Second Report on the
Readiness of the United States Securities Industry and Public Companies To Meet
the Information-Processing Challenges
of the Year 2000

June 1998

Note:   This material has been superseded by a subsequent report: The Third Report on the Readiness of the United States Securities Industry and Public Companies To Meet the Information-Processing Challenges of the Year 2000," released July 1999.

This is a report prepared by the staff of the Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings or conclusions contained herein.

Executive Summary

I. The Nature of the Problem

In the securities industry, three factors magnify the scope of the Year 2000 problem:

• The securities industry relies heavily on computerized information processing technology. As the staff wrote last year in its Report to Congress on the Impact of Recent Technological Advances on the Securities Markets, "[i]nformation and communications technologies are critical to healthy and efficient primary and secondary markets."

• The industry is enormous. There are approximately 4,950 registered investment companies in 1,100 investment company complexes, 7,500 registered investment advisers, 8,300 registered broker-dealers, 1,248 registered transfer agents, and 24 self-regulatory organizations including the exchanges, National Association of Securities Dealers ("NASD"), and clearing agencies.

• Industry participants are highly interdependent. Many are also connected to the United States and global banking communities. Thus, it is important not only that individual market participants assure that their systems are able to handle the Year 2000, but also that they can continue to communicate with other members of the domestic and global industry.

II. The SEC's Approach to the Year 2000

The Commission views the Year 2000 problem as an extremely serious issue. A failure to assess properly the extent of the problem, remediate systems that are not Year 2000 compliant, and then test those systems could endanger the nation's capital markets and place at risk the assets of millions of investors. In light of this, both the industry and the Commission's staff are working hard to address the industry's Year 2000 problems.

Chairman Levitt and the other members of the Commission have emphasized that both the agency and the industry must take the necessary steps to minimize the impact of the Year 2000 problem. The message of the Chairman and the Commission is clear: the Year 2000 problem will not be tolerated as an excuse for failing to protect investor assets.

The Commission's approach to the Year 2000 has four primary components:

(1) Industry Oversight: During the last year, the Commission has shifted its focus from educating members of the industry to monitoring their progress in solving the problem. In addition, the Commission is fully supporting the Securities Industry Association's ("SIA") industry-wide testing program and is taking steps to identify firms that have fallen behind in preparing for the Year 2000. The Commission is also participating in industry-wide contingency planning groups. The purpose of these coordinated actions is to promote remediation of as many systems as possible, so that the consequences of any Year 2000-related failures can be minimized and corrected.

(2) Issuer Disclosure: The staff issued Staff Legal Bulletin No. 5 to provide specific guidance regarding what a company should disclose about its Year 2000 issues. Through the bulletin and working with the accounting profession, the Commission staff has taken steps to urge that all public issuers address and disclose any material impacts that the Year 2000 will have on their businesses. The Commission has said it will issue an interpretation on Year 2000 disclosure requirements, and in the near future plans to write to the CEOs of public issuers reminding them of the importance of Year 2000 disclosure and the Commission's guidance regarding issuers' Year 2000 obligations.

(3) Internal Commission Systems: The Commission is working on its own systems, including mission critical systems such as EDGAR. Contingency planning is also underway, so that if any Commission system does fail it will not seriously affect the Commission's ability to regulate the securities markets.

(4) Investor Education: The Commission continues to assist investors in obtaining accurate information about the scope of the Year 2000 problem and maintains a "Year 2000" page on its web site.

III. Progress of the Industry Toward Year 2000 Compliance

Although the industry has made substantial progress in the last twelve months, much work remains to be done. The next crucial steps for the industry will be industry-wide testing and contingency planning. Below is a brief summary of the progress of each industry segment.

A. Self-Regulatory Organizations

The Commission staff believes that the progress of the SROs is very encouraging. The SROs have completed their awareness and assessment phases. Moreover, the process of remediating and testing their own systems is far enough advanced that they have begun conducting tests designed to determine whether their systems will communicate properly with the systems of their members and others in a Year 2000 environment. Internal system testing and implementation will continue until December 1998. The progress of the SROs is summarized in the following tables:

Status of Exchange and NASD Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone To Be Completed	Mar 1998	Nov 1998	Nov 1998	Dec 1998
% Completed to Date	99.2%	73.1%	51.7%	26%

Status of Clearing Agency Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone To Be Completed	Jan 1998	Sept 1998	Dec 1998	Dec 1998
% Completed to Date	100%	83.6%	62.9%	28.6%

B. Broker-Dealers

Broker-dealers are the primary intermediaries between investors and the nation's securities markets. They are therefore at the heart of much of the securities trading in our markets. The Commission's monitoring and oversight of broker-dealer progress in remediating the Year 2000 problem consists of three elements:

(1) Collaboration with the SROs: SROs, especially the NASD and the New York Stock Exchange ("NYSE"), have front-line responsibility for regulating broker-dealers. Accordingly, the Commission has worked together with the SROs to monitor broker-dealer progress. The SROs have surveyed the broker-dealers they regulate to obtain data on the progress of their Year 2000 programs and are using their surveillance and examination programs to assess independently the progress of individual broker-dealers.

(2) Direct Commission Monitoring of Broker-Dealers: The Commission has proposed rules that, if adopted, would require broker-dealers to report periodically the status of their Year 2000 programs to the Commission. The information reported will assist the staff in identifying both industry-wide and firm-specific Year 2000 problems. The Office of Compliance Inspections and Examinations ("OCIE") is also conducting selected examinations of broker-dealers' Year 2000 programs.

(3) Industry-Wide Testing: Industry-wide testing of computer systems prior to January 1, 2000 is necessary to determine how industry systems will respond to Year 2000 dates and to identify unexpected problems. Under the direction of its trade association, the SIA, and with the encouragement and participation of the Commission, the broker-dealer community is beginning this process. The SIA's testing program, an unparalleled industry testing effort, is scheduled to begin this July.

Completion Percentage for Broker-Dealer Systems

Type of Firm	39% Complete or Less1	40% Through 69%	70% Through 100%
Introducing Firms	33%	17%	50%
Clearing Firms	35%	23%	42%
Other Firms	31%	17%	52%
Total	33%	17%	50%

As industry-wide testing begins this summer, the Commission and the SROs will obtain a more complete picture of the progress broker-dealers are making in their Year 2000 programs.

C. Transfer Agents

The Commission is monitoring the ongoing progress of transfer agents in achieving Year 2000 compliance. During 1996 and 1997, examinations focused on raising the awareness of non-bank transfer agents. Based on those examinations, 98% of the non-bank transfer agents examined said that they were planning on taking corrective action. During late 1997, examiners conducted qualitative reviews of selected transfer agents' remediation programs. In 1998, examiners will conduct quantitative reviews of non-bank transfer agents that collectively perform a majority of all securities transactions. These reviews will focus on meeting completion dates and testing.

To gain a better understanding of the steps transfer agents are taking, the Commission has proposed rules that, if adopted, would require non-bank transfer agents to report periodically on the progress of their Year 2000 remediation efforts. As with broker-dealers, the data collected under these rules will assist the Commission staff in identifying weaknesses at both the industry-wide and firm-specific levels. Commission staff plan to look carefully at those firms that do not appear to be making adequate progress.

D. Investment Advisers and Investment Companies

The Commission's approach to advisers and investment companies has two primary components. First, the Commission has been working with an industry group, the Investment Company Institute ("ICI"), to obtain data to monitor the progress of the industry in addressing the Year 2000 problem. Second, through its inspections and examinations program, the Commission is obtaining independent information on the progress of the industry. In order to supplement this program, the staff is considering whether to recommend that the Commission propose a rule, similar to those already proposed for broker-dealers and transfer agents, that would require registered advisers to report their progress on making their systems Year 2000 compliant.

Current information indicates that funds are making progress toward resolving their Year 2000 problems, but much more needs to be done. A recent ICI survey indicates that a majority of funds responding to the survey plan to complete their Year 2000 programs by December 1998.

Program Completion Dates for Mutual Funds²

	1998 2ndQ or Earlier	1998 3rdQ	1998 4thQ	1999 1stQ	1999 2ndQ	1999 Post 2ndQ
Percent of Firms	3%	5%	72%	8%	11%	1%

The ICI has also urged its members to participate in the SIA's industry-wide testing program, and several major investment company complexes will participate in the initial round of testing that begins in July 1998.

The Commission is also directly monitoring the progress of investment advisers and investment companies in achieving Year 2000 compliance. During 1996 and 1997, examinations focused on raising the awareness of advisers and investment companies. Based on those examinations, 83% of advisers and investment companies were planning or taking corrective action. During late 1997, examiners conducted qualitative reviews of selected advisers' remediation programs. In 1998, examiners will collect quantitative information concerning, for example, progress on meeting completion dates and testing for a significant percentage of registered advisers. The information gathered through this process serves both to identify specific areas of potential difficulty that will need close monitoring and to validate information provided from other sources. Based upon 128 examinations conducted during April 1998, the staff prepared a snapshot view of the industry. As with the ICI survey, the data collected shows that most investment advisers and companies plan to have their Year 2000 problems corrected by the end of 1998 or during early 1999. Only a small number indicated that they did not expect to complete their corrections until mid-1999.

E. Contingency Planning

No matter how much progress the industry makes in addressing the Year 2000, it is virtually certain that some problems will not be discovered or will not be remediated in time. Given this, it is imperative that the industry engage in contingency planning to minimize the disruptive effect of these failures and to have plans in place to correct them as quickly as possible once they occur. To help oversee this effort, the Commission is participating in various government and industry contingency planning initiatives.

Each SRO is working on comprehensive Year 2000 contingency plans. Both the SROs and Commission staff participate in the Contingency Planning Working Group that is jointly sponsored by the Federal Reserve Bank of New York, the Securities Industry Association, and the New York Clearing House. The Working Group is currently considering whether to develop response scenarios for various product groups. The Commission views contingency planning as a critical milestone for successful Year 2000 compliance. As January 1, 2000 draws closer, the efforts directed at contingency planning must, and are expected to, increase substantially.

IV. International Year 2000 Efforts

Based upon its discussions with members of the U.S. securities industry as well as its own work, the staff is concerned with the progress in resolving the Year 2000 problem at the international level. To date, the U.S. financial services industry has devoted more resources to Year 2000 efforts than their foreign counterparts.

The Commission has used its membership in organizations such as the International Organization of Securities Commissions ("IOSCO") to raise awareness in the international community and to urge foreign entities to take the actions necessary to address the Year 2000 problem. Partly in response to the Commission's urging, IOSCO has been collecting data on the readiness of the international securities industry for the Year 2000 and encouraging its membership to take appropriate actions. Other international groups such as the Basle Committee on Banking Supervision are also involved in encouraging international entities to correct their Year 2000 problems. Finally, a number of industry groups and joint government-industry groups are taking an active role in promoting remediation and contingency planning efforts and in conducting international industry-wide testing. Nevertheless, risks from Year 2000 failures abroad must be a major focus of contingency planning for U.S. firms.

V. Issuer Disclosure

In addition to promoting Year 2000 remediation and contingency planning in the securities markets, the Commission staff has been actively emphasizing to issuers that they must disclose any material impact the Year 2000 may have on their business. The staff has taken a number of steps to remind issuers of their disclosure obligations so that investors receive accurate information about the companies in which they have invested. In the near future, the Chairman intends to write a letter to the CEOs of public issuers reminding them of the importance of Year 2000 disclosure and the Commission's guidance on Year 2000 disclosure.

A. Staff Legal Bulletin No. 5

In order to impress upon issuers their disclosure obligations, the staff issued and then revised Staff Legal Bulletin No. 5. The bulletin states that public issuers and registered investment companies should disclose any material impact the Year 2000 problem may have on their businesses, including the cost of remediation, the consequences of incomplete or untimely resolution of the problem, and the risk that the problems of third parties will affect their business.

