December 13, 2002
Securities and Exchange Commission
Re: File No. S7-43-02-Rules Pursuant to Section 401(b) of the
Ladies and Gentlemen:
We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the Commission's proposed rules (the "Proposed Rules") to (i) implement Section 401(b) of the Sarbanes-Oxley Act of 2002 (the "Act") and (ii) require that any earnings releases issued with respect to completed fiscal periods be filed on Form 8-K.1 We commend the Commission and its staff for the high quality and speed of their efforts in carrying out the regulatory mandates of the Act, and we appreciate the opportunity to comment on the Proposed Rules.
I. A prohibition on per share non-GAAP financial measures in Commission filings is not necessary.
While the Proposed Rules would prohibit the presentation of a per share non-GAAP financial measure in any filing made with the Commission,2 the Commission solicited comment in the proposing release as to whether this prohibition is necessary. We believe it is not necessary, provided that the most directly comparable per share GAAP financial measure is presented with at least equal prominence and that the numerator of the per share non-GAAP financial measure is quantitatively reconciled in the filing to the most directly comparable GAAP measure. In many industries, as well as in many non-U.S. jurisdictions, certain per share non-GAAP financial measures (e.g., based on constant exchange rates) are recognized by investors and analysts as key indicators of a company's performance and are an expected element of issuers' periodic disclosures to the market. We understand the Commission's concern about the presentation of per share non-GAAP financial measures in the absence of appropriate accompanying disclosures that place that presentation in context. However, where a comparable GAAP measure and a quantitative reconciliation to that comparable measure are presented, we believe a prohibition on per share non-GAAP measures does not promote investor protection in any meaningful way and that Section 401(b) of the Act does not require such a prohibition.
II. The definition of the term "GAAP" as applied to foreign private issuers should be revised.
The term "GAAP," as used in the Proposed Rules, "refers to generally accepted accounting principles in the United States, except that in the case of foreign private issuers whose primary financial statements are prepared in accordance with other generally accepted accounting principles, references to GAAP also include the principles under which those primary financial statements are prepared" (emphasis added).3 We believe that, in drafting the part of this definition that relates to foreign private issuers, the Commission merely intended to ensure that foreign private issuers would be subject to a requirement to present a quantitative reconciliation of any disclosed non-GAAP financial measure to the corresponding measure under the generally accepted accounting principles from which that non-GAAP financial measure was derived. This result can be achieved by revising the definition of "GAAP" to read as follows: "[I]n the case of a non-GAAP financial measure (i) disclosed by a foreign private issuer that prepares its primary financial statements in accordance with other generally accepted accounting principles and (ii) derived from a financial measure presented in those primary financial statements, [GAAP] refers to the principles under which those primary financial statements were prepared" (emphasis added).4
We also note that there could be uncertainty about the meaning of the phrase "primary financial statements" in the case of a foreign private issuer that prepares full financial statements in accordance with home-country GAAP for reporting purposes outside the United States and, solely for purposes of its filings with the Commission, separate financial statements in accordance with U.S. GAAP. If the U.S. GAAP financial statements were deemed to be the primary financial statements of such an issuer, then "GAAP" as defined would mean U.S. GAAP with respect to that issuer. In that case, it would appear that any non-GAAP financial measure disclosed by the issuer that was derived from home-country GAAP would have to be reconciled to U.S. GAAP, unless the issuer could avail itself of the proposed exemption from Regulation G for foreign private issuers. In circumstances where that exemption is not available, however,5 the requirement to reconcile to U.S. GAAP a non-GAAP measure derived from home-country GAAP would be, in our view, extremely burdensome and would effectively penalize the issuer for preparing full U.S. GAAP financial statements for its Commission filings rather than merely preparing a reconciliation of its home-country GAAP net income and shareholders' equity to U.S. GAAP. We therefore again urge the Commission to make clear in the adopting release that any non-GAAP financial measure disclosed by a foreign private issuer need only be reconciled to the corresponding measure under the generally accepted accounting principles from which that non-GAAP financial measure was derived.
III. The Commission should clarify certain aspects of the proposed exemption from Regulation G for foreign private issuers.
