Comments of the New York State Bar Association on S7-16-02

New York State Bar Association
One Elk Street
Albany, NY 12207
518-463-3200

Business Law Section
Committee on Securities Regulation

July 30, 2002

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549

E-mail address: rule-comments@sec.gov
Attention: Jonathan G. Katz, Secretary

Re: File No. S7-16-02
Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies
Release Nos. 33-8098; 34-45907; International Series No. 1258

Ladies and Gentlemen:

The Securities Regulation Committee of the Business Law Section of the New York State Bar Association appreciates the invitation in Release No. 33-8098 (the "Release") to comment on proposed disclosure requirements intended to enhance investors' understanding of the application of companies' critical accounting policies.

The Committee on Securities Regulation (the "Committee") is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was circulated for comment among members of the Committee, and the views expressed in this letter are generally consistent with those of the majority of members who reviewed and commented on the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.

A. Summary of Comments

The Committee supports the Commission's objective to improve the transparency of registrants' financial disclosures. We generally support the proposed new disclosures, provided that certain important exclusions and modifications recommended in this letter are made. We believe our recommended changes will benefit investors by helping to insure that the disclosures are understandable and useful, and by avoiding disclosures about contingent liabilities that would be harmful to companies and their shareholders.

We oppose requiring the disclosure of sensitivity information in proposed Section 303(c)(3)(iii) of Regulation S-K because the information elicited would be speculative and confusing, and could obscure the more pertinent proposed new disclosures. We also believe that disclosure of why different accounting estimates could have been used, and why accounting estimates are reasonably likely to change, is inappropriate and should not be required.

In addition, information about contingencies regarding litigation, environmental costs, tax liabilities and product liabilities should be limited to the quantitative and qualitative information already required by Statement of Financial Accounting Standards No. 5, Accounting for Contingencies ("FAS 5"), and other applicable accounting pronouncements. To disclose additional information about those contingencies, as would be required under the proposed rule, would jeopardize the attorney-client privilege and clients' expectation of confidentiality, could constitute admissions against interest, and would prejudice the ability to negotiate favorable settlements.

We believe that the proposed new disclosures more appropriately belong in the footnotes to the financial statements instead of the MD&A section. Accordingly, we recommend that the Commission adopt an approach to require that all of the new disclosures be in the footnotes. An alternative could be that information regarding at least the more technical accounting estimates be included in the footnotes.

We believe that the existing scope of auditor review is adequate so that it is unnecessary to require an "examination" or "review" under AT § 701¹of the proposed new MD&A disclosures. If the Commission follows our recommendations and places the disclosures in the footnotes, this would no longer be an issue.

Finally, we urge the Commission to provide specific safe harbor protection whether the disclosure is in the footnotes or in the MD&A. Automatic safe harbor protection is appropriate since the Commission is mandating disclosure of highly uncertain forward-looking information that in most cases would not otherwise be disclosed.

One disclosure we do not discuss below is whether the development and selection of the accounting estimates and their MD&A disclosures were discussed with the audit committee. While we do not object to that disclosure, we urge the Commission to give safe harbor protection if it requires audit committees to report their reviews, similar to the protection for compensation and audit committee reports in proxy statements. We believe that the proxy statement would be the appropriate location if any such report were required, although we do not believe a report is necessary.

B. Background of Existing Disclosure Requirements

1. Current Accrual Accounting Requires Use Of Estimates And Underlying Assumptions

The accrual accounting method universally used to report corporate results assigns to the current period revenues and expenses even though payment of the receivables may not have been received for the revenues and the expenses may not have been paid. This method also assigns non-cash expenses such as depreciation of tangible assets and amortization of intangibles to the applicable period. Finally, the accrual method recognizes: (i) costs and liabilities for various contingencies such as litigation and environmental costs under certain conditions even though the liability may not have been finally determined; and (ii) certain gains in limited situations even though not realized.

