Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street NW
Washington, DC 20549-0609
July 18, 2002
Re: File No. S7-16-02
Dear Mr. Katz:
We appreciate the opportunity to provide formal comments to the Chairman and Staff of the Securities and Exchange Commission (collectively, the "Commission") with respect to the proposed rule, "Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies" (Release Nos. 33-8098; 34-345907). Recent events have confirmed the critical need for corporations to communicate appropriate information about their state of affairs in a clear, concise manner.
As a company, we have always recognized the importance of providing reliable, transparent information to investors. TECO Energy is an integrated electric and gas utility holding company with important energy-related unregulated operations including independent power generation; marine transportation; coal mining and synthetic fuel production; production of gas from coal seams; and energy engineering/construction services. Unlike companies that are solely energy traders or market-makers, we have the physical assets to deliver contracted power and gas sales, as well as take delivery of and consume gas, coal and fuel oil purchases. However, we observe that many investors do not currently distinguish between energy marketers/traders and asset-intense companies like TECO Energy. We believe this lack of distinction, on the part of investors, between speculative traders and companies engaged in selling power from owned assets may be partly due to the current complicated rules that require reporting sales of power from owned assets as though they were complex trading transactions.
Scope and Background
The Commission's effort to enhance periodic financial reporting under the Securities and Exchange Acts is meritorious. Alleviating investors' crisis of confidence is of utmost importance and, in that context, we support this proposal in general. In our opinion, a corporation must provide investors with timely, reliable and relevant insight into the economic position of the entity.
However, the proposed rule only requires additional disclosure items, rather than addressing certain inconsistencies in the accounting framework. The current intricate and complex rule-based accounting framework, established over time by the FASB and similar standard-setting bodies, creates an environment that focuses companies too much on the specifics of compliance, rather than focusing on conveying the true economic substance of transactions.
While the main intent of the proposal is to provide investors with greater transparency into how management views the business, and we support this aim, we believe that the proposed rule may not effectively meet this objective. This is because we believe it will require the submission of repetitive, and in some instances, arbitrary information to investors. Thus, the information overload dilemma already created by the current rules and reporting requirements will be compounded.
The proposed rule covers a broad array of estimates used and made by management. We believe that certain estimates currently in use should be addressed in the context of the standard-setting process. Therefore, in the context of this proposed rule, we believe it necessary to limit our comments to exclude all accounting estimates related to the valuation of the following:
1. Contracts where the fair value is determined using a mark-to-model1 approach; and
2. Commodity contracts which result in physical delivery of the underlying commodity.
Current accounting standards generally require that both types of contracts be recorded at fair value, with the changes in fair value recorded in earnings.
We believe that the mark-to-model valuation approach is not consistent with the Financial Accounting Standards Board ("FASB") Concept Statements. Specifically, FASB Concept Statement No. 2 ("CON 2") postulates that reliability is a primary quality and comparability/consistency is a secondary quality that makes accounting information useful for decision makers. Reliability refers to information that is objectively verifiable and neutral, as well as a faithful representation of the economic position of a company (see CON 2, ¶62). Mark-to-model valuation approaches rely on proprietary, subjective, and potentially biased views of long-term forward price movements in time periods where no verifiable market data exists.
Current accounting pronouncements do not contemplate the scenario where the valuation of a particular contract is based on data that is materially unreliable according to CON 2. We recommend that the Commission consider alternative guidance or reporting formats that convey more reliable, consistent and transparent information to investors.
Physical Delivery Valuations
We believe that contracts resulting in physical delivery of the underlying commodity, where the commodity is used or provided in the normal course of operations of the business2, should not be subject to mark-to-market accounting treatment due to the lack of relevancy of the information. The periodic gain or loss on a contract subject to mark-to-market valuation does not accurately represent the nature of the underlying transaction. Rather, the gain or loss represents opportunity benefit or cost, not future expected net benefit or cost.
The current model for reporting and disclosing mark-to-market gains and losses for such physically-delivered contracts does not provide investors with a clear picture of the financial condition of a company. We recommend that the Commission consider the current accounting literature as it pertains to these contracts. The International Accounting Standards Board's recent exposure draft proposing an amendment to International Accounting Standard No. 39 ("IAS 39") offers a principle-based solution, which would provide investors with a more accurate view of how management operates the business.
The Commission's stated aim is to improve periodic financial reporting by offering investors a more transparent view of the estimates used by management to determine specific accounting figures. We believe investors would be best served by gaining insight into the reliability and integrity with which management selects and applies accounting estimates. To best meet the needs of investors, we offer the following observations on the proposed rule and draw particular attention to the comments related to Quantitative Disclosures:
Scope of the Proposals
1. Existing literature and requirements adequately indicate a company's accounting policies and estimation methods. The Commission is proposing that more detailed disclosure of such policies and methods be mandated.
