FINANCIAL EXECUTIVES INSTITUTE
July 2, 1999
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Subject: File No. S7-30-98
Dear Mr. Katz:
The Committee on Corporate Reporting of the Financial Executives Institute ("FEI") appreciates this opportunity to respond to the Commissionís Notice of Proposed Rulemaking, "The Regulation of Securities Offerings." FEIís members are the chief financial officers, controllers and other senior financial executives in companies throughout the United States and Canada. As such, we strongly support business and regulatory efforts that enhance the efficiency of our capital markets and promote the interests of investors and other stakeholders.
Our analysis of the proposal has focused primarily on its practical consequences. While we are supportive of the Commissionís overall objective of providing increased flexibility in the registration process, we believe that the universal shelf registration process currently available to large seasoned issuers is working very well. We encourage the Commission to extend the best elements of the current system to a wider category of participants, and to ensure that any changes designed to enhance the process will not result in unnecessary costs or delays.
We can understand that some fine-tuning in the current system may be appropriate to reflect technological advances, but we question whether a complete overhaul is really necessary. The Commission is attempting to fix something that is not broken. Rather than imposing an overhaul of the entire system, a more targeted approach would be preferable. Depending on the circumstances, tugboats are sometimes more effective than aircraft carriers.
In this regard, we believe that the proposed elimination of the current shelf registration process would have a serious adverse effect on a significant proportion of securities offerings.
Under the current shelf registration process, securities offerings of large public companies can be quickly and efficiently underwritten and funded, with no diminution of investor protection. In contrast, the Commissionís proposal imposes filing and delivery requirements that will slow transactions and impact the cost of capital.
Under the proposal, the commencement of the underwriting process would entail a number of complicated and time-consuming steps, including the preparation, review, printing, delivery to the Board of Directors (to read, affirm there are no misstatements or errors of omission, and sign), and filing of the entire registration statement plus exhibits and other offering and free writing materials, including those materials distributed by prospective underwriters on behalf of the issuer. Issuers would also have to verify that prospective underwriters have not had any SEC violations within the last five years. In addition, issuers would have to ensure they do not have outstanding disputes with the SEC on any documents incorporated by reference, or else they are not eligible to use Form B for an offering. Being subjected to Form A issuance requirements can significantly increase the cost of capital for an issuer. Even for a Form B issuance, these time-consuming steps and the requirement to deliver a term sheet to all investors before the investment decision is made can effectively delay an offering by 24 hours or more, which can significantly affect the execution and cost of the transaction. In our view, the current shelf registration process works exceptionally well and should be retained for large, seasoned issuers.
In addition, the proposal raises a number of liability concerns for issuers. Free writing, in particular, appears to be an area where the proposalís good intention of increasing the flow of information between issuers and investors will be overpowered by the liability attached to free writing. It will be difficult for an issuer to ensure that all free writing materials distributed by its underwriters have been filed. In addition, it will be difficult for an issuer to ensure the integrity of all communication distributed by its underwriters, especially given the inclusion of free writing which occurred 15 days prior to the first offer date. These factors will likely dampen the flow of free writing materials.
A further concern with free writing materials arises out of the fact that the filing requirement is limited to forward-looking information; that is, issuers are not required to file factual business communications. Most of what is deemed to be factual business communications (e.g., press releases) typically contains some aspect of forward-looking information. Thus, it may be difficult to separate communications that are purely business fact from communications that are purely forward looking. The end result may be that all issuer communications will be required to be filed. Alternatively, the liability attached to a "filed" document may create a disincentive for companies to communicate certain aspects of its business in writing.
There are also certain aspects of the proposal relating to periodic filings under the Exchange Act that raise particular practical concerns. Our views on these items are summarized below.
This aspect of the proposal represents a dramatic change from existing concepts of risk factor disclosures. Item 503(c)(1) of Regulation S-K currently requires, where appropriate, a discussion of the principal factors that make the offering speculative or one of high risk. We would expect that few companies filing on Form B would fall into the category of a "speculative" or "high risk" investment. Yet the proposal would expand the requirement for risk factor disclosures to all companies, which will lead to substantial boilerplate disclosures and would not be cost effective.
In addition, for large, complex companies operating in multiple markets and geographies, an itemization of specific risk factors would be difficult if not impossible to compile. If it could be done, the list could be so voluminous that it would become meaningless and of little value to investors. On the other hand, registrants who attempted to limit their disclosure to a select number of principal risk factors would risk significant liability for undisclosed risks that were not deemed singularly significant but which nonetheless could result in loss. In either case, the reality is that such disclosures may provide a false sense of security, providing generic descriptions of known risks and inadequate warnings about unforeseen risks.
The existing MD&A requirements under Item 303 of Regulation S-K already provide a proven means for disclosing trends, risks and uncertainties in the context of the companyís current financial condition and results of operations. A requirement to separately disclose "risk factors" would likely result in lengthy boilerplate recitations of things that could go wrong, which will provide little value to investors. Instead, we encourage the Commission to reemphasize the critical role of existing MD&A disclosure requirement as providing an overall picture of risk within the context of the companyís operations.
FEI has for many years supported the concept that management of a public company should make a concise report in its annual report of managementís responsibility for the financial statements and for a system of internal controls. Our focus and principal concern is managementís legal requirement to maintain a system of controls that provides reasonable assurance as described in the Foreign Corrupt Practices Act and the related SEC regulations. Many companies already provide this type of management report in their annual reports to shareholders.
FEI would support a requirement for this type of management report as long as the form and content of such report is not mandated by the Commission. However, since the Commissionís proposal involves the Audit Committee function, we believe that this issue should be considered as part of the Blue-Ribbon Panel recommendations rather than as part of the current proposal. Further, our support is conditioned on the continuation of the traditional concepts of "reasonable assurance" and "materiality." If other initiatives within the Commission were to significantly modify these concepts, we would need to revisit our support for the management report.
