Former Congressman Mike Oxley to Address NASPP Conference I’m very excited to announce that Former Congressman Mike Oxley will present the opening keynote address at the 21st Annual NASPP Conference. Yep, that right, Oxley of the Sarbanes-Oxley Act, or SOX as we all affectionately refer to it.
Rep. Oxley’s address will be followed by a panel of former Congressional staffers who served on the House Financial Services Committee and the Senate Banking Committee, who will explain how things really get done in DC. The two addresses together should be very enlightening!
Don’t miss out on these great presentations–register for the Conference today! And remember, you heard about it here first, in the NASPP Blog!
NASPP To Do List Here’s your NASPP “to do” list for this week.
Sometimes a blurb on an equity compensation “happening” crosses our desks, and it’s hard to know whether it’s the start of a new trend, or just an isolated occurrence. This was the case when I recently came across an SEC no-action letter on Sarbanes-Oxley 402 (the provision of the Act that covers loans to officers and directors). I hesitated to blog about it, but then decided that it could be a useful and interesting clarification in an area where the SEC has long remained silent. I realized I wasn’t alone, because Broc Romanek expressed the same sentiments in a recent CorporateCounsel.net blog.
Innovation Breeds a No-Action Letter
As far as I can tell, the circumstances leading to the no-action letter represent a one-off scenario. However, the interesting part to me was the creative approach to equity compensation that was the intent behind the request to the SEC. The company involved, RingsEnd Partners LLC, created a program for restricted stock award shares that they believed would encourage executives to hold on to award shares that they might otherwise consider selling upon vest (when taxes are typically due). As more fully described in the detailed version of the incoming letter to the SEC, participation would be voluntary, and those electing participation in the program would allow their shares to be initially taxed at grant (I’m guessing via agreement from the participant to make an 83(b) election). Underlying shares from new awards would be transferred to a trust at the time of grant. The trust would then go to a bank to obtain a loan to pay the taxes on the shares (based on the spread at the award date). The shares would be held by the trust as collateral for the loan. Once vested, no additional taxes would be due (any appreciation would later be taxed at sale), and a portion of the shares would be sold to cover the loan amount from the bank. The remaining shares (and any residual cash proceeds) would then be released to the participant. With shares free and clear, and no further amounts due until sale, RingsEnd Partners believes that participating executives will be encouraged to hold the shares, further aligning with shareholder interests. The company would have no participation in the program, other than “ministerial” tasks. Believing their arrangement would not violate SOX 402’s provisions regarding making loans to officers and directors, they sought a no-action letter from the SEC.
The Legal Details
The firm leading the charge to the SEC on behalf of the company was BakerHostetler, and they released their own summary of the events that led to the no-action letter. This is one of those times when they can articulate it much better than I can, so I will extract some of the pertinent sections:
In BakerHostetler’s Feb. 28 letter to the SEC staff, Messrs. Oxley, Gallagher and Reich sought guidance on Section 402 with regard to an innovative equity-based incentive compensation (EBIC) program that their client, financial services firm RingsEnd Partners LLC, developed with global financial institution BNP Paribas. The EBIC program contemplates that participating employees will receive company stock as incentive compensation and thereafter transfer those shares to an independently managed Delaware statutory trust. The trust could then obtain term loans from an independent banking institution, using some or all of the shares transferred to the trust as collateral. The letter notes that, in the absence of interpretive guidance on SOX 402, public companies have been reluctant to permit directors and officers to participate in the proposed program.
BakerHostetler contended that an issuer allowing its employees to participate in the EBIC program would not be extending or maintaining credit, or arranging for the extension of credit, in the form of a personal loan to employees subject to SOX 402. The lawyers noted that although a company would “need to perform certain ministerial tasks in order to allow its employees to participate in the EBIC program,” the company would “neither encourage nor discourage employee participation,” nor would the company “directly or indirectly make or guarantee the loans, or provide any extension of credit or other financial support” to the trust, its trustee, or trust beneficiaries (the employees). BakerHostetler argued that the legislative history suggests that under the final version of SOX 402, the phrase prohibiting a company from “arrang{ing} for the extension of credit” should be read no more broadly than prohibiting the company from providing a “loan guarantee or similar arrangement,” language found in earlier versions of SOX 402.
