July 18, 2002

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

Subject: File No. S7-16-02

Dear Mr. Katz:

The Committee on Corporate Reporting (CCR) of Financial Executives International ("FEI") appreciates the opportunity to respond to the Securities and Exchange Commission's (the "Commission's") Proposed Rule: Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies ("Proposed Rule") Release Nos. 33-8098 and 34-45907. FEI is a leading international organization of 15,000 members including Chief Financial Officers, Controllers, Treasurers, Tax Executives, and other senior financial executives. CCR is a technical committee of FEI, which reviews and responds to research studies, statements, pronouncements, pending legislation, proposals, and other documents issued by domestic and international agencies and organizations.

Overall, CCR supports the Commission's initiatives to improve the transparency of financial disclosures, which includes the identification of a company's significant accounting estimates. The objective should be to highlight the accounting estimates that are most important to the portrayal of a company's financial condition and results of operations and that require significant management judgment.

We believe most of our member firms made a good faith effort in response to Financial Reporting Release No. FR-60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies ("FR-60") issued in December 2001. The timing of the issuance so close to the calendar year-end reporting season left little time to react. Most of our firms believed that they were already providing investors with information on their most significant issues and accounting estimates in various sections of the 10-K.

Subsequently, we have learned that the Commission was generally not satisfied with the responses contained in the MD&A of the 2001 Form 10-K. We attribute part of this to a simple misunderstanding of the Commission's expectations. Many member firms believed that FR-60 was a request from the Commission for disclosure of critical accounting policies, and responded in kind by elaborating on the key policies already disclosed in footnotes. We believe that member firms would have provided more information on significant accounting estimates if the guidance had more clearly requested this type of discussion.

As noted above, while we agree with the underlying principles of the Proposed Rule, we have several significant issues with it. Specifically:

The remainder of our letter discusses each of our concerns in more detail.

Definition of Critical Accounting Estimate

On the surface, the definition of a critical accounting estimate appears to be relatively straight forward, yet it created considerable confusion when member firms were asked to identify their critical accounting estimates. It appears that many accounting estimates could be included in the Proposed Rule and result in excessive disclosures, which is counter to the Commission's objective to highlight only the "critical" accounting estimates. For example, based on the definition of a critical accounting estimate in the Proposed Rule, accounting estimates, like the actuarial assumptions used in estimating pension obligations, are included in the scope of the Proposed Rule. In order to comply with the Proposed Rule many companies would be required to include such disclosure because pension assumptions are about matters that are highly uncertain and different estimates could have been reasonably used and could have a material impact on a company's financial statements. However, we do not believe that the SEC intended to include pensions as a critical estimate because of the current extensive disclosure requirements regarding pensions.

We believe the problem described above results from the Proposed Rule not clearly defining "material", and registrants will be forced to rely on SAB 99 for guidance. The definition of "material impact" in SAB 99 is very narrowly defined today. We are concerned that a large number of accounting estimates have the ability to have a "material impact" in relationship to quarterly earnings and would be disclosed under the Proposed Rule as critical. We believe this to be inconsistent with the tone of the SEC release regarding a few "critical" accounting estimates. Therefore, we strongly recommend that the reference to "material impact" be removed. We believe the Commission's objective "to enhance investor's understanding of the existence of, and necessity for, estimations in a company's financial statements" can be best met by requesting companies to disclose their most significant accounting estimates. Otherwise, clearer guidance as to the definition of "material" is necessary to ensure that only those estimates that are significant to the portrayal of the registrant's financial condition are disclosed.

As the Commission has stated, "it is the responsibility of management to identify and address those key variable and other qualitative and quantitative factors which are necessary for an understanding and evaluation of the individual company." The scope of this proposal should ensure that only the most significant estimates are included. We believe FR 60 meets this objective and therefore we recommend that the Proposed Rule should be based on such guidance, which is to include disclosures about critical accounting estimates that management believes are most "critical". That is, the critical estimates are both most important to the portrayal of the company's financial condition and results, and they require management's most difficult, subjective or complex judgments.

The Commission should also make it clear that many estimates are necessary in the preparation of financial statements and that changes in other estimates not disclosed as critical may also be significant and that there is a safe harbor against second guessing.

