August 19, 2002
Jonathan G. Katz, Secretary
Securities and Exchange Commission 450 Fifth Street, N.W.
Washington DC 20549-0609
RE: Certification of Disclosure in Public Companies' Quarterly and Annual Reports;
File No. S-7-07-02
The American Council of Life Insurers appreciates the opportunity to share its views on proposed rules requiring certification of disclosure in public companies' quarterly and annual reports.1 The American Council of Life Insurers is a national trade association with 399 members which represent 75% of the total assets of all legal reserve life insurance companies in the United States, and which account for 75% of the annuity business and 76% of the life insurance business in the United States.
Many of our member companies manufacture and distribute variable annuities and variable life insurance. Life insurers register variable contracts, and the separate accounts funding them, under the Securities Act of 1933 and the Investment Company Act of 1940, respectively. Most variable contract separate accounts registered under the 1940 Act are organized as Unit Investment Trusts and are currently subject to integrated registration Forms N-4 for variable annuities, and N-6 for variable life insurance. We are, therefore, very interested in the SEC's invitation of comment concerning extension of the certification proposals to registered investment companies organized as Unit Investment Trusts.
Administrative and Legislative Background
On June 14, 2002, the SEC proposed rules that required, among other things, principal executive and financial officers to make a specified certification about the integrity of financial statements and controls. The proposal governed public companies required by Sections 13(a) and 15(d) of the Securities Exchange Act of 1934 to file periodic reports with the SEC, including Forms 10-Q and 10-K, 10-KSB, and 8-K. The proposed rules would require a company to maintain procedures to provide reasonable assurance that the company is able to collect, process and disclose the information required in the company's annual and quarterly reports. The SEC's June 14, 2002 rule proposals did not apply to any investment companies, including variable contract separate accounts.
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On July 30, 2002, President Bush signed the Sarbanes-Oxley Act of 2002 into law, which applied to a broader group of companies. Section 302 in the Act instructs the SEC to adopt by August 29, 2002, for every company which files periodic reports pursuant to Sections 13(a) or 15(d), rules which require the principal executive officer and principal financial officer-but not a non-executive chairperson-to make certain certifications in each annual or quarterly report which is "filed or submitted" with or to the SEC.
The "Section 302 certification" includes certain qualifications for knowledge and materiality and includes certain statements about internal controls. The Section 302 certification must provide that:
While Section 302 of the Sarbanes-Oxley Act of 2002 requires the principal executive officers and principal financial officers to make specific attestations in their certifications as to the company's internal controls, it does not directly address the maintenance of these requirements. The SEC's June 2002 rule proposals would require maintenance of sufficient procedures to provide reasonable assurance that the company is able to collect, process and disclose, within the time periods specified in SEC rules and forms, the information, including non financial information, required to be disclosed in their periodic and current reports.
The Act exempts registered investment companies from certain disclosure requirements. Investment companies do not have to make a management statement assessing the effectiveness of internal controls, nor do they have to disclose material off-balance sheet transactions. Similarly, SEC rules mandated by Section 401 on pro-forma financial information will not apply to investment companies. Congress believes that the objectives of those disclosure sections are adequately addressed by existing federal securities laws and the rules thereunder affecting investment companies.
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On August 2, 2002, the SEC published a supplemental rule proposal to its June 14, 2002, rule proposal on certification of periodic reports. Among other things, the SEC's revised proposal addresses the application of Section 302 of the Sarbanes-Oxley Act of 2002 to registered investment companies.
The SEC's release specifically invited comment on the manner in which the certification requirement should address registered investment companies, "including the appropriate location for the certification (for example, Form N-SAR; reports to shareholders), the appropriate individuals to provide the certification (for example, officers of the investment company itself and/or the investment adviser, administrator or depositor of the registered investment company)." The release also invited comment on how, if at all, the rule should apply to different types of investment companies, such as management investment companies and unit investment trusts, and any other matters that are specific to registered investment companies.
Statement of Position
The SEC should not extend the requirements of Section 302 to variable contract separate accounts organized as Unit Investment Trusts (UITs). Variable contract separate accounts are significantly different from the public companies Congress sought to reach in Section 302. These differences have been appropriately reflected in the disclosure and reporting forms that govern UIT separate accounts.
UIT structure, management, and function are also distinguishable from the public companies addressed by the Sarbanes-Oxley Act of 2002. As two-tier organizational structures with assets consisting of underlying mutual fund shares, UITs are not prone to the financial mischief or reporting deficiencies targeted by Congress. UIT financial statements and the range of associated accounting practices are narrow in scope relative to public companies, and subject to minimal interpretive discretion.
The mechanics of Section 302 certifications would not fit separate account UITs. Variable contract UITs do not have officers, employees, or boards of directors under their form of organization. The individuals Section 302 designates for certification functions do not, therefore, exist in UITs.
Section 302 certifications of variable contract UITs would not depict information useful to the purpose of the Sarbanes-Oxley Act of 2002. The Form N-SAR3 used by separate account UITs does not contain financial statements or other information within the intended scope of Section 302. Only six out of 111 items in Form N-SAR must be completed by UITs, in appropriate recognition of UITs' unique structure and narrow category of assets. In contrast to Form 10-K and Form 10-Q reports filed by public companies, no financial statements accompany UIT Form N-SAR reports. Separate account N-SARs are filed only once a year with the SEC, and are not distributed to contract owners under applicable SEC rules. In sum, Section 302 certifications of separate account UITs would frustrate the purpose of the Sarbanes-Oxley Act of 2002 by diluting the utility of public company certifications under Section 302 with a confusing certification of no value to the marketplace.
