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.

To be fair, the SEC bulletin does supply a list of good reasons that a misstatement below 5 percent could be considered material — for instance, if it masks an earnings change, transforms a loss into a profit, brings the company into regulatory compliance, or boosts the bonus of top management.

Nevertheless, the abundance of criteria possible under the guidelines could breed widespread corporate confusion. “You can’t have 12 people with 12 different standards” of materiality in a given circumstance, says George Victor, director of accounting and auditing at Reminick, Aarons & Co. Even though rigid numeric cutoff points should be shunned, he advises, “you have to eliminate as much as possible so that everybody is reading off the same page.”

That means managers need to get on the horn with each other if a significant change of corporate fortunes could be in the cards. Even though larger companies tend to have greater technical support and wider expertise, notes Victor, executives who work for them might find it tough to cut through the bureaucracy and make a quick call on materiality. While small companies might have smaller resources, he adds, they’re more likely to be able to “turn on a dime.”

Definitely Maybe

Materiality, however, isn’t the only term in the new triggers that cries out for clarity. The word “definitive” in “material definitive agreement” also needs defining, contends Larry Spirgel, a former special counsel in the SEC’s Corporation Finance Division.

The commission hasn’t yet said if the term refers to a signed contract or a “binding agreement,” according to Spirgel, now a lawyer with Morrison and Foerster LLP. “‘Binding’ is not helpful because it’s vaguer and encompasses a lot more arrangements than companies are comfortable with [disclosing],” he says. One frequently undisclosed agreement is the “no shop” clause common in the early stages of mergers.

The distinction isn’t merely academic. How the term is eventually defined “could have a dramatic effect on how companies disclose mergers,” says Spirgel. What’s more, he thinks, it could change how companies structure merger negotiations. They might well avoid “definitive agreements” — and the need to disclose them in an 8-K.

Another attorney, Christopher Robertson of Seyfarth Shaw LLP, thinks that a misstep in timing the disclosure of a deal could create liability risks for companies. If a company’s stock moves downward as the result of a late disclosure of an arguably material deal, shareholders could sue on the basis that the deal should have been disclosed sooner.

To buy time rather than disclose a deal prematurely — which might trigger a drop in a company’s share price, followed by a lawsuit — Robertson suggests that companies might split deals into definitive and non-definitive parts. Even though strong commitments are better than non-binding ones, a split agreement might be a useful “if there’s a natural break in a contract because part of it is fixed and part of it is proposed,” according to Robertson. That might give a company some breathing room in disclosing the latter part of the deal — or even disclosing the deal at all, if it’s the second part that would make the entire arrangement material. But delays have their risks: If the non-fixed latter part of the deal falls through, resulting in the need to exit from a material arrangement, shareholders could argue in court that the company disclosed too late.


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