SULLIVAN & CROMWELL
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OBERLINDAU 54-56, 60323 FRANKFURT AM MAIN
April 12, 1999
Mr. Jonathan G. Katz,
Securities and Exchange Commission,
450 Fifth Street, N.W.,
Washington, D.C. 20549.
Re: Notice of Proposed Rulemaking on International Disclosure Standards - Release Nos. 33-7637; 34-41014 (February 4, 1999), International Series Release No. 1182 (File No. S7-3-99)
Dear Mr. Katz:
We are pleased to have the opportunity to comment upon the proposed amendments to Form 20-F set forth in the above Release (the "Release"), which are intended to conform the non-financial statement disclosure requirements for foreign private issuers to the international disclosure standards endorsed by the International Organization of Securities Commissions ("IOSCO").
Many of our comments are in fact comments on the IOSCO standards. This leads us to the conclusion that if one of the goals of multilateral rulemaking is uniformity among adopting jurisdictions, then when the SEC is engaged in multilateral rulemaking, there should be a procedure for the public to comment on the proposed rules and on the SEC's comments (or lack of comments) during the rulemaking process. For example, would it have been possible for the SEC to have published, and invited comments on, a fairly final version of the IOSCO Technical Committee's draft of the IOSCO standards, together with the SEC's proposal to substitute those standards for the current provisions of Form 20-F?
We would be happy to discuss procedures for future multilateral rulemaking, including the IOSCO Technical Committee's consideration of the International Accounting Standards Committee's Core Accounting Standards. While we recognize the complexity of multilateral rulemaking, we believe that the SEC should nevertheless invite comments through its own public notice process (e.g., the Federal Register, the SEC Digest and the SEC website) as to the extent to which it should use those standards.
We have divided our comments on the proposals contained in the Release into two categories -- conceptual comments and technical comments.
We note three comments made by the SEC as reasons supporting the adoption of the amendments contained in the Release. First, the SEC states that it believes that the IOSCO standards will aid issuers who "would find it easier to offer or list securities outside their home country by preparing a core disclosure document that, with a minimum of national tailoring, may be accepted in multiple jurisdictions". Second, this disclosure document, according to the SEC, will "serve as an 'international passport' to the world's capital markets by reducing the barriers to cross-border offerings and listings". Third, the SEC states that this new practice would "provide a means for expanding the investment opportunities available to U.S. investors, while still ensuring that they receive a high level of information comparable to that provided by U.S. companies".
In what we believe is a contradictory statement, the SEC also notes that the proposed changes will not decrease the amount or quality of information investors will receive. The fact that the SEC does not propose to change any of its disclosure requirements that foreign private issuers find burdensome and costly to comply with (particularly the detailed reconciliation of financial statements to U.S. GAAP) means that the United States will still impose requirements that exceed a "minimum of national tailoring", defeating the idea that a core disclosure document can be prepared that can be used in "multiple jurisdictions". A foreign private issuer's "international passport" may gain it access to the U.S. capital markets, but it will still need a special U.S. visa that is costly and time consuming to obtain.
The fact that these costly and burdensome requirements will still be imposed, together with the fact that the proposed amendments would impose additional requirements on foreign private issuers, may indeed cause foreign private issuers to shun the U.S. capital markets. If they do so, they will not be required to comply with any U.S. disclosure requirements, which will leave U.S. investors with the Hobson's choice of investing on the basis of a lower level of information (and without the protection provided by the liability provisions of the U.S. securities laws) or foregoing investing in increasingly important markets.
The solution, we believe, is for the SEC to rethink whether it should give relief from some of its more burdensome requirements, such as the U.S. GAAP reconciliation. Furthermore, we believe that the SEC should not adopt the portions of the IOSCO standards that impose greater burdens on foreign private issuers than now exist under the SEC's rules, particularly where it is not known the extent to which, or even whether, other countries will adopt the IOSCO standards(1).
The resulting lack of uniformity will not defeat the SEC's goal of creating a core document that can be used in multiple jurisdictions.(2) To the extent an issuer is conducting an offering in jurisdictions that require full compliance with the IOSCO standards does not mean that its disclosure document cannot be used in jurisdictions that require less information. In cases where the United States is the only significant jurisdiction outside an issuer's home jurisdiction where an offering is proposed, the less burdensome requirements will make the U.S. capital markets that much more attractive and competitive.
