1111 Superior Avenue
Cleveland, OH. 44114-2584
tel: 216 523-4122
December 9, 2002
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
Re: File No. S7-42-02 - Proposed Rule - Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments
Dear Mr. Katz:
We are submitting for your consideration our comments concerning the proposed rule of the Securities and Exchange Commission referenced above.
Proposed Item 303(a)(4) would require that registrants disclose specified categories of information concerning "off-balance sheet arrangements" that may have a current or future material effect on their financial condition, changes in financial condition, revenue or expense, results of operations, liquidity, capital expenditures or capital resources. Disclosure would not be necessary if the likelihood of either the occurrence of an event implicating an off-balance sheet arrangement, or the materiality of its effect, is remote.
Proposed Item 303(a)(4) would define the term "off-balance sheet arrangement" as follows:
". . . off-balance sheet arrangement means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with the registrant is a party, under which the registrant, whether or not a party to the arrangement, has, or in the future may have . . . [a]ny obligation or liability, including a contingent obligation or liability, to the extent that it is not fully reflected in the financial statements (excluding the footnotes thereto) . . . Contingent liabilities arising out of litigation, arbitration or regulatory actions (not otherwise related to off-balance sheet arrangements) are not off-balance sheet arrangements."
We request that the Commission substantially revise proposed Item 303(a)(4), because (1) it is so broadly drafted that it would apply to routine contractual arrangements and business transactions that present little risk to investors, (2) it would confuse investors by imposing different disclosure standards for contingencies that are of equal concern to them and (3) it would result in unnecessary duplication of disclosures.
- The proposed definition of "off-balance sheet arrangement" is so broadly drafted that it would include such routine contractual arrangements and transactions with totally unrelated third parties as business divestiture agreements, product warranties, technology licensing agreements, agreements to purchase materials and components, agreements with administrators of employee benefit plans, collective bargaining agreements with labor unions, insurance policies, guarantees of the obligations of wholly-owned consolidated subsidiaries that are set forth on the registrant's consolidated balance sheet and product sales that may be the basis of product liability litigation. These are not the types of arrangements that were involved with the corporate scandals the led to the adoption of Section 401(a) of the Sarbanes-Oxley Act, and should not be encompassed by the disclosure requirements of proposed Item 303(a)(4). The scandals that led to the adoption of Section 401(a) involved arrangements with parties in which the registrant, or its officers or directors, had some financial interest. The definition of "off-balance sheet arrangements" should be limited to those types of arrangements.
- Proposed Item 303(a)(4) would require disclosure if the likelihood of either the occurrence of an event implicating an off-balance sheet arrangement, or the materiality of its effect, is greater than remote. This is a lower threshold for disclosure than the standard which is imposed by Release No. 33-6835, 34-26831 for other contingencies of equal concern to investors that also must be disclosed in the MD&A. The disclosures resulting from these inconsistent requirements will be confusing to investors. The existing disclosure standard set forth in Release No. 33-6835, 34-26831 should apply to all contingencies described in the MD&A.
This inconsistency would extend to litigation, arbitration and regulatory actions. Although the proposed definition of "off-balance sheet arrangements" would exclude contingent liabilities arising out of litigation, arbitration or regulatory actions, the exclusion is virtually meaningless because it excepts those actions that are otherwise related to off-balance sheet arrangements. The result would be that these actions related to off-balance sheet arrangements would be subjected to a disclosure standard that is not applicable to other litigation, arbitration and regulatory contingencies that are of equal concern to investors. This makes little sense and, as indicated above, will be confusing to investors.
- The proposed definition of "off-balance sheet arrangements" would include contingent obligations and liabilities that are disclosed in the footnotes to the financial statements, but not in the financial statements themselves. The result will simply be unnecessary duplication of disclosure, with no benefit to investors. If a contingency is disclosed in the footnotes to the financial statements, it should not have to be repeated in the MD&A.
Item 303(a)(5)(i) would require disclosure in a tabular format of specified information regarding a registrant's known contractual obligations as of the latest balance sheet date. The tabular presentation would have to disclose the amounts of the payments due under these contractual obligations for the following periods: less than one year, one-to-three years, three-to-five years and more than five years. The obligations would be separated into the following categories or into other categories suitable to the registrant's business: long-term debt, capital lease obligations, operating leases, unconditional purchase obligations, other long-term obligations and total contractual obligations.
Item 303(a)(5)(ii) would require disclosure, either in text or in tabular format, of the expected amount, range of amounts or maximum amount of contingent liabilities or commitments, aggregated by type in a manner that is suitable for the registrant's business, that are expected to expire in less than one year, in one-to-three years, in three-to-five years and in more than five years.
We request that the Commission not adopt Item 303(a)(5), because the disclosures that would be required by this item would, at best, not be helpful to investors, and, at worst, may be confusing to them, and because compliance with the requirements of this Item would be burdensome to registrants. If the Commission does adopt this item, then it would require substantial clarification.
