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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the American Society of Corporate Secretaries National Conference


Alan L. Beller

Director, Division of Corporation Finance
U.S. Securities and Exchange Commission

Toronto, Ontario
July 11, 2002

The SEC, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed are those of Mr. Beller and do not necessarily reflect the views of the Commission or its staff.

Thank you very much for inviting me here today and for the kind introduction. In my short tenure at the Commission I have developed great respect for your organization, your dedication to high standards of disclosure and corporate governance and ethics and the thoughtful and constructive way in which you provide comment and other input on our initiatives that touch on you and the corporations you represent.

And because I recognize your standards and your commitment to do the right thing, I know that you share not only my utter dismay and disappointment, and indeed my anger, at recent events in corporate America, but also my determination and commitment to see that the right thing triumphs in the end.

Let me cut right to the chase. I was last with members of the American Society of Corporate Secretaries a month ago, on June 7, at the Commission's offices in Washington, where several of your members and my staff and I had a very beneficial session exchanging views on a number of the Commission's rule-making initiatives and other subjects. While our mutually constructive interaction continues, witness the ASCS' continuing contributions to our comment process, a lot else has changed since then.

I had been invited a few months ago to give this keynote speech and then to participate in a panel on the "post-Enron" world. But we now have to recognize that since Enron, which at the time of your invitation seemed like a worst-case corporate meltdown, we have had a procession of cases that have rivaled it in the scope of both the apparent inexcusable improper behavior by corporate leaders and their handmaidens and the tragic loss for investors. And now we have WorldCom — billions of dollars of admitted topline accounting transfers, with no apparent supporting documentation. And again, incredibly, shades of Enron, none of those entrusted to provide oversight stopped what was happening.

A few weeks ago, when I started thinking about this speech, I was going to open with some remarks about how this is a very exciting time to be at the SEC. I must now tell you that while the excitement is still there, it is tempered with anxiety and determination. Anxiety that there may be more bad news hidden in bad accounting and disclosure. Determination that we at the Commission will

  • continue to root out bad actors, whether there are a few of them, as I still hope, or the problem is more systemic,
  • work ourselves and with other government authorities to punish those deserving of punishment, and
  • see through to completion the start that we have made to reform a system that has increasingly shown its age and infirmities.

I have said in the past that for the U.S. markets and market participants Enron was the definitive evidence that, for all of the strengths of our system, reform of parts of it is long overdue. I have also said that Enron is one of those catalytic events that puts everything, in this case all aspects of capital markets regulation, into play. Certainly more recent events should put to rest any notion that the system does not need reform or that there is any area of capital markets regulation that is not fairly the subject of scrutiny.

Finally, securities law and securities regulation have become not only front-page news but also front-page political news. There is strong and justified pressure for both legislative and regulatory action. There is a need to focus on desirable, measured and necessary reform, and to take bold action where appropriate. As to accounting reform, I will say only that, however the result is reached, it would appear that self-regulation of the accounting profession is dead and that the profession and its standards will be subject to oversight by a new independent body. And stronger independent oversight will be accompanied by tighter strictures on auditor independence.

In an area of central importance to the ASCS, with its commitment to the importance of quality disclosure and corporate governance, it is also clear that corporate leaders will have to accept greater accountability and responsibility. The President has called for strengthened accountability and harsher penalties for CEOs and other corporate leaders, both in his ten-point plan of March and in his speech on Tuesday. New sanctions would include:

  • Disgorgement of ill-gotten gains (including not just profits from insider trading but incentive compensation for gains that were the product of improper accounting or otherwise illusory),
  • Bars from future service as officers and directors of public companies for corporate leaders who by their past actions have shown themselves unfit for those positions of trust, and
  • Criminal penalties and jail time for financial fraud and related malfeasance.

Congress is moving in the same direction on all of these fronts.