The accrual method is thought to be superior to the alternative cash method in presenting a more accurate picture of actual operating results, financial condition and change in financial condition. But, this method of necessity requires estimates regarding events which are not known at the time, and will not be known until resolved at some future time, which could be days or months or even could stretch out over several years. Moreover, underlying these estimates are assumptions of future events and conditions which themselves will not be known until some future time.

These estimates and underlying assumptions are used to produce the single value line items that we are accustomed to reading in financial statements, albeit with a degree of uncertainty inherent in the use of estimates and assumptions. In most cases, however, companies have not chosen to publicly provide the specific estimates and assumptions constituting forecasts of future events and conditions because of potential liability under the federal securities laws.

2. Accounting Policies Have Been Addressed In Accounting Standards And Commission Disclosure Requirements For Many Years

Consideration of disclosures that should be made about accounting policies goes back many years. In 1972, the Accounting Principles Board required that business enterprises identify and describe the accounting principles followed and the methods of applying those principles that materially affected the determination of financial results.² In 1974, the Commission addressed the need to disclose unusual circumstances that subjected assumptions in applying accounting principles to substantial uncertainties³

The Commission in 1981,⁴and again in 1989,⁵provided guidance on MD&A disclosures in response to new Commission requirements to provide discussions of financial condition (including liquidity and capital resources) and trends, material changes, events and uncertainties. The uncertainties discussed appear to focus on future governmental actions or economic conditions and known trends and uncertainties which might affect future business results without addressing the specific estimates and assumptions used in reporting historical results.

The next major development was in December 1994 when the AICPA issued Statement of Position ("SOP") 94-6 relating to the disclosure of certain significant risks and uncertainties, including the use of estimates in the preparation of financial statements.⁶ The SOP required disclosure regarding uncertainties due to accounting estimates, in addition to those uncertainties due to loss contingencies already required by FAS 5. However, the SOP only required changes reasonably possible within one year from the date of the financial statements, and did not require quantification in addition to that already required by FAS 5. This information, together with a description of the principal accounting policies used by the company, is typically found in the "Summary of Significant Accounting Policies" footnote to the financial statements.

Finally, in December 2001, the Commission issued its cautionary advice regarding critical accounting policy disclosure,⁷encouraging companies to include in MD&A full explanations of critical accounting policies, judgments and uncertainties affecting the application of those policies, and the likelihood that different amounts would be reported under different conditions or using different assumptions. The Commission also advised that audit committees should review the selection, application and disclosure of the critical accounting policies.

3. The Proposals Add Quantitative, More Specific And Broader Disclosures, And Are Not Limited To Known Trends And Uncertainties And Changes Possible Within One Year

The Commission's December 2001 cautionary advice was quite general and appeared to go beyond the specifics of existing requirements. The proposals in the Release are broader than that advice and would add very specific, detailed disclosure requirements in a new Item 303(c) of Regulation S-K. In addition, the new disclosures: (i) would require companies to look into the future beyond the one-year, near term criteria of prior requirements; (2) would not be limited to matters involving known trends and uncertainties and changes; and (3) would require disclosure of certain quantitative information.

C. Sensitivity Information And Information On Accounting Estimates Not Used In The Financial Statements Should Not Be Required

We oppose the disclosure of sensitivity information that would be required by proposed Section (c)(3)(iii) because the information elicited would be speculative and confusing, and could obscure the more pertinent proposed new disclosures. For similar reasons, we also believe that disclosure of why different accounting estimates could have been used, and why accounting estimates are reasonably likely to change, is inappropriate and should not be required. While we anticipate companies will disclose that estimates and assumptions may change and have an impact on the financial statements, changes usually could occur for numerous reasons, some of which may be identified in the forward-looking statements section and some of which may not even be foreseeable at the time. Thus, we think that requiring companies to identify why estimates are reasonably likely to change would not provide meaningful disclosure, and would not be a reasonable requirement.

