Remodeling an Office the Wal-Mart Way

Last night, Mike Duke, the new CEO of Wal-Mart, spoke at the awards banquet for Oklahoma Christian University's School of Business. He also received the Christian Business Leader of the Year Award from the School of Business.

During his speech, he noted that while some executives may be spending upwards of $1 million to remodel their offices, he didn't when he moved into the CEO's office at Wal-Mart. Instead, Duke and his wife put on their jeans after church on Sunday, February 1. They headed over to the Wal-Mart home office and dusted and moved his things into the office. Grand total for the Mike Duke move into the CEO's office? The $5 he spent to buy lunch for his wife that day. My bet is that he paid for that out of his own pocket.

IASC Monitoring Committee Created

Earlier today, the SEC issued a press release announcing that the SEC, Japan's Financial Services Agency and the European Commission have established a roundtable to discuss creating a monitoring group as part of the International Accounting Standards Committee. The monitoring group would help to create channels of communication relating to the IFRS.

Convergence of GAAPs

The Committee of European Securities Regulators recently published its advice to the European Commission regarding the
"equivalence of Chinese, Japanese and US GAAP." The document recommends that the Commission:
1. Find US GAAP equivalent to IFRS for European markets;
2. Generally consider Japanese GAAP equivalent, provided the Accounting Standards Board of Japan follows the timetable set forth in the Tokyo Agreement; and
3. Wait to decide on Chinese GAAP until there is more evidence on whether issuers are using it.

Maybe this is the anti-SOX. SOX guaranteed full employment for accountant and this helps them avoid overwork from restating financials to comply with GAAP of other countries.

JP Morgan / Bear Stearns: A Play in [3] Acts?

The Cast:
Bear Stearns Directors: A group of individuals who may (or may not have) violated their fiduciary duties to shareholders. The business judgment rule applies to directors' decisions. The duties of directors in a corporation teetering on the edge of bankruptcy are murky; when a corporation is near bankruptcy, the directors' duties flow more to the corporation's creditors than its shareholders. Exactly when those duties shift is not always clear. There's already at least one class action filed against the Bear Stearns Directors.
JP Morgan Directors
Bear Stearns CEO Alan Schwartz
Bear Stearns Shareholders: Some are already suing, upset over the fact that the stock closed around $30 and the directors agreed to sell for $2. All this for a stock that had been over $60 just two weeks before. Ouch!
Extras: The Shareholders of Bear Stearns, The Bear Stearns Lawyers, The JP Morgan Lawyers, Assorted Federal Officials, Other Bear Stearns Constituencies


The Script: You can see assorted deal documents here: The Agreement and Plan of Merger, The Guaranty (an exhibit to the Agreement and Plan of Merger), Amendment No. 1 to the Agreement and Plan of Merger, with more to come.

The Plot: The Feds push Bear Stearns to enter into a buyout deal so that the Fed doesn't have to bail Bear Stearns out. JP Morgan swoops in and offers $2 per share, which is amazing considering that the stock had just closed around $30 (Where can I get a deal like that?). Bear Stearns shareholders balk; some sue. JP Morgan and Bear Stearns renegotiate certain provisions.

PCAOB on Evaluating Consistency of Financial Statements

Last week, the PCAOB adopted new Auditing Standard No. 6 on Evaluating the Consistency of Financial Statements. The press release states that it is intended to align auditors' responsibilities with SFAS No. 154 and to update auditors' responsibilities to evaluate and report on consistency of financial statements. In particular, this should clarify auditors' responsibilities in reporting on adoption of new accounting principles or corrections of material misstatements.

New SEC Guidance on Stock Options

Just before year end, the SEC staff issued Staff Accounting Bulletin 110 on accounting for stock options. The new guidance allows "eligible public companies [to] continue to use a simplified method for estimating the expense of stock options if their own historical experience isn't sufficient to provide a reasonable basis." The ability to use this approach would have expired last night without further action by the SEC.

Executive Compensation by US Multinationals

Towers Perrin recently released a survey of compensation strategies used by US multinationals. Among the findings are that US MNCs have cut the equity awards (options, restricted stock) to executives outside the US.

Companies are also changing their approaches to long-term incentive plans by differentiating award amounts baed on geography. Only 5% of companies differentiated on this basis in 2001, and the percentage has risen to 42%.

Finally, the survey found that guidelines for compensation differ according to tiers or regions established by the parent company. Some companies set award amounts as a percentage of the amount that would be awarded in the US.

A press release explaining the survey is available here.

SEC Solicits Public Comments on IFRS Use by U.S. Issuers

Yesterday, the SEC voted unanimously to publish a Concept Release seeking public comment on allowing U.S. issuers to use International Financial Reporting Standards. This would be change from current requirements mandating that U.S. issuers prepare their financials using U.S. GAAP. According to a statement by SEC chairman Christopher Cox, almost 100 countries either require or allow the use of IFRS.

The SEC's press release is available at http://www.sec.gov/news/press/2007/2007-145.htm.

New Going Concern Court Decision

The Seventh Circuit recently affirmed dismissal of a suit against Ernst & Young this week in an opinion available here (http://www.ca7.uscourts.gov/fdocs/docs.fwx?submit=rss_sho&shofile=06-3366_020.pdf). EY's audit opinion on the status of its client's financials in FYE 1995 did not did not contain a going concern qualification. And, in fact, EY's client did not go into bankrupcy until 2 years later. The trustee in bankrupcy sued EY on theories of negligence and breach of contract for failing to include a going concern qualification in its opinion.

