If you have any questions regarding the matters discussed in this issue, you may contact the authors or your regular Snell & Wilmer contact:


Jeffrey Beck


Franc Del Fosse

Matthew P. Feeney

Jeffrey A. Scudder

Brandon Batt

  Snell & Wilmer L.L.P. Snell & Wilmer L.L.P.
The Corporate Communicator
Winter 2011

2011 Annual Meeting Season

Dear clients and friends, 

We present you this issue of Snell & Wilmer’s annual year-end Corporate Communicator to help you prepare for the upcoming annual report and proxy season.  This issue highlights some of the considerations your company should focus on this annual meeting season.  In this issue we are including our customary articles on recent SEC, NYSE/Nasdaq and general corporate law developments. This year’s biggest development in our view is say-on-pay. 

We are also including articles about risk management trends, the Dodd-Frank Act’s more stringent clawback rules, and the SEC’s new Whistleblower Bounty Program.  At the current time, the SEC’s much-heralded proxy access rules are on hold pending the resolution of a lawsuit filed by the United States Chamber of Commerce.  It is anticipated that the court proceedings will be resolved in mid-2011, and we will provide you with updates when a resolution is reached. 

During 2011, members of our Business & Finance Group will continue to publish the Corporate Communicator, host business roundtables, participate in seminars that address key issues of concern to our clients and sponsor conferences and other events.  First on the calendar is our Third Annual Public Company Roundtable, which will be held in our Phoenix office on January 11, 2011.  A copy of the invitation is included in the right sidebar of this publication, and we hope you will be able to join us.  Finally, we are pleased to present our 2010 tombstone, which highlights selected deals that Snell & Wilmer’s Business & Finance Group helped our clients close during the year. As always we appreciate your relationship with Snell & Wilmer, and we look forward to helping you make 2011 a successful year.

Very truly yours,

Snell & Wilmer L.L.P.
Business & Finance Group

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A New Year’s Resolution for the Proxy Statement:  Mandatory ‘Say on Pay’

After years of anticipation (and anxiety), mandatory shareholder advisory votes on executive compensation – more commonly known as “say-on-pay” votes – are here, just in time for the 2011 proxy season.  Although the SEC has not adopted final rules as of the date of this edition of the Corporate Communicator, the say on pay resolutions must nevertheless be included in any proxy statement for an annual shareholders meeting occurring on or after January 21, 2011.


Although they have a bit more history in Europe and elsewhere, shareholder advisory votes on executive compensation are relatively new to the corporate governance scene in the United States.  Momentum for requiring say on pay has been building over the past decade, thanks in part to the post-Enron push for stronger corporate governance, lavish executive pay packages and “golden parachutes” at Disney and other prominent companies, and upward trends in executive compensation widening the disparity between CEO and general employee pay.

According to the AFSCME Office of Corporate Governance and Investment Policy, seven U.S. companies voluntarily included say on pay votes at their 2006 annual meetings.  By 2008, that number had increased to 79 companies.  In 2009, say on pay became mandatory for companies that received funds from the federal government’s Troubled Asset Relief Program (TARP).

While the momentum had already been growing and it is difficult to pinpoint a single “final straw,” the massive bonuses paid by Wall Street firms to their workers in the midst of the 2008 financial meltdown did little to dissuade Congress from including mandatory say on pay in the Dodd-Frank Act. Indeed, the Dodd-Frank Act amends the Securities Exchange Act of 1934 (the “Exchange Act”) to require that a non-binding say-on-pay vote be held at least once every three years – and that, at least every six years, shareholders be given the opportunity to cast a non-binding advisory vote on whether say-on-pay votes should be held every one, two or three years. Both proposals are required to be included for the first meeting occurring on or after January 21, 2011.

Say What?

Companies are required, at least once every three years, to provide for a separate, non-binding shareholder advisory vote in proxy statements to approve the compensation of executives.  The SEC’s proposed rules provide the following with respect to the say-on-pay vote:

  • Scope of Advisory Vote.  The shareholder vote would be to approve the compensation of the public company’s named executive officers (“NEOs”), as that compensation is disclosed in the Compensation Discussion and Analysis (“CD&A”), compensation tables and other narrative compensation disclosures required by Item 402 of Regulation S-K.  The proposed rules clarify that smaller reporting companies (generally, companies with less than $75 million in public float) would not be required to provide a CD&A; rather, the say-on-pay votes for such companies would pertain to the more limited executive compensation disclosures required to be provided by them.
  • Director Compensation Not Included.  The compensation of directors is not subject to the say-on-pay vote.
  • No Prescribed Form of Resolution.  The SEC’s proposed rules do not require companies to use any specific language or form of resolution to be voted on by shareholders, although subsequent guidance has confirmed that the SEC does expect to see the proposal appear in the form of a shareholder resolution set forth in the proxy statement.
  • Addition to CD&A.  The SEC’s proposed rules would require companies to address in their CD&A whether and, if so, how their compensation policies and decisions have taken into account the results of say-on-pay votes. This requirement would not apply to a smaller reporting company unless similar considerations would be material to an understanding of its Summary Compensation Table, in which case similar disclosure would be required under Item 402(o) of Regulation S-K.

