April 19, 2000

Securities and Exchange Commission
450 Fifth Street N.W.
Mail Stop 6-9
Washington, DC 20549-0609
Email address: rule-comments@sec.gov
Attention: Jonathan G. Katz, Secretary

Re: File No. S7-03-00
Comments on Proposed Rule, Releases No. 33-7793; 34-42354

Ladies and Gentlemen:

The Committee on Securities Regulation of the Business Law Section of the New York State Bar Association appreciates the opportunity to comment on the proposed rule, that would add new Items 302(c) and 302(d) to Regulation S-K. The Committee on Securities Regulation is composed of members of the New York State Bar Association, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was circulated for comment among members of the Committee and the views expressed in this letter are generally consistent with those of the majority of the members who reviewed the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.

A. General

We appreciate the opportunity to provide comments to the Securities and Exchange Commission on the proposed rule. The proposal would require companies to disclose: (1) valuation or loss accrual accounts, including all Statements of Financial Accounting Standards No. 5 (accounting for contingencies) (FAS 5) reserves, such as reserves for pending litigation, environmental remediation costs, contingent tax liabilities and product warranty liabilities (proposed Item 302(c); and (2) information about changes in long-lived assets and corresponding depreciation, depletion and amortization accounts (proposed Item 302(d)).

We agree with the overall goal of the Commission to eliminate abusive "earnings management." However, the proposed disclosures would jeopardize the attorney-client privilege and could constitute admissions against interest, in addition to disclosing highly sensitive, proprietary, competitive information that would result in substantial harm to issuers and their shareholders. In addition, we believe that the proposal would impose cost burdens on reporting companies in excess of the estimates in the Release. There should be a compelling need for the proposed disclosures to balance against the economic and competitive harm and the loss of attorney-client privilege, to justify the proposed new disclosures. However, there has been no showing of a compelling need, or of any real need, for the proposed disclosures. Accordingly, we respectfully urge the Commission to withdraw the proposal. If the Commission decides not to withdraw the proposal, we request the opportunity to meet with the Staff prior to adoption because of our concerns regarding attorney-client privilege and communications with clients.

B. The Attorney-Client Privilege and the Expectation of Confidentiality Would be Lost if the Proposed Disclosures are Required

The proposed disclosures about loss accruals from pending litigation, environmental, tax and certain other contingencies pose a serious risk of waiving the attorney-client privilege. The policy behind that privilege--to facilitate the full development of facts essential to proper legal representation and to encourage clients to seek early legal assistance--also serves to ensure accurate financial reporting. For example, FAS 5 specifically refers to the opinions or views of legal counsel among the factors to be considered in determining whether loss accruals are necessary.

The proposed disclosures would in effect require corporate clients to disclose otherwise privileged information, thus arguably waiving their right to assert the attorney-client privilege, and require their lawyers to waive the right to assert work product privilege, with respect to the proposed disclosures of information underlying the basis for reserves for litigation, as well as environmental remediation, tax disputes, and certain other loss accruals. It is well-established that a corporation is entitled to the protection of the attorney-client privilege, and thus, to withhold information from scrutiny by the judicial process provided that the corporation can show that (i) the information was disclosed by a corporate employee acting within the scope of that employee's corporate duties, (ii) in seeking legal advice from counsel, (iii) the information was considered confidential when made available, and (iv) its confidentiality has been maintained.

We understand that the Federal securities laws are based on the fundamental principle that full, fair and complete disclosure is the best method for assuring the integrity of the financial markets, and that there is an inherent tension between full disclosure and respecting the attorney-client and the related work product privileges. Society, however, has determined that encouraging clients to make full disclosure of information to their attorneys makes it more likely that an attorney will obtain the information needed to provide good legal advice, and that obtaining good legal advice is so important in a society governed by law as to warrant protecting the attorney-client privilege, even when giving others access to this information would further the pursuit of justice.

