May 22, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609
File No. S7-08-02Acceleration of
Periodic Reporting Filing Dates and Disclosure
Concerning Website Access to Reports
Release Nos. 33-8089; 34-45741
Dear Mr. Katz:
This letter is the response of KPMG LLP to the Securities and Exchange Commission’s request for comments on its proposed rule for accelerated periodic reporting filing dates and disclosure concerning website access to reports (the Proposed Rule or Release).
KPMG supports the Commission’s goal to provide investors with access to information that is clear, accurate and timely, and applauds the Commission’s efforts to sponsor a debate on the issues surrounding how the various constituencies can support and strengthen the United States capital markets. For some time the investing public, the SEC, and others have expressed concern over the usefulness of quarterly and annual reports. More recently, major events affecting the capital markets, and investor perception that the quality of financial reporting has deteriorated, have created the “perfect storm” that has eroded investor confidence in the capital markets. All key participants in the financial reporting process are currently in the process of reexamining their business processes and the risk assessments that underlie those processes to identify better ways to satisfy the information needs of the investing public.
The Commission understandably is concerned with the information “gap” that has evolved from the proliferation of earnings releases sometimes issued well in advance of the filing of full financial statements and MD&A. However, at a time of heightened scrutiny of corporate financial reporting and examination of how each participant in the reporting process can work to restore confidence in financial reports, we believe the primary focus of the Commission’s efforts at this time should be on the accuracy and transparency of financial reports. We agree that timeliness of information is a critical component of an effective capital market. However, we believe that the investing public would be better served, at this critical juncture, if company management, boards of directors, audit committees, auditors, attorneys and other advisors could continue to focus their efforts on improving the quality of financial reporting without the added complication of meeting accelerated filing deadlines for quarterly and annual reports.
Based on a limited survey of current filing practices, we would expect some of the larger companies may be able to meet the proposed accelerated filing deadlines. However, many companies would need to incur substantial effort and costs to comply with the deadlines in the Proposed Rule. Similarly, audit effort and costs would increase commensurate with compressed audit efforts (adjusted audit timing, methodology and approaches) as each company situation warrants.
We encourage the Commission to consider the various factors contributing to the timeliness of financial reporting as discussed below, the current reporting environment in which investors are demanding more information and, at the same time, additional responsibilities are being placed on communications among management, auditors and audit committees, and the impact of an unprecedented number of auditor changes, in reaching a final conclusion on the Proposed Rule. We offer our comments below to assist the Commission in this regard.
In the event the Commission chooses to proceed immediately with its initiatives for accelerated filing of periodic reports, as described in the Proposed Rule, we believe certain alternative reporting models would better strike the balance between quality and timeliness of financial reports. We strongly support an alternative approach requiring companies to file Forms 10-Q and 10-K based upon a specified number of days after the earnings press release. This alternative gives recognition to the effect of the factors discussed below on each individual reporting entity, and limits the “gap” between a company’s earnings press release and the date investors have access to full financial statements and related disclosures and analysis. This alternative, as well as other alternative approaches, are discussed in this letter, as well as our views on the appropriate transitioning to accelerated filing.
Our comments primarily are based on our assessment of the Proposed Rule’s effect on our ability to fulfill our professional obligations under existing generally accepted auditing standards. The extent to which we are affected is largely dependent on how the Proposed Rule will affect the reporting companies that we audit. Accordingly, our comments also reflect the results of a survey of senior management, board of directors members and audit committee members of our client base ( a total of 129 responses). While our survey may not provide statistically valid results because of the limited comment period, we believe it provides valuable insight from our registrant clients and those constituencies of the financial reporting process that will be most affected by the Proposed Rule.