B. Disclosure Review Task Forces

In order to assess the quality of disclosure being made after the bulletin was issued, staff members in both the Division of Corporation Finance and the Division of Investment Management have each formed a Year 2000 Disclosure Task Force to review disclosure documents.

Staff are reviewing both public company and investment company filings to assess the type of information issuers are disclosing. The public companies selected for review span 12 major industries and include the Fortune 100 companies and a number of small businesses. The investment companies selected for review represent over 50 investment company complexes and over 59% of investment company assets. The staff has reached a number of conclusions:

• The number of public companies disclosing Year 2000 information has increased substantially. Using text searches of the SEC's EDGAR database of filings, the staff has determined that in the first four months of 1997, approximately 11% of the annual reports filed contained the phrase "Year 2000." During the same period of 1998, approximately 70% of annual reports contained the phrase "Year 2000."

• For investment companies, the number that disclose Year 2000 information has also increased substantially. During 1997, few investment companies made any Year 2000 disclosure. In contrast, through May 1998, 81% of the new or amended registration statements filed during 1998 contained Year 2000 disclosure. Further, 24 of the 25 largest investment company complexes have made Year 2000 disclosure to their shareholders.

VI. Accounting and Auditing Considerations

Guidance issued by AICPA provides that, when conducting an audit, an auditor has the responsibility to consider the effects of the Year 2000 issue on the entity's ability to prepare financial statements in accordance with generally accepted accounting principles. Notably, the AICPA guidance does not require auditors to evaluate the effect that the Year 2000 problem will have on the entity's business operations. However, AICPA has addressed a variety of issues, including communication between the auditor and the client regarding the Year 2000, disclosure issues and the need for the auditor to consider whether Year 2000 issues will affect the client's ability to continue as a going concern. Although the AICPA guidance uses the term "may," the Commission staff believes that the procedures outlined by the AICPA should be considered appropriate practice with respect to Year 2000-related issues at this time. The staff continues to believe that accountants and auditors play a key role in informing their clients about the Year 2000 problem and in assuring that their clients' financial statements remain in accordance with generally accepted accounting practices.

VII. The SEC's Internal Systems

The Commission uses numerous computer systems on a day-to-day basis. The following tables outline the Commission's progress in identifying and remediating those systems that pose a Year 2000 problem:

Summary of 90 Commission Applications

	Total	Compliant	Applications To Be Replaced	Applications To Be Repaired	Applications To Be Retired
Mission Critical	53	8	30	10	5
Non-Mission Critical	37	11	11	10	5

Status of the 10 SEC Mission-Critical Systems Being Repaired

	Assessed	In Renovation	In Validation	Implemented
Number	10	3	0	0
Completion Date	May 1998	Feb 1999	June 1999	August 1999

The SEC's original dates for renovation, validation and implementation were set before the OMB established its most recent government-wide schedule for these tasks. The SEC staff is working to compress its timetable to come closer to the OMB-suggested dates.

The Commission's highest-priority system is EDGAR. Although the staff believes that EDGAR is Year 2000 compliant, testing of the system continues, and the staff is developing contingency plans should the system fail. In addition, the staff believes that if Year 2000 problems such as localized communications failures or utility outages prevent specific issuers from making electronic EDGAR filings, the affected issuers will be able to use the hardship exemptions in the EDGAR rules to make required filings on paper. Once the problem causing the outage is resolved, the issuer would then provide its previous filings electronically.

Another high priority mission critical system is the Commission's filer fee collection processes, which operate through the Mellon Bank in Pittsburgh. The staff is currently putting in place a contingency plan to overcome any problems that affect this link. Were the link to fail, it could be temporarily replaced by telephone calls between the Commission's staff and the staff of Mellon Bank.

In addition to remediating its own systems, the Commission is seeking to identify and plan for possible disruptions to the supply of services it receives from outside parties. The Commission has requested that building owners and other specific service providers responsible for its headquarters and Operations Center certify that they have resolved any problems that might disrupt their services. Responses are still being collected, but of those received to date, there are no indications of problems. The Commission nonetheless recognizes that its contingency planning must address the possibility of failure in as many of these infrastructure systems as possible.

VIII. Investor Education

The Office of Investor Education and Assistance ("OIEA") and other parts of the Commission are all working to educate investors about the effects of the Year 2000 changeover. In January 1998, OIEA started tracking complaints, inquiries, and comments relating specifically to the Year 2000 issue. As of June 8, 1998, OIEA had received 16 inquiries concerning the Year 2000 issue. To meet investors and listen to their concerns, the Commission has been conducting Investors' Town Meetings across the country since 1994. At each meeting, the Chairman discusses questions investors should ask before they invest, including those relating to the Year 2000. In January 1998, the SEC added a page to its web site to educate investors and others about the Year 2000 issue. The page is located at http://www.sec.gov/news/extra/y2k/home2000.htm.

IX. Conclusions

As the report that follows indicates, the Commission, SROs, industry associations, and other industry participants are devoting extraordinary amounts of time and resources to assess and repair their computer systems. The staff believes that this industry-wide effort is proceeding satisfactorily, but that areas of significant concern remain. Comprehensive street-wide testing in March 1999 will identify possible weaknesses in both systems and in linkages between systems that will need to be addressed in the following months. No matter how successful testing and remediation efforts are, there are bound to be disruptions and unexpected problems during the early months of 2000. The Commission is committed to taking the necessary steps to achieve the highest possible industry compliance rate and minimize the effect of any disruptions that occur. In addition, the Commission plans to continue to remind issuers of their obligation to provide disclosure on their Year 2000 programs.

Introduction

This Second Report on the Readiness of the United States Securities Industry and Public Companies to Meet the Information Processing Challenges of the Year 2000 prepared by the Commission staff is intended to provide the Congress and others with a quantitative and qualitative assessment of the Year 2000 program of the Securities and Exchange Commission.³ The data presented in this Report are drawn from a number of sources: direct SEC staff oversight and reviews, public company filings, the SROs with whom the SEC shares regulatory responsibilities, and broker-dealer and investment company trade associations.

The Commission's approach to the Year 2000 has four primary components:

(1) Industry Oversight: During the last year, the Commission has shifted its focus from educating members of the industry to monitoring their progress in solving the problem. Under the U.S. system of self-regulation, primary oversight responsibility for broker-dealers resides with the SROs. For Year 2000 compliance issues, the SEC is working closely with the NASD and NYSE to monitor broker-dealer efforts. In addition, the Commission is fully supporting the SIA on its industry-wide testing program and is taking additional steps to identify firms that have fallen behind in preparing for the Year 2000. The Commission is also participating in industry-wide contingency planning groups. The purpose of these coordinated actions is to promote remediation of as many systems as possible, so that the consequences of any Year 2000-related failures can be minimized and corrected.

(2) Issuer Disclosure: The staff issued Staff Legal Bulletin No. 5 to provide specific guidance regarding what a company should disclose about its Year 2000 issues. Through the bulletin and working with the accounting profession, the Commission staff has taken steps to urge that all public issuers address and disclose any material impacts that the Year 2000 will have on their operations.

(3) Internal Commission Systems: The Commission is working on its own systems, including mission critical systems such as EDGAR. Contingency planning is also underway, so that if any Commission system does fail it will not seriously affect the Commission's ability to regulate the securities markets.

(4) Investor Education: The Commission continues to assist investors in obtaining accurate information about the scope of the Year 2000 problem and maintains a "Year 2000" page on its web site.

I. Progress of the Industry Toward Meeting the Year 2000 Challenge

A. Status of the Self-Regulatory Organizations

The SROs include the nation's exchanges, its clearing agencies, and the NASD. SROs play a key role both in operating the nation's securities markets and in overseeing the companies and individuals who participate in those markets.

Since 1996, the staff has conducted four surveys of the industry's SROs (exchanges, clearing agencies, and the NASD) regarding their Year 2000 efforts. For its most recent survey, the staff requested both a narrative description of what each SRO was doing to ensure Year 2000 progress, as well as numerical data regarding systems critical to ongoing operations. In addition, the staff requested that the SROs adopt the OMB reporting format to report the progress made in moving those systems through the various phases of achieving Year 2000 compliance. The Division also requested that the SROs report on any problems meeting time schedules, and on their contingency planning efforts.

Overall, the staff found that the SROs have made significant progress in addressing the Year 2000 problem. All SROs are prepared to participate in the first phase of industry testing, which is scheduled for July 1998. In addition, all SROs have begun contingency planning.

SRO Approach to Managing their Year 2000 Efforts

The SROs have committed substantial financial and personnel resources to the Year 2000 compliance project, as illustrated by the charts below.

Costs of SRO Year 2000 Projects from 1996 through 2000

Exchanges and NASD

Year	1996	1997	1998	1999	2000	Total
Cost	$679,500	$7,635,625	$18,131,563	$15,982,744	$6,166,696	$48,596,128

Clearing Agencies

Year	1996	1997	1998	1999	2000	Total
Cost	$4,874,000	$19,496,500	$24,199,000	$17,233,000	$3,511,000	$69,313,500

Status of Systems

The SROs report that their Year 2000 efforts for all mission-critical trading and settlement systems remain on schedule for full implementation by the end of December 1998. They are also making satisfactory progress in addressing Year 2000 issues for non-mission critical systems. Non-mission-critical systems are tracked like the mission-critical systems. The major difference between SRO efforts for mission-critical and non-mission-critical systems is that non-mission-critical systems have been given longer time-frames for remediation, testing, and implementation. Nevertheless, the SROs report that all non-mission-critical systems should be fully Year 2000 compliant no later than September 1999.

The SROs are actively involved with the SIA's Third Party Vendor Software and Data and Service Provider subcommittees, which are monitoring Year 2000 compliance among vendors and market data providers. In addition, each SRO has established its own program of contacting each vendor and market data provider to determine its Year 2000 status. When a vendor claims its product is Year 2000 compliant, the SROs verify the claim by testing the product on its own systems.

The following charts describe the status of SRO efforts to remediate and test all systems:

Status of Exchange and NASD Mission-Critical Systems

Total Mission-Critical Systems	Number Already Compliant	Number Being Replaced	Number Being Repaired	Number Being Retired
363	165	49	131	18

Status of Clearing Agency Mission-Critical Systems

Total Mission-Critical Systems	Number Already Compliant	Number Being Replaced	Number Being Repaired	Number Being Retired
250	199	6	23	22

Total Mission-Critical Systems	Number Already Compliant	Number Being Replaced	Number Being Repaired	Number Being Retired
459	161	44	193	61

Status of Clearing Agency Non-Mission-Critical Systems

Total Mission-Critical Systems	Number Already Compliant	Number Being Replaced	Number Being Repaired	Number Being Retired
183	114	16	8	45

Status of Exchange and NASD Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone To Be Completed	Mar 1998	Nov 1998	Nov 1998	Dec 1998
% Completed to date	99.2%	73.1%	51.7%	26%

Status of Clearing Agency Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone To Be Completed	Jan 1998	Sept 1998	Dec 1998	Dec 1998
% Completed to date	100%	83.6%	62.9%	28.6%

Status of Exchange and NASD Non-Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone	Dec 1998	Dec 1998	Jun 1999	Sept 1999
% Completed to date	85%	62.1%	23.6%	11.7%

Status of Clearing Agency Non-Mission-Critical Systems Being Repaired

	Assessment	Remediation	Testing	Implementation
Milestone To Be Completed	Dec 1997	Dec 1998	Jan 1999	Mar 1999
% Completed to Date	100%	50.6%	44%	26.7%

Problems Affecting SRO Progress

The staff asked the SROs a number of questions regarding any problems or delays they have experienced in their Year 2000 efforts. In response, the SROs all reported that they are on schedule with their Year 2000 efforts, and that it has not been necessary for them to revise their work schedules for this project.

