August 30, 2002
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
File No. S7-22-02; Release Nos. 33-8106, 34-46084
Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date
Dear Mr. Katz:
We are submitting this letter in response to the request of the Securities and Exchange Commission for comments on the Commission's proposed rule, "Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date." We appreciate this opportunity to comment on the issues raised by the proposed rule.
We strongly support the Commission's efforts to improve the scope and timeliness of disclosure of material corporate events to investors. However, while we support the objectives of the proposed rule and acknowledge the importance of the disclosure required by many of the proposed items, in our view, the proposed rule represents a fundamental change in the reporting system for current events under the Securities and Exchange Act of 1934 (the "Exchange Act") and raises a number of very significant issues. The first part of this letter addresses our general concerns about the proposed rule. The second part addresses our specific concerns about the proposed items of Form 8-K, which we have segregated by item number, using the item numbers of the proposed rule. We have not addressed each proposed item, but only those items about which we have concerns or for which we have suggestions for improvement.
PART I - GENERAL CONCERNS
We support many of the changes to Form 8-K proposed by the Commission. However, as discussed in greater detail below, we believe that:
Extending the filing deadline for proposed items requiring a management's analysis
We agree with the Commission that disclosure of material corporate events to investors can be accelerated and we believe that, in some cases, registrants should be able to comply with the two business day filing deadline being proposed by the Commission. However, a number of the proposed items require registrants to prepare a management's analysis discussing the effects of the reportable event. In our experience, the preparation of an accurate and meaningful management's analysis requires the input of a number of individuals within a company's organization and often includes review by a company's independent auditors and outside legal counsel. We believe that, in most cases, it will be very difficult for companies to prepare and file an accurate and meaningful management's analysis within two business days given the number of persons that must review, comment on and approve the disclosure. If the currently proposed two business day filing deadline is not extended, we believe that the quality of the management's analysis will be negatively affected because the need for rapid disclosure will take precedence over its quality and will expose registrants, directors and officers to undue risk of liability. In order to maintain quality, while still meeting the Commission's goals and Congress' requirement under Section 4.09 of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") that disclosure be made on a "rapid and current basis," we recommend that the Form 8-K filing deadline be extended to five business days for those proposed items that require the preparation of a management's analysis.
We recommend an extension of the proposed filing deadline to five business days for compliance with Items 1.01 and 1.02 because these items may require more time to prepare a confidential treatment request for a material agreement that is being filed as an exhibit to the Form 8-K. We believe Item 1.02 may also raise confidentiality issues because, as proposed, Item 1.02 may result in agreements that had not previously been disclosed to be filed.
We also recommend that the filing deadline for Item 5.02 should be extended to five business days to allow for the review and response by a director or officer prior to the company's filing of the Form 8-K. We have substantial reservations about the new requirement to provide a discussion of the reasons for a director leaving the board or an executive changing responsibilities and recommend against adopting such requirement. However, if the Commission determines to proceed with requiring this level of disclosure, we believe the item should be structured to allow the required company disclosure to be reviewed, and any response by the subject director or officer, to occur prior to the time the company's Form 8-K filing is due.
For your convenience, attached to this letter as Exhibit I is a chart of our suggested filing deadline for each item.
Events triggering disclosure should be well defined and objective
The disclosure triggering events for a number of proposed items are not well defined and could create a great deal of uncertainty as to when a disclosure obligation is triggered. For example, Item 1.01 requires companies to disclose and file material agreements not made in the ordinary course of business, but does not provide an objective means by which to determine whether an agreement is material to the registrant. This lack of clarity is exacerbated by the proposed application of the disclosure to non-binding agreements. Item 1.02 requires companies to disclose the termination of a material agreement, while providing that no disclosure is required until negotiations or discussions regarding the termination are completed. Item 1.03 requires disclosure when a customer has terminated or reduced orders and the loss in revenues represents at least 10% of the company's consolidated revenues during the most recent fiscal year. In these cases, as well as in other proposed items with similar subjective disclosure triggering events, the disclosure triggering event will only be clear in hindsight, which may result in companies failing to timely file a required Form 8-K.
The Commission's proposal to greatly expand the number of items requiring companies to file disclosures on an ad hoc basis on Form 8-K will place significantly increased reporting compliance burdens on companies. Existing Form 8-K events are, by their nature, matters that senior management will clearly know about and be involved in. The Commission's proposal would potentially extend Form 8-K to matters that senior management would not necessarily know of immediately in the ordinary course of business. Thus, companies will have to implement disclosure procedures designed to cause such information to be reported up from operations, potentially from around the world, almost instantaneously. Without well defined and objective triggering events, companies will have to bear the costs of building a reporting process that by necessity generates overly inclusive information being reported up to senior management to avoid the risk that subjective judgments about materiality and other triggering elements are not made at a properly senior level. These implementation issues and costs are critical and should be key considerations in the Commission's refinement of its proposal. We believe that the Commission should ensure that each proposed item has a well defined and objective disclosure triggering event so that companies will be able to implement reasonable and cost-effective disclosure procedures that will allow them to comply with the requirements of the proposed rule on a timely and accurate basis.
Short-form registration statement eligibility should not be conditioned on timely 8-K filings
Under the proposed rule, a company that fails to file a timely Form 8-K would be ineligible to use a short-form registration statement (in particular, Form S-3), thereby severely restricting a company's ability to finance its operations through the use of shelf takedowns. Many large U.S. companies, including a number of our clients, rely to a significant extent on the quick access to the capital markets provided by shelf registration. Although we understand the Commission's interest in incentivizing companies to timely file reports under the Exchange Act, we strongly believe that the loss of a company's short-form eligibility because of the failure to comply with a Form 8-K filing deadline is too harsh a penalty. Under the proposed rule, we expect that companies will have to file a significant number of additional Form 8-Ks, which, together with the subjective nature of many of the triggering events, will increase the likelihood that companies will inadvertently miss filing deadlines. Unlike periodic reporting on Forms 10-Q and 10-K where the filing deadline is known and compliance is planned for well in advance,
Form 8-Ks are triggered by the occurrence of an event, often unanticipated. In many cases, that event may occur at the operational level of a company, and one could envision any number of circumstances in a large company where a Form 8-K filing is triggered, but the information is not quickly communicated to the individuals in the company responsible for SEC reporting. Accordingly, we do not believe that short-form eligibility should be conditioned on timely filings of Form 8-Ks.
