Cleary, Gottlieb, Steen & Hamilton

WASHINGTON, D.C. 20006-1801

75008 PARIS

RUE DE LA L01 23



one liberty plaza
new york, ny 10006-1470
(212) 225-2000
(212) 225-3999
00187 ROME

20121 MILAN

115054 MOSCOW



December 9, 2002

Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609
Attention: Jonathan G. Katz, Secretary

Re: File No. S7-42-02-Disclosure Required by
Section 401(a) of the Sarbanes-Oxley Act of 2002

Ladies and Gentlemen:

We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the Commission's proposed rules (the "Proposed Rules") to implement Section 401(a) of the Sarbanes-Oxley Act of 2002 (the "Act").1 We commend the Commission and its staff for the high quality and speed of their efforts in carrying out the regulatory mandates of the Act, and we appreciate the opportunity to comment on the Proposed Rules.

I. The rules should not set a lower threshold for disclosure concerning off-balance sheet arrangements.

Section 401(a) of the Act requires the Commission to issue "rules providing that each annual and quarterly financial report required to be filed with the Commission shall disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations) and other relationships of the issuer with unconsolidated entities or other persons that may have a material current or future effect on financial condition, results of operations, liquidity, capital expenditures, capital resources or significant components of revenues or expenses." The Proposed Rules would require the new disclosures to be included in a separately captioned section of the "management's discussion and analysis" ("MD&A").

In the Proposed Rules, the Commission interpreted the use of the word "may" in Section 401(a) to mean that disclosure concerning off-balance sheet arrangements would be required if the likelihood that they will have a material effect on the issuer is "not remote."2 The Commission acknowledged in the proposing release that the "not remote" threshold is lower than the "reasonably likely" threshold applicable to other disclosures under the Commission's current MD&A rules and solicited comment as to whether the "not remote" threshold is appropriate.

For several reasons, we firmly believe that the final rules should, consistent with historical and current principles governing MD&A disclosures, require disclosure concerning off-balance sheet arrangements only to the extent that they are "reasonably likely" to have a material effect on the financial statement line items specified in Section 401(a) of the Act. Beginning with the word "may" itself, one dictionary definition provides that the word "may" is "used to indicate possibility or probability."3 In light of the at least equal weight accorded in this definition to a probability standard that, in our view, is much closer to a "reasonably likely" rather than a "not remote" test, we believe that Congress granted to the Commission the authority to issue rules based on the higher "reasonably likely" threshold. By contrast, the same dictionary states that the word "might" is "used . . . to express . . . less possibility or probability than `may.'"4 In our view, the choice of the word "may" rather than "might" in Section 401(a) thus is consistent with a "reasonably likely" standard rather than a "not remote" standard.

This view is buttressed by consideration of the unintended consequences of applying a "not remote" threshold to the required disclosures concerning off-balance sheet arrangements. The use of the "not remote" standard would represent a significant departure from the historical analytical framework applicable to MD&A disclosures and could in fact lead to less meaningful disclosure. As noted in the proposing release, a lower threshold could give rise to "voluminous disclosure" regarding off-balance sheet arrangements that could overwhelm investors with "insignificant details." Although issuers theoretically could narrow the reach of the "not remote" standard by applying a higher threshold of materiality to contingencies with a degree of probability that is less than "reasonably likely," the prospect of hindsight reassessment of probability makes this course too risky. As a result, if "not remote" were the applicable threshold, issuers likely would feel pressured to describe a multitude of speculative scenarios, with the result that the disclosure would become confusing and opaque. We believe that it could not have been the intent of Congress to require this result. Further, as noted in the proposing release, a lower threshold for the required disclosures about off-balance sheet arrangements would tend to attribute undue prominence to those disclosures in comparison to other MD&A disclosures that are equally important, if not more so, such as the analysis of results of operations and liquidity and capital resources generally. Again, we believe that it could not have been the intent of Congress to require this result.5

For all of the foregoing reasons, we strongly urge the Commission to adopt rules requiring that an issuer make disclosures regarding off-balance sheet arrangements only to the extent that those arrangements are "reasonably likely" to have a material current or future effect on the financial statement line items of the issuer that are specified in Section 401(a) of the Act.

