SHEARMAN & STERLING
May 29, 2002
Mr. Jonathan G. Katz
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Acceleration of Periodic Report Filing Dates and
Disclosure Concerning Website Access to Reports
Release No. 33-8089 (April 12, 2002) (File No. S7-08-02)
Dear Mr. Katz:
We are pleased to submit this letter in response to the request of the United States Securities and Exchange Commission (the "Commission" or the "SEC") for comments regarding the Commission's proposal (the "Proposing Release") to accelerate the filing dates for, and to require disclosure concerning website access to, periodic reports of certain domestic reporting companies under the Securities Exchange Act of 1934 (the "Exchange Act").
The Proposing Release, in its current form, would require domestic companies that have a public float of at least $75 million, that have been reporting under the Exchange Act for at least 12 months, and that have filed at least one annual report (defined by the Proposing Release as "accelerated filers"), to file annual reports on Form 10-K within 60 days of their fiscal year end instead of the current 90 days and quarterly reports on Form 10-Q within 30 days of the end of each of the first three fiscal quarters instead of the current 45 days. As proposed, domestic companies that are not accelerated filers, foreign governments and foreign private issuers would not be subject to the accelerated deadlines.
The Proposing Release reflects the Commission's view that the Internet has "increased the market's demand for more timely corporate disclosure and the ability of companies to capture, process and disseminate this information". The Commission believes that significant technological advances of recent decades allow companies to meet the market's demand for accelerated disclosure. As a result, according to the Commission's Office of Economic Analysis, registrants on average issued their year-end and quarterly earnings releases approximately 43 days and 27 days after period end, respectively, over the last 10 years.
The Commission believes that it is now time to adjust the due dates of its mandated periodic reports to the reality reflected in the timing of earnings releases. The Commission argues that by narrowing the gap between the issuance of earnings releases and mandated periodic reports, market participants would be able to make investment and valuation decisions on a more timely basis which, in turn, could increase the efficiency of the capital markets. While the Commission recognizes that "the market's demand for accelerated disclosure should be balanced with the time that registrants need to provide such disclosure without undue burden", it points to technological advances and evidence that registrants' internal financial reporting procedures are substantially complete before earnings releases are issued.
1. Acceleration of Due Dates
While we generally agree with the Commission's view about the effect of the Internet and technological developments, we do not support the Commission's Proposing Release to accelerate the due dates of mandated periodic reports. Many registrants believe, as discussed in greater detail below, that requiring them to prepare and file mandated periodic reports on a timetable similar to earnings releases would create an undue burden for them, and may not have the effect that the Proposing Release desires.
We agree with the Commission that mandated periodic reports "contain valuable information to investors". We believe that registrants agree as well, and take seriously the preparation and filing of these reports. While the last 30 years saw dramatic changes in technology, the scope and complexity of disclosure required by the Commission to be included in periodic reports has also increased substantially. The latest of these changes include the Commission's Statement About Management's Discussion and Analysis of Financial Condition and Results of Operations (Release No. 33-8056), Cautionary Advice Regarding Disclosure About Critical Accounting Policies (Release No. 33-8040), Disclosure of Equity Compensation Plan Information (Release No. 33-8048) and Audit Committee Disclosure (Release No. 34-42266). Financial reporting in accordance with GAAP has also become increasingly more complex, particularly with respect to financial statement disclosure, accounting for business segments and accounting principles requiring estimates of future cash flows and fair values. In addition, the business environment that registrants are working in has become more complex in recent decades, with operations spread out over many continents and business practices becoming more elaborate.
Even if, as the Commission states, "as a general matter audit work is essentially completed and other steps have been taken to ensure the accuracy [of earnings releases]", for many companies additional input is required both internally and externally to finalize the financial information and to complete and file mandated reports. These reports, which include additional information not included in earnings releases, are also passed through a formal and more investigative internal review process than earnings releases, including the audit committee and the board of directors, as well as the registrants' independent auditors, before they can be filed. All of this takes additional time.
