Originally published November 4, 2004
On September 27, 2004, the Governor of the State of California signed into law Assembly Bill 1000, making changes affecting the substance and timing of the annual disclosure requirements under the controversial California Corporate Disclosure Act (the "California Disclosure Act") that was enacted in late 2002. The amendments took effect immediately and must be observed by all corporations that are incorporated or have qualified to do business in California. Publicly traded corporations should pay particular attention to the amendments as the changes mainly affect the disclosure requirements for publicly traded corporations. The amendments clarify some, but not all, of the most ambiguous of the requirements relating to the public company information disclosures that were originally enacted in 2002. In addition, as noted below, some publicly traded corporations will not be required to file their public company information in 2004.
Background of the California Disclosure Act
The California Disclosure Act, which was originally effective on January 1, 2003, substantially amended the previously existing requirement that each corporation incorporated or qualified to do business in California file periodic information statements disclosing basic information concerning its board of directors, officers and operations. The most significant change for publicly traded corporations was that a number of additional disclosures were required, including, among other things, disclosure of director and executive officer compensation, loans made to directors at preferential rates and disclosure of the name of and any nonaudit services provided by the corporation’s auditors.
The California Disclosure Act was hastily adopted near the end of the 2002 legislative session in California as a response to the collapse of Enron and other business scandals that prompted the enactment by Congress of the Sarbanes- Oxley Act of 2002. Since its adoption, the California Disclosure Act has been criticized by lawyers and their publicly traded clients for a number of serious flaws, including ambiguous language regarding exactly what information was required to be disclosed and its imposition of disclosure requirements that duplicated and, in some instances, exceeded the reporting requirements of the Securities and Exchange Commission. A more detailed discussion of the enactment of and concerns with the California Disclosure Act can be found in our November 21, 2002 Legislative Update on our website at http://www.mayerbrownrowe.com/publications/article.asp?id=210&nid=6.
The revised public company disclosure requirements described below are embodied in a separate form required to be filed within 150 days after a corporation’s fiscal year end. We have received informal guidance through discussions with the California Secretary of State’s office that publicly traded corporations whose filing periods end in October, November or December of 2004 will not be required to comply with the filing requirements of newly enacted Sections 1502.1 and 2117.1 of the California General Corporation Law (the "Corporations Code") in 2004. Instead, they will first be required to file the information required thereunder within 150 days after the end of their 2005 fiscal years.
Summary of Amendments The recently enacted amendments make both substantive changes and a number of clarifying technical changes to the California Disclosure Act. The full text of the amendments and the updated forms to be used for filings can be found at http://www.ss.ca.gov/business/corp/corp_soinfo.htm.
New Timing and Definitions
Sections 1502 and 2117 of the Corporations Code continue the pre-amendment requirements applicable to all privately held and publicly traded corporations that are incorporated or qualified to do business in California. Sections 1502 and 2117 require corporations to file a statement of information annually that discloses basic information regarding the corporation, including the names and addresses of the corporation’s directors and officers and the type of business the corporation is engaged in. This information statement must be filed within the six-month period ending with the month in which the original articles of incorporation (for a California corporation) or qualification to do business (for a non- California corporation) was filed with the California Secretary of State. For example, this means that a California corporation that filed its original articles of incorporation in July must file its annual statement of information during the months of February through July of each succeeding year.
The revised disclosure requirements for publicly traded corporations are now set forth in new Sections 1502.1 and 2117.1 of the Corporations Code. The definition of "publicly traded corporation" has been amended to clarify that these requirements apply only to a corporation (and not to non-corporate entities such as business trusts, limited liability companies, partnerships or associations) that is an "issuer" as defined under Section 3(a)(8) of the Securities Exchange Act of 1934 and has at least one class of securities listed or admitted for trading on a national securities exchange such as the New York Stock Exchange, on the Nasdaq National Market or Small-Cap Market, on the OTC Bulletin Board, or in the "Pink Sheets."
The public company disclosures required under Sections 1502.1 (for California corporations) and 2117.1 (for non- California corporations) must be filed within 150 days after the end of the corporation’s fiscal year. Prior to the amendments, the California Disclosure Act required that public company information be filed along with the basic information within the six-month period described above. Note this means that many publicly traded corporations will have two different filing deadlines in California, one for the basic information required under Sections 1502 and 2117, and one for the additional public company disclosures required in the separate filings provided for in Sections 1502.1 and 2117.1.
Revised Disclosure Requirements
The disclosure requirements for publicly traded corporations have been revised to require disclosure of the following information:
- Independent Auditor. The name of the independent auditor that prepared the most recent auditor’s report on the corporation’s annual financial statements and, if different, the name of the corporation’s current auditor.
