Business Law Prof Blog

Section 404 in Sarbanes-Oxley

This is pathetic.  The WSJ headline today on page one is "Business Lobby Wins Fight to Ease a Costly Sarbanes-0xley Rule" (Kara Scannell and Deborah Solomon).  Read the article.  There is no change in the statute; there is no change in the rule; there is only an offer of new forthcoming SEC "guidance" on how to use the rule.  We do not know what the guidance will be.  Good be good could be bad. Pathetic.  First, note that there is so much desperation on Section 404 that the mere mention of a possible improvement makes the front page of the Wall Street Journal. We do not even know what, when or how. Second, Barney Frank has declared that he will not touch the statute but that the SEC could cut back a bit on the Rule. This is the news.  The SEC has been a combination of timid and self-righteous on cries to fix the Section.  No big changes, other than general exhortations from the SEC for auditors to "be reasonable" and "principles" from the PCAOB ("choose audit for circumstances") will emerge; we have already seen such efforts.  Third, accountants will continue to do what they do now. They are conservative and fear liability and will follow excessive caution in responding to general directions.  Furthermore they have procedures in place that justify huge bills; why should they change??  Pathetic. Without some leadership in Congress this is hopeless. We need to rewrite the audit section to apply only to "central" or "crucial"  "overarching" internal control procdures (not "practices") with a red flag rule (if it smells, look) on practices.

Private Equity Going Public

Fortress Investment Group will be the first hedge fund doing an IPO on the NYSE.  Several private equity funds are trading on the Euronext Amsterdam Stock Exchange.  [KKR's is the best known.]More will come.  Several comments. First, good to see one in New York.  The Amsterdam rules make such listings easier.  Second, the IPOs make such funds available to small traders who are not wealthy enough to invest in private equity funds directly (it takes usually $1m in cash to step up).  The SEC will not like this much.  Look for more fussing on the issue at the SEC. Of course, this will encourage funds to go to Amsterdam and exclude United States investors. 

NASD/NYSE Regulatory Negotiations

The NASD and the NYSE are in discussions over how to merge all or part of their regulatory SROs (self-regulatory organizations) functions.  The WSJ says the negotiations are "gathering a critical mass."  Where is the government?  The SRO structure should not be  fait acompli for government approval.  This is critical stuff, critical for American competitiveness in the world markets, critical for integrity of the markets at home.  I do not believe we should have an SRO structure at all.  Where is the government planning on this one?  It is as if we all letting CEOs negotiate on the standards for insider trading. We should not let private privates negotiate their private advantage on such an important national question.

The Disney Award

    As sit having just read the op-ed piece by Nichalas D. Kristof in the New York Times (“American’s Laziest Man, 11/7/2006) awarding the “Eisner Award” to Darry Diller.  The award, given by Kristof to commemorate the ex-CEO of Disney’s “pathbreaking achievement in corporate rapacity,” is a shower curtain. 

          The shareholders of Tyco apparently paid $6,000 for a shower curtain for ex-CEO Dennis Kozlowski.

          Diller collected compensation valued at $469 million has year.  He was the highest-paid CEO in the

United States

.  The share price of his company, IAC/Interaction, lost 7.7% of its value last year.  For the last three years the stock, according to Kristof, was “up just 11 percent—compared to 49 percent for the S&P 500.

          I have another nominee for the Disney award, Arthur O. Sulzberger, Jr., publisher and chairman of the New York Times.  Send him the shower curtain.

          The

New York

Times, with its two sanctimonious business reporters Grethchen Morgenson and Joseph Nocera as well as its op-ed writers, have railed against excessive executive compensation for several years.  Their columns, after starting with good factual reporting, often conclude with over-the- top condemnations -- indignant, sanctimonious and full of grand standing declarations.  Yet we know that the New York Times itself has a corporate governance structure that is a mess.   

