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August 2002

In This Issue:

  • Administration: President Bush Outlines More Actions to Bolster Confidence
  • Congress: Senate Unanimously Passes Accounting Reform Bill
  • SEC I: 1st Regulation FD Enforcement Action Reported to be Settled
  • SEC II: PwC Pays $5 million to Settle Independence Violation Allegations
  • SEC III: Synopsis of Comment Letters on 8-K Insider Reporting Proposal
  • SEC IV: Staff Allows Inclusion of Proposals on Shareholder Approval of Option Plans
  • SEC V: Fannie Mae and Freddie Mac Volunteer for '34 Act Reporting
  • SEC VI: 1st Enforcement Action for Misuse of Special Purpose Entities
  • CEO and CFO Certifications: Eleven Practical Considerations
  • Insider Transaction Reporting: Practice Tips for Expedited Reporting
  • Stock Options: Controversy Continues as More Companies Expense
  • What's Up Online: 10 Common Mistakes on IR Web Pages
  • Comings and Goings: Who's Doing What and Where
  • Events Calendar

New Online Program: On Tuesday, July 23, 2002 (10 - 10:30 am EST), we will hold a complimentary teleconference "Filing via EDGAR for Non-U.S. Companies." The panel includes:

  • Elliott Staffin, Special Counsel, Office of International Finance, U.S. Securities & Exchange Commission
  • Nancy Meier, US GAAP Manager in Financial Reporting and Analysis, Novartis AG
  • Ruth Kaufman, Head, EDGAR Specialist Team, RR Donnelley Financial
  • Roslyn Tom, Partner, Dewey Ballantine LLP

SEC Reform Portal: Our SEC Reform Portal is growing by leaps and bounds. The number of law firm client memos has more than doubled in the past week. Visit the SEC Reform Portal.

Administration: President Bush Outlines More Actions to Bolster Confidence

In early July, President Bush beefed up his earlier announced 10-point plan in an effort to bolster investor confidence (see our April 2002 issue). His plans include:
  • Enhance power of the SEC to freeze improper payments to executives while company is under investigation.
  • Prevent corporate officers from receiving company loans.
  • Double maximum prison term for mail and wire fraud.
  • Require directors of publicly listed corporations to have no material relationship with the company.
  • Ask the U.S. Sentencing Commission to recommend longer prison terms for corporate executives guilty of fraud.
  • Create a new task force for the pursuit and prosecution of corporate criminal activity.
The full text of President Bush's speech is at http://www.washingtonpost.com/wp-dyn/articles/A43995-2002Jul9.html.


Congress: Senate Unanimously Passes Accounting Reform Bill

Voting 97-to-0, the Senate approved legislation sponsored by Banking Committee Chairman Paul Sarbanes (D-Md.) to tighten regulation of independent auditors and make company officers more accountable for their conduct. Not only was the unanimous vote overwhelming in nature - so was President Bush's supportive statements afterwards (since Treasury Secretary Paul O'Neill attacked the Senate package beforehand).

Just before passing the bill, the Senate unanimously added two amendments - regarding companies electronically disclosing insider stock sales within 2 days and the SEC issuing rules of professional conduct for corporate lawyers (e.g. lawyers who learn about illegal company activity would have to report the violations to senior management and, if they fail to respond, to the board or its audit committee).

The legislation now goes to a House-Senate conference, where negotiators try to resolve differences between the Senate bill and a much narrower and less restrictive measure approved by the House in April. Although this conferencing will commence soon - and many believe that the House will have to accommodate many of the Senate's stronger measures - House GOP leaders already have vowed to dilute some provisions, such as the mandate for an independent oversight board for auditors.

The Sarbanes-Oxley Act of 2002 is at http://financialservices.house.gov/media/pdf/H3763CR_HSE.PDF.


SEC I: 1st Regulation FD Enforcement Action Reported to be Settled

According to a July 17th Washington Post article, after an investigation that lasted more than a year, Raytheon Corp. reportedly is the first company that has settled with the SEC after allegedly violating Regulation FD. However, the SEC has not yet announced a settlement.

The SEC began looking into the issue after Bloomberg reported in March 2001 that the Raytheon CFO briefed analysts without making public the information he gave them. Raytheon considered the briefings a routine follow-up to the company's annual meeting with analysts.

