|Cleary Gottlieb Steen & Hamilton|
|2000 PENNSYLVANIA AVENUE, N.W.
WASHINGTON, D.C. 20006-1801
41, AVENUE DE FRIEDLAND
RUE DE LA L01 23
CITY PLACE HOUSE
|one liberty plaza
new york, ny 10006-1470
NEUE MAINZER STRASSE 52
60311 FRANKFURT AM MAIN
PIAZZA DI SPAGNA 15
BANK OF CHINA TOWER
SHIN KASUMIGASEKI BUILDING
June 24, 2002
Mr. Jonathan Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Re: Proposed Rule Regarding Form 8-K Company Disclosure of Certain Management Transactions (File No. S7-09-02)
Dear Mr. Katz:
We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the Commission's proposed rules requiring company disclosure of certain management transactions on Form 8-K set forth in Release Nos. 33-8090; 34-45742 (the "Release"). We appreciate the opportunity to comment on the matters discussed in the Release.
We commend the Commission for its efforts to improve investor access to information concerning management transactions in company equity securities. The proposed rules, however, raise a number of significant concerns. Most importantly, we do not believe the proposed reporting deadlines would provide companies with enough time to comply with the new disclosure requirements. We are particularly concerned that the Commission's proposal to require reporting of transactions and events that exceed a particular dollar threshold within two business days will prove difficult to administer. Thus, while we agree with the Commission that improved reporting of management transactions is a desirable goal, we believe the proposals in the Release may be too broad, using a club instead of a scalpel to accomplish this objective. We propose a more narrowly tailored alternative that would focus on those transactions of most interest to investors without subjecting companies to the burdens that would result from adoption of the proposed rules.
I. Alternative to the Proposed Rules
A. Reporting Deadlines and Thresholds
We do not support the Release's three-track reporting deadlines and its requirement to aggregate small transactions until they have exceeded a certain dollar value. Instead, we propose that companies disclose all reportable transactions and events by the end of the week following the week during which those transactions and events take place.1 This alternative would provide companies greater clarity as to their disclosure obligations as well as more reasonable filing deadlines. Simplifying the reporting process would save companies time and money while still providing investors with timely access to information that may indicate management's views of the company's future prospects. In fact, our alternative proposal would result in disclosure of some transactions more rapidly than the proposed rules because it does not include an exception for de minimis events.
Requiring companies to report transactions exceeding $100,000 within two business days would strain their resources. Although companies would be able to build upon their existing procedures developed for compliance with Section 16(a) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), two business days would not provide adequate time for companies to learn of a transaction, gather the relevant data, prepare and review Form 8-K reports, format the reports electronically and file the reports. Compliance costs would be particularly high since, in contrast to the monthly Section 16(a) regime, companies would be unable to prepare in advance for a fixed reporting deadline.
Extending the filing deadline to the end of the week following the week during which the transaction or event takes place would mitigate this burden significantly. The extended deadline would give companies more time to gather and review the information necessary to file Item 10 Form 8-K reports and allow them to establish weekly procedures within their pre-existing Section 16(a) compliance systems. Moreover, although certain transactions or events would not necessarily be reported as quickly under our proposal, disclosure would still be made much earlier than under the current monthly Section 16(a) regime.
Filing reports at the end of a week for all transactions and events that took place during the previous week would eliminate the need for companies to monitor the amount of each transaction for purposes of determining when each covered person crosses a de minimis threshold. Although aggregating transactions appears to be a matter of simple arithmetic, our experience suggests that in practice companies frequently have difficulty monitoring cumulative information over long periods of time. For instance, under Section 13(d) of the Exchange Act, a Schedule 13D must be filed with the Commission upon the acquisition of 5% or more of a class of a company's equity securities, and a subsequent amendment must be filed when a company acquires or disposes of an additional 1% of the outstanding securities of that class. Despite their best intentions, companies regularly err in monitoring these thresholds and filing the requisite reports. In fact, the 1% threshold presents the greatest compliance difficulty because it requires aggregation of numerous transactions over irregular time periods. We believe the framework proposed in the Release would pose similar difficulties.