Say When?

As noted above, the Dodd-Frank Act also mandated a “say-on-frequency” vote that must be held this year and at least every six years hereafter.  The SEC’s proposed rules provide the following with respect to these say-on-frequency votes, which are also non-binding and advisory in nature:

  • Scope of Advisory Vote.  The shareholder vote would be whether say-on-pay votes should occur every one, two or three years.
  • Shareholders Must be Given 4 Choices.  Although the SEC’s proposed rules permit boards to recommend how the shareholders should vote, it is clear that the resolution (and proxy card) cannot be written to seek shareholder approval of that recommendation.  Rather, shareholders must be given the opportunity to vote on whether say-on-pay votes should occur every one, two or three years – or to abstain from voting on the matter.
  • What is the “Correct” Say on Pay Frequency?  Commentators generally agree that the answer might be different for different companies, depending on their facts and circumstances.  RiskMetrics Group/Institutional Shareholder Services (ISS) has issued 2011 policy guidelines providing that it will recommend a vote for annual say-on-pay votes, which ISS believes “provide the most consistent and clear communication channel for shareholder concerns about companies’ executive pay programs.”  Certain other groups and institutional shareholders have voiced support for biennial or triennial say-on-pay votes, which might facilitate greater focus on pay for performance over time and also enable boards and compensation committees to thoughtfully consider shareholder feedback when making changes to their executive compensation programs.  A variety of other company-specific factors might be relevant in determining what frequency to propose to shareholders and implement following this year’s advisory vote.
  • Disclosure of Results on Form 10-Q or Form 10-K.  The proposed rules would require companies to disclose how frequently they will conduct say-on-pay votes in light of the results of the say-on-frequency vote.  That disclosure would be required in the Form 10-Q or Form 10-K covering the fiscal period during which the advisory vote occurred.  Note that this requirement would not alter the company’s obligation to promptly disclose the advisory vote results on Form 8-K within four business days after the meeting.

Other Notes About Say on Pay and Say on Frequency

  • No Preliminary Proxy Statement Required.  The SEC’s proposed rules would add the say-on-pay and say-on-frequency votes to the list of items that do not trigger the requirement to file a preliminary proxy statement with the SEC. 
  • Broker Discretionary Voting Prohibited.  In accordance with the Dodd-Frank Act’s specific mandate, the SEC’s proposed rules direct national securities exchanges (e.g., NYSE and NASDAQ) to expressly prohibit broker discretionary voting in say-on-pay and say-on-frequency votes.
  • No Impact on Board’s Fiduciary Duties.  Pursuant to the Dodd-Frank Act, no say-on-pay or say-on-frequency advisory vote:
    • can be construed as overruling a decision by the company or its board of directors;
    • creates or implies any change to the fiduciary duties of the company or its board of directors; or
    • creates or implies any additional fiduciary duties of the company or its board of directors.

Disclosure and Shareholder Approval of ‘Golden Parachutes’

The SEC also proposed new rules relating to the disclosure and shareholder approval of certain “golden parachute” compensation arrangements.  The details of these enhanced disclosures and “say-on-golden-parachute” votes include the following:

  • Trigger for Disclosure Requirement. Section 14A(b)(1) of the Exchange Act requires any company seeking shareholder approval of an acquisition, merger, consolidation, or proposed sale of all or substantially all of the company's assets to provide “clear and simple” disclosure regarding any agreements or understandings that the company has with its NEOs concerning compensation that is based on or otherwise relates to the proposed transaction.  The disclosure is required to be provided in the proxy statement soliciting approval of the transaction.
  • Scope of Enhanced Disclosures.  The SEC’s proposed rules would require both tabular and narrative disclosure of golden parachute arrangements with the NEOs.  The prescribed table would include amounts for the individual elements of compensation (e.g., cash severance/bonus, value of accelerated equity awards, pension or deferred compensation enhancements, perquisites, etc.) to be received by each NEO based on or relating to the transaction.  Single-trigger and double-trigger amounts and arrangements would be specifically identified in footnotes to the table.  The narrative disclosure requirements would require companies to describe, among other things, any material conditions or obligations applicable to an NEO’s receipt of payment (e.g., non-competition and non-solicitation arrangements), the specific circumstances that would trigger payment, and whether the payments would be made in a lump sum or over time (and, if so, their duration).
  • Say-on-Golden-Parachute Shareholder Advisory Vote.  As mandated by the Dodd-Frank Act, the proposed rules would require any company to provide for a separate, non-binding shareholder advisory vote on golden parachute arrangements in a proxy statement seeking shareholder approval of an acquisition, merger, consolidation or proposed sale of all or substantially all of the company’s assets.
  • Scope of Advisory Vote.  The shareholder vote would be to approve the golden parachute agreements or understandings disclosed pursuant to the requirements summarized above. 
  • Relationship with Say on Pay.  If a company seeking shareholder approval of a merger or acquisition transaction previously provided the golden parachute-related disclosure described above and incorporated a say-on-golden-parachute vote with its say-on-pay vote, the proposed rules would not require that company to provide for another advisory vote in the proxy statement relating to approval of the transaction.  This exemption would apply even if shareholders did not approve the golden parachute arrangements in the previous vote, provided that the previous disclosures were sufficient and the same golden parachute arrangements remain in effect (without modification subsequent to the previous say-on-golden-parachute vote).  In light of this exemption, commentators anticipate that some companies might voluntarily include the enhanced golden parachute disclosures and say-on-golden-parachute proposals in their annual meeting proxy statements to avoid doing so in connection with a future merger or acquisition transaction, although the extent to which the option is used may not be clear until the end of the 2011 proxy season.


