R.G. Associates, Inc.
The Fidelity Building
210 N. Charles Street, Suite 1325
Baltimore, MD 21201
Jack T. Ciesielski, CPA, CFA
Re: File No. S7-08-02
May 3, 2002
Mr. Jonathan G. Katz
Securities & Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
I am writing in response to the Commission's proposal for shortening the time frame for the filing of 10-Q's and 10-K's. Let me state that I comment as a former buy-side analyst and current accounting analyst who works closely with buy-side and sell-side institutions, rather than as an accountant for a registrant or as an auditor. I write a research service entitled The Analyst's Accounting Observer, details of which are available at www.accountingobserver.com.
First of all, I'd like to commend the Commission for taking a look at the issue and putting forth a proposal on this matter. I agree that there are ways to improve the timeliness of information supplied to investors by our financial reporting system, and I think the SEC has found an area that could prove to be a mother lode for improving the lot of investors. The window of time between the earnings release date and the time of filing of 10-Q's has probably gotten wider over the years. Earnings releases capture nearly all of the anticipation and excitement of a Super Bowl and seem to arrive earlier than they did just a few years ago, while the 10-Q still arrives at about the same time as always. During the interim, investors move securities prices on the basis of management-selected information, rather than the more complete, comparatively objective information in the filings. By the time that a 10-Q is filed, the analyst and investor community is already focusing on what to expect for the next earnings release instead of spending "quality time" with the filing just completed. This situation is particularly acute with regard to the filing of the 10-K: the first quarter earnings release is often very close to the time the 10-K becomes available. Instead of mining the 10-K's valuable data, analysts and investors are worrying about the first quarter's earnings. The focus then shifts to the next quarter, and the 10-K doesn't receive the attention it should.
Ultimately, the 10-Q's and 10-K's get treated as ancient history, rather than as valuable inputs into investment decisions. The SEC's apparent goal is to make these documents more valuable to investors by getting them into their hands much closer to the earnings release. I disagree with the proposal, however, because I don't believe its implementation will change much. There will still be a gap between the earnings release date and the time of the filing. I understand that the SEC's Office of Economic Analysis has determined that over the past 10 years, registrants on average issued their year-end earnings announcements approximately 43 days after fiscal year end, and issued their quarterly earnings announcements approximately 27 days after period end. (Being averages, I would expect there could be much variance around them.) Assuming these announcement dates remain static, shortening the filing periods as proposed would make the window much narrower. There's no assurance, though, that firms might not make their earnings announcements sooner than they do now - leaving the window still wide open.
I believe that there are firms that will have no trouble at all meeting the shorter deadlines suggested in the proposal, but I also believe many will find it difficult to comply. (At the time of this writing, it appears from the electronically transmitted responses posted to the SEC website that you have already started to hear from firms that will have problems.) The $75 million float threshold is an admirable attempt to lighten the burden for companies that might be severely affected, but this two-tiered approach makes a cut based on criteria that do not relate to the registrant's ability to produce financial information. The two-tier approach is based on a premise that a company of a certain size (more than $75 million, based on what the market thinks of its prospects) has the ability to produce more timely financials, while those below that threshold do not have the same ability. I would hesitate to presume that all companies over the $75 million mark have that ability.
Let's address only the 10-Q filing deadlines for a moment, and without regard to market capitalization, revenues, assets or any other tiering constructs. I would suggest that any gap between the earnings release date and the time of the filing is unacceptable. The solution is to require that companies file their full 10-Q's on EDGAR and make them available via a link from their own websites at the same time they announce their earnings - and give them the full 45-day reporting period to do so. I believe there are significant benefits to this approach:
First, regardless of the current criticism being heaped upon analysts, one thing is for sure: they need information to do their jobs the way they should, and this approach would put it in their hands at the right time. When the only information available is what's selected for showcasing by managements during the frenzy of the earnings release, don't expect the most unbiased, critical thinking from analysts and investors. Give them the right information to do the job when they need it at earnings release time - and if they ignore the information, then they deserve all the criticism they get. Compared to an earnings release alone, a 10-Q filing is quite objective. Management still can say what they want in an earnings release - but if accompanied by an actual 10-Q filing that might put a different spin on their view of things, they might feel less inclined towards puffery. Pro forma financial reporting has been problematic for the entire financial community in recent years, and the SEC has had to expend its resources to investigate abuses. Coordinating the earnings release with the 10-Q filing might dampen the ardor for "new metrics" that mean less, and re-emphasize the importance of all of the information in the quarterly financial package.
Second benefit: the worst that might happen with a variable-date reporting plan is that it takes firms slightly longer to release earnings in order to complete the 10-Q package. Corporate complaints that it will take too long before releasing earnings should be met with skepticism. If a firm is ready to release earnings to the world, how much serious work could remain to complete the 10-Q? The significant estimates should have already been made, and one would expect that some level of review by responsible parties has been completed. Footnotes don't often change much from quarter to quarter, and if management is ready to discuss results on a conference call or webcast, surely it has a good idea of what needs to be included in the Management's Discussion & Analysis section. Look at it another way: if the earnings releases of all companies were delayed by a week to ten days so a complete financial report is available, would capital markets grind to a halt? It would be hard to believe.
