Broc Romanek,
TheCorporateCounsel.net, GreatGovernance.com and
AccountingDisclosure.com Here are the 50 Nuggets
in no particular order:
1. Codes of Conduct - Directors should
be covered too. Although not required by
SOX rulemaking - as one of the more important
groups within a company - it makes sense that
directors should be covered by the company's code
of conduct. A few companies have written separate
codes that apply solely to their directors. Note
that the pending NYSE and Nasdaq proposals would
require codes that apply to directors.
It's easier - and more "egalitarian"
perhaps - to just insert a sentence into the
employee code of conduct that "directors are
covered under this code with regard to their
director-related activities." The proviso
regarding "director-related duties" is
necessary because the code should not cover a
director's conduct when the director is engaged in
a "day" job that does not relate to the
company.
However, this potential solution might not work
as the director's code may need to address
conflicts of interest that are unique to
directors. Independent directors may be CEOs of
other companies that they also owe duties. So
closely examine the codes to see whether language
that applies to directors needs to be finessed.
2. Codes of Conduct - Avoid having to
file a Form 8-K for a waiver of the code.
Directly influenced by events at Enron, the SEC
adopted new rules that require companies to file a
Form 8-K (or post it on the corporate website, if
previously disclosed in the form 10-K that this is
the approach the company would follow) whenever
the board approves a waiver of the company's code
of conduct for senior officers. In addition, the
proposed NYSE and Nasdaq new listing standards
will also require disclosure of waivers.
To eliminate the potential for having waivers,
codes should be scrubbed to clarify any language
that would appear to regularly require waivers -
when the matters really involve pre-approval of
certain activities. For example, a code of conduct
might prohibit a senior officer from moonlighting
- yet, the board regularly waives this provision
to permit officers to teach a semester at a local
university. This prohibition language could be
tweaked to require pre-approval for teaching.
3. Board extranets - Make sure you
weigh the pros and cons before using one.
One consideration is whether an extranet could be
used against the company in litigation - since
most electronic information is discoverable today,
unless privilege or other exceptions apply.
For example, if directors are alleged to have
breached their fiduciary duties, plaintiffs'
attorneys could examine the past activities of the
board on the extranet to determine whether
directors bothered to download the information
provided in an online board book. Plaintiffs
challenging the due care exercised by the board
(or by a special negotiating or special litigation
committee) may seek discovery of all
communications among directors via the extranet in
order to show that the members did not deliberate
fully.
Potentially making matters worse, when
directors engage in communication among themselves
via an extranet, they may become too casual in
their choice of words or may create documents that
could be used against the company in subsequent
litigation.
For the most part, privilege and other legal
considerations should not be materially different
between the electronic world and the paper world.
For example, just as in the paper world, if
directors communicate among themselves via the
extranet without involving the company's counsel,
the communication probably will not be protected
by the attorney-client privilege.
On the other hand, with an extranet, there may
be less risk of inadvertently destroying
documents; the system can be set to automatically
retain documents and dispose of them in accordance
with a company's document retention policy.
4. Committee Evaluations - Conduct
committee evaluations before board evaluations.
Although many companies conduct both their board
and committee evaluations at the same time for
convenience, we like the idea of separating them
by a few months - with committee evaluations being
conducted first. This should help to provide time
for directors to focus on each distinct group
dynamic and more importantly, the results of
committee evaluations can be considered as part of
the subsequent board evaluation.
5. Board Evaluations - Consider
splitting "questionnaire" into two
components: one oral and one in writing.
A number of companies split the format of their
board evaluations. They use a written
questionnaire for administrative issues, such as
whether the length of meetings is appropriate and
whether materials are sent out timely.
The more sensitive and substantive questions
are asked in an oral interview
("substantive" questions are those that
directly relate to the company's recent
performance issues). This can allow for more
candid and valuable feedback as some directors
might balk if asked to reduce their concerns to
writing due to perceived liability concerns.
6. Board Evaluations - Individual
evaluations are more important in light of
shareholder access debate. The need for
the nominating committee to evaluate incumbent
directors has become clearer as the movement for
shareholders to have a greater ability to nominate
their own candidates grows. For the nominating
committee to evaluate incumbent directors, it
needs information - and individual evaluations is
one logical way to gather this information.
