SEC Developments

SEC Adopts "Short" Proposal that Codifies SEC Shareholder Proposal Position

On November 28, a sharply divided SEC voted (3-1) to adopt amendments clarifying that shareholder proposals to nominate or elect a director that could result in an election contest (whether immediately or in subsequent years) may be excluded from the company's proxy statement under Rule 14a-8(i)(8).  Specifically, the amendments make clear that the election exclusion is available not only to proposals that relate to a nomination or election of directors, but also to proposals that relate to "a procedure for such nomination or election of directors."  In adopting the new rule, the SEC intends to provide some immediate guidance for shareholders and companies for the 2008 proxy season in an area left ambiguous after a Second Circuit decision last year conflicted with the SEC's longstanding interpretation of the rule. 

Opponents of the measures include labor investors, state pension funds and democratic lawmakers, including Commissioner Annette Nazareth, who voted against the rule's adoption.  In her speech to the Commission, Nazareth called the rule the "non-access release," which "stands in the way of shareholders' rights to elect the directors of the companies they own."  Investor advocate groups are certain to continue efforts to give shareholders greater access to company proxies but, at least for now, shareholders will not have access to company proxies to promote an election contest.

Also at the meeting, the SEC adopted rules intended to facilitate the use of electronic shareholder forums among shareholders, and between shareholders and the company. The new rules clarify that participation in electronic forums, which could potentially constitute a solicitation subject to the current proxy rules, would be exempt from most of the proxy rules, if the communicating party does not solicit proxy authority while relying on the exemption, subject to satisfaction of certain conditions.

SEC Issues Concept Release Seeking Suggestions for Disclosure of Activities Related to State Sponsors of Terrorism

On November 16, 2007, the SEC issued a Concept Release soliciting public comment on whether to develop mechanisms to facilitate greater access to companies' disclosures concerning their business activities in or with countries designated as State Sponsors of Terrorism. The five nations that have been designated by the U.S. Secretary of State as state sponsors of terrorism are Cuba, Iran, North Korea, Sudan and Syria. The SEC decided to issue the Concept Release after withdrawing a new web tool that linked to companies' disclosures containing references to any of the five countries. The web tool was removed last summer in response to extensive public criticism shortly after the SEC launched it. Comments are due on the Concept Release by January 22, 2008.

SEC Adopts Amendments to Rule 144 and Rule 145

On November 15, 2007, the SEC adopted the previously proposed amendments to Rule 144 and Rule 145.  The final amendments are substantially as proposed except that the final amendments do not toll the Rule 144 holding period while the security holder has entered into hedging transactions.

The rule amendments will be effective 60 days after their publication of the amendments in the federal register, which is expected to occur soon.

Davis Polk will be distributing a detailed memorandum discussing the amendments shortly.

SEC Eliminates U.S. GAAP Reconciliation for IFRS Filers and Announces Roundtables to Whether U.S. Issuers Should be able to use IFRS

On November 15, 2007, the SEC Commissioners unanimously adopted a final rule that eliminates the requirement that non-U.S. issuers reconcile financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board ("IASB") to U.S. GAAP in SEC filings.

The SEC has yet to publish the final rule release but has announced that the final rule will take effect 60 days after it is published in the Federal Register and apply to financial statements covering years ended after November 15, 2007. Accordingly, foreign private issuers with a calendar year-end will not need to provide a U.S. GAAP reconciliation in their 2007 annual report on Form 20-F provided the financial statements included in the report comply with IFRS as issued by the IASB.

The SEC has also announced that it will hold roundtables on Thursday, December 13, 2007, and the following Monday, December 17, 2007, to discuss whether to provide U.S. issuers the option of filing financial statements prepared in accordance with IFRS as issued by the IASB and other issues raised in the Concept Release issued earlier this year on this subject.

SEC Adopts Exchange Act Registration Exemptions for Compensatory Stock Options

Also on November 15, 2007, the SEC adopted two exemptions from the registration requirements of the Exchange Act for compensatory employee stock options. The first exemption will be available to issuers that are not required to file periodic reports under the Exchange Act. The second exemption will be available to issuers that are required to file those reports because they have registered under Exchange Act Section 12 a class of security or are required to file reports pursuant to Exchange Act Section 15(d). The exemptions will apply only to the issuer's compensatory employee stock options and will not extend to the class of securities underlying those options other compensation arrangements involving securities, such as restricted stock units or stock appreciation rights.

The exemptions became effective December 7, 2007.

