Ironically, Mr. Cotsakos just received his PhD from the University of London, in corporate governance. His degree was paid for by E*Trade.

The NASD proposal is the same, with one addition. The NASD proposal also covers directors' nonprofit relationships and the NASD would disqualify as independent any director who is an executive of a nonprofit corporation that receives $200,000 or 5% of the nonprofit's general revenue from the company on whose board the director sits.

The proposals gained new attention last week when a Delaware decision focused on the fact that two business school professors on Oracle's board were asked to investigate their fellow directors regarding a shareholder litigation proposal when those directors and Oracle had donated heavily to Stanford's business school. Calling the directors conflicted, the judge ruled that the determination by the board that the shareholder suit should not go forward was invalid.

There are a number of explanations for the increases in fees. One explanation is that more services are now counted as audit services such as the work by the auditors on company pension plans. Those services were once listed as "other fees," and now they are counted as audit fees. However, most companies and auditors explain the increase as being the result of extra time spent trying to ensure that the company is in compliance with Sarbanes-Oxley.

The companies that have experienced the greatest increase in audit fees are those that had Arthur Andersen as their auditors. For example, Bristol-Myers Squibb's audit fees doubled after it terminated Andersen and hired Ernst & Young. Newmont, a gold-mining company, not only had its audit fees quadruple when it hired PriceWaterhouseCoopers following its termination of Andersen, but it had to restate its earnings going back to 1999.

The three executives who were indicted are mid-level executives who were responsible for sales to large business and government customers. The indictment alleges that the three resorted to desperate means in order to meet financial targets. Those targets were critical to maintaining the value of Qwest stock and of the options that they and many executives held. One alleged transaction involves the shipping of equipment to Genuity, Inc., an Internet service provider. The sale of the equipment was at inflated prices that boosted revenue for Qwest by $100 million in one quarter. The sale was not really finalized and did not meet accounting standards for booking. But the executives are alleged to have chartered a jet to ship the equipment to Genuity in order to meet the revenue target. The shipment served as a substitute for the final contract and compliance with revenue-booking rules.

The criminal charges were accompanied by civil charges filed by the SEC. The agency seeks fines and disgorgement of profits, salaries, and bonuses from the three executives.

Refer to Chapters 8 and 48.

Why do you think the federal government indicted mid-level executives? What types of securities law violations would the indictment include?

FOR MORE INFORMATION

Dennis K. Berman and Deborah Solomon, Ex-Executives Are Indicted in Qwest Probe, WALL STREET J., Feb. 26, 2003, B1.

Barnaby J. Feder, U.S. Takes Actions in Qwest Case, N.Y. TIMES, Feb. 26, 2003, C1.

Update: December 9, 2002
WorldCom has settled fraud charges with the SEC. The charges related to the company's restatement of its earnings, reflecting a $9 billion reduction in earnings. Under the terms of the settlement, the company will hire an outside expert to improve its internal audit controls and will pay a fine (not yet specified). In addition, the company has agreed to commit no further violations. Its settlement affects the company's standing in terms of federal contracts and other opportunities, but, according to officers, represents a step forward for the company.

WorldCom is in bankruptcy and several of its officers face criminal charges. Some have entered guilty pleas, but Scott Sullivan, the company CFO, has entered a plea of innocent to all charges brought against him.

Refer to Chapter 48.

What violations did WorldCom commit with the earnings statements that were incorrect?

FOR MORE INFORMATION

Visit http://www.worldcom.com for details on the bankruptcy and the settlement.

Update: October 28, 2002
A new regulatory phenomenon has developed with the collapses of several companies and questions about the business practices of underwriters, investment bankers, and analysts. In previous investigations and indictments of companies and individuals with regard to securities issues, the states have generally deferred to or worked with the SEC to bring charges. However, a new pattern that has emerged has the state proceeding before the SEC begins. For example, New York's attorney general, Eliot Spitzer, was the first to bring charges against analysts for their misleading information. Massachusetts' secretary of the commonwealth has brought charges against investment banker Credit Suisse First Boston (CSFB) for alleged conflicts of interests with its analysts and their information released to the public.

CSFB has already paid $100 million in fines to the SEC earlier this year for its charging of excessive commissions in exchange for customers obtaining first crack at IPO offerings. Massachusetts is demanding the CSFB separate out its research division from its investment banking division and the parties have discussed yet another $100 million fine.

Gary Lynch is the general counsel for CSFB and the former head of the SEC enforcement division as well as the lawyer hired by GE to conduct the investigation of Kidder Peabody and Joseph Jett. Lynch has protested the Massachusetts case, asking that the regulators there cooperate with the SEC and other states to work a universal settlement.

Refer to Chapters 5 and 48.

Can the states regulate securities and companies involved in the securities market independently from the SEC? Why or why not?

FOR MORE INFORMATION

Randall Smith, "CSFB Unit To Face More Grief, This Time In Massachusetts," The Wall Street Journal, October 21, 2002, C1, C3.
Mark Maremont and Laurie P. Cohen, "Tyco Nears Pact With Regulators in New Hampshire," The Wall Street Journal, October 21, 2002, A3.

Update: October 14, 2002
WorldCom Update

Several weeks ago, David Myers, the former controller for WorldCom, entered a guilty plea to fraud. On October 7, 2002, WorldCom's accounting director, Buford Yates, also entered a guilty plea to fraud charges.

Both men were charged with securities fraud in relation to an accounting scandal at WorldCom that saw $5 billion in actual expenses concealed until 2002, when the company was forced to restate its earnings when the expenses were revealed. To date, WorldCom has disclosed that it had $7.2 billion in improper accounting setoffs that needed to be written down.

Mr. Myers reported to Scott Sullivan, the former CFO of WorldCom, who was indicted on fraud charges. Mr. Yates reported to Mr. Myers. The federal government now has two key witnesses against Mr. Sullivan. In entering his guilty plea, Mr. Yates stated, "I concluded that the purposes of these adjustments was to incorrectly inflate WorldCom's reported earnings in order to meet the expectations of securities analysts and mislead the investing public."

In addition to the criminal charges, the SEC has filed civil charges against Mr. Yates.

Refer to Chapters 8 and 48.

What is the difference between the civil and criminal securities fraud charges?

FOR MORE INFORMATION

Andrew Backover, "Another guilty plea in WorldCom fraud case," USA Today, October 8, 2002, p. 1B.
Jerry Markon, "WorldCom's Yates Pleads Guilty," The Wall Street Journal, October 8, 2002, p. A3.

Update: October 7, 2002
Several companies have been forced to provide more disclosure about a practice that was helping them to maintain their earnings levels. The practice is betting that the prices of their shares will rise and positioning themselves in the stock market accordingly. However, with the decline in share prices, companies that had invested in puts - a bet that share prices will rise - now have to cover those puts and the cost is $501 million for Dell Computer, $150 million for Eli Lilly, and $100 million for EDS.

