New York State Bar Association
One Elk Street
Albany, NY 12207
Business Law Section
Committee on Securities Regulation
August 29, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
E-mail address: email@example.com
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-22-02
Proposed Rule: Additional Form 8-K Disclosure
Requirements and Acceleration of Filing Date
Release Nos. 33-8106; 34-46084
Ladies and Gentlemen:
The Securities Regulation Committee of the Business Law Section of the New York State Bar Association appreciates the invitation in Release No. 34-46084 (the "Release") to comment on proposed disclosure requirements intended to provide investors with better and faster disclosure of important corporate events.
The Committee on Securities Regulation (the "Committee") is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was circulated for comment among members of the Committee, and the views expressed in this letter are generally consistent with those of the majority of members who reviewed and commented on the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.
Item 1.01: Entry into a Material Agreement.
Proposed Item 1.01 appears to encompass much of the same information required by Item 1 of the current Form 8-K (companies to report changes in control) and Item 2 (companies to report acquisitions or dispositions of assets not in the ordinary course of business), but the proposal makes clear that a broadened scope is intended. However, the proposed language is confusing and it is not clear precisely what additional events or transactions are intended to be covered.
The proposed language requires disclosure of "entry into a material agreement" and states that Item 1.01 would require disclosing letters of intent, "although this proposed item would not require disclosure about agreements still under negotiation." In our experience, letters of intent generally include a statement to the effect that they do not constitute an agreement and leave open many areas which are still under negotiation. Often, a letter of intent will say little more than that the parties are discussing a transaction involving certain assets or types of assets. Letters of intent often do not result in definitive agreements and frequently the substance of a transaction changes significantly from the letter of intent to the definitive agreement. We believe that the required disclosure should only cover definitive agreements. Because of the preliminary nature of a letter of intent, there will normally be important competitive and customer-relations reasons not to disclose negotiations unless and until they culminate in a definitive agreement.
If Item 1.01 disclosure is limited to definitive agreements, it is not clear what the broadened scope of Item 1.01 is intended to encompass beyond the current law. Some articulation of the additional information, if any, that will be required will be needed to facilitate compliance. We believe that Item 1.01 is intended to capture only material agreements which are not in the ordinary course of business. In order to clarify that point and assist companies to understand the intended scope of the required disclosure, we think that clarification that disclosure is limited to transactions not in the ordinary course of business and an indication of what, if any, events and transactions beyond those now required under Items 1 and 2 would reduce confusion and enhance meaningful disclosure and compliance.
With regard to whether disclosure should be based on a strictly financial measure or a qualitative materiality standard that would include non-financial measures, we believe that the proposal, embracing the broader qualitative standard, is appropriate. An acquisition or disposition may indicate a new direction for a company. If it does, and management has made that determination, disclosure is appropriate even if the acquisition or disposition is not "material" by traditional financial measures. If, for example, management has determined to phase out a material division, the sale of the first plant may not be quantitatively material, but disclosure of the determination to phase out the division, and that the sale of the plant is the first step in that process, is likely to be appropriate.
We believe that clarity and consistency regarding reporting under the securities laws is generally desirable and therefore suggest that disclosures under Form 8-K not be expanded beyond what is required to be filed pursuant to Item 601(b)(10) of Regulation S-K. We also note that a number of contracts filed pursuant to Regulation S-K are in the ordinary course of business and that these "ordinary course of business" items are not appropriate for disclosure under Form 8-K, which contemplates (and we believe properly should be limited to) disclosure of extraordinary events.
To disclose material acquisitions or dispositions of assets, a two business day filing requirement may not be unreasonable, although it could be burdensome to some issuers. We assume the Staff will monitor the ability of companies to comply with a two business day requirement and consider modification if unforeseen problems make two days unrealistic or adversely affect the quality of certain types of disclosures.
Item 1.02 Termination of a Material Agreement.
Many of the comments regarding Item 1.01 also apply to Item 1.02.
If a signed acquisition or disposition of assets agreement is terminated rather than consummated, identification of the agreement and the fact of termination is appropriate. A termination penalty provided for in the agreement, such as a breakup fee, is also a straightforward disclosure.
Other points of information are more problematic. Providing "a description of any material relationship between the parties other than in respect of the agreement" may require a lengthy and complex analysis. For example, if one company decided to purchase a product or group of products from another, a description of their "material relationship" might involve discussion of supply agreements, tolling agreements, buying arrangements, and competitive products. This information is likely to be tangential to investors but valuable to competitors and damaging to the registrant and thus its stockholders. It may also be voluminous and impossible to prepare in two days or even two weeks.
Similarly, "material circumstances surrounding the termination" is open-ended and may require disclosure of highly sensitive competitive information. This could, for example, include information regarding differing opinions on the validity of key patents or environmental risks. The buyer may have reserved the right not to close if its counsel or engineers were not satisfied. Disclosure of that information on Form 8-K might unfairly decrease the value of the seller's intellectual or other property, or even subject the seller to litigation from third parties, including competitors.
To require management to attempt to detail the effect of termination beyond any penalty in the agreement would be highly speculative and not in our view the type of information that Form 8-K was designed to elicit. Such a discussion could not reasonably be drafted in two, or possibly even 15, days.