- The disclosures that would be required by Items 303(a)(5)(i) and (ii) would combine such a wide variety of different contractually arrangements, many of which are executory and depend upon numerous, different future conditions or future performance by third parties in order to create enforceable obligations against the registrant, that the resulting disclosure would be of little value to investors, in addition to being extremely burdensome to prepare. This reason alone provides sufficient justification not to adopt these proposed Items.
- Both Item 303(a)(5)(i) and (ii) would appear to require aggregated disclosures of liabilities which both do, and do not, appear on the balance sheet. Since investors would have no way of identifying liabilities disclosed pursuant to these Items that also appear on the balance sheet, these disclosures could not be used in any meaningful way in conjunction with a registrant's financial statements.
- The inter-relationship between the disclosures required by Item 303(a)(5)(i) and (ii) is not clear. Item 303(a)(5)(i) would require disclosure of known contractual obligations, which might include contingent obligations. For example, the tabular presentation proposed by Item 303(a)(5)(i) would include a row for "Other Long-Term Obligations," which could include contingent contractual obligations, such as obligations to purchase products or services in the future if the registrant is able to continue its relationship with its own customer. Would these and other contingent obligations be reported in response to Item 303(a)(5)(i), or would they be reported in response to Item 303(a)(5)(ii)?
- Item 303(a)(5)(i) and (ii) propose presentations that would separate obligations into at least four different time periods, as indicated above. In our view, this approach is not suitable for contingent obligations and commitments, due to the uncertainty of the contingency.
- Item 303(a)(5)(i) proposes a tabular presentation that would include a column for payments due in less that one year. The proposed tabular presentation includes a row for long-term debt but does not include any row for short-term debt. Does this mean that short-term debt is not required to be disclosed in the table?
The heading for the proposed Item 303(a)(5)(i) tabular presentation provides for "Payments due by period." Does this mean that no disclosure would be required with respect to contractual obligations to deliver products or services, instead of making payment for products or services?
One of the rows in the proposed Item 303(a)(5)(i) tabular presentation provides for disclosure of unconditional purchase obligations. Is this row intended to apply only to those purchase arrangements for which the product or service has already been delivered at the balance sheet date, since the purchase obligation would typically be conditional upon delivery?
The last row in the proposed Item 303(a)(5)(i) tabular presentation provides for "Total Contractual Obligations." Is this row intended to be simply the totals of the other rows in the table, or is it intended to include those totals plus other contractual obligations not reflected in the other rows in the table?
- In contrast to Item 303(a)(4), which provides that no disclosure is required if the likelihood of either the occurrence or the materiality of effect is remote, Item 303(a)(5)(ii) does not include any contingency standard. If the Item 303(a)(4) standard is applicable to Item 303(a)(5)(ii), then Item 303(a)(5)(ii) should be modified accordingly.
If the Item 303(a)(4) standard is applicable to Item 303(a)(5)(ii), and if Item 303(a)(5)(ii) applies only to contractual obligations, then the resulting disclosure that would be required by Item 303(a)(5)(ii) would provide very limited benefit to investors, because that information would already appear either on the balance sheet or in response to Item 303(a)(4).
- The disclosure of contingent liabilities required by Item 303(a)(5)(ii) is not specifically limited to contractual contingent liabilities. Although Item 303(a)(4) indicates that contingent liabilities arising out of litigation, arbitration or regulatory actions (not otherwise related to off-balance sheet arrangements) are not off-balance sheet arrangements, Item 303(a)(5)(ii) does not contain any similar exclusion. If it is your intention to limit Item 303(a)(5)(ii) to contractual contingent liabilities and commitments, then that intention should be stated in Item 303(a)(5)(ii).
- If Item 303(a)(5)(ii) is intended to apply to contingent liabilities and commitments other than contractual contingencies, then the contingency standard included in Release No. 33-6835, 34-26831 should apply. If that standard were to apply, then Item 303(a)(5)(ii) would be using a contingency standard for contractual contingencies that would be different from the contingency standard used by Item 303(a)(4). The result could only be confusing to investors.
The time and effort that registrants will have to expend to comply with proposed Items 303(a)(4) and 303(a)(5) will be significant, unless those Items are limited to off-balance sheet arrangements in which the registrant or its officers or directors have some financial interest, which is the approach we strongly recommend. Otherwise, we believe that your average estimate of 37 hours per registrant seriously under-estimates this effort. In any event, we request that an adequate transition period be afforded to registrants to comply with these requirements after they become effective on or about January 26, 2003. We specifically request that these requirements not apply to annual reports on Form 10-K for calendar years ending on December 31, 2002.
If you should have any questions in connection with our comments, please let us know.
/s/ J. Robert Horst
J. Robert Horst
Vice President and General Counsel