August 26, 2002
Mr. Jonathan G. Katz
File No. S7-22-02
Dear Mr. Katz:
The AICPA is pleased to respond to the Commission's request for comments with respect to the above-captioned proposal (the Proposed Rule or proposing release).
We support the Commission's goal both to provide more prompt access to a greater range of reliable information concerning important events that affect its registrants, and to sponsor a debate on the issues surrounding how the various constituencies can support and strengthen the U.S. capital markets.
The AICPA recognizes that to keep pace with today's fast moving economy, the system of financial reporting designed nearly seventy years ago must be modernized. Economic change has outpaced the corresponding accounting and reporting for such change. In our letter dated May 23, 2002 to the Commission on its proposed rule "Acceleration of Periodic Report Filing Dates and Disclosure Concerning Website Access to Reports" (Proposed Acceleration Rule), we expressed our belief that, in the broadest sense, to modernize the accounting model, we must focus on the following areas:
In that letter we also expressed our belief that the Proposed Acceleration Rule was a step in the direction of achieving the third objective above of more timely reporting. We believe the SEC's current proposing release moves us even further towards our shared objective of timely, quality reporting for public companies.
While we generally support the items that you propose for companies to report on Form 8-K, we suggest in this letter that a difficulty with the Proposed Rule is implementation. We suggest that more care must be taken to achieve the goal of a greater range of reliable information without placing an undue and/or unrealistic burden on registrants' business practices, policies and procedures, and quality controls. For these reasons, we believe that the Commission should only require the reporting of definitive actions taken by management. Reporting of preliminary actions (e.g., non-binding letters of intent) introduces an element of uncertainty into the reporting process that is inconsistent with the notion of a "significant event" known by management and expected to have a material impact on a company's operations and financial statements. In addition, triggering events should be confined to objectively determinable reportable events so they may be applied consistently from company to company and facilitate compliance with Commission rules and regulations.
More timely reporting is an often repeated Commission goal, and we share the Commission's view that companies should publicly disseminate material information as soon as practical. In that regard, we generally support the Commission's proposal to accelerate the required filing deadline for almost all of the proposed Form 8-K items. We are concerned with the Commission's proposal to accelerate the filing deadline for Item 4.01 Forms 8-K. We believe that the reporting required by current Item 4 of Form 8-K is adequate and has been effective in revealing instances of opinion shopping and disagreements, in accordance with the stated goals of the rule when originally enacted. We further believe that shortening the deadline for this particular item will place an undue burden on registrants because, in practice, preparation and review of the disclosure provided in an Item 4 Form 8-K, and the accompanying letters from the independent accountants, require significant coordination among the company, legal counsel and the former accountants prior to filing.
Item 1.01 Entry into a Material Agreement
We agree with the Commission's objective of improving the amount and timeliness of information available to an investor by requiring additional disclosure of material agreements. Proposed Item 1.01, Entry into a Material Agreement, would require disclosure of a company's entry into all material agreements outside the ordinary course of business. Although material contracts must currently be filed as exhibits to Form 10-Q or Form 10-K, and completion of an acquisition or disposition of assets must be reported on a Form 8-K, reporting generally is not required for the "entry" into a material agreement. By adding this new disclosure item to Form 8-K, the Commission is providing more real time access to investors for important corporate events.
We support the Commission's proposal for disclosure of all material agreements not made in the ordinary course of business, but would limit disclosure to agreements unconditionally binding or binding subject to conditions. Additional and more timely disclosures are important but, as proposed by the Commission, defining "agreement" to include all material letters of intent or non-binding agreements, makes the disclosures more inclusive than necessary. Our concern is that disclosure of preliminary information in a letter of intent or non-binding agreement would not improve an investor's ability to make informed investment decisions and the uncertainty surrounding these types of agreements could be confusing or misleading. In addition, it appears the Form 8-K reporting requirement might precede any Regulation FD disclosure requirement and be at odds with the "confidentiality exception" of Regulation FD.
We believe that companies also should disclose on a Form 8-K material agreements "deemed" not to be made in the ordinary course of business under Regulation S-K Item 601(b)(10) and for which the contract is required to be filed as an exhibit, except that the Form 8-K disclosure for management contracts and compensatory plans should be limited to directors and "named" executive officers. With an exception for compensation related agreements for "other" executive officers (for which filing of exhibits would still be required), the Commission's proposal for disclosure of material agreements will be consistent with the exhibit requirements for material contracts under Regulation S-K Item 601(b)(10) of Regulation S-K. This means that all material agreements disclosed on a Form 8-K would be filed as exhibits on the next Form 10-K or Form 10-Q.
We suggest that companies be encouraged to file material agreements as exhibits to the Form 8-K, but that the required filing of the exhibit under Regulation S-K Item 601(b)(10) with the next required Form 10-K or 10-Q be maintained. Consistent with the recommendation above, no filing should be required for letters of intent or non-binding agreements.