The latest surveys show that only 25% of public
companies conduct individual evaluations. The most
popular individual director evaluation method is
the use of self-assessment questionnaires. Anyone
who handles these evaluations should take care as
this process can be quite political!
7. Board Evaluations - Consider the use
of peer reviews to evaluate individual directors.
Self-assessment questionnaires solve the risks
posed by peer reviews (these risks include
disturbed board collegiality). However,
self-assessment questionnaires can be unreliable
due to the inherent conflict of interest present
(and some people judge themselves more harshly
than they deserve as well).
If used, peer reviews should be collected by a
third party to preserve anonymity - and then the
results should be typed up so that any handwritten
comments can't be recognized as belonging to a
particular director. Then, the third party should
summarize the results - and provide each director
with a summary of the peer evaluations.
8. Executive Sessions - The independent
directors should experiment with when to hold
executive sessions. Normally, executive
sessions are held just before - or after - a
regular board meeting. Holding an executive
session after a board meeting enables the
independent directors to react to matters
discussed at the board meeting.
On the other hand, it may be preferable to hold
executive sessions before board meetings as a way
to prepare for the board meeting - and not be
sidetracked by what transpires at the board
meeting. However, these executive sessions might
last forever and exhaust directors before they get
to the board meeting. To solve this potential
problem, we like the idea of having the executive
session the afternoon before a board meeting that
commences the next morning.
Boards should experiment and determine what
works best for them. For example, Intel's board
holds executive sessions in the middle of their
board meetings.
9. Executive Sessions - Minutes should
be kept but the level of detail should be just
above the bare minimum. Most
practitioners believe that minutes should be
limited in detail - and may be so limited to just
identify that an executive session was held and
list the types of matters discussed.
The rationale for limited minutes is threefold.
One is that no employee should be present -
including the corporate secretary and assistant
corporate secretaries. In addition, the
independent directors may not wish for management
to know the details of what happened in executive
session - for the same reasons why executive
sessions are important to begin with. Finally,
there is the litigation risk concern that is
present for minutes of any meeting.
The bottom line is that directors cannot bind
the board to any course of action during an
executive session, thus extensive executive
session minutes (such as a board resolution) are
rarely necessary. But the minutes should not be
overly bare-boned as discussed in detail below in
#22.
10. Corporate Governance Guidelines -
Plan to regularly revisit the guidelines and affix
a date on the online version. It is
recommended that the guidelines should contain a
date when they are posted so investors can discern
when they were last modified (as it is an
indication of how often the board revisits the
guidelines, a sign of a board concerned with
governance).
It is also recommended that regular
consideration of changes for the guidelines be at
least tied to the annual board evaluation (since
that is when the directors are consciously
reflecting on whether change is necessary).
11. Committee Chairs - Make sure they
have lots of time and pay them for it.
Many boards are finding that serving as the chair
of a key committee can nearly become a full-time
job, particularly audit committees. In addition to
their committee duties, they can be in demand from
a number of the company's constituencies,
including major shareholders, credit agencies and
even major customers and suppliers.
In fact, for the largest companies, it can be
nearly impossible to hold the audit committee
chair position if you have a full-time job - and
acting as audit committee chair at more than two
companies seems impossible. As a result, a growing
number of companies have decided to pay committee
chairs more than other directors.
12. Negotiation with Shareholders
Regarding Shareholder Proposals - Build trust
early on. It is important to build trust
early in the dialogue. Agreeing on easier items,
such as additional disclosure, can serve this
purpose. Ensuring that everyone is kept informed
of significant developments also helps build
trust. It is important to keep channels of
communication open with the company's in-house and
outside counsel to ensure that there are no
surprises.
13. Negotiation with Shareholders
Regarding Shareholder Proposals - Establish
expectations upfront. When discussing
potential shareholder proposals with shareholders,
it is critical to establish expectations upfront.
Shareholders should have a preconceived notion of
what it would take for them to withdraw - or not
file - a proposal, and both sides should establish
expectations for the dialogue itself.
Setting internal expectations is a balancing
act. On the one hand, it is useful to have a sense
going into a dialogue of what measures short of
total implementation of the proposal would be
satisfactory. Such an understanding is even more
important when co-sponsors are involved. This
helps avoid a situation in which one sponsor wants
to settle but others do not. To handle this issue,
some proponent groups appoint a lead or primary
filer, who takes on more responsibility in
connection with the dialogue and enjoys
significant latitude to make decisions about
settlement.
