THE ASSOCIATION OF THE BAR
OF THE CITY OF NEW YORK
42 WEST 44TH STREET
NEW YORK, NY 10036-6689
COMMITTEE ON SECURITIES REGULATION
August 26, 2002
Via email: rule-comments@sec.gov
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-22-02; Release Nos. 33-8106, 34-46084
Proposed Rule -- Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Securities Regulation of the Association of the Bar of the City of New York (the "Committee") in response to Release Nos. 33-8106 and 34-46084, dated June 17, 2002 (the "Release"), in which the Securities and Exchange Commission (the "Commission") announced a proposed rule requiring additional disclosures on Form 8-K (the "proposed rule" or "proposal"). This letter supplements our comments submitted on April 10, 2002 to Release 2002-22, a copy of which is attached. Our Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to corporations, investment banks, investors and academics.
Our Safe Harbor Proposal
The Commission proposes a limited safe harbor under Sections 13 and 15(d) for a company's failure to file on a timely basis if (1) the company maintained sufficient procedures to comply with the Form 8-K disclosure requirements and (2) no officer, employee or agent of the company knew, or was reckless in not knowing, that a report on Form 8-K was required to be filed, and the company promptly files the 8-K once an executive officer becomes aware of its failure to file. We believe the proposed safe harbor should be expanded to include protection from other liability provisions, including Section 10 of the Exchange Act and Section 11 of the Securities Act. In addition, we believe the failure to file a Form 8-K on a timely basis, if the conditions for the safe harbor are satisfied, should not disqualify a company from its eligibility to use short form registration statements.
The proposed two business day filing deadline, together with the substantially expanded scope of matters covered by Form 8-K notification requirements, will create substantial burdens on issuers to collect, process and disclose required events. The failure to make an 8-K filing by a company that maintains appropriate procedures in good faith, and which is promptly corrected after an executive officer becomes aware of the omission, should not be a basis for liability. In view of the requirements for satisfying the safe harbor, we believe the quality of disclosure will not be adversely affected by expanding the safe harbor to cover other liability provisions nor by eliminating the punitive loss of short-form registration eligibility.
Although we generally support the shortened period for filing Form 8-K disclosure as proposed, we believe that it may be helpful if Form 8-K filings related to stock dispositions were required to be filed on a weekly basis and that the exhibits to the Form 8-Ks, such as material agreements, were required to be filed at a later date after the event. Under this scenario, companies would be obligated to give very prompt notice of a material agreement but would have more time to complete and file it.
1. Entry into a Material Agreement Not Made in the Ordinary Course of Business (Item 1.01)
We support an accelerated disclosure reporting obligation on Form 8-K of material definitive agreements that are now required to be filed on Form 10-Q or Form 10-K pursuant to Reg. S-K Item 601, provided that the new requirement addresses the timing problem faced by registrants that need to request confidential treatment of any portions of an agreement. Current rules require registrants to submit their confidential treatment request to the Commission concurrently with the filing of a redacted exhibit in a required filing. Division of Corporation Finance Staff Legal Bulletin No. 1 dated February 28, 1997 (with addendum dated July 11, 2001) provided guidance on the substantive and procedural requirements contained in Rule 406 under the Securities Act of 1933 and Rule 24b-2 under the Securities Exchange Act of 1934 as a result of "[a]pplications as initially filed often lack[ing] the information and analysis necessary for the staff to evaluate compliance with the requirements of the rules." In our experience, preparation of applications meeting the requirements as described in Legal Bulletin No. 1 takes significant time, and we believe that to require registrants to expend such time (and related expense) in advance of entering into an agreement in order to be prepared to submit the request within the two business day period of the proposed rule (even assuming that the terms for which redaction is required are not changed at the last minute) would impose an unreasonable and unnecessary burden. At the same time, because the filing will need to be made so quickly, it is possible that a revised redacted document will have to be filed after staff review of the confidential treatment request, and the fact of such an amended filing should not result in the original filing being deemed deficient. We would therefore respectfully suggest (1) that a registrant be permitted to file a redacted exhibit, as needed, and submit a short-form notice to the Commission requesting confidential treatment and containing the complete exhibit, with an undertaking to submit a complete confidential treatment request as detailed in Legal Bulletin No. 1 within a specified period (we would suggest 30 days), and (2) that language be added to the safe harbor provision to clarify that an amendment to a prior 8-K filing to refile an agreement for which confidential treatment was requested will not affect the sufficiency of the original filing.
We believe the filing period should be based on the date on which the definitive agreement is executed and delivered by all parties, rather than the date on the face of the agreement. Moreover, our Committee supports efforts by the Commission to avoid duplication within a Form 8-K by permitting a company to file a single Form 8-K and including a disclosure in a single place under the captions for two or more items.
We believe that the proposed Form 8-K requirement should apply only to definitive agreements which are unconditionally binding or binding subject only to conditions stated in the agreement and should not apply to letters of intent and other non-binding agreements relating to proposed transactions disclosure of which should continue to be governed by the principles set down in Basic v. Levinson, 108 S. Ct. 978 (1988), and related case law. These types of documents generally are not ripe for disclosure or filing as exhibits; to require disclosure in all cases would be disruptive to the transaction process and possibly to the market for the constituent companies' stocks. We believe that such a disclosure requirement will discourage the use of such documents, which currently serve a useful function in the negotiation process by assisting parties to a proposed transaction to summarize their non-binding understanding of the proposed terms of a transaction before proceeding to the drafting, negotiation and completion of definitive agreements. We believe that there is little benefit to public investors by requiring the disclosure of such documents or the filing of them as exhibits and considerable burdens to companies and their investors that could result from such disclosure and filing. Moreover, the disclosure requirement would cause companies subject to the periodic reporting requirements of the Exchange Act to suffer a competitive disadvantage in the merger and acquisitions bidding process in contrast to those parties that are not subject to the periodic reporting requirements.
