Monday, July 31, 2006

SEC Is Serious About CD&A

The Compensation Disclosure & Analysis discussion newly mandated by the SEC as part of its reform of executive compensation disclosure is destined to become the centerpiece of the new regime. Modeled on the MD&A, the CD&A should be a principles-based narrative overview that puts into context the compensation disclosure provided elsewhere. The CD&A would explain material elements of the company’s compensation for named executive officers. According to Chairman Cox, the CD&A provides both an obligation and an opportunity for a company to explain its compensation policies.

The SEC has repeatedly stated that boilerplate will not be acceptable in the CD&A. The perceived presence of too much boilerplate is what doomed the old compensation committee report. In fact, so emphatic is the SEC that the CD&A not become boilerplate that at least one commissioner has noted that the Division of Corporation Finance is expected to undertake procedures to discourage boilerplate. It is unclear what procedures would be undertaken.

Friday, July 28, 2006

Reproposal on Disclosure of Highly Paid Employees May Be No Better

While the SEC has dropped the universally condemned requirement that the total compensation and job positions of each of a company's three most highly compensated non-executive employees must be disclosed, the Commission’s reproposal may accomplish the same thing through an overly broad definition of policymaking. That at least appears to be the view of Commissioner Paul Atkins.

Under the reproposal, the company would have to disclose the compensation of the three most highly compensated non-executive employees, but excluding employees with no responsibility for significant policy decisions within the company. The reproposal is evidently designed to address the main argument of commenters that the compensation of non-policymaking employees should not be subject to disclosure. The SEC also said that the requirement would apply only to large accelerated filers, which is narrower than the original proposal because it now applies to fewer companies, albeit still 3,500 companies.

According to Commissioner Atkins, the devil is in the interpretation of policymaking. If, as the proposal in its current form provides, an employee becomes a policymaker through exercising "strategic, technical, editorial, creative, managerial, or similar responsibilities," he posits that few highly-compensated employees would not be policymakers. Almost every job has some of these attributes, he reasoned. Atkins also emphasized that tracking the compensation of employees who might potentially fit this bill across a large multi-national corporation with differing internal systems and managerial methods will be a costly undertaking. In his view, the reproposal goes beyond the purpose of executive compensation disclosure, which is to provide better information to stockholders for purposes of evaluating the actions of the board of directors in fulfilling its duties.

Wednesday, July 26, 2006

SEC Reforms Executive Compensation Disclosure

The SEC has adopted a sweeping overhaul of its rules governing disclosure of executive and director compensation, related person transactions, director independence and other corporate governance matters. Over the next few days, the blog will be discussing the most important revisions in this area since 1992. The broad purpose of the new regime is to improve disclosure by including all elements of executive and director compensation. It is about wage clarity, not wage controls (see SEC Press Release).

A new disclosure, the compensation discussion and analysis (CD&A), modeled on the MD&A, will address the objectives and implementation of executive compensation programs, focusing on the most important factors underlying each company's compensation policies and decisions. Despite concerns expressed by a number of commenters, the CD&A will be filed and thus be a part of the disclosure subject to Sarbanes-Oxley certification by a company's principal executive officer and principal financial officer.
Rather than eliminate the currently required compensation committee report, as proposed, the SEC will require a new furnished compensation committee report, with a statement of whether the compensation committee has reviewed and discussed the CD&A with management and, based on this review and discussion, recommended that it be included in the company's annual report on Form 10-K and proxy statement.

The SEC has dropped the universally abhorred requirement that the total compensation and job positions of each of a company's three most highly compensated non-executive employees be disclosed. Instead, it has reproposed to require disclosure of the three most highly compensated non-executive employees, but excluding employees with no responsibility for significant policy decisions within the company. The reproposal may placate commenters who argued that the compensation of non-policy making employees should not be subject to disclosure.

Tuesday, July 25, 2006

Compensation Committee's Role Will Change

It is almost certain that compensation committees will have a changed role in the corporate governance scheme after the SEC adopts the executive compensation disclosure rules. For one thing, the currently required report of the compensation committee is slated to be eliminated and replaced by the new compensation discussion and analysis (CD&A). The efficacy of the compensation committee report has been the subject of some debate, with the SEC essentially concluding that the report has become useless boilerplate. Some commenters thought that, if the report was boilerplate, it was because of the rules that restricted its content. Others urged the SEC to keep the report and beef up its content. The report is favored by many because it need only be furnished and, unlike the new to-be-filed CD&A, is not within the embrace of the Sarbanes-Oxley certification requirements. But it certainly appears that the compensation committee report will pass into history.