We also recommend that the Commission eliminate Form 5 and import the transactions covered by that form into Form 4. This change would ensure that insider transactions - including those transactions not within the ambit of Item 10 - would be disclosed in a timely manner (at the latest, ten days after the end of each month).
Our experience with foreign private issuers suggests that few of them have the complex internal monitoring systems necessary to provide the disclosure required by the Release. Although the Release would not apply to foreign private issuers, reporting under the proposal, if adopted, may become market practice in the United States and thus expected, to some degree, of foreign private issuers. If the Commission provides greater clarity as to the disclosure requirements and narrows those requirements as we are suggesting, we believe foreign private issuers would be more likely to follow the proposed reporting requirements voluntarily.
B. Covered Directors and Executive Officers
The Release would establish reporting obligations for all directors and executive officers. We believe this requirement is unnecessarily broad. In light of the additional burden any new reporting obligations would entail, we believe they should focus on those transactions most suggestive of a view about a company's prospects. Executive officers direct the day-to-day operations of a company and therefore have the most detailed and nuanced understanding of a company's ongoing performance and prospects. By contrast, directors are charged not with actual management of the company, but solely with management oversight, generally through periodic meetings with management and the company's outside auditors. Outside directors are, by definition, further removed.2 Because outside directors have a significantly more attenuated relationship with the management of a company (and frequently have little or no economic stake in the company), we believe their transactions are of less interest to investors and should not be subject to the Item 10 requirements.
In addition, information regarding an outside director's transactions may be difficult to obtain quickly because outside directors have no employment relationship with the company and are generally less accessible by the company. This administrative complexity will be heightened where the outside director has - as is sometimes the case - an antagonistic relationship with the company. Further, in light of the recent corporate governance proposals by the New York Stock Exchange and the Nasdaq Stock Market, Inc., which would require companies to retain a larger proportion of independent directors and impose on those directors greater responsibilities,3 we believe it will become increasingly difficult for companies to recruit qualified independent directors. Placing additional compliance burdens on these directors will only exacerbate this problem.
Transactions by outside directors would, of course, continue to be subject to monthly reporting under Section 16(a). In light of the above considerations, we believe the existing reporting regime strikes a better balance between the legitimate need for improved disclosure and the need for workable requirements.
C. Section 16 Exemptions and Interpretations Should Apply to Item 10
As proposed, the transactions subject to reporting under proposed Item 10 of Form 8-K are similar, but not identical, to the transactions reportable under Section 16. We believe the reportable transactions should be identical to those under the Section 16(a) reporting regime and the large body of interpretive authority, including no-action letters, that governs the application of Section 16 should be applied to Item 10 reporting.4
Section 16 of the Exchange Act was designed to prevent the unfair use of non-public information by corporate insiders for their own investment purposes. The purpose of the proposed rules is thus substantially similar to that of Section 16. Given this alignment of purpose, we believe transactions exempted under Section 16 should also be exempted from Item 10 reporting. For example, as discussed below, if gifts of company equity securities are not considered indicative of insider views of a company under Section 16, they also should not be reportable under Item 10.
Failure to apply the Section 16 interpretive regime to Item 10 reporting would burden companies with years of uncertainty until a similarly rich interpretive framework developed that could provide clarity as to the scope of the Item 10 requirements. In addition, since there is considerable overlap between Item 10 and Section 16(a), the development of an independent body of Item 10 interpretive authority risks creation of conflicting precedent with Section 16 authority in respect of identical transactions.
D. Rule 10b5-1 Arrangements
We do not believe the establishment, modification or termination of Rule 10b5-1 arrangements should be reported under Item 10. The Release reflects a well-founded concern that certain transactions by insiders may be indicative of their views of a company's prospects. Prospective arrangements for the sale or purchase of a company's securities, which may be conditional or otherwise subject to material limitations, are not, however, of comparable significance.
