May 4, 1999
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549.
Attention: Jonathan G. Katz, Secretary
Re: Release Nos. 33-7649; 34-41118
International Series Release No. 1187
File No. S7-7-99
(collectively, the "Release"
We are pleased to have the opportunity to comment on the proposals set forth in the Release. We are generally supportive of these proposals. Without suggesting that we are otherwise in agreement with every aspect, we will limit our comments to a few particular matters.
I.Release Section VI.A (Application of Proposed Rule 3-10)
The proposed rules do not define the types of securities eligible for relief but rather would, by their terms, cover any securities issued by the parent or a wholly-owned subsidiary if they are fully and unconditionally guaranteed by the parent or one or more wholly-owned subsidiaries (or by the parent and one or more wholly-owned subsidiaries). However, the Release states that "the Staff has applied SAB 53 to debt and preferred securities that are substantially the same as debt" and goes on to propose "the same scope for Rule 3-10." This inconsistency should be addressed.
We do not believe it makes sense to limit relief to debt and debt-like preferred securities. So long as the function of a subsidiary issuer or guarantor is to provide credit support for the security in question but not otherwise to define the financial rights of the holder, we do not believe that the specific terms of the security are relevant in determining whether the relief contemplated by the proposed rules is appropriate. Modern securities markets evolve rapidly, and limitations that seem sensible today may soon prove arbitrary and restrictive in light of changes in the market.
Thus, we suggest that the securities eligible for relief be broadly defined to include the following:
II.Release Section VI.B (Modified Financia Statement Reporting Requirements)
A.Definition of "Full and Unconditional Guarantee"
Assuming the proposed rules as adopted do not limit the scope of the securities eligible for relief to those that are "substantially the same as debt"(see (1) above), the definition of a "full and unconditional" guarantee in proposed Rule 3-10(h) should probably be revised so that a guarantee would qualify only if holders can immediately bring suit directly against the guarantor for the performance of any obligations owed to holders under the security.
B.Limitation of Relief to Wholly-Owned Subsidiaries
The relief granted under the proposed rules is limited to subsidiary issuers or guarantors that are "wholly-owned". The Release explains, in the context of SAB 53, that this requirement "ensures that there is no competing interest to the parent's ownership" and goes on to state that any outside voting interest in the subsidiary "breaks the financial unity between parent and subsidiary needed to justify the special relief."
We do not understand this explanation. As pointed out in the Release, there are sometimes corporate or other reasons why a non-substantial amount of the stock of a subsidiary must be held by someone other than the parent (e.g., so-called "directors qualifying shares" or shares held by local residents of a foreign subsidiary as required by foreign law). We see no reason from an investor protection perspective why relief should not be available in all situations where a parent owns substantially all (but less than all) the voting securities of a subsidiary issuer or guarantor. (See Rule 1-02(aa) of Regulation S-X.) A materiality standard generally applies to presentations of financial information in filings with the Commission, and insubstantial minority interests should not materially affect the information required to be shown under the proposed rules.
Moreover, we see no reason from an investor protection perspective why relief should not be available in situations where a parent owns less than substantially all the voting securities of a subsidiary issuer or guarantor, so long as the parent includes in its financial statements consolidating information that appropriately breaks out the minority interests. If there is only one subsidiary guarantor, the appropriate information would ordinarily be contained in the consolidating information required by the proposed rule as currently drafted, since that information would include the customary "minority interest" line items. If there is more than one subsidiary guarantor and there is a different percentage minority interest in each subsidiary guarantor, it might be appropriate for the consolidating information to include separate columns for each group of subsidiary guarantors having minority interests at a given percentage (although perhaps a special provision on this unusual case is unnecessary since the general requirements of proposed Rule 3-10(i)(10)and (11) might require this result anyway).
Thus, we think it would be appropriate to extend the proposed relief to any issuers or guarantors that are subsidiaries (as defined in Rule 1-02(b) of Regulation S-X) rather than confining the relief to "wholly-owned" subsidiaries (however defined).
If the proposed rules are modified to cover any subsidiary issuers or guarantors as suggested in the preceding paragraph, there will be no need to refine how the rules apply to non-corporate entities. However, if this suggestion is not followed and the relief continues to be limited to "wholly-owned" subsidiaries (however defined), more thought should be given to how the rules will apply to such entities. Subsidiary partnerships, trusts or other non-corporate entities may issue preferred ownership interests that are analogous in nature to preferred stock of a corporation, and it would seem unduly restrictive to require as a condition for relief that the parent own all (or substantially all) of such ownership interests. Perhaps in that case the relief should be available so long as the parent owns all or substantially all of the "participating" ownership interests in the entity in question.
