Association for Investment Management and Research
Financial Accounting Policy Committee

31 December , 2002

Jonathan J. Katz
Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re: Release No. 33-8145; 34-46788; File No. S7-43-02; Proposed Rule: Conditions for Use of Non-GAAP Financial Measures

Dear Mr. Katz:

The Financial Accounting Policy Committee (FAPC) of the Association for Investment Management and Research (AIMR)¹ is pleased to comment on the Securities and Exchange Commission's Proposed Rule: Conditions for Use of Non-GAAP Financial Measures. The FAPC is a standing committee of AIMR charged both with maintaining liaison with standard setters who develop financial accounting standards and regulate financial statement disclosures and with responding to new regulatory initiatives. The FAPC also maintains contact with professional, academic, and other organizations interested in financial reporting.

General Comments

The FAPC strongly supports the spirit and thrust of the SEC's Proposed Rule requiring public companies that disclose or release non-GAAP financial measures to

...Include, in that disclosure or release, a presentation of the most comparable GAAP financial measure and a reconciliation of the disclosed non-GAAP financial measure to the most comparable GAAP financial measure. p. 1 [Emphasis added]

As the Proposal makes clear, the question of whether companies should be permitted to release non-GAAP performance measures that by their nature are not comparable across companies and may mislead investors has been debated in the public domain for decades. The Proposal states

The Sarbanes-Oxley Act sought to eliminate the manipulative or misleading use of non-GAAP financial measures and, at the same time, enhance the comparability associated with the use of that information.

The FAPC concurs with this objective and believes that it is essential for the efficient functioning of capital markets and the rational allocation of capital. To this end, the needs of investors for timely, relevant, full and transparent information should supersede other considerations.

The FAPC believes that this requirement if enacted, and subject to our comments below, will provide investors with a more consistent and comparable basis for making informed investment decisions. Indeed, such reservations as the FAPC holds regarding the Proposal are based on concerns that certain of the proposed provisions, if enacted, could seriously weaken or even nullify the investor protections sought under this proposal.

The FAPC believes that whatever other reconciliations are required or allowed under this proposal, companies should be required to provide a full reconciliation to the U.S. GAAP net income or, for cash flow proxies, operating cash flow, including all of the line items that are, or will be, reported in the company's related income or cash flow statement. Performance measures other than net income are not standardized under U.S. GAAP. Therefore, unless companies are required to reconcile to net income, or operating cash flow, if relevant, comparability will be lost.

We believe strongly that the timing of issuance and method of dissemination of the reconciliation should not be dependent upon the method or venue of the disclosure or release, but should be consistent across all methods and all companies.

The FAPC believes it essential that the reconciliation be provided at the same time that the non-GAAP performance measure is released. Investors are able to make informed investment decisions only when they possess full and complete information. Thus, delays in the release of the reconciliations should not be permitted.

Specific Comments

Proposed Regulation G

The Proposal states, p. 5 ff:

Regulation G would require the registrant to provide the following information as part of the disclosure or release of the non-GAAP financial measure:

• A presentation of the most comparable financial measure calculated and presented in accordance with GAAP; and

• A reconciliation (by schedule or other understandable method), which shall be quantitative for historic measures and quantitative, to the extent available without unreasonable efforts, for prospective measures, of the differences between the non-GAAP financial measure presented and the comparable financial measure or measures calculated and presented in accordance with GAAP.

Question: 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?

The FAPC believes that whatever other reconciliations are required or allowed under this proposal, companies should be required to provide a full reconciliation to the U.S. GAAP net income, or, for "cash flow" proxy measures, cash flow from operating activities. This reconciliation should include all of the line items that are, or will be, reported in the company's related income statement or cash flow statement. That is, the reconciliation should use the same information that has been or will be reported in the 10-Q or 10-K filing. Performance measures other than net income are not standardized under U.S. GAAP. Therefore, unless companies are required to reconcile to GAAP net income, or operating cash flow if relevant, comparability will be lost.

