New York State Bar Association
One Elk Street
Albany, NY 12207
Business Law Section
Committee on Securities Regulation
December 23, 2002
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549
E-mail address: firstname.lastname@example.org
Attention: Jonathan G. Katz, Secretary
Re: File No. S7-43-02
Conditions for Use of Non-GAAP Financial Measures
Release Nos. 33-8145; 34-46788
Ladies and Gentlemen:
The Committee on Securities Regulation (the "Committee") of the Business Law Section of the New York State Bar Association appreciates the invitation in Release No. 33-8145 (the "Release") to comment on proposed disclosure requirements intended to implement Section 401(b) of the Sarbanes-Oxley Act of 2002 which requires rulemaking by the Commission. The Release also proposes other, additional disclosure requirements.
The Committee is composed of members of the New York Bar, a principal part of whose practice is in securities regulation. The Committee includes lawyers in private practice and in corporation law departments. A draft of this letter was reviewed by certain members of the Committee, and the views expressed in this letter are generally consistent with those of the majority of members who reviewed and commented on the letter in draft form. The views set forth in this letter, however, are those of the Committee and do not necessarily reflect the views of the organizations with which its members are associated, the New York State Bar Association, or its Business Law Section.
A. Summary of Comments
The Committee supports the Commission's objectives to implement the Sarbanes-Oxley Act directives on the use of non-GAAP financial measures and to further the statutory objective of increased real time disclosures. The present proposals are intended to improve the transparency and quality of disclosure of non-GAAP financial measures and enhance the current reporting of earnings information.
We generally support proposed Regulation G governing public disclosures of non-GAAP financial measures, provided that certain important modifications recommended in this letter are made. However, we have substantial objections to some features of proposed Item 10(e) of Regulation S-K governing use of non-GAAP measures in Commission filings, and proposed Item 1.04 of Form 8-K requiring reporting with the Commission of releases or announcements disclosing financial results and position. We have recommended changes and alternative approaches that would meet our objections.
We have recommended definitions of "publicly discloses" and "person acting on behalf of a company" and clarification of the definition of "non-GAAP financial measures" in Regulation G. These changes eliminate ambiguity and vagueness and will help insure consistent implementation by registrants. We have also proposed that forward looking statements be permitted without comparable GAAP information when that comparable information is not at the time reasonably estimable. With these changes, we support adoption of Regulation G.
Press releases, announcements and presentations disclosing financial results and position should not be subject to the requirements of proposed Item 10(e), which are applicable to reports filed with the Commission such as Forms 10-Q and 10-K. The Commission apparently intends the releases and other communications to be subject to Item 10(e) because they are required to be furnished in a Form 8-K under proposed Item 1.04 of Form 8-K. That would constitute direct regulation of the content and form of press releases and other communications by the Commission. We have serious doubts about whether the Commission has the authority to regulate the content of press releases, which we believe is not good policy in any event. Therefore, we urge that Item 10(e) not apply to the Form 8-Ks and releases and announcements furnished in the 8-Ks under Item 1.04.
If, nevertheless, Item 10(e) as finally adopted does apply to Form 8-Ks under Item 1.04, we urge that the specific prohibition against non-GAAP per share measures and the requirement for equal prominence not apply to the press releases and other communications required to be included in the Form 8-K.
With respect to Item 10(e) generally, we recommend clarifications of the prohibition on "non-recurring, infrequent or unusual" items in certain cases and the definition of "non-GAAP financial measures," and urge that forward-looking non-GAAP measures be permitted without comparable quantitative GAAP information in the same cases as permitted under Regulation G with our proposed addition.
Finally, we question the Commission's authority and the wisdom of the policy, for requiring that all press releases, announcements and other communications that disclose new or updated material information regarding financial results or position be filed as Form 8-Ks subject to Exchange Act and Securities Act liability. The press releases would be subject to Securities Act liability by incorporation by reference in registration statements and prospectuses. We believe that Item 1.04, together with the proposed application of Item 10(e) to these releases and other communications, would leave companies with two choices, neither of which serves the public interest. Companies could decide to file everything with the Commission and take the risks of increased liability, or reduce the flow of information they provide to the public.
We recommend a different approach that we believe better serves the public interest -- only the initial press release or announcement of financial results for a completed fiscal period would have to be reported in a Form 8-K, plus any public disclosure of a material change. We recommend a definition for "initial earnings release or announcement" which would trigger the Form 8-K filing. If this approach is not adopted, we propose modifications that should be made to the proposed standard for triggering the Form 8-K filing requirement. In addition, we urge that failure to file a Form 8-K will not result in the loss of eligibility to use short-form registration statements or engage in Rule 144 transactions; that the new rules not create a private cause of action; and that companies have the option of either "furnishing" the information or "filing" it in the Form 8-K.
