By Howard N. Feldman
Public companies have an obligation to disclose information that may materially affect the value of publicly held stock. The Year 2000 problem raises disclosure issues regarding a public company's actual, potential and/or unknown costs or consequences. The following is a brief overview of recent developments pertaining to the disclosure obligations relating to the Year 2000 problem.
Materiality:
The antifraud provisions of the securities laws impose a duty on registrants to disclose all material information important to a reasonable investor. The United States Supreme Court's 1976 decision in TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), holds that:
An omitted fact is material if there is a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote. . . Put another way, there must be a substantial likelihood that the disclosure of the omitted fact would have been viewed by the reasonable investor as having significantly altered the "total mix" of information made available.
Disclosure is required if a trend, event or uncertainty is currently known and may be reasonably expected to have a material effect on a company's financial condition or operation results. Securities Exchange Act Release No. 6835, 1989 SEC LEXIS 1011 at 13 (May 18, 1989). Materiality for Management Discussion and Analysis ("MD&A") disclosure is determined by using a two-step process. First, the company must objectively determine if the known trend, event or uncertainty is reasonably likely to occur; second, if the company is unable to determine that the known trend, event or uncertainty is not reasonably likely to occur, it must assume that the trend, event or uncertainty will come to fruition and evaluate whether it is reasonably likely that the trend, event or uncertainty will have a material effect on the financial condition or operation results of the company. Id. at 19.
Guidance On Materiality For Year 2000 Issues:
In a December 9, 1997 letter to the SEC, the American Institute of Certified Public Accountants urged the SEC to "provide to registrants, without delay, appropriate interpretive guidance related to the type and manner of disclosure that is to be included in 1997 annual reports." On January 12, 1998, the Divisions of Corporation Finance and Investment Management Staff of the SEC issued a Legal Bulletin in order to help provide public companies with guidance on the disclosure issue (Staff Legal Bulletin No. 5). The Legal Bulletin represents these Divisions' views. According to John Heine, deputy director of the SEC's Office of Public Affairs, the Legal Bulletin is an interpretation of correct procedure as determined by staff members who review companies' SEC disclosure documents. The Legal Bulletin explicitly provides that it is not a rule, regulation or statement of the SEC and that the SEC has not approved or disapproved the Bulletin's content.
Year 2000 Review Required:
The SEC Staffs have determined that "[c]ompanies should review, on an ongoing basis, whether they need to disclose anticipated costs, problems and uncertainties associated with Year 2000 consequences, particularly in their filings with the Commission."
Public companies file, among other things, annual statements (Form 10-Ks) and quarterly reports (Form 10-Qs). These filings contain a section known as "Management's Discussion and Analysis of Financial Conditions and Results of Operations." The SEC Staffs have determined that companies should disclose actual or potential Year 2000 costs and consequences in their MD&A if: the cost of addressing the Year 2000 issue is a material event or uncertainty that would cause reported financial information not to be necessarily indicative of future operating results or financial condition, or the costs or the consequences of incomplete or untimely resolution of the their Year 2000 issue represent a known material event or uncertainty that is reasonably expected to affect their future financial results, or cause their reported financial information not to be necessarily indicative of future operating results or future financial condition.
Further, if a company has not made an assessment of its Year 2000 situation or has not determined whether it has any material Year 2000 issues, the Staffs consider this a "known uncertainty," and this information should be disclosed.
Forced Disclosure:
It appears that the Staffs want to force companies to undertake the necessary review and make disclosure. In determining whether a company's Year 2000 issues should be disclosed, the Staffs' views are that the materiality determination to a company's business, operations or financial condition should be made without regard to related countervailing circumstances (such as Year 2000 remediation programs or contingency plans). If the Year 2000 circumstances are determined to be material, without regard to related countervailing circumstances, the nature and potential impact of the Year 2000 issues, as well as the countervailing circumstances, should be disclosed. At the least, the Staffs expect the following topics to be disclosed: the company's general plans to address the Year 2000 issues relating to its business, its operations (including operating systems) and, if material, its relationships with customers, suppliers, and other constituents; and its timetable for carrying out those plans; and the total dollar amount that the company estimates will be spent to remediate its Year 2000 issues, if such amount is expected to be material to the company's business, operations or financial condition, and any material impact these expenditures are expected to have on the company's results of operations, liquidity and capital resources. Stated simply, if a company plans to spend "material" amounts of money to bring its computers into Year 2000 compliance, disclosure is required. If a company does not know whether it will spend "material" amounts of money, disclosure is required. If a company has not yet been able to determine whether it has a Year 2000 problem, this too should be disclosed.
In addition to providing for MD&A disclosure, the Legal Bulletin provides that disclosure will be required in the "Description of Business" section of the reports if the Year 2000 issue would "materially affect a company's products, services, or competitive conditions." In determining whether to include disclosure in this section of the filing, "companies should consider the effects of the Year 2000 issue on each of their reportable segments."
Form 8-K Disclosure:
If the Year 2000 costs or consequences have reached a level of importance to security holders, companies should consider disclosing this in a Form 8-K, rather than waiting for its next scheduled quarterly report or annual statement. Form 8-Ks are required to be filed within a certain period of time following certain defined significant events and, at a registrant's option, when an event is deemed important to security holders by the registrant.
Some commentators have said that "[g]iven the widespread knowledge about the Year 2000 issue and the fact that businesses are operationally interdependent, it seems likely that the Year 2000 issue is a trend, demand, commitment, event or uncertainty for almost all registrants." Boilerplate disclosure will not be acceptable. According to the Staffs' Legal Bulletin, disclosure must be "reasonably specific and meaningful."
