is also expected that companies will include extensive caveats and other disclosure to explain the uncertainties of their estimates. Not only will this involve presenting legal analysis and insight into the cases, it may lead to lengthy disclosure of detail that requires the reader to spend more time attempting to discern what contingencies are more likely to occur and what the impact is expected to be.

Conclusions

FASB proposed the amendments to ASC 450 (formerly FAS 5) to address concerns from investors that the current disclosure regime is not sufficient. It has dedicated significant time and resources to addressing concerns raised about its 2008 Exposure Draft. Its revised proposal, however, continues to raise significant concerns about the prejudicial impact of disclosure to the disclosing company, waivers of attorney-client and work-product privilege and the actual usefulness of the information it will require to be disclosed. FASB has indicated a willingness to consider the insight and feedback of commenters, including by extending the public comment period from August 20 to September 20, 2010, but it is clear that FASB sees a need to expand the disclosure requirements.

FASB received well over 200 comment letters to the 2010 Exposure Draft, many expressing concerns similar to those raised about the 2008 Exposure Draft. Many commenters to the 2010 Exposure Draft have also voiced a concern that a December 2010 effective date is much too soon, and given the extension of the comment period, it is possible that FASB will postpone the effective date. While FASB is expected to consider those comments, the commitment it has demonstrated to revising the loss contingency disclosure requirements strongly suggests that it will amend the requirements in some manner, and it may do so soon. Companies should start assessing what changes may be needed to their disclosure controls and procedures to address the new disclosure standards and begin to gather the information.

PROXY PLUMBING CONCEPT RELEASE – A MOVE TOWARD PROXY PROCESS REFORM?

By Kimberly K. Rubel and Bree Archambault

After a unanimous vote at its June 14, 2010, open meeting, the Securities and Exchange Commission issued a Concept Release on the U.S. Proxy System (Release Nos. 34-62495; IA‑3052; IC‑29340), commonly referred to as the "proxy plumbing concept release." The Concept Release can be found at: http://www.sec.gov/rules/concept/2010/34-62495.pdf.

The Concept Release considers the proxy system as a whole, provides background on the current proxy distribution and voting process, and discusses the following three topics:

• Accuracy, transparency and efficiency of the voting process;
• Communications and shareholder participation; and
• Relationship between voting power and economic interest.

The Concept Release requests comments with regard to these topics, as well as general comments or concerns related to the proxy process. The SEC noted the inter-related nature of the various aspects of the proxy system and requested that commenters consider additional consequences of changes to one aspect of the system. The comment period is open until October 20, 2010. The SEC website has posted over 40 comment letters to date, and certain Commissioners have met individually with commenters.

Many have noted that the Concept Release is not likely to result in large-scale rule changes in the near future. The SEC has a large rule-making workload as a result of the Dodd-Frank Act, and the Concept Release is the first step in a comprehensive fact-gathering process with a goal of eventually reforming and fine-tuning the U.S. proxy system.

Accuracy, Transparency and Efficiency of the Voting Process

Over-Voting and Under-Voting

In this section, the Concept Release describes how brokers and other securities intermediaries sometimes credit their client accounts with more votes than the clients actually hold through DTC or in other ways. These discrepancies can occur when a selling broker "fails to deliver" on a trade because the clearing agency will allocate the failure to an arbitrary buying broker. Although that broker will not actually be credited for the shares through DTC, it will credit its customer accounts. Discrepancies can also occur due to securities lending, which occurs when customers buy shares on margin and the broker has the right to lend the shares (along with the associated voting rights). The customer is generally not notified that its shares have been loaned and, therefore, may assume it has the right to vote those shares.

The Concept Release considers two main reconciliation methods and acknowledges that some brokers use a hybrid approach to reconcile the discrepancies between the number of shares credited to customer accounts and the number of shares actually held through DTC. These methods are currently not regulated and, therefore, a broker-dealer will tend to reconcile in the manner advantageous to the particular firm or its client base.