Although we agree that Rule 12b-25 should be amended to include late filed Form 8-Ks, as a practical matter, we do not believe that the proposed change to Rule 12b-25 would afford companies much protection. Rule 12b-25 currently only applies to periodic reports and, by definition, the registrant would know with certainty when its filing was due so it could anticipate that it would miss a filing deadline. The reason for a late filed Exchange Act interim or annual report would be something other than a lack of awareness that a filing was due. Because many of the proposed triggering events of Form 8-Ks are based on subjective standards, the reason that a company may miss a filing deadline is more likely to be that it was unaware that a disclosure triggering event had occurred in the first place. In that case, it is unlikely that a company would then be able to meet the 12b-25 deadline. In addition, it is not clear that a registrant who inadvertently missed the filing deadline and was able to file a Form 12b-25 would be able to represent that the reason it was unable to timely file could not be eliminated "without unreasonable effort or expense" as is currently required under Rule 12b-25. Finally, publicly announcing that a company cannot meet a filing deadline, no matter what the reason, is likely to negatively affect the price of the company's stock.
The proposed safe-harbor is too narrow; a safe-harbor should be provided for private rights of action under Rule 10b-5
As discussed above, because a number of proposed items do not have well defined and objective disclosure triggering events and the proposed rule will likely result in numerous additional Form 8-K filings, we believe that a safe-harbor is absolutely necessary.
As currently proposed, the safe-harbor would only provide relief to registrants that have not timely filed a Form 8-K from actions brought by the Commission under Section 13(a) or Section 15(d) if those registrants had met the conditions of the safe-harbor. We have three significant concerns. First, the safe-harbor is too narrow and should be extended to include Rule 10b-5. Given the increased number of Form 8-K filings that will be required by the proposed rule, the difficulty in determining whether a reporting obligation has been triggered and the short time frame for filing the report, there is a good chance that a registrant will inadvertently miss a Form 8-K filing. Without a broader safe-harbor, registrants will be exposed to civil liability under Rule 10b-5 in private actions if they fail to timely file a Form 8-K. Without an effective safe-harbor for Rule 10b-5 actions, even those companies acting in good faith will be subject to inordinate risks of antifraud liability to those trading in the market simply based on good faith judgments that Form 8-K disclosures were not required or, even worse, as a result of inadvertence. Liabilities based on the value of trading could be huge and potentially crippling to a company.
Moreover, in addition to being far too limited in its application, the Commission's proposed safe-harbor is problematic in its suggestion that knowledge by any employee or agent of the company of a reportable event could trigger a Form 8-K filing. Particularly given the subjectiveness of the triggering events and, in a number of items, that the event is occurring at operational levels in the company without the involvement of senior management or those responsible for SEC reporting compliance, basing the trigger on any employee or agent's knowledge sets an unrealistically high reporting obligation. Reporting obligations should trigger when senior management is aware of the event; reportable events should be defined at a level of objective significance that senior management can reasonably be expected to be aware of and involved in the matter.
Finally, as currently proposed, the safe-harbor is based on the company being able to show that it had in place sufficient procedures to collect, process and disclose information within the specified time period. These procedures will always be judged in hindsight, in the context of an alleged disclosure failure and, thus, provide little real protection.
Form 6-K should not be amended to require the specific disclosure items of proposed Form 8-K
The proposed changes to the current reporting system on Form 8-K, would not affect the disclosures required by foreign private issuers whose securities are registered with the Commission. We concur with the Commission's continued exemption of foreign private issuers from the current reporting mandated by Form 8-K and continued reliance on home country disclosure to provide investors interim information.
We recognize that the Commission may believe that pursuant to Section 409 of the Sarbanes-Oxley Act, it should review its historic policy of relying on home country disclosures to assure that U.S. investors have access to sufficient interim information throughout the year between the mandated Annual Reports on Form 20-F. However, we do not believe that any changes to Form 6-K should be made as part of the changes being proposed to the domestic issuer current reporting system.
We believe that any change to the current reporting required for foreign private issuers would impose significant burdens on existing foreign private registrants and would be perceived by many of these companies as fundamentally changing the regulatory basis with which they agreed to comply in choosing to enter the U.S. public markets. These foreign private registrants are already subject to substantive disclosure and financial reporting obligations in their home markets and pursuant to stock exchanges on which their securities trade. Layering on additional U.S. requirements, without regard to their existing disclosure duties and practices, will impose particularly large additional compliance costs on foreign private issuers and will run contrary to notions of comity and fairness. Prior to undertaking any initiative to overhaul the Exchange Act reporting regime for foreign private issuers, the Commission should undertake a detailed review of the home markets disclosure requirements and practices to assess whether, in fact, there is any basis to conclude that a change in Commission policy is necessary for investor protection as well as fully explore with the foreign private issuer community as well as investors, financial intermediaries and other affected constituencies the complications of a Commission reversal of its acceptance of home market interim reports.
The interests of U.S. investors will not be well served by changes to the foreign private issuer registration and continuous reporting regime that have the effect of discouraging foreign private issuers from choosing to enter the American public capital markets. Foreign private issuers always have a choice as to whether to register with the Commission and become subject to its rules and direct oversight; American capital is available to them in the private and offshore markets. Changes to the regulatory system that are viewed by foreign companies as fundamentally altering the balance the Commission has historically struck between assuring that U.S. investors have adequate information and accommodating foreign companies' widely varying home country disclosure, corporate and governance obligations are likely to undermine the Commission's successful efforts to enhance the attractiveness of the U.S. public capital markets to international participation and assure the pre-eminent competitive position of the U.S. financial markets and financial services industries. With the growth of offshore equity markets and the integration of the European Union economies there are, and will continue to be, competitive challenges to the American markets.
Thus, we believe the Commission is correct in excluding foreign private issuers from the scope of its current reporting rule making initiative and strongly urge that no changes be made to the Form 6-K as part of the Form 8-K initiative.
