Full Text of Testimony(1)
Mr. Chairman and Distinguished Members of the Subcommittee:
My name is Ed Yardeni. I am the Chief Economist and a managing director of Deutsche Bank
Securities, a global investment banking firm. I appreciate the opportunity to testify today on the
issue of Year 2000 disclosure. I first testified on this subject during this Subcommittee's
November 4, 1997 hearing on "Mandating Year-2000 Disclosures for Publicly Traded
Companies." The title of my testimony at that time was The Year 2000 Problem: We Need
Answers.(2)
Conclusion
The title of my prepared remarks today is The Year 2000 Problem: We Need the Full Monty! As
a result of this Subcommittee's efforts, and new guidance from the Securities and Exchange
Commission (SEC), corporations began to include statements about the Year 2000 Problem
(Y2K) in their annual (10K) and quarterly (10Q) filings with the SEC and reports to investors
this year. After reviewing many of them, my conclusion has not changed from the last time we
met: I believe that corporations are still not providing their investors with the information they
must have to assess the risks these companies face in 2000.
Most managements have taken the position that Y2K is not "material" and, therefore, does not
require full disclosure. Those that reported the estimated cost of their Y2K project all concluded
that it is too small to have a material impact on their financial outlook. I strongly disagree. It is
true that the cost of fixing Y2K for most companies is not material because the monies are
coming out of current information technology (IT) budgets. However, the cost of failing to fix
the problem could be very material, so investors must be kept informed, on an ongoing basis,
about the potential for failure.
I can't stress this enough: The biggest risks confronting investors are not the costs of fixing Y2K
in 1998 and 1999, but the much greater costs of business disruptions, malfunctions, and outright
failures in 2000. It is precisely this vitally important information that is missing in every one of
the reports I read. The fact that most companies chose to completely ignore Y2K in their
quarterly filings--or simply copied the statement from the annual report--suggests that they
have no intention of keeping their investors informed about their progress, or lack thereof.
Background On Y2K Disclosure
In my previous testimony, I proposed that all businesses, both incorporated and unincorporated,
should be required by a new law to publicly reveal much more information about their Year 2000
Problem (Y2K). I advocated several specific reporting requirements, including:
1) total and quarterly outlays on Y2K,
2) quarterly remediation progress reports, especially for mission-critical systems,
3) risks related to noncompliant external vendors and customers,
4) litigation issues, and
5) contingency plans.
On November 10, 1997, Senator Bob Bennett (R-Utah), the enlightened chairman of this
subcommittee, introduced the "CRASH Protection Act," the Computer Remediation and
Shareholder Protection Act of 1997. This bill (S.1518) required the Securities and Exchange
Commission to amend its disclosure regulations pursuant to section 13 of the Securities
Exchange Act of 1934 to require corporations to disclose all of the above.
The SEC responded to this pressure from Senator Bennett by significantly revising its Staff
Legal Bulletin No. 5. (See Appendix A.) The first version, dated October 8, 1997, stated that
companies should treat the Y2K issue as they do any other: It was up to corporate management
to decide if it is material information that shareholders need to know to assess the future
prospects of the corporation. On January 12, 1998, the new version of Staff Legal Bulletin No. 5
advised corporate managements that if they conclude that Y2K is material, then they must "at
least" disclose:
1) the company's general plans and timetable to fix the problem and disclose in their SEC
filings the actual cost of addressing Y2K, and
2) the total dollar amount that the company expects to spend on Y2K.
They should also estimate "the costs or the consequences of incomplete or untimely resolution"
of Y2K if it is likely to be a material event. Perhaps the most important message in the SEC
Bulletin is that "disclosure must be reasonably specific and meaningful, rather than standard
boilerplate."(3)
The Y2K Disclosure Database
On my website, www.yardeni.com, I maintain a database of the Y2K statements, that appear in
the 10K and 10Q filings of the Standard & Poor 500 corporations (S&P 500) since the start of
1998.(4) It is open to the public. The data were extracted from the SEC's EDGAR database on the
Internet. I have reviewed all of the 1997 annual reports and the quarterly reports filed so far this
year.
My bottom line is that very few of the S&P 500 corporations are providing investors with the
information they must have to evaluate the possible adverse impact that Y2K might have on
earnings. They are violating the spirit, if not the letter, of the SEC's guidance. The problem is
that the SEC Bulletin does not have the force of a SEC ruling. I believe that the SEC must
immediately issue a Y2K ruling, that will mandate the level of disclosure specified in Senator
Bennett's bill. If the SEC fails to do so, then Congress should enact CRASH as soon as possible.