Compensation committees will go on, however, and indeed the SEC proposes new disclosures about them, similar to what is currently required for audit and nominating committees. The company would have to disclose the committee’s processes for the determination of executive compensation, including the scope of the committee’s authority. Any role played by consultants in determining executive compensation must also be disclosed. And importantly, the role of any executives in determining their own compensation must be disclosed.

Monday, July 24, 2006

Will the CD&A Be Filed or Furnished: We May Know this Week

As the proposed executive compensation rules move toward almost certain adoption at this Wednesday's SEC open meeting, it will be very interesting to see if the SEC heeds the comments of the American Bar Association and others concerning the filing of the brand new Compensation Discussion & Analysis and does not require that it be filed as part of the Form 10-K which, in turn, would not make it subject to the Sarbanes-Oxley Act certification requirements of Section 302. As I understand their argument, it is that the filing of the CD&A and the subsequent certification requirement will compel CEO's and CFO's to get intimately involved with the processes and even the deliberations of the compensation committee, thereby playing a role in setting their own pay. In turn, this would run counter to sound corporate governance since good governance practices dictate that senior officers should be excluded from compensation committee deliberations about their own pay. This is a plausible argument, in my opinion. If you buy the argument, it inexorably leads to the conclusion that the proposed filing of the CD&A runs counter to good corporate governance and, more broadly, runs counter to the direction that Sarbanes-Oxley wants to take the corporate community.

Friday, July 21, 2006

PCAOB Will Amend Internal Control Standard, but No Timetable Given

The PCAOB is committed to amending its auditing standard on internal controls pursuant to a framework of recognized objectives, according to Chief Auditor Thomas Ray. Indeed, he said that amending Auditing Standard No. 2 is the Board’s top priority, but, when specifically questioned, the chief auditor declined to give a time frame for when the amendments will be effected. In remarks at a just concluded AICPA conference in Chicago, he outlined elements of the Board’s amendments. For example, he said that the amendments will focus on improving high risk areas. The amendments will also retain core principles, such as reasonable assurance. Definitions will be clarified, such as material weakness and significant deficiency. The SEC has deferred to the Board to define these important terms.

Similarly, the concept of materiality will be clarified. It is not within the Board’s purview to change the definition of materiality, he noted, but the Board can provide guidance. The Board also intends to reconsider the list of strong indicators of a material weakness, such as ineffective audit committee oversight. The changes will also incorporate key concepts from the Board’s May 2005 guidance. For example, the top-down approach mentioned in the guidance will be codified in the standard. Also, the importance of integrating the financial statement audit and the internal controls audit will be strongly amplified in the amendments. In addition, the Board will provide guidance encouraging auditors to more frequently use the work of other. The amendments will also allow for the use of experience gained in prior years.

Thursday, July 20, 2006

Senate Passes Military Financial Antifraud Bill with Broader Provisions

By unanimous consent, the Senate passed a military financial products antifraud bill that completely bans investment companies from issuing periodic payment plan certificates, an outdated form of mutual fund with high up-front costs. The House passed a similar bill last year by a vote of 405-2. A conference committee can now be assigned to reconcile differences between the House and Senate versions or the House can take up the Senate version of the bill. As can be seen by the complete ban on contractual plans, the measure is broader than its military genesis. Moreover, the broad and deep bi-partisan support for this legislation argues strongly for its final passage this year.

The Military Personnel Financial Services Protection Act (S. 418) amends section 27 of the Investment Company Act to forbid the issuance and sale of periodic payment plan certificates, effective 30 days after the date of enactment. But the bill preserves preexisting rights related to existing plans, including administrative transactions, conversions, transfers, or amount or name changes. The bill also directs the SEC to submit a report to Congress on refunds, sales practices, and revenues from periodic payment plans over the last five years.


These contractual plans represent an obscure investment vehicle that has virtually disappeared from the civilian market due to its unusually high and front-loaded sales charge. The hallmark of such plans is a sales load of 50 percent, paid by the investor to the broker selling the plan, assessed against the first year of contributions. Created so that investors able to make only small monthly contributions could reap the rewards of stock market investing, contractual plans have actually been associated with rampant abuses since their introduction in 1930.

