The Reality of Real-Time Reporting

New, superfast 8-K rules under the Sarbanes-Oxley Act could spawn problems with mergers, loan covenants, and share prices. Needed: a solid risk-management plan.

The other new material events that should trigger filings are:

• The creation of a direct financial obligation, including long-term and short-term debt and capital-lease commitments, or an off-balance-sheet arrangement.

• The acceleration or increase of a direct financial obligation or an off-balance-sheet arrangement.

• Costs incurred during an exit from a business or disposal of an asset.

• Impairment of assets.

• Notice of a delisting.

• A decision that previously issued financial statements or audit reports can no longer be relied on.

The huge expansion of the kinds of events that must be revealed — and in a narrower timeframe, no less — signal the upwelling of a sea change in financial reporting, some feel. In its release accompanying the new rules, the SEC itself suggests that they’re part of a transition “towards a system emphasizing current reporting.” Former SEC chairman Harvey Pitt, now head of business consultancy Kalorama Partners, foresees a change from the current “backward looking” system of reporting. Pitt proposes a dual-level system that would include 10-Qs and 10-Ks as they exist today along with disclosure of current information, such as sales trends.

But the new real-time regime could boost a company’s risk exposures if its reporting goes awry, say attorneys and accountants. Among the potential perils: Temporarily breached loan covenants could suddenly be brought to light; promising mergers could fall by the wayside; and shareholders could sue if they learn, via an 8-K, that a company had previously been sluggish about reporting a previous mishap.

All those risks might well force a change in mindset among executives, according to Anne Swaller, practice director of Parson Consulting. Under Section 409, they might well find themselves looking at dozens of events every day, observes Swaller, and asking the same question again and again: “Is this a reportable condition?”

Is This Anything?

One big problem that executives encounter when they decide which items to report is figuring out what “material” means in the context of a given corporate event. In a staff bulletin on the subject the SEC issued in 1999, the commission spelled out the definition in purposefully broad terms: An event is material “if there is a substantial likelihood that a reasonable person would consider it important.”

Further, the SEC sharply curbed the use of “rules of thumb” — like 5 percent of net income or earnings per share — as gauges of how big a misstatement must be before reporting it is required. While such guidelines could be used as a first step in figuring out what to report, executives and auditors must “consider all the relevant circumstances” in evaluating what’s material, asserted the commission.

That leaves companies with a lot of latitude — and little guidance. Without clearly defined rules, joked Tom Manley, the CFO of software maker Cognos Inc., companies would do well to simply follow a “newspaper test.” To judge whether an event could have a material impact on corporate finances, he said, executives should ask themselves: “If it’s reported in the newspaper the next day, would you be embarrassed?”

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