Mr. Jonathan G. Katz
Re:File No. S7-22-02
Dear Mr. Katz:
We submit this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments regarding the Commission's proposal (the "Proposal") contained in Release Nos. 33-8106 and 34-46084 (the "Release") to add 11 new corporate events that would require a company to file a current report on Form 8-K under the Securities Exchange Act of 1934 (the "Exchange Act") and to shorten the filing deadline to two business days after a triggering event. We have not commented on proposals where provisions of the Sarbanes-Oxley Act of 2002 have obviated the need for additional disclosures on Form 8-K. We appreciate the opportunity to participate in this important undertaking and intend our comments to be helpful to the Commission in its efforts to protect investors by ensuring the timely disclosure of current material information.
We represent registrants of various sizes in various industries, as well as institutional investors, on a regular basis. This comment letter is responsive to issues our clients have raised in the course of our representation.
The Proposal and the Commission's Objectives
The Proposal, if adopted, would require registrants to report 11 new corporate events on Form 8-K. In addition, it would make significant changes to several existing items reportable on Form 8-K and move two items that are reportable on annual and quarterly reports to Form 8-K. Finally, it would significantly accelerate the filing deadline to two business days after a triggering event.
In the Release, the Commission sets forth its desire to "improve the delivery of timely, high-quality information to the securities markets to ensure that securities are traded on the basis of current information." We wholeheartedly support this initiative to ensure that investors receive credible information timely. However, we also recognize that registrants need time to prepare the information and are concerned that accelerated disclosure may lead to disclosure of a lower quality.
We are strongly of the view that the accelerated filing deadline under the Proposal to two business days after a triggering event simply does not afford registrants the time they need to accurately prepare their disclosures for dissemination to the investing public. If the new filing deadlines are adopted, we believe that a lower level of accuracy and completeness in the reports filed and a substantial increase in the level of late filings pursuant to Rule 12b-25 are the inevitable results. We believe that a five business day period before filing would greatly enhance the likelihood of correct and complete disclosure (and analysis where applicable).
We also believe that overall disclosure is improved if the trigger is a bright-line test rather than a generic materiality test. Specifically, the test should be based on financial measurements, similar to the determination of what constitutes a "significant subsidiary" under Rule S-X. In addition, the test should include an "otherwise material" criteria to require disclosure of events which fall short of the bright-line test. This will enable registrants to make disclosures in a uniform manner on specific occurrences and still sweep in the concept of qualitative materiality under SAB 99.
Finally, if the sine qua non of the current rule making is protection of investors, we believe the disclosure obligations should not vary among foreign registrants, small business registrants and other domestic registrants. If a foreign or small business registrant wants to have the benefits of the U.S. capital markets, it should be subject to the same rules. Investors should not receive less protection (i.e., less disclosure) because the registrant is a small or foreign entity.
1. Entry into a Material Agreement
We believe that required 8-K disclosure of a material agreement should be based on a financial measurement. The benchmark could be, e.g., 5% of revenues, 10% of net income1, or 5% of total assets and should apply whether or not in the "ordinary course of business." There also should be a "basket" of criteria for identifying otherwise material agreements to allow for voluntary disclosure of other items, which the registrant may deem material even though they fall short of meeting the bright-line test. Disclosure should be required only when a binding agreement has been entered into. If registrants were required to disclose letters of intent and other non-binding agreements, this could cause competitive harm and significantly disrupt the ability of the registrant to negotiate agreements that benefit its entire constituency, including investors. We suggest that the final rule clearly state that it is not imposing a new "duty to disclose" but rather establishing a uniform procedure for disclosure of certain transactions that meet measurable criteria.
2. Termination of a Material Agreement
The termination of a material agreement should be a disclosure item unless the agreement is terminated pursuant to its terms, for example, by the passage of time.
3. Termination or Reduction of a Business Relationship with a Customer
The termination or reduction of a business relationship with a significant customer should be a disclosure item with a bright-line benchmark. The benchmark could be a customer representing 5% of the revenues, 10% of net income or 5% of total assets in the most recent fiscal year. Again, a basket for "other material relationships" could be utilized to allow for voluntary disclosure of items when the presumptive benchmark is not reached.
4. Completion of Acquisition or Disposition of Assets
The completion of an acquisition or disposition of business assets should be a disclosure item with a bright-line benchmark. For example, disclosure should be made if an acquisition or disposition of business assets is completed representing 5% of revenues, 10% of net income, or 5% of total assets in the most recent fiscal year. Again, a basket for "other material acquisitions or dispositions" could be utilized.
5. Creation of a Direct or Contingent Financial Obligation That is Material to the Registrant
The creation of a direct or contingent financial obligation should be a disclosure item with a bright-line benchmark. For example, disclosure should be made if the financial obligation represents 5% of revenues, 10% of net income, or 5% of total assets in the most recent fiscal year. Again, a basket for "other material acquisitions or dispositions" could be utilized. This item, as proposed, also requires management to discuss the effects of the direct or contingent financial obligation on the registrant. We believe that any filing which requires management's evaluation or assessment of an event compels the implementation of a no less than five business day period for filing in order to allow management to provide such evaluation or assessment with a reasonable amount of care.