We recognize that the Commission must act on Regulation G to meet the Sarbanes-Oxley deadlines. However, proposed Item 10(e) and Item 1.04 are not subject to those deadlines. Accordingly, we respectively request that the Commission consider the establishment by the private sector of guidelines for defining and calculating non-GAAP financial measures as an alternative to proposed Item 1.04 and Item 10(e) in the case of releases, announcements and other company communications. We also respectively request that the Commission provide additional time for comment on those two proposed Items as we are not confident that the broad implications of the proposals are as widely understood as they should be.
B. Proposed Regulation G Governing Disclosures of Non-GAAP Financial Measures (Sarbanes-Oxley Section 401(b))
Proposed Regulation G would require that any public disclosure of a non-GAAP financial measure (as defined) be accompanied by the most comparable GAAP financial measure and a quantitative reconciliation to the GAAP measure. Quantitative reconciliation to GAAP would not be required in the case of a forward-looking non-GAAP measure if the comparable GAAP measure were not available without unreasonable effort. In such a case, the company would have to explain why the comparable GAAP financial measure is not available, provide any reconciling information available without unreasonable effort, and identify any information that is unavailable and disclose its probable significance. In addition, Regulation G would prohibit materially false or misleading statements.
Although Regulation G would apply to the presentation of non-GAAP financial measures in Commission filings as well as press releases or other announcements, more detailed requirements are proposed for Commission filings as discussed under Section C below. These more detailed requirements in effect supercede Regulation G where the information is included in a Commission filing or is required to be provided in a Commission filing.
Regulation G also specifies procedures that can be used to provide the comparable GAAP measures and the reconciliation to GAAP for oral or webcast presentations, provides an exemption for disclosures by foreign private issuers under certain conditions, defines non-GAAP financial measures, and provides that Regulation G shall not have any effect on Rule 10b-5 liability.
1. Regulation G should be limited to disclosures by broad distribution of non-GAAP information to the public by the company or a defined group of company officials
Regulation G would apply when the company or a person acting on its behalf "publicly discloses" the specified non-GAAP information. We assume the Commission does not intend that Regulation G would apply to every conversation or communication by company officials. For example, discussions with the company's outside attorneys or investment bankers, the other party to negotiation of a business transaction and members of the press and other media representatives, and communications with employees should not require presentation of a reconciliation to GAAP. Also, the covenants and conditions of financial agreements often are based on non-GAAP measures, and companies would be communicating with financial institutions regarding those measures. EBITDA is a common example. However, Regulation G does not define "publicly discloses" and contemplates application to non-GAAP measures made public "orally, telephonically, by webcast or broadcast or by similar means" in addition to conventional press releases and other written statements.
In addition, Regulation G would apply to disclosures made by the company or any "person acting on its behalf," but does not define who would be considered acting on behalf of the company. In light of the potentially broad reach of Regulation G, and to enable companies to monitor communications for compliance with Regulation G, the final rules should define public disclosure and persons acting on behalf of a company.
Definition of publicly discloses. We recommend that "publicly discloses" be defined as "providing broad, non-exclusionary distribution of the information to the public." This definition is taken from Regulation FD.
Definition of person acting on behalf of a company. Because the policy and operational considerations are similar for Regulation G and Regulation FD, we recommend that the definitions of "Person Acting on Behalf of an Issuer" and "Senior Official" contained in FD be adopted in Regulation G.1 In addition, the final rules or the adopting release should expressly provide that interpretations of, and a company's ability to specify persons covered by, those definitions for purposes of FD will also apply for Regulation G purposes.
2. Additional clarifications required in Regulation G.
The conditions under which forward-looking statements are permitted without comparable GAAP information should be expanded. The qualification that a reconciliation to GAAP is required for forward-looking statements only "to the extent available without unreasonable efforts," should be expanded to add "and to the extent reasonably estimable at the time".
Probably the clearest example of a forward-looking non-GAAP measure without comparable GAAP is where there is likely to be a restructuring charge or sale of a large asset or business segment with a material gain, loss or charge during the quarter, but the company does not know the magnitude yet. All that can be forecast in that situation is earnings before the expected gain, loss or charge, which cannot be quantified. Although the "available without unreasonable effort" test may capture this situation, the more precise test would be "reasonably estimable at the time," which should be added to avoid any doubt. It is important that companies have the flexibility to provide this information, such as where the non-GAAP forecast is a warning or cautionary statement about an expected downturn.
