SEC Update A P R I L 2 0 0 4 Part I SEC Adopts Additional Form - - PDF document

SEC Update

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Part I SEC Adopts Additional Form 8-K Disclosure Requirements

On March 16, 2004, the Securities and Exchange Commission (SEC) adopted additional Form 8-K disclosure requirements expanding the number of events that must be reported on Form 8-K (SEC Release No. 33-8400; 34-49424). The new disclosure requirements further the “real time” disclosure directives in Section 409 of the Sarbanes-Oxley Act of 2002, and are effective as of August 23, 2004. Pursuant to the Release, issuers who are subject to the reporting requirements of Sections 13(a) and 15(d) of the Exchange Act of 1934, as amended, other than foreign private issuers, are required to file current reports on Form 8-K within four business days of a triggering event. The amendments do not affect the filing deadline for Regulation FD disclosures, voluntary disclosures and certain exhibits. The Form 8-K items have been reorganized under section headings using a new numbering system. Eight new items have been added to the list of events that require disclosure on Form 8-K, two items were transferred from the periodic reporting requirements and two existing items will require expanded disclosure under the new rules. In addition, a limited safe harbor from liability under Exchange Act of 1934 (“Exchange Act”) Section 10(b) and Rule 10b-5 promulgated thereunder was adopted for failure to file certain of the required Form 8-K reports. Significant changes to Form 8-K are discussed below. Material Definitive Agreements Item 1.01 requires disclosure of material definitive agreements entered into outside of the ordinary course of business, as well as any material amendments to material definitive agreements. Item 1.01 does not require the material definitive agreement be filed as an exhibit to the Form 8-K; rather, as in the past, the agreement must be filed with the issuer’s next periodic report. If the agreement relates to a business combination or other extraordinary corporate transaction and the Form 8-K disclosure is the first public announcement of the transaction, the issuer may trigger additional filing obligations under Rule 165, Rule 14d-2(b) and/or 14a-12. If the disclosure of the material definitive agreement on Form 8-K satisfies the issuer’s filing obligations under those Rules, the issuer can note this by checking the appropriate box that has been added to the cover page of the Form 8-K. Item 1.02 requires disclosure of the termination of a material definitive agreement if such termination (a) is not the result of expiration of the term or completion of the obligations under the agreement and (b) is material to the company. Completion of Acquisition or Disposition of Assets Item 2.01 requires disclosure if a company, or any of its majority-owned subsidiaries, has acquired or disposed of a significant amount of assets, other than in the ordinary course of business. This Item requires basically the same disclosure as previously required by Item 2 of Form 8-K, with a few exceptions. The Release clarifies that typically a company will be required to report entry into a material definitive agreement to acquire or dispose of assets using Item 1.01 and, later, to disclose the closing of the applicable transaction under Item

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2.01. However, in some cases, acquisition or disposition agreements disclosed under Item 1.01 may not require later disclosure under Item 2.01 because Item 2.01 includes a bright-line reporting threshold. Direct Financial Obligation or Obligation under an Off-Balance Sheet Arrangements Item 2.03 requires disclosure of information with respect to direct financial obligations that are material to the company. Further, companies must disclose information about direct or contingent liabilities for material obligations arising out of an

• ff-balance sheet arrangement. Direct financial obligations include certain long-term debt obligations, capital lease
• bligations, operating lease obligations and short-term debt obligations that arise other than in the ordinary course of
• business. Disclosure is required within four business days after the company enters into an enforceable agreement, or

after the occurrence of the closing or settlement of the transaction or arrangement, under which the direct financial

• bligation arises or is created. However, a company must provide disclosure regarding off-balance sheet arrangements,

whether or not a party to the transaction or agreement, within four business days of the earlier of (a) the fourth business day after the contingent obligation is created or (b) the day on which an executive officer becomes aware of the contingent

• bligation.