Corporate Kleptocracy

Conrad Black's company, Hollinger, hired Richard Breeden (a former SEC chairman) to investigate the frauds at the company on behalf of a special committee of the board of directors. Breeden's investigative team issued a report in August of 2004 that referred to the environment at the company as a "corporate kleptocracy." As is so often the case, where widespread corporate fraud occurs, it is because the directors had their heads in the sand.

Frauds are, by their very nature, self-concealing. So it's no surprise that a fraud -- even one at the highest levels within an organization -- would go undetected for some period of time. Eventually, though, others learn of the fraud as the fraudster must engage others to perpetuate it. Red flags also appear, such as over-the-top perquisites, fees to related companies that are not at arm's length, and resignations of individuals in key positions who may be getting wise to the fraud.

Conrad Black's fraud conviction substantiates the claims made in the Breeden report that "Hollinger wasn't a company where isolated improper and abusive acts took place. Rather, Hollinger was a Company where abusive practices were inextricably linked to every major development or action."

Transactions between Black and the company are judged under the Delaware standard of "entire fairness." Instead, what we saw at Hollinger is what Breeden described as "private behavior in a public company."

Principles-Based Accounting

James Kroeker, the SEC's Deputy Chief Accountant, recently spoke on the topic of principles-based accounting. The text of the speech is here.

He noted that principles-based accounting sounds odd in view of the fact that accountants in the U.S. are governed by Generally Accepted Accounting Principles -- not Rules. Although GAAP includes the word "Principles," it is very much a rules-based approach to accounting.

The Sarbanes-Oxley Act (section 108(d)) required the SEC to study adoption of a principles-based accounting system. That study, released in 2003, is available here. The SEC staff coined the phrase "objectives-oriented" to distinguish GAAP from pure rules-based or principles-based standards. The use of the terminology focuses on the fact that bright-line tests must be used in some areas, while subjective judgment may be called for in other areas.

In the international arena, comparability will be difficult to achieve even where a rules-based approach is used. Kroeker notes that transactions will be structured in a very deliberate manner to fall on one side of the line to achieve a desired accounting treatment. Objectives-based standards, on the other hand, can be written to get at the economic substance of transactions. A focus on substance rather than legal form, will better educate investors regarding the company's transactions.

The task faced by the FASB and IASB to draft guidance that gets to economic substance of transactions will be difficult. In particular, where the guidance requires the application of professional judgement, comparability may be lost. I am skeptical about whether guidance can be drafted that will achieve the objectives of comparability and accounting treatment based on economic substance.

What Backdating is Not

Judge Alsup of the N.D. of California issued a decision on April 11 in In re CNET Networks, Inc. Shareholder Derivative Litigation. Judge Alsup reviewed the option grant practices at CNET. He noted that companies might use an incorrect grant date for reasons other than fraud. In particular, the court declined to infer backdating where the grants were issued under a plan with a pre-determined grant date, such as annual option grants to directors. Where Form 4s are filed in a timely manner, grants are made to new employees or in connection with a merger, this is further evidence that the grants were not backdated.

Judge Alsup noted that CNET's board appointed a special committee to investigate allegations of backdating and that the company repriced some options and restated financials. Because of these corrective actions, the court could not -- without more -- infer that a fraud occured.

The plaintiffs had already amended their complaint numerous times. The court invited briefing on the issue of whether plaintiffs should be allowed to conduct limited discovery on the issue of whether the members of the compensation committee were aware of backdating.

New Deferred Compensation Regs

The Treasury has issued new final regs on executive and director deferred compensation. If you're suffering from insomnia, try reading this 400-page tome. The link is here. The regs are essentially the same as those proposed in the fall of 2005.

Congressional Research Service Backdating Report

The Congressional Research Service issued a report last month on stock option backdating. The report is available here. Of particular interest are pages 8 through 10 in which the CRS lists -- without attempting to quantify -- possible costs associated with the backdating scandals. Companies take earnings hits, their debt rating is downgraded increasing their cost of capital, some companies will be delisted because they cannot produce earnings in a timely manner, companies may owe additional taxes and many companies will spend a tremendous amount of money investigating or responding to backdating allegations.

New SEC Rule 144 Interpretation

Earlier this week, the SEC's Division of Corporation Finance posted new interpretations of Rule 144, specifically addressing "Persons Deemed Not to be Engaged in a Distribution and Therefore Not Underwriters." The interpretations are available here.

The new interpretations of Rule 144 replace those from the July 1997 Manual, the March 1999 Supplement and the November 2000 Current Issues and Rulemaking Project Outline. Some of the new interpretations were originally in the Manual of Publicly Available Telephone Interpretations, but even some of these have been revised by the SEC in its latest release.

New SEC Approach to Regulation of Cross-Border Securities Transactions

Eric Sirri, the SEC's Director of Market Regulation, spoke late last week about cross-border securities transactions. The text of the speech is here. He described a two-way street, in which U.S. markets are attracting foreign investments and U.S. investors are investing abroad.

Sirri noted that the SEC may need to act under its authority to exempt certain types of transactions from the reach of the U.S. securities laws, but that in so acting the SEC must not "abdicate its obligation to protect investors and further market integrity."

Sirri noted several examples of the SEC's willingness to be flexible in adopting new rules to govern the U.S. markets. He then explained that "the time has come to reconsider our approach and to allow access under conditions that protect U.S. investors and maintain the integrity of U.S. markets." Sirri reviewed the U.S. approach to regulating markets and broker-dealers, including foreign broker-dealers, explaining that the "practical effect of current law is that foreign exchanges and foreign broker-dealers dealing directly with U.S. investors in the United States must either register or be exempt from registration."