Question: 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 all releases of earnings or non-GAAP financial measures should be required to be accompanied by all of the financial statements. Investors cannot properly evaluate the earnings or financial measures in isolation. Rather, it is essential that they have available the accrual and fair value information in the balance sheet, the components of earnings in the income statement, and the detailed operating cash flow information. This will enable investors to evaluate both the quality of the reported earnings or non-GAAP financial measures, and the associated risk. These assessments are critical to any valuation or other investment decision.

Question: Should the requirement of a quantitative reconciliation include an exception for prospective measures where the necessary information cannot be obtained without unreasonable effort?

The FAPC does not agree that an exception should be made to the requirement for "prospective measures where the necessary information cannot be obtained without unreasonable effort". These disclosures are discretionary, not mandatory. We believe that the presumption should be that, if management has sufficient information to provide a non-GAAP subset of prospective GAAP information, it can and should provide the GAAP quantitative reconciliation. Such vague and ambiguous exceptions are likely to be very broadly and generally applied, to the detriment of the quality of users' decisions based upon the fragmented information provided.

Question: Should we limit the definition of non-GAAP financial measures to historical financial measures?

Forecasts and projections of earnings and non-GAAP financial measures are among the most frequently disseminated financial measures. Such projections are thought to be a major determinant of market prices, affecting wealth, capital allocations, and the cost of capital. If market efficiency as well as consistency and comparability are to be maintained, prospective measures must be included within the scope of Regulation G.

Question: 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?

As we have indicated, the FAPC believes that the definition should be broad enough to include within its scope both historical and prospective non-GAAP financial measures, and should include any financial measure that is not calculated and presented in accordance with GAAP.

Question: 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?

The FAPC believes strongly that the exclusion from Regulation G of financial measures communicated orally would violate both the spirit and intent of the Sarbanes-Oxley Act. This exception would include many, if not most, of the most common methods of dissemination of such information including teleconferences, analyst meetings, meetings with the media, and other similar venues. We believe that the spirit and intent of this provision of the Sarbanes-Oxley Act is to protect investors and other users of financial information from the possible manipulation that can occur when ill- or un-defined non-GAAP financial measures are disseminated. Consequently, we believe that all disclosures of such information, in whatever form, and in whatever venue, must be included within the scope of Regulation G. If this exception is permitted, we could speculate that oral presentations would become a preferred choice among those disseminating such information because disclosures made in such a venue would escape the user protections inherent under the Regulation G umbrella. The needs of investors for full, fair, and complete information should come first.

Question: 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?

The FAPC concurs that the reconciliation as well as the non-GAAP financial measure should be accompanied by disclosures regarding whether the information has been reviewed or audited by the company's independent accountants. This disclosure could alert users of the information to the relative reliability of the disclosure.

Question: 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?

We agree with the proposal to require companies "that include non-GAAP financial measures in filings to also include:

• A discussion of the purpose 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."

We believe that both (bulleted) disclosures should be required. Investors and other users should be informed if management believes the measures to have a sound economic basis. The best evidence of this is whether management uses the measures in managing the business. However, we are concerned that these may become "boilerplate" disclosures that provide little, if any, useful information. Requiring that management disclose how these measures are used in specific operating and investing decisions would greatly enhance their potential usefulness to users of the information. For example, the FAPC believes that registrants should be required to state explicitly whether and which non-GAAP financial measures are used in the determination of management compensation or performance if indeed the measures are used for such purposes.

Question: 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?

The FAPC does not agree that the spirit and intent of the Sarbanes-Oxley Act would be met by permitting companies to disclose the reconciliation and components on the company's website. Company websites are neither standardized nor are they covered by regulation regarding their content, layout, accessibility, and transparency. Indeed, it can be exceedingly difficult to locate companies' financial statements, related notes, and management discussion and analysis on the websites. Moreover, we do not believe that it is in the best interests of investors to effectively require that they acquire, maintain, and become proficient in whatever hardware and software are needed to access the companies' websites, especially since these requirements are likely to differ from site to site.

