August 19, 2002
Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Re: File Number S7-21-02
Dear Mr. Katz:
We at PricewaterhouseCoopers LLP appreciate the opportunity to provide comments on the Commission's Proposed Rule: Certification of Disclosure in Companies' Quarterly and Annual Reports (the "proposed rule").
We have provided comments on the Commission's proposed Exchange Act Rules 13a-15(a) and 15d-15(a) as well as the application of the certification called for in the proposed rule to registered investment companies. Additionally, we have provided our views with respect to areas of the proposed rule which we believe should be clarified by additional interpretive guidance or should be reconciled to other provisions of the recently enacted Sarbanes-Oxley Act of 2002 (the "Act").
Proposed Exchange Act Rules 13a-15(a) and 15d-15(a)
We agree that an issuer filing/furnishing reports pursuant to Sections 13(a) or 15(d) of the Exchange Act should maintain sufficient procedures in order to provide reasonable assurance that the issuer is able to "collect, process and disclose the information, including non-financial information, required to be disclosed in its periodic and current reports..." We also believe that most companies currently have such procedures in place. Accordingly, we do not believe that significant changes will come about as a result of adopting proposed Exchange Act Rules 13a-15(a) and 15d-15(a).
However, given that each company operates in its own unique environment, if these rules are made final, we do not believe that the Commission should promulgate further requirements (by rule or otherwise) aimed at defining specific internal procedures to be employed by an issuer. Rather, we believe that management (under the leadership and direction of the issuer's audit committee and/or Board of Directors) should be permitted the flexibility to design such procedures and controls in the context of their own particular facts and circumstances to provide the reasonable assurances that are the subject of the proposed rules.
Application of the Proposed Rule to Registered Investment Companies
We understand from discussions with our investment company clients and their counsel that there is substantial uncertainty as to how, or even whether, the Section 302 certification requirements should be applied to investment companies. Since this is a matter of legal interpretation, we believe that its resolution of necessity must remain within the legal community.
However, should the Commission conclude that such certification is required from investment companies, we believe certain fundamental structural differences between investment companies and other types of businesses must be considered in connection with the promulgation of the related rules, regulations and interpretive guidance.
A unique aspect of investment companies is that they close their books and report net asset values to the public daily (or, for most closed-end funds, weekly). Daily net asset valuations are, of course, used by open-end companies to issue and redeem investor shares. Human errors are inevitable in the process of determining net asset value and sometimes those errors cross a financial reporting period-end. On occasion, those errors exceed one cent per share, suggesting an issue of compliance with Rule 2a-4 under the Investment Company Act of 1940, which generally sets a one-cent per share standard of accuracy for the daily determination of net asset value. Most funds have established, and their Boards have approved, procedures to correct such errors when detected and make whole those who have been adversely affected by them. Errors that cross a period-end are, more often than not, found before financial statements are released so they can be timely corrected, but occasionally they are not found until after the financial statements are released.1 It is at present unclear whether these routine operational corrections may call into question the validity of a Section 302 certification, even when they may reasonably be judged not to be material to the fair presentation of previously issued financial statements. If investment company certifications are required, we believe the Commission should clarify that the Rule 2a-4 standard of accuracy applies only to daily operations and is not necessarily to be applied in the evaluation of Section 302 certifications.
The investment company industry is unique in that a large proportion of its accounting records are maintained by external service providers, principally fund accounting agents and transfer agents. As a result, not all control procedures may have been designed by a single organization and responsibility is divided for the continued maintenance of internal controls; typically, a separate internal control consists of procedures established to monitor and supervise the performance of those providers. The internal control elements of the certification required by Section 302 of the Act appear to be directed principally to organizations where an issuer's signing officers are directly responsible for the design and implementation of all material internal controls. Should certifications be required for investment companies, we believe the Commission should clarify the extent to which signing officers will be considered to take responsibility for material elements of internal control principally designed and maintained by external service providers, in addition to those controls directly established by the issuer.
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We recognize the language contained in the proposed rule as well as its scope and/or applicability are in large measure statutorily defined by the Act. Although not intended to address the associated legal issues, we have presented below our views on a number of elements in the proposed rule and other related topics which we believe should be clarified or reconciled through interpretive guidance so as to provide greater clarity to the community of preparers, investors and other readers of the related disclosure documents (collectively, "preparers/users").
Clarify and Reconcile the Differences Between the Certification Required by the Proposed Rule and the Certification Required by Section 906 of the Act
As the Commission is no doubt aware, the certification specified by the proposed rule and the certification required by Section 906 of the Act differ in certain respects. Although we understand that the certification required by Section 906 of the Act may be directed more to Federal agencies other than the Commission (such as the Department of Justice), we believe that the inconsistencies between these two certifications may lead to a lack of clarity among preparers/users and that the Commission should pursue any possible avenues toward enhancing such clarity and reconciling the differences between the two certifications.