Refer to Chapter 48.

Do you see any issues with insider trading with a company investing in puts for its own stock?

FOR MORE INFORMATION

Robin Sidel, Gary McWilliams, and Thomas M. Burton, "EDS Isn't Alone in Betting on a Rising Stock," The Wall Street Journal, Sept. 27, 2002, C1, C3.

Update: October 7, 2002
A Martha Stewart Update

Douglas Faneuil was an assistant to Martha Stewart's stockbroker, Peter Bancanovic, at Merrill Lynch. Last week he entered a guilty plea to a misdemeanor charge of receiving additional compensation in violation of federal laws on broker compensation. The extra compensation included an extra week's vacation and airline tickets. The compensation was offered to him in exchange for keeping quiet about his conversations with Ms. Stewart regarding her sale of ImClone stock. Ms. Stewart sold the stock the day before the company announced that the FDA would not be approving its new anticancer drug, Erbitux.

In the paperwork for his guilty plea, someone believed to be Martha Stewart is named as a tippee in the case.

Ms. Stewart resigned her position on the board of the New York Stock Exchange on Thursday, October 3, 2002, and the price of her Martha Stewart Omnimedia Inc. stock dropped 8%. Since the time the allegations about the insider trading of Imclone has emerged, the stock has dropped to $8 per share. The stock premiered at $35 per share just two years ago.

Refer to Chapter 48.

What is a tippee?

FOR MORE INFORMATION

Jerry Markon, "Martha Stewart Could Be Charged as 'Tippee,'" The Wall Street Journal, October 3, 2002, pp. C1, C9.

Update: September 23, 2002
The latest issue in corporate governance to emerge in the wave of business scandals is that of CEO perks. During the past few months, information about Jack Welch, the retired CEO of GE, and Dennis Kozlowski, the former CEO of Tyco emerged. The list of the perks for Jack Welch includes wine, food, laundry, dry cleaning, flowers, toiletries, Knicks tickets, cook, housekeep staff, postage, newspaper subscriptions, Red Sox tickets, Yankee tickets, four homes (complete with satellite TV), restaurant tabs, jets, helicopters, and limousines. The perks were in addition to his $16.9 million in salary.

Dennis Kozlowski, former CEO of Tyco and under indictment for sales tax evasion on his multimillion-dollar art sales, had Tyco pick up the tab for a $15,000 umbrella stand; a $6,300 sewing basket; a $2,200 waste basket; $2,900 in coat hangers; $1,650 for a notebook; and $445 for a pin cushion. Tyco also paid for a birthday party for Mr. Kozlowski's wife that was held near Greece. The tab was $1,000,000.

One corporate governance expert has pointed to conflicts of interest on the board's compensation committee. That is, those who approved salaries and perks owned or were associated with companies that did business with GE or Tyco.

Shareholders have submitted proposals to curb such perks.

Refer to Chapters 3, 48, and 50.

How do shareholders make proposals? What are the requirements? Do you think what these CEOs did was ethical?

FOR MORE INFORMATION

Review the GE and Tyco SEC filings: http://www.ge.com and http://www.tyco.com. Click on investor relations and go to SEC filings. Review proxy materials.

JoAnn S. Lublin, "How CEOs Retire in Style," The Wall Street Journal, September 13, 2002, pp. B1, B2.

Update: September 16, 2002
Congress has passed the Sarbanes-Oxley bill , 15 U.S.C. Section 7201 et seq. which is the legislation passed in response to the issues surrounding the collapse of Enron, WorldCom and Adelphia, including financial reporting and the conduct of corporate officers. The key elements of that legislation are: (1) an accounting oversight board; (2) regulations on the independence of auditors; (3) corporate responsibility and governance issues including the structure of audit committees, certification of financial statements, forfeiture of bonuses and options, codes of ethics for senior financial officers, and professional responsibility rules for attorneys working with companies on certification of financial statements; (4) analysts' conflicts of interest; and (5) increased criminal penalties for fraud in financial reporting. Following is a summary of the new law from a forthcoming piece in the Corporate Finance Review:

NEW RULE/LAW

1. SEC certification of financial statements -- "untrue statement of a material fact"
2. SEC certification of financial statements - "no covered report omitted to state a material fact necessary to make the statements in the covered report, in light of the circumstances under which they were made, not misleading as of the end of the period covered by such report"
3. SEC certification of financial statements - officer signatures
4. Sarbanes-Oxley Sec. 203. Audit partner rotation. Provides for audit partner rotation once every 5 years.
5. Sarbanes-Oxley Sec. 204. Auditor reports to audit committees.
6. Sarbanes-Oxley Sec. 206. Conflicts of interest. Strict prohibitions on consulting activities beyond financial statement certification. Exceptions require board approval.
7. Sarbanes-Oxley Sec. 301. Public company audit committees. Requires members to not be employed by the company or have family members employed at the company; cannot be hired as consultants; restrictions on business with the company.
8. Sarbanes-Oxley Section 407 - Audit committee must have at least one "financial expert" as defined by the SEC.
9. Sarbanes-Oxley Sec. 304. Forfeiture of certain bonuses and profits. If the company must restate a financial statement, the officers responsible lose their bonuses for any 12-month period surrounding the original financial statement and they must return any profits realized on sales of stock.
10. Sarbanes-Oxley Sec. 306. Insider trades during pension fund blackout periods. Officers and directors cannot trade in stock during this black-out period any stock or interests acquired through company affiliation.
11. Sarbanes-Oxley Sec. 307. Rules of professional responsibility for attorneys. Attorneys must report financial fraud or misdeeds to CEO of chief counsel and if they fail to act, must report such to the audit committee. If the audit committee is not independent with regard to the issue, then the attorney must report the issue to another committee or the board itself.
12. Sarbanes-Oxley Sec. 402. Enhanced conflict of interest provisions. Sec. 403. Disclosures of transactions involving management and principal stockholders.
13. Sarbanes-Oxley Sec. 406. Code of ethics for senior financial officers. Officers must certify along with financials that the company has a code of ethics.
14. Sarbanes-Oxley Sec. 806. Protection for employees of publicly traded companies who provide evidence of fraud. Amends Federal Whistleblower Protection Act to provide coverage for employees who report financial fraud internally or to federal agencies
15. Penalties. Penalty for securities fraud has increased to 25 years. The White-Collar Crime Penalty Enhancement Act of 2002, enacted as part of the Sarbanes-Oxley bill, increases penalties for mail and wire fraud from 5 to 20 years. Violations of ERISA now carry greater penalties with "$5,000" fines for individuals increased to "$100,000"; 1 year imprisonment increased to 10 years; and company fines of "$100,000" increased to "$500,000. New provisions for certification of financial reporting impose penalties of $1,000,000 and/or 10 years and for willful violations, $5,000,000 and 20 years. Corporate Fraud Accountability Act of 2002, also part of Sarbanes-Oxley, imposes penalties for the concealment or destruction of documents related to the financial reports of a company (20 years). Penalties under the Securities Exchange Act of 1934 are increased: $1,000,000, and/or 10 years is increased to $5,000,000 and/or 20 years and company penalties are increased from $2,500,000 to $25,000,000
16. Debts from financial fraud are nondischargeable in bankruptcy.