The proposed sensitivity disclosure would be overwhelming and confusing by its volume and required detail of explanation for complex methodologies. The sensitivity analysis would frustrate the stated policy objective of the Release to provide clear, understandable disclosure that increases investor understanding of the financial presentation and position of the company. It would require issuers to quantify other possible outcomes and formulate alternative estimates that are not reflected in the issuer's financial presentation. Quantification of multiple alternative outcomes would suggest to investors shifts from the numbers presented by the company in its financial statements, based on outcomes which will often have been determined by the company and auditors to be less likely to occur than those underling the financial statements. We believe this could make the evaluation of the financial presentation more difficult.

Similarly, disclosure of why other estimates could have been used or why the selected estimates are reasonably likely to change focuses on estimates that were not selected or used, are not reflected in the financial statements, and would be speculative.

In addition, given the possible liability concerns, companies might consider it necessary to expand or maximize the estimates that could have been used, or the potential effects of changes, thereby rendering this speculative information even less meaningful.

The proposals present a real danger of information overload. There already is discussion about the possible need to provide a summary of the MD&A, which itself is supposed to present an overall view and analysis of a company. It is our opinion that clear and comprehensive disclosure of the critical accounting estimates and related information actually used in developing the financial statement numbers will improve investor understanding, not lengthy and complex sensitivity analyses or discussions of what could have been selected or what changes could occur.

D. Disclosure Of Quantitative And Other Information Regarding Contingent Liabilities Such As Litigation Should Be Limited To Disclosures Presently Required Under FAS 5 And Other Applicable Accounting Pronouncements

We urge the Commission to limit quantitative and qualitative disclosures regarding contingent liabilities related to litigation, environmental remediation costs, contingent tax liabilities, and product liability claims in the final rule to those disclosures already required by FAS 5 and other applicable accounting pronouncements.

1. Proposed Quantitative Disclosures of Loss Accruals and Contingency Reserves

In this Section D we address the disclosure of quantitative information other than the sensitivity information we opposed in Section C, above. We can understand that countervailing value may be provided by certain quantitative disclosures regarding loss accruals or reserves for balance sheet items related to specific assets and reserves related to specific revenue, which balances the additional risks of litigation companies would encounter. This would include quantitative disclosures regarding the items described in the examples contained in the Release -- the impact on revenue of estimates used for determining the costs or expenses of repairs and returns of specific classes of products and for determining impairment losses on assets. We would also consider acceptable quantitative disclosures on estimates which pertain to other reserves and loss accruals for balance sheet items related to assets such as accounts receivable and customer loans payable.

However, the proposed rule could also require quantitative disclosure of estimates related to loss accruals and reserves of other contingencies not associated with specific balance sheet asset items or not related to specific revenue. Quantitative information about these contingencies, which would include litigation and contingent tax liabilities, should not be required because that could waive the attorney-client privilege, constitute admissions against interest, and result in substantial economic harm to companies and their shareholders without offsetting benefit.

2. Comments Filed On Proposal In 2000 To Disclose Loss Accrual Accounts Support Excluding Quantitative Disclosures About Contingent Liabilities Such As Litigation

The Commission previously solicited public comment on quantitative disclosure of contingent liabilities when it proposed specific disclosure with respect to loss accrual accounts in January 2000 ("2000 Proposal").⁸ The 2000 Proposal would have required companies to provide quantitative information with respect to loss accruals for FAS 5 reserves for litigation, contingent tax liabilities, environmental remediation costs, and product liability claims. Similar information would be required by the current proposal. Those comments filed on the 2000 Proposal, including our letter dated April 19, 2000, showed how the then proposed disclosures could cause loss of the attorney-client privilege and could constitute admissions against interest. The comments also showed the economic damage to companies that would result in litigation, tax disputes, and other negotiations. The concerns raised in our letter and other commenters' letters are equally applicable to the proposed disclosures as they would apply to contingent liabilities for litigation, environmental costs, taxes and product liabilities. The 2000 Proposal was never adopted. There has been no change since those comments were filed that would lessen the concerns shown at that time.

