The Investment Counsel Association of America
August 26, 2002
Via U.S. Mail and Electronic Filing
Mr. Jonathan G. Katz
Re: Proposed Rule: Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date; Release Nos. 33-8106; 34-46084; File No. S7-22-02
Dear Mr. Katz:
The Investment Counsel Association of America1 appreciates the opportunity to submit comments on the Commission's proposed new rules and amendments requiring more timely and more extensive disclosure in current reports on Form 8-K ("Proposal").2 ICAA members collectively manage trillions of dollars in assets for institutional and individual investors, and require adequate, current, and complete information from issuers to make appropriate investment decisions on behalf of their clients. Form 8-K disclosures are an important focus for our members in terms of evaluating and assessing an issuer as an investment prospect. We support the Proposal and prior Commission initiatives aimed at improving corporate disclosure.3
Form 8-K requires issuers to report certain corporate events on a more current basis than quarterly or annual reports. The Commission's proposals would add several new items requiring current disclosure on Form 8-K, including: (i) entry into or termination of a material agreement, not made in the ordinary course of business; (ii) termination or reduction of a significant business relationship; (iii) events triggering, or the creation of, a direct or contingent material financial obligation to the issuer; (iv) exit activities including any material write-off or restructuring; (v) a determination that a material charge for an impairment of assets will be required; (vi) movement of the issuer's securities from one exchange or quotation system to another, delisting of issuer's securities from an exchange or quotation system, or a notice that the issuer does not comply with a listing requirement; (vii) determination that security holders no longer should rely on the issuer's financial statements; and (viii) limitations or restrictions on transactions in issuer securities held by the issuer's employee benefit plan. The Proposal also would move two items from quarterly and annual reports to Form 8-K current reports: (1) unregistered sales of equity securities, and (2) material modifications to rights of holders of issuer securities. Additionally, the Proposal would amend several existing Form 8-K disclosure items to include: (i) disclosure regarding the departure of a director for reasons other than a disagreement or removal for cause; (ii) appointment or departure of a principal officer and the election of new directors; and (iii) disclosure of any material amendment to an issuer's founding documents. Finally, the filing deadline for all reports on Form 8-K would be accelerated significantly under the Proposal.
The ICAA supports the Proposal and believes that it would facilitate the transmission of more meaningful and complete information to investors and the securities markets. Our specific comments and recommendations regarding certain of the proposals are set out below.
A. Materiality Standard
The Commission has requested comment as to whether the use of a materiality standard is preferable to a threshold tied to a financial measure for purposes of several disclosure items. History has shown that numbers can be manipulated to avoid disclosure requirements that may cast an issuer in an unfavorable light. A materiality standard would require management to carefully weigh the importance of a corporate event in light of all relevant circumstances, including financial measures. Given the increased responsibility of chief executive and financial officers in submitting issuer filings,4 we believe that a fuller and more meaningful evaluation will generally be made under a materiality standard. We recommend applying the materiality standard, possibly in conjunction with a presumptive financial measure that triggers materiality regardless of surrounding circumstances for appropriate items, in order to promote greater understanding and uniformity in Form 8-K disclosure.
B. Business and Operations
1. Material Agreements
The Commission proposes adding a new item that would require disclosure when an issuer enters into an agreement that is material to the issuer and that is not made in the ordinary course of the issuer's business.5 The ICAA supports this disclosure as proposed and recommends use of a materiality standard for the reasons set out in section A.
Each issuer would be required under the proposal to include the following information related to each material agreement: (i) the identity of the parties and a description of any material relationship between any of the parties other than in respect to the agreement; (ii) a brief description of the agreement; (iii) the rights and obligations of each party to the agreement that are material to the issuer; (iv) any material conditions to the agreement becoming binding or effective; and (v) the duration of the agreement and any material termination provisions. The Commission has requested comment as to whether the agreement itself should be included as an exhibit to Form 8-K. We recommend including a requirement that the agreement be attached as an exhibit to the Form 8-K or to the first 10-Q or 10-K subsequently filed, or that the issuer include a cross-reference to a prior filing that includes the agreement as an exhibit. The investment management community appreciates the opportunity to review exhibit contracts when disclosure is unclear or subsequent events, e.g., a dispute with a third party regarding performance, increase the relevance of such contract to an issuer's overall performance. A requirement that material agreements be submitted as exhibits with filings would benefit investors and the investment management community by increasing the transparency of the issuer's commitments.