In a pre-reconciliation method (generally used by brokers with more institutional investors), a broker will allocate its total permitted votes to its customers before sending voting instruction forms (VIFs). The advantage to this method is that all votes cast by the broker's customers are counted and covered by the broker's permitted votes for shares held at DTC. The disadvantages are that it can be a more expensive method for brokers to implement and the votes of the broker can be under-utilized if customers allocated votes do not return instructions (called "under-voting"). Companies concerned about obtaining a quorum, especially after the revisions to NYSE Rule 452 further limiting discretionary voting by brokers, may not advocate this method because of the risk of under-voting.

In a post-reconciliation method (generally used by brokers with more retail investors), a broker will receive VIFs from its customer accounts and then determine whether the votes actually submitted by its customers outnumber the votes that broker is credited on its position listing with DTC. This method may be less costly because the broker does not need to go through the process of allocating votes among its customers unless it receives VIFs for more shares than in may vote in the aggregate.

In both the pre-reconciliation and post-reconciliation methods, brokers holding proprietary accounts in the issuer's stock may forego their own vote of those shares in order to credit their customer accounts with a greater number of votes.

The Commission requests comment on whether brokers should disclose their reconciliation process and which method is best suited to protect investors' interests, including whether brokers should allocate the votes from their proprietary accounts to customers and whether votes should be allocated to fully paid securities before those purchased on margin.

Vote Confirmation

The Concept Release discussed the concern of some beneficial owners that they are unable to confirm that their votes have been timely received and accurately recorded by the vote tabulator. Beneficial owners cast votes through a broker or other intermediary, which uses a proxy service provider to send the votes to the vote tabulator. The participation of multiple parties in the process, where no single participant has all of the information necessary to confirm a particular beneficial owner's vote, makes it impossible under the current regime to confirm any individual beneficial owner's vote.

The SEC noted that this lack of transparency could impair confidence in the proxy system. Some might argue, however, that investors have a competing interest in maintaining the anonymity of their identity and voting record. As a potential regulatory step, the Concept Release suggests an anonymous tracking ID for objecting beneficial owners and requested comment on various other aspects of this issue.

Voting by Institutional Securities Lenders

Institutional investors will often lend out their shares in order to earn more income. The voting rights to these shares are generally transferred with the loan. As a result, in order to vote the shares on any material proposals, the institutional lender must terminate the loan and get the securities back from the borrower. A timing issue arises, however, because issuers are not required to disclose the meeting agenda in advance of the record date. As a result, institutional lenders may be unable to determine when and whether to recall the shares in order to have the right to vote the shares as of the record date.

A proposed response would be to incorporate an agenda, which may be subject to change, into the existing NYSE and other SRO requirements for advance notice of a record date and make the agenda publicly available. Alternatively, issuers could be required to disclose agendas on a Form 8-K, in a press release, or on a website posting.

The Commission also requested comment on whether investment companies should be required to disclose the percentage of shares beneficially owned by a fund that were actually voted (as opposed to those shares that were lent to another party).

Distribution Fees

One of the Concept Release topics that has garnered numerous comments is the discussion of proxy distribution fees. Issuers are required to reimburse brokers and other securities intermediaries for the reasonable expenses of distributing proxy materials to beneficial owners. Brokers usually use a proxy service provider to distribute the materials, and the service provider often bills the issuer directly. An issuer has no control over the selection of the proxy service provider or the fees negotiated or incurred through the proxy distribution process. The NYSE and other SROs have a set fee schedule of maximum reimbursement rates, and these are the rates that are commonly charged. Many issuers are concerned that the fees charged are not reasonably related to the actual costs of proxy solicitation and, therefore, do not reflect reasonable reimbursement. In addition, the NYSE and other SROs have not adopted a maximum fee schedule for a notice and access delivery model, and a number of issuers have expressed concern about fees charged when an issuer elects to use notice and access.

The Commission expresses its view in the Concept Release that this would be an appropriate time for the NYSE and other SROs to examine the existing fee schedule to determine whether it continues to reasonably reflect the actual costs of proxy solicitation. The Concept Release also suggests that an alternative approach is the creation of a centralized data aggregator that has access to information from all securities intermediaries regarding the beneficial owners of an issuer's securities. These records could be transferred to an agent of the issuer, which would serve as the distributor of the proxy materials. This would allow the issuer to choose the proxy service provider and create a more competitive marketplace.