Proposed Rule 244.100(c) would exempt from the provisions of proposed Regulation G any disclosure by a foreign private issuer of a non-GAAP financial measure derived from its primary GAAP, provided that the disclosure is made outside the United States and that certain other conditions are satisfied. Paragraph (ii) of Note 2 to proposed Rule 244.100 makes clear that this exemption would apply even if, following its release, the non-GAAP financial measure appears on one or more websites maintained by the issuer, so long as the websites, taken together, are not available exclusively to, or targeted at, persons located in the United States.
The phrase "targeted at," however, gives rise to interpretive issues that we believe should be addressed by the Commission in the final rules. In particular, the Commission should make clear that a website maintained by a foreign private issuer would not be deemed to be "targeted at persons located in the United States" solely because it is in the English language. Foreign private issuers often have shareholders located in several different countries with different primary languages and use English as a means of communicating with their shareholders without having to translate documents into numerous different languages. The communications of these foreign private issuers with their shareholders outside the United States would be unduly restricted if an English language website were viewed per se as "targeted at persons located in the United States." Moreover, even if this concern were eliminated, it is unclear what other precautions (if any) would be necessary to ensure that an English-language website would not be viewed as targeted at persons located in the United States. In light of these uncertainties and the protections afforded by the phrase "exclusively available to," we believe the Commission should delete the phrase "or targeted at" from the Proposed Rules.
In addition, for the avoidance of doubt, we believe the Commission should confirm in adopting the final rules that a non-GAAP financial measure disclosed by a foreign private issuer on a webcast will be considered to have been "made outside the United States" within the meaning of proposed Rule 244.100(c) even if persons located in the United States can access the webcast, so long as the webcast is presented on a website that is not "exclusively available to . . . persons in the United States." To the extent a foreign private issuer would be permitted to post a primary GAAP non-GAAP financial measure on a website without complying with Regulation G in reliance on paragraph (ii) of Note 2 to proposed Rule 244.100, the issuer also should be permitted to webcast on that website a presentation in which primary GAAP non-GAAP financial measures are discussed without complying with Regulation G.6
Finally, we are concerned about the effect of the Proposed Rules on annual reports of foreign private issuers that are prepared pursuant to home country requirements and customs and distributed principally in the issuer's home country. We commend the Commission for expressly recognizing, in paragraph (iii) of Note 2 to proposed Rule 244.100, that the required submission of such an annual report to the Commission on Form 6-K would not vitiate the conclusion that the report was "released only outside the United States" within the meaning of proposed Rule 244.100(c). We urge the Commission to go further, however, and permit foreign private issuers to distribute to securityholders worldwide, including in the United States, a single home-country annual or interim report not subject to technical U.S. requirements as to the content of that report, such as Regulation G.7 We believe U.S. investors are adequately protected by Rule 10b-5 under the Securities Exchange Act of 1934 (the "Exchange Act"), as well as by the Commission's ability to require that the reports, which will be submitted on Form 6-K, comply with Exchange Act Rule 12b-20.
In any event, foreign private issuers with listed American Depositary Receipts generally are required by U.S. stock exchange or Nasdaq rules to distribute their annual reports to U.S. securityholders. We believe compliance with this requirement at least should not vitiate the conclusion that the annual report was released only outside the United States. We therefore urge the Commission to amend Note 2 to proposed Rule 244.100 accordingly.8
IV. The Commission should clarify certain aspects of the proposed Note to Regulation G relating to oral, telephonic, webcast or similar disclosures of non-GAAP financial measures.
Note 1 to proposed Rule 244.100 would permit an issuer to make an oral, telephonic, webcast or similar presentation of a non-GAAP financial measure without requiring the issuer to present in the same medium a quantitative reconciliation to the most directly comparable GAAP measure, provided that, among other things, the required reconciliation is available on the issuer's website at the time the presentation is made.9 We believe that, in recognition of the give-and-take nature of the earnings calls/webcasts that typically follow the issuance of earnings releases, this exception should be slightly broader. If, during the course of such an earnings call/webcast, an investor or analyst poses a question about a non-GAAP financial measure for which the quantitative reconciliation required by Regulation G is not available on the issuer's website at the time the question is posed, Note 1 to proposed Rule 244.100 would prohibit the issuer from responding to the question. We believe, however, that the issuer should be permitted to respond to such a question, provided that the non-GAAP financial measure disclosed in response to the question is posted on the issuer's website, together with the supplemental disclosures required by Regulation G, not later than the opening of trading in the country of the principal trading market for the issuer's securities on the day following the disclosure. We therefore urge the Commission to amend Note 1 to proposed Rule 244.100 accordingly.
