June 30, 1999
Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W. Stop 6-9
Washington, DC 20549
Via e-mail: firstname.lastname@example.org
RE: The Regulation of Securities Offerings Release
Nos. 33-7606A, 34-40632A, 63 Fed. Reg. 67174
(December 4, 1998) - File No. S7-30-98
The Aircraft Carrier Release
Ladies and Gentlemen:
The Securities Law Committee of the American Society of Corporate Secretaries (the "Society") is pleased to provide comments to the Securities and Exchange Commission (the "Commission") on the rule proposals in The Regulation of Securities Offerings Release (the "Release"). The Societyís membership, now in excess of 4,000 members, represents over 1900 public companies and is regularly involved in the capital markets on behalf of those companies.
We greatly commend the Commission and its staff on this rulemaking effort. The Release is undeniably one of the most ambitious rulemaking projects in recent memory. As such, it has understandably sparked substantial debate among interested constituencies, including issuers, underwriters and investors. In light of the magnitude of the proposals and the degree of debate, and after extensive deliberation within the Societyís membership, we believe that as a matter of process, it would be best if the Commission proceeded on two different tracks. The first track would involve finalizing certain discrete proposals now, subject to the comments outlined below. The second track would involve a reproposal and reconsideration of those interrelated proposals that would entail extensive and fundamental changes to the offering process.
As a general matter, the Society believes that the rulemaking process can be finalized now on the integration proposals in proposed Rule 152 and related proposals and, subject to the comments
below, on the proposals relating to the Securities Exchange Act of 1934 (the "Exchange Act"). In contrast, the Society strongly believes that the proposals covering the offering process, communications during the offering process and prospectus delivery need to be reproposed. We have concluded that reproposal would result in a product that would more likely preserve the efficiency and integrity of our capital markets.
The Commission has proposed that directors certify that they have read each Quarterly Report on Form 10-Q and Annual Report on Form 10-K and that to their knowledge any such report does not contain any material misstatements or material omissions. The announced purpose of the proposal is to enhance the quality of disclosure. While enhancement of disclosure quality is always a laudable goal, and one that the Society heartily endorses, this proposal has far greater downside than upside and must be measured accordingly.
The Society respectfully disagrees with the rationale for the proposal. The quality of disclosure is primarily driven by securities lawyers and accounting professionals well versed in the Commissionís disclosure requirements. Members of the board of directors, in contrast, are charged with oversight responsibility with respect to the establishment of compliance processes and procedures. In exercising such responsibility, they are generally entitled to rely in good faith on experts and to delegate responsibilities to corporate management. Any notion that directors should become draftsmen of disclosure documents that can be hundreds of pages long is simply unrealistic.
It is also impractical to require a director to have read a final copy of a covered filing before it is filed and to have established a reasonable basis for the "knowledge" certification. Yet anything short of that under the proposal would expose a director to criminal liability for false statements under the False Statements Statute, 18 U.S.C. ∂1001. Implementation of such a requirement would adversely affect time schedules for the preparation of reports and would likely necessitate an extension of current due dates to accommodate director availability to read and review reports in draft form and then in final form. Such a need would fly in the face of the Commissionís desire to have Exchange Act reports filed as soon as practicable. Moreover, a certification requirement for Form 10-Qís would cause directors to want to review in detail the quarterly press release that includes much of the information that ultimately appears in the Form 10-Q. Thus, the quarterly press releases would likely also be delayed at many companies.
With or without the certification, the issuer retains the same level of liability under the Exchange Act with respect to the content of its filed reports. Although director liability is also not
currently contingent on any certifications, the converse that certification would not change the scope of potential liability is not necessarily true. The addition of the certification can be expected to give rise to additional claims of securities law liability by creative plaintiffís attorneys. It would consequently be premature to suggest that additional exposure to such liability would not result from the proposal. Indeed, in an amicus brief submitted this month by the Commission in Howard v. Everex Systems, Inc. (C.A. No. 98-17234), on appeal to the Ninth Circuit, the Commission took the position that signatures unquestionably heighten exposure to liability on a theory that "when an official signs a Commission filing, the official thereby attests to the documentís accuracy and completeness."
The addition of such a certification as yet untested in litigation can reasonably be expected to have a chilling effect on the process of attracting high quality directors. It would act as a substantial disincentive for knowledgeable persons to accept public directorships. It could also provide an opportunity to directorsí and officersí insurers to devise yet another exclusion to insurance policies intended to protect individuals willing to serve for the ultimate benefit of the investing public.
