Small Public Company Forum

Most calendar-year companies are preparing to file their 10-Ks soon, if they have not already done so. Here are three basic things to make sure you double check:

• The Economy: We’re officially out of the recession (we’re told), but the economy is in a peculiar state, with the recovery not exactly “roaring” and unemployment remaining high. If your annual report from last year is similar to most, there will have been some discussion about the economic outlook and the relationship to your business and future prospects. Most likely, these discussions are to be found in your “Business Description,” your “MD&A” section and your “Risk Factors.” Prior to filing, you should go back and review these portions of your draft 10-K and update as appropriate given the new state of the economy. For clients I have been working with, last year’s disclosures about the poor state of the credit markets (which affected their growth strategy and their sources of liquidity) needed revising, and disclosures about the impact of high unemployment required some mild updating.

• Sources of Liquidity: Last September, the SEC published guidance on the presentation of liquidity and capital resources disclosures. Prior to filing your 10-K, you should consider reviewing this guidance. To summarize, the guidance stresses the importance of:

• identifying and separately describing each internal and external source of liquidity and any material unused sources of liquidity

• disclosing known trends and uncertainties (such as economic trends and uncertainties) that have historically impacted results or are likely to shape future periods, and analyze the same from the perspective of management

• disclosing your financing arrangements during the period and their impact on your liquidity; in particular, if your financing arrangements differed from your period-end presentation on your balance sheet, variations in this arrangements should be discussed to the extent material to an understanding of your liquidity position.

A link to the SEC’s guidance can be found here: www.sec.gov/rule.

• It’s March 23rd — Do You Know Where Is Your Stock Is Quoted?: An interesting development was reported on The Corporate Counsel blog yesterday (see: thecorporatecounsel.net) (ascribing credit to Bob Dow of Arnall Golden Gregory). Essentially, recently a large number of companies have exited from the OTC Bulletin Board (OTCBB) involuntarily. Most of these companies appear to now have their common stock quoted on OTCQB platform, which is an over-the-counter market operated by the organization formerly known as “The Pink Sheets,” and now known as “OTC Markets.” In some cases, the departure of a company’s stock quotation from the OTCBB was described as being due to “failure to comply with Rule 15c-2,” which is a rule relating to minimum quotation activity. As Mr. Dow points out, some may mistake a removal so described as involving some kind of violation of securities laws by the company. Probably compounding the problem, in 2010 FINRA (which administers the OTCBB) increased the fees it charges market makers to quote stocks on the OTCBB to $6 per security per month. So, from the combined result of 15c-2 removals and increased costs to market makers, many low-price and low-volume stocks in particular have been shuttled by their market makers over to the OTCQB – in some cases without the company even knowing about it! Mr. Dow and Corporate Counsel estimate that this has happened to more than 800 companies previously listed on the OTCBB. The most recent list of deletions is here: www.otcbb.com. If you have historically been an OTCBB-quoted company, you should confirm whether your common stock remains listed on the OCTBB prior to filing your 10-K.

The Directors Roundtable Institute has set the new date for its seminar, “Practical Information and Discussion on Challenges Public Companies Face Under the Dodd-Frank Act.”  The seminar is tailored to boards of directors and their advisers.  Consider attending.

The new date is Tuesday, April 12, 2011 from 8:30 am – 11:00 am at Windows on Minnesota (IDS Center), 80 South Eighth Street, Minneapolis, Minnesota.  Registration begins at 8:00 a.m.

Joan McKown, Partner at Jones Day and Former Chief Counsel of the Division of Enforcement, SEC (1993-2010) replaces Charles Kerstetter on the panel originally scheduled.  The rest of the panel remains as originally assembled (see below).