SRO Testing

The SROs have, or will soon have, testing centers allowing members and participants to test their interfaces with the SROs for Year 2000 compliance. The National Securities Clearing Corporation, the Securities Industry Automation Corporation ("SIAC"), the Depository Trust Company, and the SIA have been conducting joint educational seminars addressing the Year 2000, with a particular focus on test plans for each SRO and the SIA's efforts regarding industry-wide testing.

As discussed in more detail below, the SIA has taken a leading role in coordinating the securities industry's Year 2000 efforts, in particular by organizing industry-wide testing. The SIA has developed test scripts for various product groups, hired a test coordinator, and scheduled testing dates. All SROs are planning to participate in the first phase of industry testing in July 1998.

B. The Broker-Dealer Community

Under the U.S. system of self-regulation, primary oversight responsibility for broker-dealers resides with the SROs. For Year 2000 compliance issues, the SEC is working closely with the NASD and NYSE to monitor broker-dealer efforts. In addition, the SEC is working with the SIA to prepare the industry for Year 2000. The SEC has also proposed a rule that would require certain broker-dealers to file periodic reports with the SEC describing Year 2000 compliance efforts.

The securities industry has established an aggressive schedule by which specific milestones should be met. Broker-dealers participating in the initial phase of industry testing must have their systems ready by July 1998. Other firms are expected to have their systems ready in the first quarter of 1999. In sum, information received from the NASD and NYSE indicates that the broker-dealer community is actively working on the Year 2000 problem. Nonetheless, as discussed below, it is not realistic to suggest that all broker-dealers will be compliant on time.

1. Overview of Industry Compliance Efforts

Monitoring Year 2000 compliance for broker-dealers has been a multi-part effort which includes the SEC, the SROs, in particular the NASD and NYSE, and the SIA. The SIA has taken a strong, proactive lead in organizing industry efforts. In 1996, the securities industry, led by the SIA, established an ambitious Year 2000 completion schedule. Under this schedule, all exchanges and clearing agencies, member firms, and participants are expected to have completed remediation, testing and implementation of their systems by December 1998. The SIA has formed a number of committees to address key elements of the Year 2000 problem, such as industry-wide testing, third party software, data provider interfaces, legal and regulatory issues, and exchange and utility testing strategy and schedules. During 1996 and 1997, the SIA developed working groups to develop test scripts and plans for different product groups (e.g., equities, mutual funds, mortgage-backed securities, etc.).

The industry will begin systems testing between firms, exchanges, and clearing agencies ("beta testing") in July 1998. From the results of this test, the industry will focus its resources on critical trading, and clearing and settlement systems. The initial beta test will involve the SROs, approximately two dozen broker-dealers, and one vendor. Other tests are scheduled throughout 1998. Industry-wide testing is scheduled for March and April 1999, and will include a broad segment of the broker-dealer community. Any systems anomalies discovered during the March and April tests will be addressed during the remainder of the year, with additional industry-wide testing scheduled as required.

In addition, the NASD and NYSE have both conducted surveys of member firms regarding the firms' Year 2000 efforts. The NASD plans to conduct a second survey asking members to certify their progress since the first survey, and will verify that the data they receive is complete and current as part of their examination process. The NYSE has established milestones for evaluating Year 2000 progress and will contact member firms quarterly to measure their progress against these milestones.⁴

The SEC meets regularly with the SIA, the NASD, and the NYSE to discuss industry status. In support of industry efforts, Chairman Levitt sent a letter to all broker-dealers reminding them of their obligations to prepare for Year 2000, and encouraging them to participate in industry testing. The remainder of this section discusses the results of the industry surveys, findings from the SEC's broker-dealer exam program, and proposed rules that would require broker-dealers to report on their Year 2000 preparations.

2. Results of Industry Surveys Regarding the Status of Systems

The NASD mailed surveys to more than 5,500 member firms to evaluate their level of preparedness for Year 2000. The NYSE also surveyed its members regarding their Year 2000 efforts. Broker-dealers who are members of both the NASD and NYSE were permitted to respond to the NYSE survey only. Therefore, NASD survey efforts target its 5,238 "designated members." The NYSE survey includes data from 327 member firms.⁵

As of June 4, 1998, 5,080 member firms responded to the NASD survey. This represents 97% of the NASD designated membership. The data are categorized by type of firm: Introducing firms, Clearing firms,⁶ and Other firms.⁷ Responses to the NASD survey match the actual breakdown of NASD membership: 62% Introducing Firms, 9% Clearing Firms, and 29% Other Firms. Overall, 97% of the Introducing Firms, 99% of the Clearing Firms, and 96% of the Other Firms responded. Some firms did not respond to certain questions; for this reason, the totals in the charts below do not equal the total responses received. Most firms reported that they would complete their Year 2000 efforts by December 1998 or January 1999.

NASD Member Firms -- Year 2000 Program Completion Percentage
(Awareness Through Implementation)

Type of Firm	Number of Firms Reporting	Firms Reporting Programs 0% Complete8	Firms Reporting Programs 1% through 39% Complete	Firms Reporting Programs 40% through 69% Complete	Firms Reporting Programs 70% through 100% Complete
Introducing    Firms	2,686	17%	16%	17%	50%
Clearing    Firms	322	10%	25%	23%	42%
Other    Firms	1,339	16%	15%	17%	52%
Total	4,347	16%	17%	17%	50%

NASD Member Firms--Remediation Timetable⁹
(Quarter in which Remediation Will Be Complete)

Type of Firm	Number of Firms Reporting	1998 2ndQ or Earlier	1998 3rdQ	1998 4thQ	1999 1stQ	1999 2ndQ	1999 Post 2ndQ
Introducing    Firms	1,599	22%	11%	36%	13%	11%	7%
Clearing    Firms	242	27%	10%	42%	9%	7%	5%
Other    Firms	799	23%	7%	44%	9%	10%	7%
Total	2,640	23%	10%	39%	11%	10%	7%

The NYSE survey includes only specialist firms and member firms that deal with the public. A total of 306 responses representing 327 broker-dealers were received.¹⁰ The results below include responses received by the end of the first quarter of 1998. As with the NASD survey, NYSE members did not respond to all questions. The NYSE has contacted member firms that did not supply complete answers, and expects a 100% response rate to its second quarter survey.

NYSE Member Firms¹¹

% Complete (as of 3/31/98)	Assessment	Remediation	Testing	Implementation
100% Complete	89%	48%	34%	32%
51-99% Completed	4%	21%	13%	16%
1-50% Completed	2%	21%	24%	20%
0% Completed	0%	3%	13%	14%
No Response	4%	7%	16%	18%

Areas of Concern

Staff concerns are directed toward obtaining complete information from those broker-dealers who have not fully responded to the SRO surveys. The SEC will also focus on those firms that report low completion rates for their Year 2000 efforts. The SEC's first priority is the clearing firms, which process transactions for other broker-dealers. As discussed below, the SEC has proposed a rule that would require broker-dealers to report their Year 2000 efforts. The data collected pursuant to this rule will build on the baseline information collected by the NASD and NYSE, and will permit the SEC and the SROs to collaboratively assess the risks associated with Introducing Firms and Other Firms that fail to show adequate Year 2000 progress. The SEC is also concerned about those firms who reported that their Year 2000 efforts would be completed later than the first quarter of 1999.

3. Commission On-Site Reviews

Beginning in 1996 and continuing through 1997, the examination program focused on awareness: getting the word out to broker-dealers and the rest of the securities industry that there was a problem that needed to be fixed. The Director of the Office of Compliance Inspections and Examinations sent letters to the SIA and others alerting them to the seriousness of the problem and that remediation efforts would be reviewed during exams. In addition, in 59 on-site examinations of selected broker-dealers, examiners asked a series of questions designed to alert firms to the problem, and to gauge whether the firm had plans to correct the problem. All 59 indicated that they were aware of the Year 2000 problem and were planning or taking corrective action.

During 1998, examiners are asking more detailed questions about all stages of the firm's Year 2000 program. As these reviews have become more in-depth, OCIE has taken steps to avoid duplicative examination oversight of registered entities, consistent with the Commission's long-standing policy. Because the SROs are taking a front-line role in performing examination oversight of broker-dealers, OCIE is conducting selected examinations of broker-dealers' Year 2000 programs. The staff also expect to conduct on-site reviews in 1999 of selected firms based upon their responses to the proposed reporting rules.

C. Non-Bank Transfer Agents

On October 22, 1997, Chairman Levitt sent a letter to all registered transfer agents stressing the importance of implementing plans and devoting adequate resources to modify their computer systems to make them ready for the Year 2000. In January 1998, the staff conducted a survey of non-bank transfer agents regarding: 1) whether the board of directors has approved and funded a plan to address Year 2000 problems; 2) what levels of management are responsible for addressing Year 2000 problems, including a description of those responsibilities; and 3) the contact person regarding Year 2000 matters.

A total of 365 non-bank transfer agents (51%) responded to the survey. Of these, 279 non-bank transfer agents (76.4%) reported that they had developed a Year 2000 plan. An additional 37 non-bank transfer agents (10.1%) reported that, although they had no Year 2000 plan, their vendors do. Forty-nine (13.4%) of the respondents indicated that they had no Year 2000 plan at that time. The SEC plans to review these 49 firms closely to determine whether they have taken appropriate steps toward Year 2000 compliance in the intervening months.

During 1996 and 1997, staff used non-bank transfer agent examinations¹² to raise awareness of the problem. The results of these examinations were as follows:

Year 2000 Examination Module Results for Transfer Agents 1996–1997

Type of Registrant	Number Examined	Aware of the Problem	Corrective Action Taken or Planned
Nonbank TAs	83	82 (99%)	81 (98%)

Examiners also conducted a number of more in-depth reviews of selected firms' remediation programs.

In early 1998, SEC examinations shifted from a qualitative to a quantitative review. Specifically, examiners are now asking a series of questions seeking specific representations about the registrant's program, and the specific dates by which components of the program will be completed. In light of the SIA's timetable, which specifies December 1998 as the date by which transfer agents (and broker-dealers) should have all their corrective work completed, with 1999 reserved for testing, the current questions focus on the corrective and testing stages of the process. Questions include the extent of the registrant's reliance on third parties to ensure Year 2000 compliance, whether the registrant has a written plan, the expected date internal systems testing will be completed, and whether the registrant will be participating in testing with outside parties or in industry-wide testing. Responses to these questions will assist the staff in monitoring industry progress and identifying firms that pose a heightened risk of a future compliance problem. Using this methodology, we expect to conduct Year 2000 reviews of a significant percentage of all active non-bank transfer agents in 1998.

As more fully described below, the Commission has proposed a rule that would require non-bank transfer agents to file reports with the Commission regarding their Year 2000 efforts. These reports will permit the SEC to target on-site reviews in 1999 to firms that are not adequately preparing for the Year 2000.

D. Investment Advisers and Investment Companies

To emphasize the seriousness of these issues, in November 1997, Chairman Levitt sent a letter to all registered investment advisers stressing the importance of implementing plans and devoting adequate resources to modifying computer systems to make them ready for the Year 2000. The Commission staff is also engaged in ongoing efforts to evaluate the Year 2000 readiness of investment advisers and investment companies. These efforts include: an ongoing dialogue with industry groups; examinations that include on-site Year 2000 reviews; analysis of Year 2000 disclosures made by investment companies; and consideration of possible Year 2000 reporting rules. The Commission staff has met a number of times with the ICI to promote Year 2000 readiness and discuss the status of Year 2000 assessment, remediation, and disclosure efforts in the industry. As part of this process, the ICI has provided the results of a member survey on the status of the industry, discussed below.

1. Results of Investment Company Institute Survey

In preparation for this report, the Commission staff asked the ICI to share the results of a survey the ICI had conducted of its members on their Year 2000 programs. The ICI's survey was conducted between March 16 and June 3, 1998. Among other questions, the ICI asked when respondents expected to complete their Year 2000 remediation programs. The chart below shows their responses.

Program Completion Dates for Mutual Funds¹³

	1998 2ndQ or Earlier	1998 3rdQ	1998 4thQ	1999 1stQ	1999 2ndQ	1999 Post 2ndQ
Percent of Firms	3%	5%	72%	8%	11%	1%

The ICI has also urged its members to participate in the SIA's industry-wide test program (discussed below), scheduled to begin in March 1999. Several major mutual fund complexes will also participate in the SIA's beta test program planned for July 1998.

2. Commission On-Site Reviews

Year 2000 Examination Module Results for Investment Advisers
and Investment Companies 1996–1997

Type of Registrant	Number Examined	Aware of the Problem	Taken or Planned Corrective Action
IAs & ICs	757	731 (97%)	627 (83%)

Examiners also conducted a number of more in-depth reviews of selected firms' remediation programs.

Beginning in the spring of 1998, SEC examinations shifted from a qualitative to a quantitative review. Exam questions now include the extent of the registrant's reliance on third parties to ensure Year 2000 compliance, whether the registrant has a written plan, the expected date internal systems testing will be completed, and whether the registrant will be participating in testing with outside parties or in industry-wide testing. Using this methodology, the staff expects to complete on-site reviews of a significant percentage of advisers and funds during the remainder of 1998.

This information has enabled the staff to prepare a "snapshot" of the state of investment companies and advisers based on 128 examinations conducted during April 1998. The staff found that 53% of registrants are relying on third party service providers to deal with the Year 2000 Problem. Several registrants indicated that they were both relying on a third party and actively working on the problem themselves. The staff found that a relatively low percentage of registrants, 31%, had reduced their plans to writing. While this may be troubling, responses to the other questions demonstrate that most firms are taking some action. Specifically, 70% of the firms indicated that they had made an inventory of all of their computer systems affected by the Year 2000 problem, 66% indicated that they were taking steps to correct the problem, and 57% indicated that they intended to test their internal systems for Year 2000 compliance.

Most firms indicated completion dates in 1998 and early 1999. Only a small number of registrants indicated that they did not expect to complete their corrections until after the first quarter of 1999. This is generally consistent with industry guidance that corrections should be completed by December 1998; however, the staff is treating these late completion dates as potential problems. The staff expects to conduct additional on-site reviews in 1999 in order to follow up with these registrants.

E. Proposed Year 2000 Reporting Rules

• Whether the reporting firm has written Year 2000 plans that address all major computer systems world-wide;

• Current progress on each stage of preparation for potential Year 2000 problems:

(i) awareness of potential Year 2000 problems;

(ii) assessment of the steps necessary to avoid Year 2000 problems;

(iii) implementation of those steps;

(iv) internal testing of software, including material exceptions resulting from such testing;

(v) integrated or industry-wide testing of software (including testing with other broker-dealers, other financial institutions, customers, and vendors); and

(vi) implementation of tested software; and

• Whether the reporting firm has a written contingency plan in the event that, after December 31, 1999, it has computer problems caused by the Year 2000 date changeover.

The Commission is now finishing its review of comment letters. Commenters were generally supportive of the rule. Many were critical, however, of the Commission's proposal to require large broker-dealers and transfer agents to file an independent public accountant's attestation verifying the basis of the reporting firm's assertions in its second Year 2000 Report. As a result, the Commission is considering alternative structures for an accountant's review.

As part of its ongoing effort to address whether advisers and funds will be prepared for the Year 2000, the staff also plans to recommend that the Commission propose a new rule that would require advisers to file reports with the Commission on their readiness for the Year 2000. The reports would be similar to the broker-dealer and transfer agent reports discussed above. If the advisers have investment companies as clients, the advisers also would be required to provide information about the preparedness of the investment companies for the Year 2000.

A regulatory requirement to file Year 2000 reports would encourage broker-dealers, transfer agents, and advisers to proceed expeditiously with their efforts to prepare for the Year 2000. As part of the adoption of the reporting rules, the SEC would also consider whether to make the reports available to the public. The SEC staff would use the reported information to obtain a more complete picture of the industry's overall Year 2000 preparations and to identify firm-specific problems. Registrants that fail to report would be in violation of federal law. Registrants that report questionable or inconsistent information could be subject to compliance examinations. Information in the reports, in conjunction with information obtained from industry groups and through the examination program, would enable the staff to focus its efforts for the rest of 1998 and 1999 on particular industry segments or firms that appear to pose the greatest risk of non-compliance.

F. Industry-Wide Testing

Each firm individually can prepare its own systems for the Year 2000, but no one can say with any certainty how these systems will perform when interconnected. Thus, integrated testing among participants, in a Year 2000 environment simulating as many aspects of a normal trading day as possible, is the only meaningful way to reduce risks of failure to the lowest possible level. In recognition of this, the SIA undertook to construct an unparalleled industry-wide test program. Below is a summary of the SIA's test program. Details of the SIA test program are available on the SIA's web site at http://www.sia.com.

Of the SIA's eight Year 2000 subcommittees, the test program relies most heavily on four subcommittees, each addressing a specific aspect of Year 2000 preparation and testing:

Subcommittee	Purpose
Exchange and Utility Subcommittee	To coordinate the test efforts of the exchanges, clearing corporations, and the depositories.
Third Party Software Subcommittee	To identify, on behalf of members, Year 2000 compliance problems originating with the vendors of hardware and software and to work toward acceptable licensing and contract agreements with these vendors.
Data Providers Subcommittee	To define a common Year 2000 industry test schedule for data feeds and to establish agreed-upon Year 2000 data formats.
Participant Street-Wide Testing Subcommittee	To define, plan and execute the SIA industry-wide test program.

General Approach

• Equities

• Listed Options

• Municipal Bonds

• Corporate Bonds

• Unit Investment Trusts (UITs)

• Mutual Funds

• Futures

• Options on Futures

• Asset-backed Securities

• Government Securities (FHLMC, FNMA, GNMA)

• Treasury Bills, Bonds and Notes

Schedule

Year 2000 testing in the securities industry began with what can be called "infrastructure" testing between the exchanges and the clearing agencies and the depositories. Once it was established that the core trading, clearing and settling systems were exchanging data properly, other industry participants were admitted to the process.

Beta testing is the first test of trading in an "end-to-end" fashion. Beginning July 13, 1998, twenty-six firms will initiate beta testing for six products: equities, options, municipal bonds, corporate bonds, UITs, and mutual funds.¹⁵ Test trades will simulate the normal, four day processing cycle (T+3). Beta tests for other product groups are scheduled throughout the remainder of 1998. Beta tests are analogous to a test of the test scripts and structure. They will be used to refine the procedures that will be used for the full street-wide testing in 1999.

Participation in industry-wide testing will be opened to the remainder of the industry in March 1999. The focus and emphasis of industry-wide testing will be on the industry's 300-plus clearing firms, since it is these firms that must secure and assume financial responsibility for every trade executed.

G. Contingency Planning

Contingency planning for the Year 2000 is a major focus for the industry. On an individual level, each SRO has contingency plans in place to avoid single-points-of-failure. In addition, all SROs report that they are currently preparing comprehensive Year 2000 contingency plans. Many of the larger market participants have informed the staff that they also are preparing contingency plans for Year 2000. As part of the proposed broker-dealer, transfer agent, and investment adviser reporting rules described above, the SEC would gather additional information on contingency planning.

Industry-wide efforts for contingency planning are being coordinated through the Contingency Planning Working Group, which is jointly sponsored by the Federal Reserve Bank of New York, the SIA, and the New York Clearing House. Participants include SROs, broker-dealers, banks, bank regulators, vendors, industry groups such as the SIA and the Bond Market Association, and the SEC. The Working Group was formed to share information on Year 2000 efforts from across the industry, and to address potential systemic risk implications. While the focus of the Working Group is principally on the U.S. domestic market, the Working Group intends to identify cross-border issues in order to determine whether these risks are being addressed by other groups. The Working Group's plans to date include arranging sessions for participants to share their individual approaches to contingency planning and establishing focus groups for telecommunications, integrated payment system testing, foreign exchange, and U.S. Government securities.

The SEC is working with other financial service regulators to establish contingency plans. In particular, the Year 2000 subgroup of President's Working Group on Financial Markets is now focusing on contingency planning issues. The SEC is also developing its own contingency plans. The staff is preparing a contingency planning framework that identifies areas within the securities markets that are critical to its functioning and that is designed to address potential breakdowns of some industry participants in Year 2000. As part of its contingency planning process, the SEC will build on this framework to devise action plans for different scenarios. This effort includes working with industry groups such as the SIA, the Securities Transfer Association and the ICI in defining critical areas and resolution scenarios.

II. International Year 2000 Efforts

The globalization of the securities industry presents perhaps the most difficult Year 2000 challenges. In recent years, U.S. investors have increasingly invested in foreign assets. At the same time, U.S. markets have become increasingly interconnected with their global counterparts. Hence, Year 2000-related failures in one foreign market may well have effects in both U.S. and other foreign markets.

Many U.S. securities firms have advised Commission staff that, while they believe the U.S. securities industry is preparing well for Year 2000, they are very concerned about Year 2000 efforts internationally. The staff is also aware of reports that some countries in other parts of the world, in particular Latin America and Asia, are seriously behind in Year 2000 efforts. To date, the U.S. financial services industry has devoted more resources to Year 2000 efforts than their foreign counterparts. However, a number of initiatives, which encompass regulators, markets and market participants, are underway to coordinate Year 2000 efforts across borders.

The Commission's primary means of encouraging other countries and foreign regulators to deal with the Year 2000 problem is through its membership in the International Organization of Securities Commissions ("IOSCO"). Partly in response to the work of the Commission within IOSCO, in July and September 1997 IOSCO issued communiqués urging its members and market participants to take appropriate action to address Year 2000 issues. In early 1998, IOSCO conducted a survey of its members regarding Year 2000. IOSCO is currently conducting a second Year 2000 survey of its members, this time focusing on testing and contingency planning. The Commission anticipates that IOSCO will publish the survey results at its meeting in September 1998.

In addition to its work within IOSCO, the Chairman and Commission staff have been working to raise international awareness of the scope of the Year 2000 problem and to urge international entities to devote as many resources as possible to solving the problem. For example, in October 1997 Chairman Levitt gave a speech before the International Federation of Securities Exchanges ("FIBV") encouraging it to take an active role in promoting remediation and contingency planning by its member exchanges. As the Chairman warned, "if we fail to correct the problems raised by the coming millennium . . . we risk serious disruptions to the world's securities and financial markets, and I daresay enormous damage to our economies."

Other international groups are also working on resolving the Year 2000 problem. For example, in September 1997, the Basle Committee on Banking Supervision ("Basle Committee")¹⁶ issued a technical paper for banks which sets forth a strategic approach for the development, testing, and implementation of Year 2000 solutions, as well as the role that central banks and bank supervisors need to play in promoting awareness of the issue and enforcing action. In April 1998, the Basle Committee, IOSCO, the G-10 Committee on Payment and Settlement Systems ("CPSS"), and the International Association of Insurance Supervisors ("IAIS") jointly sponsored a Roundtable on the Year 2000. Discussions at the Roundtable emphasized that private and public sector bodies should coordinate on a number of important issues and approaches, including strengthening and widening external testing programs, improving information sharing among market participants and their vendors and service providers, fostering increased disclosure by corporations of their Year 2000 testing and readiness results, and reinforcing the role of oversight bodies such as supervisors and auditors.

The Roundtable sponsors also established the Joint Year 2000 Council, chaired by the Federal Reserve Bank of New York. The Joint Council's objectives include: serving as a clearinghouse and focal point for Year 2000 information sharing within the global financial community, especially the regulatory community; serving as a locus for international coordination of Year 2000 testing programs and information related to Year 2000 testing; encouraging disclosure of Year 2000 readiness; providing a point of contact for private sector initiatives regarding Year 2000; serving as a coordination point for international contingency efforts; and encouraging development of market conventions and dispute resolution procedures for transaction failures. The Council will meet regularly and has agreed on a wide range of initiatives to ensure a high level of attention on the Year 2000 computer challenge within the global financial supervisory community.