Let me list my findings:
1) Of the S&P 500 companies, 409 filed 10Ks, i.e., annual reports, after the SEC guidelines
were revised on January 12, 1998. Of these, 399 mentioned Y2K in their annual reports, and 10
did not do so.
2) In their quarterly disclosures, 220 companies did not mention Y2K.
3) Only 168 of the 500 companies, or 34%, reported their estimate for the total cost of their Y2K
project in either their annual or quarterly filings.
4) Only four companies revised their numbers upward from their annual to their quarterly
reports.
5) The total outlays on Y2K estimated by the 168 companies reporting this number is $11
billion. This number is identical to the one derived for the Fortune 500 by the Federal Reserve
Board, as reported by Fed Governor Edward W. Kelley, Jr. in his testimony before the U.S.
Senate Committee on Commerce, Science, and Transportation on April 28, 1998.(5)
6) Only 66 companies have reported how much has been spent to date on Y2K. These
companies estimate that their total costs will be $4.8 billion, and they have spent $1.1 billion so
far.
In his April Congressional testimony, Fed Governor Kelley observed that many companies did
not report incurring additional costs for Y2K because they probably did not view Y2K spending
as having a "material" effect on their bottom line, and some companies probably have funded
Y2K programs with monies already budgeted to their information technology function.
I believe that corporations are not disclosing enough information about Y2K. Nearly all the
statements on the subject are only two or three short paragraphs, at most. The basic message is an
optimistic one: "We expect to have the problem fixed, but our operations could be disrupted if
we don't, or if our vendors fail to fix their Y2K problem." Most companies note that they are still
assessing their suppliers, but can't determine the impact Y2K will have on them. A discussion of
disclosures provided by some of our most successful corporations is included Appendix B.
Closing Comment
I can understand why companies are reluctant to reveal more about Y2K. Nevertheless, the Year
2000 Problem will effect us all. We need to know where we stand. We need the Full Monty!
After reading through hundreds of corporate Y2K statements, I believe that most of them were
either written, or very heavily edited, by lawyers. The corporate attorneys' main job in this case
is to protect their companies from lawsuits. Unfortunately, this parochially commendable goal is
not in the best interest of the public or even their own companies. I am amazed at the similarity
of so many statements. Clearly, corporations have violated the SEC guideline requiring specifics
rather than boilerplate.
A tougher Y2K rule from the SEC mandating greater disclosure is necessary. Companies should
disclose at least as much information as provided by the federal government agencies on a
quarterly basis.(6) Investors need to have such quarterly progress reports so that they can assess
the prospects for the year 2000 of the companies' stocks they own.
Appendix A: Excerpt from SEC Staff Legal Bulletin No. 5
| Analysis of Financial Condition. Companies should include disclosure in their
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" if:
the cost of addressing the Year 2000 issue is a material event or uncertainty that would cause reported financial information not to be necessarily indicative of future operating results or financial condition, or the costs or the consequences of incomplete or untimely resolution of their Year 2000 issue represent a known material event or uncertainty that is reasonably expected to affect their future financial results, or cause their reported financial information not to be necessarily indicative of future operating results or future financial condition. |
| Description of Business. If Year 2000 issues materially affect a company's products, services, or competitive conditions, companies may need to disclose this in their "Description of Business." In determining whether to include disclosure, companies should consider the effects of the Year 2000 issue on each of their reportable segments. |
| Form 8-K. A company's Year 2000 costs or consequences may reach a level of importance that prompts it to consider filing a Form 8-K. At their option, companies would file these reports under Item 5 of Form 8-K. 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 Form 8-Ks. |
| Accounting Considerations. The Emerging Issues Task Force considered the issue of how to properly reflect the costs of modifying computer software for Year 2000 projects in the financial statements. In July 1996, the EITF concluded that these costs should be charged to expense as they are incurred. |
| Specific Disclosure Considerations. If a company determines that it should make Year
2000 disclosure, the applicable rules or regulations should be followed. If a company has
not made an assessment of its Year 2000 issues or has not determined whether it has
material Year 2000 issues, the staff believes that disclosure of this known uncertainty is
required. In addition, the staff believes that the determination as to whether a company's
Year 2000 issues should be disclosed should be based on whether the Year 2000 issues
are material to a company's business, operations, or financial condition, without regard
to related countervailing circumstances (such as Year 2000 remediation programs or
contingency plans). If the Year 2000 issues are determined to be material, without regard
to countervailing circumstances, the nature and potential impact of the Year 2000 issues,
as well as the countervailing circumstances, should be disclosed. As part of this
disclosure, the staff expects, at the least, that the following topics will be addressed:
the company's general plans to address the Year 2000 issues relating to its business, its operations (including operating systems) and, if material, its relationships with customers, suppliers, and other constituents; and its timetable for carrying out those plans; and the total dollar amount that the company estimates will be spent to remediate its Year 2000 issues, if such amount is expected to be material to the company's business, operations or financial condition, and any material impact these expenditures are expected to have on the company's results of operations, liquidity and capital resources. |
Appendix B:
Adequate Disclosure?
