Securities Law Advisory

Transcription

1 August 11, 2004 Securities Law Advisory Disclosure Controls and Procedures: Implications of Form 8-K Amendments and a Recent SEC Enforcement Action The new Form 8-K requirements that become effective August 23, 2004, 1 will require Form 8-K disclosure of a wider range of events and will impose an accelerated filing deadline of four business days after the triggering event. Companies undoubtedly will face vexing interpretive issues about the new disclosure requirements, which will be made more difficult by time constraints that will leave little time to muster a large disclosure committee. Accordingly, companies should reassess, and perhaps redesign, their existing disclosure controls and procedures to accommodate both the new disclosure requirements and the new filing deadlines. A recent SEC enforcement initiative only reinforces the importance of designing and implementing effective disclosure controls. Overview of New Form 8-K Requirements 2 What new events are required to be reported under the new Form 8-K? Form 8-K has been revised to add eight new items, expand the disclosure requirements of two existing items, transfer to Form 8-K two additional items currently required in Forms 10-K and 10-Q, and renumber all of the items, as listed in Appendix A to this advisory. Although certain of the new disclosure events may seem relatively straightforward, others promise to be difficult to interpret in practice. For example, for purposes of the disclosure requirements relating to the creation of a material direct financial obligation (Item 2.03), companies may have to continually assess borrowing levels under revolving credit facilities. For purposes of the disclosure requirements relating to material impairments (Item 2.06), companies may have to coordinate their impairment testing procedures with their disclosure controls and procedures. The requirement to disclose material impairment charges is triggered when a decision is made that material charge for impairment is required, but that decision can be by either the board, a committee of the board, or any authorized officer. Companies should take care to clearly 1 See Final Rule: Additional Form 8-K Disclosure Requirements and Acceleration of Filing Date, Securities Act Rel. No , Exchange Act Rel. No , (Mar. 16, 2004). 2 For a more complete description of the new Form 8-K requirements, see Alston & Bird LLP Securities Law Advisory, SEC Adopts Final Rules Expanding Form 8-K Disclosure Requirements and Accelerating Filing Deadlines, articles/form%208-k%20disclosures.pdf (Mar. 24, 2004).

2 identify who in the organization has the authority to make such decisions so that proper notice of an impairment conclusion can reach those responsible for the registrant s disclosure. New Item 2.05, relating to costs associated with exit or disposal activities, raises similar issues. How quickly must the new Form 8-K be filed? Companies that are subject to the reporting requirements of Sections 13(a) and 15(d) of the Exchange Act (other than foreign private issuers that file annual reports on Form 20-F or 40-F) must file required current reports on Form 8-K generally within four business days of the occurrence of a reportable event. 3 This accelerates the reporting obligation from the current five business day or 15 calendar day reporting periods. Is there any grace period for late filings or for failures to file? Companies must file a required Form 8-K within the allotted time frames. Exchange Act Rule 12b-25, which permits late filings of Forms 10-K and 10-Q under certain circumstances, does not apply to Form 8-K filings. The SEC did recognize, however, that several of the new Form 8-K disclosure items may require a company s management to quickly assess the materiality of an event or to quickly make a determination as to whether a disclosure obligation has been triggered. Accordingly, the following Form 8-K disclosure items are subject to a limited safe harbor from public and private claims under Section 10(b) and Rule 10b-5 for a failure to timely file a Form 8-K: 4 Items 1.01 and 1.02: entry into, or termination of, a material definitive agreement; Items 2.03 and 2.04: creation of, or triggering events that accelerate or increase, a direct financial obligation or an obligation under an off-balance sheet arrangement; Item 2.05: costs associated with exit or disposal activities; Item 2.06: material impairments; Item 4.02: determinations that previously issued financial statements or a related audit report or completed interim review no longer should be relied upon (but only in the case where the company makes the determination and does not receive a notice regarding these events from its independent accountant). The safe harbor specifically provides that no failure to make a report on Form 8-K with respect to these events, where such report is required solely pursuant to the provisions of Form 8-K, shall be deemed to be a violation of Section 10(b) and Rule 10b-5. However, the safe harbor only applies to failures to report on 3 The amendments do not affect the filing deadlines for disclosures under Regulation FD, voluntary disclosures under New Item 8.01 (current Item 5), and certain exhibits. 4 The amendments do not, however, include any safe harbor from liability under Sections 13(a) or 15(d) of the Exchange Act. As a result, the new safe harbor will not affect the SEC s ability to enforce any violation of the Form 8-K filing requirements. 2

