By Electronic and Overnight Delivery
May 13, 2003
Jonathan G. Katz
Re: File No. S7-06-03
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Federal Regulation of Securities, Section of Business Law of the American Bar Association (the "Committee")( in response to the Securities and Exchange Commission's request for comments on its March 21, 2003 release described above (the "Proposing Release").
The comments expressed in this letter represent the views of the Committee only and have not been approved by the American Bar Association's House of Delegates or Board of Governors and therefore do not represent the official position of the ABA. In addition, this letter does not represent the official position of the ABA Section of Business Law, nor does it necessarily reflect the views of all members of the Committee.
Introduction and Recommendations
As discussed below, the Committee has the following principal comments:
In addition, the Committee comments below on the technical changes to Rules 13a-14(b) and 15d-14(b) and makes other technical recommendations with respect to the proposed amendments to the exhibit requirements of Item 601.
I. 906 Certification Should Not Be Required To Be Public
The Proposing Release contemplates requiring that the 906 certification be an exhibit to the related report. The legislative history of Section 906 is very limited (see Annex I), and does not explain the differences in its wording as compared with the Section 302 certification. Specifically, the legislative history neither explains the intended meaning of the phrase "accompanied by" nor suggests that the certification be made public. Accordingly, we believe that Section 906 should be applied as written, which is as a basis for criminal liability, and that policy considerations, as described below, justify the conclusion that publication should not be required. Rather, the Commission should allow the practice that has developed for alternative methods of submission of Section 906 certifications to continue. Many companies choose to include the certifications in their filings, typically as exhibits. Others choose to submit them as correspondence so that they are not available to be relied upon as a basis for civil liability. Companies should continue to have this choice.
The Commission's reasons for its proposal appear to be based primarily on administrative considerations - to facilitate tracking 906 submissions. We believe that purpose can be fully served without mandating public disclosure. For example, the Commission could program EDGAR to treat as confidential (as it does with correspondence) the exhibit number specified for the 906 certifications. Alternatively, a separate confidential form containing the 906 certifications could be required to accompany the related report. If the Commission's primary concern is public visibility of 906 compliance for tracking purposes, it can accomplish that while allowing confidential submissions by a simple mechanism that it employs for other purposes -- it can modify the periodic report form to include a box on its face that a registrant is required to check if it is simultaneously submitting the 906 certification or if it is properly not submitting the certification because the report does not contain financial statements or the filer is not an "issuer" required by the Exchange Act to file reports. If an issuer were to fail to submit a required 906 certification, or if a signing officer were to qualify the certification in a material respect, the Commission has already made clear, and could further emphasize, that existing requirements mandate explanatory disclosure.
Many companies and their counsel are concerned about the private liability implications of the Commission's proposal to require publication of the 906 certification. As a criminal statute, Section 906 should not be administered in a fashion that interferes with the balance of civil liability for disclosure. With respect to management certifications, public disclosure is already addressed in Section 302. In contrast, the 906 certification is more broadly worded (for example, it contains a "fully complies" certification without a materiality qualification and serves a different purpose - management accountability to the government prosecutorial function - than the 302 certification). Under some circumstances, a 906 certification, if publicly available to be relied upon, could be utilized by a plaintiff to allege a basis for liability that did not otherwise exist and potentially to shortcut one or more elements of a Rule 10b-5 or other cause of action on the certified report. For example, the "fully complies" certification without a materiality qualification might be asserted by a plaintiff as a separate grounds for a misstatement or to avoid a motion to dismiss where the materiality of the alleged disclosure defect is marginal. Similarly, the lack of an express knowledge qualifier, which is always implicit in the context of criminal prosecution and need not be expressly stated, might assist a plaintiff in pursuing a claim on the certified report. Rather than risk these consequences, we believe the Commission should recognize the practices that have developed and continue to permit companies to choose whether or not to make non-public submissions of 906 certifications. We believe it is not a sufficient basis to alter the civil liability balance to seek to achieve administrative convenience.
