The new rules apply to public companies with fiscal years ended after June 30, 1998 or quarters ended after August 4, 1998. For many of you, this means your 10-K due September 29th or your 10-Q due November 14th.
When is disclosure required?
The SEC's release requires Y2K disclosure if:
- a company's assessment of Y2K issues is not finished, or
- its management believes Y2K issues would have a material effect on business, results of operations, or financial condition. Management's efforts to avoid negative effects should not be considered in determining whether this condition is met.
Public companies typically make Y2K disclosure in their MDA because of the prevalence of computers and embedded technology in their business, as well as that of their customers, vendors and suppliers (including banks, insurance companies, communications carriers, etc.). Companies should consider the potential for a "domino effect": if a third party's lack of preparedness has an adverse impact on the company, the company may in turn not be able to meet obligations to other third parties. Technology companies are at additional risk if their own products are not Y2K compliant.
If you cannot clearly state that you - and all of your material customers, suppliers, vendors and other connected third parties - are Y2K compliant, you should assume that you will not be Y2K compliant. Absent written representations from third parties that they will be Y2K compliant, the SEC believes you should assume such third parties will not be ready, and evaluate the overall effect of that on your business, results of operations and financial condition.
If disclosure is made, what should you disclose?
If disclosure is made, the SEC expects to see full, fair and specific (i.e., quantifiable) disclosure of the company's:
- state of readiness - this detailed description should be similar to what your Board would expect, including answers to questions such as "will we be ready?" and "how far along are we?"
- historical and estimated costs to address Y2K issues
- risks of Y2K issues - the most reasonably likely worst case scenario
- contingency plans - how would you handle the most reasonably likely worst case scenario?
The release provides (on pages 9 through 11) very detailed examples of what the SEC thinks should be disclosed. These examples are considerably more detailed than most Y2K disclosures this firm has seen.
Other considerations
The release also makes clear that Y2K disclosure may be needed in financial statements and under other SEC rules (e.g., such as in a company's descriptions of business, material contracts, risk factors and legal proceedings).
Additionally, most Y2K disclosure relates to future events or contingencies. To obtain safe harbor protection for material forward looking statements, meaningful cautionary statements (not "boilerplate") should be included in your safe harbor disclaimers.
Plain English
On September 4, 1998, the SEC posted its new Plain English rules (77 pages), and a related Staff Legal Bulletin (10 pages in Q&A format) on its web-site (www.sec.gov). We can also provide you with a copy of these documents. All 1933 Act filings first made after October 1, 1998 must follow these new rules. This includes prospectus supplements under Rule 415(a)(1)(x) and post-effective amendments filed to include the latest annual audited financial statements or to update the prospectus under Section 10(a)(3).
What is Plain English?
The Plain English Rules apply to the organization, language and design of:
- front and back cover pages - there are very specific changes relating to how the cover pages should look and what the legends must say. Much of the traditional cover page information has been moved to the body of the prospectus.
- summary - a summary is required if the information in the prospectus is lengthy or complex. It should only highlight key aspects of the offering.
- risk factors - must be concise, logically organized, and specific to your company and your offering
Remember that an SEC rule has always required the entire prospectuses to be written in "clear, concise and understandable" language. We now expect the SEC actually to enforce this rule.
The six Plain English principles are:
- short sentences
- definite, concrete, everyday words
- active voice
- use bullets, tables, graphs and charts wherever possible, especially for complex material
- no legal jargon or highly technical business terms
- no multiple negatives
The "clear, concise and understandable" rule requires the entire prospectus to:
- present information in clear, concise sections, paragraphs and sentences
- use descriptive headings and subheadings
- avoid glossaries and defined terms
- avoid legal and highly technical business terminology
Do your 1934 Act filings need to comply with Plain English?
While the Plain English rules do not apply to 1934 Act filings, they may impact your 1934 Act filings. For example, if the SEC reviews an S-3 registration statement incorporating your 1934 Act documents by reference, it will require risk factors in the 1934 Act documents to be in Plain English. You should consider whether to voluntarily make these changes. Your shareholders will also appreciate some consistency in the two types of disclosure documents.
Could you be exposed to additional liability?
Many lawyers believe that increased liability will result from prospectus simplification, especially since this new type of disclosure has not been tested in court. On the other hand, the SEC believes that prospectus simplification will reduce liability by:
- managing shareholder expectations about risks and rewards
- deterring and making it easier to detect inconsistent statements by brokers or in sales literature
- reducing potential for mistakes and inconsistencies
The following simplification procedures could reduce risk by making the prospectus easier to read and understand:
- shorter sentences, active voice, everyday words, no multiple negatives
- describe risks in plain language
- tables, bullet points and diagrams to explain and clarify complex information
- more logical organization
- attractive graphic design with lots of white space
- more important topics earn more space, and vice versa
- one main topic to a page (or two page spread) - don't wrap disclosure
- eliminate repetition