The Washington Post article is at http://www.washingtonpost.com/wp-dyn/articles/A15842-2002Jul16.html.


SEC II: PwC Pays $5 million to Settle Independence Violation Allegations

In mid-July, PricewaterhouseCoopers agreed to pay a $5 million fine to settle SEC allegations that it failed to remain independent from companies it audits. The fine is the SEC's largest for auditor independence violations - and is the first in which the SEC found that a consulting relationship compromised an auditor's independence that eventually led to an improper audit.

Specifically, the independent auditor allowed two companies to misstate costs by improperly accounting for fees they paid for PwC's own consulting work - they were classified as capital expense rather than ordinary expense.

In addition, the SEC alleged that PwC had improper contingency arrangements between 14 clients and PwC Securities, a broker-dealer affiliate. It was alleged that this affiliate performed investment-banking services for audit clients on a contingency-fee basis - which allegedly provided a financial incentive for PwC to give clients a clean audit opinion.

Under the settlement, PwC has agreed to strengthen its internal procedures and review "modified value-added fee agreements." The PwC settlement follows SEC allegations earlier this year that Ernst & Young and KPMG also violated auditor independence rules. KPMG reached a settlement with the SEC - and Ernst & Young fought the SEC charges and won on procedural grounds because an administrative law judge found that the SEC had improperly initiated the case on a vote of only one commissioner. (See our June issue)

The SEC's press release and related litigation releases are at http://www.sec.gov/news/press/2002-105.htm.


SEC III: Synopsis of Comment Letters on 8-K Insider Reporting Proposal

In response to the SEC's proposal to require insiders to report their insider transactions on Form 8-K, the SEC has received several dozen comment letters. Below is a brief analysis of the positions taken by some of the groups that responded:

American Society of Corporate Secretaries:
  • Cover only executive officers - and define them as officers subject to Section 16(a) reporting requirements.
  • Use a deadline of Wednesday of the following week for reporting all transactions, regardless of size or type.
  • Require disclosure of only the intended transaction - not the details of the final transaction.
  • Eliminate duplicative reporting where possible.
  • Do not phase the rules based upon transaction value or type.
  • Exempt extensions of credit for which disclosure would not be required under Item 404(c) of Regulation S-K.
  • Eliminate the Form 5 - and instead include the information on the next Form 4 report after the Form 5 event occurs.
American Corporate Counsel Association:
  • Exclude non-executive directors.
  • Use a deadline of Friday of the following week for reporting all transactions, regardless of size or type.
  • Exclude granting of a stock option or the awarding of restricted stock pursuant to an employee benefit plan.
  • Create a separate form for the filing of such information.
  • Not make the new Item 10 filings subject to Securities Act liability through automatic incorporation by reference - since many of these filings may contain information provided to the company by the executive officer or director.
  • Eliminate duplicative filings.
  • Use long transition period so not effective earlier than six months after adoption.
Business Roundtable:
  • Adopt the second business day of the following week standard for all transactions.
  • Consider a six-month delayed effective date.
  • Eliminate duplicate filings.
The comment letters filed electronically on this proposal are available at http://www.sec.gov/rules/proposed/s70902.shtml.


SEC IV: Staff Allows Inclusion of Proposals on Shareholder Approval of Option Plans

In Staff Legal Bulletin 14a, the SEC staff changed its policy to allow shareholders to submit proposals that ask companies to obtain shareholder approval for all equity compensation plans that would potentially result in material dilution to existing shareholders.

Under the Staff Legal Bulletin, a company can not rely on the "ordinary business" exclusion to omit:
  • Any proposal that focuses on equity compensation plans that may be used to compensate only senior executive officers and directors; and
  • Any proposal that focuses on equity compensation plans that potentially would result in material dilution to existing shareholders, regardless of who participates in the plan.
During this past proxy season, the SEC staff held that the companies did not have to include these types of proposals in their proxy statements - because they involved "ordinary business" normally left to the discretion of management. Many of these proposals had been submitted by TIAA-CREF, which appealed the staff's decision to the Commission.

Interestingly, one company voluntarily included the proposal, Mentor Graphics, where it won support from 57% of the shares voted at the company's annual meeting. (See our June issue)

Unlike existing proposals of the New York Stock Exchange and the Nasdaq, the Staff Legal Bulletin applies to all public companies - not only companies listed or quoted on those markets.