The new Form 8-K rule should not be effective until six months after its adoption and there should be a transition period of reasonable length during which the filing deadlines would be extended
The Commission's proposed changes to Form 8-K represent a fundamental change in current Exchange Act reporting requirements. Under the existing reporting system, only major corporate events that will by their nature directly involve the most senior management of a company and others with financial and SEC reporting responsibility are required to be disclosed on Form 8-K. Because the proposed new disclosure items of Form 8-K include events of which senior management may not be aware, companies will need to design and implement new reporting procedures at various levels of their organizations that will ensure immediate communication of information up from operational levels. Compliance with these proposed rules will likely be difficult, particularly for large, multinational corporations, and best practices will undoubtedly take time to evolve. For these reasons, we strongly urge the Commission to delay effectiveness of any new rules for a period of at least six months so that registrants have ample time to develop disclosure procedures that will enable timely and accurate compliance.
We also strongly urge the Commission to consider phasing in any new Form 8-K rules over at least one year to afford issuers an ample opportunity to test and refine their procedures through trial and error. We believe that it would be unfair to expose registrants to potential liability for failing to meet the accelerated filing deadlines after changing the rules so fundamentally without giving registrants an opportunity to gain experience complying with the new rules.
PART II - SPECIFIC CONCERNS ABOUT THE PROPOSED ITEMS OF FORM 8-K
Item 1.01 - Entry into a material agreement
A well defined, objective trigger is necessary
Item 1.01 would require that registrants file a Form 8-K whenever they enter into an agreement that is material to the company and that is not made in the ordinary course of the company's business. Materiality judgments take into account numerous factors and often involve a series of judgment calls made by the company's officers and outside advisors at the end of a fiscal reporting period. If Item 1.01 is adopted, it will require that decisions about the materiality of a particular agreement be made on an ad hoc basis at any given time during a reporting period. Also, in a large company, these decisions may need to be made in the first instance at the business unit level by an employee who may not have all the information necessary to determine whether the agreement is in fact material to the corporation. Where the disclosure trigger is based on a percentage of assets, revenue or some other objective numerical standard, the determination as to whether an agreement is material would be more straightforward, however, it may be difficult to design a quantitative disclosure trigger that could be applied to all types of material agreements. Alternatively, the Commission could limit disclosure of entry into material agreements to agreements of a certain type, for example, agreements involving officers, directors or significant shareholders and agreements currently required to be disclosed under Item 2 of Form 8-K. Whichever approach is chosen, we believe that a clear and objective triggering event is necessary in order to ensure accurate and timely compliance.
Only definitive binding agreements should be disclosed
The proposed rule would require companies to disclose the execution of material letters of intent and other non-binding agreements such as exclusivity letters. We strongly believe that only legally binding definitive agreements should be required to be disclosed under the proposed rule. It is current market practice for companies to enter into letters of intent or other non-binding agreements as a first step in the negotiation of important commercial transactions. Non-binding letters of intent often contain an outline of basic terms or a provision providing for an exclusivity period during which the parties will not negotiate a similar transaction with other parties. Such non-binding agreements are useful as a basis for negotiation and make the negotiation process more efficient, but they are not a meaningful indication of whether agreement will be reached or the terms and conditions that ultimately would be contained in definitive documentation.
To require disclosure of letters of intent and other non-binding agreements such as exclusivity letters could be misleading to investors and cause a significant disruption of market practice. If letters of intent and other non-binding documentation were to be disclosed, particularly in the case of mergers or acquisitions, it could lead to speculative activity and increased market volatility. Such activity would be uninformed because investors would have no reliable way of assessing the probability or terms of a potential transaction. In addition, confidentiality is often critical in the negotiation of material transactions. It can be difficult for companies to explore transactions under the watch of employees, regulators and competitors who will have concerns that may not be in the best interests of the corporation and its stockholders. The proposed filing requirement could lead to inefficiencies as a result of companies being unwilling to commit to anything in writing until negotiations are complete or even prevent companies from exploring potentially beneficial transactions.
Letters of intent and other non-binding agreements should be viewed as part of the negotiation process and not as separate agreements. We note the Commission's statement in the release that "... although this proposed item would not require disclosure about agreements still under negotiation, there may be instances when a company is under some other duty to disclose contract negotiations." We agree with the Commission's view that the current proposal should not change current law as to when disclosure about negotiation is required, but we believe that disclosure of non-binding agreements would be inconsistent with that view. If the Commission nonetheless determines to require disclosure of non-binding agreements, it should include in Item 1.01 a provision that makes it clear that no agreement subject to continuing discussions or negotiations is disclosable.
The filing deadline should be extended to five business days
We are concerned that companies will often find it difficult to meet the disclosure requirements of Item 1.01 within two business days, given the broad scope of the types of agreements covered by Item 1.01. In addition, if the material agreement involves a commercial transaction like a supply arrangement or licensing agreement, a registrant may need to request confidential treatment of sensitive competitive information contained in those types of agreements. It would be extremely difficult for a registrant to prepare a confidential treatment request in two business days. Therefore, we recommend that the filing deadline for Item 1.01 be extended to five business days.
Interaction with Item 2.01
It is common market practice for registrants to file under current Item 5 of Form 8-K an announcement that it has entered into a material acquisition or disposition agreement that will be required to be reported under current Item 2 of Form 8-K upon its consummation. Therefore, as discussed below under Item 2.01, we believe that the trigger for disclosure of acquisition and disposition agreements under Item 1.01 should be the quantitative materiality threshold used in Item 2.01. In the event that a registrant chooses to disclose that it has entered into an acquisition agreement that may not meet the quantitative materiality threshold, then the registrant could report the agreement under Item 7.01.
Item 1.02 - Termination of a Material Agreement
The disclosure triggering event should be actual termination
Item 1.02 would require a company to disclose the termination of any material agreement to which it is a party not made in the ordinary course of business. We do not believe that the receipt of a notice of termination from the other party to an agreement should trigger a disclosure obligation under Item 1.02 without something more. There are likely to be many situations where the company holds a good faith belief that the other party is not entitled to terminate the agreement or in which the company engages in negotiations with the terminating party with the objective of perhaps entering into an amended agreement. Although the instructions to Item 1.02 state that no disclosure is required during negotiations or discussions unless or until the agreement has been terminated, we believe that a better approach would be to simply require disclosure only when the agreement is actually terminated by the parties.
Companies should not be required to disclose the termination of an agreement that has expired by its terms
Item 1.02 would also require disclosure of the termination of a material agreement that expires by its terms. We believe that such disclosure would not provide meaningful information to investors because previously filed reports would have disclosed the term of the agreement. It would be unduly burdensome to require companies to effectively provide a public register of the on-going status of material agreements with stated durations, and would not necessarily serve the interests of investors.
