October 23, 2002
Via e-mail - firstname.lastname@example.org
Securities and Exchange Commission
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Federal Regulation of Securities of the American Bar Association's Business Law Section (the "Committee")* in response to the request of the Securities and Exchange Commission in adopting Release No. 34-46427 (the "Adopting Release") for further comments on issues initially raised in its June 14, 2002 Release No. 34-46079 entitled Certification of Disclosure in Companies' Quarterly and Annual Reports (the "Original Release"), as supplemented by the Commission's August 2, 2002 release seeking comment on the certification rules required by Section 302 of the Sarbanes-Oxley Act of 2002 (the "Supplemental Release" and, together, the "Releases").
The comments expressed in this letter represent the views of the Committee only and have not been approved by the American Bar Association's House of Delegates or Board of Governors and therefore do not represent the official position of the Association. In addition, this letter does not represent the official position of the ABA Section of Business Law, nor does it necessarily reflect the views of all members of the Committee.
BACKGROUND AND RECOMMENDATIONS
In the Original Release, comments were requested on whether the proposed annual report certification should be considered to cover information required by Part III of Forms 10-K and 10-KSB ("Part III information"), as and when filed, to the extent incorporated by reference in the report. This information is required to be disclosed in annual proxy and information statements filed under Sections 14(a) and (c) of the Securities Exchange Act of 1934, as amended (the "Exchange Act"), and Regulations 14A and 14C and includes disclosures called for by Regulations S-K and S-B pertaining to directors and officers, executive compensation, security ownership of certain beneficial owners and management and certain relationships and related transactions. The Commission also requested comment on whether the proposed certifications should be extended to other documents filed under the Exchange Act, specifically referencing registration statements on Forms 10 and 10-SB, current reports on Form 8-K and portions of proxy and information statements not incorporated by reference into Forms 10-K and 10-KSB annual reports.
On August 28, 2002, the Commission issued the Adopting Release, which adopted rules requiring executive officer certification of annual and quarterly reports filed under the Exchange Act. The Adopting Release stated that the mandated "disclosure controls and procedures" pertain to proxy and information statements and, in endnote 35, that the Forms 10-K and 10-KSB certifications would be "considered to cover the Part III information ... as and when filed," even though there is no specific certification requirement relating to those documents. The Commission again requested comment on whether a separate certification should be required for documents filed under the Exchange Act besides periodic reports, and referred specifically to proxy and information statements and registration statements on Forms 10 and 10-SB. This letter addresses the Commission's requests for comments on those matters.
Our recommendation to the Commission is that a limited separate certification be required to accompany the filing of proxy and information statements if Part III information is to be incorporated by reference into a previously filed Form 10-K or 10-KSB report. However, we do not recommend certifications of Forms 10 or 10-SB registration statements.
PROXY AND INFORMATION STATEMENTS
Regardless of whether a company takes advantage of forward incorporation by reference (as permitted by General Instruction G(3) of Form 10-K and General Instruction E(3) of Form 10-KSB), the Adopting Release states that the Part III information is covered by the certification mandated by Section 302(a)(1) and (2) of the Sarbanes-Oxley Act of 2002 and Rules 13a-14 and 15d-14. The question is one of mechanics. While the Commission states that the Part III information would be covered by previously filed Forms 10-K and 10-KSB certifications mandated by the Adopting Release, we believe that construing such certifications to cover subsequently filed material may be unfair to certifying officers, who would have personal liability for the information subsequently prepared and filed. We are also concerned that the restoration of investor confidence intended by the certification system would be undermined by a process which had information certified in advance.
The Problem with Applying a Certification to Material Subsequently Incorporated by Reference
In many cases, the Part III information to be incorporated by reference from a definitive proxy or information statement will not have been finalized, or even drafted, at the time that the certifying officers are required by paragraph (b)(1) of Rules 13a-14 and 15d-14 to state that they have "reviewed" the disclosure. To accommodate this anomaly, the Adopting Release indicates, in endnote 35, that the certification covers the forward-incorporated information "when and as filed." While we agree that the incorporated Part IIII information should be certified, we do not favor a before-the-fact certification process. Instead, we propose that a separate certification, limited to the incorporated Part III information, should be executed and filed at the time of filing of the definitive proxy or information statement. Such a certification requirement would avoid the inherent unfairness and unreliability involved in deeming the basic 10-K and 10-KSB certifications to cover material that is not available at that time. Also, from a practical standpoint, to the extent any officers have not been heavily involved in ensuring proper compliance with the Part III disclosure requirements in the past, we believe a contemporaneous certification requirement will better motivate them to be actively involved in that process. This approach would also address the situation where the issuer's principal executive or financial officer has left the company between the time of the Form 10-K or 10-KSB certification and the time that the Part III information to be incorporated by reference from the definitive proxy or information statement is available for review.
