The International Law Firm of Fulbright & Jaworski - Corporate Governance
Daniel James Pirolo, Stephen W. Sides, Rachel Green, Brian P. Teaff, Antony James Corsi and Jasper G. Taylor, III
March 7, 2011
- SEC Issues Guidance on "Say-on-Pay" Rules
- UK FSA Publishes Discussion Paper on Product Governance and Intervention
- COSO Report Says Risk Oversight by Boards Still Needs Improvement
- Delaware Chancery Court Affirms Use of Poison Pill by Airgas Board
- Delaware Chancery Court Enjoins Acquisition of Del Monte Foods Co. for Twenty Days to Reopen Auction
- Businesses Beware! IRS Proposed Regulation Increases Incentives for Tax Whistleblowers
On February 11, 2011 the SEC's Division of Corporation Finance issued several new interpretations of the "Say-on-Pay" rule, addressing how the rule is phased in for smaller reporting companies.
In one area, the SEC clarified that an issuer is not disqualified from the delayed phase-in period for say-on-pay if it does not consider itself a "smaller reporting company" in other periodic filings. The only determining factor in whether an issuer is a "smaller reporting company" for purposes of the delayed phase-in rules is its public float or annual revenue on the last business day of its second fiscal quarter in 2010.
When the say-on-pay rules were adopted in January 2011 as part of the Dodd-Frank Wall Street Reform and Consumer Protection Act, "smaller reporting companies" (e.g., issuers with a public float of less than $75 million) were exempted from the rules for a two-year phase-in period.
Due to natural fluctuations in public float, some issuers were not able to qualify for "smaller reporting company" status in other 2010 and 2011 periodic filings, such as Forms 10-K and 10-Q.
In its interpretive guidance, however, the SEC reaffirmed that even if such an issuer was not a "smaller reporting company" for purposes of these periodic filings, it will qualify for the two-year phase-in of the say-on-pay rules if was a "smaller reporting company" as of the last day of its 2010 second fiscal quarter.
The issuer is eligible for this status until the first day of its 2011 fiscal year.
Similarly, an issuer that did not qualify as a "smaller reporting company" on the last day of its 2010 second fiscal quarter, but has subsequently seen its public float fall below the $75 million threshold, is not eligible for the two-year phase-in period.
Read the SEC's interpretive guidance.
On January 25, 2011 the UK Financial Services Authority ("FSA") published a discussion paper on Product Intervention (DP11/1) to prompt debate on how the FSA should approach consumer protection in the context of financial service products (financial contracts for retail customers, such as bank accounts, mortgages, insurance, investments and pensions) and related services.
In the past the FSA has concentrated on point-of-sale issues (such as advice, sales practices and product disclosure).
However, in its discussion paper the FSA accepts that the point-of-sale approach has not been effective enough to enable the FSA to anticipate and prevent consumer detriment, rather than just react to it. It was for that reason, beginning in March 2010, that the FSA sought to take a more proactive role in the development of financial services products.
In the discussion paper, the FSA explains its progress made to date and the belief that increased and earlier use of its powers will assist in preventing consumer detriment.
The paper proposes a fundamental change "to a new and more intrusive approach to the regulation of retail financial products and services, aiming to ensure that potential consumer detriment problems are identified and offset at an early stage".
It outlines potentially radical product intervention options considered by the FSA, including: product pre-approval; product banning in cases where products have the potential to cause significant consumer detriment; price capping; and banning or mandating specific product features.
The FSA recognises that significant further debate is required on this topic, and that taking a more intrusive approach to product regulation "earlier in the value chain" will require a careful balance to be struck between effective consumer protection on the one hand, and the need to preserve consumer choice on the other.
The FSA acknowledges the importance of the debate in shaping the regulatory philosophy not only of the FSA, but also its proposed successor regulator, the Financial Conduct Authority, which the UK Government proposes will assume responsibility for promoting confidence in financial services and markets later this year.
The FSA also acknowledges that the debate has a wider, international context, as it is not the only regulator in the European Union with concerns about product governance.
The consultation period for the discussion paper ends on April 21, 2011.
The Committee of Sponsoring Organizations of the Treadway Commission ("COSO") issued a report in December 2010 indicating that while boards of directors of public and private companies have made some progress in their risk oversight role, many boards are not formally carrying out their risk management duties.
According to the report, which surveyed more than 200 current and former corporate board members across several industries, a "strong majority" of respondents believed that their boards were not conducting a "mature and robust" risk oversight function.
While large public companies showed the most improvement in risk management, the survey participants' responses to key questions indicated several areas that could use significant improvement.