This qualification, expanded as discussed above, also should expressly apply to the requirement for providing a comparable GAAP financial measure.
Definition of non-GAAP measures. The definition and explanation of what constitutes financial measures that are not GAAP measures but are also not within the definition of a "Non-GAAP financial measure" subject to the requirements of Regulation G is unclear and ambiguous. It would, therefore, be preferable to include in the Regulation G definition the specific examples given in the Release of specified measures that are not GAAP and are covered as compared with specified measures that are not GAAP but are not covered.
3. We support adoption of Regulation G with the definitions and clarifications recommended in Sections 1 and 2 above.
We generally support proposed Regulation G provided that the two definitions in Section 1 are adopted and the two clarifications in Section 2 are made.
C. Proposed Requirements Governing the Presentation of Non-GAAP Financial Measures in Commission Filings; Required Form 8-K Filings of Financial Information for Completed Periods
The Release proposes requirements that would govern the use of non-GAAP financial measures in Commission filings (proposed Item 10(e) of Regulation S-K). Paragraph (e) would require disclosing the purpose of using a non-GAAP measure and why it is useful to investors and impose seven specific prohibitions. The prohibitions cover the presentation, calculation and description of non-GAAP measures plus a flat prohibition on non-GAAP per share measures. Paragraph (e) also repeats the two requirements of Regulation G to provide the comparable GAAP measure and a reconciliation to GAAP.
The Release also proposes a new Item 1.04 of Form 8-K which would require that any public announcement or press release of material non-public information "regarding" results of operations or financial condition for completed fiscal periods be filed on Form 8-K.
While we have some comments on the specifics of paragraph (e), the requirements appear to be within the widely accepted scope of the Commission's authority over the content and presentation of information in reports and registration statements required to be filed with the Commission. However, problems arise with the interplay between the proposed disclosure requirements and the proposed new Form 8-K filing requirement. As we understand it, the Commission's interpretation and intention is that press releases and other announcements filed on Form 8-K under Item 1.04 must meet the requirements of Item 10(e) in the same manner as information in Forms 10-K and 10-Q.
1. Background of presentation and regulation of non-GAAP financial measures
The presentation of non-GAAP financial measures has been the subject of much public debate and discussion, and proposed guidance. Generally this has centered around two issues. One is how to define and calculate the financial measures so that there is a common understanding of what the various terms mean and some degree of comparability among different companies. The other issue is to present non-GAAP measures in a way that is understandable and not misleading, and to provide reconciliation to GAAP. In addition, there has been opposition to any use of some non-GAAP earnings measures.
As an example, in November, 2001 Standard & Poor's issued a note with a suggested approach to calculating "operating earnings" as a measure of non-GAAP earnings.2 After consulting with securities and accounting analysts, portfolio managers, corporate executives, academic researchers and other investment professionals, a revised version was issued in May, 2002.3 The S & P approach is to define a measure called "Core Earnings" starting with reported earnings and making a series of adjustments.
Also, the Financial Executives International ("FEI") and the National Investor Relations Institute ("NIRI") have collaborated on guidelines for earnings press releases that they consider best practices for clear and consistent public statements on corporate earnings.4
The most recent Commission pronouncement was the statement providing cautionary advice regarding the use of "pro forma" financial information in earnings releases, dated December 4, 2001 (hereafter the "2001 Statement").5The 2001 Statement commends the joint FEI/NIRI earnings press release guidelines referred to above, and states that financial results will not be deemed misleading merely due to deviation from GAAP if the company in the same statement discloses in plain English "how it has deviated from GAAP and the amounts of each of those deviations."
2. The proposals would regulate the content and form of ordinary course of business communications and make such communications Commission filings incorporated by reference in registration statements with strict liability.
The releases and announcements required to be filed on a Form 8-K would be deemed filed under the Exchange Act and incorporated by reference in registration statements and prospectuses, thereby subjecting the press releases to Section 18 liability under the Exchange Act and Section 11 and Section 12(a)(2) liability under the Securities Act. This proposal by itself raises serious issues over the broad scope and ambiguity of what has to be filed and made subject to securities acts liabilities.
The proposals do not stop with filing every press release, announcement or statement containing additional or updated material information "regarding" earnings or financial position. The Commission goes on to regulate the form and content of the press releases and announcements by treating them as filed Commission documents subject to the same requirements that apply to specific, mandated disclosure items in periodic and current reports. In fact, this regulation would even extend to information in annual reports to shareholders.
