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   125 Broad Street
New York, NY 10004-2498


December 9, 2002

Jonathan G. Katz, Secretary,
       Securities and Exchange Commission,
            450 Fifth Street, N.W.,
                   Washington, D.C. 20549-0609.
  Re:   Proposed Rules Relating to Disclosure of Off-Balance Sheet
Arrangements Required by Section 401(a) of the Sarbanes-Oxley
Act of 2002 (File No. S7-42-02)

Dear Mr. Katz:

                We are pleased to respond to Release No. 34-46767 (the “Proposing Release”), in which the Securities and Exchange Commission solicited comments on its proposed rules implementing Section 401(a) of the Sarbanes-Oxley Act of 2002 (the “Act”) relating to disclosure of off-balance sheet arrangements.


                 As we have previously indicated to the Commission, we fully support the Commission’s goal of improving the overall quality and transparency of MD&A disclosure, including the proposal to require expanded discussion of off-balance sheet arrangements. However, for the reasons indicated below, we respectfully encourage the Commission to adopt appropriate limits to the scope of the required disclosures, particularly to adopt a more meaningful standard for the applicable disclosure materiality threshold. We are concerned that the current proposals will prove extremely burdensome for most companies to comply with any degree of comfort and result in additional layers of complicated MD&A disclosure without a corresponding improvement in the quality of information available to investors. We also offer specific comments on the application of the proposal to foreign private issuers and on the disclosure of contingent liabilities.

General Comments

                 The Proposals Require So Much Information That Investors Will Be More Overwhelmed Than Informed. Although we agree with the Commission’s commitment to improve the quality and transparency of MD&A disclosure and recognize the statutory directive of the Act, we believe the proposed new disclosures are more extensive than required to implement Section 401(a) of the Act and will result in voluminous disclosures that are more likely to confuse and overwhelm investors than provide important information that will enable investors to make informed investment decisions. Specifically, we believe the requirement to disclose all arrangements, the sensitive disclosure trigger and the extensive required information about each arrangement will likely result in too much disclosure, making important information more difficult to discern. Instead, we believe the Commission should adopt a more flexible and less proscriptive approach, requiring companies to discuss in general terms the level and significance of off-balance sheet arrangements as well as the Company’s reasons for pursuing such arrangements and specific disclosure in reasonable detail on those significant off-balance sheet arrangements according to current standards of MD&A disclosure.

                 We agree with the need for enhanced disclosure of off-balance sheet arrangements to enable investors to gain a better understanding of the implications of a company’s obligations and contingencies from off-balance sheet arrangements. Many of these arrangements are neither readily apparent nor easily understood from a reading of the financial statements alone. However, we believe that the extensive nature of the required disclosures for off-balance sheet arrangements, combined with the broad scope of off-balance sheet arrangements and the low reporting threshold applied by the proposals, would give investors much more information than they can meaningfully use and create an imbalance in which other potentially more significant disclosures are de-emphasized. It seems to us that the most important point is for issuers to identify those significant off-balance sheet arrangements and discuss them in qualitative terms. This would ordinarily require a discussion about the nature and purpose of off-balance sheet arrangements generally and their financial significance to the company. Many of the mandated items for discussion enumerated in the Proposing Release would, however, require lengthy disclosure whether or not the disclosures were significant to the Company. Indeed, we question whether comprehensive new rules on off-balance sheet arrangements are likely to give investors better information than would strictly applying existing MD&A standards to off-balance sheet arrangements.

                 We do not believe that the density of the proposed disclosure is required by the Commission’s statutory directive under the Act. Section 401(a) of the Act directs the SEC to implement rules requiring issuers to disclose “all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the company with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses”. As the Commission itself notes, this legislative directive is consistent not only with its own recent initiatives to enhance disclosure of off-balance sheet arrangements but also with much of the language and concepts already reflected in existing MD&A rules. In this context, the Commission observes that while only one item in the existing MD&A rules specifically identifies off-balance sheet arrangements,1other requirements of current MD&A rules already require disclosure of off-balance sheet arrangements if necessary to an understanding of a company’s financial condition, changes in financial condition and results of operations. The language of the Act is expressed in general terms, clearly leaving the details to the discretion of the Commission in implementing Section 401(a) of the Act. There is also nothing in the legislative history to support the expansive approach of the Commission. What the legislative history does reveal is that that the mischief sought to be redressed was the excessive use of special purpose entities without any corresponding disclosure. Proper application of existing MD&A standards (combined with guidelines from the Commission requiring companies to include disclosure of material off-balance arrangements) would be an appropriate response to the concern identified by the Act. Indeed, the Powers Report on the collapse of Enron itself concluded that Enron’s disclosure of its off-balance sheet arrangements did not comply with prevailing disclosure requirements.

                 The Universe of Disclosable Off-Balance Sheet Arrangements Is Too Broad. The proposed rules define the term “off-balance sheet arrangement” too broadly to include any transaction, agreement or other contractual arrangement to which an entity that is not consolidated with the company is a party, or under which the company, whether or not a party to the arrangement has, or in the future may have:

  Any obligation under a direct or indirect guarantee or similar arrangement;

  A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement;

  Derivatives, to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements; or

  Any 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).

                 While we appreciate the need to define the concept broadly to capture the range of off-balance sheet arrangements currently in use, we are concerned that the proposed definition is overbroad and will invite companies to include disclosure on off-balance sheet arrangements that are of limited value to investors in assessing how a company conducts significant aspects of its business, including external financing. In particular, we strongly encourage the Commission to narrow its proposed definition to exclude the fourth category above (i.e., any obligation or liability, including a contingent liability, to the extent it is not “fully reflected” in the financial statements). We do not believe this last category of proposed off-balance sheet arrangements, unlike the other three, presents the same opportunities for abuse by companies or confusion to investors. It also is not a category traditionally understood as an off-balance sheet arrangement and does not fall within the category of arrangements that we believe the legislative history suggests Congress was concerned with in enacting Section 401(a). Furthermore, especially with respect to contingent liabilities, we believe that this last category unnecessarily expands the universe of disclosable off-balance sheet arrangements and will likely create many difficult disclosure issues for companies, especially insurance companies, in disclosing contingencies.

                 The Disclosure Threshold of “More Than Remote” is Too Sensitive.While we appreciate the need to define the concept broadly to capture the range of off-balance sheet arrangements currently in use, we are concerned that when combined with the very low disclosure threshold, the proposals invite companies to include disclosure on off-balance sheet arrangements that are of limited value to investors in assessing how a company conducts significant aspects of its business, including external financing. So broad is the definition and so sensitive is the disclosure threshold that we fear many instances of detailed disclosure about near-remote contingencies. In comparison to the “reasonably likely” standard used elsewhere in the MD&A, we believe this will result in undue prominence to information about off-balance sheet arrangements in relation to other potentially more significant information.

                 The proposed rules would move beyond any current Commission guidance or financial reporting principle and require disclosure if there is “more than a remote” likelihood of a current or future material effect on the company. Accordingly, the proposals would require disclosure of off-balance sheet arrangements under circumstances where management concludes that the likelihood of the occurrence of a future event and its material effect is higher than remote, even though not probable. The Commission seeks to illustrate the “more than remote” test and tie it to the Congressional intent as evidenced by use of the word “may” in Section 401(a) of the Act, by restating the test in the following terms: “[A]n off-balance sheet arrangement ‘may’ have a current or future material effect, and disclosure would be required, unless management determines that the occurrence of an event and the materiality of its effect is outside of the realm of reasonable possibility” (emphasis added). We believe the Commission has attached undue weight to the word “may” in Section 401(a). We do not believe Congress intended the word to be used as the touchstone for crafting a new and potentially unmanageable probability standard for financial reporting. The extremely low threshold as well as the very real risk that companies will be subject to hindsight review based on the threshold as well as the individual certifications made under Sections 302 and 906 of the Sarbanes-Oxley Act, are likely to result in companies creating disclosures with a view towards liability risk minimization rather than disclosures intended to inform investors about the relevant aspects of the company’s operations.

                 Instead, we believe the Commission should maintain its existing “reasonably likely” disclosure standard. This is both a more reasonable and balanced approach as well as being consistent with established MD&A disclosure standards.

