April 26, 2000
Mr. Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street N.W.
Washington, D.C. 20549-0609
Re: File Number S7-31-99
Selective Disclosure and Insider Trading
Dear Mr. Katz:
PricewaterhouseCoopers LLP is pleased to comment on Release No. S7-31-99, the proposed rules for Selective Disclosure and Insider Trading (the "Release"). We applaud the Commission's efforts to address the practice of selective disclosure of material nonpublic information, and we believe that the Release highlights valid concerns, particularly with regard to the apparent pressure exerted by financial analysts on the companies they follow to achieve earnings estimates. While we believe that the rules proposed in the Release are a step in the right direction in combating these pressures, we also believe that actions may also be needed to address the source of these apparent pressures on companies. Thus, while we understand that the Commission's regulatory authority may not directly extend to the conduct and activities of financial analysts, given the apparent increasing impact of their activity on the financial reporting system, we believe this subject should be further explored with a view toward evaluating whether and how these activities should be regulated.
Although we support the overall goals and direction of the Release, there are several areas for which we think the Commission should clarify, expand, or, in some cases, change the proposal. The remainder of this letter addresses those areas.
Definition of "Public Disclosure"
We believe that if a registrant chooses to make its public disclosure through a means other than filing a Form 8-K (or it is required to make this disclosure at a time when a Form 8-K filing cannot be made due to a lack of EDGAR accessibility or the like), it should be required to file this information with the Commission within two business days of using the alternative method of disclosure. Note that for purposes of this letter, our discussion of "public disclosure" will refer to the filing of a Form 8-K (or Form 6-K for foreign private issuers).
Content of the Public Disclosure
Under present staff guidance contained in FRP 202 (ASR 142), when alternative measures of performance are presented, the staff expects "balanced" disclosures (i.e., the alternative measure should never be presented in a manner more prominent than the corresponding data under generally accepted accounting principles [GAAP] and the GAAP measure must always appear when the alternative measure appears), as well as an explanation of the reason for the presentation (i.e., why the alternative information is appropriate and what the information means). The staff has also noted that information a company discloses which would not otherwise be permitted under GAAP may also require an explanation of the existence and benefits of other alternative measures beyond the one being used by the registrant. Additionally, a footnote or other reference to the method of calculation and components should be provided.
We do not believe that a company's eventual public disclosure should be limited by requiring it to disclose only that data which was contained in its initial disclosure of material nonpublic information. To the extent that the Release requires a company to disclose alternative measures of performance, prospective financial information (PFI) or information that it would not otherwise be permitted to disclose under GAAP, we believe that a registrant should be required to make additional statements within its public disclosure, such as those required by FRP 202, to "balance" the disclosure and allow it to conform to the SEC's established rules for alternative measures. (For example, if an issuer selectively discloses EBITDA per-share amounts without also noting the GAAP earnings per share, it should be required to include both these amounts in its Form 8-K disclosures. Unless clarified, we believe the Release could inadvertently permit registrants to circumvent existing staff interpretive guidance).
By permitting an issuer to include information that is in addition to its nonpublic disclosures in the Form 8-K that is ultimately filed, the Commission would also enable the issuer to disclose the absence of a review by an independent accountant. (This disclosure is required by existing professional auditing standards relating to PFI.) This is particularly important in view of the automatic incorporation by reference of such data into certain filings under the Securities Act of 1933 (Securities Act). Since the professional auditing standards do not contain specific dissociative language that may be used in making additional disclosures, we believe language similar to the following should be used to communicate the absence of an auditor's involvement with such data:
On April 1, 200X, the Company disclosed the following prospective financial information included in this Form 8-K. Such data has been prepared by, and is the responsibility of, the Company's management. Our independent accountants, PricewaterhouseCoopers LLP, have neither examined nor compiled the accompanying prospective financial information and, accordingly, do not express an opinion or any other form of assurance with respect thereto. The PricewaterhouseCoopers LLP report (included in this Form 8-K or incorporated by reference in other Securities Act or Exchange Act filings) relates to the Company's historical financial information. It does not extend to the prospective financial information and therefore should not be misinterpreted as doing so.
