New Disclosures for Annual Reports for the Fiscal Year Ended December 31, 2003, and Proxy Statements for the 2004 Proxy Season
 
January 26, 2004
 

Accelerated Filing Deadline

The 2004 10-K and proxy season is now upon us. Under the accelerated filer rules adopted by the SEC in 2002, companies that indicated they were “accelerated filers” in their 2002 Form 10-K must file their Form 10-K for fiscal years ended on or after December 15, 2003, within 75 days after year-end. This accelerated filing deadline applies only to companies (other than small business issuers) that have equity securities listed on a national securities exchange or Nasdaq. Small business issuers and reporting companies that have only publicly traded debt outstanding continue to be subject to a 90-day filing deadline.

Reporting and Disclosure Obligations

Like last year, annual report and proxy statement reporting and disclosure obligations for public companies have changed this year as a result of the Sarbanes-Oxley Act of 2002 (the S-OX Act) and SEC rules promulgated under the Act. This year, however, annual report and proxy statement reporting and disclosure obligations also have been impacted by:

(i) new corporate governance standards and disclosure rules recently adopted by the national securities exchanges and national securities associations[1]

(ii) new SEC rules relating to nominating committee functions and security holder communications with directors

(iii) new SEC MD&A interpretive guidance

In view of the heightened sensitivity of regulators and shareholders, it is essential that all public companies fully understand and comply with the new disclosure obligations and MD&A guidance. It is clear that the SEC, SROs, shareholders and watchdog agencies will be carefully reviewing upcoming annual reports and proxy statements to ensure compliance with the new standards. In addition, experience during 2003 revealed that the staff of the SEC has become aggressive in requiring prompt amendments to annual and other periodic reports if a company’s disclosures did not comply with applicable requirements. It can be expected that this trend will continue in 2004.

Set forth below is a summary of the additional or revised annual report and proxy statement disclosure obligations applicable to domestic reporting issuers[2] (other than investment companies) resulting from the new SEC, NYSE and Nasdaq requirements.[3] A memorandum containing a more detailed review and analysis of these items can be found on the Holland & Knight Web site at http://www.hklaw.com/content/whitepapers/proxymemo.pdf

• Majority of Independent Directors. Subject to certain limited exceptions, all companies listed on the NYSE or quoted on Nasdaq are required to have a majority of independent directors on their boards by the earlier of (i) their first annual meeting after January 15, 2004 and (ii) October 31, 2004. Boards of directors must now make affirmative determinations regarding each director’s independence under the revised definitions adopted by the NYSE and Nasdaq, as applicable, and disclose those determinations in the company’s proxy statement. Companies must also disclose reliance on certain permitted exceptions to Board or Board committee independence requirements. These new director independence standards may affect the composition of a listed company’s entire board of directors as well as its audit, nominating and compensation committees.
  
• Additional Audit Committee Disclosures. New Exchange Act Rule 10A-3 mandates that virtually all companies whose securities trade in the U.S. comply with certain minimum standards regarding the composition and functions of their audit committees, including the independence of all audit committee members. For this purpose, independence is determined not only under the revised director independence listing standards applicable to the company but also pursuant to the definition of “independent” set forth in Exchange Act Rule 10A-3. At the same time it adopted Rule 10A-3, the SEC amended its disclosure requirements to provide that information regarding an issuer’s audit committee that was previously required in a proxy statement for the election of directors (including a statement regarding the independence of all members) must be also provided in the issuer’s annual report filed with the SEC. Additional disclosures are now required regarding policies and procedures related to the approval of audit and permitted non-audit services and by issuers that rely on certain permitted exemptions from the minimum standards of Rule 10A-3. For companies listed on the NYSE, if an audit committee member serves on the audit committee of more than three public companies, and the issuer does not limit the number of audit committees on which its audit committee members serve, then in each case (i) the board must determine that such simultaneous service would not impair the ability of the member to serve effectively on the company’s audit committee, and (ii) the issuer must disclose this determination in its annual proxy statement (or, if the issuer is not required to file a proxy statement, in its Form 10-K).
  
• Audit Committee Financial Expert. Domestic reporting issuers must now disclose in their annual reports whether their board of directors has determined that the issuer’s audit committee has at least one member who is an “audit committee financial expert” as defined by the SEC. If not, the issuer must provide reasons why it does not have an audit committee financial expert. Issuers are required to disclose the name of the audit committee financial expert and whether the expert is independent. Independence is determined pursuant to the revised independence definitions referred to above, which, for purposes of audit committee requirements, also require that the director be "independent" as defined in Exchange Act Rule 10A-3.
  
• Fees Paid to Auditors. Under revised rules, an issuer must now disclose fees paid to its outside auditor under the following four categories for each of the last two fiscal years:

(i) audit fees

(ii) audit-related fees

(iii) tax fees

(iv) all other fees

For the latter three categories, an issuer also is required to include a description of the nature of the services and the percentage of those services to which the audit committee applied the de minimus exception to the audit committee pre-approval requirements. The former category of “financial information technology consulting fees” (which are now prohibited under the auditor independence rules) was eliminated.

• Nominating Committee Composition, Process and Procedures. Under new SEC rules, a company must now make the following disclosures in its proxy statement regarding its nominating committee:

(i) whether it has a nominating committee (and the name of its members) and, if not, why not, and who makes nominating decisions in the absence of such a committee

(ii) the nominating committee charter, if any, must be made available to security holders, either by placing the charter on the company Web site or by including a current copy of the charter as an appendix to its proxy statement at least once every three years

(iii) whether members of the nominating committee satisfy the “independence” requirements set forth in the listing standards applicable to the company

(iv) whether the nominating committee considers candidates for director nominees put forth by security holders, and if so, the procedures to be followed by security holders in submitting recommendations

(v) if the nominating committee does not have a policy concerning the consideration of candidates recommended by security holders, the basis for the board of directors’ position that it is appropriate for the nominating committee not to have such a policy

(vi) the nominating committee’s process for identifying and evaluating candidates to be nominated as directors.

(vii) any minimum qualifications for nominating committee-recommended nominees

(viii) whether the company pays any third party a fee to assist in identifying and evaluating nominees

(ix) whether the nominating committee has rejected a candidate recommended within the preceding year by a beneficial owner of more than 5 percent of the company’s voting common stock

(x) the category of persons or entities (i.e., security holder, non-management director, chief executive officer, other executive officer, third-party search firm or other specified source) that recommended each director nominee approved by the nominating committee for inclusion in the company’s proxy statement (other than nominees who are executive officers or who are standing for re-election)

• Security Holder Communications with Directors. Under new SEC rules, a company must disclose in its proxy statement whether or not the board of directors has a process for security holders to send communications to directors and, if not, the basis for the view of the board of directors that such a process is inappropriate. If the company has such a process, the proxy statement must include (i) a description of the procedures by which security holders may communicate with the board of directors or specified individual directors, and (ii) if such communications are screened, the process for determining which communications will be relayed to the board of directors, unless that process has been approved by a majority of the company’s independent directors. A company must also disclose any policy it has with regard to director attendance at annual meetings as well as the number of board members who attended the prior year’s meeting. Alternatively, the company can post the information set forth in the previous two sentences on its Web site and provide in its proxy statement the Web site address where this information can be obtained.
  
• Codes of Ethics and Codes of Business Conduct. Domestic reporting issuers must now disclose in their annual reports, either directly or through incorporation from their proxy statements, whether they have adopted a written code of ethics. The code of ethics must meet specified standards and must apply to the issuer’s principal executive officer, principal financial officer, principal accounting officer or controller, or persons performing similar functions. If the issuer has not either adopted a code of ethics or amended an existing code of ethics to satisfy the requirements of the rules, it must state why it has not done so. An issuer must make its code of ethics publicly available either by filing a copy of its code as an exhibit to its annual report, posting the text of its code (or the relevant portions) on its Web site, or undertaking in its annual report to provide a copy of its code to any person without charge upon request. If an issuer chooses to post the code of ethics on its Web site, it must disclose its Internet address and intention to provide disclosure in this manner in its annual report. Similarly, if an issuer intends to use its Web site as the method of disclosing amendments to and waivers of its code of ethics, the issuer’s Internet address and intention to so disclose these events on its Web site also must be set forth in its annual report. In addition, NYSE-listed companies must disclose in their annual reports that the new required code of business conduct and ethics for directors, officers and employees is both available on its Web site and in print to any shareholder upon request. While Nasdaq-listed companies must also adopt a code of business conduct, the Nasdaq rules do not contain a similar disclosure requirement.
  
• Other NYSE and Nasdaq Requirements. The NYSE requires companies to disclose in their proxy statements (i) the name of the director, if any, chosen to preside at required executive sessions of non-management directors or, alternatively, the procedures by which a presiding director is selected; and (ii) the method by which interested persons can communicate directly with the presiding director or the non-management directors as a group. In it annual report, NYSE-listed issuers must disclose that the required corporate governance guidelines as well as the charters of at least its audit, compensation and nominating committees are available on its Web site and available in print to shareholders upon request. Finally, NYSE-listed companies must disclose in their annual report to shareholders the required certification to the NYSE that its CEO is not aware of any violations of the NYSE corporate governance standards. While the Nasdaq has no specific requirements regarding the appointment (or disclosure of the name) of a presiding director at executive sessions of independent directors, we recommend making such disclosure anyway. The Nasdaq also does not require that a company adopt corporate governance guidelines; we do, however, recommend that issuers adopt such guidelines and disclose them on their Web site.
  
• MD&A Aggregate Contractual Obligations. In its MD&A, a company (other than a small business issuer) is now required to disclose in tabular format the amounts of payments due under specified contractual obligations, aggregated by category of contractual obligation, for specified time periods. The required categories are: long-term debt obligations; capital lease obligations; operating lease obligations; purchase obligations; and other long-term liabilities reflected on the company’s balance sheet under GAAP. The table should include footnote disclosures to describe provisions that create, increase or accelerate obligations, and other pertinent data.

In addition to the foregoing, the SEC issued two important MD&A releases in 2003 that are required reading for all persons involved in the MD&A drafting process. Issued in early 2003, the first release summarized staff disclosure comments from its review of annual reports for 2001 filed by Fortune 500 companies in the following 10 categories: MD&A generally; critical accounting policies; non-GAAP financial information; revenue recognition; restructuring charges; impairment charges; pension plans; segment reporting; securitized financial assets; and environmental and product liability. The second, a general interpretive release issued in December 2003, encourages senior-level management participation in the MD&A drafting process and provides specific guidance regarding:

• the overall presentation and focus of MD&A (including, through executive-level overviews, a focus on the most important information and a reduction of duplicative information)
  
• emphasis on analysis of financial information
  
• known material trends and uncertainties
  
• key performance indicators, including non-financial indicators
  
• liquidity and capital resources
  
• critical accounting estimates

For more information, contact any of the following Holland & Knight attorneys at 1-888-688-8500.

Chicago	Miami	New York	Tampa
Michael J. Boland	Steven Sonberg	James M. Lurie	Chester Bacheller
Anne Hamblin Schiave	Rodney H. Bell	Lance D. Myers	Robert Grammig
	Harvey Alan Goldman

Washington, D.C.	Portland
Stephen J. Weiss	Mark A. von Bergen
Thomas Archer

[1] The NYSE has advised that its new disclosure requirements are not obligatory until the implementation date of its new substantive corporate governance requirements and, accordingly, need not be included in a Form 10-K filed before a company’s 2004 annual meeting or its proxy statement for its 2004 annual meeting. Nonetheless, we strongly advise NYSE-listed issuers to include the required disclosures.

In contrast, with one limited exception (relating to use of an “exceptional and limited circumstances” exception to Board and committee independence requirements), the Nasdaq has advised that its new disclosure requirements must be reflected in a Nasdaq-listed company’s 2003 Form 10-K and its proxy statement for its 2004 annual meeting. For similar reasons, we also advise Nasdaq companies to disclose the use or intended use of the “exceptional and limited circumstances” exception in 2003 Form 10-Ks and 10-KSBs and proxy statements for their 2004 annual meetings.

[2] Except as otherwise indicated, this memorandum addresses the new reporting and disclosure requirements as they apply to non-investment company domestic issuers, including “small business issuers.” For application of the new requirements to “foreign private issuers” and investment companies, please contact your primary attorney at Holland & Knight LLP.

[3] This memorandum does not address all of the new reporting, compliance and disclosure obligations arising under the new SEC, NYSE and Nasdaq rules but only those that relate to an issuer’s Annual Report on Form 10-K or 10-KSB for the year ended December 31, 2003, and to its proxy statement for its 2004 annual meeting. It also does not address additional or revised reporting, compliance and disclosure matters that became applicable to quarterly and current reports filed during 2003, such as the new MD&A disclosure requirements relating to off balance sheet arrangements, the filing of earnings releases, or revisions to the S-OX §§302 and 906 certifications or their related exhibit requirements.