The Proposed Regulation cites the following comment from the Senate Committee on Banking, Housing, and Urban Affairs Committee Report:

...The reconciliation presumes, and would require, the issuer to publish financial data calculated according to GAAP at the same time as it publishes pro forma data. This should enable investors to, at the least, simultaneously compare the pro forma financial data with the same types of financial disclosures (e.g., earnings) calculated according to GAAP for the comparable reporting period. [Emphasis added.]

Similarly, from Section 401(b) of the Sarbanes-Oxley Act, the Commission is directed to adopt rules requiring "that any public disclosure or release of non-GAAP financial measures by a company...be presented in a manner that"...

• Reconciles the non-GAAP financial measure presented with the financial condition and results of operations of the registrant under GAAP.

The FAPC believes that the intent of the Sarbanes-Oxley Act is to require that any disclosure of non-GAAP financial measures be accompanied simultaneously by a reconciliation to the related GAAP measure of financial condition or results of operations. Consequently, the FAPC believes that the reconciliations and related disclosures should be provided at the same time as the non-GAAP disclosures are disseminated. In addition, we believe that both the non-GAAP disclosures and reconciliations should be filed immediately with the SEC so that they will become available to all investors, not merely those present for the disclosures.

Question: 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 concur that any departures from GAAP disclosure, regardless of the nature of the disclosure, should be accompanied by more detailed disclosure. By their nature, non-GAAP disclosures are less transparent, consistent, and comparable, and require more detailed information to enable investors and other users to overcome the impediment. Consequently, in those circumstances in which documents containing the non-GAAP financial measures are not filed with the Commission, we agree that the reconciliation of those non-GAAP measures to their GAAP counterparts should be required.

Question: 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?

The FAPC believes that only GAAP measures, for example, GAAP net income, or gain or loss from discontinued operations, should be disclosed as per share amounts. Other performance and risk indicators similarly should be based upon all-inclusive GAAP measures rather than selective subsets of the information that may be misleading.

Question: Will proposed Regulation G limit the use of non-GAAP financial measures? Please explain.

The FAPC has no views on this issue.

Question: 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?

Question: 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?

The intent, as we understand it, of Regulation G is to provide investors and other users of financial information with full, complete, consistent and comparable financial disclosure. The FAPC does not agree that exceptions from proposed Regulation G for different classes of issuers would best serve this objective and the needs of users. To the contrary, we believe that all issuers should provide the same consistent and comparable information. The decision regarding the requirements for differing classes of issuers should be driven by the importance of information to the efficient functioning of financial markets rather than the desires of the issuers to provide the information and their behavior in response to full disclosure requirements.

Question: 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,³⁸ 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?
 

As we have stated, we believe that no exceptions to the proposed Regulation G should be permitted. Communications regarding potential benefits to be gained from mergers and acquisitions are considered by investors in weighing their investment decisions and shareholder ballots. Thus, it is all the more important that the full disclosure provisions of Regulation G apply to these communications. The FAPC has long held that disclosure of important assumptions is critical to proper evaluation of financial information, including forecasts and projections.

Question: 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?

The FAPC believes strongly that the Commission should enforce Regulation G. However, to the extent that investors and other users may be harmed by a company's noncompliance with the provisions, these users should have access to other redress of damages under the Regulation.
 

Question: 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 believe, subject to our specific comments and recommendations above, that Regulation G will enhance and improve the interests of investors and other users of financial information and help to protect them from misleading and manipulative disclosure practices, consistent with the intent of the Sarbanes-Oxley Act.

Proposed Amendments to Item 10 of Regulation S-K, Item 10 of Regulation S-B
And Form 20-F

General Comments

The Proposed Amendments require companies to provide:

• A presentation, with equal or greater prominence, of the most directly comparable financial measure calculated and presented in accordance with GAAP;

• A quantitative reconciliation (by schedule or other clearly understandable method) of the differences between the non-GAAP financial measure disclosed with the most directly comparable measure or measures calculated and presented in accordance with GAAP;

• A statement disclosing the purposes for which the registrant's management uses the non-GAAP financial measure presented; and

• A statement describing the reasons why the registrant's management believes such non-GAAP financial measures provide useful information to investors.

In addition, the Proposed Amendments would prohibit companies from:

• Presenting a non-GAAP financial measure in a manner that would give it greater authority or prominence than the comparable GAAP financial measure or measures;

• Excluding charges or liabilities that required, or will require, cash settlement, or would have required cash settlement absent an ability to settle in another manner, from non-GAAP liquidity measures;

• 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;

• Presenting non-GAAP financial measures on the face of the registrant's financial statements prepared in accordance with GAAP or in the accompanying notes;

• Presenting non-GAAP financial measures on the face of any pro forma financial information required to be disclosed by Article 11 of Regulation S-X;

• Using titles or descriptions of non-GAAP financial measures that are the same as, or confusingly similar to, titles or descriptions used for GAAP financial measures; and

• Presenting a non-GAAP per-share measure.

The FAPC strongly supports the inclusion of these additional amendments. We believe that these requirements and prohibitions will make clear the intent of the new regulations and will help to prevent further dissemination of misleading information.

Question: Are the proposed additional disclosures required in filings necessary in light of proposed Regulation G?

The FAPC believes that these amendments provide important clarity and definition to the principles presented in the Proposal.  

Question: 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?

As stated in the first section above, the FAPC fully concurs with this prohibition. We believe it important that non-GAAP measures that can prove materially misleading to investors and other users of the statements not be included, even with reconciliations to the GAAP measures.

Question: Should the non-GAAP financial measures be presented in a separate section of a Commission filing?
 

The FAPC believes that non-GAAP measures should be sequestered in a separate section of Commission filings, along with labels indicating clearly that the measures are not prepared in accordance with GAAP. These precautions will help to serve warning to users of the filings that the measures should be reviewed and incorporated into financial decisions only with extreme caution. Moreover, this treatment will make clear that these measures should not be regarded as economically reliable substitutes for GAAP measures.

Question: 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 that the two, that is, Commission filings and disclosures under Regulation G, should be completely consistent with the same requirements and prohibitions.

Question: 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?

As we stated above, we do not agree that an exception should be allowed for those circumstances "where the necessary information cannot be obtained without unreasonable effort". Such exceptions only invite gaming of the regulations and could well nullify their intent and effect. We prefer that such disclosures not be made at all rather than to permit a weakening of the provisions.

Question: Are there additional disclosures that should be required in filings? If so, what disclosure items would be beneficial to investors?

The FAPC would reiterate its position stated above that the disclosures should include statements about the way the non-GAAP measures are used in specific business or investment decisions made by management and should state the reasons why management believes these measures provide important economic information to investors and other users. That is, the economic basis for providing non-GAAP measures should be provided for each such measure disclosed.

Question: Consistent with current staff policy, our proposals would prohibit specified types of disclosures. Is such a prohibition necessary and appropriate?

We believe that these prohibitions are important clarifications for both preparers and users of the financial statements and related disclosures. Among other principles, they make clear that non-GAAP measures may not be substituted or promoted instead of the GAAP measures.

Question: Should the proposed requirements apply to foreign private issuers' reports on Form 20-F?

The FAPC agrees that the requirements should apply to all issuers who seek to raise capital in the U.S. markets although there may be implementation issues in some cases.

Question: Should the proposed requirements apply to filings by Canadian issuers under the MJDS on Form 40-F?

See our comment immediately above.

Question: 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.⁴¹ 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.)?
 

We believe that no exceptions should be made to the scope of these regulations, as we have stated repeatedly. The FAPC believes that disclosure of all important assumptions underlying projected benefits and synergies should be made, consistent with our long-held position that all major assumptions underlying measures and models should be prominently disclosed so that users may better evaluate the quality and risks inherent in the measures.