Item 1.03 Termination or Reduction of a Business Relationship with a Customer
Under proposed Item 1.03, Termination or Reduction of a Business Relationship with a Customer, disclosure would be required if a customer terminates, or reduces the scope of, a business relationship with the registrant and the amount of the associated loss of revenues exceeds 10% or more of the company's consolidated revenues for the most recent fiscal year. Furthermore, disclosure is triggered at a point in time at which an executive officer of the registrant becomes aware of the reportable event, but disclosure would not necessarily be required during negotiations or discussions with the customer or upon a reduction or suspension of customer orders.
While we agree with the underlying objective of the proposed Item 1.03, we are concerned that the reporting requirement as proposed would be difficult to implement consistently and reliably in practice. For example, the "awareness" of an executive officer regarding the potential finality of a customer's expressed or implied actions is not an objectively determinable reportable event. Also, changes in the nature and composition of various "business relationships" with a particular customer are common. In some cases, one aspect of a company's business with a customer may be terminated or reduced, but another aspect is initiated or increased. The proposed rule is ambiguous as to whether a significant change in a customer relationship (e.g., non-renewal of a material contract) must be reported if the registrant either has or expects to obtain different sources of revenue from that customer, such that total revenue from the customer is not likely to decrease in an amount that exceeds the reporting threshold.
As an alternative, we recommend that a more objective reporting standard would be specific to those customers that were reported under Item 101(c)(vii) of Regulation S-K in the registrant's most recent Form 10-K. Item 101(c)(vii) requires that "the name of any customer and its relationship, if any, with the registrant or its subsidiaries shall be disclosed if sales to the customer by one or more segments are made in an aggregate amount equal to 10 percent or more of the registrant's consolidated revenues and the loss of such customer would have a material adverse effect on the registrant and its subsidiaries taken as a whole." This group of customers would appear to represent those where a loss or decline in sales to a customer could exceed 10% of consolidated revenues for the most recent fiscal year. (To the extent the linkage is not made to Item 101 of Regulation S-K, the Commission should provide clarification of the registrant's responsibilities to ascertain which customers may have affiliates.)
Item 2.01 Completion of Acquisition or Disposition of Assets
We support the Commission's proposed changes to what is currently Item 2 of Form 8-K. However, it appears that the Commission is also inadvertently shortening the due date for filing audited financial statements of an acquired business. Currently, registrants have 75 days in which to provide the audited financial statements.1 In the Proposed Rule, the Commission is shortening the due date for the initial Form 8-K by 13 days without a corresponding increase in the current additional 60-day period in which registrants are permitted to file audited financial statements of an acquired business.
As we previously commented in our letter regarding the Proposed Acceleration Rule, we do not believe the due date for providing audited financial statements of an acquired business should be accelerated at all. Many business combinations involve the acquisition of entities that have either never had financial statements prepared in accordance with U.S. generally accepted accounting principles (GAAP), or have never been audited or represent divisions or segments of larger companies in which an audit has never been performed at the division or segment level. In some such instances, audits of acquired businesses cannot even begin until after the acquisition has been consummated. Thus, an implementing rule that shortens the filing due date would likely create a significant hardship for many reporting companies in terms of practicability and cost. We suggest the Commission amend the proposed Item 8.01(a)(4) of Form 8-K to lengthen the period permitted for the filing of audited financial statements from the current 60 days after the due date of the initial report to 73 days after the initial report.
Item 2.05 Exit Activities Including Material Write-Offs and Restructuring Charges and Item 2.06 Material Impairments
We believe that exit activities and impairments, when material, are significant to investors and that prompt disclosure is necessary. However, the requirement in the proposed disclosures of including the amount of any charges, using the approval of the action as the triggering event, is likely unworkable as the knowledge of the existence of an impairment, or the approval of a restructuring, may precede a reasonable estimate of the amounts associated with such an event by a considerable period of time.
The most significant practical issue related to proposed Items 2.05 and 2.06 is the lack of clarity with respect to the event triggering disclosure in Form 8-K (the "triggering event"), and whether the triggering event is intended to be consistent with the date at which accrual of a liability or recognition of an impairment is appropriate under GAAP. As previously described, if the triggering event for disclosure precedes the recognition date under GAAP, the amount of the charge and in-depth analysis of the effect of the charge on the company, will likely not be available. Clarification of this issue is particularly important given the recent issuance of guidance regarding asset impairments and restructuring activities by the Financial Accounting Standards Board ("FASB").
