May 21, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 5th Street, NW
Washington, D.C. 20549-0609
Dear Mr. Katz:
We are pleased to comment on the proposed rule to accelerate the filing of quarterly and annual reports and require additional disclosures in annual reports about how investors can obtain access to SEC filings.
Overall, we share the SEC's objective of timelier reporting of financial information to the public. We too believe that the appropriate objective is for disclosure to be as clear, accurate, timely, and complete as possible. However, there is a tension between speed and quality that must be balanced. We do not believe that an across-the-board reduction in filing deadlines will necessarily strike an appropriate balance, and it could result in a decrease in the clarity, accuracy and completeness of periodic reports. In addition, we are concerned about the feasibility and ramifications to issuers, audit committees and auditors of a broad-based acceleration of periodic reporting deadlines.
An alternative approach to improve the timeliness and completeness of financial reporting that we believe warrants consideration is correlating a company's periodic filing deadlines with its public disclosure of earnings. Under this approach, public companies would file their periodic SEC reports including GAAP financial statements and Management's Discussion and Analysis ("MD&A") within a reasonable time after their earnings announcements, but no later than existing SEC reporting deadlines. Such an approach addresses concerns over the impact of earnings releases on the financial markets and the timeliness of complete financial disclosures. Such an approach also would provide more flexibility to address the reporting considerations of each company, as well as any changes from period to period.
Our comments and recommendations regarding the proposed rule are discussed in detail below.
Alternatives For More Timely Financial Disclosure
One of the SEC's stated objectives in proposing shortened filing deadlines is to reduce the "gap" that frequently exists between the date of a company's release of earnings information to the marketplace and the date it files its periodic SEC report. During the "gap," investors are trading based on selected information, but without the benefit of complete GAAP financial statements and related MD&A. In a perfect world, investors would receive complete GAAP financial statements and related MD&A at the same time a company first publicly announces its earnings. However, this complete financial reporting package is rarely available at the time of an earnings announcement, because companies, for many valid reasons, need additional time to complete the financial reporting process. In our view, any endeavor to eliminate the "gap" would probably delay earnings announcements unnecessarily.
One way to lessen the significance of the "gap" is to encourage private sector initiatives to improve the quality and consistency of earnings releases. By promoting "best practices" with respect to earnings releases, constituents to the financial reporting process would reduce the risk that investors would trade based on materially incomplete information. For example, we would recommend as a best practice that companies provide a balance sheet, income statement, and statement of cash flows with their earnings release. Further, earnings releases also should describe the significant factors necessary to understand reported results, financial position, or cash flows. In this manner, no additional significant information about the period would be expected to be disclosed subsequently in an earnings "conference call" or in the periodic SEC report when filed. If the adoption of such best practices serves to delay the timing of earnings releases, we believe that the trade-off between quality and speed would be justified.
Correlation with Earnings Release
In order to better address the valid concerns about the impact of earnings releases on the financial markets and the timeliness of complete financial disclosures, we believe that it would be reasonable to base the due date of a company's periodic SEC report on its public disclosure of earnings following the end of each accounting period. We would suggest that an appropriate timetable would require companies to file quarterly reports within 15 business days and annual reports within 30 business days of their earnings release, subject in each case to the current reporting deadlines. Under this alternative, the due date for filing a Form 10-Q would be the earlier of 15 business days after a quarterly earnings release or 45 days after quarter-end, and the due date for filing a Form 10-K would be the earlier of 30 business days after the annual earnings release or 90 days after year-end.
We believe there are many reasons not to "rush" financial reporting, but instead to take the needed time to prepare clear, accurate, and complete financial statements and MD&A. Our suggested alternative addresses the persuasive concerns regarding the "gap" mentioned above while avoiding adverse consequences to companies that may not be capable of accelerating their financial reporting for a variety of reasons. The alternative would provide companies needed flexibility to address new or complex transactions and events, and the related accounting and disclosure requirements, which may require additional time to be fully addressed and reviewed by the participants in the financial reporting process, including audit committees. When such circumstances otherwise delay the public release of earnings, the filing deadline for the periodic SEC report similarly would be deferred. In addition, we believe the suggested interval between the earnings release and the filing deadline would provide sufficient time for management to finalize the appropriate disclosure, and for auditors and audit committees to review those conclusions.
