The International Law Firm of Fulbright & Jaworski - Corporate Governance
Antony James Corsi, Lionel G. Hest, Tarifa B. Laddon, Gregory M. Matlock, Robin Preussel Phillips, Anthony Shih, Jasper G. Taylor, III and Kirill Vahonin
January 27, 2010
- Updated SEC Disclosure Rules
- Inclusion of Shareholder Nominations in Company Proxies
- FRC Proposes Changes to the UK Combined Code on Corporate Governance
- Securities Class Action Filings Decline in 2009 According to Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research's Annual Report
- Los Angeles Federal Court Dismisses Securities Class Action Concerning Mutual Fund Management Fees
- All Texas Entities Now Subject to the Texas Business Organizations Code
- Securities Legislation on the Horizon in 2010
- IRS May Require Companies to Disclose Uncertain Tax Positions With Tax Returns
Pursuant to SEC Release No. 33-9089, dated December 16, 2009, the U.S. Securities and Exchange Commission (the "SEC") adopted certain rules requiring greater disclosure in proxies.
With respect to corporate governance, the relevant changes include the following:
- Filing companies are now required to discuss employee compensation policy and practices where such policies and practices create risks that are reasonably likely to have a material adverse effect on the company.
- The value of stock and equity awards must now be stated in "grant date fair value" terms in accordance with Financial Accounting Standards Board Accounting Standards Codification Topic 718, Compensation—Stock Compensation.
- Additional information must now be disclosed regarding serving directors and nominees, including experience and skills relevant to service as a director and other directorships held by such director or nominee in the past five years. In addition, certain legal proceedings involving directors, director nominees and executive officers during the last 10 years must now be disclosed.
- Companies are now required to disclose the board's leadership structure, including whether the company's CEO and chairman are the same person, and the reason why this structure is appropriate. Where the company has a lead independent director, the specific role of such lead independent director must be disclosed, along with the reason why this arrangement is appropriate. Finally, the company must describe the board's role in risk oversight.
These rules take effect on February 28, 2010 and therefore will affect most proxies filed this season. Officers and directors should consider the additional disclosure required by these rules and how the company will gather the relevant information, as well as how the new information required can most effectively be communicated to shareholders and the market as a whole. top
On January 14, 2010, Mary Schapiro, the chair of the SEC, appeared before the Financial Crisis Inquiry Commission (the "FCIC") to give testimony concerning the recent financial crisis. The FCIC is an entity appointed by Congress to investigate the financial crisis, and is due to publish its findings on December 15, 2010. A transcript of Ms. Schapiro's comments is available here.
Among other subjects, Ms. Schapiro discussed the general principle that boards of directors should be made more accountable to shareholders. In particular, Ms. Schapiro discussed the right of shareholders to nominate and elect directors and described existing proxy rules as placing "unnecessary burdens on this right, at the expense of the board's accountability to shareholders," which means "the election of directors can become a self-sustaining process with little actual input from shareholders." Ms. Schapiro stated that to facilitate the ability of shareholders to influence boards of directors, the SEC has re-opened for comment certain previously proposed amendments to proxy rules. The proposed amdendments require companies to include in the company's proxy materials shareholder nominations for directors and shareholder proposals for amendments to a company's governing documents that would affect the company's procedures for nominating directors. These changes were previously the subject of SEC Release No. 33-9046, dated June 10, 2009, available here. As drafted, these rules do not allow shareholders to nominate sufficient candidates to constitute a majority of the board, and require that shareholders exercising these rights meet certain minimum requirements with respect to the number of shares held and the period of time during which such shares are held.
Ms. Schapiro stated that she is committed to bringing final versions of these rules to the SEC for consideration early this year. Due to the proposed timing, it is possible that filings taking place during the current proxy season will be subject to these rules. Management and directors should consider the additional time and cost required to include shareholder nominees and proposals in company proxy materials, as well as the possible effects of increased shareholder nominations of directors. top
The Financial Reporting Council (the "FRC") is the UK's independent regulator responsible for promoting confidence in corporate governance and reporting. The FRC has recently published a report on the effectiveness of the Combined Code on Corporate Governance (the "Code"). The purpose of the Code is to promote good corporate governance and confidence in corporate reporting. The Code is "a guide to the components of good board practice distilled from consultation and widespread experience over many years." Companies are expected to adopt a "comply or explain" approach to the Code: departure from the provisions of the Code are permitted provided the reasons are explained to shareholders.
This is the third such review, the last having taken place in 2007. The FRC concluded that while, "the Combined Code and its related guidance require some updating, it remains broadly fit for purpose" and that, "the flexibility it allows remains preferable to a more prescriptive framework for corporate governance." The report contains various proposed amendments to the Code in a broad spectrum of areas, including the responsibilities of chairmen and directors, the balance and composition of the board, risk management and internal controls, remuneration, and engagement between boards and shareholders. Some of the key proposals, in summary, are as follows:
- In terms of the composition of the board, the FRC recognises that previously too much emphasis has been placed on independence of directors. The Code should reflect that the overriding consideration is whether the board is fit for purpose.
