April 17, 2000
Jonathan G. Katz
Secretary, U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
File Reference: No. S7-03-00
Supplementary Financial Information
Dear Mr. Katz:
This letter sets forth our comments on the Securities and Exchange Commission rule proposal related to Supplementary Financial Information. While we certainly understand the importance of the SEC's initiatives to eliminate discretionary management of earnings to meet analysts' estimates, we do not feel that the revised rules, as proposed, are the optimal solution. Over the past 18 months, both Arthur Levitt and Lynn Turner have made known to the financial reporting community that the SEC is looking for improved transparency of financial statements and "enhanced oversight of the financial reporting process by those entrusted as the shareholders' guardians." We feel that the SEC has taken appropriate and sufficient measures in improving the perceived earnings management problem through:
(1) the release of Staff Accounting Bulletins (SABs) on materiality considerations, restructuring charges and revenue recognition;
(2) increased focus of the SEC's review and enforcement staff on public companies which make announcements of restructuring charges and major write-offs; and,
(3) the recent issuance of new rules to strengthen the role of audit committees in the financial reporting process.
Considering these efforts, we believe that the proposal on Supplementary Financial Information results in excessive rule changes to deal with what Chairman Levitt referred to as the "numbers game".
Proposed Item 302(c) Under Regulation S-K
We feel that the SEC's focus on earnings management would benefit from the planned improvements and clarification in the rules associated with the information to be provided in the "valuation and qualifying accounts" schedule (§210.12-09 of Reg. S-X). However, we consider the proposed expansion of the disclosure requirements under new Item 302(c) of Regulation S-K to be excessive. Item 302(c) would appropriately eliminate the use of the word "reserve", a word that is not defined in any existing authoritative pronouncements, and instead concentrate on registrants' loss accruals. We agree with this aspect of the proposal, as it clarifies the intended purpose of the schedule, and requires that registrants earmark loss accruals for specific loss contingencies. We do not agree, however, with the inclusion of certain loss accrual/valuation accounts among the list of those to be identified on the schedule. For example, Item 302(c) would require disclosure of a registrant's allowance for sales returns, its FAS 5 accrual for income and franchise taxes and its probable losses from pending or ongoing litigation. Each of these items, while achieving higher transparency in financial statement disclosures, would present information that could potentially be competitively harmful.
Additionally, moving the schedule requirements from Regulation S-X to Regulation S-K, while enhancing transparency through anticipated increases in narrative disclosures, may serve only to provide more information to competitors that is proprietary in nature. The proposal indicates that "experience has shown that the more free-writing style permitted to comply with Regulation S-K may be more conducive to detailed narrative explanation that better communicates the financial reporting effects of changes in facts and assumptions." If such "changes" are material, they most likely are already disclosed in a narrative manner elsewhere.
As the proposal currently stands, we would be required to disclose changes in these accounts whether they were material or not, meaning additional disclosure under Item 302(c) for items that do not meet GAAP/SEC thresholds for financial reporting disclosure. Taking this into consideration, if the proposal is to go forward, we feel that the establishment of an earnings-based disclosure threshold would ease some of the perceived burden via reduced disclosures (see our response to question 2 in Comments on Specific Questions Posed by the SEC - page 4).
We do not feel that the expanded disclosures associated with Item 302(c) are necessary based upon the fact that any material valuation or loss accrual (or any material change to a valuation or loss accrual) would already be disclosed in the financial statements or footnotes, including:
material loss accruals that affect quarterly results are disclosed in a "Quarterly Financial Data" footnote (Item 302 of Regulation S-K);
material changes to valuation allowances for deferred tax assets or material changes in tax accruals are disclosed in an "Income Taxes" footnote (SFAS 109);
material probable losses from litigation or environmental liabilities are disclosed in a "Contingencies" footnote (SFAS 5); and,
material allowances for doubtful accounts are disclosed in an "Accounts Receivable" footnote (APB 12).
The same can be said for all of the valuation accounts or loss accruals listed in the proposal. In addition, the effects of changes from one fiscal year to the next, if material, are disclosed in management's discussion and analysis. With the exception of "Quarterly Financial Data" and management's discussion and analysis, disclosure of material items related to loss accruals and valuation accounts falls within the scope of the independent auditors' examination of the financial statements and footnotes. Since the SEC has already released SABs pertaining to materiality, revenue recognition and restructuring charges, and the SEC enforcement staff is concentrating on these "hot buttons", it would make more sense to rely on the guidance of the new SABs and the scrutiny of the independent auditors in determining the sufficiency of the appropriate disclosure. After all, it is the auditors' duty to determine whether the financial statements and related footnotes are free of material misstatement, and that registrants' disclosures are sufficient so as not to mislead financial statement users. As Chairman Levitt stated in his Numbers Game speech in September 1998, "auditors... are the public's watchdog in the financial reporting process."
In fact, our independent auditors increased the scope of their procedures related to loss accruals and valuation accounts in connection with their audit of our most recent fiscal year's financial statements. The SEC's release of the new SABs brought about a change in their approach, increasing their focus on (and ultimate documentation of) our loss accruals and valuation accounts. They have evaluated such accounts and fully documented their conclusions, and we suggest that this approach be adopted for all public companies, rather than the expansion of disclosure in Item 302(c). If companies communicate the full extent of the changes in their loss accruals and valuation accounts to their independent auditors, along with further communication to their audit committees, we feel a sufficient examination of these issues will result. Furthermore, this approach potentially eliminates the release of competitively harmful information by leaving the evaluation of loss accruals and valuation accounts to those responsible for them.