In the new guidance issued by the SEC, the agency’s staff wrote that an issuer that permits its directors and officers to participate in the plan “would not be deemed thereby, directly or indirectly, to be extending or maintaining credit, in the form of a personal loan to or for such individuals for purposes of Section 13(k) of the Securities Exchange Act of 1934” {SOX Section 402}. The SEC also wrote that an issuer that undertakes certain ministerial or administrative activities to permit its directors and officers to participate in the EBIC Program would similarly not be deemed, directly or indirectly, to be extending … or arranging for the extension of credit in the form of a personal loan to or for such individuals within the meaning of SOX 402.
Is this just a one-off scenario? Or, will this no-action letter spark a trend of creative arrangements that allow for funding of equity compensation awards in a manner that won’t evoke action from the SEC for a SOX 402 violation? Only time will tell, but it was certainly interesting to intercept.
Since it is a holiday week, I have a couple of lighter topics for my blog entry.
Behind Every Half-Baked Law Is an Over-Sensationalized Cause In his May 21 Compensation Blog entry on CompensationStandards.com, Mike Melbinger of Winston & Strawn states “…nearly every bad law in the field is the result of Congressional or agency reaction (or overreaction) to some widely publicized occurrence.” To prove it, Mike created a game in which readers can match each half-baked law (Mike’s phrase) with its cause. So you can join in on the fun, I’ve reproduced it here. Match the law on the left with its cause on the right.
Law
Cause
1. 280G
A. Enron executives
2. 409A
B. Change in control payments made to Bill Agee of Bendix in 1982
3. AMT
C. 2007 World Financial Crisis (Wow, was it really that long ago? Shouldn’t my investments have recovered by now?)
4. Dodd-Frank Act
D. Enron, Worldcom, Anderson
5. SOX
E. Treasury Secretary Joseph Barr testifies that, in 1967, there were a total of 155 individuals with incomes over $200,000 who did not pay any federal income taxes; twenty of them were millionaires.
10 pts to anyone who gets all five right. Answers next week.
Deal Cube Wars I’m not quite sure what a deal cube is–I guess it is some sort of souped-up paperweight given to lawyers to commemorate a deal they worked on–but that hasn’t stopped me from enjoying the Deal Cube Tournament that Broc Romanek is running in his blog on TheCorporateCounsel.net. Check out the cubes (he’s gotten readers to send in pictures of over 130 of them) and vote for your favorites. Some of them are quite clever. Broc’s blog is available for both subscribers and nonsubscribers, so anyone can join in on the fun.
Don’t Miss Out: Conference Early-Bird Expires on Thursday The early-bird rate for the 20th Annual NASPP Conference expires this Thursday. You can see by the program that this is going our most informative Conferences ever. You’re going to want to be there, so make sure you register by Thursday to save on your registration.
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so we keep an ongoing “to do” list for you here in our blog.
Register for the 20th Annual NASPP Conference in New Orleans. Don’t wait, the early-bird rate is only available until this Thursday, May 31.
As of June 15, 2011, SAS 70 is being replaced as the U.S. auditing standard for service organizations. Today, I explore some of the background for a SAS 70 report and why it’s being superseded.
Acronym Soup and Background Information
The Auditing Standards Board (ASB), which is a part of the American Institute of Certified Public Accountants (AICPA), issues guidance for auditors including the Statements on Auditing Standards (SAS). SAS No. 70 (SAS 70) is specifically guidance for auditors to use when “auditing the financial statements of an entity that uses a service organization to process certain transactions.” (See the AICPA site for more information.)
Section 404 of the Sarbanes-Oxley Act requires public companies to report on the effectiveness of the internal controls relating to their financial statements. The Public Company Accounting Oversight Board (PCAOB) issued Auditing Standard No. 2 in 2004–superseded by Auditing Standard No. 5 in 2007–which identified how the independent auditor evaluating a public company may rely on a “service auditor report” like the SAS 70 Type 2 report. The process breaks down like this:
An independent auditor for an issuing company must evaluate the controls that are in place to ensure the accuracy of financial reporting. If that company outsources administration processes that could impact financial reporting, the independent auditor should evaluation the controls in place at the service provider as well. A SAS 70 report can provide the necessary opinion of not only that the controls are suitably designed (i.e., a Type 1 report), but also that service company has effectively maintained each of those controls over a period of time (i.e., a Type 2 report). The issuing company auditor is, therefore, able to review the information in the Type 2 SAS 70 report instead of assessing the service provider’s internal controls directly. This saves a huge amount of time, money, and energy for both the issuing company and the service provider. The SAS 70 report has become a standard request for companies evaluating or using third-party stock plan administration service providers.