The combination of Item 10(e) and Item 1.04 as interpreted by the Commission would in effect regulate the content and form of every oral and written public communication in the ordinary course of business containing new, additional or updated material information regarding historical financial results and position. Furthermore, all such communications would have to be filed with the Commission and incorporated by reference in registration statements and prospectuses, and thus be subject to liability under Section 18 of the Exchange Act and strict liability under Section 11 of the Securities Act.
D. Item 10(e) of Regulation S-K should not apply to Form 8-Ks required by Item 1.04; Changes required if Item 10(e) were to apply to Form 8-Ks under Item 1.04
We have serious doubts about the authority of the Commission to regulate the form and content of all oral or written communications containing certain very broadly defined historical financial information. We do not believe the Exchange Act or the Securities Act envisions the regulation of content of all communications on a particular subject. Similarly, we are not aware of anything in Sarbanes-Oxley that contemplates such regulation. The Release provides no basis for, and does not discuss, the Commission's specific authority to regulate form and content of company communications generally.
Application of Item 10(e) to Form 8-Ks is not necessary for the protection of the public interest. The press releases and other communications will remain subject to Regulation G and the antifraud provisions of Rule 10b-5 even if Item 10(e) does not apply.
1. Non-GAAP per share measures should not be prohibited in press releases and other public announcements and presentations.
We are aware of the concerns of the Commission regarding alternative measures of performance as expressed in Accounting Series Release 142 ("ASR 142") issued in 1973. We also understand that the Staff routinely issues comments on registration statements and Exchange Act reports objecting to presentation of non-GAAP measures on a per share basis. ASR 142 stated that per share data other than net income, net assets and dividends should be avoided.
However, we note that the principal concerns with per share reporting in ASR 142 was with respect to cash flow amounts, and specifically to presenting "[s]ales, current assets, cash flow, total assets, cash and other similar figures" on a per share basis. We do not view ASR 142 as necessarily prohibiting any use of clearly defined and reconciled measures of operating results determined on a basis other than GAAP in all company communications.
In all events, the practice over the years has been for companies to present certain non-GAAP measures on a per share basis. These amounts have been used with or without adjustment by analysts and investors, and in the financial press. Also, the companies are not the only source of non-GAAP measures. In fact, one reason why companies should be allowed to continue providing non-GAAP per share amounts is to provide company data comparable to analysts/First Call data. Furthermore, price-to-earnings (P/E) ratios will continue to be calculated and published by various organizations. We would expect that at least some of these ratios will be based on non-GAAP earnings per share measures. Consequently, we do not understand what public interest would be served by prohibiting companies from providing or discussing non-GAAP per share measures without any exceptions.
In addition, as mentioned above, much discussion has been focused on establishing standards for defining and calculating non-GAAP performance measures on a consistent basis. Certainly, that approach should be considered as an alternative in this rulemaking process, as we discuss in Section H below.
Finally, the Release provides no basis on which this sharp departure from practice is predicated,
2. The requirement for equal prominence should not apply to press releases and other public announcements and presentations.
We have no problem with the prohibition against presenting non-GAAP financial measures in a manner that would give greater authority or prominence than the comparable GAAP financial measure as it would be applied to reports on Form 10-K and 10-Q, registration statements and reports of specific information required to be reported on Form 8-K. However, we do not think that standard can be objectively applied to oral presentations, press releases and other similar communications. The real protection for the public in those communications is the Regulation G prohibition against material misstatements and omissions, and requirements for presenting comparable GAAP measures and reconciliation to GAAP.
Accordingly, if Item 10(e) ultimately were to be applied to Form 8-Ks under Item 1.04, notwithstanding our arguments above, the prohibition of Item 10(e)(1)(ii)(A) should not apply to Form 8-Ks under Item 1.04.
E. Changes that should be made to Item 10(e) generally, even if 10(e) were not applicable to Form 8-Ks under Item 1.04
Item 10(e) would apply to Forms 10-K and 10-Q and registration statements even if, as we urge, it is not made applicable to Form 8-Ks under Item 1.04.We believe that the following changes should be made in proposed Item 10(e) generally, whether or not the Item also applies to the Form 8-Ks.
1. Clarify the meaning of the prohibition regarding items identified as "non-recurring, infrequent or unusual"; the final rules should treat this as a matter for good faith consideration and not a prohibition.