The Staff Legal Bulletin is available at http://www.sec.gov/interps/legal/cfslb14a.htm.


SEC V: Fannie Mae and Freddie Mac Volunteer for '34 Act Reporting

Under pressure from Congress, Fannie Mae and Freddie Mac volunteered to file periodic reports with the SEC as if they were subject to the Securities Exchange Act of 1934. Under the statute, they are exempt from such reporting because they are specially chartered by Congress.

The reporting change could begin as early as next year. This means these government-sponsored enterprises will be fully subject to SEC oversight and enforcement for the first time. However, they would continue to not be subject to the Securities Act of 1933 - enabling them to conduct offerings without filing with the SEC or paying filing fees.

While this represents a major policy change, it will not provide much more information to investors. For several years Fannie Mae and Freddie Mac have disclosed much of the information that other publicly traded companies have been required to file with the SEC rules.

The SEC's statement related to this policy change is at http://www.sec.gov/news/speech/spch574.htm.


SEC VI: 1st Enforcement Action for Misuse of Special Purpose Entities

The SEC and Federal Reserve Board settled a joint enforcement action with PNC Financial Services Group resulting from alleged improper accounting transactions with special purpose entities. The SEC found that, in violation of GAAP, the company transferred $762 million of volatile, troubled or under-performing loans and assets to 3 special purpose entities - which resulted in material overstatements of earnings, among other things.

The SEC's Order stated that the company should have consolidated these special purpose entities into its financial statements - and that it made materially false or misleading disclosures about these transactions.

More information is at http://www.sec.gov/news/press/2002-109.htm.


CEO and CFO Certifications: Eleven Practical Considerations

On June 26, the SEC issued an order requiring the CEO and CFO of 947 companies to file a statement in writing, under oath, that relates to the accuracy of their most recent annual report on Form 10-K - and subsequent filings. To meet the SEC's deadline, the affected companies are rushing to meet the requirements of this novel order.

The SEC has had quite a few questions and issued 2 sets of FAQs in response - here are the first set of FAQs - as well as the additional FAQs.

A number of companies that are not required to file certifications want to file them anyway. The SEC recommends they be filed as an Item 5 Form 8-K - but not sent to the SEC's secretary. The SEC noted this in its additional FAQs.

On July 29th, the SEC issued a statement strongly recommending that even the 947 companies file their certification on Form 8-K under Item 5 or Item 9 (which probably is best since this filing has less liability as a "furnished" 8-K) with the SEC. This filing is in addition to the original requirement to submit an original certification to the SEC's secretary. This statement is at http://www.sec.gov/rules/extra/staff21a1.htm.

In its statement, the SEC also is recommending that companies post their certifications on their own web sites - along with any qualifying statements they wish to make.

For the most part, companies have their own unique circumstances and should take those circumstances into consideration. Below is an analysis of various approaches to meeting this certification requirement that are being discussed:

1. Don't Vary from the Mandated Language

In its additional FAQs, the SEC has made it quite clear that no variations from the required language are permitted - including no word changes, no footnotes, no lack of notarization - and no cover letter explaining why certain changes might have been made. If the SEC receives any certifications with variations from the mandated template, it will label them as "deficient" certifications and make that publicly known.

If a company wants to make clarifying comments to investors, the SEC will allow companies to do that outside the scope of the certifications.

2. Develop a "One Time" Process

At a recent conference, Corp Fin Director Alan Beller indicated that - wearing his hat as a former law firm partner - companies would be well advised to develop a set of procedures before CEOs and CFOs execute their certifications - even if the procedures were a "one time" only situation (it would be one-time only because the order differs in scope and manner from the SEC's proposed rulemaking on the same topic).

These procedures should include input from key insiders and outside advisors on the areas that the CEO and CFO should focus on when asking about the accuracy and completeness of past disclosure.

3. Meeting with Subordinate Officers

A number of companies report that their CEOs and CFOs are holding meetings with lower level officers to obtain their assurance that the disclosure filed to date is accurate and complete. This provides one last chance for these officers to raise any concerns that they may have.