3. The Attorney-Client Privilege And The Expectation Of Confidentiality Would Be Lost If The Proposed Disclosures Were Required For Estimates Related To Contingent Liabilities Such As Litigation

Disclosure of estimates and underlying assumptions used for determining loss accruals and reserves for litigation, environmental, tax, and product liability contingencies presents a serious risk of waiver of the attorney-client privilege, and loss of the related client expectation of confidentiality.

The proposed disclosures would in effect require corporate clients to disclose otherwise privileged information, thus arguably waiving their right to assert the attorney-client privilege, and require their lawyers to waive the right to assert work product privilege, with respect to estimates and assumptions for reserves for litigation, environmental remediation costs, tax disputes, and product liability loss accruals. It is well-established that a corporation is entitled to the protection of the attorney-client privilege and, thus, to withhold information from scrutiny by the judicial process provided that the corporation can show that: (i) the information was disclosed by a corporate employee acting within the scope of that employee's corporate duties; (ii) the employee was seeking legal advice from counsel; (iii) the information was considered confidential when made available; and (iv) its confidentiality has been maintained.

Society has determined that encouraging clients to make full disclosure of information to their attorneys makes it more likely that an attorney will obtain the information needed to provide good legal advice, and that obtaining good legal advice is so important in a society governed by law as to warrant protecting the attorney-client privilege, even when giving others access to this information would further the pursuit of justice.

In addition, an attorney who knows in advance that the client may be compelled to disclose sensitive legal advice regarding whether there is "probable" liability, including increases or decreases in the probable dollar amount of liability, or other sensitive information which can be gleaned from the disclosure of the estimates and assumptions for accruals and the changes in accruals, will (in fact, must) advise the client that: (i) there is a requirement to disclose; and (ii) as a result the attorney-client privilege may be waived and confidentiality of client confidences may not be preserved.

Finally, the policy behind the attorney-client privilege -- to facilitate the full development of facts essential to proper legal representation and to encourage clients to seek early assistance -- also serves to ensure accurate financial reporting. For example, FAS 5 specifically refers to the opinions or views of legal counsel among the factors to be considered in determining whether loss accruals are necessary.

4. Disclosure Of Estimates Regarding Loss Accruals And Reserves For Contingent Liabilities Would Cause Significant Economic Harm To Companies And Their Shareholders

It is difficult to conceive of information whose disclosure would be more damaging to the financial position of registrants and the economic interest of their shareholders than the new proposed disclosures, if they were to apply to estimates for reserve and loss accruals for litigation, environmental costs, contingent taxes and product liability.

First, the disclosures could themselves constitute an admission of liability introducible in court. Depending on the level of detail that would have to be used in the disclosures, which is not clear from the Release, information on specific cases might be discerned. This would be more likely because a quantitative and qualitative discussion of any material changes to the accounting estimate and the reasons for the change would have to be disclosed.

In addition, these disclosures could affect the ability of registered companies to pursue strategies in the company's best interests. For example, in establishing reserves for a litigation or class of litigation, a factor to be considered in determining the probability of liability and estimation of loss, is the willingness and level at which a company might settle litigation. This always is an important strategic issue for a company to balance against the cost of litigation, adverse publicity and distraction from other business imperatives. We believe that the proposed disclosures would have the unintended effect over time of driving reporting companies to a more adversarial strategy in dealing with litigation in order to avoid laying out their willingness to settle and at what price. Obviously, these disclosures would severely affect a company's ability to negotiate favorable settlements, as the starting point for discussions will necessarily be the estimated amounts a company has already reserved.

Reporting companies will suffer similar economic harm in dealing with tax matters. A company's obligations to its shareholders include operating in a manner to obtain beneficial tax treatment in accordance with existing law. Because of the uncertain nature of applicable statutes, rules, regulations, interpretations and positions of taxing authorities, this necessarily will involve issues in which a legitimate tax position of a company may be challenged by taxing authorities. The required proposed disclosures could interfere with a company's ability to negotiate favorable settlements in the same manner as the ability to settle litigation would be affected.

