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Powell Goldstein LLP

GAO Issues Survey on Nonprofit Hospitals' Executive Compensation
On Friday, July 28, 2006, the General Accounting Office (GAO) made public its survey entitled "Nonprofit Hospital Systems: Survey on Executive Compensation Policies." The survey sample was of 100 hospital systems throughout the United States, each of which is recognized as tax exempt under IRC §501(c)(3).

08-05-2006

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Ross, Dixon & Bell, LLP

Indiana Court of Appeals Holds That Trial Court Abused Discretion by Refusing Protective Order in Bad Faith Litigation
Last week, the Indiana Court of Appeals in Allstate Insurance Co. v. Scroghan, No. 03A04-0410-CV-554 (July 25, 2006) addressed a variety of recurring discovery issues in bad faith litigation. Scroghan held, among other things, that an insurer sanctioned for failing to comply with an order compelling discovery could, by appealing the sanctions order, also obtain interlocutory review of the underlying discovery ruling.

Scroghan involved a host of discovery disputes arising in the course of a bad faith claim brought against Allstate Insurance Company for allegedly refusing or delaying payment on an uninsured motorist claim. One area of dispute involved plaintiff’s discovery requests for: information about the compensation of the Allstate employees involved in the claim; all manuals and documents relating to performance, evaluation and compensation, incentive programs, and retirement funds; all cost control manuals and procedures; all training manuals and materials; materials concerning Colossus, a computer program used to assist personnel in evaluating claims; and materials created in connection with Allstate’s hiring of a management consulting firm to create and implement a claim process “redesign” that included “cost control measures aimed at reducing the amount paid out on claims.” Allstate requested a protective order on the ground that these materials were trade secrets and/or confidential, but the trial court refused to enter such an order and granted a motion to compel production. The trial court also refused to certify its ruling for interlocutory appeal.

Allstate nevertheless continued to maintain its objections and declined to produce the documents pending exhaustion of all avenues of appeal. Ultimately, the trial court sanctioned Allstate and ordered it to pay $10,000 for failing to comply with the discovery order.

When Allstate appealed under Indiana Appellate Rule 14(A), which allows an interlocutory appeal as of right of orders requiring the payment of money, plaintiff argued that the appellate court could address only the sanction and had no jurisdiction to review the underlying discovery order. The Scroghan court disagreed. After conceding that there was no Indiana case law specifically discussing the issue and emphasizing that the courts “certainly do not encourage parties to intentionally violate a discovery order so as to be sanctioned and thus obtain an interlocutory appeal,” the court stated that “we can see the narrow situations, such as this one, where such a strategy may be utilized.” It noted that a party in Allstate’s position “has few options since complying with the court’s discovery order, proceeding through a trial, and ultimately winning on appeal would be a hollow victory indeed when the information . . . would then already have been disclosed.” “In such situations,” the court said, “if a party is willing to incur possibly serious sanctions to obtain review . . ., then the option should be available.”

On the merits, the court held that the trial court had abused its discretion in refusing the protective order. It remanded the case for entry of an order containing specific limitations on the use and dissemination of the materials by plaintiff’s counsel. Although it thus upheld Allstate’s position on this issue, the court nevertheless affirmed the $10,000 sanction on the ground that this “de minimis” sanction was warranted based on Allstate’s conduct involving other discovery issues in the litigation.

08-05-2006

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Ross, Dixon & Bell, LLP

Insurer's Right To Equitable Contribution For Settlement Amounts From A Non-Participating Insurer Only Requires Prima Facie Proof Of A Potential For Coverage, Not Actual Coverage
Safeco Ins. Co. of America v. Superior Court, No. B189637 (Cal. Ct. App., June 22, 2006)

In an equitable contribution lawsuit between insurers, the Second District Court of Appeal (Los Angeles) held that a settling insurer’s burden of proof to recover settlement amounts from a non-participating insurer is the same in the settlement context as it is in the defense context – a prima facie showing of the potential for coverage under the non-participating insurer’s policy – shifting the burden to the non-participating insurer to prove the absence of actual coverage.