For instance, one element of the certification specified by the proposed rule would require the signing officer to certify that:
Based on the 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 issuer as of, and for, the periods presented in the report;
Section 906 of the Act contains a similar (but nonetheless different) certification requiring the signing officers to certify that:
...the information contained in the periodic report fairly presents, in all material respects, the financial condition and results of operations of the issuer.
Recognizing, that the liability associated with each certification is different (criminal vs. civil), we believe that a lack of clarity could arise among preparers/users by two different certifications signed by the same individuals relating to the same filing. Accordingly, we believe that the Commission should promulgate rules or regulations in order to combine the two separate certifications into one that is included in the subject report.
If the certifications cannot be reconciled into a single certification, we believe the Commission should provide guidance as to the appropriate placement and/or mechanism for filing/submitting any certifications that must be either contained in (as would appear to be the case with respect to the certification required by the proposed rule) or submitted with (as appears to be the case with respect to the Section 906 certification) the subject report. Specifically, we believe that the certification(s) should be filed as an exhibit to the subject report so that preparers have a clear understanding as to the manner/mechanism in which they should provide the required certifications and investors/users have a clear expectation as to how and where they may obtain and evaluate the certifications without undue time or effort on their part.
The Certification Specified by the Proposed Rule and the Certification Required by Section 906 of the Act should Each Make Reference to Cash Flows
We recognize that the certification specified by the proposed rule as well as the certification required by Section 906 of the Act are aimed at the subject report taken as a whole, rather than just the historical financial statements contained therein thus making it difficult to specify a specific standard against which the signing officers' must evaluate the fair presentation of the financial information. However, as currently drafted, both certifications focus solely on the fair presentation in all material respects of an issuer's financial position and results of operations but neither certification references "cash flows." Given the requirements that the subject filings must also contain statements of cash flows, we believe that the certifications should be drafted to specifically reference cash flows because in the absence of such reference, investors may be confused as to why the certifications do not extend to this element of an issuer's financial information.
Clarify the Standard of Materiality to be Applied in Connection with the Certification Specified by the Proposed Rule and the Certification Required by Section 906 of the Act
The certification specified by the proposed rule and the certification required by Section 906 of the Act each indicate that the respective certifications, insofar as they pertain to the fair presentation of financial information in the subject report, should be made in the context of "all material respects." We believe the Commission should clarify that the standard of materiality that should be applied is that which is outlined in Staff Accounting Bulletin 99 (Topic 1-M) which states "[a] matter is "material" if there is a substantial likelihood that a reasonable person would consider it important."
Clarify and Reconcile Differences Between Signature Requirements of Exchange Act Forms and the Certification Specified by the Proposed Rule
As the Commission noted in its original rule proposal, the signature requirements for Form 20-F simply require the form to be signed by any authorized officer. Similarly, Form 10-Q (and Form 10-QSB) need only be signed by a duly authorized officer of the registrant and by the registrant's principal financial or chief accounting officer. However, the certification specified by the proposed rule would require the individual signatures of the principal executive and financial officers (or persons performing similar functions).
We believe these different signature requirements would lead to diminished preparer/user understanding because the officers making the certification specified by the proposed rule (as well as the certification required by Section 906 of the Act) are not necessarily the same officers that have signed the form which contains (or is accompanied by) such certification. We believe that the Commission should amend the signature requirements of all forms that will require the certification described in the proposed rule such that the forms require the signature of those persons making the certifications.
Replace the Quarterly Evaluation of Controls with a Quarterly "Updating" Requirement and Clarify and Reconcile Differences Between the Certification Required by the Proposed Rule and the Internal Control Report to be Required by Section 404(a) of the Act
The proposed rule specifies the that signing officers must make and report on their evaluation of the effectiveness of the issuer's internal controls as of a date within 90 days prior to the report. We believe this requirement to perform a full evaluation essentially every three months imposes a burden on management that does not meet the cost-benefit test.
We believe that the evaluation of the control structure should be formally made and reported on by signing officers in connection with the preparation of annual financial statements (as required by Section 404(a) of the Act) and that interim disclosures should be limited to "updating" the report contained in the most recent annual report for significant changes that have occurred since the most recent full annual certification. We believe this idea of "updating" for significant changes is consistent with the spirit of keeping disclosure document users informed without imposing the costly burden of full evaluations each quarter. This concept is one that is well founded in the Commission's rules and is applied regularly in connection with the preparation of interim disclosure documents.