And the Commission has already moved to increase accountability for corporate CEOs and CFOs. Last month the Commission proposed new rules calling for certification of annual and quarterly reports by principal executive and principal financial officers. This proposal is forward-looking — these certifications would be included in annual and quarterly reports filed following adoption of the rules. The certification is in understandable language. It calls for these officers to certify that they have read the report in question, that all information that is disclosed is materially correct, and that all important information, defined consistently with current anti-fraud and disclosure standards, is disclosed. Certification is based on what the officers know and believe is necessary to be disclosed. Thus, while a false certification would give rise to potential anti-fraud liability as well as liability under the Commission's disclosure rules, the certification does not change the materiality standard for required disclosure. The proposal also does not alter in any way the independent existing bases for liability of these officers (or other officers and directors) in cases of defective company disclosure.

What the certification does do is ensure that principal executive officers and principal financial officers will be personally involved in the review of annual and quarterly reports and will be required to think critically about the contents of these reports in the context of what they know and what they believe is important. We believe that this will improve both the quality of disclosure and investor confidence that top management is involved in important disclosure decisions.

The Commission's release also proposes rules requiring companies to maintain and periodically review internal procedures that provide reasonable assurance that information is identified, captured and evaluated for disclosure on a timely basis. Similar requirements exist today for financial reporting. Most companies also already have procedures of some sort that guide their disclosure decisions and activities. However, we believe that, in a time where many companies' operations are more complex and more far-flung, more formal procedures and more formal review requirements would improve the quality and reliability of the disclosure process.

Separately, on June 27 the Commission issued an order requiring the principal executive officers and principal financial officers of the approximately 950 largest U.S.-based corporations (those with revenues of at least $1.2 billion in their most recent fiscal year) to provide a statement under oath as to the material accuracy and completeness as to past filings with the Commission, going back to their last annual report, or, if they cannot provide such a statement, to describe the facts and circumstances that would make such a statement incorrect. In most cases the statements will be due on or before August 14. The Commission intends to make these statements public. Whereas the Commission's purpose in proposing the certification rules discussed above is to encourage greater accountability and involvement of CEOs and CFOs going forward, the Commission's purpose in issuing the order is to obtain information regarding past filings — that CEOs and CFOs state them to be correct to the best of their knowledge or explain why they are not.

Since the order, the Commission staff has received a number of questions that suggest that corporations or their counsel are looking for ways to soften the standards for the statements or otherwise modify the clear instructions and intent of the Commission. Let me be clear, the Commission will review and disclose these statements as falling within one of the two required forms. And the only statements as to material accuracy and completeness that will be accepted as following the first form are those that follow EXACTLY the form of the statement set forth in the order. All others will be treated as statements of the facts and circumstances that prevent the officers from making the statement in the prescribed form, and they will be evaluated for compliance as such.

I'd like to make two other important points regarding the certification order. First, as CEOs and CFOs review financial and other disclosure internally and with auditors and legal advisors, they may focus on areas where the proper accounting treatment is not clear, where analogies to other standards have been used or where interpretations have been made that may be aggressive.

Similar questions may arise regarding difficult areas of non-financial disclosure. In such cases, as the Commission's Chief Accountant Bob Herdman, my Division's Chief Accountant Carol Stacey, and I have all emphasized, the staff welcomes the opportunity to work with companies. Dialogue of this sort is healthy and productive for investors and for reporting companies. So please come in and talk to us now, so that you can get it right.

Second, we expect that some companies may make revisions to financial and other disclosure in connection with these certifications. Careful review by CEOs and CFOs could produce such results. Companies must make the revisions they feel are necessary and appropriate.

If prior filings have been deficient, the chips will fall where they may. However, if improper accounting or other deficiencies in disclosure that should be corrected or disclosed in connection with these certifications are not, and later come to light, the chips can be expected to fall more heavily.

In addition to these actions, I am confident that in recent months the Commission and the staff have been involved in a level and breadth of activity that must be unprecedented or nearly so. The level and focus of activity have been necessary to address needs for improvement in our markets' regulations and standards and also to address the very real problem of investor confidence.

