December 24, 2002 By e-mail: rule-comments @ sec.gov Securities and Exchange Commission
Re: Conditions for Use of Non-GAAP Financial Measures - File No. S7-43-02 Ladies and Gentlemen: We welcome the opportunity to comment on behalf of the Committee on Federal Regulation of Securities and the Committee on Law and Accounting of the American Bar Association's Business Law Section (the "Committees")1 on Release Nos. 33-8145 and 34-46768 (the "Proposing Release"), which, among other things, proposes disclosure requirements and conditions for use of Non-GAAP financial measures to implement Sec. 401(b) of the Sarbanes-Oxley Act of 2002 and filing with the Commission of certain earnings releases and similar communications. The comments expressed in this letter represent the views of the Committees 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 Committees. Summary We understand the Commission's needs to address disclosure issues related to use of non-GAAP financial measures. We believe, however, that there are certain improvements that can be made in the Commission's proposals in this regard that would simplify compliance and be of benefit to investors without sacrificing the Commission's investor protection goals. We are particularly concerned about the application of this proposal to communications subject to Regulation M-A. We believe there are two premises, with which we agree, that underlie the Commission's approach to addressing the use of non-GAAP financial measures: (1) to avoid being overly prescriptive regarding company informal communications, such as earnings announcements and other press releases and (2) to codify existing Staff positions regarding use of non-GAAP financial measures in formal SEC filings. We believe application of these premises can help guide the proper resolution of a number of issues raised by the proposals. While we understand the Commission's reasons for proposing that companies be required to "file," as opposed to "submit," earnings releases and similar communications, we do not believe that the need for such a requirement is as compelling as that for dealing with non-GAAP financial measures. We are concerned that the absence of precision as to when a "public disclosure" is made that is covered by Regulation G and Item 1.04 may mean that the Commission intends these requirements to be applicable simply to oral and telephonic disclosures, which would be extremely burdensome for preparers and, in some instances, could outweigh some of the envisioned benefits and present some difficult compliance problems. This would be particularly true if the Commission does not clearly and succinctly, in understandable language, in the text of the rules, articulate the relationship between the requirement to file earnings releases and similar communications and the Commission's proposals with regard to the use of non-GAAP financial measures in filings with the Commission, the requirements of proposed Regulation G and Regulations FD and M-A and provide relief from the duplications of coverage of the proposed requirement and the requirements of Regulations FD and M-A. We have summarized below what we believe are our more important comments. Application to Communications in Connection with Mergers and Acquisitions. We do not believe that these proposals should apply to communications subject to Rule 165, Rule 14a-12 and Item 1015 of Regulation M-A. Non-GAAP Financial Measures Definitions and Clarifications. We believe that the proposed definition of Non-GAAP financial measure could be clarified, as we indicate below, to avoid potential confusion. In addition, we believe that the Commission should add definitions of "person acting on behalf of an issuer" and "public disclosure." In addition, we recommend revisions of some of the proposed prohibitions and clarifications of the applicability of the requirements to foreign private issuers. Without a more precise definition of non-GAAP financial measure, a much narrower definition of who speaks on behalf of issuers, a definition of public disclosure, revisions to the required disclosures and revisions and clarifications of the prohibitions and the applicability of the proposals to foreign private issuers, the proposals will lead to enormous burdens on issuers and not be consistent with the interests of shareholders and could result in inadvertent violations. Filing Earnings Releases and Similar Communications (Proposed Item 1.04 of Form 8-K) Definitions and Clarifications. We believe that definitions of the following terms used in proposed Item 1.04 of Form 8-K are necessary to clarify and simplify compliance obligations:
Scope. We believe that the scope of proposed Item 1.04 of Form 8-K is too broad and overly prescriptive, and as such, it would not be "necessary or useful for the protection of investors", as provided in Sec. 409 of the Sarbanes-Oxley Act and section 13(l) of the Securities Exchange Act, which provides for real time issuer disclosure in accordance with Commission rules. We especially do not believe that these proposals should apply to communications subject to Rule 165, Rule 14a-12 or Items 1015 of Regulation M-A and certain other communications. Application to foreign private issuers. Proposed Item 1.04 would not apply to foreign private issuers and we do not believe that it would be necessary or useful to apply proposed Item 1.04 to foreign private issuers. Application to small business issuers. Subject to our comments as