The Association of the Bar
of the City of New York
42 West 44th Street
New York, NY 10036-6689

Committee on Securities Regulation

December 9, 2002

Via email: rule-comments@sec.gov

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Attention: Jonathan G. Katz, Secretary

Re: Proposed Rule: Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments
Release Nos. 33-8144; 34-46767
File No. S7-42-02

Ladies and Gentlemen:

This letter is submitted on behalf of the Association of the Bar of the City of New York by the Committee on Securities Regulation (the "Committee") in response to Release Nos. 33-8144 and 34-46767, dated November 4, 2002 (the "Release"), in which the Securities and Exchange Commission (the "Commission") has requested comments on its proposed amendments to Item 303 of Regulations S-K, Item 303 of Regulation S-B, Item 5 of Form 20-F and General Instruction B of Form 40-F under the Securities Exchange Act of 1934 (the "Exchange Act"). The Release is in response to the directive in new Section 13(j) of the Exchange Act, added by Section 401(a) of the Sarbanes-Oxley Act of 2002 (Public Law 107-204) (the "Sarbanes-Oxley Act"). Our Committee is composed of lawyers with diverse perspectives on securities issues, including members of law firms, counsel to corporations, investment banks and investors, and academics.

Please note that Committee members Wayne Carlin, of the United States Securities and Exchange Commission and Salvatore J. Graziano, of Milberg, Weiss, Bershad, Hynes & Lerach did not participate in the preparation of this letter or the decision by the Committee to submit this letter to the Commission.

The Committee commends the Commission and its staff for its efforts in addressing the extraordinary regulatory agenda imposed by the Sarbanes-Oxley Act. The Release and the proposed rules, like the other actions the Commission has taken under the Sarbanes-Oxley Act, clearly reflect the magnitude of these efforts. Our Committee believes, however, that the proposed rules may result in investor confusion and potentially misleading disclosure and that the fundamental investor protection objectives of the Sarbanes-Oxley Act would be better served if the Commission gave additional consideration to specific elements of the proposed rules, as set forth in this letter.

In addition, we believe that the proposed rules expand considerably on the congressional mandate of Section 401(a)of the Sarbanes-Oxley Act, by adding extensive and very specific requirements to the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") rules. We urge the Commission to reconsider this approach. Historically, the Commission has identified in rules the general issues and concerns that must be addressed in MD&A, and it has supplemented the rules with generally applicable guidance, with enforcement actions and with the comment process. We believe that, taking the long view, this approach has been extraordinarily successful in shaping disclosure practice. The recent financial scandals cannot fairly be attributed to weaknesses in the MD&A rules, and Congress has not asked the Commission to change its regulatory philosophy in this area.

The current proposals combine excessive detail in describing the required disclosure with excessive breadth in defining its scope. They are "check-the-box" where the existing MD&A requirements are principles-based. This is seriously at odds with the thrust of the MD&A rules, which the Release aptly summarizes in Section I. Based on our experience of the disclosure process, the proposals will have an immediate, counterproductive effect by eliciting voluminous and uninformative disclosure. The Commission has an alternative: it could address the congressional mandate by means of more generally worded rules, similar to those in the current MD&A requirements, drawing attention to the categories of concerns to be addressed and the kinds of information that may be useful in addressing it. For the vast majority of registrants, which will be sensitive to these requirements and will seek in good faith to comply, this is the best way to elicit effective disclosure. For the other registrants, additional repetition or specificity will have little or no utility.

This letter is divided into seven sections:

  • The first concerns the proposed definition of off-balance sheet arrangements;

  • The second concerns the proposed disclosure threshold;

  • The third concerns the proposed disclosures of contractual obligations and contingent liabilities;

  • The fourth responds to certain of the Commission's requests for comments concerning other MD&A disclosures;

  • The fifth concerns the application of the proposed rules to foreign private issuers;

  • The sixth responds to certain of the Commission's requests for comments concerning the proposed safe harbor; and

  • The seventh sets forth suggestions concerning the phasing-in of the proposed rule amendments.

I. Responses to certain of the Commission's requests for comments and other suggestions and comments concerning the definition of off-balance sheet arrangements

    A. Suggestions concerning the definition of off-balance sheet arrangements

      1. We believe that the current scope of proposed Rule 303(a)(4)(iii)(D) is likely to result in extensive disclosures that do not further investor protection or understanding

We believe Section 401(a) of the Sarbanes-Oxley Act was intended to improve disclosure of arrangements that were entered into for the purpose of altering a registrant's balance sheet, statement of operations or statement of cash flows principally by having a related party assume (and thereby remove from a registrant's financial statements) certain of the registrant's liabilities that would otherwise be reflected in the financial statements. We do not believe that Congress intended that Section 401(a) of the Sarbanes-Oxley Act cause the Commission to require registrants to enumerate ordinary course transactions already appropriately reflected in the financials, in MD&A or elsewhere pursuant to Regulation S-K. Such disclosures will not improve MD&A, and, as discussed below, in many cases will be redundant and will distort management's view of the business.

