Commission Proposes Disclosure Requirement and Takes Other Actions at April 30, 2002 Open Meeting


Washington, D.C, April 30, 2002 -- The Securities and Exchange Commission today voted 3-0 to approve the following matters. An audio webcast of the proceedings is available on the SEC Web site.

Proposed Disclosure Requirement in Management's Discussion and Analysis About the Application of Critical Accounting Policies

The Commission proposed a disclosure requirement for companies to include a separately-captioned section regarding the application of critical accounting policies in the "Management's Discussion and Analysis" (MD&A) section of annual reports, registration statements and proxy and information statements. The Application of Critical Accounting Policies section would encompass both disclosure about the critical accounting estimates that are made by the company in applying its accounting policies and disclosure concerning the initial adoption of an accounting policy by a company.

Critical Accounting Estimates

The proposals define an accounting estimate recognized in the financial statements as a "critical accounting estimate" if:

  • the accounting estimate requires the company to make assumptions about matters that are highly uncertain at the time the accounting estimate is made; and
  • different estimates that the company reasonably could have used in the current period, or changes in the accounting estimate that are reasonably likely to occur from period to period, would have a material impact on the presentation of the company's financial condition, changes in financial condition or results of operations.

To inform investors of each critical accounting estimate, and to place it the context of the company's financial condition, changes in financial condition and results of operations, the proposals would require the following information in the MD&A section:

  • A discussion that identifies and describes the estimate, the methodology used, certain assumptions and reasonably likely changes;
  • An explanation of the significance of the accounting estimate to the company's financial condition, changes in financial condition and results of operations and, where material, an identification of the line items in the company's financial statements affected by the accounting estimate;
  • A quantitative discussion of changes in line items in the financial statements and overall financial performance if the company were to assume that the accounting estimate were changed, either by using reasonably possible near-term changes in certain assumption(s) underlying the accounting estimate or by using the reasonably possible range of the accounting estimate;
  • A quantitative and qualitative discussion of any material changes made to the accounting estimate in the past three years, the reasons for the changes, and the effect on line items in the financial statements and overall financial performance;
  • A statement of whether or not the company's senior management has discussed the development and selection of the accounting estimate, and the MD&A disclosure regarding it, with the audit committee of the company's board of directors;
  • If the company operates in more than one segment, an identification of the segments of the company's business the accounting estimate affects; and
  • A discussion of the estimate on a segment basis, mirroring the one required on a company-wide basis, to the extent that a failure to present that information would result in an omission that renders the disclosure materially misleading.

The proposals also would include a requirement that companies update this part of the required disclosure to show material changes in their quarterly reports.

Initial Adoption of Accounting Policies

The proposals envision the addition of disclosure in annual reports, registration statements and proxy information statements regarding a company's initial adoption of an accounting policy if the accounting policy was adopted in the past year and had a material impact on the company's financial condition, changes in financial condition or results of operations. Companies would be required to disclose:

  • The events or transactions that gave rise to the initial adoption;
  • The accounting principle that has been adopted and the method of applying that principle;
  • The impact on the company's financial condition, changes in financial condition and results of operations (discussed on a qualitative basis);
  • If the company is permitted a choice between acceptable principles, an explanation that it had made such a choice, what the alternatives were, and why it made the choice it did (including, where material, qualitative disclosure of the impact on the company's financial presentation that the alternatives would have had; and
  • If no accounting literature exists that governs the accounting for the events or transactions giving rise to the initial adoption, an explanation of its decision regarding which accounting principle to use and which method of applying that principle to use.

Comments on the proposed disclosure requirements are due within 60 days following publication in the Federal Register.

Proposed Amendments for Section 31 Fees for Security Futures

The Commission proposed amendments to Rule 31-1 to clarify how assessments and fees are to be calculated by exchanges and associations under Section 31 of the Securities Exchange Act of 1934 (Exchange Act) with respect to security futures.

The proposal would amend the preamble to Rule 31-1 to clarify: (1) that a "round turn" transaction on a security future is a completed trade involving the simultaneous purchase and sale of a contract of sale for future delivery by the two parties to the trade and, (2) that the assessment is applied on each purchase and sale of each contract for future delivery.

In addition, the proposed amendments would clarify the application of paragraphs (b) and (c) of Section 31 of the Exchange Act, which require exchanges and associations to pay a fee based on the aggregate dollar amount of sales of securities. At physical settlement of a security future a sale of the underlying security occurs. The proposed amendment to Rule 31-1 would clarify how, and under what circumstances, fees based on the dollar amount of such sale of securities resulting from physical settlement of a security future, should be calculated and paid.