Similarly, we suggest that the Commission clarify that binding provisions of letters of intent and similar non-binding documents, such as no-shop or exclusivity, confidentiality and employee non-solicitation provisions, would not be subject to the proposed disclosure or exhibit filing requirements.
We note that, in certain financing and construction or project development transactions, parties occasionally enter into non-binding support or keep well agreements to ensure the financial viability of an affiliate or third party involved in the transaction. We believe that disclosure of such agreements would be appropriate where such agreements are a condition to the effectiveness of definitive agreements for the transaction or otherwise material to the transaction.
Our Committee believes that the instruction to the proposed item concerning the determination of the materiality of agreements and of whether they are entered into in the ordinary course of business provides an appropriate basis for determination of the applicability of the proposed item and is consistent with present practices for determination of the applicability of an exhibit filing requirement under Reg. S-K Item 601 (b) (10).
We encourage the Commission to implement a means to avoid duplicative filings for business combinations by including boxes on the cover page to Form 8-K so that the filer can indicate that the filing of the Form 8-K will also satisfy the filing obligation under Rule 165, Rule 14d-2(b) or Rule 14a-12.
2. Termination of a Material Agreement Not Made in the Ordinary Course of Business (Item 1.02)
We believe that there should not be a separate reporting requirement relating to the loss or termination of a material contract. It would be very easy for people after the fact with 20/20 hindsight to claim that a loss or termination was material, whereas at the time of such less or termination it was far from clear. Similarly, it is often difficult to determine whether a contractual relationship has been terminated or, beyond the scope of ordinary negotiations, whether a purported termination is a negotiation tactic. Consequently, under these circumstances, we believe that the proposed benchmarks for determining whether disclosure is required could prove difficult to apply and cause a company to be subject to second guessing if it fails to make the proposed disclosure when it believes in good faith that a purported termination of a material contract is asserted by a contractual counterparty as a negotiation tactic. Similarly, the proposed disclosure requirement could subject a company to undue negotiating pressure as a result of the company's desire to avoid second-guessing of its analysis of the applicability of the proposed disclosure obligation in the face of its good faith determination that a purported termination is a negotiation tactic. Moreover, investors could find the disclosure of a purported termination under these circumstances to be misleading. If the Commission decides to adopt this proposal, then we propose that the Commission adopt a safe harbor for a company's good faith determination as to whether a material contract has been terminated.
To the extent a material contract required to be disclosed under Reg. S-K Item 601 is terminated and the parties do not view such action as a negotiation tactic but as the termination of a material relationship, we would support an obligation to disclose the termination. We suggest that this disclosure obligation apply only to material contracts where the parties take affirmative actions to terminate them prior to the material contracts' previously specified expiration dates, not to expirations that occur in accordance with the contracts' terms.
3. Termination or Reduction of a Business Relationship with a Customer that Constitutes a Specified Amount of the Company's Revenue (Item 1.03)
We believe that there should not be a separate reporting requirement relating to the termination or reduction in a business relationship. Companies often do not know whether a customer relationship has been lost or whether the customer is just purchasing from or interacting with them less. As noted above with regard to the termination of contracts, it would be very easy for people after the fact with 20/20 hindsight to claim that a loss or reduction was material, whereas earlier in the relationship it was far from clear. We believe that this proposed item is subject to many of the same issues as proposed Item 1.02 and, to the extent the Commission plans to adopt this proposal, support the adoption of a safe harbor for good faith determinations as to the applicability of proposed Item 1.03.
We are concerned in particular that the proposed disclosure requirement attaches when a company becomes "aware" of a loss or material reduction in a business relationship. The process of ascertaining these types of changes in relationships is frequently gradual and subject to continued analysis and refinement by management. The awareness standard, combined with the short filing deadline for this proposed item, could result in frequent allegations of noncompliance with the item. Termination or reduction could easily push it into a premature determination and disclosure. Conversely, a registrant's concern about the ramifications of a failure promptly to disclose such a trectly and adversely affect the company's business. We believe that these problems will be exacerbated by the 10% threshold, which may prove to be difficult to measure at any time other than at the end of a fiscal quarter. Moreover, we would support the institution of a higher threshold for companies that do not satisfy the Form
S-3 market capitalization test in order to avoid disclosure that, in absolute dollar (rather than percentage) terms, is not significant to investors and could be misleading. In those cases, we propose that a 20% threshold apply.
4. Creation of a Direct or Contingent Financial Obligation That is Material to the Company (Item 2.03)
We believe, as a general matter, that prompt disclosure when a registrant or a third party enters into a transaction or definitive agreement that creates a material financial obligation is a prudent revision to Form 8-K. We believe that disclosure of such an agreement within two business days is also appropriate. We also support the proposed materiality requirement that is necessary in order to balance the need for prompt disclosure of material information to investors with a registrant's need to conduct its business in a reasonable and productive fashion. There are several items, however, that we believe should be modified before adoption.