In this regard, proposed Rule 303(a)(4)(iii)(D) includes within the definition of "off-balance sheet arrangement" any transaction, agreement, or other contractual arrangement under which the registrant has, or in the future may have, " ... any obligation or liability ... to the extent it is not fully reflected in the financial statements (excluding the footnotes thereto)." The proposed definition would, therefore, require registrants to enumerate in MD&A all transactions, agreements, or other contractual arrangements with third parties that may have a current or future material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources. We note that, if applied to every contract to which an entity unconsolidated with the registrant is a party without regard to the intent of the transaction, by its terms, clause (D) of proposed Rule 303(a)(4)(iii) would literally require disclosure of all of a registrant's obligations to third parties that are not fully reflected in the registrant's financials (excluding the footnotes thereto). These would include, for example, the vast majority of garden variety employment, consulting and service agreements, leases, licenses, royalty agreements, purchase agreements, lending commitments and construction contracts.

We believe the proposed enumeration would also duplicate information already, and appropriately, required elsewhere in filings, without any resulting benefit to investors. Specifically, the proposed definition of "off-balance sheet arrangement" would include contractual arrangements already comprehended by Items 101, 402 et seq. and 601 of Regulation S-K, and, therefore, already routinely described in registrants' annual, quarterly, and proxy filings. In addition, under U.S. generally accepted accounting principles ("U.S. GAAP"), many such arrangements are reflected in a registrant's income statement as current operating expenses, and to the extent such arrangements have materially affected, or, in the future, may reasonably be expected to affect, financial condition or results of operations, Item 303 of Regulation S-K already requires they be discussed in MD&A. As a consequence, the principal effect of clause (D) of proposed Rule 303(a)(4)(iii) is extensive redundancy without additional transparency.1

In addition, we believe disclosure of such arrangements as a group in a separate section of MD&A is likely to give undue weight to their significance. As indicated above, many of these arrangements are reflected in a registrant's income statement as current operating expenses, and, as such, they already are required to be accorded appropriate significance in the financial statements and MD&A. Also, to the extent such arrangements are expected to have a material effect on financial condition or results of operations in the future, disclosure is already required by the existing MD&A rules.

Consequently, we believe that the definition of "off-balance sheet arrangements" should be reformulated by the Commission so that it targets transactions involving special purpose vehicles or otherwise designed to alter a registrant's balance sheet, statement of operations or statement of cash flows rather than targeting all obligations and liabilities not fully reflected in the financial statements (excluding the footnotes thereto). If the Commission believes the proposed format of the definition should be retained, we believe it is essential that the definition be revised so that (i) it excludes ordinary course obligations, particularly where the registrant itself is the primary obligor and (ii) disclosure pursuant to proposed Rule 303(a)(4) of executory arrangements contemplated by proposed clause (iii)(D) is limited to executory arrangements not otherwise described pursuant to Items 101, 303(a)(1)-(3), or 402 et seq. of Regulation S-K.

      2. We believe MD&A disclosure of litigation, arbitration and regulatory actions related to off-balance sheet arrangements should be consistent with disclosure of litigation, arbitration and regulatory actions related to non-off-balance sheet arrangements

The final sentence of clause (D) of proposed Rule 303(a)(4)(iii) appropriately excludes from the definition of off-balance sheet arrangements contingent liabilities arising out of litigation, arbitration, or regulatory actions. However, the proposed exclusion only covers litigation, arbitration, and regulatory actions " ... not otherwise related to off-balance sheet arrangements". Consequently, the final sentence of clause (D), as currently drafted, suggests the possibility that all such litigation, arbitration, and regulatory actions related to off-balance sheet arrangements, regardless of materiality, would require disclosure, if the related off-balance sheet arrangements required disclosure. That would, of course, be inconsistent with the approach taken in Item 103 of Regulation S-K. Therefore, we believe clause (D) should be revised to clarify that litigation, arbitration, and regulatory actions related to off-balance sheet arrangements require disclosure, only if material to the consolidated financial condition or results of operations or cash flow of the registrant itself.

    B. We believe any disclosure pursuant to proposed Rule 303(a)(iv) of derivatives should exclude disclosure already required by Item 305 of Regulation S-K, and a definition of derivatives consistent with Item 305 should be included

Proposed Rule 303(a)(4)(iii)(C) includes within the definition of off-balance sheet arrangement " ... derivatives to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements ..." As a consequence, the proposed definition would require registrants to enumerate in MD&A all derivatives that may have a current or future material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures, or capital resources.