We have a number of technical comments on the proposed amendments, but there is one proposal -- the proposed deletion of Rule 3-19 of Regulation S-X -- that we believe provokes such serious problems that, if not resolved, it could severely decrease the number of foreign private issuers that are willing to assume the regulatory burden necessary to access the U.S. capital markets. Further, we believe that this proposal, if adopted, would unfairly change the rules for those foreign private issuers which have already subjected themselves to the SEC's reporting obligations.
Following are comments on the proposal to delete Rule 3-19, as well as the balance of our technical comments on the proposed amendments.
Proposal to Delete Item 3-19
It is our experience that for a foreign private issuer, the most difficult, time consuming and costly factor in complying with the SEC's rules is the preparation of the U.S. GAAP reconciliation. For the most part, we believe that a qualitative description of the principal differences between an issuer's home country GAAP and U.S. GAAP, together with quantitative information as to the impact of truly material variations, would provide adequate protection for investors. We urge the SEC to conduct a study to see how much the U.S. GAAP reconciliations are used by investors. (We note that quantitative reconciliations are seldom used in Rule 144A offerings.)
The burden of preparing U.S. GAAP reconciliations would be exacerbated under the SEC's proposal to delete Rule 3-19 of Regulation S-X. If proposed Item 8 is adopted, audited financial statements may not be older than 15 months at the time of offering or listing and financial statements covering at least the first six months of the year must be included if an offering or listing occurs more than nine months after the end of the last fiscal year. (Furthermore, if the issuer's shares are not traded anywhere, the audited financial statements may not be more than 12 months old at the time the document is filed.(3))
While many issuers are required under local rules to publish their local GAAP financial statements within the time periods that would be required by proposed Item 8, our experience has been that the U.S. GAAP reconciliation, particularly for first time filers, often takes several weeks to complete after the completion of the local GAAP financial statements. If the SEC's proposal is adopted, a typical foreign private issuer could face a "black-out" period (i.e., a period in which it could not sell securities to the public in the U.S.) beginning in April and continuing until it produced audited, U.S. GAAP-reconciled financial statements for its most recent fiscal year. Furthermore, an issuer that could not produce six-month interim, U.S. GAAP-reconciled financial statements prior to September 30 could face a "black-out" period beginning in October.
While we would prefer that the provisions of Rule 3-19 not be changed in this respect, or at a minimum, that audited financial statements as old as 17 months be permitted, if the SEC is determined to adopt the substance of Item VIII of the IOSCO standards, we strongly urge it to adopt an approach similar to that currently found in Rule 3-19(f) -- i.e., that in Securities Act and Exchange Act registration statements it not require a quantitative U.S. GAAP reconciliation for the most recent audited period if (a) the document includes a quantitative reconciliation for the prior two fiscal years and a description of the major differences between home country GAAP and U.S. GAAP and (b) any material variations that are not quantified in such earlier reconciliation are quantified in the document (or in a document incorporated by reference).
With respect to the shortening of the permitted age of financial statements of first-time filers, the "black-out" period begins even earlier, and a foreign private issuer filing for the first time cannot even file after the beginning of a new fiscal year until it has audited financial statements for the most recently completed fiscal year, unless it has gone to the expense of auditing an interim period within that fiscal year. As indicated above, compliance with the U.S. GAAP reconciliation requirements are particularly time-consuming for first-time filers.
We suggest that, at a minimum, the SEC apply the same requirements with respect to the age of financial statements to foreign private issuers filing for the first time that it applies to non-reporting domestic issuers, which are permitted to file and become effective with audited financial statements as old as 13˝ months, provided that unaudited interim financial statements as recent as the third quarter of the most recently completed fiscal year are included.(4) Our suggestion made earlier to adopt the approach of Rule 3-19(f) and not require a quantitative U.S. GAAP reconciliation for the most recent financial statements if the document includes such a reconciliation for earlier periods would be very helpful in resolving a real problem for foreign private issuers filing for the first time, particularly if amendments shortening the permitted age of financial statements are adopted.
Other Technical Comments
Following is the balance of our technical comments. A number of them concern requirements for additional information that is not material to investors, sometimes presenting real logistical problems.