We believe that the standard of a proposed transaction or an agreement that creates a material direct or contingent "financial obligation" should be changed to a transaction or an agreement that creates material indebtedness or material contingent obligations relating to indebtedness. Many ordinary course commercial agreements create material direct and contingent financial obligations. For example, product purchase agreements, leases and software license agreements often create material direct financial obligations and material contingent financial obligations are created through such customary provisions as deferred payment obligations and indemnity clauses. It appears through the commentary of the release and the examples identified in the proposed instructions to new Item 2.03 that the principal concern underlying the proposal relates to indebtedness and guarantees and similar instruments relating to indebtedness. If the rule were not limited to agreements relating to indebtedness, there would be substantial overlap with the Commission's proposal in Item 1.01 to disclose all material agreements not made in the ordinary course of business. Proposed Item 2.03 does not, however, include an ordinary course exception, other than for short-term debt instruments. Including an ordinary course exception is another possible alternative to alleviate the issues presented above, but the Committee believes an ordinary course exception in Item 2.03 could lead some registrants to conclude that credit agreements that provide working capital would not need to be disclosed, and we don't believe the Commission intended for such a result with the proposed Item 2.03.
We also recommend a quantitative test for determining materiality, which would require disclosure of such a transaction or agreement but would not be the sole factor in determining what constitutes a material contract. We recommend a provision similar to the current disclosure requirement in Item 3 of Form 10-Q which requires the disclosure of material defaults with respect to debt that exceeds 5% of the total consolidated assets of the registrant and its subsidiaries. If the agreement relating to a direct or contingent indebtedness obligation met such a threshold, disclosure would be required but, if the threshold was not met, a registrant would need to analyze whether the transaction or agreement could still be considered material.
We also believe that the requirement to discuss management's analysis of the effect of the obligation on the company would be very difficult to assess at the time of its incurrence and will not provide meaningful disclosure. The Form 8-K disclosure should include a discussion of the registrant's reasons for incurring the obligation (e.g. repayment of other debt or to finance an acquisition), but it would require an extensive discussion of "MD&A" and "risk factor" type disclosure to provide a meaningful and thorough description of the possible effects of the obligation on the company. We do not believe such a detailed analysis is appropriate and would be very burdensome to complete within 2 business days. The proposed rule contemplates cross-referencing to a Rule 424 prospectus with respect to a public debt incurrence, which would likely have such MD&A and risk factor disclosure, but such a cross reference would not be available for a private placement of debt or debt incurred under a credit agreement. We also note that the registrant's future subsequent periodic reports will likely discuss the effects of the obligations in its MD&A and financial statements.
In addition to the concerns discussed above, we note that the requirement in the proposed rule to disclose material private placements of debt securities, for example, would require naming the initial purchasers of the securities and may result in general solicitation problems. Naming the initial purchasers would run afoul of Rule 135c, which currently provides a safe harbor from Section 5 for unregistered offerings by existing filers.
5. Events Triggering a Direct or Contingent Financial Obligation That is Material to the Registrant (Item 2.04)
We do not have the same concerns with the use of the phrase "financial obligation" within proposed Item 2.04 as we do within proposed Item 2.03. This proposed disclosure requirement arises only after a triggering event, so the concerns with picking up ordinary course obligations outlined above are not present in this item. Similarly, a discussion of management's analysis of the effect of the financial obligation on the registrant is also more appropriate in this Item because the triggering event has occurred and investors should be informed of the registrant's course of action. We support a similar quantifiable test of 5% of the total consolidated assets of the registrant and its subsidiaries before mandating disclosure. We also support not requiring disclosure when the company is still negotiating waivers or amendments of the triggering events and deleting Item 3 from Part II of Forms 10-Q and 10-QSB as unnecessarily duplicative. In addition, we believe that disclosure within two business days is also appropriate.
6. Exit Activities Including Material Write-Offs and Restructuring Charges (Item 2.05)
We believe that the triggering event for this proposed item requiring disclosure of material write-offs and restructuring charges has been appropriately defined to be the definitive commitment by the Board of Directors or the registrant's officers authorized to take such action if Board approval is not required. This not only avoids premature disclosure, but makes the reporting requirement parallel applicable accounting requirements. As we stated in our April 10, 2002 letter in response to Release 2002-22, these write-offs and restructuring charges are usually the result of thorough reviews of the registrant's assets, operations and business plans. To require premature disclosure or to require disclosure at each stage of the deliberative process would unnecessarily interfere with corporate management and risk damaging aspects of the business that are being considered for discontinuation, but may ultimately be refocused and retained. Moreover, we do not believe that there are other individuals or groups that typically have the responsibility of taking this type of action. Specifically, in response to the question posed in the Release, in our experience audit committees do not customarily take these actions; rather action of this significance is usually taken by the board of directors or pursuant to authority specifically delegated by the board.
We do believe that there should be a clear objective measurement of materiality for Item 2.05. We suggest that consideration be given to adopting a common standard of materiality that would be applicable to all Form 8-K Items that are based on disclosure of events that may have a similar impact. For example, the current Item 2.01 measurement of significance for the disposition of assets could also be applied to Item 2.05 to measure materiality of assets being written off and restructuring charges and to Item 2.06 to measure materiality of a charge for impairment to assets. This would mean that disclosure would be required if write-offs and restructuring charges exceeded 10% of total assets or involved the exit of an activity that involved a business that is significant under 11-01 of Regulation S-X.
We believe the scope of events covered by proposed Item 2.05 is appropriate. As for the scope of disclosure, we believe it is appropriate given the two business day filing requirement. We believe that the goal of this Item and most other Items should be to provide prompt disclosure of clearly significant corporate events. It should not accelerate all of the disclosure that current rules require in Form 10-Q or 10-K. Not only would this probably not be possible within the two business day time period, it could potentially reduce the quality of the disclosure. It could also interfere with the corporate governance process to the extent it prevents a proper opportunity for consultation among accounting personnel, outside independent accountants, management and boards of directors and audit committees. Therefore, we do not believe it would be practical within the two business day time frame to require disclosure of all of the information required by Emerging Issues Task Force Issues Nos. 94-3 and 95-3 and Staff Accounting Bulletin No. 100.