Refer to Chapters 3, 6, 8, 37, 39, 40, 41, 48, and 50.

FOR MORE INFORMATION

Go to http://www.senate.gov and go to bill status for complete copy of the legislation.

Update: September 9, 2002
Tyco shareholders, led by an activist and well-known shareholder, Ralph Whitworth, are demanding that the company place up for election a new slate of directors that does not include any of the directors who served because of former CEO, Dennis Kozlowski. Mr. Kozlowski has left the company and is under indictment for sale tax evasion related to his art collection. The company has concerns about its financial statements and status.

Mr Whitworth says that he has organized 16% of the outstanding shareholders' votes and would like to see 9 of 11 Tyco directors replaced. Mr. Whitworth has already begun proxy solicitation.

Refer to Chapter 48.

What is required for a shareholder to be able to solicit proxies from other shareholders?

FOR MORE INFORMATION

Visit the Tyco website: http://www.tyco.com.
Joann S. Lublin, "Tyco Shareholders Plan Proxy Fight To Oust Directors," The Wall Street Journal, August 21, 2002, p. A3, A6.

Update: August 26, 2002
Michael J. Kopper was a former financial executive at Enron Corporation and a first lieutenant to Andrew Fastow and was often referred to as one of "Andy's boys." Kopper entered a guilty plea to two felony counts of money laundering and conspiracy to commit wire fraud. He also agreed that he would surrender $12 million in funds that he obtained from serving as a principal in many of Enron's off-the-books partnerships.

In exchange for the lesser felony charges and perhaps lighter sentence, Mr. Kopper is said to have promised to cooperate fully with federal prosecutors in providing information about Ken Lay, Jeffrey Skilling, and Fastow, the former chairman, CEO, and CFO, respectively, of Enron.

Refer to Chapters 8 and 48.

Given Mr. Kopper's involvement with trading with Enron on energy contracts and the financial reporting, what other crimes do you think the federal prosecutors might have charged Mr. Kopper with?

FOR MORE INFORMATION

Jonathan Weil and Kathryn Kranhold, "First Guilty Plea In Enron Case Expected Today," The Wall Street Journal, August 21, 2002, A1, A6.

Update: August 19, 2002
The issue of stock options as compensation for corporate executives has been subject to increasing scrutiny over the past few months with the collapse of Enron and WorldCom and revelations relating to executives there cashing out their stock options with net multi-million-dollar gains. There are several calls for reform on stock options:

• Warren Buffett's proposed reform is to require corporations to expense the granting of options at the time they are granted to the officers. Boeing, Winn-Dixie, Coca-Cola and GE have decided to follow this path and are now booking their options. The cost appears not to be significant, but symbolic to shareholders in terms of disclosure and the restoration of trust. For example, the impact on Coca-Cola is a reduction in earnings per share of one cent.
• Federal Reserve Chairman Alan Greenspan has called for better rules with regard to disclosure of the amount of options involved and their potential cost to the company
• William Miller, head of the $11 billion Legg Mason Value Trust, a fund that has outperformed the Standard & Poor's 500 index for 11 straight years, plans to propose to the companies in which his firm holds stock that executives who are granted options be prohibited from selling any shares they gain through those options during the time that they are corporate executives. In other words, he would impose a mandatory holding period for executives until they have left the company.

Others are concerned about the inherent conflict of interest in options because, with so many options on the line, executive officers could be tempted to lower the share price to collect new options at lower prices. There is room for manipulation, in short, of the options and the shares when top-ranking executives' compensation is tied to significant numbers of options.

Refer to Chapter 48.

What current requirements exist for disclosure of options to executive officers?

FOR MORE INFORMATION

Aaron Lucchetti, "Restricting Options: Key Fund Manager Gets Touch on Issue of Executives' Pay," The Wall Street Journal, April 15, 2002, C1, C21.

Update: August 12, 2002
This proxy season saw shareholders obtain some victories on shareholder proposals. Fifty-six percent of EMC Corp.'s shareholders voted to approve a shareholder proposal that the Board of EMC "take the steps necessary to nominate candidates for Director so that, if elected by the shareholders, there would be a majority of independent Directors. When sufficient independent Directors are elected we request that the Audit, Compensation and Nominating Committees be composed entirely of independent Directors."

At Mentor Graphics Corp., 56.7 percent of the shareholders approved a resolution requiring shareholder approval for significant stock-option plans.

Shareholder proposals are rarely successful; so, it is significant not only that these two resolutions passed, but also that they are provisions related to corporate governance, a concern for shareholders given the accounting scandals of the past year involving public companies.

Refer to Chapter 48.

What is the process for shareholder proposals?

FOR MORE INFORMATION

Jerry Guidera, "Shareholder Activists Win To Big Ones," The Wall Street Journal, May 9, 2002, C1, C11.

Update: August 12, 2002
The following chart is adapted from a forthcoming piece in Corporate Finance Review and the Cal Western Law Rev. by Professor Jennings. It provides a summary of the issues surrounding the corporate collapses of 2001-2002.

Refer to Chapters 3, 8, and 48.

What are the types of penalties the companies and individuals could face for the various charges? What securities laws do you think were violated? Discuss the ethical issues involved in the conduct of the companies and officers.

Update: August 5, 2002
On July 30, 2002, President Bush signed PL 107-204 (HR 3763), the SARBANES-OXLEY ACT OF 2002, called the Investor Confidence Act, the Public Accounting and Corporate Accountability Act, Public Company Accounting Reform and Investor Protection Act of 2002, and numerous other names that reflect its purpose of restoring investor confidence in financial reporting. The description of the Act is as follows: An Act To protect investors by improving the accuracy and reliability of corporate disclosures made pursuant to the securities laws, and for other purposes.

New portions of the law appear at 15 U.S.C. Section 7201, including a beginning definition section. However, many of the provisions amend the Securities Exchange Act of 1934, found at 78 U.S.C. Section 1 et seq.

The following is a summary of the new law that was posted on the House and Senate Web sites.

- Title I: Public Company Accounting Oversight Board - Establishes the Public Company Accounting Oversight Board to: (1) oversee the audit of public companies that are subject to the securities laws; (2) establish audit report standards and rules; and (3) investigate, inspect, and enforce compliance relating to registered public accounting firms, associated persons, and the obligations and liabilities of accountants.

