Federal Securities Lawyer & Attorney : Porter Wright Law Firm : Securities Exchange Law : Serving Ohio, Washington DC, Florida

SEC Commissioners will meet on Monday to consider implementation of a plan to require companies to file financial statement information in an interactive format known as XBRL (extensible business reporting language).

XBRL or data tagging is the process of identifying accounting principals with unique data tags that allow financial statements to be easily downloaded into various applications for quick comparisons over time and across industries. Currently more than 70 companies voluntarily disclose financial information using XBRL in an SEC pilot program, and at least 20 mutual funds voluntarily submit risk/return summaries from their prospectuses in XBRL.

Mandatory XBRL reporting is predicted to take several years to implement while the SEC deals with the following questions/concerns:

• XBRL is predicted to increase transparency and usability of financial information, but what will it cost companies to comply?
  
• What liability should result if financial information is improperly “tagged” and therefore mistakenly misleading? Should XBRL documents be considered “furnished” rather than “filed” during a phase-in period?
  
• How much time will auditing and finance professionals need to learn the new system? The SEC’s Advisory Committee on Improvements to Financial Reporting has suggested the SEC wait three years.
  

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The IRS issued Revenue Ruling 2008-13 to clarify what constitutes “performance-based” compensation under Internal Revenue Code Section 162(m).  This classification is important because Code Section 162(m) generally prohibits public companies from deducting compensation in excess of $1 million to the CEO and certain named executive officers.  If the compensation is performance-based, however, this deduction limitation does not apply.

Under prior guidance, an executive could receive a performance award (either cash or equity) upon involuntary termination without cause, termination for good reason, or retirement, without regard to whether performance goals were actually met. In Revenue Ruling 2008-13, the IRS reversed its position, holding that such an award will not be treated as performance-based compensation under Code Section 162(m). This ruling puts many executive compensation plans and employment agreements at risk in light of the new restrictions on deductions for non-performance-based compensation that exceeds $1 million.

For more information on this latest guidance, you may view our recent law alert.

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Earlier this week the US Department of Treasury released its self-commissioned study, the “Blueprint for a Modernized Financial Regulatory Structure.” In part in response to the current financial crises of lenders and investment banks, the Department of Treasury has proposed an overhaul of the way the federal government regulates securities, banks, investment banks, and the various services they offer.

One theme of the Blueprint is to give more power to the Federal Reserve, especially in the context of regulating banks and investment banks. Some commentators are predicting that investment banks will eventually have to fully report all direct and indirect holdings of securities, including the amount and the basic characteristics.

The Blueprint is unclear on whether increased power for the Federal Reserve means decreased power for the SEC, but some are predicting as much. What is clear is that the Blueprint calls for some significant changes to how the SEC operates, including the following:

• Create “core principles” to apply to securities clearing agencies and exchanges;
• Make it easier for securities products to be approved;
• Expand registration of investment companies, including registration of new “global” investment companies; and,
• the most significant: merge with the Commodity Futures Trading Commission

Most politicians predict the Blueprint will not become law and even Treasury Secretary Henry Paulson has called it “aspirational.”

Interestingly, the Blueprint calls for increased regulation across the board—presumably because market participants have failed to regulate themselves in the form of how they value their assets and liabilities—and at the same time calls for streamlining the rule-making process of self-regulatory organizations to allow US markets to remain competitive worldwide.

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Effective February 4, 2008, smaller reporting companies may begin preparing their SEC reports and registration statements using the same forms as other SEC reporting companies but with scaled disclosure requirements. Eventually, there will be no special “small business” forms such as Forms 10-KSB and SB-2.

Companies qualify as a smaller reporting company if they:

1. have a common equity public float of less than $75 million or
2. are unable to calculate their public float and have annual revenue of $50 million or less.

Public float is calculated as of the last business day of the second fiscal quarter.

Companies with a public float between $25 million and $75 million would not have qualified as “small businesses” under the old rules, but can now choose to alternate between the disclosure requirements of smaller reporting companies and other companies, with some limitations.

Note the following key differences in disclosure obligations:

• Smaller reporting companies do not have to disclose risk factors;
• Smaller reporting companies need only provide two years of analysis and financial statements, as opposed to three years, in their Management Discussion & Analysis; and
• Smaller reporting companies need only provide 3 of the 7 compensation tables in their proxy statement.
  

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In an effort stop identity theft and intrusions into online brokerage accounts, the SEC has proposed amendments to Regulation S-P to provide more specific requirements for protecting personal information. Regulation S-P requires certain institutions to safeguard customer records and information. It was adopted in 2000 in direct response to the Gramm-Leach-Bliley Act, which requires every financial institution to inform its customers about its privacy policies and imposes limits on the disclosure of personal customer information to third parties.

The proposed amendments to Regulation S-P create more specific requirements for protecting information and responding to security breaches, including requiring financial institutions to designate which employees coordinate information security programs. The amendments also broaden the scope of the disposal of customer records and information and the requirements for such disposal. The SEC has specifically requested comment on what should be considered “personal information.”