The Society conducted a recent survey of its members on this issue. Results of the survey confirm our membersí concerns. Out of 380 respondents, a total of 343 opposed the certification requirement, 121 of whom elaborated that they felt it would necessitate burdensome procedures and 28 of whom elaborated that they believed it could result in board resignations. In summary, the Society respectfully requests that the Commission delete any director certification requirements. This position applies to all filings and to any form of certification.
The Commission proposes to expand the number of persons required to sign certain forms, including Form 10-Q, to include principal executive officers and a majority of the board of directors. Those signing Form 8-K reports would have to certify that they had provided a copy to the board members. The announced purpose of the proposals is to improve the quality of Exchange Act reports by encouraging director participation in the drafting process.
As to signatures in general, the Society believes that it is always critical for logistical reasons to allow conformed signatures and signatures by power of attorney for all signing individuals on all forms. Although signing individuals take signature requirements very seriously, individuals are not always physically available to sign documents manually and must rely on trusted representatives to sign on their behalf. Signing individuals can be unavailable for any number of personal and business reasons at any given time.
As to the purpose of the proposal to encourage active participation in the preparation of Commission filings, the Society doubts the premise of the proposal as to directors. In their oversight role, it is more important for directors to establish compliance processes and procedures rather than to undertake the disclosure process directly. We believe it misconstrues the role of directors to suggest otherwise. Even the Blue Ribbon panel on audit committees did not recommend board signatures on Form 10-Q filings. We are further concerned about the scope of potential exposure to liability given the Commissionís views expressed in the amicus brief noted above.
As to requiring signatories of a Form 8-K to certify that they have provided a copy of the Form 8-K to each director, the Society objects to this proposal to the extent it is intended to require delivery of a copy in advance of filing for review and comment. Given the current nature of the Form 8-K and the Commissionís desire to accelerate the filing deadlines of Form 8-K, it is impractical to expect directors to be provided, i.e. delivered, an advance copy.
To the extent directors are traveling, it may also be impossible to get an advance copy of the filing to them in a secure manner. Most directors are frequent travelers at home and abroad and may be unable to be reached at all for periods of time or may only be able to be reached through an insecure method such as a hotel fax that heightens the risk of leaks of material nonpublic information. The Society would not object, however, if signatories were required to certify that a copy of the filing would be sent to the regular office locations of the members of the board of directors on the date of filing.
The Commission proposes to accelerate the due dates of annual and quarterly Exchange Act reports. The announced purposes are to benefit investors with more timely disclosure and to reduce the problem of selective disclosure to analysts and institutional investors. The Commissionís desire to minimize opportunities for selective disclosure and to make information available to the marketplace as rapidly as practicable is well understood.
The Society shares the Commissionís concern with respect to selective disclosure. To the extent selective disclosure issues exist, however, the Society believes that acceleration of due dates will not really address those issues.
While the Society certainly agrees that more timely disclosure always stands to benefit investors, we believe that acceleration of the current due dates will strain the capabilities of many issuers and increase the possibility of inaccurate filings to the detriment of the investing public. We submit that the goal of accuracy and completeness should always supersede the desire for speed.
Preparation of Exchange Act reports involves several processes that must primarily occur in sequential steps, not concurrent steps. First, the financial data must be collected. For large global issuers, this process presents a significant challenge and implicates a number of considerations, such as foreign currency translation. For any issuers that will be reporting extraordinary items, substantial effort is involved in evaluating the scope of such items and preparing appropriate substantiation. For issuers subject to segment reporting, further complications apply. Then consolidation must be done. In the case of the annual audit, the audit must be completed and the audit committee process completed.
After that, the financial results must be analyzed and tested against the requirements of Item 303, Managementís Discussion and Analysis of Financial Condition and Results of Operations. Once that is done, the text of the Exchange Act report must then be written in accordance with the applicable disclosure standards. We note in this regard the scope of such disclosure standards keeps expanding, not contracting. Once drafted, such reports then undergo an extensive review process internally and often externally in order to ensure accuracy and completeness. Several drafts are circulated before an issuer deems a report in final form for filing.
Although for some issuers technology has enabled acceleration of the data gathering process on the front end, the entire process is quite labor intensive. That is the case for both large and small issuers. While it is true that issuers on a voluntary basis have sometimes accelerated the process in the context of filing a registration statement, such an effort has typically involved substantial additional cost and substantial supplemental staffing through external assistance.