If the Commission believes, as we do, that it is important to distinguish between data with which an individual independent accountant has been involved from that with which it has had no involvement, it should provide both the mechanism and the time to include such cautionary language for the protection of investors.
Timing of the Public Disclosure
We certainly understand the merits of "prompt" disclosure (disclosure within twenty-four hours), but believe that this may be difficult to implement in practice. Because we believe there is a benefit in providing the balanced disclosures which we suggested above, we recommend that the Commission consider what emphasis will be placed on balanced disclosures, as well as the time that it will take registrants to compile the information. For example, when an issuer makes a planned "intentional" disclosure of information that is not balanced, the "balanced" information should be readily available and should be included in the Form 8-K filing.
With regard to unintentional disclosures, there is obviously an incentive to have the nonpublic information on file as soon as possible (i.e., within twenty-four hours). However, given the nature and unpredictable occurrence of unintentional disclosures, the company may not have an opportunity to compile the additional "balancing" component of the information for a public disclosure in a Form 8-K filing within twenty-four hours. Therefore, we propose that in the case of an unintentional disclosure, the registrant be permitted to file an "incomplete" Form 8-K within one business day from the original disclosure, to be followed by a Form 8-K/A including the balanced data, within three business days of the initial unintentional, nonpublic disclosure. The filing of the initial Form 8-K should be given safe-harbor treatment under the proposed Regulation FD and rules for Form 8-K and thus not be deemed defective in these instances.
In summary, we would support that registrants making intentional nonpublic disclosures be required to make a balanced public disclosure by the next business day after the initial disclosure (a nonpublic disclosure made on a Friday would require a press release prior to Monday). With regard to unintentional disclosure, the Commission should require (1) that such disclosures which are identical to the nonpublic information (which may not be balanced) be filed within one business day of the nonpublic disclosure and (2) that balanced disclosures, if not included in the initial filing, be filed within three business days of the nonpublic disclosure. We recommend that business days be used for this requirement versus hours because the hours requirement would be impractical to monitor. Additionally, the use of business days would be consistent with current Commission rules.
Definition of an Employee
We believe that the definition of an employee should be broadened to encompass anyone who works for the company. This would limit the potential for a company to intentionally avoid publicly disclosing material information merely based on the position of the individual selected by management to make the announcement.
Definition of "Any Person Outside of the Issuer"
We believe that the Commission should clarify this definition, because it is open for interpretation. For example, the definition could be read that when a confidentiality agreement is not signed, a Rule 144A filing (or other private, exempt offering) will require an existing public company to file a Form 8-K that discloses any incremental information that had not been previously disclosed.
The Commission needs to consider how this definition would apply to closed-end investment companies. For example, it may be argued that an employee of an affiliate of a closed-end fund (e.g., an employee of the investment adviser or administrator) who selectively discloses material nonpublic information would not be considered an "agent of the issuer" under the Release's definition.
Disclosure during an Initial Public Offering
Existing rules require that a registration statement be materially complete at the time that it is declared effective. Therefore, it is reasonable to assume that any material and relevant information currently required by Regulations S-K and S-X would be included in the registration statement at the effective date. Consequently, we believe that initial public offering companies should be subject to the Release at the time they become subject to the periodic reporting requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934.
Issuers Covered by the Release
We agree that the proposed rules should apply, and be limited to, closed-end investment companies. As noted in the Release, open-end funds are engaged in continuous offerings and already have an obligation to update prospectuses for any material events. Further, since open-end funds "trade" daily at net asset value (NAV), there is no opportunity to profit from inside information, since the only effect would be to trigger sales or redemptions at NAV.
For a closed-end fund, we believe that the departure of a portfolio manager would be an issue only if the individual were well known and the fund directly identified with that person. The Commission should clarify this point in the Release. Other possible instances of selective nonpublic disclosure include a major portfolio realignment, a proposal to change the fund's investment direction, a change in tax status (i.e., from a pass-through entity to a taxable corporation), or a potential business combination involving parties affiliated with the fund.
