The concept of materiality is the cornerstone of the disclosure system established by the federal securities laws. It serves a variety of functions, operating both as a principle for inclusion and exclusion of information in investor oriented disclosure documents and as a standard for determining whether a communication (filed or otherwise) omits or misstates a fact of sufficient significance that legal consequences should result. Further, the concept functions as a standard for determining in a particular instance whether a person considering a securities transaction has knowledge such that he should be barred from effecting transactions lest he have an unfair advantage over others. Although the functions of the materiality concept are clear, its application in any particular instance may not be. Both as articulated by the courts and as set forth in 1/ Commission rules, the definition is not readily translatable into objective criteria. Because of this, there is no certainty that reporting companies, their advisers, the Commission and its staff and the other participants in the securities markets who are continuously making materiality judgments in their different contexts share an understanding of the concept or that their views accord with the perceptions of those who use disclosure documents. The Committee analyzed and reviewed discussions of the materiality concept submitted to it and otherwise available and although no recommendation is forwarded to the Commission the Committee believes a summary of its views may be useful. 1/ In its most recent pronouncement on the issue, the TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, carries over to contexts other than proxy solicitation. a requirement for the furnishing of information as to The Committee is unsure how much uncertainty is associated with the application of the materiality concept. In response to the question "How should the standard of materiality be defined under the federal securities laws?" a number of commentators on Release 5707 stated that existing definitions are adequate. Moreover, with few exceptions, the companies in the Committee's case study indicated both a willingness and an ability to work with the materiality concept as currently formulated. To the extent there is a problem however, the Committee is of the view that the Commission should not attempt to develop an objective definition of materiality that will have general applicability to all fact situations. In the Committee's opinion the materiality of a particular fact must be determined after evaluating the significance of that fact within the total business and financial circumstances of the company including its impact on future financial performance. Because management has available the information necessary to make this evaluation it has major responsibility for doing so. Although the initial materiality determination is management's, this judgment is, of course, subject to challenge or question by the Commission or in the courts. The Committee believes that the Commission can pursue certain policies which will assist both reporting companies and the courts in applying the materiality concept. First, because materiality, as a general proposition, should reflect the perceptions of both users and preparers as to what is material, consultations with these groups can assist the Commission in identifying new categories of information which are material as well as other disclosure problem areas. This belief underlies the Committee's recommendation that the Commission develop industry guides. The contribution which preparers of information can make is evidenced by the pattern of disclosure which has developed in the cash tender offer area. The Commission's schedule for disclosure has been a skeleton outline. Moreover, there has been essentially no staff processing of the filed material. Expanded disclosures have resulted primarily from judge-made law and, more importantly, from the views of bidders and their advisers as to what was appropriate. Secondly, to the extent the Commission deems guidance in the application of the concept of materiality necessary, it should amend its disclosure requirements to reduce uncertainty. Where feasible, the clarification Schedule A to the 1933 Act represents a Congressional expression of categories of information which are material If the problem is not with a category of information but rather with identifying when an event within a category is significant, the Commission may consider establishing numerical benchmarks for materiality. It has done this in its requirement that a legal proceeding which involves primarily a claim for damages need not be reported if the amount involved exclusive of interest and cost does not exceed 10 percent of the current assets of the registrant and its subsidiaries on a consolidated basis. The definition of "significant subsidiary" in Regulation S-X is another example. This approach may be particularly useful in the case of financial statement disclosures because it is only feasible when the fact in question is readily quantifiable. Numerical benchmarks can be of several kinds; there are advantages to each. A fixed determinant ("Five percent of revenues is material.") gives the greatest certainty, and provides a safe harbor for companies. Management does not have to guess as to what the SEC and the courts will view as material. However, a fixed determinant also may |