June 28, 1999
Mr. Jonathan Katz
U.S. Securities and Exchange Commission
Mail Stop 6-9
450 Fifth Street, N.W.
Washington, DC 20549
Re: File No. S7-3-99 (Release Nos. 33-7637; 34-41014)
International Disclosure Standards
Dear Mr. Katz:
This letter is the response of Arthur Andersen LLP to the Securities and Exchange Commission's request for comments on its proposal to conform the non-financial disclosure requirements for foreign private issuers to the international disclosure standards endorsed by IOSCO in September 1998.
We are in favor of actions by regulators that lower barriers to cross-border securities offerings without sacrificing information needed for investor protection. Although we have several recommendations regarding specific aspects of the proposal, we generally support the Commission's efforts to conform to the non-financial disclosure standards endorsed by IOSCO. The Commission's proposal is an appropriate and important step forward in facilitating efficient markets for cross-border transactions.
The Commission's 1988 policy statement refers to a goal of developing "an integrated international disclosure system". A core disclosure document that requires little tailoring in order to move across markets represents, as the Release states, an "international passport to the world's capital markets". The challenge facing national securities regulators, including the Commission, is to balance the goal of enhancing the efficiency of global capital markets with the goal of insuring that investors have access to timely, relevant, and complete information. Without diminishing the importance of the changes proposed in the Release, we believe that more work is needed to address (a) consistency in the disclosure of financial information in cross-border securities offerings and (b) consistency in the disclosures between domestic and foreign registrants. We recognize that IOSCO and the Commission will soon address harmonization of financial reporting standards for cross-border transactions. We encourage the Commission to also consider how these harmonized disclosures and standards should apply to domestic registrants.
The remainder of this letter offers our observations on specific elements of the proposal. Our comments are limited to aspects of the proposal that affect financial reporting.
When the Commission adopts the new rules, existing foreign registrants will have to determine what, if any, changes are necessary to their disclosures. We suggest that the Commission include a cross-reference table in the final release to show where each current requirement has been dealt with in the new requirements. This would help existing registrants transition to the new rules. It also might help ensure that no significant current requirement has been omitted inadvertently.
Form 20-F - General Instructions
Timeliness of Information
Proposed General Instruction C. (b) requires information to be provided in a registration statement as of "a date reasonably close to the date of the filing" and in the annual report as of "the latest practicable date". Those "dates" are not defined. It also is not clear why the timeframes are different in each case. How does "a date reasonably close to the date of the filing" differ from "the latest practicable date"? The likely result of this lack of clarity is that each registrant will interpret these requirements differently.
We suggest that the Commission provide further guidance to clarify its intent and increase the consistency with which these rules will be applied.
Proposed General Instruction E. (c) requires the financial statements to be audited in accordance with U.S. generally accepted auditing standards. The proposed rule is more specific than Rule 2-02 of Regulation S-X which refers to "generally accepted auditing standards." We question whether the specific reference to U.S. auditing standards in the proposed rule is intended as a point of clarity or is intended to change present practice related to audits of financial statements of foreign registrants. Currently, the SEC staff accepts an auditor's report stating that the audit was conducted in accordance with local auditing standards, so long as the auditor also states that the local standards are substantially similar (or similar in all material respects) to auditing standards in the U.S.
We believe current practice is appropriate and consistent with the objective of the Commission's rules. We do not believe current practice should change. For a foreign auditor to say the audit has been conducted in accordance with auditing standards that are "substantially consistent" with U.S. standards, the auditor must ensure substantive compliance with all of the U.S. authoritative standards. But the complete compliance may not be feasible. For example, there may be differences, albeit minor, in the form of the auditor's report. Altering the auditor's report to make it fully comply with U.S. auditing standards could make it unusable in other countries, including the registrant's home country. Further, if each country had such a requirement, the auditor's report would need to be rewritten to conform to the standards of each country where it would be used. This result runs counter to the objective of the proposed rules.
Our understanding is that the Commission did not intend to modify existing practice in this area. It would be helpful to confirm this, either in the narrative that accompanies the final release or in the text of General Instruction E.
Form 20-F - Item 1 - Information about the Auditor
Proposed Item 1 of Form 20-F requires disclosure of the names and addresses of the company's auditors for the preceding three years, "together with their membership in a professional body". We have three questions regarding this requirement.