We believe that the Commission needs to clarify the responsibility of a business development company (BDC) or small business investment company (SBIC) when a nonpublic selective disclosure is made by the management of a portfolio company and not the BDC/SBIC. It would make sense to create some attribution rules whereby (1) the investee's management would have the responsibility to report the selective disclosure to the BDC/SBIC on the same trading day and (2) the BDC/SBIC would be required to file a Form 8-K within one business day of having been notified. An exception to this would be if the investee is a public company and the BDC/SBIC believes, in good faith, that the investee has filed/will file the required Form 8-K timely.
We support permitting closed-end investment companies to make a public disclosure by filing a Form 8-K. However, we do not believe that creating a new item 11 is necessary, as the mere filing of a Form 8-K by an investment company should result in the desired effect. There does not seem to be reasonable justification for or benefit to the public in singling out (by way of creating a new item) closed-end investment companies for special disclosure in the Form 8-K.
With respect to foreign private issuers, we believe that the Release could deter foreign companies from entering the U.S. market, since foreign issuers are currently subject to both (1) the SEC's annual reporting requirements and (2) their home country's requirements. The Release indicates that NASDAQ, NYSE and ASE membership requirements stipulate that all members make timely disclosures of material information, irrespective of whether a member is a foreign or domestic entity. In our experience, most foreign companies provide only that information which must be disclosed under their home country's rules. We believe that requiring foreign private issuers to make additional disclosures could adversely affect how many foreign companies enter the U.S. market. The Commission should give this factor special consideration in determining whether the Release should apply to foreign private issuers. An SEC decision to exclude foreign private issuers in the interest of keeping the U.S. markets open to them would be consistent with the Commission's previous initiatives to reduce disclosure requirements for foreign private issuers.
If the Commission determines that it is appropriate to exclude only certain foreign private issuers, rather than all foreign private issuers, we believe that certain companies should still be exempt from the Release. At a minimum, the exemption should apply to those companies that have a reporting obligation under Section 12 solely as a result of having exceeded (1) the U.S. shareholder threshold or (2) the minimum assets threshold. In any event, we doubt that compliance on the part of such companies would be rigorous, given that such companies would not have taken any direct measures to have their securities purchased by U.S. shareholders (i.e., no offering would have been made in the U.S. and there would have been no marketing or solicitation in the U.S.).
Although the Commission does not currently require foreign private issuers to file a Form 6-K, we do not believe this limitation makes the proposed requirement to file a Form 6-K less useful. We believe that Section 18 should not apply to foreign private issuers, which is consistent with current regulations.
Role of the Independent Accountant - Foreign Private Issuers
In certain circumstances, a registrant's independent accountant may have issued reports that do not comply with auditing standards generally accepted in the United States (U.S. GAAS). For example, in some jurisdictions, an independent accountant can issue a report that resembles an audit opinion issued under U.S. GAAS. However, the level of work that must be performed in order to be able to issue the report under the auditing standards of the foreign jurisdiction might only be equivalent to the level of work that is put into a review or compilation engagement in the United States. We believe that it is not appropriate to include an independent accountant's report that does not comply with U.S. GAAS in a Form 8-K (or Form 6-K). In fact, we believe that the Release should provide a mechanism to ensure that the removal of these reports occurs before unwarranted reliance is placed upon them by U.S. investors.
In respect to foreign private issuers, adding this mechanism would allow the independent accountant to require the removal of a registrant's audit, review, or other special-purpose report that had been issued pursuant to local standards and for local purposes (such as a PFI report or a working-capital adequacy report). We believe that the exclusion of such reports is not inconsistent with the intent and spirit of the Release, which is to prevent analysts or other insiders from having an advantage (by way of possessing material information about a registrant's operations or planned activities) over the general public in securities trading.
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We appreciate the opportunity to express our views and would be pleased to discuss our comments or answer any questions that the SEC staff may have. Please do not hesitate to contact Robert Herz (973-236-7217) or Jay Hartig (973-236-7248) regarding our submission.
Very truly yours,