On the other hand, there is a need for
flexibility and an open mind. Setting expectations
among participants also requires balancing.
Shareholders and companies should agree on the
utility of deciding, before beginning discussions:
1) who will participate in the dialogue,
2) the scope of the discussion, and
3) how progress will be measured.
Sometimes, understanding the scope of the
discussion is not as easy as it sounds. The
shareholder proposal rule's substantive exclusions
may lead a shareholder to draft a proposal in a
particular way to ensure that it will pass muster
with the SEC, when the shareholder's real concern
is something quite different. Also, a shareholder
may see an issue, such as board independence, as a
way to begin talking about more sensitive matters,
such as the competence and stature of directors.
14. Negotiation with Shareholders
Regarding Shareholder Proposals - Be realistic.
This concept means different things to
shareholders and companies, but the core concept
is the same: companies exist to make a profit, and
the issues raised by shareholders are not always
at the top of the CEO's "to-do" list.
Most shareholders realize it is often unrealistic
to expect that a shareholder proposal alone will
effect a change in corporate behavior, especially
when the proposal asks the company to do something
that it believes is not in its economic best
interest. In such cases, it may be necessary for
the shareholder to publicize the issue using the
media, involve consumers or organize
demonstrations in addition to engaging in a
dialogue with the company.
For their part, although corporate governance
and corporate responsibility issues are important,
top company officers are busy handling many other
pressing matters. Accordingly, it may not be
possible to ensure that a CEO can meet with a
shareholder. Sometimes proponents simply do not
understand why the CEO cannot attend meetings to
negotiate over a proposal. It is realistic though,
in the eyes of both companies and shareholders, to
expect that someone with functional responsibility
over the subject matter of the proposal will
attend such meetings. These employees normally are
quite open to the dialogue process.
15. Negotiation with Shareholders
Regarding Shareholder Proposals - Timing isn't
everything, but it's not irrelevant. Many
shareholders and companies report reaching
agreement without a proposal ever being filed. For
shareholders seeking to avoid having to draft a
proposal and defend it against a no-action
challenge - especially if legal fees would be
involved - such a resolution can be ideal. Some
shareholders prefer to keep their activism low-key
and shun the spotlight whenever possible. Some
companies state that they - or their senior
company officers - view the filing of a proposal
as a sign that they have failed. Others claim that
the negotiation process is generally more amicable
if a proposal has not been filed with the SEC
staff.
The key to reaching an early agreement is to
commence discussions early. Many shareholders send
letters or call potential target companies well in
advance of the shareholder proposal deadline to
inform them of issues of concern and initiate
discussions. Sometimes, a company and shareholder
have been in dialogue on an issue for several
years and can simply pick up where they left off.
At times, though, due to an impending deadline
(in the case of shareholders) or a proposal that
arrives with no warning (in the case of
companies), a pre-filing dialogue is not possible.
Some shareholders believe that some companies do
not feel sufficient pressure to engage in a
dialogue until a proposal has been filed. Reading
between the lines, these may be the companies that
are "battle-fatigued" from working in
industries or at companies with more than an
average number of shareholder issues without
sufficient support from within the company.
In such cases, the parties generally begin
discussions while simultaneously evaluating the
feasibility of a no-action request. It does not
usually make sense to refrain from negotiating
simply because a no-action request is pending or
contemplated. However, a dialogue can be squelched
by ad hominem attacks in a company's no-action
letter. Individual shareholders are sometimes put
off by the fact that a company has sought
no-action relief, but institutional investors
usually understand that such a request is part of
the process.
Of course, it is easy to feel pressured because
the deadline for mailing proxy materials is close
at hand and there is a very real risk that the
parties agree to a resolution that one or both
parties winds up regretting. This concern
underscores the importance of setting expectations
in advance.
16. Negotiation with Shareholders
Regarding Shareholder Proposals - Settlement is
not always the best outcome. At times,
allowing a proposal to go to a vote is the better
choice. Shareholders often maintain that when the
goal is visibility for an issue, letting a
proposal (or a group of proposals on the same
topic) be put in the proxy can be more beneficial
than any potential settlement.
However, there's a fine line between rallying
support and grandstanding. Some shareholders
believe that a reputation for obtaining high votes
on occasion can help convince companies to settle
in the future. Sometimes companies see the merit
in putting certain proposals to a vote, especially
when the cost of settling is too high or when the
company is proud of its record on the subject of
the proposal, and would welcome the opportunity to
tout its achievements in the proxy statement and
to the media.
