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Duane Morris, LLP

Stock Options Backdating Controversy Raises Issues
One of the dominant stories of late in the equity compensation area is the revelation by numerous companies that they are being investigated, by the government or in internal investigations, in the fast-spreading controversy generally referred to as ""stock option backdating."" Every day, it seems, additional companies announce the receipt of subpoenas or the commencement of internal investigations regarding their stock option grant practices. Moreover, several senior executives have already been terminated or forced to resign for their role in such practices. The government investigations are being separately pursued by the U.S. Securities and Exchange Commission (SEC) and the U.S. Department of Justice and it appears likely more companies will be targeted.

In addition to the governmental investigations, numerous civil suits have been filed against companies and their officers and directors, alleging breach of fiduciary duty, and several senior executives have already been terminated or forced to resign due to their roles in option grant practices. The Internal Revenue Service has also indicated that, due to the significant tax effects that option backdating can have, it likely will also investigate these situations.

The investigations, and companies' disclosures that their practices were being scrutinized, were initially fueled by numerous stories in the press exposing unusual correlations between option grant dates at certain companies and the date on which the companies' stock reached relatively low trading prices. The question to be answered by these investigations is whether corporations used stock option grants to improperly enrich their senior executives. These investigations focus on two main issues: (1) whether options were ""backdated,"" or granted retroactively as of a date when the stock price was low, creating a built-in profit, and (2) whether options were granted immediately before corporate announcements that were likely to increase the price of the shares.

Consequences of Investigations

The issues raised by these numerous investigations include tax, accounting, securities law disclosure, corporate governance and insurance issues. Key implications include:

Accounting Issues: Prior to certain recently adopted rules, if an option was granted with an exercise price at or above the market price at the date of grant, the company was not required to recognize that grant as an expense. Thus, by backdating an option, a company could preserve this ability to avoid a compensation expense. Even under the new rules, backdating an option could substantially lower the expense the company must recognize. The failure to have properly accounted for this expense could require a company to restate its financial statements.

Securities Law Disclosure Issues: Failure to have disclosed backdating conduct in a company's SEC filings could mean that the company's disclosures concerning its executive compensation were inadequate or contained misstatements, potentially leading to liability for securities violations.

Corporate Governance: Backdating conduct may raise a question as to the authority to grant the options, particularly if the plan under which the options were granted does not permit the grant of ""discounted options."" This question becomes more pertinent if shareholder approval for the issuance of such stock options is required by the company's state of incorporation.

Employee and Company Tax Issues: An award of an in-the-money stock option may create unfavorable tax consequences for the employee and could create a withholding obligation and corresponding liability for the company. It could also result in the company losing a deduction for the compensation expense when the option is exercised. Further, at-the-money options are considered performance-based compensation and can therefore be deducted for tax purposes even if executives are paid in excess of $1 million. However, if the options were effectively in-the-money on the decision date, they might not qualify for such tax deductions. Additionally, incentive stock options must be granted at an exercise price at or above the market price at date of grant; an option which has been backdated to try to meet this requirement would not be eligible for favorable incentive stock option treatment. Also, a backdated option, whether incentive or non-qualified, could be subject to rigid exercise rules or an additional 20 percent excise tax.

Insurance Coverage: Companies may need to notify their directors and officers (D&O) liability insurance carriers of potential backdating issues, to preserve claims under the policy for costs incurred due to an investigation or shareholder action.

Because of the potential liability involved (both civil and criminal), companies that suspect backdating conduct may have occurred need to evaluate the numerous compliance issues and may want to consider promptly consulting counsel. Boards of directors may want to seek independent counsel to discuss potential issues involved.

If a company determines that backdating conduct has occurred and material problems are present, it may want to initiate a plan for self-correcting. The SEC tends to be receptive to companies that self-identify and any consequences that may be forthcoming would likely be less burdensome if a company is proactive rather than reactive, especially in a situation where it is faced with a subpoena or shareholder lawsuit.

Any company that issues stock options may want to undertake a complete review of its compensation practices and procedures, including the award of stock option grants. This review should include all of the issues addressed above.

About Duane Morris

In response to the stock option backdating controversy, Duane Morris LLP has formed a multidisciplinary team of lawyers with experience in the following areas to assist companies that either are involved in an investigation or would like to perform an internal review of their practices: corporate compliance, securities law compliance, employee benefits and executive compensation, internal investigations, white-collar criminal defense and securities litigation.