If the company enters into a facility, program or similar arrangement that gives rise to direct financial obligations in connection with multiple transactions, the company must disclose such arrangement and its material obligations as they

• arise. Finally, if the obligation to be disclosed is a security, or a term of a security, that has been or will be sold pursuant

to an effective registration statement of the company, a Form 8-K is not required if the prospectus contains the information required by Item 2.03 and is filed within the required time period under Securities Act Rule 424. Item 2.04 requires disclosure on Form 8-K if a triggering event occurs causing the increase or acceleration of a direct financial obligation of the company and the consequences of the event are material to the company. Further, Item 2.04 requires disclosure if a triggering event occurs causing a company’s obligation under an off-balance sheet arrangement to increase or be accelerated or causing a company’s contingent obligation under an off-balance sheet arrangement to become a direct financial obligation of the company, and the consequences of any such event are material to the company. Similar to the requirements of Item 2.03, disclosure is required if a triggering event occurs in respect of an obligation described above, whether or not the company is a party to the transaction or agreement. However, no disclosure is required unless and until a triggering event has occurred in accordance with the terms of the relevant agreement, transaction or arrangement and all conditions to such occurrence have been satisfied, except the passage of time. It should be noted that, for purposes of Item 2.04, the term “direct financial obligation” differs slightly from that found in Item 2.03 in that it includes certain obligations that arise out of off-balance sheet arrangements. Costs in Connection with Termination of Employees or Disposition of Assets Item 2.05 requires the issuer to provide disclosure regarding the company’s commitment to enter into an exit or disposal plan or to dispose of a long-lived asset or terminate employees pursuant to a plan of termination described in paragraph 8

• f FASB Statement of Financial Accounting Standards (SFAS) No. 146, in each case under which material charges will be

incurred under generally accepted accounting principles (GAAP) applicable to the company. If at the time of the commitment and filing of the related Form 8-K the company is unable to make a good faith estimate of the charges, then it must file an amendment to its Item 2.05 Form 8-K within four business days after it is able to come up with such an estimate of the charges. Material Impairments Item 2.06 requires disclosure if a company concludes that a material charge for impairment to one or more of the company’s assets, including, without limitation, an impairment of securities or goodwill, is required under GAAP applicable to the company. As is the case under Item 2.05, if at the time of filing of the Form 8-K the company is unable to make a good faith estimate of the charges, then it must file an amendment to its Item 2.05 Form 8-K within four business days after it is able to come up with such an estimate of the charges. Despite the foregoing disclosure requirement, instructions to Form 8-K provide that no disclosure is required on Form 8-K if the conclusion regarding the material

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change is made in connection with the preparation, review or audit of financial statements and the plan is disclosed in the company’s periodic report related thereto. Delisting; Failure to Satisfy Listing Standards; Transfer of Listing Item 3.01 requires disclosure related to delisting and transfer of listing of securities of the issuer. First, subject to certain exceptions, disclosure is required if a company receives notice from the national securities exchange or national securities association that maintains the principal listing for any class of the company’s common equity (collectively, the “Listing Agent”) of (a) the company’s (or its securities’) failure to satisfy continued listing standards; (b) the exchange’s submission

• f an application to delist the class of the company’s securities; or (c) the association’s completion of all necessary steps

to delist the security from its automated inter-dealer quotation system. Second, disclosure is required if the company has notified the Listing Agent that the company is aware of material noncompliance by the company with a continued listing

• standard. Disclosure is required under these first two items regardless of whether there is a period under which the

company can cure the noncompliance or deficiency. Third, disclosure is required if the Listing Agent issues a public reprimand letter or similar communication indicating that the company has violated a continued listing standard. Fourth, a company must disclose any definitive action it takes to cause the listing of its common equity to be withdrawn from the national securities exchange or terminated from the automated inter-dealer quotation system (as the case may be) on which its principal listing is maintained. This last disclosure requirement includes any action taken to transfer listing or quotation of securities to another exchange or quotation system, as well as action by the company to delist the class of securities. Unregistered Sales of Securities Item 3.02 requires disclosure of sales of unregistered equity securities unless the equity securities sold in the aggregate since the issuer’s last report filed under Item 3.02 or last periodic report, whichever is more recent, constitute less than