Item 1. Identity of Directors, Senior Management and Advisers. We believe that the portion of this item, which will be applicable only to Securities Act and Exchange Act registration statements, requiring that the names of the company's principal bankers and legal advisers be provided "to the extent the company has a continuing relationship with such entities", should be deleted. Not only is the requirement not clear, it will undoubtedly raise in many minds (particularly those unfamiliar with the SEC process) the question whether being named increases one's liability exposure.
As a practical matter, this requirement would be difficult requirement to comply with. What is meant by "bankers" -- commercial bankers? Investment bankers? Lenders? M&A advisers? A typical issuer uses several legal advisers. Should it list its local legal advisers? Its securities law specialists -- home country or host country?
We question the relevance of this information to investors. We note that the stated purpose of this item is to identify the "company representatives and other individuals involved in the company's listing or registration", yet it requires the identification of bankers and legal advisers "to the extent the company has a continuing relationship with such entities", while also requiring the naming of the "legal advisers to the issue", a concept that is not well established in U.S. capital markets transactions. Is this requirement intended to require naming the legal advisers to the underwriters in a typical U.S. capital markets transaction?
Added instructions to Item 1, or comments in the adopting release, answering these questions would be helpful.
Item 2. Offer Statistics and Expected Timetable. We suggest that the portion of this item requiring the disclosure of the proposed offering time schedule be deleted, at least in the case of a typical U.S. capital markets transaction, where the time schedule depends heavily on market conditions and other unpredictable factors.
Item 4. Information on the Company. The Release states that banking and insurance companies must continue to comply with Industry Guides 3 and 6, respectively, but we were unable to find that requirement in the amended Form 20-F (i.e., there does not appear to be an equivalent of the last instruction to Item 1 of the current version of Form 20-F.)
Item 6. Directors, Senior Management and Employees. We believe that some confusion may develop in respect of this Item, in view of the fact that the proposed definitions state that in the United States the persons referred to by the term "administrative, supervisory or management bodies" "correspond to" a U.S. company's "executive officers", as defined in Securities Act Rule 405 and Exchange Act Rule 3b-7.(5) (Implicitly, the term "directors", for purposes of a U.S. company, would, therefore, mean its board of directors.) On the other hand, we have traditionally perceived "administrative, supervisory or management bodies" of continental European companies (and Latin American companies that have them) to be the counterparts of U.S. companies' boards of directors (or somewhere between boards of directors and shareholders, in the case of supervisory boards in some cases), while "directors" of such entities usually correspond to U.S. companies' executive officers. Given that there would not appear to be any significant difference in the disclosure required by the proposed amendments with respect to directors as opposed to members of "administrative, supervisory or management bodies",(6) we are not sure that this makes any difference as far as disclosure is concerned, but it could cloud issues, such as who signs a registration statement and liability issues. We suggest that the portion of the definition indicating the meaning in the United States be deleted or an instruction be added indicating that how the terms "administrative, supervisory or management bodies" and "directors" are interpreted where the U.S. is the host country will depend on the functions of such bodies or persons.
We strongly support continuing the practice of not requiring that individual compensation amounts be disclosed, if not required in the company's home country and not otherwise publicly disclosed, and not requiring that individual share ownership be disclosed if the individual's compensation is not disclosed.
Item 7. Major Shareholders and Related Party Transactions. We have two comments on this proposed item -- one regarding the disclosure of principal shareholders, particularly the definition of "beneficial owner", and the other regarding related transactions.
(a) Disclosure of principal shareholders and the definition of "beneficial owner" -- Proposed Item 7 would lower the ownership reporting threshold for principal shareholders from 10% to 5% and add a definition of "beneficial owner". As a matter of principle, we do not object to this proposal, even though in some cases the increased disclosure of personal wealth may be unsettling. We believe that the inclusion of a definition of "beneficial owner" is helpful, given that Form 20-F currently does not define "ownership", and could codify current practice of using the definition of "beneficial owner" found in Exchange Act Rule 13d-3 when addressing issues of "ownership" of securities.
We note, however, that notwithstanding the Release's statement that these proposed amendments would conform the disclosure requirements regarding ownership by principal shareholders to those required for U.S. issuers, the definition of "beneficial owner" appears to be significantly broader than the definition found in Exchange Act Rule 13d-3, in that it includes as a beneficial owner of a security not only anyone who has the power to vote or dispose of the security (the criteria found in Rule 13d-3), but also anyone who has the power "to receive the economic benefit of ownership" of the security, a criterion not found in Rule 13d-3.