We agree with the Commission that earnings information that has been released into the marketplace should be filed with the Commission on an expedited basis. However, we recommend that a minimum period of one to two days be permitted between the issuance of an earnings press release and the filing of the Form 8-K, to provide sufficient time for the Edgarization process.
However, in some cases a company may be ready to issue an early press release containing certain earnings information but may not yet possess the balance sheet information required by Item 301. Rather than delaying issuance of the press release, it would be preferable to allow the expedited 8-K to be filed with earnings information only. We therefore recommend that the expedited 8-K requirements be focused on earnings information rather than the selected financial data requirements of Item 301.
We acknowledge that in light of technological developments since 1934, when the current due dates were established, one would think that such a proposal would be acceptable. However, along with technological advances has come an increasingly complex business environment, as well as increased reporting and disclosure requirements. This fact, coupled with other proposals in the release that will result in an acceleration of due dates, causes us to believe this is an unrealistic expectation.
Based on our experience, in most cases the basic financial statements (income statement, balance sheet, cash flow statement and changes in stockholdersí equity) could be prepared and filed on a shortened time schedule. However, additional time is generally needed to prepare the additional disclosures required in a 10-Q or 10-K filing, including financial statement footnote disclosures, tables, and MD&A information, including the Commissionís market risk disclosures. To a large extent, much of the information required to be disclosed under current requirements is generated solely for compliance purposes, and is not used by management in running the company. Efforts at "disclosure simplification" or "disclosure effectiveness" have not been successful in reducing the level and complexity of the required information. Without such a rationalization, we do not believe it is realistic to shorten the due dates for Form 10-K and Form 10-Q.
In addition, those companies which currently incorporate by reference their Annual Reports to Shareholders with their Form 10-K filings (or publish and mail both in a single combined document) may encounter difficulty in meeting the accelerated due date. These companies may be forced to file a separate Form 10-K in advance of the Annual Report to Shareholders, which will be less efficient and more costly.
While we agree with the expedited filing of 8-Ks for material events, we do not believe it is reasonable to require a one-day due date for reporting any of these items. We do not believe that one day would permit sufficient time for even the most basic level of evaluation by the company and its legal and accounting advisors. A minimum of 2 to 3 business days should therefore be provided in cases of material default, changes in auditors or resignations of directors.
The principal executive officers and directors of a company have a responsibility to ensure that there is an adequate process in place to ensure the accuracy and integrity of financial reporting. It is fully appropriate for the operation of this financial reporting process to be delegated to managers with the requisite level of professional training and experience. As described above, we support a requirement for management to report on its responsibility over the financial reporting process. However, we do not believe it is reasonable to expect executive officers and directors to be sufficiently familiar with the detailed disclosures in periodic reports to be in a position to provide the proposed certification. This aspect of the proposal could have the unintended consequences of discouraging service on corporate boards (due to the potential liability) or delaying the filing of periodic reports (due to the time required to perform the necessary review and obtain the necessary signatures). Further, the proposal will pose the administrative burden of requiring the reconfiguration of board meeting dates, particularly during the quarterly periods.
We are generally supportive of the Commissionís efforts to promote plain English disclosures. However, we are aware of several recent cases where this initiative has caused delays in the registration process attributable solely to successive rounds of plain English review. If the Commissionís initiative is to succeed, it must be implemented in a reasonable fashion and permit an adequate period of transition. Most companies would welcome constructive criticism of their efforts at plain English, but not at the expense of delaying their transactions.
In our view, the staff review process can play an important role in ensuring the overall quality of financial reporting. However, we have a significant concern with the current staff review environment, in which the staff appears to utilize its review as a means for inducing changes in financial reporting outside of the normal due process channels. Recent examples include companiesí accounting for restructuring charges, acquired in-process research and development, and loan loss reserves. Under the proposal, we are fearful that this situation could be exacerbated such that companies that have received notification of staff review may find it extremely difficult to access the markets until the results of the review, if any, can be determined. We urge the Commission to carefully review the need to balance the objectives of the staff review process with its stated desire to maintain the setting of accounting rules in the private sector.
Including auditor examination or review of MD&A in a list of suggested due diligence procedures for underwriters may expose underwriters to de facto liability for failing to perform such procedures. Thus we are concerned that the Commissionís proposal will have the effect of significantly increasing auditor involvement in MD&A. We seriously question the need for a separate auditor review of MD&A, which will result in significant costs being incurred with little impact on the reliability of the data. Responsibilities of the underwriter should be performed by the underwriter, not shifted to the shareholdersí representatives.
Further, the report of the AICPA Special Committee on Financial Reporting found that users did not support auditor reporting on MD&A for two reasons: (1) they feared that auditor involvement might discourage management from reporting subjective information that may be hard to verify but that is nevertheless important to users; and (2) they questioned whether auditors have the intimate understanding of the business and skills necessary to audit managementís discussion effectively Ė users see MD&A as the place for managementís perspective on the business, and they do not want outsiders interfering with the communication of that view. We strongly agree with these concerns and would not support a proposal that would effectively require increased auditor involvement in the MD&A.
We are concerned that this aspect of the Commissionís proposal would create a new category of professional and an incremental layer of costs for which there is no apparent demand or need in the marketplace. We see no value added from the type of review described above, the substance of which is already performed by management, auditors and underwriters. We question why underwriters, who are assumed to be qualified professionals, should be encouraged to delegate important responsibilities to other parties, independent or otherwise.
We would be pleased to discuss our views further with the Commission.
Vice President Ė Professional Development
and Technical Activities