Automotive & Construction Equipment
General Motors discusses Y2K in its annual report, but the topic is not mentioned at all in the
subsequent quarterly filing. GM states that it spent $40 million during 1997, mostly to assess the
problem. It expects to spend about $360 million-$500 million on the remainder of the project,
with the majority expected to be incurred in 1998. GM's "target date for completing its Year
2000 modifications is December 31, 1998, with additional testing and refinements to identified
systems planned for 1999." The company acknowledges that the "inability of GM or significant
external interfaces of GM to adequately address Year 2000 issues could cause disruption of
GM's business operations."
In the April 27, 1998, issue of Fortune, Ralph J. Szgenda, the chief information officer of
General Motors, said that there are "catastrophic problems" in every GM plant. I called the
reporter to verify this blunt quote, and was informed that the word "catastrophic" was repeated
several times during the interview with GM's top IT man. Of course, the word "catastrophic"
does not appear once in GM's all-too-brief discussion of Y2K in its annual report. I wonder why
GM did not update investors on its progress in its quarterly filing. Is the company on schedule to
finish most of the project by the end of the year? What about its vendors? Which ones are at risk
of failing to meet the millennium deadline? What about GM's Asian vendors, given that the
turmoil in that region may be distracting many companies from giving enough attention to Y2K?
Ford says in its annual report that, "at present it does not anticipate any significant exposure
related to the year 2000 issue for its current or future products." No such assurances are given
about past products. Why not? Is there a chance that cars built prior to 1997 won't function
properly in 2000? The automaker believes that Y2K will not have a material effect, unless
suppliers or dealers have problems, in which case Ford "could be adversely affected." No update
was provided in the quarterly filing.
Caterpillar, in its annual report, was mostly concerned that if "modifications and conversions by
us, or those with which we do business, especially foreign and domestic governments and their
agencies, are not made in a timely manner, this matter could have a material adverse impact on
our financial position or results."
Computers & Electronics
In its annual report, IBM sees no material impact, but admits that "it is uncertain whether, or to
what extent, the company may be affected..." The company's great concern is lawsuits "for
damages from products and services that were not Year 2000 ready. The company believes that
any such claims against it will be without merit." Compaq also expects lawsuits, but doesn't
dismiss them: "Such claims, if successful, could have a material adverse impact on future
results." The company has been selling Y2K-ready PCs only since October 7, 1997! Computers
sold prior to that date "may require firmware updates to pass the test. Older systems sold by
Compaq may not have upgradeable firmware and, thus, may not be able to pass the test." A
similar warning is not offered by IBM. Dell notes that hardware products shipped since the end
of 1996 are Year 2000 compliant, and earlier Dell-branded hardware products can be made Year
2000 compliant through BIOS upgrades or software patches. Dell does not mention lawsuits.
Digital Equipment, in one paragraph on the subject, notes that some internal computers are not
Y2K compliant, but should be ready in time. However, there is no discussion at all about the
computers sold by the company to others. There must be problems with them. How else to
explain the 285% increase in earnings during the quarter ended April 30, 1998, from a year ago
for Accelr8 Technology Corp., which sells a Y2K product designed to fix the huge installed base
of Digital's VMS systems. These minicomputers are widely used in manufacturing, government,
distribution, chemical, publishing, pharmaceutical, and automotive industries.
Motorola mentions Y2K in one sentence in its annual report only: The company says that
"Unanticipated impact of Year 2000 issues, particularly the failure of products from major
suppliers to function properly in the Year 2000" might have a material impact on future results.
That's all they say. There is no mention whatsoever of the extent of Y2K compliance for
products Motorola has been selling. Interestingly, William E. Kennard, the chairman of the
Federal Communications Commission (FCC) testified before Congress on April 28, 1998 about
Y2K and telecommunications. He listed a number of his "Biggest Concerns," including the
following:
Radios for police, fire, and other emergency services could fail due to Year 2000 problems.