We have encountered very complicated share ownership structures among the many foreign private issuers with whom we have worked. A typical situation is a family-owned enterprise, where the actual or contingent "economic benefits" of share ownership may be distributed among, say, the widow, children and grandchildren of the founder, but the power to vote and dispose of the shares is concentrated in the hands of one or two children or grandchildren who are executive officers of the issuer. The widow of the founder may still receive dividends from over 5% of the shares, but have no say in the running of the enterprise or the disposition of those shares. Such an interest would not be required to be disclosed by a U.S. domestic issuer, and we see no benefits in requiring a foreign private issuer to do differently.
Accordingly, we suggest that the reference to the power "to receive the economic benefit of ownership" of a security be deleted from the second sentence of the definition of "beneficial owner" or that an instruction be added that makes it clear that the definition of "beneficial owner" is not intended to expand the definition found in Rule 13d-1.
(b) Related Party Transactions. We do not object, as a matter of principle, to the expansion of the disclosure requirements with respect to related party transactions found in proposed Item 7. We do, however, object to the removal of the instruction in current Item 13 that requires the disclosure of related party transactions only to the extent disclosed to shareholders or otherwise made public. In our experience, local GAAP and regulatory requirements are generally adequate in requiring the disclosure of truly material related party transactions. We are concerned that an independent requirement for disclosure in the SEC's rules may result in some awkwardness locally without providing any additional material information to investors. Furthermore, we believe that a lot officers, directors and shareholders of foreign private issuers will find this an unacceptable intrusion into their privacy, causing them to avoid the U.S. capital markets.
In any event, we strongly urge that an instruction similar to Instruction 3 to Item 404(c) of Regulation S-K be added in order to reduce the burden of compliance for banks and other lending institutions.
We also note that although there is no specific requirement to do so in the text of proposed Item 7, one of the stated purposes of Item 7 is to provide information as to "whether the terms of such transactions are fair to the company". We believe that it would be helpful to add an instruction that stated that all that is required is sufficient information for an investor to make a judgement as to the fairness of the transaction.
Item 8. Financial Information. For comments on this proposed item, see "-- Proposal to Delete Item 3-19" above.
Item 8.A.5. retains the requirement found in Rule 3-19(f) that where financial information more current than that required by this standard have been published, such financial information must be included, together with a description of the material variations from U.S. GAAP and, where the material variations are not quantified in other financial statements included in the document (e.g., where the primary financial statements are prepared on the basis of U.S. GAAP), a quantification of material variations. This requirement is something of a trap for the foreign private issuer that files U.S. GAAP financial statements, because it will not have included a qualitative description of the differences between local GAAP and U.S. GAAP or a quantification of the variations. It would be very helpful if the proposal could allow some period for the preparation of the reconciling material. Otherwise, a company is faced with the dilemma of having to delay the local release until it has prepared the information required by the SEC.
We also note that Item 8.A.5 goes beyond what is currently required by Item 3-19, and requires that if an issuer publishes financial statements that cover a more current period than that required by this standard, the more recent financial statements must also be included in the document. This is bound to create confusion and impose timing problems. It is unlikely that whatever more recent financial statements that are published locally will contain the same footnote information, etc., as the interim financial statements required by this standard. We believe that the best solution to this problem is to eliminate this requirement. We believe that this should be acceptable, because the summary information required by Item 8.A.5 should provide adequate disclosure. The next best solution would be an instruction indicating that the requirement for the inclusion of the more recent financial statements only applies if the locally published financial statements contain substantially the same information as is required by this standard for interim financial statements (e.g., a cash flow statement). Finally, if this suggestion is not adopted, an instruction should be added that indicates that the more recent financial statements do not have to comply with the requirements of Item 8.A.5 or include a U.S. GAAP reconciliation (except as specified in clauses 1 and 2 of the proposed instructions to Item 8.A.5).
We also suggest that Item 8.A.5 only apply to Securities Act filings. We see no reason to incur the added expense, and perhaps delay, of including the more recent financial information or statements in connection with an Exchange Act registration which is not being done in connection with a public offering of securities. Our suggestion is consistent with how we understand Item 3-19(f) is currently interpreted.
