May 23, 2002

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

Dear Mr. Katz:

We are pleased to submit this letter in response to the Commission's request for comments on its proposal to accelerate the filing by certain public companies of annual reports on Form 10-K and quarterly reports on Form 10-Q and to require these companies to disclose in their annual reports information regarding website access to their reports, as contained in Release No. 34-45471 (the "Release").

Summary

We appreciate that investors want timely disclosure of quarterly and annual financial information and recognize that the Commission is attempting to accelerate the reporting of such information without placing undue burdens on issuers or risking a diminution in the quality of the information contained in quarterly reports on Form 10-Q and annual reports on Form 10-K. However, as more fully explained below, we respectfully suggest that before changing the deadlines the Commission should conduct empirical research to determine whether the processes used to prepare periodic reports are reasonably susceptible to across-the-board acceleration, even among the largest public companies, and, if so, to what degree. Since reporting companies are the best source of this information, we suggest that the Commission request its Office of Economic Analysis to develop a questionnaire for registrants that specifically asks about the audit and other processes needed to prepare these reports. We also offer specific comments on one aspect of the proposed website access disclosure rules.

Acceleration of Deadlines

Empirical Study Is Needed. The Release makes clear that that the Commission's accelerated filing proposal is based, in large part, upon a desire to narrow the gap between the time when earnings are announced and the time when reports for the corresponding period are filed with the Commission. The proposal assumes that issuers will be able to meet the proposed 60-day and 30-day deadlines because, on average over the last 10 years, companies have announced year-end earnings approximately 43 days after the fiscal year end and quarterly earnings approximately 27 days after the quarter end, and the Commission believes that audits and reviews of financial statements are substantially complete by the time companies issue earnings announcements. The Release also cites a survey earlier this year by the National Investor Relations Institute ("NIRI") which indicated that 40% of its members believed that they would be able to meet the proposed 10-K deadline and that 46% believed that they would be able to meet the proposed 10-Q deadline. Only a small sampling of reporting companies (406) responded to this survey, but the survey nevertheless indicates that a majority of these companies do expect to have difficulty meeting the proposed new deadlines.¹

The Release cites no evidence to support the Commission's apparent belief that audits and reviews of financial statements are substantially complete by the time companies issue earnings announcements. Likewise, there is little discussion of the procedures that occur after audit and review work is complete, such as Audit Committee review and preparation of footnotes, Management's Discussion and Analysis of Financial Condition and Results of Operations (MD&A) and other narrative disclosures. Based upon our experience and discussions with clients, we are concerned that this belief may not be correct. Indeed, many of our clients who have discussed the Release with us are concerned that they would be unable to meet the new reporting deadlines with confidence.

Sufficiently compressing the many steps involved in preparing the periodic reports after earnings are announced may not be possible for many issuers. Audit reports often are dated after earnings announcements by several weeks or more.² Even when audit field work is substantially complete at the time earnings are announced, we believe that the full financial statements, particularly the cash flow statements and full footnotes that must be included in the issuer's report, will not generally have been prepared and often are not available until at least a week after earnings are announced. MD&A and other narrative disclosures that must appear in the 10-K or 10-Q report rely, in part, on these materials and thus typically follow the preparation of those items. Meaningful Audit Committee review can only occur after the full financial statements, including footnotes, have been prepared. MD&A also needs to be approved by the Audit Committee for many companies. Moreover, good corporate governance and disclosure procedures will require adequate time to review these disclosures internally and with outside counsel before they are released to the public.

Since the existing deadlines were established, both the Commission and accounting standard-setters like the Financial Accounting Standards Board have added many disclosure requirements to Form 10-K and Form 10-Q. These include quarterly segment disclosures, annual derivatives and market risk disclosures and the recently required periodic impairment testing for goodwill. In addition to the existing disclosure requirements, the Commission has proposed and promised to propose in the coming months new accounting and disclosure requirements, such as the recent proposal relating to critical accounting policies. Thus, registrants will be required to report even more information than before. The Release does not take into account the impact of these initiatives and the need for registrants to prepare to respond to them.

We recommend that the Commission request its Office of Economic Analysis to develop a questionnaire for registrants that specifically asks about the audit process and the critical milestones in the process of writing 10-Q quarterly reports and 10-K annual reports. We suggest that this questionnaire should inquire about the state of audit or review work at the time earnings are released, the timing and content of auditor review and sign-off on the audit report, the registrant's Audit Committee review of financial statements and discussions with management and independent auditors, the drafting of footnote disclosures, MD&A and other narrative disclosures and any other steps in preparing periodic reports that the registrant believes to be important. We suggest that this questionnaire be sent to all U.S. reporting companies. Alternatively, the questionnaire could be sent to a statistical sampling of U.S. reporting companies, but the sample should be broad enough to capture small, middle and large size companies across a range of industries. This approach would serve the dual purpose of gathering empirical information regarding the audit and reporting processes and alerting registrants that the accelerated filing proposal especially warrants their attention and direct comment.

