[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 <<a href="http://
www.itaa.org/softpr7.htm">http://
www.itaa.org/softpr7.htm</a>>.
    \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 <<a href="http://
www.senate.gov/">http://
www.senate.gov/</a><difference>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 <<a href="http://www.sec.gov/news/studies/
yr2000.htm">http://www.sec.gov/news/studies/
yr2000.htm</a>> for the 1997 report and <<a href="http://www.sec.gov/news/
studies/yr2000-2.htm">http://www.sec.gov/news/
studies/yr2000-2.htm</a>> for the 1998 report.
    \13\ These questions can be found at <<a href="http://www.sec.gov/
consumer/y2kaskit.htm">http://www.sec.gov/
consumer/y2kaskit.htm</a>>.
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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 <<a href="http://www.sec.gov/rules/
othern">http://www.sec.gov/rules/
othern</a>> 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 <<a href="http://
www.sec.gov/news/extra/y2kcfty.htm">http://
www.sec.gov/news/extra/y2kcfty.htm</a>>.
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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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[[Page 41398]]

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.
---------------------------------------------------------------------------

    (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), <<a href="http://www.fdic.gov/publish/
archive/press/97">http://www.fdic.gov/publish/
archive/press/97</a> 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.''
---------------------------------------------------------------------------

    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.
---------------------------------------------------------------------------

    \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.
---------------------------------------------------------------------------

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), <<a href="http://
www.sec.gov/rules/proposed/ia-1728.htm">http://
www.sec.gov/rules/proposed/ia-1728.htm</a>>. 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 <<a href="http://
www.rutgers.edu/accounting/raw/gasb/gasbhome.html">http://
www.rutgers.edu/accounting/raw/gasb/gasbhome.html</a>>.
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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