2. Termination of Business Relationships
The proposals would create a new item that requires disclosure when an issuer becomes aware that a customer terminates or reduces the scope of a business relationship with the issuer and the loss of revenues to the issuer from such termination or reduction equals 10% or more of the issuer's consolidated revenues during the issuer's most recent fiscal year.6 The Commission has requested comment as to whether the 10% test should be higher or lower, or whether disclosure under this item should be based on a materiality standard. We support the addition of this new item, but recommend modifying the proposal to require disclosure subject to a materiality standard, possibly in conjunction with a presumptive financial threshold of a certain percentage, for the reasons discussed in section A.
C. Financial Information
1. Completion of Acquisition or Disposition of Assets
Proposed Item 2.01 would continue to require the same basic disclosure required by existing Item 2, which requires disclosure if an issuer or any of its majority-owned subsidiaries has acquired or disposed of a significant amount of assets, other than in the ordinary course of business.7 The proposed item would eliminate disclosure about the nature of the business in which the acquired assets were used and whether the company acquiring the assets intends to continue such use. The proposed item would further revise the wording regarding disclosure of the source of funds to make the requirements clearer.
We agree that investors and the securities markets would benefit from continued prompt reporting related to the issuer's completion of its acquisition or disposition of a significant amount of assets and thus support maintaining the basic disclosure requirements in this respect. Nevertheless, we propose modifying the test for determining a "significant amount of assets" to follow a materiality standard. Under the current standard, issuers are required to disclose only acquisitions or dispositions of assets whose value or cost exceeds 10% of the issuer's total assets. We believe that the benefits of a materiality standard discussed in section A outweigh those of familiarity. This conclusion is supported by the Commission's concern that the application of the current standard could result in inconsistencies between the disclosure in this section and that provided with respect to material agreements.
2. Bankruptcy or Receivership
We support the proposed minor changes to existing Item 3 to break out embedded lists from the text and relocate certain language into an instruction item.8 We agree that the streamlining amendments will make this item more understandable.
3. Creation or Triggering of a Material Direct or Contingent Financial Obligation
The ICAA supports the proposed new items that would require an issuer to disclose information whenever it or a third party enters into, or triggers, a definitive transaction or agreement that creates any material direct or contingent financial obligation on the issuer.9 When entering into an obligation, each issuer would be required to include the following information: (i) a brief description of the transaction or agreement, including identification of the parties to the agreement; (ii) the nature and amount of the issuer's material direct or contingent financial obligation, including a description of events that may cause the obligation to arise, increase or become accelerated; (iii) if applicable, the name of any underwriters or placement or other agents for the transaction or any persons performing a similar function in the case of a private transaction, and the amount of any fee or other compensation paid to them, or the name of any lenders or other persons who are beneficiaries of the obligation; and (iv) a discussion of management's analysis of the effect of the direct or contingent financial obligation on the issuer. We recommend including a requirement that the documentation surrounding the transaction or agreement be included as an exhibit to Form 8-K for the reasons discussed in section B.1.
We also recommend adding disclosure as to whether the audit committee or comparable committee has reviewed and approved the issuer's entry into a transaction or agreement that creates a material direct or contingent financial obligation on the issuer. This requirement would serve to encourage better communication between senior management and the audit committee in addition to providing important disclosures to asset managers, investors, and others.
4. Material Write-Offs and Restructuring Charges; Material Impairments
The ICAA supports the proposed new item that would require disclosure when the board of directors or the issuer's officers definitively commit the issuer to a course of action, including a plan to terminate or exit an activity under which the issuer will incur a material write-off or restructuring charge under generally accepted accounting principles.10 In response to the Commission's specific request for comment, the ICAA recommends that an issuer be required to update its report if there is a material change in the amount or expected effect of the write-off or restructuring charge.