First, it is not clear to us how the requirement to disclose "membership in a professional body" should be met. What if there is no professional body in that country? What if membership is limited to individuals rather than organizations? What if membership is not mandatory? In some countries, firms are permitted by a professional body to describe the firm in a particular way (e.g. chartered accountants). Often, however, it would be individuals, rather than the firm, who belong to the professional body. We suggest that the Commission modify the rule or provide guidance in the final release to clarify the disclosure required when the firm is not a member of a professional body.
Second, the rule does not state whether the auditor information is limited to the registrant's principal auditor or should apply to the principal auditor and any other auditor named in the principal auditor's report. We suggest the Commission clarify this in the final release.
Third, it does not appear that auditors, principal bankers and legal advisers must consent to the description provided in response to Item 1. Proposed Item 10. G. addresses consents but only in the context of statements or reports (vs. descriptions) attributed to an expert. We believe that consents should be required from anyone named as an adviser or auditor in Item 1. We suggest that Item 10. G. require that the registrant obtain a written consents from anyone named as principal banker, legal adviser or auditor in Item 1.
Form 20-F - Item 3 - Statement of Capitalization and Indebtedness
Proposed Item 3. B. requires a "statement of capitalization and indebtedness" as of a date no earlier than "60 days prior to the date of the document." The text of the Item explains that the statement of capitalization should show "the company's capitalization on an actual basis and, if applicable, as adjusted to reflect the sale of new securities being issued and the intended application of the net proceeds therefrom." The statement is to include both "indirect and contingent indebtedness."
Although "capitalization tables" often are presented in an offering document in the U.S., there are no rules governing their format or content. A customary practice has developed and the SEC staff has provided informal guidance on certain aspects of presenting such tables. Conversely, a "statement of indebtedness" generally is not presented in a U.S. offering document but is required or customary in other countries. It is our understanding that, similar to capitalization tables in the U.S., a customary practice has often developed without clear rules as to how a statement of indebtedness should be prepared. The proposed rule provides little guidance regarding the form and content of the statement.
We believe that the Commission should define the information to be presented in the historical and as adjusted statement. Absent clarification, issuers will not interpret the requirements and present this information consistently. For example, does "indirect indebtedness" include operating leases? Does "contingent indebtedness" include guarantees for which performance is deemed remote or reasonably possible? Should the adjustments to reflect "the intended application of the net proceeds" be limited to factually supportable adjustments which would be permitted by Article 11 of Regulation S-X or can the presentation assume that the transaction occurred as of an earlier date and reflect the forecasted operating improvements resulting from using the proceeds to purchase more efficient equipment? Should the statement be presented in accordance with the accounting principles used in the registrant's primary financial statements? If so, should the statement be reconciled in any way to U.S. accounting principles? We suggest that the Commission clarify these requirements by expanding the rules, expanding the glossary of defined terms, or adding illustrations and discussion in an appendix.
We also are unclear as to the meaning of the "date of the document" for purposes of presenting the statement of capitalization and indebtedness. Is this the date the registration statement is filed or effective? We note that proposed Item 8. A. 5 also refers to the "date" of the document. Should these two references be interpreted similarly? Further, we note that a statement of capitalization and indebtedness as of a date no later than 60 days of the "date of the document" is more current than the most recent financial information presented in the registration statement. We question the merits of this inconsistency, particularly considering the fact that companies in many jurisdictions may not prepare monthly consolidated financial statements.
The Instruction to Item 3. B. does not appear to address the type of best efforts offering where the issuer retains the proceeds of whatever amount is sold and there is no minimum. We presume that no capitalization table is permitted in that type of "best efforts" offering but we suggest the final rules clarify this point.
Form 20-F - Items 4 and 5 - Segment Information
Proposed Item 4. B., "Business overview," states:
"The information required by this item may be presented on the same basis as that used to determine the company's business segments under the body of accounting principles used in preparing the financial statements."
Proposed Item 5, "Operating and Financial Review and Prospects," states:
"Information provided also shall relate to all separate segments of the company. Provide the information specified below as well as such other information that is necessary for an investor's understanding of the company's financial condition, changes in financial condition and results of operations."
We have the following questions about how these requirements should be applied in practice:
1. What if no segment information is presented in the primary financial statements because that set of accounting principles does not require segment disclosures? May a registrant omit discussions of its business segments in Items 4 and 5?