Additionally, there are a number of differences between the terminology used in the proposed rule as compared to seemingly similar terminology used in Section 404(a) of the Act (which pursuant to the Act will be the subject of future Commission rulemaking) which we believe will result in diminished clarity for preparers/users.
For instance, the proposed rule requires signing officers to certify that they "are responsible for establishing and maintaining internal controls" whereas the internal control report to be required in annual reports pursuant to Section 404(a) of the Act requires that management state their responsibility "for establishing and maintaining an adequate internal control structure and procedures for financial reporting."
The Section 404(a) internal control report speaks to the undefined qualitative aspect of "adequacy" while at the same time limiting the report to financial reporting. The certification specified in the proposed rule is silent with respect to adequacy but appears to encompass a broader range of internal controls (e.g., not limited to financial reporting). Given that both the Section 404(a) report and the certification that is the subject of the proposed rule will appear in the same annual report, we believe that the differences in terminology will lead to diminished preparer/user clarity and therefore that the terminology should be made consistent.
Similarly, as noted above, the proposed rule requires the signing officers to certify that they "have evaluated the effectiveness of the issuer's internal controls as of a date within 90 days prior to the report." However, the internal control report required pursuant to Section 404(a) must contain an assessment, as of the end of the most recent fiscal year of the issuer, of the effectiveness of the internal control structure and procedures of the issuer for financial reporting." We believe that this apparent difference between the required timing of the evaluation under each of the two rules will result in a lack of preparer/user clarity because as discussed below, they may be presented with two different reports/certifications regarding internal controls in the same filing as of different dates.
The Commission should clarify the phrase contained in the proposed rule "within 90 days prior to the report" so that there is no misunderstanding as to the time frame for the required evaluation. For instance, if the date of the report is the date on which it is filed (or the date that appears on the signature page), such report may be filed more than 90 days subsequent to the date of the most recent financial statements included in the filing (e.g., a 10-K filed pursuant to Exchange Act Rule 12b-25 or in the case of a foreign private issuer which is not required to file its annual report on 20-F until 180 days after its year-end) thus necessitating an evaluation of controls for a period that is more recent than the financial statements included in the subject report. Additionally, if the certification requirements specified by the proposed rule are made applicable to amendments to previously filed annual or quarterly reports, the proposed rule as drafted would appear to require another evaluation of internal controls at some point within 90 days of the date of the amended quarterly or annual report.
If the interim evaluation requirements contained in the proposed rule are retained, we believe the Commission should conform the language in the proposed rule to the corresponding language contained in Section 404(a) of the Act by requiring that the required internal control evaluation be made as of the date of the most recent balance sheet included or required to be included in the subject filing pursuant to the appropriate regulations (S-X or S-B).
Furthermore, given the level of effort that will be required for an issuer to make the controls evaluation, we believe the Commission retains the control certification provisions contained in the proposed rule that it should delay the effectiveness of this portion of the certification until the date that the first internal control report required by Section 404(a) of the Act is disclosed.
Additionally, although not specifically related to the proposed rule, we would like to highlight two matters for the Commission's consideration in connection with the future rulemaking required by Sections 404 and 103 of the Act insofar as it will relate to the internal control assessment and reporting by public accounting firms.
As noted above, Section 404(a) of the Act requires the Commission to adopt rules requiring management to include in an issuer's annual report, an assessment of the effectiveness of the issuer's internal control structure and procedures for financial reporting as of the end of the issuer's most recent fiscal year. Section 404(b) of the Act requires the Commission to adopt rules requiring a registered public accounting firm that prepares or issues the audit report for the issuer to attest to and report on the assessment made by management.
We wish to emphasize to the Commission that because an issuer's internal control structure is not static, attesting to management's assessment of the effectiveness of an issuer's internal control structure will likely be an undertaking that requires the design and execution of an extensive set of procedures. We believe that the forthcoming rulemaking (whether from the Commission or the soon to be created Public Company Accounting Oversight Board) should recognize that the procedures to be undertaken by public accounting firms in order to meet this new reporting responsibility will likely need to be performed throughout the fiscal year to which management's assertions relate in addition to after the close of such year.
We also wish to emphasize to the Commission (and the Public Company Accounting Oversight Board when ultimately constituted) that Section 103(a)(2)(iii) of the Act specifies a level of detail to be included in the report required by Section 404(b) of the Act from each registered public accounting that far exceeds the level of detail that is outlined for management/officer reporting/certification under the provisions of either the proposed rule or Section 404(a) of the Act. We believe the Commission's rules should be drafted so as to provide that management's report is the appropriate medium for communicating its conclusions regarding the various detailed elements associated with the issuer's control structure (e.g., the individual items enumerated in Section 103(a)(2)(iii)(II)(aa)-(bb)). We believe the report of the registered public accountant should be directed toward attesting to management's report rather than the primary location of the conclusions regarding individual elements of the control structure.