3 Form 8-K; therefore, material misstatements or omissions contained in a Form 8-K (or in other disclosures relating to a reportable event, such as a press release) will still be subject to Section 10(b) and Rule 10b-5. Also, Forms 10-Q, 10-QSB, 10-K and 10-KSB have been amended to require disclosure of any previously undisclosed Form 8-K events that occurred during the reporting period covered by the periodic report. Accordingly, the new safe harbor for a failure to report effectively extends only until the due date of the periodic report covering the period in which the Form 8-K was not timely filed. The safe harbor also does not protect companies from failing to honor any separate obligation (i.e., other than from Form 8-K) they may have to disclose the same information. Will a company that relies on the safe harbor still be S-2 or S-3 eligible and can shareholders still use Rule 144? A failure to timely file a Form 8-K for a safe-harbor disclosure item will not cause a company to become ineligible to use Form S-2 or S-3, so long as the company has filed the disclosure required by the safe-harbor disclosure item on or before the date that it files its Form S-2 or Form S-3 registration statement. A failure to timely file a Form 8-K for any disclosure items that are not covered by the safe harbor will cause the company to lose its S-2 or S-3 eligibility for the 12-month period following the due date of the Form 8-K. The final rules also amend Securities Act Rule 144 to clarify that satisfaction of the current public information condition in Rule 144 for a sale of securities pursuant to that rule does not require a company to have filed all Form 8-K reports during the 12-month period preceding such a sale of securities. However, Rule 144(h) still requires a security holder to represent that he or she does not have material nonpublic information about the company at the time of the sale. Implications for Disclosure Controls and Procedures Every company should reassess its disclosure controls and procedures in light of the new Form 8-K requirements and consider the need to implement new procedures as appropriate. As with other disclosure controls and procedures, procedures for addressing the new Form 8-K requirements will vary from company to company based on internal reporting structures and the size and complexity of the company s business. Consider forming smaller disclosure teams to address Form 8-K events. Many companies have adopted disclosure committees that include representation from many components of their businesses. This may facilitate thorough preparation of periodic reports, such as Forms 10-K and 10-Q, but a large committee may be ill suited to address fast-breaking disclosure issues of the types contemplated by the new Form 8-K. Smaller groups, consisting of a few key members of the disclosure committee who have the broadest perspective on the company s operations, may be best suited to make quick decisions about Form 8-K disclosures. Responsibilities for particular types of reportable events could be assigned by subject matter, such as financial and accounting events, contractual events and extraordinary events, to key persons responsible for monitoring 3