The Proposed Rule
General Comments
As one step in improving the usefulness of reports, the Commission proposes to accelerate the due dates of Forms 10-K and 10-Q. In the Release, the Commission specifically cites “…advances in communications and information technology…” over the 30 years since the current filing deadlines were established as making it “…easier for companies to process and disseminate information swiftly.” Although the technological advancements in the last 30 years have enhanced the reporting process for many companies, these benefits have been offset by several developments. First, significant changes in economic conditions, the complexity of business transactions and business models and the proliferation of complex accounting standards have occurred over the last three decades, requiring significant time to research and analyze the raw data to reach appropriate measurement and disclosure conclusions. Second, the technological advancements to which the Commission refers have primarily occurred in the database and enterprise system areas. While versatile and complex, these advancements have resulted in a quicker compilation of raw data, not a reduction in the time required of management to analyze increasingly complex transactions, develop informative disclosure tailored to the company’s unique financial and operational activities, and meet the expanded disclosure requirements that have evolved during this period. Third, the Commission’s requirements with respect to the content of quarterly and annual reports has increased significantly over that 30-year period particularly in ways that require careful analysis and articulation. Specifically, the Commission’s requirements for disclosures about management’s discussion and analysis of financial condition and results of operations required by Item 303 of Regulation S-K as well as the market risk disclosure required by Item 305 of Regulation S-K are disclosures that have been added during the last 20 years. Each of these requirements is extensive, the compliance with which requires significant management involvement in the analysis of raw data and assessment of qualitative factors for disclosure. Similarly, independent accountants must devote the appropriate time to assess these complex and “nonstandard” transactions for appropriate accounting and disclosure. Finally, technological advancements do not impact the speed at which an audit committee can thoughtfully consider a company’s financial reporting issues and engage in constructive dialog with management and the independent accountants. Eighty-three percent of our survey respondents believe that the proposed accelerated due dates would not provide companies with enough time to prepare their reports. The acceleration of filing due dates may have the unintended effect of sacrificing quality for timeliness at a time when renewal of confidence in corporate reporting is critical.
The Commission also notes in the Release that companies release quarterly and annual earnings well before they file their Forms 10-Q and 10-K. “While these press releases do not contain all of the information included in quarterly and annual reports, it appears that companies and their auditors have developed efficiencies over the years that allow them to generate financial data quickly… We understand as a general matter that the audit work is essentially completed and other steps have been taken to ensure their accuracy.” While audit and review fieldwork may be substantially complete at the time earnings are released (this assertion of substantial completion of independent accountants’ fieldwork is by no means universal), we believe it is important for the Commission to consider that earnings press releases ordinarily contain only limited income statement and operating data and generally omit the extensive disclosures otherwise required by the SEC and generally accepted accounting principles in quarterly and annual reports. These disclosures include the notes to the financial statements, financial statement schedules, MD&A, industry guide information and other requirements that must be prepared by management, subjected to appropriate procedures by the independent accountants as set forth in the applicable auditing standards, and reviewed by the audit committee.
In the Release, the Commission seeks comment on improving the flow of information to investors and the markets. We note that once any accelerated filing deadlines are implemented, the intervals at which companies will report will be consistent with the current reporting intervals (i.e., quarterly). Accordingly, any acceleration of filing deadlines must be coupled with meaningful changes in disclosure requirements for material events that occur between periodic reports, in order to achieve meaningful progress in the timeliness of information flow. We encourage the Commission to proceed expeditiously with its announced intent in this regard.
Factors Contributing to the Timeliness of Reporting
We believe that the accelerated filing requirements as currently proposed will create several practical difficulties that may improve timeliness but will likely compromise the quality of reporting. In its Release, the Commission relies on the existence of earnings releases that are issued shortly after a period end as evidence that registrants have the current capability to prepare financial information on an accelerated basis. As previously discussed, these press releases ordinarily contain limited financial information and minimal disclosures, as the full set of financial statements have not been prepared.
Significant advances in technology over the past decade have increased the speed at which companies are able to gather and aggregate information, and many companies have reduced their closing cycles. However, many of the financial disclosures needed to comply with the Commission’s reporting requirements exceed what currently can be produced with even the best accounting and reporting systems. The filing of accurate and quality information requires significant management analyses, including those related to significant estimates, reviews by legal and other professional advisors, and substantive communications between auditors, management and audit committees on accounting and reporting practices, proposed disclosures and audit findings.
