By Stephen M. Honig
It is almost impossible to keep up with the Securities and Exchange Commission these days.
Below are the highlights of the summer season, and a glimpse at upcoming events, in those areas affecting in-house counsel.
If the SEC has dropped any additional bombshells between press deadline for this article and the moment you are reading it, I can only offer my apologies.
Reporting
Most significantly, the SEC has approved yet another one-year extension for smaller public companies to comply with Section 404(b) of the Sarbanes-Oxley Act. This section requires outside auditors to state whether the company has maintained effective internal control over financial reporting.
This requirement long has applied to larger SEC-reporting companies, but not to non-accelerated filers (with public floats below $75 million).
The SEC has postponed the requirement for auditor attestation to fiscal years ending on or after Dec. 15, 2009 (previously, Dec. 15, 2008). The Commission premised its extension on its fear that non-accelerated filers would incur additional auditor costs prior to it releasing a study on the cost effectiveness of 404(b).
The Commission left untouched the obligation to file management's own assessment of internal financial controls under Section 404(a) of SOX, for annual reports for fiscal years ending on or after Dec.15, 2007.
A technical adjunct permits management reports for non-accelerated filers to be considered as "furnished" with the SEC and not "filed." Filed reports are subject to a high statutory standard for accuracy under the Securities Exchange Act of '34. The SEC was concerned management might provide a report concluding the company's internal controls over financial reporting were adequate, while subsequently the company's auditors could arrive at a different conclusion.
The language of business
The SEC also has proposed a rule, as anticipated in my January column in In-House, to require the electronic filing of financial reports for all registrants, including 10-Qs and annual reports, using XBRL (extensible business reporting language).
XBRL requires computer readable tags to be associated with each number and footnote in the financial statements. When all reporting companies use uniform tags, it becomes possible to generate comparative data concerning all companies in a selected group. This permits more specific analysis of company performance, and places these analytical tools in the hands of the average investor rather than just in the hands of sophisticated securities analysts.
The move to XBRL will be phased in over time. The SEC's action is itself not even final. The Commission has been collecting comments and at press time has yet to offer its final form of proposed regulation. The draft regulation calls for a phased implementation. Beginning in 2009, the 500 largest U.S. companies reporting under GAAP (companies with a public float in excess of $5 billion) will become XBRL compliant for periods beginning on or after Dec. 15, 2008. All other companies would be phased in over a three-year period.
The SEC's draft also urged smaller companies, although not required immediately to comply, to attempt implementation on a voluntary basis (there are already over 70 voluntary XBRL filers).
XBRL is used extensively overseas, and its reach is growing. The accounting profession has expressed some concern about XBRL's interface with accounting standards under the International Financial Reporting Standards, which leads us to SEC action on IFRS.
Death of GAAP?
In December 2007, the SEC released a final rule allowing "foreign public issuers" to use financial statements prepared under IFRS - a system that allows more latitude for professional judgment, and fewer automatic rules and exceptions, than provided in the GAAP standards.
The SEC eliminated a requirement to reconcile IFRS reports to GAAP presentation, so presently numerous offshore filers present financials which are neither GAAP-compliant nor GAAP-reconciled.
There also is general expectation the SEC will mandate IFRS for all U.S. companies.
On Aug. 27, the SEC proposed a plan that would: (i) require all reporting companies to use IFRS in a phased roll-out between 2014 and 2016; (ii) permit large multinationals to switch sooner; and (iii) require several intervening SEC votes to permit the various stages of implementation to proceed.
The proposed plan is currently subject to a 60-day comment period ending at the end of October.
Among proposed preconditions to pulling the trigger on mandatory conversion to IFRS are the narrowing of differences between GAAP and IFRS standards, and the assurance of funding to support the International Accounting Standards Board in London.
IFRS accounting might enhance the competitiveness of U.S. capital markets, particularly since not all foreign issuers are presently eligible to use IFRS in the United States. Many U.S. companies are multinational and are subject to multiple reporting requirements (GAAP compliance in the U.S. and IFRS elsewhere). Adopting IFRS would be advantageous.
A switch to IFRS for a wholly domesticated public U.S. company would not create that benefit. But it has been suggested that smaller domestic companies would experience simplified and less expensive financial reporting using IFRS once initial implementation costs are absorbed.
However, the SEC on Aug. 27 noted that the cost of converting U.S. companies to IFRS would be significant.
It is beyond the scope of this column to analyze differences between GAAP and IFRS, but you should note that accounting for income taxes and inventory valuations are materially different under the two regimes.