Other jurisdictions have questions whether this approach is necessary to protect U.S. investors, or is simply protectionism of U.S. firms and markets. While the SEC must comply with its mandate to protect investors, Sirri posits that the Commission can do more "to reduce costs and frictions of obtaining foreign securities in the US, without jeopardizing investor protection for US investors."

With respect to the SEC's exemptive authority (Exchange Act § 36, 15 U.S.C. 78mm, enacted as part of the National Securities Markets Improvement Act of 1996), the SEC would have to determine that exempting foreign broker-dealers and exchanges is in the public's best interest. Sirri proposes a cooperative approach under which U.S. brokers could join foreign exchanges in other jurisdictions, provided that the other jurisdiction cooperates with the SEC to protect investors. He noted that this approach "would avoid the foreign exchange from needing to file its changes in rules for approval by the SEC."

On the flip side, the SEC would ease requirements for foreign brokers that are subjected to a regulatory scheme comparable to the SEC's. In particular, he believes that foreign broker-dealers could be allowed to deal directly with qualified institutional buyers regarding purchases of government or foreign securities in the U.S. without the need for registration here.

For more on this proposal, read the recent article, A Blueprint for Cross-Border Access to U.S. Investors: A New International Framework, by Ethiopis Tafara and Robert Peterson, two SEC staffers, at 48 Harv. Int'l L. J. 31 (2007).

CEO and CFO Certifications in Canada

Stikeman Elliott, a top-notch Canadian law firm, has posted a newsletter on its web site about The current status of CFO and CEO certifications in Canada. The newsletter discusses the certification rules (Multilateral Instrument MI 52-109 (2003)), which are effective for most Canadian issuers for filings covering FYE December 31, 2006. Like certifications under Sarbanes-Oxley, in Canada the CEO and CFO must also certify that they have reviewed the annual financials and MD&A and that based on their knowledge there are no untrue statements of material fact, nor are there material omissions. The certifications also cover disclosure controls.

South Korea is Courting Foreign Issuers

South Korea's Financial Supervisory Service rolled out its DART system in English at the first of the month. DART stands for "Data Analysis, Retrieval and Transfer System." Like EDGAR, the system is a repository for corporate filings. Issuers can be searched by name, and users can also review recent filings. The DART home page is available here.

South Korea also recently issued disclosure guidelines for foreign issuers. Those guidelines are available here. The Financial Supervisory Service says that it issued the guidelines because of recent increased interest of foreign companies in issuing stock or listing in Korea. To facilitate registration of foreign issuers, the FSS is also rolling out an electronic registration system.

It looks as if South Korea is effectively facilitating the capital flight predicted in the recent Interim Report of the Committee on Capital Markets Regulation.

EU Parliament Adopts Resolution on Shareholders' Voting Rights

This past week, the EU Parliament voted on a proposal about shareholders' voting rights. The text of the resolution, along with explanatory material, is available here. The intention is to resolve problems associated with cross-border voting by shareholders in listed companies. Shareholders who reside in countries other than the listed company's home country should be able to vote their shares just as easily as shareholders in the listed company's country. The company should allow for electronic participation in the meeting by the shareholders (Article 8).

Shareholders must receive disclosure documents in a timely manner and sufficiently in advance of the meeting to allow them to consider the documents and then to cast their votes. Specific information about the meeting must be included in the disclosure documents (Article 5). The shareholders should also have a mechanism to place items on the agenda and to ask questions regarding items already on the agenda (Articles 6 & 9). Proxy holders should observe instructions provided to them by the shareholders (Article 10).

Following the meeting, the results of the voting should be disclosed. At a minimum, the results of the meeting should be disclosed on the company's internet site (Article 14).

The provisions in the EU directive set minimum expectations of the information and procedures that should be available to shareholders. EU member states may go beyond the EU directive in establishing rules and procedures to facilitate even better the shareholders' exercise of their rights.

Springloading at Tyson

On February 6, Delaware Chancellor Chandler ruled on several issues in a case against Tyson Foods. Among the issues addressed were:
1. Futility of pre-suit demand;
2. Tolling of the statute of limitations; and
3. Whether the business judgment rule protected directors from liability for issuing springloaded options.

Springloaded options are those granted just prior to the announcement of positive news. In other words, options are granted at today's price but with near certainty that today's price is too low. This creates an almost automatic built-in gain for the executives receiving the options.

On the springloading issue, Chancellor Chandler noted that "A committee of independent directors enjoys the presumption that its actions are prima facie protected by the business judgment rule." In this case, though, plaintiffs appear able to overcome this strong presumption.

Chancellor Chandler described granting of springloaded options as a "much more subtle deception" than backdating, which has received a lot of press in the past few months. But, according to Chandler, "[g]ranting spring-loaded options, without explicit authorization from shareholders, clearly involves indirect deception. A director's duty of loyalty includes the duty to deal fairly and honestly with the shareholders for whom he is a fiduciary. It is inconsistent with such a duty for a board of directors to ask for shareholder approval of an incentive stock option plan and then later to distribute shares to managers in such a way as to undermine the very objectives approved by the shareholders. This remains true even if the board complies with the strict letter of a shareholder-approved plan as it relates to strick prices or issue dates."

The Chancellor views the question before the court as one of bad faith and breach of the directors' duties, rather than as a question of violation of the federal securities laws. Based on the plaintiffs' adequate allegations of breach of fiduciary duty and bad faith, the Chancellor denied the defendants' motion to dismiss that count of the complaint.

By way of background, the SEC has gone after Tyson before on various issues. In 2004, the SEC investigated Tyson's inadequate disclosures regarding perquisites to Don Tyson and John Tyson. The SEC determined that from 1997 to 2003, Tyson's proxy statements were incomplete and misleading.