Factors contributing to the timeliness of reporting in an accelerated filing timeframe include:
In addition, because of investors’ increasing demands for more disclosures, and new disclosure requirements in Management’s Discussion and Analysis, we would expect that companies will need to devote more resources to prepare these qualitative and quantitative disclosures. For example, the guidance included in Financial Reporting Release (FRR) No. 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies, FRR No. 61, Statement About Management’s Discussion and Analysis of Financial Condition and Results of Operations, and the proposed rulemaking in Release Nos. 33-8098/ 34-45907, Disclosure in Management’s Discussion and Analysis about the Application of Critical Accounting Policies, all serve to provide an expectation that additional resources and time will be necessary in the near term to provide the thoughtful, meaningful qualitative and quantitative disclosures so required.
Based on our experience, the following examples offer typical timelines from year-end to filing on Form10-K and from quarter end to filing on Form 10-Q for a large (Fortune 500) and a smaller ($100 million market capitalization) registrant.
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Days After Period-End |
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Example Fortune 500 |
Example Smaller |
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|
Registrant |
Registrant |
||
|
|
Form 10-Q |
Form 10-K |
Form 10-Q |
Form 10-K |
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|
|
|
|
|
|
Period ended raw data availabl |
7-10 |
7-10 |
25-35 |
25-40 |
|
Auditor begins final fieldwork |
7-10 |
7-10 |
25-30 |
25-40 |
|
Consolidation and analysis |
8-29 |
8-29 |
25-45 |
30-60 |
|
Audit Committee, Senior Management
|
16-27 |
16-27 |
33-43 |
33-58 |
|
Earnings announcement |
18-29 |
18-29 |
35-45 |
45-60 |
|
Complete drafting of MD&A, notes, |
|
|
|
|
|
other sections of filing |
25-35 |
30-50 |
35-40 |
60-70 |
|
Senior Management reviews |
30-40 |
50-60 |
40-45 |
70-80 |
|
Auditors, outside lawyers, investor |
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|
|
|
relations reviews |
30-40 |
60-75 |
40-45 |
70-90 |
|
CEO reviews |
35-40 |
60-75 |
40-45 |
70-80 |
|
Audit Committee/Board reviews/Audit |
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|
|
|
Committee meeting |
35-40 |
75-90 |
40-45 |
70-90 |
|
File Exchange Act report, EDGAR |
40-45 |
80-90 |
43-45 |
85-90 |
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As demonstrated in these timelines, significant activity occurs subsequent to the earnings announcement. By accelerating and compressing the financial reporting process, additional stress will be applied to certain critical aspects of the reporting process that in many cases may impact the quality of the information subject to audit or review. When asked how the proposed accelerated due dates would affect the reliability and accuracy of Exchange Act reports, 73 percent of our survey participants responded that reliability and accuracy would suffer.
Audit committees are demanding additional time, including meetings and other communications, of management and independent auditors in dispensing their responsibilities. The increasing expectations of audit committees’ involvement in the financial reporting process, coupled with increasingly complex transactions and authoritative literature, has and will continue to result in additional time commitments of all three components of the “three-legged stool”--- audit committees, management and the independent auditors. For a large portion of the registrant population affected by the Proposed Rule, we are concerned that the accelerated filing dates so proposed may inadvertently serve to inhibit the evolution of audit committees’ active involvement in the financial reporting process. We are encouraged by the active involvement of audit committees, and any regulatory change that could serve to hamper that involvement in a meaningful way, directly or indirectly, would be counter-productive.
In summary, we believe that companies with a market capitalization of less than $1.0 billion will incur significant costs to comply with the Proposed Rule. In addition, implementation of the Proposed Rule on this portion of the registrant population may well result in a risk that quality of information and disclosure will suffer at the perceived benefit of accelerated distribution of information. Please see Proposed Alternatives below.