- In terms of risk management and internal controls, the FRC proposes to require the board to satisfy itself that appropriate systems are in place to enable it to identify, assess and manage key risks.
- In terms of remuneration, the FRC recommends that performance-related remuneration be aligned to the long-term success of the company.
- The FRC has also taken into account the separate review of the governance of banks and financial institutions conducted in 2009 by Sir David Walker, and proposes to adopt those of Sir David's recommendations it considers are applicable to all listed companies.
The FRC's proposals are open for consultation until March 5, 2010. Subject to that, the FRC intends that the revised Code will be published in April or May 2010, and it will apply to accounting periods beginning on or after June 29, 2010. The Code will be renamed, "The UK Corporate Governance Code" to emphasise the Code's status, particularly to foreign investors and foreign companies listed in the UK. top
On January 5, 2010, Stanford Law School Securities Class Action Clearinghouse and Cornerstone Research released Securities Class Action Filings – 2009: A Year in Review. The annual report concludes that federal securities class action filings declined dramatically in 2009 compared to 2008. The 169 filings in 2009 represent a 24% decrease from 2008 and fall 14% below the annual average of filings between 1997 and 2008.
The report's key findings include the following:
- 4.6% of companies on the S&P 500 index were named as defendants in a securities class action in 2009 (compared to 9.2% in 2008). The number of S&P 500 index financial firms named as defendants plummeted from 32.6% in 2008 to 11.5% in 2009.
- Unique public issuers named as defendants dropped by 32%.
- The percentage of filings against foreign issuers declined to 12.4%
- The financial sector's 84 filings represents the highest level of activity at roughly half of all filings.
- Among the cases resolved in 2009, 41% were dismissed and 49% settled. Of the dismissals, the majority were resolved after the first ruling on a motion to dismiss but before summary judgment.
Dr. John Gould, Senior Vice President of Cornerstone Research, concluded that "[p]erhaps most striking this past year was the rapid decline of credit crisis securities class action filings, which followed an equally quick ascent in 2007 and 2008."
The United States District Court for the Central District of California has recently given judgment in what one of the lawyers for the defense described as the first securities case against a mutual fund to go to trial in 20 years. The plaintiffs brought suit on behalf of investors in eight funds against Capital Research and Management Company ("Capital Management") and American Funds Distributors, Inc. The Plaintiffs challenged as excessive the more than $15 billion in investment advisory, transfer agency, Rule 12b-1 and administrative service fees paid over a six-year period. After a two-week bench trial last summer, Judge Gary Feess dismissed the case in a 105-page opinion issued on December 28, 2009.
Judge Feess held that the plaintiffs did not meet their high burden of proof, which was to demonstrate that the relevant fee was "so disproportionately large that it bears no reasonable relationship to the services rendered and could not have been the product of arm's-length bargaining" (citing Gartenberg v. Merrill Lynch Asset Mgmt., Inc., 694 F.2d 923, 928 (2nd Cir. 1982)). The Court noted that this standard establishes a very low threshold for mutual fund companies and a very high hurdle for plaintiffs. To determine whether the Gartenberg standard has been met, the court was required to consider "all facts in connection with the determination and receipt of such compensation," including: (1) the nature and quality of services rendered; (2) the profitability of the fund to the investment adviser; (3) fall-out benefits (profits to the adviser that would not have occured but for the existence of the fund); (4) economies of scale; (5) comparative fee structures; and (6) the independence of the unaffiliated directors and the care and conscientiousness with which they performed their duties. Gartenberg, 694 F.2d at 929-30. The Court found for the defendants on each of the six Gartenberg factors.
In dismissing the case and entering judgment for the defendants, the Court also concluded that the plaintiffs failed to demonstrate that the defendants breached the fiduciary duty imposed on them by Section 36(b) of the Investment Company Act of 1940 with respect to compensation received for various services rendered to the funds. top
Effective January 1, 2010, the applicability of the Texas Business Organizations Code (the "TBOC") expanded to cover all Texas business entities. The TBOC was enacted in 2003 and reorganized into one code the provisions of several business entity statutes, including the Texas Business Corporation Act, the Texas Limited Liability Company Act, the Texas Revised Limited Partnership Act, the Texas Revised Limited Partnership Act and the Texas Non-Profit Corporation Act. The TBOC automatically applied to any Texas entity formed on or after January 1, 2006. Any Texas entity formed before that date could make an affirmative election to be governed by the TBOC, but otherwise remained governed by the previous business entity statute. Now, all Texas entities will be governed by the TBOC, regardless of their formation date. The TBOC will also govern all foreign (i.e., non-Texas) business entities, regardless of their formation date.
The TBOC employs a new organization and terminology not found in the previous business entity statutes. Title 1 of the TBOC contains the common provisions that generally apply to most types of entities and includes new common terms for all entities. For example, under the TBOC, an "entity" may be either "domestic" (i.e., formed under Texas law) or "foreign" (i.e., formed under the laws of another jurisdiction). As an additional example of the TBOC's streamlining effects, the most common instrument used to form an entity in Texas under the TBOC is the "certificate of formation", which replaces articles of incorporation, articles of organization, certificates of limited partnership and similarly-styled documents. The remaining titles of the TBOC apply to specific kinds of entities, except for Title 8, which contains miscellaneous and transition provisions.