Tyson has also litigated important matters in Delaware previously. When Tyson agreed to purchase IBP, it put a "material adverse change" clause into the purchase agreement. Then, when Tyson learned that the SEC had issued a comment letter about IBP's financials, Tyson tried to back out of the deal. Protracted litigation ensued, with the Delware courts eventually telling Tyson it had to move forward with the deal. Then, the Compensation Committee at Tyson gave the executives cushy bonuses for doing the deal they fought so hard to avoid.

The EU Transparency Directive UK Implementation

On January 20, the U.K. implemented the EU's Transparency Directive. The Transparency Directive contains periodic reporting requirements and applies to issuers listed on the London Stock Exchange and other EU markets. The Financial Services Authority's publication on implementation of the Transparency Directive is available here.

NYSE and Tokyo Stock Exchange Establish Alliance

Last week, the NYSE and the Tokyo Stock Exchange announced that they had entered into a strategic alliance "to jointly develop and explore new opportunities in trading systems and technology, investor and issuer services, investment products, and governance and regulation." The press release is here.

Working groups will begin to meet regularly regarding each of these areas of interest. From the international corporate governance perspective, the measures that will be taken to assure that issuers who list on one exchange "have improved access to investors in the other" is critical. This is one more example of the mechanisms of convergence that is occurring with respect to international corporate governance issues.

And You Thought FAS 5 Was Bad: 27 Levels of Likelihood

I recently ran across a handy table from PWC on the terminology used in the IFRS to describe varying levels of likelihood. The table and PWC newsletter are available here.

As it so happens, there are 27 levels of likelihood or similar concepts used in the IFRS. 27!!!! In order, they are (with thanks to PWC for compiling the list): virtually certain, no realistic alternative, highly probable, reasonably certain, substantially all, substantially enacted, highly effective, principally, significant, major part, probable, more likely, likely, may but probably will not, reasonably possible, possible, unlikely, extremely unlikely, minimal probability, sufficiently lower, insignificant, remote, extremely rare, virtually none, not genuine (highly abnormal and extremely unlikely to occur).

All of this makes you wonder how those of us in the U.S. got along under FAS 5 with the terms probable, reasonably possible and remote all these years.

I believe that it is at least "highly probable" and probably even "virtually certain" that the auditors and the lawyers will bill quite a lot for the discussions necessitated by these terms. All of the debate on the likelihood of a certain event is "extremely unlikely" to yield any real benefit to the financial statement users.

Re-Thinking SEC's Regulations

Christopher Cox, Chairman of the SEC, spoke last week on 'Re-Thinking Regulation in an Era of Global Securities Markets." The text of the speech is available here.

Cox noted how important global consolidation of the world's capital markets has become, stating "Ever more public companies are raising capital beyond their geographic boundaries, and investors large and small are increasingly allocating their capital -- and their business assets -- outside their home countries." On the plus side, global integration gives investors more choices,lower transaction costs and opportunities to diversify risk.

National regulators must provide a strong regulatory scheme that will protect investors. The SEC is allying with other regulators in order to protect investors and provide timely and accurate information. Cox noted that because of globalization, he has spent a tremendous amount of time meeting with his counterparts in other countries.

CEO Blogging Update

I've blogged previously about CEO blogging (see my posts here and here). Now, The Economist is reporting that the 800 or so CEOs and chairmen in attendance at the World Economic Forum in Davos, Switzerland are being encouraged to start blogging.

Although I favor giving shareholders more timely and useful information, I am skeptical that CEO blogging is the way to do it. And if I were a CEO, I would avoid blogging until the liability issues are addressed. Even The Economist notes that most CEOs probably view blogging "as a reckless risk in the liability-laden world. . . ."

A CEO blog could be a good way to reach certain groups of people and make the CEO seem human, but unless the general counsel is peering over the CEO's shoulder, it's too risky without the creation of safe harbors. In particular, I believe that corporations face Reg FD compliance issues and security issues. In addition, there's no body of law to address what a company's liability will be under the federal securities laws if misleading information is posted.

SEC Not Hijacking IFRS

John White, the SEC's Director of the Division of Corporation Finance, tried to assuage international concerns about the SEC's role in the IFRS last week. In a speech to the Practising Law Annual Institute on Securities Regulation in Europe White discussed foreign private issuer deregistration (see my prior postings here and here), SOX Section 404 implementation, and the SEC's review process for IFRS. The speech is available here.

White explained by process by which Corp Fin reviews filings for issuers using the IASB's IFRS. This review process is similar to the review process used for domestic filers. Initial comments from the staff are normally just in the nature of informational requests. White stated, "our initial comments do not seek to change anyone's accounting." He also commented that "we are not seeking to be the last word on IFRS in the international arena" and "[b]ecause there seems to be considerable unease on this point in some quarters, I want to be very clear that in commenting on IFRS financial statements, the SEC staff is not trying to commandeer IFRS."

Finally, White discussed the convergence of IFRS and GAAP, noting that currently foreign private issuers must do a reconciliation of their financial statements to U.S. GAAP if IFRS or another country's GAAP was used to prepare the financials. White noted that it is not the SEC's goal to pressure the IFRS to mimic U.S. GAAP. It is possible that a reconcilation of IFRS and U.S. GAAP will be accomplished by 2009 and the SEC is working closely with regualtors from around the world on this.

Ensuring Confidence in Japan's Capital Markets

Taizo Nishimuro, the CEO of the Tokyo Stock Exchange, spoke at the World Congress of Accountants back in November. The text of his speech is here. He spoke on recent efforts of the TSE and the Japanese Institute of CPAs to ensure trustworthy financial reporting and on the convergence of international accounting standards.