to the scope of Item 1.04 and our other comments on this Item, we have no objection to the Commission applying that Item to small business issuers. Safe harbors and related matters. We believe that the Commission should provide safe harbors from liability for proposed Item 1.04 disclosures. I. Application to Communications in Connection With Mergers and Acquisitions We believe that proposed Regulation G and Item 10 of Regulation S-K should not apply to disclosures relating to business combination transactions that are subject to Rule 165 or Rule 14a-12, or to disclosures that are required under Item 1015 of Regulation M-A. In enacting Rule 165 and amendments to Rule 14a-12 three years ago, the adopting release specifically identified as one of the Commission's goals the promotion of communications with security holders and the markets in the context of business combination transactions to permit the dissemination of more information to security holders on a timely basis, including information about the terms, benefits and risks of a planned extraordinary transaction. The Commission noted that "free communications relating to business combination transactions are in the public interest and consistent with the protection of investors." We believe that the proposed rules governing disclosure of non-GAAP financial measures would undermine these goals and, contrary to the objectives underlying the adoption of Rule 165 and amendments to Rule 14a-12, the proposed rules would have a potentially chilling effect on the quality and quantity of information that issuers make available to security holders and the markets about business combination transactions. As noted by the proposing release, disclosures about business combination communications often include statements regarding the potential benefits sought to be obtained by the business combination, such as synergies, valuations, and dividend amounts. Many acquiring companies include in press releases and in other communications relating to such transactions the anticipated pro forma effects of the transaction, including the pro forma impact on EBITDA, cash flow, and numerous other non-GAAP financial measures--all of which measures would be subject to additional disclosures under the proposed rules. These non-GAAP financial measures have become a routine part of press releases and investor/analyst meetings, particularly in transactions involving companies where these pro forma consequences may be viewed as more meaningful to investors and the markets than the pro forma consequences of the transaction on GAAP financial measures. For example, with the application of purchase accounting to business combination transactions and the resulting periodic write-down of impaired assets, including goodwill, the pro forma consequences of a transaction on earnings per share, a GAAP financial measure, may be a much less relevant measure to investors and the markets of the anticipated benefits of a proposed transaction to a company, than the pro forma impact on its EBITDA or cash flow. Compliance with the proposed rules will undoubtedly require considerable time and effort to prepare the requisite GAAP financial measures and the reconciliation of the disclosed non-GAAP financial measures to the most comparable GAAP financial measure. Management teams will need to work closely with accountants to prepare and review such required disclosures. Unlike a public offerings of securities or the preparation of other annual or periodic filings with the Commission, disclosures pertaining to a business combination transaction will invariably require detailed analysis of the financial statements of two companies. As a practical matter, we believe that it is unrealistic to expect that parties to business combination transactions will be able to prepare the additional disclosures required under the proposed rules in a timeframe consistent with the initial announcement of the transaction. As a result, if the required additional disclosures for non-GAAP financial measures cannot be prepared on a timely basis, the new rules would have the effect of reducing rather than enhancing the quality and quantity of information made available to the market at the important first announcement of the transaction. In the mergers and acquisitions arena, compliance with the proposed rules will also create serious limitations on the ability of parties to use non-GAAP financial measures following the initial announcement of business combination transactions. Rule 425, Rule 14a-12 and Rule 14d-2(b)(2) all require that specified written communications in connection with business combination transactions be filed with the Commission no later than the date of first use or publication, as applicable. In contested takeover situations, the same day filing requirement, coupled with the required new disclosures, could effectively prevent hostile bidders in tender and exchange offers, and shareholders in proxy fights, from soliciting tenders or soliciting votes on the basis of poor management performance, where that performance is indicated by non-GAAP financial measures. For example, hostile bidders might not be able to wage campaigns (or respond on a real time basis to incumbent management claims) about a company's stock trading performance where the relevant performance criteria relate to non-GAAP financial measures, such as stock price performance as multiple of EBITDA or funds from operations. In this regard, business