For example, the recognition date for exit activities in the proposed rule appears to employ a "commitment date" concept similar to that used in Emerging Issues Task Force (EITF) Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (including Certain Costs Incurred in a Restructuring), which requires a liability for exit costs be recognized at the date of an entity's commitment to an exit plan. However, in Statement of Financial Accounting Standards (SFAS) No. 146, Accounting for Costs Associated with Exit or Disposal Activities, the FASB concluded that an entity's commitment to a plan, by itself, does not create a present obligation to others that meets the definition of a liability in FASB Concepts Statement No. 6, Elements of Financial Statements. Therefore, SFAS No. 146 nullifies the recognition requirements of EITF 94-3 and requires a liability for costs associated with an exit or disposal activity be recognized when the liability is incurred, which may be much later than the date management commits to a plan.
Another example relates to the impairment of long-lived assets under Statement of Financial Accounting Standards No. 144, Accounting for the Impairment or Disposal of Long-Lived Assets. Under the proposed items, it is not clear if the disclosure of an asset impairment would be required when events or changes in circumstances indicate the carrying amount of the asset may not be recoverable, upon completion of a recoverability test which indicates the carrying amount is not recoverable, or upon determining the fair value of the asset. Also, while management having the appropriate level of authority may conclude an impairment charge is required to be recorded under GAAP, the amount of the charge may not be known until much later.
We propose that the triggering event be conformed with the recognition date under applicable GAAP or, at a minimum, that the Commission adopt a two-stage disclosure process similar to that for acquiree financial statements (e.g., initial disclosure at the definitely committed date for Item 2.05 and at the date that a recoverability test in which an impairment is indicated is completed for Item 2.06, followed by detailed disclosures at a specified period of time after the initial disclosure).
Item 3.03 Unregistered Sales of Equity Securities
Under proposed Item 3.03, Unregistered Sales of Equity Securities, companies would be required to disclose information required by Item 701 of Regulation S-K regarding the company's sale of equity securities that are not registered under the Securities Act of 1933. Currently, such information is required to be provided for the most recently completed quarter in a company's annual report on Form 10-K and quarterly reports on Form 10-Q. While we agree that more timely disclosure of such information is appropriate, we believe that, as a practical matter, the Commission should not require a Form 8-K to be filed for unregistered equity sales below a specified threshold. Instead, when the aggregate amount of unreported sales exceeds the specified threshold, a Form 8-K report should be required. We believe that an appropriate reporting threshold would be one based on a percentage (e.g., one-half of one percent) of the company's outstanding common equity shares as of its most recent fiscal year end.
Item 4.01 Changes in Registrant's Certifying Accountant
We believe that the current reporting required by Item 4 of Form 8-K is adequate and has been effective in revealing instances of opinion shopping and disagreements, in accordance with the stated goals of the rule when originally enacted. We do not believe that the current five-day filing deadline needs to be shortened to two days because there is no evidence that any added value or investor protection would be derived from such a change. We further believe that shortening the deadline for this particular item will place an undue burden on the both registrants and their former auditors because, in practice, the text of Item 4 disclosures frequently require discussion and modification prior to filing.
Due to the coordination required between the registrant and its auditor accompanied with the member firm's reporting requirements by the SECPS (which is also a five-day requirement), the Committee believes that the five-day timeframe is necessary for both registrants, which may be seeking consultation with their legal counsel prior to filing, and the former auditors to diligently meet the disclosure requirements of Regulation S-K Item 304.
Employee Benefit Plans
We suggest that, under proposed Item 4.01, only if there is a change in the auditor of a registrant's employee benefit plan ("Plan"), and that auditor is different from the auditor of the registrant, should the Plan file a Form 8-K and report the change in auditor. In situations where the registrant and the Plan have the same auditor, and the registrant and the Plan change auditors (both engaging the same new auditor), the Committee believes that the reporting of the event by the registrant/sponsor alone should suffice. In virtually all other instances, a Form11-K filer meets its reporting obligations by reference to the filings of the Plan sponsor, and there seems to us to be no reason why meeting a Form 8-K filing obligation should differ.
In situations where the Plan and the sponsor/registrant have the same auditor, the Commission should consider adding a requirement to the instructions to Form 11-K whereby the Plan would either disclose any such change in auditors pursuant to Regulation S-K Item 304 or, at a minimum, list the reports on Form 8-K filed by the sponsor/registrant. This would enable the Plan to disclose the change in auditor by the sponsor/registrant to the readers of the Form 11-K. For situations in which the Plan has a different auditor than the sponsor/registrant, as discussed in the previous paragraph, the report of the change in Form 8-K should suffice.
We also note that under section II.F. "Conforming Amendments," item 2, the Commission has proposed to delete Item 9, "Changes in and Disagreements with Accountants on Accounting and Financial Disclosure." We believe these disclosures are relevant and meaningful to investors, and searching for a Form 8-K should not be the only way investors can become aware of reportable issues. We believe that Item 9 of Form 10-K, therefore, should not be deleted because information required by the existing Item 9 provides important disclosures to investors regarding auditor changes and potential disagreements and other reportable events.
