Year 2000 Law Bulletin: A New Interpretive Release by the SEC Regarding Disclosure of Y2K Issues by Public Companies

In the SEC.s July 29, 1998 Interpretive Release ("July 1998 Release") regarding Year 2000 disclosure obligations of public companies, the SEC explained that it expected virtually all companies to address these issues in the MD&A sections of 10-Q and 10-K filings with the SEC.¹ The July 1998 Release also explained that for disclosure to be meaningful, companies for which Year 2000 issues presented a material event or uncertainty had to address four categories of information: state of readiness; costs; risks and contingency plans.²

The SEC recently published a new interpretive release, which became effective on November 9, 1998 ("November 1998 Release")³ The November 1998 Release provides additional information . in the form of responses to "frequently asked questions" . clarifying the SEC.s position on several key issues raised by the July 1998 Release. In particular, it addresses the following issues:

• Can a company comply with the July 1998 Release.s guidance if it does not respond to every issue described in the Release?

The November 1998 Release indicates that the applicability and level of disclosure required depends largely on the time at which disclosure is made and the facts and circumstances unique to each company. The SEC explains that the July 1998 Release should not be used as an exhaustive "checklist." It reiterates that companies "for which Year 2000 issues present a material event or uncertainty . . . have to address" the following subjects in order for their disclosure "to be meaningful": state of readiness; costs; risks; and contingency plans. The SEC adds, however, that "[t]he level of detail that a company provides under each category depends on each company.s facts and circumstances" and "may vary over time."

• Under the "cost" category, what should be included as a Year 2000 cost?

The July 1998 Release required disclosure of both historical and estimated costs of remediation. The November 1998 Release explains that although costs will vary for each public company, some typical costs to include are those associated with professional advisors, purchases of software and hardware and the direct costs of internal employees working on Year 2000 projects. In situations where the internal cost is unknown, this should be disclosed. Where the company has some record of the internal costs, disclosure of the type and amount of known costs should be made, in addition to the types of internal costs incurred, for which the company cannot determine an amount.

• Under the "risks" category, what level of detail should a company include in its "most reasonably likely worst case scenario?"

The November 1998 Release explains that companies must disclose "potential consequences that they believe are reasonably likely to occur." The SEC explains that this is intended to elicit disclosure "of the impact on a company if its systems, both information technology and potential non-information technology do not function" and the company "has to implement its contingency plan."

The SEC provides the following guidance to clarify this. First, if a company is uncertain about the Year 2000 readiness of a supplier and has a contingency plan to stockpile inventory, "then disclosure of this potential consequence and its costs are required." Second, companies "need not address all possible catastrophic events, including failure of the power grid or communications, unless a company becomes aware that a material disruption in these basic infrastructures is reasonably likely to occur." Third, "if a company is unable to obtain assurances" relating to a "material and significant relationship".such as a key supplier of raw materials ."a statement to that effect should be made."

• What is an example of a good Year 2000 disclosure?

Despite numerous requests, the SEC has declined to prescribe a particular disclosure or disclosure format, for fear of establishing a boilerplate template which would displace the use of more diverse disclosures which reflect the varying circumstances each company (and industry) faces. The November 1998 Release explains that meaningful disclosure should be made by taking the facts and circumstances of the company into account and "by closely reading the Release and the existing rules and regulations that the Release interprets." Although there are no clear templates for a company to follow, the importance of Year 2000 issues has prompted the SEC to add that it may provide a range of sample filings in the near future, as an illustration of how companies should follow the SEC.s guidance. The SEC has indicated that it will soon submit a report to Congress on the adequacy of disclosures.

Both the SEC and legislators continue to monitor the adequacy of these public disclosures. In particular, Senator Bennett, chairman of the Special Committee on the Year 2000 Technology Problem, expressed concern about these disclosures in a recent letter to the SEC, and asked the Commission what steps it plans to take against companies that fail to make proper disclosures.

These issues will receive even greater attention as the millennium approaches. The SEC has made clear that the content required in Year 2000 disclosures will evolve over time (for example, additional detail about contingency planning may be required as January 1, 2000 draws near). Several securities lawsuits have already been filed based on allegedly misleading disclosures about Year 2000 matters, and litigation of this kind will become much more prevalent over the next few years. Accordingly, companies must continue to exercise care in addressing Year 2000 issues in securities filings and should monitor filings by similarly situated companies in order to understand the "state of the art" in making these disclosures.

Footnotes:

¹ Statement of the Commission Regarding Disclosure of Year 2000 Issues and Consequences by Public Companies, Investment Advisers, Investment Companies, and Municipal Securities Issuers, SEC Release No. 33-7558 (July 29, 1998).

² The SEC.s First Release is analyzed in Heller Ehrman White & McAuliffe.s September 1998 Law Bulletin, The Year 2000 Problem: SEC Interpretive Release Regarding Disclosure of Year 2000 Issues. This can be accessed on the firm.s web site, http://www.hewm.com.

³ Frequently Asked Questions About the Statement of the Commission Regarding Disclosure of Year 2000 Issues and Consequences by Public Companies, SEC Release No. 33-7609 (eff. Nov. 9, 1998).