Helen W. Melman
Attorney at Law
815 Moraga Drive
Los Angeles, California 90049
Telephone (310) 472-4191
Facsimile (310) 472-4091
June 20, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-09-02
Dear Mr. Katz:
I am writing to comment on the proposed amendments to Form 8-K set forth in Securities Act Release No. 8090. I am a corporate and securities attorney in private practice who has represented public companies for over 20 years. The following comments are my own.
The SEC proposes to require companies to promptly file a Form 8-K to report transactions by directors and executive officers ("insiders") in company equity securities. The SEC's rationale for the proposed amendments is that an insider's transactions in a company's securities provide information to investors regarding the insider's views of the company's performance or prospects and that investors should have timely access to this information. My principal objection to the premise of the Release is the significance which is being placed on insiders' transactions serving as "possible market signals" on which investors should rely. The foundation of the securities laws is that financial and business information contained in an issuer's current and periodic reports should serve as the basis for informed investment decisions. Instead, the proposed Item 10 disclosures and the tone of the Release place undue emphasis on insiders' securities transactions and encourage investors to rely on "inferences" about an insider's true views about his company's prospects as a basis for making investment discussions.1
Proposed Item 10 of Form 8-K requires the disclosure of "any other material information regarding the transaction." Since the stated objective of the proposed rule is to provide investors with the insider's view of the company's prospects, does the SEC intend that Item 10 will require insiders to disclose (and defend) their reasons for engaging in transactions so that investors do not leap to the wrong "inference" concerning the stock's future value? For example, an insider could decide that it is necessary for him to respond to Item 10 as follows:
"Mr. Insider has advised the Company that he sold the stock because he needed cash to pay for his daughter's wedding, but that he otherwise would not have sold the stock at this time." (The intended "market signal" being that the stock is not tanking.)
It is also possible that responses to Item 10 will evolve into boilerplate disclosures which will be of no use in helping investors make "informed" decisions, such as:
"Ms. Insider has advised the Company that she bought/sold/pledged/hedged/exercised for personal reasons which do not necessarily reflect her views on the Company's prospects. The Company urges investors to carefully review all of the Company's reports on file with the SEC prior to making any investment decisions concerning the Company's securities."
An unintended consequence of these inferred market signals is that they could become self-fulfilling prophecies, since investors will simply follow the lead of insiders. Or, if an investor buys stock after an insider buys stock and the stock price does not go up, will plaintiffs' lawyers be able to bring a class action lawsuit against the issuer or the insider because the Item 10 disclosure constituted a misleading "market signal"? For these reasons, the vague provision of Item 10 requiring disclosure of "other material information" should be deleted and only objective information, such as that already provided in Forms 4, should be required.
The proposal requires the immediate reporting of too many transactions which are of little value to investors. The SEC relies on studies cited in the Release that indicate that executive trading patterns are of predictive value to investors, who can profit (or avoid losses) from having such information on a more timely basis. According to one article cited in the Release, however, the value of this information depends on the nature of the information, with large volume trades by high-ranking insiders having the most predictive value, since there are a "gazillion reasons" for insider transactions.2 Another study concludes that only insider purchases, and not sales, are of predictive value.3
At a minimum, there is little benefit to investors to know within a week about issuer compensatory awards or option grants to insiders, especially in the case of periodic awards or grants pursuant to formula plans which have been previously disclosed to shareholders. Since an award or option grant does not involve an investment decision which reflects an insider's views of the issuer's prospects (as does an option exercise or an open market purchase or sale), reporting these transactions on a Form 4 in the ordinary course is adequate disclosure.
Given the wide range of market capitalization of companies, the proposed $100,000 threshold for the accelerated filing deadline is both low and does not bear a direct relationship to an amount that would be considered significant to the market or investors. Instead, this threshold should be based on a percentage of each issuer's public float or its outstanding shares as reported in the most recent Form 10-Q or Form 10-K, since these amounts are directly related to the market for each particular issuer's securities.
The proposed two business day filing deadline is unrealistic. My clients are small public companies that do not have in-house counsel, so, like many other public companies, they will have to rely on outside counsel to be available and to respond immediately in order to meet a two business day filing deadline. This may not always be feasible. Time is also required to "Edgarize" the Form 8-K prior to filing.
The SEC's estimated cost to issuers of complying with Item 10 of Form 8-K is too low. As the SEC recognized, the complexity of the proposed rules will require the assistance of outside counsel. However, instead of the three-quarters hour per Form 8-K of outside legal time assumed by the SEC, I believe 1.5 hours is more accurate (and, alternatively, allows for higher hourly rates than the $300 assumed). The SEC also failed to take into account the filing costs. Based on information provided by a well known Edgar filing agent, a simple two-page Form 8-K will cost at least $300 to file. My estimate would thus result in a total cost of $941.25 per report, consisting of $191.25 for in-house staff, $450 for outside counsel and $300 for Edgar filing, which is more than two times the SEC's estimate of $416 per report. Assuming 21 reports per year, the estimated annual cost to each issuer will be about $20,000, in addition to the cost of duplicative Section 16 reports, which is also typically borne by issuers.
