Amendments to the California Corporate Disclosure Act of 2002

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1 California Corporate Law Roundup for the Legislative Session Corporate & Securities We are issuing this alert to review a number of significant developments in the area of corporate law during California s last legislative session. This edition includes brief summaries of two bills affecting corporations in California enacted by the Legislature and signed by Governor Schwarzenegger, one of which implements significant changes to the California Corporate Disclosure Act of 2002, including new requirements for filing Corporate Disclosure Statements. The Governor vetoed a third bill relating to disclosure of corporate elections procedures. This edition additionally summarizes proposed changes by the Department of Corporations to the filing requirements for securities transactions that qualify for the limited offering exemption under Section 25102(f) of the California Corporate Securities Law. A complete copy of the text of each of the bills discussed below is available on the California Legislative Counsel s website at A copy of the Corporate Disclosure Statement form can be found on the Secretary of State s website at A complete copy of the text of the amendments proposed by the California Department of Corporations can be found on the department s Web site at ( Amendments to the California Corporate Disclosure Act of 2002 On September 27, 2004, Governor Schwarzenegger signed Assembly Bill 1000, which clarifies various provisions and definitions in the California Corporate Disclosure Act of 2002 (CDA) and brings the CDA in conformity with certain federal reporting requirements, including those enacted under the Sarbanes-Oxley Act of The bill, effective September 27, 2004 as an urgency statute, amends California Corporations Code sections 1502 and 2117, and adds California Corporations Code sections and , to change the filing requirements for publicly traded corporations, in an attempt to make compliance easier and to harmonize the disclosures to a certain degree with federal standards. Before September 27, 2004, all publicly traded domestic and foreign corporations were required to disclose certain information concerning their operations when filing their initial or annual Statements of Information with the Secretary of State. The bill makes several changes to the information required to be disclosed and specifically requires that all publicly traded corporations disclose this information by filing a separate Corporate Disclosure Statement within 150 days after the end of the fiscal year of the Corporation, rather than including it as part of its Statement of Information. In addition, the bill clarifies the definitions for publicly traded corporations, executive officer, loan and compensation.

2 Summary of Changes In addition to requiring that a separate Corporate Disclosure Statement be filed, Assembly Bill 1000 revised the information to be disclosed as follows: Auditor Information. The Statement must provide the name of the independent auditor that prepared the most recent auditor s report and, if different, the name of the independent auditor employed by the corporation on the date of the Statement. The time period for reporting the description of other services to be performed by the independent auditor has been changed from the previous twenty-four months to the two most recent fiscal years and the period between the end of its most recent fiscal year and the date of the Statement. Finally, the previous requirements of providing the date of the last report prepared for the corporation by the independent auditor as well as attaching a copy of the most recent independent auditor s report have been deleted. Bankruptcies. The corporation must now disclose only whether an order for relief has been entered in a bankruptcy case (rather than indicating whether any bankruptcy was filed) within the ten years preceding the date of the Statement. Executive Officers Compensation. In addition to disclosing the compensation of its five most highly compensated executive officers who are not directors, the corporation must disclose the compensation paid to its chief executive officer if not already disclosed. This changes the previous requirement that required disclosure of compensation paid to the CEO and the five other most highly compensated executive officers to approximate more closely the federal disclosure requirements. Fraud Convictions. The corporation must disclose whether any member of its board of directors or any executive officer has been convicted of fraud within the ten years preceding the date of the Statement, but only if the conviction has not been overturned or expunged. Loans to Directors. The corporation must describe any loans made to any director during the corporation s two most recent fiscal years (rather than the previous twenty-four months) at an interest rate lower than the interest rate available from unaffiliated commercial lenders generally to a similarly situated borrower. Material Legal Proceedings. The Statement requires a description of any material legal proceedings, other than ordinary routine litigation incidental to business, to which the corporation or any of its subsidiaries is a party or to which any of their property is subject. The Statement also must describe any material legal proceeding during which the corporation was found legally liable by entry of a final judgment or final order that was not overturned on appeal during the five years preceding the date of the Statement.