For the Commission to adopt regulations which would require disclosure of information provided in connection with legal advice will have the effect of compelling corporate clients to waive the attorney-client privilege. Moreover, there may be circumstances under which the effect of the proposed regulations would also compel corporate attorneys to waive the work product privilege. In addition, clients have the expectation of confidentiality of communications with corporate counsel. See, Canon 4 of the Code of Professional Responsibility - A Lawyer Should Preserve the Confidences and Secrets of a Client.

Finally, in the long run, adoption of the proposed disclosures may defeat the very purpose for which they are adopted, and even have the reverse effect from that which is intended. An attorney who knows in advance that he or she will be compelled to disclose sensitive information regarding whether there is "probable" liability , including increases or decreases in the probable dollar amount of liability, or other sensitive information which can be gleaned from the disclosure of the basis for accruals and the changes in accruals, will (in fact, must) advise the client that: (1) there is a requirement to disclose; and (2) as a result the attorney-client privilege may be waived and confidentiality of client confidences may not be preserved. A necessary result will be to encourage reporting companies to make less than complete disclosures to their attorneys. The consequence, however unintended, might well be financial statements which contain less accurate evaluations of litigation and other loss contingency reserves.

C. The Proposed Disclosures Would Cause Significant Competitive and Economic Harm to Reporting Companies with Resulting Economic Harm to Their Shareholders

It is hard to think of more damaging disclosures to the competitive and financial position of reporting companies and the economic interest of their shareholders, than the new reserve and loss accruals specified in the proposing Release. Only plaintiffs, the plaintiffs' bar, taxing authorities, and competitors will benefit.

The proposed rule would require that all reserve and loss contingencies be reported, separately by major class of loss accrual accounts, including the following reserves:

For each of the above reserves, reporting companies would have to disclose:

First of all, the disclosures could themselves constitute an admission of liability introducible in court. In any event, it would provide a roadmap for plaintiffs' attorneys to use in discovery. Depending on the level of detail or aggregation which would have to be used in the disclosures, which is not clear from the proposing Release, information on specific cases might be discerned. This would be more likely on an on-going basis when additions and deductions to previously reported balances would have to be separately disclosed. Moreover, the Release would require that changes in assumptions used in estimating the reserve that had a material effect on the change would have to be disclosed, which could very easily be tied to specific litigation.

In addition, these disclosures could affect the ability of reporting companies to pursue strategies in the company's best interests. For example, in establishing reserves for a pending litigation or class of litigation, a factor to be considered in determining the probability of liability and estimation of loss, is the willingness and level at which a company might settle litigation. This always is an important strategic issue for a company to balance against the cost of litigation, adverse publicity and distraction from other business imperatives. We believe that the proposed disclosures would have the unintended effect over time of driving reporting companies to a more adversarial strategy in dealing with litigation in order to avoid laying out their willingness to settle and at what price. Obviously, these disclosures would severely affect a company's ability to negotiate favorable settlements. The starting point for discussions will necessarily be the amount a company has already reserved.

Reporting companies will suffer similar economic harm in dealing with tax matters. A company's obligations to its shareholders include operating in a manner to obtain favorable tax treatment in accordance with existing law. Because of the uncertain nature of applicable statutes, rules, regulations, interpretations and positions of taxing authorities, this necessarily will involve issues in which a legitimate tax position of a company may be challenged by taxing authorities. The required proposed disclosures would interfere with a company's ability to negotiate favorable settlements in the same manner that the ability to settle pending litigation would be affected. Similarly, over time we believe that a company's tax strategy will be adversely affected.

These disclosures would reflect, and as a result invite comparison of, litigation, tax, pricing and contracting strategies of competitors. It is easy to imagine this occurring in the initial filings by competitors, if the proposal were adopted. The competitive harm would be more severe with respect to overseas competitors not subject to similar disclosure requirements. We would also expect the plaintiffs' bar to review these filings to see which companies are "easy pickings".

These disclosures not only would interfere with a company's ability to effectively manage its litigation, tax matters and competitive strategies, but they would also interfere with negotiations and contractual relations with suppliers and customers. In particular, the proposal would require disclosure of information on reserves with respect to loss contracts. It is expected that these contracts would probably be long-term, major contracts with on-going implementation and administration issues requiring negotiations and settlement. Again, reporting companies would be severely disadvantaged in dealing with a customer or supplier if these reserves accruals were disclosed. This would also provide competitors with helpful information on margins and costs they otherwise would not have. Finally, it is possible that both sides of the same long-term contract may be taking and disclosing reserves. The proposed disclosures would turn the financial statements into a strategic negotiation exercise.