We believe that disclosure of termination of a material agreement not in the ordinary course of business, and of any penalty incurred or provided for in the agreement, should be sufficient. Such a limited disclosure could reasonably be done in two business days. We believe that requiring additional descriptive material is likely to have damaging competitive effects, likely to place company officers in the position of speculating about what might have been, and likely to make prompt disclosure impossible.
Item 1.03 Termination or Reduction of Business Relationship Customer.
Form 8-K requires reporting "events" and the proposed item contemplates that "termination or reduction of business relations with a customer" will be an "event" that occurs at a specific, determinable time and has a specific, determinable monetary value. Such events may be clear in hindsight, but short of expiration of a long term contract in the ordinary course or a dramatic conflict preceding the termination and an immediate conclusion that the relationship is irretrievable, such "events" are difficult for many companies to pinpoint.
Some relations with customers are governed by long-term contracts with regular and predictable payments. (Such contracts if material are currently filed pursuant to Regulation S-K item 601(b)(10)(B).) When such a contract accounts for 10% or more of a company's revenues and is terminated, either when the contract expires or prematurely, termination is likely to be an easily recognizable event. If a contract terminates in the ordinary course, that is, expires at the end of its term, it seems intuitively inappropriate to report that expiration as a Form 8-K event. It is an expected, not an unexpected, event. If it is terminated early, reporting is possible, but the two day limit may be difficult. If the termination is amicable, the parties are likely to be in negotiations for a reduction or hiatus, or an extension of time in which to perform or accept delivery. In that case, there may be a "suspension of orders" but the time and amount cannot be determined, and therefore, whether the suspension will affect 10% of last year's revenues cannot be determined until negotiations are completed. Disclosure requirements should not result in the impairment of business relationship. This provision risks causing that result.
Many large companies will have several material contracts that are frequently adjusted to accommodate customers. This often happens when sales are made to a number of that customer's subsidiaries. Determining when a 10% reporting threshold has been met may be an administrative challenge. Such a requirement may encourage companies to structure their relationships so as to multiply the number of contracts with one customer, thereby increasing administrative costs but decreasing the likelihood that any one contract, if terminated, will trigger a filing requirement. Such a course of action would not be beneficial to the company or its investors.
For many businesses, long term contracts with regular and predictable payments are not typical. Some businesses provide services on a project basis. Once the customer's business is analyzed and a report written and recommendations made, or the computer or manufacturing system is built and installed, the project is complete. The process is unremarkable; it is how business is done. Additional projects may or may not be ongoing. Additional systems may or may not be ordered by the same customer. Other systems may be ordered. For such businesses, substitution of customers accounting for 10% of last year's revenues may be routine and unremarkable. Requiring an 8-K report every time a project is completed seems likely to be confusing to investors and burdensome to providers. The most likely beneficiaries, if any, are competitors.
For some businesses, a reduction in orders, even in a material amount, is likely to occur over time, and whether reduction by a particular customer constitutes 10% of revenues for the most recent fiscal year will be apparent only later. "Just in time" replenishment of inventories may occur more or less automatically, and only after an examination of the books over a period of time will the reduction in sales become apparent. The calculation and determination will be even more difficult and complex if demand for a product is seasonal.
For some businesses, purchasing is done on a seasonal basis, and reporting loss of a particular customer without reporting gains of others may itself be misleading. For example, a buyer of a clothing store chain might purchase a designer's spring line because last year's sold well, but not purchase the fall line. Is the failure to purchase the fall line a reportable event if the spring line last year accounted for 10% of the designer's revenues in that year? What if the chain only buys the spring line every year? What if the chain always buys the spring line, but decides not to one year, and then buys the fall line, which it has never bought before, making up the loss of revenue from the spring line? If it doesn't buy the spring line but says it will make it up by buying the fall line, is loss of the spring line still a reportable event? If the chain then does not order the fall line, is that a reportable event? Suppose the chain doesn't buy the spring line, but three other chains, not previously customers, do purchase the spring line and production does not permit accepting more orders. May the designer not report loss of business for its spring line if there is a compensating order "in house"? Is it enough if the compensating order is "expected"? "Promised"? Losing some customers, even 10% customers, and replacing them with others is often routine.
If the 10% threshold is used, and the decrease in orders is apparent only over time or in retrospect, filing under Forms 10-K or 10-Q is likely to provide appropriate disclosure. Reporting on Form 8-K has traditionally been limited to extraordinary events. To expand reporting to include routine events is likely to dilute rather than increase its value to investors.
It is not clear exactly what specific events the Commission believes proposed Item 1.03 would force companies to disclosure, or disclose sooner, to the benefit of investors. Dramatic customer defections are likely to be widely reported in the press. Requiring immediate reporting on pain of running afoul of the securities laws may make it impossible to reestablish a relationship that might otherwise have been salvaged to the benefit of investors. Gradual eroding of a profitable relationship will be difficult for a company to pinpoint and report. Subjecting a company to securities law violation for failure to report, within a narrow time period, a gradual erosion when it crosses a particular financial threshold may require a level of monitoring that imposes costly administrative burdens without corresponding benefits. For disclosures of erosion past a certain threshold, a two business day filing deadline (or even a 15 day deadline) may, as a practical matter, be impossible to meet.
Item 2.01 Completion of Acquisition or Disposition of Assets.