FYI, the TSE is the world's second largest market based on capitalization, which exceeded USD 4.5 trillion at the time of the speech. Almost 24% of all stock traded on the TSE is traded by foreign investors, and 50% of all brokerage orders come from foreign investors. Japanese investors hold around 12.85 (USD) trillion in financial assets, but Japanese investors are far less likely than U.S. investors to hold stock. One of the goals of the TSE is to shift investors in Japan into the capital market. The TSE is still working to fix some of the systems glitches experienced last fall when trading had to be suspended for several hours.

Nishimuro also noted that Japan has experienced several high-profile financial frauds in the last year. In one instance, the outside auditors were involved. Consequently, the Japanese Institute of CPAs has stengthened its ethics code and taken additional steps to enhance the quality of outside audits. Beginning in 2008, listed companies must file an "Internal Control Report" which sounds a great deal like the SOX 404 review that U.S. companies have been conducting.

The speech also includes a description of the uniquely Japanese "consolidated earnings digests." The TSE requires standardized reports and these reports convey information to the market as soon as the main information that will be contained in the issuer's securities filings is known. On the average, this gives investors important information about 2 months sooner than the filing date for the reports. The TSE is also working with companies on XBRL reporting.

Nishimuro also noted concern that Japaneses accounting standards will become "merely a local phenomenon" and explained that the TSE is working with others on international accounting standards.

ASX Seeking Comments on Outcomes v. Practices Based Corporate Governance Principles

The Australian Stock Exchange is seeking comments on whether the ASX Principles should continue to be based on practices rather than outcomes. See the posting on the ASX website from Shann Turnbull of the International Institute for Self-governance here.

Turnbull's argument is that check-the-box regulations are less effective than outcomes based approaches. He argues that if an entity can prove that its approach results in good governance, which he defines as "the ability of corporations to maximize their ability to operate on a socially acceptable self-governing basis to minimize the need for government and its regulators to become involved."

NYSE Acquiring Stake in India's National Stock Exchange

The NYSE has announced plans to invest $115 million to acquire a 5% interest in India's National Stock Exchange. See the Dow Jones news blurb here. Other "pedigreed foreign institutions" (the NSE's term) that are investing capital in exchange for 5% stakes are Goldman Sachs, General Atlantic and Softbank Asia's Infrastructure Fund.

The NSE has been around since 1992 and was created after being recommended from a study of new capital markets. The NSE ranks third in the world in the number of equity market trades, number one in equity futures and fourth globally in index futures.

With its English legal system, India has advantages over other developing markets in the corporate governance arena. But it has not developed a reputation for strong enforcement. For those interested in reading about India's corporate governance landscape in more detail, see this paper by Rejesh Chakrabarti or the IFC's report here.

Perhaps as groups like the NYSE and Goldman Sachs take ownership stakes in the NSE, we will see further convergence in corporate governance practices and over time India will develop a capital market that is marked by strong enforcement practices.

IPO in China

Fred Tung over at The Conglomerate blog posted a piece about the success of the IPO by China's Industrial and Commercial Bank, which raised around $22 billion in a hugely oversubscribed IPO. Tung notes that this is despite the fact that China has a number of governance issues, several of which I've noted in previous posts such as the one on the OECD's report about corporate governance practices in China and the posting on the ISS 2006 Global Investor Survey.

The closely linked ownership structures of so many companies in China and the prevalence of state-owned enterprises has caused China's progress in the corporate governance area to creep along at glacial speed. Perhaps over time, the influence and expectations of foreign investors will prompt better disclosure and governance practices in China.

OECD Publishes Assessment Tool

In December, the OECD published Methodology for Assessing the Implementation of the OECD Principles on Corporate Governance. The document is available here.

The OECD's assessment tool contains a chapter on each OECD corporate governance principle and discusses assessment criteria with respect to each principle. The approach used in the methodology is qualitative rather than quantitative, using a scale similar to the scale used in other OECD assessments of observed/implemented, broadly observed/implemented, partly observed/implemented,not observed/implemented, and not applicable. Where a principle has been partly observed/implemented or not observed/implemented, the assessor must analyze why this principle has not been implemented. Is it due to the lack of an appropriate legal framework for regulation or redress of wrongs? Is there poor regulatory enforcement? Are market mechanisms weak?

Due to the qualitative nature of the assessment and the need to apply professional judgment, the OECD notes the importance of a reviewer's familiarity with the corporate landscape in a particular country. Application of anecdotal evidence will be less helpful that application of statistical indicators.

Termination of Foreign Private Issuer's Registration

A few days ago, the SEC reproposed amendments to the rules that govern when a foreign private issuer may terminate registration of its equity securities under Section 12(g) of the Securities Act, and its reporting obligations under Section 13(a). See here for the proposed rule. The proposed rule is open for comments.

The changes were first proposed in December of 2005 and the SEC received more than 50 comments regarding the earlier proposal. Many of the comments noted that the SEC's proposal, while a step in the right direction, continued to make it difficult for issuers in whom U.S. investors have very little interest to deregister. The new proposal incorporates suggestions made by several commentators.

Corporate Governance in East Asia

There's a conference scheduled for February 9-10 on Corporate Governance in East Asia. See here for conference information. The conference will be held at Kyushu University Nishijin Plaza in Fukuoka, Japan.

Survey on India's Business Climate for Private Equity Investors

Wharton and Bain & Co. are conducting a survey on the business climate in India. The survey is for firms involved in private equity investments in India and results are due to be published in a white paper. The survey is here.