Item 10(e) would prohibit adjusting "a non-GAAP performance measure to eliminate or smooth items identified as non-recurring, infrequent or unusual, when the nature of the charge or gain is such that it is reasonably likely to recur." While we understand why the Commission is concerned about use of these terms, the proposed prohibition would be difficult to apply. The Release provides no guidance on what is intended.
For example, although a company in good faith believes that an excluded gain, loss or charge is not likely to recur, it may yet recur because of changes in general economic conditions, global political conditions, technology or conditions in the company's specific industry that were not expected at the time. In addition, the terms refer to types of items which by their nature tend to be non-recurring, infrequent or unusual. That does not mean that in any particular case or for any particular company the item could not recur. Furthermore, unusual often means that it is not a part of the company's typical or ordinary operations, which does not suggest that it will not recur. GAAP permits and requires exclusion of "extraordinary items' under a very strict and narrow definition. In contrast, non-GAAP adjustments should accommodate a lesser degree of unusualness or infrequency.
In addition, exactly what is meant by the prohibition is unclear. For example, it is not clear if the provision is intended to prohibit characterizing or labeling an item as "non-recurring, infrequent or unusual," or is intended to prohibit adjusting for or excluding the item. We believe what is significant is that the item is quantified and accurately identified or described. Investors can then make their own judgments about whether or not exclusion of the item was appropriate.
If, notwithstanding the foregoing, the Commission intended to prohibit adjusting for or excluding items, we believe the proposed provision is unworkable and not in the public interest. First, the terms "non-recurring, infrequent or unusual" are labels and characterizations and not specific events, activities, occurrences or transactions. We are not aware of any precise definition of what specific events, activities, occurrences or transactions would be prohibited. In addition, a decision on whether a particular adjustment is appropriate depends on the specific item, the circumstances affecting the item and the company, and the definition and purpose for using the specific non-GAAP financial measure, none of which is considered in the proposed Item 10(e) provision. Furthermore, the prohibition could impair the predictive value of certain non-GAAP measures and obscure trends intended to be highlighted. Being prohibited from excluding a gain on the sale of a significant asset not in the ordinary course of business would be one example.
Finally, a prohibition on adjusting or excluding items would defeat comparability if non-GAAP results for prior periods were adjusted for certain types of gains, losses or charges that recurred and could not be adjusted in current results. We do not read Item 10(e) as requiring restatement of prior non-GAAP measures calculated making adjustments believed at the time to be appropriate. We note that, in the case of GAAP, restatement is a very serious matter with complex and strict conditions and criteria.
For all of the above reasons, we urge the Commission to provide in the final rules that the provision is intended to address whether an item should be identified or labeled as "non-recurring, infrequent or unusual," and is not intended to prohibit adjusting for or excluding any item. In addition, because of the inherent uncertainties involved, we urge that instead of a prohibition, the final rules include an instruction that the company consider the reasonable likelihood of the item recurring within the foreseeable future in its good faith judgment. We suggest that the two years following the fiscal period be used as the measure of the foreseeable future.
2. Forward-looking non-GAAP measures should be permitted without comparable quantitative GAAP information in certain cases.
Item 10(e) would prohibit providing forward-looking non-GAAP measures without also providing the comparable quantitative GAAP measure and reconciliation to GAAP. This is in contrast to Regulation G which would allow forward-looking statements without the quantitative GAAP information where it is not available without unreasonable effort. We recommend in Section B.2. above that Regulation G also permit forward-looking measures where the comparable quantitative GAAP information is not reasonably estimable at the time.
The final rules under Item 10(e) should permit forward-looking non-GAAP measures without comparable GAAP measures and reconciliation to GAAP under the same conditions as permitted under Regulation G (including our recommended change where GAAP is not reasonably estimable) for the same reasons discussed above in Section B.2. It is important that companies have the flexibility to provide this information in Commission filings, such as where the non-GAAP forecast is a warning or cautionary statement about an expected downturn that is disclosed in press releases and other communications.
3. The definition of non-GAAP measures should be clarified.
The definition of a non-GAAP financial measure should be clarified in the same manner as we recommended for Regulation G, and for the same reasons, as discussed above in Section B.2.
F. Form 8-K filings should be required for only the initial earnings release or announcement for completed periods and any material changes publicly disclosed thereafter in the reported information
Again, we have serious doubts about the Commission's jurisdiction and authority to require that all company communications containing new, additional or updated material information in the specified subject area become Commission filings under the Exchange Act and by incorporation under the Securities Act. We do not believe that the Commission has set forth a supportable rationale on why all of these communications should be required to become Commission filings.