combination transactions should be exempted from both proposed Regulation G and Item 10 of Regulation S-K because the limited exemptions from filing non-GAAP financial measures under proposed Regulation G will provide no relief for business combination transactions. While proposed Regulation G would allow issuers using non-GAAP financial measures that are released orally, telephonically, in a webcast or broadcast by similar means, to provide the required accompanying information on the registrant's website, the filing requirements under Rule 425, Rule 14a-12 and Rule 14d-2(b)(2) would effectively require that publicly disseminated information in the context of business combination transactions be filed, therefore becoming subject to the additional disclosure requirements under Item 10 of Regulation S-K. As a result, the limited exemptions available for filing non-GAAP financial measures under Regulation G will be largely unavailable in the mergers and acquisitions arena. Accordingly, with respect to business combination transactions, where there is no record or evidence of abuses in the use of non-GAAP financial measures, we believe, on balance, that issuers, investors and the markets are better served by timely dissemination of non-GAAP financial measures under the current regime, where such communications remain subject to potential liability under Section 10(b), Section 12(a)(2) and Rule 14a-9, as applicable, than they would be under the proposed rules, where companies unable to prepare the requisite disclosures on a timely basis would have to remain silent with regard to critical non-GAAP financial measures. Similar concerns also apply to the application of the proposed rules to the required disclosures under Item 1015 of Regulation M-A concerning reports and analyses prepared by financial advisors. In these reports, the investment banks frequently include analyses based upon non-GAAP financial information pertaining not only to the parties to the particular business combination transaction, but also to other companies and other transactions that the advisors deem relevant. These analyses, which include discounted cash flow analyses, public company analyses, and precedent transaction analyses, are generally prepared starting with publicly available GAAP financial information, which the bankers then analyze to estimate non-GAAP financial measures for the relevant companies and transactions. In such instances, neither the parties to the transaction nor the investment banks preparing the reports would be able to prepare the required additional disclosures required under the proposed rules, nor would such additional disclosure be meaningful to security holders or the markets. Accordingly, we believe that proposed Regulation G and Item 10 of Regulation S-K should not apply to required disclosures under Item 1015 of Regulation M-A. II. Non-GAAP Financial Measures A. Definitions We believe that several of the terms used in the proposals relating to non-GAAP financial measures must be clarified to assure compliance and simplify the burdens of compliance.
B. Scope
C. Content of Disclosure in Non-SEC Communications
D. Prohibitions in SEC Filings
E. Application to Foreign Private Issuers
F. Application to Small Business Issuers We agree with the Commission's proposal to require small business issuers to comply with the proposed rule. Non-GAAP financial measures should be understandable by investors in both small and large companies. G. Safe Harbors and Related Matters We recommend that the Commission add to Regulation G its view articulated in Footnote 31 to the Proposing Release that non-compliance with Regulation G will not affect the availability to registrants of the use of the short forms for registration under the Securities Act and the use by stockholders of Rule 144. We believe that proposed Regulation G and Item 10 of Regulation S-K should not apply to disclosures relating to business combination transactions that are subject to Rule 165 or Rule 14a-12, or to disclosures that are required under Item 1015 of Regulation M-A. III. Filing of Earnings Releases- Item 1.04 of Regulation S-K Neither Sec. 401(b) nor Sec. 409 of the Sarbanes-Oxley Act compel "filing" of earnings releases and similar communications. Accordingly, while we support the submission of earnings releases on Form 8-K pursuant to item 9 of that form or any successor items, we question whether a "filing" requirement is either "necessary" or "useful" for the protection of investors and the public interest, particularly in view of the acceleration of the period for filing Forms 10-K and 10-Q. Sec. 409 of Sarbanes-Oxley and section 13(1) of the Exchange Act only require public disclosure of the required information "on a rapid and current basis." Those statutory provisions do not require a "filing" of that disclosure with the Commission. Earnings releases, by their very nature, are "rapid and current" and, if submitted via EDGAR, would be widely and immediately disseminated. This would be seem to satisfy the statutory provisions without the need for a "filing" requirement. Moreover, we believe that these proposals are overly prescriptive and inconsistent with the Commission's past practices with respect to informal communications. A. Definitions If this proposal is adopted, we believe that the terms used in proposed Item 1.04 of Form 8-K discussed below must be clarified to assure compliance and simplify the burdens of compliance.