In Safeco, construction companies insured by Safeco Insurance Company of America (“Safeco”), American States Insurance Company (“American States”) and Century Surety Company (“Century”) tendered to all three insurers the defense of seventeen separate lawsuits alleging property damage arising from the insureds’ work during the periods of all three insurers’ policies. Safeco and American States accepted the insureds’ tender of the defense and settled several of the lawsuits. Century rejected the tenders claiming that the “other insurance” provision in its policies made its coverage secondary to Safeco’s and American States’ policies.

Safeco and American States sued Century for equitable contribution for both defense costs and settlement sums they paid on behalf of their mutual insureds. The trial court resolved the “other insurance” issue against Century, but denied summary judgment to Safeco and American States on their contribution claims, reasoning that even if Century had a duty to defend, it was not required to contribute toward any settlements unless it was established as a matter of law that its policies actually covered the underlying claims.

On a petition for writ of mandate, the parties agreed that a settling insurer need only establish a potential for coverage to recover defense costs from a non-participating insurer, but disagreed about the showing necessary to recover a settlement contribution. The Second District Court of Appeal sided with Safeco and American States. It held that once an insurer proves the potential for coverage under a non-participating insurer’s policy, the absence of actual coverage is an affirmative defense that the non-participating insurer must raise and prove. The court reasoned that when a duty to defend is shown, a non-participating coinsurer is presumptively liable for both the costs of defense and settlement, waiving the right to challenge the reasonableness of the settlement. While it retains the ability to raise other coverage defenses, it has the burden of proving that there is no coverage under its policy.

08-05-2006

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Ross, Dixon & Bell, LLP

Without An Excess Judgment, An Excess Insurer Has No Equitable Subrogation Rights Against A Primary Insurer That Fails To Settle Within Its Limits
In a decision that declined to follow contrary precedent, the Second District Court of Appeal (Los Angeles) held that an excess insurer cannot maintain an equitable subrogation action against the primary insurer for unreasonably refusing to settle, where the underlying claim did not go to trial and there was no excess judgment against the insured.

In RLI, the insured was involved in a traffic accident that resulted in a fatality. The deceased’s survivors sued the insured and initially offered to settle their claim for $1 million – the limit of the insured’s primary policy. The primary insurer rejected that offer; one year later, the lawsuit settled for $2 million, with the primary insurer paying its $1 million policy limit and the excess insurer paying $1 million.

The excess insurer brought an equitable subrogation lawsuit against the primary insurer based on the primary insurer’s failure to accept a reasonable settlement demand within its policy limits. The trial court granted the primary insurer’s motion for judgment on the pleadings, agreeing with the primary insurer that because the underlying case settled and did not result in an excess judgment, there was no actionable claim. The Second District Court of Appeal affirmed.

The RLI court relied chiefly on the California Supreme Court’s decisions in Hamilton v. Maryland Cas. Co., 27 Cal. 4th 718 (2002), and Commercial Union Assurance Cos. v. Safeway Stores, Inc., 26 Cal. 3d 912 (1980), both of which made clear that where an insurer is providing a defense, the insured’s agreement to a pretrial settlement resulting in a stipulated judgment in excess of policy limits does not support a claim for the insurer’s refusal to settle within limits. Until there is a judgment following an actual trial that fixes the insured’s liability, the insured has suffered no harm by the mere potential for an excess judgment.

The RLI court reasoned that because the underlying action was resolved by a settlement, not an excess judgment, the insured had no assignable cause of action for the primary insurer’s earlier failure to settle within its policy limits. Because the excess insurer’s rights were entirely derivative of the insured’s, the court affirmed the trial court’s dismissal of the excess insurer’s equitable subrogation claim.

In reaching its decision, the RLI court declined to follow Fortman v. Safeco Ins. Co., 221 Cal. App. 3d 1394 (1990), which held that an excess judgment was not a prerequisite to an excess insurer’s equitable subrogation action against a primary insurer. The RLI court found Fortman “unpersuasive,” observing that it was contrary to the California Supreme Court’s Hamilton decision, was based on principles of equitable contribution among coninsurers that exist independent of the insured’s rights, and that it arose in a context where the primary insurer abandoned its insured, entitling the insured to settle on the best terms possible and giving rise to an assignable bad faith claim against its primary insurer for its refusal to defend.