We also believe that, where website disclosure of the quantitative reconciliation required by Regulation G would suffice to permit oral, telephonic, webcast or similar disclosure of a non-GAAP financial measure, disclosure of the quantitative reconciliation in a filing made by the issuer with the Commission also should suffice. We urge the Commission to amend Note 1 to proposed Rule 244.100 accordingly.10
V. The Commission should relax the conditions applicable to "post-transaction measures" disclosed in connection with business combination transactions.
Section 401(b) of the Act does not expressly require the Commission to impose conditions on the disclosure of "post-transaction measures" in the context of business combination transactions, and the legislative history suggests that such disclosures were not a principal focus of concern of Congress as it adopted Section 401(b).11 In the proposing release, the Commission therefore solicited, appropriately in our view, comment as to whether an exception from certain aspects of the Proposed Rules for post-transaction measures would be appropriate. For the reasons described below, we believe that, if the final rules apply to post-transaction measures at all, it would be appropriate to create certain exceptions.
First, the Commission should make clear in the adopting release that projections of GAAP measures (e.g., revenue, operating income, net income) on a pro forma basis that reflect the consummation of a business transaction will not be viewed as non-GAAP measures merely because they assume cost savings or other synergies that cannot in any meaningful sense be calculated in accordance with GAAP. Second, the Proposed Rules should not require reconciliation of any projection of a non-GAAP measure (e.g., EBITDA or adjusted EBITDA) appearing in disclosures required by Item 1015 of Regulation M-A (summary of fairness opinion of financial advisers). Third, we believe that the same-day filing requirements of Rule 425 under the Securities Act of 1933 (the "Securities Act") and Rule 14a-12 under the Exchange Act make impractical the enhanced disclosures required by proposed Item 10(e) of Regulation S-K. In particular, hostile bidders in tender and exchange offers, and insurgent shareholders in proxy contests, could effectively be prevented from using historical non-GAAP financial measures as the basis for an argument that incumbent management is underperforming. Moreover, the same-day filing requirement effectively obliterates the distinction between the less stringent requirements of proposed Regulation G and the more stringent requirements of proposed Regulation S-K Item 10(e) as applied to post-transaction measures. For all of these reasons, we urge the Commission to provide in the final rules that post-transaction measures included in materials filed pursuant to Rules 425 or 14a-12 will not be deemed "filed" for purposes of proposed Regulation S-K Item 10(e).
VI. Non-GAAP financial measures contained in, or incorporated by reference into, registration statements currently on file with the Commission should be "grandfathered."
The Proposed Rules do not address the status of non-GAAP financial measures that may be included in, or incorporated by reference into, outstanding effective registration statements under the Securities Act, including registration statements on Form S-8 and shelf registration statements. We assume the Commission intended to have the proposed amendments to Regulation S-K, Regulation S-B and Form 20-F apply to documents filed with the Commission after the effective date of the final rules, including prospectus supplements filed under Securities Act Rule 424(b) in connection with offerings made under a shelf registration statement. We also assume the Commission did not intend to require wholesale amendments of outstanding effective registration statements or the documents incorporated by reference therein to either delete non-GAAP financial measures, such as EBITDA, or add the supplemental disclosures required by the Proposed Rules. This approach would be consistent to a significant extent with the approach taken by the Commission in adopting the plain English rules;12 in that context, prospectus supplements filed under Rule 424(b) subsequent to the effective date of the rules were required to comply with the plain English requirements, but the accompanying base prospectus, the form of which had been contained in a registration statement declared effective prior to the effectiveness of the plain English rules, was not required to be revised, despite also being filed under Rule 424(b) together with the plain English prospectus supplement. We strongly urge the Commission to make clear that the final rules will not apply to documents filed with the Commission prior to the effective date of the rules or to documents filed thereafter to the extent that they incorporate by reference documents filed prior thereto.