17. Director Education - Assist your
directors to select worthwhile programs.
As can be expected with the NYSE's proposal - and
the focus by ISS - on director education, numerous
director education opportunities have arisen. As
so many of these opportunities are unproven, the
ability to gauge the relative worth of each one is
invaluable as most directors are very busy and
asking them to spend a day (or two) at a
conference is a lot to ask.
Peggy Foran of Pfizer wisely suggests that
directors attend educational events where they
might also serve as speakers - and where they can
interact with as many institutional investors as
possible. Unfortunately, these type of
opportunities might not exist for smaller
companies.
18. Board Meetings - Develop a theme
for a strategic planning session that includes an
educational component. The need for the
board to periodically meet over an extended period
of time to conduct strategic planning is well
known. By developing a theme, the planning can be
even more focused. And by bringing in experts to
facilitate a portion of the meeting by providing
instructional advice, all of the directors might
be able to meet their director education
"requirements" for the year.
19. Board Committee Meetings - Although
a "check the box" mentality should be
avoided, checklists are useful to ensure that all
matters contemplated by the committee charter and
corporate governance guidelines are addressed.
With an ever-growing list of responsibilities, it
is useful to have checklists for each committee to
ensure that their obligations are being met. These
checklists should be regularly updated by the
corporate secretary.
20. Board Committee Meetings - Pay more
for committee meetings. As committee
meetings grow longer - sometimes longer than
regular board meetings - some companies have
decided to pay directors the same amount for
attending a committee meeting as attending a board
meeting.
To ensure that director compensation doesn't
get too high, it might be necessary to have
separate meeting fees for regular committee
meetings and less formal (e.g. teleconference)
"business" committee meetings.
21. Board Materials - Improve
information flow between board committees and
entire board. In this era of perceived
heightened board liability, it is not uncommon for
directors to want to see minutes for each board
committee meeting - even though they don't serve
on each committee.
As state law dictates that each director is
entitled to rely on the same information to
approve an action, it is important that all
directors have the opportunity to review any board
documents they wish, even if an inside director
asks to review sensitive compensation committee
materials or minutes. Remember that a key
component of Smith v. Van Gorkum was the failure
of directors to have materials well enough in
advance in order to prepare thoroughly.
22. Board Minutes - No more
"bare-boned" minutes. Although
many companies have traditionally followed the
school of thought that board minutes should be
relatively "bare-boned," we believe that
boards should take care to provide sufficient
detail in their minutes so that they more clearly
reflect what transpired.
It is not that the minutes need to be so
detailed as to reflect what a particular director
said - but that they provide some level of detail
as to whether discussions took place (as opposed
to merely noting that a specific action was
approved). This might be important if a government
investigation or lawsuit ensues - but also will
assist independent auditors and underwriters in
their due diligence endeavors.
Although some practitioners might continue to
believe that minimal minutes are sufficient if the
practice is followed consistently, I don't agree
with this notion. If the judge says that the
record on a particular issue isn't sufficiently
detailed to support the duty of care or good
faith, the defense can't say with a straight face
"Oh, don't worry, we always leave a bare
bones record behind?" Besides, you probably
wouldn't even be able to get the history of bare
bones into evidence, even if the litigators wanted
to.
In fact, for major corporate actions, it might
even make sense to have a litigation-savvy lawyer
draft the minutes because they may be scrutinized
at a level that will make the board wish it had
approached the documentation process as though it
were documenting the actions of a special
committee in a merger. Remember that it is clear
that boards and board committees have the
authority to hire independent counsel - and this
may be an appropriate role for such counsel.
Recent cases have certainly faulted the corporate
record left behind, preventing directors from
establishing that they have met a duty of care or
good faith (e.g., the reference in Disney to the
effect that only one and one half pages of the
minutes covered the approval of Mr. Ovitz's
contract).
The bottom line is that the minutes should
include a description of each major item that
includes a summary of the topic, the major issues
presented, the major factors taken into account -
or relied upon - by the board, the board's
decision and, in appropriate cases, the
alternatives considered (e.g., particularly for
some of the audit committee decisions that mandate
this). Also, in connection with matters discussed
by the auditors with the audit committee, the
minute taker should ensure the minutes line up
with the records on those topics that the auditors
now have to retain for seven years.