SSAE 16
The Standards on Standards for Attestation Engagements No. 16 (SSAE 16) replaces SAS 70 as of June 15, 2011. The new standard is intended to bring U.S. auditing practices more in line with the international standard, ISAE 3402. Like SAS 70, SSAE 16 consists of a Type 1 and a Type 2 evaluation, Type 2 being the necessary follow-up to determine if controls are being effectively performed over time. Companies with a current Type II SAS 70 report may transition directly to the Type 2 SSAE 16 report. You can tell the essential difference between SAS 70 and SSAE 16 in their names alone. SAS 70 is an audit standard that requires only the auditor’s assessment of controls. SSAE is an attestation standard that requires the company to also demonstrate the effectiveness of controls. SSAE 16 requires management at a service organization to provide not just a description of the controls in place, but of the system as a whole. (SAS 70 only requires a description of controls.) In addition, management must attest to the suitability of the system in a written statement that includes a description of the criteria used to make this assertion and the risks that could threaten the company’s ability to effectively maintain the system.
A Little Appreciation, Please
If you’re at an issuing company and the SAS 70 report is something you ask for–or better yet, something you automatically receive–from your stock plan administration service providers, I think it’s time to take a moment to appreciate the effort that’s going to go into the new standard. When you do get your hands on that SSAE 16 report, give it a good look before you pass it on to your auditors. It will give you some serious insight into what controls your service provider feels are essential, which can help you design some of your own internal controls. It can also shed light on what procedures you may need to update in order to help your service provider achieve the control objectives in the report, which in turn helps your company get through that portion of your audit.
With this being the week after a holiday (and, for many, the first day back after a long weekend), I thought something a little lighter might be in order for the blog. So today I feature another entry from John Hammond of AST Equity Plan Solutions and poet laureate of the NASPP blog.
The Email By John Hammond
The email hit my inbox and I wept a tiny tear The email that I knew would come had confirmed my greatest fears The age of innocence long forgot – the days were simpler then Back when I set foot in this place in 1997.
I was a stock vet of two years plus, hired on the spot Seemed like a great deal at the time with the options that I got The stock went nuts at first, but you know how it ends I stuck it out when times got tough, me and several friends
When I started, I cleaned up shop–of the basics they were remiss My stock plan shelves are sure to have a bobble-headed Elvis And next to Elvis on that shelf in a spot almost as great Is my stock plan procedure manual, a beacon strong and straight
And this manual has been wonderful, it helped through thick and thin The three splits in two years were huge–the one stock swap that I did It’s been exterminator–desk de-wobbler–I am so glad I penned it A procedure manual’s a wonderful thing, I highly recommend it
Back to the beginning of my poem–that email that made me cry Was from a woman in IA who’d like to watch me die We have a history outside of work, a few years back we dated Who knew a break up over fax would be so ill-fated
The email started innocent–“Hello John, How are you?” But the subject line had told it all: “Procedural Review” She knew I ran a loose ship, but she never seemed to catch me And she’s tried a lot since getting the “it’s not you…it’s me” facsimile
In the past, IA looked at transactions and events My captive broker dollars had been wonderfully spent I showed them a SAS-70, though I know they never read it I made that mistake a few years back and thoroughly regret it
She copied nine people on the email–of sarcasm I am a fan (That’s how many people saw that fax before it hit her hands) Of course she knew I’d get the jab–she even went one better She wrote, “I really respect what you do”–a sentence from my letter
So each procedure she’ll review controls on how we do stuff “The scandals have brought a greater need–no measure seems enough” She’s been studying for a while to find my Achilles heel She figured out procedures and I think my fate is sealed
See, that manual that I use so much…I am exaggerating It was desk de-wobbler for 18 months, if I’m not mistaken So she has me where she wants me–internal audit heaven I must confess the last time they were changed was ’97
My excuses for not updating is like it is for many We changed the way we did things just far too frequently It always seemed best to wait until projects had finished But then I’d start a bigger one and its importance would diminish
We’ve had 14 acquisitions, and sold five units in that time We’ve had two broker changes and those projects were all mine I’m making no excuses, you all know how I feel It’s just my procedures have never been a very squeaky wheel
So the chess game has begun, but she already has my queen The bishops, rooks and pawns and that little horsy thing The meeting is in two days–checkmate’s what it’s about Just trying to come up with any way… that I could ask her out.