08-05-2006

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Morrison & Foerster, LLP

Overview of FTC's Rambus Decision
Today, the Federal Trade Commission (FTC) issued its opinion in the Matter of Rambus, Inc., Docket No. 9302, and found that the technology company engaged in exclusionary conduct that enabled it to monopolize markets for computer memory technology. The Commission has requested additional briefing of remedial issues before it “exercise[s] its broad remedial powers.”

Background
The original FTC complaint against Rambus, Inc. was issued on June 18, 2002, charging that the company monopolized certain computer memory technology markets through a pattern of anticompetitive and exclusionary conduct during its participation in the Joint Electron Device Engineering Council (JEDEC), an industry-wide standard-setting organization for technologies for dynamic random-access memory (DRAM) chips. The complaint alleged that Rambus concealed its patents and patent applications until after the standards were adopted, and then later brought patent infringement lawsuits against JEDEC members who practiced the standard. In 2004, Administrative Law Judge Stephen J. McGuire dismissed the complaint, holding that: (i) JEDEC’s rules did not impose a clear duty on Rambus to disclose its patents and patent applications; (ii) Section 5 of the FTC Act did not impose a duty on Rambus to disclose its relevant patents to JEDEC or act in good faith towards other members; and (iii) Rambus’s failure to disclose its patents and patent applications could not constitute “exclusionary conduct” sufficient to support a claim for monopolization pursuant to Section 2 of the Sherman Act.

Today’s Opinion
Today’s unanimous FTC opinion, written by Commissioner Pamela Jones Harbour, reversed ALJ McGuire’s decision and found that Rambus violated Section 5 of the FTC Act by engaging in exclusionary conduct, and that Rambus’s conduct contributed to its acquisition of monopoly power in markets for computer memory technology.

The FTC’s de novo review of the evidence led it to set aside all the findings and conclusions of the ALJ and instead find that Rambus “exploited its participation in JEDEC to obtain patents that would cover technologies incorporated into now-ubiquitous JEDEC memory standards, without revealing its patent position to other JEDEC members.” The FTC concluded that “[a]s a result, Rambus was able to distort the standard-setting process and engage in an anticompetitive ‘hold-up’ of the computer memory industry.”

Factual Findings
The FTC found:
Despite JEDEC’s policy and practice that members were expected to reveal their patents and applications that later might be enforced against those practicing the standard, Rambus refused to disclose the existence of its patents and applications.
Rambus took actions to purposefully mislead members of JEDEC, causing them to believe that Rambus was not seeking patents that would cover the standards under consideration by JEDEC.
Rambus was able to gain information about the pending standard via its participation in JEDEC and then successfully amend its existing patent applications to ensure that the company’s patents would cover the standard ultimately decided upon by JEDEC.
Legal Conclusions

Using the analytical framework of Section 2 of the Sherman Act, the FTC found that Rambus’s conduct was deceptive, had the purpose and effect of gaining market power, and constituted exclusionary conduct for purposes of Section 2. The Commission rejected each of the company’s proffered procompetitive justifications for its conduct and further explained that even if Rambus had been successful in establishing a procompetitive justification for its conduct, such a justification would not outweigh the anticompetitive effects of the exclusionary conduct, particularly considering the potential of such conduct to distort the processes of industry-wide standard-setting bodies.

Remedies
While the Commission found that Rambus violated Section 5 of the FTC Act, it did not order a remedy for the violation. The Commission has requested additional briefing of remedial issues before it “exercise[s] its broad remedial powers.

08-05-2006

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Morrison & Foerster, LLP

SEC Announces Approval of Final Rules on Executive Compensation Disclosure -- New Requirements Designed to Address Options Back-Dating Controversy
On July 26, 2006, the SEC approved final rules on executive and director compensation disclosure and issued a press release announcing the final rules. (http://www.sec.gov/news/press/2006/2006-123.htm) The SEC has not yet released the full text of the final rules themselves, but a detailed release containing the final rules is expected to be issued shortly. The final rules will mandate significant changes in the format and scope of disclosure of executive and director compensation.

