[Federal Register Volume 63, Number 149 (Tuesday, August 4, 1998)]
[Rules and Regulations]
[Pages 41394-41404]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 98-20749]
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SECURITIES AND EXCHANGE COMMISSION
17 CFR Parts 231, 241, 271, 276
[Release Nos. 33-7558; 34-40277; IA-1738; IC-23366; International
Series Release No. 1149]
Statement of the Commission Regarding Disclosure of Year 2000
Issues and Consequences by Public Companies, Investment Advisers,
Investment Companies, and Municipal Securities Issuers
AGENCY: Securities and Exchange Commission.
ACTION: Interpretation.
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SUMMARY: The Securities and Exchange Commission (``we'' or ``the
Commission'') is publishing guidance for public companies, investment
advisers, investment companies, and municipal securities issuers
regarding their disclosure obligations about Year 2000 issues. This
release provides guidance to public companies so they can determine
whether their Year 2000 issues are known material events, trends, or
uncertainties that should be disclosed in the Management's Discussion
and Analysis of Financial Condition and Results of Operations
(``MD&A'') section of their disclosure documents. This release also
sets forth our guidance regarding specific matters for companies to
address in their MD&A Year 2000 disclosure. In addition, we address the
need for companies to consider the Year 2000 issue in connection with
other rules and regulations and when they prepare financial statements.
Finally, we remind municipal securities issuers, as well as public
companies, investment advisers, and investment companies, that the
anti-fraud provisions of the federal securities laws apply to
disclosure about the Year 2000 issue. This guidance supersedes the
current staff guidance in revised Staff Legal Bulletin No. 5 (``Staff
Legal Bulletin'').
EFFECTIVE DATE: August 4, 1998. For information regarding the first
periodic reports filed by public companies that should follow this
release's guidance, see Section I.A.
FOR FURTHER INFORMATION CONTACT: Broc Romanek or Joseph Babits, Office
of Chief Counsel, Division of Corporation Finance at 202-942-2900 (with
respect to public companies), Anthony Vertuno, Division of Investment
Management, at 202-942-0591 (with respect to investment companies);
Arthur Laby, Division of Investment Management, at 202-942-0716 (with
respect to investment advisers), and Mary Simpkins, Office of Municipal
Securities, at 202-942-7300 (with respect to municipal securities).
SUPPLEMENTARY INFORMATION:
I. Executive Summary
The ``Year 2000 problem'' arose because many existing computer
programs use only the last two digits to refer to a year. Therefore,
these computer programs do not properly recognize a year that begins
with ``20'' instead of the familiar ``19.'' If not corrected, many
computer applications could fail or create erroneous results. The
extent of the potential impact of the Year 2000 problem is not yet
known,
[[Page 41395]]
and if not timely corrected, it could affect the global economy.
A. Public Companies \1\
Congress enacted the Securities Act of 1933 and the Securities
Exchange Act of 1934 to provide for full and fair disclosure to
investors.\2\ Our disclosure framework requires companies to disclose
material information that enables investors to make informed investment
decisions. For public companies, our authority basically is directed
towards eliciting disclosure.
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\1\ As used in this release, ``public companies'' generally
refers to corporate and similar issuers, rather than investment
companies and investment advisers, which are addressed separately.
\2\ The Securities Act of 1933 (``Securities Act'') can be found
at 15 U.S.C. 77a et seq. The Securities Exchange Act of 1934
(``Exchange Act'') can be found at 15 U.S.C. 78a et seq.
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Under this disclosure framework, all companies must provide
specific categories of information. Companies have the flexibility,
however, to tailor disclosure to their particular circumstances. In
almost every case, we rely on this general framework and rarely provide
specific guidance on any particular issue. Companies already disclose
in their MD&A their assessment of known trends, demands, commitments,
events or uncertainties that are likely to have a material impact.\3\
MD&A is designed to allow investors to see the company through the eyes
of management. Investors deserve no less with respect to management's
assessment of their company's Year 2000 problems. To help companies
with their disclosure obligations, we are providing specific guidance
on what public companies should consider when disclosing information
about their Year 2000 readiness.\4\
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\3\ Item 303 of Regulations S-K (17 CFR 229.303) and S-B (17 CFR
228.303). The interpretive guidance in this release applies equally
to companies that file forms under Regulation S-K and small
businesses that file forms under Regulation S-B. Foreign private
issuers should follow the guidance in this release, including MD&A
disclosure called for by Item 9 of Form 20-F (17 CFR 249.220f).
\4\ In 1988, we followed a similar approach when we specifically
addressed the disclosure issue of illegal or unethical activities
relating to government defense contract procurements. See Securities
Act Rel. No. 6791 (August 1, 1988), 53 FR 29226 (August 3, 1988).
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This follows similar actions taken by our staff. During the past
year, the staff of the Divisions of Corporation Finance and Investment
Management issued and then revised the Staff Legal Bulletin to provide
specific guidance regarding Year 2000 disclosure obligations.\5\ Both
of the Divisions created task forces to determine the effectiveness of
the guidance.
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\5\ The Staff Legal Bulletin was first issued on October 8, 1997
and revised on January 12, 1998.
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While the number of companies disclosing Year 2000 issues has
increased dramatically, the task force surveys show that many companies
are not providing the quality of disclosure that we believe investors
expect. In response to continuing concerns regarding this important
issue, we are providing more extensive guidance in this formal
Commission interpretive release. This release supersedes the revised
Staff Legal Bulletin.
Public companies should apply this interpretive guidance
immediately after August 4, 1998. Companies with June 30th or July 31st
fiscal year ends need to follow this guidance when they file their
annual reports. Companies with quarter ends after the effective date of
this release also need to follow this guidance.
We encourage companies with quarters that end on June 30th or July
31st to consider this guidance in their quarterly reports.
This release provides our guidance based on the current
requirements of the federal securities laws. It briefly addresses a
number of disclosure requirements, but focuses on MD&A. We address two
important issues under MD&A--whether companies are required to provide
Year 2000 disclosure and the type of Year 2000 disclosure that is
required. As discussed in Section III.A below, we believe a company
must provide Year 2000 disclosure if:
(1) Its assessment of its Year 2000 issues is not complete, or
(2) Management determines that the consequences of its Year 2000
issues would have a material effect on the company's business, results
of operations, or financial condition, without taking into account the
company's efforts to avoid those consequences.
We expect that for the vast majority of companies Year 2000 issues
are likely to be material, and therefore disclosure would be required.
When a company has a Year 2000 disclosure obligation, we believe that
full and fair disclosure includes:
(1) The company's state of readiness;
(2) The costs to address the company's Year 2000 issues;
(3) The risks of the company's Year 2000 issues; and
(4) The company's contingency plans.
Each company also must consider if its own Year 2000 circumstances
require MD&A disclosure of additional information. This release
provides suggestions to help companies meet their disclosure
obligations. In addition to MD&A, this release reminds companies that
Year 2000 disclosure may be required in their financial statements and
under other rules and regulations, as discussed in Sections III.B and C
below.
B. Investment Advisers and Investment Companies
Because of the key role that investment advisers and the investment
companies they manage play in the financial markets, we believe it is
important for us to monitor the progress of these entities in preparing
for the Year 2000, regardless of the materiality of any individual
entity's Year 2000 issues. We believe that the best approach to
monitoring the readiness of investment advisers and investment
companies is to require that registered investment advisers provide
detailed reports to us. In June 1998, we proposed a rule to implement
this approach, as discussed in Section III.D below. Under the proposal,
investment advisers would describe their Year 2000 preparedness, and
that of any investment companies that they advise, in publicly
available reports.
Investment advisers and investment companies that conclude that the
Year 2000 issue is material to their operating results and/or financial
condition would need not only to report to us but also to include
disclosure in their public filings. Investment advisers and investment
companies are reminded of their obligations under the anti-fraud
provisions of the federal securities laws. These entities should follow
the guidance provided in Section III.D.