18th Annual NASPP Conference Scheduled for Sept 20-23, the 18th Annual NASPP Conference is timed perfectly to help our members prepare for mandatory Say-on-Pay. Just announced–we’ve added a special Say-on-Pay track, featuring key advice and real-world strategies from in-the-know practitioners. Register for the Conference today.
NASPP New Member Referral Program Refer new members to the NASPP and your NASPP Conference registration could be free. You can save $150 off your registration for each new member you refer, up to the full cost of registration. You’ll also be entered into a raffle for an Apple iPad and the new members you refer save 50% on their membership–it’s a win-win!
NASPP “To Do” List We have so much going on here at the NASPP that it can be hard to keep track of it all, so I keep an ongoing “to do” list for you here in my blog.
The Sarbanes-Oxley Act contains an umbrella clawback provision requires that the CEO and CFO give back incentive compensation and stock sale profits in a year prior to any restatement that was caused by misconduct or fraud. Last year, the SEC filed a landmark complaint against the CEO of CSK Auto Corp (see the SEC Press Release) that sought to recoup incentive compensation resulting from accounting fraud without actually alleging that the CEO participated in the fraud. While Sarbanes-Oxley does not require that the executive actively participate in the fraud in order for the clawback provision to be invoked, this case marked a first for the SEC to open a case against an executive without alleging actual misconduct on the part of the individual.
For individual companies, a clawback is a contractual provision that provides the company with a means of recouping incentive compensation or stock sale profit from executives or top employees. The provision may apply to fraud, incentive resulting from incorrect financials, violation of non-compete provisions, or other violation of other specific restrictions within the agreement. Companies may include both equity compensation and cash bonuses in clawback provisions.
The existence of a clawback provision does not mean that a situation that violates the restrictive provisions will automatically result in funds being returned to the company. Most likely, the company will need to initiate legal proceedings in order to recoup any profits. Additionally, unless the agreement between the company and the executive details the repayment process, the company may need to negotiate the timing and manner of repayment.
Shareholders
Shareholders are most interested in performance-based clawback provisions that recoup profits resulting from accounting fraud. These types of clawbacks provide a critical protection to shareholders by forcing the executives to share in the financial losses related to inaccurate financial statements. This goes beyond performance-based pay arrangements where the executive only benefits if certain goals are reached (with the intention of aligning executive pay-out with shareholder benefit) because it reaches back to profits already realized by the executive rather than reducing future payout.
The use of clawback provisions can be helpful when companies are justifying their executive compensation.
Recent or Pending Legislation
Companies participating in the TARP are required to have clawback provisions relating to “materially inaccurate” financial statements. Additionally, TARP companies are required to exercise their clawback rights except in cases where they can demonstrate that it would be “unreasonable” to do so. This was further highlighted in the October determinations from the Treasury (see our alert). For more information on the TARP or other provisions under the Emergency Economic Stabilization Act of 2008, see our Economic Stimulus Legislation portal.
The proposed Senate bill, Restoring American Financial Stability Act (also known as the Dodd bill), goes one step further and recommends that all public companies be required to set clawback policies pertaining to inaccurate financial statements.
For Stock Plan Administrators
Hopefully, you will not need to deal with enforcing any clawback provisions your company may have. However, it’s a good idea to know if the company has clawback provisions in place and if there is a corporate policy on initiating repayment if they are triggered. One issue with clawbacks is that they may not be included in documentation that is normally accessible to stock plan administrators. They may be part of an employment or other separate agreement.
If you want to really take it one step further, educate yourself on the additional implications of recouping profit under a clawback provision. This may include how to handle previously remitted tax withholding or whether there are any 409A issues relating to the repayment method.
For more information on clawbacks and other provisions, check out the materials and audio from the Executive Compensation Conference, which we offered free of charge this year to everyone who attended the NASPP Conference.
More NASPP Value
We’ve added a new portal to the NASPP site, Shareholder Approval. It includes information on shareholder approval of stock plans, compensation, and options exchanges. Additionally, you will find exchange listing rules, legislation, proxy advisory firm recommendations, and more!