5. Current Requirements Of FAS 5 And Other Commission And Accounting Requirements Adequately Protect Investor Interests -- There Has Been No Showing Of A Legitimate Need for Additional Disclosures Of Estimates Used For Loss Accruals Or Contingency Reserves In Addition To FAS 5

There has been no showing of the compelling need, or any real need at all, for the additional disclosures with respect to these contingent liabilities necessary to justify the possible loss of the attorney-client privilege and other resulting harm to companies and their shareholders. Furthermore, current requirements of FAS 5 and other accounting pronouncements adequately protect investor interests. There is significant and detailed guidance governing loss accrual and the establishment of reserves for contingencies under current accounting rules, and the adequacy of this guidance has not been challenged.

There are stringent standards for establishing the reserves that we urge be excluded from the proposed new rule. Also, there is significant review and oversight of the process. In the first instance, the decision as to whether to establish, and if so the amount of, a reserve or accrual is the responsibility of management. This would involve the company's accountants responsible for financial and SEC reporting and the company's chief accounting officer and chief financial officer. Because many of these decisions on reserves and accruals and underlying estimates and assumptions are based on legal issues, the process often also involves the opinion and advice of company counsel. The decision is then subject to review by the company's independent auditors. We note that independent auditor review now is mandated for interim financial statements as well as the annual audit, under Commission rules.

Further, the independent auditor is required to discuss certain matters with the company's audit committee or chairman of the audit committee, for both annual audited and unaudited quarterly financial statements under recent requirements, including:

items that have a significant impact on the representational faithfulness, verifiability, and neutrality of the accounting information included in the financial statements, including estimates, judgments, and uncertainties; and
the process used by management in formulating particularly sensitive accounting estimates and the basis for the auditor's conclusions regarding the reasonableness of those estimates.

E. The Proposed New Disclosures More Appropriately Belong In The Footnotes To The Financial Statements Instead Of The MD&A Section

The proposed new disclosures in large part expand or enhance already existing requirements for financial information in the financial statement footnotes. The new disclosures necessarily would have to be read in connection with the footnote providing a summary of significant accounting policies, which typically is the first footnote. We see no need to arbitrarily bifurcate the disclosure on accounting policies and estimates. Accordingly, we recommend that the new disclosures, with the deletions we propose in this letter, be included in the footnotes to the financial statements.

1. Comprehensive Information On Accounting Policies And Estimates Is Already Required In The Footnotes

In accordance with current accounting pronouncements and Commission requirements, financial statements already include substantial information about accounting policies and the use of accounting estimates. These requirements include APB 22: Disclosure of Accounting Policies; SOP 94-6, Disclosure of Certain Significant Risks and Uncertainties; and Staff Accounting Bulletin No. 74, concerning disclosures when an accounting standard has been issued but not yet adopted.

2. Including The Required Information In The Financial Statement Footnotes Would Consolidate The Disclosures On Accounting Policies In One Location; Plain English Could Be Specified

One of the overarching objectives of the MD&A is to provide in one section of a filing disclosure enabling investors to assess a registrant's financial condition and results of operations.⁹ Because the existing footnote disclosures are so inherent to an understanding of the use of accounting estimates, placing the proposed new disclosures anywhere else insures that this objective will not be meet. All pertinent information on accounting estimates should be in the financial statement footnotes in order to have a comprehensive disclosure in one section.

In proposing that the disclosures be included in the MD&A section, the Commission in the Release reasons that less technical language customarily used outside financial statements may elicit a more understandable explanation. We appreciate the concern about overly technical language, and note that the subject of the proposed disclosures is by its nature complex and technical. However, instructions to any pronouncement used to require that the proposed disclosures be included in the footnotes could specify plain English presentation for this particular disclosure.

3. Footnote Disclosure Would Permit Unified Auditor Involvement In Financial Statement Information And Provide Greater Assurance

The Release (Section III.E) discusses what would be required if the proposed MD&A disclosures were subjected to the auditing process. Instead of the auditing process, the Release asks for comments on requiring "examination" or "review" under AT § 701. However, if the footnote approach is used, the auditing process would provide greater assurance and all financial statement information would have the same level of auditor involvement. Although the audit process would be applicable only to the annual financials, auditor review is required for the interim financial statements in quarterly reports on Form 10-Q. In all events, the interim information would have the same treatment as the other interim financial statement information.