23. Board Committee Minutes - Have them
signed by multiple parties if necessary.
Particularly with more boards holding concurrent
committee meetings to save time, it is
increasingly impossible for corporate secretaries
to attend all meetings. Many committees use an
employee from the related functional department to
serve as assistant secretary to take minutes (e.gs.
controller employee for audit committee; human
resources employee for compensation committee).
Those persons should be trained in the
"art" of taking minutes and should
execute the minutes. Quite a few boards also
require the committee chairs to sign the committee
minutes. This serves to ensure that the committee
chair has carefully read them.
24. "Independence"
Determination - Use open-ended question in D&O
questionnaire to capture "soft"
relationships. This type of information
should be collected for the board's benefit when
it makes its independence determination; it's not
collected for purposes of public disclosure. The
questionnaire should explain this difference and
note which questions are not being asked for
disclosure purposes. This serves to allay any
fears that the answers will be disclosed to those
potentially sensitive questions.
However, in some cases, public disclosure
beyond what is required might be recommended so
that it doesn't look like the board has something
to hide (and avoid media embarrassment). The
challenge here is that some directors inevitably
will be sensitive about providing this type of
information even in the D&O questionnaire.
25. "Independence"
Determination - Talk to each director's assistant
and share your D&O questionnaires with the
corporate secretaries at any companies associated
with your directors. As it is fairly
common for a director to delegate filling out a
D&O questionnaire to his or her assistant, it
is important that you walk the assistant through
the questionnaire to help ensure that the
appropriate information is obtained. Developing
this relationship is critical for this and other
purposes.
In addition - so long as permission has been
procured of the implicated director - provide a
copy of your D&O questionnaire to the
corporate secretary at that company so they are
not blindsided by a question from their CEO (who
sits on your board) as to why their questionnaire
varies so greatly from your questionnaire. The
relationship with that corporate secretary can be
critical as well.
However, realize that some companies do not
want to have anything to do with an officer's
board service - typically for liability reasons,
as the company's indemnification protection likely
doesn't extend that far.
26. "Independence"
Determination - Be careful who your sister marries.
As the definition of "independence"
broadens, it becomes necessary to probe deeper -
and more regularly - into the personal lives of
your directors. If you are a director on an audit
committee and your brother-in-law takes a job at
KPMG, you might have trouble maintaining your
director seat.
It might make sense to open each board meeting
by asking all directors whether they have entered
into any new business/charitable relationships or
have new personal relationships that could change
their independence status. It's the type of matter
that needs to be constantly brought to their
attention - like Section 16 reporting - to ensure
they are sensitive to it.
27. Audit Committees - Be sensitive to
when the audit committee should seek their own
outside advice. If you represent the
company and recognize a situation where the audit
committee might be in an adversarial position
vis-a-vis management, you should seriously
consider advising the audit committee to hire its
own independent advisors, including its own
counsel. Otherwise, you might be in a conflicted
situation yourself and could have trouble
rendering advice to the audit committee.
Make sure the audit committee charter
contemplates the ability to hire its own advisors
before this type of situation arises - and that
the audit committee has interviewed and has such
advisors "waiting in the wings" in case
such a scenario arises. Because the need for
advisors arises often in a crisis situation when
time is of the essence.
Some general counsels have told their boards
that a good rule of thumb is to hire independent
counsel anytime there is a management integrity or
conflict issue. By providing this type of
guidance, the board can avoid hiring counsel in
situations where it really doesn't need to hire
them.
28. Audit Committees - For larger
companies, reduce the burden on the audit
committee by forming a finance committee.
This finance committee can consist of some
directors who are not considered
"independent" and handle tasks that are
financial in nature, yet are not required to be
addressed by a committee comprised solely of
independent directors.
These types of tasks might include budget
review, compliance and even serve as the qualified
legal compliance committee (so long as one member
of the audit committee and two other independent
directors are on the committee).
29. Corporate Governance Ratings -
Don't leave any of your score "on the
table." Some companies engage in
certain corporate governance practices that can
boost their "score" at the various
rating services - but don't get credit for them
because either they are unknown to the services or
for other reasons.
For example, ISS takes into consideration only
information that is made publicly available for
its CGQ service. Thus, a company might meet some
of the criteria and tell ISS staffers so - but ISS
won't take it into account unless it is posted on
a web site, in a SEC filing or somehow otherwise
put into the public domain.
