December 13, 2002 Mr. Jonathan G. Katz
RE: S7-43-02 Dear Mr. Katz: The Securities and Exchange Commission ("SEC") has requested comment on new rules and amendments to address public companies' use of financial information that is based on methodologies other than Generally Accepted Accounting Principles (GAAP). This letter provides the Federal Reserve Bank of Atlanta's comments regarding the SEC's proposed rules. Requests for Comments on Proposed Regulation G
Yes, in the interests of regulatory parity and providing equivalent financial information to investors across companies, Regulation G should apply to all registered companies that publicly disclose non-GAAP financial measures. Requiring reconciliation to the most directly comparable GAAP financial measure rather than to specific GAAP financial measures in all cases is more appropriate. This is because reconciliation to the most directly comparable GAAP measure incorporates regulatory flexibility to address non-GAAP financials measures that may be introduced in the future. No, step-by-step reconciliation to the most directly comparable GAAP financial measure for each non-GAAP financial measure is adequate. If a company chooses to present a net income, assets, net cash flow, balance sheet, or cash flow statement on a non-GAAP basis, however, then reconciliation to the specific GAAP versions would be appropriate. No. If necessary information cannot be obtained, the issuer should not present the financial measures. Alternately, the issuer could use estimates for the difficult-to-obtain information, with a full explanation of how the estimates were derived. No. The accuracy and reliability of forward-looking financial measures are more important to investors' decisions. Pro forma presentation of such forward-looking measures should be reconciled to GAAP to allow investors to compare across countries and over time. Regulation G and the proposed definition for non-GAAP financial measure should apply to disclosures of material information including any financial measure calculated and presented other than in accordance with GAAP. We believe the definition should be broader, so that Regulation G would apply, for example, to non-GAAP operating, statistical, or financial measures whenever there is a GAAP equivalent or near equivalent. No. It is not uncommon for investment decisions to be based, at least in part, on information provided orally in corporate conference calls. Excluding oral communications would be inconsistent with the general intent of the Sarbanes-Oxley Act to improve comparability and transparency. Further, such exclusion would diminish the effectiveness of Regulation G in particular in providing investors with reconciliations of GAAP and non-GAAP measures. There is a risk of investor confusion with regard to whether GAAP/non-GAAP reconciliations have been reviewed by independent audit. Requiring companies to disclose whether their independent accountants have reviewed or audited the reconciliation is necessary to reduce the possibility of confusion. Yes, all communications subject to Regulation G should require a discussion of the purposes for which the company's management uses the non-GAAP measure. All communications about a company's financial performance are used, to varying degrees, in the investment decision-making process. Requiring such discussion would assist investors in evaluating and appropriately weighing a company's GAAP and non-GAAP financial measures in those decisions. At a minimum, companies should be required to file the information necessary to satisfy Regulation G with the Commission since filings are superior for purposes of creating and preserving a public record. Companies also should be able to post such information to their website. If companies are permitted to use their websites in lieu of Commission filings to satisfy disclosure requirements, then those companies should be required to have technology that allows investors to be notified electronically when new information is posted to the website. We do not believe that all of the additional disclosures are necessary for non-GAAP measures used outside of Commission filings. We do, however, believe that some of the proposed additional requirements for Commission filings are appropriate for all uses of non-GAAP financial measures, with slight modifications. Those requirements and prohibitions are as follows (with recommended changes italicized): As an example of non-recurring or extraordinary items that should be covered by the prohibition on eliminating or smoothing such items, consider the case of a company that is an active acquirer of other firms. In our opinion, an active acquirer is likely to have merger-related charges on a recurring basis (i.e., in some companies mergers & acquisitions are essentially a "line of business"). In such cases, a company should not eliminate merger-related charges when presenting GAAP or non-GAAP financial measures. Additionally, unfunded pension liabilities are a good example of an item that should be included in the prohibition on excluding charges or liabilities that will require cash settlement. Current estimates of unfunded pension liabilities exceed $111 billion. These significant additional liabilities should be disclosed to the investing public. No. Regulation G will not necessarily limit the use of non-GAAP financial measures. There will remain legitimate instances in which companies do not feel that GAAP measures accurately reflect the company's true financial condition or economic performance. In those cases, companies will continue to use non-GAAP measures if they believe such measures provide better information to the marketplace. Regulation G will, necessarily, require companies to present GAAP equivalents of non-GAAP measures and to explain the reasoning behind the use of non-GAAP measures. These requirements may reduce the use of non-GAAP financial measures by companies that are unable or unwilling to provide the required reconciliations and explanations, but it is not clear that such a reduction would be either widespread or undesirable. The limited exception for Regulation G for foreign private issuers strikes an appropriate balance between providing useful information to investors, providing regulatory parity, considering the needs of foreign private issuers to communicate with their home markets, and avoiding undue extra-territorial extension of Commission regulations. Broadening the exception would deprive U.S. investors of useful information regarding foreign private issuers. As stated above, we believe that the limited exception is appropriate. Applying certain Commission rules and regulations to foreign private issuers prevents such issuers from gaining an unfair advantage over U.S. companies by having more lenient filing requirements. Another reason to apply Commission rules and regulations to foreign private issuers is to provide U.S. investors with information necessary to make investment decisions about foreign securities traded on domestic exchanges. In general, foreign registrants should conform to the same filing requirements and GAAP standards as U.S. registrants for securities traded in the U.S. This ensures that U.S. investors have a consistent, albeit imperfect, standard (GAAP) to use in evaluating filings from all companies traded on the domestic exchanges regardless of where they are domiciled. It is not clear whether eliminating the limited exception would result in foreign private issuers de-registering and exiting the U.S. capital markets. The U.S. markets