July 19, 2002

Mr. Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549-0609

Re: Disclosure in Management's Discussion and Analysis
About the Application of Critical Accounting Policies
67 FR 35620 (May 20, 2002); File No. S7-16-02

Dear Mr. Katz:

America's Community Bankers (ACB)1 is pleased to comment on the Securities and Exchange Commission's (SEC) proposal to require public companies to include in the Management's Discussion and Analysis (MD&A) section of disclosure documents a discussion of accounting estimates and policies that are used in the preparation of financial reports2. The proposal would require a discussion about the critical accounting estimates a public company uses when applying its accounting policies and disclosure of the initial adoption of an accounting policy that has a material impact on the company's financial performance. While our comments are specific to the concerns of our community bank members, we believe these concerns will be shared by other small business organizations.

ACB Position

ACB supports the SEC in its efforts to improve the quality of corporate disclosure and to make the financial presentation of a public company's results of operations more transparent to shareholders and the general public. ACB does not believe, however, that the current proposal will meet the SEC goal of enhancing an investor's understanding and analysis of a company's financial performance and may have the opposite effect of confusing the investor. The amount of information required to be provided about accounting estimates, particularly the requirement to provide quantitative information using alternative assumptions and estimates, would add a large amount of subjective data that would be of questionable use to an investor's analysis of the company's financial performance and condition. A requirement to provide this additional detail in the MD&A also would conflict with the SEC's goal of accelerating the filing of annual and quarterly reports. Furthermore, providing detailed information about assumptions and estimates used by a company could have a negative competitive effect since that information would give competitors insight into the company's business strategies and forecasts.

ACB believes that current accounting principles and SEC rules on information to be included in a company's MD&A and financial statements are adequate to elicit sufficient disclosure about items (including accounting estimates) that could produce material changes to financial performance or condition. ACB notes that in addition to this proposal on accounting estimate disclosure, the SEC is considering other changes to improve the information that is contained in the MD&A section of public disclosure documents.3 To the extent that the SEC believes additional accounting disclosure is necessary, any such proposal should be contained in a more comprehensive revision to the MD&A section focusing on what management considers to be the most important factors in determining financial results. This would ensure that any discussion of accounting estimates would be fully integrated with the remainder of the MD&A discussion and all items that have an impact on financial results would be presented in a coordinated fashion.

ACB members, half of whom are publicly traded, recognize the importance of avoiding accounting irregularities in the financial institution industry since reputation and integrity are so vital to the industry's success. Community banks and their financial performance are subject to substantial regulation and oversight by Federal and state bank regulators which helps ensure the integrity of financial reports. In fact, community banks have been successful recently in attracting capital because investors view the banks, with their straightforward business operations, as safer investments during this uncertain time.4 The amount of information that would be required by this proposal will provide no significant benefit, but will be considerably burdensome for our community bank members and other small business organizations and could act as a disincentive to nonpublic companies who may consider looking to the public markets for capital.

The Proposal

The proposal would require that public companies add to the MD&A section of disclosure documents certain information about critical accounting estimates and disclosures about the initial adoption of an accounting policy that has a material impact on a company's financial presentation.

Critical Accounting Estimates

A critical accounting estimate would be an accounting estimate that requires assumptions to be made on matters that are highly uncertain when different estimates that reasonably could have been used, or changes in the estimate that are reasonably likely to occur from period to period, would have a material impact on the company's financial performance or condition. The company would have to disclose a substantial amount of information for each critical accounting estimate, including a description of the estimate, the methodology and assumptions used, the significance of the estimate to financial performance, and any known trends, demands, commitments, events or uncertainties that are reasonably likely to occur and materially affect the methodology or assumptions described. The company also would have to discuss why different estimates could have been used or why the estimate is reasonably likely to change from period to period. Disclosure would have to include a quantitative analysis showing the results to financial performance assuming that reasonably possible near-term changes occur, both negative and positive, in the most material assumptions underlying the estimates, or assuming that the accounting estimate was changed to the upper and lower end of a range of reasonable possibilities. A quantitative and qualitative discussion of material changes to accounting estimates used in the past also would have to be included.

ACB believes that any potential benefit to investors of having this detailed information would be far outweighed by the burden, cost and negative consequences of providing this disclosure. Providing the amount of detailed information about accounting estimates, assumptions and methodology required by the proposal will provide critical information about a financial institution's operations, forecasts and business strategies that could be useful to competitors. While ACB could support a requirement to provide general information about the critical accounting estimates that are material to financial performance, and believes that such information already should be provided under current rules, the more detailed information will not add much useful information to an investor, but could negatively impact the reporting company from a competitive standpoint.

The requirement to provide quantitative and qualitative information about the impact of alternative assumptions or an upper and lower range of estimates will only add additional confusion since most investors would not have the information or expertise necessary to analyze the likelihood that the alternative scenarios will occur. In addition, if there is more than one critical accounting estimate involved, and the SEC anticipates that the vast majority of companies would have three to five, or if several material assumptions underlie an estimate, the discussion would become extremely complex and confusing. The accounting information would overwhelm and upstage the discussion about the results of operations contained elsewhere in the MD&A that may actually provide useful information to the investor. A requirement to provide this level of detail and analysis also would conflict with the SEC's stated goal of accelerating the filing deadlines for quarterly and annual reports. Although ACB is not taking a position on the acceleration proposal in this letter, ACB believes that it would be difficult for companies to perform the extra amount of work and sophisticated modeling that would be required for the preparation of the quantitative and qualitative analysis in a shortened filing period.