With respect to our suggestion to determine the periodic reporting requirements based on the date of a company's earnings release, we anticipate that there are two primary concerns regarding such practice. The first concern is what constitutes an "earnings release." Some companies disclose close to the period-end whether management expects results to vary significantly from expectations. In our view, this "pre-release" of earnings would not constitute an earnings release for the purpose of determining when a periodic report is due, because such "pre-release" represents management's expectations subject to the financial close process. In other instances, a company may disclose key operating information such as revenues, gross profit, and even operating income, but exclude the conventional measures of net income or earnings per share. Overall, we do not believe the limited disclosure of financial data, exclusive of net income and earnings per share, should be considered to constitute an earnings release; however, it would be important to monitor practice as it develops and to consider new and unusual circumstances.
The second concern we anticipate is for potential confusion from periodic reporting deadlines that may vary from company to company and from period to period. In addressing this issue, it is important to note that the financial markets already operate in an environment of significant variability in the timing of earnings announcements and the filing of periodic SEC reports. Consequently, we believe that investors and the financial markets will readily adapt to the direct correlation of the timing of earnings releases and periodic SEC reporting. From a regulatory compliance standpoint, it obviously is important to be able to monitor compliance with reporting deadlines. To facilitate that determination, we suggest that the SEC require companies to disclose on the cover page of their periodic report the date they made their earnings announcement and indicate whether or not the periodic report has been timely filed.
While we believe that the alternative discussed above achieves the appropriate balance between speed and quality, we understand that the SEC may consider other alternatives suggested in the proposing release, as well as in other comment letters received. Accordingly, we are providing the following comments should the Commission decide not to adopt our suggested approach.
First, we believe the SEC should reconsider the proposed definition of an accelerated filer. We believe the criterion of public float in excess of $75 million is too low. The SEC's proposed threshold would affect many issuers that have insufficient market trading activity to warrant the costs of accelerated filings. We recommend that the SEC, perhaps as an initial step, consider establishing the threshold for accelerated filers at a market capitalization of common equity in excess of $1 billion. By doing so, the accelerated filing requirements would apply to approximately the largest 750 U.S. public companies. These companies generally would have the level of market capitalization and investor interest, as well as the resources available, to justify accelerated reporting. In addition, we suggest that the determination of accelerated filer status be made annually as of the beginning of the issuer's fiscal year end using a consistent market capitalization criterion. We believe that this approach would provide companies and their auditors needed time to plan for the reporting deadline applicable to that year end. Finally, we agree that the definition of an accelerated filer should exclude companies that file only by virtue of public debt, preferred stock, or limited partnership interests.
Second, we suggest that the Commission reconsider the significant reduction in the interval between the end of the reporting period and the filing deadline. As proposed, the current interval would be reduced by one third for both annual and interim reporting periods. We believe that many companies will find it difficult to comply with such a significant reduction in reporting deadlines. Therefore, should the SEC undertake a broad-based reduction, we suggest that the SEC only shorten the reporting deadlines for annual reports to 75 days following year-end. For the reasons discussed below, we suggest that the SEC maintain the current reporting deadline for quarterly reports at 45 days following the quarter-end. The SEC could then evaluate the impact of those deadlines and determine whether filing deadlines should be further reduced.
Third, as indicated above, we believe that companies and their auditors need adequate time to plan for any shortening of the periodic reporting deadlines. Therefore, we urge you to defer the effective date of any change in reporting deadlines until the fiscal year beginning after the date the Commission adopts any final rule. We concur that Form 10-K should be the first report affected by any rule change and that Form 10-Qs filed thereafter would become subject to the shorter deadlines. Such transition provisions would provide affected parties sufficient time to prepare for an accelerated reporting schedule. Should the Commission retain its proposed transition, we believe the Commission should consider adopting a temporary modification to Rule 12b-25 for at least the first fiscal year in which any accelerated deadlines apply. Such temporary relief should allow companies to file their periodic reports within current timeframes, including the current extension provisions provided under Rule 12b-25, without an adverse consequence. That is, in the first year of accelerated reporting, a company could file a Form 12b-25 that would permit it to file its quarterly report within 50 days of its quarter-end and its annual report within 105 days of its fiscal year-end, without adverse consequences. This would encourage companies to meet the shorter reporting periods, but it would still allow companies additional time to make the changes in processes, technologies and resources necessary to comply.
Observations Regarding the SEC's Proposed Rule on Accelerated Filing Dates
As suggested by our recommendations above, we are concerned about the feasibility and ramifications of the proposed acceleration of periodic reporting deadlines for many registrants. We believe, based on our experience and knowledge of the financial reporting process, that many companies meeting the accelerated filer definition will have difficulty complying with the shorter filing deadlines, considering the roles and responsibilities of management, auditors and the audit committee. Even for companies that could satisfy the accelerated deadline without significant expense, we are concerned that the reduced timeframes could lead to a reduced quality of financial reporting.
One premise of the SEC proposal is that technological advances should allow for faster financial reporting. We do not agree that this proposition is necessarily true. Technology advancements have certainly permitted companies to generate financial data more effectively and efficiently, and in greater volume. However, the time required to prepare and review complete and insightful qualitative disclosures, such as financial statement footnotes and MD&A, has significantly increased given the increased volume and complexity of accounting standards, related financial disclosure requirements, and the expectations of regulators and investors for robust MD&A. At the same time, technological advances have not had as significant an impact on the ability to address the qualitative aspects of financial reporting, and the business environment has become more complex (e.g., transaction structures, taxation issues, global operations).
In the rule proposal, the Commission expressed its impression that a company's audit or review is substantially complete by the time of its earnings announcement. We do not agree that this perception applies universally, or even in most cases. The status of the auditor's work as of the date of the earnings release necessarily varies from company to company. In some cases, significant work remains to be performed and little, if any, assurance can be ascribed to the publicly disclosed results. More often, the external auditor may have performed the majority of the audit or review procedures, or even substantially completed the audit fieldwork. However, in nearly every case, the auditor has not obtained all of the evidential matter necessary to express an opinion, has not performed all required reviews and approvals of the work performed (including the concurring partner review), and has not performed any verification of financial statement disclosures, given that those disclosures often have not been completed by management as of the earnings release date. The completion of the audit or review, including necessary quality control procedures and required communications with audit committees, often requires substantial additional effort following the earnings release date.
Also, from the company's perspective, after the earnings release, there is a significant amount of time and effort required to complete all the steps necessary to file a periodic report with the Commission. As a general matter, the same individuals involved in the financial closing and earnings release also are involved in the preparation of the financial statements, MD&A and other portions of the periodic report to be filed with the SEC. In order to comply with the proposed acceleration of reporting, companies in many cases will have to reengineer their financial close process (including closing financial systems prior to the period-end and recording estimates of intervening activity, as well as recording the results of foreign operations and equity investees using a lag period); accelerate the receipt of necessary information from equity investees, foreign subsidiaries, and specialists (e.g., actuaries, geologists, appraisers) if possible, or developing estimates if not; modify or upgrade existing information systems; and increase their staffing levels. We believe that these changes could involve significant one-time and ongoing costs for some companies. In addition, some of these changes could result in less timely information being reported and introduce a greater use of subjective estimates.
We also are concerned about the potential effects of the accelerated reporting deadlines on the quality of financial reporting and the effectiveness of the oversight of the financial reporting process. With less time, there might be a tendency toward the increased use of boilerplate disclosure, such as that used in the prior period or by comparable companies, without significant modification for recent developments or the issuer's unique circumstances. The preparation of clear, plain English financial statement footnote disclosures and high quality, insightful MD&A requires a significant commitment of time by financial and executive management. After management prepares those disclosures, auditors need sufficient time to verify and consider the adequacy of those disclosures. In addition, the audit committee and the board of directors need adequate time to review the disclosures and the periodic SEC report before it can be filed. We are concerned about the potential adverse effects of the proposed rules at a time when audit committees are rising to the challenge of assuming a more proactive role in the financial reporting process.
While we support the objective of timely financial reporting, we believe that the changes proposed pose a significant risk of reducing the overall quality of financial reporting. For these reasons, we urge the Commission to establish SEC reporting deadlines based on each company's demonstrated ability to publicly report its earnings for the period in question. This approach would directly limit the length of any "gap" between the date of a company's earnings release and its periodic SEC report without adversely affecting companies that require more time to "get it right the first time."
Specific Requests for Comment
We would like to comment on certain other questions in the rule proposal that we believe warrant further consideration.
Q - Would the current filing extension periods remain sufficient under accelerated deadlines?
We do not believe that any changes should be made to the current Rule 12b-25 extensions of 5 days for quarterly reports and 15 days for annual reports, absent the potential provision of temporary relief in transition as discussed above. In our view, the current extensions remain appropriate should an issuer be unable to meet any shorter reporting deadlines adopted by the Commission.
Q - Should the Commission make conforming revisions to accelerate the timeliness requirements in Regulation S-X for Rules 3-01 and 3-05?