In recent years, the contractual plan has fallen further into disrepute. The GAO has identified three reasons supporting its recommendation urging Congress to ban contractual plans. First, less-costly and widely accessible alternatives exist for small investors to begin and maintain investments in mutual funds. Second, only 10 to 43 percent of investors that purchased contractual plans between 1980 and 1987 had completed the full 15 years required under the contract. As might be expected, investors who did not complete the contract paid much higher effective sales loads than investors in conventional mutual funds. Third, and perhaps most important, contractual plans have been associated with sales practice abuses for decades.

Another provision of S.418 reorganizes and codifies in section 204 of the Investment Advisers Act provisions of the National Securities Markets Improvement Act, in which Congress directed the SEC to establish an electronic filing system, and mandated the creation of a public disclosure program, for investment advisers. Pursuant to this directive, the SEC designated the NASD to operate the electronic filing system, which is called the Investment Adviser Registration Depository (IARD), and created an internet-based public disclosure program containing investment adviser registration and disciplinary information.

The bill codifies the SEC's designation of the NASD as the operator of the IARD, although it requires a toll-free telephone listing, or electronic means, for receiving and responding to inquiries for registration information. It also provides the NASD with immunity from liability for actions taken in good faith in operating the investment adviser public disclosure program.

The bill also clarifies that state securities laws apply to securities activities conducted on federal land and facilities, including military installations in the U.S. and abroad. The state within which the base is located would have primary jurisdiction in cases when multiple state laws would otherwise apply. With respect to overseas military bases, the state that issued the resident license of the agent in question would have jurisdiction.

Finally, the measure amends section 15A(i) of the Exchange Act, which requires securities associations to maintain a toll-free telephone listing to receive inquiries regarding disciplinary actions involving its members and to respond to those inquiries in writing. The amended language requires the association to establish an easily accessible electronic or other process, in addition to the toll-free telephone listing, to respond to inquiries about registration information. The securities association also will be required to adopt rules relating to inquiries and responses, and on the establishment of an administrative process for disputing the accuracy of registration information. Consistent with current law, the association and participating exchanges will not be liable to any persons for actions taken or omitted in good faith under this provision.

Wednesday, July 19, 2006

The Coming of Basel II Casts Lead Regulator Debate into Stark Relief

The growing debate about the most effective way to regulate international banks has intensified with the impending implementation of the Basel II accords. The debate, however, goes beyond Basel II implementation and touches international securities firms and accounting firms, as well as banking groups.

Recently, Federal Reserve Board Governor Susan Schmidt Bies said that the cross-border implementation of Basel II could create challenges for banks operating in multiple jurisdictions. This is exacerbated by the fact that some countries plan to introduce Basel II more broadly than the US, where only the large international banks will be initially affected. Gov. Bies quickly added that it is entirely appropriate for all Basel-member countries to have their own rollout timelines and their own ways of addressing matters left to national discretion under the Accord.

Since the issue is bigger than Basel II, it has to be placed in the proper context. The growing prevalence of large banks and securities firms operating in a number of countries has led to an effort to find the most effective means of regulating these international institutions. An increasingly popular approach has been designating a lead regulator for the global bank or firm. Under the lead regulator approach, the bank or securities firm is supervised by the regulator of the country where it is headquartered or has its principal place of business. Even if a bank did extensive business in another country, the host country, it would still be exclusively regulated by its home country regulator. For example, while Deutsche Bank is one of the largest players in the U.K. markets, its lead regulator would be the German BaFin. Similarly, U.S. global banks and securities firms would be regulated solely by the Federal Reserve Board and the SEC despite their substantial activities in the U.K. or Germany.

Returning to the cross-border implementation of Basel II, Gov. Bies advised banks to pay close attention to the Basel Committee’s recent guidance on the sharing of information between host and home jurisdictions in the Basel II environment. Indeed, the effective implementation of Basel II depends on such cross-border information sharing. The Basel Committee developed a number of principles to guide this essential information-sharing process. While the Basel Committee guidance is designed for banks, the principles are broad enough to have some value when applied to other international entities.