- Non-audit Services. Any "other" (meaning non-audit) services performed for the corporation by the corporation’s independent auditor and certain of the auditor’s affiliates during the corporation’s two most recent fiscal years and during the period between the end of its most recent fiscal year and the date of the statement of information. Pre-amendment, the required disclosure was of non-audit services during the 24 months prior to filing.
- Director and Officer Compensation. The compensation for the most recent fiscal year paid to each member of the board of directors and each of the five most highly compensated executive officers who are not members of the board of directors. The compensation paid to the CEO must also be disclosed, if the CEO is not among the five most highly compensated executive officers. These requirements are broader than the SEC disclosure rule, which generally only requires disclosure for the CEO and the four other most highly compensated executive officers, in addition to disclosure of director compensation arrangements. The definition of "executive officer" has been amended to parallel the definition of "officer" in Rule 16a-1 under the Securities Exchange Act of 1934. In addition, the definition of "compensa tion" for purposes of Sections 1502.1 and 2117.1 of the Corporations Code now refers specifically to the compensation disclosure requirements set forth in Item 402 of SEC Regulation S-K.
Previously, there was some question as to whether the compensation of additional executive officers beyond the five most highly compensated executive officers was required to be disclosed when one or more of the five most highly compensated executive officers are also directors. This was because the term "executive officer" was defined as "the five most highly compensated officers excluding any officer who is also a member of the board of directors." It was also unclear whether compensation information was to be provided for the most recent fiscal year or some other time frame, such as the trailing twelve months preceding the filing.
- Loans to Directors. A description of any loan made to any member of the board of directors by the corporation during the two most recent fiscal years at an interest rate lower than the rate available from an unaffiliated commercial lender to a similarly-situated borrower. The definition of "loan" now specifically excludes advances for expenses and payments by the corporation of life insurance premiums to the extent permitted by the laws of the corporation’s state or place of incorporation. Also, prior to the amendments, the language required disclosure of loans at a "preferential loan rate," but did not define what that meant.
- Bankruptcy Proceedings. Whether an order for relief has been entered in a bankruptcy case with respect to the corporation, its executive officers or any member of its board of directors, within the 10 years prior to the date of the statement of information. Pre-amendment, the disclosure obligation only covered voluntary bankruptcy filings. Now, every case, voluntary or involuntary, must be disclosed, except for successfully contested involuntary cases in which no order for relief is entered. The time period and scope of this California disclosure requirement are different from corresponding SEC disclosure requirements.
- Fraud Convictions. Whether any member of the board of directors or any executive officer has been convicted of fraud during the past 10 years, if the conviction has not been overturned or expunged. Prior to the amendments, there was no exception for "overturned or expunged" fraud convictions. The time period and scope of this California disclosure requirement are also different from corresponding SEC disclosure requirements.
- Material Legal Proceedings. A description of (i) material pending legal proceedings, other than ordinary routine litigation incidental to the corporation’s business, that would be required to be disclosed under Item 103 of SEC Regulation S-K (the standard used for determining disclosure of legal proceedings in a company’s SEC reports on Forms 10-K and 10-Q) and (ii) material legal proceedings in which the corporation was found liable on final judgment or final order that was not overturned on appeal during the five years prior to the date of the statement of information. Pre-amendment, the required disclosure was for violations of "federal security laws or any banking or security provision of California law" during the prior 10 years in which a judgment exceeding $10,000 was entered.
The amendments have removed some of the ambiguities and other problems that previously existed in the California Disclosure Act. However, not all problems have been resolved and, as with any legislation, new questions of interpretation may surface.
For example, the director and executive officer "compensation" is now determined with reference to the relevant SEC definition under Item 402 of Regulation S-K. The statement of information provided by California to make such compensation disclosure, however, has a different and more limited number of categories of compensation than that under Item 402, which requires disclosure of a number of separate categories of compensation, including salary, bonus, other annual compensation, restricted stock awards, securities underlying options and payouts under long-term incentive plans. Presumably the value of the categories of compensation required to be disclosed under Item 402 and not separately captured in the California form will need to be combined to fit under one or more of the limited categories provided in the California form.
Legal counsel should be consulted to assure compliance with the newly-updated disclosure requirements. Among other things, affected companies will want to review and, if needed, update their director and officer questionnaires to ensure that they obtain the necessary information under the amended disclosure requirements. Note that as before, monetary and other penalties may apply for noncompliance and that a knowing filing of a false material statement by a director, officer or agent of a corporation is punishable under the California Code as a felony.
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