11.06.2002
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Updates
On September 28, 2002, Governor Gray Davis signed the California Corporate Disclosure Act (the "Disclosure Act"). The Disclosure Act becomes effective on January 1, 2003, and will require more frequent and, for public corporations, additional disclosure by California corporations and foreign corporations qualified to transact business in California. Generally, any corporation that enters into repeated and successive transactions of its business in California, other than in interstate or foreign commerce, is required to register with the California Secretary of State. The effect of the Disclosure Act on publicly traded corporations will be to require public disclosure of certain compensation and other information that currently is not required to be disclosed under federal securities laws.
Current Disclosure Requirements
Sections 1502 and 2117 of the California Corporations Code require all domestic and foreign corporations to file every two years with the California Secretary of State a statement containing the following information:
- the names and business or residential addresses of the corporation's chief executive officer, secretary and chief financial officer;
- the address of the corporation's principal executive office;
- the address of the corporation's principal business office in California, if any; and
- a statement of the general type of business activity that constitutes the principal business activity of the corporation.
In addition to the above information, domestic, but not foreign, corporations must disclose the following:
- the names and business or residential addresses of the corporation's incumbent directors; and
- the number of vacancies on the corporation's board, if any.
Additional Disclosure Requirements for Publicly Traded Corporations
On January 1, 2003, privately held corporations must begin filing the above information annually, rather than once every two years. Other than this more frequent filing requirement and a filing fee (see below), privately held corporations will see little change from the application of amended Sections 1502 and 2117. Publicly traded companies, however, which also will be required to begin filing the above information annually, must make the following additional disclosures:
- Auditor: The name of the corporation's independent auditor and a description of any non-audit services performed for the corporation during the previous 24-month period by the auditor, its parent corporation, subsidiary or corporate affiliates.1
- Audit Report: The date of the last report prepared by the independent auditor and a copy of such report. It is not clear from the text of the Disclosure Act what specific report is being requested. Presumably, the Secretary of State's office will clarify this requirement in its publication of the annual statement form.
- Compensation: The annual compensation of each member of the corporation's board of directors and the five most highly paid executives who are not members of the board. This compensation disclosure must include any shares or options to purchase shares that were "not available to other employees of the corporation."
- Loans to Directors: A description of any loans, including the term and amount, made to directors of the corporation at a "preferential" loan rate during the previous 24-month period.
- Bankruptcy: A statement of any bankruptcy filings made by the corporation, or its executive officers or directors during the previous 10-year period.
- Fraud Convictions: A statement of any fraud convictions of any director or executive officer during the previous 10-year period.
- Violation of Laws: A statement of violations of any federal securities laws or any securities or banking provisions of California law during the previous 10-year period for which the corporation was found liable in an action before a federal or state court or regulatory agency or a self-regulatory agency in which a judgment over $10,000 was entered.
The Disclosure Act defines "publicly traded company" broadly to include corporations with securities listed or admitted to trading on a national or foreign exchange or corporations subject to two-way quotations, such as both bid and asked prices, that are regularly published by at least one broker-dealer in the National Daily Quotation Service or similar service. Pursuant to the Disclosure Act, all information statements filed in connection with Sections 1502 and 2117 will be available and open to the public. In addition, by December 31, 2004, all information statements will be available to the public via an online database to be established by the California Secretary of State.
Differences from Federal Disclosure Requirements
Although publicly traded companies already are subject to significant disclosure requirements pursuant to federal securities laws, in certain areas the Disclosure Act requires that publicly traded companies disclose different and additional information from that required by the federal securities laws. The following table summarizes the principal differences between disclosure requirements under the Disclosure Act and disclosure requirements under federal securities laws.
