SEC A.D. (After Donaldson): What's Next For Public Cos.

For the past few years, the Securities and Exchange Commission sort of resembled an accidental regulator. It was led by a chairman who wasn’t supposed to get the job, it experienced an exodus of senior staffers, and it chased an ambitious agenda that was mostly forced upon it by outside events.

Donaldson

But as the gang prepares to break up—Chairman William Donaldson is leaving at the end of June, Commissioner Harvey Goldschmid is heading back to Columbia Law School sometime during the summer, and enforcement chief Stephen Cutler is already gone—it can proudly boast that it was one of the most successful administrations—or at least among the busiest—in decades.

It implemented the Sarbanes-Oxley Act, mandated that investors receive the best price from the various stock exchanges, created new governance rules for mutual funds, and required hedge funds to be slightly more regulated than they have been in the past. In addition, the Commission significantly increased its own communications with the entities it regulates, holding roundtables and soliciting feedback on a variety of issues including the internal control provisions of Sarbanes-Oxley, the impact of SOX on small public companies, and the shareholder director nomination process.

Perhaps most significantly, Chairman Donaldson—who got the job when former SEC Chair Harvey Pitt resigned under political pressures—proved that you can check your political ideology at the door when you run a high-profile, critical agency whose policy decisions have widespread ramifications. As a result, the Republican chairman frequently lined up with the two Democratic commissioners—Goldschmid and Roel Campos—to pass a number of initiatives such as the one requiring hedge funds to register by next year, thus snubbing Republican commissioners Cynthia Glassman and Paul Atkins.

Don't Count On A Rollback

As Donaldson and other others gear up to leave, the hyperbolic set and some shareholder activists are stirring up fears of a reactionary, revisionist SEC—one that will aggressively rollback recent rulemaking and turn its back as Corporate America runs amuck, pre-Enron style. Even Donaldson fears as much, asserting at the press conference to announce his resignation, “I’m hoping there is no legalistic rollback of key items.”

Don’t count on a rollback, however, say most experts, who range from corporate lawyers to governance experts and even the commissioners themselves.

Cox

For one thing, most experts stress that incoming Chairman Christopher Cox and the rest of the remaining commissioners agree that Sarbanes-Oxley is proper; in fact, Cox voted for it as a Republic Congressman from California. And virtually no one actually believes that when a new group of five commissioners assembles—probably sometime after the summer—they will target specific new rules to reverse.

Though it is expected that the new group may tinker with some rules at the margin, most experts agree that the new administration will spend most of its time over the next few years digesting and assessing the flurry of new rules that were implemented during Donaldson's tenure. Which is actually what groups like the U.S. Chamber of Commerce and the Business Roundtable have been advocating all along, especially when the notion of, say, proxy access is posed to them.

Elson

“Complete scale-back wildly overstates the case,” asserts Charles Elson, who chairs the John L. Weinberg Center for Corporate Governance the University of Delaware. “You have to ignore the volume on both sides.

“Don’t expect to see an actual reversal of rules,” agrees Derek Meisner, who spent five years with the SEC’s Division of Enforcement. “That may alienate Cox from his own staff." According to Meisner, now of counsel for Kirkpatrick & Lockhart Nicholson Graham, "The fear that Cox is more politically aligned with Atkins and Glassman, and will try to impede the enforcement agenda is misplaced.”

Garris

Adds Dennis Garris, partner at Alston & Bird: “The Commission has already gone through a regulatory period—Sarbanes-Oxley, they were super aggressive on enforcement matters. Now they are in a phase of interpreting, administering and enforcing all of the regulations they adopted.”

Glassman

Even the SEC's commissioners are not expecting wholesale changes. Last week, Commissioner Glassman told Compliance Week, “Absent a big surprise, I would expect that you won’t see a flurry of rule-making that you’ve seen in the last three years. If that’s the case, it would be a good opportunity to re-assess all of the rules we have in place to make sure they are accomplishing their objectives effectively and efficiently. That was one of my personal goals when I joined the Commission.”

Dead, Or Comatose?

However, certain initiatives that were on the table during the Donaldson administration are now probably dead—or at least comatose. That includes the issue of proxy access, which Donaldson initially seemed excited about, but later cooled toward as major pro-business groups aggressively lobbied against it.

