April 14, 2000
Jonathan G. Katz, Secretary
United States Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File No. S7-03-00
Comments on Release Nos. 33-7793; 34-42354
Dear Mr. Katz:
On behalf of the American Society of Corporate Secretaries, Inc. (the "Society"), we are pleased to have the opportunity to respond to the Commission's request for comments on the Releases regarding the addition of Items 302(c) and 302(d) to Regulation S-K (the "Releases").
The Society has over 4,000 members who represent approximately 2,800 corporations in the United States and Canada, ranging from the largest multinational industrial companies to start-ups and other small companies. Our members typically have the responsibility to make company filings with the Commission and to comply with related securities laws and regulations.
We commend and fully support the Commission's goal to eliminate abusive earnings management and to increase the transparency of financial reporting in the financial statements, as these relate to public companies.
Regulation S-K, Item 302(d)
We do not object to the potential requirement in proposed Item 302(d) to include information concerning annual activity in both property, plant, and equipment and intangible assets, along with the related salvage values, accumulated depreciation, depletion and amortization, so long as this information may be provided by class of asset. The inclusion of such information should provide sufficient analytical information so that annual changes in amounts and activity in these accounts are transparent to investors. While it is true that this additional level of annual reporting will result in companies incurring added time and cost requirements, we believe that these incremental amounts, in general, will not be a significant burden as the required information is, on the whole, readily accessible. However, we do believe that the proposed requirement to disclose this information by estimated useful life would substantially increase the amount of detailed information that would need to be compiled and disclosed without a corresponding increase in the usefulness of the information that would be provided. Also, we do not believe that the proposed level of reporting detail should be required for interim reporting purposes.
Regulation S-K, Item 302(c)
We strongly object to certain provisions of the proposed Item 302(c). These could cause registrants to incur significant economic costs.
In reviewing the list of commonly reported loss accrual and/or valuation accounts that the Commission would expect registrants to present within proposed Item 302(c), we do not object to the inclusion of information related to asset-based reserves. However, we do object to the requirement to include loss accruals recorded pursuant to Financial Accounting Standards Board ("FASB") Statement No. 5 and loss accruals related to probable losses from pending litigation. The reason for our objection lies in the underlying nature of these loss accruals and the implications to a company of third parties becoming aware of this information. Concerning loss accruals recorded pursuant to FASB Statement No. 5, as an example, we object to disclosure of loss accruals related to tax matters.
In regard to loss accruals related to probable losses from pending litigation or tax disputes, requiring a company to disclose this information would limit its ability to manage effectively its litigation and dispute resolution with government agencies. First, allowing a third party to know that a company has a loss accrual recorded could be interpreted as an admission of liability by the company. Second, allowing a third party to know the amount that the company has recorded for a loss accrual would effectively sabotage a company's settlement posture. Such disclosure would mean that what a company considered the endpoint of settlement negotiations would become the starting point. Thus the proposal would provide a strong incentive for a company to accrue the lowest possible number. The proposal could have the opposite of what was intended; accruals could become less accurate.
Furthermore, requiring a company to disclose FASB Statement No. 5 tax loss accruals would also effectively limit a company's ability to pursue tax minimization strategies, and would, in effect, be disclosing a company's tax strategies to its competitors.
The proposal would also require a company to abandon its attorney-client privilege in disclosure of what would otherwise be privileged information. This privilege lies at the heart of our system of justice. Litigants suing a company would have a critical advantage since they would retain the advantage of attorney-client privilege and have no obligation to disclose their view of the worth of the case. In addition, all material litigation is presently required to be disclosed under S-K 103. The requirements of S-K 103 ensures that shareholders are adequately informed, while the new proposed rule informs them at the cost of destroying shareholder value.
Note that the above discussion, while specifically addressing tax and general litigation matters, is also applicable to other types of accruals included within the new proposed rule. As an example, we point to the same concerns in dealing with accruals related to product warranty and environmental remediation matters. In addition, providing information on product warranty liabilities will only benefit competitors, especially non-U.S. competitors who are not subject to the proposed requirements.
Finally, disclosure of one of the enumerated asset-based reserves - excess of estimated costs over revenues on contracts (loss contracts) - could be so economically harmful to the disclosing company, both with respect to existing and future customers and competitors, that its disclosure should not be required. We do not believe that any possible benefit to investors of such disclosure could justify the potential economic harm to the disclosing company.
Additionally, we believe that existing requirements within both Regulations S-X and S-K already provide for transparent financial reporting. Related to the compilation of financial statements and the related notes, Regulation S-X provides for specific thresholds in determining whether amounts can be aggregated within a given financial statement caption or need to be separately disclosed on either the face of the financial statement or within the notes to the financial statements. Related to an understanding of a registrant's financial condition, changes in financial condition and results of operations, Regulation S-K provides for specific discussion and analysis of the registrant's financial statements that the registrant believes will enhance a reader's understanding of its financial condition, changes in financial condition and results of operations. The above noted requirements in total already provide for a reporting framework which will ensure that any amount recorded within an account that would require disclosure under proposed Item 302(c) would already require disclosure should the amounts be material.