II. The Commission should simplify the Proposed Rules.

The specific disclosure requirements set forth in the Proposed Rules6 are extremely detailed, and for several reasons we urge the Commission to reconsider this approach. First, the Proposed Rules are far more detailed than is expressly required by Section 401(a) of the Act. Issuers already face the daunting task of complying with the entire range of obligations created by the Act within the short time frames specified by the Act, and we do not believe that the Commission should add to that compliance burden by creating specific disclosure requirements that are not expressly required by the Act when, in our view, such requirements would not provide significant benefits to investors.

In addition, based on our experience with the disclosure process, we believe that such detailed disclosure requirements will result in disclosure that is both unnecessarily complex and mechanical, even if "reasonably likely" rather than "not remote" is the applicable disclosure threshold. This result, which will only serve to confuse investors, is particularly likely if the Proposed Rules are adopted without the benefit of any transition period. Moreover, adopting a "check-the-box" approach (which both the Commission and others in fact have criticized in the accounting context) will likely fail to elicit thoughtful disclosure, while at the same time undermining the more principles-based approach of the existing MD&A rules. We believe that the Commission should, consistent with its historical philosophy in the area of MD&A, address the mandate of Section 401(a) by means of a more general proposal that would identify the categories of concerns to be addressed and the kinds of information that may be useful in addressing those concerns. We believe that most registrants will seek in good faith to comply with this sort of approach and that, for the other registrants, additional specificity will have little or no utility.

In any event, the Commission should reduce the level of detail expressly required from foreign private issuers under the Proposed Rules. The detailed, "check-the-box" approach of the Proposed Rules runs counter to the Commission's substantial efforts at global harmonization of disclosure standards. The current MD&A requirements of Form 20-F were adopted in 1999 as part of a complete revision of the Form based on international disclosure standards adopted by the International Organization of Securities Commissions ("IOSCO") in September 1998 (the "IOSCO Standards").7 The IOSCO Standards represent a negotiated approach reflecting U.S. disclosure requirements in many important respects, including in the area of MD&A. The Commission was right in supporting a harmonized approach and in demonstrating its support by making the United States one of the first countries to adopt the IOSCO Standards. Extensive new disclosure obligations not expressly required by Section 401(a) of the Act would clearly undermine this hard-won achievement.

III. The rules should expressly provide that foreign private issuers need only provide the required disclosures with respect to their primary GAAP financial statements.

Foreign private issuers that file Annual Reports on Form 20-F or Form 40-F with the Commission typically do not prepare their primary financial statements in accordance with United States generally accepted accounting principles ("U.S. GAAP") but rather prepare financial statements in accordance with some other comprehensive body of accounting principles ("non-U.S. GAAP") and are generally required to provide a reconciliation of net income and shareholders' equity to U.S. GAAP. The proposed rules do not make clear whether foreign private issuers must provide the required disclosures with respect to the impact of off-balance sheet activities on the specified financial statement line items both under non-U.S. GAAP and, to the extent relevant to the U.S GAAP reconciliation, under U.S. GAAP. Given that the Proposed Rules do not include amendments to the provisions of Form 20-F and Form 40-F that require reconciliation of non-U.S. GAAP financial information to U.S. GAAP,8 we believe that the Commission did not intend to expand the U.S. GAAP reconciliation requirements to require additional disclosures concerning off-balance sheet transactions. This view is supported by the the Commission's interpretive release of January 22, 2002 (the "January 2002 Release") relating to disclosure concerning off-balance sheet arrangements, contractual obligations and contingent liabilities and commitments,9 which did not expressly require any additional disclosures from foreign private issuers on a U.S. GAAP basis. Requiring additional disclosures concerning off-balance sheet transactions on both a U.S. GAAP and a non-U.S. GAAP basis would impose a significant compliance burden on foreign private issuers that would not be shared by domestic issuers. We therefore strongly urge the Commission to confirm in the final rules that, as we believe the Commission intended, foreign private issuers need only provide the required disclosures with respect to their primary financial statements.

IV. The Commission should clarify by rule that the forward-looking statements safe harbor applies to all forward-looking statements made in MD&A.