Finally, the proposed amendments would permit The Options Clearing Corporation to pay Section 31 assessments and fees on behalf of exchanges and associations in the same manner in which it currently does for options transactions.

Comments on the proposed amendments are due within 30 days following publication in the Federal Register.

Proposed Rule and Amendments for Transactions of Investment Companies With Portfolio and Subadviser Affiliates

The Commission proposed a new rule and several rule amendments governing exemptions for transactions between investment companies and their affiliated persons. The Investment Company Act of 1940 (1940 Act) contains a number of provisions that prevent persons who may be in a position to take advantage of an investment company (fund), from entering into transactions or arrangements with the fund. These include prohibitions on "affiliated transactions" and "joint transactions" with affiliated persons.

The 1940 Act, however, gives the SEC authority to issue orders and adopt rules permitting these transactions when the SEC determines that an exemption is "necessary or appropriate in the public interest and consistent with the protection of investors." The Commission proposed to codify in a new rule and amendments to several current rules a number of orders that have been issued to funds permitting affiliated and joint transactions with two types of affiliates. The rule and rule amendments would eliminate the need for funds to obtain individual exemptive orders, in the following circumstances that are not likely to raise the concerns that the Act was intended to address.

  1. Transactions with Portfolio Affiliates. Currently, SEC rules permit a fund to enter into transactions with a company that is affiliated with the fund as a result of the fund's ownership interest in the company. This type of affiliated person is unlikely to be in a position to take advantage of the fund. The Commission is proposing that the rules be expanded to permit funds to enter into transactions and arrangements with companies that are similarly affiliated with other funds in the fund complex. This is largely a technical change necessitated because the current exemptive rule pre-dated the widespread organization of mutual funds into fund complexes.
  2. Transactions with Subadviser Affiliates. Fund advisers are also "affiliated persons" of a fund. As a result, an adviser to a fund cannot engage in transactions with the fund (or any other fund in the fund complex) such as selling securities to the fund, which would be a form of self-dealing. The SEC has, however, issued a number of orders permitting subadvisers to enter into transactions and arrangements with other funds in the complex that other subadvisers advise. These transactions do not involve self-dealing because the subadviser participating in the transaction is not the subadviser making the decision on behalf of the fund to enter into the transaction. The SEC orders and the recommended rules prohibit the subadvisers from discussing securities transactions with each other to prevent reciprocal arrangements.

The Commission proposed these changes because many advisers today are-or are affiliated with-broker-dealers and underwriters. Currently, once such an adviser becomes a subadviser of a fund, all of the other funds in the fund complex-even if they are advised by a different subadviser-are precluded from entering into a range of transactions with the adviser/broker-dealer unless they obtain an exemptive order from the SEC, or can rely on the SEC's exemptive rules.

Comments on the proposed rule and amendments are due within 60 days following publication in the Federal Register.

Amendments of Rule for Acquisition of Securities During the Existence of an Underwriting or Selling Syndicate

The Commission also adopted amendments to rule 10f-3 of the Investment Company Act of 1940, which allows a fund that has certain affiliations with an underwriting participant to purchase securities during an offering. The amendments expand the exemption provided by the rule to permit a fund to purchase U.S. government securities (including securities issued by government-sponsored entities (i.e., GSEs)) in a syndicated offering. These amendments will become effective on May 10, 2002.

Amendment of Rule for Delegation of Authority to the Secretary

The Commission amended its delegation rules to streamline the process for administrative proceedings against securities professionals.

The federal securities laws permit the Commission to start administrative proceedings against securities professionals, such as registered representatives of broker-dealers who have been enjoined by courts from violating specified laws or have been convicted of specified crimes. In many cases, when the Division of Enforcement first seeks Commission authorization to begin an injunctive action in district court, it also seeks authority to bring a follow on administrative proceeding based on the anticipated injunction or a conviction. This follow on administrative action must, of course, be delayed until the successful completion of the district court litigation.

The amended delegation rule will streamline the process for beginning the administrative proceedings after the entry of the court injunction or criminal conviction. It will permit the Commission's Secretary to issue an order instituting the proceedings as soon as the injunction or conviction has been entered. Further, in cases where a respondent consents to the maximum relief available-a bar from association-the amended rule authorizes the Secretary to issue a settled order making findings and imposing sanctions. This will expedite consideration of these routine matters.

Last modified: 4/30/2002