4 each type of event and for formulating and distributing for review appropriate disclosure within the required time periods. Although not expressly required, companies may also want to consider delegating authority to the chair or another member of the Audit Committee to review financial and accounting related disclosures on Form 8-K in order to facilitate participation by the committee within the required time periods. Determinations of the materiality of a potentially reportable event will often require the input of various disciplines legal, financial and operational. Procedures should be developed to ensure that appropriate persons review the materiality of these events when identified by disclosure committee members responsible for monitoring those events. A company s legal department and/or outside counsel should be notified as soon as possible about a potential event that may require disclosure so that considerations of materiality and disclosure language can be reviewed by appropriate persons within the applicable time constraints. Companies may also ask their independent accountants to review financial and accounting disclosures. Consider expanded outreach programs to facilitate prompt reporting of potential Form 8-K disclosure events. Regardless of whether a portion of a larger disclosure committee is designated to serve as a Form 8-K disclosure team, companies should consider redesigning their internal procedures to facilitate prompt reporting of potential Form 8-K disclosure events and to help avoid any confusion or delay in the preparation and review of company filings. For example, companies may wish to add a standard pre-signing procedure to their contracting process that includes an anticipatory analysis of the materiality of the contract before it is signed. Similar procedures could be developed for other subject matters covered by the new Form 8-K. These efforts may include establishing minimum numeric thresholds for anticipating and reporting new agreements and off-balance sheet obligations, and expanding employee education programs to include specific instruction on the new Form 8-K requirements. Employee education should be both procedural and substantive, and include alerting key personnel that they may need to be on call to prepare disclosures for senior management review under the accelerated filing deadlines. Companies may also wish to consider limiting the authority of personnel with respect to certain activities, including entering into and terminating material contracts, creating off-balance sheet obligations or, as noted above, approving impairment charges. Consider revising quarter-end procedures to specifically assess whether Form 8-K disclosure events were reported promptly and completely. At the end of each quarter, before the Form 10-Q or 10-K is filed, companies should specifically assess whether required Form 8-K filings were made on a timely basis and whether those filings contained appropriate disclosures. This is important both as a component of management s evaluation of the effectiveness of the company s disclosure controls and procedures and to ensure that the benefits of the safe harbor are preserved when the safe harbor must be relied upon. 4

5 Implications of Recent SEC Enforcement Initiative As if the new Form 8-K requirements themselves were not daunting enough, the SEC s recent Regulation FD enforcement action against Siebel Systems, Inc. ( Siebel ) reinforces the importance of companies designing and operating robust disclosure controls and procedures, including vigorous employee education programs, particularly as they relate to Form 8-K disclosures. Regulation FD Overview 5 Regulation Fair Disclosure or FD prohibits an issuer (or a person acting on behalf of an issuer 6 ) of publicly traded securities from selectively disclosing material nonpublic information. 7 Under Regulation FD, it is a violation of federal securities laws for an issuer to disclose material information to securities industry professionals or investors who are likely to trade on such information, without also disclosing the information to the public. Thus, Regulation FD requires an issuer making an intentional disclosure of material nonpublic information to a covered person or entity to make a simultaneous disclosure of that information to the public. When an issuer makes an unintentional disclosure of material nonpublic information, Regulation FD requires the issuer to disclose the information to the public promptly. Siebel II On June 29, 2004, the SEC announced that it was charging Siebel with violations of Regulation FD, Exchange Act Rule 13a-15, and an SEC cease-and-desist order issued in November The SEC also charged Siebel s CEO and its former investor relations director with aiding and abetting Siebel s violations. The SEC s complaint against Siebel alleges that the company s CEO made selective disclosures at private meetings with institutional investors, and that those disclosures materially contrasted with the disclosures made to the public concerning Siebel s business activity levels, deal flow, and the impact of the recent economic downturn on its business. In a series of conferences held on April 4, April 23, and April 28, 2003 with industry professionals and investors, Siebel allegedly made public statements concerning its disappointing first quarter 2003 results, which were attributed to the lagging economy and deals [in the pipeline] that 5 For a more detailed summary of Regulation FD, see Alston & Bird LLP Securities Law Advisory, New SEC Regulations Address Selective Disclosure and Clarify Insider Trading, (Aug. 2000) and Alston & Bird LLP Securities Law Advisory, A Report on Regulation FD How the SEC Is Interpreting It and How Public Companies Are Responding, (Mar. 1, 2001). 6 The phrase a person acting on behalf of an issuer generally means any senior official of the issuer, or any other officer, employee, or agent of an issuer who regularly communicates with securities industry professionals or with holders of the issuer s securities. An officer, director, employee, or agent of an issuer who discloses material nonpublic information in breach of a duty of trust or confidence to the issuer is not considered to be acting on behalf of the issuer. See 17 C.F.R (c). 7 Issuers for the purpose of Regulator FD include companies that have a class of securities registered under Section 12 of the 1934 Act or are required to file reports under Section 15(d) of the 1934 Act. 8 Securities & Exchange Commission v. Siebel Sys., Inc., et al., Litigation Rel. No , lr18766.htm (June 29, 2004). 5