Normally, each officer that has oversight over an area that is implicated in the company's disclosure is included on the disclosure team (e.gs. treasury department because liquidity and investments are described). At a minimum, the members of the disclosure team that are recommended in the SEC's rule proposal on certifications should be included.

The issue arises whether these meetings should be held in one group or on an individual basis. The benefits of individual meetings is that officers may be more willing to raise issues if they are not in front of their peers. On the other hand, officers may be more forthcoming if they are in a group where they see that other members are raising issues.

4. Checklist of Matters to Discuss

At these disclosure meetings, it is recommended that the CEO and CFO use a checklist.

It is recommended that this checklist include the matters that are identified in the long-form representation letter that management provides to the independent auditors. The bottom line is that the discussion should follow a due diligence approach as if a new Form 10-K was being drafted (arguably without a duty to update - but this can be difficult to dissect if a subsequent event raises some doubt about the accuracy of a prior disclosure).

Some practitioners have counseled that an extensive checklist should not be used - since it would be discoverable in litigation. Each company should take the approach it feels comfortable with - similar to any due diligence situation.

5. Board Involvement in Discussion

If a disclosure team is assembled for a frank conversation with the CEO and CFO, the chair of the audit committee should be notified in advance (rather than hear disapproval after the fact).

Then, the chair may ask the entire audit committee what role it should play in the review process. Some audit committees may want to play an active role in designing the process - others may want to wait to review the contents of sworn statements. Of course, the audit committee should get actively involved if the review process detects a problem.

After the review, the audit committee should meet to discuss the results - before the certifications are executed. In its "Additional FAQs," the SEC noted that the CEO and CFO must each personally meeting with the audit committee to enable them to each certify that the contents have been reviewed with the audit committee.

6. Supporting Certificates from Subordinate Officers

Due to the "knowledge" qualifier in the requisite certification (and general duties of inquiry), some CEOs and CFOs are requesting lower level officers to execute supporting certificates. Others believe that these are unnecessary and can be unproductive to the process of verifying the disclosure. In fact, it is questionable how much a CEO or CFO could rely on these "shadow certificates" in good faith if a legal action arose.

These certificates should be limited in scope to the area of responsibility to which the officer is dedicated and not precisely mirror what the CEO and CFO provide to the SEC. In fact, the CEO or CFO might be in a stronger position if the supporting certificate is tailored to the knowledge and responsibility of the subordinate. Mere mirroring certificates do not document the steps taken by the senior manager to discover the reasonably available facts upon which his or her certificate is based. The officer should strive to ensure that it has no duty of inquiry and can rely on any information provided by other employees, including subordinates.

Limiting the scope of the underlying certificate can be challenging since the request is coming from the CEO or CFO. However, subordinate officers should inquire whether outside counsel can be asked to at least review the certificates they are asked to sign. The issue then becomes whether outside counsel is permitted under its terms of engagement to represent the officer. The argument supporting this review is that the certificate supports the CEO and CFO certifications and are closely intertwined with them.

7. Document the Process and More

In addition to documenting the process and procedures employed leading up to the time the CEO and CFO execute their certification, it is recommended that the company document the quarterly process and procedures used to draft the disclosure for each 10-Q and 10-K.

The benefit is that there is then a compliance record of how the company drafts disclosure. The risk is that the company then must ensure that it is using those procedures each quarter.

8. Try to Get "Comfort" from Independent Auditors and Outside Lawyers

Following the advice of Alan Beller, companies may engage outside advisors to ensure that their disclosure is accurate and complete. As part of this analysis, companies may want to obtain some type of writing to support the fact that these advisors reviewed the disclosure, such as a Rule 10b-5 opinion.

Note that the SEC is not providing any interpretative advice on what are the definitions of "review" and "best of my knowledge." The SEC believes those interpretations are best left to counsel.

9. Deciding Whether to File the Certification Early

If a CEO or CFO files its certification before the due date for its next Form 10-Q - i.e. before August 14th - the certification does not have to cover the disclosure for that 10-Q. The SEC made this clear in its "Addition FAQs."

The benefit is that the certifying officer is then not "on the hook" for that disclosure. The risk is that investors and journalists may portray this as an evasive move and wonder if there is problematic disclosure in the 10-Q.

If a company files its Form 10-Q early (e.g. August 10th), it can still wait until August 14th to file its certification.