Disclosure Examples:
1.Citicorp Annual Report for 1997
Citicorp recognizes that the arrival of the Year 2000 poses a unique worldwide challenge to the ability of all systems to recognize the date change from December 31, 1999 to January 1, 2000 and, like other companies, has assessed and is repairing its computer applications and business processes to provide for their continued functionality. An assessment of the readiness of external entities which it interfaces with, such as vendors, counterparties, customers, payment systems, and others, is ongoing.
Citicorp expects that the principal costs will be those associated with the remediation and testing of its computer applications. This effort is under way across the corporation, and is following a process of inventory, scoping and analysis, modification, testing and certification, and implementation. A major portion of these costs will be met from existing resources through a reprioritization of technology development initiatives, with the remainder representing incremental costs.
Citicorp does not anticipate that the related overall costs will be material to any single year. In total, Citicorp's global operations and technology organization estimates that its costs for the remediation and testing of computer applications will amount to approximately $600 million over the three-year period from 1997 through 1999, of which approximately $150 million was incurred in 1997. 2.J.P. Morgan & Co. Incorporated 1997
Costs associated with efforts to prepare our systems for the year 2000 approximated $95 million in 1997. In 1998, we will continue our efforts to prepare our systems for the year 2000. The total cost to become year-2000 compliant is estimated at $250 million, for internal systems renovation and testing, testing equipment, and both internal and external resources working on the project. Remaining costs will be incurred primarily in 1998. Efforts to prepare for the economic and monetary union in Europe (EMU) are also well underway. 1998 costs are expected to be approximately $65 million. Refer to the Operating risk section of Risk management for more information.
The year 2000 initiative -- With the new millennium rapidly approaching, organizations are examining their computer systems to ensure they are year 2000 compliant. The issue, in simple terms, is that many existing computer systems use only two numbers to identify a year in the date field with the assumption that the first two digits are always 19. As the century is implied in the date, on January 1, 2000, computers that are not year 2000 compliant will assume the year is 1900. Systems that calculate, compare, or sort using the incorrect date will cause erroneous results, ranging from system malfunctions to incorrect or incomplete transaction processing. If not remedied, potential risks include business interruption or shutdown, financial loss, reputation loss, and/or legal liability.
J.P. Morgan has undertaken a firmwide initiative to address the year 2000 issue and has developed a comprehensive plan to prepare, as appropriate, our computer systems. Each business line has taken responsibility for identifying and fixing the problem within its own area of operation and for addressing all interdependencies. A multidisciplinary team of internal and external experts supports the business teams by providing direction and firmwide coordination.
Working together, the business and multidisciplinary teams have completed a thorough education and awareness initiative and a global inventory and assessment of our technology and application portfolio to understand the scope of the year 2000 impact at Morgan. We presently are renovating and testing these technologies and applications in partnership with external consulting and software development organizations, as well as with year 2000 tool providers. We are on target with our plan to substantially complete renovation, testing, and validation of our key systems by year-end 1998 and to participate in industry-wide testing (or streetwide testing) in 1999. We are also working with key external parties, including clients, counterparties, vendors, exchanges, depositories, utilities, suppliers, agents, and regulatory agencies, to stem the potential risks the year 2000 problem poses to us and to the global financial community.
3.Chittenden Corp. Form 10-K for year-ended December 31, 1997
The Year 2000 problem, which is common to most corporations concerns the inability of information systems, primarily computer software programs, to properly recognize and process date sensitive information as the year 2000 approaches. The Company has commenced an assessment of the majority of its systems and is in the process of developing a specific workplan to address this issue. The Company currently believes it will be able to modify or replace its affected systems in time to minimize any detrimental effect on operations. While it is not possible, at present, to give an accurate estimate of the cost of this work, these costs may be material to the Company's results of operations in one or more fiscal quarters or years, but are not expected to have material adverse impact on the long-term results of operations, liquidity, or consolidated financial position of the Company.
4.SCM Microsystems, Inc. Form S-1 Registration Statement dated March 10, 1998
Many currently installed computer systems and software products are coded to accept only two digit entries in the date code field. These date code fields will need to accept four digit entries to distinguish 21st century dates from 20th century dates. As a result, many companies' software and computer systems may need to be upgraded or replaced in order to comply with such "Year 2000" requirements. Although the Company believes that its products and systems are Year 2000 compliant, the Company utilizes third-party equipment and software that may not be Year 2000 compliant. Failure of such third-party equipment or software to operate properly with regard to the Year 2000 and thereafter could require the Company to incur unanticipated expenses to remedy any problems, which could have a material adverse effect on the Company's business and operating results. Furthermore, the purchasing patterns of customers or potential customers may be affected by Year 2000 issues as companies expend significant resources to correct their current systems for Year 2000 compliance. These expenditures may result in reduced funds available to purchase products and services such as those offered by the Company, which could have a material adverse effect on the Company's business and operating results.
Ongoing Assessment Required:
One assessment is not enough. As previously explained, the Legal Bulletin provides: "Companies should review, on an ongoing basis, whether they need to disclose anticipated costs, problems and uncertainties associated with Year 2000 consequences. . ."
Consequences For Failing To Disclose:
According to the October 22, 1997 Senate Testimony of Brian Lane, the Director of the SEC's Division of Corporation Finance, "[c]ompanies that fail to take this requirement seriously and do not provide adequate disclosure in their Commission filings run the risk of Commission enforcement action . . . ." Thus, in addition to potential civil exposure to stockholders, companies also face potential governmental enforcement proceedings.
AUTHOR'S NOTE: This article is intended to provide an overview of the issues involved, and is not a substitute for professional advice based on a review of particular circumstances.
Howard Feldman is a partner at the Law firm of Dickstein Shapiro Morin & Oshinsky LLP. For more information on the Year 2000 Legal Strategies Team, please contact David M. Nadler at (202) 828-2281 or Click Contact Link or visit our website on Click Contact Link
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