In a related context, the SEC recently acknowledged the limited value of financial statements of the separate account UIT and the life company. In April 2002, the SEC adopted new Form N-6, an integrated registration form for variable life insurance separate accounts organized as UITs. Under the financial statement requirements of Form N-6, variable life insurance prospectuses are not required to include the financial statements of either the registrant or the insurance company depositor. Instead, the full financial statements of the registrant will be in the Statement of Additional Information (SAI), which is available to investors upon request, free of charge.
The SEC moved the financials out of the VLI prospectus due to their limited utility in a purchase decision. The SEC's action simplified prospectus disclosure by jettisoning financials with marginal informational value. The change was also designed to parallel the treatment of financials in Form N-4, the integrated registration form for variable annuity separate accounts organized as UITs. For the same reasons, Section 302 certifications of separate account UIT financials are unnecessary and counterproductive.
Section 302 certifications of UIT separate accounts would be functionally impractical because mutual funds are the core assets of UIT separate accounts. All of the elements of the Section 302 certification have no relevant applicability to a two-tier investment company structure. In essence, any putative signatory to the UIT certification would be verifying the financials of the underlying mutual funds, which are separate and independent from the separate account. The UIT is not in a position to make representations concerning the financials of underlying funds in its portfolio. It is neither necessary nor appropriate to require the separate account UIT to make a Section 302 certification about underlying mutual fund financials.
The legislative history of the Sarbanes-Oxley Act of 2002 focuses sharply upon "public companies," and "operating companies." Nothing in the legislative history can be construed to suggest that Congress intended the Section 302 certifications to apply to UIT separate accounts. Indeed, the legislative history states that the certifications will provide informational value to securities traded in the secondary market. Variable contracts are not traded in the secondary market. The legislation recognized that registered investment companies were different from operating companies and exempted investment companies from certain disclosure requirements. Investment companies are excluded from certification requirements involving internal controls, off -balance sheet transactions and pro-foma financial information.
Separate account UITs are outside the scope of the Congressional hearings or any expressed legislative concern. The purpose, function and structure of UITs share nothing in common with the features of operating companies like Enron or Worldcom. It is extremely unlikely that similar financial statement abuses could occur in separate account UITs because of their limited category of mutual fund assets, and the concomitant absence of discretion in applicable accounting policies and practices. For the same reason that the SEC chose not to include UITs or other investment companies in its June 14, 2002 initiative for certifying financial statements, UIT separate accounts should be excluded from Section 302 certification requirements. Nothing in the Sarbanes-Oxley Act of 2002 directs the SEC to expand its June rule proposal specifically to include UIT separate accounts.
At best, the conceptual nexus for including UIT separate accounts in the SEC's August 2, 2002 supplemental request for comment is a coincidental quirk of having a periodic report under the 1934 Act, Form N-SAR. The substance and purpose of the Section 302 certifications have no practical application to UITs or informational value in the marketplace.
While it is commendable to raise a broad range of issues in a supplemental rule proposal following significant new legislation, the SEC should carefully avoid an illogical application of its proposed certification rules to UIT separate accounts. These entities can be justifiably differentiated from the true focus of Section 302 certifications. It would be out of character for the SEC to require signatories to make certifications about financials of independent mutual funds in UIT portfolios.4
Thank you for your attention to our views. If any questions develop, please call.
Carl B. Wilkerson
|1||The proposals appeared in Release Nos. 34-46300 (August 2, 2002) and 34-46079 (June 14, 2002).|
|2||Senator Michael Enzi stated in the Congressional Record on July 25, 2002 that "[w]ith respect to section 302, the conference recognizes that results presented in financial statements often necessarily require accompanying disclosures in order to apprise investors of the company's true financial condition and results of operations. The supplemental information contained in these additional disclosures increases transparency for investors. Accordingly, the relevant officers must certify that the financial statements together with the disclosures contained in the periodic report, taken as a whole, are appropriate and fairly represent, in all material respects, the operations and financial condition of the issuer."|
|3||The Form N-SAR is the only 1934 Act report filed by UIT Separate Accounts pursuant to Section 15(d) of the 1934 Act, the trigger for Section 302 certification requirements. While Form N-SAR is technically a report filed pursuant to the 1934 Act, it is uniquely an investment company report, and widely considered to be a report filed under the Investment Company Act of 1940, rather than a periodic report typically filed by public companies under the 1934 Act.|
|4|| Certain mutual life insurance companies operate separate accounts to fund variable annuity contracts for self-employed individuals and their employees (HR-10 plans). These separate accounts are excluded from the 1940 Act definition of "investment company" by Section 3(c)(11) of the 1940 Act, but the contracts are registered under the Securities Act of 1933 on Form N-4. The 1933 Act registration results in 1934 Act reporting obligations under Section 15(d).
The reasons why a Section 302 certification should not apply to registered UIT separate accounts apply with equal force for these unregistered UIT separate accounts. In addition, life company financials relate to solvency, and not the fluctuating net asset value of variable contract separate accounts, which are not guaranteed by the life insurer sponsoring the variable contract. Mutual life insurance companies prepare their financial statements in accordance with accounting standards prescribed by state law. These standards are designed primarily to assure solvency. In contrast, Section 302 of the Sarbanes-Oxley Act requires certification that an issuer's financial statements "fairly present" its financial condition and results of operations in order to fulfill the informational needs of investors who both buy and sell their securities in a secondary market.
Certification of a mutual life insurance company's financial statements in accordance with Section 302 would not serve the interests of investors in variable annuity contracts and would not be in accord with the fair intent of this legislation. Identical treatment should be accorded registered and unregistered UIT separate accounts. Certification in either case does not fulfill informational needs germane to existing or future contract owners. Rather, it could present a misleading implication that the financial condition of the life insurance company has a bearing on the performance of the variable contract separate account.