Proposed Item 2.01 would carry forward the existing requirements of Form 8-K Item 2. If the Commission adopts the new reporting requirements of proposed Items 1.01 and 1.02, we believe the Commission should harmonize the thresholds for reporting under those items and proposed Item 2.01. We suggest requiring Item 2.01 reporting of completion of any acquisition or disposition transaction first reported under Item 1.01. We would do this by (i) adding an instruction to Item 1.01 to the effect that any "significant" acquisition or disposition should be deemed to be "material" and thus reportable under Item 1.01, and (ii) moving the substance of instructions 3 and 4 of Item 2.01 to Item 1.01. While these changes might theoretically increase the number of Form 8-K reports required to be filed, they would also make the reporting requirements simpler and easier to understand, both for reporting companies and investors.
We also have three specific comments on the text of proposed Item 2.01. First, in clause (c), we would require disclosure of "the formula or principle followed in determining the amount of . . . consideration" only in cases where there is a material relationship between the parties to the transaction of the sort referred to in clause (d). Where the parties are not affiliated, this disclosure should not be required. Registrants may sometimes choose to explain the pricing of a transaction to persuade the market of its merits, but for competitive or other reasons may wish not to describe an underlying pricing formula. In those latter cases, the required disclosure of the "nature or amount of consideration" should be sufficient. We believe the requirement in existing Item 2(a), to disclose "the principle followed" in determining the consideration, has not generated meaningful disclosure, and we recommend deleting it.
Second, in clause (e), the language should be clarified (presumably, "a description of the transaction" is meant to refer to the financing transaction), and the requirement to disclose funding sources should be scaled back. Since Item 2.01 relates to completed transactions, the registrant will have already obtained the funding. Unless the funding source was a party to the acquisition/disposition, or an affiliate of one of those parties, its identity should be immaterial to investors at that point. Moreover, if funding was obtained from an unregistered offering of securities (for example, in the "Rule 144A market"), a disclosure naming the underwriters would arguably constitute a "general solicitation" that could preclude the underwriters from completing the sale of any unsold allotments. We therefore recommend deleting from clause (e) any requirement to name funding sources, other than funding sources that are parties to the transaction or affiliates of such parties.
Third, the definition of "disposition" in instruction 2 includes a "mortgage" or a "hypothecation of assets." We would agree that a mortgage can be used by the mortgagor to divest any substantive economic interest it has in an asset. More commonly, however, mortgages are used to provide security interests in routine financings, where the borrower retains substantive economic ownership and use. Proposed item 2.03 may well require disclosure of such arrangements in the context of describing "direct financial obligations." We believe the Commission should clarify that Item 2.01 is not intended to cover such routine financing arrangements.
Item 2.02 Bankruptcy or Receivership.
Proposed Item 2.02 would carry forward the substantive requirements of existing Form 8-K Item 3. We do not have any comments on this proposed Item.
Item 2.03 Creation of a Direct or Contingent Financial Obligation That Is Material to the Registrant.
Proposed Item 2.03 would impose significant new disclosure requirements with respect to direct and contingent financial obligations. As a threshold matter, we believe the two categories of obligations raise fundamentally different disclosure concerns and should not be treated together in a single combined item.
Broadly speaking, direct obligations are more numerous and are more likely to be routine and easily understood. They are also more likely to have been publicized by the direct obligor in the process of incurring the obligation. Form 8-K disclosure of direct obligations should focus on filling in the existing public record. Contingent obligations, on the other hand, are less likely to have been publicized by the registrant and more likely to require detailed explanation. Combining the two categories in a single item is unnecessarily confusing. For example, clauses (b) and (e) clearly apply only in the context of contingent obligations, while clause (c) would usually be germane only to direct obligations. We therefore recommend limiting Item 2.03 to indirect obligations, and creating a separate, and much more narrowly focused, Form 8-K item covering previously undisclosed direct obligations.
We believe that a general "materiality" standard is the appropriate threshold for disclosure of contingent obligations. The significance of such obligations necessarily depends on the probability of the obligation being triggered, as well as the dollar size if triggered. Moreover, a quantitative trigger in effect invites registrants to "structure around" the disclosure requirement. If the Commission nonetheless adds a quantitative definition of materiality, we suggest it be based on a percentage of equity or net income (since we believe these are better indicators of financial strength in the context of contingent events), rather than assets or revenues.
The definition of "contingent financial obligation" should be revised by deleting the last clause, "and all other obligations that exist or may arise under an agreement," as that clause encompasses literally any contractual obligation of any nature whatsoever. Also, the sentence should clarify that "guarantees, co-obligor arrangements" apply to repayments of loans, etc., or rental payments, and not to general contractual obligations, and do not cover standard contract indemnifications. The definition of "keepwell agreement" should be limited to arrangements where the "provision of funds or property" is for the purpose of supporting or enhancing the recipient's ability to meet its obligations. As proposed, the term may be understood to encompass a wide range of transactions in the ordinary course of business, including, for example, a contract for the sale of goods at fair value. Clarification that disclosure is limited to contingent financial obligations not in the ordinary course of business would reduce confusion and enhance meaningful disclosure and compliance.
We do not believe that clause (c), requiring disclosure of underwriters and underwriting compensation, belongs in an Item focused on contingent financial obligations. Nor do we believe it should be included in an Item requiring disclosure of direct obligations of the registrant. This information may be material to investors purchasing those direct obligations, but Form 8-K is aimed at the market in general, not a particular group of investors. Such detailed information is simply not material to an understanding of the registrant or its financial condition or results of operations.