It is particularly noteworthy that the final rules require unprecedented disclosure related to stock option grants intended to address the recent options back-dating controversy embroiling many public companies. We believe it is important for management and compensation committees to evaluate now and to anticipate going forward how a company’s proposed, current and past compensation policies, plans and practices would be presented to the public under the final rules for several reasons:

Many compensation committees may wish to develop and adopt new policies and procedures or more formally memorialize existing policies and procedures in order to provide a clearer executive compensation disclosure.
Substantial amounts of new data will need to be captured, analyzed and discussed under the final rules, which may be difficult to complete if companies wait to start until next year’s proxy season.
Compensation committees and management should quickly assess the impact of the new disclosure requirements with regard to option grants in the current year.
The final rules will be generally effective for Forms 10-K and proxy statements filed for fiscal years ending on or after December 15, 2006. It is unclear why the SEC elected not to seek public comment on the new provisions in the final rules covering disclosure on options practices. This bulletin is based upon information contained in the SEC press release announcing the final rules and statements by the SEC Staff at the open meeting approving the final rules. See our Corporate Law Bulletin at http://www.mofo.com/news/updates/bulletins/bulletin02144.html for a discussion of the rules as originally proposed in January 2006.

Below is a discussion of the SEC’s newly mandated disclosure regarding options grant practices followed by a summary of some of the key provisions of the final rules with a focus on the changes from the previously proposed rules.

New Disclosure Regarding Options Grant Practices

The final rules require detailed disclosures regarding the process, timing, pricing and rationale for stock option grants. These disclosures fall into two major categories: disclosures relating to the selection of stock option exercise prices that differ from the stock price at the time of grant (e.g., granting options with discounted prices, including “back-dating”) and disclosures related to any process of coordinating the timing of grants with disclosures of non-public information (e.g., so-called “spring-loading” and “bullet-dodging”). Among the required disclosures are:

Detailed tabular disclosure specifying (i) the grant date of options used by the company for expensing the options under the new stock-based accounting regulations (FAS 123R), (ii) the total fair value of the option on the grant date under FAS 123R, (iii) any variance between the closing market price and the exercise price of an option on the grant date, (iv) the date the compensation committee or board of directors took action to grant the option if this date is different from the grant date of the option, and (v) a description of the methodology for determining the option exercise price if it varies from the closing market price per share on the grant date.
A plain English narrative in the new “Compensation Discussion and Analysis” (“CD&A”) section (described below) discussing:
whether the company coordinates option grants with the release of non-public information;
how the timing of option grants to executives fits in the context of grants to employees in general;
the role of the compensation committee in the timing of option grants and how it takes into account non-public information in making option grants;
any delegation by the compensation committee of the administration of option grants;
the role of executives in the timing of option grants; and
whether the company sets the grant date of options in coordination with the release of non-public information, and whether the company plans to time (or has timed) its release of non-public information for the purpose of affecting executive compensation.

The CD&A will also require specific analysis and disclosure of the rationale for the selection of option grant dates and methods used to select the terms of options grants.
Full and accurate compliance with these new options disclosure requirements will require careful fact-finding and analysis of processes that were not previously the focus of attention at many companies. Moreover, since the final rules will generally be effective for proxies filed on or after December 15, 2006, they appear to require companies to disclose information about any timing of option grants made during this current fiscal year (e.g., a fiscal year ending December 31, 2006), notwithstanding the fact that some companies no doubt already made such grants weeks or months prior to this announcement of the final rules.1 The final rules, when published, may provide additional clarification on how and whether these past grants need to be addressed, but it is important that management and compensation committees start thinking now about how best to properly comply with these new disclosure requirements and the potential shareholder reaction to the description of these matters in next year’s proxy.

It should also be noted that the SEC has indicated it will target for enforcement action those companies it determines have deliberately mischaracterized their options grant practices.

Finally, it should be noted that, on July 28, 2006, the PCAOB issued its Staff Audit Practice Alert No. 1 “Matters Related to Timing and Accounting for Option Grants,” which provides that auditors should assess the nature and potential magnitude of the risks associated with the granting of stock options and perform procedures to appropriately address those risks.

""Compensation Discussion and Analysis"" and ""Compensation Committee Report"" Will Both Be Required

As anticipated, the final rules require a new “Compensation Discussion and Analysis” intended, in the spirit of the “Management’s Discussion and Analysis” (“MD&A”) section currently found in 10-K filings, to give shareholders greater insight into executive compensation policies, plans and programs as seen through the eyes of management as affirmed by the compensation committee.