The Commission has heretofore resisted requests from practitioners to adopt rules pertaining to the filing or language of the 906 certification on the basis that it is a criminal statute within the jurisdiction of the U.S. Department of Justice, not the Commission. If the Commission determines nonetheless to require the submission of 906 certifications as periodic report exhibits, it is critical that the Commission also identify permissible modifications so that the language of the certification is more appropriate for a publicly filed document on which investors will rely. Practitioners have become reasonably comfortable with the lack of knowledge and materiality qualifications because to date the liability ramifications of an allegedly false certification are criminal in nature, meaning that at least knowledge qualifications are implied as contemplated by Section 906. If the statement is public and investors rely on it, allegations in the context of a civil liability claim concerning the truthfulness of the certification may not have the benefit of knowledge and materiality concepts that are not expressly set forth, and certifiers will justifiably have a cause for concern that their statements may have the legal effect of a warranty. We therefore would urge the Commission, if it were to require public filing, to recognize that the certification may be qualified by the knowledge of the officer and that "in all material respects" may be added to the "fully complies" clause to be consistent with the "fairly presents" clause.
If the public filing requirement is retained, we support the Commission's proposal to specify that the certificate is "furnished" not "filed" and is not automatically incorporated by reference in Securities Act filings.
II. Section 906 Certifications Should Not Be Applicable to Forms 6-K, 8-K and 11-K Filings
On April 11, 2003, Senator Biden introduced into the Congressional Record a statement entitled "Legislative History of Title IX of the Sarbanes-Oxley Act of 2002"1 in which he stated that it was his understanding at the time he submitted Section 906 as an amendment to S. 2673 that the Section 906 certifications were required to accompany Forms 6-K, 8-K and 11-K filings, at least when those reports contain financial statements. Senator Biden reaches this conclusion despite the explicit reference in Section 906 to periodic reports and his acknowledgement that Forms 6-K and 8-K are normally referred to as "current reports." That distinction, however, is fundamental to the Exchange Act's reporting scheme and is reflected in footnote 37 of the Proposing Release, where the Commission reaches the opposite conclusion with respect to the application of Section 906 to Forms 6-K and 8-K. Despite its title, this statement is not legislative history in the accepted sense. Under principles of statutory construction established by the U.S. Supreme Court, courts should not give any weight to this statement as reflecting the intent of Congress because the statement was issued after enactment - in fact, more than nine months following enactment.2 Although the statement of Sen. Biden does not discuss whether 906 certifications must be published, the statement includes assertions about the meaning of several other provisions of Section 906. These should be considered only the personal opinions of Sen. Biden that would not be given judicial deference. Likewise, we urge the Comission, for policy reasons, to maintain its position that 906 certifications are inapplicable to Forms 6-K, 8-K and 11-K filings.
The application of Section 906 to Forms 6-K and 8-K would create substantial practical burdens. Application of Section 906 would cause a significant change in the reporting obligations of foreign private issuers. The Commission generally does not require the interim financial statements of foreign private issuers to be reconciled to U.S. GAAP. The Section 906 certification that the financial statements "fairly present" the issuer's financial condition and results of operations could result in a de facto reconciliation requirement, because corporate officials may be concerned that home country accounting standards that adopt a different approach than U.S. GAAP would not be viewed as satisfying the "fairly presents" standard.
The most common reason a Form 8-K would contain financial statements would be to provide Item 7 information regarding a significant acquisition. If Section 906 applied to the Item 7 disclosure, the CEO and CFO of the acquiror would have to personally certify the acquiree's financial statements within 75 days of the close of the transaction. The 906 certification would be required on a "real time" basis for submissions pursuant to Item 9 and within 5 business days in the case of an Item 12 submission if those submissions contain financial statements. We do not believe this is what was intended, notwithstanding Senator Biden's statement to the contrary, and such a requirement would be unreasonable in light of the information to be certified.
Finally, Senator Biden's statement does not acknowledge the important distinction between reports that are "furnished," rather than "filed" with the Commission. Form 6-K and Item 9 and 12 of Form 8-K disclosures are "furnished," not "filed," a distinction that is fundamental to the Exchange Act reporting scheme and reflected in the current proposals.
Senator Biden's reference to Form 11-K is also inconsistent with the Commission's reading of the the Act. The Form 11-K is not listed in the Item 601 exhibit table. This is consistent with the Commission's statement in footnote 47 to Release No. 33-8124 that the Section 302 certification requirement does not apply to annual reports on Form 11-K. Accordingly, we suggest that the adopting release clearly state that the Section 906 certification is not required to be submitted with the Form 11-K. We do not believe there is any reason to require that the Section 906 certification, but not the Section 302 certification, be submitted with the employee benefit plan's report filed on Form 11-K. Employee benefit plans are generally subject to registration under the Securities Act of 1933 only if they permit employees to purchase employer securities through payroll deductions or with out-of-pocket funds. In that case the employer files a registration statement (most often on Form S-8) that covers the employer securities. If, in addition, the plan involves "plan interests" - usually only if the shares are held in trust or if payment is significantly deferred - an indeterminate amount of "plan interests" are registered by the plan on the Form S-8 filed by the employer. The plan administrator or the trustee signs the registration statement with respect to the "plan interests." The plan is thus the "issuer" only with respect to the inchoate "plan interests," not the underlying employer securities, and it is this registration of "plan interests" that subjects the plan to the Form 11-K reporting requirements.