2. A foreign registrant filing annual financial statements in accordance with Item 17 of Form 20-F prepared in accordance with U.S. accounting principles may omit from its financial statements segment information that conforms with Statement 131. May that foreign registrant also omit segment information in preparing the information required by Items 4 and 5?
3. The text of Item 5 does not indicate which accounting principles are to be used in discussing segment results. What if the accounting principles used in the primary financial statements identify reportable segments that differ significantly from those that would result under Statement 131? We had understood that the SEC staff would expect MD&A for foreign private issuers to discuss segment information on both bases if the latter provided additional information that would be useful to investors.
We suggest that the Commission modify the rules or provide guidance in the release covering the final rules to address these questions.
Form 20-F - Item 8 Financial Information
Age of Financial Statements
Proposed Item 8 contains the following requirements:
We do not understand the different timeframes in these rules. According to the Instruction to proposed Item 8. A. 4., "the time of the offering" means the effective date. But the other terms are not defined. Are the "time of the offering" and the "date of the document" are essentially the same? If so, then the "date of the document" also must mean the effective date. Or does the date the "document is filed" refer to the filing date? If so, is that the same meaning as in Item 3. B. on Capitalization and Indebtedness?
We suggest that consistent terminology be used in discussing the various timeframes. We believe that preparers, auditors and advisers are familiar with terms such as "filing date" and "effective date" and suggest that the Commission's rules use these familiar terms rather than introducing new ones. We also believe it would be in the best interest of both registrants and investors to have consistency as to the age of financial statements required both at filing date and effective date. At present, Regulation S-X requires that the financial statements presented in a filing be current at the date on which the registration statement is filed, as well as the date on which the registration statement becomes effective. We suggest that the proposed requirements also apply at both the date of filing and effective date.
Putting aside the issues of clarity and consistency, we have significant reservations about registrants' ability to comply with the proposal when we consider the requirements of Item 17 or Item 18 of Form 20-F. We believe the IOSCO recommendations may implicitly assume that the issuer's home country financial statements would be sufficient. Thus, there was no need for IOSCO to consider the effort or time needed to reconcile the home country financial statements to another accounting framework. But the Commission has not yet addressed the issue of harmonization in financial reporting and thus the adoption of IOSCO's age of financial statement rules places a significant burden, perhaps unintended, on foreign issuers. For example:
A foreign issuer may have no difficulty preparing audited home country financial statements within the time periods required by proposed Item 8. However, our experience is that foreign filers prepare the reconciliation to U.S. accounting principles (as well as any additional disclosures required by U.S. accounting principles) after they prepare their primary financial statements. Preparing (and auditing) the U.S. information requires additional resources and time. The existing age of financial statement rules for foreign registrants acknowledge the incremental effort by providing up to 6 months for year-end audited financial statements. The proposed rule provides only 3 months (Item 8.A. 4.'s requirement that the last year of audited financials be no older than 15 months). The same concern applies to unaudited interim financial information.
We also note that the proposal accelerates the filing of financial statements only when a company is raising capital. Presently, the age requirements for financial statements under the 1933 Act and the 1934 Act generally are the same. (The one exception is Rule 3-01(c) of Regulation S-X.) The proposed rules would result in earlier updating under the 1933 Act than under the 1934 Act. We do not understand why an investor in a newly issued security is entitled to more timely financial information that an investor who is considering buying or selling a security that is already registered.
We agree that some acceleration in the timeliness of financial reporting by foreign registrants is both feasible and appropriate. However, we encourage the Commission to reconsider its current proposal. As an initial step, we suggest that the existing age requirements for financial statements be accelerated by one month, e.g. audited year-end financial statements for foreign registrants could be no older than 17 months at the date a registration statement goes effective (vs. 18 months under the existing rules). We suggest that this accelerated time frame also apply to annual reports (i.e. due no later than 5 months after year-end). Similar consideration should be given to the age requirements for unaudited interim financial statements in registration statements.
Interim Financial Statements
Proposed Item 8. A. 5. is consistent with current Rule 3-19(f) of Regulation S-X. Both rules require a foreign registrant that reports operating results for a period more recent than is presented in the registration statement to include this additional information in the registration statement. The more current information is not required to be reconciled to U.S. accounting principles, although narrative explanation of differences in accounting principles must be provided and any material new reconciling items that have not previously been quantified in the filing must be quantified.
