Speech by SEC Chairman:
Opening Statement at the SEC Open Meeting
Chairman Mary L. Schapiro
U.S. Securities and Exchange Commission
September 17, 2010
Good Morning. This is an open meeting of the U.S. Securities and Exchange Commission on September 17, 2010.
Over the coming months, the Commission will be engaged in a very active rulemaking agenda, largely focused on implementing the Dodd-Frank financial reform law.
But today we consider proposals from our staff that, while not directly related to the financial legislation, do address issues that were brought into focus by the financial crisis.
The proposed rules we are considering today, if adopted, would shed greater light on a company's short-term borrowings, including a practice some refer to as balance sheet "window-dressing." Under these proposals, investors would have better information about a company's financing activities during the course of a reporting period — not just a period-end snapshot. With this information, investors would be better able to evaluate the company's ongoing liquidity and leverage risks.
As the Commission has long advised, disclosure about liquidity and capital resources is critical to assessing a company's prospects for the future, and even the likelihood of its survival. This principle was borne out during the recent financial crisis, when many business failures were the direct result of liquidity constraints. Short-term borrowings represent an important piece of a company's overall liquidity and capital resources picture.
Illiquidity in the markets as a whole can impact short-term borrowing, often severely and rapidly. When market liquidity is low, for example, financing rates may increase or terms may become unfavorable; it may be more costly or even impossible to roll over short-term borrowings; and for financial institutions, demand depositors may withdraw funds.
But even when market conditions are stable, short-term financing arrangements can present complex accounting and disclosure issues. Due to their short-term nature, a company's use of these arrangements can fluctuate significantly during a reporting period. As a result, presentation of period-end amounts alone may not adequately reflect that company's funding needs or activities during the period.
Short-term borrowings, and variations in the timing of these transactions, occur across many industry sectors. For example, a bank that routinely enters into repurchase transactions during the quarter may limit that activity at quarter-end. This can result in disclosure of a period-end amount of outstanding borrowings that does not necessarily reflect the bank's ongoing business operations or related risks.
Likewise, a retailer may have significant short-term borrowing during the year to finance inventory. If those borrowings are repaid by year-end, the year-end disclosure may not fully inform investors of the importance to the company of this type of borrowing.
We are not suggesting there is anything wrong with these borrowing practices — indeed, they may reflect the best financing alternatives available to a company. But investors should have the tools to better understand how companies finance their businesses and how much risk they take on through borrowings that, simply because of timing, do not show up on the balance sheet.
I believe that investors will benefit from additional transparency in this area, particularly when the difference between short-term borrowing during a reporting period varies significantly from the snapshot that is presented at period-end. The proposed rule amendments before us today should address this gap in our current disclosure requirements.
In addition to these proposed rules, the Commission is also considering whether to issue an interpretive release providing guidance on existing MD&A requirements for liquidity and funding disclosure. If approved, this guidance will be effective immediately upon publication in the Federal Register.
The interpretive release reiterates long-standing MD&A principles as they apply to disclosure of critical liquidity matters, so that MD&A disclosure keeps pace with the increasingly diverse and complex financing alternatives available to companies.
Specifically, the guidance would make clear that, under current law, a registrant cannot use financing structures (whether "on-balance sheet" or "off-balance sheet") that are designed to mask the registrant's reported financial condition.
Second, the guidance would emphasize that leverage ratios and other financial measures included in filings with the Commission must be calculated and presented in a way that does not obscure the company's leverage profile or reported results.
And, lastly, the guidance would address divergent practices that have arisen in the context of tabular disclosure of contractual obligations, to urge companies to focus on providing informative and meaningful disclosure about their future payment obligations.
Before I ask Meredith Cross to discuss the proposed rules and interpretive guidance, I would like to thank Meredith, as well as Paula Dubberly, Wayne Carnall, Felicia Kung, Christina Padden, Stephanie Hunsaker, Paul Dudek, John Nolan, Sharon Blume, Steve Hearne, and Chris Windsor in the Division of Corporation Finance; Jim Kroeker, Paul Beswick, Jeff Minton, Wes Bricker and Jeff Cohan in the Office of the Chief Accountant; David Fredrickson and Bryant Morris in the Office of the General Counsel; Emre Carr in the Division of Risk, Strategy and Financial Innovation; and Susan Nash, Mark Uyeda and Kieran Brown in the Division of Investment Management.
Now I'll turn the meeting over to Meredith Cross, Director of the Division of Corporation Finance, to hear more about the Division's recommendations.