The Society consequently urges the Commission not to accelerate the due dates of these filings. The burden of accelerating the process would ultimately fall on those personnel collecting the financial data.. The practical effect of acceleration would, in some cases, enhance the likelihood of errors at the data gathering levels and thereby have the effect of degrading the quality and accuracy of the data provided. If the Commission determines to do so despite our concerns, we would recommend that the effective date be postponed at least a year, as we believe that many issuers will be required to increase their internal staff support and revamp their internal management reporting processes in an effort to comply.
The Commission proposes to require disclosure of Item 301 information on a Current Report on Form 8-K following the end of a reporting period and to mandate such disclosure within a prescribed time period. The announced purpose is to make the disclosure of financial results uniform and to require all issuers to release earnings data earlier.
The Society has no objection to a requirement that financial results be filed as part of a Current Report on Form 8-K. And, although we think that issuers should be encouraged to file as soon as practicable and to include Item 301 information, we believe that the Commission should not mandate that a Form 8-K be filed unless a press release is issued prior to the filing of the related periodic report and should not mandate that the content of such filings include Item 301 information.
As to the timing of the Form 8-K, there are a number of smaller issuers that are simply unable to determine and release financial results in advance of the filing of the related periodic report. The proposed filing deadline would unduly penalize these issuers and could result in an increase in the unintentional disclosure of inaccurate financial data. The Society recommends that the Commission instead either exempt smaller issuers from the proposed deadline or require the filing of the Form 8-K in conjunction with the issuance of the press release, assuming it is issued before the filing of the related periodic report.
As to the content of the information, earnings press releases vary according to industry practice and the dictates of the marketplace. The Society sees no need to mandate the disclosure items in this context. Indeed, use of the Item 301 approach could result in either overinclusion or underinclusion of information deemed relevant by the issuer and the issuerís investors. We would therefore prefer that the content of the disclosure not be prescribed.
The Commission has proposed to mandate risk factor disclosure in periodic reports under the Exchange Act. While the Society recognizes that many issuers are currently making forward looking disclosures in their periodic reports on a voluntary basis, we do not believe the proposal mandating "risk factor" disclosure should be adopted in its current form. As currently formulated, the proposal uses a disclosure standard different from that contained in the Private Securities Litigation Reform Act ("PSLRA"). We would propose using the PSLRA standard, namely "important factors that could cause actual results to differ materially from those in the forward-looking statement," rather than "the most significant factors" relating to future performance. In addition, rather than mandating such disclosure, we believe that such disclosure should be made, where applicable, in the issuerís judgment. In the event, in the issuerís judgment, any such disclosure is not appropriate, then likewise, no such disclosure should be mandated in Exchange Act filings. This approach would be akin to Item 503 risk factor disclosure that is only required where appropriate.
The Commission has requested comment on the advisability of requiring the filing of a management report to the audit committee of the board of directors as a means to enhance the quality
of disclosure in Exchange Act reports. Although the Society truly doubts that such a filing would enhance the quality of such disclosure, we believe that this issue should be reviewed in conjunction with upcoming rules that the Commission plans to propose later this year on audit committees. We therefore recommend that the Commission solicit comment on this proposal as part of that rulemaking process. Accordingly, the Society reserves comment on this issue until that time.
The Commission proposes to add a number of disclosure items for reporting on a Form 8-K and to accelerate reporting deadlines. The Society does not object to the additional disclosure items. Nor do we object to shorter reporting deadlines as a general matter. However, we believe that any reporting deadline shorter than the earlier of two business days or the date of a press release is too short to accommodate completion of the reporting process.
Similar to Exchange Act reports, the preparation of a Form 8-K not only involves identifying that the triggering event has occurred. It also involves analyzing the factors underlying the event, preparing the necessary disclosure, having that disclosure reviewed by the required levels within the organization and by outside advisors and then edgarizing and filing the report. In the case of the Form 8-K, the process can be complicated by the availability on short notice of internal personnel and external advisors. We consequently urge the Commission to delete any requirement of a one business day filing deadline and not to mandate any filings in less than two business days.
The Society has been a strong advocate of plain English disclosure in filings under the Securities Act of 1933 and has no objection to extension of plain English to Exchange Act reports. We would suggest, however, that a carefully staged transition be made with the goal of maximizing compliance and avoiding any delays in staff review.