Proposed Item 302(d) Under Regulation S-K
We do not feel that the proposed schedule disclosure concerning property, plant and equipment, intangible assets and their related depreciation, depletion and amortization expenses serves a significant purpose to the users of the financial statements. Just as the SEC concluded in 1995, with the issuance of Financial Reporting Release (FRR) 44 (which eliminated the requirements of Rules 12-06 and 12-07 of Regulation S-X), we feel that a majority of the information included on the proposed Item 302(d) is redundant to information included in the GAAP financial statements and footnotes. Additionally, a summary of material capital additions, retirements and other changes is usually included in the "Financial Condition" section of management's discussion and analysis.
While it is true that the information included in the financial statements and management's discussion and analysis is not as detailed as that required by the proposed rule, we do not feel that the benefits realized from including such detail are proportionate to the effort required to prepare the schedule. We believe that there is sufficient transparency in the reporting of property, plant and equipment, intangible assets and related depreciation, depletion and amortization without the proposed resumption of the supplemental reporting requirements in Item 302(d).
Similar to our opinion on Item 302(c), we feel that independent auditors help to ensure that there is sufficient disclosure in the financial statements with regard to the accounts subject to Item 302(d). Furthermore, we believe that the additional disclosure requirements set forth in the proposal provide nothing more than information overload to the average financial statement reader. In other words, it seems unnecessary to cater to analysts' requests for additional information, when they represent only a fraction of all financial statement users. If the independent auditors feel that disclosure is adequate to avoid misleading the financial statement readers, why add more disclosure requirements? Only five years after the SEC concluded that such disclosure was unnecessary and redundant, not much has changed, so why reverse your decision?
Comments on Specific Questions Posed by the SEC
1. Are there other specific loss accrual or valuation accounts that should be added to the list of accounts identified within proposed Item 302(c)?
If the rule is adopted as proposed, the list of loss accrual and valuation accounts provided appears to be fairly all-inclusive, and as such, no additional items need to be added. To reiterate our point, we feel that the majority of items listed in the proposal would be disclosed elsewhere in the financial statements or footnotes, if material. Such disclosures are subject to the scrutiny of independent auditors, who are qualified to make a determination about the sufficiency of the language included, and inclusion of them in a supplementary schedule would only result in redundancy.
2. Should specific percentage tests be used to trigger specific account disclosures within the proposed rules? For example, should disclosure of loss accrual account activity be required only when the balance sheet item and change during the period exceeds a certain pre-established numerical threshold (for example, 5% of total assets or 3% of pretax income)? If so, what is an appropriate threshold?
As we have indicated in our earlier comments, we feel that if the rule is adopted as proposed, the use of a threshold to determine which accounts should be disclosed is appropriate. As the SEC is mainly concerned with management of earnings, we believe that an income statement-based measure would serve best as a threshold to trigger disclosure. In terms of a specific pre-established threshold, using 3% of net earnings may be more appropriate than 3% of pretax income - as suggested above - due to the fact that management of net earnings is the basis of the SEC's concern. Taking this into consideration, we do not feel that the use of a balance sheet-based threshold would be appropriate.
3. Should the placement of the proposed data be moved within MD&A or to some other section of the filing to enhance the prominence of the disclosures?
If the rule is adopted as proposed, we do not feel that moving the information to another section of the filing would be appropriate. As we have indicated above, we feel that a majority of the information required by the proposal is redundant to current disclosures in other sections, including MD&A, so altering the placement of the schedule would not provide a significant benefit.
4. Should presentation of the proposed data be limited to the Form 10-K?
If the rule is adopted as proposed, we agree with limiting the applicable information to the Form 10-K (or equivalent filings - e.g., Form 20-F).
5. Should the disclosure requirements be restricted to those registrants that exceed a certain size or meet some other threshold? If so, what would be the appropriate threshold?
If the rule is adopted as proposed, we feel that the rules should apply to all SEC registrants. Our opinion is based upon the fact that smaller companies should not be exempt from the level of transparency desired by the SEC. We feel that exclusion of smaller businesses would send a message that full disclosure is imperative only for larger companies, and that users of smaller companies' financial statements should not expect the same quality in financial reporting.
6. Are there circumstances where registrants may appropriately exclude disclosure about loss accruals related to litigation because of concerns about confidentiality while still conforming with GAAP? If so, please describe such circumstances such circumstances in detail.
If the rule is adopted as proposed, we have identified our concerns over disclosing information that could be competitively harmful. Taking this into consideration, it would seem appropriate to exclude any loss accruals associated with litigation that fall outside of conformity with GAAP. Using such a method as a benchmark would create an objective basis for inclusion or exclusion of information.
7. Should the disclosures concerning valuation and loss accrual account activity be required when interim financial statements are presented?
If the rule is adopted as proposed, we do not feel that the inclusion of such information is warranted in interim filings. As we described in our comments above, material changes from the previous year-end and prior quarter will be disclosed in the notes to the interim financial statements, or at the very least, in MD&A. As new rules require more thorough reviews (in accordance with SAS 71) of interim financial statements by independent auditors, we believe the adequacy of disclosure will be evaluated by them. We reiterate our belief that anything further would result in redundancy.
8. Should the disclosures concerning changes in property, plant, equipment and intangible assets and related accumulated depreciation, depletion and amortization be required when interim financial statements are presented?
Same as response to #7.
To summarize, we support the SEC's previous efforts concerning earnings management; however, based upon the rule as currently proposed, we do not support the additions of Items 302(c) and 302(d). We feel that via continued improvements in the efforts of independent accountants and increased communications of potential issues with audit committees, the need for further disclosure to serve the needs of analysts is unwarranted.
If you wish to discuss this letter, please contact John Miscioscia at (203) 622-3484.
/s/ Robert T. D'Alessandro
Robert T. D'Alessandro
Senior Vice President and Chief Financial Officer
/s/ John R. Miscioscia
John R. Miscioscia
Director - Corporate Accounting