Many of these systems are quite old and manufacturers may not be able to provide fixes for all of
them. Wireless systems could fail, just when they might be needed as backup to wireline
telephones.(7)
Motorola does have a Y2K website that notes that the company has more than 10,000 different
products.(8) Many products have still not been assessed for Y2K compliance.
Intel, in its annual report, admits that it was still "assessing the capability of its products sold to
customers over a period of years to handle the year 2000 and has a plan in place to address
product issues during 1998." Yet "management believes that the likelihood of a material adverse
impact due to problems with internal systems or products sold to customers is remote and
expects that the cost of these projects over the next two years will not have a
material effect on the Company's financial position or overall trends in results of operations."
Notice that only the "next two years" were mentioned. What about 2000? Intel's most successful
products are microprocessors, logic devices that act on information provided by other parts of a
computer system. The company states, "There are no specific date functions in Intel processors.
All Intel processors can handle dates in the 21st century. The assessment of whether or not a
complete system will operate correctly in the 21st century depends on the BIOS capability and
software design and integration."(9)
In its annual report, Texas Instruments admitted that it was still "assessing the scope of
Year 2000 issues in its physical plant and infrastructure and will soon begin corrective
actions." The company is sufficiently concerned about the failure of third parties that it is
"developing contingency plans to minimize potential disruptions." The company notes that,
based on assessments to date, its current products are ready for Year 2000. Now the bad news:
"Obsolete and discontinued products, as well as divested product lines, are not included in this
assessment." No new information was provided in the first-quarter 1998 report.
Telecommunications
AT&T provided investors with one short paragraph on Y2K in both its annual and quarterly
reports. The company expects to spend $350 million on Y2K in 1998, and was still "assessing
the impact to us, if any, in 1999." Much more information is provided to the public at AT&T's
website, but most of it is vague and of little investment value.(10)
In its annual report, Worldcom informed investors, "At this time, the company believes that the
cost of addressing Year 2000 issues is not material to its future operating results or financial
position." Yet, management admitted that it was still gathering information about its suppliers:
"In the event that any of the company's significant suppliers do not successfully and timely
achieve Year 2000 compliance, the company's business or operations could be adversely
affected."
Worldcom's quarterly Y2K statement was identical to its annual report. Did management learn
anything new that should have been disclosed to investors? Worldcom did not mention that it
hopes to acquire MCI, which also reports that Y2K isn't material, though the company did say it
would spend $400 million in 1998 and 1999. MCI also noted that it expects to be compliant on
or before December 31, 1999. In its annual report, GTE expected to spend $350 million on the
project, but spent only $67 million through 1997. This number was up to $98 million in the
quarterly filing. Sprint provided investors with a four-paragraph Y2K statement that was
identical in the annual and quarterly report. No mention was made of the fact that the company
has 50 million lines of code--in 46 different computer languages on 43 different platforms--that
are affected.(11) Sprint started its project in 1996.
In its annual report, Lucent was confident that "based on available information, that it will be
able to manage its total Year 2000 transition without any material adverse effect on its business
operations, products or financial prospects." In the first-quarter report, management hedged by
observing that "given the uncertain consequences of failure to resolve significant Year 2000
issues, there can be no assurance that any one or more such failures would not have a material
adverse effect on Lucent."
Electric Utilities
Niagara Mohawk Power is one of the only companies I found that warned investors about
embedded chips. They can be found within generation, transmission, and distribution and gas
equipment, and may be date-sensitive. No other utility mentioned the risk of noncompliant
embedded chips. There are embedded chips in chemical and steel plants, food and drug
processing, aircraft, oil rigs, health care equipment, communications systems, elevators, and
security systems. Yet only Niagara Mohawk Power chose to disclose this risk. The company
admits that it retained a leading computer services and consulting firm only at the end of 1997
and won't even have a complete "inventory of exposures, including an assessment of priorities,
costs and resources" until the third quarter of 1998! No cost estimate was provided, presumably
because it is not known.
Gas Transmission & Distribution
Consolidated Natural Gas, in its annual report, blandly noted that "assessment of its exposure
is expected to be completed during 1998." So "renovation and replacement of existing programs
will continue through 1999." Enron devoted one short paragraph to Y2K in its annual report:
The company "continues to assess and modify its computer systems to ensure they will operate
properly in the year 2000. Enron management anticipates that these Year 2000 costs, which will
be incurred over the next two years, will not have a material impact on Enron's financial position
or results of operations." Again, management is limiting its analysis to 1998 and 1999. Peoples
Energy and Columbia Energy believe Y2K isn't material.