III.Release Section VI.C (Recently Acquired Subsidiary Issuers or Guarantors)
The proposed rules include a special provision relating to recently acquired "significant" subsidiaries. This provision measures significance by comparing the purchase price (or net book value) of the new subsidiary to the consolidated shareholders' equity of the parent. Immaterial acquisitions by a company with a large market capitalization but a small or negative shareholders' equity may trip this test in inappropriate circumstances. Thus, we suggest the test measure the significance of the acquired assets in the same manner as significance is measured by Rule 1-02(w)(1) and (2) of Regulation S-X (at the 20% rather than 10% threshold, as contemplated in an analogous context under Rule 3-05 of Regulation S-X).
IV.Release Section VI.D (Instructions for Condensed Consolidating Information Under Proposed Rule 3-10)
The proposed rules would require foreign issuers to reconcile all of their consolidating information to U.S. GAAP. Reconciliation of consolidated information helps investors compare financial information of various companies whose financial statements have been prepared on different bases. We don't believe reconciliation of consolidating (as distinct from consolidated) information would prove similarly useful. The purpose of consolidating information is to enable the investor to see what portion of each consolidated line item comes from a particular subsidiary or group of subsidiaries. If the consolidated information is on a basis other than U.S. GAAP and the consolidating information is on the same "apples versus apples" basis, we see no point in reconciling the consolidating information to U.S. GAAP.* We also think that this requirement would discourage certain foreign issuers from subjecting themselves to the public reporting requirements of the U.S. securities laws, with the result that more foreign issuers will avoid the U.S. market or will confine themselves to the Rule 144A market.
V.Release Section VII.A (Request Regarding Specific Proposals)
Certain parent companies, in reliance on existing practice, currently include summarized rather than consolidating information about subsidiary issuers in their financial statements. It may be burdensome for such companies to reproduce the detail needed to present consolidating information for periods prior to adoption of the proposed rules. Thus, we believe it would be appropriate to apply the new rules to these situations only for periods that begin after adoption.
We believe that the situation where a parent and one or more subsidiaries are co-obligors on a security presents the same issues as those where one or more subsidiaries guarantee a parent security.* Thus, we see no reason why this situation should be excluded from the proposed relief.
C.Exceptions from Requirement for Consolidating Information
The Release requests comment as to whether there should be an exception from the requirement to provide consolidating information where (a) the parent company issuer has no independent assets or operations, (b) substantially all assets and operations are in guarantor subsidiaries and (c) the non-guarantor subsidiaries are inconsequential. We don't believe consolidating information would provide useful information to investors in this context, since consolidating information would essentially track the consolidated financial statements and would therefore be superfluous. Thus, we support this exception. We also point out that the tests set forth in (b) and (c) above seem to be addressing the same point, so we would suggest that the test set forth in (c) be deleted; if that test is retained, we would then suggest that additional text be added to explain what it means and how it differs from the test in (b).
More generally, we believe that consolidating information will not be useful to investors in any situation where a parent or subsidiary issues a security and substantially all of the parent's consolidated assets and operations are in the parent, the issuer (if not the parent) and the guarantor subsidiaries combined. (See Example Nos. 1, 4, 8, 12, 16 and 20 in Appendix A to the Release.) Thus, we would support expanding to this situation the broader relief proposed for finance subsidiaries.
VI.Release Section VII.B (General Request Regarding Debt Offerings)
The Release requests comment as to whether additional financial disclosures should be required for offerings of debt that are not guaranteed. Under general disclosure principles, parent company issuers with subsidiaries that owe material third party debt typically disclose the level of that debt and include structural subordination risk factors in their filings. Parent company investors are in effect advised to view that debt as representing a prior obligation analogous to secured debt. We believe current practice sufficiently protects parent company investors, and we therefore see no need to expand the required financial disclosures in this context.
VII.Miscellaneous (Allocation of Securities Under a Shelf Registration)
The Commission currently requires a registrant filing a shelf registration statement that covers securities issued by the parent and securities issued by an operating subsidiary to allocate the amount to be sold among the securities to be sold by the parent (and its finance subsidiaries) on the one hand and each class of securities that may be sold by the operating subsidiary on the other. The Release implicitly recognizes that securities issued by an operating subsidiary and guaranteed by the parent ordinarily trade primarily on the basis of the parent's credit. In that context, the allocation requirement does not protect any material interests of investors and serves only to limit the financing flexibility of registrants. Thus, as part of the process of adopting the proposed rules, we suggest that the Commission consider modifying its approach so that a registrant will not need to effect such an allocation to the extent that the operating subsidiary's securities are eligible for relief under the rules as adopted.
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We would be happy to discuss any questions you may have with respect to the comments set forth herein. We ask that any questions be directed to Alan Sinsheimer (212-558-3738), Bob Buckholz (212-558-3876) or Jack Bostelman (212-558-3840) in our New York office.
Very truly yours,
SULLIVAN & CROMWELL