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The California Corporate Disclosure Act |
Federal Securities Laws2 |
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Auditor; Auditor's Report |
Non-audit services performed by auditor or its affiliates in previous 24 months. File copy of most recent report from auditor. |
Item 9(e) of Regulation 14A of the Securities Exchange Act of 1934 requires disclosure of audit fees as well as all other fees paid by the corporation to its principal accountant for the most recent fiscal year. In addition, the corporation's audit committee or board of directors must disclose if it has considered whether the provision of non-audit services by the principal accounting firm is compatible with maintaining the accountant's independence. Sections 201 and 202 of the Sarbanes-Oxley Act of 2002 prohibit registered public accounting firms that provide audit services to a corporation from contemporaneously performing certain non-audit services. The performance of non-audit services not otherwise prohibited must be pre-approved by a corporation's audit committee and the approval of such non-audit services must be disclosed in the corporation's periodic filings. |
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Compensation |
Compensation, including options or shares not available to other employees of the corporation, of directors and 5 most highly paid executive officers who are not also directors. The California Corporations Code does not define "compensation" and until the Secretary of State clarifies this definition, corporations may find compliance with this disclosure provision difficult. |
Item 402 requires compensation disclosure of certain "named executive officers," including the CEO and the other four most highly compensated executive officers,3 and of directors. (The Disclosure Act and Item 402 may require disclosure of compensation for different executives.) Item 402 generally provides detailed guidance as to what constitutes "compensation." Item 402(b)(2)(iii)(C) requires disclosure of certain compensation not properly categorized as salary or bonus while Item 402(b)(2)(v) further requires disclosure of all "other compensation" (as therein defined). |
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Loans to Directors |
"Preferential" loan terms to directors in previous 24 months. The Disclosure Act does not define "preferential interest rates." |
Item 404(a) requires disclosure of all transactions since the beginning of the corporation's last fiscal year (or currently proposed) between the corporation (or any subsidiary) and a director or executive officer in excess of $60,000 and in which the director or executive officer has a material interest. Item 404(c) requires disclosure of any indebtedness in excess of $60,000 during the last fiscal year owed to the corporation or its subsidiaries by (i) any of the corporation's directors or executive officers, (ii) immediate family members of the directors or executive officers, (iii) corporations or organizations of which a director or executive officer is an executive officer and (iv) any beneficial owner of 10% or more of the equity securities of the corporation. |
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Bankruptcy |
Bankruptcy filings by the corporation, executive officers or directors in previous 10 years. |
Item 401(f)(1) requires disclosure of bankruptcy filings by directors and executive officers in previous 5 years if such disclosure is material to the evaluation of such individual's ability or integrity. |
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Fraud Convictions |
Fraud convictions of any director or executive officer in previous 10 years. |
Item 401(f)(2) requires, if such disclosure is material to the evaluation of an executive officer or director's ability or integrity, disclosure of the following (if occurred in previous 5 years): (i) a conviction in a criminal proceeding of any director or executive officer, (ii) naming of any director or executive officer in a pending criminal proceedings or (iii) an order or judgment enjoining or limiting such individual from certain activities, including engaging in any type of business or engaging in any activity with respect to the purchase or sale of any security or commodities. |
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Violation of Laws |
Corporation's liability in excess of $10,000 for violations of securities or banking laws or California law in previous 10 years. |
Item 103 requires disclosure of material pending legal proceedings to which a corporation or subsidiary is party or to which their property is subject, other than ordinary routine litigation incidental to the corporation's business. |
When to File
The Disclosure Act does not change the current filing period. A domestic corporation must file the statement during the month in which it filed its original articles of incorporation with the California Secretary of State or during the 5-month period preceding such month. A foreign corporation must file the statement during the month in which it filed for a certificate of qualification from the California Secretary of State pursuant to Section 2105 of the California Corporations Code or during the 5-month period preceding such month. By contrast, annual reports must be filed with the Securities and Exchange Commission within 90 days of the end of the corporation's fiscal year (with allowances for certain information to be incorporated by reference from later-filed proxy statements). As a result, in many instances, corporations may be required to file federal and California annual reports at different times. In addition to the annual filing requirement, in order for a corporation to change its agent for service of process or such agent's address, the corporation must file a current statement, including all of the information required under Sections 1502 and 2117. A corporation may make permissive, but not required, filings at any time when the information currently on file with the Secretary of State has changed. Such filings must include all of the required information, not merely the revised information. The California Secretary of State will send a form for the filing of the annual statement to the corporation approximately three months prior to the close of the applicable filing period.
Fees
The Disclosure Act imposes a new $5.00 disclosure fee that a corporation must pay when filing the annual statement. This fee will be in addition to any other fees currently required. The fees will fund the Victims of Corporate Fraud Compensation Fund, which the Disclosure Act establishes, and the establishment and maintenance of an online database.
Certification
The Disclosure Act requires domestic corporations to certify that the information filed with the California Secretary of State is true and correct. No similar provision applies to foreign corporations.
1 In addition, amended Section 2117 requires foreign corporations to disclose any services performed for the corporation by an agent or corporate partner of the independent auditor.
2 Unless otherwise indicated, the Items referenced in this column can be found in Regulation S-K of the Securities Exchange Act of 1934. This Update does not address other states' securities laws or current or proposed Nasdaq or NYSE rules.
3 Please note that an "executive officer" is defined differently under the Disclosure Act and under federal securities laws. The Disclosure Act defines "executive officers" as the five most highly compensated officers of the corporation, other than any officer who is also a director. Rule 3b-7 of the Securities Exchange Act of 1934 defines "executive officer" to include a corporation's president, any vice president in charge of a principal business unit, division or function or any officer or other person who performs policy making functions. In addition, under Rule 3b-7, executive officers of a corporation's subsidiary may be deemed executive officers of a corporation if they perform policy-making functions for the corporation.