Innumerable covenants in agreements of U.S. companies, particularly debt obligations, would have to be revisited if IFRS accounting is implemented, since U.S. lawyers typically draft debt covenants in terms of GAAP accounting.
Death of Edgar?
It is not just GAAP that is at risk of being replaced. The venerable Edgar system - the electronic access to SEC filings that everyone uses to read registration statements, '34 Act filings, proxies, and indeed just about everything that a company files with the Commission - is about to be, if not slain, at least enhanced out of recognition.
On Aug. 19, the SEC announced a "successor" to Edgar that is designed to "give investors far faster and easier access to key financial information...." The system, dubbed "IDEA" for Interactive Data Electronic Applications, at first will enhance but ultimately will replace Edgar.
Basically, in Edgar you call up a company and read its disclosures. If you wish to compare two companies, you look them both up seriatim. With IDEA, you can search the filings of all companies, and can call up by a single query the comparison of the desired information between the two companies (or, indeed, any number of companies).
The system interfaces with XBRL, under which certain filed data will be tagged to permit its retrieval in this fashion.
The press release announcing the adoption of IDEA doesn't discuss the manner in which non-financial data will be tagged or formatted, or whether that tagging will entail ultimate changes in the forms or manner of effecting Commission filings.
The Commission presumably will give us all adequate advance notice for any changes in what we file, and, although the IDEA logo will appear immediately on the SEC website, the transition will allow interactive data filings to be searched through IDEA only later this year.
And as for Edgar? The press release tells us that "investors and others who currently use EDGAR will be able to continue doing so for the indefinite future. During the transition to IDEA, investors will be able to take advantage of new interactive, IDEA-like features that will be grafted onto EDGAR in the short run."
We will all need to train ourselves with these new tools, and whether IDEA will also force a retraining of our filing methods (aside from XBRL for financials) remains to be seen.
Websites
In July, the SEC also promulgated new guidance on "corporate use of websites." This guidance, superseding prior pronouncements, was immediately effective and addresses:
When the posting of information to a website becomes "public" for purposes of company compliance with Regulation FD (the regulation dealing with inadvertent leakage of material, non-disclosed information to a select audience);
Avoiding liability related a company website, including dealing with outdated data, linking to third party information, and handling information in blogs and shareholder forums;
Avoiding formal disclosure rules for information "informally" posted; and
Understanding what information must be "printer friendly."
Shareholder proxies
Finally, this summer an unprecedented procedure played out between the SEC and the Delaware Supreme Court. Shareholder rights activist Lucien Bebchuk, a Harvard Law School Professor and stalwart of the Harvard Corporate Governance Project, crafted a shareholder proposal for a mandatory bylaw requiring the company to pay expenses of a successful short slate of dissident directors.
CA, Inc. (formerly Computer Associates) submitted an "SEC no action" request, seeking to exclude the proposal because it violated Delaware law.
Delaware law (uniquely) now permits the SEC to refer matters to its state Supreme Court. The SEC asked the court about the legality of the proposal.
While upholding the general propriety of shareholder bylaw proposals, the court ruled that this bylaw proposal violated Delaware law because a board should have the discretion as to whether solicitation costs should be reimbursed. No bylaw can require reimbursement, the court said.
There are technical issues presented by this case which may permit proposals of similar bylaw provisions for other companies, even in Delaware, however.
The future
At the August meeting of the American Bar Association, the SEC made it clear that its agenda for the remainder of the year, and 2009, will be quite active.
The SEC is working on a formal guidance pertaining to defining "materiality," and concerning the manner in which erroneous '34 Act reporting is corrected. The Commission is considering the requirement for an executive summary in '34 Act reports. A "roadmap" for IFRS implementation is being considered, along with accounting guidance for '34 Act reports in general.
While not certain, it is likely the SEC will recommend amendments to Regulational D - the much-relied-upon rules which provide a safe harbor exemption from the necessity to register private offerings of securities.
And the Commission is expected to propose guidance based on experiences during the first year of electronic proxy solicitation, perhaps in time for the next proxy season. Finally, the staff will look at the rules relating to reporting of beneficial ownership, a complex issue impacting '33 Act and '34 Act filing compliance.
We are approaching the end of Chairman Cox's tenure in heading the Commission, and three replacement members are being added. Through all this, the Commission's staff has adopted an activist regulatory agenda; at the same time it maintains a vigorous compliance effort.
Reprinted with permission from New England In-House, a bimonthly publication of Dolan Media.
© 2008 Dolan Media, All Rights Reserved.
September 2008 / NEIH