6. Events Triggering a Direct or Contingent Financial Obligation That is Material to the Registrant
An event triggering a direct or contingent financial obligation should be a disclosure item with a bright-line benchmark. For example, disclosure should be made if the event triggering a financial obligation represents 5% of revenues, 10% of net income, or 5% of total assets in the most recent fiscal year. However, we think requiring disclosure while a registrant is negotiating waivers or amendments of triggering events creates real problems and may undermine the likelihood of a successful completion of those negotiations. Further, if this item is adopted, Item 3 from Part II of Forms 10-Q and 10-QSB should be deleted as this information does not warrant duplicate disclosure.
7. Exit Activities Including Material Write-Offs and Restructuring Charges and Material Impairments
Consistent with the accounting rules for write-offs and restructurings, the triggering event for disclosure of an exit activity and a material impairment should be the point at which the board of directors commits its company to a course of action. We believe that disclosure should be required only if the expected charge or material impairment would represent 5% of revenues, 10% of net income, or 5% of total assets in the most recent fiscal year.
This requirement to provide disclosure is further complicated by the requirement to provide estimates and analysis of the write-offs. If management is to make estimations and provide analysis, they should be provided safe harbor protection under the Exchange Act. Further, five business days would be a more reasonable timeframe to allow management to evaluate the effects and consult with the necessary outside advisors. Finally, if there is a material change to the write-off or impairment, a registrant should not be required to file an amendment to its Form 8-K. Rather, the registrant should be required to file an additional Form 8-K.
8. Rating Agency Decisions
We are not of the view that it is better disclosure policy for a registrant to disclose a rating agency decision. Since ratings organizations typically disclose rating changes via press releases, the relevant information is already publicly disclosed. Registrants should not also be required to disclose ratings changes made by independent rating agencies unless, for example, the registrant was engaged in an offering of securities, which might be affected by the ratings change.
9. Notice of Delisting or Failure to Satisfy Listing Standards; Transfer of Listing
We believe that the appropriate time for a registrant to disclose a possible delisting is contemporaneously with its receipt of notice that its securities may be delisted from a national securities exchange or association. We think that such disclosure should be required to be made promptly and prominently, and the notice should be filed as an exhibit to the Form 8-K. However, requiring management to include an analysis of the effects of the delisting or failure to satisfy a listing standard is probably unnecessary (the investors can make these determinations on their own) and will likely result in boilerplate disclosure.
10. Unregistered Sales of Equity Securities
We think that disclosure should be made of sales of unregistered equity securities only if such sales achieve specified levels such as any single transaction amounting to 5% of the registrant's outstanding shares or to the extent that the cumulative level of unreported transactions equals or exceeds 10% of the registrant's outstanding shares. We think this structuring of disclosure would be meaningful to investors especially in light of the nature of certain common PIPE transactions and equity lines. Further, if this item is adopted, as proposed, Item 2 from Part II of Forms 10-Q and 10-QSB should be deleted as this information does not warrant duplicate disclosure.
11. Non-Reliance on Previously Issued Financial Statements or a Related Audit Report
While we agree with the disclosure item for non-reliance on previously issued financial statements or a related audit report, we think it difficult to expect management to formulate and report their plan to alleviate the reliance issue within two business days. Five business days would be a more appropriate timeframe.
12. Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers
We agree that the resignation or removal of a director or principal officer or the declination to stand for re-election in the case of a director have ramifications for the investors and therefore should be disclosed. When a director or principal officer leaves a registrant, no disclosure is necessary if there is no dispute between the departing person and the registrant. In addition, if an officer leaves a position for a promotion within the same organization, disclosure seems unnecessary.
13. Amendments to Articles of Incorporation or Bylaws; Changes in Fiscal Year
We believe that only bylaw amendments that affect corporate governance should be reported on Form 8-K. There are mundane bylaw amendments (including de facto amendments when a board has the power to amend the bylaws and adopts a resolution that supersedes the express term of the bylaw) that may not be as important to an investor and these amendments do not warrant disclosure on a Form 8-K.
Our Recommendations for Improving Investor Access to Material Information
The significantly shortened filing deadlines are not reasonable, in our view. We agree with the Commission that "quality should [not] be sacrificed for the sake of speed", and, accordingly, it is our view that five business days is reasonable as it would allow timely disclosure without sacrificing the quality of disclosure.
A bright-line test based on a financial measurement as opposed to a generic test based on materiality is the appropriate test to determine when an important corporate event must be disclosed. A bright-line test would ensure specific disclosures at concrete times.
Finally, we think the same rules that apply to domestic registrants should also apply to small business registrants and foreign registrants. Investors need protection irrespective of the nature of the registrant and they should not receive less disclosure because the registrant is small or foreign. Small business registrants and foreign registrants should be held to the same standard as domestic registrants.
While we support the Commission's desire to protect investors by ensuring timely disclosure of relevant information, we strongly believe that a filing deadline of two days for current reports on Form 8-K is inconsistent with many of the Commission's stated objectives. For this reason, we strongly urge that the Proposal be reformulated. We believe our recommendations as to a reformulated proposal would enable investors to have more timely access to material information, without creating substantial administrative burdens and increasing the risk of lower quality disclosure.