We also believe that current accounting guidance effectively deals with material changes in the amount or expected effect of write-offs and restructuring charges. Therefore, we do not favor requiring a company to update its report on Form 8-K for this purpose, but believe that the currently required updates in periodic filings are adequate.
7. Any Material Impairments (Item 2.06)
Many of our comments on proposed Item 2.05 are also applicable to proposed Item 2.06. However, we believe impairments are more frequently the result of the application of generally accepted accounting principles to the facts and circumstances surrounding the decline in the value of an asset, many of which may be beyond the control of a company, rather than affirmative action by a company leading to the termination of an activity. Also, while the involvement of the board of directors or audit committee might not be required by generally accepted accounting principles, as is the case for write-offs and restructuring charges, we suggest that disclosure should not be required until after the company has completed whatever corporate governance procedures it reasonably believes are appropriate. While we believe the test of materiality and disclosure trigger should be similar to Items 2.05 and 2.06, we believe that the disclosure of the asset's carrying value after the impairment charge should be disclosed, along with a discussion of the particular facts and circumstances that let to the conclusion that the charge was appropriate. Also, here we believe it is more likely that a company may not have sufficient time to gather the information required to be disclosed, including the calculation of an estimate of the amount of the impairment charge. In that instance, we suggest that an initial Form 8-K be supplemented when the additional information becomes available.
8. A Change in Rating Agency Decision, Issuance of Credit Watch or Change in a Company Outlook (Items 3.01-3.02)
We believe that it is appropriate for the SEC to require a company to file a Current Report on Form 8-K disclosing changes in debt, preferred stock or other ratings by nationally recognized statistical rating organizations ("rating agencies"), including decisions by such rating agencies to place securities on "credit watch" but excluding industry-wide "negative outlook" decisions. Although entire industries are placed on "negative outlook" notice, the disclosure that is material to investors is the change in a company's rating or company outlook, rather than the fact that the rating agencies are contemplating upgrading or downgrading an entire industry.
Even though it is common practice for rating agencies to issue press releases about rating changes promptly, we believe that the announcement of the decision is material to investors and that companies should bear the obligation of disclosing the information by filing a Current Report on Form 8-K. Investors should be able to track company filings and not have to rely on rating agency releases.
We also believe that the required disclosure should be limited to ratings by "nationally recognized statistical rating organizations" or "NRSROs" (as that term is used in Rule 15c3-1(c)(2)(vi)(F) of the Securities Exchange Act of 1934). Currently, in order for a rating agency to become an NRSRO, the agency must satisfy detailed criteria established by the SEC. The single most important criterion is that the rating organization is nationally recognized, which means the organization is recognized in the United States as an issuer of credible and reliable ratings by the users of securities ratings. Given the widespread use of the NRSRO concept in the Wall Street community and the specified attributes required to achieve NRSRO designation status, NRSRO is the appropriate concept to form the basis of disclosure.
In addition, we submit that the requirement should apply to the company and its securities, other than the securities of bankruptcy-remote, special purpose entities. If these special purpose entities are themselves reporting persons, then they, not their parent, should be required to file a Form 8-K disclosing a rating change. We agree with the SEC's proposal that the only exception to this requirement would be situations where the company is obligated to provide credit support to a special purpose entity.
We also believe that the proper filing period would be the second business day following the registered's receipt of a rating agency decision. Rating agency decisions are often made at the end of the business day. Requiring a filing on the next business day would not give a company sufficient time to gather the necessary facts needed to be included in the filing.
9. Movement of the Company's Securities from One Exchange or Quotation System to Another, Delisting of the Company's Securities from an Exchange or Quotation System or a Notice that a Company Does Not Comply with a Listing Standard (Item 3.02)
While we endorse the Commission's proposal to require a company to file a current report when a class of its securities has been delisted or is reasonably certain to be delisted, we are concerned about the proposed requirement to report "any notice" (Release, page 19) of a failure to comply with listing standards. In many instances, companies that are below continued listing standards develop remedial programs with the relevant exchange or securities association that will bring them into compliance over a reasonably short period of time. Premature announcements of the possibility of delisting would complicate, rather than promote, formulation of such a remedial plan, for example, by possibly resulting in further deterioration of the company's stock price. We believe that a current report with respect to a prospective delisting should only be required when the delisting has become reasonably certain.
We also note that the proposal, as drafted, applies only to a notice received from "the principal trading market for a class of the registrant's common stock or similar equity security," although a delisting of any class of the registrant's securities, from that principal market, would be covered. A situation which is not addressed is where a class of debt or equity security is to be delisted from another exchange which happens to be, for example, the only exchange on which the subject debt or equity security is listed.
10. Conclusion or Notice that Security Holders No Longer Should Rely on the Company's Previously Issued Financial Statements or a Related Audit Report (Item 4.02)
We generally endorse the Commission's proposal as written. We do note, however, that the two business day filing requirement appears to be unrealistic as it leaves little time for management's analysis and discussion (internally and with the auditors) of what can be very complex or detailed issues. Furthermore, it allows little or no time for a registrant's audit committee to perform its function in these circumstances.