Question: 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 companies should be required to provide consistent non-GAAP measures and reconciliations from period to period. If a company has determined that a non-GAAP measure previously used is no longer relevant, is no longer used by the company's management for the purpose previously identified, and no longer provides useful information to investors, it should be required to explain the basis for this determination. Since we have earlier recommended that management be required to disclose how these measures are used in specific operating and investing decisions, when a non-GAAP measure ceases to be used for the purpose identified, investors should be informed of the measures that are or will be used in its place.

Proposed New Item 1.04 of Form 8-K

This amendment would require registrants to "file a Form 8-K within two business days of any public announcement or release disclosing material non-public information regarding a registrant's results of operations or financial condition for an annual or quarterly fiscal period that has ended."

In addition, "if non-public information is disclosed orally, telephonically, by webcast, broadcast, or similar means, Item 1.04 would not require the registrant to file a Form 8-K if:

• The disclosure initially occurs within 48 hours of a written release or announcement filed on Form 8-K pursuant to Item 1.04;

• The presentation is accessible to the public by dial-in conference call, webcast or similar technology;

• The financial and statistical information contained in the presentation is provided on the registrant's website, together with any information that would be required under proposed Regulation G; and

• The presentation was announced by a widely disseminated press release that included instructions as to when and how to access the presentation and the location on the registrant's website where the information would be available."

General Comments

The FAPC has serious concerns and reservations about these provisions. We believe that the requirement that a Form 8-K be "filed within two business days of any public announcement or release disclosing material non-public information" may ill serve the interests of the vast majority of investors and other users of financial information. As recent Commission enforcement actions in connection with Regulation FD disclosures have clearly demonstrated, significant trading resulting in major price movements typically occurs well within 24 or 48 hours of the release of price-sensitive information. That is to say, those investors with privileged access to the information may materially benefit to the exclusion of investors who do not have such access. Indeed, much research indicates that the majority of price movements in response to information will occur within that two-day window. Thus, we believe that the Commission should reconsider how best to protect those investors who may lack privileged access to information.

With regard to dial-in conference calls, webcasts, and other similar technology, this rule does not make clear what is meant by the term "accessible". For example, there is no indication of whether all interested investors would need to be accommodated by the technology or whether a handful or even one or two would suffice. For example, the number of access lines could well be restricted by the company, again making access effectively available only to privileged investors.

Please see our comments above regarding use of companies' websites for dissemination of material price-sensitive information.

The proposed regulation does not make clear what would constitute a "widely disseminated press release". The FAPC observes that requirements to serve legal notification are sometimes met by publication in obscure print media. We doubt that this is the intent of the Commission, however, it is not clear what media would serve to fulfill the requirements nor is it clear which would best serve the needs of investors without privileged access to information.

Concluding Remarks

The Financial Accounting Policy Committee appreciates the opportunity to express its views on the Commission's Proposed Rule: Conditions for Use of Non-GAAP Financial Measures. If the Commission or staff have questions or seek amplification of our views, please contact Rebecca McEnally at 1-434-951-5319 or at rebecca.mcenally@aimr.org. We would be pleased to answer any questions or provide additional information you might request.

Respectfully yours,

/s/ Jane Adams __________________________ Jane Adams Chair, Financial Accounting Policy Committee

/s/ Rebecca Todd McEnally __________________________ Rebecca McEnally, Ph.D., CFA Vice-President, Advocacy, AIMR

cc: AIMR Advocacy Distribution List
Patricia Doran Walters, Senior Vice-President
Professional Standards & Advocacy

____________________________

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With headquarters in Charlottesville, VA, and regional offices in Hong Kong and London, the Association for Investment Management and Research® is a non-profit professional organization of 61,000 financial analysts, portfolio managers, and other investment professionals in 113 countries of which 48,800 are holders of the Chartered Financial Analyst® (CFA®) designation. AIMR's membership also includes 118 affiliated societies and chapters in 29 countries. AIMR is internationally renowned for its rigorous CFA curriculum and examination program, which had more than 100,000 candidates from 143 nations enrolled for the June 2002 exam.