June 1, 2016
I am an attorney in private practice in Irvine, California. I am writing in my individual capacity and not on behalf of my law firm or any of my law firm's clients.
I previously served as California's Commissioner of Corporations and in that capacity administered and enforced California's securities laws. I have taught as an adjunct professor at the University of California, Irvine and Chapman School of Law. I have also served as Co-Chairman of the Corporations Committee of the Business Law Section of the California State Bar and Chairman of the Business and Corporate Law Section of the Orange County (California) Bar Association. As indicated above, this letter is written in my individual capacity and not on behalf of either of these groups.
Although the new rule is permissive, its effect will be to limit discretion and innovation on the part of issuers. The adopting release acknowledges that the Commission's "current rules do not prohibit a registrant from including voluntary information, such as a summary, in its Form 10-K". By adopting a rule that allows the inclusion of summary information subject to specific conditions, the implication appears to be that the voluntary inclusion of information has been narrowed to just what is permitted by the new rule. Thus, the Commission appears to have moved from "everything is permitted (subject to the antifraud provisions of the securities laws)" to "nothing is permitted, except as specifically allowed by the new rule".
The Commission has sought comment on whether it should mandate a summary. I oppose the adoption of such a mandate. The Commission acknowledges in its adopting release that issuers are already permitted to include a summary in their Form 10-Ks, but few have done so. Because the Commission has not identified any impediment to such disclosures, it appears that there is little investor demand for summaries. Therefore, mandating a summary would be arbitrary and capricious.
The Commission has sought comment on whether it should impose limitations on the length of summaries. The Commission should not impose any limitation absent evidence demonstrating that investors are being harmed by excessively prolix summaries. In the absence of such evidence, I believe a limitation on the length of summaries would be arbitrary and capricious.
The Commission has asked whether registrants should be required to file a Form 10-K amendment to include Part III information to be incorporated by reference. The Commission has provided no indication as to why this would be necessary or desirable. Therefore, the imposition of such a requirement would be arbitrary and capricious.
The new rule adopts an entirely novel standard of disclosure - the summary must be presented "fairly and accurately". Although an independent auditor's report includes an opinion as to whether the financial statements "present fairly, in all material respects, an entitys financial position, results of operations, and cash flows in conformity with generally accepted accounting principles", the "present fairly" standard is not found elsewhere in Regulation S-K (other than as to the financial statements in the Rule 13a-14(d)/15d-14(d) certifications). See AS 2815: The Meaning of "Present Fairly in Conformity with Generally Accepted Accounting Principles". The Commission's requirement that each item in the summary be "presented fairly" would make more sense if the summary includes only financial information. However, the rule allows an issuer to include a summary of the "information required by this form". Therefore, the rule does not limit the information disclosed in the summary to just the financial statement information included in the Form 10-K.
Similarly, the accuracy standard included in the new rule is unprecedented. Under Rule 10b-5, a filer must not "make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading".