December 13, 2002
Mr. Jonathan G. Katz, Secretary
Re: File No. S7-43-02
Dear Mr. Katz:
We at PricewaterhouseCoopers LLP appreciate the opportunity to comment on the Commission's Proposed Rule: Conditions for Use of Non-GAAP Financial Information (the "proposal(s)" or the proposed rule(s)").
We support the Commission's overarching goals to enhance the transparency surrounding the use of non-GAAP financial information. We believe that the proposed rules are indeed consistent with many of the concepts embodied in the Sarbanes-Oxley Act of 2002 (the "Act"), and other broader initiatives aimed at restoring investor confidence, namely the cautionary releases issued by the SEC in December 2001 cautioning both registrants and investors of the risks associated with non-GAAP financial information.
We agree that non-GAAP financial information should be understood in the context of the most directly comparable GAAP measure, and that the reconciliation to the most directly comparable GAAP financial measure will provide better and more valuable information to investors. We are also of the view that changes to the existing reporting framework should include strengthening the basis for higher quality earnings releases. Therefore, we support the Commission's initiative of requiring press releases to be placed on file on Form 8-K. The Commission's initiative is consistent with our views expressed on Release No. 33-8106 (File Number S7-22-02) and Release No. 33-8089 (File Number S7-08-02).
In addition, we believe that Regulation G should be applicable to foreign private issuers, as it would provide investors with useful information and reduce investor confusion over the use of non-GAAP measures. However, we recognize that the Commission may conclude that because of the territorial principle it cannot require the application of Regulation G if disclosure is made outside the United States. Our response to Question 15 in the attachment to this letter discusses this matter in greater detail and provides suggestions if the Commission were to keep the limited exception.
However, as suggested in our response letter to Release No. 33-8089, we also continue to strongly encourage the Commission to move forward expeditiously with the FASB, to develop relevant Key Performance Indicators ("KPIs") and a regimen to promote or require their disclosure by registrants on a current basis. Relevant information to investors may, and in fact more frequently does, take the form of non-accounting information. In this era of complex accounting rules, which are aimed at the complex business environment, rather than compressing the GAAP reporting timeframes and regulating the presentation of non-GAAP financial information, the SEC should encourage the development of pertinent and consistent KPIs and their continuous and timely delivery to investors and analysts.
In the attachment to this letter, we have expressed our views on the specific questions that appear in the Release. Our responses should be considered in conjunction with the general comments expressed above.
We appreciate the opportunity to express our views and would be pleased to discuss our comments or answer any questions that the staff may have. Please do not hesitate to contact Jay P. Hartig at 973-236-7248 or James F. Harrington at 973-236-7203 regarding our submission.
Attachment - Responses to detailed questions
Proposed regulation G
1. As proposed, Regulation G would apply only to companies that are required to file reports pursuant to Section 13(a) or 15(d) of the Exchange Act. Should we expand the scope of the regulation to apply to all companies that publicly disclose non-GAAP financial measures, excluding registered investment companies?
Yes, we believe that Regulation G should apply to all companies that publicly disclose non-GAAP financial measures. We believe that it would enhance the level of care companies would bring to those disclosures and provided greater transparency for readers.
2. As an alternative to requiring reconciliation to the most directly comparable financial measure calculated and presented in accordance with GAAP, should we require reconciliation to specific GAAP financial measures in all cases, such as net income and cash flow from operating activities? If yes, to which GAAP financial measures should we require reconciliation?
We believe requiring reconciliation to the most directly comparable financial measure is appropriate. Non-GAAP financial information is typically derived from a GAAP financial measure. The key is to provide the non-GAAP financial information in the context of its most directly comparable GAAP measure. While in a large number of cases, we expect the non-GAAP financial measure to be reconciled to such key GAAP measures as net income or cash flows from operating activities, we do not believe that there should be a mandate to reconcile the non-GAAP financial measure to specific GAAP financial measures in all cases, as long as the non-GAAP financial measure is reconciled to a well-understood GAAP financial measure.
However, we believe it is important that the reconciling items be clearly described by the registrant. As a result, we would expect reconciling items to be highlighted to the reader in an appropriately disaggregated level of detail and explained in plain English.
In addition, due to the fact that registrants do not calculate these non-GAAP measures in the same fashion, we believe that the reader should be alerted by a footnote or other disclosure that the measure presented may not be comparable to similarly titled measures reported by other companies. We believe that this would be consistent with the staff's current policy.
Finally, we recommend that the GAAP measure be the one at the bottom of the reconciliation so as to place greater prominence on it. If the non-GAAP measure is at the bottom of the reconciliation, we are concerned that it may receive more attention than the GAAP measure.
3. Should the presentation of certain non-GAAP financial measures require the presentation of a reconciled (full or summary) consolidated balance sheet, income statement and cash flow statement? If so, which non-GAAP financial measure(s) should trigger this requirement?
We believe that the reconciliation to the most-directly comparable GAAP financial measure would be sufficient.
4. Should the requirement of a quantitative reconciliation include an exception for prospective measures where the necessary information cannot be obtained without unreasonable effort?
We do not believe that there should be an exception for prospective measures where the necessary information cannot be obtained without unreasonable effort. We believe that non-GAAP prospective financial measures are prepared from GAAP data, therefore, a registrant should be able to disclose the most directly comparable prospective GAAP financial measure.
5. Should we limit the definition of non-GAAP financial measures to historical financial measures?
No. We believe that prospective measures should be included.
6. Does the proposed definition of "non-GAAP financial measure" capture non-GAAP information where enhanced disclosure is appropriate? Does the proposed definition capture the pro forma financial information that the Sarbanes-Oxley Act targets? Should Regulation G apply to disclosures of material information including any financial measure calculated and presented otherwise than in accordance with GAAP? Is the proposed definition otherwise too narrow or too broad? If so, how should it be changed?
We believe the definition is appropriate. However, as mentioned in our answer to Question 2, we believe it is important that the reconciliation be clearly presented and explained to the reader.
7. Should we exclude non-GAAP financial measures communicated orally from the proposed regulation? Would such an exclusion be consistent with the terms of the Sarbanes-Oxley Act?
We concur with the Commission's proposal to require a registrant to include in its regulation non-GAAP financial measures communicated orally. We believe the inclusion is consistent with the Act, which is applicable to "pro forma" measures in any public disclosure, press or other release.
8. Is there a danger that investors would consider the reconciliation to have been audited or reviewed by the issuer's independent auditors? Should Regulation G require companies to disclose whether the reconciliation has been reviewed or audited by their independent accountants in order to avoid investor confusion?
We believe that many investors and readers of non-GAAP data are under the impression that the auditor was associated with the non-GAAP data and has, in some way, approved the non-GAAP adjustments as "proper." These mistaken impressions are likely to continue and users will believe that such information has been subjected to audit or review by an independent accountant.
As a result, we believe issuers should be required, absent an auditor's review or examination, to disclose that such non-GAAP data and reconciliation have not been audited or reviewed by an independent accountant.
9. In this release, we propose to require companies that include non-GAAP financial measures in filings to also include a discussion of the purposes for which the company's management uses the non-GAAP financial measure and why management believes the presentation of the non-GAAP financial measure provides useful information to investors. Should we require that information in all communications that are subject to Regulation G? If so, why? If not, why not?
Yes, we believe that this type of information should also be included in all communications that are subject to Regulation G. Again, we believe that the key is to provide the non-GAAP financial information in the context of its most directly comparable GAAP measure, and to explain to the reader the usefulness of the non-GAAP information. We believe it provides insight to investors and readers to understand why and for what purpose management uses this information to manage the company.
10. Should we allow registrants greater latitude to satisfy the requirements of proposed Regulation G by posting the non-GAAP financial measure's components and the comparative GAAP financial measure on their website or in their Commission filings?
We do not believe that the proposed rule should provide greater latitude to registrants in terms of posting the non-GAAP financial measure on the registrants' website. Disclosure of significant events or information solely on a company's website is not in our opinion an adequate way of providing present or future investors, as well as readers with useful and relevant information. We believe that the posting of information on websites used should be restricted to a limited number of circumstances.
11. As proposed below, and consistent with staff practice, the Commission generally has more detailed disclosure requirements where non-GAAP financial measures are included in Commission filings. Should we require these additional disclosure requirements in all cases, even in documents not filed with the Commission?
We believe the more detailed disclosure requirements should be limited to documents filed with the Commission. However, as stated above, we believe that (1) the purposes for which the company's management uses the non-GAAP financial measure and (2) why management believes the presentation of the non-GAAP financial measure provides useful information to investors and readers should be required by Regulation G.
12. Should we prohibit the presentation, whether or not included in filings with the Commission, of certain non-GAAP financial measures (for example, certain per-share measures or liquidity measures that exclude cash items)? If so, which measures?
We believe it is appropriate to limit the prohibition of items such as per share measures or liquidity measures that exclude cash items to filings made with the Commission. However, see our answer to question 11.
13. Will proposed Regulation G limit the use of non-GAAP financial measures? Please explain.
We do not believe that proposed Regulation G will necessarily limit the use on non-GAAP financial measures. The reconciliation to the most directly comparable GAAP financial information will enhance the credibility of the disclosures made and provide investors and readers with valuable information.
14. Is the limited exception from Regulation G for foreign private issuers appropriate in furtherance of the purposes of the Sarbanes-Oxley Act? Should the exception be broader or more limited? If so, how?
We recommend that the Commission further clarify the applicability of the term "limited exception." Specifically, the Commission should clarify how the condition to use the limited exception which states, "the disclosure is made by or on behalf of the registrant only outside of the United States, or is included in a written communication that is released by or on behalf of the registrant only outside the United States" will be applied. The use of faxes and e-mail has effectively eliminated the significance of national borders in disseminating information. However, it is our understanding that where a company physically sends information, not its ultimate intended source of communication, will be the key determining factor in the eligibility to rely on the limited exception. To illustrate, it is our understanding that under the proposed rules, if a German company sends a press release to Dow Jones in the United States, it would be subject to the requirements of Regulation G. If, instead, the company sends the press release to a Dow Jones office in London, it would not be subject to Regulation G because of the limited exception. This is true even though the company expects that the press release will be distributed in the US. The adopting release should specifically address a situation in which a non-US company sends out a press release to a news source physically located outside the United States for which it is expected that the information will be distributed in the United States. See response to comment 15 for possible recommended changes to the definition and applicability of the definition for limited exception.
15. Does the limited exception from Regulation G for foreign private issuers deprive U.S. investors of material information? Alternatively, would eliminating the limited exception for foreign private issuers deprive U.S. investors of non-GAAP financial measures? Furthermore, would eliminating the limited exception from Regulation G for foreign private issuers result in foreign private issuers de-registering and exiting the U.S. capital markets?
We believe that the disclosure requirements under Regulation G provide the investor with useful information. The Commission's proposed rules address a concern of investor confusion over the use of non-GAAP measures. Accordingly, investors could be confused when reading a press release by a company that has relied upon the limited exception and presented non-GAAP information that excludes the disclosures required by Regulation G.
We do not believe that eliminating the limited exception for foreign private issuers would deprive US investors of non-GAAP financial measures. Companies that want to disclose such information, because they believe it would be useful to investors, can and will disclose such information. The incremental disclosures required by Regulation G would not preclude many companies from providing such information. We recognize that the Commission may conclude that because of the territorial principle that it cannot require the application of Regulation G if the disclosure is made outside of the United States. To reduce possible investor confusion, we offer two suggestions for the Commission's consideration:
For those companies that are not relying on the limited exception, the Commission should consider expanding the requirements of Regulation G to stipulate that disclosure should be provided of the GAAP that is being used for purposes of the reconciliation of the non-GAAP information. In this regard, the Commission should indicate that the reconciliation should be to the GAAP in the primary financial statements, and that it is not necessary to additionally reconcile the non-GAAP amounts to the US GAAP reconciled amounts.
While we have not conducted a survey of our clients, we do not believe eliminating the limited exception from Regulation G for foreign issuers will result in a large number of companies de-registering and exiting the U.S. capital market. However, some of our clients are investigating the feasibility and implications of de-registering because of other aspects of the Sarbanes-Oxley Act.
16. Proposed Regulation G would apply to disclosures of non-GAAP financial measures that represent projections or forecasts of results of business combination transactions ("post-transaction measures") and that are filed with the Commission as information pursuant to the communications rules applicable to business combination transactions, as well as non-GAAP financial measures of each registrant that are used to calculate post-transaction measures. Should there be an exception from certain of the requirements of Regulation G for post-transaction measures or other measures filed as information under the business combination rules? Should such measures be treated differently under Regulation G? If so, how? Business combination communications often include brief statements regarding the potential benefits to be achieved by the business combination (e.g., synergies, valuations, dividend amounts, etc.). Either instead of or in addition to the requirements of proposed Regulation G, should the rules specifically require the disclosure of any assumptions or bases underlying these measures?
We do not believe that such financial measures should be treated differently. Regulation G should apply to disclosures of non-GAAP financial measures that represent projections or forecasts of results of business combination transactions. We believe that the non-GAAP financial measure has been prepared from the GAAP data, therefore, a registrant should be able to provide the disclosures required by Regulation G.
17. Should Regulation G be enforceable by the Commission only or also by private plaintiffs? Should language be included in Regulation G that makes explicit the manner in which it is to be enforced?
We believe that Regulation G should only be enforceable by the Commission and that the language of the Regulation and the adopting release make that clear.
18. Will proposed Regulation G meet the goals of Section 401(b) of the Sarbanes-Oxley Act? Does proposed Regulation G meet those goals in the most appropriate manner? Is there a way to achieve these goals that is less burdensome than that in proposed Regulation G? If so, what is it?
We have no additional comments.
Amendments to Item 10 of Regulation S-K, Item 10 of Regulation S-B and Form 20-F
19. Are the proposed additional disclosures required in filings necessary in light of proposed Regulation G?
Yes, we believe the additional requirements would be beneficial to investors and readers. In particular, we believe that (1) the discussion of the purposes for which management uses the non-GAAP financial information and (2) why management believes the presentation of the non-GAAP financial measure provides useful information to investors will be informative to investors and readers.
20. Consistent with current staff policy, our proposal would prohibit the use of non-GAAP per-share measures. Is such a prohibition necessary, or would it suffice to reconcile both the numerator and denominator of the non-GAAP per-share measure with comparable GAAP measures, respectively?
We believe that the reconciliation process if adopted would address the Staff's previous concerns over the presentation of per share data, such that it should not be necessary to extend further the Commission's policy prohibiting the use of non-GAAP per-share measures. In this regard we note that completion of the FASB project on Financial Performance Reporting by Business Enterprises would also help standardize such measures to a point where the disclosure of per share data may not be as problematic as it has been in the past.
21. Should the non-GAAP financial measures be presented in a separate section of a Commission filing?
We do not believe that the non-GAAP financial measure should be presented in separate section of a registrant's filing. In our view, the disclosures should be integrated within the filing in order to put them in their GAAP context. If the non-GAAP financial information were to be presented in a separate section, there could be a risk that a reader would focus on the non-GAAP financial information without obtaining a full understanding of the GAAP financial information and the interaction between the non-GAAP financial measure and the GAAP financial measure.
22. Should the requirements for filings and those required in Regulation G be different? For example, should the requirement that the GAAP measure in a filing be presented with equal or greater prominence be included in Regulation G or not included in Item 10 of Regulation S-K and Item 10 Regulation S-B?
We believe the more detailed requirements applicable to documents filed with the Commission should be maintained. As stated above in Question 11, we believe that the only additional requirements that should be included in Regulation G should be (1) the discussion of the purposes for which management uses the non-GAAP financial information and (2) why management believes the presentation of the non-GAAP financial measure is useful.
23. Should the requirement that a quantitative reconciliation of prospective measures be included in the filing have an exception similar to that proposed in Regulation G where the necessary information cannot be obtained without unreasonable effort?
No. See our comments above on Question 4.
24. Are there additional disclosures that should be required in filings? If so, what disclosure items would be beneficial to investors?
We believe that the proposed disclosures are appropriate.
25. Consistent with current staff policy, our proposals would prohibit specified types of disclosures. Is such a prohibition necessary and appropriate?
Yes, we believe such a prohibition is appropriate.
26. Should the proposed requirements apply to foreign private issuers' reports on Form 20-F?
We note that the proposed rules provide an exemption for non-GAAP measures included in filings made by foreign private issuers that would otherwise be prohibited, but that are expressly permitted under the GAAP used in the primary financial statements. We recommend that the Commission clarify and expand how the term "expressly permitted" will be interpreted. The accounting standards in many countries allow the disclosure of what would be characterized as a non-GAAP measure. For example, in the UK, companies are allowed to disclose various earning per share amounts based on the guidance included in FRS 3 - Reporting Financial Performance. Many companies disclose on the face of the financial statements an alternative EPS number that adjusts for certain items - depreciation, exceptional items, etc. The specific alternative EPS amount, which is an amount defined by the company, is not expressly permitted by FRS 3, but the concept that an alternative EPS amount can be disclosed on the face of the income statement is expressly permitted by FRS 3. The adopting release should address if in this type of situation whether the disclosure would be considered to have been expressly permitted by the GAAP used in the primary financial statements.
The issue of non-GAAP disclosures in the financial statements of foreign private issuers was discussed at the May 23, 2002 meeting of the AICPA International Practices Task Force. At that meeting, the Task Force considered whether alternative per share amounts should be permitted to be disclosed in SEC filings and concluded that, provided registrants complied fully with the requirements of the home country GAAP in presenting alternative per share amounts, such measures could be presented in SEC filings if appropriately described. Using the disclosure provisions included in UK FRS 3 as a model, the Task Force concluded that the disclosures should: (1) be presented on a consistent basis over time, (2) be reconciled to the amount required by local GAAP, (3) list the items for which an adjustment is being made and disclose the effect of each item on the calculation, (4) present the GAAP per share measure at least as prominently as the non-GAAP per share measure, (5) explain the reasons for calculating the non-GAAP per share measure and (6) present the reconciliation and explanation adjacent to the GAAP earnings per share measure (or include a reference to where the GAAP earnings per share can be found).
The disclosures should ensure that the performance measures used are not misleading.
We recommend that the Commission modify the proposed rule to be in line with the conclusions of the AICPA International Practices Task Force that would require an explanation and reconciliation of non-GAAP information rather than a prohibition of such non-GAAP information.
Regardless of the Commission's rules, foreign private issuers will disclose non-GAAP measures in the financial statements included in their annual reports that are distributed to all shareholders. Accordingly, US shareholders will receive financial statements that include non-GAAP measures. Prohibiting companies from disclosing such information in Commission filings that is distributed in the annual report to shareholders will not enhance investor protection. We believe investor protection can best be met by having companies providing the appropriate disclosures in the filings made with the Commission.
We believe the criteria to be able to use the exception regarding the disclosure of a non-GAAP amount in the financial statements should be if the disclosure is allowed vs. expressly permitted under the GAAP used in the primary financial statements provided that disclosures similar to that presented above are included in the financial statements.
27. Should the proposed requirements apply to filings by Canadian issuers under the MJDS on Form 40-F?
While not commenting on the continuation of the MJDS, we believe that the requirement to disclose such information is inconsistent with the principles of the MJDS system. Securities Act Release No. 6902 that established MJDS states that qualifying Canadian companies can meet the Commission's reporting requirements by providing disclosure documents prepared in accordance with the requirements of the Canadian securities regulatory authority. The concept is that with the exception of the requirement to provide a reconciliation to US GAAP, the document filed with the SEC is simply a wrap of the document submitted to the Canadian regulators that has been prepared in accordance with the Canadian requirements. By requiring this disclosure, the Commission would be deviating from the fundamental principle of the establishment of MJDS. Since the adoption of the MJDS system over ten years ago, the Commission has made many more significant changes to the reporting requirements that apply to foreign private issuers without modifying the MJDS system.
28. As with Regulation G, in the case of business combinations, the proposed requirements would apply to "post-transaction measures" filed as information under the communication rules applicable to business combination transactions. Is an exception from certain of the requirements for post-transaction measures or other measures filed as information under the business combination rules appropriate? Should such measures be treated differently? If so, how? Either instead of or in addition to the requirements of proposed Regulation G, should the rules specifically require the disclosure of assumptions or bases underlying announcements of potential benefits to be achieved by the business combination (e.g., synergies, valuations, dividend amounts, etc.)?
See our response to Question 16.
29. If a company presents a non-GAAP measurement for a previous completed fiscal period, should it be required to present that same non-GAAP measurement in future filings where the previous period is compared to a recent completed fiscal period? For example, if a company presents a non-GAAP financial measurement that for the first fiscal quarter of 2002, should it be required to present the same non-GAAP measurement for the first fiscal quarter of 2003?
We believe that conceptually non-GAAP financial information should be treated in a similar fashion for comparable periods. However, it could result in the production of non-relevant information in certain cases. For instance, if a non-GAAP disclosure was important in a Q1 2001 comparison to Q1 2000, it may not necessarily be relevant to a Q1 2002 comparison to Q1 2001.
Proposed Item 1.04 of Form 8-K
30. Is proposed Item 1.04 necessary given Regulation FD and proposed Regulation G?
Yes, we believe proposed Item 1.04 is appropriate, as it will encourage registrants to exercise greater care when preparing their press releases. It will also ensure greater consistency between the information provided in press releases and the information provided with other filings with the Commission.
31. Should the Commission define "public disclosure" for purposes of proposed Item 1.04?
We believe a definition of "public disclosure" would be useful. Registrants would benefit from greater clarity.
32. Proposed Item 1.04 would apply only to disclosures regarding completed annual or quarterly fiscal periods. Should we expand the scope of proposed Item 1.04 to require the filing of all material updates to estimates for current or future fiscal periods?
We believe that an expansion of scope would be warranted. Press releases including any historical information should be treated similarly irrespective of whether they coincide with a period that will ultimately be included in a filing with the Commission. We do no see any merit in treating certain periods differently than others.
33. Will proposed Item 1.04 have the effect of decreasing the extent to which public companies make public announcements or releases of material non-public information regarding completed fiscal periods? If so, what are the specific factors that would result in that decrease? Why would those factors result in that decrease?
No, we do not believe that proposed Item 1.04 would have the effect of decreasing the extent to which public announcements or releases of material non-public information are made, but we believe it will indeed introduce more rigor and care in the preparation of press releases by registrants.
34. Is the posting of the complementary information on a website sufficient disclosure or should a filing be required for this information as well?
We believe that posting the information on the website is sufficient disclosure.
35. Regulation G requires that any information provided on a website be available at the time the original public communication is made. Is it necessary for Item 1.04 to contain the same timing requirement?
We believe the timing in the proposed rule for Item 1.04 is adequate.
36. Should we require forward-looking information to be considered filed for purposes of Section 18 of the Exchange Act? Should forward-looking information, where appropriate, be incorporated by reference into a registration statement, proxy statement or other report?
No, we do not believe that forward-looking information should be considered filed for purposes of Section 18 of the Exchange Act.
37. Should the disclosure requirements of Item 10 of Regulation S-K and Item 10 of Regulation S-B apply to complementary information not filed with the Commission?
No, we do not believe that the requirements should be extended to complementary information not filed with the Commission.
38. Would the application of Item 1.04 only to disclosures regarding completed annual or quarterly periods cause public companies to increase their disclosure of intra-period information, rather than disclosure regarding completed periods, in an effort to avoid the requirements of Item 1.04?
No. However, as stated in our cover letter, we continue to strongly encourage the Commission to move forward expeditiously with the FASB, to develop relevant Key Performance Indicators ("KPIs") and a regimen to promote or require their disclosure by registrants on a current basis. Relevant information to investors and readers may, and in fact more frequently does, take the form of non-accounting information. In this era of complex accounting rules, which are aimed at the complex business environment, rather than compressing the GAAP reporting timeframes and regulating the presentation of non-GAAP financial information, the SEC should encourage the development of pertinent and consistent KPIs and their continuous and timely delivery to investors and analysts. Such information could indeed be presented to investors on monthly basis, which would further alleviate the Commission's concerns about registrants providing intra-period releases rather than quarterly releases.