Proposed Changes in Corporate and Financial Disclosure

The bankruptcy of Enron and the subsequent indictment of Arthur Andersen LLP have led to the reconsideration of many long-standing rules related to corporate disclosure and the practice of auditors. The current environment virtually ensures that change will take place for almost every public company in how they disclose certain information to the public. The changes could also affect the obligations and liabilities of individuals serving as officers and directors. The following is a short summary of potential rule changes that the Securities and Exchange Commission (the "SEC" or the "Commission") may adopt in light of the recent events. This Legal Alert also briefly discusses the plan put forth by President Bush to change corporate disclosure, as well as items of legislation currently under consideration by Congress.

• SEC Proposals. On February 13, 2002 the SEC announced that it would propose new rules to amend the corporate disclosure system. The SEC indicated that rules would be proposed relating to the following topics: (1) acceleration of insider reporting; (2) acceleration of filing of periodic reports; (3) website disclosure of a company’s SEC filings; (4) additions to the list of 8-K events; and (5) disclosure of critical accounting policies. Since that time, the SEC has indicated that these five topics would be addressed in four separate rule releases.

• On April 12, 2002 the SEC issued two proposed rules related to (1) Form 8-K disclosure of certain management transactions and (2) the accelerated filing of periodic reports and website disclosure.
• Acceleration of Insider Reporting. The SEC is proposing to revise Form 8-K to require a company to report information about (1) directors’ and executive officers’ transactions in the company’s equity securities (including derivative securities transactions and transactions with the company); (2) directors’ and executive officers’ arrangements for the purchase or sale of the company’s equity securities intended to satisfy the conditions of Rule 10b5-1(c); and (3) loans of money to directors and executive officers made or guaranteed by the company or an affiliate of the company (SEC Release No. 33-8090; 34-45742; File No. S7-09-02). Reports relating to loan transactions with an aggregate value of $100,000 or greater would be due within two business days. Reports of transactions and loans with a smaller aggregate value, grants and awards pursuant to employee benefit plans and Rule 10b5-1 transactions would generally be due on the second business day of the following week. Reports of transactions and loans with an aggregate value of less than $10,000 would be deferrable until the aggregate cumulative value of those unreported events for the same officer or director exceeds $10,000.

• Accelerated Filing of Annual and Quarterly Reports and Website Disclosure. The SEC proposed rule changes that would accelerate the filing of periodic reports for certain companies (SEC Release No. 33-8090; 34-45741; File No. S7-08-02). Accelerated filing would only apply to companies: (1) with a public float greater than $75 million as of a date within no more than 60 and no less than 30 days before the end of the company’s last fiscal year; (2) that has been subject to the reporting requirements for at least 12 calendar months preceding the filing of the report; and (3) that has filed at least one annual report previously. For these companies, termed "accelerated filers," the due date for annual reports would be 60 calendar days after the company’s fiscal year end. The due date for quarterly reports on Form 10-Q for accelerated filers would be 30 days after the end of each of the first three quarters of the company’s fiscal year.

• At the spring meeting of the Business Section of the ABA, SEC staff members indicated that two releases are currently being drafted relating to (1) other changes to Form 8-K and (2) MD&A for critical accounting judgments and estimates. While we do not know the final form that these proposed rules will take, the press release indicates that the proposals may include the following.
• Expanded 8-K Filing Requirements. Items that in the future may require the filing of an 8-K report include: (1) changes in rating agency decisions and other rating agency contacts; (2) defaults and other events that could trigger acceleration of direct or contingent obligations; (3) transactions that result in material direct or contingent obligations not included in a prospectus filed by the company with the SEC; (4) offerings of equity securities not included in a prospectus filed by the company with the Commission; (5) waivers of corporate ethics and conduct rules for officers, directors and key employees; (6) material modifications to rights of security holders; (7) a departure of the company’s CEO, CFO, COO or president (or persons in equivalent positions); (8) notices that reliance on a prior audit is no longer permissible, or that the auditor will not consent to use of its report in a Securities Act filing; (9) a definitive agreement that is material to the company (negotiations of agreements would be excluded from this requirement unless and until a definitive agreement is entered into); (10) any loss or gain of a material customer or contract; (11) any material write-offs, restructurings or impairments; (12) any material change in accounting policy or estimate; (13) a movement or de-listing of the company’s securities from one quotation system or exchange to another; and (14) any material events, including the beginning and end of lock-out periods, regarding the company’s employee benefit, retirement and stock ownership plans.

• Critical Accounting Policies. The SEC will also propose amendments to its rules to provide for disclosure of critical accounting judgments and estimates in the Management’s Discussion and Analysis. The proposal may include a full explanation of critical accounting policies, "the judgment and uncertainties affecting those policies, and the likelihood that materially different amounts would be reported under different conditions or using different assumptions." It is expected that this release will codify and clarify SEC guidance from December.

