Can A Possible Reg. FD Violation Turn Into An 8-K Breach?

Can a possible Reg FD violation turn into an 8-K breach?

This is one of the questions surrounding AFC Enterprises, the fast food company that operates Cinnabon, Popeye’s and Church's fried chicken.

Last week, AFC filed its long-awaited 10-K for 2002, restating previously-reported earnings by $27.4 million over a three-year period due to what it called "accounting errors."

The food franchiser said the restatement boosted earnings for the first three quarters of last year by $3.1 million but pared profits by $21.3 million for fiscal 2001 and by $9.2 million in 2000.

The company had initially warned about possible restatements back in March.

In last week’s exhaustive government filing and accompanying press release, the company said earnings were impacted by at least 22 different issues, including how it treated gains associated with unit conversions, impairment of long-lived assets and post-employment payments to a former officer.

Hidden Gem

While the restatement was the big event in the 10-K, tucked inside was another interesting issue.

AFC also said the Securities and Exchange Commission is looking into a possible violation of Regulation Fair Disclosure (FD).

The company said that on April 30 — more than six months ago — it received from the SEC an informal nonpublic inquiry from the Commission requesting voluntary production of documents and other information, mostly related to the company's announcement March 24 that it would restate its financial results for fiscal 2001 and the first three quarters of fiscal 2002.

"The SEC is also investigating whether the disclosure of certain financial information in November 2002 was in compliance with SEC Regulation FD," the 10-K stated.

According to Dow Jones, the November Reg FD matter could relate to an analysts briefing on Nov. 7, 2002, when it gave analysts a peek at lower earnings guidance hours before webcasting the news. The revised number was in packets of information distributed to those attending the session, the wire service added.

At the time, the SEC said that as a matter of policy it would not have any comment on the matter.

The Questions

These revelations raise other interesting questions.

If the company "received an informal, nonpublic inquiry from the SEC" back in April, why did it wait until December to reveal this development? Shouldn’t the company have revealed the inquiry in an 8-K shortly after it learned about it?

And does this delay put the company in violation of the SEC’s rules regarding 8-K filings, especially if the SEC does conclude there was wrongdoing at the company?

No, say lawyers.

Dallett

"There is no automatic disclosure obligation because the SEC is looking at you," insists Matthew Dallett, partner with the Boston law firm, Palmer & Dodge, who stresses he has zero knowledge of the AFC situation. "That may or may not be material." And anyway, he said, "You don't necessarily have to disclose on Form 8-K just because it's material."

In fact, Dallett points out that there are only three instances when you are required to disclose an event to the public on any SEC form:

If there is a line item requirement on a form;

To correct a prior mistake; or

If there is an historical statement on which the public is still relying that the company has determined is no longer true.

"The fact that the SEC is talking to you is not an 8-K line item disclosure even if it could have a material impact," Dallett explains.

Disclosure

However, MD&A disclosure may be required in the next 10-Q or 10-K if the investigation creates a material uncertainty. Companies may decide to disclose the event voluntarily so that the company or executives may trade company stock without insider trading liability.

Also, if companies voluntarily disclose material information to one person, they must must generally disclose it to everyone (the essence of Reg. FD).

"The stock exchanges do say that you need to disclose material events promptly, but there has always been a sense that there might be legitimate corporate reasons to delay," Dallett says.

Not 8-k?

But, what about the 8-K? Aren't there required disclosures for that document?

Not as many as you might think.

Dallett says companies are only required to reveal nine events on this form. "It's a fairly short list," he notes.

They include:

A change in control;

Acquisition or disposal of a material amount of assets;

A bankruptcy filing;

Change in the independent accountant;

Resignation of a director as a result of a dispute;

A change in the fiscal year;

Release of quarterly or annual earnings;

Amendment or waiver of the company’s code of ethics;

A blackout on trading company stock through a benefit plan.

Changes Coming?

Now, more than a year ago the SEC proposed a long list of additional items that would trigger an 8-K filing.

Not only does the proposal add a long list of new items to be disclosed — including

the loss of a significant customer and a change in a rating agency decision — but it would require the form to be filed within two days of the event occurring (see box at top right).

However, the Commission still hasn't acted that proposal.

"If the new rule is adopted, it would fundamentally change the dynamic," says Dallett. "The list is so long, and the events must be revealed in two days, it would be practically hard to comply."

Regarding investigations, the proposed 8-K rule would not specifically require a disclosure that the SEC is looking at a company. This is likely because the SEC just may be gathering information — the probe may not be significant in some cases, Dallett adds.