In addition, IOSCO continues to update the special Year 2000 section on its web site at http://www.iosco.org. This section includes information on the testing and readiness of the securities industry and markets worldwide. The CPSS maintains a special section on the Bank for International Settlement's web site at http://www.bis.org that provides information on the testing plans and readiness status of payment and settlement systems worldwide. The IAIS is working with its members to urge insurance companies to implement detailed action plans to resolve the Year 2000 problems associated with their business activities. The Basle Committee, IOSCO, CPSS and IAIS are prepared to take further joint action to promote the Year 2000 readiness of the global financial industry.

The private sector is also undertaking initiatives regarding international Year 2000 compliance. The SIA, in conjunction with its International Operations Association, sent an "international scorecard" to over 700 foreign regulators, exchanges, banks, clearing organizations, and broker-dealers asking for information about their Year 2000 efforts. While the SIA is still collecting and analyzing data from the scorecard, one immediate result has been requests by foreign entities to participate in the SIA's testing program. The London Investment Bankers Association has agreed to take the lead in coordinating test efforts with the United Kingdom, while the Swiss Banking Corporation has agreed to act as coordinator in continental Europe.

In addition, a number of banks and investment firms have formed the Global Year 2000 Coordinating Group. The Coordinating Group was established to identify areas where coordinated initiatives could improve the readiness of global financial institutions to meet the challenges created by Year 2000. In particular, the Coordinating Group plans to gather and disseminate information on the Year 2000 readiness of cash payment and settlement systems; securities clearance and custody systems; stock, bond, futures, and commodity exchanges; and foreign exchange and derivatives trading firms. It is also planning a series of regional meetings with regulators and industry participants in Asia, Latin America, and Europe. The Coordinating Group has opened membership to all interested financial services providers. Its efforts are directed by a steering committee composed of the founding participants plus at least one representative from each of the countries identified as having relevant financial markets.¹⁷ The Coordinating Group has established Working Groups on Market Infrastructure Readiness, Financial Industry Readiness, and Third Party Service Provider Readiness.

Despite the efforts underway by global organizations, international Year 2000 efforts remain an area of concern for the Commission. The Commission will use its best efforts to work with regulators in other countries to address Year 2000 concerns, and will continue to urge U.S. firms to press their international counterparties for a more responsive approach abroad. The Global Year 2000 Coordinating Group is an important component of international Year 2000 efforts. Nevertheless, risks from Year 2000 non-compliance abroad must be a major focus of contingency planning for U.S. firms.

III. Issuer Disclosure

The Commission staff believes that public and investment companies must disclose any material effects that the Year 2000 problem or their own Year 2000 remediation efforts will have on their business. As discussed below, to date, the staff has published a legal bulletin on issuers' disclosure obligations, and has surveyed the quantity and quality of the disclosure made by public issuers and investment companies.¹⁸ Although the number of issuers discussing Year 2000 has increased significantly, the staff is concerned that much of the disclosure is not informative. The legal bulletin and the survey results are discussed below. In light of these results, in the near future, Chairman Arthur Levitt will mail a letter to chief executive officers of public companies to remind them of the significance of the Year 2000 issue and the Commission's guidance regarding companies' Year 2000 disclosure obligations. The Commission also has said it will issue an interpretive release that sets forth its views regarding the application of its disclosure requirements to the Year 2000 issue.

A. Staff Legal Bulletin No. 5

The Commission's disclosure framework requires that public companies and investment companies disclose material information about themselves to the public.¹⁹This enables investors to make informed decisions. Although the Commission's disclosure framework requires companies to provide specific categories of information, it is flexible enough to enable companies to tailor disclosure to their particular circumstances. In almost every case, the Commission relies on this general framework and does not provide specific guidance on any particular issue. However, with respect to the Year 2000 issue, the Commission's staff made an exception and provided specific guidance as to what public companies should consider when disclosing information about their Year 2000 readiness.²⁰

On October 8, 1997, the Divisions of Corporation Finance and Investment Management issued a joint Staff Legal Bulletin reminding those entities with disclosure obligations that the Commission's rules and regulations apply to Year 2000 issues, just like any other significant issue.²¹On January 12, 1998, the Divisions revised the Staff Legal Bulletin to provide more specific guidance under existing Commission rules and regulations.²²The staff intended this guidance to alleviate the uncertainty expressed by some members of the accounting and legal professions regarding what a company should disclose about its Year 2000 issues.²³

For corporate issuers, the revised Staff Legal Bulletin explains that public companies may have a Year 2000 disclosure obligation in their Commission filings because an applicable form or report requires the disclosure. The most likely regulation triggering disclosure on a Commission form or report is "Management's Discussion and Analysis of Financial Condition and Results of Operations."²⁴This is also known as "MD&A." In their MD&A, companies must discuss known trends, demands, commitments, events, or uncertainties that are likely to have a material impact on them.

With regard to Year 2000 issues, MD&A requires disclosure if:

• The cost of addressing these issues is a material event or uncertainty that would cause reported financial information not to be necessarily indicative of future operating results or financial condition, or if

• The costs or the consequences of incomplete or untimely resolution of these issues represent a known material event or uncertainty that is reasonably expected to affect future financial results, or cause reported financial information not to be necessarily indicative of future operating results or future financial condition.

• If the company has not yet started to assess its Year 2000 issues;

• If the company has started to assess its Year 2000 issues but has not yet determined whether these issues are material; or

• If, after assessing its Year 2000 issues, the company has determined that these issues could be material to its business, operations, or financial condition, irrespective of any remediation plans or insurance coverage. In other words, the company must have determined the materiality of its Year 2000 issues on a "gross" basis.

• Its plans to address the Year 2000 issues that affect its business and operations; and

• Its timetable for carrying out these plans.

• An estimate of its Year 2000 costs and any material impact it expects these costs to have on its results of operations, liquidity and capital results;

• Its historical Year 2000 costs;²⁶ and

• How it could be affected if its customers, suppliers and other constituents are not Year 2000 ready.

Investment companies are also obligated to assess whether or not Year 2000 disclosure is required, including whether it needs to be disclosed in registration statements. The Staff Legal Bulletin states that "under the Investment Advisers Act of 1940 and the Investment Company Act of 1940, investment advisers and investment companies may be required to make appropriate disclosure to clients and shareholders if operational or financial obstacles are presented by the Year 2000." Further, the Investment Company Act provides that it is unlawful for investment companies to omit from registration statements and other public filings "any fact necessary in order to prevent the statements made therein, in light of the circumstances under which they were made, from being misleading." Specifically, investment companies are required by Item 5 "Management's Discussion of Fund Performance" of Form N-1A to describe in their registration statements the experience of their investment adviser and the services that the advisers provide. In response to this Item, investment companies may need to disclose the effect that the Year 2000 issue would have on their advisers' ability to provide services described in their registration statements.

Investment companies also rely heavily on other external service providers such as transfer agents, custodians, broker-dealers, fund administrators, and pricing services. Similar concerns should be disclosed if investment companies believe that the Year 2000 issue will affect their other service providers' ability to provide the services described in their registration statements.

The Divisions of Corporation Finance and Investment Management both request companies to confirm they have considered the revised Staff Legal Bulletin and their Year 2000 disclosure obligations. The staff includes this request in the comment letters it sends to companies whose registration statements or periodic filings have been selected for review. For example, since late 1997, the Divisions of Corporation Finance and Investment Management have issued the following comment to public and investment companies as a standard part of their review of a filing:

Please see Staff Legal Bulletin No. 5 (CF/IM). In this bulletin, we explain what public companies should disclose about Year 2000 issues in their filings. Please supplementally confirm to us that you disclose in this filing all required information about Year 2000 issues.

The purpose of these comments is to increase companies' awareness of the Year 2000 problem and assist them in meeting their disclosure obligations.

B. Public Company Disclosure

First, the Task Force searched the Commission's electronic filing system, EDGAR, to compare how many public companies have been providing Year 2000 disclosure at different points in time. The results of these searches show that only 10% of the annual reports filed by public companies during the first four months of 1997 contain the phrase "Year 2000." For the quarterly reports filed after the staff published Staff Legal Bulletin No. 5, this percentage increased to 25%. After the staff published revised Staff Legal Bulletin No. 5 in January 1998, 70% of the annual reports contained the phrase "Year 2000."

While the number of companies disclosing Year 2000 issues had increased dramatically, the Task Force's survey shows that many companies are not following the specific guidance provided in revised Staff Legal Bulletin No. 5. The Task Force read the Year 2000 disclosure in the filings of 1,023 public companies to see if the disclosure contains certain information based on the specific guidance provided in revised Staff Legal Bulletin No. 5. To compile the 1,023 annual reports, the Task Force randomly selected companies from 12 industry groups, including 66 small business filers. The aim was to compile a sampling of filings that would fairly represent a cross-section of public companies. The Task Force also surveyed the most recent annual or quarterly reports filed by the Fortune 100 companies that are publicly held.²⁷ Based on the specific guidance provided in revised Staff Legal Bulletin No. 5, the Task Force looked for the following eight categories of information:

(1) The status of the company's assessment of its Year 2000 issues;

(2) The level of detail in the disclosure relating to the company's remediation plan;

(3) The estimated timetable for completing a company's assessment and/or its plan;

(4) Whether a company intends to or is evaluating its Year 2000 issues with entities with whom a company has material relationships;

(5) Whether a company discloses how much has been spent on Year 2000 issues to date;

(6) Whether a company discloses an estimate of the amount to be spent on Year 2000 issues;

(7) Whether a company addresses, and the level of materiality, of its Year 2000 issues; and

(8) Whether a company includes cautionary language in its Year 2000 disclosure.

The Commission is concerned that while a larger number of companies mention Year 2000 in their annual reports, much of the disclosure is not meaningful. Perhaps many companies are not providing the type of disclosure specified in Staff Legal Bulletin No. 5 because companies are concerned that forward-looking disclosures would be a lightning rod for the plaintiffs' bar. Several class-action lawsuits regarding Year 2000 warranties have already been filed.²⁸ Companies, therefore, have every incentive to provide complete forward-looking information regarding their Year 2000 readiness.

The Task Force evaluated whether companies sought specifically to avail themselves of the safe harbor under the Private Securities Litigation Reform Act of 1995 or included general cautionary language. Because it was possible for companies to do both, and many did, the percentages for the categories below total more than 100%.

Cautionary language:	Percentage
Statutory safe harbor language; specifically mentions Year 2000 issues; and appears physically near the other Year 2000 disclosure	7%
Statutory safe harbor language: specifically mentions Year 2000 issues: but does not appear near to or in the same section as other Year 2000 disclosure	6%
Statutory safe harbor language: does not: mention Year 2000 issues; or appear near to or in the same section as other Year 2000 disclosure	59%
Disclosure includes general cautionary language with the Year 2000 disclosure	43%
No disclosure regarding the statutory safe harbor or general cautionary language on Year 2000 issues	19%

The Commission and its staff continue their efforts to increase the frequency and quality of Year 2000 disclosure made by public companies. The efforts to date have raised the consciousness of the public companies regarding this issue, but have not fully succeeded in obtaining the quality of disclosure that investors need.

The Commission has targeted the annual reports that public companies will file during the next year as the best opportunity to gain meaningful disclosure sufficiently in advance of the next millennium. In the near future, Chairman Arthur Levitt will mail a letter to chief executive officers of public companies to remind them of the significance of the Year 2000 issue and the Commission's guidance regarding companies' Year 2000 disclosure obligations.

The Commission has said it will issue an interpretive release in the near future that sets forth its views regarding the application of its disclosure requirements to the Year 2000 issue. The interpretive release would formalize current staff guidance and, among other things, remedy the apparent misconception that the Year 2000 issue is material and, therefore, must be disclosed only if the costs of remediation are material. The interpretive release will clarify that companies must, in addition to considering costs, determine materiality based on the potential consequences of inadequately resolving their Year 2000 issues. Further, the Commission's interpretive release may form the basis of Commission enforcement actions against companies that fail to disclose material information regarding their Year 2000 issues.