We would observe that this requirement places a significant, perhaps unintended, burden on foreign companies who elect to present their primary financial statements using U.S. accounting principles. For example, a foreign registrant that prepares its primary financial statements in accordance with U.S. generally accepted accounting principles will not have discussed or quantified the differences between local accounting principles and U.S. accounting principles. Consequently, assuming the foreign registrant continues to use local accounting principles in its home jurisdiction, if it does not wish to delay its U.S. filing it will need to:
The Commission should consider whether this requirement necessarily operates in the public interest.
Reviews of Interim Financial Statements
Proposed Item 8. A. 5. states that if interim financial statements have been reviewed by an auditor, and that review is referred to in the document, the auditor's review report must be included in the filing. It is unclear whether a registrant would be permitted to refer to a "review" if that review had not been conducted in accordance with U.S generally accepted auditing standards. Without specifying the standards under which such a review must be conducted, it is possible that the expression "review" could be interpreted to mean engagements that fall substantially short of the procedures required to perform a review in accordance with U.S. auditing standards. Because the audit of financial statements in U.S. filings must be substantially consistent with U.S. generally accepted auditing standards, we believe that the Commission did not intend for reviews to be referred to unless they were conducted substantially in accordance with U.S. generally accepted auditing standards. We suggest that the final rule clarify this requirement.
Proposed Item 8. A. 2. requires comparative financial statements that cover the last three financial years. Because "financial statements" are defined to include a balance sheet, a literal reading of the proposal requires three audited annual balance sheets, rather than just the two presently required. The additional audited balance sheet would be a significant change from present practice and also introduce another difference between the financial information required for domestic and foreign registrants. If this is a correct reading of the rule, we suggest that the Commission highlight this change in the release covering the final rules.
Qualified Audit Opinions
The Instructions to Item 8. A. 3. recommends that situations involving an auditor's report containing a disclaimer or qualification should be discussed well in advance of the filing . We suggest that the Commission require, rather than recommend, pre-clearance of these situations.
Form 20-F - Item 10 - Additional Information
Proposed Item 10. G. states:
"Statement by experts. Where a statement or report attributed to a person as an expert is included in the document, provide such person's name, address and qualifications and a statement to the effect that such statement or report is included, in the form and context in which it is included, with the consent of that person, who has authorized the contents of that part of the document."
This requirement appears to apply to both registration statements and periodic reports.
Does an auditor's report in an annual report on Form 20-F represent a "statement by experts" under proposed Item 10. G.? We ask that the Commission clarify how Item 10. G. applies in a periodic report.
We also request guidance on whether the discussion of "qualifications" applies to an auditor that is named as an expert. Unlike other experts, auditors are subject to the qualification requirements of Article 2 of Regulation S-X. Therefore, a discussion of qualifications of auditors appears redundant.
Regulation S-X - Amendment to Rule 3-12
Rule 3-19 of Regulation S-X applies to the financial statements of foreign businesses for the purposes of providing acquired business and investee financial statements pursuant to Rule 3-05 and Rule 3-09. Currently, Rule 3-19 applies to both domestic and foreign registrants that acquire or invest in foreign businesses. The proposal would delete Rule 3-19 and amend Rule 3-12 to require that financial statements of a foreign business required under Rules 3-05 and 3-09 conform to the age of financial statement rules in new Item 8. A. 4. of Form 20-F.
Our experience indicates that it is more difficult to obtain U.S. financial reporting information for foreign acquirees and investees than for foreign registrants. Earlier in this letter we discussed our concerns regarding a foreign entity's ability to provide U.S. financial reporting information as quickly as the proposal would require. In addition, we wonder whether the proposal adequately considers whether the benefits of this more timely information for a foreign acquiree or investee exceed the increased difficulties of updating the financial statements of a foreign acquiree or investee. Further, we observe that this proposal affects domestic registrants making investments and acquisitions outside the U.S. We doubt many domestic registrants are aware of the important consequence this proposal would have on them. We suggest the Commission reconsider the proposed amendment of Rule 3-12 of Regulation S-X.
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We appreciate the opportunity to comment on the rules the Commission has proposed.
If you would like to discuss our comments, please do not hesitate to contact us. Please contact Ms. Amy A. Ripepi at 312-507-7258 or via electronic mail at firstname.lastname@example.org.
Very truly yours,
/s/ Arthur Andersen LLP