Certainly the proposed Item 1.04 Form 8-K filings are not necessary to insure adequate public disclosure since broad public disclosure is already provided for by Regulation FD, which may include filing or furnishing press releases on a Form 8-K. The Commission recognizes this, but insists that an additional Form 8-K filing be required, which has the apparent effect of subjecting the company to extensive potential liability and providing a basis for the Commission to assert jurisdiction over the form and content of the release or announcement.
The Release points to Section 409 of Sarbanes-Oxley which requires registrants to "disclose to the public on a rapid and current basis such additional information concerning material changes in the financial condition or operations of the issuer," as the Commission determines by rule is necessary or useful for the protection of investors and in the public interest. No time period is provided for the Commission to adopt these rules.
We believe that what Section 409 contemplates is the type of requirements the Commission has proposed and are pending, adding a number of new, specific events to be reported on Form 8-K and significantly accelerating the filing dates.6 Those filings would provide information on carefully defined, material events and developments occurring during the period between Form 10-K and 10-Q filings. The General Accounting Office considered that Form 8-K proposal as the existing structure associated with Section 409 in a side-by-side analysis of existing structures and Sarbanes-Oxley requirements.7
In contrast to Section 409, the present proposals do not cover material changes but information on historical financial results and position. Furthermore, Section 409 does not require that the public disclosure be in a filing with the Commission. In fact, the proposed requirements are triggered only after there already has been a public disclosure. The proposals do not require companies to disclose any specific information or any information at all. It is only if the company does decide to disclose some information, which thereby would already accomplish the objective of Sarbanes-Oxley to disclose to the public.
Moreover, in light of the additional potential liabilities and burdens that would be imposed, the proposals could have a chilling effect on the early release of financial information by companies, and actually work at cross purposes with the objective of Section 409 for more disclosure on a rapid and current basis. Instead of subjecting these voluntary releases and announcements to additional Exchange Act and Securities Act liabilities, the public interest requires that companies be given safe harbor protection to encourage "rapid and current" disclosures.
1. The Commission should consider the approach suggested by a Subcommittee of the ABA Business Law Section in comments on accelerated filing dates for Forms 10-K and 10-Q if it concludes that a Form 8-K filing is necessary.
If the Commission nonetheless believes that a Form 8-K filing is necessary where results are publicly disclosed before the Form 10-Q or 10-K is filed, it should consider the proposal made by a Subcommittee of the ABA Section of Business Law in comments to the Commission proposal for accelerating the filing dates for periodic reports ("ABA Proposal").8 The Release cites the ABA Proposal in support of the present proposals. However, the proposals in the Release do not follow the specifics of the ABA Proposal.
The ABA Proposal would require a company to file a Form 8-K reporting certain summary financial information when the company announced quarterly and annual earnings results. The press release would not be required to be included in the 8-K; and the rules would not specify which earnings metrics would be reported but would leave that to the company to determine. In addition, the information would not be deemed to be "filed", but instead the company would have the option of filing or "furnishing" under present Item 9 of Form 8-K, which would be the same treatment afforded under Regulation FD.
We would support the approach of the ABA proposal with a modification that the press release or other announcement be included as part of the 8-K. With that modification, Item 1.04 would be changed to provide the following
- A Form 8-K would be required upon the initial public disclosure by the company of earnings results for a completed fiscal quarter or years.
- The press release or other announcement would be included in the Form 8-K.
- No other information would be necessary or required in the Form 8-Kother than to briefly identify the announcement or release.
- Companies would have the option to "furnish" the information under Item 9, or "file" the information under the Exchange Act with incorporation by reference in the same manner as under Regulation FD.
- The reference to "forward-looking information" in the modification of proposed Item 6.01 of Form 8-K (currently Item 9) would be changed to refer to "information" generally to reflect that all information included in the Form 8-K could be furnished under Item 6.01 (currently Item 9).
In addition, it would be reasonable to require an amended or new Form 8-K if the company publicly discloses a material change in the information previously provided in the Form 8-K.
2. Recommended definitions of initial earnings release or announcement.
Under the above proposal, Item 1.04 would require a Form 8-K only for the initial release or announcement publicly disclosing results for a completed fiscal quarter or year prior to filing the Form 10-K or 10-Q. Requiring an amended or additional Form 8-K in the event of public disclosure of a material change in reported financial results or position would appear reasonable.
