Corporate Finance News 

June, 2006 -

Things To Think About This Proxy Season Prior to Drafting Update director and officer questionnaires, including “independence” criteria for directors Most public companies follow the “best practice” of having all directors and executive officers complete a standard form of questionnaire each year to verify the accuracy of information about the person that is reported in the 10-K Report and proxy statement. Testing independence of directors should not be left for self-assessment or other casual process. Rather, it is something that companies should actively evaluate. You should include questions that will elicit information to address the issues of (1) director “independence”, (2) audit committee member “independence” and (3) status as an “audit committee financial expert”. Note that the independence definitions are different for NYSE, AMEX and NASDAQ companies and are more stringent for Audit Committee members, and that amendments to the NYSE and Nasdaq governance rules were approved in the fall of 2004. Determine if your nonqualified deferred compensation plans need amending in light of the American Jobs Creation Act of 2004, and if so, whether shareholder approval is required The AJCA of 2004 became effective on January 1, 2005, and companies have until December 31, 2005 to amend any plans, agreements or arrangements that provide for “nonqualified deferred compensation” in order to avoid having severe tax penalties imposed on the participants in those plans. Some amendments may require shareholder approval under NYSE, AMEX or NASDAQ listing standards. You should also be familiar with the IRS initial guidance on this new law, Notice 2005-1, which was issued on December 20, 2004. The initial guidance clarifies some definitional terms that are typical in deferred compensation plans and exempts certain types of deferred equity payments from coverage. Determine if shareholder-approval under IRC §162(m) is required for any plans or amendments Remember that executive bonus performance goals need to be re-approved by shareholders at least every five years to assure that such bonuses qualify as “performance based compensation” under Section 162(m) of the Internal Revenue Code. Therefore, if your shareholders initially approved executive performance goals in 2000 or earlier, they may need to be re-approved by shareholders this year. Understand the shareholder proposal procedures Shareholder proposals are becoming increasingly popular. If you have received a request from a shareholder to include his or her proposal in the Company’s proxy statement this year, and if you plan to exclude it for one of the 13 permitted substantive reasons provided in the Rule, you must be familiar with the required time schedule for doing so. You should also be aware of recent Staff Legal Bulletin 14B (September 2004) which sets forth the SEC’s staff positions limiting your ability to exclude proposals because they make unsupported factual assertions, state opinions of the shareholder proponent or make statements that may be interpreted in a manner unfavorable to you, and Staff Legal Bulletin 14A (July 2002) which sets forth the SEC staff’s position limiting your ability to exclude proposals relating to executive compensation (SLB 14, issued in July 2001, also contains helpful guidance to deal with a shareholder request to include a proposal in your proxy statement). You should also be aware of the SEC’s pronouncements on the ability of a shareholder/proponent to make reference to an internet Website in his or her proposal, and under what circumstances these kinds of references are inappropriate. Consider “householding” of proxies and annual reports The SEC’s rule which permits “householding” allows a company to satisfy its delivery requirements for annual reports and proxy statements by delivering one copy of such documents to a household in which several shareholders are residing, provided that the prior consent of all such shareholders is properly obtained. Shareholder consent can be in the form of an affirmative written consent by the shareholder or an implied consent that can be inferred if the shareholder does not respond within 60 days to a proper advance notice from the Company. If you are thinking about using this delivery method to save expenses, be sure to consult with an expert familiar with the provisions of the SEC’s rule on householding. The Proxy Statement Consider modernizing your Proxy Statement More and more companies have decided to make their proxy disclosure document “user friendly” by re-writing it in “plain English,” and many are including extensive “Q&A” discussions to make the proxy statement easier to read. Although current SEC Rules do not require that annual meeting proxy statements be written in plain English, many companies have done so anyway as part of their ongoing efforts to improve communication with their shareholders. The Q&A discussions typically cover the procedural information in the proxy statement such as voting, director nominations, submitting shareholder proposals, additional information, etc. The rest of the proxy statement would focus on plain English disclosure concerning director elections, other proposals, executive compensation and stock ownership information. Disclose corporate governance practices and consider any