SEC Fills Corporate Finance Positions and Announces Departure of Deputy Enforcement Director

The SEC recently filled the following staff positions in the Division of Corporation Finance:

Brian Breheny was named Deputy Director for Legal and Regulatory Policy. As Deputy Director for Legal and Regulatory Policy, Mr. Breheny will join Shelley E. Parratt, Deputy Director for Disclosure Operations, in overseeing the Division's day-to-day activities. Mr. Breheny has served as the Chief of the Office of Mergers and Acquisitions in the Division of Corporation Finance since July 2003.

Tom Kim was named Chief Counsel and an Associate Director of the Division. Mr. Kim has served as Counsel to SEC Chairman Christopher Cox since 2006, having joined the staff of the Commission as Counselor to the General Counsel.

Wayne Carnall was named the Chief Accountant in the Office of Corporation Finance. Mr. Carnall will be the principal advisor to John White, Director of the Division, on accounting and auditing matters. Mr. Carnall was previously a partner at PricewaterhouseCoopers and prior to that, was a member of the SEC staff.

The SEC also announced the departure of Peter H. Bresnan, Deputy Director of Enforcement, on December 5, 2007.

SEC Extends Current Fee Rate

The SEC has announced that the continuing resolution funding the SEC for fiscal year 2008 since October 1, 2007, has been extended further through December 14, 2007. Therefore, the fee applicable to the registration of securities will remain at its current rate of $30.70 per million of securities registered for the time being.

As previously announced, five days after the date of enactment of the SEC's regular appropriation, the Section 6(b) fee rate applicable to the registration of securities, the Section 13(e) fee rate applicable to the repurchase of securities, and the Section 14(g) fee rate applicable to proxy solicitations and statements in corporate control transactions will increase to $39.30 per million dollars of securities registered.

The SEC will issue an additional notice to announce the date upon which the future fee rate increase will become effective.

SEC Renames Division of Market Regulation as Division of Trading and Markets

The SEC has changed the name of the Division of Market Regulation to the "Division of Trading and Markets." According to the SEC, the new name better reflects the Division's full range of responsibilities.

The Division of Trading and Markets is responsible for policy development regarding markets, broker-dealers, clearing agencies, transfer agents, and other market participants. In addition to regulating major securities market participants, the Division provides consolidated oversight of five internationally active U.S. securities firms. The Division also oversees rating agencies and the business continuity practices and automation controls of the trading markets.

SEC Issues SAB 109 Regarding Written Loan Commitments Recorded at Fair Value Under GAAP

The SEC has issued SAB No. 109, Written Loan Commitments Recorded at Fair Value Through Earnings. According to the SEC, the SAB provides the staff's views on the accounting for written loan commitments recorded at fair value under generally accepted accounting principles (GAAP). To make the staff's views consistent with current authoritative accounting guidance, the SAB revises and rescinds portions of SAB No. 105, "Application of Accounting Principles to Loan Commitments."

The SAB revises the SEC staff's views on incorporating expected net future cash flows related to loan servicing activities in the fair value measurement of a written loan commitment. The SAB retains the staff's views on incorporating expected net future cash flows related to internally developed intangible assets in the fair value measurement of a written loan commitment.

SEC Speaks

SEC Staff Members Highlight SEC Priorities and Concerns at PLI Institute on Securities Regulation

At the PLI 39th Annual Institute on Securities Regulation in mid-November, various practitioners and SEC staff members provided their views on pending and recent securities law developments. Highlights include the following:

Private Offering Reform. John White, Director of the Division of Corporation Finance, noted that the private offering proposals issued to date (which amend or propose to amend Rule 144, Rule 145 and Regulation D) represent what he thought that they could get done now but they may propose additional reforms going forward. For example, while only limited advertising would be allowed pursuant to the Rule 507 proposal issued over the summer, this is only one small step and the SEC may allow additional advertising at some point in the future.

Gerry Laporte, Chief of the SEC Office of Small Business, noted that if the Rule 507 proposal allowing limited advertisements in certain Regulation D private offerings is adopted, companies should be careful about adding anything not explicitly specified in Rule 507 to the advertisements. In drafting this proposal, the SEC staff was envisioning that these advertisements would look like tombstone ads. Mr. Laporte also noted that while only the issuer is able to publish the limited advertisement permitted by Rule 507 (and not initial purchasers in a 144A transaction), the SEC did consider the intersection of Rule 507 and Rule 144A. If the SEC adopts Rule 507, there would likely be further discussion of how it intersects with Rule 144A.

Deregistration. Paul Dudek, Office of International Corporation Finance, noted that once a FPI files a Form 15F to deregister, it can stop its Exchange Act filings immediately even though its deregistration will not be effective for 90 days. Mr. Dudek went on to note that while some issuers have expressed concern that the process relies on an objection from the SEC, issuers should not worry because if the SEC has a problem with the Form 15F they will get in touch with the company.