One principle is that the respective roles of home and host country regulators should be clearly communicated to banks with significant cross-border operations in multiple jurisdictions. The home country regulator would lead this coordination effort in cooperation with the host country regulators. In addition, information-sharing arrangements should focus on information that is relevant for regulators to carry out their duties; and such information should be provided in a timely manner. In the case of a host regulator this would primarily be information enabling it to monitor, assess and deal with the material risks to which the bank in its jurisdiction is exposed. A home country regulator would generally need information concerning risks that would have a material impact on the banking group as a whole. In any request for information from another regulator, the requesting regulator should be prepared to explain why it needs the information in order to ensure that the most appropriate information is supplied.


The Basel Committee sees a difference between factual and judgmental information, such as examination reports and assessments of rating systems. Judgmental information, which can be provided only by regulators, can be the most valuable part of the information exchange.
Since a pragmatic approach to home-host information sharing implies that the arrangements should be flexible and tailored to the particular circumstances, the Basel Committee envisions a menu of options. The principles underline the need to avoid redundant or uncoordinated qualification and approval work, reasoned the committee, and it is expected that the group-wide Basel II implementation exercises will shed light on what particular procedures may be appropriate for specific banking groups.

Returning to the broader debate over whether it is effective to designate a lead regulator, UK FSA chair, Sir Callum McCarthy has noted that, while the lead regulator approach has the advantage of simplicity, it also poses a number of significant concerns. For example, different regulators have differing levels of power and resources to deal with global firms that may pose systemic risk in the countries in which they operate. And not all countries have the same approach to financial regulation. For example, there could be a problem with transparency and standards in some offshore jurisdictions. But even aside from well known egregious cases, there remain questions about the implementation of international rules and standards, whether from global organizations such as IOSCO or from EU directives. There is a further problem in that compensation schemes are not uniform. For example, deposit insurance in the US applies to deposits payable in the US, but does not extend to deposits in branches of US banks that are payable outside the US.

For these reasons, the chairman is extremely wary about concentrating power in the hands of a single lead regulator unless the concept allows for some dialogue between home and host regulators. The simplicity for the bank or firm that would be achieved by having only one worldwide regulator is highly desirable, he admitted, but the approach must deal with a range of issues.


One issue is to recognize the reality that there are varying levels of risk. A lead regulator must recognize, for example, the widely different risk levels inherent in a small bank operating only in wholesale markets and in a large bank whose failure would pose a systemic risk to the host country. In this regard, the chairman called for the development of protocols as to the duties of both the lead regulator and the host country regulator on issues such as exchanging information and taking joint action.

As an example of the cooperative approach he favors, the chairman praised a system developed with regard to two global Swiss banks under which there are twice a year meetings of the Swiss Banking Commission, their lead regulator, and the Federal Reserve Bank of New York and the FSA, which together comprise the three most relevant regulators in the three capital markets of most importance to the banks. At the meetings, views are compared, information exchanged and actions coordinated.

Congressional Inaction on Soft Dollars Heightens Importance of SEC Guidance

The SEC has issued an interpretive release on the use of soft dollars, which promises to be seminal. SEC Chairman Christopher Cox has described soft dollars as an anachronism. Others have been even tougher. In a recent Wall Street Journal op-ed piece, Benn Steil, director of international economics at the Council of Foreign Relations, criticized soft dollars as a kickback scheme and called on Congress to abolish the practice. But in my view Congress will not repeal Section 28(e) of the Exchange Act. Historically, Congress has shown little enthusiasm for one statute ``fixes’’ of the federal securities laws, which means that any change in this area would have to come as part of broad market reform legislation, which is highly unlikely to occur. If I may be permitted a strained analogy, Congress is as reluctant to legislate one statute ``fixes’’ of the securities laws as it is to legislatively overrule one US Supreme Court opinion. But congressional inaction heightens the importance of the SEC’s interpretation.


The Commission cautions that eligible research services are limited to advice, analyses, and reports under the statute. This means that traditional research reports and market data satisfying the eligibility criteria of Section 28(e) are eligible for the safe harbor as research, but that computer hardware is not. The release also indicates that mass-marketed publications are not eligible under the safe harbor. Chairman Christopher Cox explained that the purpose of the release is to better circumscribe the use of soft dollars, which he described as essentially inflated brokerage commissions, to ensure that they are used only for research.

According to the Commission, the statutory analysis of brokerage and research requires a three-step process: the application of eligibility criteria; the money manager's lawful and appropriate use of the items; and the money manager's good-faith determination that the commissions paid are reasonable in light of the value of the services received.