Most plans filing Forms 11-K are subject to extensive regulation under ERISA,3 including a requirement to file annual reports on Form 5500. Forms 5500 are signed by the plan administrator (a position statutorily created under ERISA). No individual serves in an equivalent position to a CEO or CFO with respect to a plan. The plan administrator must certify the correctness and completeness of the Form 5500 and its accompanying statements (including financial statements) and attachments. Form 5500 is signed under penalties of perjury, which include a fine of up to $10,000 ($100,000 for a willful violation) and imprisonment for up to 5 years (10 years for a willful violation). ERISA also imposes various administrative penalties for inaccurate or incomplete filings. Plans subject to ERISA are permitted to file their Form 5500 financial statements as part of the Form 11-K in lieu of creating separate financial statements. In our experience, plans routinely do submit Form 5500 financial statements as part of the Form 11-K filing. We believe the ERISA certification requirements applicable to Form 5500 obviate the need for additional certification under Section 906.
III. Proposed Technical Changes
Should the Commission decide to require the Section 906 certification as a publicly available exhibit, we have the following recommendations.
The Proposal would amend Item 601 of Regulation S-B and S-K to add the certifications required by Section 906 of the Sarbanes-Oxley Act to the list of required exhibits as new Item 32. To provide clarification, we suggest adding a footnote to the Item 601 exhibit tables under Regulation S-B and S-K indicating that Exhibit 32 is only required for filings by "issuers" as defined by Section 2(a)(7) of the Sarbanes-Oxley Act. Proposed Rules 13a-14(b) and 15d-14(b) should be similarly revised to indicate that "issuer" has the meaning set forth in Section 2(a)(7) of the Sarbanes-Oxley Act.
Under Section 2(a)(7) of the Sarbanes-Oxley Act, "issuer" means an issuer (as defined in Section 3(a)(8) of the Exchange Act) the securities of which are registered under Section 12 of the Exchange Act, that is required to file reports under Section 15(d) of the Exchange Act or that files, or has filed, a registration statement that has not yet become effective under the Securities Act and that has not been withdrawn. This definition would not include companies that file periodic reports on a voluntary basis, i.e., pursuant to an indenture covenant.
In order to avoid inferences of non-compliance with the Section 906 certification requirement, we suggest (in the event the Commission determines not to provide an indicator on the facing page of the periodic report, as we suggest in Part I of this letter) that companies who are voluntary filers or submitting a periodic report not containing financial statements, such as an amendment to the periodic report, be urged (or required) to include as Exhibit 32 a statement to that effect.
We further suggest adding clarification by means of a footnote to the Item 601 exhibit tables under Regulations S-B and S-K that Exhibit 32 is only required for filings containing financial statements. This would make clear that exclusion of Exhibit 32 from an amendment to a report that does not require financial statements is proper (such as when the non-financial portion of a report is amended).
We also suggest clarifying in a footnote to the Item 601 exhibit tables under Regulation S-B and S-K that unless the report specifically requires that the Section 906 certification be included as an exhibit, the Section 906 certification would not need to be submitted with the report. This would clarify that the Section 906 certification is not required to be submitted with other reports that might erroneously be deemed to be "periodic reports" (as traditionally understood), which is consistent with the Commission's statement in footnote 37 to the Proposing Release that the Section 906 certification is not required for Forms 6-K or 8-K.
Proposed Rules 13a-14(b) and 15d-14(b) provide that "Each report . . .must be accompanied by certifications in the form specified in paragraph (b)(32) of Item 601. . . ." However, there is no form "specified" in paragraph (b)(32) of Item 601. We suggest that the Commission provide such a form along the lines suggested in Part I above. If the Commission elects not to provide such a form, we would recommend that Rules 13a-14(b) and 15d-14(b) be amended to read as follows: "Each report . . . must be accompanied by certifications required by paragraph (b)(32) of Item 601. . ." (language underscored to highlight recommended change).