C. Investment Company Disclosure

Like the Division of Corporation Finance, the Division of Investment Management formed a task force after the revised legal bulletin was issued to assess whether investment companies are providing meaningful disclosure about Year 2000 issues. The Task Force surveyed over 11,000 filings made by registrants since January 1, 1998. The Task Force looked for:

(1) The presence of Year 2000 disclosure in new registration statements and amendments to existing registration statements made since January 1, 1998;

(2) Whether Year 2000 disclosure was added in new registration statements and amendments that did not initially include such disclosure after receiving staff comments;

(3) Whether the 25 largest investment company complexes had made Year 2000 disclosure; and

(4) The quality of Year 2000 disclosure.

Summary of Investment Company Quantitative Disclosure

The Task Force reviewed the Year 2000 disclosure by the 25 largest investment company complexes. These complexes have assets in excess of $2.8 trillion and represented 59% of investment company assets as of December 31, 1997. Twenty-four of these complexes have made Year 2000 disclosure to their shareholders. In addition, the Task Force surveyed 740 registration statements filed since January 1, 1998 and found that 81% of these contained Year 2000 disclosure. The staff's policy of issuing a Year 2000 comment to registrants may have contributed to the high occurrence of Year 2000 disclosure.

This chart presents Year 2000 disclosure contained in initial investment company registration statements and amendments filed in calendar year 1998.

	No. of Filings	%
Investment Companies
New Registration Statements	96	56%
Amendments	446	43%
Insurance Products
New Registration Statements	44	27%
Amendments	210	30%

As mentioned above, the Division gave Year 2000 comments to all registrants that filed new registration statements and amendments but did not initially include Year 2000 disclosure. In most cases, Year 2000 disclosure was subsequently added to the final registration statements by the time they were used to sell to the public.

Investment companies may make Year 2000 disclosure in their registration statements (and prospectuses) or in their shareholder reports. Year 2000 disclosure was included in 6% of the shareholders reports. All other investment companies made Year 2000 disclosure in their registration statements. The revised Staff Legal Bulletin indicated that investment companies may be required to include Year 2000 disclosure in their registration statements. However, the staff continues to receive inquires asking whether Year 2000 disclosure may be appropriately included in the investment company's shareholder report. The staff has encouraged such reporting, and considers that it may be especially appropriate in cases where a registrant has concluded that the materiality of the problem does not warrant discussion in the registration statement. The following table provides information on whether and how the 25 largest investment company complexes made disclosure:²⁹

Year 2000 Disclosure Status of 25 Largest Investment Company Complexes
($2.8 Trillion in Assets)

	Investment Adviser	Name of Investment Company Complex	Assets in Millions (12/97)	2000 Year Disclosure
1	Fidelity Mgt. & Research	Fidelity	549,077.4	No30
2	Capital Research & Mgt.	Capital Research	242,930.3	Yes - P
3	Merrill Lynch/Fund Asset Mgt.	Merrill Lynch	200,590.1	Yes - P
4	Vanguard Group	Vanguard	197,689.8	Yes - S
5	Putnam Investment Management	Putnam	179,584.8	Yes - P
6	TIAA-CREF Investment Management	CREF/Insurance Products	118,612.1	Yes - P
7	Dean Witter Intercapital Inc.	Morgan Stanley/Dean Witter	98,254.6	Yes - P
8	Franklin Advisers	Franklin	95,538.6	Yes - P
9	Dreyfus Crop	Dreyfus	95,142.9	Yes - P
10	Smith Barney Inc.	Smith Barney	95,029.3	Yes - P
11	Federated Investors	Federated	87,691.9	Yes - P
12	Price (T. Rowe) Associates	T Rowe Price	83,428.9	Yes - P
13	Wellington Mgt./Vanguard	Vanguard	79,203.2	Yes - S
14	AIM Advisors	Amvescap/AIM	77,448.8	Yes - P
15	American Express Financial	IDS	75,367.7	Yes - P
16	Oppenheimer Funds Inc.	Oppenheimer	74,843.2	Yes - P
17	Alliance Capital Mgt.	Alliance	65,665.6	Yes - P
18	Massachusetts Financial Services	MFS	57,830.2	Yes - P
19	Schwab (Charles) Inv. Mgt.	Charles Schwab	54,799.7	Yes - P
20	Janus Capital Corp.	Janus	53,962.5	Yes - P
21	Templeton Investment Counsel	Franklin/Templeton	52,098.1	Yes - P
22	Prudential Mutual Fund Mgt.	Prudential	52,003.9	Yes - P
23	Scudder Kemper Investments/IL	Kemper	48,381.4	Yes - P
24	American Century /Investors Research Corp.	American/Twentieth Century	48,244.7	Yes - P
25	Scudder Kemper Investments/MA	Scudder	46,111.7	Yes -P

Legend:
P =	Disclosure in their investment company registration statements.
S =	Disclosure in a separate brochure addressing the issue.

Summary of Investment Company Qualitative Disclosure

The Task Force also made a qualitative examination of the disclosure by 50 investment company complexes. From this screening, from the examinations performed by the inspections staff and from the ICI survey, the staff understands that most investment companies have begun their remediation efforts and many investment companies (72%) have targeted the fourth quarter of 1998 for completing corrections of the Year 2000 problem. However, the Task Force found that most investment companies' Year 2000 disclosure was generic and did not specify the extent to which assessment and remediation efforts have been completed. In fact, most investment companies' (90%) Year 2000 disclosure indicated that they were identifying their Year 2000 exposure. Most (94%) of the investment companies described the Year 2000 issue in general terms, most (81%) indicated their reliance on external service providers in order to be Year 2000 compliant, and most (88%) made no mention of costs. Typically, an investment company's Year 2000 disclosure acknowledges the Year 2000 problem, states that the problems are being addressed and that the problems will be resolved, and that it cannot guarantee that its remediation efforts will prevent all problems. The general nature of investment company Year 2000 disclosure possibly can be explained by the heavy reliance by investment companies on external service providers (such as advisers, administrators, transfer agents, brokers, custodians) that have represented to the investment companies that they anticipate being Year 2000 compliant. Thus, the Year 2000 compliance of most investment companies is largely in the hands of other entities whose readiness they are not in a position to vouch for. However, as previously described, the Commission is considering proposing rules that would require investment advisers that advise investment companies to provide information on their Year 2000 readiness that could well provide better and more complete information to the public about fund readiness than attempts to improve the quality of fund prospectus disclosure. The results of the qualitative analysis are summarized below:

Table of Qualitative Findings in Investment Company Disclosure

Assessment – the extent to which the company has assessed the seriousness of its Year 2000 technology problems.
Assessment	Percentage
Completed	2%
In process	90%
To be started	6%
No mention	2%
Plan – the extent to which a company described its plan to remedy its Year 2000 technology problems.
Plan	Percentage
Detailed description	12%
General description	58%
No mention	30%
Timetable – the time frame within which a company intends to complete its assessment and/or its remediation plan. The Task Force considered disclosure such as "in time" or "by the year 2000" as "No mention."
Timetable	Percentage
Mentioned	23%
No mention	77%
Relationships – whether a company plans to evaluate or is evaluating the Year 2000 technology problems of those entities with which it has material relationships. i.e., external service providers such as advisers, brokers, and transfer agents.
Relationships	Percentage
Mentioned	81%
No mention	19%
Historical Costs – the amount of money a company has already spent on Year 2000 issues to date.
Historical Costs	Percentage
Mentioned	2%
No mention	98%
Estimated Costs – the amount of money a company estimates it will spend on Year 2000 issues.
Estimated Costs	Percentage
Mentioned	12%
No mention	88%
Materiality – whether a company disclosed that the Year 2000 issue is material to its business and, if so, the level of materiality.
Material Impact	Percentage
Could be material	31%
Materiality unknown	39%
Not material	13%
No mention	17%
Cautionary Language – whether companies included specific, general, or no cautionary language.
Cautionary Language	Percentage
General	94%
Specific	0%
No cautionary language	6%

D. Public Utility Holding Company Disclosure

The Commission regulates the financing activities and corporate structure of 19 registered public utility holding companies under the Public Utility Holding Company Act of 1935 ("PUHCA"). These 19 companies together represent 30% of the U.S. gas and electric industries.

Because of the important role that public utility holding companies play in the economy, in December 1997, Chairman Levitt sent a letter to the chief executive officer of each registered holding company emphasizing the importance of implementing plans and devoting resources to modify its systems in preparation for the Year 2000. Chairman Levitt also reemphasized the importance of providing investors with meaningful disclosure concerning any material effects that Year 2000 problems may have. The staff has raised the importance of Year 2000 readiness in meetings with the industry and during its inspections of registered public utility holding companies.

The staff also reviewed the disclosure of all 19 registered holding companies. The staff found that all the companies addressed Year 2000 issues in their disclosure. The review of disclosure by holding companies revealed that:

• All disclosed that they are aware of the Year 2000 problem, and most have completed their assessment phase and have initiated steps to address the problem;

• Most disclosed that the Year 2000 would not have a material effect on their company's results of operations or financial position given their corrective action;

• The companies indicated that their corrective actions depended, in part, on external suppliers and contractors;

• Individual disclosures of estimated costs ranged from $2 million to $95 million and;

• Many companies disclosed the possible effect of non-Year 2000 compliant systems could have on their generation, distribution, and other systems.

As described above, under PUHCA, the Commission is responsible for overseeing the organization, financial structure, securities issuances, acquisitions and affiliated transactions of public utility holding companies and their subsidiaries. Other federal and state agencies have the technical expertise to evaluate the effect of the Year 2000 problem on the reliability of utility operations. For example, the Department of Energy has asked the North American Electric Reliability Council to help prepare the electric supply and delivery systems of North America for transition to the Year 2000. The staff's inquiry regarding Year 2000 issues has focused largely on the public disclosures of registered holding companies. The staff has not made an independent assessment of the readiness of public utility holding companies for the Year 2000.

IV. Accounting and Auditing Considerations

Accountants and auditors play an important role in ensuring the accuracy of public issuers' financial statements. Year 2000 issues can affect financial statements in a number of ways. For example, if the accounting systems used by an issuer are not Year 2000 compliant, the financial statements may be affected. In addition, the Year 2000 problem may impose significant costs on an issuer, including the cost to remediate its systems, and may also threaten the ability of the issuer to continue in business.

Because of these potential effects, staff in the Office of the Chief Accountant has focused on how the Year 2000 changeover impacts the role of accountants and auditors. In particular, the Office has been working with the Emerging Issues Task Force ("EITF"), the Financial Accounting Standards Board ("FASB"), the Auditing Standards Board, and the American Institute of Certified Public Accountants ("AICPA") on Year 2000 issues, and has met with representatives of accounting firms and audit practitioners in order to better understand how they address Year 2000 concerns. The Office also has provided comment and interpretive advice to other SEC offices working on Year 2000-related rulemaking activity.

A. Current Practices of Major Accounting Firms

Based upon the staff's discussions with accounting firms, the staff understands that they are taking the potential impact of the Year 2000 issue on their clients' financial statements seriously. As a threshold matter, most major accounting firms have decided not to accept engagements to correct issuers' Year 2000 problems. Instead, the accounting firms have focused on advising their clients where potential Year 2000 problems might occur. Moreover, the staff understands that the firms have developed procedures to draw their clients' attention to the Year 2000, and that these procedures are applicable worldwide, not just to U.S. issuers. In fact, firms have indicated that they will do a significant amount of work whenever they believe that Year 2000-related issues pose a serious threat of affecting the client's financial statements. Where appropriate, this work will include bringing in computer specialists in order to obtain an understanding of the client's systems that are affected by the Year 2000 problem.³¹

As an example of what firms are doing, the staff described in last year's report how one international audit firm, as a matter of policy, required a warning about the Year 2000 problem in the management letters that were issued to all of their clients following the audits of 1996 financial statements. Other major firms indicated they have been taking a similar approach, and that this practice has continued in connection with more recent audits.

