April 11, 2000
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington D.C. 20549-0609
Re: File No. S7-03-00
Release Nos. 33-7793; 34-42354;
Supplementary Financial Information
Dear Mr. Katz:
The purpose of this letter is to provide a note of caution to the present process of expanding financial disclosure. On its face, under the rubric of achieving greater "transparency" in financial reporting, the Release would reverse six decades of wisdom in determining what is "material" under the federal securities laws. This cannot have been intended. Properly managed, the current process can avoid this pitfall while improving disclosure.
Since 1933, much truly significant information about registrants has not been considered "material" under the securities laws. There are many reasons for this. A sufficient reason is that disclosure of such significant information would aid the adversaries and competitors of registrants more than it would aid the security holders of registrants. Such disclosure would not further the primary purposes of the securities laws: capital formation and fair, orderly securities markets.
Examples of undoubtedly significant information which have not been considered "material" under the securities laws include:
The Coca-Cola formula.
The anti-trust defense strategy of IBM.
The tax strategies of tax litigants.
The specialty steel alloy formulas of Bethlehem Steel Corporation.
The medical history and psychological profile of the CEO and senior executives.
The details of raw material and inventory reserves of manufacturing companies.
The breakup defenses and strategies of ATT.
The computer codes of Silicon Valley companies.
The asbestos defense strategy of Johns Manville.
The pricing strategies of consumer goods companies.
The transfer pricing strategies of multinational corporations.
The antitrust strategy of Microsoft.
None of the undoubtedly significant information listed above has been considered "material" under the securities laws. It has not been the subject of disclosure. Not as "confidential treatment" disclosure. Not to anyone.
The specific reasons why the securities laws have never considered such undoubtedly significant information to be "material" vary with the contexts. Underlying all of the reasons and contexts is the subtext that the securities laws never set out on a foolish quest for disclosure of all important information for its own sake. Rather, they have always been grounded in a collective wisdom which sensed when information would aid capital formation and orderly securities markets and when, on the other hand, it would aid the adversaries and competitors of the disclosing companies.
In the area of pending and threatened litigation, the historic 1975 agreement between the ABA and the AICPA preserved the crucial element of attorney-client privilege while clarifying the liturgy of representations among registrants, attorneys and auditors and of resulting public disclosure by registrants.
In the area of financial reserves, recent Commission initiative has addressed the role of the audit committee and the role of the auditors. These initiatives did not disturb the fundamental relationship with public audiences, including the investing community: the registrant sets the reserves; the auditor reviews them; neither discloses to the public the competitive or privileged details of those reserves. It is enough for the investing community to know that the registrant is winning or is losing or is experiencing change, and that auditors have rendered their opinion on the financial statements.
Otherwise put, the securities laws have never put on blinders which would require them to view disclosure solely in terms of the interests, prurient or otherwise, of the players in the securities markets. The securities laws have never required registrants to perform like ancient Greek athletes, naked on the athletic field, while their competitors and litigation adversaries are permitted the advantages of armor, secrecy and guile. Historically, the securities laws have recognized that their basic purposes - capital formation and fair, orderly markets - are best served by tailoring disclosure requirements to the balance between investor need and investor detriment, and by refraining from requirements which would see registrants and their investors forfeit the advantages of confidential strategy, planning and anticipation, and lawyer-client privilege.
The Proposed Disclosure
On its face, the Release would abandon the wisdom of the last six decades. The Release would require a registrant to:
"List separately," and
"Describe the nature of," and
"Disclose" the "various elements comprising a registrant's liability for," and
"Describe the nature of any changes in the assumptions used in estimating"
any and all of the following:
Product warranty liabilities;
Liabilities for employee termination costs;
Liabilities for environmental costs;
Deferred tax assets;
Liabilities for discontinued operations;
Contingent income and franchise tax liabilities;
Probable losses from pending litigation.
Such disclosure, if mandated, would delight competitors, current litigants, prospective litigants and tax authorities. It would spell corresponding disaster for the stockholders of publicly held companies by miring these companies in litigation, compromising their defenses in such litigation, and compromising their confidential competitive advantages within their respective industries. The net result would be to harm investors and breed further unrest in the already roiled securities markets.
Despite the best efforts of the Commission, the securities markets of the United States, while in many respects the fairest in the world, are increasingly fraught with fraudulent practices. False statements are deliberately circulated in an effort to adversely affect stock prices. An "environment of lawlessness" pervades the Internet. The laws governing short selling are flouted and not enforced. Price spreads are manipulated. The excessive market swings of the past week have undoubtedly been exacerbated by such underlying market behaviors which are in the interest of neither capital formation nor orderly markets.
This current era of ungovernable markets is the absolutely wrong time to strip registrants of legal privilege, to compromise their litigation defenses, or to require disclosure of their strategies to competitors - by enlarging the accepted understanding of what is "material" in terms of disclosure, albeit in the financial context. That is not what the securities laws have ever been about or ever should be about.
Accordingly, without repeating the detail presented in comment letters from others, it is the sole purpose of this letter to urge that the present process of considering the expansion of financial disclosure should observe and preserve, and not compromise:
The 1975 ABA/AICPA agreement re FASB No. 5;
The interests of tax, commercial, environmental and other litigants; Confidential competitive advantage.
We appreciate the opportunity to present these comments.
Richard H. Troy
Senior Vice President, General Counsel and Secretary
Cc: The Honorable Arthur Levitt, Chairman
The Honorable Norman S. Johnson, Commissioner
The Honorable Isaac C. Hunt, Jr., Commissioner
The Honorable Paul R. Carey, Commissioner
The Honorable Laura S. Unger, Commissioner
David Becker, Esq., General Counsel
David Martin, Esq., Director, Division of Corporation Finance