Clarify Covered Reports Under Both the Proposed Rule and Section 906 of the Act
The proposed rule provides that the subject certification must be "in each annual or quarterly report filed or submitted."
In the supplemental information on the proposed rule, the Commission indicated that the certification requirement would apply for annual reports on Forms 20-F and 40-F. However, the release did not address the applicability to information submitted on Form 6-K. We do not believe the certification process should be applicable to information provided on Form 6-K. The information that is furnished to the Commission on this Form is required based on disclosure requirements and practices in other countries and stock exchanges. While some of the information may be comparable, or even more extensive than that provided in the US, much of it will be substantially less than what is provided under the Commission's rules for domestic companies.
We believe that in many situations compliance with the requirements of Form 6-K would result in the submission of financial information in which the signing officers could not conclude that it fairly presents, in all material respects, financial condition and results of operations (e.g., a Form 6-K could include only selected financial information). In addition, most of the information provided on Form 6-K has been prepared using the accounting standards of the issuer's home county, and a reconciliation to US GAAP is frequently not provided. The inclusion of home country GAAP in the annual report on Form 20-F without a reconciliation to US GAAP would result in the auditor needing to qualify their report as it would not fairly present the financial information under the Commission's requirements. Accordingly, it would be difficult for the signing officers to conclude that the inclusion of such information in a submission on Form 6-K fairly presents financial condition and results of operations in all material respects for purposes of the US market. We recommend that text of the rules specify that the certification does not apply to Form 6-Ks.
Similarly, we believe that the proposed rule should affirm that the certification specified by the proposed rule would not be required in a Current Report on Form 8-K filed/furnished for the purpose of placing on file quarterly or annual financial statements together with management's discussion and analysis of financial condition and results of operations and other information that would normally be included in an annual or quarterly report because such report would not constitute an "annual or quarterly report."
On a related topic, the language contained in Section 906 of the Act indicates that the certification required by that section must accompany "[e]ach periodic report containing financial statements filed by an issuer with the Securities and Exchange Commission pursuant to section 13(a) or 15d of the Securities Exchange Act of 1934..." We believe that the Commission should provide in its rules a clear definition of "a periodic report." Specifically, we believe that the Commission should clarify that Current Reports on Form 8-K (whether filed or furnished) and all reports on Form 6-K (which are furnished rather than filed and are therefore presumably excluded from Section 906) are not required to contain the Section 906 certification, without regard to whether they include financial statements. Again, we recognize that the Section 906 certification may be primarily directed to Federal agencies other than the Commission, however, given the direct linkage to the Commission's forms, we believe that SEC leadership in clarifying this matter would foster greater compliance with this section of the Act.
Furthermore, we believe that the Commission should clarify that the certification specified in the proposed rule would be required in "transition reports" filed on Form 10-K or 10-Q (or 10-KSB or 10-QSB). Presumably, "transition reports" would constitute periodic reports for purposes of Section 906 but it is not clear whether they would constitute an "annual or quarterly report" for purposes of complying with the proposed rule. Additionally, we believe that the Commission should clarify that new certifications under the proposed rule and Section 906 of the Act are required in connection with the preparation and filing of amendments to previously filed covered reports. However, in the case of amendments to previous filings, we believe that the Commission should modify the certification specified by the proposed rule to be in the context of the original filing as amended.
Additionally, we believe the Commission should clarify that the certification specified by the proposed rule (as well as the certification required by Section 906 of the Act) are not applicable to Annual or Transition Reports filed on Form 11-K. Such reports, which are filed pursuant to Section 15(d) of the Exchange Act, would appear to meet the requirements for including both certifications, however, the plans making such filings may not have principal executive or financial officers and important elements of the system of internal control may rest with outside service provides, trustees and plan administrators. Similarly, we believe the Commission should clarify that the provisions of the proposed rule (and Section 906) are not applicable to Unit Investment Trusts which do not have Boards of Directors, are not considered to have "management" in the traditional sense of discretionary control over even investment selection and which have no requirements to send periodic financial statements to their unitholders.
In summary, we believe that the Commission should:
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We appreciate the opportunity to express our views and we commend the Commission and its Staff for the speed with which it is responding to the requirements of the Act and for its other efforts to help restore investor confidence. We would be pleased to discuss our comments or answer any questions that you may have. Please do not hesitate to contact Jay P. Hartig (973-236-7248) regarding our submission.
|1||This could come about through such causes as the improper set-up of a fixed-income security in computerized accounting records, resulting in the incorrect accrual of interest income not detected until a coupon payment is due, or failure to recognize a corporate action on an equity security not identified until cash and/or new securities are received.|