11. Any Material Limitation, Restriction or Prohibition, Including the Beginning and End of Lock-Out Periods, Regarding the Registrant's Employee Benefit, Retirement and Stock Ownership Plans (Item 5.04)
The proposed new Item 5.04 would require a company to disclose any known event that would have the effect of materially limiting, restricting or prohibiting participants in an employee benefit, retirement or stock ownership plan from acquiring, disposing or converting their holdings, other than a periodic or other limitation, restriction or prohibition based on presumed or actual knowledge of or access to material non-public information, if that plan is broadly available to the company's employees. While this is an issue of importance to plan participants, we do not believe the timing of lock-out periods is material to investors generally. Plan sponsors are required by their fiduciary obligations under ERISA to give notices to participants regarding the timing of lock-out periods as well as other material events relating to the plans. Congress is currently considering legislation that would require companies to give employees at least a 30-day advance notice of any significant period where employees cannot access their accounts. We do not believe adding a Form 8-K filing obligation to the direct notices participants receive with respect to these matters is material to the markets or necessary for investor protection, nor is it the most efficient or effective method of notifying participants of plan-specific information.
12. Unregistered Sales of Equity Securities by the Company (Item 3.03)
We generally agree with this proposal. We believe it would be helpful administratively if there were a once a week filing requirement and indication on Edgar that the Form 8-K relates to equity sales.
13. Material Modifications to Rights of Holders of the Company's Securities (Item 3.04)
We generally agree with this proposal.
The Committee commends the Commission for putting forth the Release and proposing new standards of disclosure. It is the belief of the Committee that the investment community would be well served if the Commission gave additional consideration to specific elements of the proposed rule, as set forth in this letter.
Please note that Committee members Wayne Carlin of the United States Securities and Exchange Commission and David Jaffe of the National Association of Securities Dealers, Inc. did not participate in the preparation of this letter or the vote by the Committee to submit this letter to the Commission. In addition, this letter does not necessarily reflect the individual views of members of the Committee.
Members of the Committee would be pleased to answer any questions you might have regarding our comments, and to meet with the Staff if that would assist the Commission's efforts.
Respectfully Submitted,
/s/ Charles M. Nathan, Jr.
Charles M. Nathan, Jr., Chair of Committee on
Securities Regulation
/s/ N. Adele Hogan
N. Adele Hogan, Co-Chair of the Committee
on Securities Regulation Disclosure
Subcommittee
/s/ Richard R. Langan
Richard R. Langan, Co-Chair of the Committee on Securities Regulation Disclosure Subcommittee
cc: Alan Beller, Director
Division of Corporation Finance
Securities and Exchange Commission
Disclosure Subcommittee
Stephen P. Farrell
Jeffrey N. Gordon
Nicholas Grabar
David Greenwald
Adele Hogan
Richard F. Langan, Jr.
Michael E. Lubowitz
Rise B. Norman
Neila B. Radin
Eric S. Robinson
Norman D. Slonaker
Steven J. Slutzky
ATTACHMENT
THE ASSOCIATION OF THE BAR
OF THE CITY OF NEW YORK
42 WEST 44TH STREET
NEW YORK, NY 10036-6689
COMMITTEE ON SECURITIES REGULATION
April 10, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
Re: Press Release 2002-22: SEC to Propose New Corporate Disclosure Rules
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Securities Regulation of the Association of the Bar of The City of New York (the "Committee") in response to Release 2002-22 dated February 13, 2002 (the "Release"), in which the Securities and Exchange Commission (the "Commission") has announced its intention to propose new corporate disclosure rules. Our Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to corporations, investment banks and investors, and academics.
This letter is divided into two sections:
We are commenting on the press release instead of waiting for the actual proposing release because of the significant issues raised, the Commission's express request for comments and our Committee's interest in staying involved in the process. We are confident the actual rules will be integrated and will not overlap each other or current disclosure items in Form 8-K.
In a few instances noted below, we would suggest that a safe harbor be implemented for the proposed disclosure obligation. These proposed safe harbors tend to relate to new and very broad disclosure obligations where questions of materiality are highly subjective. It would seem that, in a limited number of circumstances where companies comply in good faith with these new requirements, they should be granted a safe harbor if their difficult materiality judgments turn out to be wrong with the benefit of 20/20 hindsight. We also believe it would be helpful if the ramifications for good faith oversights or slight delays due to administrative corporate snafus were specified. We recommend that the safe harbor provide that good faith attempts at compliance that turn out in hindsight to have been made in error would not result in adverse action by the Commission or civil liability.
Please note that Committee members Wayne Carlin, of the United States Securities and Exchange Commission, David Jaffe, of the National Association of Securities Dealers, Inc., and Salvatore J. Graziano, of Milberg, Weiss, Bershad, Hynes & Lerach, did not participate in the preparation of this letter or the vote by the Committee to submit this letter to the Commission.
1. Comments on the Commissions' Suggested Form 8-K Revisions
(a) Changes in rating agency decisions and other rating agency contacts
We believe that it is appropriate for the SEC to require a company to file a Current Report on Form 8-K disclosing changes in debt ratings by nationally recognized statistical rating agencies ("rating agencies"), including decisions by rating agencies to place securities on "credit watch" but excluding industry-wide "negative outlook" decisions. Often, entire industries are placed on "negative outlook" notice. The disclosure that is material to investors is the change in a company's rating or company outlook (as opposed to an industry outlook), rather than the fact that the rating agencies are contemplating upgrading or downgrading an entire industry. Furthermore, we believe any new disclosure requirement should be limited to changes in rating agency decisions and should not extend to other contacts that a company may have from time to time with a rating agency. Companies are often contacted by rating agencies with requests for additional information and compelling disclosure of each such contact could result in a host of Form 8-K filings disclosing information of no particular interest to or impact on investors, thereby diminishing the relative importance of Form 8-K filings. In addition, companies often contact rating agencies to update them on the status of their business or to discuss the ratings implications of transactions under consideration. Mandating a filing each time a company has contact with the agencies to discuss developments in the company's business would again result in a large number of superfluous Form 8-K filings. Moreover, such a disclosure obligation may also discourage the confidential sharing of information and jeopardize companies' abilities to carefully consider and plan transactions. Such a requirement may also disrupt the market, as investors would be tipped off to numerous possible transactions, many of which may not be publicly disclosed, be fully developed or actually occur.