In proposed Rule 152, the Commission proposes to resolve much of the metaphysics surrounding integration of securities offerings. Although pitfalls identified in the comment process should be addressed, the Society endorses resolution of integration issues as part of this rulemaking. Adoption of these proposals would clearly enhance the capital raising process and provide relief to issuers that for legitimate business reasons need to switch from a public to a private offering or vice versa. The Society commends the Commissionís efforts to resolve integration issues that have plagued practitioners for some time.
The Society believes that those proposals relating to the Securities Act registration process, communications during the offering process and prospectus delivery should be reconsidered and reproposed. The current proposals would revamp the entire offering process in the United States. And they would slow the process down. The slowdown would be costly, and the additional costs would be borne by issuers. In some cases, the proposals would even reverse prior changes made in that process that have functioned quite effectively for many years without any demonstrated record of abuse.
The access to and liquidity of our capital markets is the envy of the world. The offering process should not be redesigned in a wholesale fashion without extensive deliberation and thoughtful consideration of potential consequences. Such deliberation and consideration are now underway. We do not believe they should be concluded through final rulemaking without reproposal.
We encourage the Commission to repropose these matters taking into account the views of all interested constituencies. Reproposal would be a testament to the Commissionís resolve to continue the evolution, not a revolution, of the regulatory process. We have consequently limited our comments at this juncture to fundamental concerns about the adverse effects of the proposals in their current form. Indeed, some of the beneficial aspects of the proposals such as automatic effectiveness of registration statements and exemption from final prospectus delivery for some issuers are overshadowed by other proposals that more than counteract the apparent benefits.
The shelf registration process is a critical avenue to capital raising in the United States and hence is a critical component of the registered offering process. It is the preferred method of raising debt and equity capital for reporting companies. Although shelf registration would be technically available under the proposed regulatory regime, the benefits of the process would be largely emasculated. We respectfully disagree with the Commissionís premise that shelf registration would no longer be necessary, and we submit that the Commissionís proposals fail to demonstrate any compelling need to revamp shelf registration.
To the contrary, the Society firmly believes that it is important to preserve shelf registration in its current form. Issuers can now file a universal registration statement, have it declared effective after Commission staff review, offer securities off the shelf essentially at will, file a prospectus
supplement up to two days following the sale and deliver a prospectus and a prospectus supplement to investors along with the confirmation of sale.
Unlike the current shelf system, the proposals would require delivery of as yet unspecified information to investors before the investment decision is made, would require an amendment to the registration statement before a shelf takedown, and would substantially expand the amount of material that would have to be filed as part of the registration statement or a post-effective amendment to it in advance of sale. These changes would undoubtedly overshadow any perceived benefit to automatic effectiveness of both Form B registration statements and post-effective amendments thereto in the shelf context. The Society would rather preserve the status quo which has worked so well without abuse.
The Commission proposes to require the delivery of information to potential investors in advance of the investment decision. Although the Commission is rightly concerned that information be available to prospective investors before they make their purchase decisions, we believe the proposal underestimates the effectiveness of the current system in doing so. As a general proposition, the Society believes that such delivery should be mandated only as it is now through Rule 15c2-8 with respect to initial public offerings. For novel securities and relatively unknown reporting issuers, the marketplace has historically dictated and should be allowed to continue to dictate when advance delivery is necessary to the offer and sale of a security by reporting issuers. Otherwise, the periodic reporting record of issuers, secondary source information from analysts, and specific offering information dispersed by underwriters and communication services afford a strong basis for relying on the marketplace to make relevant information available to prospective investors.
More specifically, this proposal would also adversely affect the timing benefits of shelf registration by requiring advance delivery of information before sale rather than a prospectus along with the confirmation of sale. For reporting companies, such delivery would be absolutely unnecessary in the case of single class common stock. Moreover, it is unnecessary for investment grade debt sold on the basis of issuer name and rating. For bought deals and medium term note programs, it would also provide no meaningful disclosure. For "at the market" secondary offerings, it would be impossible to effect.
The Commission proposes to require the filing of post-effective amendments prior to a shelf takedown. Even though such amendments will be effective upon filing without staff review, this proposal would undeniably delay the shelf offering process. Now a prospectus supplement only needs
to be filed within two business days following the takedown. That period is logistically necessary to draft the disclosure document and to have it reviewed, edgarized and filed. Time is of the essence in shelf transactions, particularly medium term note programs. The need to accelerate the filing is not readily apparent, particularly given that most investors buy debt instruments based on their investment rating, not the disclosure document.