4. As An Alternative, Footnote Disclosure Could Be Provided For At Least Highly Technical Accounting Estimates

If, notwithstanding the foregoing reasons, the Commission does not chose to place the entire proposed disclosures in the footnotes, as an alternative we urge that at least some of the most technical critical accounting estimates be included in the footnotes rather than the MD&A. This would include all disclosures with respect to those estimates. We believe that accounting estimates regarding pensions, taxes, inventory valuations and stock options, which already are discussed in the footnotes, fit that criterion and should be in the footnotes in all events. In addition, we expect that accounting professionals would be able to identify others that also are highly technical and should remain in the footnotes.

5. Adoption of Footnote Disclosure

There are a number of possible ways to provide for the proposed disclosures in the financial statement footnotes, including interpretation of existing requirements, adoption of new accounting pronouncements, and amendment of Regulation S-X. The choice depends on issues such as relative authority of the Commission and standards-setting bodies, interpretation of existing requirements, and consultation and cooperative action among the Commission and standards-setting bodies. If the Commission decides to pursue footnote disclosure, which we recommend, we would be happy to work with the Staff to help in developing the most appropriate approach. However, the Commission should provide for adequate safe harbor protection in connection with whatever approach is adopted.

F. The Existing Scope Of Auditor Review Is Adequate Without Requiring AT § 701 Examination Or Review Of The New MD&A Disclosures

The Release asks for comments on whether the independent auditors should be required to undertake an "examination" or "review" of the proposed new MD&A disclosures under AT § 701. If our recommendation to place the proposed disclosures in the financial statement footnotes is followed, this is no longer an issue in light of the annual auditing process. In addition, interim disclosures would have the same auditor review as the rest of the interim financial statements.

If the Commission nevertheless chooses to place the disclosures in the MD&A, we believe that the independent auditors should review the proposed new MD&A disclosures for consistency with the audited financial statements, and apply audit tests to the critical accounting estimates used in preparing the audited financial statements. However, current accounting pronouncements already require those procedures.¹⁰ For example, under UA § 342, the auditor is required to evaluate accounting estimates to obtain reasonable assurance that all estimates that could be material have been developed by management and that those estimates are reasonable, as part of the audit.

Furthermore, the auditors also are required to discuss sensitive accounting estimates with the audit committee for annual audited financials,¹¹which has been extended to the interim financial statements in the quarterly reports on Form 10-Q as well.¹² Thus, it is not necessary to require the additional review or examination.

Companies, of course, would remain free to arrange with their auditors for an examination or review of any new MD&A disclosures. Also, there may be situations, such as financings, where a company may have negotiations with underwriters or banks about whether to require an examination or review by the auditors.

G. The Commission Should Provide Specific Safe Harbor Protection

Companies preparing GAAP financial statements of necessity are required to make estimates and underlying assumptions regarding events and circumstances which are not known at the time, and will not be known until some future time. However, in most cases, companies do not publicly provide these specific estimates and assumptions due to concerns that they would constitute forecasts under federal securities law liability standards. That would change under the proposed Rule, which would mandate that companies disclose such estimates and assumptions.

As the Release recognizes, some of the required disclosures would necessity making forward-looking statements, with all of the implications for potential liability that entails. The answer in the Release to concerns about this additional liability is to include an instruction in the proposed rule to encourage registrants to consider the terms, conditions and scope of the safe harbor provisions when drafting Item 303(c) disclosures.

1. Safe Harbor Protection is Justified and Essential

We believe that the Commission should provide specific safe harbor protection, similar to Item 305(d) of Regulation S-K adopted in 1997 requiring quantitative and qualitative disclosures about market risk. The nature of the new disclosure requirements and potential liability risks to registrants are analogous to those of the market risk requirements.