Changes Should Be Voluntary. In order to encourage issuers to file their 10-K and 10-Q reports as soon as they reasonably can, we suggest that the Commission institute a voluntary "best practices" program instead of immediately changing the mandatory deadlines. As part of this program, the Commission could amend the cover pages of Forms 10-K and 10-Q to provide boxes that an issuer could check if it was filing 15, 10 or 5 days (for 10-Qs) or 30, 20 or 10 days (for 10-Ks) early. Such a box would make early filing easier to track for the Commission as well as for the public and business news services. This would be beneficial in two ways. The Commission would easily be able to incorporate valuable information about early filing and the magnitude of acceleration that early filers are comfortable with into any empirical study that it undertakes. Moreover, favorable publicity about early filing or negative publicity with regard to those not filing early could motivate those issuers to file early who can do so without jeopardizing the quality of their reports.

A Bifurcated Approach Could Be Instituted. If the Commission wishes to mandate some earlier filing, an alternative to the proposed across-the-board changes could be to bifurcate the deadlines for portions of the Form 10-K, and possibly also the Form 10-Q. Those portions more susceptible to early filing could be subject to an accelerated deadline, whereas those portions that are more difficult for issuers to finalize would remain subject to existing deadlines. Although it is difficult to distinguish between those disclosures that would be appropriate for accelerated filing and those that would not be, it might be possible to require issuers to file the income statement and the balance sheet in the Form 10-K within 60 days and to allow the existing deadlines to continue for other portions, such as the full text of the footnotes, cash flow and surplus statements, segment, derivative and market risk disclosures and MD&A. The Commission should seek further input from issuers, perhaps as part of the empirical study discussed above, regarding the matters potentially appropriate for mandatory early filing without sacrificing quality.

Required Changes Should Initially Be More Modest. If the Commission decides not to defer deadline acceleration pending the results of an empirical study, and does not wish to take a bifurcated approach, we suggest that the Commission accelerate the filing deadlines more modestly than it initially proposed. We would recommend that the Commission initially adopt a 40-day deadline for the quarterly report on Form 10-Q and an 80-day deadline for the annual report on Form 10-K.³ These periods would still provide more prompt disclosure to investors and the market but with less risk that the quality of information disclosed in periodic reports would be diminished or that issuers would be unable to file on time and thus become subject to consequent penalties, such as loss of Form S-3 eligibility for 12 months. The Commission could revise these periods in future rulemaking if the results of the empirical study recommended above indicate that they could be further shortened.

Based on our discussions with issuers, we believe that the Commission's proposed 15-day shortening of the Form 10-Q deadline is more problematic than the proposed 30-day shortening of the 10-K deadline. We surmise that the process is such that for 10-Q reporting there is a basic minimum number of steps that just cannot be compressed into 30 days for many issuers.

Phase-In Should Be More Gradual. If the Commission adopts the accelerated deadlines as proposed, we would suggest that the effectiveness of new deadlines should be phased in over a longer period in order to enable registrants to develop procedures necessary to comply with the much shorter deadlines while at the same time assimilating any new disclosure requirements that the Commission may adopt over the next year. In the interim, earlier filing should be urged only as a best practice. Alternatively, if the Commission adopts the rules as proposed and makes them effective as indicated in the Release, the rules should provide that late-filing will not affect the availability of short-form registration, the availability of Rule 144 for resales of restricted and control securities and the availability of Form S-8 for resales of employee benefit plan securities, so long as the report is filed within the current 90-day and 45-day deadlines.

Finally, in order to address the Commission's concern that companies make more complete information available to the market at the time that they announce their earnings, the Commission might also consider requiring earnings releases be accompanied by a U.S. GAAP condensed income statement, as in the proposal in the 1998 "Aircraft Carrier" release.

Inclusion or Incorporation of Website Information

In a footnote, the Release indicates that an accelerated filer's inclusion of its website address in its Form 10-K annual report as required by the proposed new rules would not, by itself, include or incorporate all information available at that site into the Form 10-K "unless the company otherwise acts to incorporate the information by reference." The Release then explains that the Commission "would not consider the presence of the Internet address to make the company's website part of the company's filing if the company takes reasonable steps to ensure that the address is inactive (for example, by removing 'a>href' tagging) and includes a statement to denote that the address is an inactive textual reference only."

We believe that these positions are somewhat inconsistent, in that the first sentence of the footnote indicates that the company would have to take active steps to incorporate website information by reference if it wishes to do so, while the second indicates that the company must take active steps to disavow inclusion or incorporation (including a statement denoting that the address is an inactive textual reference). In any event, this may be a trap for the unwary. We recognize that the Release more or less restates the language set forth in the Commission's interpretive release on the Use of Electronic Media, Release No. 33-7856 (April 28, 2000). However, in this context, where the rule would require accelerated filers to disclose their website address as part of a larger disclosure regarding electronic availability of Exchange Act reports and whether such reports are maintained on the company's website, we believe that it is clear that the company's website address would not be provided in order to include or incorporate the information contained on that website into the report, and the Commission should adopt a presumption that such website information is not incorporated by reference into the Form 10-K annual report by a mere statement of the company's website address, even if the hyperlink is active, unless the company specifically incorporates such information.

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We appreciate this opportunity to comment on the Commission's proposal to accelerate periodic report filing dates and to require disclosure concerning website access to periodic and current reports, and would be happy to discuss any questions the Commission may have with respect to this letter. Any such questions may be directed to John T. Bostelman (212-558-3840) or Richard R. Howe (212-558-3612) in our New York office or to Eric J. Kadel, Jr. (202-956-7640) in our Washington office.

Very truly yours,
 
 
SULLIVAN & CROMWELL