THE ASSOCIATION OF THE BAR
OF THE CITY OF NEW YORK
42 WEST 44TH STREET
NEW YORK, NY 10036-6689
COMMITTEE ON SECURITIES REGULATION
August 19, 2002
Via email: firstname.lastname@example.org
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
Attention: Jonathan G. Katz, Secretary
File No. S7-21-02; Release Nos. 34-46079 and 34-46300
Proposed Rule: Certification of Disclosure in Companies'
Quarterly and Annual Reports
Ladies and Gentlemen:
This letter is submitted on behalf of the Committee on Securities Regulation of the Association of the Bar of the City of New York (the "Committee") in response to Release No. 34-46079, dated June 17, 2002 (the "June Release") and Release No. 34-46300, dated August 2, 2002 (the "August Release"). The releases relate to proposed rules of the Securities and Exchange Commission (the "Commission") that will require (i) certain certifications by each reporting company's principal executive officer and principal financial officer in the company's quarterly and annual reports and (ii) each domestic reporting company to maintain sufficient procedures to provide reasonable assurances that the company is able to collect, process and disclose the information required to be disclosed in its reports under the Securities Exchange Act of 1934, as amended (the "Exchange Act"). Our Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to corporations, investment banks and investors and academics.
Section 302 of the Sarbanes-Oxley Act of 2002 (the "Sarbanes-Oxley Act") provides that the Commission shall, by rules that become effective not later than August 29, 2002, require, for each company filing periodic reports under Section 13(a) or 15(d) of the Exchange Act, that:
The principal executive officer and the principal financial officer or officers, or persons performing similar functions, certify in each annual or quarterly report filed or submitted under either such section of the Exchange Act that-
(1) the signing officer has reviewed the report;
(2) based on the officer's knowledge, the report does not contain any untrue statement of a material fact or omit to state a material fact necessary in order to make the statements made, in light of the circumstances under which such statements were made, not misleading;
(3) based on such officer's knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the company as of, and for, the periods presented in the report;
(4) the signing officers-
(A) are responsible for establishing and maintaining internal controls;
(B) have designed such internal controls to ensure that material information relating to the company and its consolidated subsidiaries is made known to such officers by others within those entities, particularly during the period in which the periodic reports are being prepared;
(C) have evaluated the effectiveness of the company's internal controls as of a date within 90 days prior to the report; and
(D) have presented in the report their conclusions about the effectiveness of their internal controls based on their evaluation as of that date;
(5) the signing officers have disclosed to the company's auditors and the audit committee of the board of directors (or persons fulfilling the equivalent function)-
(A) all significant deficiencies in the design or operation of internal controls which could adversely affect the company's ability to record, process, summarize, and report financial data and have identified for the company's auditors any material weaknesses in internal controls; and
(B) any fraud, whether or not material, that involves management or other employees who have a significant role in the company's internal controls; and
(6) the signing officers have indicated in the report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of their evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.
Although the Commission had previously proposed a different certification standard in the June Release,1 it stated in the August Release that it will adopt a form of certification that will conform to the requirements of the Sarbanes-Oxley Act.
The Commission is also proposing to require every domestic company subject to the reporting requirements of Section 13(a) or Section 15(d) of the Exchange Act to maintain sufficient procedures to provide reasonable assurance that the company is able to collect, process and disclose the information required to be disclosed in its Exchange Act reports.
The Committee fully supports the efforts to improve the disclosure system by requiring that a reporting company's principal executive officer and principal financial officer be actively involved in the preparation of Exchange Act reports. The Committee also understands the time constraints that the Commission faces in implementing the rules required under the Sarbanes-Oxley Act. The Committee is proposing the following clarifications and suggestions for the rules to be adopted by the Commission under Section 302(a).
Section 302(a) of the Sarbanes-Oxley Act states that the Commission shall, by rule, require for each company filing periodic reports under Section 13(a) or 15(d) of the Exchange Act that each of the principal executive officer and the principal financial officer make certain certifications in each annual and quarterly report filed or submitted under the Exchange Act. The Commission should confirm in the proposed rules that the certifications will only be required in regularly scheduled disclosure documents, such as Forms 10-K, 10-Q, 20-F and 40-F. We believe Forms 8-K and 6-K were intended to be excluded because they are not "quarterly or annual reports." In addition, because these forms are required to be filed in a short time frame following the occurrence of specific events, it would be difficult for the certifying officers to comply with the detailed review of internal controls mandated by the Sarbanes-Oxley Act.