30. Reporting Up - Draft a policy that
is not overly detailed. There is no need
for an elaborate "reporting up" policy.
Similarly, if its too rigid, it might depart from
what the SEC's rule requires - and is more likely
to be violated in practice. In addition, you don't
want to create obligations that the rule doesn't
impose. It is important to have a policy in
writing for compliance and educational purposes.
31. Reporting Up - Draft the policy so
that it encourages communication to the top
- The policy should be drafted so that its nature
is that of a set of "guidelines" or
"suggested procedures." This is because
each lawyer bears the burden of his or her own
obligation, regardless of what is in the policy.
The policy should foster an approach that the
reporting lawyer, supervisor and general counsel
will work together. The general counsel likely
will need help to make sure the response is
adequate - and the "response" might
actually be a series of "responses" as
the general counsel learns more facts and has the
benefit of more time to conduct analysis.
32. Reporting Up - Informally identify
who is a "supervisory" attorney and
limit the number of supervisory attorneys
- Before an issue arises, it is a good idea to
identify who is a "supervisory" attorney
so that each lawyer clearly knows his or her
particular obligations. For purposes of Rule 205,
"supervisory" attorneys don't
necessarily have to include all lawyers that
actually supervise other lawyers in practice. In
fact, it is probably desirable to limit this group
so that only a handful of lawyers have
responsibility for determining what is an
"appropriate" response (for a sizable
legal department or law firm, we hear that the
typical size of that group is about half a dozen).
33. Reporting Up - Consider requiring
each lawyer to certify annually that they are in
compliance. It drives home the level of
importance of the legal department's or law firm's
policy and helps to show that the company or firm
has a sound compliance system. Of course, the key
is to ensure that these certifications are
collected each year. No small task, especially in
a large legal department - and may become more of
an administrative burden than the benefits it
delivers, particularly if some lawyers refuse to
sign their certifications.
Other issues to ponder - if only
"securities" lawyers are subject to the
reporting up rules, do you have different
certifications? And if a company doesn't have the
code of ethics signed by all employees annually,
why should this policy have any special
certification attached to it?
34. Internal Controls - Coordinate them
with your disclosure controls and procedures.
As you overhaul your internal controls to comply
with the upcoming attestation requirements, you
should try to coordinate your efforts to implement
Section 404 of Sarbanes-Oxley and the related
rules with your existing disclosure controls and
procedures and the disclosure committee's
activities. It is important that the disclosure
committee has a clear understanding of the
relationship between internal controls and
disclosure controls and procedures.
Keep in mind that good internal controls are
vastly more extensive than disclosure controls -
and internal controls are unrelated to disclosure
controls for the most part.
35. Internal Controls - Consider using
boutique firms to upgrade and document your
internal controls. One debate that has
raged recently is the extent to which companies
can use their independent auditors to help upgrade
and document their internal controls. The pros of
doing so include the fact that the same auditors
will be attesting to the controls later - so they
are the ideal one to ensure they are "up to
snuff" now. The cons of this approach is that
independent auditors are limited in what they can
do since they will be the entities that later
attest to what is developed at their clients - and
the SEC has warned that the auditor clearly must
be independent when it provides its attestation.
Some experts, like former SEC Chief Accountant
Lynn Turner, advise the use of boutique firms to
assist in the preparation - firms like Ten Eyck
and Provident. The argument is that the use of
these boutique firms saves money as they can offer
more senior talent compared to a Big 4 firm. A
drawback to that approach is that the Big 4 firms
have sophisticated tools for testing internal
controls that the boutiques might not have.
We have heard of a few companies that actually
have hired other Big 4 firms to assist in the
preparation. This solution solves that concern -
but might prove expensive. However, due to the
potential negative consequences for lack of
compliance in this area, it is one area that you
don't want to "chisel" and not spend the
money required to get "up to speed."
Regardless of what approach your company takes,
ensure that your independent auditors don't go too
far in "assisting" to help set up your
internal controls, as that might taint their
ability to attest later.
36. Subcertifications - Don't be a cop
if you can help it. Some companies have
tasked counsel to act as "cop" to
collect subcertifications. This can be an ugly
job. For example, the heads of business units
might turn to their own business unit lawyers to
render advice as to whether to sign - and these
lawyers might not have the appropriate background
to render sound advice. Even worse is the tricky
task of handling someone who refuses to execute a
subcertification.
