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Surprise! The SEC Coins A Nearly Novel Disclosure Requirement

Earlier this month, the Securities and Exchange Commission added a new paragraph (i) to Item 407 requiring a company to describe any practices or policies regarding hedging transactions.  The fact that the SEC took this action should have been no surprise because Section 955 of the Dodd-Frank Wall Street Reform and Consumer Protection Act required the SEC to do so.  I was surprised, however, to see that the final rule includes a novel disclosure standard.  I was especially surprised because this standard was not included in the text of the rule as proposed.  Thus, the public was denied any opportunity to comment on the standard.

"Fair is foul and foul is fair"

As adopted, Item 407(i) requires a company to provide a "fair and accurate" summary of its practices or policies.  That sounds innocuous until one considers that Regulation S-K nowhere else imposes a "fair and accurate" disclosure standard (the standard does make an appearance in Rule 403(c) under the Securities Act requiring a fair and accurate English translation).  The concept of accuracy seems clear enough, but what does it mean for a summary to be "fair"?  Originally, the word "fair" meant pleasing or attractive (e.g., "Show a fair presence and put off these frowns"  Wm. Shakespeare, Romeo and Juliet, Act I, scene 5).  Eventually, it acquired a sense of being equitable or in accordance with the rules.  Shakespeare in fact also employs this meaning of "fair" as when Hector in Act 5, scene 3 of Troilus and Cressida states "O, 'tis fair play".  (See also, King John, Act 5, scene 2 and The Tempest, Act 5, scene 1).  Neither sense of the word seems particularly apt when applied to a summary of a hedging policy.

The term "fair presentation" does, of course, have a specialized meaning for accountants.  Thus, an accountant expresses an opinion on whether a company's financial statements present fairly, in all material respects, an entity's financial position, results of operations, and cash flows in conformity with generally accepted accounting principles.  Significantly, the Public Company Accounting Oversight Board explains that this opinion as to "fairness" is given in reference to GAAP:

"The independent auditor's judgment concerning the 'fairness' of the overall presentation of financial statements should be applied within the framework of generally accepted accounting principles.  Without that framework, the auditor would have no uniform standard for judging the presentation of financial position, results of operations, and cash flows in financial statements."

Auditing Standard 2815.03.  

The problem with the SEC's use of "fair" in new Item 407(i) is that there is no external framework, such as GAAP, by which the SEC or registrants may determine the fairness of their disclosures. 

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About this Author

Keith Paul Bishop, Corporate Transactions Lawyer, finance securities attorney, Allen Matkins Law Firm
Partner

Keith Paul Bishop is a partner in Allen Matkins' Corporate and Securities practice group, and works out of the Orange County office. He represents clients in a wide range of corporate transactions, including public and private securities offerings of debt and equity, mergers and acquisitions, proxy contests and tender offers, corporate governance matters and federal and state securities laws (including the Sarbanes-Oxley Act of 2002 and the Dodd-Frank Act), investment adviser, financial services regulation, and California administrative law. He regularly advises clients...

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