Our multidisciplinary team assists clients with respect to (1) internal audits of stock option pricing and grant practices, (2) employee benefits and executive compensation practices, (3) SEC enforcement defense, (4) securities litigation defense, (5) insurance recovery, (6) white-collar criminal defense and (7) tax matters.

08-04-2006

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Dorsey & Whitney, L.L.P.

US Souring on SOX? New Treasury Secretary Warns that Sarbanes-Oxley Is Hurting US Competitiveness
Hank Paulson, the former head of Goldman Sachs worldwide who left that position last month to become the new US Secretary of the Treasury, has used the occasion of his first public address as Secretary to suggest that the US Sarbanes-Oxley Act of 2002 has caused too much damage to US competitiveness internationally and should be revised.

Early in his speech, Paulson noted that the US had taken ""corrective measures to address corporate scandals and increase investor confidence"" following the Enron and WorldCom failures. But, he added, ""often the pendulum swings too far"". He said that the US now needed to follow its initial corrective measures with ""a period of readjustment"", and that ""the challenge"" facing the US is ""to achieve the right regulatory balance to allow us to be competitive in today's world"".

The Secretary of the Treasury has no authority to amend SOX or the rules that have been promulgated under it, and he has no authority over the US SEC or the PCAOB (Public Company Accounting Oversight Board), the new agency that drafts SOX auditing rules. Changes to SOX must be made principally by the US Congress, which itself wrote most of the detail in SOX about which non-US companies complain.

Nevertheless, the person serving as Treasury Secretary is usually listened to carefully by US legislators and regulators when speaking on broad policy issues. And, this particular Treasury Secretary will likely be listened to even more closely, due to his personal background as a top international financier and his position as a late entry in the Bush cabinet charged with finding solutions to a number of economic issues that are currently worrying Washington.

Paulson's swipe at SOX is part of a general concern in the US that may soon lead to real efforts to change the law. The US has its next Congressional elections in November 2006, at which time both Senator Paul Sarbanes and Representative Mike Oxley, the sponsors of the law, plan to retire from office. The Congress that meets following this election will likely be more open to amending the statute, which at that time will be over four years old and will have generated a substantial track record that should help SOX critics argue for meaningful revisions. And, at that time, Hank Paulson should still be Treasury Secretary.

08-04-2006

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Dorsey & Whitney, L.L.P.

SEC Revises Executive Compensation Disclosure Rules
Yesterday, the SEC approved amendments to the executive compensation disclosure rules. See the SEC's press release available on its website here: http://sec.gov/news/press/2006/2006-123.htm.

The final rules also amend the disclosure requirements for related party transactions, director independence and other corporate governance matters and security ownership of officers and directors. In addition, the new rules modify Form 8-K requirements for disclosing new or amended executive employment arrangements.

The new rules will be effective for proxy statements and Forms 10-K for fiscal years ending on or after December 15, 2006. For Forms 8-K, compliance will be required for triggering events that occur 60 days or more after publication of the final rules in the Federal Register.

The final rules have not yet been published. According to the SEC’s press release and the discussion at the SEC meeting yesterday, the final rules will be substantially as proposed earlier this year, with a few important changes. In particular:

The so-called ""Katie Couric"" disclosure requirement—requiring companies to disclose the titles and pay of up to three additional highly paid non-executive employees—was not included in the final rules. Instead, the SEC will re-propose revised rules for public comment. The revised rule proposal would apply only to large accelerated filers and would exclude employees that have no responsibility for significant policy decisions within the company or a significant subsidiary or business unit.

The SEC approved new requirements for disclosing option grant practices and policies, requiring that companies disclose more about the timing of option grants and the setting of exercise prices. Specifically, companies will need to disclose the closing market price of the stock on the option grant date if higher than the exercise price. They will also need to disclose if the date action was taken to approve the grant is different than the stated grant date. As previously proposed, companies will need to disclose the fair value of the option grant as determined under FAS 123R. This new disclosure will be reflected both in the tables and in the Compensation Discussion and Analysis section, or CD&A. The CD&A requirements have been expanded to require companies to disclose clearly their practices and procedures for timing option grants and setting exercise prices, including whether options were granted to executives before the release of material non-public information. The SEC’s final rule release will include guidance for companies on this disclosure.