10. Call the SEC if Questions Arise

Alan Beller urged companies to contact the SEC - either Corp Fin or the Office of the Chief Accountant if any questions arise. The hotline for procedural questions is (202) 942-2808. Substantive questions should be directed towards Corp Fin Chief Accountant Carol Stacey or SEC Chief Accountant Bob Herdman.

11. Tell the CEO and CFO that SEC Comments are Coming

The SEC staff is in the process of sending out comment letters to companies on their latest 10-K filings. Corp Fin Director Alan Beller has indicated that several dozen comment letters have already been sent to companies.

It is probably wise to inform CEOs and CFOs that they may get comments from the SEC staff after they submit their certifications. This can be a sensitive topic as the comments may raise issues after the officers have just signed off on the accuracy and completeness of their reports. The SEC staff has confirmed that it can not indicate whether a comment letter will be forthcoming - or otherwise hasten the comment letter process so that comments are received before the certification deadline.

If you want to see Law Firm Client Memos on this topic, go to the
SEC Reform Portal

Insider Transaction Reporting: Practice Tips for Expedited Reporting

According to Rachel Geiersbach of CSX Corporation, in anticipation of the SEC adopting rules - or Congress passing a related statute - companies should begin planning for expedited filing of insider transactions. Although these words of wisdom could change depending on the nature of the adopted rules, she recommends that companies:

1. Understand the key impacts of the proposals
  • The issuer - not the insider will be liable for missing or late reports.
  • The expedited reports will be considered "filed" and incorporated by reference into subsequent SEC filings.
  • Additional types of transactions not currently reported on Form 144 or Section 16 forms must be reported.
2. Establish or revise the company's insider transaction compliance program
  • The program should reflect the new reporting requirements.
  • The program should be enforceable - and enforced in a verifiable manner so that the issuer will be in a position to take advantage of the SEC's safe harbor in the event of a missing or late report.
  • The program should include pre-clearance of all transactions, including employee plan transactions.
  • Consider barring transactions in any third-party derivatives involving the company's securities.
3. Educate officers and directors regarding the new reporting requirements
  • New types of transactions to be reported include the establishment of 10b5-1 plans, loans made or guaranteed by the issuer or its affiliates, and other transactions that are the "economic equivalent" of transactions in the issuers securities, such as the pledge of securities as collateral for a non-recourse loan.
  • Under current proposals, nearly all transactions that are currently reported pursuant to Section 16 must be reported on an expedited basis on a Form 8-K, but Rule 144 and Section 16 filings must still be made.
  • The issuer must be informed about all transactions, including gifts, immediately.
4. Establish new reporting procedures
  • Determine which person or department will be responsible for expedited reporting. Additional staff will likely need to be trained.
  • Unless the SEC provides a standardized reporting format, the issuer will need to decide whether to use a tabular or textual reporting format.
  • Determine how the EDGAR filing will be accomplished. Will this be done through the issuer's accounting group or financial printer - or can it be done directly by the staff responsible for gathering the information?
  • E-mail for insiders, their assistants, and brokers to provide the required information to the issuer.


Stock Options: Controversy Continues as More Companies Expense

In mid-July, Coca-Cola, Bank One Corp. and several other companies announced that they will expense the cost of stock options starting with the 4th quarter. A number of other companies are considering similar steps. Boeing and a handful of other companies already expense options.

Congress remains stalled on this issue - the Senate refused to take up an amendment offered by Sen. Carl Levin (D-Mich.) that would have instructed regulators to adopt rules to expense options. Pressure from the technology industry remains high - as these companies generally have granted more options than companies in other industries.

According to a report by Bear Stearns & Co., 38 companies would have experienced an earnings decline of more than 50% last year if required to deduct options as an expense - and 20% of the profit reported by S&P's 500 companies would have been erased.

In mid-July, the International Accounting Standards Board adopted a rule that would treat options as an expense. All European Union companies - as well as companies in Australia and several other nations that follow the IASB regulations - must adopt the board's standards by the beginning of 2005. This places more pressure on FASB to adopt a rule for U.S. to expense options. (Something FASB wanted to do years ago - but retreated in the face of substantial Congressional pressure)


What's Up Online: 10 Common Mistakes on IR Web Pages

According to an excellent analysis by Dominic Jones of Blunn & Co., the 10 most common mistakes on IR Web pages are:

1. Burying the best material - the most useful information often is buried in repurposed print documents three or four layers down from the IR homepage - a better approach is to extract high-demand information from repurposed documents and place it on the IR homepage or one level below.