Tuesday, July 18, 2006

UK Big Four Audit Firms Pass Inspection

The UK regulator of public company audits has completed inspections of the Big Four audit firms and found no systemic weaknesses in their overall quality control systems. However, improvement is needed in the extent to which the overriding importance of audit quality is reflected in the firms’ human resources processes. The Professional Oversight Board also conducted inspections of what are sometimes called the Following Five audit firms and found a similar need for improvement. But generally, the Board found that audits had been conducted to a high or acceptable standard. The Big Four firms have a dominant share in the audit of larger UK companies, auditing 97 percent of the FTSE 250.


Unlike the PCAOB, the POB does not make public the inspection reports for individual audit firms, although it is currently considering whether to go the PCAOB route and conduct public inspections of audit firms. But the Board did note that it cooperated with the PCAOB on at least one firm audit inspection.

At this time, the Board is inclined to take the intermediate step of naming in its annual report any audit firms that have failed to cooperate with the Board’s inspection process. This ``naming and shaming’’ approach would give audit firms the opportunity to address the Board’s concerns in private reports, but with the prospect of public disclosure of the nature of the weaknesses that the Board has identified when the opportunity for improvement is not taken.

The Board feels strongly that a written report to the audit committee is a key element of audit quality; and was happy to report that the quality of reporting is receiving a high level of attention at all the firms.That said, the Board did identify some areas for improvement, including communicating audit planning information to the audit committee.

Monday, July 17, 2006

SEC Keeps Momentum Going on Easing of Internal Control Mandates

With the issuance of the SEC's concept release on management's reports on internal controls, it appears that the drive towards ameliorating the impact of Section 404 on public companies is moving inexorably to the provision of some form of relief from the burdens imposed by that statute. The other front in this offensive is the PCAOB and its Auditing Standard No. 2, which some have called mind-boggling. The Board has basically committed to amending Auditing Standard No. 2. What is heartening about this two-prong effort is that the SEC and PCAOB will coordinate the reform offensive. The May 2005 guidance from the SEC and the Board, while helpful, does not appear to have done the job. More will be needed. One interesting question posed in the concept release is why the majority of companies, both foreign and domestic, selected the COSO framework rather than the UK's Turnbull Report. While the SEC did not mandate a particular internal controls framework, COSO has become the de facto framework, even for foreign companies.

Friday, July 14, 2006

Law Professors and Trade Groups Duel on Efficacy of SEC-Banking Guidance

The SEC and the federal banking agencies have developed guidance for banks and securities firms that engage in complex structured finance transactions. Recently, a group of four prominent law professors, in an unprecedented comment letter, asked the agencies to withdraw the guidance, essentially claiming that the guidance permissively condoned fraud by listing characteristics so strongly suggestive of fraud and then requiring banks and firms to do nothing. This comment letter received some play in the financial press. What did not receive such play was a comment letter from ISDA, the Securities Industry Association, and the Bond Market Association refuting the law professors' position. Describing the professors' comments as more sensational than substantive, the trade groups said that the professorial fear of reckless indifference by financial institutions to fraudulent transactions is contradicted by the considerable steps that banks and securities firms take to better manage the dangers posed by elevated risk transactions. Contrary to the professors' contention, emphasized the associations, the guidance is clear that transactions presenting heightened risks should be subjected to enhanced scrutiny.

Thursday, July 13, 2006

European Commission Adopts Watchful Waiting on Hedge Funds

In the wake of the report of an expert group, the European Commission has adopted a watchful waiting stance regarding hedge fund regulation. The report made a strong case for the proposition that the hedge fund industry has made a positive contribution to the sound functioning of the financial markets without regulatory oversight. But the Commission cautioned that, as hedge funds seek to serve a broader investor base, closer regulatory engagement will be triggered. Even the expert group recognized the need for the independent valuation of the illiquid and complex assets of hedge funds. That said, however, the group believes that such valuation should be managed by codes of conduct and best practices rather than by regulation. After fully digesting the report, and taking in other information, the Commission plans to publish a White Paper in November setting out its conclusions.
SEC Should Not be Applying Business Judgment Rule

I want to return for a moment to what I consider the rather remarkable comments by SEC Commissioner Paul Atkins on the protections that the judicially-created business judgment rule affords corporate boards that engage in springloading options grants. He also warns that the SEC must not undercut the business judgment rule through its enforcement actions. In my view, this approach wrongly places the SEC in the position of having to apply the business judgment rule to a set of circumstances. If the Commission is to eschew an enforcement action out of respect for the business judgment rule, it follows that the Commission will have to decide if the board that granted the options could properly avail itself of the protection of this ancient rule.