additional governance changes to enhance the company’s corporate governance rating. With the increased emphasis on corporate governance issues you should consider adding or enhancing disclosures made in the proxy statement which highlight your corporate governance practices. This enables investors to better understand your corporate governance framework and facilitates the ability of corporate governance rating services such as Institutional Shareholder Services (ISS) to collect data. Most noteworthy is the practice of establishing a new “Corporate Governance” section in the proxy statement. You may also want to consider appending corporate governance guidelines, committee charters and codes of ethics to the proxy statements, and adding a reference in the proxy statement to the website address where these can be accessed. Rethink and improve the Compensation Committee Report Director Alan Beller of the SEC’s Division of Corporate Finance has come out strongly in favor of more meaningful discussion in the Compensation Committee’s Report. Rather than using a boilerplate report from prior years, the report should be drafted from scratch, with input and nvolvement of the committee members, and not just by management itself. Some key points to include are (1) a meaningful discussion of the “compensation philosophy” of the committee, (2) a description of the basic “drivers” used by the committee when deliberating the CEO’s pay; (3) discussion of the emphasis placed on performance visà- vis a benchmark or a peer group as compared to that placed on simple achievement of established targets, (4) describe how the committee uses a complete tally of all forms of cash and non-cash compensation flowing to the CEO and the other named executives in order to be able to support the recommended conclusion that such compensation has been found to be “reasonable” under the circumstances, and (5) describe the committee’s policy on “pay equity,” if any, that is applied to assure shareholders that the CEO and other named executives are being compensated at levels that are fair in terms of the compensation paid to other management employees. Improve overall disclosures regarding executive compensation Shareholder activism over the past year has focused on executive compensation issues and option and stock pay plans. Much discussion has ensued regarding what investors want to see in terms of compensation disclosure. Improved compensation disclosure and better disclosure of equity plans is becoming key to having successful results in shareholder votes. Companies should therefore consider expanding the disclosure regarding any perquisites received by executive officers as well as projected payouts under supplemental executive retirement plans, changein- control agreements, deferred compensation programs, and other types of severance agreements. Maintaining documentation that provides a fair, objective analysis as to the value that each perquisite is assigned is also a critical job to be done. The message from the SEC’s recent enforcement proceeding involving General Electric Company, and other similar proceeding, should not be ignored. The Annual Report Include management’s internal control report and auditor’s report SEC rules implementing Section 404 of the Sarbanes-Oxley Act require public companies to include in their annual reports a report by management on the company’s “internal control over financial reporting” and an accompanying auditor’s attestation report. The new rules define the term “internal control over financial reporting” to mean a process designed by, or under the supervision of, a company’s principal executive and principal financial officers and effected by the board of directors, management and other personnel to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. Management’s annual internal control report must contain: • a statement of management’s responsibility for establishing and maintaining adequate internal control over financial reporting for the company; • a statement identifying management’s framework for evaluating the effectiveness of internal control; • management’s assessment of the effectiveness of internal control as of the end of the company’s most recent fiscal year; and • a statement that the company’s independent auditor has issued an attestation report on management’s assessment. The auditor’s attestation report regarding management’s assessment of the effectiveness of the company’s internal controls and procedures must be included in the company’s 10-K. In addition, the content of CEO and CFO certifications regarding the accuracy and completeness of periodic reports will need to be revised to cover internal control over financial reporting. While not specifically required, the SEC has indicated that it would consider an annual report to shareholders to be misleading if the internal controls reports are omitted and they include disclosures regarding a material weakness in the company’s internal controls. Under the compliance schedule, most companies that are accelerated filers must comply with this requirement and the related auditor attestation report requirement for its first fiscal year ending on or after November 15, 2004. For accelerated filers that have a market cap of under $700 million, the management assessment and related auditor attestation report can be