Disclosure should not be required for agreements that were not previously filed
The termination of a material agreement should only be disclosed if the material agreement itself was previously disclosed. It is potentially confusing to investors for a company to disclose the termination of an agreement when the agreement was not disclosed or required to be disclosed. In order to avoid this problem, we recommend that Item 1.02 only require disclosure of the termination of a material agreement that was filed as an exhibit under Item 1.01 of proposed Form 8-K or Item 601(b)(10) of Regulation S-K.
Item 1.03 - Termination or Reduction of a Business Relationship with a Customer
Item 1.03 should not be adopted; disclosure should be added to Form 10-Q
Item 1.03 would require disclosure when a company becomes aware that a customer terminates or reduces the scope of a business relationship with the company and the loss of revenues to the company from this termination or reduction equals 10% or more of the company's consolidated revenues during the company's most recent fiscal year. We believe the application of the proposed test will be difficult in practice. As currently drafted, the disclosure trigger is forward-looking, referring to the "amount of loss of revenues" to the company in the most recent fiscal year. This type of forward-looking test would essentially require a company to make a projection at any given point in the year about the expected total revenues of a major customer. In many cases, companies do not have written agreements with their customers or have non-binding blanket purchase orders, making it difficult for companies to determine if there has been a change in the scope of the business or if the reduction in business is permanent or temporary. For example, in a situation where there is a gradual reduction of a sales relationship over a number of months, a company would be required to make a difficult assessment of the point at which the reduction in revenue from the customer had crossed the 10% threshold. As a result, the disclosure triggering event will not be known until well after the event has occurred, resulting in the possibility that a company would fail to comply with the disclosure requirements of the proposed rule. Also, disclosure of this isolated piece of information could be misleading and result in investors placing too much weight on the disclosure.
Currently, disclosure regarding a registrant's significant customers pursuant to Item 101(c)(1)(vii) of Regulation S-K is required to be made annually in the registrant's Form 10-K. Given the difficulty in applying the disclosure trigger proposed in Item 1.03, we suggest that as an alternative to proposed Item 1.03, Form 10-Q be amended so that registrants are required to disclose on a quarterly basis, rather than annually, the information required by Item 101(c)(1)(vii) of Regulation S-K. We believe that quarterly updates about the company's significant customers in the context of management's discussion and analysis of the quarterly results is a more appropriate way to disclose this information.
Item 2.01 - Completion of Acquisition or Disposition of Assets
The trigger for disclosure of the completion of an acquisition or disposition of a significant amount of assets contained in existing Form 8-K, Item 2 should be retained
Item 2.01, which is substantially the same as current Item 2 of Form 8-K, requires a company to disclose information whenever it or any of its majority-owned subsidiaries has completed the acquisition or disposition of a significant amount of assets, other than in the ordinary course of business. Instruction 4 to current Item 2 of Form 8-K sets a quantitative standard for determining whether an acquisition or disposition of a significant amount of assets is reportable using a test based on whether (i) the equity in the net book value of the assets or the amount paid or received for the assets exceeds 10% of the total assets of the registrant and its consolidated subsidiaries or (ii) if it involved a business which is significant. We agree with the retention of this test for disclosure of the completion of an acquisition or disposition of a significant amount of assets because reporting companies and investors are familiar with it and it provides a well defined and objective disclosure trigger.
The Commission requested comment on whether the thresholds for disclosure used in proposed Items 1.01, 1.02 and 2.01 with respect to agreements to acquire or dispose of assets should be harmonized so that all three items use either the 10% of assets test or the materiality test. In our view, the standard for agreements relating to the acquisition or disposition of assets should be the 10% of assets test for each item.
Item 2.03 - Creation of a Direct or Contingent Financial Obligation that is Material to the Registrant
The definition of "contingent financial obligation" is too broad
As currently proposed, the definition of "contingent financial obligation" includes "guarantees, co-obligor arrangements, obligations under keepwell agreements, obligations to purchase assets and any similar arrangements and all other obligations that exist or may arise under an agreement." This definition is extremely broad and would likely cover nearly every type of agreement that a company enters into, including ordinary course commercial agreements that require the payment of cash for goods or services at a date in the future. We suggest that, at a minimum, all agreements made in the ordinary course of business, not just those mentioned in instruction 4, be expressly excluded from the definition.
Adopt an objective disclosure threshold
Item 2.03 would require a company to disclose information whenever it or a third party enters into a transaction or agreement that creates any material direct or contingent financial obligation to which the company is subject. Given the broad range of agreements that Item 2.03 could potentially cover, we believe that it is extremely important that the Form 8-K filing trigger be clearly defined. We suggest that a quantitative test be adopted, based either on a percentage of assets or cash flow from operations or some other financial measure.
Names of underwriters should not be disclosed
We believe that the disclosure of the names of the underwriters or placement or other agents and the amount of any fees or other compensation paid to them is unnecessary and is not material to investors. Therefore, we suggest that Item 2.03(c) be deleted.
The definition of "keepwell agreement" is too broad
Instruction 5 to Item 2.03 defines a keepwell agreement as "any agreement or undertaking under which the registrant is, or would be, obligated to provide or arrange for the provision of funds or property to an affiliate or third party." As drafted, we believe the definition is too broad since it could cover many different types of ordinary course commercial transactions. For example, a supply contract would obligate the company to provide funds to the third-party seller. Accordingly, we suggest that the definition of keepwell agreement exclude agreements made in the ordinary course of business and also that the definition be tied to the provision of credit support.
Item 2.04 - Events Triggering a Direct or Contingent Financial Obligation That is Material to the Registrant
Adopt an objective disclosure threshold
Item 2.04 would require a company to disclose events triggering a direct or contingent financial obligation that is material to the company. Given the broad range of agreements that Item 2.04 could potentially cover, we believe that it is extremely important that the filing trigger be clearly defined. We suggest that the same quantitative test be used for the purposes of Items 2.04 and 2.03.