The business judgment rule is a case-driven quintessential creation of judge-made common law, to be interpreted by the courts. We are told that one of the reasons that so many companies incorporate in Delaware is to be in a jurisdiction with courts that are expert in corporate law and to partake of the certainty that comes with consistent interpretations of corporate doctrines, such as the business judgment rule, which has been interpreted over decades in countless Delaware court decisions. Does the SEC, can the SEC, really want to be put in a position of applying the business judgment rule?

Wednesday, July 12, 2006

Atkins Imports Business Judgment Rule Into SEC's World

In his recent speech defending the springloading of options grants, SEC Commissioner Paul Atkins invokes the business judgment rule no less than six times. It is rare for an SEC official to invoke or even mention the judicially created business judgment rule which, at the end of the day, is quintessentially a creature of state law. While in the wake of Sarbanes-Oxley we have certainly moved closer to a federal corporate law, the business judgment rule has not yet become part of the SEC's lexicon. Springloading has been defined as a practice under which a company purposefully schedules an option grant ahead of good news or postpones the grant until after bad news. The commissioner posits that the decision to grant the options is one protected by the business judgment rule and should not be second-guessed. He goes on to warn that SEC enforcement actions in the options area could undercut the business judgment rule. This may be a position of first impression.

The business judgment rule is ancient and essentially bars judicial inquiry (and now possibly SEC inquiry) into the actions taken by corporate officers and directors in good faith and in the honest pursuit of the legitimate purposes of the company. The rule is informed by a deep respect for all good faith board of directors decisions. Once the rule is properly invoked, it presents a formidable barrier to any inquiry into the decisions taken by the board. The remarks by Commissioner Atkins are extraordinary and even historic in that they marry the business judgment rule to SEC decisions to seek an enforcement action. The rule was created by the courts on the bedrock principle of judicial reluctance to substitute a court's judgment for that of the board. Importing the business judgement rule into the SEC's enforcement process may involve the Commission in deciding whether a board's action had a good faith rational business purpose. That would be an historic first.
Delaware Court Nails Duty to Act in Good Faith

After sailing through uncharted waters beset by the fog of hazy jurisprudence, the Delaware courts have arrived in the sunny uplands of a clear duty to act in good on the part of corporate fiduciaries. In its recent ruling in the Walt Disney Company Securities Litigation, the Delaware Supreme Court held that a duty to act in good faith exists on two different levels. The first level is the concept that it is bad faith when a corporate fiduciary's conduct is motivated by an actual intent to do harm. The second level is that bad faith is evidenced when a corporate fiduciary engages in an intentional dereliction of duty. This second type of bad faith occurs when corporate officers and directors, with no conflicting self-interest in a decision, still engage in misconduct that is more culpable than simple inattention or failure to be informed of all the material facts. Thus, t
he duty of good faith has been defined by reference to what is bad faith. I believe that this opinion squarely places squarely places the duty to act in good faith in the same pantheon with the traditional duties of due care and loyalty. As with many doctrines in Delaware corporate governance, the duty to act in good faith developed in an evolutionary manner and did not spring full-blown from the head of Zeus.

Tuesday, July 11, 2006

Hedge Fund Trading Reaching Critical Mass

There is a growing recognition that hedge funds, these opaque and often illiquid vehicles, have become significant components of the financial markets. In a recent speech, Martin Wheatly, chair of the Hong Kong Securities and Futures Commission, noted that hedge funds provide a major source of market liquidity. Rather incredibly, it is estimated that in New York and London about 40-50 percent of securities trading comes from hedge funds. In Hong Kong, about 30 percent of the daily turnover on the stock market comes from hedge funds. These numbers, in my view, increase the pressure for regulation of these investment vehicles. Even the appeals court panel in the Goldstein opinion mentioned that hedge funds remain secretive about their positions even to their own investors. Given the above numbers, is that state of affairs appropriate or safe?