B. AICPA Guidance on Year 2000-Related Accounting Issues

The AICPA also has taken steps to alert the auditing profession to the seriousness of the Year 2000 problem, and to provide guidance to the profession regarding the application of accounting, disclosure, and auditing standards to Year 2000 issues. The AICPA guidance is important because it encourages all accounting firms to adopt the practice of warning clients about the Year 2000 problem. The guidance further suggests that auditors can direct their clients' attention to Year 2000 Issues by means of engagement letters, management letters, and discussions with management and audit committees.³²

As clarified in the AICPA's guidance, as part of an audit of an entity's financial statements, an auditor has the responsibility to consider the effects of the Year 2000 issue on the entity's ability to prepare financial statements in accordance with generally accepted accounting principles. The AICPA guidance does not require auditors to evaluate the effect that the Year 2000 problem will have on an entity's business operations. Although some may encourage auditors to go beyond evaluating whether the Year 2000 problem will affect the accuracy of the entity's financial statements, and perform this further analysis of its effect on the entity's business operations, it is not clear that auditors have the resources or expertise to perform that task without incurring substantial costs that would be passed on to audit clients.

The AICPA's guidance is summarized briefly below. Notably, although the term "may" is used throughout that guidance, perhaps suggesting that the guidance is discretionary, the Commission staff believes that the procedures outlined by the AICPA should be considered appropriate practice with respect to Year 2000-related issues at this time. The staff therefore expects that registrants will comply with AICPA's guidance. If they do not do so, registrants should be prepared to justify why the procedures were not followed.

Accounting and Disclosure

In the accounting and disclosure area, the AICPA's guidance includes, among other things, discussions of the following issues:

• accounting for costs associated with modifying computer software for the Year 2000,³³

• when revenue should be recognized and in what amounts for licensing, selling, leasing, or otherwise marketing computer software,³⁴

• consideration of product-warranty or defect issues,³⁵

• revenue recognition when the right of return exists,³⁶

• costs associated with selling, leasing, or marketing software,³⁷

• the impact of Year 2000 issues on the impairment of long-lived assets,³⁸

• the accounting for costs of software developed by a company for its own use,³⁹ and

• the disclosure of risks and uncertainties in areas such as the impairment or amortization of capitalized software costs, inventory valuation, long-term-contract accounting, warranty reserves, reserves for sales returns and allowances, or litigation.⁴⁰

Auditing

In the auditing area, the AICPA guidance discusses the following issues, among others:

• Amounts and Disclosures in Financial Statements: Because the remediation and replacement of computer systems that are not Year 2000 compliant will generally occur during 1998, there may be an increased risk of misstatement in the financial statements. For example, any or all of the accounting issues listed above may become a significant issue. As a result, auditors may need to (1) evaluate the effect of Year 2000 issues in their audit plans for 1998 financial statements, (2) identify specific controls that are likely to prevent or detect material misstatements, and (3) perform tests to evaluate the effectiveness of such controls.⁴¹

• Disclosures Outside the Financial Statements: The auditor has a responsibility to consider whether Year 2000 disclosures that are presented outside the financial statements (such as in Management's Discussion and Analysis of Financial Condition and Results of Operations) are materially misstated or are inconsistent with information, or the manner of its presentation, in the financial statements. If the auditor concludes that such is the case, the auditor must decide whether the financial statements, his report, or both, require revision.⁴² If the auditor concludes that the financial statements do not require revision, the client should be requested to revise the other information. If the other information is not revised, the auditor should consider other actions such as revising the report, withholding the use of the report in the document, or withdrawing from the engagement.

• Communications With the Client: During the audit of the client's financial statements, the auditor may obtain information about a client's progress on its Year 2000 compliance efforts that the auditor may wish to communicate to senior management and the audit committee.⁴³

• Consideration of an Entity's Ability to Continue as a Going Concern: The AICPA's Auditing Standards Board recently issued an interpretation of the auditing standard related to the "going concern" issue.⁴⁴ The auditing standard currently states, in part, that:

Under this standard, if the auditor concludes that there is a substantial doubt about the entity's ability to continue as a going concern, the audit report should include an explanatory paragraph to reflect that conclusion.⁴⁶ The newly issued AICPA interpretation states that Year 2000 issues might lead to "conditions and events" that raise substantial doubt about the entity's ability to continue as a going concern. "Conditions and events" for this purpose include, but are not limited to the absence of effective remediation plans, the actions of others affecting the entity,⁴⁷ the Year 2000 problems of customers, vendors and service providers, and the material costs that the client will incur to correct the problem and that could cause severe financial difficulties. The interpretation also references audit procedures that may be used to address these issues.⁴⁸

• The Processing of Transactions by Service Organizations: The AICPA also issued an interpretation of the auditing standard on the processing of transactions by service organizations (an entity that processes transactions for another entity called a user organization)⁴⁹ to address the Year 2000 Issues relating to audits of those organizations.⁵⁰ Among other guidance, the interpretation states that if the auditor of a service organization becomes aware of design deficiencies at the service organization that potentially could affect the processing of user organizations' transactions in future periods, the service auditor may choose to communicate this information to the service organization's management and consider advising management to disclose this information and its plans for correcting the design deficiencies.

  In sum, the staff believes that accountants and auditors play a key role in informing their clients about the Year 2000 problem and in assuring that their clients' financial statements remain in accordance with generally accepting accounting practices. The staff will continue to work with AICPA and the accounting firms to monitor whether accountants fulfill this role.

  V. Commission Internal Systems

  Responsibility for ensuring that Commission systems are Year 2000 compliant rests with the Executive Director and the agency's Associate Executive Director for Information Technology. The Office of Information Technology began its Year 2000 work in July 1996. Today, a task force of seven staff oversee the assessment, renovation, testing and implementation of all Commission internal systems.

  A. Progress Toward Year 2000 Compliance

  The following tables summarize the ongoing progress toward Year 2000 compliance for the Commission's internal systems:

  Status of Commission Internal System Renovation

  Cost of Commission Internal System Repairs
  

  Fiscal Year	1997	1998	1999	2000
  Annual Cost	$337,860	$1,559,500	$2,550,000	$850,000
  Cumulative Cost	$337,860	$1,897,360	$4,447,360	$5,297,360

  Summary of 90 Enterprise Applications
  

  	Total	Compliant Systems51	Applications To Be Replaced	Applications To Be Repaired	Applications To Be Retired
  Mission Critical	53	8	30	10	5
  Non-Mission Critical	37	11	11	10	5

  EDGAR, as one of eight Commission enterprise systems that the staff has determined to be compliant, is the subject of continuing, extensive review. The system's custom code (written in C and C++) will undergo an independent verification and validation review by an outside contractor in the third quarter of 1998 to validate the original assessment. EDGAR will also change dramatically over the next year and a half as the system undergoes extensive modernization pursuant to a new contract expected to be awarded in June 1998. New versions of EDGARLink (software used by filers), a new EDGAR document structure, as well as completely new dissemination and text management subsystems will all need to be put into place before the end of 1999. As these new components are added, they will be exhaustively tested to ensure the system remains compliant. EDGAR will undergo a second independent verification and validation review at the ten-month point of the new contract.

  As the summary chart above indicates, thirty of fifty-three mission critical systems will be replaced. The replacement effort has been split into several groups. The first group of eleven replacement systems is currently undergoing development testing and will enter Year 2000 validation testing at the end of June 1998. A second group of eleven will have been implemented by the end of 1998. Of the systems remaining, a contract will be let for seven, and one (payroll) will be transferred to another federal agency.

  Status of the 10 Mission-Critical Systems Being Repaired
  

  	Assessed	In Renovation	In Validation	Implemented
  Number	10	3	0	0
  Completion Date	May 1998	Feb 1999	June 1999	August 1999

  The Commission previously intended to complete its Year 2000 implementation by December 1998, however, implementation is now scheduled to be completed by August 1999. The Commission staff recognizes that its dates for renovation, validation, and implementation do not meet OMB's revised schedules for when OMB recommends that these tasks be completed. The staff is now working to compress its scheduled implementation dates to come closer to the OMB-suggested dates.

  In addition to working on its enterprise systems, the Office of Information Technology is engaged in assessing, repairing, replacing and retiring a number of PC-based systems located throughout the Commission. The status of this activity is shown in the chart below:

  Summary of 81 PC-Based Applications
  

  	Total	Compliant	To be Replaced	To be Repaired	To be Retired	Pending Assessment52
  Mission Critical	54	10	31	1	3	9
  Non-Mission Critical	27	2	11	1	7	6

  Infrastructure and Environmental Systems

  The Commission has requested certifications from either the building owners or from specific service providers responsible for its headquarters and Operations Center facilities for the following systems, services or equipment:

  1) Elevators
  

  2) Phones
  

  3) Street Power
  

  4) Emergency Generator Power
  

  5) Emergency Building Lighting
  

  6) Environmental Systems (HVAC)
  

  7) Automated Door Locking/Entry/Exiting Systems
  

  8) Emergency Annunciation Systems
  

  9) Emergency Fire Detection and Suppression Systems.

  Responses have not been received to all of these inquiries as of the date of this report, but of those received to date, none suggests there are any problems. All of the items above will be a part of the Commission's contingency planning.

  B. Contingency Planning for the Commission's Internal Systems

  The Commission's risk management strategy for its internal systems starts with its highest priority system, EDGAR. Although the staff has assessed EDGAR and believes that it is Year 2000 compliant, it will continue to review and test the system up through the end of 1999.

  Electronic filing after January 1, 2000 depends on the existence of two essential infrastructure elements: power and telecommunications (for both the filer and for the Commission). Outages and problems on either the filer's side or the Commission's side can be dealt with by existing Commission rules and regulations which permit filers to self-certify to a hardship exemption, and make their filings in paper. Although the hardship exemption permits the issuer to file in paper, it also requires the filer to follow up later with a confirming electronic copy when the problem has cleared. This helps to ensure the electronic filings database remains complete.

  An essential component of a properly constructed contingency plan is a well documented set of procedures that apply to each affected application. As the contingency plan for each system is developed, Commission staff are preparing written guidance to follow in the event of a system failure.

  VI. Investor Education

  The Office of Investor Education and Assistance ("OIEA") was added to the Commission Task Force during the past year in recognition of the fact that as the century change gets closer, investor concerns will grow. OIEA, as the Commission office with which investors have the most direct contact, will play an important role in the months ahead in giving investors accurate information on the status of the securities industry's Year 2000 remediation efforts, and by providing specific advice and guidance to investors on steps they can take to assess for themselves whether entities handling their investments are ready for the Year 2000.

  The Commission's efforts to reach out to investors on the Year 2000 issue include the following measures:

  Investor Complaints and Inquiries

  In 1997, the Commission received over 46,000 complaints and inquiries. A database of complaint information tracks breaking trends, allowing the office to identify problems and issues in the securities industry. The information gathered from investor inquiries helps direct the Commission's examination and enforcement resources to the areas of greatest need. In January 1998, we started tracking complaints, inquiries, and comments relating specifically to the Year 2000 issue. As of June 8, 1998, the office had received 16 inquiries concerning the Year 2000 issue.

  Investor Town Meetings and Seminars

  To meet investors and listen to their concerns, the Commission began to organize Investors' Town Meetings throughout the country in 1994. To date, Chairman Levitt has spoken at 25 town meetings. These events attract between 600 and 1200 investors and result in media coverage that reaches millions more. At each meeting, the Chairman discusses questions investors should ask before they invest, including those relating to the Year 2000. Seminars follow the town meetings so investors can learn more about specific topics of interest.