We believe the proposed disclosures pursuant to Rule 303(a)(4) with respect to derivatives referred to in clause (iii)(C) substantially duplicate disclosures required pursuant to Item 305 of Regulation S-K (Quantitative and Qualitative Disclosures About Market Risk). Accordingly, either Item 305 should be amended to reflect any such disclosure it does not already require and clause (iii)(C) should be deleted, or disclosure pursuant to proposed Rule 303(a)(4) of derivatives contemplated by proposed clause (iii)(C) should be limited to derivatives not otherwise described pursuant to Item 305 of Regulation S-K. In that connection, if proposed Rule 303(a)(4)(iii)(C) is not deleted, the term "derivatives" should be defined as, or replaced by the term, "market risk sensitive instruments" (as defined in paragraph 3 of General Instructions to Items 305(a) and 305(b) of Regulation S-K), which itself is defined by reference to the relevant accounting literature.

    C. We believe it is appropriate to apply to off-balance sheet arrangements the Commission's existing policy of excluding preliminary negotiations from MD&A disclosure

Until the terms of an arrangement - off-balance sheet or otherwise - are defined and the arrangement is unconditionally binding (subject only to customary closing conditions), we believe disclosure would, of necessity, likely be ambiguous and frequently changing, and, therefore, unhelpful to an investor. At the same time, any obligation to disclose an arrangement prior to its becoming defined and unconditionally binding would impose an incalculable and unfair burden on registrants to determine, and frequently re-consider, whether or not, and what, to disclose with respect to ongoing negotiations. Furthermore, in many circumstances, premature disclosure could jeopardize the consummation of the arrangement itself. Accordingly, we agree with the approach taken in proposed paragraph 13 of Instructions to proposed Rule 303(a).

II. Responses to certain of the Commission's requests for comments on, and other suggestions and comments concerning, the proposed disclosure threshold

    A. We believe that it is appropriate under the language in Section 401(a) of the Sarbanes-Oxley Act and consistent with the Commission's publicly stated position as to the purposes of MD&A to apply the "reasonably likely" disclosure threshold that is currently applicable in MD&A to any additional disclosure about off-balance sheet arrangements

      1. Section 401(a) of the Sarbanes-Oxley Act does not require the Commission to adopt a lower disclosure threshold for off-balance arrangements

First, we believe that the "reasonably likely" standard is consistent with the language of Section 401(a) of the Sarbanes-Oxley Act. The word "may" in the Sarbanes-Oxley Act allows for a broad range of meanings in the context of the threshold for disclosure. This range certainly includes the "reasonably likely" disclosure threshold currently applicable throughout MD&A, and, absent a legislative history requiring otherwise, "may" should be presumed to have a meaning consistent with the existing disclosure threshold throughout MD&A.

Second, we do not believe that the legislative history of the Sarbanes-Oxley Act indicates that Congress intended to require the Commission to adopt a lower disclosure threshold for off-balance arrangements than the disclosure threshold that is applicable to the remainder of MD&A under long-standing Commission rules and guidance. We believe that if Congress intended to require the Commission to lower the disclosure threshold for this narrow category of information, it would have said so explicitly in Section 401 of the Sarbanes-Oxley Act or addressed the issue in the related legislative history. We are not aware of any legislative history that mandates this result, and we note that, in proposing the lower disclosure threshold, the Commission did not cite any such legislative history as the basis for its proposal.2 Furthermore, while the legislative history of the Sarbanes-Oxley Act does refer to the fact that there was testimony that enhanced disclosures concerning off-balance sheet arrangements are necessary to prevent future Enron-type problems, there is no suggestion that manipulation of the MD&A disclosure threshold itself led to any of the well-publicized accounting failures of recent history or that it creates loopholes that undercut clear disclosure. Consequently, we do not believe the difference between the wording of Section 401(a) of the Sarbanes-Oxley Act, on the one hand, and current Item 303 of Regulation S-K and the 1989 MD&A Release, on the other hand, requires the adoption of a lower disclosure threshold for off-balance sheet arrangements.

In addition, while the proposed "remote" disclosure threshold may be consistent with, although not required by, the language of Section 401(a) of the Sarbanes-Oxley Act, it is our view that the "reasonably likely" disclosure threshold is not only consistent with the language of Section 401(a) of the Sarbanes-Oxley Act, but, for the reasons discussed in Section II.A.2. below, is better suited to promoting both the Commission's stated goals for MD&A and Congress' intention to improve the transparency, clarity and quality of MD&A disclosures.

