Update from the Practicing Law Institute’s 40th Annual Institute on Securities Regulation
By: ROBERT K. RANUM & ELIZABETH M. DUNSHEE
December 8, 2008
The Practicing Law Institute held its 40th Annual Institute on Securities Regulation in New York in mid-November. Speakers included SEC staff from the Divisions of Corporation Finance and Enforcement and various other experts in the field. Several notable themes emerged, including the following:
Expect Fundamental Changes in the Regulatory Institutions Governing Securities, Commodities, Banking and Investment Banking. Since the Treasury’s March 2008 release of the “Blueprint for a Modernized Financial Regulatory Structure,” which contemplates expanding the power of the Federal Reserve and condensing public agencies charged with oversight and regulation, there has been continued consideration of an overhaul of our regulatory institutions. Panelists at the Institute acknowledged that the new administration will continue to address gaps and inefficiencies in the current regulatory structure. SEC Chairman Christopher Cox noted that consolidation of the SEC and the Commodity Futures Trading Commission could improve investor protection, and one panelist speculated that “Next year we’ll be talking about a new SEC combined with other regulatory institutions.”
Prepare to Comply with Restrictions and Disclosure Requirements for Executive Compensation that are Currently Applicable Only to Participants in the Troubled Asset Relief Program (TARP). A panelist summarized the political mood on executive compensation by quoting Senator Christopher Dodd, who views the compensation regulations in TARP “as the beginning, not the end.” Therefore, all registrants should be aware that these rules may be applicable to them in the future. The rules prohibit golden parachute payments, do not allow deductions for compensation to named executive officers that exceeds $500,000 and require a clawback for compensation calculated on the basis of “materially inaccurate” performance metrics. More likely to involve immediate spillover is the requirement for compensation committees to ensure that compensation arrangements do not promote “unnecessary and excessive risks.” All companies, not just TARP participants, should consider identifying the types of compensation that would incentivize officers to take short- and long-term risks and analyze such risk-based compensation decisions in the Compensation Discussion and Analysis (CD&A). A proper risk analysis is two-fold, addressing goals (which should be balanced, include financial and non-financial criteria, incorporate benchmarks, and allow the compensation committee to exercise discretion) and awards (the type and vesting or holding requirements of which should be structured to encourage long-term performance).
Risk Management Procedures are Increasingly Important for All Registrants. In light of the recent failures of significant financial institutions, participants in several panels noted that all companies should examine the structures in place to identify and manage risk and ask whether the company culture, strategy and compensation programs support those structures. Panelists noted that the method for risk analysis would vary from company to company, but that it may be appropriate to have a separate risk committee with oversight provided by the full board. While acknowledging that director independence is still an important consideration, Marty Lipton, the well-known corporate governance expert, highlighted the importance of focusing on risk by stating that “Maybe we need less independence on boards and more directors who understand the business and the strategic risks of the business.”
Expect a Heightened Look at Liquidity Disclosure and a Renewed Focus on Management’s Discussion and Analysis. Disclosure regarding liquidity is particularly important during the credit crisis. Panelists noted that companies who use short-term funding for long-term assets are suffering a constant liquidity risk and should make appropriate disclosures. In addition, it is important for companies to analyze their credit agreements for default risks and triggers. Companies at risk of default should craft a risk factor to address the issue.
The SEC staff cautioned that, while the current state of the economy and its impact on liquidity has affected the performance of many registrants, “boilerplate” risk factors remain unwarranted. Staff panelists reiterated that risk factors should be clearly worded and specific to the registrant, and explained that some of the more generic language it has seen in the risk factor disclosures may be better suited for the business description or the MD&A.
Several staff panelists reiterated the continued importance of the MD&A and encouraged registrants to review the SEC’s December 2003 guidance.1 In addition, the SEC accounting staff has issued “advance guidance” in the form of two “Dear CFO” letters relating to fair value disclosures.2 John White, Director of the SEC’s Division of Corporation Finance, noted that board materials provide insight into the company’s risks and performance outlook and may indicate to management what should be disclosed as a known trend or uncertainty.
The SEC will not be conducting a targeted review of CD&As this year, but this portion of the Proxy Statement remains important. Registrants should review John White’s October 21 speech to the Proxy Disclosure Conference in New Orleans.3 The staff explained that the most frequently issued comments will continue to relate to performance targets. Companies must address the nexus between disclosure and competitive harm if they choose not to disclose the targets. As noted above, compensation committees should prepare for the spillover effect of TARP requirements and begin implementing a risk analysis as a component of their decision-making processes. Any changes to compensation programs due to performance metrics affected by current economic conditions, or any repricing programs implemented because of decreasing stock prices, should be appropriately explained. Additionally, as some panelists opined that the Say on Pay movement would regain momentum in the coming year, compensation committees should be prepared to use the CD&A to rationalize and market their chosen compensation programs.
The SEC Wants to Assist Registrants During the Credit Crisis and Desires to Improve Understanding of its Rules. John White noted that the Division of Corporation Finance is trying to accelerate its review process and encouraged companies to call the Division if there are any questions during the drafting process. He further explained that the Division is undertaking a comprehensive transparency initiative, which will make greater use of the SEC website and include the following:
- expanding the comment process to make SEC guidance known before reports are submitted—for example, posting “advance reviews” in the form of Dear CFO letters to the SEC website;
- updating interpretations;
- posting Division statements on the SEC website on the same day meetings are held;
- posting shareholder proposal letters;
- publishing a Division agenda;
- posting staff observations;
- posting a description of the review process and explaining how to communicate with the staff;
- creating a web intake form for interpretive advice, in addition to hotline numbers currently in place; and
- posting an Accounting Disclosure and Interpretation Manual on December 9, 2008, which will officially document practices already in place and update information from the Accounting Disclosure Rules and Practices Training Manual published in 2000.
Expect the Division of Corporation Finance to Finalize its XBRL Proposal Before Year-End and to Broaden Interactive Data Requirements in the Future. The SEC plans to finalize its proposal to require use of interactive data or XBRL prior to year-end. Next year, the SEC expects to broaden the use of interactive data through its 21st Century Disclosure Initiative, which will apply to the text of reports in addition to financial statements.
The Staff May Consider Revising E-Proxy Rules Next Year. The staff acknowledged reports that some investors have attempted to “vote the notice” that companies are required to provide regarding online availability of proxy materials. Accordingly, the staff is considering amending the notice requirements to require less specific information and permit the inclusion of educational materials on e-proxy procedures. The staff is also considering shortening the 40-day notice period to 30 days in order to encourage early compliance with e-proxy rules and provide additional flexibility to issuers.
The regulatory landscape is changing, but investor protection and transparency continue to be important themes. Keep watching for updates and initiatives from the SEC. If you would like more information regarding this update, please contact any of the attorneys in the Fredrikson & Byron Securities Group.
1 The December 2003 guidance is available at http://www.sec.gov/rules/interp/33-8350.htm.
2 The March 2008 letter is available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0308.htm. The September 2008 letter is available at http://www.sec.gov/divisions/corpfin/guidance/fairvalueltr0908.htm.
3 Mr. White’s speech is available at http://www.sec.gov/news/speech/2008/spch102108jww.htm.