Risk & Compliance

Exchanges: We Can Meet Our Own Standards

NYSE, Nasdaq say they come up to their own governance standards -- sort of. Plus: FASB sees derivatives as liability, and companies balking at expe...
Craig SchneiderMay 19, 2003

Officials at the major U.S. stock exchanges reported to the SEC last week that corporate governance practices at the bourses themselves were either on a par — or would soon be on a par — with the governance standards required of companies listed on the exchanges.

Richard Grasso, New York Stock Exchange chairman, is allowing some room for revision, however. Reportedly, he noted in a letter to SEC Chairman William Donaldson that the exchange’s governance committee would hold several days of hearings in June for which NYSE’s various constituents could make written submissions.

The NYSE is a private self-regulatory organization owned by its members. Hence, Grasso noted, “its governance structure is quite different from that of its profit-maximizing listed companies.” The head of the NYSE also noted that, unlike publicly traded companies, the exchange has three constituencies (broker member-owners, listed companies and the investing public.) Therefore, its board “embodies a ‘legislative’ model of checks and balances among constituent representatives,” acting by “compromise and consensus,” the NYSE head said.

Grasso, however, continues to draw criticism for nominations to the NYSE board. Consider the aborted nomination of Citigroup Inc. Chairman and CEO Sanford Patrick Weill. Grasso supported the nomination of Weill for a non-industry slot on the NYSE board of directors even though Citigroup was one of the companies at the center of a government investigation into alleged bias in stock research.

Weill withdrew his nomination after New York Attorney General Eliot L. Spitzer, who spearheaded the probe into analyst conflict-of-interests, called it an “outrage.”

Grasso conceded on Friday that the Weill nomination was “bad mistake,” according to The Washington Post. Other critics point to the fact that the membership of the exchange’s board is too heavily tilted toward NYSE member firms and NYSE-listed companies.

Responding to such criticisms, a NYSE spokesman told Dow Jones Newswire that, as far as specific changes to governance procedures are concerned, “everything’s on the table.” He also highlighted the Big Board’s moves to strengthen corporate governance among its listed companies as evidence of the NYSE’s commitment to good governance.

For its part, the Nasdaq stock market reportedly declared that its governance structure met that required of any company traded on the exchange. Its practices were apparently overhauled in the wake of the market’s trading scandal in the mid-1990s. The incident, according to Dow Jones, led to organizational changes at Nasdaq and at its parent, the National Association of Securities Dealers.

Nasdaq General Counsel Edward Knight, however, is not saying that the exchange has reached “some stage of perfection.” Indeed, officials at the exchange appear to believe the board nomination process could stand more examination. “The staff’s interpretation of ‘fair representation’ appears to require that a specific number of board seats be filled solely by the members of the stock market,” Nasdaq said in its report to the SEC.

But Nasdaq has a large public shareholder base that would be partially disenfranchised in order to give exchange members more control over Nasdaq, officials at the exchange added. “Moreover, the concept of member representation seems particularly outmoded in application to an all-electronic exchange that has no seats or ‘members’ in the traditional sense.”

Regulatory Filing Review: More Inquiries

Federal regulators and prosecutors will not likely be taking much time off this summer — certainly not with business at Johnson & Johnson, Gateway and Amerco still pending. All four companies announced last week that they are being investigated by one or more government agencies.

Management at Johnson & Johnson said that the Federal Trade Commission, the Attorney General’s office in New York, and the Attorney General’s office in Connecticut, have separately issued subpoenas seeking documents relating to the company’s marketing of sutures and endoscopic instruments. The focus of the inquiries, according to the Johnson & Johnson’s regulatory filing, focuses on discounts to customers “that are predicated on the hospital achieving specified market share targets” for both product categories. Johnson & Johnson management says the operating companies involved are responding to the subpoenas.

In other pastures, Gateway management announced in its most recent quarterly filing that the U.S. Attorney’s office has commenced a preliminary inquiry into the company’s financial filings. The personal computer maker has been busy responding to an investigation launched by the Securities and Exchange Commission. That probe centers on the company’s financial results in 2000. Gateway says the new inquiry relates to “the same time period and subject matter” as the SEC case. The company claims it is cooperating fully with the inquiry and “does not believe that any current officer is a target of either investigation.”

Management of U-Haul parent Amerco said that the SEC has been conducting a “fact-finding inquiry” regarding its financial statements. The company believes the investigation is a result of erroneous advice that Amerco claims it accepted from its former independent auditor, PricewaterhouseCoopers. U-Haul’s parent says in its regulatory filing that it is cooperating fully with the SEC’s review.

Theodore Sonde, a former senior SEC enforcement official that represents Amerco, called the SEC investigation “not surprising, given that the company had restated certain financial statements, discharged its former auditors and retained new independent accountants, all within the past year.”

Companies Dragging Feet on Option Proposals

It doesn’t look like Intel Corp., one of the loudest critics of the push to require companies to expense of stock options, will have much to worry about if its shareholders vote to adopt the controversial idea this Wednesday.

Why? Boards of directors at 17 other companies have already been hit with similar votes by shareholders. But the proposals at the companies are non-binding. Hence, the boards of these 17 corporations have so far not followed through on what their shareholders have asked for.

In fact, most seem to be waiting to see what the Financial Accounting Standards Board and regulators require before making any switch, according to Patrick McGurn, special counsel at Institutional Shareholder Services. Apple Computer and Fluor Corp. are two companies that recently indicated they would wait to expense employee stock options until FASB finalizes its standard on the matter.

In general, more than 230 companies have decided to expense stock options ahead of any FASB rule requiring the practice, according to McGurn. “The tide of momentum is shifting,” he says. “No one can point to a company that has expensed that has had a negative repercussion. You really have to discount those arguments.”

Still, managers in many industry sectors continue to raise arguments against expensing options based on the lack of an accurate valuation tool for measuring such options. Intel’s CFO Andy Bryant, voiced his own objection recently. “Abuse should be addressed by holding directors accountable for their decisions concerning executive compensation,” Bryant reportedly wrote in a letter to shareholders last month.

The Intel measure — sponsored by the United Brotherhood of Carpenters and Joiners Pension Fund, which owns more than 30,000 shares — is non-binding. But even if Intel’s board decides not to follow the recommendation to expense options, the pension fund won’t likely be offended. Consider the words of Ed Durkin, a Carpenters’ spokesperson, in response to Fluor’s decision: “Our proposal was non-binding because we do not believe that an individual company should be compelled to expense options while its industry peers do not.”

FASB Issues Rules on Derivatives, Redeemable Shares

FASB has issued a new statement that aims to improve accounting for certain financial instruments, including mandatorily redeemable shares, put options, and forward purchase contracts.

Under previous regulations, companies could account for these instruments as equity. Under Statement 150, Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity, they will be booked as liabilities.

The new statement is intended to clarify the ambiguous nature of the instruments. In addition to those obligations already mentioned, obligations that could be settled with shares are also considered liabilities. Most of the statement’s provisions of are consistent with the existing definition of liabilities in FASB Concepts Statement No. 6, Elements of Financial Statements.

Later this year, FASB is expected to expand this initiative by tackling accounting for convertible bonds, puttable stock, and other instruments not covered by statement 150.

The new statement will apply to all financial instruments entered into or modified after May 31, 2003. Otherwise, it will become effective at the beginning of the first interim period beginning after June 15, 2003. For private companies, mandatorily redeemable financial instruments will be subject to the provisions of statement 150 for the fiscal period beginning after December 15, 2003.

(Editor’s note: To download the full text of FAS 150 from FASBís website, click here.)