C. Municipal Issuers
Municipal issuers also have disclosure obligations. Our regulatory
authority over disclosure by issuers of municipal securities is not as
broad as our authority over disclosure by public and investment
companies. Generally, municipal securities offerings are, by statute,
exempt from registration and municipal securities issuers are exempt
from the reporting provisions of the federal securities laws, including
line-item disclosure rules. Municipal securities issuers, and persons
participating in the preparation of municipal securities issuers'
disclosure, however, are subject to the anti-fraud provisions of the
federal securities laws.\6\
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\6\ Section 17(a) of the Securities Act, 15 U.S.C. 77q(a);
Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C.
78j(b); and Rule 10b-5 promulgated thereunder, 17 CFR 240.10b-5. See
Statement of the Commission Regarding Disclosure Obligations of
Municipal Securities Issuers and Others (``Municipal Securities
Interpretive Release''), Securities Act Rel. No. 7049 (March 9,
1994), 59 FR 12748 (March 17, 1994).
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[[Page 41396]]
Approximately 50,000 state and local governments have over $1.3
trillion in municipal securities outstanding.\7\ Municipal securities
issuers, like other organizations, have Year 2000 issues. Year 2000
problems may affect their operations, creditworthiness, and ability to
make timely payment on their indebtedness. We encourage municipal
securities issuers and persons who assist in preparing their disclosure
documents to consider whether Year 2000 issues may be material to
investors. If material, the disclosure documents used by municipal
issuers should contain a discussion of Year 2000 issues to avoid
misleading statements or omissions that could violate the anti-fraud
provisions. In Section III.E, we provide guidance to municipal issuers,
and persons assisting in the preparation of their disclosures,
regarding Year 2000 disclosure.
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\7\ SEC Staff Report on the Municipal Securities Market (The
Division of Market Regulation), September 1993, p. 1, The Bond Buyer
Securities Data Company 1998 Yearbook, 1998, p.64.
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II. Background
A. Significance of the Year 2000 Issue
As the end of this century nears, there is worldwide concern that
Year 2000 technology problems may wreak havoc on global economies. No
country, government, business, or person is immune from the potential
far-reaching effects of Year 2000 problems. President Clinton recently
stated that ``all told, the worldwide cost will run into the tens,
perhaps the hundreds of billions of dollars, and that's the cost of
fixing the problem, not the cost if something actually goes wrong.''
\8\ Some estimates that include not only software and hardware costs,
but also costs related to business interruptions, litigation, and
liability, run in the hundreds of billions of dollars.\9\
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\8\ Speech of July 14, 1998 to National Academy of Science.
\9\ See, e.g., ``Year 2000 Time Bomb,'' U.S. News & World
Report, June 8, 1998, page 45; ``Experts Say Bug Will Be Costly, So
Will The Cure,'' Chicago Tribune, March 2, 1998, page C1; and
``Debunking Year 2000's Computer Disaster,'' Los Angeles Times, Nov.
3, 1997, page A1.
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Only one thing is certain about the impact of the Year 2000--it is
difficult to predict with certainty what truly will happen after
December 31, 1999.\10\ To reduce the impact of this potentially
serious, widespread problem, many public officials and private
commentators have spoken out about the need to plan properly now.\11\
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\10\ Year 2000 problems have already occurred and will continue
to occur before the Year 2000. The Information Technology
Association of America recently conducted a survey showing that 44%
of responding companies have already experienced Year 2000
disruptions in their business. This survey can be found at <http://
www.itaa.org/softpr7.htm>.
\11\ The United Nations recently passed a resolution calling on
member states to cooperate on global awareness initiatives and
called upon the public and private sectors to share Year 2000
information. See U.N. Passes Year 2000 Appeal (June 26, 1998)
<www.news.com/News/Item/0,4,23624,00.html>. President Clinton has
formed the President's Council on the Year 2000 Conversion, and the
Senate has established the Senate Special Committee on the Year 2000
Technology Problem to focus and provide leadership to reduce the
impact of this issue. On July 14, 1998, the President held a press
conference to stress the importance of assessing and remedying the
Year 2000 problem and promised to send proposed legislation to
Congress addressing liability issues relevant to the Year 2000. The
President's Council's web site can be found at <http://www.y2k.gov>.
The Senate Special Committee Chairman, Senator Robert Bennett, has a
web site with materials relating to the committee at <http://
www.senate.gov/bennett/y2k.html>. In addition, in
November 1997, Senator Bennett introduced legislation, the Year 2000
Computer Remediation and Shareholder Protection Act of 1997 (S.
1518), which would require public companies to disclose their Year
2000 issues. Finally, Representatives Dreier and Cox recently
introduced legislation to encourage companies to fix their Year 2000
problems, the Y2K Liability and Antitrust Reform Act (H.R. 4240).
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We intend to intensify our efforts to elicit meaningful disclosure
from companies about their Year 2000 issues. Only through that
disclosure can investors make informed investment decisions. We believe
that companies have sufficient incentive to provide meaningful
disclosure to investors and meet their Year 2000 disclosure
obligations. These incentives include business reasons, investor
relations concerns, and possible referrals to our Division of
Enforcement.
B. Staff Efforts Regarding Year 2000 Disclosure: Divisions of
Corporation Finance and Investment Management
The Year 2000 issues faced by the securities industry and ourselves
are very serious. Every Division and Office within the Commission has
participated in special initiatives to promote Year 2000 readiness in
the securities industry, the capital markets, and their underlying
industries.\12\ Our staff has been providing reminders and guidance to
companies for over a year regarding their Year 2000 disclosure
obligations. To educate investors, the Office of Investor Education has
posted on our web site a series of questions that investors can
use.\13\
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\12\ In June of 1997 and 1998, the staff provided reports to
Congress on the Readiness of the Securities Industry and Public
Companies to Meet the Information Processing Challenges of the Year
2000 (``Staff Report to Congress on Year 2000''). Both of these
reports are on our web site at <http://www.sec.gov/news/studies/
yr2000.htm> for the 1997 report and <http://www.sec.gov/news/
studies/yr2000-2.htm> for the 1998 report.
\13\ These questions can be found at <http://www.sec.gov/
consumer/y2kaskit.htm>.
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In May 1997, the Division of Corporation Finance updated its
Current Issues and Rulemaking Projects outline to discuss the need for
public companies to disclose the effect of Year 2000 technology
problems.\14\ On October 8, 1997, the Divisions of Corporation Finance
and Investment Management issued a joint Staff Legal Bulletin reminding
entities with disclosure obligations that our rules and regulations
apply to Year 2000 issues, just like any other significant issue.\15\
On January 12, 1998, the Divisions revised the Staff Legal Bulletin to
provide more specific guidance under existing rules and
regulations.\16\
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\14\ The update described generally the nature of these issues
and the disclosures that public companies should make. The latest
Current Issues Outline can be found at <http://www.sec.gov/rules/
othern> and scroll to it.
\15\ The Staff Legal Bulletin contains the staff's specific
guidance on good disclosure practices in the Year 2000 context.
\16\ In the revised Staff Legal Bulletin, the staff's guidance
focused on MD&A, but also noted that other rules might require
disclosure. The staff stated that a company should disclose, at a
minimum: its plans to address the Year 2000 issues that affect its
business and operations, including operating systems; material
effects if its customers, suppliers, and other constituents are not
Year 2000 ready; its timetable for carrying out these plans; and, if
material, an estimate of the Year 2000 costs and any material impact
it expects these costs to have on its results of operations,
liquidity, and capital resources.
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After the Staff Legal Bulletin was revised, the Division of
Corporation Finance created a Year 2000 task force to determine how
many public companies are addressing the Year 2000 issue and to assess
whether the disclosure being provided is meaningful. The task force
found that only 10% of the annual reports filed by public companies
during the first four months of 1997 contain the phrase ``Year 2000.''
For the quarterly reports filed after the staff published the Staff
Legal Bulletin, this percentage increased to 25%. After the staff
revised the Staff Legal Bulletin in January 1998, 70% of the annual
reports contained the phrase ``Year 2000.''
To evaluate the quality of the Year 2000 disclosure, the task force
read the Year 2000 disclosure in the filings of 1,023 public companies
selected from 12 major industries, including 66 small business issuers.
The task force believed that this sampling of filings fairly
represented a cross-section of public companies. The task force also
surveyed the most recent annual or quarterly reports filed by the
Fortune 100
[[Page 41397]]
companies that file periodic reports with us.\17\
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\17\ Seven of the Fortune 100 companies are not required to file
periodic reports with us.
