Apart from their potential for wreaking havoc on mergers, real-time reporting requirements could generate bad news about a corporation’s borrowing arrangements. Indeed, the violation of the terms of a significant loan covenant can be a reportable event under the new rules, notes Victor. Such a disclosure could hurt the company’s share price or harm investor confidence in management, he says.
Before the advent of Section 409, a company had elbowroom to be in temporary breach of the debt-to-equity ratio or similar requirements in a lending covenant. Although the company might be in technical violation of the loan, it had until the end of the quarter to buy a waiver from the lender. That would enable the borrower to maintain the loan rather than pay it off on an accelerated basis.
Now, however, a company might not be able to get a waiver quickly enough to avoid disclosing the covenant breach in an 8-K, according to Victor. To avoid such perils, he advises, executives need to keep a sharp, continuous eye out for breaches of the ratios in their loan agreements.
Better Late Than Inaccurate?
On a more personal level, the pressures imposed by real-time reporting can add to the legal liabilities of finance chiefs and their bosses. As part of the Section 302 certification of financials by CFOs and CEOs, the executives must attest that they’ve installed adequate disclosure controls. But if the company files an 8-K late, “is that a sign that their disclosure controls are ineffective?” asks Spirgel. Tardiness might make investors question a company’s competence in getting material information up to the C-suite swiftly enough, he explains — and lawsuits against officers and directors as well as the company itself might follow.
Yet while the risks of Section 409 could be formidable, few companies are up to snuff in managing them, say compliance experts. The main reason for the lag is that their compliance focus has been on Section 404, which compels CFOs and CEOs to sign off on the adequacy of internal finance controls. Further, companies are in the midst of phasing in speeded-up periodic reporting strictures: By the end of 2005, companies will have only 60 days beyond the end of their fiscal year to file their 10-K, compared with 90 days in 2002. “Most organizations right now are concentrating on 404,” says Swaller, “so there’s been a little neglect, quite frankly, of 409 and accelerated reporting dates.”
What can executives do to manage the risk of being caught by surprise by one of 409′s “material” events? The most obvious step might simply be to file late and take the time to make the needed adjustments. While late filing might spur doubts about a company’ disclosure controls, the downside of filing an inaccurate 8-K could be much worse, according to Spirgel.
Under a safe-harbor provision in the new rules, in fact, the SEC gives late filers a bye until the end of their current reporting period. In an earlier commission proposal, seasoned issuers of stocks and bonds would have had to file an S-1 form — a long form normally used by first-time issuers — if they came in with a late 8-K. “If you used an S-1 every time you had material information, you would have to stop selling and amend the registration,” adds Spirgel. “It would have made trading in public markets very difficult.” Under the new rules, a late filing won’t cost a company its eligibility to file an S-2 or S-3 short form when it raises capital. In contrast, there’s no protection for incorrect reporting.