As corporations prepare their annual reports for filing with the Securities and Exchange Commission, they’ll notice a number of changes to Form 10-K. While many of the changes are straightforward and easily obeyed, experts say some of the new disclosure requirements may force issuers to spend extra time preparing their filings.
Callori
“Any time there’s any meaningful change to the disclosure process, companies need to make sure they afford a little extra time to address the new issues,” notes Frederick Callori, a corporate lawyer at Choate, Hall & Stewart.
Among other things, new rules adopted late last year modified the filing deadlines for 10-Ks and 10-Qs for certain issuers, and created a new class of “large accelerated filers.” Those issuers—generally defined as issuers with public floats of $700 million or more, which have also been a reporting company for at least one year, have previously filed at least one annual report, and aren’t eligible to use Form 10-KSB or Form 10-QSB—will have shorter filing deadlines for 10-Ks starting with fiscal years ending on or after Dec. 15, 2006.
While issuers shouldn’t have too much trouble determining which filing deadlines apply to them, other new disclosure requirements might be more tricky. In particular, experts say, issuers may need to take time to prepare the new required disclosure of unresolved SEC comments and risk factor disclosures.
Unresolved SEC Comments
Beginning with their 10-Ks for fiscal years ending on or after Dec. 1, 2005, accelerated filers and large accelerated filers must disclose the substance of any material unresolved written SEC comments concerning their Exchange Act filings that were issued more than 180 days prior to the fiscal year-end. Companies can describe their position on any unresolved comments. The start of the 180-day period is the date the SEC originally made the comment.
Callori says companies must carefully consider whether they have any unresolved comments that are material and require disclosure in this year's Form 10-K.
“If issuers conclude a comment is material, they want to be careful to satisfy their 10-K disclosure obligations and explain their side of the issue,” he explains. “It’s delicate balancing act. Companies don’t want to prematurely alarm the market about something that has yet to be resolved, so they need to be careful to make sure their position is understandable in the discussion of the comment and the back and forth with the SEC.”
Creating the disclosure for unresolved SEC comments can be “a time consuming process,” adds Callori.
Smith
Alan Smith, a partner in the corporate practice of Orrick, Herrington & Sutcliffe, says the new disclosure gives the SEC “a big hammer to force issuers to resolve things more quickly.” The prospect of having to provide detail about an unresolved issue with the SEC “forces companies to air their dirty laundry in public, in a way most issuers won’t be desirous of wanting to do,” he says.
Another area that issuers might need time to prepare is a new obligation to disclose risk factors. Beginning with their 10-Ks for fiscal years ending on or after Dec. 1, 2005, all filers other than asset-backed issuers are required to include “plain English” risk factor disclosures in their Form 10-K. Those risk factors must be updated quarterly to reflect material changes.
Companies should assess whether they have any new risk factors that are pertinent and update any old risk factors to make sure they’re current, Callori says. “Issuers that haven’t been in the public markets for some time may not have any risk factors in their 10-Ks. If they haven’t done any public offerings recently, their risk factors may need to be updated,” he says.
Smith notes that while 10-K disclosure wasn’t required before, most issuers already were disclosing risk factors in their quarterly reports. But for those that haven’t been disclosing risk factors, “it’s a significant change,” he says. “Updating the company’s risk factors requires thought and time.”
RULE CHANGES
The excerpt below is from a Choate Hall & Stewart memorandum titled, "Recent Rule Changes Affecting Annual Reports On Form 10-K":
New Disclosure Requirements
Unresolved SEC Comments
Beginning with Annual Reports on Form 10-K for fiscal years ending on or after Dec. 1, 2005, companies that qualify as accelerated filers and large accelerated filers will have to disclose in their Form 10-K the substance of all material unresolved written SEC comments concerning their Exchange Act filings that were issued more than 180 days prior to the fiscal year-end. The beginning of the 180-day period is the date the SEC originally made the comment that has not been resolved. Companies will be able in their Form 10-K to describe their position on such unresolved comments.