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Based on the specific guidance provided in the revised Staff Legal
Bulletin, the task force looked for eight categories of information.
The task force discovered that companies were providing a wide variety
of Year 2000 disclosures. While the number of companies disclosing Year
2000 issues has increased dramatically, the task force survey shows
that many companies are not providing the quality of detailed
disclosure that we believe that investors would expect.\18\
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\18\ The task force survey is on our web site <http://
www.sec.gov/news/extra/y2kcfty.htm>.
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In its review of Year 2000 disclosures made by investment
companies, the Division of Investment Management found that twenty-four
of the twenty-five largest investment company complexes have made Year
2000 disclosure to their fund shareholders. In addition, the Division
surveyed 740 registration statements of investment companies filed
since January 1, 1998, and found that 81% of these contained Year 2000
disclosure.\19\ Typically, investment companies' Year 2000 disclosure
was generic and included acknowledgment of the Year 2000 issue, that
the issues are being addressed and will be resolved, and that they
cannot guarantee that its remediation efforts will prevent all
consequences.
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\19\ The Division of Investment Management also reviewed the
disclosure of all of the public utility holding companies registered
with us under the Public Utility Holding Company Act of 1935. While
we regulate the corporate and financial structure of registered
public utility holding companies under that Act, these companies are
subject to the same disclosure obligations as other public
companies, including the MD&A requirement. The interpretive guidance
provided in this release is therefore specifically applicable to
public utility holding companies.
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The generic nature of an investment company's Year 2000 disclosure
may be related to its Year 2000 compliance reliance on entities whose
Year 2000 readiness efforts it does not control. Investment companies
rely heavily on external service providers (e.g., investment advisers,
transfer agents, brokers, and custodians) that may have represented to
the investment companies that they anticipate being Year 2000
compliant.
C. The Statutory Safe Harbors for Forward-Looking Information
We recognize that companies face difficult disclosure challenges
due to the forward-looking nature of Year 2000 issues. In drafting
disclosure documents, companies necessarily have to address
uncertainties and describe future events relating to their Year 2000
issues. To help companies in this task, we provide the following
interpretive guidance regarding the application of the two statutory
safe harbors for forward-looking information provided by the Private
Securities Litigation Reform Act of 1995.\20\
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\20\ There is a statutory safe harbor for both the Securities
Act and the Exchange Act. See Section 27A of the Securities Act (15
U.S.C. 77z-2) and Section 21E of the Exchange Act (15 U.S.C. 78u-5).
The statutory safe harbors have certain limitations. For example,
the safe harbors do not by their terms apply to lawsuits in state
court. We note, however, that pending legislation would address
class actions brought in state court. The Securities Litigation
Uniform Standards Act of 1998, S. 1260, and its companion bill, H.R.
1689, recently have been passed by Congress.
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The statutory safe harbors apply to forward-looking statements \21\
provided by eligible companies. \22\ Almost all of the required MD&A
disclosures concerning Year 2000 problems contain forward-looking
statements. For example, in our view, a projection of capital
expenditures or other financial items--such as the estimated costs of
remediation and testing--is a forward-looking statement because it
anticipates how remediation and testing will proceed in the future.
\23\
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\21\ ``Forward-looking statement'' is defined in Section 27A to
include: (A) a statement containing a projection of revenues,
income, earnings, capital expenditures, or other financial items;
(B) a statement of the plans and objectives of management for future
operations; (C) a statement of future economic performance; [and]
(D) any statement of the assumptions underlying or relating to any
statement described in subparagraph (A), (B), or (C).
In addition, Securities Act Rule 175 (17 CFR 230.175) and
Exchange Act Rule 3b-6 (17 CFR 240.3b-6) provide some protection for
similar ``forward-looking statements'' that may apply to companies
that are excluded from the statutory safe harbors.
\22\ The statutory safe harbors apply to disclosures made by: a
company; a person acting on behalf of the company; an outside
reviewer retained by the company making a statement on behalf of the
company; or an underwriter, with respect to information derived from
information provided by the company. See Securities Act Section
27A(a) and Exchange Act Section 21E(a). There are exclusions from
the statutory safe harbors for specific types of filings, and
companies need to review the safe harbors before relying on them.
For example, the safe harbors are not available to initial public
offerings or investment companies. See Securities Act Section 27A(b)
and Exchange Act Section 21E(b).
\23\ Statements included in a financial statement prepared in
accordance with generally accepted accounting principles are not
covered by the statutory safe harbors. See Securities Act Section
27A(b)(2)(A) (15 U.S.C. 77z-2(b)(2)(A)); Exchange Act Section
21E(b)(2)(A) (15 U.S.C. 78u-5(b)(2)(A)). Consequently, statements of
estimated costs included in MD&A disclosure outside the financial
statements would generally be covered. Inclusion of those costs in
the financial statements, or discussion of them in the footnotes to
the financial statements would be not be covered.
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A company's statement regarding the estimated future costs due to
business disruption caused by vendors, suppliers, customers, or even
the possible loss of electric power or phone service, typically would
be a statement of future economic performance, as well as a projection
of a financial item. Much of the description of a company's Year 2000
problems would be part of a forward-looking statement because the
statement contains assumptions concerning estimated costs or plans for
future operations. Contingency plans that assess which scenarios are
most likely (such an assessment is typically necessary in deciding
which scenarios to spend time and money preparing for) would be
forward-looking statements of plans and objectives of management for
future operations.
Some matters that are simply statements of historical fact are not
forward-looking. For example, historical costs are not forward-looking.
Similarly, whether a company has a contingency plan at all would be a
matter of fact. Whether a company actually has performed an assessment
would be a fact, as would its inventory of hardware, software, and
embedded chips. However, a description of the problems that the company
anticipates, which form the basis of its assessment, is sufficiently
forward-looking to constitute either a forward-looking statement or an
assumption relating to a forward-looking statement. Similarly,
statements identifying the remediation phase that a company currently
is in would be a matter of fact, but timetables for implementation of
future phases, including estimates of how long the internal and third-
party testing phases will take, would be forward-looking statements, at
least until the phases are completed.
For the statutory safe harbors to apply, material forward-looking
statements must be accompanied by ``meaningful cautionary statements.''
\24\ The meaningful cautionary statements cannot be boilerplate
language.\25\ The safe harbors do not apply if the statement was
knowingly false when made. Furthermore, the statutory safe harbors were
meant to apply only to private actions in federal court.\26\
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\24\ Securities Act Section 27A(c)(1)(A)(i) (15 U.S.C. 77z-
2(c)(1)(A)(i)); Exchange Act Section 21E(c)(1)(A)(i) (15 U.S.C. 78u-
5(c)(1)(A)(i)). Further, certain courts have adopted the ``bespeaks
caution'' doctrine to afford protection of forward-looking
statements that are accompanied by full and meaningful discussion of
their limitations and assumptions See, e.g., In re Donald J. Trump
Casino Sec. Litig., 7 F.3d 357 (3rd Cir. 1993), cert. denied, 114
S.Ct. 1219 (1994).
\25\ See H.R. Conf. Rep. No. 104-369 (1995).
\26\ Securities Act Section 27A(c)(1) (15 U.S.C. 77z-2(c)(1));
Exchange Act Section 21E(c)(1) (15 U.S.C. 78u-5(c)(1)). In contrast,
Securities Act Rule 175 and Exchange Act Rule 3b-6 also would apply
to Commission actions.
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III. Our Specific Disclosure Guidance
As the end of the century draws near, the Year 2000 technical and
legal issues become increasingly material to investors. We are
concerned that some companies may not be meeting their Year 2000
disclosure obligations. With each passing month, the extent of the Year
2000 risks become more evident and companies' obligations to disclose
their Year 2000 issues becomes clearer. Investors need to know how
companies are addressing these issues.
The federal securities laws are dynamic and responsive to changing
circumstances. As companies remediate their Year 2000 issues, their
circumstances change as they discover new issues. Companies need to
adjust their disclosure accordingly. In almost all cases, companies
will have material events and changes requiring updated Year 2000
disclosure in each quarterly and annual report filed with us.\27\
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\27\ Item 303(b) of Regulation S-K (17 CFR 229.303(b)) and Item
303(b)(2) of Regulation S-B (17 CFR 229.303(b)(2)) set forth the
MD&A requirements for interim reports. In a 1989 interpretive
release (``1989 Release''), we noted that companies need to update
known trends, demands, commitments, events, and uncertainties for
any material change in each subsequent periodic report. Securities
Act Rel. No. 6835 (May 18, 1989), 54 FR 22427 (May 24, 1989), text
at note 40.
