America's Community Bankers
December 13, 2002
Jonathan G. Katz
Re: Conditions for Use of Non-GAAP Financial Measures
America's Community Bankers ("ACB")1 is pleased to comment on the proposal2 to implement section 401(b) of the Sarbanes-Oxley Act of 2002 ("Sarbanes-Oxley").3 This proposal implements the Sarbanes-Oxley provision enacted to address public company disclosure of non-Generally Accepted Accounting Principles ("GAAP") financial information.
Sarbanes-Oxley was enacted to strengthen public company corporate governance and financial disclosure in an effort to restore investor confidence in the public markets. Many of the law's provisions, including Section 401(b), are to be implemented through rules issued by the Securities and Exchange Commission ("Commission").
In this proposal, the Commission has proposed rules and amendments to address public companies' disclosure or release of certain financial information that is derived on the basis of methodologies other than in accordance with GAAP. The Commission has proposed a new disclosure regulation, Regulation G, for disclosure or release of non-GAAP information and proposed an amendment to Item 10 of Regulation S-K and Item 10 of Regulation S-B for additional guidance in that regard. The proposal also would require filing of earnings press releases and similar announcements on Form 8-K, with those filings subject to the guidance in proposed amended Item 10 in Regulation S-K and Item 10 in Regulation S-B.
Section 401(b) of Sarbanes-Oxley requires public companies to present pro forma information in a manner that does not contain an untrue statement of a material fact or omit to state a material fact necessary to make the pro forma financial information not misleading. The statute requires that the rules must also require pro forma financial information to be reconciled to the financial condition and results of operations reported by the public company under GAAP. Section 401(b) of Sarbanes-Oxley refers to "pro forma financial information." In its proposal, the Commission states that material information containing or accompanied by non-GAAP financial measures appropriately delineates the scope of what is required under Section 401(b). The Commission has proposed the use of the term "non-GAAP financial measures" to mean the type of information intended to be disclosed pursuant to Section 401(b) of Sarbanes Oxley. This is to eliminate confusion that may result because the term "pro forma financial information" is already used in securities regulations to mean something other than what is intended in section 401(b).4
ACB generally supports the proposal. In light of recent events, we believe that it is necessary to improve the transparency and quality of disclosure of non-GAAP financial measures and related reporting of earnings information to investors. However, we request clarification of certain aspects of the proposal. Specifically, we believe that certain information should not be treated as non-GAAP financial measures based on both the intent of section 401(b) of Sarbanes-Oxley and the stated objectives of the proposed Commission rulemaking.
We request that the Commission confirm that:
Support for Improved Reporting of Non-GAAP Financial Information
ACB supports the proposed non-GAAP financial measures framework. The integrity of the financial reporting system requires that all public companies report in a consistent manner based on a common set of accounting and presentation standards. Therein lies the importance of all public companies reporting based on GAAP disclosures and GAAP presentations. Non-GAAP financial information, including pro forma earnings, is not subject to the same sort of consistent and rigorous standards. Non-GAAP financial reporting by itself has no specific meaning nor uniform characteristics found in GAAP. Non-GAAP financial information, including pro forma earnings, covers a broad set of financial presentations that may exclude certain income and expense items required to be reported under GAAP.
Recent experience has shown that the flexibility under non-GAAP reporting can result in misleading information. If reconciled and compared to analogous GAAP financial measures, such information can be helpful by excluding nonrecurring items such as nonrecurring gains on sales. There is nothing inherently wrong in using a number other than the "bottom line" arrived at through GAAP for valuation purposes if the information is presented within a consistent GAAP-based analytical framework.5
The starting point must be a set of comparable financial data based on GAAP. In addition to the financial statements and accompanying footnote disclosures, management has numerous opportunities to describe the results of operations, elaborate on financial events and explain financial information that should be discounted. For instance, this can be done as part of disclosures in Management's Discussion and Analysis.
Clarification on Specific Reporting Requirements
Compliance with Bank Regulatory Capital Requirements
ACB is concerned that the proposal may be interpreted to require reconciliation of regulatory capital compliance calculations and presentation to GAAP by the publicly held holding company parents or affiliates of banking companies. Such reconciliation is inconsistent with the intent of Section 401(b) of Sarbanes-Oxley. Regulatory capital compliance calculations and presentations clearly do not mislead investors, analysts or the financial markets in general, nor do they distort presentation of GAAP capital. Rather, this information enhances and builds on GAAP reporting of capital. The regulatory capital compliance information provides more detailed and better information about capital adequacy and resources than the information required under GAAP. Required regulatory capital reconciliation to GAAP would not add to investor understanding of the financial institution holding company's financial statements.
We request that the Commission state in the final regulation that bank holding companies, savings and loan holding companies or financial holding companies do not need to reconcile their affiliated bank's regulatory capital information to GAAP measures.
"Managed Portfolio" Presentation
The proposal should not be interpreted to require a change in the current reporting by a public company of its managed portfolio. The Commission's proposal specifically states that its definition of non-GAAP financial measures excludes certain operating and statistical and numerical measures that do not have a comparable GAAP measure.6 We believe that the managed portfolio presentation not only falls under the exceptions to the non-GAAP measures that would require reconciliation but also enhances an investor's understanding of complex financial institutions' strategy and operations.
For more than a decade, publicly held financial companies have reported managed portfolio information. The managed portfolio presentation includes information on loans that are serviced for others, including loans that may be part of a structured financing or securitization, as well as on-balance sheet loans. Investors have found the current managed portfolio presentation a valuable addition to on-balance sheet reporting and helps investors understand the earnings, operation and financial position of public companies, especially when the growth and importance of secondary markets for financial assets is considered.
The Rules Should be Confined to Issuers who File Periodic Reports with the Commission
Section 401(b) of Sarbanes-Oxley addresses disclosures by public companies that file periodic reports and over which the Commission has jurisdiction. Section 401(b) specifically directs the Commission to issue final rules on pro forma financial information included "in any periodic or other report filed with the Commission pursuant to the securities laws." Although the language goes on to require rules addressing the use of pro forma financial information in any public disclosure or press or other release, we believe the intent was to still cover only those companies who file periodic reports with the Commission and not to extend the Commission's authority to issue rules affecting private companies.
In accordance with the goal of Section 401(b) and the implementing rulemaking to improve the transparency and quality of information provided by public companies that file reports with the Commission, proposed Regulation G should apply only to those companies that are required to file periodic reports with the Commission pursuant Section 13(a) or 15(d) of the Securities Exchange Act of 1934. We request that the scope of the rule be clarified.
In summary, ACB agrees with the framework proposed by the Commission to report non-GAAP financial measures and to reconcile non-GAAP reporting to comparable GAAP presentations. The proposal supports the goal of greater transparency of financial statements and will provide investors with the necessary information to analyze the financial position, operations, cash flow and earnings of public companies. ACB, however, requests clarification on three specific issues: treatment of regulatory capital reporting, treatment of managed portfolios, and limiting the scope of the rule to companies that file periodic reports with the Commission.
ACB appreciates the opportunity to comment on these important matters and would be happy to provide you with any additional information you would like regarding the laws and regulations that govern banking organizations. If you have any questions, please contact the undersigned at (202) 857-3121 or via e-mail at firstname.lastname@example.org, or Steve Davidson at (202) 857-3158 or via e-mail at email@example.com.