Disclosure in Management's
|File No. S7-42-02|
Comments of the Edison Electric Institute
The Edison Electric Institute (EEI) is the association of the United States investor-owned electric companies, international affiliates and industry associates worldwide. Our U.S. members serve nearly 90 percent of all customers served by the investor-owned segment of the industry. They generate almost 70 percent of all the electricity generated by electric companies in the country and service about 70 percent of all ultimate customers in the nation.
EEI is submitting these comments in response to the proposed rulemaking by the Securities and Exchange Commission (SEC or the Commission) entitled "Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments," published in the Federal Register on November 8, 2002 at 67 Fed. Reg. 68054. That notice seeks comment on the Commission's proposal, as directed by new Section 13(j) of the Securities Exchange Act of 1934, added by Section 401(a) of the Sarbanes-Oxley Act (Act) of 2002, to require disclosure of off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of an issuer with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.
EEI agrees with the Commission's objectives of providing investors with the information and analysis necessary to gain a more comprehensive understanding of the implications of a company's obligations and contingencies from off-balance sheet arrangements that are neither readily apparent nor easily understood from a reading of the financial statements alone; and to better inform investors of the aggregate impact of short- and long-term contractual obligations and contingent liabilities and commitments, from both on- and off-balance sheet activities, by presenting a total picture in a single location in filings made with the Commission.
EEI does have comments on parts of the proposal to improve its workability for the Commission's consideration.
II. EEI comments on the Commission's Proposal
A. Definition of Off-Balance Sheet Arrangements
The proposed rules identify the scope of off-balance sheet arrangements potentially subject to disclosure to include "any transaction, agreement or other contractual arrangement...under which the registrant...has, or in the future may have" one or more of several potential obligations or transactions, including any obligation or liability, whether contingent or not. Further, the proposal indicates that one group of those potential obligations or transactions is "derivatives, to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements...."
EEI recommends two modifications to the definition of off-balance sheet arrangements to ensure that the final rule is more focused and improves disclosure rather than simply resulting in an increased volume of disclosure covering routine transactions. For reasons we discuss below, we are concerned that the proposed definition of off-balance sheet arrangements is too broad and that the text of the proposed rule regarding derivatives does not clearly reflect the explanatory commentary in the proposal.
We believe that the proposed definition of an off-balance sheet arrangement will include within its scope virtually every executory contract entered into by an entity. When combined with the proposal's low disclosure threshold as discussed later, this definition is likely to produce extremely lengthy disclosures about routine business transactions. We are concerned that the additional volume of disclosures that could result would be unlikely to add to reader knowledge and understanding and instead, by their sheer volume, may actually detract from readers' ability to focus on matters that are most critical. We do not believe that this result would benefit readers of financial reports, nor is it necessary in order to comply with the intent of the Act and address the abuses that led to the enactment of Section 401(a). Therefore, we recommend that the definition of an off-balance sheet arrangement be appropriately circumscribed in order to avoid the need to evaluate and disclose routine transactions entered into in the normal course of business.
Additionally, in the text of the proposed amendment, the definition of an off-balance sheet arrangement includes "derivatives to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements." It appears that this would incorporate all derivatives designated as normal purchases and normal sales and accounted for on the accrual basis under Statement of Financial Accounting Standards No. 133. However, elsewhere in the proposal, the explanatory commentary on this part of the definition cites as an example "derivatives that are classified as stockholder's equity under GAAP." Further, in explaining how to apply the proposed disclosure threshold, the proposal indicates the need to review only "equity-linked or -indexed derivatives."
We believe that this inconsistency should be addressed and resolved in the final rule. The proposal appears to focus on equity-linked or -indexed derivatives, but the text of Item 303(a)(4)(iii)(C) in the proposed rule does not reflect this intent as written and would result in contracts meeting the technical definition of a derivative but that were entered into in the normal course of business being considered off-balance sheet arrangements for potential disclosure, even though such contracts would be covered by other accounting and disclosure requirements related to loss contingencies. This would substantially increase the potential volume of disclosures, particularly if the proposed lower disclosure threshold is adopted in the final rule. Therefore, we recommend that the portion of the text of the proposed rule defining off-balance sheet arrangements be revised to clarify that it refers only to equity-linked or -indexed derivatives.
B. Off-Balance Sheet Arrangements - Disclosure Threshold
EEI believes that the proposed "remote" disclosure threshold for off-balance sheet arrangements goes beyond the requirements of Section 401(a) of the Sarbanes-Oxley Act and could potentially add to investor confusion and heightened frustration with financial disclosure. Such a potential result would be diametrically opposite to the aims of Sarbanes-Oxley.
While a reading of Section 401(a) can yield the interpretation reflected in the Commission's proposed rule, we believe that such an interpretation is far stricter than in that found in Generally Accepted Accounting Principles (GAAP) and other SEC rules. Utilizing the "remote" criterion is likely to add considerably to the volume and cost of disclosure by registrants without adding commensurate value for investors, who may be overwhelmed by the greater volume of disclosure. Investors may also be unnecessarily alarmed by disclosure of potential problems or events for which the likelihood of occurrence is extremely low. Also, applying the "remote" standard to the off-balance sheet arrangement section of Management's Discussion and Analysis (MD&A), while retaining the "reasonably likely" standard for the remainder of MD&A is likely to attribute undue prominence to the off-balance sheet arrangement information being disclosed. Disclosure of an off-balance sheet arrangement is appropriate when it becomes reasonably likely (rather than remote) that the arrangement may have a material current or future effect and is more in keeping with the spirit of more transparent financial reporting underlying Sarbanes-Oxley. Utilizing the reasonably likely standard will also result in more comparable disclosures among registrants by maintaining consistency within MD&A.
Should the Commission elect to retain the "remote" disclosure standard for off-balance sheet arrangements set forth in the proposed rule, we believe that standard should not be extended to the other sections of MD&A for the same reasons outlined above. The volume and cost of the additional information being provided will not produce commensurate benefits to investors and other users of financial statements and may instead produce confusion and unnecessary alarm.
To summarize the concerns of EEI and our members, we request that the proposed definition of an off-balance sheet arrangement be circumscribed to avoid the need to disclose routine transactions entered into in the normal course of business, and that the text of the proposed rule defining off-balance sheet arrangements be revised to clarify that it refers only to equity-linked or -indexed derivatives. We also believe that the proposed "remote" disclosure threshold for off-balance sheet arrangements goes beyond the requirements of Section 401(a) of the Sarbanes-Oxley Act and should be changed to a "reasonably likely" standard for disclosure of an off-balance sheet arrangement consistent with the present standard for MD&A. Nevertheless, if the proposed disclosure threshold for off-balance sheet arrangements is retained, we believe that it should not be extended to the remainder of MD&A.
If the Commission or its staff have any questions about these comments, please contact either me at the following phone number or David Stringfellow at (202) 508-5494.
David K. Owens
Executive Vice President, Business Operations
Edison Electric Institute
701 Pennsylvania Avenue, N.W.
Washington, DC 20004
December 9, 2002