SEC Adopts New Form 8-K Requirements

Transcription

1 MARCH 11, 2004 SEC Adopts New Form 8-K Requirements Today, the Securities and Exchange Commission voted to adopt amendments to Form 8-K, the form used by public companies to report specified corporate events on a current basis. The amendments add eight new disclosure items to Form 8-K, expand disclosure requirements under two existing items, and transfer two items from the periodic reports to Form 8-K. The adoption of these new disclosure requirements is one of the most important developments in disclosure rule-making in many years and represents a significant shift toward the real time disclosure called for under Section 409 of the Sarbanes Oxley Act of The amendments will become effective on August 23, The eight new disclosure items include entry into a material non-ordinary course agreement; termination of a material non-ordinary course agreement; creation of a material direct financial obligation or a material obligation under an off-balance-sheet arrangement; triggering events that accelerate or increase a material direct financial obligation or a material obligation under an off-balance-sheet arrangement; material costs associated with exit or disposal activities; material impairments; notice of delisting or failure to satisfy a continued listing rule or standard; transfer of listing; nonreliance on previously issued financial statements or a related audit report or completed interim review (restatements). 1 of 7

2 The two disclosure items transferred, in part, from the periodic reports are unregistered sales of equity securities; material modifications to rights of security holders. The amendments also expand disclosure required with respect to departure of directors or principal officers, election of directors, or appointment of principal officers; amendments to articles of incorporation or bylaws and change in fiscal year. The amended rules require that Form 8-Ks be filed within four business days, rather than the five business and fifteen calendar day filing deadlines applicable under current rules. The amendments also create a limited safe harbor under Exchange Act Section 10(b) and Rule 10b-5 for failure to file Form 8-K timely in the case of certain items, provided the required disclosure is made in the issuer s next periodic report. The safe harbor will not apply to, or impact, any other duty to disclose that an issuer may have. At the open meeting at which these amendments were adopted it was indicated that in the case of certain late filings of Form 8-K the new rules provide some relief to issuers regarding loss of eligibility to use Forms S-2 and S-3 for the registration of securities and that similar relief is provided in certain situations regarding the availability of Rule 144. The full text of the adopting release has not yet been posted on the SEC Web site. SEC Proposes Amendments to Form 20-F The SEC also voted today to propose amendments to Form 20-F that would permit foreign private issuers that change their basis of accounting to the International Financial Reporting Standards (IFRS) to include only two years of audited financial statements in their SEC filings for the first year of reporting under IFRS. Form 20-F generally requires that companies provide in SEC filings three years of audited financial statements, prepared on a consistent basis of accounting. The proposed amendments would apply to foreign private issuers that publish IFRS financial statements for the first time for any financial year beginning no later than January 1, The proposed amendments would also require that any company that adopts IFRS for the first time, in any financial year provide disclosure related to exceptions from IFRS on which it relied; include a specified level of information in a reconciliation from its previous system of accounting to IFRS. 2 of 7

3 These proposals affect, in particular, foreign issuers located in the European Union (EU), which under current EU law will generally be required to adopt IFRS for reporting on their 2005 financial year. The proposals are intended to ease the burdens faced by foreign issuers when they adopt IFRS for the first time, and to improve the quality of financial disclosure provided to investors. The proposals are also intended to encourage other foreign companies to switch their accounting voluntarily to IFRS. The proposals will be open for public comment for a thirty-day period following their publication in the Federal Register. PCAOB Adopts Auditing Standard No. 2 An Audit of Internal Control Over Financial Statements Performed in Conjunction with an Audit of Financial Statements At its public meeting on March 9, 2004, the Public Company Accounting Oversight Board (PCAOB) approved its Auditing Standard No. 2, addressing the requirement of Sections 404(b) and 103(a)(2)(A) of Sarbanes Oxley for accountants attestation report on management s assessment of internal controls. Auditing Standard No. 2 is subject to SEC approval. Accounting Standard No. 2 evolved from the proposal issued by the PCAOB on October 7, 2003, after reviewing over 190 comment letters and contains significant changes from the proposal. While the SEC has not yet set a timetable for reviewing and approving Accounting Standard No. 2, it must take action before the provisions relating to management s assessment of and report on internal controls and the related certification of Section 404(a) of Sarbanes Oxley can be implemented. In brief, Auditing Standard No. 2 provides for an integrated and inseparable audit of both financial statements and internal control over financial reporting, rather than a separate attestation engagement to report on management s assessment of internal control; an evaluation of management s assessment of internal control as a tool to assist the auditor to plan the audit and provide some basis to determine the extent to which the auditor may rely on the work of others; clear referral to the COSO Internal Control Integrated Framework as a standard to allow more flexibility to auditors in assessing special considerations for small and medium-size companies (and elimination of the appendix in the original proposal); annual walkthroughs by the auditor of a transaction in each major class of transactions from its origination, through the company s accounting and information systems and financial report preparation processes to the transaction s report in the company s financial statements; 3 of 7