Instead of amending Form 8-K, I suggest that the SEC focus on improving the timing of and information conveyed in existing reports.4Proposed Item 10 of Form 8-K contains two pages of detailed instructions for information which is largely duplicative of that provided in Forms 4. The Section 16 rules have already spawned a wealth of treatises, outlines and sample forms to assist practitioners and issuers in completing the forms. Proposed Item 10, which requires disclosure of "substantially similar, but not identical transactions," will only add to this complexity with little incremental benefit to investors. The numerous Form 8-K filings will also dilute the value of the Form 8-K as a means of alerting the public to material company developments.
The SEC already requires the filing of Forms 144 in advance of open market sales by insiders pursuant to Rule 144 and Forms 4 to report numerous types of transactions in equity securities. As a means of providing more timely information of proposed sales transactions, the SEC should require that Forms 144 be filed on Edgar and that the report cover proposed sales only within the next 30, rather than 90, days. The Section 16 rules can easily be changed to require more transactions to be reported on Form 4 rather than on Form 5 (such as dispositions to the issuer). The filing deadline for Form 4 should also be changed (with, I assume, the prompt action of Congress) to provide for different filing deadlines based on the size and type of transaction along the lines proposed in the amendments to Form 8-K.
The Release states that it is important for investors to have timely information concerning transactions that relate both to the market for the issuer's equity securities and to the insider's relationships with the company. Therefore, only that information which is directly related to the market should be reported on an accelerated basis and other information should be reported in the normal course in periodic reports.
With respect to the proposed Item 10 disclosures concerning insider loans and guarantees, the SEC should distinguish between loans or guarantees used to engage in transactions in issuer securities or which are secured by issuer securities, on the one hand, and loans or guarantees that may be characterized as additional compensation, on the other. The former should be reported on Form 8-K under the standard 15 day deadline, whereas the latter should be reported on Form 10-Q. Alternatively, the SEC could require these transactions to be reported on an accelerated Form 8-K only after they exceed a materiality threshold which is based on the insider's last reported compensation, in the case of an officer (such as 50% of annual salary plus bonus), or a percentage of the issuer's assets, in the case of directors.
Finally, the numerous statements in the Release that insider transactions serve as "market signals" suggest that the SEC and investors believe that insiders routinely violate Rule 10b-5 and that the proposed amendments are necessary to "promote fair dealing" in the public markets. This premise of the Release offends me. Any such perceived violations should and can be dealt with through existing criminal and civil remedies (and Congress should support these efforts with increased funding), rather than by mandating an avalanche of Form 8-K filings.
Taking the foregoing concerns into account, and recognizing that more timely reporting of insider transactions that have a direct and significant impact on the market is a valid objective, instead of Item 10, I propose the following:
1. All Section 16 forms should be required to be filed on Edgar. The SEC could require issuers to file the forms on behalf of their insiders, but retain the ultimate responsibility and liability on the insider, where it belongs. This would obviate the need for dealing with related issues such as "filed" status and Form S-3/Rule 144 eligibility. The SEC could also facilitate Edgar filing by allowing insiders to use the issuer's Edgar filing codes.
2. The deadlines for Section 16 forms should be based on the nature and size of the transaction and the identity of the insider.
A. Impose a five business day filing deadline for Forms 4 relating to:
B. Impose a deadline of five business days after month-end for all other Form 4 reports.
C. Pending Congressional approval of filing date amendments to Section 16, the SEC could require that Forms 4 be filed by the issuer with a Form 8-K cover page.
3. Insider loans and guarantees should be reported:
A. On Form 8-K (15-day deadline) if they involve issuer securities and exceed a materiality threshold based on the insider's compensation; and
B. On Form 10-Q for all other insider loans and guarantees.
In conclusion, I believe that the SEC can achieve its objectives by refining its existing reporting scheme and improving the immediate availability and ease of filing under Edgar, instead of imposing burdensome, expensive and duplicative disclosure requirements on all issuers in reaction to the misdeeds of a few insiders.
Thank you for your consideration.
Very truly yours,
/S/ Helen W. Melman
HELEN W. MELMAN
|1||An example of how "inferences" are drawn from insider transactions and used by investors is contained in paragraph 1 of the comments of J. Spears, May 8, 2002. Mr. Spears admits that his inferences may "[leave] aside possible personal reasons" for insider transactions.|
|2||A. Beard, "Insiders' Trades Spark Outsiders' Interest," Financial Times (April 8, 2002).|
|3||J. Lakonishok and I. Lee, "Are Insiders' Trades Informative?," Review of Financial Studies, Vol. 14, Issue I (Spring 2001).|
|4||See, J. Moreland, "Two Modest Proposals for Fixing Insider Trading Rules," TheStreet.Com (Feb. 11, 2002).|