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A. Specific Guidance for Year 2000 Disclosure Under MD&A
The following specific guidance sets forth the type of Year 2000
disclosure that companies should provide under MD&A and other rules and
regulations.
1. Basic MD&A Analysis
MD&A is intended to give investors the opportunity to look at a
company through the eyes of management by providing both a short and
long-term analysis of the company's business--with particular emphasis
on the company's prospects for the future. MD&A requires a discussion
of liquidity, capital resources, results of operations, and other
information necessary to an understanding of a company's financial
condition, changes in financial condition, and results of operations.
The language of the MD&A requirement is intentionally general. This
reflects our view that a flexible approach best elicits meaningful
disclosure and avoids boilerplate discussions.
One of the challenges that a company faces when drafting its MD&A
is discussing forward-looking information. One of the few regulations
that require forward-looking disclosure, MD&A contains a variety of
formulations calling for this information, including a requirement to
disclose known material events, trends or uncertainties.\28\
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\28\ A general instruction in MD&A states that companies ``shall
focus sepcifically on material events and uncertainties known to
management that would cause reported financial information not to be
necessarily indicative of future operating results or of future
financial condition.'' Item 303(a) of Regulation S-K, Instruction 3
(17 CFR 229.303(a)). For small businesses, Item 303(b) of Regulation
S-B (17 CFR 228.303(b)) states in part that ``discussion should
address the past and future financial condition and results of
operation of the small business issuer * * *'' for each of the last
two fiscal years. Item 303(b) of Regulation S-B contains an
instruction (Instruction 1) similar to Instruction 3 of Item 303(a).
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In the 1989 Release, we gave guidance to companies on various
aspects of MD&A disclosure. Under the 1989 Release, companies should
apply the following analysis to determine if they should disclose
forward-looking information.
Where a trend, demand, commitment, event, or uncertainty is known,
management must make two assessments:
(1) Is the known trend, demand, commitment, event or uncertainty
likely to come to fruition? If management determines that it is not
reasonably likely to occur, no disclosure is required.
(2) If management cannot make that determination, it must evaluate
objectively the consequences of the known trend, demand, commitment,
event or uncertainty on the assumption that it will come to fruition.
Disclosure is then required unless management determines that a
material effect on the company's financial condition or results of
operations is not reasonably likely to occur. The determination made by
management must be objectively reasonable, viewed as of the time the
determination is made.
This test essentially requires companies to disclose forward-
looking information based on currently known events, trends or
uncertainties that are reasonably likely to have material effects on
the company's financial condition or results of operations.\29\ Because
of the prevalence of computers and embedded technology in virtually all
businesses and the potential consequences of not adequately addressing
the Year 2000 problem, we believe that almost every company will need
to address this issue.
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\29\ In addition to the analytical guide, the 1989 Release
provides several examples of forward-looking disclosure. These may
be useful to help companies determine the type of forward-looking
information that should be provided when they have triggered the
1989 two-part test.
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2. How We Interpret MD&A in the Year 2000 Context''
a. Whether to Disclose Year 2000 Issues. The first decision that a
company must make is whether it has an obligation to provide any
disclosure regarding its Year 2000 issues.\30\ By applying the 1989
Release's guidance regarding forward-looking information, we believe
that a company must provide Year 2000 disclosure if:
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\30\ The Year 2000 issue is certainly ``known'' to all
companies. The problems associated with this issue have been widely
publicized, and no company can reasonably argue that it does not
know about the Year 2000 issue.
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(1) Its assessment of its Year 2000 issues is not complete, or
(2) Management determines that the consequences of its Year 2000
issues would have a material effect on the company's business, results
of operations, or financial condition, without taking into account the
company's efforts to avoid those consequences.
Our two-part test is substantially similar to the revised Staff
Legal Bulletin's guidance for whether companies have a Year 2000
disclosure obligation. We believe that a large majority of companies
will meet one or both of these tests and therefore will be required to
provide Year 2000 disclosure. We expect that significantly more
companies will be providing Year 2000 disclosure in future disclosure
documents than the 70% found by the task force.
Under the first test, a company's assessment should take into
account whether third parties with whom a company has material
relationships are Year 2000 compliant. The determination of whether a
relationship is material depends on the nature of the relationship.
For vendors and suppliers, the relationship is material if there
would be a material effect on the company's business, results of
operations, or financial condition if they do not timely become Year
2000 compliant. The same analysis should be made for significant
customers whose Year 2000 readiness could cause a loss of business that
might be material to the company. The company also should consider its
potential liability to third parties if its systems are not Year 2000
compliant, resulting in possible legal actions for breach of contract
or other harm.
In our view, a company's Year 2000 assessment is not complete until
it considers these third party issues and takes reasonable steps to
verify the Year 2000 readiness of any third party that could cause a
material impact on the
[[Page 41399]]
company. We understand that this is often done by analyzing the
responses to questionnaires sent to these third parties. In the absence
of receiving responses to questionnaires, there may be other means to
assess third party readiness.\31\
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\31\ A company's statement of its own readiness based on third
party representations would be forward-looking and fall within the
statutory safe harbors. Further, a company's reasonable reliance on
the third party statements would be assumptions underlying that
statement and also entitled to safe harbor protection.
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Under the second test, companies must determine whether they have a
Year 2000 disclosure obligation by evaluating their Year 2000 issues on
a ``gross'' basis.\32\ In other words, in the absence of clear evidence
of readiness, a company must assume that it will not be Year 2000
compliant and weigh the likely results of this unpreparedness.\33\ As
part of this analysis, the company must assume that material third
parties will not be ready either, unless these third parties have
delivered written assurances to the company that they expect to be Year
2000 compliant in time. The test is driven by measuring the
consequences if the company is not prepared, rather than the amount of
money the company spent, or plans to spend, to address this issue.\34\
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\32\ The gross basis determination is similar to the analysis in
Staff Accounting Bulletin (SAB) No. 92 (June 8, 1993) relating to
accounting and disclosures related to loss contingencies. In SAB No.
92, our staff gave guidance regarding the need to separately
disclose environmental liabilities and related potential claims for
recovery, unless the recovery was probable. The staff stressed the
uncertainties related to potential claims for recovery. We stress in
this release the uncertainties related to remediation, third
parties, litigation, insurance coverage and other contingencies in
the Year 2000 context.
\33\ If a company has substantially completed its testing and
assessment of third party issues, and thus has a reasonable basis to
believe that it is Year 2000 ready, it need not make this
assumption. Thus, MD&A disclosure may not be required, although we
encourage all companies to address the Year 2000 issue and describe
their Year 2000 status.
\34\ In considering whether potential Year 2000 consequences are
material, companies may offset quantifiable dollar amounts of those
consequences that would be covered by Year 2000-specific insurance
policies, provided that the policies have a sufficiently broad
coverage to cover all risks.
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b. What to Disclose about Year 2000 Issues. Once a company
determines that it has a Year 2000 disclosure obligation, it has to
decide what to disclose about its Year 2000 issues. MD&A does not
require categories of specific information because each company has to
consider its own circumstances in drafting its MD&A. For Year 2000
disclosure to be meaningful, we believe that companies will have to
address the following four categories of information in their MD&A, as
discussed in more detail below:
(1) The company's state of readiness;
(2) The costs to address the company's Year 2000 issues;
(3) The risks of the company's Year 2000 issues; and
(4) The company's contingency plans.
The disclosure should be specific to each company and quantified to
the extent practicable. Some companies may have to provide this
information by business segment or subdivision.\35\ Companies should
avoid generalities and boilerplate disclosure. In addition, each
company must consider if its own Year 2000 circumstances require that
additional matters be disclosed.
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\35\ Item 303(a) of Regulation S-K (17 CFR 229.303(a)).