A requirement to provide the quantitative information could increase a company's potential for liability since alternative estimates or the use of ranges will be based solely on management's judgment and will be subject to change due to unforeseen events. This is particularly the case for financial institutions since assumptions often need to be made about hard to predict changes to more general economic and specific industry conditions. The sensitivity analysis could leave the institution exposed to liability to the extent that management fails to take into account some remote events that actually do occur. Although the proposal would apply the safe harbor protection for forward-looking statements to the accounting information, it is unclear what level of protection would exist since this is the first time that SEC rules would require the use of forward-looking information in the MD&A.

ACB believes that current accounting principles and SEC rules on information to be included in MD&A and financial statements are adequate to elicit sufficient disclosure on accounting issues. General information about the effect of accounting policies and estimates on financial performance and condition already should be disclosed under existing SEC rules. For example, MD&A disclosure rules currently require a discussion of a company's results of operations, liquidity and capital resources and other information necessary to an understanding of the company's financial presentation. Public companies also must disclose known trends, demands, commitments, events and uncertainties that are reasonably likely to occur and have material effects. Furthermore, companies are required to provide in financial statements specific information about accounting policies and estimates to inform investors that the effect of future events are uncertain and are, therefore, subject to change. With regard to certain activities of financial institutions, such as financial asset securitization, accounting principles already require that a company analyze and provide information about sensitivity of results to specified changes in assumptions.5 If the SEC believes that additional disclosure is warranted, an alternative, more desirable and more effective approach would be to adopt industry specific, best practices guidelines that more clearly address SEC concerns and clarify disclosure requirements for particular industry activities.

The proposal would require disclosure about whether senior management has provided information about critical accounting estimates to the audit committee or other board committee with oversight of the financial reporting process. ACB believes that management should be discussing the adoption of accounting policies and information related to assumptions and estimates used in the preparation of financial statements with the appropriate oversight committee. Investors expect that the oversight committee is properly conducting its oversight function and is aware of material accounting decisions made by management. ACB does not oppose the proposal to add disclosure in the MD&A regarding communication between management and the audit committee if the SEC believes that the requirement could serve as a catalyst for insuring that the appropriate discussion takes place.

Adoption of an Accounting Policy

The proposal would require a public company to provide certain information about the initial adoption of an accounting policy in a separate section of the MD&A. A company would have to discuss the event or transaction giving rise to the initial adoption, a description of the principle adopted and the method of applying the principle, and the impact on financial performance. The company also would have to provide a discussion of whether alternative accounting principles were available and, if so, why the alternatives were not chosen and the impact of the alternatives. If no accounting literature exists to govern the accounting of the event or transaction, an explanation of the company's decision to use the chosen principle and the manner of application must be discussed.

As the proposal indicates, current accounting principles require a public company to discuss the adoption of a significant accounting policy in the notes to financial statements, but the disclosure requirement may not elicit an adequate description of the policy's impact on financial performance.6 ACB believes that any discussion of the impact on financial performance resulting from the adoption of a significant accounting policy would be more appropriately included with other information about the policy in the notes to the financial statements. ACB does not, however, oppose disclosing this information in the MD&A if the SEC believes that it would be more visible to investors. ACB also supports inclusion of information about how the company decided to use the chosen policy when other alternatives existed or there was no accounting literature addressing the subject. ACB opposes, however, any requirement to discuss the impact on financial performance that would result from the use of another available accounting policy for the transaction or event. It would place a significant burden on the reporting company and it is not clear how this information could be beneficial to investors if it is not the policy chosen by the company.


ACB supports the SEC in its efforts to bring more transparency to the financial information disclosed by public companies so that investors will have faith in the integrity of the public markets. ACB hopes that any changes to disclosure adopted by the SEC will provide meaningful and useful information to investors while minimizing the burden on reporting companies.

ACB appreciates the opportunity to comment on this matter. If you have any questions, please contact the undersigned at (202) 857-3121 or via e-mail at cbahin@acbankers.org, or Diane Koonjy at (202) 857-3144 or via e-mail at dkoonjy@acbankers.org.


Charlotte M. Bahin
Director of Regulatory Affairs
Senior Regulatory Counsel

1 ACB represents the nation's community banks of all charter types and sizes. ACB members, whose aggregate assets exceed $1 trillion, pursue progressive, entrepreneurial and service-oriented strategies in providing financial services to benefit their customers and communities.
2 67 Fed. Reg. 35620 (May 20, 2002).
3 67 Fed. Reg. 35622-35623 (May 20, 2002).
4 John Reosti, `Flight to Safety' Driving Capital to Small Banks, American Banker, July 10, 2002.
5 Financial Accounting Standards Board Statement of Financial Accounting Standards No. 140.
6 67 Fed. Reg. 35635-35636 (May 20, 2002).