A definition is needed although in most cases the initial earnings release or announcement will be obvious. However, questions could arise in the event of a pre-release of certain information such as frequently occurs when a company determines that results will be less than previously publicly disclosed. For example, in such a case, the company may publicly disclose revenues if they were materially less than forecast or expected without knowing or disclosing net income. Or, the company may say that net income will be less than forecast by some percent or give a range or just provide a qualitative indication. There may be other unique situations where a company may have reason to release incomplete results.
We believe that the most practical approach would be to use earnings information that includes quantitative net income or earnings per share. Companies almost always report both together. If a company were to report a comparable non-GAAP measure, Regulation G would require that such data be accompanied by GAAP net income. In addition, the concept of what constitutes "publicly discloses" that we recommend for Regulation G in Section B.1. above should be used in identifying the initial earnings release or announcement.
Accordingly, "the initial release or announcement of earnings" should be defined as "the company initially providing broad, non-exclusionary distribution to the public of quantitative net income or earnings per share for a completed fiscal quarter or year."
G. Other Changes that should be made in Item 1.04
While we urge that Item 1.04 be changed to require a Form 8-K only upon the initial release or announcement of earnings, if the Commission nonetheless intends to adopt Item 1.04 without that limitation, the following modifications should be made.
1. The standard for requiring a Form 8-K is overly broad and ambiguous and should be modified if Item 1.04 is not limited to requiring a Form 8-K only for the initial earnings release or announcement.
We believe that the proposed standard to require a Form 8-K filing if the registrant or any person acting on its behalf makes any public announcement or release of material information regarding results of operation or financial condition for a completed period is impermissibly vague and ambiguous, and will be extremely burdensome for companies to implement. We urge the Commission to make the following modifications, which we believe are consistent with the public interest.
Definition of any person acting on behalf of a registrant. The same definition that we recommend in Section B.1.above for Regulation G should be adopted for Item 1.04.
Definition of "makes any public announcement or release . . . disclosing" material information. The same definition that we recommend in Section B.1.above for "publicly discloses" under Regulation G should be used here.
Disclosing material non-public information regarding results of operations or financial condition. This proposed standard for triggering the requirement to file Form 8-Ks arguably could pick up almost any information about a company. For example, would any information of the type that would be included in Management's Discussion and Analysis of Financial Condition and Results of Operations constitute information "regarding" results or financial condition? The problem is exacerbated by the uncertainty in the materiality standard. Faced with this, companies would have two choices, neither of which is desirable -- file everything on Form 8-K or substantially reduce the information provided. The solution, which we believe is consistent with the public interest, is to use public disclosure (as defined above) of "material, non-public results of operation or financial condition" as the trigger for requiring a Form 8- filing. Similarly, updated Form 8-K filings should be required only upon public disclosure of any "material update of results of operations or financial condition previously reported on Form 8-K."
2. Item 1.04 should give companies the option to either "furnish" the Form 8-K information under current Item 9 with no incorporation by reference, or to "file" the information.
Proposed Item 1.04 would require that a registrant file specified information on Form 8-K within two business days of the public announcement or release disclosing material non-public information regarding results of operations or financial condition for a completed annual or quarterly fiscal period. The Form 8-K information would be "filed" under the Exchange Act and be incorporated by reference in Securities Act filings. The result would subject the company to liability under Section 18 of the Exchange Act and Section 11 and Section 12(2) of the Securities Act. The requirement that the Form 8-K information be "filed" would interfere with goals of the Commission and Sarbanes-Oxley, such as encouraging continuous and prompt disclosure, and would be unfair to companies that voluntarily provide earnings information prior to filing Form 10-Ks or 10-Qs. Those concerns will still exist even if our recommendation that Item 1.04 be limited to requiring a Form 8-K for only the initial release or announcement is adopted.
Item 1.04 does not require that specific information or any information at all be publicly disclosed and reported in a Form 8-KK. Under those circumstances, it would be unfair to impose additional liability in addition to the Rule 10b-5 antifraud liability that will exist even if the information is "furnished." In addition, imposing additional liability could chill the amount of disclosure companies are willing to provide. Some companies might see the increased potential liability as a reason to abandon altogether the practice of providing earnings information outside the context of a periodic report on Form 10-Q or Form 10-K.
3. The final rules should expressly provide that failure to file Form 8-Ks required by Item 1.04 will not result in a loss of eligibility for the company to use short-form registration statements and shareholder to engage in 144 transactions.
Denying companies the use of short form registration statements could cause enormous damage to the capital raising efforts of many companies. It also could result in the creation of recision rights for completed transactions, with substantial potential liabilities. The potential for damage to investors makes this provision essential. Furthermore, for the reasons discussed in Section 2 above, it would be unfair to impose such a harsh result on companies that voluntarily publicly disclose earnings information before being required to in Forms 10-K and 10-Q.