The Commission's activity has been extraordinary across the spectrum of its divisions and offices. Important activities have included our working with the SROs regarding new rules for and the ongoing investigation of research analysts. We have been actively involved with and received excellent cooperation and responsiveness from professional groups that represent issuers and their officers, including not only the American Society of Corporate Secretaries but also the Business Roundtable, Financial Executives Institute and the National Institute for Investor Relations.

A vigorous enforcement program is key to a successful regulatory function, and we have had strong and successful enforcement activities, including increases in real time enforcement and real penalties. In particular, to address and deter financial fraud and other corporate malfeasance, we are already seeking increased instances of disgorgement of ill-gotten gains and officer and director bars where those remedies are appropriate. In the case of WorldCom we filed a fraud case against the company within a day of the announcement of its accounting restatement, moving quickly to prevent improper payments to officers or directors or destruction of documents. Within 48 hours of the filing, we sought and obtained from the court an order appointing former Commission Chairman Richard Breeden a corporate monitor.

Turning to the Division of Corporation Finance, several areas deserve particular attention.

First, corporate governance. In February, Chairman Pitt called on the New York Stock Exchange and the Nasdaq to examine issues of corporate governance, corporate accountability and listing standards in light of Enron. The New York Stock Exchange constituted a special committee, composed of members of its Board and other advisory committees, to study these issues. The Nasdaq promptly called on its existing council on listing standards to do the same. Since then both the New York Stock Exchange and the Nasdaq have come forward with bold and far-reaching proposals that, when implemented, will produce the most substantial reforms in corporate governance in decades. Among the advances that one or both have proposed are:

  • Requiring stockholder approval of stock option programs;
  • Requiring listed companies to have a majority of independent directors;
  • Tightening the standards of independence to reduce relationships between independent directors and either the company or its executives;
  • Requiring nominating and compensation committees, as well as audit committees, to be composed entirely of independent directors;
  • Requiring each of those committees to have written charters; and
  • Advocating additional disclosure of a number of corporate governance matters.

The Commission and its staff, including Chief Accountant Bob Herdman, my Deputy Director Marty Dunn, the Chairman's Counsel Consuelo Hitchcock and me, have appeared before both the New York Stock Exchange and the Nasdaq as part of their processes of developing their new proposed requirements. The corporate governance efforts, while impressive to date, are also still a work in progress. We look forward to continued interaction with both institutions as they move forward with these and additional proposals. We also intend to consult with both institutions regarding harmonization of their proposals where appropriate to provide the strongest possible corporate governance standards for our listed companies.

Finally, as Director of the Division of Corporation Finance, I hope it does not surprise you that I want to spend some time on our disclosure program. The Division currently has five sets of rule proposals either out for comment or, in two cases, for which the comment period has recently closed. In at least two cases, Congress is looking at enacting similar measures by legislation. This represents a level of activity by the Division that must be unprecedented or nearly unprecedented. And, much more important than quantity, I am confident that the proposed rules, if adopted (or comparable legislation, if enacted), will significantly change the Commission's disclosure regime.

On June 12, in addition to the CEO/CFO certification and related proposals that I have already discussed, the Commission approved proposals for a significant expansion of current reporting requirements on Form 8-K.

Existing Form 8-K requires disclosure of six events that can best be described as idiosyncratic, from the closing of significant acquisitions and dispositions — not the agreement, mind you, which might well be a material event, but the closing, which could occur months and months later — to the requirement to disclose on a current basis the earth-shaking change in a company's fiscal year. We are proposing adding thirteen items that would trigger mandatory current disclosure, and significantly broadening two existing items.