The SEC retained the existing requirements for a performance graph and compensation committee report, albeit in revised form. Under the final rules, the performance graph will be moved from the proxy statement to the annual report to shareholders under Regulation S-K Item 201. The compensation committee report will be different in scope and will contain a statement as to whether the compensation committee has reviewed and discussed the CD&A with management and recommended that the CD&A be included in the company’s annual report on Form 10-K and proxy statement. While the revised compensation committee report will be ""furnished"" to the SEC (as is currently the case), the CD&A will be required to be ""filed"" as previously proposed. As a result, the CD&A will be subject to the liability and disclosure requirements of the federal securities laws, including the CEO and CFO certification requirements.

A separate column in the summary compensation table will report the annual change in the actuarial present value of accumulated pension benefits and above-market or preferential earnings on nonqualified deferred compensation, so that these amounts can be deducted from total compensation for purposes of determining the named executive officers, or NEOs. The final rules will continue the practice under current rules of only requiring disclosure of above-market or preferential earnings on deferred compensation accounts in the Summary Compensation Table, rather than all earnings, as previously proposed. However, the Nonqualified Deferred Compensation Table will require disclosure of all earnings, as previously proposed.

The Pension Benefits Table will require disclosure of the actuarial present value of each NEO's accumulated benefit under each pension plan, computed using the same assumptions (except for the normal retirement age) and measurement period as used for financial reporting purposes under GAAP, rather than disclosure of the estimated annual retirement payments, as previously proposed.

The columns of the Summary Compensation Table were revised to place the Total Compensation column on the far right and to add the new column described above. The SEC attached a form of this table to its press release linked above.

Conclusion

The new rules are designed to bring greater transparency to the disclosure of executive compensation and attempt to strike a balance between ""rules-based"" disclosure requirements (aimed at encouraging comparability of disclosure from company to company) and ""principles-based"" requirements (aimed at flushing out all elements of compensation at a particular company regardless of how they may be categorized). The SEC has been clear that companies that hide or mislead investors about their compensation practices will be subject to enforcement action. In this environment, boards, compensation committees and management will need to prepare executive compensation disclosure thoughtfully and carefully—using solid disclosure controls and procedures—to ensure that they are providing a complete, accurate and timely description of their compensation programs, practices and procedures.

08-04-2006

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Stinson, Morrison & Hecker, L.L.P.

Security Breach Laws: Disclose and Tell
Before long, we all may have our personal data wrongly disclosed.

As published in the July issue of the Ingram's magazine. Posted with permission.

Security Breach Laws: Disclose and Tell
Kansas City Partner Tim Feathers examines the security breach/notification laws that 33 state have recently passed, and he offers how companies can best comply with these laws and secure their data. The article appeared in the July issue of the Ingram's magazine.

08-04-2006

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Mayer Brown LLP

Mayer, Brown, Rowe & Maw advises Corona Energy Holdings on its sale
Mayer, Brown, Rowe & Maw LLP has advised the shareholders of Corona Energy Holdings Limited (""Corona"") on their agreement to sell the entire issued share capital of Corona to Macquarie Bank. The agreement is subject to EU approval.

Based in London, Corona is the UK's largest independent supplier of gas to industrial and commercial customers in the United Kingdom.

The Mayer, Brown, Rowe & Maw team was led by corporate partner Robert Hamill assisted by Duncan Wilson. Competition partner Gillian Sproul and tax partner Peter Steiner also advised on the sale.

Henry Davey of Herbert Smith acted for the purchaser.

08-04-2006

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Mayer Brown LLP

Mayer, Brown, Rowe & Maw LLP leads expert training for packaging industry
Mayer, Brown, Rowe & Maw LLP's Brussels regulatory practice group has been invited by Emap to conduct a two-day workshop on EU and US law affecting the packaging industry in late September. The workshop, to be held in Cambridge, UK, on 26 and 27 September 2006, will be conducted by Dr. Anna Gergely, principal scientific and regulatory advisor, and Sébastien Louvion, senior associate. The program will provide in-depth legal analysis and practical advice on establishing compliance with EU and US regulation of food contact materials, EU regulation of drug packaging materials, and EU regulation of water pipes.

Emap plc is a UK-based media company with activities in the UK, France and around the globe including radio stations, TV channels, advertising, conferences, and a wide portfolio of consumer and business magazines, including European Plastics News and Plastics and Rubber Weekly, two sponsors of the Cambridge workshop.

08-04-2006

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Seyfarth Shaw LLP

California Supreme Court Enforces Proposition 64's Limitations on Who Can Sue Under California's Unfair Competition Statute
California's Unfair Competition Law (UCL), which has historically been a boon for plaintiffs lawyers bringing overtime and discrimination claims, was narrowed significantly on July 24, 2006.

08-04-2006

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