I hope to see you there.  Again, many thanks to my friend Rachel Polson from Baker Tilly Virchow Krause, LLP for alerting me to this event.  A link to the invitation appears below:

Invitation

Credit to Rachel Polson, audit partner with Baker Tilly Virchow Krause, LLP

This posting results from a series of posts and responses in the blogosphere regarding what a board should recommend when it comes to the “frequency vote” (the say-on-pay shareholder advisory vote) this proxy season.  Some context for this blogospheric brouhaha is in order:

First, Mark Borges and Broc Romanek, both of whom are greatly respected and tireless contributors to (among other fabulous resources) the Proxy Disclosure Blog and Advisors Blog, respectively, contained on the CompensationStandards.com subscription website, took the position that by and large, given the results of frequency votes thus far, there is no reason to make a triennial vote recommendation.  Broc went so far as to write:  “I’m not sure why companies continue to recommend triennial now that the early meeting results bear out that shareholders will often reject that frequency . . . . It’s a reminder of what shareholder engagement is all about – listen to your shareholders and act on what they say.  Clearly, many companies are choosing to operate in a bubble.”

Next, certain bloggers broke ranks with Borges and Broc—among them, my colleague Marty Rosenbaum (www.onsecurities.com)—writing that:

“The board should make recommendations based on its judgment about what is in the best interests of the company and its shareholders, after considering all relevant factors. For a company with stable management, sound pay practices and a long-term perspective on compensation, the board may legitimately believe that a triennial vote is the best option. And some large shareholders, notably the United Brotherhood of Carpenters, BlackRock Institutional Trust Company and Wellington Management Company, agree with this approach and will generally favor a triennial vote. Should the board ignore their viewpoints, especially if they are large shareholders?“

I largely echo the sentiments expressed by Marty Rosenbaum. I believe it is a mistake for the board to make frequency suggestions based entirely, or even significantly, on the likely outcome of the vote.  Instead, and like any other act of the board, the board’s decision to make a frequency recommendation should be made in light of the directors’ fiduciary responsibilities and duties.  In this regard, it is worth remembering that Delaware and most other state law provides that a director’s duty is owed to the corporation itself—not to the shareholders (See, e.g., Del. Stat. §145; Minn. Stat. §302A.251; Nev. Rev. Stat. §78.138).  As business lawyers know from our days in law school, a corporation is composed of many constituents of which the shareholders are just one—an important one to be sure, but again, just one constituent.  Furthermore, nothing in the SEC’s frequency-vote rules appears to change the standard upon which directors should make their frequency-vote recommendation.  In sum, the relevant standard is not “what is in the best interests of the shareholders?”

Therefore, it appears wrong for the board to approach this decision and recommendation any differently than any other decision it makes.  The board must seek the answer to the question: “what is in the best interest of the corporation?”  In this regard, the board, and the board alone, is in the best position to evaluate this complicated question and express its considered business judgment.  The board, for example, has access to information (and higher quality information) that none of the other corporate constituents have.  The frequency vote is, after all, an advisory vote for this very reason.  Input from the shareholders is helpful and informative; it is not, however, a directive.

As Marty rightly points out, there may be situations in which a triennal recommendation would be difficult to justify (e.g., after or with impending management changes or other kinds of corporate instability).  Furthermore, if a board has done its homework and is cognizant of the prevailing winds, a shareholder advisory vote for annual say-on-pay frequency, made in the face of a triennial board recommendation, should be no reason for panic:  the SEC’s final advisory-vote rules give public companies 150 days after the annual meeting to report a final decision on frequency.

In upcoming posts, I plan to offer a matrix of considerations for a board when determining what frequency to recommend and, in light of 10-Ks being due for calendar year reporting companies, a brief revisit of the SEC’s guidance on MD&A liquidity disclosures from last fall.

Submitted by:  Paul Chestovich, Maslon Edelman Borman & Brand, LLP

I’ve just learned that the SEC speaker is unable to attend tomorrow’s program, “Practical Information and Discussion on Challenges Public Companies Face under the Dodd-Frank Act.”  The hosts plan to reschedule the program, and I will let you know when more information is available.

On Tuesday, February 15, 2011, The Directors Roundtable Institute will host a seminar tailored to boards of directors and their advisers that you should consider attending.  The seminar is called “Practical Information and Discussion on Challenges Public Companies Face Under the Dodd-Frank Act.” 

The seminar is being held from 8:30 am – 11:00 am at Windows on Minnesota (IDS Center), 80 South Eighth Street, Minneapolis, Minnesota.