The Proposed Rules contain a limited safe harbor for "forward-looking information," and the Commission specifically requested comment in the proposing release as to whether the proposed safe harbor should be expanded to cover all forward-looking information in MD&A, regardless of whether such information relates to off-balance sheet arrangements. As there are important interrelations between the different subsections of the MD&A (e.g., between the discussion of liquidity and capital resources and the discussion of off-balance sheet arrangements), it could be difficult in practice to determine which statements are in fact specifically covered by the proposed safe harbor. In addition, given the importance that the Commission historically has placed on encouraging registrants to provide forward-looking information in the MD&A, we do not see a meaningful policy reason to limit the proposed safe harbor provisions to the required disclosures concerning off-balance sheet arrangements. To promote more meaningful disclosure throughout the MD&A, and to avoid interpretive questions as to where the proposed safe harbors for disclosures concerning off-balance sheet arrangements begin and end, we encourage the Commission to expressly clarify in the final rules that the safe harbors apply to forward-looking statements made in any part of the MD&A and not merely to those made in the required disclosures concerning off-balance sheet arrangements.

V. The rules should provide for a transition period.

Particularly if the detailed disclosure requirements set forth in the Proposed Rules and noted in Part II above are not simplified prior to their adoption, the Commission should provide for a transition period. Absent any transition period, and in light of the requirement of the Act that final rules under Section 401(a) of the Act be adopted not later than January 26, 2003, the final rules would apply to Annual Reports on Forms 10-K, 20-F and 40-F filed with the Commission with respect to calendar year 2002, which, in the case of Form 10-K, would require implementation within two months of adoption. While the Proposed Rules mirror in many respects the guidance provided by the January 2002 Release, the Proposed Rules go on to require disclosure of significant additional information not required by the January 2002 Release. As a consequence, we expect that the new rules will impose significant data collection burdens on issuers with respect to information that has not historically been captured by their internal data collection systems. We believe that many issuers will not be in a position to provide meaningful disclosure in an annual report in response to aspects of the Proposed Rules that were not covered by the January 2002 Release unless they have had in place, during the year covered by the report, data collection procedures that would record, process, summarize and report the relevant information. For this reason, we respectfully suggest that the final rules first take effect with respect to annual reports for fiscal years ending on or after September 15, 2003. We believe that, pending effectiveness of the final rules, the Commission and investors would be able to take significant comfort from the fact that reporting issuers will continue to be guided by the January 2002 Release in connection with their disclosures concerning off-balance sheet arrangements.

* * * * *

We thank you for the opportunity to comment on the proposed rules. We would be happy to discuss with you our comments or any other matters that you feel would be helpful in your review of the proposals. Please do not hesitate to contact Craig B. Brod or Leslie N. Silverman in New York (212-225-2000) or Edward F. Greene in London (44-20-7614-2200) if you would like to discuss these matters further.

Very truly yours,


1 SEC Release Nos. 33-8144; 34-46767 (November 4, 2002).
2 The Commission noted in the proposing release that the term "remote," for this purpose, would have the meaning assigned to it in the Financial Accounting Standards Board's Statement on Financial Accounting Standards ("SFAS") No. 5, "Accounting for Contingencies." SFAS No. 5 states that the likelihood of a future event is "remote" if "the chance of the future event occurring is slight." [Emphasis added.]
3 Webster's Collegiate dictionary 719 (10th ed. 1995).
4 Id. at 737 (emphasis added).
5 We do not believe that it would be appropriate to solve this problem by lowering the threshold for other MD&A disclosures to "not remote." Substantial law and lore have developed regarding MD&A disclosures that currently guide issuers and their advisers in the preparation of the MD&A. In the absence of a clear legislative mandate to apply the "not remote" threshold to all MD&A disclosures, we do not believe that one possible interpretation of Section 401(a) as applied to off-balance sheet arrangements should lead to such a dramatic change in the general MD&A requirements. This is particularly the case in light of the fact that, due to the statutory deadline of January 26, 2003, final rules under Section 401(a) will likely be adopted without further opportunity for comment. Moreover, we note that applying the "not remote" threshold to all MD&A disclosures would merely compound the problem of voluminous disclosure of insignificant details.
6 See, e.g., paragraphs (A) through (D) of proposed Item 303(a)(4)(i) of Regulation S-K.
7 Release Nos. 33-7745; 34-41936 (September 28, 1999).
8 Item 17 of Form 20-F and General Instruction C(2) to Form 40-F.
9 Release Nos. 33-8056; 34-45321; FR-61.