Some of the comments received to date indicate that public companies consider the lack of competition and the fee structure unfair. One commenter stated, "Companies should be able to select the distributors of their communications and should not be forced to pay for a system in which proxy fees and intermediary services are determined by third parties." Another commenter submitted a copy of a letter to FINRA dated July 2009, arguing that the expense charged by a service provider was unreasonable because the fee was based on the distribution to 3,349 beneficial owners but resulted in only 9 submitted votes.

Communications and Shareholder Participation

Issuer Communications with Shareholders

The Concept Release also addressed communications with shareholders who hold shares through a securities intermediary ("in street name") and the challenges issuers face in reaching those shareholders. The use of a centralized netting facility and depository is considered essential in order to process the $1.48 quadrillion dollars in annual transactions in the U.S. markets but creates obstacles to communication between issuers and the beneficial holders of their stock. Investors who hold shares in street name elect status as either an objecting beneficial owner (OBO) or a non-objecting beneficial owner (NOBO). OBOs are estimated to account for 52 percent to 60 percent of all public company shares. Some brokers may use this as the default status when opening new accounts. Issuers may request lists of NOBOs in order to communicate directly with those shareholders; however, the expense of obtaining these lists can be prohibitive for widely held public companies.

The Concept Release discusses suggestions such as the 2004 Business Roundtable proposal to eliminate OBO status completely, creating a more direct and efficient communication process between issuers and their shareholders. Under this proposal, shareholders who wished to remain anonymous to the issuer would incur the cost of holding shares through a separate nominee. Advocates of this proposal have also suggested segregating the functions of beneficial owner data aggregation and proxy communications distribution. This would allow issuers to choose proxy service providers and encourage competition, as discussed above in the distribution fee section.

The Altman Group, a proxy solicitation and corporate governance consulting firm, has suggested a more iterative change in the rules, which would require that the identity of all beneficial owners be made available to issuers once a year, in preparation for the annual meeting. Additionally, suggestions to increase investor education regarding the election of OBO status or a requirement to renew the election were mentioned in the Concept Release.

The SEC also recognized that the elimination of OBO status (either completely or once annually) may infringe on the privacy rights of investors. For example, institutional investors may elect OBO status in order to protect competitive information such as investing strategies.

Retail Investor Participation

The SEC noted the historically low levels of retail investor voting, which has recently been compounded by the NYSE prohibition on broker discretionary voting in uncontested director elections and the increased number of companies using majority voting. The result for some companies is difficulty obtaining either a quorum or necessary votes for directors in a majority voting system. The SEC noted that some people have argued the new notice and access rules, allowing website posting of proxy materials, have resulted in an even further decline in retail participation.

Several methods of increasing retail participation are discussed, including many web-based information sources. These include the SEC's own addition to its website at www.investor.gov/proxy-matters, suggestions that broker websites should include information regarding upcoming proposals and the related proxy materials, creation or improvement of online forums designed to encourage discussions among investors of upcoming issues for a vote, and improved use of the internet to distribute proxy materials.

The most controversial proposal to increase retail participation discussed in the Concept Release is advance voting instructions (also referred to as "client directed voting"). Under this suggestion, when an investor opens an account with a broker, they would give advance voting instructions that would guide the broker's vote of their shares on all upcoming matters. The instructions could include: voting in accordance with (or against) the board's recommendations; voting in accordance with a particular interest group or proxy advisory firm's policies; or voting in proportion to the broker's instructed votes. The instructions could be revoked at any time or with regard to any particular issue or proposal.

This type of system is currently prohibited by the proxy rules and creates a tension with the policy objective of obtaining informed investor votes. The Concept Release notes that instructions may be more or less detailed. More specific voting instructions may be more likely characterized as an informed vote. For instance, indicating a particular subject matter, such as corporate governance or executive compensation, where the instructions are to vote in accordance with an interest group or proxy advisory firm's policies, would make the grant of discretion less broad and lessen concerns about uninformed votes.

Data-Tagging

The Concept Release also discusses the potential to require or allow data-tagging, similar to the recently implemented XBRL rules for financial statements and other information, in order to expedite investor access to the information contained in proxy materials. The SEC requests comment on which parts of the proxy materials, if any, are best suited for data-tagging.