• ne percent of the company’s outstanding securities of that class. The threshold is five percent of the class for small

business issuers. This item also covers issuances through conversion and similar transactions, provided, that they are above the applicable threshold. The information to be disclosed is the same as that required by subsections (a) and (c) through (e) of Item 701 of Regulation S-K and that is currently required in certain items of Forms 10-Q, 10-QSB, 10-K and 10-KSB. The disclosure requirement arises as of, and must be made within four business days after, the earlier of the time that a company enters into an enforceable agreement for the sale of such securities or the time of closing or settlement of the transaction or arrangement if there is no such agreement. Despite this new Form 8-K item, the disclosure requirements set forth in the periodic reports will remain in place and, therefore, issuances not reported on Form 8-K must continue to be reported in periodic reports. Material Modifications to Rights of Security Holders Item 3.03 requires disclosure regarding material modifications to the rights of holders of the company’s registered securities and the general effect of any such modifications. This disclosure is the same as that previously required by Items 2(a) and (b) of Forms 10-Q and 10-QSB. Once disclosure has been provided on Form 8-K regarding such material modifications, the company need not make duplicative disclosure in any subsequently filed periodic reports. Non-Reliance on Financial Statements Item 4.02 requires disclosure on Form 8-K in the event that the company’s board of directors, a committee thereof or an authorized officer determines that any of the company’s previously issued financial statements covering one or more years or interim periods no longer should be relied upon because of an error in such financial statements as addressed in Accounting Principles Board Opinion No. 20. In addition, certain disclosure must be provided if the company’s independent accountants advise the company that disclosure should be made or action should be taken to prevent future reliance on a previously issued audit report or interim review. In the event the company receives such advice from its accountant, it must provide its Form 8-K

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disclosure to the accountant simultaneously with filing thereof with the SEC and later amend its Form 8-K by filing the accountant’s response indicating whether the accountant agrees with the statements in the Form 8-K. Any such amendment must be made within two business days after receipt of the accountant’s response. Departure of Directors or Principal Officers The disclosure required by Item 5.02 expands disclosure previously required and is no longer triggered by actions resting solely with the director (i.e., if the director provides a letter to the company and requests that the company publicly disclose the matter). This Item has been moved to Item 5.02 and has been amended such that Item 5.02(a) requires disclosure on Form 8-K if a director has resigned or refuses to stand for re-election to the board because of a disagreement with the company that is known to an executive officer of the company, on any mater relating to the company’s operations, policies or practices, or if a director has been removed for cause from the board. Any correspondence received by the company from the director regarding the circumstances must be filed as an exhibit to the Form 8-K. The company’s Form 8-K disclosure must be provided to the affected director simultaneously with filing thereof with the SEC, and the company must later amend its Form 8-K to include any response received from the director related to such disclosure. Any such amendment must be made within two business days after receipt of the response. Item 5.02(b) requires disclosure in the event the company’s principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer or any person performing similar functions retires, resigns, or is terminated from that position. Further, disclosure is required when a director retires, resigns, is removed or declines to stand for re-election and the company is not required to provide disclosure under Item 5.02(a). The appointment of a new principal executive officer, president, principal financial officer, principal accounting officer, principal operating officer or person performing similar functions must also be disclosed pursuant to new Item 5.02(c). Pursuant to Item 5.02(d), in the event a new director is elected or appointed, other than by a vote of the stockholders at a meeting convened for that purpose, the company must provide disclosure related to such election or appointment and such director. Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year Pursuant to Item 5.03, if a company with a class of equity securities registered under Section 12 of the Exchange Act amends its articles of incorporation or bylaws and such amendment was not proposed in a previously filed proxy or information statement, then the company must disclose the effective date of the amendment and a description of the provision adopted or changed. If the document as amended is not filed as an Exhibit to the company’s Form 8-K, it must be filed as an exhibit to the company’s next periodic report. Further, if the company changes its fiscal year other than by a vote of its stockholders or by amendment to its articles of incorporation or bylaws, the company must disclose the date of the determination to make such change, the date of the new fiscal year end and the form on which the report covering the transition period will be filed. Safe Harbor; S-2 and S-3 Eligibility; Rule 144 In light of the quick time frame in which companies may have to asses materiality or whether a disclosure obligation has arisen under the new Form 8-K requirements, in connection with adoption of the new disclosure items, the SEC adopted a limited safe harbor from public and private claims under Exchange Act Section 10(b) and Rule 10b-5 for a failure to timely file a Form 8-K with respect to the following items: Item 1.01 – Entry into a Material Definitive Agreement; Item 1.02 – Termination of a Material Definitive Agreement; Item 2.03 – Creation of a Direct Financial Obligation or an Obligation under an Off-Balance Sheet Arrangement of a Registrant; Item 2.04 – Triggering Events that Accelerate or Increase a Direct Financial Obligation under an Off-Balance Sheet Arrangement; Item 2.05 – Costs Associated with Exit or Disposal Activities; Item 2.06 – Material Impairments; and Item 4.02(a) – Non-Reliance on Previously Issued Financial Statements