In addition, a Form 8-K requirement to identify underwriters could create a significant problem for the "Rule 144A market." If disclosure of an underwritten offering in that market is to be required within two business days of pricing, both the issuer and underwriters need a safe harbor to assure that disclosure will not be deemed to constitute a "general solicitation" that could preclude underwriters from completing the sale of any unsold allotments.
As applied to direct obligations, we suggest narrowing the required disclosure to focus on transactions that have not previously been disclosed. We also recommend eliminating any requirement to report any registered sales of securities, or any borrowings under any previously announced commitment. We also recommend clarifying instruction 4 to eliminate a requirement to disclose any borrowings in the commercial paper market.
Item 2.04 Events Triggering a Direct or Contingent Financial Obligation That Is Material to the Registrant.
Proposed Item 2.04 would enhance and clarify disclosure requirements relating to default situations. We agree with the definition of "triggering event," which is the heart of the proposed Item. In particular, we believe it is essential that the Commission (i) maintain the proviso deferring the reporting obligation during the pendency of negotiations and (ii) limit the override of the proviso to triggering notices from parties "with the right to do so." These elements are critical to a company's ability to avoid premature disclosure that could unnecessarily damage the interests of its investors. In our view, the proposed definition strikes the proper balance.
Our comments on the definitions of "contingent financial obligations" and "keepwell agreement," noted above in respect of Item 2.03, apply to Item 2.04 as well.
We believe that a qualitative "materiality" standard should apply to Item 2.04, although this issue is less clear-cut than in the case of Item 2.03, since the probability of the contingency is no longer an issue. We believe that the qualitative standard, by necessitating consideration of all the surrounding circumstances, will provide the best results. If a quantitative standard is adopted, we believe it should be based on equity or net income (since we believe these are better indicators of financial strength), not on assets or revenues.
Finally, we agree that Item 3 of Form 10-Q should be deleted if proposed Item 2.04 is adopted.
Item 2.05 Exit Activities Including Material Write-Offs and Restructuring Charges.
Proposed Item 2.05 would expand disclosure requirements relating to restructuring and other "exit activities." We believe the triggering event for this proposed Item is appropriately drawn. The concept of "committing" to a course of action is necessarily an elastic one, but it is also the earliest practicable disclosure point; disclosure made prior to that point would be speculative. To further encourage prompt disclosure, we suggest that clauses (d) and (e) be modified (or an instruction be added) to clarify that if the amount of the charge, or its cash component, is not known, the registrant may disclose an estimated range, or alternatively may provide an explanation of the method and timeframe it will follow to determine the amounts or range. Finally, we do not believe audit committees are commonly charged with making the decisions covered by the proposed Item, but other committees may be. We would add a reference to "any appropriate committee of the Board," without specifying which one, in the first sentence of the proposed Item.
Item 2.06 Material Impairments.
Proposed Item 2.06 would add a new requirement to disclose material impairments when the Board or an authorized officer "concludes" that a charge is required. We believe that, as proposed, this Item would create an intolerable potential for second-guessing disclosure decisions, and should not be added to Form 8-K.
Unlike restructurings, which result from decisions taken by management, impairments can arise without management's having done anything. They may arise gradually, over time, and be subject to considerable uncertainty. The point when management "concludes" that an impairment is required to be recognized will often be highly subjective, particularly where the possibility of impairment has been considered over a period of time. With 20:20 hindsight, it will often be tempting to assert that management "must have known" (or "must have concluded") prior to the point at which it disclosed.
We believe that a percentage of equity or net income is the appropriate measuring rod to determine reporting of asset charges. However, if company assets is to be used, we believe that disclosure should be required for asset charges which exceed not less than 5% of the company's long-term assets. Any percentage less than 5% may overload investors with speculative detail and result in registrants burying "shareholders in an avalanche of trivial information-a result that is hardly conducive to informed decision making." Basic Inc. v. Levinson, 108 S.Ct. 978 (1988).
If the triggering event for proposed Item 2.06 were the recording of the impairment charge, we doubt the proposed Item would in fact generate very much additional disclosure, but we would not find it objectionable. A description of the competitive or economic factors that led to the charge is appropriate and would inform investors.
Item 3.01 Rating Agency Decisions.
Proposed Item 3.01 would require issuers to disclose if a rating agency to which the issuer has provided information notifies the issuer of a change in the rating for any debt, preferred security or other indebtedness of the issuer, including indebtedness the issuer has guaranteed or with respect to which the issuer has a contingent financial obligation. Item 3.01 also proposes disclosure if a rating agency has refused to rate the issuer or has placed any class of the issuer's securities on "credit watch" or similar status or taken any similar action. Although the proposal is an effort to make the investing public aware of such actions, it is in potential conflict with Section 702 of the Sarbanes-Oxley Act of 2002, and therefore should not be acted upon at this time until the two provisions can be harmonized.
The proposal would apply to rating changes or refusals by a credit rating agency "to whom the registrant provides information". While the proposal excludes furnishing information the issuer files with the Commission and the issuer's annual report to stockholders, this is not sufficient to deal with an unsolicited rating. Many issuers respond to requests for information by the public, stockholders and investors. These responses often include, in addition to SEC filings and the annual and quarterly reports to stockholders, company press releases and other information about the company and its products and services. The fact that these materials were provided to a credit rating agency should not subject the issuer to the requirements of Item 3.01. The reporting requirement, if any, should apply only to credit rating agencies with which the issuer has entered into a contractual relationship for that agency to perform credit rating services.