Our proposal is consistent with the certification process where the Part III information is physically included in the Form 10-K or 10-KSB when it is first filed. In that case, the Part III information can actually be "reviewed" by the certifying officers at the time the certification is made. Our proposal is also consistent with the certification process where the Part III information, like other information, is filed by amendment to Form 10-K or 10-KSB, such as when the definitive proxy or information statement is not filed until more than 120 days following the issuer's fiscal year end. In that case, the issuer is required to amend the Form 10-K or 10-KSB to include the Part III information. The resulting amendment must include a certification with respect to such information (see text accompanying endnote 48 to the Adopting Release). According to informal guidance provided by SEC staff members, the content of the certification accompanying such an amendment is limited to that required by paragraphs (b)(1) and (2) of Rules 13a-14 and 15d-14. Thus, when the Part III information would be included in the Form 10-K or 10-KSB, or an amendment thereto, the certification would appropriately reflect an actual opportunity to review the information being certified. We believe that the certification filed with a Form 10-K or 10-KSB amendment adding Part III information provides the appropriate model for certifying Part III information that is included in a definitive proxy or information statement and made part of the Form 10-K or 10-KSB by virtue of forward incorporation by reference.
Scope of Certification Should be Limited
A separate certification of Part III information in definitive proxy and information statements should be limited in scope as follows:
Part III information includes the disclosure required to be "filed" pursuant to Regulation S-K or S-B Items 201(d) (disclosure regarding equity compensation plans), 401 (information about directors and executive officers), 402 (a)-(h) and (j) (executive compensation, except for repricing information, the compensation committee report and the performance graph), 403 (beneficial ownership table), 404 (certain relationships and related transactions) and 405 (compliance with Section 16(a) of the Exchange Act). The Part III information contained in proxy statements is, or should be, under the direct or indirect control of a company's certifying officers or the disclosure committee that they supervise. It is therefore an appropriate subject for their certification.
Officers should not certify information that is not, or should not be, under their direct or indirect control. For example, officers should not have to certify shareholder proposals, financial information of a target company (or pro forma financial information based in part on the target company's financial information) and fairness opinions of financial advisors that are not, or should not be, under their direct or indirect control. Further, they should not certify portions of the proxy statement, such as the compensation committee report, the audit committee report, repricing information and the performance graph, that are "furnished" rather than "filed" with the SEC, especially where, as with the "independent" committee reports, the purpose of the disclosure would be undercut if the certifying officer could influence its content.
The Part III information is the only part of a proxy or information statement that is part of an "annual or quarterly report filed or submitted" under Section 13(a) or 15(d) of the Exchange Act (i.e., Form 10-K and Form 10-KSB). Accordingly, consistent with Section 302 of the Sarbanes-Oxley Act of 2002, which only applies to periodic reports, and the approach if the Part III information were physically included in the Form 10-K or Form 10-KSB, the Part III information is the only part of the proxy or information statement that should be certified.
Text and Filing of Certification
We suggest that the required certifications be filed immediately following the Schedule 14A cover page and that the certifications be in the form attached to this letter as Exhibit A.
As indicated in Exhibit A, the text of the certification should be limited to the matters detailed in Section 302(a)(1) and (2) of the Sarbanes-Oxley Act and subsections (b)(1) and (2) of Rules 13a-14 and 15d-14. We believe that this is consistent with the Commission's current intention, as expressed in endnote 35 to the Adopting Release. In other words, the only certification that a registrant's officers should make with respect to Part III Information is that such officer has "reviewed" the Part III information being filed and that, based on such officer's knowledge, the Part III information contained in the registrant's definitive proxy or information statement "does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading...."
Since Part III information does not contain the sort of "financial information" intended to be encompassed by the requirements of Section 302(a)(3) of the Sarbanes-Oxley Act, we do not believe that part of the certification is relevant. This view is consistent with endnote 35 to the Adopting Release, which relates solely to paragraph 2 of the Rule 13a-14 and 15d-14 certifications.
Consistent with the SEC's informal guidance regarding the form of certification to be included in amendments to periodic reports, repeating paragraphs 4 through 6 of Section 302(a) is also unnecessary. As noted in endnote 37 to the Adopting Release, the disclosure controls and procedures required by Rules 13a-15 and 15d-15 already encompass definitive proxy and information statements. Item 307(a) of Regulation S-K requires disclosure of conclusions "about the effectiveness of a registrant's disclosure controls and procedures." In accordance with Rule 13a-14 and 15d-14, senior officers must already certify as to disclosure controls and procedures, including controls and procedures related to definitive proxy and information statements. Since the controls and procedures related to definitive proxy and information statements will be in place and will have been reviewed at the time of the Form 10-K or 10-KSB certification, it is appropriate to make the entire controls and procedures certification at the time that the Form 10-K or 10-KSB is filed. It is not appropriate or necessary to repeat the part relating to proxy and information statements at the time of any later proxy certification. Similarly, it is not necessary to repeat the certifications relating to internal controls. These certifications were designed to be made on a quarterly basis, and we believe that is the appropriate interval between certifications as to effectiveness of disclosure controls and procedures and of internal accounting controls.