• r a Related Audit Report or Completed Interim Review (in the case where a company makes the determination and does

not receive a notice described in Item 4.02(b) from its accountant). The SEC did not adopt the proposed safe harbor from liability under Section 13(a) or 15(d), therefore the SEC may enforce any of the Form 8-K filing requirements under those sections.

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The safe harbor as adopted provides that failure to file a report on Form 8-K that is required solely pursuant to the provisions of Form 8-K shall not be deemed to be a v iolation of Section 10(b) and Rule 10b-5 under the Exchange Act. However, any material misstatements or omissions will continue to be subject to Section 10(b) and Rule 10b-5 liability. The safe harbor extends only until the due date of the periodic report of the company for the relevant period. Therefore, failure to make such disclosure in the applicable periodic report will subject the company to potential liability under Section 10(b) and Rule 10b-5 in addition to liability under Section 13(a) or 15(d). Failure to timely file a report on Form 8-K for the items covered by the safe harbor will not result in a company losing its eligibility to use Forms S-2 and S-3. However, the company must be current in its Form 8-K filings with respect to such items at the time of filing the Form S-2 or S-3. Further, a company need not have filed all required Form 8-K reports during the 12 months preceding a sale of securities pursuant to Rule 144 to satisfy that Rule’s “current public information” condition. * * * * * Issuers should consult Form 8-K and the instructions thereto for the specific disclosure currently required by each new or revised item of Form 8-K. Further, issuers should keep in mind that disclosure set forth under any item on Form 8-K must include all material information that is necessary to make the required disclosure not misleading, in light of the circumstances under which it is made. Finally, the SEC has made conforming changes throughout Form 8-K to various items and instructions, as well as conforming changes to other Forms pursuant to which companies make periodic and

• ther filings. All Forms and revisions thereto should be reviewed carefully to ensure that adequate and complete

disclosure is provided as required.

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Part II SEC Releases Interpretive Guidance Regarding MD&A

On December 19, 2003, the Securities and Exchange Commission (SEC) published interpretive guidance regarding the requirements for Management’s Discussion and Analysis of Financial Condition and Results of Operation, or “MD&A” (Release Nos. 33-8350; 34-48960; FR-72), which was effective as of December 29, 2003. MD&A is required by certain items of Regulation S-K, Regulation S-B, Form 20-F and Form 40-F. The Release does not modify existing legal requirements or create new legal requirements regarding MD&A; instead, it provides guidance on the overall presentation, focus and content of MD&A as well as guidance on disclosures in MD&A regarding liquidity, capital resources and critical accounting estimates. The SEC published the Release to assist companies in preparing MD&A disclosure that is easier to follow and understand and in providing information that more completely satisfies the SEC’s previously enunciated principal objectives of MD&A. These objectives include providing information about the quality and potential variability of a company’s earnings and cash flow so that readers can ascertain the likelihood that past performance is indicative of future performance as well as giving readers a view of the company through the eyes of management by providing both a short- and long-term analysis

• f the business.

Guidance Regarding Presentation of MD&A The Release provides that MD&A should be presented in clear and understandable language. In order to improve the clarity and understandability of MD&A, the SEC advises companies to prepare MD&A with a strong focus on the most important information, which should be provided in a manner intended to address the objectives of MD&A. In particular, the Release advises that:

• Companies should consider whether a tabular presentation of relevant financial or other information may

help a reader’s understanding of MDA.

• Companies should consider whether the headings they use assist readers in following the flow of, or
• therwise assist in understanding, MD&A, and whether additional headings would be helpful in this

regard.