37. Subcertifications - Reconsider your
"subcertification" culture.
Don't forget that your disclosure controls and
procedures should be an evolving dynamic and that
it might make sense to reduce the number of
employees that execute subcertifications if you
find that some of them don't add value to the
process.
We have heard a number of companies that have
cut down on the number of employees that sign
subcertifications. One approach we like is that
only the head of business units are required to
sign - and that the disclosure committee has the
discretion to ask others to sign. The disclosure
committee might elect to exercise this discretion
based on information they gather during the
diligence process.
38. Subcertifications - Reconsider
whether you should sign one if you are not
indemnified. If you are one of the
"chosen" asked to execute a
subcertification, research whether you are an
indemnified party under the company's corporate
governance documents. If not, be scared - and push
for a change in the subcertification culture to
reduce the number of employees that are required
to sign them. On the other hand, some believe that
signing a subcertification should not require
indemnification, since it is delivered only
internally. The argument is that all the
subcertification really says is that an employee
has done his or her job with respect to the public
filing,
39. Disclosure Committee - Reconsider
who is on the disclosure committee.
Another evolving component of your disclosure
controls and procedures is who sits on your
disclosure committee.
As "accelerated filing" for 10-Ks and
10-Qs approaches - as well as more 8-K filings -
you want to make sure the disclosure committee is
not too large and is comprised of employees that
can meet on short notice and on a regular basis.
40. Disclosure Diligence - Educate
anyone that might contribute to the disclosure
process. Education can be a tough task
but is important to illustrate that the disclosure
committee is performing its job adequately.
Education is an ongoing task and should be
performed each quarter in some cases.
One practice we like is to send out a copy of
SAB 99 - or an executive summary - each quarter to
anyone that is asked to contribute to the
disclosure process. This should assist to explain
the sensitive nature of the elusive
"material" standard.
41. Drafting Sessions - Use for each
Form 10-Q if practical. A growing
practice is to hold drafting sessions, even for
each Form 10-Q. Obviously, this works more easily
for companies whose operations are not spread over
the globe. Still, videoconferences and
teleconferences might fit the bill for
multi-national companies.
The key reason for drafting sessions is to
allow the disclosure committee to control the
"master" of the document rather than
delegate that responsibility to one single person.
This should produce a better disclosure document
and avoids placing too much responsibility on one
member of the disclosure committee.
42. Quarterly Review by Independent
Auditors - Ask for it in writing. Some
companies have asked their independent auditors to
render their quarterly review in writing to
document the process. This can help if the company
plans an offering and needs diligence
documentation for underwriter's counsel.
Some companies have even gotten a quarterly
letter from their outside counsel to the effect
that "to the best of their knowledge, this
disclosure document meets the SEC's rules and
regulations."
Because of the amount of work that must be
done, it is possible that companies will not be
willing to pay to get a letter. Hopefully, the
company's advisors might include it as part of the
services they already provide.
43. Earning Releases - Consider issuing
them at the same time as filing the Form 10-Q.
As accelerated filing becomes a reality, we expect
more companies to forego staggered releases of
these two documents. Combining them will save
management a lot of time as well as the audit
committee. Some companies have already implemented
this practice, such as Gillette, even though it
means their earning releases are issued a few
weeks after their peers.
One added benefit: If your Form 10-Q precedes
your press release, you are not required to file
the press release on a Form 8-K. While this is not
of much benefit to companies that hold conference
calls - because a Form 8-K needs to precede the
call - it will eliminate the need to file a Form
8-K for many companies.
44. Regulation G - For filed documents,
be prepared to defend "non-recurring"
items. The SEC staff's FAQs state that
companies must satisfy "the burden" of
demonstrating the usefulness of any non-GAAP
financial measure that excludes recurring items.
The staff has not enunciated standards by which
companies will be evaluated in satisfying this
standard - but instead states that the
acceptability of eliminating a recurring item or
items from the most directly comparable GAAP
financial measure depends on all of the facts and
circumstances. This is not a new practice for the
staff as it has historically reviewed disclosures
that appeared in filed documents and commented on
the acceptability of certain presentations.