In addition, in the case of a Form 6-K filing, we note that a Form 6-K, including a Form 6-K containing quarterly financial statements or information, is "furnished" to the Commission and is not deemed to be "filed" for purposes of Section 18 of the Exchange Act or otherwise subject to the liabilities of that section. Therefore, we do not believe that a Form 6-K containing quarterly financial statements or information is the equivalent of a quarterly report on Form 10-Q and that it would be inconsistent with the nature of the submission of the Form 6-K to the Commission that a Form 6-K containing quarterly financial statements or information be certified.
The Commission should also clarify that the Section 302(a) certifications must only be made by companies that are required to file reports under Section 13(a) or 15(d) of the Exchange Act. Many companies currently voluntarily file reports under Section 15(d) with the Commission. We are concerned that if the Commission were to require these companies to include the certifications under Section 302(a), many of them would elect to cease filing reports. We believe that investors would be better served if these companies were to continue filing periodic reports.
Although the August Release states the Commission will adopt rules under Section 302 of the Sarbanes-Oxley Act that will apply to foreign private issuers, we believe that the full application of all provisions of Section 302(a) to foreign private issuers could have an adverse impact on the U.S. capital markets. Increased potential liability and the difficulty of complying with these rules could make foreign issuers less likely to list their common stock in the United States or to raise capital in the U.S. public markets. Many foreign issuers have governance structures and home disclosure regimes that are different from those in the United States. In particular, the internal controls and procedures requirements of the proposed rules may be inconsistent with the laws or practices of a number of foreign private issuers' home jurisdictions and local stock exchange requirements. As a result, applying the proposed rules for maintaining internal controls and procedures to foreign private issuers may oblige them to satisfy two sets of possibly conflicting regulatory requirements, thus raising additional issues that do not exist for domestic companies. We believe that Section 302(b) (which states that U.S. companies who reincorporate in foreign jurisdictions cannot escape the legal force of Section 302) implies that there would be some different or modified treatment for foreign private issuers who did not reincorporate or redomicile from the United States. The Commission was aware of these concerns in the June Release and exempted foreign private issuers from proposed Rules 13a-15(a) and 15d-15(a). We recommend that the Commission exempt foreign private issuers from the portions of Section 302(a) relating to internal control procedures and audit committee communications.
Section 302(a)(3) of the Sarbanes-Oxley Act requires the certifying officers to state that, to their knowledge, the financial statements, and other financial information included in the report, fairly present in all material respects the financial condition and results of operations of the reporting company, as of, and for, the periods presented in the report. We do not believe that this was intended to change existing financial disclosure requirements for reporting companies. Rather, the purpose was to add procedures that would enhance the quality of compliance. Currently, the financial statements and financial information in quarterly and annual reports must comply with generally accepted accounting principles and applicable Commission rules and regulations, such as Regulations S-K and S-X and Rule 12b-20. The Commission should confirm that the certifications under Section 302(a) of the Sarbanes-Oxley Act are intended to ensure that the covered reports contain all information that is required to be disclosed under existing disclosure standards and are not designed to expand a company's disclosure obligations, except for the explicit disclosure requirements of Section 302(a) relating to internal controls, evaluations of internal controls and disclosures to the audit committee. If the Commission views the Section 302(a) certification standards differently, it should provide guidance to reporting companies.
In the implementing rules, the Commission should confirm that all certifications under Section 302(a) are based on the knowledge of the certifying officer. Sections 302(a)(2) and (3) have explicit references to knowledge but the other sections do not. Because of the mandated internal control reviews, we believe that all of the certifications under Section 302(a) were meant to be limited to the knowledge of the officers.
Also, the term "knowledge" is not defined in the Sarbanes-Oxley Act. The June Release stated that the "proposed certification is subjective in nature, in that it is limited to the knowledge of the principal executive officer and the principal financial officer and to their belief as to whether the information would be important to a reasonable investor. The principal executive officer or principal financial officer would not, as a result of the proposed certification requirement, have to separately inquire as to information not known to him or her by virtue of his or her certification of the contents of the company's periodic reports." Footnote 48 of the June Release noted that the certification requirement is not intended to change the current duty of inquiry by officers. We believe that the rules should define knowledge as actual knowledge of the officer making the certification. Other than the review and evaluation of internal controls required under Section 302 of the Sarbanes-Oxley Act, the rules should state that the certification process is not intended to, and does not itself, create an independent duty of inquiry.
We are concerned that if the proposed rules fail to address the applicable knowledge standard, there could be confusion as to whether the Sarbanes-Oxley Act creates a new duty of inquiry for principal executive officers and principal financial officers. We believe that Congress did not intend to change existing law in this area and that it did not intend to require the principal executive officer and principal financial officer of every public company to review, investigate and concur with all disclosure decisions made by their company. We are concerned that in larger companies, this requirement will either be unattainable as a practical matter or will require an inordinate amount of time that will take officers away from other pressing matters. For this reason, we suggest that the Commission make it clear that actual knowledge is the operative standard.