Comments on the SEC’s proposed rules were due on November 18, 2010.  We will keep our clients and friends apprised of any revisions to the proposed rules or further developments once final rules are adopted.

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Latest Disclosure Developments – MD&A and Beyond

Commission Guidance on Presentation of Liquidity and Capital Resources Disclosures in MD&A

In September 2010, the SEC issued interpretive guidance to improve discussion of liquidity and capital resources in MD&A.  At the same time, the SEC also proposed new disclosure requirements relating to short-term borrowings.  The guidance and proposed rules were issued partially in response to questionable window dressing transactions engaged in by Lehman Brothers, commonly referred to as “Repo 105” transactions.  The commission guidance was effective immediately and the proposed rules are anticipated to be finalized shortly.  We believe the SEC’s interpretative guidance and the new rules reflect a renewed emphasis by the SEC on disclosures about liquidity and capital resources.

The SEC’s interpretative guidance “reminds” companies to identify and separately describe internal and external sources of liquidity and to discuss material unused sources of liquidity.  The SEC made clear that this disclosure, like other disclosures within MD&A, should provide insight into the company’s liquidity through the eyes of management.  The focus of the disclosure is on known trends or demands, commitments, events or uncertainties that will, or that are reasonably likely to result in, a company’s liquidity increasing or decreasing in any material way. 

In the guidance the SEC identified additional important trends and uncertainties relating to liquidity.  For example:

  • difficulties in accessing the debt markets;
  • reliance on commercial paper or other short-term financing arrangements;
  • maturity mismatches between borrowing sources and the assets funded by those sources;
  • changes in terms requested by counterparties and changes in the valuation of collateral; and
  • counterparty risk. 

The interpretative guidance is designed to provide transparency about a company’s actual liquidity position that may be obscured or masked by window dressing practices.  For example, by reducing short-term borrowings before the end of a reporting period.  In other words, the focus is on inter-period variations that are not reflected on the period-end balance sheet. The release also makes it clear that companies need to disclose information about repurchase arrangements and securities lending or similar transactions involving the transfer of financial assets with an obligation to repurchase such assets that have a material impact on liquidity, but that are not otherwise reflected in the financial statements or MD&A.  The guidance also reminds registrants that while disclosure of leverage ratios is permissible, companies need to consider non-GAAP implications as well as provide a clear explanation of the calculation methodology of the leverage ratio(s). 

The SEC also discussed the Contractual Commitments table and acknowledged that industry groups and others have raised questions of the staff about how to treat certain liabilities and contractual commitments in the table.  Rather than providing any specific guidance however, the SEC emphasized the importance of the table and basically told companies to be as transparent as possible. 

Proposed New Rules Regarding Short-term Borrowings Disclosure

The proposed rules call for a new separately captioned subsection of MD&A  comprised of a comprehensive explanation of the company’s short-term borrowings, including both quantitative and qualitative information.  The proposed disclosures about short-term borrowings are modeled after rules that are currently applicable to bank holding companies.[1]  The required disclosures would apply equally to Form 10-Ks and Form 10-Qs.  In other words, there is no short form or abbreviated disclosure for Form 10-Qs.[2]

Like the interpretive guidance, the focus of the proposed rules is on liquidity risk and inter-period variations not reflected in the balance sheet as the result of window dressing, whether strategic or cyclical.  The proposed release identifies the following five categories of short-term borrowings:

  • federal funds purchased and securities sold under agreements to repurchase;
  • borrowings from banks;
  • commercial paper;
  • borrowings from factors or other financial institution; and
  • any other short-term borrowings reflected on the company’s balance sheet.

For each specified category of short-term borrowings, companies would have to disclose in tabular form the following information: 

  • The amount of short-term borrowings at the end of the reporting period and the weighted average interest rate on those borrowings. 
  • The average amount of short-term borrowings outstanding for the reporting period and the weighted average interest rate on those borrowings.
  • For financial companies, the maximum daily amount outstanding during the reporting period.
  • For all companies other than financial companies, the maximum month-end amount outstanding during the period. 

The proposed rules define a Financial Company as a company engaged to a significant extent in the business of lending, deposit taking, insurance underwriting or providing investment advice, or that is a broker or dealer. Thus, the definition will capture many companies outside the traditional “banking” industry.  Companies that are engaged in financial and non-financial businesses may provide separate short-term borrowings disclosure for their financial and non-financial business operations. 