However, the FAQs probably reflect the fact
that Item 10(e) may push the staff more into what
may be described as merit regulation with respect
to disclosures of non-GAAP financial measures,
where the staff is the arbiter of whether a
company has sufficiently justified its desire to
present a non-GAAP financial measure. This in turn
may result in a greater divergence between
disclosures that appear inside and outside of
SEC-filed documents, as companies struggle to
present information that they may view as useful
or responsive to their investors, and yet which
may not meet the staff's standards of
acceptability.
The bottom line is that companies should
carefully review their reasons for - and goals in
- disclosing non-GAAP financial measures that have
the effect of eliminating the effect of recurring
items so that they can be clearly articulated and
defended.
45. Regulation G - Use clear
descriptions for cash flow measures. The
staff's FAQs state that cash flow measures must
include a clear description of its calculation and
the requisite reconciliation - as well as any
material limitations on its use as a liquidity
measure.
One recommendation is that when a company
presents free cash flow in a manner that reflects
adjustments to operating income or other items
that are not commonly expected to be reflected in
that financial presentation, the non-GAAP
financial measure should be labeled with a term
such as "adjusted free cash flow" or
"modified free cash flow" and the
variance be clearly highlighted. This same
recommendation applies equally to disclosures of a
variation to any other "common" non-GAAP
financial measure.
46. Regulation FD - Don't forget to
consider it deciding what to do with press
releases. The Regulation G adopting
release really contains two different things:
rules governing the use of non-GAAP information
and an amendment, effectively, to Regulation FD by
adding Item 12 to Form 8-K. When you draft a press
release, ask yourself this simple question: Does
the press release contain material, non-public
information about a completed period? Many
companies now are filing press releases left and
right that they never previously would have viewed
as raising Regulation FD issues - so its important
to ask this question. If the press release does
not raise Regulation FD issues, and you do not
need it on file in connection with a subsequent
conference call, it does not raise Item 12 issues.
Hint: If you do not hold conference calls, file
your Form 10-Q before you issue your press
release.
47. Whistleblowing Policies - Adopt
general procedures that are not overly detailed.
The procedures should be general in nature and
easy to understand and follow. They do not need to
be lengthy, but they should, at a minimum,
address:
- how to submit complaints, including how
employees can submit anonymous complaints or
concerns;
- the scope of matters covered by the
procedures and guidelines as to the content
and detail of complaints;
- how the company retains complaints;
- who will handle complaints and the process
for evaluating, investigating and resolving
them; and
- the role of the audit committee in reviewing
and/or investigating complaints.
Detailed whistleblower procedures might be
right for some companies that look to the
procedures as a roadmap for both the company and
complainants in addressing and resolving
complaints. The risks of such procedures, however,
are that employees might not be able to understand
the "fine print," and might find the
complexity of the procedures intimidating, thus
reducing the likelihood that they will submit
complaints.
As a result, detailed procedures could defeat
two key purposes of the SEC's new rule: to
facilitate disclosures regarding questionable
accounting matters and to alert the audit
committee to potential problems before they have
serious consequences. It is also worth noting that
the greater the level of detail, the greater the
likelihood that the company will fail to comply
with its own procedures, which could ultimately be
a factor in a subsequent lawsuit, including a
securities class action suit.
48. Whistleblowing Policies - Ensure
your process can be quickly completed if necessary.
In some cases, it might be important to resolve a
whistleblower complaint quickly. Although this
expedited treatment should not shirk any of the
company's responsibilities, the lack of a quick
resolution could harm the company greatly.
We already have heard of cases where an audit
committee or independent auditor wouldn't bless an
earnings release until a complaint was resolved. A
harsh result indeed.
49. Whistleblowing Policies - Don't
forget to track employees that walk into office to
complain. With so much attention being
paid to "hotlines," it is easy to forget
to address the relatively common situation where
an employee actually voices a concern
face-to-face. The whistleblowing policy should
address these situations and the company should
train employees to recognize when they arise - so
that they don't inadvertently violate the policy.
50. Independent auditors - Don't allow
your auditors to limit its exposure with an
indemnity clause in its engagement letters.
We hear that some independent auditors are trying
to limit their liability by including indemnity
provisions in their engagement letters, for both
audit and non-audit services. These provisions
limit the auditors' exposure to the amount of
their fees. Push back. Also push back on overly
broad management representation letters. There is
essentially no basis in the accounting literature
for many of the imposing additions that have crept
into many of these letters during the past year.