Voting Power and Economic Interest

The separation of the voting rights from an economic stake in the issuer and the resultant misalignment of voting power has been a matter of concern in recent years.

Proxy Advisory Firms

The Concept Release examines the role of proxy advisory firms in influencing shareholder votes. Proxy advisory firms are often used by institutional investors to analyze and recommend voting positions on proposals for shareholder vote, including director elections, shareholder proposals and board-recommended corporate actions. These same proxy advisory firms also serve as consultants to issuers to help recommend corporate governance practices. The Concept Release notes that RiskMetrics Group (recently acquired by MCSI, Inc.) is generally noted to be the dominant firm in the industry and requests comment on the effects of this lack of competition.

The Concept Release considers two issues around proxy advisory firms – conflicts of interest and lack of transparency or accuracy. Given its dual role, a proxy advisory firm may have a conflict when it issues a recommendation to institutional investor clients and simultaneously serves as a consultant on the same matter for its issuer client. A conflict can also exist if the proxy advisory firm rates issuers' corporate governance and is hired by issuers to advise on corporate governance practices. One proposed approach to this problem is to change the exemption for proxy advisory firms from the proxy rules and require specific disclosure regarding the presence of a potential conflict. The Concept Release also suggests interpretive guidance requiring more thorough disclosure of any relationship (such as consulting services) with the issuer or other interested party.

The second issue is that proxy advisory firms may make recommendations on materially inaccurate or incomplete information. The Concept Release mentions several approaches that may address this concern, for example, requiring that issuers be shown a draft of the recommendation before it is finalized to review for errors or requiring proxy advisory firms to disclose certain information regarding its recommendations.

The SEC seeks comment on the role of proxy advisory firms and the types of regulation needed to protect investors, whether issuers are influenced by proxy advisory firms' recommendations to modify or change proposals or adopt specific governance policies, and whether existing procedures by proxy advisory firms are sufficient to ensure recommendations are based on accurate and complete information.

Dual Record Dates

The Concept Release addresses the 2009 change to Delaware corporate law allowing separate record dates for notice of meetings and the right to vote at the meetings. Under this new law, the record date for the right to vote shares can be the same day as the meeting. Issuers may be inhibited from using this optional aspect of Delaware law because current proxy rules require materials to be made available to shareholders entitled to vote in advance of the meeting.

The Concept Release recognizes the pros and cons of changing its rules to allow issuers to implement a separate record date for voting rights set closer to the meeting. Two record dates may allow meetings where more of the voting shareholders also have an economic interest in the issuer. (With one record date, when trades occur between the record date and the meeting, some voters no longer hold an economic stake in the issuer.) On the other hand, inadequate time for investors to receive and consider proxy materials may lead to uninformed voting decisions. The SEC requests comment on whether to allow dual record dates and, if so, to whom proxy materials should be distributed – shareholders entitled to notice of the meeting or those entitled to vote at the meeting.

Empty Voting and Decoupling

The final topic addressed in the Concept Release is the issue of empty voting – where the person or entity holding the right to vote shares in an issuer does not also hold an economic interest in the issuer and, therefore, may not be assumed to be voting with the goal of increased shareholder value, which is a foundational assumption in the operation of U.S. corporate governance. In fact, some voters may benefit if the share price of the issuer decreases. Economic and voting rights can become separated or "decoupled" in various ways: when investors lend their securities (and the associated voting rights); when shareholders engage in hedging transactions, such as credit derivative swaps or put options; when trading occurs between the record date and meeting date; and when a plan trustee votes an employee stock ownership plan's unallocated shares.

The SEC requests comment on the ways in which decoupling can occur and the nature and extent of that decoupling and the effects on shareholder voting. The SEC also asks for comment as to whether the beneficial versus detrimental effects of decoupling can be identified and disclosed. Proposed regulatory responses include required disclosure by investors holding empty voting power (based on the premise that disclosure would allow other investors to recognize the importance of their own vote and encourage more participation) and a more drastic proposed change to allow investors to vote by proxy only to the extent of their net long position, or their net economic position in the issuer's equity.

