Thacher Proffitt & Wood
May 23, 2002
Mr. Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549
Re: SEC's Proposal to Accelerate Periodic Report Filing (File No. S7-08-02)
Dear Mr. Katz:
We are submitting this letter on our own behalf and on behalf of a number of our publicly held clients in response to the Securities and Exchange Commission's (the "SEC" or the "Commission") request for comments regarding the Commission's proposal to accelerate periodic and transition report filing deadlines. In light of the recent, well-publicized events involving Enron Corp. ("Enron") and the resulting loss of billions of dollars in investor equity, we understand the desire on the part of investors and the SEC for more accurate, clear, timely and extensive disclosure from reporting companies. We respect the SEC's initiative and determination to effect positive change to assuage the present and real concerns of the investing public and to limit the possibility of another Enron disaster from occurring again, and we appreciate the opportunity to participate in this undertaking. We are concerned, however, that the general drive for more disclosure more quickly may not ultimately benefit investors, as accurate disclosure may be sacrificed to meet accelerated deadlines.
The SEC has sought to shorten the due dates for quarterly and annual reports since as early as November, 1998 when the Commission issued a release requesting comment on the matter. In response to the SEC's request, most of those who commented believed that a shortening of the filing periods would be overly burdensome, particularly for small companies. Several of these commenters pointed to the fact that the benefits derived from technological advances over the past 30 years had been offset by additional and more complex reporting requirements. In an attempt to learn more about these concerns, the SEC recently hosted roundtable discussions in New York, Washington, D.C. and Chicago where the same concerns for smaller companies were again expressed. Thereafter, the SEC announced its current proposal, in which it appears to have compromised by proposing to require that only those reporting companies with at least a $75 million float, and with some experience as reporting companies under the Securities Exchange Act of 1934, as amended (the "Exchange Act"), file accelerated reports. Based on our experience representing publicly held and traded companies, particularly in the financial institutions industry, and on numerous conversations with our clients and other companies with which we have worked over the years, and for the reasons set forth below, we oppose this proposal and urge the SEC to leave the periodic report filing periods as they are.
Increased Disclosure Demands
The deadlines for filing periodic reports have remained unchanged in the 30 years since their initial establishment, yet those 30 years have been marked by a clear drive by the SEC to encourage and require more and better public disclosure. In addition to the SEC review and comment process by which many disclosure initiatives are implemented, the SEC has periodically provided general guidance on the substance of periodic disclosures. For example, in 1989, the SEC issued Financial Reporting Release No. 36 which provides significant guidance on the SEC's expectations for the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") section of annual reports, quarterly reports and registration statements. The SEC's guidance on periodic disclosures has accelerated in recent years. In 2000, the SEC promulgated Regulation FD generally requiring public disclosure of nonpublic information disclosed to brokers, dealers, investment advisers or persons associated with any of them. Most recently, on May 20, 2002, the SEC proposed rules to require disclosure of critical accounting policies in the MD&A section of annual reports, registration statements and proxy and information statements.
In addition to the disclosure requirements of general applicability, financial institutions face a greater disclosure burden as a result of the SEC's Industry Guide 3, which requires financial holding companies to disclose statistical information, generally in tabular form, as part of the business or MD&A section of the annual report. Our typical client's annual report on Form 10-K now includes over 20 statistical tables in addition to the consolidated financial statements and notes thereto. Disclosure of the numerous statistical data required by Guide 3 demands a reasonable timetable in which to prepare, review and verify the information. To require that all the information required by financial holding companies be prepared and disclosed a full month earlier, in the case of annual reports, is an undue burden placed upon this industry.
The foregoing are just a few examples to illustrate that the trend toward more disclosure does not appear to be waning. Yet the SEC is simultaneously seeking to require that disclosure be made accessible on an expedited basis. A drive either for more disclosure within existing time frames or for faster disclosure but at a reduced level, individually, may be appropriate particularly in light of the Enron fallout. However, a focus on both, simultaneously, is unreasonable.
Timing with Press Releases
Much of the SEC's argument for accelerating periodic reporting appears to stem from the fact that reporting companies are already disclosing financial information to their shareholders soon after the end of a fiscal period via press releases. The SEC has stated that hundreds of public companies issue press releases to announce quarterly and annual results well before they file their reports with the SEC and appears to assume that, because reporting companies are responsible for the information in these announcements, the accelerated filing deadlines being proposed would not be unduly burdensome since such information has already been prepared and audited. At the same time, the SEC also recognizes that the press releases do not generally contain all of the information included in quarterly and annual reports and that the amount of information and the manner of the information's presentation in these press releases varies from company to company. Yet, the SEC has requested comment on whether, instead of the acceleration of filing periods being proposed, it should require companies to file their reports at some point after the first release of earnings information for that period, and it has also requested comment on whether such a requirement would delay earnings announcements.