(Sec. 101) Prohibits Board membership from including more than two certified public accountants.

(Sec. 102) Mandates registration with the Board by any public accounting firm that performs or participates in any audit report with respect to any issuer.

(Sec. 105) Empowers the Board to impose disciplinary or remedial sanctions upon registered public accounting firms and their associated persons who are in violation of this Act, including the securities laws relating to the preparation and issuance of audit reports and the obligations and liabilities of accountants with respect to them.

Restricts liability to intentional conduct, or repeated instances of negligent conduct. Authorizes Board sanctions upon a registered accounting firm or its supervisory personnel for failure to supervise.

(Sec. 106) Places within the purview of this Act: (1) foreign public accounting firms that prepare or furnish an audit report with respect to any issuer; and (2) audit workpapers. (Sec. 107) Grants the Securities and Exchange Commission (SEC) general oversight of the Board and the power to review Board actions, including general modification and rescission of Board authority.

(Sec. 108) Amends the Securities Act of 1933 to: (1) authorize the SEC to recognize, as "generally accepted" for purposes of the securities laws, any accounting principles established by a standard setting body; and (2) direct the SEC to study and report to Congress on the adoption by the U.S. financial reporting system of a principles-based accounting system.

Title II: Auditor Independence - Amends the Securities Exchange Act of 1934 to prohibit a registered public accounting firm from performing specified non-audit services contemporaneously with a mandatory audit. Requires preapproval for non-audit services not expressly forbidden by statute.

(Sec. 203) Mandates: (1) audit partner rotation on a five-year basis; and (2) auditor reports to audit committees of the issuer.

(Sec. 206) Prohibits a registered public accounting firm from performing statutorily mandated audit services for an issuer if the issuer's senior management officials had been employed by such firm and participated in the audit of that issuer during the one-year period preceding the audit initiation date.

(Sec. 209) States that it is the intention of this Act that, in supervising nonregistered public accounting firms and their associated persons, appropriate State regulatory authorities should make an independent determination of the proper standards applicable, particularly taking into consideration the size and nature of the business of the accounting firms they supervise.

Title III: Corporate Responsibility - Vests the audit committee of an issuer with responsibility for the appointment, compensation, and oversight of any registered public accounting firm employed to perform audit services. Requires committee members to be a member of the board of directors of the issuer, and to be otherwise independent.

(Sec. 302) Requires the chief executive officer and chief financial officer of an issuer to: (1) certify that periodic financial statements filed with the SEC fairly present, in all material respects, the operations and financial condition of the issuer; and (2) forfeit certain bonuses and compensation received following an issuer's accounting restatement owing to noncompliance with securities laws.

(Sec. 305) Authorizes a court to prohibit a violator of certain SEC rules from serving as an officer or director of an issuer if the person's conduct demonstrates unfitness to serve (the current standard is "substantial unfitness").

(Sec. 306) Prohibits insider trades during pension fund blackout periods. States that profits realized from such trades shall inure to and be recoverable by the issuer irrespective of the intent of the parties to the transaction.

Title IV: Enhanced Financial Disclosures - Instructs the SEC to require by rule: (1) disclosure of all material off-balance sheet transactions and relationships that may have a material effect upon the financial status of an issuer; (2) the presentation of pro forma financial information in a manner that is not misleading, and which is reconcilable with the financial condition of the issuer under generally accepted accounting principles.

(Sec. 401) Directs the SEC to study and report to Congress on: (1) the extent of off-balance sheet transactions and the use of special purpose entities; and (2) whether generally accepted accounting rules result in financial statements that reflect the economics of such off-balance sheet transactions in a transparent fashion to investors; and (3) the extent to which special purpose entities are used to facilitate off-balance sheet transactions.

(Sec. 402) Prohibits a corporation from making personal loans to its corporate executives. Cites exceptions for home improvement and manufactured home loans made in the ordinary course of the consumer credit business of such issuer and made on terms that are no more favorable than those offered to the general public.

(Sec. 403) Reduces the mandatory period for principal stockholders or senior executives to disclose changes in ownership of securities or security-based swap agreements to two business days after changes were executed (presently ten days after the close of a calendar month). Includes electronic filing within such mandate to disclose.

(Sec. 404) Directs the SEC to prescribe rules mandating inclusion of an internal control report and assessment within requisite annual reports. Requires a public accounting firm that issues the audit report to attest to, and report on, the assessment made by corporate management.

(Sec. 406) Directs the SEC to issue rules requiring a code of ethics for senior financial officers of an issuer applicable to the principal financial officer, comptroller or principal accounting officer.

(Sec. 407) Sets a deadline for the SEC to promulgate rules mandating issuer disclosure whether its audit committee comprises at least one member who is a financial expert.

Title V: Analyst Conflicts of Interest - Requires the SEC to adopt rules governing securities analysts' potential conflicts of interest, including: (1) restricting the prepublication clearance or approval of research reports by persons either engaged in investment banking activities, or not directly responsible for investment research; (2) limiting the supervision and compensatory evaluation of securities analysts to officials who are not engaged in investment banking activities; (3) prohibiting a broker or dealer involved with investment banking activities from retaliating against a securities analyst as a result of an unfavorable research report that may adversely affect the investment banking relationship of the broker or dealer with the subject of the research report; and (4) establishing safeguards to assure that securities analysts are separated within the investment firm from the review, pressure, or oversight of those whose involvement in investment banking activities might potentially bias their judgment or supervision.

Directs the SEC to adopt rules requiring securities analysts and broker/dealers to disclose specified conflicts of interest.

Title VI: Commission Resources and Authority - Authorizes appropriations for FY 2003 to the SEC for: (1) additional compensation, salaries and benefits; (2) enhanced oversight of auditors and audit services; and (3) additional professional staff for fraud prevention, risk management, market regulation, and investment management.

(Sec. 602) Grants the SEC censure authority in connection with appearance and practice before the Commission. Sets forth rules of professional responsibility for attorneys representing public companies before the SEC, including: (1) requiring an attorney to report evidence of a material violation of securities law or breach of fiduciary duty to the chief legal counsel or the chief executive officer of the company; and (2) if corporate executives do not respond appropriately, requiring the attorney to report to the audit committee of the board of directors.

(Sec. 603) Amends the Securities Exchange Act of 1934 and the Securities Act of 1933 to grant Federal court authority to prohibit specified brokers, dealers, or issuers from participating in offerings of penny stock.

(Sec. 604) Amends the Securities Exchange Act of 1934 and the Investment Advisers Act of 1940 to authorize SEC censure or restriction of associated persons of brokers and dealers who are subject to any final order of certain State regulatory entities barring them from engaging in the business under their regulatory purviews. Title

VII: Studies and Reports - Mandates studies and reports to Congress by: (1) the Comptroller General regarding the consolidation of public accounting firms, and the impact upon the capital formation and securities markets; and (2) the SEC regarding the role and function of credit rating agencies in the operation of the securities market.