Considerations of the Proposed Rule on the Auditing Model
In addition to the factors affecting companies’ abilities to produce complete, accurate and meaningful information in an accelerated environment, we , as independent auditors, likely will need to modify our audit timing and methodology to address audit risk resulting from this compressed and accelerated environment. We will need to adapt our quality control system to address how effective audit procedures will be performed to meet our obligations under generally accepted auditing standards and the interpretations thereto. For example, in certain cases, expanded procedures will need to be performed to address the increased risk of material misstatement relative to a compressed closing schedule for a particular company. These expanded procedures will need to consider the effect of an accelerated reporting environment on an entity’s internal control processes, the additional use of estimates in the closing process, and the difficulty of obtaining independent verification or confirmation of information.
Our current business model has been developed based on the existing filing deadlines, and recognizes the large number of registrants with calendar fiscal years. Given that business model, we have devoted significant resources to the development and implementation of “continuous auditing” that encompasses risk-based and systems-based audit methodologies, recognizing that technology advances over the past decade have increased the speed at which companies are able to gather and aggregate accounting information, leading to reductions in closing cycles. Even with this implementation of continuous auditing, our business model still experiences a significant demand spike in the months of January through March. With respect to quarterly reviews, again, our business model has been built around the spike demand periods surrounding the quarters ended March, June and September, and the existing 45-day filing deadline.
As a firm, we are firmly and deeply committed to the goal of providing audit and review services to support the collective goal of providing investors with access to information that is clear, accurate and timely. To that end, we are continuously in the pursuit of improvement to our audit methodology and quality control system. If the Commission proceeds to implement the Proposed Rule, we strongly encourage it to consider our comments below, under Implementation and Transition Period, to make the final rule effective for affected companies as of the end of their first fiscal year beginning after the date of the final adoption of the rule. In addition to providing appropriate time for affected companies to adjust their systems and internal processes, this effective date will provide auditing firms the appropriate time to adjust their business models.
Proposed Alternatives
Among the Commission’s stated reasons for proposing to accelerate the filing dates for periodic reports is to lessen the “gap” between a company’s announcement of earnings and the filing of its Exchange Act reports with GAAP financial statements and MD&A. Based on the Commission’s stated reason above and the consideration of the various factors described above, we believe the Commission’s objective of acceleration of the current reporting deadlines is best achieved in the current reporting environment by tying the due dates of the Forms 10-Q and 10-K to the date of a company’s earnings press release. If the Commission believes this alternative is not preferable, we have suggested other alternatives for its consideration.
We share the Commission’s concerns about the role of earnings releases in the financial reporting process. As observed in the Release, the delay in the filing of reports with the SEC means investors often make decisions without timely access to the more extensive disclosures provided in the Exchange Act reports. It would be ideal if investors were provided access to a company’s GAAP financial statements and the related MD&A at the same time a company publicly announces its periodic earnings. As a result, investor decisions would be better informed by access to a complete financial reporting package. However, for many valid reasons, complete financial statements and MD&A are seldom available at the time of a company’s earnings release. Any attempt to eliminate the “gap” entirely may unnecessarily delay the company’s earnings release because of the factors described above.
We understand that the Commision has not pursued rulemaking to prescribe the form and content of corporate earnings releases. However, we believe that the markets and the investing public would benefit from improved practices surrounding earnings announcements. The Commission already has taken a first step in improving earnings release practices by issuing FRR-59, Cautionary Advice Regarding the Use of "Pro Forma" Financial Information in Earnings Releases. Just recently, Standard and Poor’s released its definition of “core earnings” in its Measures of Corporate Earnings in an attempt to generate discussion that would lead to a consensus on how earnings should be calculated, thus bringing more uniformity and clarity to earnings analyses and forecasts. We believe that additional private sector initiatives to promote best practices in corporate earnings releases will help to improve their quality. For example, we would recommend as a best practice that a corporate earnings release include as an attachment certain minimum basic condensed financial information prepared on a basis consistent with GAAP: that information could be in the form of a condensed balance sheet, income statement and statement of cash flows. In addition, we believe that as a best practice the corporate earnings release should include all material information pertinent to an enhanced understanding of periodic results, such as any explanations of amounts or changes that ultimately will be publicly disclosed in an earnings “conference call” or in MD&A when the Exchange Act report is filed. The adoption of such best practices would lessen the concern over the “gap” and the potential that investors may be operating with materially incomplete information. If the adoption of such best practices serves to delay the timing of earnings releases, we believe that the trade-off between quality and speed would be justified. Further, the market place would reward companies that provide improved earnings release information.