IOSCO Priorities

Jane Diplock, Chairman of New Zealand's SEC and of the Executive Committee of the International Council of Securities Associations, gave a speech last month at the IOSCO's general meeting in Tokyo. Diplock's speech (available here)addressed the IOSCO's priorities of providing consistent worldwide securities regulation and providing for information exchange among regulators.

Diplock reiterated the goals of the IOSCO: protection of investors, market fairness and transparency, and reduction of systemic risk. To achieve these goals, the IOSCO is providing assistance to regulators in emerging markets. The IOSCO has also issued a Multilateral Memorandum on Consultation, Cooperation and Exchange of Information to allow signatory regulators to provide timely assistance to each other in addressing cross-border securities fraud issues. So far, regulators in 34 countries have signed on to the MOU.

Developing a Bond Market in China

China's DTC, the Asia Securities Industry and Financial Markets Association and the Securities Industry and Financial Markets Association issued a press release this week announcing plans to cooperate in the development of a bond market in China. The ASIFMA and SIFMA will assist China's DTC in developing and implementing international best practices regarding transparency and settlement.

The development of a strong and liquid Chinese bond market will provide issuers with additional capital-raising opportunities and will provide investors with additional investment opportunities.

EDGAR Upgrade

The SEC announced yesterday that EDGAR, the Commission's electronic database, has been upgraded to allow full-text searches of disclosure documents. This is good news for investors, but it's especially good news for lawyers and accountants searching for other companies that have had similar disclosure issues. The text of the SEC's press release is here. Now, those doing research in the SEC's database can use Boolean searches, wild card searches and key word searches.

Women on the Board

The Wellesley Centers for Women issued a report in late October about the relationship of the percentage of women on boards of directors and corporate governance practices. The WCW report finds that there is a critical mass of women in the boardroom for the company to benefit significantly from their perspectives, interpersonal skills and understanding of certain issues. Companies that have at least 3 women on the board of directors tend to benefit in the area of governance. If only one or two women are on the board, those one or two women may simply be viewed as tokens and those women may not be able to influence the discussion in the ways that 3 or more women can.

Interestingly, Norway seems to be way ahead of many other countries in having women on boards of directors, but Norway got there through legislation. Since 1985, Norway has required that public companies have a board comprised of at least 40% (depending on board size) women. Now, women hold about 44% of the public company board seats in Norway.

Legislation seems to be an extreme solution, but the Wellesley report is probably right about there being a certain critical mass. I serve on a college's board of trustees and when I joined the board, it was the first time one of my fellow trustees could say, to his delight, "Ladies and gentlemen . . . "

IASB Report from CEOs of the International Audit Networks

The IASB has posted a report entitled, "Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Networks." The report, written by the 6 largest global auditing firms, discusses "how global financial reporting and public company auditing procedures must adapt to better serve capital markets around the world."

The six topics addressed in detail in the report are:
1. defining investor informational needs;
2. aligning the roles of various stakeholders in the governance process;
3. assure a "vibrant, sustainable" auditing profession;
4. provide a business reporting model to deliver relevant and timely information (think XBRL);
5. take steps to assure that large, collusive frauds are rare; and
6. report and audit financial information "pursuant to globally consistent standards."

Both short-term and long-terms steps are outlined to achieve these goals. Near-term efforts include convergence of the IASB and FASB standards, launch a process for convergence of auditing standards, and take steps to assure that regulatory oversight is consistent among various jurisdictions. Long-term steps would be geared toward disclosure of user-customized information, much of which may be non-financial in nature, which is accessible more frequently than is currently the case.

A couple of interesting observations from the report include:

1. The U.S. is one of the only major capital markets in which foreign companies are not allowed to use IFRS, although the process is underway to harmonize U.S. GAAP with the IFRS. If convergence plans continue, the SEC might allow foreign issuers to report using IFRS by 2009. See page 9 of the report.
2. The definition of independence varies from country to country. Although the International Federation of Accountants has adopted a definition of independence, few countries follow it. France has independence standards that may have extraterritorial effects on multinational companies seeking auditing services. See page 11 of the report.
3. Auditors are challenged to address the expectation gap between what an audit is supposed to accomplish and what it actually can accomplish. In other words, stakeholders expect auditors to discover fraud. But even when auditors accomplish their work following all applicable auditing standards, some frauds will still escape detection. After all, frauds are, by their very nature self concealing.
4. Global auditing firms eschew complete integration for a number of reasons including licensing and education requirements, ownership limitations and liability concerns. At times, this means that auditing services are performed by a fairly loose network of related entities.

Changes to Canada's Securities Laws

The OSC's most recent Carswell Bulletin outlines several changes that have been proposed to Canada's securities laws. Here's a link to the bulletin; scroll down to Chapter 9 for Legislation.

In mid-October, Canada's Minister of Finance proposed a series of amendments that will harmonize Ontario's securities laws with the laws of other Canadian jurisdictions. There is no single, national securities regulator in Canada. Instead, each province has its own regulatory scheme.

Among the proposed changes are:
1. Giving the OSC authority to designate as an insider anyone who has access to material information about the issuer in the ordinary course. Presumably, this would allow finance and accounting personnel, as well as attorneys working on the issuer's deals, to be designated as insiders for reporting purposes.
2. Harmonize Ontario's definitions of terms "insider," "director" and "officer" with the definitions in other Canadian jurisdictions.
3. Harmonize certain prospectus issues with other Canadian jurisdictions.
4. Provide courts with authority to order restitution.

Luxembourg's New Investment Fund Law

Ernst & Young has just issued a report explaining Luxembourg's new law that will allow investments by "informed investors." The report is here.