There are a variety of reasons why a person may enter into a Rule 10b5-1 plan. Many executive officers have concentrated positions in company stock as a result of the company's compensation policies, and they may be seeking to balance a need for investment diversification or liquidity against the not insignificant risk of "insider trading" liability under Rule 10b-5. The existence of a Rule 10b5-1 plan no more indicates an insider's view of a company's prospects than, for example, a universal shelf registration statement indicates a company's intention to allocate the entire shelf to equity securities. In other words, requiring disclosure of the mere presence of these plans would attribute meaning where none may exist.
We do not support the Commission's proposal to include loans generally among the transactions covered by Item 10. Loans to a director or executive officer that are not in the form of company equity securities, or that do not finance the purchase or involve the pledge of company equity securities, are unrelated to the goal of promoting disclosure of transactions or events that may be indicative of management's view of a company's prospects. Loans not involving company equity securities are also indistinguishable from the many other types of compensation received by an executive officer or director, disclosure of which is not required on Form 8-K. On the other hand, we do support the disclosure of company loans that are in the form of, or that finance or involve the pledge of, company equity securities.
F. Format and Content of Item 10 Reports
The Release does not mandate a particular format for Item 10 Form 8-K reports. We believe it would be highly desirable to adopt a specified tabular format (mirroring Form 4, as discussed below) to facilitate comprehension and comparison by investors. The new form should include the same codes now employed for Form 4 submissions, supplementing the form with any new codes necessitated by Item 10, including a code for transactions that occur pursuant to Rule 10b5-1 arrangements. Without such a format, the major purpose behind the Release - namely, improving investor access and comprehension of insider actions - would be undermined. Moreover, a standardized format would ease considerably the burden on companies filing their Form 8-K reports.5 We understand that striking the proper balance between standardized reports that are easy to read and tailored reports that better capture the idiosyncrasies of individual transactions presents difficult trade-offs, but we recommend that the Commission accord substantial weight to the benefits of a standardized form, as it has in other contexts such as Section 16(a).
The proposal would require Item 10 reports to contain information generally required by Forms 4 and 5 under Section 16(a). This requirement offers companies the benefit of consistency. However, the Release also includes an additional requirement that the Item 10 reports provide "any other material information" in respect of equity securities and derivative securities transactions. This provision would require companies to tailor each report to the specific transactions reported, and its ambiguity and potentially vast scope would make it even more difficult, if not impossible, for companies to know when they have assembled all the necessary information. For this reason, we suggest removing this catch-all requirement and utilizing the Form 4 format for Item 10 filings.
II. Suggestions in the Event Item 10 is Adopted as Proposed
As indicated above, we do not support the adoption of Item 10 as proposed in the Release. If, despite our concerns, the Commission decides to adopt Item 10 as proposed, we urge it to implement the suggestions set out below in order to reduce the burdensome impact of the new requirements and make them more workable.
Two business-day deadline and dollar threshold for accelerated reporting
Even if the proposals are adopted in the proposed form, we strongly believe the two business-day deadline for reporting transactions or loans over $100,000 would not give companies adequate reporting time. If the Commission implements its proposal, it should extend the reporting deadlines to provide companies with sufficient time to compile the information. In our view, eliminating the two business-day deadline and requiring all reports to be filed by the second business day of the week following a reportable event represents a more reasonable period in which to expect companies to compile, review and report transactions and events with respect to their executive officers and directors.
If the accelerated filing time for large transactions is retained, the Commission should adopt a higher threshold for triggering expedited reporting. If companies are required to expend significant resources to meet stringent filing requirements, the benefits should match the costs. Our experience suggests that transactions by insiders up to $1,000,000 are not significant enough to warrant accelerated disclosure. We would recommend that accelerated filing apply only to transactions or events in excess of $1,000,000.
Dollar thresholds for de minimis events
The Commission solicits comment as to whether the dollar threshold for reporting should vary depending on whether the reportable event is a transaction or a loan. As discussed above, we believe the Commission should eliminate all thresholds from the Release. However, if the Commission chooses to implement any thresholds at all, we believe a single aggregate threshold should be consistently applied to all transactions and events. The type of transaction or event should not affect the dollar threshold. Simplicity will ultimately lead to more accurate and timely disclosure at a lower cost to companies.