In addition, markets have recently been operating in a low interest rate and relatively stable environment. The shelf system was adopted in a high interest rate, volatile market environment. It is critical not to overlook the importance of speed should such a market environment ever return. Delay always entails risk, and increased risk increases costs. It is the issuer, not the underwriter, that bears such costs. In order to preserve this timing benefit of post-sale, not pre-sale, filing, the Society would be willing to endorse a press release requirement as to the occurrence of a shelf takedown on a same day basis in situations where the amount or type of security being sold is material to the issuer.
The Commission proposes to add various disqualification criteria to the use of proposed Form B. Two of the criteria are particularly disturbing to the Society. One disqualification would arise if executive officers or directors of the issuer, or the underwriters were within the past five years found to have violated provisions of the federal securities laws or were convicted of securities fraud. Another disqualification would occur if an issuer had not "resolved" staff comments on an Exchange Act report.
Disqualification for failure to "resolve" staff comments is unnecessary for several reasons. It is a rare issuer that would not on an expeditious basis use every reasonable effort to resolve staff comments. It should remain within the reasoned discretion of the issuer, its counsel and its accountants to assess the materiality of outstanding staff comments before proceeding with an offering. The ability to proceed with an offering should not be held ransom to submitting to staff comments that the issuer and its advisors determine in good faith to be immaterial.
No offering proceeds in any event without a legal opinion with respect to materially misleading statements and omission of material facts in a prospectus. An outstanding staff comment of a material nature that remained unresolved would preclude issuance of such an opinion. The legal opinion is thus a formidable stop-gap measure with respect to any possible disregard of material staff comments.
Disqualification of the issuerís use of Form B due to the actions of other parties should also not be pursued. No issuer should be held to a strict liability standard should the disqualifying activities of such parties be unknown to the issuer. The issuer should be able to rely in good faith on
written inquiries and representations in this regard without any requirement of independent investigation. Issuers should not otherwise be subject to a rescission offer should such a disqualification be triggered.
The Commission proposes to encourage freer communications by issuers before and during the offering period. The Society endorses the proposal, in concept, as a means to increase availability of information to investors when its availability would be most helpful. Definitional ambiguities and filing constraints have accompanied the proposal, however, and cast doubt on its utility absent significant modifications.
As proposed, at the time of filing a registration statement or prior to its first use, free writing would have to be filed. This requirement would burden issuers to round up all free writing material throughout the underwriting community, as the requirement applies to material circulated "by and on behalf of the issuer." Such material is not necessarily generated or reviewed by the issuer, and the issuer does not control the content of such free writing. Failure by third parties to produce such material to the issuer would also wrongly result, we believe, in liability exposure to the issuer. Imposing liability on the issuer for material it does not control is inappropriate. On a separate note, delay would also result due to the time it would take to collect the material, edgarize it and file it. This logistical delay would be yet another adverse consequence to the benefits today of shelf takedowns. We therefore believe that free writing should not have to be filed.
The proposal also leaves unresolved how to determine the duration of the "offering period," given that it is proposed to commence upon an undefined "first offer." We believe that a bright line test is essential to removing the chilling effect of potential Section 5 liability for gun jumping.
Responsible issuers make every effort to use the registration forms they are qualified and entitled to use. The consequences of using the wrong form are quite dire. The Society believes that it is inappropriate to delete from current regulations the presumption as to use of the proper form. At the very least a good faith standard should apply. Moreover, to the extent the Commission includes disqualification provisions as to the use of any given registration form, issuers should not be subject to rescission offers as to disqualifications not within the issuerís actual knowledge. The Commission, we believe, should maintain the presumption and continue to rely, as it has in the past, on the stop order process and other enforcement mechanisms to deal with bad actors.
The Society thanks the Commission for this opportunity to comment on the Release and truly commends both the Commission and the Staff on this ambitious rulemaking process. If you have any questions on our views, please let us know.
/s/ Margaret M. Foran
Margaret M. Foran
Securities Law Committee
/s/ Marilyn Mooney Marilyn Mooney
The Aircraft Carrier Release Task Force
cc: The Honorable Arthur Levitt
The Honorable Norman S. Johnson
The Honorable Isaac C. Hunt, Jr.
The Honorable Paul R. Carey
The Honorable Laura S. Unger