Cox: CD&A ‘Overlawyered;’ Backdating Help

The head of the Securities and Exchange Commission continued to hammer home the message recently that executive compensation is a top agency priority these days, while also giving corporate lawyers an earful on what the SEC expects of them under the expanded disclosure regime.

Stressing the point that corporate counsel plays “a vital role” in the success of the recent reforms, SEC Chairman Christopher Cox also gave lawyers some not-so-subtle hints on what the SEC does not want to see in the disclosures under its new rules.

“Already we’re seeing examples of overlawyering that are leading to 30- and 40-page long executive compensation sections in proxy statements,” Cox said in a March 8 speech to the Corporate Counsel Institute. Some companies are including columns in their summary compensation tables even when there’s nothing to report in them, which Cox said is the kind of “slavish adherence to boilerplate disclosure” that the SEC is trying to stamp out.

While promising that the SEC is giving people “some grace in getting used to the new rules,” he warned that the requirement for plain English disclosure will be “increasingly strictly enforced in the coming year.”

Cox said corporate counsel can play an important role in the new Compensation Discussion and Analysis section, which he said should provide “a qualitative look at the company’s executive compensation policies and shed light on the quantitative tabular data.”

Cox

“This is your chance to plainly tell the company’s compensation story,” he said. “I urge you to take the opportunity and make the most of it.”

Cox said the actions of in-house lawyers will determine how successful the SEC reforms will be. “From the disclosures you make, to the structure of your boards of directors, to the way you respond to investor concerns and the way you solicit proxies, your implementation of our regulations is the fulcrum upon which the entire effort rests,” he told the group.

While he praised in-house lawyers as “crucial gatekeepers” responsible for safeguarding shareholders’ interests by advising companies on disclosure standards and all of the requirements of our securities laws, Cox also reminded corporate counsel of their duty to report to senior management or the board if they find evidence of material violations of federal securities laws or breaches of fiduciary duty.

“When professionals—lawyers or accountants—fail to live up to their responsibility, the Commission will bring enforcement actions,” he warned, pointing to the SEC actions against the general counsels at Comverse Technologies, Monster Worldwide, and McAfee for their roles in alleged options timing schemes and other recent enforcement actions against lawyers.

Meanwhile, Cox said the SEC will tag the executive compensation data using XBRL “for at least several hundred of the largest public companies.” The SEC expects to have the information—and an interactive tool on the SEC Web site to let users “slice and dice” it—available in June.

SEC Relents On Tender Offer Payment Rules For Options Fixes

The SEC’s Division of Corporation Finance has issued a pair of no-action letters granting two issuers relief from tender offer “prompt payment” rules, enabling them to do tender offers to amend discounted stock options for their rank-and-file employees.

Relief granted in separate Feb. 28, 2007, letters to Adobe Systems and CNET Networks bridges the gap between two conflicting regulatory requirements, notes David Mittelman, an attorney at the law firm Reed Smith and a former legal branch chief in the Division of Corporation Finance.

Adobe Systems and CNET Networks each sought exemptive relief from the SEC so they could offer their rank-and-file employees replacement options reflecting a correct measurement date, plus a cash payment to compensate them for the value lost due to correcting the measurement date.

Mittelman

The move allows rank-and-file employees to avoid adverse tax consequences imposed by Section 409A of the Internal Revenue Code. That section hits options granted at a discount from fair market value especially hard; coupled with parallel state law provisions, Mittelman says, employees may owe upwards of 85 percent in taxes and penalties for incorrectly dated options—which most workers probably never knew were misdated.

The SEC’s decision enables Adobe and CNET to defer the cash payment until next year. Normally, upon expiration of a tender offer, a company must promptly pay for the securities tendered, in conflict with the 409A rules, which prohibit a cash payment until the next calendar year.

Mittelman notes that the SEC has a history of providing relief from the tender offer rules to benefit employees. In 2001, the Division of Corporation Finance issued an exemptive order enabling companies to replace worthless, “underwater” options for newly repriced options six months later.

While the SEC decision is helpful to employees and companies, Mittelman notes that insiders, (who likely benefited most from incorrectly dated option grants), are expressly excluded from the scope of the no-action letters. The no-action letters also won’t affect a company’s potential SEC liability for option “timing” practices, he notes.

Public companies that issued a substantial number of options to employees with incorrect measurement dates should consider this type of employee option tender offer, Mittelman says. However, he notes that a company will have to make a separate application to the SEC for relief from the prompt payment rules, because the relief is in the form of individual no-action letters rather than a broad exemptive order.

“As a practical matter, a company needs confidence in the completeness of its internal review of option dating practices,” Mittelman says. “Because of other tender offer requirements, a company must be able to identify all eligible options granted to employees and be able to provide reliable financial statements to employees.”

The letters can be found in the box above, right.