In addition to these tabular disclosures, companies would be required to include a narrative discussion of the following:

  • A general description of the company’s short-term borrowing arrangements (including any key metrics or other factors that could reduce or impair the company’s ability to borrow under the arrangements and any collateral posting arrangements) and the business purpose of each arrangement.
  • The importance to the company of its short-term borrowings to its liquidity and capital resources.
  • The reasons for the maximum amounts reported during the period and the reasons for differences between the average short-term borrowings and period end short-term borrowings. 

In the proposing release, the SEC also requested the public comment on the need for disclosure of leverage ratio(s).  The SEC is requesting comment about whether to require leverage ratio disclosure and, if so, how such leverage ratio(s) should be calculated.

In summary, the SEC’s interpretive guidance and proposed new disclosure rules are designed to provide additional transparency about a company’s capital resources and short-term borrowings.  Obviously, the SEC is concerned about window dressing practices through which companies obscure much larger outstanding inter-period borrowings than reported at the end of a period and identify for investors with more transparency short-term liquidity risks facing a company.

Coming Later in 2011

As a result of the Dodd-Frank Act companies should start preparing now for the following new disclosure items and other corporate governance rules that we anticipate will be implemented during 2011, effective for the 2012 proxy season:

  • independence considerations relating to compensation committees;
  • the relationship of executive pay to a company’s financial performance;
  • CEO pay verses median employee pay (i.e., the Pay Disparity Ratio);
  • employee and director hedging policies;
  • policy relating to compensation recovery (i.e., clawbacks);
  • disclosures about the company’s board leadership structure with respect to the CEO and Chairman roles; and
  • for affected companies, coal and mine safety disclosures; resource extraction disclosures (i.e., payments to the US or foreign governments for the purpose of the commercial development of oil, natural gas or minerals); conflict materials (i.e., whether conflict materials that are necessary to the functionality or production of a product manufactured by the company originated in the Congo or an adjoining country).

In light of the recently adopted and pending Dodd-Frank rule making, companies should consider taking the following actions during 2011:

  1. Begin to consider the impact of the Pay Disparity Ratio.  For example, consider implementing an internal pay equity study to determine if any changes should be made in anticipation of the pay disparity ratio disclosure requirements. 
  2. Review and evaluate your existing hedging and clawback policies in light of the new disclosure requirements. 
  3. Review your company’s advance notice bylaw and similar provisions as well as your director qualification standards in anticipation of the proxy access rules becoming effective in 2011. 
  4. Evaluate your compensation committee model and structure, including the role of the compensation consultant and the policies relating to the selection and retention of any compensation consultant(s).  We believe the new compensation committee disclosure rules will be the high profile disclosure for 2011 and, as we have indicated previously, we believe the compensation committee/compensation consultant model will evolve to a structure similar to that of the audit committee/auditor model already in place for public companies.

[1] Industry Guide 3, Statistical Disclosure by Bank Holding Companies. [Back]

[2]As proposed, Smaller Reporting Companies would not be required to provide the quarterly disclosures unless material changes occurred during the interim period. [Back]

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Current Trends in Risk Management and Risk Oversight


Over the last decade of corporate meltdowns and scandals, the concepts of risk management and risk oversight have become increasingly important to corporations and corporate culture.  Realizing the value of proper risk management and risk oversight, boards of directors are ever more concerned about the risks their companies may be facing.  The point of risk management and risk oversight is not to eliminate risk from the corporation’s activities and strategy, but rather to enable the board and management to fully understand, monitor and manage the risks facing the company.  As one corporate director put it, “without risk, you have no business.”

To be clear, the board of directors should not be managing the risk of a company.  Instead, the board’s role is to oversee the risk management activities of the company’s management.  The board is responsible to oversee and direct the company’s chief executive officer and senior managements’ involvement in risk management and the implementation of the board’s policies.  This oversight function by the board ensures that the company’s risk policy is properly aligned with the company’s risk profile and overall corporate strategy.  The seminal case in this area, In re Caremark International Inc. Derivative Litigation, established the basic rule that directors are only liable for a failure of board oversight when there is “sustained or systematic failure of the board to exercise oversight – such as utter failure to attempt to assure reasonable information and reporting systems exist.”

The SEC has made risk management and risk oversight a priority.  In December of 2009, the SEC adopted rules requiring proxy statement disclosure of “the extent of the board’s role in the risk oversight of the registrant, such as how the board administers its oversight function, and the effect that this has on the board’s leadership.”  These rules also require proxy statement disclosure of “the registrant’s compensation policies and practices as they relate to the registrant’s risk management.”

As a result of these new rules, proxy statements should now disclose how the board administers its risk management oversight function, including what committee(s) the board has established or assigned the responsibility to monitor risk and how each committee effectively communicates with the board (and each other).  Compensation policies must be analyzed by the board or a designated committee (most commonly, the compensation committee) for any inappropriate risk-taking incentives given to the company’s executive officers and non-executive employees.  According to a recent survey conducted by Deloitte & Touche, 86% of S&P 500 companies disclose in their proxy statements that the full board is responsible for risk management, 58% disclose that the audit committee is the primary committee responsible for risk management oversight, and only 4% disclose that they have a separate committee devoted to risk management oversight.