6 slipped. In its public disclosures, Siebel stated that revenues would fall short because, among other things, its performance depended on the economy. In late April 2003, however, Siebel s CEO and former investor relations director met privately with institutional investors and industry professionals. The SEC alleges that the disclosures made in the private meetings were materially different from Siebel s earlier public disclosures. For example, the SEC alleges that the CEO stated that Siebel s business activity levels were better, new deals were coming back into the pipeline, the pipeline was growing, and there were approximately $5 million of deals in its pipeline. Such statements contrasted with Siebel s previous public stance, however, that its economic situation was uncertain and the downward trend in the market for its products had caused the pipeline to dry up. The SEC claims that the CEO and former investor relations director had been aware of Siebel s prior public disclosures and that the CEO had answered questions during the private briefings that Siebel had refused to answer publicly just days before. According to the SEC, rumors about the positive statements made by the CEO began to circulate shortly after the meetings. Several institutional investors, who were present at the private briefings, and their clients purchased Siebel shares, which caused an increase in the trading volume and price of Siebel s stock. The SEC complaint alleges that Siebel knew about the rumors and knew about the positive impact that the nonpublic disclosure had had on its stock. The SEC contends that Siebel should have filed a Form 8-K (or used some other Regulation FD-compliant means of dissemination) disclosing the material nonpublic information that the CEO disclosed during the private briefings. 9 It is important to note that Siebel had already been the subject of a cease-and-desist order for previous alleged violations of Regulation FD and Section 13(a) of the Exchange Act. 10 According to the SEC, the company had failed to improve its Regulation FD compliance. The SEC focused on the fact that the former investor relations director had communicated with Siebel s general counsel about any disclosure obligations created by the private briefings, but failed to inform the general counsel of the nonpublic statements made by the CEO and denied the rumors that were circulating about those statements. The SEC also seemed particulary concerned that, despite the earlier cease-and-desist order, (1) neither the company s former investor relations director nor his staff had received any training regarding Regulation FD and (2) that the company lacked a formal policy on Regulation FD compliance. 9 The SEC s theory appears to rest on the following elements. Rule 13a-15 applies to all Exchange Act reports, including Form 8-K. Siebel s disclosures of material non-public information to stockholders and securities industry professionals triggered a Regulation FD disclosure obligation, which could have been satisfied by furnishing of a Form 8-K or utilizing some other Regulation FDcompliant method of disseminating the information. However, because Siebel did not utilize any other Regulation FD-compliant method, its failure to furnish a Form 8-K constituted a violation of Rule 13a See Press Release: SEC Brings First Regulation FD Enforcement Actions, (Nov. 25, 2002); In the Matter of Siebel Systems, Inc., Exchange Act Rel. No , (Nov. 25, 2002); Securities & Exch. Comm. v. Siebel Sys., Inc., Civil Action No. 1:02CV02330 (JDB), complaints/comp17860.htm (D.D.C. Nov. 25, 2002). For a more complete description of the earlier Regulation FD enforcement action against Siebel, see Alston & Bird LLP Securities Law Advisory, SEC Announces First Enforcement Actions Relating to Regulation FD; Plaintiffs Bar Attempts to Allege a Private Cause of Action Under Regulation FD, First%20Enforcement%20Actions.pdf (Dec. 3, 2002). 6

7 Implications of Siebel II This is the first enforcement action charging a violation of Exchange Act Rule 13a-15, which requires an issuer to maintain disclosure controls and procedures designed to ensure that information required to be disclosed by the issuer in the reports that it files of submits under the Exchange Act is recorded, processed, sumarized and reported, within the time limits specified in the Commission s rules and forms. This enforcement action illustrates that it is imperative that public companies maintain appropriate disclosure controls for dealing with institutional investors and securities analysts, particularly in one-on-one meetings, which Regulation FD compliance always difficult to monitor. Companies should promulgate a formal company policy regarding Regulation FD compliance. Companies should also institute formal training programs, focused on Regulation FD compliance and, now, the new Form 8-K filing requirements, in addition to regular training regarding the disclosure requirements applicable to periodic reports. 7