• President Bush’s 10-Point Plan. On March 7, 2002, President Bush announced a 10-point plan to strengthen the disclosure required of public companies. The following summarizes the President’s proposals.
• Plain English Quarterly Disclosure. This proposal requires that investors have access to quarterly information that would allow a company’s financial performance, condition and risks to be evaluated. The SEC would be tasked with ensuring that public companies provide "plain English" disclosure that is fair and accurate.
• Reporting of Critical Events. This proposal would expand the list of events that would require the filing of a Form 8-K.
• CEO Attestation. This proposal would require the CEO of a public company to personally vouch for the veracity, timeliness and fairness of the company’s disclosure, including the financial statements. The CEO will personally attest each quarter that the company’s disclosure is fair and accurate and discloses the information that a reasonable investor should have to make an informed decision.
• Disgorgement. This proposal requires CEO bonuses and incentive-based forms of compensation to be disgorged if accounting statements are restated due to misconduct.
• Loss of Leadership Position. This proposal would allow the SEC to ban individuals from serving as officers or directors of public companies if they engage in serious misconduct.
• Officer and Director Transactions in Company Securities. This proposal requires companies to disclose significant transactions involving the purchase and sale of company stock by officers and directors within two days of execution.
• Limitation on Other Services by Auditors. This proposal would require the SEC to establish guidelines whereby audit committees could prohibit an external auditor from performing any other service to the audit client, if such service would compromise the independence of the auditor. Rules prohibiting an outside auditor from performing internal audit functions for the same client and requiring more detailed disclosure of fees paid to an auditing firm and its affiliates would be created. Additionally, the choice of auditor would be directly reported to the shareholders by the audit committee.
• Accounting Regulatory Board. This proposal would require the creation of an independent regulatory board, under the supervision of the SEC, to develop standards of professional conduct and competence.
• Increased Oversight of the FASB. This proposal requires the SEC to exercise more effective oversight of the Financial Accounting Standards Board to insure its independence and require the prompt promulgation of standards that reflect economic reality.
• "Best Practices" Accounting Standards. This proposal would require auditors to compare a company’s financial controls with the best practices of the industry and to report such findings to the audit committee. The audit committee would then be required to discuss these findings and potential improvements with management, the Board of Directors and the auditor.
• Legislative Initiatives. The following is a summary of three items of legislation that is representative of proposals currently being considered by Congress. Additional legislations is also under consideration at this time. All of the following bills have been referred to committees. Only H.R. 3763 has had hearings at this time.

• H.R. 3763 – The Corporate and Auditing Accountability, Responsibility and Transparency Act of 2002. This bill would, among other things, (1) require the establishment of a public regulatory agency that will review all accountants and certify that a reviewed accountant is qualified to certify financial statements; (2) require that if an auditor provides non-audit services to an audit client, the auditor will no longer be considered independent; (3) outlaw an officer, director or affiliated person of an issuer from taking any action to willfully and improperly influence, coerce, manipulate or mislead any independent public or certified accountant engaged in the performance of an audit of such issuer for the purpose of rendering such financial statements materially misleading; (4) require the real time disclosure of certain information regarding the financial condition of the issuer; (5) require the electronic disclosure of insider and affiliate transactions; (6) prohibit insider trading during pension black-out periods; (7) require more in-depth disclosure of off-balance sheet transactions and related party transaction; and (8) require a review of corporate governance practices.
• H.R. 3818 – Comprehensive Investor Protection Act of 2002. This bill would, among other things, (a) prohibit the rendering of certain non-audit services by an issuer’s auditors; (b) require the rotation of an issuer’s auditor every four years; (c) make changes to certain audit committee governance practices; (d) make it illegal for any officer, director or affiliated person of an issuer to take any action to unduly or improperly influence, coerce, manipulate or mislead any independent public or certified accountant in the performance of an audit of the financial statements of the issuer; (e) create a public accounting regulatory board; (f) prohibit insider trading during pension fund blackout periods; (g) create rules that provide for greater disclosure of off-balance sheet transactions and related party transactions; (h) require issuers to provide timely information with respect to significant events and trends, including among other things, known and reliable financial information through each fiscal quarter, known trends in an issuer’s business that would be material to investors and assessments of developments during and between fiscal quarters and the factors that may have modified prior forecasts or otherwise changed preliminary financial results that the issuer may have provided; (i) require the establishment of a risk rating system whereby the SEC will assign issuers a risk rating to determine the frequency of SEC reviews of the issuer’s periodic reports; (j) electronic disclosure of affiliate transactions; (k) provide for auditor joint and several liability under the Exchange Act under certain circumstances; (l) restore aiding and abetting liability under the Private Securities Litigation Reform Act; and (m) make it illegal for an accountant to knowingly and willfully to destroy records created in connection with any audit, review or engagement of an issuer for a period of seven years.
• S. 2004 – Investor Confidence in Public Accounting Act. This bill, among other things (a) require the designation of an independent accounting board; (b) prohibit the rendering of certain types of other services by auditors and the adoption of certain enhance requirements regarding auditor independence; (c) require the mandatory registration of public accounting firms; (d) make it unlawful for any officer, director or affiliated person of an issuer to take any action to willfully and improperly influence, coerce, manipulate or mislead any registered independent public accounting firm engaged in the preparation or issuance of an audit report for the purpose of rendering any such audit report materially misleading; (e) require enhanced disclosure regarding related party transactions; and (f) require electronic disclosure of affiliate transactions.

In conclusion, it appears certain that the events surrounding the bankruptcy of Enron and the subsequent indictment of Arthur Andersen will lead to changes in the responsibilities of public companies and their officers and directors to shareholders and the market in general. Both the executive and legislative branches have responded quickly to the concerns raised by these events. It seems inevitable in the environment created by Enron that some change will take place. It remains to be seen, however, just how significant the changes will be.

We will continue to monitor all of these issues very closely and will provide updates of important developments. The Chair of our Securities Practice Team, W. Randy Eaddy is serving on the Business Advisory Group to a Congressional Committee that is working on initiatives to produce certain of these changes. We would be pleased to discuss any of the issues presented in this Legal Alert with interested readers.