Conclusion

While the comments solicited by the Concept Release are still coming in, the SEC is undertaking the first step toward systemic reform. As a broad overview of the proxy system, the Concept Release contains some general recurring themes. These themes include an emphasis on greater disclosure requirements, as opposed to regulatory responses that directly address the issues at play – for instance, disclosure by brokers of which reconciliation method they use, disclosure by proxy advisory firms of potential conflicts of interest, and disclosure by investors of empty-voting positions. Another theme is the repeated tension between encouraging a greater voting percentage (improving retail participation, decreasing the risk of under-voting, allowing dual record dates) and the policy objective of informed investor votes.

AN ADMIRABLE IDEA SWEEPS TOO BROADLY ... AND IS CORRECTED: NEW YORK AMENDS ITS STATUTE REGARDING POWERS OF ATTORNEY, AGAIN.

By Troy M. Calkins and Eric Marr

As of September 12, 2010, a mistake that was never intended was undone. On that date, the 2010 amendments to the New York law regarding powers of attorney, signed by Gov. David A. Paterson on August 13, 2010, went into effect. Previously, New York had adopted, effective September 1, 2009, sweeping revisions to its statute regarding powers of attorney. On their face, the 2009 amendments appeared to apply to all powers of attorney, including those used in corporate transactions. This circumstance led 51 law firms to generate a white paper in January 2010 explaining why such a broad interpretation would be inappropriate and, in several instances, inconsistent with existing New York law. While this white paper had much support among the corporate bar, the ambiguity remained. New York finally clarified its law in the 2010 amendments to make it clear that the 2009 amendments were not intended to apply to all powers of attorney. The 2010 amendments, which were retroactively effective as of September 1, 2009, effectively eliminated the unintended consequences of the 2009 amendments.

Background – the 2009 Amendments

The impetus for the 2009 amendments was an admirable concern for the elderly. The New York State Law Revision Commission had come to the conclusion that an older individual looking to appoint a person to help him or her manage his or her personal finances and estate planning might not realize the extent to which powers of attorney can give away control of the individual's assets and property, making the elderly person more susceptible to fraud by those agents. To protect older individuals, New York adopted the 2009 amendments, which required, among other things, that certain mandatory wording be used in powers of attorney, including a warning to the principal that "you give the person whom you choose (your 'agent') powers to spend your money and sell or dispose of your property during your lifetime without telling you." The 2009 amendments also required that powers of attorney be manually signed and notarized to be effective. Finally, the 2009 amendments created a default rule that, unless a power of attorney stipulated otherwise, any power of attorney executed in New York would automatically revoke all other powers of attorney previously executed by the same individual. The problem was that powers of attorney are used in numerous corporate contexts that have nothing to do with the above concerns. In these contexts, the 2009 amendments caused ambiguity and expense, in the best case, and subjected companies to risk of failed process, in the worst case.

By drawing the definition of a power of attorney broadly, defining it as any "written document by which a principal with capacity designates an agent to act on his or her behalf," the requirements of the 2009 amendments appeared on their face to apply to the powers of attorney signed in connection with numerous routine corporate transactions, including: registration statements and periodic filings with the SEC; the filing of Section 16 reports, such as Form 3 and Form 4; many LLC and LP agreements enabling managers and general partners to take certain actions; and the granting of a proxy in connection with shareholder voting, which is arguably a specialized, limited form of power of attorney. In these contexts, the 2009 amendments: (i) added unnecessary cost and expense by requiring notarization; (ii) required misleading wording in that these limited purpose powers of attorney clearly did not give the agent the right to dispose of a principal's property as suggested in the mandated form; (iii) created a new risk of failure to comply with SEC reporting where a director who signed a power of attorney regarding a corporate filing, subsequently and before the applicable document was filed, executed another power of attorney regarding an unrelated personal matter, thus revoking the first power of attorney, potentially without the company's knowledge; and (iv) threatened the proxy process of all companies that received any proxies from residents of (or anyone who signed their proxy in) New York, as those proxies would not only be arguably invalid for failure to comply with the form and notarization requirements, but also would also be subject to revocation without company knowledge.