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(1) The Company's State of Readiness. When a company has to provide
disclosure regarding a known material event, trend, or uncertainty, it
first has to describe that event, trend, or uncertainty.\36\ A company
should describe its Year 2000 issues in sufficient detail to allow
investors to fully understand the challenges that it faces. We suggest
that the description be similar to that provided to a company's board
of directors--which typically is non-technical plain English and
answers the important questions--such as ``will we be ready?'' and
``how far along are we?'' So far, most companies have provided only a
cursory description of their Year 2000 issues.
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\36\ For example, Instruction 3 to Item 303(a) of Regulation S-K
(17 CFR 229.303(a)) states that the discussion and analysis should
include ``descriptions and amounts'' of matters that would have an
impact on future operations and have not had an impact in the past.
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A full description of a company's Year 2000 readiness will
generally include, at the very least, the following three elements.
First, the discussion should address both information technology
(``IT'') and non-IT systems.\37\ Non-IT systems typically include
embedded technology such as microcontrollers.\38\ These types of
systems are more difficult to assess and repair than IT systems. In
fact, companies often have to replace non-IT systems since they cannot
be repaired. To date, only a few companies have addressed non-IT issues
in their disclosure.\39\ We are concerned that companies are
overlooking non-IT systems when they provide Year 2000 disclosure.\40\
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\37\ Companies in some industries, such as software and hardware
manufacturers, also may need to discuss whether their products will
be Year 2000 compliant, and related consequences.
\38\ For example, most equipment and machinery, such as
elevators, contain microcontrollers. For more information regarding
the Year 2000 risks of embedded technology, see the Institution of
Electrical Engineers web site, <http://www.iee.org/2000risk>
\39\ Reportedly, some companies only recently became aware that
their non-IT systems have Year 2000 issues. See, e.g., ``Industry
Wakes Up to Year 2000 Menace,'' Forbes, April 27, 1998 at 163.
\40\ A good description of a company's Year 2000 issues would
address whether all its hardware and software systems, and all of
its embedded systems contained in the company's buildings, plant,
equipment and other infrastructure, have been assessed. If this
assessment is not complete, the company should disclose the kinds
and percentage of hardware and software systems and embedded systems
that remain to be assessed.
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Second, for both their IT and non-IT systems, companies should
disclose where they are in the process of becoming ready for the Year
2000.\41\ The status of the company's progress, identified by phase,
including the estimated timetable for completion of each remaining
phase, is vital information to investors and should be disclosed.\42\
There are no universal definitions for the phases in a Year 2000
remediation program.\43\ However, for the most part, the phases are
self-explanatory, and we recommend that companies briefly describe how
they define each phase. Another challenge is describing the status of
multiple computer systems. Companies should tailor the disclosure and
the format for their own particular circumstances.\44\
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\41\ Companies should discuss their progress in a manner that
will best inform investors about where the company is on their
timetable. For example, some companies may decide that the amount of
money spent may be their best indicator of progress, while other
companies may decide that labor still required to be undertaken may
be a more appropriate indicator.
\42\ We are particularly concerned about the testing phase.
Experts have stated that companies with numerous systems and third
party relationships should be planning to conduct testing for at
least one year. Serious consideration should be given to disclosing,
as of the end of each reporting period: (1) What kinds and
percentage of the company's hardware and software systems have been
tested and verified as Year 2000 compliant, (2) what kinds and
percentage of embedded systems have been tested and verified as Year
2000 compliant, and (3) what testing and verification methodology
was used.
\43\ Public companies and municipal issuers should consider the
phases identified by the General Accounting Office in its checklist
guide to Federal agencies. The guide describes five phases
representing a major Year 2000 activity or segment--awareness,
assessment, renovation, validation, and implementation. General
Accounting Office, GAO/AIMD-10.1.14, Year 2000 Computing Crisis: An
Assessment guide (1997). The guide is available as a PDF file on the
GAO web site at <http://www.gao.gov/y2kr.htm>. Investment advisers
and investment companies should consider the phases identified in
our Investment Advisers Year 2000 Reports release, cited in note 68
below.
\44\ Companies may want to disclose the average phase for all of
their mission critical systems or may want to use a chart to
disclose the status for each mission critical system.
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The third essential component is a description of a company's Year
2000 issues relating to third parties with which they have a material
relationship. Due to the interdependence of computer
[[Page 41400]]
systems today, the Year 2000 problem presents a unique policy issue.
For example, if a major telecommunications company discloses that it
may have a business interruption, this may require many other companies
to disclose that they too may have a business interruption, if
material. Thus, each company's Year 2000 issues may affect other
companies' disclosure obligations. Companies should disclose the nature
and level of importance of these material relationships, as well as the
status of assessing these third party risks.\45\
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\45\ Item 101(c)(vii) of Regulation S-K sets forth the
circumstances under which identification of material customers is
required. 17 CFR 229.101(c)(vii).
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(2) The Costs to Address the Company's Year 2000 Issues. Companies
must disclose material historical and estimated costs of remediation.
This includes costs directly related to fixing Year 2000 issues, such
as modifying software and hiring Year 2000 solution providers. In most
cases, the replacement cost of a non-compliant IT system should be
disclosed as an estimated Year 2000 cost. This is so even if the
company had planned to replace the system and merely accelerated the
replacement date.\46\ A company does not need to include the
replacement cost as a Year 2000 estimated cost if it did not accelerate
the replacement due to Year 2000 issues.
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\46\ If a system is replaced, as part of the description of
phase progress, a company should disclose the date of replacement
and the status of testing for Year 2000 compliance with the new
system.
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(3) The Risks of the Company's Year 2000 Issues. Companies must
include a reasonable description of their most reasonably likely worst
case Year 2000 scenarios. The essence of MD&A is whether the
consequences of a known event, trend, or uncertainty are likely to have
a material effect on the company's results of operations, liquidity,
and financial condition. If a company does not know the answer, this
uncertainty must be disclosed, as well as the efforts made to analyze
the uncertainty and how the company intends to handle this uncertainty.
For example, companies must disclose estimated material lost revenue
due to Year 2000 issues, if known.
(4) The Company's Contingency Plans. Companies must describe how
they are preparing to handle the most reasonably likely worst case
scenarios. This information will help investors evaluate the company's
Year 2000 exposure by answering the important question--``what will the
company do if it is not ready?'' Under this category of information,
the company must describe its contingency plans.\47\ We recognize that
describing contingency plans may be particularly challenging. Many
companies have not yet established a contingency plan. In this case,
the company should disclose that it does not have a contingency plan,
whether it intends to create one, and the timetable for doing so.
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\47\ For example, a company might disclose that it stands ready
to switch vendors, has back-up systems that do not rely on
computers, or has stockpiled raw materials in the months before Year
2000. Contingency plans typically include: identification of the
companies' systems and third party risks that the plan addresses; an
analysis of strategies and available resources to restore
operations; and a recovery program that identifies participants,
processes, and any significant equipment needed.
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(5) Suggested Disclosure. We cannot address the virtually unlimited
number of differing circumstances relating to Year 2000 issues that may
require a company to provide disclosure. For example, the departure of
a senior management member who heads the company's Year 2000 project
may be material for some companies but not all companies. Some
companies face material Year 2000 risks outside the United States.\48\
Software and hardware manufacturers must address whether their products
will be Year 2000 compliant and may face potentially greater litigation
risks than companies in other industries. Companies regulated by other
agencies, such as financial institutions, may face formal supervisory
or enforcement actions relating to Year 2000 issues that need to be
disclosed.\49\
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\48\ It is widely reported that some countries, and
organizations within those countries, are not intensively acting to
remediate their Year 2000 issues. See, e.g., ``Governments Aid
Companies in Preparation,''Journal of Commerce, Feb. 25, 1998, page
A4.
\49\ In November 1997, the FDIC issued Orders to Cease and
Desist against three Georgia banks relating to Year 2000 readiness.
See FDIC Press Release, ``Orders to Cease and Desist Issued Against
Georgia Banks,'' PR-83-97 (11/17/97), <http://www.fdic.gov/publish/
archive/press/97 press/pr9783.html>.
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Companies must be aware that providing the minimum level of Year
2000 disclosure set forth in the four categories of information above
may not be enough to meet their disclosure obligations. Each company
must consider if its own Year 2000 circumstances require disclosure of
other matters. The following suggestions are intended to help companies
meet their disclosure obligations. While each of the suggestions may
not be relevant for each company, all companies should consider them.