In addition, we submit that the requirement should apply to the company and its securities, and not to the securities of bankruptcy-remote, special purpose entities. If these special purpose entities are themselves reporting persons, then they, not their parent, should be required to file a Form 8-K disclosing a rating change. The one exception to this view would be situations where the company is obligated to provide support to a special purpose entity.
We believe that the proper filing period would be the second business day following a rating agency decision. Rating agency decisions are often made at the end of the business day. Requiring a filing on the next business day would not give a company sufficient time to gather the necessary facts needed to be included in the filing.
Finally, we suggest the Commission seek further guidance on what disclosure obligations, if any, a company should have for unsolicited ratings issued by an entity that is not a recognized rating agency with which a company has had contacts in the past. We believe rating agencies sometimes issue unsolicited ratings with no notice to or involvement of companies. We believe it may be inappropriate for companies to be required to report these unsolicited ratings.
(b) Transactions in the company's securities, including derivative securities, with executive officers and directors
We are withholding our comments until the proposing release is issued.
(c) Defaults and other events that could trigger acceleration of direct or contingent obligations
We believe, as a general matter, that prompt disclosure of defaults and other events that could trigger acceleration of a registrant's direct or contingent obligations is a prudent recommendation. We believe, however, that materiality and other qualitative parameters need to be imposed on such a requirement in order to balance the need for prompt disclosure of material information to investors with a registrant's need to conduct its business in a reasonable and productive fashion. We recommend including materiality provisions similar to the current disclosure requirement in Item 3 of Form 10-Q which requires the disclosure of material defaults with respect to debt that exceeds 5% of the total consolidated assets of the registrant and its subsidiaries. We would also recommend including the provision from the Form 10-Q rules requiring that the disclosure only be made after expiration of any grace or notice periods set forth in the relevant agreement or instrument. Moreover, we would support an expansion of the current Form 10-Q requirement relating to traditional debt instruments to include the analysis of material defaults under all material obligations of a registrant or that through cross-default provisions would result in material defaults or accelerations of the maturities a debt. Any new rule needs to contain flexibility, however, to allow a registrant to refrain from immediate disclosure if it reasonably believes that a resolution of the matter will be implemented promptly and in a fashion that will not have a material impact on the registrant or its stockholders. If a registrant fails to comply with a financial covenant contained in its revolving credit agreement, for example, it will frequently discuss the issue with its lenders and, in many instances, negotiate with the lender to waive that default or modify the relevant provision in the agreement in a mutually satisfactory way to avoid a default. We believe that it would be imprudent to require immediate disclosure of defaults in such a situation because it could potentially impede the negotiation process relating to some defaults where acceleration, although contractually possible, is not reasonably likely to occur and therefore not a material risk to investors. Therefore, we would support a time frame to allow for such negotiations before requiring disclosure, such as the current Form 10-Q requirement that includes a 30 day period to cure material defaults other than principal, interest and other required payments before mandating disclosure. Furthermore, to the extent a waiver or amendment is obtained, we believe disclosure should not necessarily be required unless the terms of the waiver or amendment themselves are material.
We believe this disclosure requirement as to "other events" and whether the consequences will be material should be given "safe harbor" treatment.
(d) Transactions that result in material direct or contingent obligations not included in a prospectus filed by the company with the Commission
We believe that any reporting requirement relating to material direct or contingent obligations should carve out transactions that are required to be disclosed under any other Form 8-K item, be limited to material definitive agreements that are now required to be filed on Form 10-Q or Form 10-K pursuant to Reg. S-K Item 601 and must set clear standards for materiality and ripeness in order to balance public interests in disclosure with the interest of a company in the efficient conduct of its business. We suggest that materiality could be addressed on several levels, such as the amount of the obligation as a percentage of net worth or net income and the amount of the obligation as a percentage of total assets, with the goal to avoid imposing disclosure requirements for transactions that are in the ordinary course of business. Moreover, we believe that the disclosure requirement should not be triggered until the registrant has entered into a binding contractual obligation giving rise to the material direct or contingent obligation. We believe that non-binding preliminary commitments or commitments that may be cancelled at any time without financial consequences should not trigger a disclosure obligation. The terms of an obligation contemplated by a registrant often change between the commitment stage and the execution of a definitive agreements and often transactions involving an obligation contemplated by a commitment or non-binding undertaking are not consummated. We believe that disclosure of a commitment or other non-binding undertaking would increase the risk that a transaction that may otherwise be in the best interests of a registrant would not be consummated and may impede the registrant's ability to seek completion of the transaction on terms most favorable to the registrant. To require premature disclosure or to require disclosure at each stage of the deliberative process would unnecessarily interfere with corporate management and risk damaging business relationships and transactions and may, indeed, confuse the securities markets.
We believe the filing period should be five business days after the definitive agreement related to such transaction is executed by all parties (not the date on the face of the agreement).
We believe this disclosure requirement should be given "safe harbor" treatment.