• Many companies’ MD&A could benefit from adding an introductory section or overview that would

facilitate a reader’s understanding. The overview or introduction should include the most important matters on which a company’s executives focus in evaluating financial condition and operating performance and provide the context for the discussion and analysis of the financial statements, and it should not be duplicative.

• Companies should consider using a “layered” approach that presents information in a manner

emphasizing the disclosed material information and analysis that is most important. Examples of layered approaches include using an overview or introduction to the MD&A or beginning a section of the MD&A that contains detailed analysis with a statement of the principal subjects covered in more detail in the section. With respect to overviews and introductions, the Release suggests that a good overview or int roduction would provide a balanced, executive-level discussion of the most important themes or other significant matters with which management is concerned primarily in evaluating the company’s financial condition and operating results. In particular, according to the Release, a good overview or introduction would:

• include economic or industry-wide factors relevant to the company;
• serve to inform the reader about how the company earns revenues and income and generates cash;
• discuss the company’s lines of business, locations of operations, and principal products and services; and

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• provide insight into the company’s material challenges, risks and opportunities on which the company’s

executives are most focused for both the short and long term, as well as the actions taken to address these opportunities, challenges and risks. The Release indicates that the SEC would expect the introduction or overview to change over time in order to remain current and it discourages the use of boilerplate disclaimers and language in any introduction or overview. Guidance Regarding Content and Focus of MD&A With respect to the content and focus of MD&A disclosure, the SEC advises companies to emphasize material information that is required regarding the company’s financial condition, operating performance and future prospects, or that promotes investor understanding. The Release also suggests that companies should de-emphasize or, if appropriate, delete immaterial information that is not required and does not promote such understanding. The Release provides the following general guidance with respect to the content and focus of MD&A: Focus on Key Indicators of Financial Condition and Operating Performance. The Release advises that companies should identify and address those key variables and other qualitative and quantitative factors which are peculiar to and necessary for an understanding and evaluation of the individual company. In preparing MD&A, companies should consider whether disclosure of all key variables and other factors, both financial and non-financial, that management uses to manage the business would be material to investors and therefore required. Key variables may include information relating to external

• r macro-economic matters as well as those specific to a company or industry. Ultimately, according to the Release,

MD&A should provide a frame of reference that allows readers to understand the effects of material changes and events and known material trends and uncertainties arising during the periods being discussed, as well as their relative importance. Focus on Materiality. Companies are required to provide certain specified material information in their MD&A as well as

• ther material information that is necessary to make the required information not misleading. The Release notes,

however, that MD&A is less effective if it includes unnecessary detail or duplicative or uninformative disclosure that

• bscures material information. The Release suggests that information in a company’s MD&A that is no longer material or

useful, such as where there has been a change in the company’s business or the information has become stale, should be revised or deleted. Focus on Material Trends and Uncertainties and Analysis. The Release emphasizes the importance of the discussion and analysis in MD&A of known trends, demands, commitments, events and uncertainties. Known trends, demands, commitments, events and uncertainties must generally be disclosed unless management concludes that they are not reasonably likely to occur or have a material effect on the company’s financial condition or results of operations. The Release notes that disclosure decisions concerning known trends, demands, commitments, events and uncertainties should generally involve:

• consideration of financial, operational and other information known to the company;
• identification of known trends and uncertainties; and
• assessment of whether these trends and uncertainties will have, or are reasonably likely to have, a

material impact on the company’s liquidity, capital resources or results of operation. When MD&A addresses known material trends, events, demands, commitments and uncertainties, companies should consider including, and may be required to include, an analysis explaining the underlying reasons or implications, interrelationships between constituent elements, or the relative significance of those matters. Guidance Regarding Liquidity and Capital Resources The Release addresses the following areas of particular concern in the preparation of disclosure in MD&A regarding liquidity and capital resources:

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Cash Requirements. In order to provide a clear picture of a company’s ability to generate cash and to meet future cash requirements in MD&A, the SEC advises companies to consider whether the following information would have a material impact on liquidity:

• funds necessary to maintain current operations, complete current projects and achieve future plans;
• commitments for capital or other expenditures; and
• the reasonably likely exposure to future cash requirements associated with known trends or uncertainties,

and an indication of the time periods in which resolution of the uncertainties is anticipated. Sources and Use of Cash. A company’s discussion and analysis of cash flows should not merely recite changes and