Third benefit: the 30-day mandated deadline is a one-size-fits-all approach that ignores market-based incentives, while a flexible deadline approach makes those incentives more powerful. The markets are demanding relevant, reliable information, and when it doesn't get it - when there are restatements or SEC investigations - it exacts a very large and sudden cost on offending firms. That's not mere hypothetical value; it's a developing trend that could raise the cost of equity capital for all firms in the long run. Investing in the financial reporting function is usually viewed by corporate chieftains as a cost center sinkhole - but investment in solid-citizen finance professionals, with the financial support for adequate systems and moral support for applying conservative accounting principles, should look like an appealing insurance policy against the greater cost that the market will demand for the intolerance of accounting sleaze. That should encourage firms to make the necessary investments to provide financial information in timely fashion. If the market rewards firms that meet investors "first with the most,"that's a powerful incentive for firms to spend on the infrastructure needed for financial reporting
Fourth benefit: imposing the 30-day limit might produce the unintended consequences of firms producing more boilerplate disclosures and less robust information in the 10-Qs, while a flexible filing approach might not encourage the same corner-cutting. There will also likely be some firms just on the margin of being able to produce such information reliably in this time frame; I believe there is a risk of lesser reliability in the financial statements for some of these firms.
In sum, leaving the 45-day filing period intact, but with the requirement that 10-Qs must be filed simultaneously with the earnings release, is a better solution. It will encourage firms to invest what they must in order to file in time if they want to release earnings earlier than 45 days. If they don't want to invest a dime, the only penalty they face is releasing earnings later. It's up to them - and what they think the market expects of them.
I would urge the Commission to separately rethink the proposal in terms of the 10-Q and 10-K documents. As I outlined above, I think the 45-day window for the 10-Q with "variable release/filing" would produce all of the intended benefits of the 30-day window, with much less disruption and better information provided to the markets at earnings release time. With regard to the 10-K, however, a slightly different approach might work better than simply contracting the 90-day window to 60 days.
Synchronizing the full year earnings release to the 10-K package in the fourth quarter would be more of a problem. The 10-K reporting package requires so much more information than the 10-Q that it would be difficult to have it completed by a time that investors would reasonably expect earnings to be released. I believe that the Commission should instead give serious consideration to the requirement of a fourth quarter 10-Q subject to the same suggested requirements for the first three quarters. The idea of a fourth quarter report is not new. In fact, it was a recommendation of the AICPA's Special Committee on Financial Reporting in their report, "Improving Business Reporting - A Customer Focus," released in 1994. The following passage from that report is worth mentioning here:
"The Committee believes reporting on the fourth quarter would be useful to users. Management's insight into trends and the effects of unusual and non-recurring items is as useful in the fourth quarter as it is for the first three quarters. Without fourth-quarter reporting, many users have no access to that insight.
Fourth-quarter reporting should be no different from reporting on other quarters except for disclosure of significant year-end adjustments. Notes related to year-end balance sheet amounts can generally be omitted if the fourth-quarter financial statements are included in annual reporting.
The Committee also believes public companies can report on the fourth quarter at acceptable cost. Most, if not all, of the information that would be reported for the fourth quarter, such as unusual and non-recurring items, management has had to identify and consider in developing the annual report. Further, the fourth-quarter report could be abbreviated by cross-referencing to material included in the annual report."
It's worth noting that the Committee producing the above recommendation was not composed of starry-eyed analysts with insatiable demands for information; in fact, there were no analysts on the Committee. It was composed mostly of members drawn from the ranks of public accounting, including the current FASB chairman; a former FASB member; two former SEC Chief Accountants; and numerous other practitioners who are aware of the costs and feasibility of such an endeavor.
The 10-K report could be filed sometime after the fourth quarter 10-Q. I would agree that the existing 90 days would be too long, but given the additional burden of producing a fourth quarter 10-Q document, the proposed 60 days would probably be too short. On the other hand, producing the fourth quarter 10-Q should involve some of the same work needed to produce the 10-K. I would propose leaving the 10-K filing at 90 days, with a two-year time frame to shorten it to 75 days. That would give registrants a chance to find out how to cope with the additional 10-Q demands and adapt that work to meeting the 10-K requirements.
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The basic premise underlying the federal securities laws is that if companies provide markets with better information, participants will make better investment decisions - and ultimately direct capital to its best use. While the current proposal appears to be a step in supporting that premise, I believe that flexible filing dates coordinated with earnings releases for 10-Qs would be more effective.
That concludes my comments. If there is anything that I can clarify, please do not hesitate to call. Best regards.