Further, as drafted, the proposal may be overly broad. For example, it applies to debt securities the issuer has guaranteed or as to which it has a contingent financial obligation. Many debt offerings are supported by a bank letter of credit or private insurance obtained by the issuer. The proposal could be read as imposing upon the issuer of such credit enhanced debt an obligation to file a Form 8-K when it is advised that the rating of the underlying credit support provider is changed or becomes subject to "credit watch" or similar action.
Section 702 of the Sarbanes-Oxley Act requires the Commission to conduct a study and report to the President, the House Committee on Financial Services and the Senate Committee on Banking, Housing and Urban Affairs on the role and function of credit rating agencies. In particular, this study is to cover:
Many of the issues relating to Item 3.01 that the Commission has raised are to be covered by this statutorily mandated study. We believe it is appropriate that the Commission defer action on proposed Item 3.01 until completion of this study. At that time it may be appropriate to republish this proposal or an amended version based on the results of that study.
Item 3.02 Notice of Delisting or Failure to Satisfy Listing Standards; Transfer of Listing.
This Item would require a registrant to furnish certain information pursuant to Form 8-K if it has received notice from the national securities exchange or national securities association that is the principal trading market for a class of the registrant's common stock or similar equity securities to the effect that the registrant or a class of the registrant's securities does not satisfy the listing requirements or standards of the exchange or association, or that a class of the registrant's securities has been delisted from or by the exchange or association. We agree with the Commission that information regarding delisting or possible delisting of a registrant's common stock from the principal exchange or association on which it trades is material information that should be promptly disclosed by an registrant.
We believe Item 3.02(a) should clarify that disclosure is not required under circumstances where a registrant has received an inquiry from a national securities exchange or national securities association regarding compliance with applicable listing requirements or standards. Such an inquiry permits the exchange or association to confirm compliance with its requirements or standards, and often does not result in any delisting action. In order to avoid any unnecessary confusion regarding the types of communication which would give rise to a Form 8-K filing obligation pursuant to Item 3.02, we suggest that an instruction to the Item be added to provide that the Item does not require disclosure of any inquiry or other communications by an national securities exchange or association that does not constitute a notice that the registrant has failed to satisfy a listing requirement or standard.
We believe Item 3.02 should confirm that a filing on Form 8-K pursuant to this Item is required in the event that a national securities exchange has notified a registrant that trading in its securities has been suspended and that the exchange is commencing appropriate procedures to remove the listing of the registrant's securities. We also believe that it should be made clear in the Item that disclosure is required notwithstanding a determination by a registrant to appeal a delisting notice.
We believe that Item 3.02(a) should clarify that a report on Form 8-K is required to be filed if a registrant receives notice that its securities will cease to meet the requirements on one market maintained by a national securities association, even if such security will continue to trade on another market maintained by that association, such as a registrant whose common stock will no longer meet the listing criteria of the Nasdaq National Market but which will meet, and continue to trade, on the Nasdaq SmallCap Market.
Item 3.02(a)(1) as proposed requires disclosure of the date that the registrant received the notice. In the event that a registrant is unable to confirm the date of receipt of the notice within its organization, we would suggest that a registrant be permitted to state either the date of the notice from the national securities exchange or association, or the date that the registrant received the notice.
Item 3.02(a)(3) would require the registrant to discuss its planned response to the notice. In view of the significance of a delisting notice, and the likelihood that the a response will require the involvement of the Board of Directors of the registrant and others, we believe it should be made clear in the Item that the disclosure relating to the planned response need only be given to the extent known at the date the Form 8-K is required to be filed. If no response has been determined at such time, we believe it would be appropriate for a registrant to file either a new Form 8-K or an amended Form 8-K to disclose a planned response once the response has been approved by the registrant.
We suggest, in subsection (b) of Item 3.02, that an exception be added with respect to mergers and acquisitions subject to Regulation M-A. We do not believe that a registrant should be obligated to file a report of Form 8-K with respect to definitive steps taken by the registrant to cause the listing or quotation of a class of its common stock or similar equity securities to be terminated, if such steps have been taken pursuant to a merger or acquisition subject to Regulation M-A. We believe that adequate disclosure is currently required by Regulation M-A regarding the merger or acquisition and its effects on shareholders.
Item 3.03 Unregistered Sales of Equity Securities.
We agree that investors would benefit from more prompt disclosure of unregistered sales of a material percentage of a company's equity securities in a single transaction or a series of related transactions. In determining that percentage, we believe that the appropriate base is the company's outstanding shares, not its market float. Since this item only deals with unregistered equity securities, it should not have an immediate effect on the market float, but can have a significant dilutive effect on all existing securityholders. Although any percentage could be too high or too low in any particular instance, we believe that Form 8-K disclosure is appropriate only for sales of unregistered securities in a material amount, and suggest that the appropriate percentage is 10% of the outstanding securities of that class. We believe that companies should remain obligated to disclosure other, non-material unregistered sales of their equity securities in their Forms 10-Q and 10-K and that there is value in requiring companies to list (including by incorporation by reference) sales made during the relevant fiscal quarter and disclosed in Form 8-K. Under this construct, there would be no necessity for companies to aggregate non-material sales that were not part of the same transaction or series of related transactions, since they would be disclosed in the next Form 10-Q or 10-K. We do not believe that current reporting of the issuance of a non-material percentage of a company's equity securities in any single or series of related transactions serves a significant public interest that cannot appropriately wait for a Form 10-Q or 10-K filing. We do not know of any issues which have arisen over the meaning of "sell equity securities in a transaction." In addition, the Commission has made explicit that a company does not have an obligation to make disclosure under this item until the later of either a definitive agreement for the sale or the sale is effected. Accordingly, we do not see any need to further define that term.