Title VIII: Corporate and Criminal Fraud Accountability - Corporate and Criminal Fraud Accountability Act of 2002 - Amends Federal criminal law to prohibit: (1) knowingly destroying, altering, concealing, or falsifying records with the intent to obstruct or influence an investigation in a matter in Federal jurisdiction or in bankruptcy; and (2) auditor failure to maintain for a five-year period all audit or review work papers pertaining to an issuer of securities. Directs the SEC to promulgate regulations regarding the retention of audit records containing conclusions, opinions, analyses, or financial data.

(Sec. 803) Amends Federal bankruptcy law to make non-dischargeable in bankruptcy certain debts that result from a violation relating to Federal or State securities law, or of common law fraud pertaining to securities sales or purchases.

(Sec. 804) Amends the Federal judicial code to permit a private right of action for a securities-fraud claim to be brought not later than the earlier of: (1) five years after the date of the alleged violation; or (2) two years after its discovery.

(Sec. 805) Directs the United States Sentencing Commission to review and amend Federal sentencing guidelines to ensure that the offense levels, existing enhancements, and/or offense characteristics are sufficient to deter and punish violations involving: (1) obstruction of justice; (2) record destruction; (3) fraud when the number of victims adversely involved is significantly greater than 50 or when it endangers the solvency or financial security of a substantial number of victims; and (4) organizational criminal misconduct.

(Sec. 806) Prohibits a publicly traded company from discharging or otherwise discriminating against an employee because of any lawful act by the employee to: (1) assist in an investigation of prohibited conduct by Federal regulators, Congress, or supervisors; or (2) file or participate in a proceeding relating to fraud against shareholders.

Delineates remedies for such aggrieved employee, including reinstatement, back pay, and compensatory damages.

(Sec. 807) Subjects to a fine and imprisonment any person who defrauds shareholders of publicly traded companies.

Title IX: White-Collar Crime Penalty Enhancements - White-Collar Crime Penalty Enhancement Act of 2002 - Amends Federal criminal law to increase criminal penalties for: (1) conspiracy to commit offense or to defraud the United States, including its agencies; and (2) mail and wire fraud.

(Sec. 904) Amends the Employee Retirement Income Security Act of 1974 to increase the criminal penalties for violations of such Act.

(Sec. 905) Directs the United States Sentencing Commission to review Federal Sentencing Guidelines to: (1) ensure that they reflect the serious nature of the offenses and the penalties set forth in this Act, the growing incidence of serious fraud offenses, and the need to deter and punish such offenses; and (2) consider whether a specific offense characteristic should be added in order to provide stronger penalties for fraud committed by a corporate officer or director.

(Sec.906) Amends Federal criminal law to require senior corporate officers to certify in writing that financial statements and the disclosures therein fairly present in all material aspects the operations and financial condition of the issuer.

Subjects to criminal liability any person who recklessly and knowingly violates such requirement, including maximum imprisonment of: (1) ten years for willful violation; and (2) five years for reckless and knowing violation.

(Sec. 908) Subjects to a maximum ten-year prison term anyone who corruptly tampers with a record with intent to impair the object's integrity or availability for use in an official proceeding, or otherwise impedes an official proceeding.

(Sec.909) Amends the Securities Exchange Act of 1934 to authorize the SEC to seek a temporary injunction to freeze extraordinary payments earmarked for designated persons or corporate staff under investigation for possible violations of Federal securities laws.

(Sec. 910) Requests the United States Sentencing Commission to: (1) promptly review sentencing guidelines applicable to securities and accounting fraud; and (2) expeditiously consider promulgation of new sentencing guidelines to provide an enhancement for senior corporate officers who commit fraud and related offenses. Prescribes guidelines for Commission consideration, including a request that it ensure that the sentencing guidelines and policy statements reflect the serious nature of securities, pension, and accounting fraud and the need for aggressive and appropriate law enforcement action to prevent such offenses. Sets a deadline for promulgation of such guidelines.

(Sec. 911) Amends the Securities Exchange Act of 1934 and the Securities Act of 1933 to authorize the SEC to prohibit a violator of rules governing manipulative and deceptive devices, and fraudulent interstate transactions, respectively, from serving as officer or director of a publicly traded corporation if such person's conduct demonstrates unfitness to serve.

Title X: Corporate Tax Returns - Expresses the sense of the Senate that the Federal income tax return of a corporation should be signed by the chief executive officer of such corporation.

Refer to Chapters 3, 8, and 48.

Make a list of all the the statutes noted in the summary that will change as a result of this new Act.

FOR MORE INFORMATION

Go to http://www.senate.gov and plug in "accounting" to find the new legislation as well as its history in both the House and Senate.

Update: June 17, 2002
The U.S. Supreme Court has issued another landmark decision on insider trading and fraud under Section 10(b) of the 1934 Securities Exchange Act. The case is SEC v. Zandford, 122 S.Ct. 1899 (2002) and involves the conduct of a broker in relation to his client.

Between 1987 and 1991, Charles Zandford was employed as a securities broker in the Maryland branch of a New York brokerage firm. In 1987, he persuaded William Wood, an elderly man in poor health, to open a joint investment account for himself and his mentally retarded daughter. According to the SEC's complaint, the "stated investment objectives for the account were 'safety of principal and income.' " The Woods gave Zandford discretion to manage their account and a general power of attorney to engage in securities transactions for their benefit without prior approval. Relying on Zandford's promise to "conservatively invest" their money, the Woods entrusted him with $419,255. Before Mr. Wood's death in 1991, all of that money was gone.

In 1991, the National Association of Securities Dealers (NASD) conducted a routine examination of Zandford's firm and discovered that, on over 25 separate occasions, money had been transferred from the Woods' account to accounts controlled by Zandford.

Zandford was charged and convicted on 13 counts of wire fraud, sentenced to prison for 52 months, and ordered to pay $10,800 in restitution.

The SEC then filed a civil complaint alleging that Zandford had violated § 10(b) and Rule 10b-5 by engaging in a scheme to defraud the Woods and by misappropriating approximately $343,000 of the Woods' securities without their knowledge or consent. The District Court entered summary judgment against Zandford and enjoined him from engaging in future violations of the securities laws and ordered him to disgorge $343,000 in ill-gotten gains.