remain the most liquid and the most trusted relative to alternative exchanges, and it is likely that many foreign issuers would seek compliance with Regulation G in order to maintain access to the capital and liquidity of the U.S. markets. Regulation G should apply to business combination communications, including post-transaction measures, because investors rely on those communications to make investment decisions. Furthermore, the rules should also require disclosure of the assumptions or bases underlying any potential benefits to be obtained by the business combination, including, but not limited to, the examples given above. No, we do not believe that Congress intended a private right of enforcement action in the Sarbanes-Oxley Act, because the Act only provides for criminal fines and penalties whereas other securities laws expressly provide a private right of action. However, whether or not the Commission decides to incorporate a private right of action in Regulation G, the regulation's language should explicitly state the possible means of enforcement. Yes, we believe that the proposed regulation, subject to the changes recommended herein, meets the goals of Section 401(b) of the Sarbanes-Oxley Act in an appropriate manner. In our opinion, Congress intended, through Section 401(b), to require companies to present financial statements and measures in a fashion that promotes comparability across companies. The proposed Regulation G does so, while still permitting companies the flexibility to introduce alternate financial measures if those measures are reconciled to GAAP accounting measures. Requests for Comments on Proposed Amendments to Item 10 of Regulation S-K, Item 10 of Regulation S-B and Form 20-F
Much of the coverage of the proposed amendments to Item 10 of Regulation S-K, Item 10 of Regulation S-B, and Form 20-F is duplicative of the proposed Regulation G. However, if the Commission wishes to incorporate the more extensive and detailed disclosures and prohibitions not required by Regulation G, then the proposed amendments to Regulations S-K and S-B and Form 20-F are necessary. Alternately, we recommend that Regulation G require management discussion and analysis of the additional information provided by the non-GAAP measures and the ways in which the company uses the non-GAAP measures. It would suffice to reconcile both the numerator and denominator of the non-GAAP per-share measure with comparable GAAP measures. Requiring such reconcilement would meet the legislative goals of Section 401(b) while still permitting corporate flexibility in reporting. We further believe that per-share disclosure is, in many cases, more useful to investors than other disclosures, and so request that the Commission reconsider the prohibition contained in Financial Reporting Codification Section 202.04 on reporting per-share non-GAAP financial measures in Commission filings. No. It would be more useful to investors to present non-GAAP financial measures with the associated GAAP financial measures, the reconciliation, and the required disclosures. Further, incorporating the non-GAAP financial measures into the relevant section of the filings may help investors assess the use of and reason for the non-GAAP measures by the registrant. We do not object to the different requirements for Regulation G disclosures and Regulation S-K and S-B filings. A clear reconciliation of the two measures, combined with a discussion and disclosure from management, provide investors with adequate information for corporate communications that are not Commission filings. For this reason, we propose incorporating the management discussion and disclosure requirements of Item 10 into Regulation G. As discussed earlier, we believe the exception should not apply to Regulation G. Likewise, it should not extend to the proposed amendments to Regulations S-K and S-B and Form 20-F. If necessary information cannot be obtained, the issuer can not accurately present the financial measures. Alternately, if the issuer uses estimates for the difficult-to-obtain information, a full explanation of how the estimates were derived is necessary. Not all of the prohibitions are necessary. In general, reconciliation eliminates the need for most of the prohibitions. However, three of the prohibitions (listed below) would decrease the likelihood of confusing the investor and should be included. The prohibitions are: Requests for Comments on Proposed New Item 1.04 of Form 8-K
It is not clear that Item 1.04 is necessary, given the filing and disclosure requirements of Regulation FD and proposed Regulation G, except to the extent that the Commission proposes to apply the more stringent disclosure requirements and prohibitions in the proposed amendments to Regulations S-K and S-B and Form 20-F to Item 1.04 of Form 8-K. Yes. If Item 1.04 is adopted, incorporating a definition of "public disclosure" would provide more regulatory certainty and clarity. If proposed Item 1.04 is adopted, the scope should be expanded to require the filing of all material updates to estimates for current or future fiscal periods. If the scope of 1.04 is expanded to require the filing of all material updates to estimates for current or future fiscal periods, it is unlikely that proposed Item 1.04 will 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. Even absent an expanded scope of proposed Item 1.04, companies will still have incentives in the form of market discipline to make public announcements or releases of material non-public information regarding completed fiscal periods. Companies should be required to file the information necessary to satisfy these requirements directly with the Commission, although the companies should be free to post such information to their website as well. As we noted previously, if companies are permitted to use their websites for disclosures, those companies should be required to have technology that allows investors to be notified electronically when new information is posted to the website. We believe Commission filings are preferable, however, to create and preserve a consistent and complete public record. Commission filings also provide investors with the benefit of a single location for information regarding multiple public companies. No, it appears the timing requirement in Regulation G would cover the timing needs of Item 1.04. However, a consistent timing requirement in Item 1.04 should not create any difficulties. Yes. Forward-looking information is at least as important to investors as historical information for the purposes of investment decisions. Forward-looking information included in Commission filings should be considered filed for the purposes of Section 18 of the Exchange Act and should be subject to the same regulations as other filings. It is possible that the application of Item 1.04 only to disclosures regarding completed periods would cause public companies to increase their disclosure of intra-period information in an effort to avoid the requirements of Item 1.04. This is one reason we support the extension of the scope of Item 1.04 to intra-period information. The Federal Reserve Bank of Atlanta commends the Commission's efforts to restore public trust and confidence in the U.S. financial markets. Requiring registrants to reconcile non-GAAP financial measures to GAAP and provide a discussion of their use of such measures is an important step toward improving market transparency. We hope these comments are helpful to you in that effort.
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