We believe that highlighting certain critical estimates may be useful, insofar as such information is relevant to the financial condition of the company. We believe that a requirement to disclose alternative policies or the impact of alternative estimates will provide a large quantity of hypothetical information to users and not provide a transparent view of the business through `management's eyes.'
Accounting Estimates Covered Under the Proposals
2. Certain critical accounting estimates provide insight into confidential information that may be used against a company by competitors. In a transactional (i.e., commodity, equity or fixed-income trading) environment, disclosure of known trends, demands, commitments, events or uncertainties that are reasonably likely to occur extends to forward price curve estimates, estimated volatility measures and other proprietary, confidential information which may be used by competitors in price negotiations.
In order to avoid placing reporting companies at a competitive disadvantage, we believe that disclosure of specific price estimates, volatility measures, forward-looking trends, and sensitivities to changes in those estimates do not provide significant additional transparency beyond the information required under Item 305(a) of Regulation S-K ("Reg. S-K") for financial instruments. We recommend that the Commission limit the scope of the current proposed rule to exclude those estimates that impact the valuation of financial instruments subject to disclosure under Item 305. However, we believe additional qualitative information should be incorporated into Item 305(b) to ensure consistency with the proposed disclosure for estimates which impact items other than financial instruments.
3. We believe the proposed definition of a critical estimate inappropriately includes mark-to-model valuation estimates. We recommend that the Commission consider our views expressed in Scope Exclusions-Mark-to-model valuations and in Comment 2 above.
4. Quantifying the sensitivity or impact of changes in some critical accounting estimates is impractical. For example, a company may conclude that a critical estimate is the discount rate used in determining present value calculations for accounting purposes. Generally, companies will use a uniform discount rate to assess impairment of goodwill and long-lived assets, determine the fair value of financial instruments, and calculate the initial value and accretion expense for asset retirement obligations. To provide individual point sensitivities on the discount rate for all individual calculations would not serve to improve investors' understanding and would be impractical.
We believe that a detailed qualitative discussion in such instances would be more appropriate.
5. Requiring companies to disclose the impact of the sensitivity of a critical estimate to changes in that estimate is, in practice, very difficult. Oftentimes a critical estimate is composed of multiple variables, which may or may not have offsetting effects. The proposed rule would require companies to assess the impact of a change in each of these variables, or attempt to hold one or more variables constant. Requiring management to report sensitivities for certain estimates is likely to result in a lack of consistency and relevancy of the information provided to investors due to the lack of guidance relating to calculating movements in underlying variables.
We believe that permitting an alternative disclosure approach requiring additional qualitative discussion of the process used to determine the initial critical estimate will enable companies to provide more relevant information to investors.
Disclosure Relating to Segments
6. Companies, such as ours, with diversified segments will be unduly burdened in reporting a potentially significant number of critical estimates under the proposed definition. Companies with segments, which operate in unrelated industries, are likely to conclude that different critical estimates apply to each segment, thus increasing the number of critical estimates reported. For example, under the proposed definition, a company with similar operations to TECO Energy, might conclude that several different critical estimates exist for the coal mining, independent power production, regulated utility and marine transport segments. Furthermore, the determination of materiality, as defined in SAB 99, would force a company to evaluate the potential impact of an estimate on the reported results of the segment, not the consolidated entity. Under this evaluation, an increased number of estimates are likely to meet the proposed definition of a critical estimate.
We recommend that the Commission establish a fixed maximum number of critical estimates and mandate that companies disclose the critical estimates that are most likely to significantly impact their financial condition or reported results. As an alternative, we recommend that the Commission clarify that the determination of a critical estimate is to be based on the materiality of the consolidated financial condition or consolidated reported results of the entity-specifically excluding the assessment of materiality based on the reported results of individual segments.
7. Disclosing critical estimates for each segment is likely to create significant confusion due to the repetition of information in various sections of the filing. We believe that the segment information disclosures should only refer to a specific section of the MD&A that details the application of the critical accounting policies under the proposed rule.
We support the Commission's aims to restore investor confidence and enhance the usefulness of regularly reported financial information. As currently proposed, the rule serves to initiate a discussion of what additional information will be useful for investors. However, in its current form, the proposed rule is unduly burdensome and does not achieve the level of differentiation between the sale of production from assets and trading that we believe is appropriate.
We will continue to actively support the Commission, accounting standard-setters and regulatory agencies in order to achieve the goal of enhancing the relevancy and reliability of reported financial information.
/s/ Gordon L. Gillette
Senior Vice President - Finance, and CFO
TECO Energy, Inc.
/s/ Shirley A. Myers
Vice President, Corporate Accounting and Tax
TECO Energy, Inc.
1 Mark-to-model is defined, for the purposes of this comment letter, as any valuation approach whereby an instrument or portion of an instrument (such as years 6-10 of a 10-year natural gas sales contract) is valued using prices and other significant inputs which are either (a) not directly observable, or (b) cannot be inferred based on observable, quoted market prices which extend beyond the term of the instrument. