October 21, 2010Client Alert

Developments in Securities Law - October 2010


Internal Control Over Financial Reporting

On September 15, the SEC adopted amendments to its rules and forms to conform them to new Section 404(c) of the Sarbanes-Oxley Act (“SOX”), as added by Section 989G of the Dodd-Frank Act. Section 404(c) provides that Section 404(b) of SOX shall not apply with respect to any audit report prepared for an issuer that is neither an accelerated filer nor a large accelerated filer. An accelerated filer is an issuer with a public float of $75 million or more, but less than $700 million. A large accelerated flier is an issuer with a public float of $700 million or more. Prior to enactment of the Dodd-Frank Act, a non-accelerated filer would have been required, under existing SEC rules, to include an attestation report of its registered public accounting firm on internal control over financial reporting in the filer’s annual report filed with the SEC for fiscal years ending on or after June 15, 2010.

All issuers, including non-accelerated filers, continue to be subject to the requirements of Section 404(a) of SOX which, along with its implementing rules, require that an issuer’s annual report include a report of management on the issuer’s internal control over financial reporting.

Proposed Rules on Short-Term Borrowing Arrangements in MD&A

On September 17, the SEC voted to publish for comment proposed rules that would require issuers to increase disclosure of short-term borrowing arrangements in the Management’s Discussion and Analysis (the “MD&A”). The proposed rules are intended to address concerns that, because an issuer’s short-term borrowings may vary widely during a given reporting period, period-end disclosures may not accurately reflect an issuer’s ongoing liquidity and investment risks.

If adopted, the proposed rules would create a new section in the MD&A related to liquidity and capital resources that would provide disclosure of each specified category of short-term borrowings at the end of the reporting period and the weighted-average interest rate on those borrowings. In addition, the proposed rules would require the following:

• Quantitative disclosures of intraperiod short-term borrowing amounts for each category, including the average and largest amount of short-term borrowings outstanding during the period;

• Qualitative disclosures for each category, including the reason for material differences between the average and period-end amounts of short-term borrowings.

The proposed rules would apply to all issuers with short-term borrowings; however, the methods used to determine the average and maximum amounts of short-term borrowings outstanding would vary, depending on whether the issuer meets the definition of a “financial company.” Under the proposed rules, “financial companies” would include broker-dealers and issuers involved in the businesses of lending, deposit-taking, insurance underwriting, or providing investment advice.


Interpretive Release on Liquidity and Capital Resources Disclosures in MD&A

On September 17, the SEC issued an interpretive release reiterating its long-standing guidance regarding liquidity and capital resources disclosure requirements in the MD&A.

The interpretive release reminds issuers of the requirement to identify and describe internal and external sources of liquidity (including material unused sources of liquidity) as well as known trends, demands, commitments, events or uncertainties that are reasonably likely to result in the issuer’s liquidity increasing or decreasing in any material way. The release identifies several important trends and uncertainties relating to liquidity for issuers to consider when preparing their MD&A including: difficulties accessing the debt markets, reliance on commercial paper or other short-term financing arrangements, maturity mismatches between borrowing sources and the assets funded by those sources, changes in terms requested by counterparties, changes in the value of collateral, and counterparty risk.

Depending on an issuer’s circumstances, if borrowings during a reporting period are materially different than the period-end amounts contained in the issuer’s financial statements, disclosure about the intra-period variations is required under current rules to facilitate investor understanding of the issuer’s liquidity position. Any capital or leverage ratio disclosure should be accompanied by a clear explanation of the methodology and disclosure as to why the ratio is useful to understanding the issuer’s financial condition.

Lastly, the interpretive release addresses divergent practices that have arisen in the context of the tabular disclosure of contractual obligations by emphasizing that the disclosure should be prepared in a manner consistent with the objective of providing information about contractual obligations and commitments in a single location so as to improve transparency of short-term and long-term liquidity and capital resource needs.

The interpretive release is applicable to periodic reports filed after September 28, 2010, including third quarter Form 10-Q filings for calendar year-end issuers.


Interactive Data and Detail Tagging

Questions 146.14, 146.15 and 146.16 (released September 17, 2010) provide compliance guidance regarding interactive data filing and detail tagging. A filer must assess its filing status at the end of each fiscal year and then follows the phase-in provisions for that status in the filings it makes during the immediately following fiscal year. A filer must block text tag each significant accounting policy within the significant accounting policies footnote, as well as other footnotes where significant accounting policies are references. Finally, a filer does not need to detail tag monetary values, percentages and/or numbers that are descriptive in nature such as attributed increased sales to the $1.99 pancake special (the increased sales figure itself would need to be tagged); sales of 1% fat milk (the sales figure itself would need to be tagged); or docket number 34-4589.


SEC Puts Proxy Access Rules on Hold; Likely until 2012

As we mentioned in our report last month, there was a general expectation that the new proxy access rules would be challenged in court. On September 29, the U.S. Chamber of Commerce and the Business Roundtable filed suit against the SEC, objecting to the new proxy access rules. The petitioners cited concerns about the cost to companies, as well as the potential influence special interest shareholders would have at the expense of regular shareholders. The petitioners, represented by Eugene Scalia and Amy Goodman, asked the SEC to stay the rules’ November 15 effective date pending resolution of the lawsuit, which the SEC, in a rather unexpected move, granted on October 4, 2010. The lawsuit alleges that the rules are unlawful under the Securities Exchange Act, the Investment Company Act and the Administrative Procedure Act, in addition to violating the First and Fifth Amendment rights of issuers.

It was already a stretch for companies to comply with the November 15 effective date for the 2011 proxy season. Assuming the rules survive judicial scrutiny they will not likely become effective until the 2012 proxy season.

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