The ICAA similarly supports the proposed new item that would require disclosure if the board of directors or the issuer's officers conclude the issuer is required to record a material charge for impairment to one or more of its assets, including an impairment of securities or goodwill, under general accepted accounting principles. We recommend that these disclosure items be based on a materiality standard for the reasons discussed in section A.
D. Securities and Trading Markets
1. Rating Agency Decisions
The ICAA strongly supports the proposed new item requiring an issuer to file a report when it receives a notice or other communication from a rating agency to the effect that the organization has decided to: (i) change or withdraw the credit rating assigned to the issuer or its securities; (ii) refuse to assign a credit rating to the issuer or its securities; (iii) place the issuer or its securities on a "credit watch" or similar status; or (iv) take any similar action.11 While rating organizations typically issue press releases about rating changes promptly, we believe that investors and the securities markets would benefit from having this information disclosed in a uniform manner. This disclosure should be required regardless of any contractual relationship between the issuer and the agency; however, we recommend limiting this item to nationally recognized statistical rating organizations.
We support the proposed requirement that an issuer disclose any notice received from the national securities exchange or national securities association that is the principal trading market of a class of the issuer's securities, that the issuer or a class of its securities no longer satisfies the listing requirements or standards of the exchange or association, or that a class of securities has been delisted. This is particularly appropriate in light of the stronger corporate governance standards being adopted by exchanges.12 We believe that the issuer should provide disclosure when it receives notice about a possible delisting, as well as when the stock is actually delisted. Naturally, the issuer would have an opportunity to disclose any negotiations or circumstances surrounding a notice about a possible delisting. We believe that the proposal captures the material aspects of the notice, and that the issuer should not be required to file a copy of the notice as an exhibit.
3. Unregistered Sales of Equity Securities
The ICAA strongly supports the proposal to move items describing the sale of unregistered equity securities from annual and quarterly reports to Form 8-K.13 We agree that investors and the securities markets will benefit from more timely information relating to the unregistered sales of equity securities, given the significant dilutive effect such sales can have on existing holdings. With respect to the Commission's specific requests for comment, we recommend limiting these reports to significant or material sales. We recommend that the obligation to disclose should be based on a materiality standard that incorporates a presumptive financial measure (e.g. a certain minimum percentage of the issuer's outstanding shares or market float), which if met would require disclosure independent of surrounding circumstances. We further recommend that issuers continue to reference these sales and transactions in quarterly and annual reports to provide readers with an aggregate listing of sales made during the relevant periods.
4. Material Modifications to Security Holder Rights
The ICAA strongly supports the proposal to move items describing material modifications to the rights of issuer security holders and the general effects of such modifications, from quarterly reports to Form 8-K. Given the importance of this information to investors, all changes and modifications should be disclosed regardless of the percentage of issuer assets represented. We recommend that the issuer continue to reference these modifications in annual and quarterly reports .
E. Matters Related to Accountants
The ICAA strongly supports the proposed new item requiring disclosure when an issuer's audit committee, board of directors, or officers conclude that the issuer's previously issued financial statements no longer should be relied upon. Similarly, we strongly support the proposed disclosure when an issuer receives notice from its accountant that the issuer should take action to prevent future reliance on a previously issued report related to any such financial statements.14
The issuer would be required to disclose: (i) the date on which the conclusion was reached or notice was received; (ii) a description of the events giving rise to the conclusion or notice related to the reliability of the financial statement; (iii) a statement of whether the audit committee, or the board of directors in the absence of the audit committee, discussed with the accountant the subject matter giving rise to the conclusion or notice; and (iv) a description of management's plans to alleviate the reliance issue. We strongly support this disclosure as proposed and believe that the issuer's accountants should be furnished with the disclosure on the same day the Form 8-K is filed.