(e) Offerings of equity securities not included in a prospectus filed by the company with the Commission
Since registrants are required under existing disclosure standards to report recent sales of unregistered securities in their quarterly and annual reports on Forms 10-Q and 10-K, the proposed change to Form 8-K would shift the disclosure standard for these transactions from a periodic to a current timeframe. We believe this proposal could be expanded to cover all offerings, including debt offerings. We believe, however, that, while investors may be interested in access to information concerning these types of transactions on a current basis, the Form 8-K disclosure requirement for recent sales of unregistered securities should be subject to an objective standard of materiality and should relate to the issuance date rather than the commitment date. The materiality threshold could be tied to a specified dollar amount of consideration received by the issuer for the securities issuance or, in circumstances where the securities issued are of a class or series that was previously outstanding, a specified percentage of the outstanding securities of that time or series. Any requirement for public disclosure of offerings should be consistent with Rule 135(c).
(f) Waivers of corporate ethics and conduct rules for officers, directors and other key employees
Because corporate ethics and conduct rules are not uniform among reporting companies, disclosure of the type proposed by the Commission will not be uniform. Instead, we suggest that the Commission consider limiting the disclosure requirement to transactions involving material conflicts of interest with directors or executive officers. One approach we suggest the Commission explore would be to base disclosure on corporate action with respect to "conflicting interests" as defined in Section 8.60 of the Model Business Corporation Act. Nearly every jurisdiction has provisions of their corporation law that address conflicts of directors, and many also included "interested" officers. See Sections 143 and 144 of the Delaware General Corporation Law and Sections 713, 714 and 719 of the New York Business Corporation Law.
We believe this disclosure requirement should be given "safe harbor" treatment.
(g) Material modifications to rights of security holders
We support the Commission's concept of requiring accelerated reporting of material modifications (including, without limitation, changes to the maturity date, principal amount or interest rate) to the rights of security holders who hold registered securities or securities that are material to the company (using the 5% of the total consolidated assets of the company and its subsidiaries threshold found in Item 3 of Form 10-K) so long as such modifications were not contemplated by the original instrument and were the direct result of actions taken by a company.
We believe the appropriate time period for disclosure would be within five business days of adoption.
(h) Departure of the company's CEO, CFO, COO or president (or persons in equivalent positions)
We support prompt disclosure of the departure of a company's Chief Executive Officer, Chief Financial Officer, Chief Operating Officer or President. We believe that it is important that the Commission retain the "departure" concept in any rulemaking. The filing requirement should arise only on the earlier of the individual no longer serving in that capacity or a public announcement by the company or the individual that departure will occur on an identified date. We believe it would be imprudent and potentially misleading to investors to require immediate disclosure upon rumors about the succession plans of companies or upon other opportunities being offered to executive officers.
We believe it would be appropriate to have a similar disclosure obligation when such positions are filled. Please see Section 2(d) below.
(i) Notices that reliance on a prior audit is no longer permissible, or that the auditor will not consent to use of its report in a Securities Act filing
We recognize the desirability of requiring prompt disclosure when an auditor formally advises a reporting company that it is withdrawing its opinion. Item 4 of Form 8-K and Item 304 of Regulation S-K to which Item 4 refers, require detailed disclosure, within 5 business days of a change in a reporting company's auditors, of not only the change but also of any unresolved disagreements or differences of opinion with the auditors. Form 8-K and Regulation S-K Item 304 do not now address the situation where a formerly engaged auditor notifies a reporting company that it is withdrawing its opinion for earlier years' financial statements. While this should be addressed, we do not believe that the standard for filing a current report should be simply an auditor advising an issuer not to rely on its earlier opinion or an auditor's refusal to consent to the use of its opinion in a Securities Act filing since these standards could require current report filings that are not necessary. Not infrequently formerly engaged auditors decline to consent to the use of their reports or earlier years' financial statements in Securities Act filings because of their general concerns as to potential liability, rather than any specific issue as to the continuing accuracy of those reports. In other situations, where following adoption of an accounting principle audited restatements of some earlier years' financial statements are not required, auditors may advise their clients not to use those statements or their opinions thereon unless the financial statements are restated and audited. In neither of these situations would a current report appear warranted. We, therefore, believe that an auditor's formal withdrawal of an opinion is the appropriate standard that should necessitate prompt disclosure.
(j) Definitive agreement that is material to the company (negotiations of agreements would be excluded from this requirement unless and until a definitive agreement is entered into)
We support an accelerated disclosure reporting obligation on Form 8-K of material definitive agreements that are now required to be filed on Form 10-Q or Form 10-K pursuant to Reg. S-K Item 601. We believe the filing period should be five business days after the definitive agreement is signed by all parties (not the date on the face of the agreement).
(k) Any loss or gain of a material customer or contract
We believe that there should not be a separate reporting requirement relating to the loss or gain of a material customer or contract. Companies often do not know whether a client has been lost or is just purchasing from or interacting with them less. It would be very easy for people after the fact with 20/20 hindsight to claim that a loss or gain was material, whereas earlier in the relationship or at the beginning of a contract period it was far from clear. It is often difficult to determine whether a company has gained a customer and how meaningful that relationship will be.
To the extent a material contract required to be disclosed under Reg. S-K Item 601 is terminated and the parties do not view such action as a negotiation tactic but as the termination of a material relationship, we would support an obligation to disclose the termination. We suggest that this disclosure obligation only apply to material contracts where the parties take affirmative actions to terminate them prior to the material contracts' previously specified expiration dates, not to expirations that occur in accordance with the contracts' terms. Similarly, the execution of material contracts (as currently defined in Reg. S-K Item 601) would be required to be disclosed within five business days. Please see Section 1(j) above.
