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Corporate Alert: SEC Amends Executive Compensation Disclosure Requirements, Delaware Asserts Spirit of Common Law Over Letter of SEC Regulations, Electronic Discovery
January 2007
Authors: Edward B. Stevenson, Irwin A. Kishner

SEC Amends Executive Compensation Disclosure Requirements

On December 22, 2006, the Securities and Exchange Commission (the "SEC") adopted an amendment to its executive and director compensation disclosure rules. The impact of the amendment allows companies in many cases to report lower upfront values for stock options granted to executives. The amendment is intended to conform the reporting of stock and option awards under the SEC rules to the Financial Accounting Standards Board Statement of Financial Accounting Standards No. 123: Share-Based Payment (as revised in 2004, "FAS 123R").

The amendment modifies Item 402 of Regulations S-K and S-B by allowing for disclosure of the compensation cost of stock and option awards over a requisite service period as described in FAS 123R. FAS 123R defines this requisite service period as the period or periods over which an employee is required to provide service in exchange for a share-based payment. The SEC's rules on executive and director compensation disclosure, adopted in July 2006, formerly required disclosure of the full grant date fair value as compensation when a grant was made.

The SEC takes the position that the amendment provides investors with a more accurate picture of the compensation earned by a director or officer during a particular reporting period, consistent with the principles underlying FAS 123R. The amendment is criticized by some investor advocates, however, as allowing companies to obscure the value of long-term executive compensation packages.

Delaware Asserts Spirit of Common Law Over Letter of SEC Regulations

A Delaware court recently upheld—for the second time in the past two years—the state's corporate laws in the face of conflicting SEC regulations, citing the "spirit" of the Delaware law and SEC rules in general as the controlling factor. This decision cuts against the strict compliance mandated by the SEC.

In Esopus Creek Value LP v. Hauf, a public company sought to sell substantially all of its assets. Under its certificate of incorporation and Delaware law, the company was required to put the sale to a stockholder vote. However, the company was delinquent in its SEC filings, and as a result, was prohibited under SEC rules from calling a meeting or soliciting stockholder proxies. The company sought to get around this contradiction by effecting the sale through a bankruptcy proceeding, which would not require a vote, although the company was not insolvent. The plaintiff stockholders in Esopus filed a complaint to enjoin any sale without a vote.

The Delaware Court of Chancery ruled that, based on the spirit of the Delaware law requiring a stockholder vote on such a significant event for the company, the SEC would not interpret its delinquent filings rules so strictly as to deprive stockholders the vote, despite the "letter" of the rules. The court reasoned that a strict interpretation of the SEC rule would "cut directly against the policy of a strong stockholder franchise that underlies the SEC's rules on the distribution of proxy and information statements."

Although this case dealt with one of the finer points of SEC regulation, coupled with Newcastle Partners L.P. v. Vesta Insurance Group, Inc., a similar Delaware case from 2005, it shows the Delaware courts' willingness to override the letter ofthe SEC rules in accordance with the spirit of Delaware corporate common law.

Electronic Discovery

On December 1, 2006, the Federal Rules of Civil Procedure were amended to address electronic discovery in Federal court litigations. As a result of these new rules, it is critically important that your company has procedures in place to preserve and produce electronic records, including emails. If a company deletes emails which may be subject to discovery in a litigation or in response to a subpoena, the company can be subject to severe civil and criminal penalties and sanctions.

We are currently working with a number of our clients—of various sizes and in a wide variety of fields and industries—to make sure that they have appropriate electronic records policies in place. We want our clients to be familiar with these rules changes and be prepared to address the preservation and production of electronic records in the most efficient and effective manner.

Herrick has a team of experienced attorneys and litigation support specialists who have a national reputation in this area. We can help prepare your company for electronic discovery and help set up electronic records policies. If your company has an electronic discovery protocol in place, we can review it and offer suggestions on appropriate revisions. If you don't have such a protocol in place, you should, and we can help you do so at your earliest convenience.

For more information on these issues or other corporate matters, please contact:

Irwin Kishner at 212.592.1435 or ikishner@herrick.com
Edward Stevenson at 973.274.2025 or estevenson@herrick.com 

Copyright © 2007 Herrick, Feinstein LLP. Corporate Alert is published by Herrick, Feinstein LLP for information purposes only. Nothing contained herein is intended to serve as legal advice or counsel or as an opinion of the firm.