Disclosure Overload

We believe that the level of detail required by the Proposed Rule is overwhelming and does not provide insight on the management of the company. We believe that expanding the MD&A disclosure by a few pages for each significant issue will not add to the quality of MD&A disclosure. Rather, it will add to the current problem of disclosure overload. The Proposed Rule is counter to the Commission's original objective, which is to highlight the significant accounting estimates. The proposed disclosure requirements are so expansive that they would overshadow management's discussion of other significant business issues. We encourage the Commission to provide more limited guidance and permit registrants to share discussions of information they believe would provide a clear depiction of management's development and use of significant estimates. As noted by Chairman Harvey L. Pitt in a June 2002 speech, disclosure that is "user-friendly, and designed to inform" is the Commission's aspiration. Since important issues vary by company, we believe this is best accomplished by general MD&A guidance, versus a one-size fits all approach that leads to disclosure overload and a "check the box" approach to disclosure. A requirement to concisely discuss a firm's most significant accounting estimates seems reasonable and is consistent with the Commission's objectives.

We continue to believe that disclosure overload is a significant issue and we urge the Commission to perform a comprehensive review of current disclosure requirements to determine whether they are still appropriate. As we mentioned in our comment letter dated May 21, 2002 regarding File No. S7-08-02, the overall burden of required disclosures is a significant stumbling block for many registrants attempting to accelerate their filings. This burden only increases with the Proposed Rule. Therefore we believe it imperative that the Commission initiates a project to alleviate the burden of current disclosures. We would be glad to participate in such a project to identify the "non-essential" disclosure requirements.

The following are our detailed comments on the Proposed Rule, as it relates to our concerns of disclosure overload.

Segment Disclosures

We believe that the disclosure of critical accounting estimates by segment should not be required. We believe that the disclosure by segment will only increase the size of the disclosure and not provide meaningful information. We are also concerned that based on the scope outlined in the Proposed Rule, there will be a significant amount of disclosures around critical estimates for each segment to ensure that the disclosures are not materially misleading.

Sensitivity/Quantitative Analysis

We strongly disagree with the Proposed Rule's requirements to include a sensitivity/quantitative analysis in the critical accounting estimate disclosures, as we do not believe that the information will be beneficial to users, and may only serve to confuse users. Sensitivity analyses can be misleading, especially when there are several significant assumptions that may be inter-related that are used to develop an estimate. When there is more than one material assumption, there may not be any benefit to change one assumption and hold the others constant, as the assumptions may be dependent on one another. In addition, there may be mitigating factors that would not be readily discernable to the reader and could lead to a misinterpretation of the information provided. Instead, the disclosure should provide an appropriate level of qualitative information that can be easily understood and interpreted. We believe it is more beneficial to disclose those assumptions management had to make, why those assumptions were chosen, and what would cause those estimates to change, rather than providing a sensitivity analysis or a range of estimates. We believe that a robust qualitative disclosure could provide much more meaningful information than required quantitative disclosures and still achieve the Commission's objective of highlighting to shareholders a company's significant estimates.

Specifically, we are significantly concerned with the requirement to select and disclose a range of estimates/sensitivities "that a company reasonably could have used" as it relates to the disclosure of potential liabilities resulting from litigation and tax audits. Companies would be required under the Proposed Rule to disclose possible conclusions in litigation and or tax audits, both of which are inherently subject to a wide range of outcomes and the disclosure of which could undermine a company's negotiating position.

Moreover, the "hindsight exposure" of being second-guessed is clearly a no-win situation for companies and their shareholders. Having to continually explain to shareholders and analysts why a certain assumption or estimate was not used detracts the users from understanding the true results of management's decisions. We are also concerned that analysts would inappropriately use this information to create a range of possible EPS numbers each quarter based on the range of estimates that would be disclosed under the Proposed Rule. This type of unintended reaction could further undermine financial reporting, as users will look to the higher or lower estimate in the range to assess the company's performance, which may not be the results that management uses to assess performance.