Triggering event should be revised to prevent premature disclosure
As currently proposed, a Form 8-K filing is required after a third party to an agreement having the right to do so notifies a registrant that a "triggering event" has occurred. We believe that such disclosure would provide the third party with a powerful bargaining tool against a company whose competitive position, or customer and supplier relationships, might be threatened by disclosure of a triggering event that could, but for the disclosure, be resolved through negotiations. If negotiations were to result in an amendment to the agreement, such agreement may be reportable under Item 1.01, if it satisfied the materiality test, or otherwise reportable under Item 7.01, if the company deemed it important. We believe that any disclosure under Item 2.04 should merely report events, not influence or otherwise change them.
Accordingly, we suggest that the definition of "triggering event" in Item 2.04(b) be revised to include as subclause (iii) a requirement that the party to the agreement having the right to do so (A) notifies the reporting company that an accelerating event has occurred and that any amounts owing under such agreement are due and payable or (B) takes some other formal step such as the commencement of a foreclosure proceeding or the demand of a collateral trustee to deliver collateral to secure payment of the financial obligation owed, directly or indirectly, by the reporting company. As a result, we also suggest that the reference to notification in the proviso of the definition be deleted.
In addition, since a triggering event might be cured by something other than an amendment to the underlying agreement, we suggest that the proviso include a reference to action taken by the defaulting party, or by any other obligor including the reporting company, that would cure the triggering event.
Item 2.05 - Exit Activities Including Material Write-Offs and Restructuring Charges
Item 2.05 should not be adopted
We do not believe that requiring disclosure of an isolated financial item and an analysis of its effect on the company's or a particular segment's financial condition is appropriate outside the context of a company's disclosure of interim or annual financial results. It will be extremely difficult and potentially misleading for a company to discuss the effect that a single piece of financial information may have on the company's financial results and condition out of the context of the overall financial information for that company. Also, the rule would effectively require companies to discuss their financial condition in the middle of the quarter without the benefit of having complete information that has been reviewed by the company's independent auditors. We strongly believe that disclosure of this type is more appropriately made in a periodic report so that the information can be put in the context of the company's financial results.
Triggering event should be revised to prevent premature disclosure
If the Commission nonetheless adopts Item 2.05, we believe that the triggering event needs to be revised so that disclosure of the event is not made prematurely or does not affect the proposed course of action. It is possible, for instance, for a board of directors or other authorized officer or officers of a reporting company to commit to a course of action to exit a line of business but then to seek the input from advisors such as legal counsel or accountants, or to seek the input from or to provide notice to interested constituencies such as labor unions or government officials, as a result of which modifications are made to the proposed course of action. Therefore, we suggest that disclosure be required, if at all, only after the company has received all such input and has completed all actions that the company's decision-makers deem appropriate.
Item 2.06 - Material Impairments
Item 2.06 should not be adopted
Item 2.06 would require disclosure when a company's board of directors or the company's officer or officers authorized to make the relevant conclusion, if board approval is not required, concludes that the company is required to record a material charge for impairment to one or more of its assets, including an impairment of securities or goodwill, under generally accepted accounting principles. For the reasons discussed in our comments on Item 2.05, we suggest that the Commission not adopt Item 2.06.
Triggering event should be revised to prevent premature disclosure
A company will usually decide whether it will need to take an impairment charge as part of preparing its annual financial statements. There are certainly circumstances when a company may need to undertake an impairment review after a subsequent triggering event has occurred that affects the value of an asset. For example, a company may need to undertake a goodwill impairment review if one of its major customers files for bankruptcy protection. In those types of situations, a decision that an impairment charge is necessary may be made early, but the process to determine the amount of the charge is likely to take an extended period of time. Often a company will hire a valuation expert to assist in valuing the asset. Therefore, while management may have decided to take an impairment charge, the work necessary to determine the amount may not be completed sometime after the decision was made. If the Commission decides to require disclosure of material impairment charges, we suggest that the disclosure not be triggered until the final amount of the charge has been determined.
Item 3.01 - Rating Agency Decisions
Item 3.01 should not be adopted
We suggest that the Commission not adopt Item 3.01. Based on the public comment received in response to its 1994 rulemaking proposal to require issuer disclosures of ratings, the Commission is well aware of companies' concerns, including liability concerns, with respect to mandated disclosure of ratings. Credit rating changes are published by the rating agencies through numerous news outlets, the Internet, and other publications; news of a credit rating change will be in the marketplace in real time. Moreover, we believe the Commission has already effectively addressed ratings disclosure in its 2002 MD&A guidance. In its January 2002 MD&A release, the Commission provided interpretative guidance on Item 3.03 of Regulation S-K in certain areas, including liquidity and capital resources.1 In that release, the Commission suggested that, in preparing MD&A, registrants should consider credit ratings in identifying trends, demands, commitments, events and uncertainties that require disclosure. We believe that the MD&A disclosures are the appropriate and most informative place for a discussion of the significance of ratings to a particular company and that credit rating changes are made publicly available by the rating agencies through numerous news outlets and the Internet, such that news of a credit rating change will be in the marketplace in real time.
We also note that Section 702 of the Sarbanes-Oxley Act directs the Commission to conduct a study of the role and function of credit rating agencies in the operation of the securities market. We believe that the Commission should defer considering any rule changes with respect to credit rating disclosures until the study is completed.
In the event that the Commission nonetheless decides to adopt Item 3.01, we propose the changes set forth below.
The filing deadline should be extended to five business days
Credit rating changes, at least those issued by the nationally recognized statistical rating organizations, are widely disseminated through press releases issued by the rating agencies promptly after they decide to take action. As previously discussed in our general comments, we believe that companies should have five business days to prepare a meaningful management's analysis.
Disclosure should be required only for negative credit rating changes
Item 3.01 would require disclosure of any change in a company's credit rating or outlook without distinguishing between negative or positive changes. In addition, the proposed item requires disclosure whether or not the change is material to the company. We do not believe disclosure will provide investors with meaningful information in every situation where there is a ratings change. Instead, we recommend that disclosure be required only when a rating has been downgraded or when a company has been put on credit watch. We note that, under the Commission's current policy on credit ratings as set forth in Regulation S-K, Item 10(c)(2)(ii), a company need only consider reporting a material change.