Risk Factor Disclosure
Beginning with Annual Reports on Form 10-K for fiscal years ending on or after Dec. 1, 2005, companies that qualify as accelerated filers and large accelerated filers will be required in a new section of their Form 10-K to include “Plain English” risk factor disclosures “where appropriate.” These risk factors are required to be updated on a quarterly basis to reflect material changes.
Tax Shelter Penalties
As a result of the American Jobs Creation Act of 2004, companies are required to disclose whether they have had certain tax shelter penalties assessed against them by the Internal Revenue Service in connection with transactions deemed to be abusive or for tax avoidance purposes. The disclosure is to be included in “Item 3. Legal Proceedings” and must include: (i) the amount of the penalty; (ii) whether the amount has been paid in full; (iii) a reference to the section and subparagraph of the Internal Revenue Code under which the penalty was determined; and (iv) a description of the penalty. These disclosures are required for any penalty that relates to a return or statement for which the due date is after October 22, 2005, and must be disclosed on the Form 10-K for the fiscal year in which the IRS sends notice and demand for payment of the penalty. Failure to disclose the tax shelter penalty as required may result in an additional penalty being imposed (which also would need to be disclosed).
Check-The-Box Requirements
Through various “check-the-box” designations on the cover page of Form 10-K, companies will now be required to indicate whether they are:
A well-known seasoned issuer;
A voluntary filer;
A large accelerated filer, accelerated filer or a non-accelerated filer; and/or
A shell company.
Source
Recent Rule Changes Affecting Annual Reports On Form 10-K (Choate Hall & Stewart)
The SEC has also made a point of letting issuers know that “their preference is that they don’t want issuers to restate risk factors every period,” he adds. “They want issuers to specifically cite any risk factors that have changed, which is a practice that hasn’t been common. That puts the burden on the issuer to identify for investors what’s most important.”
In addition to thinking about whether they face any new risks that previously weren't disclosed, Smith says issuers also need to think about the order and priority of those risk factors. Since their top risk may change from quarter to quarter, companies should consider whether their most important risk is indeed listed first in this particular filing period.
More Checkups
New check-the-box designations on the cover page of Form 10-K require issuers to indicate whether they are a well-known seasoned issuer, a voluntary filer, a large accelerated filer, accelerated filer or a non-accelerated filer, or a shell company. While most of the checkbox disclosures are straightforward, Smith notes that one of the new items has caused some confusion. The way the item related to voluntary filer status is written has created some confusion about which box to check. It reads: “Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.”
“The answer is, if you’re a voluntary filer, you check the yes box,” Smith says.
Another new disclosure item issuers might easily overlook is the disclosure of tax penalties required by the Internal Revenue Service; companies must now disclose any tax shelter penalties assessed against them by the IRS in connection with transactions deemed to be abusive or for tax avoidance purposes. The disclosure is required for any penalty that relates to a return or statement with a due date after Oct. 22, 2005 and must be disclosed in the 10-K for the fiscal year in which the IRS sends notice and demand for payment of the penalty. Failure to disclose such a penalty could result in an additional penalty, which would also have to be disclosed.
While it will only affect a small number of issuers, Smith says the disclosure is a “potential gotcha” simply because issuers may not realize they to have to include the information in their annual report. “It’s unusual in that an agency other than the SEC is mandating disclosure in a 10-K,” he says.
While some of the changes may require issuers to spend some extra time preparing their 10-Ks, Smith notes that one change that will make life easier for some smaller issuers: the ability to exit accelerated filer status more easily.
Any accelerated filer whose public float has dropped below $50 million can now file an annual report on a non-accelerated basis for the same fiscal year that the determination of public float is made. The rules include a similar provision for exiting out of large accelerated filer status for companies whose public float has dropped below $500 million.
“That will be a tremendous opportunity for some companies,” Smith says. “When an issuers exits accelerated filer status, the requirements are less stringent in terms of disclosure and the timing for filing 10-Ks and 10-Qs.”
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