B. Scope We believe that the scope of proposed Item 1.04 is much broader than is necessary or useful to protect investors or the public interest or to satisfy the requirements of Sec. 409 of the Sarbanes-Oxley Act, particularly as it relates to oral and telephonic communications. Sec. 409 of the Sarbanes-Oxley Act added section 13(l) Real Time Issuer Disclosure to the Securities Exchange Act. That section provides that issuers shall disclose to the public "on a rapid and current basis" such additional information containing material changes in financial condition or operations of the issuer as the Commission, by rule, deems is "necessary" or "useful" for the protection of investors and the public interest. We believe that requiring earnings releases to be "submitted" to the Commission would be "useful." However, we do not believe that Item 1.04 should extend to "oral" or limited telephonic or similar dissemination of earnings information. The Commission should rely on Regulation FD to police such communications. We are particularly concerned that, if Item 1.04 covers more informal communications, such as oral and limited telephonic communications, by anyone "acting on behalf of" an issuer, there must be a provision, as in Regulation FD, for a deferred filing when a responsible company official discovers a communication subject to Item 1.04. We believe that the Commission should add such a deferred filing provision, if it determines to adopt Item 1.04 with the proposed coverage. We further believe that earnings releases that are required to be filed under cover of Form 8-K pursuant to proposed Item 1.04 should not be subject to the more stringent disclosure requirements of Item 10(e) of Regulation S-K or Item 10(h) of Regulation S-B. Rather, earnings releases should be submitted under Item 9 of Form 8-K or any successor Item of that form. If the Commission should determine to apply these Items of Regulation S-K to filings pursuant to proposed Item 1.04 (See Proposing Release, II.C), it should clarify whether they apply to the requirement to "briefly identify" the earnings release or the earnings release itself, which would be required to be filed as an exhibit to the report. We do not believe that the former would be useful and the latter would subject all earnings releases to this Item and make much of the coverage of Regulation G superfluous, unless the issuer could satisfy the stringent requirements of Item 1.04(b) of Form 8-K. Moreover, it would require rewriting of earnings releases or making them subject to the prohibitions of Item 10(e) (ii) (A) through (F) of Regulation S-K or Item 10(h)(ii) (A) through (F) of Regulation S-B, which are not applicable, under proposed Regulation G, to non-GAAP financial measures used in earnings releases. It is troubling to envision an earnings release that complies with proposed Regulation G that must be rewritten to comply with Item 1.04 and those Items of Regulations S-K or S-B. The Commission should not through the device of requiring filing of earnings releases be over-prescriptive regarding informal communications by companies. If it is the Commission's intent to prohibit the communication of non-GAAP financial measures that do not comply with Items 10(e) or 10(h), although not required by Sarbanes-Oxley, it should propose to do so directly, subject to notice and comment procedures. Should the Commission determine to require that earnings releases must be filed, we suggest the following:
We would not require the earnings press release itself to be included, inasmuch as it often includes extraneous comments of the chief executive or financial officer that companies should not be obligated to submit under EDGAR. We would not specify which earnings metrics would be subject to this disclosure mandate, instead preferring to leave it to the registrants to determine, based on market forces, the information they believed would best portray the operations for the reported period. We would require, however, that the financial data be at least as detailed as that contained in the press release. As earnings data that would be included in the Form 8-K under our alternative would of necessity be subjected to less scrutiny and analysis than the information included in the Form 10-Q, the earnings data, like the financial information and MD&A in Part I of the Form 10-Q, should not be deemed to be "filed" for purposes of Section 18 of the Exchange Act. We suggest that such information be allowed to be filed or furnished under Item 9 of Form 8-K and that the information be deemed to be automatically superseded upon the filing of the Form 10-K or the Form 10-Q. This alternative would get the released earnings into the Exchange Act disclosure system sooner and it would enhance the quality of this information because registrants would know that the information will become part of the formal reporting system. In addition, because earnings releases typically contain an explanation of the reported results, the alternative we suggest would get summary information into the reporting system, which SEC officials have indicated would be advantageous to investors. In addition, should the Commission determine to apply Items 10(e) and 10(h) to Item 1.04 filings, it should provide on the face of Item 1.04 or in the instructions to Form 8-K that Items 10(e) and 10(h) apply. We suspect that very few registrants would