Under our alternative approach, we propose that the date for filing the periodic Exchange Act report be determined based on the date of a company’s earnings release, subject to a maximum length of time following the close of the period. Such an approach would directly limit the potential length of the “gap”. We believe it is reasonable to expect a public company to file its Exchange Act report, with complete GAAP financial statements and MD&A, within a reasonably short time after its earnings release. We propose that the due date for filing Form 10-Q be the earlier of 45 days after the end of the quarter or 15-20 days after a quarterly earnings release, and the due date of Form 10-K be the earlier of 90 days after the end of the fiscal year or 35-45 days after the annual earnings release. We believe that a properly designed interval after the earnings release would provide a company sufficient time to prepare the financial statement disclosures required by GAAP and to complete the analysis of operating results and financial conditions necessary to prepare MD&A. Properly designed intervals also will allow auditors sufficient time to complete their review of quarterly results and their audit of financial results, including performing necessary quality control procedures, and fulfilling their communication responsibilities to management and audit committees. Also, properly designed intervals would provide audit committees and boards of directors sufficient time to exercise meaningful oversight of the financial reporting process and review of financial reports. Although we have included example intervals for the Commission’s consideration, we recommend that the Commission, if such a system is implemented, undertake an analysis specifically directed at identifying the appropriate interval between earnings releases and the related filing dates.
With respect to our preferred alternative, we anticipate two significant practical concerns about correlating the due date of the periodic filing to the date of the company’s earnings release. First, will the variability of the due date of the periodic report be confusing? We believe that this concern is limited to a concern about assessing regulatory compliance with timely filing requirements and a company’s status as a timely filer. At present, investors and the market adapt quite well to variability in the timing of earnings releases and periodic reports. Currently, many companies notify investors and the public of the date that they expect to announce periodic results, and the market adapts to that timetable. In addition, many companies file their Exchange Act reports before the current deadlines and financial news services notify investors and the public about the availability of those reports. However, in order to address the concern about monitoring timely filing, we suggest that the Commission modify the cover page of Forms 10-Q and 10-K for the registrant to note the date of its first public disclosure of periodic results and to indicate whether or not the report has been filed within the prescribed timeframe.
The second concern we anticipate involves the definition of what constitutes an “earnings release.” In most cases, we believe that the identity of an earnings release is clearly evident. However, in some cases, companies “pre-release” earnings to the extent they expect performance to be materially different than market expectations. Although such announcements may occur following the period end, in our view they should not be considered earnings releases because they disclose expectations for the period subject to a complete financial close and finalization of periodic results. In other cases, a company might disclose extensive financial information about the period, but omit traditional measures of earnings. For example, a company might disclose, among other things, revenue, gross margin and earnings from operations without disclosing net income or earnings per share. Generally, we believe that such disclosure should not be considered to constitute an earnings release for purposes of determining the company’s periodic reporting deadline, as key measures including net income and earnings per share are generally missing from such releases. We suggest that the Commission consider whether the final rule should include a definition of an “earnings release” or some form of guidance. In any event, it will be important to monitor practice as it develops, and to consider new and unusual circumstances.
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Percentage of all Registrants |
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|
Market |
Total |
Percentage of |
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|
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Capitalization |
Number of |
Market |
Percentage of |
|
|
In Billions ($) |
Registrants |
Capitalization |
Registrants |
|
Total |
8,826 |
3,770 |
100% |
100% |
|
> $1B |
8,253 |
820 |
94% |
22% |
|
$1B - $750M |
141 |
162 |
2% |
4% |
|
$750M - $500M |
141 |
230 |
2% |
6% |
|
$500M - $250M |
145 |
402 |
2% |
11% |
|
$250M - $100M |
93 |
565 |
1% |
15% |
|
$100M - $75M |
16 |
193 |
0% |
5% |
|
$75M - $0M |
37 |
1,398 |
0% |
37% |
Our limited analysis is based on market capitalization, not public float, and only considers calendar year-end registrants. We would not expect a significant difference in trend if public float and all registrants were utilized in such an analysis. We believe the above data supports a conclusion that the $75 million threshold included in the Proposed Rule be increased. For example, increasing the threshold to $1.0 billion would significantly reduce the number of registrants affected by the Proposed Rule (those most likely to incur significant costs and be at risk for not being able to meet the accelerated deadlines), while at the same time not significantly affecting the amount of market capitalization covered using the higher threshold to define an accelerated filer. We recommend that the Commission undertake an analysis to consider whether increasing the public float threshold will meet its stated objective, while at the same time considering the costs and risks of the Proposed Rule relative to smaller registrants.