Luxembourg has always been an issuer-friendly place, and the new law should make it even more so. The Specialized Investment Fund Law will replace Luxembourg's 1991 institutional investor fund law. The new law will allow investment funds to be sold to "informed investors" and defines that term in a way that is very similar to the SEC's definition of an "accredited investor." Under the new law, an informed investor is one of the following:

1. an institutional investor;
2. a professional investor; or
3. any other investor who declares in writing that he is an informed investor and invests at least 125,000 euros or has a bank or finance professional certify that he can adequately understand the investment.

More on CEO Blogging

About a month ago, I blogged about Sun Microsystem's CEO asking the SEC for guidance on whether a blog could be used as the shareholder communication vehicle under Regulation FD. That posting is here. Now, Christopher Cox has responded to Schwartz's inquiry. The response and Schwartz's musings about it are posted here.

In the response letter, Chairman Cox noted, "[A]corporate website is a tremendous vehicle for the broad delivery of timely information (and in the case of Sun, you note that your website receives an average of nearly one million hits per day). Many other companies are finding that this is true, and increasingly are posting significant amounts of information on their websites. Indeed, because information that is not "selectively disclosed" or that is not material nonpublic information is not subject to the public dissemination provisions of Regulation FD, Sun and other public companies can already do this without implicating the provisions of Regulation FD."

In other words, the Internet is a great tool and CEOs and their companies are welcome to post all sorts of interesting information on their web sites and blogs, so long as the information isn't selectively disclosed and isn't material non-public information.

Although shutting the door for now on the use of blogs and websites to comply with Reg FD, Chairman Cox did note an interest in discussing the issue with interested groups. In light of the lukewarm response from Cox, I doubt that many executives will start blogging as a way to communicate with constituencies on important issues. Everyone will wait to see whether the SEC can work out how the Internet can be used to broadly disseminate material information. Funny thing is, though, that the Internet seems to be a far more efficient way to disseminate timely information than other ways.

Annual Reports in Europe

CFO Magazine posted an article about annual reports in Europe. An issue that has caused a lot of consternation amoung European executives is a section of proposed amendments to the Companies Act that requires executives to report on consideration of various constituencies in their decision-making processes.

The approach to governance and reporting issues in Europe is generally principles-based rather than rules-based. The U.S. follows a rules-based approach. Therefore, executives in Europe are asked to report in narrative fashion with very little guidance on issues that are difficult to measure in any meaningful way.

Because the proposed rules had been published well in advance of this year's reporting season, many companies went ahead with publication of annual reports that attempted to comply with the proposed rules requiring a narrative "Operating and Financial Review." Those proposed rules were abandoned in late November of last year, after many companies had already spent a great deal of time on the new style of reporting. For more information, visit the Companies House web site. The abandonment was a surprise in many circles, because the proposed OFR was the result of recommendations coming from a working group assembled by the Department of Trade and Industry.

PCAOB Issues Options Guidance

Earlier this week, the PCAOB issued a 28-page document "Staff Questions and Answers: Auditing the Fair Value of Share Options Granted to Employees." The document, available here, will assist auditors in applying FAS 123, the SEC's Staff Accounting Bulletin 107, and the PCAOB's statements regarding auditing of stock option plans.

Best Price Rule Change by SEC

Yesterday, the SEC announced approval of a change to the best-price rule, which requires that all shareholders receive the same price for their shares in a tender offer. The purpose of the change was to clarify application of the rule where a shareholder receives compensation for services.

Federal courts applied the best-price rule in different ways, with some applying the "integral-part test" and holding that the best-price rule applies to all integral parts of a tender offer including compensation, severance and other arrangements entered into in connection with the tender offer. Other courts applied a bright-line test and applied the best-price rule only to arrangements which were entered into and performed between commencement and closing of the tender offer. Application of the two different tests made it difficult for companies making a tender offer to know what should and should not be included in the pricing for purposes of the best-price rule.

The revised rule provides that "the consideration paid to any security holder for securities tendered in a tender offer is the highest consideration paid to any other security holder for securities tendered in the offer." The rule also "exempts compensatory arrangements from the rule so long as specific substantive standards are satisfied, and includes a safe harbor that hinges upon approval of independent members of the board of directors."

The SEC's press release announcing approval of the revisions is here. The text of the revised rule should be posted soon to the SEC's web site. The proposed rule is located here.

The Fox Watching the Henhouse? Internal Audit Reporting

Cfo.com ran an article this week entitled, "Should Internal Audit Report to the CFO?" This is an important issue because of the widely held view that having the internal audit department report to the company's CFO is tantamount to having the fox watch the henhouse. If the CFO is cooking the books, then arguably the internal auditors whose salaries and terms of employment are set by the CFO have a conflict of interest that may persuade them to overlook the CFO's shenanigans.

Other possible reporting relationships include having the internal audit department report directly to the CEO or having a dotted-line reporting relationship to the head of the company's audit committee. If the internal audit head reports to the CEO, this sends a message to the entire company about the importance of the internal audit function. Whether internal audit reports to the CEO or CFO, the "tone at the top" is extremely important in assuring that the organization views the function as critical to internal controls and accurate financial reporting.

Whether internal audit reports to the CEO or the CFO, though, there should be a strong relationship with the audit committee and, particularly, the chair of the audit committee. At every audit committee meeting, both the internal audit head and the outside auditors should have opportunities to meet separately with the audit committee. These executive sessions should be conducted without management's presence.

It's also a good practice for the head of the internal audit department to have a relationship with the chair of the audit committee. Regular phone calls regarding important issues can keep the audit committee chairman in the loop and will assure that the internal audit department has the leeway it needs to complete its job effectively.

