The New 8-K Disclosure Rules Are Far-Reaching

For those who cannot sleep at night as they wrestle with securities disclosure issues (and I know from experience that this is not a farfetched scenario), the Security and Exchange Commission’s new 8-K rules offer no cure for insomniacs.

The new rules, adopted in March and effective Aug. 23, might seem innocuous at first, as just another set in a long line of Sarbanes-Oxley related rulemakings. But after reading the SEC’s March 8-K Release, it begins to look like the new rules, which increase the number of reportable events from 12 categories to 22 categories and impose an accelerated filing deadline for most events of four business days following the triggering event – rather than the old five business days or 15 calendar days – are different than prior SEC rulemakings.

The new rules require quicker and more detailed disclosure of a greater number of events and triggers – enough to make anyone need a sleeping pill!

The SEC is ushering in a completely new era of disclosure. The “chatter” among securities lawyers and informal statements from the SEC suggest that the new rules are among the most important and far-reaching regs of the past several years, perhaps more so than many of the other

Sarbanes-Oxley mandated rule changes.

Rather than rehash the details of the new rules or provide "practical tips," this article will flag several examples of rule nuances that companies will likely confront and that may keep their disclosure lawyers (and executives) up at night. There are many more twists and turns than the length of this article will permit, but I hope that these examples give the reader a flavor of some of the dicey "materiality-determination" and timing issues that are lurking out there.

Executive Employment Agreements As ‘Material Agreements’

Prior to the new 8-K rules, Item 601 of Regulation S-K required and still requires the filing of all employment agreements for "named executive officers," and employment agreements for other executive officers that are material in amount or significance.

Under Item 1.01 of the new 8-K rules, a company must file with an 8-K any material definitive agreement not made in the ordinary course of business. Putting aside the question for now of whether an employment agreement is made in the ordinary course of business, is an executive employment agreement "material"? While for most companies the dollars and benefits paid to an executive are not financially material (which is often how "materiality" is analyzed), isn’t it true that, particularly for senior executives, the terms under which they will be employed by the company, including their responsibilities and possible termination triggers, are material in the context of the company’s future operations?

Even with this different approach to analyzing materiality, it is still a gray area (as with most things subject to the materiality test). However, adding to the confusion is the SEC’s footnote in the 8-K Release suggesting that anything that would have to be filed under Item 601 of Regulation S-K – such as these employment agreements – is something it deems to be material and required to be filed with an 8-K.

A strict reading of the 8-K rules indicates that such employment agreements may not need to be filed, but the SEC’s footnote then implies that they do need to be filed.

Amendments To Agreements

There are several issues that arise from the new requirement that amendments to material agreements be filed on an 8-K.

One issue is that there may be agreements that are not material when entered into, and therefore not required to be filed (including those entered into prior to Aug. 23), but become material upon a later amendment. After Aug. 23, the amendment will have to be filed.

Another issue being discussed is whether a filing is triggered by a change in circumstances that cause a contractual relationship to become material without the contract having actually been amended between the parties. The example often cited here is of an initial contract and purchase order under which a company begins selling product to a customer in an amount not material to the company, but then, over time, the customer increases its purchases in the ordinary course such that the purchased amounts now are material.

The current thinking on this issue (subject to change, of course, based on any forthcoming formal or informal SEC guidance) is that under a technical reading of the rules, an 8-K need not be filed, since the contract was not formally amended. However, assuming this is the case, the question must be asked whether the agreement may still need to be filed with the company’s next 10-Q as an agreement that became material during the fiscal quarter covered by the 10-Q.

Termination Of Direct Financial Obligations

New Item 2.04 requires disclosure of a triggering event that causes the acceleration or increase of a direct financial obligation of the company, and the consequences, if the consequences of the event are material. Whew!

The first trick here is recognizing in the first place that a triggering event has occurred, which may not be so easy. The second trick is making sure to satisfy the SEC’s requirement, which is not in the 8-K rules but, as pointed out by the SEC in the 8-K Release, stems from the general anti-fraud provisions of the securities laws that the disclosure should include any additional information necessary to make the required disclosure not misleading.

This means that companies should consider including discussion in the disclosure of the possible impact and effect the acceleration or increase in the direct financial obligation will have on their financial condition.

Material Charge For Impairments

New Item 2.06 of the 8-K requires disclosure when a company’s board of directors, a board committee, or an authorized officer if board action is not required, concludes that a material charge for impairment to one or more of its assets is required under GAAP.

The scenario might play out like this. An "authorized officer" concludes that a material charge must be taken but needs one or two weeks to determine the amount of the charge. However, since the "conclusion" has been made that a charge is required, the company must file an 8-K within four business days of the determination, even though it does not yet know the amount of the charge.

The SEC recognized that this may occur and permits the company to file the 8-K without citing the actual charge so long as the 8-K is amended later when the charge is known. Companies in this situation, however, will certainly wrestle with the market risk of filing an 8-K stating that a material charge will be taken but not being able to state the amount of the charge, versus filing with a possible range of the charge amount (which, of course, could later turn out to be substantially off, causing, among other things, the Safe Harbor from Section 10(b) and Rule 10b-5 that the SEC has provided for Item 2.06 to not apply).

The lessons to be learned at this still-early stage is that the new 8-K disclosure triggers can be tricky to spot, tricky to analyze, and tricky to implement.

Plus, as has increasingly been the case over the past several years, the rules are not just the rules. What constitutes good disclosure must be gleaned from SEC comments and statements made in the discussion and footnotes of the 8-K Release.

Andrew Merken is a corporate and securities partner at Burns & Levinson LLP in Boston. He can be reached at (617) 345-3740 or [email protected]. For more information on the firm, visit www.burnslev.com.