With respect to Rule 3-01, we believe that the timeliness of financial statements in a 1933 Act registration statement should be consistent with the requirements of 1934 Act reports. Therefore, we would support changes to S-X Rule 3-01 necessary to conform to any changes the Commission adopts to its periodic reporting deadlines. However, we believe that the Commission also should consider eliminating the current requirements under Rule 3-01 (c) and (d) that, under certain conditions, require audited financial statements to be provided in a Securities Act registration statement when such statements are not yet required to be filed in periodic SEC reports for the benefit of secondary market investors. We believe that the current requirements of Rule 3-01 (c) and (d) create an artificial distinction and serve to unreasonably deprive some companies access to the public capital markets for periods of time.
With respect to audited financial statements of acquired businesses, we do not believe any change should be made to the current requirements of Rule 3-05. We do not see any reason why an accelerated filer should be expected to file audited financial statement of an acquired business on a more accelerated basis than other public companies. In our view, the ability to obtain the audited financial statements of a significant acquired business generally is unrelated to any circumstances of the issuer that cause it to be an accelerated filer for purposes of its own financial statements.
The Commission's proposed rule is silent as to any consideration of "conforming changes" to S-X Rule 3-09 regarding the audited financial statements of significant equity investees, joint ventures, and subsidiaries not consolidated. We concur that the current provisions of Rule 3-09 should remain unchanged. That is, accelerated filers should continue to be able to file audited financial statements under Rule 3-09 by means of an amendment to their Form 10-K within the currently prescribed periods.
Q -- Should the Commission make a conforming change to the date by which all schedules required by Article 12 of Regulation S-X may be filed as an amendment to the annual report?
As a best practice, we believe that any required Article 12 schedules should be included in the Form 10-K as filed. However, we recognize that in some cases those schedules may require additional time to assemble, review and verify. Accordingly, we would support a conforming change to continue to allow Article 12 schedules to be filed as an amendment within 30 days of the due date of the Form 10-K.
Q -- Should the Commission make a conforming change to the date by which companies have to file their definitive proxy information involving the election of directors?
We do not believe that any change should be made to the 120 day time period within which companies may incorporate by reference into the Form 10-K disclosures from their definitive proxy statement. We see no reason why a company that is an accelerated filer also should accelerate its annual proxy statement or amend its Form 10-K within 90 days of its fiscal year end. We believe that the current reporting timeframe for such annual disclosures about directors and executive officers is well established and sufficient for the needs of investors.
Q -- Should the Commission make conforming changes to the reporting dates of foreign private issuers?
We encourage the Commission to reconsider the reporting deadlines of foreign private issuers in light of any changes that are made for domestic registrants. We believe this is important in maintaining a "level playing field." However, we believe that any proposed changes should be the subject of separate rulemaking so that affected parties have adequate opportunity to comment on the specific proposed changes. Also, as indicated previously, we recommend the SEC consider deferring the proposed transition of any accelerated reporting rules for domestic companies, which would allow the SEC to propose and adopt analogous rules for foreign private issuers using common transition periods. Consistent with our recommendation to correlate the SEC reporting deadline to a company's earnings release, we suggest that Form 20-F should be due within a reasonable time of a foreign private issuer's distribution of audited financial statements to shareholders or filing its annual audited financial statements in its home jurisdiction.
Disclosure Concerning Website Access to Reports
We are supportive of the objective of real-time, no-cost Internet access to corporate reports. Accordingly, we concur that it is a best practice for companies to provide such access on their websites. However, some companies currently rely on hyper-links on their websites to provide access to their EDGAR filings on the SEC's website. Given that real-time access cannot be realized through such hyper-links, we support the SEC's undertaking to eliminate the current 24-hour delay in posting filings to its website.
In addition, we believe that the Commission should reconsider the current requirement to "EDGARize" corporate filings. This process is unduly time-consuming and inconsistent with the proposal to require more timely filings. As an alternative, the SEC should explore the use of PDF documents for filing purposes, which would result in faster, less costly filings.
We share the SEC's concerns about the timeliness of financial information reported to the public, but we do not believe that an across-the-board reduction in filing deadlines will achieve the appropriate balance between speed and quality. We believe the proposal could have the unintended consequence of decreasing the clarity, accuracy, and completeness of periodic reports. As a result, we believe that the Commission should give strong consideration to our suggestion of correlating a company's deadlines for filing its SEC annual and quarterly reports with its public disclosure of earnings. Such an approach would provide more flexibility to address the reporting considerations of each company, as well as any changes that a company might encounter over time. Such an approach also would address the valid concerns about the impact of earnings releases on the financial markets and the timeliness of complete financial disclosures, while avoiding adverse consequences, such as lower quality disclosures, in other circumstances.
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We would be pleased to discuss our comments with the Commission or its staff at your convenience.
Very truly yours,
/s/ Ernst & Young LLP