      2. The existing "reasonably likely" standard is better suited to promoting the Commission's stated goals for MD&A

In the Release, the Commission states that the three interrelated purposes of MD&A are:

  • To provide a narrative explanation of a company's financial statements that enables investors to see the company through the eyes of management;

  • To improve overall financial disclosure and provide the context within which financial statements should be analyzed; and

  • To provide information about the quality, and potential variability, of a company's earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.

    • The Release goes on to state that:

    MD&A disclosure should provide investors with an understanding of management's view of the financial performance and condition of the company, as well as an appreciation of what the financial statements show and do not show, important trends and risks that have shaped the past and trends and risks that are reasonably likely to shape the future.

    We believe the "remote" disclosure threshold is at odds with these goals for MD&A. Absent a clearly contrary Congressional mandate, these goals appear to us to be best served by a uniform disclosure standard for the MD&A, including disclosures related to off-balance sheet arrangements, that requires management to filter through the many possible outcomes for a transaction or category of transactions and identify the ones that it believes are reasonably likely to occur. We also believe that the "reasonably likely" disclosure threshold applicable elsewhere in MD&A is preferable to the "remote" disclosure threshold because the application of the lower "remote" disclosure threshold to the disclosure of off-balance sheet arrangements would attribute undue prominence to information about off-balance sheet arrangements in relation to the remainder of the information presented in MD&A.

    Experience suggests a "remote" disclosure threshold would lead management to overload MD&A with information of a worst-case scenario nature, rather than information that provides a reader with management's snapshot of the company's risk profile and performance. In practice, we believe registrants would, in order to minimize litigation risk, construe "remote" to mean "not theoretically possible," leading to lengthy, but meaningless, boilerplate disclaimers about outcomes that may be theoretically possible, but that management considers unlikely.

    Also, as discussed later, registrants will feel obligated to add to this lengthy list, extensive cautionary statements and bespeaks caution language, resulting in investor confusion about what is likely to happen. We believe that the sheer volume of this disclosure could overshadow and distract investor attention away from the much more important analysis of the underlying financial performance of the business and, with respect to off-balance sheet arrangements, from what management believes is reasonably likely to occur. Finally, we note that if the "reasonably likely" disclosure threshold for off-balance sheet arrangements is adopted, registrants would still be required to provide information that is otherwise material under the probability/magnitude test.3 We believe that this type of balancing analysis is the appropriate way for MD&A to address outcomes that are not reasonably likely, but very material.

      B. The Commission should not consider amending current MD&A rules to change the existing "reasonably likely" disclosure threshold to the "remote" disclosure threshold proposed in the Release.

    For the reasons discussed in Section II.A. above, we do not believe that the "remote" disclosure threshold proposed in the Release is consistent with the Commission's stated goals for MD&A. Consequently, we do not believe the Commission should consider amending current MD&A rules to change the existing "reasonably likely" disclosure threshold to the "remote" disclosure threshold proposed in the Release.

    III. Responses to certain of the Commission's requests for comments, and other suggestions and comments concerning, the proposed disclosures of contractual obligations and contingent liabilities

      A. We do not believe that the proposed MD&A disclosures required by proposed Rule 303(a)(5) should be adopted

    We believe that the proposed tabular disclosure of contractual obligations and contingent liabilities and commitments is neither required by the Sarbanes-Oxley Act nor an improvement in transparency of disclosure. In addition, as proposed we believe it would impose an enormous compliance burden on many registrants, far beyond the burdens estimated by the staff in the Release.

    The Release acknowledges that Section 401(a) of the Sarbanes-Oxley Act does not require the tabular disclosure proposed in Rule 303(a)(5). We believe that the Commission's other instructions and directives regarding MD&A likewise do not require such disclosure to achieve the objectives of MD&A, namely: to provide investors with management's view of the financial performance and condition of the registrant and to explain the financial statements and the trends and risks that are reasonably likely to shape future financial performance.

    Some of the proposed line items for tabular disclosure are already presented in registrants' reports in a manner that is easy to locate and provides sufficient detail. For example, long-term debt is required to be disclosed in a note to financial statements that sets forth the total amount for each obligation, interest rates and the amounts maturing in each year over the next five years, as well as restrictions on borrowings and dividends, possible increases in interest rates and fees and other material effects. Lease obligations of registrants are required to be disclosed in notes to financial statements that set forth future minimum rental payments for each of the next five years and in the aggregate for all remaining years. If purchase obligations are fixed, they, too, are disclosed in notes to financial statements. It is neither necessary nor helpful to disclosure to repeat in MD&A the notes to financial statements relating to these obligations.

