A number of new disclosure items go into effect before the end of the year, which some experts suspect may have gone unnoticed because they are not exactly earth-shattering.
Littenberg
“I think a lot of people are not aware of this stuff,” asserts Michael Littenberg, partner with Schulte Roth & Zabel in New York City. That’s partially because none of the deadlines pertain to issues as high-profile as stock option expensing or internal control over financial reporting. In addition, at least one of the new requirements is being mandated not by the Securities and Exchange Commission or even one of the stock exchanges, but by the Internal Revenue Service.
Under the American Jobs Creation Act of 2004, companies must disclose in either their 10-K or 10-KSB (for small businesses) penalties imposed on them—or one of their consolidated subsidiaries—by the IRS for failing to satisfy tax disclosure requirements regarding "reportable transactions." That’s according to an update by the law firm of McGuire Woods, which explains that, in general, "reportable transactions" are transactions that have been identified by the IRS as inherently abusive.
The disclosure is effective for any penalty that relates to a return or statement due after October 22, 2005. According to the law firm, failure to disclose a penalty results in another penalty of $200,000, which in turn gives rise to an additional disclosure obligation.
According to another report published by Cydney Posner of Cooley Godward, a public company must disclose the penalty on the 10-K that relates to the fiscal year in which the IRS sends the company notice and demand for payment of the penalty, or—if the company pays the penalty in full prior to being sent notice and demand—the fiscal year in which the penalty is paid. If the company fails to make the required disclosures, the disclosure must be made on the next 10-K until the disclosure is made.
Interestingly, attorneys say this may be one of the first disclosure requirements mandated by an agency other than the SEC or an exchange. As a result, they are not sure who would actually enforce this disclosure, since it was not mandated by the SEC.
“It’s kind of an odd thing,” concedes B. Michael Jones, a partner with McGuire Woods, adding that this rule will not impact many companies. “It’s not clear who enforces it.”
“This is an atypical circumstance,” adds Littenberg at Schulte Roth & Zabel. He says it remains to be seen whether the SEC will be looking for this disclosure when it conducts reviews of filings, which must be performed every three years on a rotating basis. “This is one that is hard to police except through cooperation between the SEC and IRS, or if a problem comes to the attention of the plaintiffs bar.”
The SEC did not respond to requests for comment.
Quarterly Updates On Risk
A few other disclosures requirements are mandated by the new rules stemming from the reform measures related to IPOs and offering securities. These provisions go into effect on December 1, 2005.
First, all companies will be required to include in their 10-K a risk factor discussion. This doesn’t just apply to newly public companies, but existing companies as well, including the oldest, bluest chip companies like IBM and GE. “Many of them did it voluntarily [until now],” Jones points out.
And experts note that the disclosures will not be simple, boiler-plate language. Littenberg figures some of the largest companies could wind up devoting as many as 15 pages discussing as many as 30 risk factors.
A client alert from the law firm of Bingham McCutchen explains that companies affected by the requirement should use the standard for risk factor disclosure for Securities Act registration statements found in Item 503(c) of Regulation S-K, which requires that the discussion does not present risks that could apply to any issuer or any offering. “Explain how the risk affects the issuer or the securities being offered,” it notes.
In addition, companies must provide quarterly updates of the risk factor discussion if there is a material change. “This is now another drill that management and counsel must go through every quarter,” Littenberg explains. “This is a fair amount of work for the people involved—it requires time and thought.”
Unresolved Comments
Also starting Dec. 1, certain affected companies must disclose whether they have pending, unresolved SEC comments on their filings. The requirement impacts “accelerated filers” and the newly-defined category of Well-Known Seasoned Issuers, according to Bingham McCutchen.
These filers must disclose in their 10-K any written comments that the SEC staff made in connection with a review of reports that the issuer believes are material, were issued more than 180 days before the end of the fiscal year covered by the annual report, and remain unresolved as of the date of the filing of the Form 10-K or Form 20-F, the law firm elaborates.
“The disclosure must be sufficient to disclose the substance of the comments,” it explains. “Staff comments that have been resolved, including those that the staff and issuer have agreed will be addressed in future Exchange Act reports, do not need to be disclosed. Issuers can provide other information, including their position regarding any such unresolved comments.”
According to Littenberg, the SEC is using the rule to encourage companies to close out their comments. “They don’t want them drawn out,” he explains. He says that open comments tend to be accounting-related. “So, in an ideal world, this gets the comments cleared,” he adds.
Voluntary Filers And WKSIs
Also beginning Dec. 1, companies that are voluntary filers will now be required to check a “yes or no” box that will appear on the 10-K, 10-KSB or 20-F, for foreign private issuers. In most cases, voluntary filers are issuers that have, at some point, completed a registered offering and have continued to file periodic reports even after their reporting obligation has been suspended, Bingham McCutchen explains.
Under Section 15(d), companies must file a 10-K and other periodic reports for the year in which it made a registered offering. That section suspends the filing requirements if the company has fewer than 300 holders of record of the class of securities that created the obligation. However, the law firm points out that some companies continue to file voluntarily even though they are not required to do so. “The SEC adopted this new requirement because it felt it important that the public know that certain issuers are not required to continue to file Exchange Act reports and may cease doing so at any time, for any reason, without notice,” it adds.
Also beginning Dec. 1, issuers must disclose on the cover page of their 10-K whether they fall within the newly created definition of well-known seasoned issuer. Again, this is a “yes or no” box.
On August 22, companies were required to check a similar box indicating whether they are a shell company.
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