An impressive panel of presenters has been assembled for this event, including Professor John Matheson, my contracts professor from the University of Minnesota Law School.  Professor Matheson is always informative and entertaining.  Also among the presenters are Peter Keller (CPA) from Baker Tilly Virchow Krause, LLP (a co-founder and sponsor of the Small Public Company Forum); Charles Kerstetter from the SEC’s Division of Enforcement (Chicago office); Trevor Gunderson, Vice President and Associate General Counsel from General Mills; and Joy Newborg and Philip Colton from the law firm of Winthrop & Weinstine.

I plan on attending and hope to see you there.  Many thanks to my friend Rachel Polson from Baker Tilly Virchow Krause, LLP for alerting me to this event.  A link to the invitation appears below:

Invitation

Posted by Paul Chestovich

Credit to Rachel Polson, audit partner with Baker Tilly Virchow Krause, LLP

Borne of the recent recession and post-recession obsession with risk, risk oversight and risk abatement, one of the more befuddling SEC disclosure requirements for public companies, and smaller reporting companies in particular, is the new SEC rule requiring that proxy statements contain the “risk oversight” disclosure described under Regulation S-K, Item 407(h) as follows:

Briefly describe the leadership structure of the registrant’s board, such as whether the same person serves as both principal executive officer and chairman of the board, or whether two individuals serve in those positions . . . .  This disclosure should indicate why the registrant has determined that its leadership structure is appropriate given the specific characteristics or circumstances of the registrant.  In addition, disclose the extent of the board’s role in the risk oversight of the registrant, such as how the board administers its oversight function, and the effect that this has on the board’s leadership structure. (italics added)

It is easy for officers and directors, busy with running a business operation, to react negatively or carelessly to this requirement.  For example, it is easy for companies to respond to the first part of the disclosure requirement regarding the separation of board and CEO functions, and then summarily ignore the last sentence (italicized above).  On the other end of the spectrum, some companies reactively form a “risk oversight committee,” or schedule inordinate time or entire meetings, for the purpose of reviewing risks facing the company.

Below are some simple bullet points designed to give smaller reporting companies in particular some sense of direction when considering how to respond to these requirements through policy/practice changes and preparing the actual narrative disclosures in their public filings:

• Don’t overreact.  A public company board of directors and its committees cannot, and should not, be involved in day-to-day risk management, and similarly should not concern themselves with risks that are not material to the business.  Analysts have pointed out that the Board’s function should be risk “oversight” rather than risk “management”.  Case law relating to the fiduciary duty of care directors owe to their companies consistently supports this approach.  Enterprise risk management should focus on those risks that are likely, if they should come to pass, to adversely and materially affect key elements of success in your business.
• The “Whos” and the “Whens”.  Think carefully about who on the board should be providing risk oversight function.  For the risk oversight structure, it would rarely be desirable to have a chairman/CEO leading this effort (although involvement will be important).  For many companies, no new committee will be necessary – the entire board or the audit committee, whose functions already include the oversight of financial and disclosure related risk, will be an appropriate choice.  Depending on the number, nature and magnitude of risks, and the stage of development in which your company is in, you may reasonably decide to review risk-related matters at a board level anywhere from once per year to quarterly.
• What are they doing?  Meetings or discussions designed to oversee risks should involve, at least in part, management personnel whose job it is to actively monitor and manage those risks.  The board should determine what management is doing about identified risks, how it may be attempting to identify additional risks, and whether actions are consistent with prior directives of the board.  In those conversations, the board should speak with a clear voice so as to effectively communicate to management its wishes, directives and concerns. The minutes of Board meetings should reflect that the Board did its job in examining the risk management process, including asking questions of management, without focusing on the details of specific questions and answers.
• Other Resources.  Your management and board personnel may not have the experience or skills to effectively identify all material risks.  Other risks may be legal or regulatory, scientific, or accounting-based.  It is entirely appropriate to solicit from these types of professionals (most likely outside of the boardroom meeting) updates and ideas on new or developing potential risks and what, if anything, might be done.
• Culture.  To the extent the board of directors may wish to exert influence over day-to-day risks, it would ordinarily be advisable to accomplish this through discussions with executive management designed to satisfy the board that day-to-day practices and policies, and overall messages and corporate culture, are consistent with the company’s overall risk tolerance as agreed upon by the board.
• Don’t forget compensation.  The “compensation risk assessment” disclosure technically does not apply to smaller reporting companies.  See Regulation S-K Item 402(s).  Nevertheless, when crafting agenda for the board or committee that oversees or will oversee enterprise risk management, compensation risk should not be ignored.  This is one area where the board itself does make direct decisions that may impact risk taking by executives and the company.