    The proposed requirement to disclose in tabular form with explanatory text or footnotes all other long-term obligations and purchase obligations is enormously burdensome. It will require registrants to assemble data not otherwise required for the preparation of financial statements, such as payments due by period under ordinary supply agreements, employment agreements, collective bargaining agreements and ordinary financing arrangements, such as revolving credit agreements, even including projected commitment fees that vary by the amounts drawn and undrawn. For example, in order to present the proposed tabular disclosure of contractual obligations:

    • A registrant that manufactures complex equipment could be required to review and project annual payments under thousands of purchase orders and supply contracts, wages and benefits payable to hourly workers under union contracts and countless other ordinary course items;

    • A registrant in a construction business could be required to review and calculate projected payments under thousands of agreements with subcontractors and service providers as well as acquisition and permit costs;

    • A registrant that produces entertainment could be required to estimate payments to artists and distribution payments that will ultimately vary based on the success of the production; and

    • A bank holding company registrant could be required to report as a line item the aggregate lending obligations of all of its bank subsidiaries under outstanding commitments, estimating the amount a customer will draw each year.

    The proposed tabular disclosure does not improve transparency in MD&A because it would require discussion of data not comparable to line items in financial statements and, in some cases, involving only estimates of future amounts that cannot be known at the reporting date. This information about inherently uncertain matters must also be quantified, without the benefit of any standards providing rigor or comparability. Moreover, the proposed tabular disclosure of contractual obligations distorts the context within which financial statements are analyzed because it presents only the liabilities arising out of ordinary business contracts, not the assets or revenues arising out of those contracts. MD&A is supposed to be management's fair view of the company's financial condition and results, not a compilation of data reported elsewhere in notes to financial statements or new data not comparable at all to reported financial information. We urge the Commission not to adopt proposed Rule 303(a)(5).

    If greater clarity in currently-required disclosure is the objective of the proposal, it can be achieved by application of existing instructions. If a guide to the location of information is required, cross-reference instructions will suffice.

    We also note that an unintended result of the proposal may be that, because some of the data required by the proposal would be from sources other than the registrant's financial records, auditors might be precluded by SAS 72 from providing comfort to financial intermediaries on this information.

    For these reasons, we suggest that, if the Commission believes a table is required in MD&A, the Commission consider adopting, as an alternative measure, a requirement that all contractual obligations and contingent liabilities that are otherwise required to be presented in financial statements and related notes and elsewhere in quarterly and annual reports be aggregated in a table in MD&A. We think this would greatly reduce the burden on registrants while providing investors to convenient access to this information.

      B. If proposed Rule 303(a)(5) is adopted, definitions of "contractual obligations" and "contingent liabilities and commitments" should be included

    If the Commission adopts proposed Rule 303(a)(5), it will be essential to define "contractual obligations" and "contingent liabilities and commitments." The definitions must include a materiality threshold so that registrants are not required to identify every contract, contingency or commitment, no matter how insignificant, evaluate them and disclose the potential exposure period-by-period. The definition should exclude ordinary course of business purchase orders and contracts for goods and services, as well as items for which U.S. GAAP would not require any disclosure on the face of the financial statements or in notes to financials.

    Importantly, the definition of contingent liabilities or commitments must exclude litigation, arbitration and regulatory actions so that the standard for disclosure of such contingencies is not inadvertently changed by the proposed rule.

    If the Commission adopts proposed Rule 303(a)(5), definitions of line items will also be essential so that readers will be able to make meaningful comparisons among registrants' disclosures of contingent liabilities and commitments.

    IV. Responses to certain of the Commission's requests for comments concerning other MD&A disclosures

      A. We do not believe that the Commission should further amend the MD&A rules to require more specific disclosure about relationships and transactions with persons or entities that derive benefits from their non-independent relationships with the registrant or the registrant's related parties

    The Commission has requested comment as to whether to amend the MD&A rules to require more specific disclosure about relationships and transactions with persons or entities that derive benefits from their non-independent relationships with the registrant or the registrant's related parties.

    In Release No. 33-8056, FR-61 (January 22, 2002) (the "January 2002 Commission Statement"), the Commission stated that registrants should consider whether investors would better understand financial statements, if MD&A included descriptions of all material transactions involving related persons or entities. In its current form, Item 303 of Regulation S-K requires registrants to include discussion of transactions with any person or entity, including related persons or entities, whether defined in accordance with FAS 57 or otherwise, in cases in which such discussion is necessary to an understanding of, among other things, (a) the registrant's financial condition, changes in financial condition, and results of operations, (b) known trends, demands, commitments, events, or uncertainties that will materially affect a registrant's liquidity or capital resources, (c) a registrant's material commitments for capital expenditures and the source of funds needed to fulfill such commitments, (d) unusual or infrequent events or transactions or significant economic changes that affect income from continuing operations, (e) known trends or uncertainties that have had or the registrant reasonably expects to have a material effect on net sales or revenues or income from continuing operations, and (f) known events that will cause a material change in the relationship between costs and revenues.

    We believe the existing rules would require identification of a party to a transaction as "related", if that is relevant to an understanding of the matters referred to in (a) through (f) above. We believe these existing requirements of Item 303 of Regulation S-K, together with the gloss on these requirements in the Instructions to Item 303(a) and the requirements of Items 402 et seq. of Regulation S-K, amply cover the subject of related party transactions and their relevance to a registrant's financial condition and results of operations. If complied with, these requirements should enable an investor to discern the effect of related party transactions on a registrant's financial condition and results of operations. Our experience suggests the overwhelming majority of registrants are sensitive to these existing requirements. We believe that, to the extent registrants are sensitive to these existing requirements, additional rulemaking is unnecessary; and, to the extent registrants are not sensitive to these existing requirements, further repetition or specificity would have little or no utility.

      B. We believe that, if the Commission intends to require registrants to comply with the factors identified in the January 2002 Commission Statement, the Commission should formally propose them and provide an opportunity for comment

    The Commission has requested comment as to whether it should codify the factors identified in the January 2002 Commission Statement for management's consideration in identifying trends, demands, commitments, events, and uncertainties that require disclosure with respect to liquidity and capital resources, and whether there should be other factors included in such a codification.

    We believe the existing MD&A rules, together with the rules regarding disclosure of off-balance sheet arrangements required by the Sarbanes-Oxley Act, provide appropriate guidance with respect to liquidity and capital resources. Our experience suggests the overwhelming majority of registrants are sensitive to such requirements. Again, we believe that, to the extent registrants are sensitive to these existing requirements, additional rulemaking is unnecessary; and, to the extent registrants are not sensitive to these existing requirements, further repetition or specificity would have little or no utility.

    If, in practice, the staff intends to treat the factors identified in the January 2002 Commission Statement as rules, we urge the Commission to promulgate a new proposal embodying the precise language it wishes to codify, with an appropriate opportunity for public comment.

    V. Responses to certain of the Commission's requests for comments on, and other suggestions and comments concerning, the application of the proposed rules to foreign private issuers

      A. We believe there are valid reasons for the proposed rules to impose different disclosure standards to MD&A included in foreign private issuers' annual reports on Form 20-F or 40-F

    We believe that, although Section 401(a) of the Sarbanes-Oxley Act does not distinguish between foreign private issuers and U.S. companies, it does not require that the same rules be applied to Form 20-F and 40-F reports as are applied to Form 10-K reports. Congress should not be presumed to have taken away the Commission's rule making authority simply because various types of issuers were not identified in the Sarbanes-Oxley Act.

    For years the Commission, as well as the national securities exchanges and Nasdaq, have recognized the need for flexibility in the context of a global securities market and have allowed foreign private issuers to report in accordance with home country GAAP or disclosure requirements, with a reconciliation to U.S. GAAP or an explanation of differences in requirements. The current MD&A requirements of Form 20-F were adopted in 1999 as part of a complete revision of the Form as discussed in Release No. 33-7745 (September 28, 1999). Before 1999, Form 20-F had virtually the same MD&A requirements as Regulation S-K. In the 1999 amendments, the Commission replaced almost all the requirements of Form 20-F with international disclosure standards adopted by the International Organization of Securities Commissions ("IOSCO") in September 1998 (the "IOSCO Standards"). The IOSCO Standards were the end product of a lengthy process involving regulators in many jurisdictions, in which the Commission's representatives negotiated an international consensus on high-quality disclosure standards that are modeled in many important respects on existing U.S. disclosure requirements-most importantly, for MD&A. This was a substantial accomplishment, and the Commission very promptly built on it by making the United States one of the first jurisdictions to adopt the IOSCO Standards. In doing so, the Commission underlined its "strong support for high quality international standards and encourage[d] other jurisdictions to follow suit." By adding extensive new requirements to Item 5 of Form 20-F in response to the Sarbanes-Oxley Act, the Commission will undermine the achievement represented by the IOSCO Standards and the 1999 amendments. This is not required by the Act or by the disclosure concerns that have motivated the Commission to go beyond the requirements of the Act.

    The Multijurisidictional Disclosure System and the requirements for Form 40-F were discussed and harmonized over a two-year period with the Canadian Securities Administrators who adopted a corresponding National Policy Statement, as discussed in Release No. 34-29354 (June 21, 1991). Subsequent changes have been the subject of similar coordination. We believe that extending the MD&A proposals for Form 40-F beyond what is required by Canadian rules, which are otherwise well harmonized with U.S. rules, is inconsistent with the principles underlying MJDS, including a long-standing recognition that Canadian disclosure requirements provide adequate protection for U.S. investors in seasoned, substantial Canadian reporting companies. In this regard, we note, for example, that the Ontario Securities Commission and the Ontario Legislative Assembly are taking disclosure and enforcement initiatives that are in harmony with, but different from, the provisions of the Sarbanes-Oxley Act and the Commission's proposed rules. Such substantial disclosure regulation should be respected by the Commission and not overridden by the proposed rules.

    We have found nothing in the legislative history of the Sarbanes-Oxley Act that indicates that Congress intended to abrogate the understandings reached by the Commission with ISOCO and the Canadian Securities Administrators regarding disclosure practices. We believe that the Commission should not adopt such major changes to 20-F and 40-F requirements as have been proposed in the Release without first having formal substantive consultations with IOSCO and the Canadian Securities Administrators for the purpose of continued flexibility and harmonization.

    If the Commission wishes to apply the proposed rules to foreign private issuers without consultation with IOSCO or the Canadian Securities Administrators, we believe that the Commission should amend the proposed rules as they apply to annual reports on Forms 20-F and 40-F to provide that they do not require disclosure in MD&A of matters that are not required to be disclosed under IOSCO Standards or the Canadian standards applicable under MJDS, respectively, or the reconciliation of home country GAAP to U.S. GAAP.

    Separately, we note that the Commission has, by rule, exempted foreign private issuers from other requirements of the Exchange Act when the language of the Exchange Act does not distinguish between foreign private issuers and U.S. companies. If the Commission is able, by rule, to exempt foreign private issuers from provisions of Sections 14 and 16 of the Exchange Act, it should not feel compelled to apply the same rules to 20-F and 40-F reports as it does to 10-K reports merely because the Sarbanes-Oxley Act did not distinguish between foreign private issuers and U.S. companies.

    In the context of a global market, foreign private issuers have a continuing concern about making different disclosure in the various markets in which their securities trade, a problem that will be exacerbated if the Commission adopts MD&A rules that require disclosure that is not required by either IOSCO Standards or Canadian standards. In addition, foreign private issuers that are subject to substantial disclosure regulation in their home countries are sometimes resentful of Commission rules that have the effect of substituting new U.S. disclosure rules for established, meaningful home country disclosure practice.

    It is important to the U.S. role in the global securities markets that our rules not drive foreign private issuers away from our markets or lead foreign private issuers to return to the practice of excluding U.S. investors from participating in global offerings in order that the issuer not become subject to unduly burdensome U.S. rules.

      B. We believe that Form 6-K reports should be excluded from the proposed rules

    We agree with the Commission's position that Form 6-K reports should be excluded from the proposed rules for the reasons stated in the Release. Foreign private issuers may submit interim financial information under cover of Form 6-K pursuant to home country requirements and not Commission requirements. Form 6-K is not a periodic or quarterly report required to be filed in accordance with the Commission's standards. In addition, Form 6-K technically is submitted, not filed.

    VI. Responses to certain of the Commission's requests for comments on, and other suggestions and comments concerning, the proposed safe harbor

      A. We believe that the proposed safe harbor should be expanded to include all MD&A disclosures made in response to the proposed Rules that are presented in good faith with a reasonable basis

    The Commission has included in the Release a proposed a safe harbor for forward-looking information, and has requested comment on the need for the proposed safe harbor and whether it would afford sufficient protection. We believe that there is a need for a safe harbor, because the proposed rule will require, not encourage, management to disclose forward-looking information. We believe that this is a very important distinction. Because the structure of the current safe harbor protection was developed to "encourage" forward-looking information, the Commission should reexamine the current statutory and rule safe harbors in the context of the forward-looking information required by the proposed rule. We believe it is important to remove any doubt about the eligibility for the safe harbor of all information of the type required by the proposed rule. We also believe that, if the Commission adopts the proposal to lower the disclosure threshold from "reasonable likely", the amount and scope of cautionary language necessary to meet the conditions for the statutory safe harbors in Sections 27A(c)(1)(a)(i) of the Securities Act of 1933 (the "Securities Act") and 21E (c)(1)(a)(i) of the Exchange Act and the cautionary language necessary for protection by the "bespeaks caution" legal doctrine developed by the courts will increase dramatically. We believe there will be a tendency for this language to expand to cover every conceivable eventuality, to become boilerplate and to provide no additional meaningful disclosure to investors. The end result would be to add to MD&A, not only the large amount of disclosure of what is theoretically possible, albeit not reasonably expected, as set forth above, but also extensive cautionary language, which will obscure the investor's opportunity to look at the company through the eyes of management, who focus on what is reasonable likely to happen and the factors that will drive the business. We suggest that the appropriate test for protection of required forward-looking disclosures is that the statement be made in good faith with a reasonable basis. We believe that Rule 175 under the Securities Act and Rule 3b-6 under the Exchange Act are a more appropriate safe harbor test for this information than the statutory safe harbors in Sections 27A of the Securities Act and 21E of the Exchange Act, as currently contemplated by the proposed rule.