8 This Securities Law Advisory is published by Alston & Bird LLP ( to provide a summary of significant developments to our clients and friends. It is intended to be informational and does not constitute legal advice regarding any specific situation. This material may also be considered advertising under applicable court rules. If you have any questions or would like additional information, please contact your Alston & Bird attorney, any member of the Alston & Bird Securities Practice Group or any of the following attorneys who contributed to this Securities Law Advisory: David E. Brown, Jr dbrown@alston.com Oni A. Holley oholley@alston.com Gary C. Ivey givey@alston.com Beth R. MacDonald bmacdonald@alston.com Michael P. Reed mreed@alston.com Peter Q. Bassett pbassett@alston.com Dennis O. Garris dgarris@alston.com Mark F. McElreath mmcelreath@alston.com Frank M. Conner III fconner@alston.com M. Hill Jeffries hjeffries@alston.com Nils H. Okeson nokeson@alston.com J. Vaughan Curtis vcurtis@alston.com John A. Jordak, Jr jjordak@alston.com Jonathan H. Talcott jtalcott@alston.com Todd R. David tdavid@alston.com John L. Latham jlatham@alston.com Bryan E. Davis bdavis@alston.com Brad S. Markoff bmarkoff@alston.com If you would like to receive future Securities Law Advisories electronically, please forward your contact information including your address to securities.advisory@alston.com. Be sure to put subscribe in the subject line. Atlanta: One Atlantic Center 1201 West Peachtree Street Atlanta, Georgia, USA, Fax: Charlotte: Bank of America Plaza 101 South Tryon Street, Suite 4000 Charlotte, North Carolina, USA, Fax: New York: 90 Park Avenue New York, New York, USA, Fax: Research Triangle: 3201 Beechleaf Court, Suite 600 Raleigh, North Carolina, USA, Fax: Washington, D.C.: 601 Pennsylvania Avenue, N.W. North Building, 10 th Floor Washington, D.C., USA, Fax: Alston & Bird LLP 2004

9 Securities Law Advisory August 11, 2004 Appendix A Reconciliation of New Form 8-K Items New 8-K Item Topic Corresponding Prior 8-K Item 1934 Act Form from which it was transferred 1.01 Entry into a Material Definitive Agreement 1.02 Termination of a Material Definitive Agreement 1.03 Bankruptcy or Receivership Item Completion of Acquisition or Disposition of Assets Item Results of Operations and Financial Condition Item Creation of a Direct Financial Obligation or an Obligation Under an Off-Balance Sheet Arrangement 2.04 Triggering Events that Accelerate or Increase a Direct Financial Obligation or an Obligation Under an Off- Balance Sheet Arrangement 2.05 Costs Associated with Exit or Disposal Activities 2.06 Material Impairments 3.01 Notice of Delisting or Failure to Satisfy a Continued Listing Rule or Standard; Transfer of Listing 3.02 Unregistered Sales of Equity Securities 10-K (Part II, Item 5(a)) and 10-Q (Part II, Item 2(c))

10 3.03 Material Modification to Rights of Security Holders 10-Q (Part II, Item 2) 4.01 Changes in Registrant s Certifying Accountant Item Non-Reliance on Previously Issued Financial Statements or a related Audit Report or Completed Interim Review 5.01 Changes in Control of the Registrant Item Departures of Directors or Principal Officers; Election of Directors; Appointment of Principal Officers Item Amendments to Articles of Incorporation or Bylaws; Change in Fiscal Year Item Temporary Suspension of Trading Under Registrant s Employee Benefit Plans Item Amendments to the Registrant s Code of Ethics, or Waiver of a Provision of the Code of Ethics Item Regulation FD Disclosure Item Other Matters Item Financial Statements and Exhibits Item 7 10