The final rules require that the CD&A address the objectives and implementation of executive compensation programs and focus on the most important factors underlying each company’s compensation policies and decisions. The CD&A is required to be “filed” (not just “furnished”) with the SEC and, as a result, is subject to the liability provisions of the Securities Act of 1933 and the Securities Exchange Act of 1934. Moreover, this section will be subject to the Sarbanes-Oxley certification requirements for the CEO and the CFO.

Since the final rules will be generally effective for proxies filed on or after December 15, 2006 (and thus impact companies’ 2007 proxies), it is important that management and compensation committees think now about how the executive compensation analysis they undertake this year will be described in next year’s proxy as well as how best to keep a record of the process of analysis.

The final rules, unlike the proposed rules, require that the CD&A be filed in addition to (rather than in place of) a separate compensation committee report that companies are already required to furnish. The final rules, however, modify the content of the compensation committee report and require that it state whether the compensation committee has reviewed the CD&A with management and, based on this review, whether it has recommended that it be included in the 10-K and proxy. This revised approach is designed to foster discussion among the compensation committee and management about a company’s executive compensation practices and disclosure. In addition, the final rules undo the proposed elimination of the traditional stock performance graph set forth in the proposed rules.

Disclosure of Non-Executive Officer Compensation

Under the proposed rules, companies would have been required to disclose the compensation of up to three non-executive officers whose total compensation exceeded that of any “named executive officer.” In response to public comments that this rule (the so-called “Katie Couric Rule”) would require disclosing competitive information about salaries of key non-management employees, the SEC has now “re-proposed” this rule such that it would only apply to companies that are “large accelerated filers,” and then only to employees with responsibility for significant policy decisions within the company, a significant subsidiary or division. The re-proposal of this rule by the SEC means that it remains subject to additional public comment.

The revised rule proposal, consistent with the previously proposed rules, would not require disclosure of the names of these non-executive officers, but would still require identification by job position. This will enable people familiar with the company to easily deduce these employees’ identities, and thus we remind compensation committees to take into account now the impact of this disclosure on their overall compensation program.

Separate Treatment for Increases in Actuarial Present Value of Pension Benefits and Above-Market or Preferential Earnings on Nonqualified Deferred Compensation

The final rules will provide for a separate column in the Summary Compensation Table to report the annual change in the actuarial present value of accumulated pension benefits and above-market or preferential earnings on nonqualified deferred compensation. As a result, these amounts can be excluded from the compensation amount used to determine which officers need to be identified as named executive officers based on total compensation. Many commentators had complained that including these amounts for the purposes of determining the named executive officers would lead to inconsistency from year to year as a result of differing returns on individual investment portfolios, and the SEC appears to have addressed this problem.

Quantification of Change in Control Benefits

The proposed rules included a detailed description of termination and change-in-control benefits for Named Executive Officers, including a quantification of these benefits. The final rules require that, in quantifying these benefits, companies must assume that the event triggering the benefit occurred on the last business day of the last fiscal year and that the stock price to be used for calculating the value of applicable benefits would be the price on such date.

Modification of Form 8-K Rules

The final rules will modify the requirements in Form 8-K to limit the disclosure of some employment arrangements and material amendments to only those with “named executive officers.” These modifications to Form 8-K will take effect earlier than the other changes and will be effective for triggering events that occur 60 days or more after publication of the final rules in the Federal Register.

Footnote

1 The SEC press release states “Disclosure will also be required where a company has not previously disclosed a program, plan or practice of timing option grants to executives, but has adopted such a program, plan or practice or has made one or more decisions since the beginning of the past fiscal year to time option grants.

08-05-2006

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Kramer, Levin, Naftalis & Frankel, LLP

SEC Adopts Changes to Disclosure Requirements Concerning Executive Compensation and Related Matters
The SEC issued a press release on July 26, 2006 announcing the adoption of changes to the rules requiring disclosure of executive and director compensation, related person transactions, director independence and other corporate governance matters, and security ownership of officers and directors. The new rules include a sweeping overhaul of the disclosure requirements for executive compensation, intended to significantly improve the quality of this disclosure.

08-05-2006

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