Texas business entities are not required to make any filings with the Texas Secretary of State to comply with this expansion of the applicability of the TBOC. Moreover, updating governing or other documents only to employ the terminology used in the TBOC is not required under the law. However, if a Texas entity is revising its formation documents for other reasons, it should consider amending such documents to be consistent with the TBOC's terminology. As a general rule, acts, contracts or transactions that were consummated on or after the TBOC became applicable to an entity are governed by the TBOC, and those consummated before such date are governed by the previously applicable business statute. top
Two bills introduced over the summer by Sen. Arlen Specter, D-Pa., could have a major impact on securities litigation. Both appear to be securities plaintiff-friendly and may increase the volume of securities litigation as well as the cost to companies to defend that litigation.
The Liability for Aiding and Abetting Securities Violations Act of 2009 aims to overturn the Supreme Court's interpretation of pleading limitations on the private right to action under the securities laws. The Bill would allow private securities plaintiffs to name accounting firms, lawyers, investment bankers and other service providers who are alleged to have aided and abetted companies in perpetrating securities fraud. The legislation is intended to reverse Stoneridge Investment Partners LLC v. Scientific-Atlanta, Inc., 552 U.S. 148 (2008) and Central Bank of Denver v. First Interstate Bank of Denver, 511 U.S. 164 (1994). Both cases ruled that the private right of action in a securities fraud case does not extend to third parties who did not make alleged misstatements or perform misleading actions upon which investors relied. The Bill is currently in the Senate Judiciary Committee, where Senator Specter introduced it.
Also in Committee is the Notice Pleading Restoration Act, which seeks to overturn Bell Atlantic Corp. v. Twombly, 550 U.S. 544 (2007) and Ashcroft v. Iqbal, 129 S.Ct. 1937 (2009). Those decisions require factual specificity in pleadings and provide that only a complaint that states a plausible claim for relief will survive a motion to dismiss. In securities fraud cases, those standards have required plaintiffs to make specific allegations of fraud instead of broad claims regarding fraudulent activities. The Bill aims to restore pleading standards set forth in the Supreme Court's decision in Conley v. Gibson, 55 U.S. 41 (1957), which states that a plaintiff's complaint "should not be dismissed for failure to state a claim unless it appears beyond doubt that the plaintiff can prove no set of facts in support of his claim which would entitle him to relief." top
On January 26, 2010, the Internal Revenue Service ("IRS"), in Announcement 2010-9, stated that it plans to implement new reporting rules that will require many business taxpayers to report uncertain tax positions on such taxpayers' U.S. federal income tax returns. These new reporting requirements constitute a significant departure from the IRS's prior "policy of restraint" in seeking information contained in tax accrual workpapers. Calling the proposal "a major step toward transparency," IRS Commissioner Douglas Shulman said that the plan is intended to help the IRS determine the "nature and materiality of a taxpayer's uncertain tax positions" when making audit decisions.
Existing business tax returns do not currently require that taxpayers identify and explain uncertain tax positions underlying such taxpayers' returns. Many taxpayers, however, are already required by FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an Interpretation of FASB Statement No. 109 ("FIN 48"), to identify and quantify uncertain tax positions taken in the return for financial accounting purposes. Taxpayers not subject to FIN 48 may be subject to other requirements regarding accounting for uncertain tax positions, such as International Financial Reporting Standards and country-specific generally accepted accounting standards.
In Announcement 2010-9, the IRS announced its intention to largely set aside its policy of restraint and require taxpayers to report uncertain tax positions on their tax returns. Specifically, the IRS is developing a schedule, which will be filed with the Form 1120, U.S. Corporation Income Tax Return, or other applicable business tax return, that will require certain taxpayers to provide information about their uncertain tax positions that affect their U.S. federal income tax liability. As described in Announcement 2010-9, the schedule will require (i) a concise description of each uncertain tax position for which the taxpayer or a related entity has recorded a reserve in its financial statements, and (ii) the maximum amount of potential U.S. federal tax liability attributable to each uncertain tax position (determined without regard to the taxpayer's risk analysis regarding its likelihood of prevailing on the merits). Further, "uncertain tax positions" will include any position related to the determination of any U.S. federal income tax liability for which a taxpayer or a related entity has not recorded a tax reserve because (i) the taxpayer expects to litigate such position, or (ii) the taxpayer believes such position will not be examined by the IRS.
The IRS indicates that reporting would be mandatory for a business taxpayer (i) with assets exceeding $10 million, and (ii) that prepares financial statements, or is included in the financial statements of a related entity that prepares financial statements, if that taxpayer or related entity determines its U.S. federal income tax reserves under FIN 48, or other accounting standards relating to uncertain tax positions involving U.S. federal income tax.
These proposed reporting requirements have not yet been finalized, and the IRS has invited public comments (which are to be received by March 29, 2010). top
Antony James Corsi
Lionel G. Hest
Tarifa B. Laddon
Gregory M. Matlock
Robin Preussel Phillips
Jasper G. Taylor, III