We also believe that if the Commission adopts a threshold, the $10,000 de minimis proposal is too small. We believe most investors do not focus on management transactions of this size, and companies should not be forced to undertake the significant time and expense that would be required to capture such transactions. We believe $60,000 would be a more appropriate de minimis threshold since it would include those management transactions and events required to be disclosed under Item 404 of Regulation S-K and therefore already subject to compliance procedures.
Aggregation period for smaller events
We believe the Commission should adopt a limited aggregation period for smaller events beyond which reporting would no longer be required. Because executive officers and directors must report a wide range of transactions in a company's equity securities and derivative securities on Form 4 at the end of each month, the aggregation period should not extend past the end of a month. Once a Form 4 is filed, any previous transactions by an executive officer or director will have been disclosed, obviating the need for a filing by the company.
Ten percent beneficial owner transactions
The Commission asks in the Release whether there would be any benefit in requiring reporting with respect to ten percent beneficial owners of a company's equity securities. We agree with the Commission's view that these owners do not share the same fiduciary duties to a company as directors and executive officers. Moreover, these owners are in many cases not involved in the management of the company, and their transactions are not necessarily indicative of management's views of the company. Indeed, as the Release notes, the relationship of these owners with management is often antagonistic, making the collection of the information necessary for the company to file an Item 10 Form 8-K extremely difficult, particularly under the rigid deadlines proposed in the Release. We believe the disclosure by these owners under Section 16(a) is sufficient and their transactions should remain outside the scope of Item 10.
Since the Release is targeted at disclosure of transactions that may reflect management's view of the future prospects of a company, we do not believe gifts of equity securities by a director or executive officer should be reportable under Item 10 of Form 8-K. Large stockholders in a company donate company stock for tax, estate planning and other reasons often having little to do with their views of the company's prospects. For this reason, gifts are already exempt from reporting under Section 16(a).
Loans by affiliates
The Commission questions whether requiring disclosure of loans to executive officers and directors by affiliates is too broad. We believe it is. The Commission proposes requiring disclosure of loans to executive officers and directors because they involve the use of company assets for arrangements not available to shareholders of the company generally. This rationale might apply to loans by a subsidiary but does not to loans by a company's parent or sister company.
III. Technical Suggestions
We also make the following technical suggestions that we believe should be incorporated into the final form of the proposal to ensure its successful implementation.
Interchangeability of Form 4 and Form 8-K
We believe reports under Item 10 of Form 8-K should satisfy an executive officer's or director's Section 16(a) reporting requirements on Form 4 and vice versa, provided that in the case of a Form 4, it is filed electronically as permitted by Regulation S-T. Since both forms would generally contain identical information, permitting one filing to satisfy the other would prevent duplicative filings that would otherwise burden companies and potentially confuse investors. Indeed, the need for interchangeability reinforces the argument for creating a single form that satisfies both reporting obligations.
Safe harbor provisions
Acknowledging the challenges posed by requiring companies to institute new compliance systems, the Release creates a safe harbor provision designed to protect companies that (1) implement procedures that provide reasonable assurance of Item 10 compliance, (2) follow such procedures and (3) promptly correct any violation. We agree with the concept of providing a safe harbor to companies that work to meet the Item 10 requirements. Any company satisfying the three requirements of the proposed safe harbor, however, would have successfully filed a timely report on Form 8-K in the first place (barring, perhaps, some unlikely computer failure). As written, the safe harbor does not provide adequate protection for companies that have established the appropriate procedures but have been unable to meet their obligations despite their good faith efforts. We believe it would be appropriate to modify the second safe harbor criterion to include a "good faith efforts" clause that exempts from sanction or other liability companies meeting this criterion. A higher standard of care would unduly penalize companies in an area of significant administrative complexity without any concomitant benefit to investors.