We believe that coordination of the timing of the earnings press release with the corresponding periodic report fails to recognize the substantive difference in the purpose of each document and the process by which each document is prepared. The earnings press release currently is not specifically required by law or SEC rules, although it is required under applicable stock exchange and Nasdaq Stock Market rules. The historical legal impetus for the earnings press release can be found in SEC Rule 10b-5, which prohibits insider trading on material nonpublic information. Insiders may not trade in their company's stock (nor may the company repurchase its own stock) unless material financial information is released to the public. The courts and the SEC have long recognized that a press release is the most effective means of disseminating information to the public. Over time, the press release has also been shaped by the demands of investors and analysts for dissemination of a company's financial performance at the earliest possible date. One of the principles behind Regulation FD is the recognition of this use of the press release. However, public companies generally do not view the press release as a replacement for the SEC's required periodic reports. Quarterly earnings press releases typically are not subject to external auditor review and, although annual earnings press releases often are not released until the external auditor has "signed off" on the balance sheet and income statement, the full set of financial statements and notes are not available for review until well after the press release is issued. Further, the periodic reports to the SEC have specific requirements that, as noted above, the SEC has enhanced over time. The purpose of these reports is to provide a comprehensive view of the financial condition and operating results of the company at a particular point in time and for the relevant reporting period. Periodic reports carry specific standards of liability set forth in the Exchange Act itself, whereas the press release is subject to the general antifraud standard of Rule 10b-5. Unless the SEC intends to propose a significant change in its approach to liability for periodic reports and press releases or intends to specifically regulate the press release process, it should not, through changes to the periodic report filing deadline, attempt to equate these two significant yet fundamentally different methods of disclosure. Finally, we believe that correlating the timing of periodic reports to the issuance of press releases would only delay earnings announcements, which would not serve the interests of the investing public. To the extent the SEC is primarily concerned with the swift dissemination of material information to the markets and investors, we respectfully suggest the SEC focus on the present system of press releases and Current Reports on Form 8-K.
Increased Costs and Likelihood of Errors
The extensive disclosure already imposed on reporting companies takes significant time and is expensive to prepare, internally review and be reviewed by independent auditors and legal counsel. The cost associated with such preparation and review is felt by all reporting companies regardless of size. Preparation of the periodic reports, particularly the annual report on Form 10-K, requires more than a mere regurgitation of numbers; it requires comprehensive analysis, which takes time to do accurately. In our experience, public companies generally maintain adequate but efficiently staffed accounting, auditing and reporting departments to meet the present disclosure demands imposed upon them. Accelerating the pace of report filing will result in either increasing the already high cost associated with periodic reporting, due to expenses related to the addition of more personnel, or result in higher incidences of inaccuracies, or both.
In addition to the burdens that would be placed on the reporting companies themselves, there would be increased pressure imposed on auditing firms and outside counsel, which would translate into higher auditing and legal fees. As a result of having to do the same job in a far more compressed time frame, such firms will invariably increase their charges. However, it is not only the additional cost associated with greater fees or increased personnel that makes this proposal objectionable, it is the reality that the stretched resources of the reporting companies, auditing firms and outside counsel will result in greater inaccuracies, which is certainly the converse of what the SEC is seeking to achieve.
Effect on Audit Committee
Accelerating filing deadlines also may have a very real, adverse effect on a company's ability to retain qualified persons to sit on its audit committee. In light of Enron, audit committees are already assuming greater roles than before, including reviewing their company's annual reports on Form 10-K and quarterly reports on Form 10-Q. These committees are made up of outside directors who presumably have professional and independent duties outside their duties as directors. Accordingly, these committees need a greater, not lesser, amount of time to adequately perform their duties. Accelerating filing deadlines will not serve the best interests of shareholders or potential investors if fewer qualified persons will be willing to sit on the committees. The SEC, in this proposal, is simply not giving reporting companies enough time to have the required disclosures prepared, internally reviewed by management and the audit committee, independently audited and legally reviewed, significantly increasing the likelihood that, at every step of the way, the possibility of error will increase as a result of requiring more in less time.
The concerns described above with accelerated reporting become magnified in the case of small and midsize companies. The $75 million market capitalization threshold was established by the SEC to coincide with the market capitalization requirement for eligibility for use of Form S-3. We believe using the Form S-3 eligibility threshold as the benchmark for expedited reporting is misguided. The benefit of eligibility to use From S-3 is to allow for greater use of the SEC's integrated disclosure concept and incorporation by reference. The presumption supporting the eligibility requirement is, in essence, the larger the company then the greater the visibility of the company to the public and the more widely available information regarding the company is likely to be. However, simply because a company is more visible to the public does not mean it is more likely to be able to compress the time frame for preparation, review and filing of periodic reports. Further, the greater visibility a company already has should not correlate to a greater need for the public to receive expedited information. Rather, the enhanced visibility suggests that market forces (large shareholders, analysts) will push such companies for more disclosure in the form of increased press releases.
We also believe that the $75 million threshold does not accurately reflect the economics of how smaller to medium sized companies are run. It has been our experience in working with medium capitalization companies ($100 million to $3 billion market capitalization) in the financial institutions industry that such companies pride themselves on their operating efficiency and low cost platforms, which serve as significant components of their efforts to provide increasing and attractive returns on equity for their shareholders. We believe that the acceleration of the filing periods being proposed will have a greater impact on these companies than the SEC has considered. If, despite the concerns expressed herein, the Commission intends to adopt the accelerated filing requirements as proposed, we respectfully suggest that the SEC significantly increase the $75 million market capitalization threshold.
We hope the comments set forth herein are helpful in your efforts to modify the periodic reporting requirements applicable to public companies. We would be pleased to discuss these comments in greater detail at your convenience. Please call the undersigned at (212) 789-1438 if you have any questions regarding the foregoing.
Very truly yours,
Thacher Proffitt & Wood
Robert C. Azarow, Esq.