Under proposed Rules 13a-15(a) and 15d-15(a), each domestic reporting company is required to adopt and maintain sufficient procedures to provide reasonable assurance that it is able to collect, process and disclose the information required to be disclosed in its Exchange Act reports. Additionally, under Section 302(a) of the Sarbanes-Oxley Act, the principal executive officer and principal financial officer must evaluate the internal controls of their company on a quarterly basis. With respect to proposed Rules 13a-15(a) and 15d-15(a), the Committee agrees with the Commission that it should be left to each company to develop its own procedures based upon its own circumstances and that the proposed rules should not apply to foreign private issuers. However, the Commission should clarify how the proposed rules and the Sarbanes-Oxley Act will interact. For example, what is the meaning of internal controls for purposes of Section 302(a)? Are internal controls supposed to be the disclosure procedures described in proposed Rules 13a-15(a) and 15d-15(a) or financial controls? If the meaning of internal controls is the same as the disclosure procedures in proposed Rules 13a-15(a) and 15d-15(a), it would seem that the proposed rules have been superseded and should be withdrawn. Also, we believe it would be useful if the Commission could provide some examples of what steps should be taken by the principal executive officer and principal financial officer in the quarterly evaluations of their company's internal controls under Section 302(a). Should the evaluation be conducted by the officers and employees under their supervision or by a third party?
Special purpose entities that issue asset-backed securities, employee benefit plans and investment companies have different governance and management structures than typical reporting companies under the Exchange Act. These types of entities are either highly regulated or subject to strict contractual limitations. For example, special purpose entities and their activities are governed by very detailed operating and other agreements. Investment companies are subject to the Investment Company Act of 1940 and employee benefit plans are subject to ERISA. In addition, all of these entities do not have traditional management structures. Special purpose entities depend on servicers and other third parties to perform their contractual duties, employee benefit plans rely on plan trustees and investment companies retain investment advisors and other third parties. In view of their unique structures and strict contractual and/or legal requirements applicable to them, these types of issuers should not be subject to Section 302(a) (which is designed for more typical reporting companies). If the Commission determines that Section 302(a) should apply to these types of issuers, it should further study these issuers and their special circumstances before adopting any rules.2
Section 302(c) of the Sarbanes-Oxley Act requires the rules be effective by August 29. In view of these new substantive requirements of Section 302(a) and the time that companies will need to adopt new procedures, we believe the Commission should grant companies additional time to prepare by having the new rules go into effect at August 29 but only having them apply to annual or quarterly reports for periods ending after August 29.
Finally, we believe that the Commission should urge the Administration and Congress to eliminate the inconsistencies between the certification requirements under Sections 302 and 906 of the Sarbanes-Oxley Act, through a technical amendment to Section 906 that removes all but the criminal sanctions and adds a reference to the Section 302 certifications. Two sets of certifications, with different standards for the same covered SEC reports, serve no reasonable purpose. Furthermore, the certification under Section 906 should only be required for the same Exchange Act forms as the Section 302 certification.
Please note that Committee members Wayne Carlin of the United States Securities and Exchange Commission, David Jaffee of the National Association of Securities Dealers, Inc., and Salvatore J. Graziano of Milberg, Weiss, Bershad, Hynes & Lerach, did not participate in the preparation of this letter or the vote by the Committee to submit this letter to the Commission.
Members of the Committee would be pleased to answer any questions you might have regarding our comments, and to meet with the Staff if that would assist the Commission's efforts.
/s/ Charles M. Nathan
Charles M. Nathan, Chair of Committee on Securities Regulation
cc: Alan Beller, Director
Division of Corporation Finance
Securities and Exchange Commission
|1||Under the June Release, a company's principal executive officer and principal financial officer each would have to certify in an annual report that: (i) he or she has read the report; (ii) to his or her knowledge, the information in the report is true in all important respects as of the end of the period covered by the report; (iii) the report contains all information about the company of which he or she is aware that he or she believes is important to a reasonable investor as of the end of the period covered by the report. For purposes of the certifications, "important to a reasonable investor" would mean (i) there is a substantial likelihood that a reasonable investor would view the information as significantly altering the total mix of information in the report and (ii) the report would be misleading to a reasonable investor if the information was omitted from the report. The quarterly report certifications would have been substantially similar to the annual certifications, except that the narrower disclosure required in the quarterly reports would be considered.|
|2||In addition to determining who should make the certifications, the Commission would need to determine which forms the certifications will apply to. For example, issuers of asset-backed securities have been permitted to file monthly servicing or pooling reports under Form 8-K in lieu of regular reports. We do not believe these types of reports should be subject to certification requirements.|