Included would be:

  • Entry into a material agreement not made in the ordinary course of business;
  • Termination of a material agreement not made in the ordinary course of business;
  • Departure or appointment of directors or senior officers;

  • Termination or reduction of a business relationship with a customer that constitutes a specified amount of the company's revenues;
  • Creation of a direct or contingent financial obligation that is material to the company;
  • Events triggering a direct or contingent financial obligation that is material to the company, including any default on or acceleration of an obligation;
  • Exit activities including any material write-off or restructuring;
  • Any material impairment;
  • A change in a rating agency decision, issuance of a credit watch or change in a company outlook;
  • Movement of the company's securities from one national securities exchange or inter-dealer quotation system of a registered national securities association to another, delisting of the company's securities from an exchange or quotation system, or a notice that a company does not comply with a listing standard;
  • Notice to the company from its currently or previously engaged independent accountant that the independent accountant is withdrawing a previously issued audit report or that the company may not rely on a previously issued audit report;
  • Any material limitation, restriction or prohibition, including the beginning and end of lock-out periods, regarding the company's employee benefit, retirement and stock ownership plans;
  • Unregistered sales of equity securities by the company;
  • Material modifications to rights of holders of the company's securities; and
  • Disclosure regarding any material amendment to a company's certificate of incorporation or bylaws.

Further, we would reduce the timing deadline for filing all current reports to two business days from the existing five or fifteen days. We believe that these proposals not only are significant in their own right, but also represent the first steps in our planned move to a disclosure system that relies more on affirmative obligations for current disclosure. In this era of investor access to sophisticated trading and information technology and instant communications, investors demand and require more current information regarding the most important events about a company. Today we are facing an environment where preventing unfair informational advantage, which has historically been the objective of many of the Commission's disclosure requirements, is not enough. We must promote affirmative current disclosure to enable investors to make the best capital allocation and investment decisions. Our proposed expanded 8-K disclosure requirements are, I believe, a big step in this area.

The Commission has earlier proposed, in April, additional current disclosure requirements by companies regarding transactions by their insiders. These requirements would include company requirements to disclose transactions in company equity securities and derivatives by executive officers and directors, within two business days for the largest transactions and weekly otherwise. Filings would be required to be made by companies on EDGAR. Current insider transaction requirements range from monthly to annually and are generally made in paper format. In addition, the proposals would require disclosure for the first time of the establishment or amendment of so-called Rule 10b5-1 plans and would also require current disclosure of loans, guarantees or similar arrangements by companies or affiliates to insiders.

The comment period for this proposal closed in late June, and we have received a considerable amount of helpful comment that the staff and Commission will consider, again including the ASCS' letter. I know that this proposal is of particular interest to the ASCS, and my colleague Mauri Osheroff, Associate Director of the Division, will be discussing in detail these comments and the open issues on this proposal later in the conference.

Recent disclosure proposals have also included the proposal in May of increased disclosure in Management's Discussion and Analysis, or MD&A, regarding the application of critical accounting policies. This proposal is designed to provide better information about the estimates that a company makes in applying those significant accounting policies that are the most subjective and complex and that have the greatest impact on financial condition and results. Information regarding sensitivity would be required. This disclosure should provide very important information to improve understanding of the financial statements and of the company's performance.

Finally, in April we proposed accelerating the filing deadlines for annual reports from 90 to 60 days and the deadlines for quarterly reports from 45 to 30 days. These proposals mirrored reductions that were suggested but not formally proposed in 1998. The comment period for this proposal has expired, and we have received more than 300 letters, including the late arrivals.

Many of the letters have contained comments that will be helpful to the Commission in considering its final decision. Representatives of investors have been nearly uniform in supporting accelerated filing. Groups representing issuers have in many cases undertaken and reported surveys. Again, this is a proposal of great interest to the ASCS, and you contributed a very thoughtful letter including some most interesting survey results. Your letter and others from these groups suggest some concern with the 60-day proposed deadline for annual reports and considerable concern over the 30-day proposed deadline for quarterly reports, as well as concerns over costs. The over-riding theme has been that undue acceleration of deadlines may cut too far into the time necessary to analyze information and review the reports, as well as reduce the time available for those, such as CEOs, CFOs and audit committees, whom we and others have urged to be more rather than less involved. The point has been made that, while technology has speeded up many of the tasks necessary to prepare these reports, companies have grown more complex and our disclosure requirements much more extensive, and that these trends outweigh any advances in technology.