The National Association of Corporate Directors publishes reports containing suggested best practices for board oversight of risk management.  Public companies and their boards of directors may wish to refer to this resource and others, as well as their legal advisers, accountants and internal controls professionals, as they periodically revisit and re-craft the manner in which they oversee risk management.  Legal advisers should definitely be consulted in preparing proxy statement disclosures designed to comply with Regulation S-K Item 407(h).

The SEC Staff has published a presentation called “SEC Staff Review of Common Financial Reporting Issues Facing Small Issuers.”  The presentation is similar to the document issued in 2009. 

As noted in the presentation overview, the purpose of the document is to provide a sample of issues that the SEC Staff of the Division of Corporation Finance frequently encounter when reviewing filings for smaller public companies as well as an overview of developments with the Division.

It is suggested that chief financial officers and controllers of smaller reporting companies review the presentation and consider the guidance as applicable to the company’s upcoming Form 10-K filing for 2010.

The presentation includes updates on the following:

1. Key SEC developments
2. SEC comment letter process
3. Detailed comments related to financial reporting issues (i.e., MD&A disclosures, business combinations, equity transactions, revenue recognition, etc.)
4. Internal control over financial reporting
5. Form 8-K, and
6. Resources for companies to contact for assistance within the SEC.

Link to the SEC presentation.

Submitted by Rachel Polson, audit partner with Baker Tilly Virchow Krause, LLP

The Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Act”), enacted on July 21, 2010, imposed several new requirements on public companies relating to executive compensation and corporate governance.  Among other things, the Act requires public companies to hold several types of shareholder advisory votes on executive compensation, starting in 2011.  On October 18, 2010, the SEC issued proposed rules to implement these requirements of the Act and expressed its intent to adopt final rules sometime between January and March 2011.  Even though the SEC was authorized to exclude smaller companies or other categories of companies from the application of these requirements, the SEC declined to do so.  Therefore, the advisory vote requirements will apply to smaller reporting companies as well as larger companies, unless the SEC changes its approach before the rules become final.

The following is a brief summary of the new requirements, followed by some “Frequently Asked Questions” about the “frequency vote” in particular, together with some general considerations to weigh when deciding what frequency to recommend to shareholders in your proxy materials.

SUMMARY

Key provisions in the Act’s advisory-vote requirements, as interpreted by the proposed SEC rules:

• Say-on-Pay Vote:  Public companies must hold a non-binding shareholder vote on executive compensation (the “Say-on-Pay vote”) at the first annual meeting on or after January 21, 2011.  Pursuant to this vote, shareholders will be asked to approve the executive pay described in the proxy statement (including the compensation tables and any narrative disclosure in the proxy statement).  This vote must be held no less frequently than once every three years.
• Frequency Vote:  Also, at the first annual meeting on or after January 21, 2011, public companies must hold a separate non-binding vote (the “frequency vote”) in which shareholders will express their opinion on whether the Say-on-Pay vote should be held annually, biennially, or triennially.  The frequency vote must be held at least once every six years.  After their annual meetings, companies must disclose on Form 10-Q whether they will abide by the shareholders’ preference on frequency.
• Requirements Not Subject to Adoption of Final SEC Rules:  The above requirements to hold the Say-on-Pay vote and the frequency vote at the first annual meeting on or after January 21, 2011 are effective regardless of whether the final SEC rules have been adopted.
• Parachutes Disclosure and Say-on-Parachutes Vote:  The proxy materials to approve any merger, sale of assets or similar transaction must include enhanced disclosure of the “golden parachute” compensation to executives related to the transaction, including a table and narrative disclosure.  The proxy materials must also include a separate shareholder advisory vote on the parachute compensation (the “Say-on-Parachutes vote”), unless the enhanced disclosure was part of a prior Say-on-Pay vote and there are no new arrangements.  In contrast to the Say-on-Pay vote and the frequency vote, the parachutes disclosure and Say-on-Parachutes vote requirements are not effective until the final SEC rules go into effect.