In sum, we urge the Commission to delete FASB Statement No. 5 loss accrual accounts, including the specific enumeration of loss accrual accounts,1 from proposed Item 302(c). The enumeration of loss contract accruals also should be deleted. Corresponding changes should be made in the instructions, including the deletion of Instruction No. 5. We have no problem with retaining accruals for liabilities for exit and employee termination costs related to a restructuring or a business combination, and liabilities for costs of discontinued operation.
Additionally, the Commission has asked for responses to specific questions raised in the proposal. Taking into consideration the above discussion, should the Commission choose to move forward with the proposed rules, our views on these matters are as follows:
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)?
No. We believe that the list of specific accounts (with the deletions we suggest above) provides an adequate basis for registrants to determine the overall message that the Commission is trying to communicate. As the proposal clearly states that the list is "suggestive rather than all-inclusive", we do not believe that there is a need to add other specific loss accrual or valuation accounts to the list provided within the proposal.
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?
No. We do not believe that specific percentage tests should be used to trigger account disclosures within the proposed rules. Rather, a materiality test should apply for requiring disclosure, based on general materiality principles without a specific numerical definition.
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?
No. We believe that in general, all of the information provided within filings required under Regulation S-K must be read and analyzed as a whole. Accordingly, we do not believe that placement of the proposed data within MD&A or some other section of the filing is necessary to highlight the prominence of the disclosure.
4. Should presentation of the proposed data be limited to the Form 10-K?
We believe that for the vast majority of registrants, the major reporting implications of Regulation S-K revolve around Form 10-K and Form 10-Q. Accordingly, as we discuss below on whether there is the need to include the disclosure requirements within proposed Items 302(c) and 302(d) in interim financial statements, we do believe that the presentation of the proposed data, if required, should be limited to the Form 10-K. However, as discussed in our response to Question 7, below, if in specific circumstances the information was of a material impact to a registrant, we believe that current Commission guidance would appropriately require the information to be disclosed.
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?
No. If disclosure is deemed important, it should apply to registrants regardless of size of the company.
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 in detail?
We believe that both GAAP and the current Commission Regulations are designed to ensure that users of financial statements are adequately informed as to the financial status of the applicable entity. We do not believe, however, that the intent of either GAAP or the current Commission Regulations is to require information to be disclosed which would be to the detriment of the applicable entity. As we previously discussed, detailed disclosure in the areas of legal, environmental, tax, product warranty and loss accruals as would be required under the proposed rules could interfere with the competitive business practices of a registrant and destroy shareholder value, which would be disadvantageous to investors. We believe that current GAAP, specifically FASB Statement No. 5, requires adequate disclosure when dealing in these areas.
7. Should the disclosures concerning valuation and loss accrual account activity be required when interim financial statements are presented?
No. Rule 10-01 of Regulation S-X indicates the following in referring to disclosures related to interim financial information: (1) the disclosure should be sufficient so as to make the interim information presented not misleading; (2) the registrants may presume that users of the interim financial information have read or have access to the audited financial statements for the preceding fiscal year and that the adequacy of additional disclosure needed for a fair presentation, except in regard to material contingencies, may be determined in that context; (3) disclosure shall be provided where events subsequent to the end of the most recent fiscal year have occurred which have a material impact on the registrant; and (4) where material contingencies exist, disclosure of such matters shall be provided even though a significant change since year end may not have occurred. We believe that Rule 10-01 already provides the substance of what the Commission would achieve by including the disclosure requirements of proposed Item 302(c) in interim financial statements.
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?
No. Please refer to our response to Question 7. Similarly, we believe that Rule 10-01 already provides the substance of what the Commission would achieve by including the disclosure requirements of proposed Item 302(c) in interim financial statements.
Should the Commission or its Staff have questions concerning the comments in this letter or desire additional information to assist it in preparing the adopting release, please do not hesitate to contact us.
Very truly yours,
/s/ Margaret M. Foran
Margaret M. Foran
Securities Law Committee
/s/ Carol Crofoot Hayes
Carol Crofoot Hayes
Subcommittee on Financial Disclosure
cc: David B. H. Martin
D. Craig Nordlund
Gwenn L. Carr
David W. Smith
Karl R. Barnickol
Michael J. Holliday
1 The following enumerated items should be deleted from proposed Item 302(c): excess of estimated costs over revenues on contracts (loss contracts); liabilities for environmental costs; contingent income and franchise tax liabilities recorded pursuant to FASB Statement No. 5; product warranty liabilities; and probable losses from pending litigation.