In the Release, the Commission questioned whether the accelerated filing deadlines as proposed should be shortened or lengthened. Only 25 percent of our survey respondents indicated agreement with the accelerated deadlines in the Proposed Rule. For the reasons previously discussed, we believe that accelerated filing dates may negatively impact the quality of quarterly and annual reports. If the Commission proceeds with its current proposal to accelerate filing due dates, we believe a Form 10-K filing date of between 75 and 90 days following year end is a more realistically achievable goal. Although only 34 percent of the registrants in our analysis with a market capitalization over $1.0 billion filed within 75 days of December 31, 2001, we believe these registrants are the most likely to have the appropriate resources to implement the processes necessary to file within that deadline. However, we strongly believe that the current Form 10-Q filing date of 45 days following quarter end does not enjoy the same flexibility, especially for smaller companies, and therefore should not be reduced. For larger registrants, it may be possible to accelerate their Form 10-Q filing deadline by a few days; however, we believe the market place should drive more timely information from these larger companies.
Other Considerations
As discussed in the Release, the Commission also is considering how the proposed accelerated due dates would affect the age of financial statement requirements for Securities Act registration statements as well as the filing dates for other Exchange Act reports. We have the following comments as they relate to these areas:
Implementation and Transition Period
In the current environment in which there is so much emphasis and need to improve the quality and transparency of financial reporting, we are concerned that adding accelerated timing to the mix at this time will put an inappropriate stress on an increasingly burdened function. As we survey the current environment, we note the following conditions and changes already in place:
In short, the implementation of accelerated filing deadlines, on top of the other changes occurring in the current financial reporting environment, will place additional, significant demands on the existing resources devoted to the financial reporting process.
The Commission currently proposes to make the Proposed Rule effective for companies that meet the public float and reporting history requirements as of the end of their first fiscal year ending after October 31, 2002. Companies, accounting firms, and other affected entities must plan and implement changes in their business processes and staffing levels to adjust to the accelerated reporting model. These changes will take time. Calendar year 2002 operating budgets may restrict the ability of many companies to acquire the requisite resources. Audits for companies with December 31, 2002 year-ends are already in the planning stages. We recommend that the Commission make its final rule effective for companies that meet the public float and reporting history requirements as of the end of their first fiscal year beginning after the date of the final adoption of the rule.
The Commission should also consider a gradual phase-in of the accelerated filing requirements over at least a two-year time frame. The Commission has a history of phasing in new rules that significantly impact company-reporting requirements, including the implementation of electronic filing on EDGAR and more recently, Market Based Risk disclosures. This approach would facilitate an orderly transition to revised business models and the increased implementation cost borne by investors.
Additional consideration should be given to the currently proposed criteria for determining when an accelerated filer enters the accelerated filing system. It appears that the criteria as currently designed could initially subject some filers to accelerated filing during an interim period. We believe this situation could cause confusion. We also believe that companies and their auditors would need more than 60 days notice to prepare to meet the accelerated due dates when companies meet the accelerated filer criteria for the first time. We recommend that companies determine their filing status based on their prior year determination and public float as described in the Proposed Rule and, if the criteria are met, begin accelerated filing with the following year’s Form 10-K.
We appreciate the opportunity to comment on the Proposed Rule. If you have any questions about our comments please contact Sam Ranzilla at (212) 909-5837 or Melanie Dolan at (202) 533-4934.
Very truly yours,
/s/ KPMG LLP