1. Disclose historical and estimated costs related to their Year
2000 issues, even if disclosure of the dollar amounts is not required
because these amounts are not material.
2. As of the end of each reporting period, disclose how much of the
total estimated Year 2000 project costs have already been incurred.
3. Identify the source of funds for Year 2000 costs, including the
percentage of the IT budget used for remediation. This allows investors
to determine whether Year 2000 funds will be deducted from the
company's income.
4. Explain if other IT projects have been deferred due to the Year
2000 efforts, and the effects of this delay on financial condition and
results of operations.
5. Describe the use of any independent verification and validation
processes to assure the reliability of their risk and cost estimates.
The use of independent verification may be particularly important in
the testing phase.\50\
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\50\ Companies may retain experts or advisers to evaluate their
Year 2000 readiness. The retention of experts and whether an
evaluation has been performed would be historical facts. Statements
made by the experts about the company's readiness likely would be
statements ``on behalf of the company'' about its future economic
performance and therefore entitled to protection under the statutory
safe harbors. Similarly, the company's disclosure of the expert's
evaluation is likely to be an assumption regarding its own statement
of future economic performance and fall within the statutory safe
harbor.
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6. Use a chart to provide Year 2000 disclosure. The chart may help
investors track a company's progress over time, as it is updated, and
make peer comparisons based on the same data. In addition, a chart can
reduce lengthy Year 2000 disclosure that otherwise may overwhelm other
disclosure.
7. Include a breakdown of the costs, such as disclosure of costs to
repair software problems, and costs to replace problem systems and
equipment.
B. Year 2000 Financial Statement Considerations
Existing accounting and auditing standards provide guidance
concerning the accounting and disclosure issues arising from the Year
2000 problem. Matters that companies and their auditors should consider
include the following.
1. Accounting and Disclosure in Financial Statements
Costs of Modifying Software. A company's need or plan to modify its
own software for Year 2000 compliance does not result in a liability
that is
[[Page 41401]]
recognized in financial statements. Instead, the costs of modifying the
software are charged to expense as they are incurred.\51\
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\51\ See Emerging Issues Task Force (``EITF''), Issue No. 96-14,
``Accounting for the Costs Associated with Modifying Computer
Software for the Year 2000,'' which notes the remarks of our former
Chief Accountant, Michael Sutton, at the July 23-24, 1997 meeting of
the EITF that future costs to modify software for Year 2000 problems
are not a currently liability, and the staff would object to the
accrual of such costs.
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Costs of Failure to Be Year 2000 Compliant. Operating losses
expected to result if a company, its suppliers, or customers fail to
correct Year 2000 deficiencies are recognized only as they are
incurred.
Disclosure of Year 2000 Related Commitments. Companies should
consider the need to disclose payments to be made pursuant to
unfulfilled or executory contracts or commitments with vendors to
remediate Year 2000 noncompliance problems.\52\
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\52\ See FASB Statement No. 5, paragraph 18. See also AICPA,
Statement of Position 94-6, ``Disclosure of Significant Risks and
Uncertainties.''
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Companies also should consider the need to disclose the potential
for acceleration of debt payments due to covenant defaults tied to Year
2000 readiness.
Revenue and Loss Recognition. Year 2000 issues may affect the
timing of revenue recognition in accordance with AICPA Statement of
Position 97-2, Software Revenue Recognition. For example, if a vendor
licenses a product that is not Year 2000 compliant and commits to
deliver a Year 2000 compliant version in the future, the revenue from
the transaction should be allocated to the various elements--the
software and the upgrade. Entities also should consider FASB Statement
No. 48, Revenue Recognition When the Right of Return Exists, relating
to any product return issues such as for products containing hardware
and software, including whether the necessary conditions have been met
to recognize revenue in the period of sale, whether that revenue should
be deferred, or whether an allowance for sales return should be
provided.
Allowances for Loan Losses. The credit quality of a loan may be
affected by the failure of a borrower's operating or other systems as a
consequence of a Year 2000 issue or a borrower's failure to comply with
debt covenant terms regarding Year 2000 issues. Creditors' allowances
for loan losses, however, should be provided only for losses incurred
as of the balance sheet date, and should not be based on the effects of
future events.
Losses from Breach of Contract. Possible losses from asserted and
nonasserted claims of breach of contract or warranty due to Year 2000
noncompliance must be disclosed in notes to the financial statements,
and must be recognized as a liability if those losses are probable and
reasonably estimable.\53\ For example, companies selling products with
an express or implied warranty of Year 2000 compliance may have a
potential liability that must be evaluated at each balance sheet date.
Companies will be required to disclose potential lawsuits when there is
at least a reasonable possibility that a loss, or additional loss, may
be incurred even if the amount of loss cannot be reasonably estimated.
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\53\ See FASB Statement No. 5, paragraphs 24-26.
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Impairment of Assets. Certain companies may need to consider if a
write-down of capitalized software may be required in accordance with
the guidance of FASB Statement No. 86, Accounting for the Costs of
Computer Software to Be Sold, Leased or Otherwise Marketed. Also, Year
2000 compliance issues may indicate impairment of long-lived assets
that contain hardware or software and require application of the
guidance in FASB Statement No. 121, Accounting for the Impairment of
Long-Lived Assets and for Long-Lived Assets to Be Disposed Of. An
adjustment to the estimated useful lives of hardware or internal use
software may be appropriate even if the assets are not considered to be
impaired. In addition, companies should consider the accounting for
costs associated with developing or obtaining computer software for
internal use, as discussed in AICPA Statement of Position 98-1,
Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use.
Disclosure of Risks and Uncertainties. A company must explain any
risk or uncertainty of a reasonably possible change in its estimates in
the near term that would be material to the financial statements.
Examples of estimates that may be affected by Year 2000 issues include
estimates of warranty liability, reserves for product returns and
allowances, capitalized software costs, inventory, litigation, and
deferred revenue.\54\
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\54\ See AICPA, Statement of Position 94-6, ``Disclosure of
Significant Risks and Uncertainties.''
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Additional guidance concerning accounting and auditing issues
related to the Year 2000 issue is included in The Year 2000 Issue--
Current Accounting and Auditing Guidance, published by the AICPA on
October 31, 1997.\55\
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\55\ This publication can be found on the AICPA web site at
<http://www.aicpa.org/members/y2000/intro.htm>.
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2. Auditor Responsibilities
Conducting the Audit. Existing generally accepted auditing
standards provide guidance that would apply to performing an audit
involving Year 2000 issues. The AICPA publication, The Year 2000
Issue--Current Accounting and Auditing Guidance, also addresses
auditing issues related to the Year 2000 issue. The auditor should
consider professional standards concerning matters such as planning and
supervision of the audit, auditor responsibilities for disclosures
outside the financial statements in filings made with us, processing of
transactions by service organizations, and auditor communications with
the client, management and audit committee.\56\
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\56\ See AICPA, Codification of Statements on Auditing
Standards, section (``AU Section'') 311, ``Planning and
Supervision.''
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Although the term ``may'' is used throughout the AICPA's guidance,
perhaps suggesting that the guidance is discretionary, we believe that
the procedures outlined by the AICPA should be considered appropriate
practice at this time and we expect companies and their auditors to
comply with that guidance. If they do not, they should be prepared to
justify why the procedures were not followed.\57\
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\57\ In the 1998 Staff Report to Congress on Year 2000, our
Office of Chief Accountant expressed this view on page 49.
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``Going Concern'' Issues. An auditor must evaluate whether or not
the procedures performed during the course of the audit identify
conditions and events that, in the aggregate, indicate there could be
substantial doubt about the entity's ability to continue as a going
concern. Year 2000 issues, either alone or when considered in relation
to other conditions and events, may indicate going concern issues about
an entity. The going concern issues may affect the disclosures in the
financial statements and result in a modification of the auditor's
report.\58\
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\58\ See AU Section 9341, ``Effect of the Year 2000 Issue on the
Auditor's Consideration of an Entity's Ability to Continue as a
Going Concern.''