“If it’s not dead, it’s dormant,” Elson asserts. On the other hand, Elson thinks the majority-vote issue could replace proxy access as a potential way to give shareholders some say in the director nomination process.

Meisner

Few expect the SEC to roll back its new requirement that hedge funds register by February 2006. In fact, Kirkpatrick’s Meisner predicts that, once the rule becomes effective, there will be a “marked increase” in the number of referrals from the inspection staff to the enforcement staff due to a lack of internal controls. “It will be the natural consequence of registration,” he adds.

Regarding the internal control provisions of Sarbanes-Oxley, most agree that there is no turning back. That's partially due to the fact that the SEC has been relatively responsive to issuer feedback, delaying its effective date twice, and providing recent guidance on the topic. In addition, many companies are already complying with SOX 404. However, the Commission has stated that more guidance will be forthcoming, and some expect additional clarification of the provision's scope. “We will continue to see further refinements,” asserts Meisner. “You may not see changes to the language, but a scaling back to how implement [the rule] or the types of circumstances under which the SEC will seek enforcement."

Even Donaldson acknowledged during his press conference last week that, "We had to go through year one with those rules in order to react to how we made them, applied, and to get at inefficiencies in applying 404 standards. What we are seeing is that the application can be reviewed and we are taking steps to start that ball rolling.”

Expensing, Enforcement, And Other Initiatives

Pierce

Don’t expect changes to the timetable or the rules related to the expensing of stock options, either. “At this point, I’d be surprised,” says Morton Pierce, chairman of Dewey Ballantine's management and executive committees.

Again, that's partially because a large number of companies have already voluntarily adopted this policy, and have done so with minimal impact on overall market value.

As the first wave of companies gear up to implement this accounting rule next month, the prevailing feeling is that any changes in the timing or scope of the rule must come from the Financial Accounting Standards Board.

Enforcement is another area that will likely not be scaled-back, as most parties are still mindful of the high-profile fraud cases that are still fresh in investors' memories. “When you are confronted with an Enron or a WorldCom, you go after it, whether you are pro-business or not, or pro-regulation or not,” says Pierce, an unabashed pro-business attorney who is adamantly opposed to such proposed rules as proxy access.

However, most experts do expect the new SEC administration to move ahead and approve initiatives that are already working their way through the process. This includes finalizing new rules on how companies register securities and communicate during the offering process.

In fact, wire services were reporting this week that the SEC will hold an open meeting on June 29 to vote on rules to let companies talk more freely about public stock offerings. According to Reuters, the open meeting will take place the day before Chairman Donaldson steps down.

Less clear is how aggressive the SEC might be an proposing new rules related to compensation disclosure. As Compliance Week reported back in November, the Securities and Exchange Commission is considering steps that would require more meaningful and complete disclosure of executive compensation in public filings. That was according to Division of Corporation Finance Director Alan Beller, who described the Commission’s new emphasis on compensation transparency at an industry conference in San Francisco.

Beller

The existing mandate, described in Item 402 of Regulation S-K, sets forth required disclosures with respect to executive compensation. But since Item 402 was codified in 1992, executive compensation has diversified into a complex matrix of offerings that includes cash, bonuses, stock options, perquisites, and—increasingly—variations of restricted stock, some of which might be performance based.

“The 1992 rules are not only detailed, but they’re also static,” said Beller during his speech. “They may need updating to address more effectively methods and approaches to compensating executives. Among the issues that the SEC staff was reviewing at the time of Beller's speech: inappropriate categorization of items as perks, the valuation of perks, and possible pay disclosure for more than the top five officers.

Pierce at Dewey Ballantine is hopeful that the new SEC administration will back off from cracking down compensation minutiae, like the value of personal corporate airplane usage. Instead, he hopes the SEC spends the next couple of years or so trying to determine whether the flurry of new laws over the past few years was an over-reaction. “I would hope they will allow things to settle,” he says. “Get a good working of the rules; get comfortable with them. The corporate world needs some time to settle down and live with these new rules.”

Adds Garris at Alston & Bird: “The Commission has been running 100 miles per hour reacting to scandals, but I hope they realize a lot of companies are doing the right thing.”