Alternative Accounting Policies

We strongly object to including discussions of the impact of alternative accounting policies. We believe that this type of disclosure will only invite "second guessing" and result in companies having to continually explain their choices in selection of accounting policies. Furthermore, there would be an incremental non-value adding cost incurred to comply with and reconcile alternative accounting policies. We believe the focus of the disclosure should be on the policy adopted, not those policies rejected. Further expanding the MD&A disclosure to include the effect of utilizing alternate possible accounting policies or changes in policies that did not have a material impact we believe would lead to, in the SEC's words "overly extensive disclosure of marginal use."

Format and Content

We support the Commission's view of MD&A, as expressed in Financial Reporting Release No. FR 36, Management's Discussion and Analysis of Financial Condition and Results of Operations; Certain Investment Company Disclosures, that a "flexible approach elicits more meaningful disclosures and avoids boilerplate discussions which a more specific approach could foster." This flexible approach should apply to both the format and content of MD&A. The disclosure should be consistent with the information management uses to develop significant estimates and should focus on decisions made by management.

We are against the creation of a stand-alone section of MD&A that gives the "appearance" that these accounting estimates are more important than other business issues. We believe that the MD&A should focus on providing a narrative explanation of the financial statements from a management perspective. Companies should be allowed to choose where the information is presented. Integrated disclosure may help to minimize redundant disclosure in the Form10-K. The understanding of a subject within the discussion is actually more meaningful when the underlying accounting policy is included with it. The estimate can be easily highlighted as critical versus including as part of a separate section.

The accounting rules already require footnote disclosure of this information and MD&A is not intended to restate information that has been included in either the financial statements or the notes to the financial statements since they are considered an integral part of the statements. The MD&A is designed to "provide such other information that the registrant believes to be necessary to an understanding of its financial condition, changes in financial condition, and results of operations." We request that registrants be allowed to continue with this responsibility and to add appropriate disclosure concerning critical accounting estimates, where needed.

We believe that such an approach will encourage companies to "go further" and will differentiate management that has done a thorough integrated analysis from management that compiled data superficially and off line.

Accelerated Filings

If this proposal moves forward, we request that the Commission consider the proposal on accelerated filing deadlines when deciding on an appropriate effective date for the Proposed Rule. As discussed in our comment letter on accelerated filing deadlines, we believe there exists today a significant amount of non-essential disclosures that should be eliminated before new disclosures are required and filing deadlines are accelerated. We therefore urge the Commission to address this issue before consideration of shortened filing deadlines. We are concerned that the quality of the disclosure in filings will diminish, as registrants will work to meet all of the reporting requirements in this accelerated timeframe.

Other Items

  • Management should be allowed the flexibility to decide what presentation format works best for their particular situation. Mandating standardized formats for quantitative disclosures should be avoided.

  • Since the board of directors sign and approve the 10-K, a boilerplate statement indicating the company's senior management has discussed the development and selection of the accounting estimate is not warranted. It should be presumed that appropriate discussions have taken place. A required disclosure such as this becomes meaningless when it becomes just another item on the firm's disclosure checklist. Practically speaking, there should never be unresolved concerns of the audit committee related to any of the MD&A disclosure.

  • We oppose a requirement that critical accounting estimate disclosures undergo an auditor examination comparable to that enumerated in AT §701. Most likely this would result in an increase in the cost of the audit without a significant benefit. The auditors have presumably audited these estimates in connection with the audit of the financial statements and additional scrutiny seems unnecessary. In addition, the information provided in the MD&A would generally be forward-looking, so their responsibility would be limited in that respect.  

  • We fail to understand why the proposal has been extended to the "initial adoption" of an accounting principle and includes the requirement to discuss those principles, which were previously immaterial. This appears to contradict the phrase "initial adoption". It seems that an accounting principle adopted which had a previously immaterial impact but which became material would be addressed in a footnote and not repeated in MD&A. For long established companies this proposal on initial adoption will not add much value.

    * * *

    We appreciate the Commission's consideration of these important matters and welcome the opportunity to discuss any and all issues with the Commission at its convenience. If you have questions regarding this letter, please feel free to call David Sidwell at (212) 270-1892.


    Frank H. Brod
    Chair, Committee on Corporate Reporting
    Financial Executives International

    David H. Sidwell
    Chair, SEC Subcommittee of the Committee on Corporate Reporting
    Financial Executives International