4 identification of significant accounts both quantitatively, at the financialstatement caption and note-disclosure level, and qualitatively, based on company structure, differing risks and other factors, to determine which controls to test; identification of relevant assertions, such as: does the asset exist? did the transaction occur? are loans included in accounts payable? etc., for which the company should have controls; testing and evaluating the effectiveness of the design of controls based on inquiries, observation, walkthroughs, and an assessment of whether the controls are likely to detect or prevent misstatements if they operate as designed; testing of various controls annually to obtain evidence of the effectiveness of controls for all relevant assertions for all accounts and disclosures every year, with some variation of testing from year to year (with examples for making the annual decisions on which controls to test provided in Appendix B to Auditing Standard No. 2) and at various times throughout the year, including specifically those designed to prevent or detect fraud; limited ability to use the work of others, including internal auditors, other company personnel, and third persons working on internal control at the direction of management, taking into account the competence and objectivity factors described in SAS No. 65 but requiring that the auditor s own work provide the principal evidence for the audit opinion. The key product of the internal control portion of the audit is the determination of whether any control deficiency is a significant deficiency : one which by itself, or in combination with other control deficiencies, results in more than a remote likelihood of a misstatement of the company s annual or interim financial statements that is more than inconsequential will not be prevented or detected. A significant deficiency would be classified as a material weakness if, by itself or in combination with other control deficiencies, it results in more than a remote likelihood that a material misstatement in the company s annual or interim financial statements will not be prevented or detected. All significant deficiencies and material weaknesses identified by the auditor must be communicated in writing to the audit committee. All control deficiencies must be communicated to management in writing, with notice to the audit committee that the communication has been made. Auditing Standard No. 2 provides that an unqualified opinion may only be expressed by the auditor if the auditor has identified no material weaknesses in internal control after having performed all of the procedures that the auditor considered necessary in the circumstances. An opinion may be qualified or disclaimed if the auditor cannot perform all the procedures it determines necessary under the circumstances. The auditor s report has two opinions: one on management s assessment and one on the effectiveness of internal control over financial reporting. If a material weakness in internal control is identified, management may not conclude that the company s internal control over financial reporting is effective. If management cannot reach that conclusion, neither can the auditor. The auditor may, however, under those circumstances issue an unqualified opinion on management s assessment, if management properly identified the material weakness and concluded that internal control was not effective. 4 of 7

5 Finally, Auditing Standard No. 2 clarifies, somewhat, the incongruous concept of the auditor evaluating the effectiveness of the audit committee s oversight of the company s external financial report and internal control over financial reporting. Paragraphs of the Standard contain several key statements: Although the audit committee plays an important role within the control environment and monitoring components of internal control over financial reporting, management is responsible for maintaining effective internal control over financial reporting [and] this standard does not suggest that this responsibility has been transferred to the audit committee. The company s board of directors is responsible for evaluating the performance and effectiveness of the audit committee; this standard does not suggest that the auditor is responsible for performing a separate and distinct evaluation of the audit committee... [but because of the role of the audit committee] the auditor should assess the effectiveness of the audit committee as part of the understanding and evaluating of those components [of internal control over financial reporting]. The auditor is to consider the audit committee members independence from management, the clarity of articulation of the audit committee s responsibilities in its charter or otherwise, the understanding which management and the audit committee demonstrate of those responsibilities, the committee s involvement and interaction with the auditors and the internal auditors, as well as with other internal financial management, such as the CFO and the chief accounting officer, whether the questions raised of the auditor and management indicate an understanding of critical accounting policies and judgmental accounting estimates, and the responsiveness of the audit committee to issues raised by the auditor. If the auditor determines that the audit committee s oversight is ineffective, it should be regarded as at least a significant deficiency and [as] a strong indicator that a material weakness in internal control over financial reporting exists. The work papers documenting that conclusion would be interesting. Since the SEC has already postponed twice the effectiveness of management s report on internal controls, awaiting PCAOB action on Standard No. 2, quick action now that the Standard has been adopted seems likely. If you have any questions or require further information regarding these or other matters, please call your regular Nixon Peabody contact or feel free to contact one of the attorneys listed below: in our Boston office, Al Jordan ( ) in our New York City office, Richard Langan ( ) in our Rochester office, Deborah Quinn ( ) in our San Francisco office, Steven Plevin ( ) in our Washington, D.C. office, John Partigan ( ) 5 of 7

6 For a complete list of the securities law practice group members, please refer to the final page of this Securities Law Alert. The foregoing summary is provided by Nixon Peabody for education and informational purposes only. It is not a full analysis of the matter summarized and is not intended and should not be construed as legal advice. This publication may be considered advertising under applicable laws. If you are not currently on our mailing list and would like to receive future publications of Securities Law Alert or if you would like to unsubscribe from this mailing list, please send your contact information, including your name and address, to lblaney@nixonpeabody.com. Prior publications of Securities Law Alert are available on our Web site ( 6 of 7

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