Dodd-Frank Act  

The Dodd-Frank Act was passed on July 21, 2010 and requires certain financial institutions and certain other issuers to establish a risk committee that includes at least one risk expert with prior experience managing risk at a large company.  It is unclear to what extent public companies not subject to these requirements will nevertheless voluntarily adopt these practices in the name of “best practices” or “good corporate governance,” but experience suggests that this will occur to at least some degree. 

The Dodd-Frank Act also requires the SEC to enact say-on-pay and say-on-golden parachute rules that provide shareholders with an advisory vote regarding the compensation packages for the company’s executives.  In doing so, shareholders will have the opportunity to assess, among other things, whether a company’s compensation program incentivizes management to pursue an inappropriate level of risk.  The proposed say-on-pay and say-on-golden parachute rules are discussed in greater depth later in this issue and can be found by clicking here.

Recommendations for 2011

It is more important than ever for boards and management to pay special attention to risk management and risk oversight.  The board should review annually the company’s risk management policies and procedures from an oversight perspective, and evaluate if these policies are being effectively implemented throughout the company.  The board should recognize that an open line of communication between the board and management is crucial for the board to effectively administer its risk management oversight responsibilities.  With the right policies and lines of communication in place, the board will be able to focus on ensuring that management (as well as the board itself) is setting the “tone at the top” so that the company’s risk management policies and processes are consistently integrated and implemented throughout the company. 

The board should review annually and evaluate its risk management plan, expectations, and strategy with management and appropriate board committees to ensure it has sufficient risk management and risk oversight processes in place from a risk management perspective.  Through its interactions with management and the various committees, the board should have a thorough understanding of the company’s current risks and the policies in place to mitigate, or at least monitor and understand, these risks. While these reviews and discussions are recommended at least once per year, the board must be able to meet to discuss unique risk-related problems throughout the year on an as-needed basis.  In this regard, a board must not ignore “red flags” that indicate a breakdown (or the absence) of risk management policies.  In 2009, the Delaware Court of Chancery refused to dismiss shareholder claims against AIG’s directors, relying in part on a theory that the defendants had “consciously failed to monitor or oversee the
company’s internal controls.”

Each company should also assess whether its current board composition is appropriate to understand the current risks within the company or the company’s industry.  Companies should consider training their existing and incoming directors about the risks associated with the company’s business and its industry in general.  Companies should consider director candidates with risk management experience and/or significant relevant industry experience. 

Let us offer a final, somewhat editorial note.  One of the unintended consequences of “director independence” reforms over the past decade has been the population of many corporate boards with directors who are well versed in corporate governance matters but have little or no experience in, or knowledge of, a company or its industry.  This has serious implications for a company’s risk management oversight process.  In 2009, the CEO was the only non-independent director in 59 out of the Fortune 100 companies and in about one-half of the S&P 500 companies.  On September 23, 2010, the New York Stock Exchange Commission on Corporate Governance, which was created in 2009 in response to the financial crisis, issued its report.  The Commission adopted seven principles, and the seventh one warrants special notice. 

[T]he Commission notes that in recent years it has become common to have the company’s CEO as the only non-independent director on the board.  The Commission recognizes that the NYSE’s listing requirements do not limit a board to only one non-independent director, and believes that the appointment of a minority of directors who possess in-depth knowledge of the company and its industry could be helpful for the board as it assesses the company’s strategy, risk profile, competition and alternative courses of action.  The Commission does not wish to imply that an independent director cannot have equally deep knowledge of the company as a non-independent director.  Rather the Commission believes that, as provided for under the NYSE’s listing standards, a properly functioning board can include more than one non-independent director.

This last principle may signal a movement of the pendulum towards a more balanced position focused on independent directors and perhaps to the expansion of “inside” director participation on corporate boards.

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The Unintended Consequences of Dodd-Frank’s Whistleblower Protection

One of the more unknown quantities coming forth out of the provisions of the Dodd-Frank Act is contained in the much written about whistleblower/bounty provisions.  These bounty provisions affect all companies subject to the federal securities laws and have commentators scratching their heads regarding the potential impact of the bounty program under which the SEC will pay awards to whistleblowers who provide the SEC with information about securities law violations.  Pursuant to the Dodd-Frank Act, the SEC has until April 17, 2011, to adopt final rules and the period during which the SEC sought comment on its proposed rules expired December 17, 2010.

Section 922 of the Dodd-Frank Act added a new section 21F to the Securities Exchange Act of 1934 which provides that the SEC shall pay rewards to whistleblowers who provide original information about violations of the federal securities laws.  Under this program, whistleblowers have the opportunity to obtain a cash bounty if the information they provide leads to an enforcement action in which the SEC collects a monetary sanction (i.e., penalties, disgorgement and/or interest) totaling at least $1 million.  These provisions contained in the Dodd-Frank Act also prohibit retaliation, whether in the form of a poor performance review or termination, against whistleblowers and provide for redress in the federal courts.

