Current Reports and the Resignation of Directors

One of the topics we have discussed on this Blog has been the efforts by the Securities and Exchange Commission to influence the substance of corporate governance through the use of disclosure requirements.  A paper on the subject is here. 

One example is the requirement that the company file a current report on Form 8-K whenever a director resigns or refuses to stand for reelection because of a disagreement (or had been removed because of the disagreement). See Item 5.02 of Form 8-K.  The filing requirement necessarily means that the disagreement will become public.  As a result, boards have an incentive to resolve the disagreement rather than risk disclosure.  The threat of disclosure, therefore, provides the dissenting shareholder with leverage, something particularly useful whenever disagreements occur over financial disclosure. 

An example of the incentive to work things out without triggering the need to file an 8-K occurred recently in connection with the fiasco at Hewlett Packard.  See In re Hewlett Packard, Exchange Act Release No. 55801 (May 23, 2007).

With that in mind, we note that the staff has just issued updated instructions to the current report that apply to the director disagreement provisions.  They demonstrate the breadth of the requirement and a number of fuzzy interpretive issues that can arise. 

For one thing, the disclosure obligation is triggered by "notice" of the decision to resign or not stand for reelection, "regardless of whether" the decision "is conditional or subject to acceptance."  As the staff noted:

• Answer: With respect to any resignation, retirement or refusal to stand for re-election reportable under Item 5.02(b), the Form 8-K reporting obligation is triggered by a notice of a decision to resign, retire or refuse to stand for re-election provided by the director, whether or not such notice is written, and regardless of whether the resignation, retirement or refusal to stand for re-election is conditional or subject to acceptance. The disclosure shall specify the effective date of the resignation or retirement. In the case of a refusal to stand for re-election, the registrant must disclose when the election in question will occur, for example, at the registrant’s next annual meeting.

The staff acknowledged the line between notice of a resignation and discussions over the possibility of a resignation, the former subject to disclosure, the latter not subject to disclosure.  The distinction?  "Whether communications represent discussion or consideration, on the one hand, or notice of a decision, on the other hand, is a facts and circumstances determination."  Finally, the staff concluded that a company needed to have in place "appropriate disclosure controls and procedures" in order "to determine when a notice of resignation, retirement or refusal has been communicated to the registrant."  The filing requirement does not, however, apply when a director dies.  See Staff Position ("Item 5.02(b) of Form 8-K does not require a registrant to report the death of a director or listed officer.").  

With respect to the requirement that a company disclose the retirement, resignation or termination of certain top officers (including the CEO and CFO), the staff made clear that disclosure had to occur upon a reduction in the officer's "duties and responsibilities," even if the title stayed the same. As the staff noted:

• Question: A registrant’s principal operating officer has his duties and responsibilities as principal operating officer removed and reassigned to other personnel in the organization; however, the person remains employed by the registrant, and the person’s title remains the same. Is the registrant required to file a Form 8-K under Item 5.02 to report the principal operating officer’s termination?
• Answer: Yes. The term “termination” includes situations where an officer identified in Item 5.02 has been demoted or has had his or her duties and responsibilities removed such that he or she no longer functions in the position of that officer.

This is true even if the officer temporarily relinquishes his or her duties and requires disclosure both at the time of relinquishment and when the duties are resumed.  As the staff noted:

• 217.02  When a principal financial officer temporarily turns his or her duties over to another person, a company must file a Form 8-K under Item 5.02(b) to report that the original principal financial officer has temporarily stepped down and under Item 5.02(c) to report that the replacement principal financial officer has been appointed. If the original principal financial officer returns to the position, then the company must file a Form 8-K under Item 5.02(b) to report the departure of the temporary principal financial officer and under Item 5.02(c) to report the “re-appointment” of the original principal financial officer.

Likewise, disclosure is triggered not on the actual date of resignation but on the date when notice is given.  This is true even where the employment contract requires advance notice of any resignation.  As the staff noted:

• 217.05  If, pursuant to a contractual provision in a named executive officer’s employment contract or otherwise, the registrant must notify the named executive officer of the termination of his or her employment a specified number of days prior to the date on which the named executive officer’s employment would end, an Item 5.02(b) Form 8-K filing requirement is triggered on the date the registrant notifies the named executive officer of his or her termination, not on the date the named executive officer’s employment actually ends. [April 2, 2008]

The requirements are detailed.  They mandate quick disclosure of changes at the board and changes in top management.  Companies unaware of these interpretations may find themselves in an unwanted disclosure situation.  That certainly happened to Hewlett Packard.