Implementation: The Need to Avoid Double Certification
If a company chooses to include some or all Part III information directly in its annual report on Form 10-K or 10-KSB, either in the initial filing or in any amendment, then the senior officers of such reporting company should not be required to repeat their certification of such Part III information when such information appears in the registrant's definitive proxy or information statement. Conversely, if a company chooses to avail itself of the incorporation by reference of some or all Part III information from the definitive proxy statement, which it plans to file after the Form 10-K or 10-KSB is filed, the certifying officers should not have to cover such Part III information in the certifications that they file with the Form 10-K or 10-KSB. Thus, if the Commission adopts a separate certification requirement for Part III information contained in definitive proxy and information statements, Rules 13a-14 and 15d-14 should be amended to exclude any Part III information incorporated by reference into an annual report from the certifications required to be made by a registrant's senior officers at the time of filing the Form 10-K or 10-KSB. In addition, the statement in endnote 35 to the Adopting Release with respect to proxy and information statements should be withdrawn. Without such changes, a separate certification requirement for definitive proxy and information statements would create a "double" certification of incorporated Part III information, which could create unnecessary confusion.
FORM 10 AND 10-SB REGISTRATION STATEMENTS
We do not recommend a certification requirement for Exchange Act registration statements on Forms 10 and 10-SB. A certification requirement for registration statements would be a significant expansion of the certification process, which was designed to bring renewed focus on the importance and reliability of periodic reports filed under the Exchange Act by public companies. Despite adopting two separate certification requirements in the Sarbanes-Oxley Act of 2002, Congress did not give any indication that it believed that certification was necessary in the context of a registration statement, and instead limited the certifications to periodic reports. Since neither Section 302 nor 906 applies to registration statements, such a requirement would extend the certification requirements beyond Congress's intended scope.
Like the registration process under the Securities Act of 1933, as amended, Forms 10 and 10-SB normally are prepared with the assistance of counsel in a process in which the company's disclosures are crafted following extensive due diligence and drafting sessions. The filing of an Exchange Act registration statement is a significant event in the life of the company and is normally done with the benefit of months of planning and preparation. For that reason, a certification is not necessary to bring adequate rigor to the process.
In addition, the Section 302 certifications regarding internal controls would not work in the context of an initial registration under the Exchange Act. The certification must be made at the time of filing. But the certification would require the CEO and CFO to review disclosure controls and procedures that are not mandated by new Rule 13a-15 until after the registration statement goes effective. The Rule 13a-14 certification contemplates that the disclosure controls have been in place and that an evaluation of those controls has occurred within 90 days prior to the filing.
Amending the disclosure controls provisions to mandate that they be in place at the time of filing rather than effectiveness is not the answer. The disclosure control and certification provisions would normally become effective immediately upon effectiveness and thus would then be part of the many new governance and reporting procedures dictated by the federal securities laws and the SROs. Consistent with the approach the Commission has implemented with the timing of periodic reports, the requirements applicable to the registrant will increase as it gains experience with the reporting process. The first step of getting the registration statement filed should not be subject to procedures and certification requirements that the company and its principal officers may not be in position to follow at this initial stage of its public life.
OTHER EXCHANGE ACT FILINGS
Because of the exceptionally large number of reports that the Commission has developed for filing under various provisions of the Exchange Act (we count about100), it is impractical for us to address the question of whether the Commission should require certification of "other documents and reports" without a more focused proposal or request for comment. However, we have three observations on the general notion of extending the requirements for further certifications.
First, we believe that further certifications would be burdensome, of undemonstrated necessity and not within the clearly articulated scope of Section 302 of the Sarbanes-Oxley Act. Secondly, we have witnessed the profound impact that Sections 302 and 906 certifications have had on executive officers; we are very concerned that a proliferation of certifications would devalue these impacts and the benefits perceived by investors of the certification process. Finally, there are practical limitations on the extent to which some certifications can be obtained, either because of inability to verify other issuers' data, the inappropriateness of the certification language to the information reported or extremely short filing deadlines (such as the Commission has proposed for current reports on Form 8-K). If the Commission is concerned about any particular report or filing, we would of course be pleased to offer our views on any specific proposition.
We appreciate the opportunity to submit comments. Members of the Committee are available to meet with the Commission or the Staff and to respond to any questions.
I, [identify the certifying individual], certify that:
1. I have reviewed this definitive [proxy/information] statement of [identify registrant]; and
2. Based on my knowledge, the information contained in such [proxy/information] statement that is incorporated by reference into Part III of the [Form 10-K/Form 10-KSB] previously filed by the registrant with respect to the fiscal year ended [insert date] does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by such annual report.
*Provide a separate certification for each principal executive officer and principal financial officer of the registrant. See Rule 13a-14 and 15d-14. The required certification must be in the exact form set forth above.