filed up to 45 days after the 10-K filing deadline (which remains at 75 days following fiscal year end) for reports relating to fiscal years ending between November 15, 2004 and February 28, 2005, although few companies are likely to avail themselves of this temporary extension due to the disclosure issues that would arise. A company that is not an accelerated filer must begin compliance with these requirements for its first fiscal year ending on or after July 15, 2005. Improve MD&A by using a more “layered approach” and with better consideration of SEC rules. The following helpful hints will be useful to management as it drafts the MD&A: • Add an “Overview” section. The SEC has promoted a more “layered” approach to drafting the MD&A, with the goal of giving more prominence to the more important areas of management’s discussion and analysis. One way of achieving this goal is by adding an introduction or executive-level overview to the MD&A. This overview should not be a mere summary, but should provide a roadmap for the rest of the MD&A, making the entire section easier for investors to follow. • Avoid boilerplate analyses and simple disclosure of percentage changes over prior year. MD&A should present insight into the companies’ past performance or business prospects as understood by management and analyze the meaning of its results. Simple disclosure of percentage changes over the prior year is not sufficient. • Use tabular presentations and more headings. In discussing the general topic of MD&A layout or organization, the SEC has encouraged companies to consider the use of tabular presentations and more (or clearer) headings. • Provide forward-looking information where there are known trends or uncertainties. During the past year, the SEC staff has been more aggressive in using the “known trend and uncertainties” disclosure requirement in Item 303 to elicit more forward-looking information. Forward looking information is required where there are known trends, uncertainties or other factors enumerated in the rules that will, or that are reasonably likely to, result in a material impact on the company’s liquidity, capital resources, revenues and results of operations. Focus on known facts, events or changes that make the current results not necessarily indicative of future performance. • Discuss key performance indicators that management uses to run the business. The SEC has urged companies to identify and discuss key performance indicators, including non-financial ones, which management uses to run the business. With regard to the discussion of key performance indicators, the SEC expects companies to be thoughtful about the format in which their disclosures are made. • Improve your disclosure and discussion of critical accounting policies. The SEC has placed a heavy emphasis on disclosure of critical accounting estimates and policies. The SEC reminded companies to address how the company arrived at the estimate, how accurate the estimate or assumption has been in the past, why the company’s accounting estimates or assumptions bear the risk of change, how much the estimate or assumption has changed in the past and whether the estimate or assumption is reasonably likely to change in the future. Although the subject matter may be the same, the SEC made it clear that MD&A disclosure should supplement, not duplicate, the description of accounting policies contained in the notes to the financial statements. • Provide required disclosures if non-GAAP financial information is presented. The disclosure and presentation of non-GAAP financial measures are governed by several different sets of SEC rules. Management should pay particular attention to these requirements. Activities After the Dust Settles Update the corporate website and archive old information. The uncertainty of whether companies have a duty to update their statements that were true when made is further complicated in the context of statements made on a company’s website, as such information is continuously available and companies do not frequently monitor their websites for staleness. While noting that this is a gray area, the SEC, in certain contexts, has encouraged companies to archive certain documents for a specific period of time (e.g., archive earnings call webcasts for one year). In offline contexts, the SEC has indicated that it believes that a duty to update information exists when investors are still relying on material prior statements that are misleading. This latter view should encourage companies to more actively monitor their websites. In particular, companies should engage in the following website management activities: • designating one or more employees to be responsible for updating website content (including someone from the legal department); • dating content that is posted, particularly for timesensitive content (including dating content that has been moved to an “archive” section); • verifying on a regular basis that website content is accurate and timely and if not, removing or archiving it (e.g., removing offering materials promptly after the prospectus delivery period ends); • verifying on a regular basis that links are active and that third party content is not objectionable; and • creating a separate “archive” web page for historical documents.



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