3 Clarification of Definitions The bill also revises and clarifies the following definitions: Publicly traded corporation is now defined as a company that meets the definition of issuer under the Securities Exchange Act of 1934 (Exchange Act) and has securities listed or traded on a national securities exchange, on the Nasdaq Stock Market s National or Small- Cap Markets, the OTC Bulletin Board or on the Pink Sheets. This change narrows the CDA s application to a smaller universe of companies that more closely comports with the goals of the CDA to provide relevant information regarding publicly traded companies. Executive officer is now specifically defined as the chief executive officer, president, any vice president in charge of a principal business unit, or any other officer of the corporation who performs a policymaking function. This definition closely tracks the definition of executive officer in the SEC s rules for annual reports and proxy statements by public companies under the Exchange Act. Compensation includes all plan and non-plan compensation as those terms are defined by the SEC regulations. This change provides greater clarity as to what information must be disclosed regarding executive and board compensation, and provides for greater consistency between state and federal reporting requirements. Loan specifically excludes an advance for expenses, the corporation s payment of life insurance premiums and an advance of litigation expenses as permitted according to the applicable laws of the state or place of incorporation, thus clarifying which loans need to be disclosed. Filing Fee There is no filing fee for the Corporate Disclosure Statement. Communications Between Shareholders and Directors by Electronic Means Senate Bill 1306, signed into law by Governor Schwarzenegger on August 23, 2004, permits the use of electronic transmission as a means of communication between corporations and its directors, officers and shareholders, between limited liability companies and its members, and between partners. The bill defines electronic communications as delivery by facsimile, electronic mail, posting on an electronic message board or network that the corporation, partnership or limited liability company has designated for those communications or other means of electronic communication. These other forms of electronic communication are acceptable so long as they create a record that may be reduced to a clearly legible paper form and so long as the recipient has consented to such use and the corporation, partnership or limited liability company has in effect reasonable measures to verify the sender. Additionally, SB 1306 expands the means by which shareholders and directors of a corporation and members of a limited liability company may attend and participate in meetings. The bill permits

4 holding shareholder meetings by means of electronic communications so long as the form of communication allows the corporation to authenticate the identity of the attending shareholder, provides for shareholder access to participate in and vote at the meeting, and provides a means for taking a record of such participation by the shareholder. It permits the electronic transmission of the corporation s annual report to shareholders, shareholder consents and notices to shareholders. It also permits books and records of corporations, partnerships and limited liability companies to be kept in non-written forms so long as they may be reduced to a clearly legible paper form. Veto of Corporate Elections Disclosure Act As first introduced, Assembly Bill 2752 would have required publicly traded corporations incorporated or qualified to do business in California to have in place corporate election procedures and a process for shareholders to recommend candidates for election as directors and propose binding resolution. The final form of the bill sent to the Governor would have required the filing of those portions of a corporation s articles of incorporation and bylaws that relate to the nomination and election of directors. It also would have required corporations to make them available upon request to shareholders. AB 2752 received strong opposition from the Corporations Committee of the Business Law Section of the State Bar of California and the California Department of Corporations on the basis that the proposed legislation would have required disclosure already mandated under existing law and would have been duplicative of or even in conflict with the SEC s ongoing rulemaking efforts. Under existing law, publicly traded corporations are required to file with the SEC their governing instruments, including their articles of incorporation and bylaws, as well as a description of their shareholder nomination procedures in their proxy statements. In addition, the California Corporate Disclosure Act (discussed above) already requires the filing of annual statements with the Secretary of State disclosing specified information. The Governor vetoed AB 2752, maintaining that it places a new, unnecessary filing requirement on California business. In his veto message, the Governor encouraged proponents of the bill to work with the SEC to make information easier for investors to find, without placing a new filing requirement on companies seeking to do business in California. Electronic Filing of Limited Offering Exemption Notices Companies that rely on the limited offering exemption under Section 25102(f) to offer and sell securities in California are required to file notices in the form prescribed under rules adopted by the California Department of Corporations (DOC). In September 2004, the DOC proposed changes to Rule that requires the notice be filed electronically online using the DOC s Web site ( unless the company required to file the notice qualifies for a hardship exception. In general, the filing may continue to be made in person or by mail only if computer equipment is unavailable without unreasonable burden or expense, or the information requested on the DOC s electronic notice or Internet filing process cannot be obtained and provided without unreasonable burden or expense. In either case, the hardship exception would be available only if an explanatory cover letter in a prescribed form is included with the notice filing. The DOC staff is currently reviewing the September proposal in light of the public comments it received. We anticipate that the DOC will adopt this release in the first quarter of 2005.

5 Further Information If you wish either to obtain a more detailed explanation of these developments and their ramifications or develop a strategy for responding to the changing regulatory landscape, please contact the Pillsbury Winthrop securities attorney with whom you work, or Brian M. Wong ( or bwong@pillsburywinthrop.com), who serves on the Corporations Committee of the Business Law Section of the State Bar of California, Stanton D. Wong ( or sdwong@pillsburywinthrop.com), one of the co-leaders of the Pillsbury Winthrop securities practice team, or Linda C. Williams ( or lwilliams@pillsburywinthrop.com). This publication is issued periodically to keep Pillsbury Winthrop LLP clients and other interested parties informed of current legal developments that may affect or otherwise be of special interest to them. The comments contained herein do not constitute legal opinion and should not be regarded as a substitute for legal advice Pillsbury Winthrop LLP. All Rights Reserved.