The review procedures of audit committees, in particular, has been the focus of the Commission and national stock exchanges and trading systems in recent years (the Release on Audit Committee Disclosure (Release No. 34-42266 (Dec. 22, 1999)) and related changes in the rules of the New York Stock Exchange, the National Association of Securities Dealers, Inc. and the American Stock Exchange, as well as the Release on Revision of the Commission's Auditor Independence Requirements (Release No. 33-7919 (Nov. 21, 2000)). These rules encourage, if not require, audit committees to review and discuss the registrant's financial statements with management, scrutinize auditors' independence and, on the basis of these procedures, recommend to the board of directors that the financial statements be included in the registrant's periodic reports. At a time when audit committees are becoming the gatekeepers of corporate governance, we are concerned that shortening the filing due dates for mandated periodic reports may serve to undermine their ability to fulfil this role.
It is true that significant technological advances have taken place over the last 30 years. In some cases, however, these advances have simply made it possible for registrants to report on more complex and geographically dispersed operations within the current time limits. Time is still required to compile and analyze financial data, especially if the registrant has numerous or widespread operations. Registrants must still discover, understand and resolve complex accounting and other disclosure issues.
Preparation of mandated periodic reports involves several steps that are primarily sequential, not concurrent, beginning with the collection of financial data. This data collection may present a significant challenge for multijurisdictional companies and companies with global operations and may implicate a number of other considerations, such as foreign currency translation. Any registrant that will be reporting extraordinary items will have to evaluate the scope of such items and prepare appropriate substantiation. Segment reporting creates further complications. Consolidated financial statements must be prepared after collecting data from various reporting entities. The consolidation process includes elimination of intercompany amounts and the preparation of other corporate level adjustments. After that, the independent accountants and the audit committee must complete their respective review processes. Then the text of the periodic report must be written in accordance with the applicable and ever growing body of disclosure standards. Once drafted, such reports then are reviewed internally and often externally in order to ensure accuracy and completeness. Several drafts are usually circulated before a registrant deems a report to be in final form for filing.
Through the example of one of our clients, we would like to present the difficulty that registrants may face if required to prepare mandated periodic reports within a 33 per cent shorter period of time. This client, a domestic company with many years of reporting history under the Exchange Act, operates through a number of subsidiaries located throughout the United States. Despite its experience in filing Exchange Act reports, having a relatively straight-forward business with no segment reporting or foreign operations and the use of sophisticated accounting software, it takes the company between 43 and 45 days to file its quarterly reports on Form 10-Q and longer to file its annual report on Form 10-K.
The company typically needs 7 to 10 working days to prepare working papers at the subsidiary level. An additional 5 working days are required to review and analyse those working papers and prepare the consolidated financial statements internally. To be able to complete this process, our client relies on third party reserve information to become available on time. Once the consolidated interim financial statements are completed, the external auditors' review can commence. The auditors typically take 5 working days to complete the review of the financial statements and related working papers before signing off on the quarterly financial statements. After the auditors complete their work, the audit committee and board of directors meet to formally approve the financial statements and issue the earnings release. This happens typically 20 working days, or 30 calendar days after period end. At this stage, however, the quarterly report is typically not complete, despite the fact that our client starts preparing it as soon as the external auditors arrive to review the draft financial statements. The mandated quarterly report is typically ready for review by the external auditors and legal counsel 25 working days after period end. Their review and comment takes 3 working days before a new draft report incorporating their changes is sent to the audit committee. The audit committee needs another 3 working days to review and comment, after which the report is finalized and filed with the Commission, 30-32 working days, or 43-45 calendar days, after period end.
As mentioned above, this company does not have foreign subsidiaries, significant joint ventures or other organizational attributes that could lead to the need for additional time to prepare and file mandated reports. Even so, timing of report preparation, particularly on a quarterly basis, can still be affected by acquisitions, availability of third party data, implementation of new accounting pronouncements and other nonrecurring events.
As stated earlier, the Commission's Office of Economic Analysis has determined that registrants on average issued their quarterly earnings releases approximately 27 days after the period end over the last 10 years. Given that 27 days is an average number, the 30 day filing due date for quarterly reports proposed by the Commission appears to be too short. We believe that there is a real danger that a large number of companies may have difficulties filing quarterly reports on time and we do not see how registrants can be expected to save 15 days in this process without undue burden or sacrificing reliability and accuracy.