Late Form 8-K Filings. The SEC staff is willing to provide Form S-3 eligibility waivers for certain missed Form 8-K filings so that a company does not lose its Form S-3 eligibility in situations where the "punishment doesn't fit the crime." Companies in this situation are encouraged to call the staff to discuss the possibility of a waiver.

Corporation Finance Review Process. Shelley Parratt, Deputy Director, Division of Corporation Finance, said that there are currently no SEC review priorities, it is really just "business as usual." She went on to say, however, that equity lines and PIPES always remain a big area of focus. Ms. Parratt also provided an overview of the filing review process noting that the office of Corporation Finance considers the following when conducting filing reviews:

  • To review or not to review. Corporation Finance reviews hundreds of companies more frequently than once every three years. They have a pretty rigorous program in place where they evaluate Form 10-K disclosure before they decide to do a more fulsome review. They have recently increased their legal staff so people should expect an increase in legal reviews.
  • To comment or not to comment. The staff tries to limit their comments to those topics that could affect disclosure. They only pursue those things that they think are big issues that could materially affect investors.
  • What type of comments to issue. The staff generally issues comments in the form of questions, requests to revise the current disclosure or requests to revise future disclosure. If the staff merely asks a question, the issuer should not assume that it needs to revise its disclosure. The staff may be just trying to find out more information.
  • How will the staff phrase the comment and/or respond to the issuer's response? Ms. Parratt emphasized that issuers and their advisors should let the staff know if they do not understand the staff's comment or response. In addition, issuers and advisors should let the staff know if they do not agree with the staff's assessment and should go up the chain if necessary.

Ms. Parratt also noted that an oral or written response to comments is fine, although the staff will likely ask an issuer to follow-up with a written response.

First-Year Executive Compensation Disclosures. Similar to what was discussed in the SEC staff report on executive compensation, Ms. Parratt and others noted the following about the first-year executive compensation disclosures:

  • Plain English. The staff really wants people to focus on clear and understandable disclosure.
  • Analysis. The staff feels many companies can improve upon the analysis in their compensation disclosures.
  • Format. Some companies went beyond what was required by the rules and provided helpful additional information. If issuers provide alternative summary compensation tables, however, they should make sure that they explain the difference between the alternative table and the required table and make it clear that the alternative tables are not part of the required tables.
  • Compensation Discussion & Analysis. The staff noted four main themes in their comments:
    • Philosophies and decision mechanics. Issuers should focus more on substance, less on mechanics.
    • Differences in compensation policies and decisions. Issuers need to describe any differences in their compensation policies and decisions with respect to different named executive officers. The staff is not asking companies to disclose private matters such as that one executive made significantly less than the others because of personnel issues. It is more likely that this type of disclosure would be material and therefore required when one executive makes significantly more than others. The staff understands that in these situations, the executive may be making significantly more because he or she is being groomed for a higher position and the company may have concerns about disclosing its succession plan, but the staff feels that the disclosure can be carefully crafted to address these concerns.
    • Benchmarks. Companies should describe how they use comparative compensation information and how it affected their compensation decisions.
    • Performance Targets. Mr. White noted that some companies have expressed concern that they will be giving guidance by providing their performance targets. Despite this, companies must disclose their performance targets, if material, although the company can avail itself of confidential treatment protection if it can meet the standard. Mr. White went on to note that for some companies, performance targets are different than their guidance and they should explain these differences in their filings. Ms. Parratt echoed these comments and also stated that in assessing the materiality of performance targets, issuers should consider not only whether the targets would be material to an investor's investment decision but also whether the targets would be material to an investor's vote for directors.
  • This Year's Comment Process. Lastly, Mr. White warned issuers that they should not assume that the staff will wait until after proxy season is over this year to submit comments. They did this last year as a one time accommodation-they will let people know what their approach will be this year.

Miscellaneous Disclosure Pointers.

  • When asked whether something that is included in the financial statements and is also responsive to a Regulation S-K requirement must be repeated within the financial statements and the body of the Form 10-K, Mr. Dudek said it depends on the significance of the item. While the staff seeks to reduce the incidence of duplicative disclosure, it may be appropriate in some instances to repeat the information if it is very significant.
  • When asked whether companies can rely on analogous filings in making disclosure decisions, the staff said it depends on the circumstances but you should feel free to bring analogous transactions to their attention.
  • The staff is aware that many companies only file new exhibits with their Form 10-Q (rather than listing the new exhibits and those that are still applicable from the Form 10-K list) and does not object to this practice.

SAB 99. Mr. White's personal view is that SAB 99 should cut both ways so that a company can decide that an item that is quantitatively material but not qualitatively material is in fact not material. Despite his view, Mr. White believes that SAB 99 is currently written to apply in only one direction and only says that an item that is not quantitatively material may be material if it is qualitatively material. The Advisory Committee on Improvements to Financial Reporting is currently looking at the issue of materiality and Mr. White hopes that they will make recommendations consistent with his view.