If our suggestion to limit disclosure under this item to unregistered sales of a material percentage of a company's equity securities is adopted, we believe that a filing within two business days of a triggering event is feasible. We are, however, concerned that the speed required to effect this filing will result in mistakes which could result in investor confusion. We thus believe that an additional two or three business days to make the filing would better balance the interests of prompt disclosure with the interests of accurate disclosure.
Item 3.04. Material Modification to Rights of Security Holders.
We support the proposal to move this item from Form 10-Q to Form 8-K, and believe that the proposed requirement to file within two business days of the modification should not be unduly burdensome to issuers. We believe it is appropriate to require disclosure of material modifications only if the class of securities modified is registered.
As a technical matter we suggest that the phrase "... and such modification was not reported in a publicly filed definitive proxy statement or information statement under Section 14 of the Exchange Act ..." be changed to read "... and the effectiveness of such modification has not previously been reported in a report filed under Section 13 of the Exchange Act ...". Generally a definitive proxy or information statement will describe a proposed modification, assuming a vote or consent of holders of registered securities is required, but not the fact that the modification has been approved. A filing pursuant to proposed Item 3.04 should not be required if the fact of the modification is already contained in any report filed pursuant Section 13 of the Exchange Act. We believe it is appropriate, if the modification and its general effect have been described in a definitive proxy statement or information statement under Section 14, to permit the response to Item 3.04 to incorporate that description by reference to the Section 14 filing.
Item 4.01. Changes in Registrant's Certifying Accountant.
We concur in the proposed deletion in renumbered Item 4.01, and do not believe any changes to the substantive requirements of existing Item 4 are required.
We believe similar disclosure should not be required regarding a change in auditor of a company's employment benefit plan if that auditor is different from the company's independent accountant. The auditor for the employment benefit plan is engaged to express an opinion on the condition of that plan. The disclosures appropriate for participants in the benefit plan should be governed by employee benefit laws and regulations and not be dealt with as a matter of securities regulation. Appropriate disclosures as to the impact an employee benefit plan - and particularly its funding requirements - may have on the issuer of registered securities are covered by existing requirements applicable to the issuer's financial statements. Neither the financial statements of the benefit plan nor a change in auditors of an independently-managed benefit plan should be relevant to holders of the issuer's registered securities.
Item 4.02. Non-Reliance on Previously Issued Financial Statements or a Related Audit Report.
We agree that a company should promptly disclose its receipt of notice from its auditors that investors should not rely on a previously issued report on financial statements filed under the Exchange Act. We also agree with the specific proposed disclosures and the process for obtaining the auditor's agreement or disagreement with the disclosures. Although the time periods proposed are short, the withdrawal by an auditor of its audit report is a sufficiently significant event to require notice in the two business day time frame.
We also agree that prompt disclosure should be required when a company concludes that previously issued financial statements filed under the Exchange Act should no longer be relied upon. However, we are concerned that the simple conclusion that a restatement of previously issued financial statements will be required will often precede by several days even the preliminary determination of the extent of the incorrect financial statement disclosure or the nature of the events which gave rise thereto. A premature disclosure, without a reasonable degree of accuracy of the nature and amount of the problem, could do incalculable harm to the company, its security holders and the investing public. Accordingly, we believe that the triggering event should be the preliminary determination of the underlying events and the preliminary quantification of the problem giving rise to the restatement.
Section 5.01 Changes in Control of Registrant.
We agree with the Commission's proposal to clarify and reorganize Item 1 of existing Form 8-K. We also support the modification permitting incorporation by reference provided that the reference text in the Item 5.01 disclosure clearly identifies the referenced report by date to enable investors to easily locate the incorporated information.
Item 5.02 Departure of Directors or Principal Officers: Election of Directors: Appointment of Principal Officers.
We support the Commission's proposal to require disclosure when a director resigns or declines to stand for re-election, whether or not such action is due to a disagreement, or is removed for cause. We agree that the present requirement for disclosure is too narrow. We also support the proposed rule requiring the registrant to file any written communication concerning these matters from the director as an exhibit to the Form 8-K. However, we believe that a director should have the right to request that any communication from him or her be kept in confidence, in which event the Item should not require filing. We also disagree with the requirement that the registrant describe the circumstances of the director's decision, whether or not the director delivers a written communication to the registrant.
Because of the subjectivity of an individual's decision-making process and the potential risk of misinterpretation, we do not believe the registrant should be required to describe the circumstances of a resignation or declination to stand for re-election in the absence of a writing from the director. In many cases a resignation or declination to stand for re-election will be requested by the company because the director has not made an adequate contribution to board activities. Requiring a company to detail this will not aid investors, but could be seriously embarrassing and damaging to the director, and risk liability to the company. There may also be medical or other reasons regarding personal circumstances that a director would prefer to keep private. Requiring disclosure may have the effect of discouraging a director from stepping aside when it is in the issuer's best interest for him or her to do so.