Frequency Vote FAQs

What must be covered by the frequency vote?

The frequency vote, which some have called the “Say-When-On-Pay” vote, must allow shareholders to express their opinion on whether the Say-on-Pay vote should be held every one year (annual), two years (biennial) or three years (triennial).  Proposed SEC rules require that shareholders be offered four choices on the company’s proxy card – annual, biennial, triennial, or a vote to abstain.  The SEC has proposed an amendment to Rule 14a-4 to permit the form of proxy cards to conform to these four choices.  Currently, on any vote other than the election of directors, the rule requires three choices (for, against or abstain). However, the proposing release confirms that the SEC will not object if shareholders are offered the four choices on the proxy card in the frequency vote, even before Rule 14a-4 is amended.

What if we can’t accommodate a vote with four possible choices in 2011?

The SEC’s proposing release highlights a possible logistical problem with the frequency vote in the coming year.  The SEC acknowledges that Broadridge and other service providers may need to reprogram their systems before they can handle a vote with four choices.  As a transitional matter, the SEC has stated that until the final rules go into effect next year, it will not object if companies offer only three choices (annual, biennial or triennial), without offering an “abstain” alternative.  Broadridge recently said it would be ready to handle four choices for 2011 shareholders meetings.

How often does the frequency vote need to be taken?

Under the Act, the frequency vote must be held no less often than once every six years. 

Does the frequency vote have any binding effect?

The frequency vote is a non-binding advisory vote, similar to the Say-on-Pay vote.  However, in the proposed rules, the SEC has created consequences for companies that do not abide by the preference expressed by the shareholders.  In this regard, the rules will amend Form 10-K and 10-Q to require that a company disclose its decision on how frequently it will conduct the Say-on-Pay votes in light of the results of the shareholder frequency vote.  This disclosure will be required in the filing for the quarter in which the frequency vote occurred.  If the company does not adopt a policy consistent with the results of the shareholder frequency vote (determined on a plurality vote basis), then proposed amendments to Rule 14a-8 will allow shareholders to introduce their own proposals on the frequency of Say-on-Pay votes and the company would not be permitted to exclude any such proposals.

WHAT FREQUENCY TO RECOMMEND?

Many companies will take the position that a triennial vote is preferable because they will want to avoid the effort, expense and disruption of holding a Say-on-Pay vote every year or every two years.  Further, some commentators have favored a triennial vote because it can encourage shareholders to take a long-term (as opposed to a short-term) view of compensation matters, and many companies have long-term incentive compensation plans that include 3-to-5 year measurement periods.  A triennial vote would also provide companies and their compensation committees with the most time to thoughtfully react to the results of advisory Say-on-Pay votes.

Nevertheless, annual Say-on-Pay votes can have advantages in some cases, and companies should consider their current relationships with shareholders and other factors.  For example, annual Say-on-Pay votes would give shareholders a regular means of expressing disenchantment with the company’s pay practices without feeling as though they have to vote against individual directors, or against a resolution to authorize a new or expanded equity compensation plan.  In addition, an annual frequency vote may become routine and efficient and be viewed as “pro-shareholder.”

Companies should attempt to determine the preferences, if any, of their large shareholders.  Anecdotally, many shareholders prefer annual votes, and Institutional Shareholder Services (ISS) recently stated its position that it will support annual Say-on-Pay votes.  However, some institutional investors have expressed the view that a biennial vote or triennial vote would be preferable, so they are not forced to analyze every company’s proposal every year.

EXAMPLES

For a description of some examples of proxy statements that include the Say-on-Pay and frequency vote language, see my recent post from the ON Securities Blog.

Submitted by Martin R. Rosenbaum, Partner at Maslon Edelman Borman & Brand, LLP.