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Resignation of an Independent Auditor. Item 4 of Form 8-K requires
a company to file a Form 8-K within 5 business days if its principal
auditor resigns.\59\ The company must disclose in the Form 8-K any
disagreements on accounting or reportable events that relate to Year
2000 issues. The company must request the auditor to review its
[[Page 41402]]
disclosures and invite comment on their completeness and accuracy.
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\59\ Form 8-K (17 CFR 249.308).
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C. General Guidance for Public Companies' Year 2000 Disclosure Under
Other Regulations
Other federal securities rules or regulations may require
disclosure related to companies' Year 2000 issues. The following is a
list of rules and regulations that companies should consider.
1. Description of Business \60\
This item requires a description of the general development of the
business of the company, its subsidiaries, and any predecessors during
the past five years (or the period the company has been in business, if
shorter). Among other things, this item requires a discussion of:
\60\ Item 101 of Regulation S-K (17 CFR 229.101). Item 101 of
Regulation S-B (17 CFR 228.101) and Item 1 of Form 20-F require
similar disclosure. A company may need to address Year 2000 issues
related to each reportable segment.
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--Any material changes in the mode of conducting the business;
--The principal markets for the company's products and services;
--Competitive conditions in the business; and
--Financial and narrative information about the company's industry
segments.
2. Legal Proceedings.\61\
A company must describe material pending legal proceedings in which
the company or any of its subsidiaries is a party, or to which its
property is subject. Generally, no information is required regarding
claims for damages unless the amount involved exceeds ten percent of
the current assets of the company and its subsidiaries on a
consolidated basis. However, it may be necessary to describe routine
litigation where the claim differs from the usual type of claim \62\
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\61\ Item 103 of Regulations S-K (17 CFR 229.103) and S-B (17
CFR 228.103), and Item 3 of Form 20-F.
\62\ Instruction 1 to Item 103 of Regulation S-K, and Item 3, of
form 20-F.
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3. Material Contracts \63\
A company must file as an exhibit certain contracts that are
considered material to its business. These contracts include contracts
upon which the business is substantially dependent, such as contracts
with principal customers and principal suppliers.
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\63\ Item 601(b)(10) of Regulations S-K (17 CFR 229.601(b)(10))
and S-B (17 CFR 228.601(b)(10)), and Item 19 of Form 20-F.
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4. Risk Factors \64\
Registration statements filed under the Securities Act must include
under the caption ``Risk Factors'' a discussion of the factors that
make the offering speculative or risky. This discussion must be
specific to the particular company and its operations, and should
explain how the risk affects the company and/or the securities being
offered. Generic or boilerplate discussions do not tell investors how
the risk may affect their investment.
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\64\ Item 503(c) of Regulations S-K and S-B. This item was
amended in Securities Act Release No. 7497 (January 28, 1998) to
require companies to describe risk factors in plain English. 63 FR
6370 (Feb. 6, 1998). This amendment takes effect October 1, 1998.
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5. Form 8-K \65\
Year 2000 issues may reach a level of importance that prompts a
company to consider filing a Form 8-K under Item 5 of the form. In
considering whether to file a Form 8-K, companies should be
particularly mindful of the accuracy and completeness of information in
registration statements filed under the Securities Act that incorporate
by reference Exchange Act reports, including Forms 8-K.\66\
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\65\ Item 5 may be used by a company to report on Form 8-K any
events, for which information is not otherwise required by the form,
that the company deems of importance to securityholders.
\66\ General Instruction B.4 of Form 8-K.
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6. Any Additional Material Information Necessary to Make the Required
Disclosure Not Misleading
In addition to the information that the company is specifically
required to disclose, the disclosure rules require disclosure of any
additional material information necessary to make the required
disclosure not misleading.\67\
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\67\ Securities Act Rule 408 (17 CFR 230.408), Exchange Rules
12b-20 (17 CFR 240.12b-20) and 14a-9 ( 17 CFR 240.14a-9). Companies
also should consider the anti-fraud provisions of the Securities Act
and the Exchange Act. These anti-fraud requirements apply to
statements and omissions both in Commission filings and outside of
Commission filings. Securities Act Section 17(a), Exchange Act
Section 10(b), and Exchange Act Rule 10b-5. Companies also should
consider potential civil liabilities under Securities Act Sections
11 (15 U.S.C. 77k) and 12(a)(2) (15 U.S.C. 77l(a)(2)) and Exchange
Act Section 18 (15 U.S.C. 78r).
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D. Guidance for Year 2000 Disclosure for Investment Advisers and
Investment Companies
Because of the key role that investment advisers and the investment
companies they manage play in the financial markets, we believe that it
is important that investment advisers provide detailed reports on their
Year 2000 readiness to the Commission. In June 1998, we published for
comment a proposed rule to require investment adviser Year 2000
reports.\68\ Since these reports will be publicly available, they will
help analysts and the public, as well as the Commission, to evaluate
the progress of investment companies and investment advisers in
addressing the Year 2000 issue. In addition to these reports,
investment companies and investment advisers that conclude that the
Year 2000 issue is material to their operating results and/or financial
condition are required to provide disclosure in accordance with other
statutory provisions.
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\68\ Investment Advisers Year 2000 Reports, Release Nos. IA-1728
and IC-23293 (June 30, 1998), 63 FR 36632 (July 7, 1998), <http://
www.sec.gov/rules/proposed/ia-1728.htm>. Comments must be received
on or before August 10, 1998.
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The anti-fraud provisions of the Investment Advisers Act generally
impose on investment advisers an affirmative duty, consistent with
their fiduciary obligation, to disclose to clients or prospective
clients material facts concerning their advisory or proposed advisory
relationships.\69\ If the failure to address the Year 2000 issue could
materially affect the advisory service provided to clients, an adviser
that will not be able to, or is uncertain about, its ability to address
Year 2000 issues has an obligation to disclose that information to its
clients. The adviser must provide the disclosure in a timely manner so
that the clients and prospective clients may take steps to protect
their interests. In addition, investment advisers that are public
companies have disclosure obligations under the Securities Act and
Exchange Act and should follow our interpretive guidance for public
company disclosure in Sections III. A, B, and C.
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\69\ Sections 206 (1) and (2) of the Investment Advisers Act of
1940 (15 U.S.C. 80b-6 (1) and (2)). See SEC v. Capital Gains
Research Bureau, Inc., 375 U.S. 180 (1963).
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The Investment Company Act provides that it is unlawful for
investment companies to omit from registration statements and other
public filings ``any fact necessary in order to prevent the statements
made therein, in light of the circumstances under which they were made,
from being misleading.'' \70\ If investment companies determine that
their Year 2000 risks are material, they are required to discuss such
risks in their registration statements and other public documents and
should follow the guidance provided in this section. \71\
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\70\ Section 34(b) of the Investment Company Act of 1940 (15
U.S.C. 80a-33(b)).
\71\ In evaluating these risks, investment companies should
consider whether Year 2000 issues present material risks for their
investment portfolios as well as for investment company operations.
See, eg., Item 4 of Form N-1A (17 CFR 274.11A), and Item 8 of Form
N-2 (17 CFR 274.11a-1).
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[[Page 41403]]
Whether Year 2000 issues are material depends upon the particular
facts and circumstances for each investment company. Consideration
should be given, for example, to whether Year 2000 issues affect an
investment company's own operations, and its ability to obtain and use
services provided by third parties, or its portfolio investments.
Investment companies could face difficulties, among other things,
performing various functions such as calculating net asset value,
redeeming shares, delivering account statements and providing other
information to shareholders. Because many investment company operations
are performed by external service providers, we expect that investment
companies would, as a matter of course, discuss Year 2000 issues with
their service providers and seek reasonable assurance from these
service providers that they will address Year 2000 issues so as to
allow the continuation of the provided services without interruption,
and consider carefully the responses provided.\72\
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\72\ When assessing the Year 2000 readiness of an external
service provider that is a registered broker-dealer or transfer
agent, the Year 2000 reports that are required to be submitted to us
by most broker-dealers and transfer agents are one source of
information.