Item 9. The Offer and Listing. This proposed item contains a number of minor changes from existing disclosure requirements that we believe will add considerable expense or confusion, without providing any useful information to investors, such as:
•Underwriters' addresses must be disclosed. Although Securities Act Schedule A may contemplate it, the SEC has not required the disclosure of underwriters' addresses since the adoption of Form S-1 in 1942. Requiring addresses now would create monumental logistical problems, particularly under the U.S. system, where the final underwriting group is not decided until pricing.
•In describing the manner in which the price of securities for which there is not an established market is established, not only must the factors considered in such determination be disclosed (which is what Item 505 ("Determination of Offering Price") of Regulation S-K requires), but "the parameters or elements used as a basis for establishing the price" must also be disclosed. What is intended by this phrase should be clarified. It would be even more helpful if an instruction were added, or a comment made in the adopting release, to the effect that nothing more is required than is currently required by Item 505 of Regulation S-K.
•The dilution disclosure does not appear to be limited to non-reporting issuers. It would be helpful if this were clarified.
•A breakdown of expenses, similar to what is now required by Part II of most registration statement forms, is required to be included in the Prospectus. These seem to be unnecessary details to bring to investors' attention.
•The intention of any person to acquire more than 5% of the securities offered must be disclosed in all offerings, not just initial public offerings. Not only is this not material to an investor, it is information that may not be available at the time an offering document is being finalized. The fact that a purchaser may acquire or actually acquires more than 5% of an offering may not be known until after the offering has been priced.(7)
•Any reservation of securities for shareholders, directors or employees and any intended participation by major shareholders, directors and members of management must be disclosed, regardless of amount. The general rule that we follow is that if less than 5% of an offering is reserved, no disclosure is required. An instruction indicating a similar de minimis exception would be appreciated.
Amendment of Definition of "Foreign Private Issuer". The Release proposes that Rule 405 under the Securities Act and Rule 3b-4 under the Exchange Act, both of which contain the definition of "foreign private issuer", be amended to base the ownership test of whether more than 50% of an issuer's outstanding voting securities are held of record by residents of the U.S. on the calculation method used in Rule 12g3-2(a) under the Exchange Act. The SEC particularly asked for comments on whether the Rule 12g3-2(a) "look through" of the record ownership of broker-dealers should be limited to U.S. broker-dealers. We believe that it should be limited to the U.S. offices of broker-dealers, on the theory that it is reasonable to assume that customers with accounts that are maintained outside the U.S. are not U.S. residents. In addition, we believe that, as is the case with depositaries, if the issuer receives contrary information from the U.S. office of a broker-dealer as to a customer's residence, it may rely on that information in calculating the number of shares held by U.S. residents.
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We would of course be pleased to elaborate further on our comments and otherwise to assist the SEC in considering the proposals made in the Release. Any questions or requests for additional comments should be addressed to Edwin D. Williamson (202-956-7505) or Toryah S. Cameron (202-956-7040) of our Washington, D.C. office.
SULLIVAN & CROMWELL
1. It would be ironic indeed if the United States, generally perceived as having the strictest disclosure standards, tightened them further to conform to IOSCO standards that no other major market country adopted.
2. Lack of uniformity does not equate to lack of consistency, and we believe it is the latter principle that should govern.
3. We note that this proposed exception to the 15-month rule, reducing the permitted age of financial statements for first-time filers to 12 months as of the date of filing, retains the phrase used in the IOSCO standards "unless the host country regulator permits otherwise". Since the SEC is the "host country regulator" for the purposes of the proposed amendments, we are puzzled as to the meaning of this phrase.
4. Because many foreign private issuers prepare semiannual, but not quarterly, financial statements, we would suggest that the requirement for unaudited interim financial statements be relaxed to permit non-reporting foreign private issuers to comply by filing unaudited interim financial statements covering the first half of the most recently completed fiscal year.
5. It is not clear whether this portion of the definition is intended to interpret the requirements where the U.S. is the home country or where it is the host country.
6. There are a few minor differences. A director's "principal [outside] directorships" and the terms of any employment agreement for post-employment compensation must be disclosed. This latter requirement clearly implies that directors are employees.
7. It is not clear how or whether this requirement would work for a Form B issuer's offering under the procedures that are proposed in the "aircraft carrier" release as replacements for the current shelf offering procedures.