For more information on this topic, see "Internal Audit Reporting Relationships: Serving Two Masters" from The Institute of Internal Auditors. The IIA report notes that internal audit departments have different relationships with different constituents. Internal audit reports up to either the CEO or CFO, provides consultation to operational managers, and provides assurance to the audit committee.

Backdoor Compensation: Stock Options and Buybacks

When companies accumulate excess cash and cast about for ways to use that cash, they have several options: increase dividends, pay down debt, do acquisitions, and engage in share buybacks. There are several solid reasons for engaging in share repurchases.

Buybacks are a tax-efficient way to return money to shareholders. As the company buys its shares back, the value of the shares outstanding will increase because each shareholderes shares now represent a larger piece of the pie. The shareholders won't owe taxes on the increase until they later sell their shares. Buybacks are also a way for management to signal to the market that the company's stock is undervalued and that the company expects solid performance ahead. Finally, when interest rates are low, paying down debt may not be a good option for all of that excess cash. Some companies like buybacks because of the EPS boost they get; profits are divided among fewer shares in calculating EPS resulting in higher earnings per share.

Here's another reason companies may engage in buybacks: as a company buys back its shares, the stock price increases and this provides back-door compensation to executives because their stock options are worth more. It would be possible, for example, for an aggressive buyback program to cause underwater options to become in-the-money options. The buyback will almost certainly cause the value of in-the-money options to increase.

When companies do share splits, they account for the split as they calculate options. For example, a company that does a 2-for-1 share split will convert employees' options to options for twice as many shares at half the price. If Bob has 100 options at $10 per share, after the 2-for-1 split he will have 200 options at $5 per share.

When companies engage in buybacks, there's no similar accounting adjustment with respect to stock options. So the increase in the stock price results in compensation to executives as the value of their stock options increases. Nice trick.

Foreign Private Issuer Deregistration

Last December, the SEC proposed rules regarding the deregistration of foreign private issuers (see my blog posting regarding the proposed rule). Yesterday, the SEC announced an open meeting on December 13 to consider those proposed rules, as well as proposed rules regarding Section 404 of the Sarbanes-Oxley Act, the internet availability of proxy materials and Rule 14a-8 regarding shareholder proposals.


The proposed rules regarding foreign private issuers allow those issuers to exit the SEC reporting system if they:
1. have filed or furnished all require reports during the prior 2 years;
2. have not offered securities in the U.S. for at least the past 12 months (with a few exceptions such as sales to employees and sales of commercial paper); and
3. have had securities listed under their home country reporting regimes for the past 2 years or longer.

In addition to these requirements, the issuer must meet one of the following additional conditions:
1. no more than 5% of the shares are held by U.S. residents; or
2. the U.S. average daily trading volume is not more than 5% of the company's average daily trading volume in its primary market;
3. the class of shares is held by no more than 300 shareholders worldwide or in the U.S.

Foreign private issuers with debt securities issued in the U.S. can terminate their SEC reporting under the Exchange Act if that have filed or furnished all required reports including at least one annual report and within 120 days of filing a new Form 15F, the debt securities are held by fewer than 300 holders worldwide or 300 U.S. holders.

Foreign private issuers which meet these requirements may exit the U.S. reporting system. They must, however, make available to U.S. investors via the Internet reports that they are required to file in their home countries.

Japan's New Legislative Framework for Investor Protection

Japan's Financial Services Agency posted yesterday two documents explaining the country's New Legislative Framework for Investor Protection -- "Financial Instruments and Exchange Law." The 16-page pamphlet summarizes the changes to Japan's laws. Changes are being made to the definition of securities, the scope of derivative transactions, disclosure rules, tender offer rules and various other significant provisions.

The changes represent a comprehensive revision to Japan's laws. Four laws will be abolished and consolidated in the new Financial Instruments and Exchange Law; these are the Financial Futures Trading Law, the Law Concerning Foreign Securities Firms, the Law Concerning the Regulation of Investment Advisory Services Relating to Securities, and the Law Concerning the Regulation of Morgage Business. Eighty-nine other laws will be amended and, in some ways, consolidated into the new law.

Nose In, Fingers In: The (New?) Role of Corporate Directors

Today's Wall Street Journal contains a special section on corporate governance under the title, "Move Over, CEO: Here Come the Directors." For decades, the prevailing view of the role of corporate directors has been a "nose in, fingers out" view, meaning that directors are supposed to be nosey but they aren't supposed to run the business; that's the job of the executives.

Directors are supposed to exercise independent judgement, ask probing questions of management, and push for more information if the answers seem flimsy or inaccurate. In appropriate circumstances, they should replace managers. Executives are charged with the day-to-day operations of the business, with guidance from the board of a high-level, strategic nature.

But according to the cover of the WSJ section, today's directors are in "the trenches to talk to investors or employees." A board that is engaged with various constituencies can monitor the company's activities better than a disengaged board, but it can also get in the way of the executives whom the board has hired to run the company. Outside directors may, for example, not be well versed in the art of dealing with analysts and may misstate information about the company. Outside directors who try to influence executives with respect to personnel decisions and other similar matters risk distracting the executives from running the company. Instead, the executives may end up spending too much time responding to questions and comments on routine managerial issues.

One way for directors to learn more about the company is for the company to appoint senior executives to serve as a liaisons with the board members. These positions can be rotated from year to year so that board members learn about the company from other executives and gradually are exposed to likely successors to the CEO. Board members might also be invited to attend meetings with analysts, with the understanding that the CEO and CFO will do most of the talking. Board members from other industries should focus on acquiring industry knowledge, perhaps by reading trade journals or attending conferences.

In the end, though, the board should establish the strategic direction of the company and monitor the company's progress, but it should leave the running of the company to the CEO and other executives it has selected.