(l) Any material write-offs, restructurings or impairments
We believe that any reporting requirement in the area of material write-offs, restructurings or impairments must set clear standards for materiality and timeliness so as not to unnecessarily interfere with the corporate decision making process. We suggest that materiality could be addressed on several levels, such as the amount of the write-off as a percentage of net worth or, possibly, net income, the revenue or net income of the operations being discontinued as a percentage of total revenue or net income and the amount of the impairment as a percentage of total assets. The standards in Item 2 of Form 8-K would appear appropriate for this purpose.
The Commission should appreciate that restructurings and impairment charges do not begin with the decision to incur a charge. Rather, they begin with a review of the company's assets and operations and an analysis of business plans and what changes could be appropriate. Initial decisions are made and unmade during the process. The plans change as they are tested against business and financial models and as they are discussed with the Board of Directors or the Audit Committee. To require premature disclosure or to require disclosure at each stage of the deliberative process would unnecessarily interfere with corporate management and risk damaging aspects of the business that are being considered for discontinuation but ultimately are retained and refocused. This does not even address the personnel impact of premature disclosure.
We suggest that the Commission follow the guidance in Staff Accounting Bulletin No. 100 and Emerging Issues Task Force Issues Nos. 94-3, and 95-3 and Accounting Principles Board Opinion No. 17 and Statement of Financial Accounting Standards No. 121. This would link disclosure to the accounting treatment and require disclosure when the company is committed to a plan by management having the appropriate level of authority. Each company, as it currently does for accounting purposes, would decide the appropriate corporate governance practices for the transaction, i.e., whether the plan could be adopted by management or the Board of Directors or through some other process.
We believe this disclosure requirement should be given "safe harbor" treatment.
(m) Any material change in accounting policy or estimate
We believe that the disclosure requirement for changes in accounting policy or estimates should generally follow current disclosure requirements in the accounting literature, in particular Staff Accounting Bulletin No. 74 and APB Opinion No. 20. Staff Accounting Bulletin No. 74 enumerates disclosure principles that, although applicable by their terms only to formally issued but not yet adopted accounting standards, nevertheless provide, in our view, appropriate disclosure principles applicable to changes in accounting policies or estimates that are within management's judgment. SAB 74 makes clear that disclosure of the effects of an accounting standard that has been issued but not yet adopted should be disclosed in the same manner, and subject to the same standards, as other known material trends in a registrant's MD&A. Disclosure is required in the MD&A of "known material changes" that "the registrant reasonably expects will have a material impact on future sales, revenues or income . . ." As proposed, the requirement for Form 8-K disclosure would apply to "any material change in accounting policy" regardless of the materiality of its impact and regardless of the materiality of the accounting policy to the registrant's financial statements. More importantly, both SAB 74 and APB Opinion No. 20 state that any accounting change should be reported in manner that will facilitate analysis and understanding of the financial statements.
We believe that, consistent with this guidance, the discussion of the proposed change in accounting policy should be included within the MD&A, as part of a registrant's Form 10-K and Form 10-Q filings with the Commission, rather than in a Form 8-K. In this way, management can describe the new accounting standard and its anticipated effect in the same document that contains the company's financial statements. This will provide the appropriate context for an understanding of the accounting change and its effect on the registrant's financial results, making the information more informative, particularly if the proposed change would affect more than one line item of the financial statements. Finally, by keeping the disclosure obligation to the Form 10-Q and Form 10-K filings, where the changes and estimates can be put in context with reported financial statements, the rigor of closing the books on a reporting period and involving the Audit Committee are retained and companies are more likely to "get it right the first time".
We believe this disclosure requirement, at least with respect to estimates, should be given "safe harbor" treatment.
(n) Movement or de-listing of the company's securities from one quotation system or exchange to another
We support this proposal as long as disclosure is required after the movement or de-listing is formalized, not when companies are engaging in preliminary discussions about corporate efforts to avoid delisting.
(o) Any material events, including the beginning and end of lock-out periods, regarding the company's employee benefit, retirement and stock ownership plans
The unfortunate timing of the lock-out period under the Enron 401(k) plan prevented participants from changing their investment allocations during a period in which Enron's stock price fell dramatically. The Department of Labor is already investigating the circumstances relating to the lock-out and considering whether any further regulatory action is required to protect plan participants. However, while this is an issue of importance to plan participants, we do not believe the timing of lock-out periods is material to investors generally. Plan sponsors are required by their fiduciary obligations under ERISA to give notices to participants regarding the timing of lock-out periods as well as other material events relating to the plans. The House Ways and Means Committee has recently approved a bill (H.R. 3669) sponsored by Representatives Portman and Cardin that would require companies to give employees at least a 30-day advance notice of any significant period where employees cannot access their accounts. We do not believe adding a Form 8-K filing obligation to the direct notices participants receive with respect to these matters is material to the markets or necessary for investor protection. Furthermore, to the extent that this item could encompass public disclosure of trading "blackouts" imposed by companies on directors and officers due to potential insider trading concerns (e.g., during the course of merger negotiations), it could force premature public disclosure of sensitive corporate matters.
2. Suggested Additional Form 8-K Items
We believe the Commission may wish to consider whether additional matters should be covered in required Form 8-K disclosures, including the following:
Members of the Committee would be pleased to answer any questions you might have regarding our comments, and to meet with the Staff if that would assist the Commission's efforts.
Respectfully submitted,
/s/ Charles M. Nathan
Charles M. Nathan, Chair of Committee on Securities Regulation
/s/ N. Adele Hogan
N. Adele Hogan, Co-Chair of the Disclosure Subcommittee
/s/ Richard F. Langan
Richard F. Langan, Jr., Co-Chair of the Disclosure Subcommittee