In light of the events of the past several months and
the current state of global financial systems and credit
markets, reporting companies should consult with their
counsel regarding the possible effects of these events
on a company’s disclosure obligations with the United
States Securities and Exchange Commission (“SEC”).
Enhanced or modified disclosure may be required in
a number of provisions of a company’s public filings,
including (i) Management’s Discussion and Analysis
of Financial Conditions and Results of Operations
(“MD&A”), (ii) the risk factor disclosure requirements of
Item 503(c) of Regulation S-K, and (iii) Compensation
Discussion and Analysis (“CD&A”). In addition,
companies should keep in mind the triggering events
of Form 8-K, as there are several items that are more
likely to require disclosure in the current economic
climate. Each of the foregoing disclosure obligations
are addressed briefly below.
Management Discussion & Analysis of Financial
Condition and Results of Operations
Companies are required to provide the MD&A section
in annual reports on Form 10-K, and are required to
disclose “material changes in those items” in quarterly
reports on Form 10-Q. Regulation S-K states that
the MD&A is intended to provide investors with the
information “necessary to an understanding of [a
company’s] financial condition, changes in financial
condition and results of operations.” One of the key
elements of the MD&A is the discussion and analysis
of “known trends, demands, commitments, events and
uncertainties.” This year reporting companies need to carefully
consider their MD&A disclosure based on current
market conditions. This process should include a
consideration of recent events to determine developing
trends that could have a material impact on their results
of operations, liquidity and/or capital resources. Any
such disclosure should be prominently disclosed
and fully discussed. Below is a discussion of certain
developments that warrant particular attention in light of
the current economic environment.
With respect to revenue disclosure, companies should
disclose the possible impact of the economic conditions
on the company’s income. In making such disclosure,
companies should keep in mind the fact that disclosure
requirements applicable to known trends include broadly
applicable developments. For example, though the
economic recession crosses industry lines and affects
the vast majority of businesses, a company must still
discuss this trend in the MD&A, tailoring disclosure to
its business and financial results.
With respect to liquidity and capital resources disclosure,
a company should evaluate its ability to meet upcoming
cash requirements over both the short-term and the
long-term. Given the current environment, merely
stating that a company has adequate cash resources
is probably not sufficient, particularly if there are known
material trends, or uncertainties, related to cash flow,
capital resources, capital requirements or liquidity.
The following are examples of certain items relating to
liquidity and capital resources that may be appropriate
to discuss as a result of the current market conditions:
- the sufficiency of the availability under funding
arrangements, any uncertainty surrounding the
ability to access funds when needed, and any
implications of not being able to access the funds;
- the implications of known or reasonably likely
changes in credit ratings or credit rating outlook,
and management’s expectations with respect to
credit ratings;
- any uncertainty or trends surrounding future
compliance with financial covenants, and the
material implications of a breach;
- the capacity for additional borrowings under the
most restrictive financial covenant, whether there
is otherwise an ability to raise these funds, and
whether this amount is sufficient or insufficient for
current and long-term needs;
- any uncertainties relating to the commercial paper
market, committed and uncommitted borrowings,
cash and securities held at financial institutions,
illiquid investments, future pension funding, share
repurchase programs and dividend payments;
- potential problems collecting accounts receivable
and other amounts due from major customers and
other obligors as a result of bankruptcies or other
circumstances; and
- potential supply chain disruption or other problems
due to the financial difficulties or bankruptcies of
major suppliers.
Risk Factors
Regulation S-K requires companies to provide a
discussion of their risk factors in the Form 10-K and
material updates to those risk factors in the Form 10-
Q. This year, it is likely that a company’s risk factors
will require updating to reflect known or potential
risks relating to market conditions, such as the ability
to access credit markets, compliance with financial
covenants, the sufficiency of unused availability under
financing arrangements and the ability to comply with
continued listing standards. As companies draft MD&A
portions of their periodic reports to reflect current
economic trends (as suggested in the section above),
risk factor disclosure should be revised accordingly.
When preparing this year’s periodic reports,
management should also evaluate the market’s indirect
effect on the company’s financial results and outlook.
That is, management should consider the impact of
current market conditions on the company’s customers
and suppliers and include appropriate risk factors to
the extent such impact does, or could, materially affect
the company’s business.