This overbroad application of the 2009 amendments was probably not intended by the Law Revision Commission that recommended the amendments. For example, the Commission expressly stated in its recommendation: "A power of attorney may also be used in commercial and business transactions but powers of attorney used for those purposes are beyond the scope of the Commission's Recommendation." In addition, the title of the law as passed was "Statutory Short Form and other Powers of Attorney for Financial Estate Planning (emphasis added)." In short, it appears that the intent was that the 2009 amendments be limited in scope, unfortunately the drafting did not clearly reflect this intent.

In response to this conundrum, 51 law firms signed a white paper that, in essence, stated that in some corporate contexts, the 2009 amendments made no sense. Among other things, the white paper (i) highlighted the several inconsistencies between the 2009 amendments and New York Business Corporation Law Section 609, which expressly deals with proxies, and argued that the NYBCL should govern, and (ii) raised the question of the internal affairs of corporations and whether New York has the right to interfere with the proxy process of a Delaware corporation, for example, just because the proxy of one of its shareholders is executed in New York. Notwithstanding the collective thinking of a number of prestigious New York law firms reflected in the white paper, the problems with the 2009 amendments remained embedded in the language of the statute and many corporations were reluctant to rely on the white paper in the face of the explicit language of the 2009 amendments. In addition, several other law firms published alerts and memos advising their clients of the problems outlined above. In due course, the New York legislature got the message.

The Fix – the 2010 Amendments

New York took the better part of a year to correct these issues, but it did get them corrected, and did so retroactively. The 2010 amendments add a new Section 5-1501C to the statute that exempts certain powers of attorney from the applicability of the statute, specifically:

• a power of attorney given primarily for a business or commercial purpose, including without limitation:
• 1. a power to the extent it is coupled with an interest in the subject of the power;
  2. a power given to or for the benefit of a creditor in connection with a loan or other credit transaction;
  3. a power given to facilitate transfer or disposition of one or more specific stocks, bonds or other assets, whether real, personal, tangible or intangible;
• a proxy or other delegation to exercise voting rights or management rights with respect to an entity;
• a power created on a form prescribed by a government or governmental subdivision, agency or instrumentality for a governmental purpose;
• a power authorizing a third party to prepare, execute, deliver, submit and/or file a document or instrument with a government or governmental subdivision, agency or instrumentality or other third party;
• a power authorizing a financial institution or employee of a financial institution to take action relating to an account in which the financial institution holds cash, securities, commodities or other financial assets on behalf of the person giving the power;
• a power given by an individual who is seeking to become a director, officer, shareholder, employee, partner, limited partner, member unit owner or manager of a corporation, partnership, limited liability company, condominium or other legal or commercial entity in his or her capacity as such;
• a power contained in a partnership agreement, limited liability company operating agreement, declaration of trust, declaration of condominium, condominium bylaws, condominium operating plan or other agreement or instrument governing the internal affairs of an entity authorizing a director, officer, shareholder, employee, partner, limited partner, member, unit owner, manager or other person to take lawful action relating to such entity;
• a power given to a condominium managing agent to take action in connection with the use, management and operation of a condominium unit;
• a power given to a licensed real estate broker to take action in connection with a listing of real property, mortgage loan, lease or management agreement;
• a power authorizing acceptance of service of process on behalf of the principal; and
• a power created pursuant to authorization provided by a federal or state statute, other than this title, that specifically contemplates creation of the power, including without limitation, the power to make health care decisions or decisions regarding disposition of remains.

For good measure, the 2010 amendments also flipped the presumption regarding revocation, providing that, unless the principal explicitly provided otherwise, the execution of a power of attorney does not revoke any power of attorney previously executed by the principal. The 2010 amendments therefore address the various concerns that had been raised in response to the 2009 amendments since they became effective in September 2009. Moreover, the 2010 amendments apply retroactively to September 1, 2009, and, therefore, validate any powers of attorney that were executed in the corporate context between the two sets of amendments, the validity of which may have been in doubt under the 2009 amendments. The correction provided by the 2010 amendments should ease any concerns regarding the use of powers of attorney in New York in the corporate context, returning the use of powers of attorney in the business context to pre-2009 business as usual.

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.