Thanks to all who were able to attend the September 2010 Small Public Company Forum event at Maslon Edelman Borman & Brand, LLP, co-sponsored by Moquist Thorvilson Kaufmann Kennedy & Pieper, LLC.  If you were unable to join us or would like to share the informative sessions with your colleagues, we have provided event podcasts and materials below for your use.

As noted in the seminar, we invite you to provide comments and feedback, by clicking on the “Comments” link  in the upper right corner of this post or in the gray box following the post. We encourage you to do so and hope to hear from you! 

Small Public Company Forum Event – September 29, 2010

Session One: XBRL for Smaller Reporting Companies
Presented by John D. Woodburn, President, Woodburn Group

Podcast  |  Materials

Summary:  John’s presentation provides the basics of what XBRL is, as well as important information about the SEC’s XBRL mandate, filing requirements and relevant timeline, and XBRL implementation options, planning, and budgeting.  He also offers a comparison of available XBRL tools.

John is a specialist in the application of technology to accounting processes.  He was named one of the 100 most influential people in accounting technology in America by Accounting Today.  John is a co-author of the AICPA Strategic Electronic Business Initiative, and he chaired the AICPA Electronic Business Task Force.  He is a CPA (inactive), with prior experience at Ernst & Young, and also served as controller for Proex Photo Systems prior to founding Woodburn Group.

Session Two: (Dodd) Frank Talk About New Governance and Compensation Requirements
Presented by Martin Rosenbaum and Paul Chestovich, Partners, Maslon Edelman Borman & Brand, LLP

Podcast  |  Materials

Summary:  Marty and Paul review recent changes to public company governance and compensation requirements effected by the Dodd-Frank Act, including mandatory say-on-pay votes, proxy access provisions, and new compensation disclosure requirements.  Their presentation includes discussion about what smaller reporting companies should do now to get ready for the implementation of those requirements.

Reminder: Please Join us for the upcoming Small Public Company Forum Event

September 29, 2010 – Small Public Company Forum Event
Hosted by Maslon Edelman Borman & Brand, LLP and Moquist Thorvilson Kaufmann Kennedy & Pieper, LLC

RSVP
Please RSVP by Wednesday, September 22, 2010, by emailing RSVP@maslon.com

Event Details:
Wednesday, September 29, 2010 | Registration: 7:30 a.m. | Program: 8:00 a.m. – 9:30 a.m
Complimentary Seminar with Continental Breakfast
Maslon Edelman Borman & Brand, LLP | 3300 Wells Fargo Center | 90 South Seventh Street | Minneapolis, MN  55402

Session One: XBRL for Smaller Reporting Companies
Presented by John D. Woodburn, President, Woodburn Group

John’s presentation will provide attendees with the basics of what XBRL is, as well as important information about the SEC’s XBRL mandate, filing requirements and relevant timeline, and XBRL implementation options, planning, and budgeting.  He will also offer a comparison of available XBRL tools.

John is a specialist in the application of technology to accounting processes.  He was named one of the 100 most influential people in accounting technology in America by Accounting Today.  John is a co-author of the AICPA Strategic Electronic Business Initiative, and he chaired the AICPA Electronic Business Task Force.  He is a CPA (inactive), with prior experience at Ernst & Young, and also served as controller for Proex Photo Systems prior to founding Woodburn Group.

Session Two: (Dodd) Frank Talk About New Governance and Compensation Requirements
Presented by Martin Rosenbaum and Paul Chestovich, Partners, Maslon Edelman Borman & Brand, LLP

Marty and Paul will review recent changes to public company governance and compensation requirements effected by the Dodd-Frank Act, including mandatory say-on-pay votes, proxy access provisions, and new compensation disclosure requirements.  Their presentation will include discussion about what smaller reporting companies should do now to get ready for
the implementation of those requirements.

Validated parking will be offered in the Gaviidae Common parking ramp. Enter ramp on 6th Street (one-way eastbound). Parking is limited.

Contact us for more information:
 
Paul Chestovich, Partner
Maslon Edelman Borman & Brand, LLP
p 612.672.8305 | paul.chestovich@maslon.com | bio

Mark Leitner, CPA
Moquist Thorvilson Kaufmann Kennedy & Pieper LLC     
p 952.656.2643 | mark.leitner@mtkcpa.com | bio