Compensation Discussion & Analysis
Companies participating in the U.S. Treasury
Department’s Capital Purchase Program under the new
T.A.R.P. framework are subject to certain restrictions
on executive compensation and will need to carefully
review and revise their CD&A information to reflect
these restrictions. |
In connection with the T.A.R.P. laws,
the SEC has focused on the relationship between
incentive compensation and excessive risk-taking by
management that could be detrimental to the company. The SEC has encouraged all companies, not just those
institutions receiving T.A.R.P. assistance, to analyze
their compensation programs and consider how their programs might encourage risky behavior on the part of
management, making changes to avoid it if necessary.
Of course, if these considerations constitute a material
part of compensation policies and decisions for the
fiscal year, they should be discussed in the upcoming
CD&A.
As with the MD&A, companies should also take the
current economic state into account when drafting
this year’s CD&A and discuss the impact it has had
on compensation policies and philosophies. When
drafting the CD&A disclosure, companies should
consider whether outstanding awards or plans have
been modified as a result of the economy, or whether
performance standards or conditions have been waived
or amended. Additionally, companies should discuss,
to the extent relevant, whether the overall compensation
structure has been revised or the elements making up
executive compensation packages have been changed
or are weighted differently than in the past. Finally,
any changes to the processes by which executive
compensation is determined must be addressed in
the CD&A.
Earlier in 2008, the SEC released general guidance on
CD&A disclosure based on its review of last year’s proxy
statements and annual reports that companies should
address in addition to the guidance noted above. The
SEC calls for more analysis of the material elements of
compensation, the reasons for the varying elements
and amounts of compensation and how compensation
programs support companies’ compensation
philosophies and objectives. CD&A disclosure
should also include more discussion of the factors
considered when approving each element of executive
compensation packages and how decisions relating to
one element affect decisions relating to others. After
a thorough analysis of how compensation decisions
are made, a company must explain why it believes the
decisions made are appropriate.
Finally, if performance targets are material to a company’s
compensation program, they must be disclosed unless
the company believes, with good reason, that disclosure
of the targets would cause significant competitive harm.
In such cases, the CD&A must set forth an explanation of
how difficult it is for executives to meet the performance
targets and the criteria for determining target levels.
This explanation should tie the degree of difficulty in
achieving performance targets to the amounts received
for performance levels.
Form 8-K Disclosure Requirements
In this economic climate, companies should keep
in mind whether any form 8-K triggering events have
occurred. The following is a list of certain Form 8-K
items that are most likely to be triggered during these
times:
- Item 1.01: amendment of a material agreement;
- Item 1.02: termination of a material agreement;
- Item 2.01: disposition of a significant amount of
assets;
- Item 2.04: occurrence of a triggering event that
increases or accelerates a financial obligation;
- Item 2.05: costs associated with exit or disposal
activities, including plant closings and reductions
in force;
- Item 2.06: discovery of a material impairment;
- Item 7.01: disclosure of material, non-public
information; and
- Item 8.01: release of other material information
(e.g., material changes to risk factors occurring in
between the filing of quarterly and annual reports).
Form 8-Ks filed under Items 2.04 and 2.06 are less
common than others noted above, but are important
items to monitor given the state of the credit and stock
markets. For example, if an event of default occurs
under long- or short-term debt arrangements or capital
or operating lease obligations, a Form 8-K may be
required pursuant to Item 2.04. In addition, a Form 8-K
under Item 2.06 is required if a company determines that a material charge for the impairment of assets,
such as its securities or goodwill, is necessary.
Companies need to be ever mindful of the Regulation FD
prohibition of selective disclosure of material, non-public
information. Many companies have reported receiving
an increased number of inquiries from concerned
investors and market participants. By giving guidance,
reassuring advice, updates or other facts about the
company’s business in response to such inquiries,
the company may unintentionally be in violation of
Regulation FD, therefore triggering a Form 8-K under
Item 7.01. In light of a rise in investor communications,
companies may wish to update the public with material
information prior to such communications by filing a
Form 8-K under Item 7.01 in anticipation of releasing it
during a private conversation
Conclusion
In this market, companies should approach the
preparation of disclosure documents with a view
toward managing the expectations of shareholders and
providing the public with information that does more
than simply satisfy the requirements of SEC disclosure
regulations. Management should place particular
emphasis on giving the public complete information,
focusing on trends, risks and uncertainties, and avoid
the boilerplate disclosure of the past. More useful,
tailored disclosure will increase the efficiency of an
SEC document review, but more importantly, will help
reduce the chances of SEC enforcement actions and
shareholder suits that rise during a tough economic
climate.
For more information about the content of this article
or assistance in drafting your company’s disclosure,
please contact any of the attorneys listed below. |