First, the COSO report states that the robustness of risk oversight processes could be enhanced in several ways.
While most of the survey's respondents believed their risk oversight process is at least "effective," most also believed that the monitoring and reporting of risks should be more structured.
Less than 15% of the participants thought that their board was "fully satisfied" with these processes.
Respondents to the COSO survey also indicated that risk reporting to the board of directors, as well as monitoring of the risk management process, could be improved. Participants in the survey generally stated that analysis of external variables, limits of key risks, and shortcomings in managing key risks were not addressed on an annual basis. If such risks are not addressed at least annually, the report indicates, they may not be addressed at all.
Therefore, COSO believes that both public and private companies have an opportunity to improve their risk reporting processes and enhance the structure and regularity of such reporting.
Furthermore, half of the survey participants stated that their companies have no formal process to assess whether their risk management function is sufficiently funded. While this issue was not as significant at larger public companies, an "overwhelming majority" of respondents indicated that these processes could be improved.
Finally, the COSO report suggested that companies can do more to keep their boards apprised of significant risk, and that boards themselves could do a better job of self-evaluating their risk oversight performance. Relatively few organizations, the survey said, have a "defined and rigorous" method for reporting risks to the board.
Almost half of the respondents indicated that management does not have a process to ensure that deficiencies are remediated appropriately, and over one-third stated that their organization does not regularly assess "extreme high impact" events. Less than 10% of respondents believed that their board's self-evaluation process was robust and mature.
Based on the results of this survey, the COSO report contained several recommendations for improving boards' risk oversight effectiveness, including:
- implementing a more structured process for reporting risk to the board,
- focusing at least annually on how the company's business environment has changed and the risk that may have developed, and
- incorporating questions on risk oversight to the board's periodic evaluation of its performance.
Read the full COSO Report.
On February 15, 2011, the Delaware Court of Chancery declined to enjoin defensive measures employed by the board of directors of Airgas, Inc. ("Airgas") in resisting an attempted takeover by industrial gas rival Air Products and Chemicals, Inc. ("Air Products").
Air Products made its first hostile bid to acquire all of Airgas's shares in early 2010 for $60 per share. After months of talks between the companies about a possible negotiated acquisition or combination, Air Products' final tender offer was $70 per share, short of the $78 per share the Airgas board believed the company was worth.
The Airgas board unanimously rejected the bid, and deployed several defensive measures which Air Products alleged denied the Airgas stockholders the choice of whether to tender their shares. The defensive measures included a stockholder rights plan which triggers the issuance of new shares if a stockholder's ownership percentage exceeds 15%, or poison pill.
In addition, Airgas maintained a staggered board of directors, had not opted out of Delaware General Corporation Law § 203 (prohibiting business combinations with any interested stockholder for three years following the time that such stockholder became interested) and included a supermajority merger approval provision for certain business combinations in its Certificate of Incorporation.
Air Products and certain Airgas stockholder plaintiffs challenged these defensive measures. In deciding whether to enjoin the defensive measures, the Court stated that this case addressed the fundamental question of "who gets to decide when and if the corporation is for sale in the context of a hostile tender offer," and ultimately concluded that "the power to defeat an inadequate hostile tender offer ultimately lies with the board of directors."
Specifically, in concluding that the Airgas board had discharged its fiduciary duties under the Unocal standard, the Court found that the Airgas board had "articulate[d] a legally cognizable threat (the allegedly inadequate price of Air Products' offer, coupled with the fact that a majority of Airgas's stockholders would likely tender into that inadequate offer) and ha[d] taken defensive measures that fall within a range of reasonable responses proportionate to that threat."
While the Court cautioned that a board of directors cannot "just say never" to a hostile tender offer, a board that acts in good faith, and concludes that a hostile tender offer poses a legitimate threat to the corporate enterprise after reasonable investigation and in reliance on the advice of outside advisors, may deploy defensive measures including a poison pill and staggered board of directors in response to that hostile offer.
Air Products withdrew its tender offer to acquire Airgas immediately after the case was decided. The opinion is styled Air Products & Chemicals, Inc. v. Airgas, Inc., C.A. No. 5249-CC (Del. Ch. Feb. 15, 2011).
Delaware Chancery Court Enjoins Acquisition of Del Monte Foods Co. for Twenty Days to Reopen Auction
On February 14, 2011, the Delaware Court of Chancery enjoined the shareholder vote of the leveraged buyout of Del Monte Foods Co. ("Del Monte"), as well as the deal protection measures employed by the buyers.