Thoughtful suggestions as to how the proposals could be modified have also been made. These have included considering longer periods than 60 or 30 days and generous phase-in periods for accelerated deadlines over time. These will all give the Commission and the staff much food for thought. In particular, I can say with certainty that the Commission and staff are committed to avoid any rule that unduly sacrifices accuracy for speed. But we also believe that accelerated disclosure is beneficial to investors and markets, and we are committed to regulation for the benefit of investors, and not for the convenience of registrants.

I must say that some of the comments seem to have missed the point. The suggestion that reducing these deadlines in any way, even though they have been unchanged for decades, will almost certainly result in seriously defective or "half-baked" disclosure gives too little credit to both the Commission, to companies, and to the people in this room. A number of commenters have also taken the opportunity to suggest that there are better ways to close the "information gap" between filing of earnings releases and periodic reports. We agree that the quality of earnings releases, including the use of measures of performance and analysis based on pro forma rather than GAAP measures, is cause for concern. The Commission issued a cautionary statement regarding the use of pro forma financial information in December 2001, and we are considering additional ways to address the use of pro formas and other aspects of earnings releases. However, the proposal to accelerate deadlines for annual and quarterly reports is not designed principally to address this "information gap." The proposal grew out of a belief that waiting three months for the information in an annual report is too long, and that issuers, without sacrificing quality, can do better. In short, the accusations of some of the commenters are true — we want both better and faster disclosure.

Beyond our existing rule proposals, MD&A deserves some additional attention. As our recent release on application of critical accounting policies points out, we are thinking of MD&A as accomplishing three inter-related purposes:

  • to provide a narrative explanation of companies' financial statements that enables investors to see the company through the eyes of management;
  • to improve overall financial disclosure and provide the context within which financial statements should be analyzed; and
  • to provide information about the quality of, and potential variability of, a company's earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

In that release we also indicate that we are considering further MD&A changes. While there have been Commission statements on particular topics, including the December 2001 and January 2002 releases, there has been no general Commission statement updating or supplementing the Commission's views on MD&A since 1989, and it may well be time to consider new interpretive guidance. We are also considering the proposal of a mandated summary or overview of MD&A. Further, we are considering whether further action is necessary in the area of non-GAAP or pro forma measures in MD&A.

Finally, we can all identify some of the information that should be emphasized in MD&A in the coming year, and indeed the Commission has done so in its recent releases. In addition to application of critical accounting policies, it is important to consider whether there is sufficient disclosure and clarity regarding the use of off-balance sheet financing. Related party transactions merit more attention. Cash, cash flows and liquidity deserve more and better disclosure in MD&A than the rote recitations of the numbers and changes in the cash flow statements that we see too often. As an example, focusing on the specific debt covenants, risks to financing plans and ratings concerns of the particular issuer, rather than generalized disclosure about these subjects, would be a significant improvement in disclosure.

As a final point, I would remind you that our review process, which is too often overlooked in a discussion of the Division's activities, has a critical role to play in fostering improvements in disclosure. Our comment process is an invaluable tool we use to provide important general and specific direction, and that process can affect disclosure broadly over time. We have completed screening of the Fortune 500 with fiscal years through February 28, and I can tell you that we have decided to review at some level a very significant number of the filings we have screened. So not only new rules but also our operations and review process are key elements of our disclosure and investor protection program.

With all of these activities, the Commission and the staff are working full time, and in some cases more than full time, to provide an improved system of regulation of our capital markets and to restore seriously damaged investor confidence. These are serious times, and it is important to us to have organizations such as the American Society of Corporate Secretaries as our partners and allies in these efforts.

It is a pleasure to be here this morning and I am very grateful to have this opportunity to share some of my views with you. Again, thank you very much.



Modified: 07/18/2002