2. Not enough context on the site - Retail and professional investors have vastly different information needs. No one expects you to explain the fundamentals of accounting, but the more context you provide about your industry and your business, the better. Witness EMC's award-winning IR website with its extensive background information on the data storage industry.

3. Following the crowd - A problem with aggregator services is that all IR Web pages begin to look the same. A prepackaged solution often isn't a good one from either the company or the user's perspective. The bread and butter of aggregator sites is short-term earnings related information - but when the focus turns to more long-term fundamental measures and non-financial value drivers, the aggregators are found wanting. Usability is also not the aggregators' forte.

4. Overuse and misuse of PDFs - As a rough guide, PDFs should only be used in addition to an HTML file, and only to provide the user with a way to get a PostScript quality printout of a document. You should never provide them as a way to view a document online.

5. Unusable audio and video archives - For most investors, real-time streaming media is one of the best things to happen to investor relations. But once the real-time event is over, streaming media's value plunges precipitously. This is where written transcripts of audio and video files are invaluable. For guidelines on how to present them, see the AOL TimeWarner site. As well, most executive presentations are scripted, so it shouldn't be difficult to provide a copy online, such as IBM does.

6. Scrolling text and distracting animation - Reading online is difficult enough, but scrolling text is next to impossible to read. Scrolling text is commonly applied on IR websites to news headlines and stock quotes. Neither of these uses for scrolling text adds value to a site and may actually reduce its effectiveness.

7. Flash for the sake of it - Sites built entirely in Flash suffer from a host of usability problems. The King Pharmaceuticals site is one which is built using Flash. The site suffers from long download times and a unique user interface which both confusing and hard to use. Even limited Flash use can hurt a site's effectiveness. Take a look at this page from American International Group. One common use of Flash that won't be missed if you avoid it, is for introduction or splash pages.

8. Slow download times - Most Internet connections in North America are still based on the 56K dial-up technology. Watch out for items made available as downloads in non-standard formats, including PowerPoint, Word, PDF and Flash. Wherever possible, these documents should be converted to HTML.

9. Jargon, legalese and marketese - Using plain language can dramatically enhance the usability of an IR website for both retail and professional investors. Research by author and usability consultant Jakob Nielsen shows that users prefer fact to fluff.

10. Credibility gaps and gaffes - I put this at number 10 not because it's the least important mistake, but because it's impossible for me to provide an exhaustive list of the things than can undermine your company's credibility online. Perhaps the most important rule to remember is that it's much harder to hide things online than it is in the physical world. Missing information, "happy copy," and being thin-skinned are some key things that can undermine your credibility.

A more comprehensive discussion of these 10 common mistakes is available at http://www.irwebreport.com/features/feature010501.htm.


Comings and Goings: Who's Doing What and Where

In Congress, the four Commissioner candidates waiting to be confirmed by the Senate - Harvey Goldschmid, Paul Atkins, Roel Campos and Cynthia Glassman (who is already a Commissioner under a recess appointment) are believed to be close to being confirmed. President Bush has been criticized for not having a full Commission during this critical juncture in the marketplace.

Events Calendar

Upcoming events of interest include:
  • RealCorporateLawyer.com's "Filing via Edgar for Non U.S. Companies" - July 23th at 10 am EST - course materials now available at http://www.realcorporatelawyer.com/CLE/CLEHome.html.
  • American Bar Association's "2002 Annual Conference," Washington D.C., August 8-13
  • State of Wisconsin's, "Directors' Summit," Madison, Wisconsin, September 4-6. See http://uwexeced.com/directorssummit/.
  • SEC's "Annual Small Business Forum," Arlington, Virginia, September 26-27
  • National Association of Stock Plan Professionals' "2002 Annual Conference," Las Vegas, September 29- October 2
  • American Corporate Counsel Association's Annual Conference, Washington D.C., October 20-23
  • PLI's "34th Securities Law Institute," New York City, November 6-9
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 ©2002 RR Donnelley Financial

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