4. Regulation G and Item 1.04 of Form 8-K should expressly provide that they do not create any private cause of action.
We agree with the general proposition expressed by the Commission in the Release that (1) compliance or non-compliance with the requirements of Regulation G would not affect a person's liability under Section 10(b) or Rule 10b-5, and (2) facts and circumstances of a company's disclosures (including disclosures under Regulation G) could give rise to a
Rule 10b-5 violation. We also agree that the Commission could bring an enforcement action under both Regulation G and Rule 10b-5 if the facts and circumstances warrant.
The Commission should make express what is already implicit in those propositions, that Regulation G does not create any private right of action. That express statement should also be included in Item 1.04, for the reasons discussed in Sections 2 and 3 above.
H. The Commission should consider the establishment of guidelines for defining and calculating non-GAAP measures by the private sector as an alternative to Item 10(e) and Item 1.04.
Another approach, which we would support, is the establishment of guidelines for defining and calculating non-GAAP measures. This is an approach proposed by commenters on the same Commission proposal referred to above for accelerated filing dates for periodic reports.9 We are sure that the accounting and financial industries, investors, legal professional associations, the media, corporations and other participants and professionals in the financial markets would be happy to participate. As discussed above, a lot of work has already been done.
Although these guidelines should not be mandatory Commission requirements, we believe that there would be great market pressure for companies to conform. In any event, investors would know which companies' results are provided in accordance with the guidelines.
I. The Commission should permit additional time for interested parties to provide informed comments before taking action on proposed Item 10(e) and Item 1.04
We urge the Commission to allow additional time for interested parties to analyze the proposals and prepare comments on proposed Item 10(e) and Item 1.04. These proposals would affect a broad range of investors, professionals and the media in addition to public companies. We are not confident that all interested parties are aware of the broad implications of the proposals, particularly because the Release does not expressly highlight these effects.
Under Sarbanes-Oxley, the Commission has to act on Regulation G. However, it is free to re-propose Item 10(e) of S-K and Item 1.04 of Form 8-K, providing more of its rationale for the more significant aspects of the proposals such as prohibiting non-GAAP per share measures and requiring that all communications with additional or updated material financial information as specified be filed under the securities acts. An alternative would be to extend the comment period on Item 10(e) and Item 1.04. In all events, we believe that additional time for comment would best serve the public interest.
We hope the Commission finds these comments helpful. We would be happy to meet with the Staff to discuss these comments further.
COMMITTEE ON SECURITIES REGULATION
By___ Gerald S. Backman
GERALD S. BACKMAN
CHAIRMAN OF THE COMMITTEE
Michael J. Holliday, Chair
Paul D. Brusiloff
Richard E. Gutman
The Honorable Harvey L. Pitt, Chairman
The Honorable Paul S. Atkins, Commissioner
The Honorable Roel C. Campos, Commissioner
The Honorable Cynthia A. Glassman, Commissioner
The Honorable Harvey J. Goldschmid, Commissioner
Alan L. Beller, Esq., Director of Division of Corporation Finance
Jackson A. Day, Acting Chief Accountant
Giovanni P. Prezioso, Esq., General Counsel
|1|| Rule 101(c) and (f), Regulation F-D.
|2|| Measures of Corporate Earnings, Standard & Poor's, released November 7, 2001.
|3|| Measures of Corporate Earnings, Standard & Poor's, revised May 14, 2002.
|4|| FEI/NIRI Earnings Press Release Guidelines, December 9, 2001.
|5|| Release Nos. 33-8039; 34-45124; FR-59, dated December 4, 2001.
|6|| Release Nos. 33-8106; 34-46084, dated June 17, 2002.
|7|| Appendix XXIII, Side-by-Side of the Existing Corporate Governance and Oversight Structure and the Sarbanes-Oxley Act of 2002, GAO-03-138 Financial Restatements, October 2002.
|8|| Comments of the American Bar Association Subcommittee on Disclosure and Continuous Reporting of the Committee on Federal Regulation of Securities, Section of Business Law, dated June 4, 2002, on Release Nos. 33-8089 and 34-45741, dated April 12, 2002.
|9|| Comment letters of Ernst & Young LL.P, May 21, 2002; KPMG LL.P, May 22, 2002; National Investor Relations Institute, May 20, 2002; and PricewaterhouseCoopers LL.P, May 23, 2002.