The Court of Appeals reversed the summary judgment and remanded with directions for the District Court to dismiss the complaint because the complaint did not establish all the elements of a § 10(b) violation. Specifically, the conviction did not necessarily establish that his fraud was "in connection with" the sale of a security. The court of appeals held that the sales of the Woods' securities were merely incidental to a fraud that "lay in absconding with the proceeds" of sales that were conducted in "a routine and customary fashion," and was a "scheme was simply to steal the Woods' assets" rather than to engage "in manipulation of a particular security." The Court of Appeals indicated it would not "stretch the language of the securities fraud provisions to encompass every conversion or theft that happens to involve securities." Adopting what amounts to a "fraud on the market" theory of the statute's coverage, the court held that without some "relationship to market integrity or investor understanding," there is no violation of § 10(b).

However, the U.S. Supreme Court reversed the court of appeals and reinstated the district court's summary judgment, finding that the conduct of the broker as indeed a violation of 10(b):

More recently, in Wharf (Holdings) Ltd. v. United Int'l Holdings, Inc., 532 U.S. 588, 121 S.Ct. 1776, 149 L.Ed.2d 845 (2001), our decision that the seller of a security had violated § 10(b) focused on the secret intent of the seller when the sale occurred. The purchaser claimed "that Wharf sold it a security (the option) while secretly intending from the very beginning not to honor the option." Although Wharf did not specifically argue that the breach of contract underlying the complaint lacked the requisite connection with a sale of securities, it did assert that the case was merely a dispute over ownership of the option, and that interpreting § 10(b) to include such a claim would convert every breach of contract that happened to involve a security into a violation of the federal securities laws. We rejected that argument because the purchaser's claim was not that the defendant failed to carry out a promise to sell securities; rather, the claim was that the defendant sold a security while never intending to honor its agreement in the first place. Similarly, in this case the SEC claims respondent sold the Woods' securities while secretly intending from the very beginning to keep the proceeds. In Wharf, the fraudulent intent deprived the purchaser of the benefit of the sale whereas here the fraudulent intent deprived the seller of that benefit, but the connection between the deception and the sale in each case is identical.

In United States v. O'Hagan, 521 U.S. 642, 117 S.Ct. 2199, 138 L.Ed.2d 724 (1997), we held that the defendant had committed fraud "in connection with" a securities transaction when he used misappropriated confidential information for trading purposes. We reasoned that "the fiduciary's fraud is consummated, not when the fiduciary gains the confidential information, but when, without disclosure to his principal, he uses the information to purchase or sell securities. The securities transaction and the breach of duty thus coincide. This is so even though the person or entity defrauded is not the other party to the trade, but is, instead, the source of the nonpublic information." The Court of Appeals distinguished O'Hagan by reading it to require that the misappropriated information or assets not have independent value to the client outside the securities market. We do not read O'Hagan as so limited. In the chief passage cited by the Court of Appeals for this proposition, we discussed the Government's position that "[t]he misappropriation theory would not ... apply to a case in which a person defrauded a bank into giving him a loan or embezzled cash from another, and then used the proceeds of the misdeed to purchase securities," because in that situation "the proceeds would have value to the malefactor apart from their use in a securities transaction, and the fraud would be complete as soon as the money was obtained." Even if this passage could be read to introduce a new requirement into § 10(b), it would not affect our analysis of this case, because the Woods' securities did not have value for respondent apart from their use in a securities transaction and the fraud was not complete before the sale of securities occurred.

. . . The SEC complaint describes a fraudulent scheme in which the securities transactions and breaches of fiduciary duty coincide. Those breaches were therefore "in connection with" securities sales within the meaning of § 10(b).

Refer to Chapter 48.

Does 10(b) now apply to brokers who embezzle from their clients securities accounts?

Update: May 27, 2002
Merrill Lynch, one of Wall Street's largest investment houses, reached a settlement with New York Attorney General, Eliot Spitzer. Mr. Spitzer had begun an investigation into Merrill Lynch's practices with regard to its internal research analysts and its brokers. The concern that emerged was that, while internal analysts had their doubts about certain stocks, the firm continued to tout them. Merrill Lynch continued to court the investment banking business of the stock-issuing companies. The analysts were not permitted to issue any negative information to brokers nor, through the brokers, to Merrill Lynch clients.

For example, Spitzer's office uncovered e-mails in which Merrill Lynch analysts referred to the shares of Infospace as a "piece of junk." However, the analysts publicly gave Infospace stock the highest rating.

The settlement is a complex one that requires Merrill Lynch to pay $100 million in fines, a figure that represents that largest Wall Street fine of the past 15 years. Also, Merrill Lynch agreed to modify many of its current practices such as:

• Analysts' pay cannot be tied to the investment banking portion of Merrill Lynch operations. Analysts must be paid for the services they render to the clients who pay brokers for advice in structuring their portfolios
• There are no restrictions on analysts' recommendations for "buy" and "sell" on stocks that Merrill Lynch's investment banking side is promoting
• Analysts can still recruit investment banking business, something that might induce them to promise favorable ratings for the brokerage side of the business

The settlement accompanies a new series of rules promulgated by the Securities Exchange Commission on analysts. Under the new SEC rules,

• Analysts cannot be given or accept incentives for favorable research
• Analysts cannot be supervised by members of the investment banking side of the brokerage house
• Analysts' pay and bonuses cannot be tied to specific investment banking deals
• Analysts are not permitted to trade against their recommendations

Refer to Chapter 48.

Does 10b apply in these circumstances? Were the analysts using inside information to profit?

FOR MORE INFORMATION

See the new SEC rules at http://www.sec.gov
"Merrill Lynch deal won't restore investor's trust," USA Today, May 23, 2002, 10A.
Randall Smith and Aaron Lucchetti, "How Spitzer Pact Will Affect Wall Street," The Wall Street Journal, May 22, 2002, C1, C3.

Update: May 20, 2002
In a shareholder vote on a proposal by the Stanley Works corporation to become a resident of Bermuda in order to avoid federal and state income taxes, the attorney general for the state of Connecticut announced that he would challenge the final vote (85% in favor and 15% against) because some of the employees were confused about their voting rights under the shares held in their 401(k) plans.

Following the announcement, Stanley Works announced that it would conduct a revote on the issue of moving the company offshore. The company acknowledged that there might have been some confusion about voting under the 401(k) plan. John M. Trani, Chairman and Chief Executive Officer, stated in a company press release: "Stanley's integrity is the most important asset of our company. Even the appearance of impropriety is unacceptable. That is why the decision was made to proceed with a revote. However, our strategy has not changed. Enabling our company to better compete by leveling the global playing field is strategically important and highly beneficial for our shareowners, employees, customers and all our other stakeholders. Being competitive is the best way to preserve U.S. jobs. A legislative overhaul of the tax system is preferred, but until that happens we must proceed in the best available manner. Upon the planned reincorporation, Stanley will continue to pay significant amounts of U.S. taxes on U.S. income."

Refer to Chapter 48.

What are the rules for shareholder votes on company proposals? What are the rules on proxy solicitation and voting shares for others?