Item 4.02 Non-reliance on Previously Issued Financial Statements or a Related Audit Report
We agree with the Commission's proposed Item 4.02 requiring disclosure on Form 8-K when a registrant's audit committee, board of directors, or other authorized officer(s) concludes that any previously issued annual financial statements should no longer be relied upon, or when the registrant receives notice from its current or former independent auditor that action should be taken to prevent future reliance on a previously issued audit report. While the text of the proposed amendment to Form 8-K clearly requires review of the disclosures by the independent auditor in both instances, the language of the proposing release suggests that such a process would occur only in the latter case, when the auditor provides notice to the company. We recommend that the Commission clarify in the final rules that the issuer must provide the independent auditor with the Form 8-K disclosures, and be required to file by amendment any responding letter from the auditor, in all cases when such a disclosure is made. That is, we believe that the auditor should be provided the opportunity to comment on the Item 4.02 disclosures whether the company concluded that the previously issued financial statements should no longer be relied upon or whether the auditor notified the company of the need for action.
In the proposing release, the Commission requests comment on whether Item 4.02 should be expanded to "require disclosure of events relating to a company's quarterly financial statements." We believe that the requirements of Item 4.02 should cover quarterly financial statements.
Critical Accounting Policies
In the proposing release, the Commission questioned whether a change in a company's critical accounting policies (as defined in Release No. 33-8098) should be disclosed on Form 8-K. We strongly believe that changes in critical accounting policies should not be an event reported on Form 8-K. Critical accounting policies, and changes therein, can best be understood in the context of a full set of financial statements. Requiring disclosure of a change in critical accounting policies in a Form 8-K will undoubtedly result in the reader of the current report not having the information necessary to make an informed assessment of the change on the financial information of the company. We believe the appropriate place for such disclosures is in quarterly and annual reports.
Foreign Private Issuers
We believe that the Commission should not apply the reporting requirements of Form 8-K to foreign private issuers ("FPIs"). Generally, other information that is provided by FPIs in Form 6-K is based upon the requirements of the home country of the FPI or by stock exchange requirements. We point out that the Commission's rules and regulations for FPIs were designed so that the FPI is required to file an annual report similar to that provided by U.S. domestic companies, thus achieving a balance between investors' need for information and the incremental cost to the FPI. A change in the current reporting system may impose an undue burden on the FPI and additional costs, thereby increasing the chances that the FPI would elect not to register securities in the U.S. markets.
For information that the Commission describes as a "high level of importance" such as a change in auditors or a bankruptcy petition, we believe that the proposed reporting requirements for Form 8-K would be inconsistent with the current system. However, we remind the Commission that as for a change in auditors, the existing AICPA International Practices Task Force would support a rule change whereby the disclosure required by Item 304 of Regulation S-K would be included in the annual report on Form 20-F with respect to filings under the 1934 Act and the disclosures would be the same as a domestic issuer in filings under the 1933 Act.
We believe that the Commission should consider issuing a separate proposal specific to FPIs, so that these companies have the opportunity to respond to the Commission's suggested changes to the current FPI reporting system. We also believe that other international bodies will want to express their views as well, to ensure that there is a consistent reporting system among the various countries, many of which have already developed interim reporting requirements and periodic requirements similar to those found in Form 8-K.
Amendments to Rule 12b-25 and Form 12b-25 Regarding Late Filing
We agree with the Commission's proposal to amend Rule 12b-25 to provide for a two-day extension for those items filed on Form 8-K that require disclosure within two business days of a triggering event.
By significantly increasing the number of reportable events that must be disclosed on Form 8-K, while simultaneously reducing the filing deadline, the proposal greatly increases the likelihood of a company unintentionally missing a filing deadline. As currently proposed, even a short delay in filing a required Form 8-K beyond the extension provided on Rule 12b-25 would result in the registrant losing its short form filing status and therefore limit its ability to quickly access the capital markets.
In its final rule, we recommend the Commission allow for this possibility by administratively providing exemptions for minor violations. The Commission proposed such an exemption, subject to certain conditions, in its Proposed Rule: Form 8-K Disclosure of Certain Management Transactions. For example, that proposal includes a change in the General Instructions to Form S-3 that reads:
"For purposes of this paragraph, a registrant will be considered as having filed all the material required to be filed under section 13 or 15(d) of the Exchange Act and has having filed in a timely manner all reports required to be filed notwithstanding that the registrant may not have timely filed one or more current reports on Form 8-K (§249.308 of this chapter) required to be filed solely to disclose the occurrence of an event or events specified in Item 10 of Form 8-K."
The AICPA appreciates the opportunity to comment on the Proposed Rule. We would be pleased to discuss these comments with you at your convenience.
Jay P. Hartig