Safe harbor protection is particularly called for in this case. The nature of the disclosures is inherently uncertain. In fact, a principal criterion for determining what matters to disclose is that they are highly uncertain. The broad disclosure requirements of highly uncertain matters involving subjective judgment are bound to lead to claims in litigation based on hindsight. Furthermore, these disclosures are of forward looking statements that in almost all cases companies have not provided voluntarily, but will be disclosing only because mandated by the Commission.

Certainty of safe harbor protection is especially critical because, to be fully effective, it should be available to defendants as a defense under the Private Securities Litigation Reform Act ("PSLRA") in motions to dismiss complaints. The present availability is subject to how a court treats the defense in a particular case. If a court were to decline to consider the safe harbor defense on the grounds that it raises a question as to whether the cautionary language is sufficiently "meaningful", safe harbor protection would be significantly diminished. Registrants should not be forced to risk a determination in possible litigation that they do not have safe harbor protection for these new disclosures of statements that are unquestionably uncertain.

With respect to providing meaningful cautionary language, the financial statement footnotes already contain a discussion about the use of estimates and assumptions in preparing financial statements, and that actual results could vary from those estimates. We recommend that the disclosures be in the footnotes, which already have the cautionary language. Even if the Commission requires that the new disclosures be in the MD&A, the disclosures address the results, financial condition and changes in condition reported in the financial statements. In that case, the new disclosures necessarily will be read in connection with the financial statement footnotes which include cautionary language.

Finally, the Commission's objective of providing clear, concise and understandable information might not be achieved, and the most relevant disclosures possibly obscured, if companies had to provide a number of disclaimers in the new Critical Accounting Estimates section in order to be eligible for safe harbor protection. Indeed, this possibility was recognized in Section III.H of the Release where it states that "the purpose of the proposed disclosure would be hindered if a company were to include disclosures that consisted principally of blanket disclaimers of legal responsibility . . . in light of the uncertainties . . . ."

2. The Final Rule Should Provide Automatic Safe Harbor Protection Under The PSLRA

Automatic safe harbor protection is appropriate in this case for the proposed disclosures. Accordingly, the Commission should provide in the final rule that all quantitative and qualitative information proposed under new Item 303(c) of Regulation S-K, whether required in MD&A or in the footnotes, except for historical facts, is deemed "forward-looking statements" accompanied by meaningful cautionary statements meeting the requirements of, and entitled to the full protection of, the safe harbor provisions of Section 27A of the Securities Act and Section 21E of the Exchange Act.

The final rule also should provide that the safe harbor protection applies to all types of issuers and transactions, to issuers and any other persons specified in Section 21E(a) and Sections 27A(a), and to statements in financial statements. Section 21E(b) and Section 27A(b) contemplate that the Commission may issue rules, regulations or orders that apply the safe harbor provisions to financial statements and various types of issuers and transactions otherwise excluded by those subsections. Section 21E(a) and Section 27A(a) provide protection to issuers, persons acting on their behalf, outside reviewers, and underwriters.

It is important to expressly provide for safe harbor protection for financial statements if the Commission follows our recommendations to place all or part of the disclosures in the footnotes. The Commission initially proposed such financial statement safe harbor protection in 1996 for market risk information that could have been included in the footnotes.¹³ Because the disclosure ultimately was required to be disclosed outside the financial statements and footnotes, that safe harbor was not needed and was not adopted.¹⁴

Subsection (g) of both Section 21E and Section 27A grant the Commission authority to provide exemptions with respect to liability "that is based on a statement or that is based on projections or other forward-looking information," if consistent with the public interest and the protection of investors, as determined by the Commission. We believe that the findings made by the Commission in the Release about the value and benefit to investors, and the risks and concerns discussed above, provide conclusive support for such determination in this case.