Whistleblower awards (based on a percentage of collected penalties) are to be paid from a special fund (the SEC Investor Protection Fund) for which more than $400 million has already been budgeted.  Under Section 922, whistleblowers shall be paid between 10 to 30 percent of the monetary sanctions collected in the SEC enforcement action and in any related actions or criminal proceedings brought by the Attorney General of the United States or state attorney general or by an appropriate regulatory authority or self-regulatory organization.

Most commentators agree that these new provisions should make companies more aware of taking prophylactic actions to prohibit mistreatment of whistleblowers; however, it is the unintended consequences that are the topic of much debate.  Chief among these unintended consequences is the puzzling incentive that has been created wherein whistleblowers seem to benefit from keeping their concerns from their employers.  In other words, a whistleblower only receives an award if they provide information that is not already known to the SEC from another source.  Thus, if the company or its management reports a matter that has been raised by the whistleblower through the company’s compliance system, ethics hotline or other internal program, then the whistleblower may not be eligible for an award because that information would have already been reported to the SEC.  Accordingly, many commentators believe that an unintended consequence of this new program will be to undermine the effectiveness of existing and future company compliance programs because Section 922 has effectively created a robust disincentive for whistleblowers with knowledge of unlawful activity to utilize internal company compliance procedures.

Ultimately, companies may want to consider taking some, or all, of the following actions in light of these new whistleblower provisions:

  • utilize advisers, senior management and boards to review and revise existing procedures and program and liability coverage in light of whistleblower activity;
  • consider conducting internal audits regarding the effectiveness of whistleblower procedures and programs;
  • enhance protections for whistleblowers;
  • consider creating new (or enhancing old) incentives for employees to utilize internal company compliance procedures and programs;
  • develop procedures and programs that effectively train employees and communicate that the company supports whistleblower reporting;
  • consider implementing policies that require employees to report to the company unlawful activity (regardless of whether the employee blows the whistle outside the organization); and
  • pursue policies and programs that encourage ethical behavior at all levels and properly document reporting activity.

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Dodd-Frank Act Expansion of “Clawback” Penalties Suggests “Wait and See” Approach

A “clawback” is a policy to recoup compensation in the event that certain adverse events or circumstances occur at a later date. The term “clawback” rose to the general U.S. public’s consciousness following the large corporate meltdowns occurring around 2002.  Under the Sarbanes-Oxley Act, clawbacks were utilized as a sword to prohibit executive officers from retaining compensation perceived to be excessive.  More specifically, under the Sarbanes-Oxley Act, in the event a public company is required to prepare an accounting restatement due to the material noncompliance with any financial reporting requirement, as a result of misconduct, the chief executive officer and chief financial officer must disgorge any bonus, other equity or incentive-based compensation, and any profits from sales of the company’s stock received during the 12-month period following the public issuance or filing with the SEC (whichever occurs first) of the noncompliant financial information.  Under the Sarbanes-Oxley Act, enforcement of clawbacks has been limited to the SEC (i.e., no private right of action).  The Dodd-Frank Act has expanded the compensation clawback provisions of the Sarbanes-Oxley Act in severable notable ways. According to the SEC’s recently released calendar for implementing the Dodd-Frank Act, the SEC expects to propose rules during the summer of 2011.

The Dodd-Frank Act calls for the SEC and stock exchanges to implement rules requiring companies to develop and disclose clawback policies for the recovery of incentive-based compensation granted to any current or former executive officer during the three-year period preceding an accounting restatement that is based on erroneous data corrected in the restatement. The amount of compensation recoverable is the excess of what was actually paid to the executive over the amount that would have been paid under the restated amounts.   

The language in the Dodd-Frank Act (regarding clawback provisions) is broader than the Sarbanes-Oxley Act in a various key ways, including: (1) the Sarbanes-Oxley Act only applies to the chief executive officer, and the chief financial officer, whereas the Dodd-Frank Act applies to all executive officers, (2) the Sarbanes-Oxley Act has only a one-year look-back, whereas the Dodd-Frank Act has a three-year look-back, and (3) the Sarbanes-Oxley Act requires misconduct, whereas the Dodd-Frank Act does not utilize “misconduct” as a trigger or a requirement but rather the triggering event is merely a restatement resulting from “erroneous data.”
Based on the SEC’s publicly disclosed calendar, these new clawback rules will likely be applicable sometime in 2011.  Given that timeframe, a “wait and see” approach to these provisions may be appropriate and any rush to substantial actions to comply may end up falling under the “no good deed goes unpunished” rubric. Notwithstanding the foregoing, public companies, particularly their boards and compensation committees, may want to consider the following interim actions pending implementation of the final rules:

  • Commence a comprehensive review of existing company clawback policies with a view to understanding (1) which executives are covered, (2) the applicable look-back period, (3) what acts or events are captured under such clawback policies, and (4) who is (or who should be) responsible for administering and enforcing the applicable policies;
  • In light of the foregoing review, determine whether there is board level support of expanding current policies above and beyond expected Dodd-Frank Act compliance, including whether the company may want to (1) include in its future clawback policies misconduct that does not result in an accounting restatement, (2) expand the reach of the future clawback policies to also include highly compensated employees (or, alternatively, all employees) rather than just executive officers, and (3) include the recoupment of other forms of compensation in its future clawback policies other than just “incentive based compensation” (as required by the Dodd-Frank Act); and
  • Seek updates and guidance from trusted advisers and consultants.