Filed Status of Reports
The obstacles companies would face in compiling all the information required for Item 10 Form 8-K reports, coupled with the proposed reporting deadlines, militates against considering the reports "filed" for purposes of liability for material misstatements under Section 18 of the Exchange Act, unless companies specifically provide that the information is to be considered filed under the Exchange Act or incorporate it by reference into a filing under the Securities Act of 1933 or the Exchange Act. Previously, in response to concerns that disclosures made under the short timeframes required by Regulation FD could lead to Exchange Act liability, the Commission permitted information to be "furnished" but not "filed" pursuant to Item 9 of Form 8-K. We believe the same standard should be applied to Item 10 reports.
Disclosure of Late Filings
The Commission solicits comment as to whether companies should be required to disclose in their annual reports any director or executive officer failure to comply with their company's Item 10 procedures. Regulation S-K already requires companies to identify on an annual basis members of management who file Section 16 reports late.6 We believe that because of the novelty of the reporting proposed by the Commission, this type of disclosure should only be required in the case of a transaction that exceeds a threshold amount, such as $1,000,000. Establishing a "shaming threshold" would focus investor attention on truly significant transactions. Moreover, it would punish only those individuals whose transactions were so large that it strains credulity to believe they merely "forgot" to notify the company.
We support website disclosure of the information reportable under Item 10 of Form 8-K. This proposal represents a natural extension of the Commission's often repeated goal of providing investors with better access to information about companies, as well as "democratiz[ing] the capital markets by enabling many small investors to access corporate information just as readily as large institutional investors."7
We believe companies will need considerable time to develop and implement the necessary accounting and compliance procedures to comply with the Release's reporting requirements, particularly if the Commission retains the two business day deadline for certain transactions. We do not think the staggered two-month and four-month transition periods in the Release will be sufficient. We recommend instead a six-month transition period for the entire proposal.
* * *
We thank you for the opportunity to submit this comment letter. We would be happy to discuss with you any of the comments described above or any other matters you feel would be helpful in your review of the proposal. Please do not hesitate to contact Leslie N. Silverman, Janet L. Fisher or Arthur H. Kohn (212-225-2000) if you would like to discuss these matters further.
Very truly yours,
CLEARY, GOTTLIEB, STEEN & HAMILTON
cc: The Honorable Harvey L. Pitt, Chairman
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Cynthia A. Glassman, Commissioner
Alan L. Beller, Director, Division of Corporation Finance
|1||The Commission states in the Release that the date of a reportable transaction or event would be the date on which the parties enter into an agreement. This standard may unfairly disadvantage parties to an agreement that provides for the initial pricing, or the maximum number of underlying shares, to be established over a number of days following the date on which the parties enter into the agreement. We therefore suggest, in the case of such transactions, that the triggering date be deemed to be the date on which all the initial economic terms have been established.|
|2||The term "outside directors" as we use it includes both "independent" directors and those directors nominated by large stockholders of a company who may not be considered independent. Our proposal to exclude from the Item 10 reporting requirements transactions and events with respect to this latter category of directors is consistent with the Commission's proposal to exclude transactions and events in respect of ten percent beneficial owners.|
|3||See generally Report of the New York Stock Exchange Corporate Accountability and Listing Standards Committee (2002); Proposed Rule Change by the National Association of Securities Dealers, Inc. to Modify the Definition of the Term Independent Director (June 18, 2002).|
|4||Since February 1991, the Commission has issued 210 no-action letters with respect to Section 16 under a system in which no duplicative matters were addressed. This figure does not include the extensive collection of interpretive letters that were carried forward from the pre-1991 regime.|
|5||In order to avoid delays caused by the use of outside printing operations to file reports under EDGAR, the Commission should develop alternative filing platforms for Item 10 reports. We recommend that the Commission either: (i) establish a direct Internet link that would allow companies to complete and submit a prescribed form on-line; or (ii) permit companies to submit their reports electronically as a word processing document, following the same procedures the Commission provides for submission of comment letters to rule proposals.|
|6||See Regulation S-K, Item 405(a)(2).|
|7||SEC Release Nos. 33-8089; 34-45741 (Apr. 13, 2002).|