3. The Rule Should Provide Protection For Failure To Include A Particular Estimate Or Assumption

The Commission requested comments on whether it should limit the number of accounting estimates that may be discussed. Whether or not there is a limit, there is a risk for companies that have many possible estimates that the estimate and assumption that actually changes and causes the greatest impact was not included in the estimates disclosed. That could lead to claims in hindsight that the company did not disclose the required estimates. To avoid this risk, we urge that the final rule expressly provide that failure to include a particular estimate that subsequently changes in a manner having a material impact does not constitute non-compliance with the rule. This is similar to the treatment in the Conference Report on the PSLRA regarding the listing of factors that could cause forward-looking statements not to come true.

**********************************************

We hope the Commission finds these comments helpful. We would be happy to meet with the Staff to discuss these comments further.

Respectfully submitted,

COMMITTEE ON SECURITIES REGULATION

By Gerald S. Backman
GERALD S. BACKMAN
CHAIRMAN OF THE COMMITTEE

Drafting Committee:

Michael J. Holliday
Edward H. Cohen
Richard R. Howe
Guy P. Lander
Cathleen McLaughlin

Copy to:

The Honorable Harvey L. Pitt, Chairman
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Cynthia A. Glassman, Commissioner
Alan L. Beller, Esq., Director of Division of Corporation Finance
Giovanni P. Prezioso, Esq., General Counsel

Endnotes

¹ Codification of Statements on Standards for Attestation Engagements ("AT") § 701, Management's Discussion and Analysis.
² APB 22: Disclosure of Accounting Policies, issued April 1972.
³ Accounting Series Release No. 166, December 23, 1974.
⁴ Release Nos. 33-6349, 34-18120, September 28, 1981.
⁵ Release Nos. 33-6835; 34-26831; IC-16961; FR-36, May 18, 1989 ("1989Release").
⁶ SOP 94-6, December 30, 1994. SOP 94-6 is the origin of the usual statement in financial footnotes that "the presentation of financial statements in conformity with GAAP requires the use of management's estimates," and additional discussion of the use of estimates, and the cautionary language that actual results could differ from estimates.
⁷ Release Nos. 33-8040; 34-45149; FR-60, December 12, 2001.
⁸ Release Nos. 33-7793, 34-42354, January 21, 2000.
⁹ 1989 Release, Section III. A.
¹⁰ Codification of Statements on Auditing Standards ("AU") § 550, Other Information in Documents Containing Audited Financial Statements; and AU § 342, Auditing Accounting Estimates.
¹¹ UA § 380, Communication with Audit Committees.
¹² UA § 722, Interim Financial Information.
¹³ Release Nos. 33-7280; 34-37086, April 9, 1996.
¹⁴ Release Nos. 33-7386; 34-38223; IC-22487; FR-48, January 31, 1997.

¹	Codification of Statements on Standards for Attestation Engagements ("AT") § 701, Management's Discussion and Analysis.
²	APB 22: Disclosure of Accounting Policies, issued April 1972.
³	Accounting Series Release No. 166, December 23, 1974.
⁴	Release Nos. 33-6349, 34-18120, September 28, 1981.
⁵	Release Nos. 33-6835; 34-26831; IC-16961; FR-36, May 18, 1989 ("1989Release").
⁶	SOP 94-6, December 30, 1994. SOP 94-6 is the origin of the usual statement in financial footnotes that "the presentation of financial statements in conformity with GAAP requires the use of management's estimates," and additional discussion of the use of estimates, and the cautionary language that actual results could differ from estimates.
⁷	Release Nos. 33-8040; 34-45149; FR-60, December 12, 2001.
⁸	Release Nos. 33-7793, 34-42354, January 21, 2000.
⁹	1989 Release, Section III. A.
¹⁰	Codification of Statements on Auditing Standards ("AU") § 550, Other Information in Documents Containing Audited Financial Statements; and AU § 342, Auditing Accounting Estimates.
¹¹	UA § 380, Communication with Audit Committees.
¹²	UA § 722, Interim Financial Information.
¹³	Release Nos. 33-7280; 34-37086, April 9, 1996.
¹⁴	Release Nos. 33-7386; 34-38223; IC-22487; FR-48, January 31, 1997.