Coastal Corp. was willing to acknowledge that Y2K could have an adverse material impact if
Y2K modifications and conversions are not made, or are not completed on time. "There can also
be no assurance that the systems of other companies on which the Company's systems rely will
be timely converted, or that any such failure to convert by another company would not have an
adverse effect on the Company's systems."
Good point. Kathleen Hirning, the chief information officer of the Federal Energy Commission,
testified in Congress on May 14, 1998. Here is her particularly relevant comments about the gas
transmission and distribution business:
Both the gas and oil industries use Supervisory Control and Data Acquisition Systems (SCADA)
to acquire information from remote sections of pipeline, and to control the flow of fuel at remote
locations by using computers linked to satellite and telephone communication systems. SCADA
systems allow pipeline operators to obtain timely information, and allow producers to have
access to information for purchasing distribution services based on the current volume of gas in a
pipeline. Information provided by SCADA systems is accessed by users to purchase
transportation service, check on billings, or arrange storage of gas that has been transported
through a pipeline. Year 2000 compliance will be critical for SCADA systems.
Clearly, the gas transmission and distribution business depends on the Y2K compliance of
telecommunications, satellites, and embedded chips. Investors need to know the status of all
these systems.
Energy
Mobil "is developing contingency plans to alter business relationships, in the event certain third
parties fail to become year 2000 compliant." I wonder if any of them disclosed to their investors
that they are at risk of losing the Mobil account? Mobil's Y2K statement reveals that the
company spent all of 1997 assessing the problem. Nevertheless, management seems remarkably
confident that they will complete the project on time. Exxon admits that "comprehensive plans
for achieving Year 2000 compliance were finalized during 1997, and implementation work was
under way at year-end." Impressively, the company believes it can completely fix its systems in
1998. However, contingency plans are being prepared to mitigate the "potential disruption to
business operations."
Airlines
Earlier this year, Delta Airlines informed investors that it is "assessing Year 2000 issues
concerning its relationships with third parties on which Delta relies, including key business
partners, the Federal Aviation Administration [FAA], the U.S. Department of Transportation,
airport authorities, and suppliers." It warned, "There can be no assurance that the systems of third
parties on which Delta relies will be Year 2000 ready in a timely manner. The failure of third
parties to remediate their respective systems could have a material adverse effect on Delta's
business, financial condition, results of operations and liquidity."
None of the airlines mention that the FAA has a "model that will use the status of FAA systems'
Y2K compliance to determine the percentage of air traffic capacity afforded with that status. The
model will show, for example, that based on the current number of Y2K compliant systems, and
based on the character of those systems, the FAA systems could manage X% air traffic
capacity."(12)
Financial
Bank of America disclosed that it will spend $380 million to fix Y2K issues. This is the only
company I found that specifically noted that monies were set aside for "retention and incentive
payments." The sum is $80 million. Of the remaining $300 million budget, $131 million had
been spent through the first quarter. If this bank is putting up such big bucks to retain and attract
Y2K programmers, it may be at the expense of less-endowed organizations. I did not find any
report that disclosed the loss of key IT people and resulting setbacks in the remediation effort. I
have to believe that some companies must be experiencing this problem.
Citicorp will spend $600 million from 1997 through 1999. In other words, it only started last year. It spent $230 million so far: $80 million during the first quarter and $150 million in 1997. There is no mention of the fact that Citicorp does business in more than 100 countries, or what the risks are to the company if telecommunication, electric utility, and other vital systems fail to work in some of those countries in 2000.
* * *
1 All opinions are entirely my own and may or may not be shared by my company and its management.
2 http://www.senate.gov/~banking/97_11hrg/110497/witness/yardeni.htm
3 http://www.sec.gov/rules/othern/slbcf5.htm
4 http://www.yardeni.com/cyber.html#Y1.19
5 http://www.bog.frb.fed.us/boarddocs/testimony/19980428.htm
6 http://www.itpolicy.gsa.gov/mks/yr2000/exec.htm
7 http://www.fcc.gov/Speeches/Kennard/Statements/stwek824.html
8 http://www.mot.com/GSS/MCG/y2k/Y2K_mcg.html
9 http://support.intel.com/support/year2000/overview.htm
10 http://www.att.com
11 From presentation by Bob Bender, director, Long Distance Technology, Sprint Corp., "Countdown 2000, the Future Is Now!" at Spring '98 Government/Industry Forum: Telecommunications Year 2000 Compliance, sponsored by US General Services Administration.
12 http://www.faay2k.com/html/projplan.asp
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