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Discussion of Year 2000 issues and their effect on an investment
company may need to be made in response to specific items of the
registration forms for investment companies. For example, open-end
investment companies (mutual funds) are required by Item 6 of Form N-1A
to describe in their prospectuses the experience of their investment
adviser and the services that the adviser provides. In response to this
item, investment companies may need to disclose the effect that the
Year 2000 issue would have on their advisers' ability to provide
services described in their registration statements. Item 7 of that
form requires funds to describe their pricing procedures and purchase
and redemption procedures. Investment companies should consider the
effect of Year 2000 issues on the effectiveness and operation of these
procedures. Investment companies also may need to consider the effect
of the Year 2000 issue in discussing their investment strategies and
risks, and consider whether their investment objectives or policies
need to be changed in light of Year 2000 concerns. \73\
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\73\ See e.g., Item 4 of Form N-1A (17 CFR 274.11A), Item 8 of
Form N-2 (17 CFR 274.11a-1).
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Although those provisions are not specifically applicable to
investment companies, investment companies seeking further guidance in
preparing Year 2000 disclosure may find it helpful to review the
provisions of this release applicable to other public companies and
their preparation of MD&A disclosure. For example, investment companies
may find it appropriate to include disclosure about the costs of
remedying their Year 2000 issues, any liabilities associated with these
problems, or contingency plans to deal with their disruptions that may
occur when Year 2000 issues are encountered.
Investment companies that conclude that the Year 2000 is not
material to their financial operating results and/or financial
condition may nonetheless choose to include Year 2000 disclosure in
periodic reports to shareholders or in special reports to shareholders
on Year 2000 matters. We encourage such reporting, and consider that it
is particularly appropriate in cases in which an investment company
concludes that the materiality of the problem does not trigger a
disclosure obligation in a registration statement. Finally, when
providing Year 2000 disclosure, investment advisers and investment
companies should avoid boilerplate disclosure that may not be
meaningful to shareholders.
E. Guidance for Year 2000 Disclosure for Municipal Issuers
Generally, municipal securities offerings are exempt from
registration and municipal securities issuers are exempt from the
reporting provisions of the federal securities laws, including line-
item disclosure rules. However, they are not exempt from the anti-fraud
provisions. Disclosure documents used by municipal issuers are subject
to the prohibition against false or misleading statements of material
facts, including the omission of material facts necessary to make the
statements made, in light of the circumstances in which they are made,
not misleading.\74\
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\74\ See Municipal Securities Interpretive Release, cited at
note 6 above.
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Issuers of municipal securities and persons assisting in preparing
municipal issuer disclosures are encouraged to consider whether such
disclosures should contain a discussion of Year 2000 issues. Persons,
including ``obligated persons'' as defined in Rule 15c2-12,\75\ who
provide information for use in disclosure documents or in ongoing
disclosure to the market, are urged to consider their own Year 2000
issues. Year 2000 issues should be considered in preparing all
disclosure documents, whether in the context of an official statement,
continuing disclosure provided in compliance with a disclosure
covenant, or other information that is reasonably expected to reach
investors and the trading markets.\76\
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\75\ Exchange Act Rule 15c2-12 (17 CFR 240.15c2-12).
\76\ See Municipal Securities Interpretive Release.
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Whether Year 2000 issues are material depends upon the particular
facts and circumstances for each municipal issuer. Consideration may be
given, for example, to whether Year 2000 issues affect internal
operations of an issuer or affect an issuer's ability to provide
services and meet its obligations, including timely payment of its
indebtedness.
Because of the varieties of municipal issuers and of municipal
securities, the examples provided below may or may not apply to a
particular issuer and an issuer may be subject to facts and
circumstances requiring disclosure not described below. Issuers and the
persons assisting in disclosure preparation should give careful
consideration to Year 2000 issues within the context of the facts and
circumstances applicable to the disclosing issuer or the securities.
Examples of Potential Year 2000 Problems
For municipal issuers, Year 2000 issues may be divided into three
categories: Internal, External and Mechanical. Internal Year 2000
issues may arise from an issuer's own operations and materially affect
its creditworthiness and ability to make timely payment of its
obligations. External Year 2000 issues may arise from parties, other
than an issuer, that provide payments that support the debt service on
an issuer's municipal securities. Such payments may include, for
example, health care reimbursement payments and payments under housing
and student loan programs, as well as payments made by an obligated
person under a lease, loan or installment sale agreement in a conduit
financing.
Mechanical Year 2000 issues may arise if Year 2000 problems disrupt
the actual mechanical process used to send payments to bondholders. For
example, many municipal securities pay interest semiannually on January
1 and July 1 of each year, or have periodic sinking fund installments
due to an indenture trustee or fiscal agent. Issuers may wish to
determine whether Year 2000 issues affect their ability to identify and
meet such obligations in a timely manner and to disclose any measures
that will be undertaken if an issuer determines it
[[Page 41404]]
will not be able to meet such obligations.
Issuers of general obligation debt may wish to consider, for
example, the adverse effects, if any, Year 2000 issues may pose to
their ability to assess and collect ad valorem taxes and allocate
receipts and disbursements to proper funds in a timely manner to make
debt service payments when due. In addition, while Year 2000 issues may
not directly affect an issuer's ability to pay debt service, they may
affect an issuer's general accounting and payment functions, which may
be material to investors.
Revenue bond issuers may wish to consider, for example, any adverse
effects Year 2000 issues may have on their ability to collect and
administer the revenue stream securing their bonds and their ability to
make timely payment of principal and interest on their obligations, as
well as adverse effects to general accounting and payment functions,
which may be material to investors.
Conduit borrowers, such as hospitals, universities and others, may
wish to consider, for example, any adverse effects Year 2000 issues may
have on their ability to deliver services, collect revenue and make
timely payment on their obligations, including the obligation to pay
debt service relating to municipal securities, which may be material to
investors.
All issuers and conduit borrowers also may wish to consider the
impact of Year 2000 problems facing third parties on their own ability
to satisfy their responsibilities.
Other examples of suggested disclosure for consideration include,
but are not limited to, the costs associated with fixing an issuer's
Year 2000 problems, any loss associated with fixing an issuer's Year
2000 problems, any loss an issuer may incur because of Year 2000
problems, and any liabilities associated with an issuer's Year 2000
problems.
While not binding on issuers of municipal securities, issuers and
persons assisting in preparing municipal issuer disclosure seeking
further guidance may wish to review Sections III.A, B, and C of this
release applicable to public companies.\77\ The anti-fraud provisions
of the federal securities law prohibit materially false and misleading
statements or omissions, including those relating to the Year 2000
issues we have discussed in this release.
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\77\ See also Proposed Governmental Accounting Standards Board
Technical Bulletin No. 98-a, ``Disclosures about Year 2000 Resources
Committed,'' July 24, 1998. It can be found at <http://
www.rutgers.edu/accounting/raw/gasb/gasbhome.html>.
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List of Subjects
17 CFR Parts 231, 241, and 276
Securities.
17 CFR Part 271
Investment companies, Securities.
Amendments to the Code of Federal Regulations
For the reasons set forth in the preamble, the Commission is
amending title 17, chapter II of the Code of Federal Regulations as
follows:
PART 231--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES ACT OF
1933 AND GENERAL RULES AND REGULATIONS THEREUNDER
1. Part 231 is amended by adding Release No. 33-7558 and the
release date of July 29, 1998, to the list of interpretative releases.
PART 241--INTERPRETATIVE RELEASES RELATING TO THE SECURITIES
EXCHANGE ACT OF 1934 AND GENERAL RULES AND REGULATIONS THEREUNDER
2. Part 241 is amended by adding Release No. 34-40277 and the
release date of July 29, 1998, to the list of interpretative releases.
PART 271--INTERPRETATIVE RELEASES RELATING TO THE INVESTMENT
COMPANY ACT OF 1940 AND GENERAL RULES AND REGULATIONS THEREUNDER
3. Part 271 is amended by adding Release No. IC-23366 and the
release date of July 29, 1998, to the list of interpretative releases.
PART 276--INTERPRETATIVE RELEASES RELATING TO THE INVESTMENT
ADVISERS ACT OF 1940 AND GENERAL RULES AND REGULATIONS THEREUNDER
4. Part 276 is amended by adding Release No. IA-1738 and the
release date of July 29, 1998, to the list of interpretative releases.
Dated: July 29, 1998.
By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 98-20749 Filed 8-3-98; 8:45 am]
BILLING CODE 8010-01-U