SOX 404. Mr. White reminded participants that the SOX 404 guidance issued this past summer is optional and Daniel Goelzer of the PCAOB echoed this sentiment. Companies that already have an effective process in place do not need to change their procedures unless they want to.

Delinquent Filers. In response to a question, the staff noted that if an issuer is delinquent in filing several Form 10-Ks, the staff will likely work with the issuer to allow it to file one catch-up Form 10-K, including one catch-up SOX 404 report.

E-proxy. Mr. White noted that over 40 companies have used voluntary e-proxy to date. The SEC is going to study how all of this works this year so that it can determine if it needs to do any "clean-up" rulemaking.

XBRL. Mr. White emphasized that XBRL is a top priority for Chairman Cox and noted that it is possible that the SEC might issue a proposing release as early as this coming spring mandating the use of XBRL by certain filers.

FINRA/NASD Developments

New Fairness Opinion Rule Effective December 8, 2007

As of December 8, 2007, new NASD Rule 2290 requires member firms to comply with certain disclosure and procedural requirements in rendering fairness opinions. The rule purports to address concerns that shareholders are not sufficiently informed of potential conflicts of interest between the firm rendering the opinion and the parties to the transaction.

NASDAQ Developments

NASDAQ Forms PORTAL Alliance to Create Industry-Standard Facility for 144A Equity Securities

NASDAQ has announced that a group of securities firms and The Nasdaq Stock Market intend to form The PORTAL Alliance, an industry standard facility designed to serve the market for 144A equity securities.

According to NASDAQ, the founding members of The PORTAL Alliance are Bank of America, Bear Stearns, Citi, Credit Suisse, Deutsche Bank, Goldman Sachs, JPMorgan, Lehman Brothers, Merrill Lynch, Morgan Stanley, NASDAQ, UBS and Wachovia Securities. NASDAQ also notes that the collaboration is subject to the execution of a definitive agreement and regulatory approvals.

The PORTAL Alliance will work with third-party service providers to create an open, industry-standard facility for the private offering, trading, shareholder tracking and settlement of unregistered equity securities sold to qualified institutional buyers.

FASB Developments

FASB Issues FASB Statements No. 141 (R), Business Combinations and No. 160, Noncontrolling Interests in Consolidated Financial Statements

On December 4, 2007, the FASB issued FASB Statements No. 141 (revised 2007), Business Combinations, and No. 160, Noncontrolling Interests in Consolidated Financial Statements. The statements are effective for fiscal years beginning after December 15, 2008.

Statement 141(R) requires the acquiring entity in a business combination to recognize all (and only) the assets acquired and liabilities assumed in the transaction; establishes the acquisition-date fair value as the measurement objective for all assets acquired and liabilities assumed; and requires the acquirer to disclose to investors and other users all of the information they need to evaluate and understand the nature and financial effect of the business combination.

Statement 160 requires all entities to report noncontrolling (minority) interests in subsidiaries in the same way-as equity in the consolidated financial statements. Moreover, Statement 160 eliminates the diversity that currently exists in accounting for transactions between an entity and noncontrolling interests by requiring they be treated as equity transactions.

FASB Issues Preliminary Views on Financial Instruments with Equity Traits

On November 30, 2007, the FASB issued Preliminary Views on Financial Instruments with Characteristics of Equity. The purpose of the document is to solicit comments on the FASB's views on distinguishing between equities and liabilities or assets. Comments on the proposals are due by May 30, 2008.

The document discusses the board's preferred, but controversial, "basic ownership" approach, which limits the instruments that can be classified as equity to the lowest residual interests in an entity. The holders of those instruments are viewed as the owners of the entity. All other instruments represent either liabilities or assets. An instrument that reduces the net assets available to the owners of the entity is a liability; and an instrument that enhances net assets available to the owners is an asset. Under this approach, forward contracts, options, and convertible debt would be classified as liabilities or assets. This approach would represent a major change to current accounting and reporting practice.

Other Developments and DP&W Memos

IRS Announces a Corrections Program Under IRC Section 409A

On December 3, 2007, the IRS released guidance with respect to a limited voluntary compliance program that applies to certain unintentional operational failures to comply with Section 409A. IRS Notice 2007-100 provides relief for unintentional operational failures that are corrected in the same tax year in which they occur and that are reported to the IRS. The Notice also provides transitional relief until December 31, 2008, for unintentional operational failures that are not corrected in the same tax year, but that do not exceed a specified amount (such amount being the limit on elective deferrals that would apply to qualified plans for the year of the operational failure). Finally, the Notice describes and seeks comments on a potential corrections program that involves larger amounts of money.