D. There Has Been No Showing of a Legitimate Need for the Additional Disclosures

In light of the loss of the attorney-client privilege and the substantial harm to reporting companies and their shareholders if the proposal were adopted, there should have to be a compelling case for requiring the additional disclosures. However, there has been no showing of any real need for the additional disclosure.

1. Investors and Analysts Covering Specific Companies
Have Not Been Seeking this Information from Companies.

We are not aware that this information is a priority item for securities analysts following registered companies or institutional or individual investors. Some of our Committee members who represent large and small companies report that their client companies have not been seeing requests for this information from analysts or institutional or individual investors. There has been no showing of a pressing need for this information or that disclosure of this information is essential for analysts covering registered companies or the companies' investors.

The proposing Release does refer to a letter request from the Association for Investment Management and Research for detailed schedules of property, plant and equipment and related accumulated depreciation, depletion and amortization, similar to the disclosure the Commission rescinded in 1994 in accordance with the views of a majority of the commentators. Again, analysts covering registered companies and institutional and retail investors have not been asking for this information, and the cost and burden on the companies to gather the information would be significantly in excess of the amounts estimated in the proposed Release. While some parties may favor the proposed disclosures, there is no need shown that would justify the harm to reporting companies and their shareholders and the additional cost and burden.

2. Current Requirements of FAS 5 and Other
Commission and Accounting Pronouncements
Adequately Protect Investor Interests

To begin, we are discussing reserves or accruals that have been charged against income and are fully reflected in reported results. This means that reported earnings should reflect all costs that are attributable to operations under applicable accounting standards. The proposal does not attempt to change the underlying rules governing when to reserve or accrue or how much to reserve or accrue. Therefore, the proposal will not change reported earnings, and no claim is made in support of the proposal that the present requirements are deficient. However, we believe if adopted the proposal would have the unintended consequence of pushing reporting companies to delay making certain reserves and reserving smaller amounts, with a resulting impact on reported earnings.

In addition to total earnings, there is also the classification of the reserves and accruals on the income statement. Generally, the reserves and accruals are distributed to the appropriate cost-causing line item on the face of the income statement. Thus, the reader of the financial statements will have an accurate picture of the level of various types of costs and expenses, including Costs of Goods; Selling, General and Administrative; Research and Development; and various ratios such as gross margin and operating margin. That the reader may not know how much of any specific line item may be attributed to a reserve or loss accrual in no way changes the fact that the reader is given an accurate picture of the magnitude of various specific items, categories and ratios of costs and expenses.

Even without adoption of the proposal, the amounts, changes and other details of the following reserves are already disclosed under current accounting rules:

Additionally, based upon a spot survey we did of 20 representative reporting companies, we believe that all or almost all reporting companies are disclosing allowances for doubtful accounts, receivables and uncollectibles, and that most companies disclose valuation allowances on deferred tax assets, where material, in the schedules to Form 10-K.

That leaves undisclosed essentially the reserves or accruals whose disclosure would be most damaging to reporting companies such as pending litigation, environmental remediation costs, contingent tax liabilities, warranty claims and contractual reserves.

Finally, there are stringent standards for establishing the reserves and significant review and oversight of the process. In the first instance, the decision on whether to establish, and if so the amount of, a reserve or accrual is the responsibility of management. This would involve the company's accountants responsible for financial and SEC reporting and the company's chief accounting officer and chief financial officer. Because many of these decisions on reserves and accruals are based on legal issues, the process often also involves the opinion and advice of company counsel. The decision is then subject to review by the company's independent auditors. We note that independent auditor review now is mandated for interim financial statements as well as the annual audit, under recently adopted Commission rules.