  The Year 2000 Page on the SEC Web Site

  In January 1998, the Commission added a page to its web site listing all the information the SEC has created on the Year 2000 issue. The URL address for this page is:

  http://www.sec.gov/news/extra/y2k/home2000.htm

  and is accessible from the Commission's home page at http://www.sec.gov. This page allows people to see all of the Commission's Year 2000 activities in one place, and currently provides the following information:

  • Questions for investors to ask about the Year 2000;

  • Issuer disclosure obligations related to the Year 2000;

  • Statements and testimony of the Chairman and Commissioners on the Year 2000 issue;

  • Proposed rules requiring reports from brokers, dealers, and transfer agents on their readiness for the Year 2000; and

  • The Division of Market Regulation's Year 2000 Work Program, which is a useful exam and review checklist that can be used to assess a company's Year 2000 program.

  Conclusion

  The Commission, the SROs, trade associations, and other participants that comprise the securities industry are devoting extraordinary time and resources to assessing and repairing their computer systems in order to be prepared for the century date change. From the staff's perspective, this effort is proceeding satisfactorily. However, there remain areas of concern. Focused, concentrated efforts by the Commission, the SROs, and industry participants on all problem areas and problem firms will be required to minimize to the greatest extent dislocations resulting from the Year 2000 problem. In addition, no matter how successful testing and remediation efforts are, there are bound to be disruptions and unexpected problems during the early months of 2000. The Commission is committed to taking the necessary steps to achieve the highest possible industry compliance rate and minimize the effect of any disruptions that occur. In addition, the Commission plans to continue to remind issuers of their obligation to provide disclosure on their Year 2000 programs.

  1Nearly one-half of the firms in this category reported "0%" completion. It appears that many (if not most) of the firms that reported zero percent completion are small firms relying on third party vendors for their information processing services, and, therefore, have no direct remediation program; SEC and NASD staff will closely follow up with such firms to validate both the reason for the figure reported and the validity of the assumptions underlying such an assessment.

  2Data provided by the Investment Company Institute. Information reflects responses to the ICI's questionnaire dated March 16, 1998. Responses were received from 77 investment company complexes between March 16 and June 3, 1998, and represent 66.0% of industry assets. Two of these firms did not provide a response to the question on completion date.

  3This is a report prepared by the staff of the Securities and Exchange Commission. The Commission has expressed no view regarding the analysis, findings or conclusions contained herein.

  4The NYSE milestones are: 1) identification of systems that need to be reviewed and upgraded; 2) review of systems and code plus appropriate changes; 3) successful testing of upgraded systems by users; 4) implementation of upgraded systems; and 5) determination that outside vendors' systems are Year 2000 compliant.

  5The NYSE did not include "floor brokers" in their survey, because these entities rely on systems provided by the exchange, which are included in the exchange's own remediation efforts. For similar reasons, the staff and SRO efforts to date have not included smaller, individual options market makers. In addition, there are approximately 800 inactive firms registered with the Commission.

  6Introducing firms are broker-dealers that, under a contractual arrangement with a clearing firm, transmit funds, securities and orders of customers to the clearing firm, which executes the orders and maintains custody of the customer funds and securities. Clearing firms are broker-dealers that process transactions and maintain custody of funds and securities either for themselves or on behalf of another broker-dealer. In addition to holding funds and securities, clearing firms are contractually responsible for the settlement of the securities transactions of the other broker-dealer and the maintenance of certain records relating to those transactions.

  7NASD identifies firms in its "other" category as insurance companies, investment companies, merger and acquisition companies, limited partnerships and other firms not specifically designated as introducing or clearing.

  8It appears that many (if not most) of the firms that reported 0% completion are relying on third party vendors for their information processing services, and therefore have no direct remediation program. SEC and NASD staff will closely follow up with such firms to validate both the reason for the figure reported, and the validity of the assumptions underlying such an assessment.

  9The number of firms responding to this particular question on the NASD survey is reduced from the number reporting on percent completed because of the manner in which NASD's Question 12 was asked: "When is your firm scheduled to complete the following major milestones of its Year 2000 project." Consequently, firms that reported either zero percent completed (no internal program), or that they were finished, generally did not respond to this question. For the purposes of this table "Remediation" refers to the repair of a system through code repair, internal testing and final implementation within the firm.

  10Some entities that have more than one registered broker-dealer filed one comprehensive report.

  11Due to rounding, some of these figures do not add up to 100%.

  12The Securities Exchange Act of 1934 identifies the bank regulators as the Appropriate Regulatory Agencies (ARAs) for bank transfer agents. At the same time, the Commission is authorized to examine bank transfer agents, and it does so on a regular cycle. To avoid duplicative reviews of bank transfer agents' Year 2000 programs, the Commission agreed with the bank regulators that the bank regulators would examine all bank transfer agents for Year 2000 compliance.

  13Information reflects responses to the ICI's questionnaire dated March 16, 1998. Responses were received from 77 investment company complexes between March 16 and June 3, 1998 and represent 66.0% of industry assets. Two firms did not provide a response to the question on completion date.

  14The staff also conducted a large number of non-cycle cause examinations, special purpose examinations, and training examinations for state regulators during this period.

  15The firms participating in beta testing account for approximately 50% of each day's normal trading volume.

  16The Basle Committee was established by the central bank Governors of the Group of Ten countries in 1975. It consists of senior representatives of banking supervisory authorities and central banks from Belgium, Canada, France, Germany, Italy, Japan, Luxembourg, the Netherlands, Sweden, Switzerland, the United Kingdom, and the United States.

  17The Coordinating Group is currently comprised of representatives from 73 financial institutions in 19 countries: Argentina, Australia, Brazil, Canada, China, Denmark, France, Germany, Hong Kong, Italy, Japan, Mexico, the Netherlands, Singapore, South Korea, Spain, Switzerland, the United Kingdom and the United States.

  18For detailed results of the survey of public issuers, see Staff of the United States Securities and Exchange Commission, Year 2000 Disclosure Task Force Survey (June 1998). A copy of the survey is available on the Commission's web site at http://www.sec.gov.

  19 State and local governments are subject to the same Year 2000 problems as anyone else, and their operations (such as their ability to collect revenue, administer budgets and make timely payments, including payments to investors in their bonds) could be adversely affected. However, municipal bond issuers are not subject to the same line-item provisions as are publicly-owned corporations or investment companies. Consequently, they are not obligated to follow the guidance provided by Staff Legal Bulletin No. 5. Issuers of municipal securities are subject to the anti-fraud laws, however, and should include material facts regarding potential effects of Year 2000 problems on their operations as well as their ability to make timely debt service payments in their disclosures, whether in primary offerings or in making statements to secondary markets. The SEC's Office of Municipal Securities will continue to encourage issuers of municipal bonds and parties assisting issuers in preparing their disclosures to provide accurate, material information to investors on Year 2000 issues. In addition, the Office of Municipal Securities and the Municipal Securities Rulemaking Board will work cooperatively in the next year and a half to alert dealers in municipal securities to the Year 2000 issue, both as it may affect their operations and the securities they sell.

  20 In May 1997, the Division of Corporation Finance updated its Current Issues and Rule Making Projects outline to discuss the need for public companies to disclose the effect of Year 2000 technology problems. The update described generally the nature of these issues and the disclosures that public companies should make.
  

  21 A staff legal bulletin represents the staff's views only and is not a rule, regulation, or statement of the Commission.
  

  22 Revised Staff Legal Bulletin No. 5 supersedes the original bulletin and is located on the SEC's web site at http://www.sec.gov/rules/othrindx.htm.
  

  23 In addition, Senate Financial Services and Technology Subcommittee Chairman Robert Bennett has introduced legislation, the Year 2000 Computer Remediation and Shareholder Protection Act of 1997 (S. 1518), which would require public companies to disclose their Year 2000 issues.
  

  24 See Item 303 of Regulations S-K and S-B.
  

  25 This guidance is not exclusive. Compliance with the Staff Legal Bulletin does not necessarily constitute compliance with the disclosure requirements of the federal securities laws. Companies need to consider these laws and the SEC's rules and regulations in addition to the bulletin.
  

  26Revised Staff Legal Bulletin No. 5 did not request this disclosure. Rather, companies are required to make this type of disclosure in the "Results of Operations" section of MD&A.

  27Seven of the Fortune 100 companies are not publicly held.

  28The Information Technology Association of America has compiled a list of pending class-action lawsuits regarding Year 2000 warranties. See http://www.itaa.org/Y2Klaw.htm#Lawsuit .

  29This table was compiled using information from three separate sources: Lipper Analytical Services, Inc. Summary Statistics, First Edition 1998, Lipper Closed-End Fund Performance Analysis Service January 31, 1998, and Morningstar Principia for Variable Annuities/Life January 1998.

  30 Representatives of Fidelity have informed the staff that they are aware of the Staff Legal Bulletin and believe that Year 2000 issues will not materially affect their ability to provide the services described in their registration statements. Personnel at Fidelity have been working on Year 2000 corrections since 1996, report frequently to the fund boards, and continue periodically to review the need for disclosure. In addition, they are considering providing supplemental communication to shareholders about Year 2000 issues.

  31 The accounting firms have indicated that they are aware of the auditor independence issues and are maintaining their independence with respect to the services offered in connection with correcting Year 2000 problems.
  

  32The guidance is contained in the report entitled The Year 2000 Issue: Current Accounting and Auditing Guidance ("Guidance"). It was published in November 1997 by the AICPA and summarized the existing accounting, disclosure, and auditing standards at that time. The AICPA plans to update the Guidance later this summer and add guidance relating to specific industries.

  33 The Guidance includes a discussion of the decision by the EITF in 1996 to expense such costs, and notes the remarks of the SEC's Chief Accountant at the July 23-24, 1997 meeting of the EITF that future costs to modify software for the Year 2000 problems are not a current liability, and the SEC staff would object to the accrual of such costs.
  

  34AICPA Statement of Position ("SOP") 97-2, "Software Revenue Recognition."

  35FASB No. 5, "Accounting for Contingencies."

  36FASB Statement No. 48, "Revenue Recognition When Right of Return Exists."

  37Statement No. 86, "Accounting for the Costs of Computer Software to Be Sold, Leased, or Otherwise Marketed."

  38FASB Statement No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."

  39AICPA SOP 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use."

  40AICPA SOP 94-6, "Disclosure of Certain Significant Risks and Uncertainties."

  41AICPA, "Codification of Statements on Auditing Standards," section ("AU Section") 319.47 - .48

  42AU Section 550

  43AU Sections 325 and 380.

  44AU Section 9341. The interpretation is available on the AICPA's web site http://www.aicpa.org and will be effective when published in the Journal of Accountancy in July.

  45AU Section 341.02

  46AU Section 341.12

  47One such action specifically mentioned is regulatory action. Under the SEC's financial responsibility rules, broker-dealers and non-bank transfer agents must maintain, on a current basis, certain books and records. The staff of the SEC has indicated that regulatory action involving termination of operations would result if a broker-dealer or non-bank transfer agent could not maintain these books and records on a current basis because it was not Year 2000 compliant.

  48AU Section 341.14-.16. In addition, the interpretation covers other items relating to the Year 2000 issue, such as "Using the Work of a Specialist," since the auditor may not have (nor would be expected to have) specialized skill or knowledge in these areas. AU Section 341.22-.27.

  49

50The interpretation appeared in the March 1998 Journal of Accountancy.

51Systems in this category have been assessed as compliant. Software, databases, communications, interfaces and operating systems have been reviewed, and a judgment made that the system will function properly in a Year 2000 environment. These systems, however, will continue to be reviewed and tested thoroughly in order to minimize the risk that they will experience an unexpected failure.

52Assessments of commercial products are based upon certifications provided by the vendor of each product. The Commission is waiting for vendor letters in the case of all of the mission-critical systems and two of the non-mission-critical systems. The Commission will address the remaining four non-mission-critical systems itself.

http://www.sec.gov/news/studies/yr2000-2.htm