Monday, July 10, 2006

Coordinating with PCAOB Compels August Adoption for Exec Comp Rules

Last week the Wall Street Journal reported that the SEC has asked the PCAOB to hold off on issuing guidance on the back dating of stock options until the Commission can address the issue of the back dating of options in its soon-to-be-adopted executive compensation disclosure rules. The PCAOB is reportedly not happy about waiting to coordinate with the SEC, but will hold off as requested. It seems to me that the fact that the PCAOB will now delay its guidance on the back dating of options in order to accommodate the SEC's rulemaking timetable increases the pressure on the Commission to adopt the executive compensation rules sooner rather than later. And, indeed, an SEC spokeman is quoted as saying that the Commission expects to adopt the rules in August. So, it looks more and more as if we will have a new executive compensation disclosure regime adopted by Labor Day.

Saturday, July 08, 2006

Hedge Fund Regulation Proceeding World-Wide

Despite the recent US federal appeals court ruling striking down the SEC's hedge fund adviser rule, efforts to get a regulatory grip on the hedge fund industry are proceeding worldwide. Recently, Martin Wheatly, chair of the Hong Kong Securities and Future Commission noted that efforts to regulate hedge funds have begun in a number of jurisdictions. He specifically noted that the UK's Financial Services Authority has set up a center of hedge fund expertise to increase its oversight of 25 of the largest hedge fund managers in the UK. The FSA also collaborates with the London Investment Bankers Association on the establishment of regular six-monthly surveys of the exposures to hedge funds of London-based banks providing prime brokerage services. In Hong Kong, he related, licensing requirements are imposed on hedge fund managers operating there, regardless of whether the fund being managed is offered to local retail investors or only to professional invesors. About 80 hedge fund managers and advisers are currently licensed by the SFC, operating 148 hedge funds.

Friday, July 07, 2006

President Delegates Internal Control Exemption to Intelligence Czar

The President has authorized the Director of National Intelligence to exempt companies for national security purposes from the recordkeeping and internal control provisions of Exchange Act Section 13(b)(2). The memorandum, dated May 5, 2006, was published in the Federal Register on May 12, 2006.

Executive Comp Rules Slated for Summer Adoption--UPDATED

A strong consensus has emerged that the SEC's executive compensation rulemaking proposals will be adopted later this summer.


UPDATE: See related post above.

Wednesday, July 05, 2006

Is Sarbanes-Oxley Chilling Foreign Issuers from Listing in US?

I have determined that this blog will not shrink from discussing the big macro issues of the impact of securities regulation on the financial markets and the movement of capital. And there is no bigger issue in this regard than the growing evidence that the Sarbanes-Oxley Act, and particularly its Sec. 404 internal controls mandates, are chilling foreign private issuers from listing on US exchanges.

The fact is that the number of foreign private issuers peaked at around 1300 just before 2002 and has not moved upward since the passage of Sarbanes-Oxley. In addition, almost all of the recent Chinese company IPOs have listed outside the US, ie in Hong Kong. Also, many European accounting organizations recently rejected the introduction of a European equivalent to Sec. 404 internal controls in favor of an evolutionary principles-based approach. This was in response to a discussion paper issued by the European Federation of Accountants. The Chartered Accountants Institute of Scotland was particularly vocal in stating that it would oppose any movement towards a Sarbanes-Oxley rules-based approach in the European Union. It is no secret that many EU bodies consider Sarbanes-Oxley a prescriptive rules-based regime.

It is time for a public debate on the question of whether the Sarbanes-Oxley Act is indeed chilling the movement of capital into the US. Would this be an unintended consequence of the Act, or one that should have been foreseen. When it comes to global markets, regulation does not operate in a vaccum. Rather, regulation has consequences.
Hedge Fund Ruling Puts Ball in Congress' Court

The recent DC Circuit's ruling that the SEC 's hedge fund registration rule is arbitrary seems to really doom regulatory efforts to get a handle on the exploding world of private equity. It is ironic that the appeals court panel acknowledged the need to somehow regulate this private world that has the potential to create a financial market systemic crisis, but at the same time struck down efforts to monitor this risk. With hedge funds generating around 30 to 40 percent (depending on the source) of equity trading on exchanges, we seem to be reaching a critical mass. The inventive lawyers at the SEC tried to get around the statutory investment adviser 15 client rule by counting investors in the funds as clients. But the court rejected that approach in favor of counting the funds as clients, which effectively doomed the effort to register advisers to hedge funds. It seems to me that Congress must step up and change the statute in order to save the SEC's effort to obtain a window into the secretive world of hedge funds before a major financial crisis. Let us hope that Congress can be proactive on this issue instead of reactive.