                 Formal Review of MD&As and Greater Reliance on Changes in GAAP. As with disclosure of critical accounting policies, we would encourage the Commission to consider whether the type of improved MD&A disclosure it seeks to promote would be more constructively achieved not by establishing an overbroad disclosure trigger but rather by undertaking a comprehensive formal review of MD&As and providing the marketplace with examples of good and bad MD&A disclosure, including with respect to off-balance sheet arrangements. This was last done in connection with the Commission MD&A release in 1989 and we believe the time is ripe for a similar formal review. Examples are more likely to convey the Commission’s message and result in higher quality disclosures than overbroad prescriptions.

                 Although the Act mandates the Commission to adopt disclosure rules on off-balance sheet arrangements, we would encourage the Commission to consider whether much of the highly detailed proposed disclosure on off-balance sheet arrangements is more appropriately left to incremental and thoughtfully considered changes in GAAP by appropriate standard-setting bodies than by the Commission, especially in light of FASB’s project to revise guidance for consolidation of special purpose entities. We respectfully suggest that the Commission work with the existing standard-setting bodies to encourage them to revise their standards to broaden the required disclosures to cover many of the items in the Commission’s proposal, such as disclosure of contingent liabilities and other items not “fully reflected” in the financial statements. This could result in more focused disclosures that address many of the issues sought to be addressed in the Proposing Release while remaining consistent with the Commission’s statutory mandate, which we believe gives the Commission the implementing flexibility to take the approach suggested above.

                 More Detailed Guidance Is Needed on the Application of the Proposed Rules to Different Industries.If the Commission nevertheless decides to implement the rules in the form proposed, we would urge the Commission to provide more detailed guidance on the application of the proposed rules to different industries. The proposed rules are likely to affect different industries in very different ways. For example, insurance companies and banks are likely to be heavily affected because they use securitizations and special purpose entities more frequently than other companies. We are concerned that financial institutions will be affected disproportionately and would encourage specific examples focused on the type and level of disclosure expected of different industries.

Specific Comments

                 Foreign Private Issuers.The proposals would apply to foreign private issuers without exception. We believe this approach is not consistent with the Commission’s current disclosure regime for foreign private issuers and its policy of balancing the need to ensure that the disclosure standards for foreign private issuers are consistent with acceptable standards of investor protection while encouraging access by foreign private issuers to U.S. capital markets by respecting home-country requirements. It also ignores the clear and wide discretion the Act gives the Commission to exempt foreign private issuers from the Commission’s implementing rules if it considers this warranted. Moreover, as the Commission itself concedes, extension of the proposals to the U.S. GAAP reconciliation of foreign private issuers adds a further layer of complexity and expense to the reconciliation process. If the Commission is unprepared to grant a blanket exemption for foreign private issuers, we suggest the Commission not apply the proposed rules to the reconciliation process and defer to home-country disclosure, but permit no disclosure where U.S. GAAP reconciliation would consolidate the arrangement.

                 The Commission Should Clarify That the Proposed Disclosure of Contingencies Is Not Required in the Absence of a Binding and Definitive Agreement. If the Commission disagrees with our suggestion to narrow the definition of off-balance sheet arrangements to exclude contingencies not “fully reflected” in the financial statements, we urge the Commission to clarify final rules that only those contractual contingencies are covered by the off-balance sheet disclosure rules. This is implicit in the Proposing Release, but should be made clear in the final rules to prevent creating confusion and an extremely difficult and time-consuming disclosure process for companies (especially insurance companies).

*           *           *

                 We appreciate the opportunity to comment to the Commission on the proposed rules, and would be happy to discuss any questions the Commission may have with respect to this letter. Any questions about this letter may be directed to John T. Bostelman (212-558-3840), David B. Harms (212-558-3882), Robert E. Buckholz, Jr. (212-558-3876) or Robert W. Reeder III (212-558-3755) in our New York office or Scott D. Miller (650-461-5620) in our Palo Alto office.
  Very truly yours,

cc: Giovanni P. Prezioso
General Counsel

Jackson M. Day
Acting Chief Accountant

Alan L. Beller
Director, Division of Corporation Finance

1   See Item 303(a)(2)(ii) of Regulation S-K.