F. Corporate Governance and Management
1. Changes in Control
The ICAA supports the proposed revised wording regarding the source of funds used to effect a change in control of the issuer to more closely track Item 3 of Schedule 13D.15 We believe this modification clarifies the subject disclosure. We also support the proposal that issuers be able to respond to this disclosure by incorporation by reference to an earlier report whenever possible.
2. Changes in Directors and Officers
The ICAA strongly supports the proposed items requiring disclosure when: (i) a director resigns or declines to stand for re-election due to a disagreement or is removed for cause; (ii) certain officers resign or are terminated, a director resigns, is removed or declines to stand for re-election for any reason other than as a result of a disagreement for cause; and (iii) a new officer is appointed or a new director elected. The proposal requires a description of the circumstances related to a director's resignation, declination to stand for re-election or removal, when it is due to a disagreement or removal for cause. We agree that this level of disclosure is appropriate for directors, but may not be necessary for an officer departing under similar circumstances, because the nature of the relationship between a director and the issuer's securities holders is sufficiently different. We recommend, however, that issuers be required to describe any disagreement between a departing officer and the issuer that relates to an accounting matter or corporate ethics.
3. Amendments to Articles or Bylaws
The ICAA supports the proposed requirement that an issuer report amendments to its articles of incorporation or bylaws that are not disclosed in a proxy statement or information statement filed by the issuer.16 We recommend, however, that this requirement be limited to amendments considered to be material to the issuer or its security holders.
G. Boilerplate Explanations
We agree with the Commission that boilerplate-type statements that an event may have a material adverse effect on the issuer, or similar statements provide limited useful disclosure. We strongly support the Commission's aim of obtaining responses that are specific to the issuer and provide quantitative information whenever possible.
H. Waiver of Corporate Codes of Conduct
The Commission has requested comment as to whether disclosure should be required on Form 8-K when an issuer waives its corporate ethics or conduct rules.17 Since the release of the Proposal, the Commission has been directed by Congress to require prompt disclosure on Form 8-K of any change in or waiver of an issuer's code of ethics for senior financial officers.18 The New York Stock Exchange has also submitted, since the release of the Proposal, a final rule proposal to the Commission that would require its listed companies to disclose when a code of ethics is waived for a director or executive officer.19 Given the importance of this information to investors and the securities markets, we believe that the waiver of an issuer's code of ethics for any director or executive officer, together with the board's reasons for approving such waiver, should be required disclosure on Form 8-K if self-regulatory organizations fail to adopt such requirements.
I. Shortened Filing Deadline
The proposal would shorten the time period for filing required current reports on Form 8-K from five business days to two business days.20 Certainly, investors would benefit from receiving the information on as current a basis as possible. Nevertheless, the benefits of receiving such information on an accelerated basis should be weighed against the need to obtain accurate information on an item-by-item basis.
We also are concerned that the shortened filing deadline creates a potential penalty for sellers of restricted securities. Under the Proposal an issuer that misses the two-business-day deadline is no longer eligible for short-form registration on Form S-3 for the period of one year, and Rule 144 sales would be suspended pending the filing of the required report.21 Sellers of restricted securities would therefore suffer the potential unintended penalty of being prevented from selling such securities as a result of an issuer's delay in complying with the filing requirements of Form 8-K. We recommend that the Commission rectify this unintended result by specifying that an issuer that is delayed in a Form 8-K filing would be limited in its sale of primary offerings, but still eligible to use short-Form S-3 for secondary offerings (i.e., registered offerings by selling shareholders only). We also request that the Commission clarify that resales by third party non-insiders under Rule 144 are permitted, despite a delayed filing under Form 8-K, given that such third party would have no knowledge of, or control over, the status of a Form 8-K filing.
* * * * * *
We agree with the Commission that additional and more timely disclosure by issuers of significant events may reduce opportunities for deception and manipulation. The ICAA strongly supports the Proposal and the series of initiatives taken by Commission to improve the corporate disclosure and financial reporting system. We appreciate the opportunity to comment on this important development and would be pleased to provide any additional information.
KAREN L. BARR
cc: Harvey L. Pitt, Chairman