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Odds & Ends

Close Call:  Proxy Access Put on Hold Following Court Challenge

In our January 2010 edition of the Corporate Communicator, we noted that most observers agreed that proxy access was coming, and that the only remaining questions surrounded “when” and “how.”  After a tumultuous year full of developments on the proxy access front, the proxy access remains in limbo.

Many of these same observers raced to interpret what they thought were the answers when the SEC adopted (by a 3-2 vote) proxy access rules on August 25, 2010, only to have the SEC put its implementation of the rules on hold five weeks later following a court challenge jointly filed by the Business Roundtable (“BRT”) and the Chamber of Commerce (“Chamber”).  The proxy access rules and related amendments adopted by the SEC would have provided stockholders of public companies with an alternative means to nominate director candidates and have those nominees included in the company’s proxy materials.  Many believe that proxy access would give activist stockholders increased leverage in board/stockholder relations and would result in more contested director elections, although the extent of those potential impacts remain to be seen.

Among other things, the BRT and Chamber alleged in their petition that the SEC failed to properly assess the rules’ likely impact on efficiency, competition and capital formation, as required by the federal securities laws. The U.S. Court of Appeals for the D.C. Circuit agreed to consider the matter on an expedited basis, meaning that a decision could come as early as summer 2011.  As a result, the implementation of SEC proxy access rules will not be applicable to public companies until, at the earliest, the 2012 proxy season.

Director Qualification Bylaw Amendments

Many public companies are reviewing their bylaw provisions (if any) related to director qualifications.  Now, more than ever, boards are searching for that proper mix of qualifications (e.g., experience, background, education and skills) among their members to provide a bulwark against, among other things, the constant second-guessing boards face by activist shareholder groups, regulators and the investor community.  In addition, 2010 was the first year in which public companies needed to address their director qualifications in their annual meeting proxy statements.  Public companies also now must disclose diversity considerations, if any, that the board utilizes in considering director nominees.  Finally, because of proxy access, public companies are evaluating whether to implement bylaw provisions to require that all director nominees (no matter the source) meet minimum qualifications.  Against this backdrop, many public company boards are considering director qualification bylaw amendments. 

Many commentators have raised concerns regarding the perceived benefits of director qualification bylaw amendments, which may unnecessarily limit your pool of director candidates or possibly create the basis for claims from dissident shareholders.   Other commentators have noted that director qualification bylaw amendments could be beneficial to public companies with dissident shareholders and may be used to support an argument in a no-action request to the SEC that a nominee’s failure to meet a director qualification bylaw provision should result in exclusion of the nominee from the proxy materials pursuant to Rule 14a-11.  Ultimately, any determination by a public company to include a director qualification provision in its bylaws should be preceded by a detailed, facts and circumstance based, analysis. Such an analysis would take into account multiple considerations including but not limited to state law, benefit versus downside in light of the intended purpose, and the company’s stockholder base, including anticipated stockholder reaction to such an amendment.  With respect to state law considerations, many states, including Delaware, provide public companies the flexibility to include qualifications for directors in company bylaws although traditionally most public companies have opted for minimal stated qualifications in the bylaws (if any at all) and have instead looked to corporate guidelines to describe director qualifications.

Credit Rating Agencies Lose Express Exemption Under Regulation FD – But Does It Matter?

On September 29, 2010, the SEC amended Regulation FD to delete former Rule 100(b)(2)(iii), which provided a specific exemption for disclosure of material nonpublic information to credit rating agencies.  The amendment, which was required by the Dodd-Frank Act, took effect on October 4, 2010. 

Regulation FD generally requires public companies to publicly disclose any material nonpublic information that is disclosed (whether intentionally or unintentionally) to certain “covered persons,” including broker-dealers, investment advisers, investment companies, hedge funds and holders of the company’s securities (if it is reasonably foreseeable that the holder will trade in the company’s securities on the basis of the information).  The required public disclosure is typically made on Form 8-K.