FOR MORE INFORMATION

David Cay Johnston, "Stanley Voids Bermuda Vote and Promises To Try Again," The New York Times, May 11, 2002, B1, B14.
http://www.stanleyworks.com Press release of May 10, 2002.

Update: April 29, 2002
With the recent shareholder vote on the approval of the Hewlett-Packard merger with Compaq have come challenges to the votes. The SEC is now investigating the vote and the proxies. One allegation is that HP coerced 17 million votes from Deutsche Asset Management. The allegation was that it was able to do so because it threatened to withhold future business from Deutsche Bank. In the days leading up to the vote on the merger, HP closed a $4 billion credit line with Deutsche Bank. The SEC has scheduled a trial on the votes and these issues. Any finding of coercion in the solicitation of proxies would be a violation of Section 14 of the 1934 Securities Exchange Act.

Refer to Chapter 48.

FOR MORE INFORMATION

Jon Swartz, "SEC, Feds Scour H-P Voting Records," USA Today, April 16, 2002, 1B.

Update: March 25, 2002
In December the SEC passed a new rule on the disclosure of stock options. It just took effect on March 15, 2002, not quite in time for the annual proxy and annual report season. Most companies will not be affected until next year. For the past decade shareholder groups have been encouraging the SEC to adopt stricter disclosure rules. The stricter rules would apply to the impact on both company profits and the value of shareholders' interests of stock options awarded to executives.

The new rule requires the disclosure of both shareholder-approved option plans and those that are in existence but have not yet been approved by the shareholders. A market survey shows that about 30 percent of publicly held companies have nonshareholder-approved stock option plans that are not disclosed in the annual proxy statements. Five years ago, there were only 5 percent of companies with such plans. These plans are plans that apply to a wide range of employees and are not restricted to officers. The result is that the numbers and their impact need not be reported to the shareholders in that section of the proxy statement that discloses executive compensation and stock option plans.

Under the rule, the companies will be required to disclose the following:

• Weighted average exercise price of all outstanding options, warrants, and rights
• Number of shares held in reserve to be used for the stock option plan
• The information must appear in the proxy statement as well as in the 10K

Refer to Chapters 48.

What is the effect of not disclosing this information to shareholders?

FOR MORE INFORMATION

Stephanie Strom, "S.E.C. Widens Rule Covering Stock Options," The New York Times, December 20, 2001, C1, C9.

Update: February 18, 2002
The Enron debacle continues to unfold on many fronts. Mr. Kenneth Lay, the former chairman on the board of Enron, appeared before Congress and took the Fifth Amendment, refusing to testify about the company and his activities, although he did express sadness over what had happened.

In the civil suits pending, the federal district judge presiding over the securities fraud case appointed the University of California system as the lead plaintiff in the case. Under the Private Securities Litigation Reform Act of 1998, judges must designate a lead plaintiff in the case in order to ensure that all the lawyers representing various clients protect all of the plaintiffs' interests without resulting duplicate legal billing for those bringing the suit. The designation of a lead plaintiff is a means of consolidating the work.

The University of California system is a plaintiff because it held Enron stock in its pension fund for its employees. Its attorney is William Lerach, a leading class-action attorney who has also had his share of colorful legal cases such as one brought against Milli Vanilla, a duo group whose Grammy award was taken away when it was discovered that they were lip-synching all of their songs. Mr. Lerach has won more than $1 billion in shareholder class action lawsuits, focusing mainly on junk bond litigation.

Refer to Chapters 8 and 47.

What is the significance of taking the Fifth Amendment? Why is this right available? What do you think is the basis for the lawsuit brought by the Enron shareholders?

FOR MORE INFORMATION

Michael Brick, "Class-Action Lawyer Will Lead Fraud Cases in Enron Debacle," New York Times, February 16, 2002, B1, B4.

Update: February 4, 2002
The following chart shows securities litigation in federal district courts in the United States. As you review the chart, keep in mind that the Private Securities Litigation Reform Act, passed in 1996, was intended to curb securities litigation.

Refer to Chapter 48.

FOR MORE INFORMATION

"Securities Lawsuits," National Law Journal, January 28, 2002, B1.

Update: February 4, 2002
Albert Dunlap, "Chainsaw Al," the former CEO of Scott Paper and Sunbeam, has agreed to settle a securities fraud class action lawsuit brought against him and other former Sunbeam executives by Sunbeam shareholders. Mr. Dunlap will pay $15 million to settle his portion of the suit.

Sunbeam is in Chapter 11 bankruptcy and Mr. Dunlap was removed as CEO at the end of 1998 after significant accounting irregularities resulted in a restatement of Sunbeam's earnings for the six quarters preceding the last one of 1998.

Arthur Andersen Company had served as the external auditor for Sunbeam and it agreed to settle the shareholder suit against it for $110 million. That settlement was reached in May 2001.

No one, including Andersen in its settlement, admitted any guilt as part of the settlement agreement. The SEC has fraud charges pending against Dunlap and others.

Refer to Chapter 48.

What statutory provision would the shareholders be using as the basis for their litigation against Andersen and Dunlap?

FOR MORE INFORMATION

Kelly Greene, "Dunlap Agrees To Settle Suit Over Sunbeam," Wall Street Journal, January 15, 2002, A3.

Update: January 28, 2002
The Enron bankruptcy has resulted in Congressional hearings, calls for regulatory reform for auditors, and changes in regulation of employee retirement plans. The Enron case presents a flurry of business law and legal environment issues.

For example, the original creation of the partnerships that Enron did business with had officers of Enron as the partners in those partnerships. In fact, they were enjoying substantial returns in their roles as partners. Issues that arise here are conflicts of interest and the liability of the partners and officers for the transactions. Issues of disclosure to the board and perhaps the shareholders also arise.

Enron paid little federal income tax because it had created over 800 corporations located in the Cayman Islands and managed to avoid federal tax liability by channeling earnings through a wide range of businesses and corporations located there. Questions that arise here relate to international law and the jurisdiction of the United States over wholly owned subsidiaries of Enron incorporated and located in other countries. Also, there is the constitutional issue of taxing the income of companies whose earnings come from operations outside the United States.

Enron employees had retirement plans through the company and were permitted to hold up to 62 percent of their retirement savings in Enron stock. In fact, the company's program for matching the stock chosen for investment made it rather tempting for employees. As the value of the company's stock was declining, the officers placed a lock on trading by the employees for 30 days, with the result being, for many employees, the loss of most of their retirement funds. Because of the high exposure employees have when they are so heavily invested in their employer's stock, Congress is considering more regulation under ERISA with regard to these types of retirement plans.

There is the story of Sherron S. Watkins, the former accountant who became an Enron officer and wrote a letter, now referred to as the smoking gun, to chairman and CEO Ken Lay expressing concern about Enron's accounting practices and financial reports. In her memo she reports a conversation she overheard in which one middle manager said to another manager, "I know it would be devastating to all of us, but I wish we would get caught. We're such a crooked company."