VII. The Commission should clarify the interaction of the proposed amendments to Form 8-K with the proposed amendments to Regulation S-K.
The proposed amendments to Form 8-K generally would require that any earnings release issued with respect to a completed quarterly or annual fiscal period be "filed" as an exhibit to a Form 8-K.13 Any information "filed" with the Commission would, however, be subject to proposed Regulation S-K Item 10(e), which would require certain supplemental disclosures and prohibit the presentation of certain types of non-GAAP financial measures. As a result, with respect to earnings releases, the proposed amendments to Form 8-K effectively would prohibit issuers from disclosing per share non-GAAP financial measures that Regulation G otherwise would permit. As noted in Part I of this letter, we believe the Commission should not prohibit per share non-GAAP measures in Commission filings, provided that certain conditions are satisfied. If, however, the final rules do prohibit per share non-GAAP measures in Commission filings, we strongly urge the Commission to revise the proposed amendments to Form 8-K to provide that (i) issuers are permitted, but not required, to include in the earnings release filed on Form 8-K any non-GAAP financial measures that are permitted by Regulation G but prohibited in Commission filings pursuant to proposed Item 10(e) of Regulation S-K and (ii) the non-GAAP financial measures contained in any such earnings release would not be required to be accompanied by the supplemental disclosures required by proposed Item 10(e) of Regulation S-K.14
VIII. The Commission should revise the proposed exemption from Item 10(e) of Regulation S-K for non-GAAP financial measures "expressly permitted" by a foreign private issuer's primary GAAP.
The instruction to proposed Item 10(e) of Regulation S-K provides that a non-GAAP measure otherwise prohibited in filings with the Commission may be included in a foreign private issuer's filings with the Commission if, among other things, the non-GAAP financial measure "is expressly permitted under the GAAP used in the registrant's primary financial statements included in the filing with the Commission." We note, however, that the concept of a "non-GAAP financial measure" that is "expressly permitted" by the relevant GAAP appears to be self-contradictory. We believe that most non-U.S. generally accepted accounting principles do not expressly permit the presentation of measures of financial performance, financial condition or cash flows that are not calculated and presented in accordance with those accounting principles. As a consequence, the proposed exemption appears to be of very limited utility. We therefore urge the Commission to revise the instruction to proposed Item 10(e) of Regulation S-K to provide that a non-GAAP financial measure is permitted in a Commission filing of a foreign private issuer if, among other things, the non-GAAP financial measure is "not expressly prohibited" by the issuer's primary GAAP or by its principal home-country securities regulator.
IX. The final rules should provide for a transition period.
Section 401(b) of the Act requires that the rules of the Commission thereunder be adopted not later than January 26, 2003. As a result, the final rules are likely to be adopted at roughly the same time as a substantial number of issuers have just released year-end results with respect to calendar year 2002 or are just about to do so. To avoid the circumstances in which the content of earnings releases for calendar year 2002 would vary depending solely on whether they were released before or after adoption of the final rules, and to avoid requiring issuers either to comply on very short notice with the final rules or to postpone their earnings releases, we urge the Commission to provide that Regulation G will first take effect with respect to completed fiscal periods ending on or after March 31, 2003 in the case of domestic issuers and June 30, 2003 in the case of foreign private issuers. To avoid a similar issue with respect to Annual Reports on Forms 10-K and 20-F for calendar year 2002, we urge the Commission to provide that the proposed amendments to Regulation S-K, Regulation S-B and Form 20-F will first take effect for filings made with the Commission by domestic issuers on or after April 1, 2003 and by foreign private issuers on or after July 1, 2003.
* * * * *
We thank you for the opportunity to comment on the Proposed Rules. We would be happy to discuss with you our comments or any other matters you feel would be helpful in your review of the proposals. Please do not hesitate to contact Craig B. Brod or Leslie N. Silverman in New York (212-225-2000) or Edward F. Greene in London (44-20-7614-2200) if you would like to discuss these matters further.