Although the express exemption for credit rating agencies has been eliminated by this rule change, many commentators have advised that public companies do not need to change the manner in which they interact with credit rating agencies that are registered with the SEC as nationally recognized statistical rating organizations (“NRSROs”).  These commentators reason that NRSROs are not “covered persons” for purposes of Regulation FD, relying in part on the Credit Rating Agency Reform Act of 2006, which clarified that NRSROs are not to be considered “investment advisers” as long as they do not issue recommendations as to whether securities should be purchased, sold or held. Going forward, as a general practice, public companies dealing with credit rating agencies may want to consider entering into a specific confidentiality agreement prior to disclosing any material nonpublic information to such agencies, especially those that are not NRSROs.[1] 

Interactive Data (XBRL) Filing Requirements Applicable to Non-Accelerated Filers for Fiscal Periods Ending on or after June 15, 2011

Almost two years ago, the SEC adopted rules requiring public companies to provide their financial statements to the SEC and on their corporate web sites in an interactive data format using the eXtensible Business Reporting Language (“XBRL”).  By allowing software applications such as databases, spreadsheets and financial reporting systems to recognize and process tagged financial information, XBRL is designed to make that information easier for investors, analysts and others to retrieve and analyze.  In its adopting release, the SEC also stated that its rules were intended to assist in automating regulatory filings and business information processing – and to increase the speed, accuracy and usability of financial disclosure while reducing the costs associated with the disclosure.

The SEC’s final rules included a three-year phase-in period for implementation, which was based on issuer size.  Large Accelerated Filers were required to comply with the interactive data reporting requirements in the latter half of 2010.  The reporting requirements will be applicable to all public companies, including smaller reporting companies and other non-accelerated filers, beginning with any periodic report containing financial statements for a fiscal period ending on or after June 15, 2011 (unless that report is a Form 10-K, in which case the rules would apply to the next Form 10-Q).  For most companies, the rules require XBRL interactive data files to be provided with the Form 10-Q for the fiscal quarter ending on June 30, 2011.

Set forth below is additional information about the SEC’s interactive data reporting requirements:

  • Interactive data files are to be filed as exhibits to the corresponding filing (typically, a Form 10-K or Form 10-Q, although the rules also apply to registration statements and Form 8-Ks containing revised or updated financial statements).
  • Initially, a company is only required to tag its financial statement footnotes and schedules individually as “blocks of text.”  After one year of such tagging, the company will also required to tag the detailed quantitative disclosures within the footnotes and schedules. 
  • The interactive data file exhibits will be required at the same time as the corresponding filing with the following two exceptions:
    • each public company is entitled to a 30-day grace period for its initial XBRL filing (which is to be made via an amendment to the corresponding filing); and
    • each public company is entitled to a similar 30-day grace period for its first XBRL filing that includes detailed tagging of its financial statement footnotes and schedules.
  • Any public company that does not provide or post required interactive data on the date required will lose its Form S-3 and Form S-8 eligibility – and will not be deemed to have available adequate current public information for purposes of Rule 144 of the Securities Act of 1933 (the “Securities Act”) – until such time as the required interactive data is provided or posted.
  • Each public company must post any interactive data file(s) to its web site by the end of the calendar day on which the file(s) are provided to the SEC, and the file(s) must remain accessible on that web site for at least 12 months.

Principal SEC Filing Fee Rate Increases 62.8% for 2011

On December 22, 2010, President Barack Obama signed a continuing resolution funding the SEC and various other federal agencies for approximately two months.  The bill was deemed the SEC’s “regular appropriation” for fiscal year 2011 and therefore triggered changes in the rates of fees collected by the SEC.  Accordingly, effective December 27, 2010, the fee rate applicable to the registration of securities increased 62.8%, from $71.30 per million dollars to $116.10 per million dollars.  Effective January 21, 2011, the fee rate applicable to securities transactions on national securities exchanges (e.g., NYSE and NASDAQ) and the over-the-counter markets will increase 13.6%, from $16.90 per million dollars to $19.20 per million dollars.

Powers of Attorney in New York – Part II

In 2009, the State of New York amended the statutory requirements for powers of attorney executed in that state to address potential abuses by agents holding such powers.  The stringent requirements were considered to apply, for example, to individuals executing powers of attorney within the State of New York in connection with SEC filings (e.g., registration statements).  As a result, many people wisely began using a separate form for any power of attorney executed by an individual within the State of New York.

Effective as of September 13, 2010, New York enacted revisions to its statutes to clean up the above referenced unintended consequence – and several others.  The 2010 revisions generally clarify that the 2009 requirements do not apply to powers of attorney given primarily for business or commercial purposes.  Specifically, the 2009 requirements do not apply to (among other powers):

  • proxies or other delegations of power to exercise voting rights or management rights;
  • powers created on a form prescribed by a government or governmental agency for a governmental purpose;
  • powers authorizing a third party to prepare, execute, submit and/or file a document with a government, governmental agency or other third party; or
  • powers given by current or future directors, officers, shareholders, employees, partners, limited partners, members, unit owners or managers of a legal or commercial entity in that person’s capacity as such.

The 2010 revisions intended to address the SEC filing issue and most (if not all) of the other concerns raised by the business and legal communities following the 2009 amendments.  Because the 2010 revisions were retroactive, powers of attorney granted between September 1, 2009 and September 13, 2010 are valid (without re-execution) if they comply with the revised requirements (even if they would have been invalid under the 2009 amendments).

[1] The 10 firms registered as NRSROs include A.M. Best Company, Inc., Fitch, Inc., Moody’s Investors Service, Inc. and Standard & Poor’s Ratings Services, among others. [Back]

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