If disclosure of the circumstances is required only when the director provides a letter, we believe that the Commission should dispense with the procedure regarding a response from the director. In such case, the letter (as well as the exhibit) speaks for itself and we do not believe that a procedure requiring the former director to comment upon the Company's disclosure would provide any additional meaningful information to the investor.
We recommend that the Commission maintain in the proposed Item 5.02 the language in present Item 6(b) to make clear that the registrant may rebut statements made in the director's written communication regarding the disagreement.
We agree with the proposal requiring disclosure when an enumerated officer resigns or his or her employment is terminated. We would not, however, require a description of the reasons for the event. Such disclosure might jeopardize the company's legal rights in any employment litigation and could be unnecessarily embarrassing and damaging to the officer.
We agree with the SEC's proposal on appointment of principal officers, but do not believe it is appropriately filed in a Form 8-K. We believe disclosure of this type of information would be sufficient in the next report on Form 10-Q or Form 10-K.
Unlike the information required by Item 5.02(c), we believe that the appointment of new directors should be filed in a Form 8-K and agree with the proposal.
Item 5.03 Amendments to Articles of Incorporation Or By-Laws; Change in Fiscal Year.
Proposed Item 5.03(a) would add a new reporting requirement within two business days after any amendment to a company's articles of incorporation or by-laws, unless such amendment was previously disclosed in a proxy statement or information statement. Although we believe there is a legitimate need for prompt disclosure of changes in corporate management or structure that affect the rights of a company's securities holders, proposed new Item 5.03(a) is overly broad and in most cases unnecessary, since amendments to the articles of incorporation or by-laws which affect the rights of securities holders will either (1) require stockholder approval, and therefore be disclosed in a proxy statement or information statement, or (2) be reported elsewhere under the new reporting requirements of Form 8-K.
Amendments which do not require stockholder approval are typically housekeeping in nature, and do not affect any significant stockholder rights. An example of an amendment to a company's articles of incorporation that would not require stockholder approval is a change of its registered agent in Delaware or the address of such registered agent. Clearly, this is not the type of amendment that would warrant disclosure for the protection of the rights of securities holders. Yet, under the provisions of Item 5.03(a), a reporting company would be required to file a Form 8-K within two business days of any such amendment. Amendments to other provisions, such as changes to the company's indemnification of its directors and officers, would be better dealt with on a quarterly reporting basis in the company's Form 10-Q.
Likewise, there are few provisions in a company's by-laws which would require immediate disclosure, unless they result in a material modification to the rights of the company's securities holders (an item which would otherwise be required to be reported pursuant to proposed Item 3.04, if not otherwise reported in a proxy statement or information statement). Additionally, while it rightfully could be argued that a change in directors, without the approval of securities holders, such as by an amendment to the by-laws increasing the number of directors constituting the board (which often can be effected by board action alone) and the appointment of a new director by the board to fill the vacancy between annual meetings of the securities holders, would be considered important information required to be disclosed to securities holders, proposed Item 502 sufficiently expands the disclosure requirements of current Item 6, by requiring, among other things, this type of disclosure in proposed Item 502(d). Proposed Item 5.02 also adds disclosure requirements relating to the appointment of new officers, similarly making the reporting of any amendments to the company's articles of incorporation or by-laws effected to carry out such actions, equally superfluous.
We have no comment with respect to the proposal to report a company's determination to change its fiscal year, which is substantially unchanged from Item 8 of current Form 8-K.
Item 5.04 Material Events Regarding the Registrant's Employee Benefit, Retirement and Stock Ownership Plans.
Proposed new Item 5.04 of Form 8-K would require a company to report within two business days after it becomes aware of any event that will occur that would materially limit the ability of participants in any employee benefit, retirement or stock ownership plan from acquiring, disposing or converting assets under any such plan. This proposed Item would not require a company to report any such event if it occurs periodically, such as a blackout period prior to the release of material non-public information by the company. We believe that, while this information should be promptly provided to participants in such applicable plans, this information is not of material importance to other investors and should not be included as a disclosure item in Form 8-K. Additionally, we believe that, although sophisticated investors may not be confused by the public disclosure of this information, there could be a significant number of investors who will misinterpret such information as a broader restriction on the transferability of the company's securities, possibly resulting in an unjustified market reaction.
We note the Commission's acknowledgement of House and Senate bills which deal with notification of plan participants of transaction restriction periods. A substantial portion of these bills was incorporated into Section 306 of the Sarbanes-Oxley Act of 2002. Such provision, which primarily prohibits any purchase or sale of securities acquired by directors and officers, in connection with their services, during pension fund blackout periods, also requires plan administrators of pension plans to provide participants with 30 days prior notice of any such transaction restriction periods. We believe that this requirement is far more beneficial to plan participants, in that many of them never review their employer's Form 8-K.
Therefore, we recommend that proposed Item 5.04 not be included in the revisions to Form 8-K, as we believe that Section 3.06 of the Sarbanes-Oxley Act of 2002 effectively addresses the Commission's concerns with respect to all applicable issues.