Further, the independent auditor is required to discuss certain matters with the company's audit committee or chairman of the audit committee, for both annual, audited and quarterly financial statements under new requirements which implement the Blue Ribbon Panel on Audit Committees recommendations, including:

Finally, the audit committee itself will be composed entirely of directors who are independent of the company and its management and who are financially literate.

E. The Generation and Collection of Information for the Proposed Disclosures Would Impose Significant Cost Burdens

We believe that the Commission's annual cost estimate in the proposing Release of $6,500 per registered company on an on-going basis after the initial start-up cost, or a total of $18,850,000 in aggregate for 2900 registered companies, substantially understates the cost that would be imposed by the proposed disclosures. In addition, the Commission's estimated initial start-up cost also is substantially understated. While we are not providing cost information, we understand that some registered companies or associations or organizations will provide the Commission with cost estimates based on the experience of a number of corporations. We also understand these cost estimates will be far in excess of the Commission's figures which were based on information provided by a single, diversified multi-division registrant. The reason for this disconnect between the cost figures used by the Commission and the corporate experience of reporting companies apparently is attributable to an assumption used by the Commission that the information needed for preparation of the disclosures is presently readily available. As we understand it, corporations with many units doing business in multiple locations would be required to develop and capture information far in excess of what they currently generate to manage their businesses and meet present compliance requirements.

F. Set Out Below Are Comments on the Specific Questions Raised in the Proposing Release

1. Are there other specific loss accrual or valuation accounts that should be added to the list of accounts identified within proposed Item 302(c)?

No. We believe that the Commission should withdraw the proposal because several of the loss accruals would harm companies and their shareholders.

2. Should specific percentage tests be used to trigger specific account disclosures within the proposed rules? For example, should disclosure of loss accrual account activity be required only when the balance sheet item and change during the period exceeds a certain pre-established numerical threshold (for example, 5% of total assets or 3% of pretax income)? If so, what is an appropriate threshold?

If the proposal is adopted, a materiality threshold should be provided without providing specific quantitative tests. Materiality should be determined by existing general principles.

3. Should the placement of the proposed data be moved within MD&A or to some other section of the filing to enhance the prominence of the disclosure?

If the proposal is adopted, we believe that the information should be in the Schedule to Form 10-K. Also, we believe that any disclosures should be supplementary financial information not part of the audited financial statements and MD&A.

4. Should presentation of the proposed data be limited to the Form 10-K?

Yes. Presentation of the additional disclosures, if required, should be limited to the Form 10-K.

5. Should the disclosure requirements be restricted to those registrants that exceed a certain size or meet some other threshold? If so, what would be the appropriate threshold?

We believe that a size threshold would not be appropriate.

6. Are there circumstances where registrants may appropriately exclude disclosure about loss accruals related to litigation because of concerns about confidentiality while still conforming with GAAP? If so, please describe such circumstances in detail.

See Sections B and C above regarding litigation reserves, as well as other loss contingencies such as contingent tax liabilities and environmental reserves.

7. Should the disclosures concerning valuation and loss accrual account activity be required when interim financial statements are presented?

No. If the proposal is adopted, the harm to reporting companies and their shareholders would be increased if the disclosures were required for interim financial statements.

8. Should the disclosures concerning changes in property, plant, equipment, and intangible assets and related accumulated depreciation, depletion, and amortization be required when interim financial statements are presented?

Same as response to Question 7.


We hope that you will find these comments helpful. For the reasons discussed above, we respectfully urge the Commission to withdraw the proposal. Because of the importance of this matter, we would welcome the opportunity to meet with you to discuss these comments further.

Respectfully submitted,


/s/  GUY P. LANDER / by MJH

Guy P. Lander
Chairman of the Committee

Drafting Committee:

Michael J. Holliday
Micalyn S. Harris

Copy to:
The Honorable Arthur Levitt, Chairman
The Honorable Paul R. Carey, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Norman S. Johnson, Commissioner
The Honorable Laura Simone Unger, Commissioner
David M. Becker, General Counsel
David B. H. Martin, Director, Division of Corporation Finance
Lynn E. Turner, Chief Accountant
Harvey Goldschmid, Consultant to the Chairman