There is also the concern that audit firms will give preference to their largest accounts when it comes to completing registrants' periodic reports by shorter due dates. Audit firms will be swamped with requests from registrants to complete their review at an earlier date and within a shorter period of time. If the Proposing Release is adopted, these audit firms will have 33 per cent less time over which they can spread out their work, at the same time coming under more pressure to avoid audit failures. Audit firms are likely to give preference to their largest accounts and do their best to try to accommodate their other clients. As a result of this, compliance with the tighter due dates may be made even more difficult for those clients that may be most in need of an expert advisor to ensure that their disclosure is accurate and complete.
2. "Accelerated Filer" Definition
The Proposing Release would subject only accelerated filers to the new due dates for filing periodic reports. Given the definition of "accelerated filer", the Commission seems to have taken the view that registrants capable of availing themselves of the benefits of on-demand financing are the least likely to find it difficult to provide the market with periodic reports on an accelerated timetable. We are not sure that this basis of differentiation is the right one.
Some registrants have elaborate and expensive internal reporting systems, some have operations concentrated into a small number of subsidiaries located within one or two countries and some have more influence over the timing of the review by their auditors than others. Depending on its specific circumstances, a registrant may or may not be able to report without undue burden on the accelerated basis proposed by the Commission. We are concerned that the level of public float and the length of time that a registrant has been a reporting company may not be a reliable indicator of the ability of registrants to file mandated reports sooner.
In addition, the Commission requested comment on whether the public float requirement for purposes of accelerated reporting should be higher or lower, how that level would be consistent with the level currently required for use of shelf registration statements, and whether that level should also be raised. Based on these questions, we are concerned that the Commission may be inclined to use the accelerated filer definition to determine who is eligible for the use of shelf registration statements. If this is the case, we believe that the Commission should address these eligibility requirements in a separate proposal, which would allow registrants and members of the financial community to focus on and analyze this issue specifically. We believe that many commentators that address the size issue for accelerated filing may not have appreciated the possibility that the Commission would condition the availability of "on demand financing" on accelerated filer status.
3. Earnings Releases
As the evidence of the Commission's Office of Economic Analysis shows, registrants have responded and will continue to respond to the market's demand for accelerated corporate disclosure by issuing earnings releases ever closer to the end of their fiscal year or quarter. The Commission is concerned, however, that "earnings releases are generally less complete in their disclosure than quarterly or annual reports and can emphasize information that is less prominent in quarterly or annual reports". While we do believe that information in earnings releases needs to be accurate, we do not necessarily agree that all information mandated in periodic reports is required to accomplish that goal. If all such information was required to make earnings releases accurate a more direct approach would be to prohibit earnings releases in advance of filing mandated periodic reports, thus having the opposite effect of making more information available to the public sooner. If the Commission's concern is with pro forma earnings information that is included in earnings releases, we believe the issue should be addressed directly as in the Commission's recent cautionary advice.
4. Closing Remarks
While our letter focuses mainly on the issues raised by the Proposing Release in the context of quarterly reports, the same issues also exist in the context of annual reports. While it is true that under the Commission's proposal registrants would have 60 days to complete their mandated annual report compared to 43 days they need on average to issue their earnings releases according to the Commission's Office of Economic Analysis, annual reports must disclose, compared with quarterly reports, substantially more information than what is included in earnings releases. In addition, the internal and external review process of annual reports is substantially longer than that of quarterly reports. As a result, registrants require, compared to quarterly reports, substantially more time to prepare annual reports after earnings releases are issued.
We believe that as a consequence of the factors discussed above and particularly the trend toward more disclosure, it is not practicable to shorten the filing due dates of periodic reports given the Commission's commitment to reliable and accurate disclosure. As a result, the Proposing Release, in its current form, is not likely to provide the solution for the Commission's intent of getting more and better quality information to the public sooner. In addition, we believe that the overall cost to market participants of this regulatory change outweighs its perceived benefits.
* * *
We appreciate the opportunity to comment on the Proposing Release.
If the Commission or the staff has any questions concerning the foregoing, please call Richard B. Vilsoet at (212) 848-7620.
Shearman & Sterling
/s/ SHEARMAN & STERLING