Liability Issues and the Proposed Safe Harbors
The safe harbor that would be provided by the Release is very limited. It would protect a company that failed to timely file a required Form 8-K only from liability for a violation of Section 13 or Section 15(d) of the Exchange Act, and then, only if all three of the following conditions are satisfied:
Any safe harbor, however limited, provides meaningful protection to companies only if there is some certainty that it will be available. The proposed safe harbor does not provide that certainty. It is conditioned on subjective tests that the new set of procedures, to be established without existing standards to meet new requirements, is "sufficient" and provides "reasonable assurance" of compliance. Also, it is to be expected that there will be a wide variation in procedures between, for example, a small company in a single line of business and a large, global company with multiple lines of business. In addition, in some cases the triggering event is itself somewhat subjective and uncertain. Furthermore, the safe harbor is based on the knowledge or recklessness of every employee of the company, an impossible condition to monitor or establish. Finally, these conditions will necessarily be applied in hindsight after the procedures in fact failed in their objective to cause all Form 8-Ks to be filed timely.
We believe that these problems with the safe harbor proposal can be fixed, as follows, to provide more meaningful protection for issuers, while still protecting the public interest.
"(i) On the Form 8-K due date, the company maintained procedures intended in good faith to permit the company to collect, process and disclose, within the specified time period, the information required to be disclosed by Form 8-K, provided that failure of a company to timely file a Form 8-K does not create a presumption that the company's procedures do not satisfy the conditions of this subsection (c); and"
"(ii) The company filed a Form 8-K with the Commission containing the required information not later than two business days after a person designated in writing by an executive officer of the company (as defined in Rule 3b-7) to be responsible for filing Form 8-Ks, or in the absence of any such designation, such an executive officer, became aware of the company's failure to file the required Form 8-K."
Failure To Timely File A Required Form 8-K Should Not Affect A Company's Eligibility To Use Short-Form Registration Statements Or The Ability Of Securityholders To Resell Under Rule 144.
The Release points outs that: (1) a company would lose its ability to use short form registration statements; and (2) its security holders could not rely on Rule 144 to resell securities, if the company fails to make a timely Form 8-K filing. We can think of no justification for such a harsh and onerous result, particularly where new, much more stringent time limitations are being imposed and it will be challenging to institute the necessary procedures to effect the required filings on a timely basis, let alone the collection, analysis, drafting and review of the reports. Denying companies the use of short form registration statements could cause enormous damage to the capital raising efforts of many companies. It also could result in the creation of recission rights for completed transactions, with substantial potential liabilities. The potential for damage to investors makes an effective safe harbor essential.
In light of the fact that companies will remain liable under Section 10(b) and Rule 10b-5 of the Exchange Act and Sections 11, 12 and 17 of the Securities Act, we believe that failure to timely file required Form 8-Ks should not affect a company's eligibility to use short form registration statements or a company's current reporting stature under Rule 144(c). There is precedence for this treatment in the Commission's proposals for Form 8-K disclosure of certain management transactions in a company's equity securities and loans. Under the proposed amendment to Rule 144(c) and proposed amendments to the Forms and General Instructions for Forms S-2, S-3 and S-8 in Release Nos. 33-8090; 34-45742, April 12, 2002, even though the management transaction Form 8-Ks would have been deemed filed and incorporated by reference in registration statements (as would be true in this case), a company would have remained eligible to use short form registration statements and been deemed to meet the current public information condition of Rule 144 even if it failed to file the required report. The Commission also provided similar treatment with respect to Form 8-Ks required under Regulation FD. (See Rule 103 of Regulation FD.) We believe the same rationale should govern the safe harbor for failure to timely file Form 8-K.
The Rules Should Expressly Provide That A Form 8-K Report Is Not An Admission Of Materiality.
The Commission should expand the concept of present Instruction B.5 of Form 8-K, which states that an Item 5 or Item 9 report is not deemed an admission as to materiality, to apply to all Form 8-Ks in light of the greatly increased list of items that have to be reported. In addition, even though many of the proposed Form 8-K requirements are phrased in terms of materiality, we expect that companies in some cases, out of an abundance of caution, will file reports covering information that they may not concede is material, particularly since the time to analyze and make materiality determinations will be so short. An expanded materiality provision would be consistent with the Commission's statement in the Release that it does not intend to affect existing law regarding the determination of the materiality of information. We recommend that the Commission add the materiality provision as a separate paragraph in Rules 13a-11 and 15d-11, in order to assure its effectiveness in litigation.
We hope the Commission finds these comments helpful. We would be happy to meet with the Staff to discuss these comments further.
COMMITTEE ON SECURITIES REGULATION
By Gerald S. Backman
GERALD S. BACKMAN
CHAIRMAN OF THE COMMITTEE
Edward H. Cohen, Chair
David L. Carey
Henry Q. Conley
Stephen M. Davis
Michael J. Holliday
Micalyn S. Harris
Scott M. Miller
Morris N. Simkin
The Honorable Harvey L. Pitt, Chairman
The Honorable Paul S. Atkins, Commissioner
The Honorable Cynthia A. Glassman, Commissioner
The Honorable Harvey J. Goldschmid, Commissioner
The Honorable Roel C. Campos, Commissioner
Alan L. Beller, Esq., Director of Division of Corporation Finance
Giovanni P. Prezioso, Esq., General Counsel