The definition of "rating agency" should be limited to NRSROs
The instructions to Item 3.01 define "rating agency" as an entity whose primary business is the issuance of credit ratings. The definition is too broad because there are numerous organizations that provide credit ratings. Many of these organizations issue ratings on an unsolicited basis without any contact with the rated company. However, credit ratings that are widely disseminated and relied upon by the investing community are primarily those issued by nationally recognized statistical rating organizations ("NRSROs"). Accordingly, we recommend that the definition of "rating agency" be limited to NRSROs as that term is used in Rule 15c-1 of the Exchange Act. This approach is consistent with the distinction made by the Commission between NRSROs and non-NRSROs in other areas of the federal securities laws. If our recommendation is adopted, some consideration should be given to requiring disclosure under Item 1.01 when a company has voluntarily published a rating assigned by a non-NRSRO in a Securities Act or Exchange Act filing and that rating has been downgraded.
Item 3.01 should be triggered only when ratings are solicited
As currently drafted, Item 3.01 requires a Form 8-K filing when the registrant is notified by any rating agency to whom the registrant provides information other than reports filed with the Commission. The reference to providing information is too narrow; if retained, it should exclude rating agencies to whom an issuer simply provides any already publicly available information. However, rather than providing more guidance as to when a company has provided sufficient information to a rating agency to require disclosure of a ratings change, we suggest that disclosure only be triggered when a company has solicited a rating, i.e. it has co-operated with the rating agency by providing access to management.
Refusals to assign a credit rating should not be disclosed
Item 3.01(a)(2) would require disclosure if a rating agency had refused to assign a credit rating to the company or any of its securities. It is our understanding that a rating agency may refuse to assign a rating if it believes that a company has not been forthcoming with information or has not provided requested information. In addition, often a company solicits a rating of a particular class of securities on a confidential basis as part of the process of structuring the terms of the security or offering. In these cases, the rating agency may not assign the requested rating or may refuse to rate the security as structured. We do not believe that disclosure under Item 3.01 is appropriate under these circumstances and would likely result in confusion to the investing public. Accordingly, we would suggest that Item 3.01(a)(2) not be adopted.
Industry outlook changes should not be required to be disclosed
The Commission requested comment on whether industry outlook changes should be added to the disclosure requirements of Item 3.01. We believe a company should only be required to file a Form 8-K if its own ratings are actually downgraded in the context of a general industry outlook change.
Item 3.02 - Notice of Delisting or Failure to Satisfy Listing Standards; Transfer of Listing
Timing of disclosure should be consistent with requirements of the relevant stock exchange
Item 3.02 would require disclosure when a company receives a notice from a national securities exchange or national securities association stating that the company, or its listed securities, no longer satisfy the listing requirements of the exchange or association. Under the rules of the New York Stock Exchange ("NYSE"), the rules of the American Stock Exchange ("Amex") and the rules of The Nasdaq Stock Market ("Nasdaq"), companies are required to publicly announce through a press release that the NYSE, Amex or Nasdaq has notified the company that it no longer meets the continued listing requirements of the respective exchange or association. The NYSE requires a U.S. listed company to issue a press release within 45 days of receipt of a letter from the NYSE disclosing that the company has fallen below the continued listing standards of the NYSE.2 The Nasdaq requires a public announcement by the company of a Written Notice of Staff Determination to prohibit continued listing of a company's securities as promptly as possible, but not more than seven calendar days following its receipt.3 Similarly, Amex requires a public announcement by the company indicating that Amex has determined to remove the company's securities listing and the reasons for the determination as promptly as possible, but not more than seven calendar days following receipt of written notification.4 Each of the NYSE, Amex and the Nasdaq has specific procedures and proscribed time frames to allow a company an opportunity to respond.
There is no question that the potential for delisting of a class of a registrant's equity securities from its principal trading market is a material development of which investors should be made aware. We believe, however, that the trigger for disclosure should be consistent with the public disclosure requirements of the relevant exchange or association. For example, the rules of the NYSE require a listed company to contact the NYSE regarding failure to meet continued listing standards within 10 business days after it receives a letter from the NYSE to discuss the contents of the letter and to provide any information of which the exchange may not have been aware when it issued the letter. Disclosure prior to that 10-day period would be premature and would deprive a company the opportunity to address the NYSE's concerns and possibly resolve the issue without disrupting the trading market for its securities. Alternatively, if the Commission does not wish to defer to deadlines for public disclosure imposed by the relevant securities exchange or association, we suggest that the Form 8-K filing not be triggered during the time that the registrant is in discussions with the relevant exchange or association. We also recommend that Item 3.02(a) be clarified to refer only to written notices.
Because a significant period of time may elapse between the initial public disclosure of the potential for delisting and a final decision by the exchange or association to suspend trading in a company's stock and delist, we believe that another Form 8-K filing would be appropriate at the time that the delisting decision is made final.
The actual notice should not be required to be filed as an exhibit
The Commission requested comment on whether the actual written notice received from the exchange should be filed as an exhibit to the Form 8-K filing. We believe that the currently proposed disclosure in Item 3.02 is sufficient and that filing the actual written notice is unnecessary. If the Commission decides to require the filing of the actual written notice, then Items 3.02(a)(1) and (2) should be deleted.
Item 3.03 - Unregistered Sales of Equity Securities
Disclosure should be limited to large sales of unregistered equity securities
Item 3.03 would require a company to accelerate the disclosure of information regarding the company's sale of equity securities in a transaction that is not registered under the Securities Act. These transactions are currently required to be disclosed under Forms 10-Q and 10-K. We do not believe that investors would benefit from disclosure of every unregistered sale of equity securities. In addition, such a requirement could result in numerous, relatively unimportant Form 8-K filings. We believe, however, that investors would benefit from rapid disclosure of unregistered sales of material amounts of equity securities. Accordingly, we recommend that disclosure should be limited to large sales of equity securities, using 1% of outstanding shares as the threshold. We would propose retaining the current disclosure in Part II, Item 2(c) of Form 10-Q and Part II, Item 5(a) of Form 10-K so that registrants could continue to report all unregistered sales of equity securities that fall below the 1% threshold on a quarterly basis.
Issuances of equity securities upon conversion should be excluded
Issuances of equity securities upon conversion of convertible securities should not be disclosed as long as the underlying unregistered sale of the convertible securities has been previously disclosed in a Form 8-K or other periodic report. Requiring such disclosure would not provide investors with additional information since the public has already been made aware of the convertible nature of the originally issued securities.