          The latest news on the issue is a missive by a major New York Times shareholder, Morgan Stanley Investment Fund, complaining about the NY Times board.  The investment fund, owned by Morgan Stanley, is run out of

London

and holds 7.6 percent of the company’s Class B shares.  The Fund ran an unsuccessful campaign last year to encourage shareholders to withhold votes for the New York Times board because of poor managerial performance. 

          The letter contains the following complaints.  A family trust, the Ochs-Sulzberger family, owns Class B shares and elects 9 of 13 directors to the New York Times board.  Class B shares constitute a miniscule .6% of the voting stock of the company.  The family trust controls the bulk of the Class B shares.  Class A shares, 99.4% of the voting stock of the company, elect only 4 of the 13 directors. The family also holds 19% of the Class A shares.

          The dual class voting structure has been in place since 1969, when the paper went public.  Only the family trust, with a vote of 6 out of 8 members, which includes the Times CEO himself, can reverse the structure.

          The top executives at the New York Times, several of whom are family insiders, get paid too much given the performance of the paper.  Moreover the board has approved lavish new offices. 

          The papers circulation is failing like a rock with revenues down close to 40% in the last quarterly report from the same period last year. Stock in the New York Times has lost one-half its value over the past four years.  Stock price was in the low $50s in mid 2002; it is now at $22 or so.

          There are rumors that the Ochs-Sulzberger family is considering a leveraged buyout to take the company private.  In leveraged buyouts by managers of their own companies conflicts of interest abound.

          In a hoot, the board turned to the number one anti-shareholder lawyer in the country for "advice" -- Marty Lipton of Wachtell Lipton Rosen & Katz.  Lipton issued a report stating that the structure was normal for the media and that the company, other than the dual class board, uses "state of the art" governance procedures.

          I will not stay awake nights awaiting columns by Kristof, Morgenson or Nocera bemoaning the New York Times dual class governing structure and its overpaid executives.   

Securities Market Regulation in Europe

The European Union has passed a new directive, the Markets in Financial Instruments Directive (known as MIFID), that will be their version of the Sarbanes-Oxley Act of 2002.  Europe believes it has passed the better legislation.  The Directive intends to harmonize national laws in order to increase securities market competition across boarders, increase competition from off-exchange trading and make their markets more transparent.  The Directive is based on "principles" rather than "detailed prescriptions."  Objectors claim the Directive is too vague and, in some cases, too constraining (best execution rules for debt instruments and derivatives, for example).

Hedge Funds in London

New York and its environs are the home to sixty percent of the world's hedge funds, down from over 80% in 2002.  London is the home to twenty-five percent, up from only 15 percent in 2002.  Much of the increase in an awaking in Europe to hedge funds.  At issue is a difference in regulatory philosophy.  In London they register with the FSA (Financial Service Authority) but there is little litigation over failures; in the United States they do not register but litigation over failures is common.  The better method?  I believe ours is but the jury is out. 

Stock Options Scandal

We know that close to 200 firms back-dated option grants to give in the money options and claim they were giving at the money options.  We now also know that firms were back-dating exercise dates as well as grant dates to understate taxable gains on exercise.  All this was done across the high-tech industry under the mantra that "everyone was doing it" and the practice was "in the best interest of the firm ... to hire the best employees."  All and all it was an amazing example of the self-rationalization of corrupt behavior.      

Rule 10b5-1 Plans

The SEC promulgated a safe harbor rule, Rule 10b5-1, to allow senior executives to sell stock without violating insider trading sanctions.  The rule requires creation when there is no inside information and selling on fixed dates (or fixed prices) over time.  Well -- researcher Alan D. Jagolinzer of Stanford has discovered that Plan Rule10b5-1 purchasers beat the market by, on average 5.6%.  We should not be surprised:  I do not know who is the bigger piker, the SEC by creating a safe harbor that insiders will use to their advantage or the insiders who, by now should know, that some financial PH.D. will make a splash by checking  out their Plan purchases against market averages and discover their consistent "luck."  The SEC will be pressed to check out the lucky Plan participants and find out whether they did have nonpublic information handy when they began their Plans.  Again, proof backing up suspicion will be the problem.