    Also, we suggest that information required by proposed Rules 303(a)(5)(i) and (ii) also be deemed forward-looking. These proposals require management to make certain assumptions and estimates of when payments will be required and when liabilities and commitments will expire, and should be equally protected.

      B. We believe that the proposed safe harbor should be expanded to apply to all forward-looking information in MD&A

    The Commission has asked whether the proposed safe harbor should be expanded to apply to all forward-looking information in MD&A. We believe it should, and that to do so, will encourage companies to provide a more fulsome discussion of the business and its prospects.

    VII. Suggestions concerning the phasing-in of the proposed rule amendments

    All of the proposals in the Release, if adopted, would require an enormous amount of work on the part of registrants. In addition, many of the proposals would require the collection and disclosure of information that may not have previously been tracked in the required disclosure format. Given these and the many other new burdens being placed on registrants at this time, we believe that it would be appropriate for the Rule amendments proposed in the Release to be phased in over time. Specifically, we propose that the Rule amendments proposed in the Release first apply with respect to disclosures concerning fiscal years ending on or after September 15, 2003 for domestic registrants and September 15, 2004 for foreign private issuers. This is consistent with the rules implementing Section 404 of the Sarbanes-Oxley Act and should provide sufficient time for companies to implement the necessary procedures to collect and disclose the required information.

    * * * * *

    Members of the Committee would be pleased to answer any questions you might have regarding our comments, and to meet with the Commission staff, if that would assist the Commission's efforts.

    Respectfully submitted,

    /s/ Charles M. Nathan, Jr.

    Charles M. Nathan, Jr., Chair
    Committee on Securities Regulation

    /s/ Steven J. Slutzky

    Steven J. Slutzky
    On behalf of the Ad Hoc Subcommittee
    Members named below

    cc: Alan Beller
    Director
    Division of Corporation Finance
    Securities and Exchange Commission

    Ad Hoc Subcommittee:


      Kevin Keogh
      Edward W. Kerson
      Norman D. Slonaker
      Steven J. Slutzky

    ____________________________
    1 The following example illustrates the extent of the redundancy and the extent to which the proposed rule would capture ordinary course business transactions the Sarbanes-Oxley Act was not intended to address:
    The registrant, a widget distributor, enters into an agreement with a third party on January 1, 2003. In a nutshell, the agreement provides that (a) the third party agrees to supply the registrant with all the registrant's requirements of Type A widgets through December 31, 2005 (with Type A widgets comprising 30% of the registrant's total sales in 2002), (b) the third party agrees to ship and invoice widgets within 30 days of receipt of each order, and (c) the registrant agrees to pay $10 per widget (subject to a formula adjustment, based on the number of widgets purchased each year) within 30 days of receipt of each shipment. The registrant believes its sales of widgets generally, and Type A widgets, in particular, are not likely to change dramatically in the foreseeable future.

    Because the agreement may have a current or future material effect on the registrant (accounting, as it does, for substantially all cost of goods sold of a product that comprised 30% of total sales in the preceding year, and that is expected to comprise a substantial percentage of total sales in the coming years), and because the future liability of the registrant under the agreement is not reflected as a liability in the financial statements (and, therefore, is presumably "not fully reflected in the financial statements (excluding the footnotes thereto)", the proposed rule would require discussion of the agreement in the separately captioned section of MD&A dealing with off-balance sheet arrangements. Such discussion would duplicate disclosures already specifically required by Items 101(c)(vi), 303, and 601(b)(10)(ii)(B) of Regulation S-K and by the notes to the registrant's financial statements (not to mention the fact that, during the life of the agreement, the registrant's financial statements would reflect purchases of Type A widgets and their subsequent resales). The extent of the redundancy would increase, of course, if the third party were related to the registrant.

    2 In this regard, the House Report on the Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2002 (Report 107-414), as well as the Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2002 (H.R. 3763) (the "CAART Act") as adopted by the House of Representatives on April 24, 2002, both specifically included the "reasonably likely" disclosure threshold for MD&A disclosures related to off-balance sheet arrangements. The text of the CAART Act was ultimately conformed to the final language of the Sarbanes-Oxley Act in conference. In our view, the Commission's past clear and well understood statements on the "reasonably likely" disclosure threshold for MD&A, together with the House of Representatives' specific use of the same "reasonably likely" disclosure threshold in its pre-conference version of the Corporate and Auditing Accountability, Responsibility, and Transparency Act of 2002, indicate that Congress was aware of the "reasonably likely" disclosure threshold and did not intend to impose a different disclosure standard.
    3 See Note 75 of the Release which cites Rule 408 under the Securities Act and Rule 12b-20 under the Exchange Act.