be aware that Item 10(e) or Item 10(h) apply to current reports on Form 8-K. Indeed, the currently applicable instruction to Form 8-K, General Instruction C, does not refer to Item 10 of Regulation S-K or S-B. C. Relationship to Regulation FD (proposed Items 1.04 and 6.01 of Form 8-K) In the Proposing Release, II.C, the Commission states that: "[t]oday, these types of announcements are subject to Regulation FD." [footnote omitted] See also, footnote 44 to the Proposing Release.2 The Commission goes on to state, however, that, unlike Regulation FD, information filed under proposed Item 1.04 of Form 8-K "always would be considered filed for liability purposes." [footnote omitted] We question the necessity of this approach, which is not required under Sec. 401(b) of Sarbanes-Oxley.3 D. Relationship to Proposed Regulation G Proposed Regulation G would not impose the prohibitions under Subitems 10(e) and 10(h) to communications of non-GAAP financial measures not included or required to be included in reports filed with the Commission. We believe that similar treatment should be afforded earnings releases and similar communications required to be filed submitted under Item 9 of Form 8-K as we have suggested. E. Application to Foreign Private Issuers As proposed, Item 1.04 would not apply to foreign private issuers, since they are not required to file reports on Form 8-K and no corresponding amendment to Form 6-K was proposed. (We also do not believe that Forms 6-K furnished to the Commission are subject to Item 10 of Regulation S-K or S-B.) We do not believe that proposed Item 1.04 should apply to foreign private issuers. Foreign private issuers currently are required to furnish earnings releases to the Commission under cover of Form 6-K. Since November 4, 2002, foreign private issuers have been required to submit these reports through the Commission's EDGAR system and, thus, they are immediately available upon acceptance in that system. Moreover, earnings releases of foreign private issuers could be subject to the provisions of proposed Regulation G. Also, foreign private issuers are not subject to Regulation FD. Subjecting them to proposed Item 1.04, at least as presently drafted, would have the essential effect, in some circumstances, to a back door application of Regulation FD, which would be inconsistent with the Commission's determination to exclude foreign private issuers from the coverage of that Regulation. F. Safe Harbors and Related Matters We do not understand why the Commission's proposal does not to permit a submission under current Item 9 (proposed Item 6.01) of Form 8-K that satisfies Regulation FD to satisfy Item 1.04 also, thereby avoiding making the submission subject to liability under section 18 of the Exchange Act. The earnings release itself or other public communication would be subject to the anti-fraud provisions of the Exchange Act and the Commission's enforcement authority thereunder would not be diminished no matter what item the information were filed under. Moreover, since section 18 liability is seldom, if ever, successfully pursued, subjecting a registrant to `liability" under that section does not seem to warrant imposing confusing and duplicative filing requirements on the registrant. We also believe that the information provided pursuant to that Item 9 should not be incorporated by reference automatically in registration statements on Form S-3 or other registration forms relying on incorporation. We believe it would be particularly unwise to subject oral or telephonic communications reporting earnings for a completed fiscal period to liability under section 11 of the Securities Act of 1933. If the Commission should determine to require earnings releases to be filed pursuant to an item of Form 8-K other than Item 9, we recommend that the Commission provide that a late filing will not cause the registrant to lose its eligibility to use Form S-3. This relief would be especially needed where the filing requirement is triggered by an unscheduled disclosure during an analyst conference call taking place beyond the 48 hour period provided for in proposed Item 1.04(b)(1) of Form 8-K. We further believe that, if the Commission determines to adopt Item 1.04, as proposed, oral and telephonic communications disclosed in filings pursuant to that Item should not be deemed to be admissions as to the materiality of such communications. See General Instructions B.5 to Form 8-K (Regulation FD information). G. General We believe that the cross reference to Rel. 33-8706 (see footnote 42 to the Proposing Release) for other possibly applicable requirements of Form 8-K is confusing. The release adopting the proposals for filing of earnings releases and similar communications should be self contained. We believe that, in this letter, we have responded to the Questions regarding proposed Item 1.04 of Form 8-K in the first, second and fourth bullet points under that caption. We respond below to the other six bullet points.
We appreciate the opportunity to comment on these proposals. Representatives of our Committees are available to discuss our comments with representatives of the Commission, if the Commission believes that such a discussion would assist its consideration of the proposals which are the subject of our letter.
cc: Hon. Harvey L. Pitt, Chairman
Drafting Group
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