Finally, we note this statement in the Proposing Release: "[A] failure to furnish the Section 906 certifications would cause the periodic report to which they relate to be incomplete, thereby violating Section 13(a) of the Exchange Act" (text at note 44). The ramifications of this statement (including as a result of a tardy 906 submission occasioned by the need to meet a periodic report filing deadline at a time when a required 906 signatory is temporarily unavailable) would include, in addition to the penalties established by the Sarbanes-Oxley Act, the adverse consequences to Form S-3 status, Form 144 availability and perhaps private actions based on "line item materiality" or otherwise. Such results, normally consequent to a "filing" failure, seem inappropriate to a submission required only to be "furnished" rather than "filed." Failure to "furnish" other disclosures does not carry such consequences, and we believe the same result should attach here as well. If the Commission agrees, we request it expressly retract or modify this statement in the adopting release.
The Committee appreciates the opportunity to comment on the proposal and respectfully requests that the Commission consider the recommendations set forth above. We are prepared to meet and discuss these matters with the Commission and the staff and to respond to any questions.
cc: William H. Donaldson, Chairman
LEGISLATIVE HISTORY OF SECTION 906
House and Senate Bills. The House bill (H.R. 3763) passed on April 24, 2002 did not contain a management certification provision. The Senate bill (S. 2673) passed on July 15, 2002 contained a version of the Section 302 civil certification provision, albeit a more simplistic one than contained in the Sarbanes-Oxley Act as enacted. The Senate version of Section 302 required CEOs and CFOs to certify two matters: (1) the "appropriateness" of the financial statements and disclosures included in the report and (2) that those financial statements fairly present, in all material respects, the issuer's operations and financial condition. This provision was identical to the version approved by the Senate Banking Committee. The report of the Senate Banking Committee describes the provision as an adoption of the proposal in the President's 10-point plan announced on March 7, 2002 that "CEOs would personally attest each quarter that the financial statements and company disclosures accurately and fairly disclose the information of which the CEO is aware that a reasonable investor should have to make an informed investment decision."4
A counterpart of the Section 906 criminal certification provision was not included in the Senate Banking Committee's version of the bill but was instead added on the Senate floor as an amendment from Senators Biden and Hatch.5 The version of Section 906 added by the Senate was substantially identical to the Senate's Section 302 civil certification provision, except that, in addition to the CEO and CFO, the chairman of the board would also have been required to make the criminal certification (but not the civil certification).
The House passed a supplementary bill (H.R. 5118) containing several criminal provisions on July 16, 2002, the day after the Senate passed its bill. That bill, which was also considered by the Conference Committee considering the Senate bill, contained a provision similar to the Senate bill's Section 906 criminal certification provision, except that the certification covered only one matter that the financial statements fairly and accurately represent, in all material respects, the operations and financial condition of the issuer, and the penalties were somewhat steeper.
Conference Bill. The Conference Committee resolved the competing Senate and House bills, and made further changes. The Conference Committee bill was enacted without change as the Sarbanes-Oxley Act.
The Conference Committee refined the two elements of the Senate bill's Section 302 civil certification into six separate elements, which more closely corresponded to existing securities law concepts. The Committee substituted for the "appropriateness" certification a Rule 10b-5-like certification. The Committee also added certifications about financial and non-financial internal controls. These six elements of the civil certification in the conference bill and the Sarbanes-Oxley Act as enacted were apparently borrowed verbatim from an earlier bill introduced in the House on April 9, 2002 by Representative LaFalce, who was a member of the Conference Committee.6 In introducing his original bill, Representative LaFalce stated that it was an attempt to "[give] legislative substance and real teeth to meritorious portions of President Bush's 10-point plan" and that "[v]iolation of the certification provisions may be enforced by the remedies granted to the SEC under Securities Act of 1934, including criminal penalties for any willful violations of such certifications."7
There was no Conference Committee report to explain the reasons for these changes, and no one addressed this issue in the debate on passage of the conference bill in the full House and Senate. The Conference Committee's version of the Section 906 criminal certification provision did not conform to the changes made to the civil certification provision. Instead, the "appropriateness" element of the Senate's Section 906 certification was changed to a certification that the report "fully complies" with the Exchange Act requirements. The financial statement certification in the Senate's Section 906 certification provision was also retained, with only editorial changes. The criminal penalties were conformed to the more severe penalties in the House bill provision, and the chairman of the board was removed from the list of officers required to certify.8
The fact that the Section 906 certification was not conformed to the Section 302 certification was never explained.9