The Del Monte board of directors had been exploring the possibility of a potential sale of the company, but called off its process in early 2010. However, the Court found that its investment banker continued discussions with certain bidders, resulting in a $19 per share joint offer from two bidders in late 2010.
Before an agreement was reached on price, Del Monte's investment banker reached an agreement to provide buy-side financing. As a result, Del Monte was forced to engage another investment banker to provide a non-conflicted fairness opinion.
Nonetheless, once a deal was in place, including a go-shop provision, termination fee, and matching rights, Del Monte's original investment banker was charged with managing the go-shop process.
The Court expressed significant concern with the investment bank's efforts, including the cooperation with two bidders to form a joint bid without consulting the Del Monte board, the decision to seek to offer buy-side financing while advising the board, and running the go-shop process while standing to benefit from significant fees related to the buy-side financing.
In addition to the direct criticisms of the investment bankers, the Court found that "the buck stops with the Board." After concluding that the Board failed to "take an active and direct role in the sale process," the Court enjoined the shareholder vote and enforcement of the deal protection mechanisms for twenty days in order to reopen the auction for potential topping bids.
The opinion is styled In re Del Monte Foods Co. S'holders Litig., C.A. No. 6027-VCL (Del. Ch. Feb 14, 2011).
Businesses beware! Tax whistleblowers now have an increased incentive to reveal a taxpayer's confidential information to the Internal Revenue Service ("IRS"). In Proposed Treasury Regulation § 301.7623-1(a) (REG-131151-10) (the "Proposed Regulation"), the Department of the Treasury has expanded the circumstances in which a tax whistleblower can collect an award for providing information to the IRS.
Because the Proposed Regulation provides increased incentives for tax whistleblowers, businesses should take additional measures to protect themselves.
Authority for Payments Made to Tax Whistleblowers
Under Internal Revenue Code Section 7623(a), the IRS is authorized to pay a tax whistleblower such sums as it deems necessary for detecting underpayments of tax or detecting and bringing to trial and punishment persons guilty of violating the internal revenue laws or conniving at the same, in cases where such expenses are not otherwise provided for by law.
Any amount payable under Section 7623(a) is to be paid from the proceeds of amounts collected by reason of the information provided, and any amount so collected is to be available for such payments. Since December 20, 2006, the Whistleblower Office has had the responsibility for the administration of the enforcement of awards made under Section 7623.
Subject to exceptions, Section 7623(b)(1) authorizes the IRS to pay awards between 15 and 30 percent of the collected proceeds (including penalties, interest, additions to tax and additional amounts) to a tax whistleblower if the IRS proceeds with an administrative or judicial action that results in collected proceeds based on information provided by the whistleblower.
An action is based on information provided by the tax whistleblower if the IRS would not have acted but for the receipt of the whistleblower's information.
To be eligible to collect an award for providing information about a business taxpayer, a tax whistleblower must provide the IRS with information that leads to an administrative or judicial action involving more than $2 million (including tax, penalties, interest and additional payments).
Proposed Regulation Expands Circumstances in Which Tax Whistleblowers Can Collect an Award
Under the current version of Treasury Regulation § 301.7623-1(a), award payments are tied directly to the additional taxes that the IRS receives as a result of a tax whistleblower's information. Thus, a tax whistleblower is eligible to receive an award only if the information results in the IRS collecting additional taxes.
For example, a tax whistleblower would not be entitled to receive an award if the information provided merely resulted in the IRS denying a false refund claim or a reduction of an overpayment credit balance.
The Proposed Regulation changes this result by clarifying that for purposes of Section 7623, both proceeds of amounts collected and collected proceeds include: tax, penalties, interest, additions to tax, and additional amounts collected by reason of the information provided; amounts collected prior to the receipt of information if the information provided results in the denial of a claim for refund that otherwise would have been paid; and a reduction of an overpayment credit balance used to satisfy a tax liability incurred because of the information provided.
It is anticipated that tax whistleblower claims against large corporate and institutional taxpayers may increase in light of the Proposed Regulation and the enhanced awareness of the tax whistleblower program.
Such taxpayers should be aware of the Proposed Regulation and develop policies and procedures to address the enhanced possibility of future whistleblower claims.
The Proposed Regulation would be effective for any awards paid after the final regulations are published in the Federal Register. The Department of the Treasury and the IRS requested comments on the clarity of the Proposed Regulation and how it may be made easier to understand.
A public hearing may be scheduled if requested by a person timely submitting written comments, and comments must be received by April 18, 2011.
Daniel James Pirolo
Stephen W. Sides
Brian P. Teaff
Antony James Corsi
Jasper G. Taylor, III