There have been allegations that Andersen and Enron employees were destroying records, in advance of their usual time for destruction under company policies. Andersen has stated that it halted the shredding once it had notice of an SEC investigation. It is a criminal violation to shred documents that are necessary for an ongoing investigation.

David Duncan, the Andersen partner in the Houston office assigned to the Enron account, took the Fifth Amendment when he was called to testify before Congress. Newspapers are exploring the campaign donations of Enron and its officers and that information can be found at http://www.fec.gov.

Finally, employees from Arthur Andersen, Enron, and accounting groups have been called to testify before Congress regarding everything from the shredding of documents to whether new rules are necessary for auditors and their roles in certifying financial statements.

Refer to Chapters 3, 7, 8, 43-50.

Discuss the issues outlined above. Include a discussion on whistleblowers and whether they are protected under the law.

FOR MORE INFORMATION

Richard A. Oppel Jr., and Kurt Eichenwald, "Arthur Andersen Fires An Executive for Enron Orders," New York Times, January 16, 2002, A1, C7.

Jim Yardley, "Author of Letter to Enron Chief Is Called Tough," New York Times, January 16, 2002, A1, C6.

John Waggoner, "How to protect yourself from spooky stuff like Enron, New York Times, January 25, 2002, 3B.

Thomas A. Fogarty and Jayne O'Donnell, "Andersen execs point finger at fired partner," USA Today, January 25, 2002, 1B.

Update: January 21, 2002
A 17-year-old has been charged by the SEC with stock fraud. The SEC has accused Cole Bartiromo of raising at least $1,000,000 through an Internet securities offering for a company that was supposed to conduct online betting but which did not exist.

Mr. Bartiromo has returned to the SEC $900,000 of the money he raised and has agreed to cooperate with the SEC in its investigation.

The case is one of a new style of enforcement under the new SEC chairman, Harvey Pitt. Mr. Pitt has established as a focus for the agency's resources cases in which the SEC can move in quickly and get back the money investors have lost. The recovery in this case of nearly all of the money invested is an example of how the agency hopes to proceed, focusing on ongoing investments rather than waiting for complaints after the fact.

Mr. Bartiromo has been an outstanding Little League baseball player in California over the years and was well known over the Internet for his acquisition and trading of sports memorabilia. He has been offered "six figures" for some of his collection and has appeared on ESPN with his father for interviews on his valuable items. It was this reputation that enabled him to garner investors for the online-betting securities offering.

Refer to Chapter 48.

What section of the 1933 Securities Act applies? What is the liability of an offeror? If the online betting company did not exist, what would the charges be?

FOR MORE INFORMATION

Michael Schroeder, "Another Teen Is Cited by SEC for Stock Fraud," Wall Street Journal, January 8, 2002, C1, C9.

Update: January 14, 2002
Walter Hewlett, the son of the late William Hewlett, a co-founder of Hewlett-Packard, filed a proxy to solicit shareholders for their votes in the upcoming meeting scheduled for the approval of Hewlett-Packard's acquisition of Compaq Computer, Inc. Mr. Hewlett is joined in his proxy proposal by his two sisters as well as by the trustees of a Hewlett Trust.

Refer to Chapters 46-48.

Who must file proxy solicitation materials? What is included in them?

FOR MORE INFORMATION

You can view the proxy solicitation by going to www.sec.gov. Click on their EDGAR box heading. Go to the Archives and select years 2001-2002. Type in Hewlett-Packard and select ALL for types of filings. All those filings with the designation 14A are related to the proxy solicitation for the acquisition meeting.

Update: November 5, 2001
The Securities Exchange Commission (SEC) has announced that it will be checking regular and annual reports (10Ks, 10Qs and 8Ks) more carefully because it is concerned about the levels of disclosure and the accuracy of the information the companies are providing. The SEC fears that companies are simply providing perfunctory information and not even updating substantive information such as business addresses, phones and the expiration of contracts such as leases or union contracts.

Because of this new crackdown on regular reports, the following is a list of areas to pay particular attention to when completing SEC required reports:

1. Don't miss the deadlines
2. Even missing the deadline by one hour requires the company to file an 8K disclosing that it missed the deadline for its 10Q or 10K
3. Watch for changes in the SEC forms on disclosure and be certain you put the correct information in the relevant areas of the forms
4. Discuss all significant revenue changes, providing complete explanations
5. Make sure you include all of the exhibits mentioned in the report such as financial statements
6. Disclose when contracts expire, whether with suppliers, customers, landlords or unions
7. Make sure that there is full and accurate disclosure about management stock ownership
8. Be sure to send the required 7 copies to the SEC
9. Disclose all options and information about those options and their costs, price and periods
10. If the annual meeting is delayed, disclose that and explain why and fill out the additional form the SEC requires for delayed annual meetings

Refer to Chapter 48.

What companies are required to file these types of reports under the Securities Exchange Act of 1934? What happens if this information is not disclosed on the reports in a timely fashion?

FOR MORE INFORMATION

Merrill Freed and Erik Ojala, "Avoiding Common Blunders in Periodic SEC Filings," 15 Insights: Corporate and Securities Law Advisor (2001).

Update: September 24, 2001
The issue of insider trading has emerged in the aftermath of the disaster at the World Trade Center in New York City. When the stock markets reopened on Monday, September 17, 2001, there were issues raised because of unusual activity in stocks that were hit the hardest: airlines and insurance. Those investigating have been able to discover that investors based in Europe have purchased puts in those companies and expected to yield substantial amounts of money from their purchases.

Puts work as follows:

• Company A is very bullish on its own stock.
• Company A decides to sell put options in order to earn extra cash.
• Puts give the buyer the right to sell back the stock to the company at a specific price within a specified time (for example, one year).
• Company A's stock is trading at $100 per share. The company sells 1 million put options on its stock exercisable at $100 within one year
• Investors buy the puts at $10 a share. Company A pockets $10 million.

One year later:

• If the stock price is $100 or more, the puts expire worthless. Company A has made $10 million.
• If the stock price drops to $50, the investor can buy shares in the open market at $50 and then exercise the puts. Company A must buy back the shares at $100. The company's loss of $50 million is partially offset by its $10 million gain from sale of the puts for a net loss of $40 million.

Alternatives:

• Company A could pay the investors the $50 difference between the exercise price and the current market value of the stock. The investors would keep the stock.
• The company could pay the difference by giving the put holder a share worth $50. This alternative increases the shares outstanding and dilutes earnings per share.

In the case of the WTC disaster, someone with advance knowledge of the attacks bet that the stocks of these companies would go down and purchased the puts accordingly. However, there is a hold on the payments as investigators continue to look into trading on inside information and tracing the links of those who bought the puts.

See Chapter 48.