Item 3.04 - Material Modification to Rights of Security Holders
Moving disclosure from Form 10-Q to Form 8-K
The Commission requested comment on whether the disclosure required by Item 3.04 should be accelerated by requiring disclosure on Form 8-K instead of Form 10-Q, as currently required. We have no objection to moving the disclosure required by Part II, Items 2(a) and (b) of Form 10-Q to Form 8-K since proposed Item 3.04(a) excepts material modifications that were reported in a publicly filed proxy statement, resulting in very few instances that will require a Form 8-K filing. If this disclosure is moved to Form 8-K, we do not believe that it is necessary for a registrant to continue to report this information on Form 10-Q. If the Commission decides to nonetheless retain Part II, Items 2(a) and (b) of Form 10-Q, we note that the addition to Item 3.04(a) of this exception makes it inconsistent with the disclosure currently required by Part II, Item 2(a) of Form 10-Q and assume that all material modifications, whether or not reported in a publicly filed proxy statement, would be disclosed under Item 2(a). To the extent that Part II, Item 2 of Form 10-Q is deleted, we would suggest moving the instruction to Item 2 to Form 8-K.
Limit disclosure to registered securities
The Commission requested comment on whether the disclosure required by Item 3.04 should be limited to modifications of registered securities. We believe that such disclosure should be limited to registered securities. In the case of unregistered debt securities, material modifications to an indenture or other instrument defining the rights of a holder generally would not be made without the consent or notification of the security holder and, therefore, unregistered debt holders would not need the benefit of additional disclosure. In addition, we do not believe that disclosure of material modifications of unregistered debt securities would add significantly to the quality of information generally available to investors.
Item 4.01 - Changes in Registrant's Certifying Accountant
The Commission requested comment on whether Item 4.01 disclosure of changes in a registrant's certifying accountant should also be extended to changes in a company's employment benefit plan auditor if that auditor is different from the company's independent accountants. We do not believe that a change in the auditor of a company's employment benefit plan is material to investors. Accordingly, the same level of disclosure regarding a change of the independent accountant of a company's employment benefit plan is not necessary.
Item 5.02 - Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers
The existing disclosure requirements regarding director terminations and officer departures should be revised to require disclosure of the fact of, but not the reason for, the departure
In our experience, registrants often issue a press release upon the termination or resignation of a director or officer disclosing the fact of the termination or resignation. We believe it is appropriate for the Commission to formalize this practice and require registrants to disclose on Form 8-K the name of the departing director or officer, his or her position with the registrant, the fact of his or her departure, the date of departure and the name of a replacement, if any.
We believe that Item 6 of Form 8-K and the proxy rules provide for an adequate level of disclosure regarding the reasons for the departure of a director. In addition, we believe that Item 5 under the current Form 8-K rules would enable a registrant to provide sufficient information regarding the reasons for the departure of an officer or director in those cases where the registrant deems the reasons to be material to security holders.
The proposed items raise unclear interpretation issues and, if adopted, would interfere with sensitive corporate governance matters. Proposed Item 5.02(a) would apply where a director resigns or declines to stand for re-election "because of a disagreement with the registrant." In many situations, it is not clear whether a director's decision is the result of a disagreement with the company or is due, exclusively or principally, to other reasons (which may be personal, financial or otherwise). We believe the proposal inappropriately requires registrants to probe the reasons for a director's decision - reasons that may be complicated. The proposed rule is unlike current Item 6, where a director's submission of a letter describing the issue or a director's request to submit such letter resolves any ambiguity regarding the existence of a disagreement. We believe that it may also be appropriate to require disclosure of the fact that a director was removed for cause, but we note that such occurrences are rare.
Proposed Item 5.02(a), if adopted, may also interfere with the ability of registrants to negotiate settlement agreements with departing directors, particularly where the director also serves as an officer of the registrant. The terms of a director's departure are also subject to complicated negotiations with the board or remaining management that typically continue well past the date of the individual's resignation. Requiring the proposed level of disclosure within two business days of resignation could jeopardize the ability of the parties to reach a mutually satisfactory agreement.
For essentially the same reasons, we believe that Item 5.02(b) should not be adopted as it would require a description of the reasons for an officer's or director's departure.
Disclosure of the appointment of a new executive officer and election of a new director is generally appropriate
We believe that the disclosure required by the proposed Items 5.02(c) and (d) is generally appropriate. However, the requirement to provide a "brief description of any arrangement or understanding pursuant to which an officer is selected as an officer" is overly broad and would include disclosure of routine corporate processes such as the engagement of headhunting firms and other human resources related decisions. In addition, we believe the rule should be limited to apply only as to an individual who is, or who is expected to be for the year in which he or she is engaged, one of the registrant's named executive officers within the meaning of Item 402(a)(3) of Regulation S-K in order to make the proposed rules consistent with the registrant's proxy statement disclosure obligations.
Item 5.03 - Amendments to Articles of Incorporation or By-laws; Change in Fiscal Year
The disclosure required by Item 5.03(a) should only be required if the amendments are material
Item 5.03(a) would require a company to disclose any amendment to its articles of incorporation or by-laws if the amendment was not disclosed in a proxy statement or information statement filed by the company. If the Commission adopts Item 5.03(a), we suggest that a Form 8-K filing be required only when changes to the company's articles of incorporation or by-laws are material to security holders.
Item 5.04 - Material Events Regarding the Registrant's Employee Benefit, Retirement and Stock Ownership Plans
Item 5.04 should be deleted because the disclosure it would provide investors is not relevant and is already covered by existing law
Item 5.04 would require that a company disclose, within two business days, any event that would materially limit, restrict or prohibit transactions in its employee benefit, retirement and stock ownership plans. This rule specifically targets "blackouts" (or "lockdowns") imposed on transactions in 401(k) plan accounts, which have received significant media coverage as a result of the losses in retirement savings suffered by participants in the Enron Savings Plan during the time of a blackout. 5 For the reasons stated below, the Commission should not require this disclosure on Form 8-K.
Blackouts are used primarily for administrative purposes, such as changing recordkeepers, fund managers, or trustees, or to address valuation issues, technology changes or, in limited cases, unusual market conditions.6 Plan administrators make such changes in order to manage costs, improve efficiency and plan features for participants (i.e., by adding Internet features, changing investment options, or shortening the period of time during which participants may change investments or contribution decisions from quarterly or monthly or daily). 7 Typically, the implementation of a blackout only affects plan participants. The provision of notice to all investors would be superfluous and time-consuming for issuers. Blackouts affect only employee-participants and their beneficiaries under a company's savings plan, not all shareholders in the company. It is difficult to see how, in most instances, notice of a blackout would provide investors with information that is relevant to them in making investment or trading decisions. To the contrary, it may serve to confuse investors. For instance, in the event that investors associate news of a blackout with the Enron stock decline and a substantial loss in retirement savings (as discussed in footnote 5), their reaction may have unjustified and unnecessary negative market implications.
The process of implementing a blackout is subject to the fiduciary standards of the Employee Retirement Income Security Act of 1974, as amended ("ERISA"), and, therefore, is already adequately regulated by federal law. All prudent plan administrators (even without the new Sarbanes-Oxley Act requirements discussed below) would construe ERISA as requiring advance notice and disclosure of blackout periods to participants.
Finally, Congress has already enacted notice requirements for blackout periods. 8 Effective as of January 26, 2003, Section 306(b) of the Sarbanes-Oxley Act will impose a 30-day notice requirement on the plan administrator to inform the affected plan participants and beneficiaries of a planned blackout period.9 The Sarbanes-Oxley Act provides for the method of communication, delivery and the content of the notice. The notification must be in writing but may be delivered in electronic form or any other form that is reasonably accessible to participants and beneficiaries. Thus, Congress has already legislated the issue of what notice is required upon occurrence of a plan blackout.
In response to the Commission's question regarding the appropriateness of carving out trading blackouts applicable to those with presumed or actual knowledge of or access to material non-public information, while we believe such trading blackouts would be appropriate, disclosing the fact that a trading restriction has been placed upon on a limited group of executive officers or employees may suggest to other investors that there exists material information that may affect the value of the issuer's stock, and may lead to speculation of the reasons for the blackout.
In summary, due to the administrative nature of blackouts, their frequent occurrence, their lack of relevance to ordinary investors, their coverage by ERISA and Congress' recent action in this area, the Commission should not require this disclosure on Form 8-K and, accordingly, Item 5.04 should be deleted.
* * *
We appreciate the opportunity to comment on the proposed changes to Form 8-K, and would be happy to discuss any questions the Commission may have with respect to our comments. Questions may be directed to Danielle Carbone (212) 848-8244, Marc Rossell (212) 848-7450, John Wilson (415) 616-1215, or Linda C. Quinn (212) 848-8747.
Very truly yours,
Shearman & Sterling
|1||See Release Nos. 33-8056; 34-45321; FR-61, "Commission Statement about Management's Discussion and Analysis of Financial Condition and Results of Operations."|
|2||See NYSE Listed Company Manual, Section 802.02.|
|3||See NASD Manual - The Nasdaq Stock Market, Rule 4815(b).|
|4||See Amex Company Guide (Listing Standards, Policies and Requirements), Section 402(g).|
|5||Enron's blackout started October 29, 2001 and ended November 12, 2001. During the blackout, the value of Enron's stock fell from $13.81 to $9.24. Prior to the commencement of the blackout period, from January 2, 2001 through October 28, 2001, Enron stock had already lost 81% of its value. While participants did lose value in their retirement savings and were unable to trade in their accounts during that time, the concerns raised as a result of the imposition of blackouts are not best addressed by disclosure to all shareholders in Form 8-K.|
|6||Sherwin P. Simmons, "Lock-out or Blackout Periods," Annual Spring Employee Benefits Law and Practice Update (ALI-ABA Video Law Review), April 18, 2002, page 3.|
|7||PSCA Releases Answers To Frequently Asked Questions About Lock-Out Periods (last modified July 31, 2002) http://www.401khelpcenter.com/press/pr_psca_012202.html.|
|8||H.R. 3763, 107th Cong., Sec. 306(b) (2002).|
|9||The notice must include the reasons for the blackout period, an identification of investments and other rights affected, the beginning date and length of the blackout period, and a statement that the participants should evaluate the appropriateness of their current investment decisions in light of their inability to direct or diversify assets during the blackout period. After notice is given, if the blackout period is extended, accelerated or postponed, the administrator must provide notice as soon as reasonably practicable.|
|Item Number||Description||Suggested Filing Deadline|
|Section 1 - Registrant's Business and Operations|
|Item 1.01||Entry into a Material Agreement||Five business days|
|Item 1.02||Termination of a Material Agreement||Five business days|
|Item 1.03||Termination or Reduction of a Business Relationship with a Customer||Item proposed to be moved to Form 10-Q|
|Section 2 - Financial Information|
|Item 2.01||Completion of Acquisition or Disposition of Assets||Two business days|
|Item 2.02||Bankruptcy or Receivership||Two business days|
|Item 2.03||Creation of a Direct or Contingent Financial Obligation That Is Material to the Registrant||Five business days|
|Item 2.04||Events Triggering a Direct or Contingent Financial Obligation That Is Material to the Registrant||Five business days|
|Item 2.05||Exit Activities Including Material Write-Offs and Restructuring Charges||Item proposed to be deleted, but if adopted - five business days|
|Item 2.06||Material Impairments||Item proposed to be deleted, but if adopted - five business days|
|Section 3 - Securities and Trading Market|
|Item 3.01||Rating Agency Decisions||Item proposed to be deleted, but if adopted - five business days|
|Item 3.02||Notice of Delisting or Failure to Satisfy Listing Standards; Transfer of Listing||Consistent with requirements of the national securities exchange or association on which the registrant's securities are listed|
|Item 3.03||Unregistered Sales of Equity Securities||Two business days|
|Item 3.04||Material Modifications to Rights of Security Holders||Two business days|
|Section 4 - Matters Related to Accountants|
|Item 4.01||Changes in Registrant's Certifying Accountant||Two business days|
|Item 4.02||Non-Reliance on Previously Issued Financial Statements or a Related Audit Report||Five business days|
|Section 5 - Corporate Governance and Management|
|Item 5.01||Changes in Control of Registrant||Two business days|
|Item 5.02||Departure of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers||Five business days|
|Item 5.03||Amendments to Articles of Incorporation or By-laws; Change in Fiscal Year||Two business days|
|Item 5.04||Material Events Regarding the Registrant's Employee Benefit, Retirement and Stock Ownership Plans||Item proposed to be deleted|