• ther information evident to readers from the financial statements but instead should focus on the material factors

necessary to an understanding of the company’s cash flows and the indicative value of historical cash flows. This discussion and analysis should explain how the cash requirements identified in the MD&A fit into a company’s overall business plan, focus on the resources available to satisfy those cash requirements, and, where there has been material variability of historical cash flows, focus on the underlying reasons for those changes and the reasonably likely impact of those changes on future cash flows and cash management decisions. The company’s discussion and analysis of liquidity should also focus on material changes in operating, investing and financing cash flows and the reasons underlying those

• changes. To the extent material, a company must provide disclosure regarding its historical financing arrangements and

their importance to cash flows, and a company should discuss and analyze the following:

• its internal debt financing;
• its use of off-balance sheet financing arrangements;
• its issuance or purchase of derivative instruments linked to its stock;
• its use of stock as a form of liquidity; and
• the potential impact of known or reasonably likely changes in credit ratings or ratings outlook.

Debt Instruments, Guarantees and Related Covenants. The Release notes that there are at least two circumstances in which companies should consider whether discussion and analysis of material covenants related to their outstanding debt may be required. First, the Release advises companies that are, or are reasonably likely to be, in breach of those covenants to disclose material information regarding any such breach and to analyze the impact on the company, if

• material. The analysis should include the steps that the company is taking to avoid or cure the breach, the reasonably

likely impact of the breach, and alternate sources of funding. Second, companies should consider the impact of debt covenants on their ability to undertake additional debt or equity financing. Guidance Regarding Critical Accounting Estimates Generally, the MD&A disclosure rules require companies to address material implications of uncertainties associated with the methods, assumptions and estimates underlying the company’s critical accounting measures. The Release advises that companies should consider whether they have made accounting estimates and assumptions where:

• the nature of such estimates or assumptions is material due to the levels of subjectivity and judgment

necessary to account for highly uncertain matters or the susceptibility of such matters to change; and

• the impact of such estimates and assumptions on financial condition or operating performance is material.

This disclosure should supplement the disclosure of accounting policies that are already disclosed in the notes to the financial statements and provide greater insight into the quality and variability of information regarding financial condition and operating performance.

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The SEC also advises companies to address why their accounting estimates or assumptions bear the risk of change. To the extent material, companies should analyze how they arrived at the estimates, how accurate the estimates and assumptions have been in the past as well as how much the estimates and assumptions have changed in the past and whether they are likely to change in the future. About Venable Venable is a strongly grounded law firm with a century-long history, energized by recent growth. Through offices in Maryland, Washington, DC and Virginia, we work with a diverse local, national and international clientele. Our business is providing service and we recognize that our continued success depends on delivering that service faster, more efficiently, and with high quality. Venable attributes its success to the success of its clients. We are committed to building relationships that transcend the usual role of legal advisor. Our practice areas are built not only on legal experience, but also on knowledge and understanding of each client's industry. Our attorneys work as partners with clients, advising them on a number of levels. When clients face a challenge or opportunity, we immediately bring an experienced team from diverse specialties to coordinate advice. We seek not only to respond to our client's current legal issues, but also to identify potential problems early. Our 420-plus attorneys comprise a team of skilled, experienced professionals. Our clients rely on our great breadth of experience and sound legal judgment for assistance in achieving solid and practical business solutions. We represent businesses of all sizes - from emerging companies to large national and international companies in industries that include financial, manufacturing, hospitality, health care, transportation, mass media information technology, as well as governmental entities, nonprofits and individuals. ******************************* For more information about the matters discussed in this SEC Update, please contact Beth Hughes at (703) 760-1649, Tuck Washburne at (410) 244-7744, Alan Yarbo at (410) 244-7622, Anita Finkelstein at (202) 344-4905, Ariel Vannier at (202) 344-4867, Melissa Warren at (410) 244-7695, Michael Conron at (410) 244-7424, Fred Spindel at (202) 344-4732 or Matthew Swartz at (703) 760-1660. SEC Update is published by the Corporate Finance and Securities Group of Venable LLP. It is not intended to provide legal advice or opinion. Such advice may only be given when related to specific fact situations.