Finally, the amendments permit some transfer of information to third parties without notice to the investor when the investor follows a representative who moves from one brokerage or advisory firm to another. The proposed exemption would allow firms with departing representatives to share limited customer information with the new firm for use in contacting the investor and offering a choice about whether to follow the representative to the new firm. The proposal is presented as a way of maximizing choice for the investor.

The SEC is accepting comments for 60 days from publication. Presumably some comments will address what the new rules mean in terms of the costs of compliance.

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Last week the House of Representatives Committee on Oversight and Government Reform rescheduled a hearing on CEO termination payments in connection with the mortgage lending crisis. In January, Committee Chairman Henry Waxman sent letters to Citigroup, Merrill Lynch and Countrywide Financial asking them to justify payments to outgoing CEOs despite significant subprime-related losses and decreasing stock values. The hearing follows a December 2007 hearing on the use of compensation consultants to determine CEO pay. Scheduled to testify, presumably to justify their compensation, are Angelo Mozilo, CEO of Countrywide, E. Stanley O’Neal, former CEO of Merril Lynch, and Charles Prince, former CEO of Citigroup.

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As the Green Movement continues, more institutional investors are becoming concerned with the potential costs and risks of investing in projects that produce high amounts of carbon. This was the topic of a recent meeting of investors in New York organized by the United Nations Foundation and Ceres, a coalition of investors and environmental groups.

Investors have asked the SEC in the past to require carbon footprint disclosures, but the SEC has declined, and many companies are against such disclosures. The investors are not being altruistic; they are reacting to potential costs that could affect their investments, including 12 bills currently in Congress that would raise costs for companies that emit too much carbon. Investors what to know what is a company’s “climate risk,” which includes risks associated with the costs of carbon production, diminished reputation for not being green, and costs associated with environmental forces such as hurricanes that tend to disrupt energy-based investments.

The investors, including investment banks and pension and retirement funds, have a lot of power if they can agree on strategies for obtaining carbon footprint disclosures. The organizers of the meeting claimed those that attended collectively control trillions of dollars in capital.

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Brokerage firms that issue fairness opinions regarding corporate transactions have new disclosure obligations that will likely require changes to form documents used to draft the opinions and the internal procedures that govern the process. The Financial Industry Regulatory Authority (“FINRA”) has established a new Rule 2290 that requires disclosure of potential conflicts of interest between firms that render fairness opinions and the parties to the corporate transactions that are the subject of the fairness opinions. The rule is designed to alert shareholders that a fairness opinion regarding a potential transaction is not necessarily rendered by a completely independent third party. FINRA is concerned that shareholders may not be aware that the firm issuing a fairness opinion is often an advisor to a party to the transaction whose compensation may be contingent upon the success of the deal.

The new rule addresses this concern by requiring specific disclosures if a member firm issuing a fairness opinion knows or has reason to know that the fairness opinion will be provided or described to the company’s public shareholders. Even if an opinion is prepared only for use by the board of directors of a client, shareholders of the client will now be made aware of potential conflicts of interest – including contingent compensation arrangements – because fairness opinions are usually included in materials provided to public shareholders.

FINRA Rule 2290 Disclosure Requirements

The following new disclosures are required by Rule 2290:

• whether the member firm has acted as a financial advisor to any party to the transaction;

• whether compensation for the opinion is contingent upon the success of the transaction;

• material relationships during the past two years between the member firm and any party to the transaction;

• whether the member firm independently verified any of the information that formed a substantial basis for the fairness opinion and was supplied to the member by the company requesting the opinion;

• whether the fairness opinion was approved or issued by a fairness committee; and

• whether the fairness opinion addresses the fairness of the amount or nature of the compensation from the transaction to certain insiders relative to the compensation to shareholders.

FINRA Rule 2290 Procedure Requirements

Several member firms that issue fairness opinions may have already implemented many of Rule 2290’s newly required disclosures. These firms should also ensure, however, that they meet the new rule’s procedural requirements for issuing fairness opinions. Member firms that issue fairness opinions must have written procedures regarding the approval of all fairness opinions, not just those that will be provided to shareholders. Additionally, the written procedures must describe when the member firm will use a fairness committee to issue a fairness opinion and the process by which the valuation analyses used in the fairness opinion will be evaluated.

The new rule is already in effect and has been approved by the Securities and Exchange Commission. Member firms should review their templates for fairness opinions and the procedures by which fairness opinions are rendered to ensure compliance with the new rule.

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The Securities and Exchange Commission (“SEC”) recently adopted certain rule amendments mandating that the information required to be filed on Form D under the Securities Act of 1933 (“Form D”) be filed electronically through the internet.  The information required by Form D will be filed electronically with the SEC through a new online filing system that will be accessible from any computer with Internet access and the data filed will be available on the SEC’s web site.  In addition, the amendments revised Regulation D promulgated under the Securities Act of 1933 and Form D to simplify and restructure Form D and update the information required by Form D.

View Final Rule

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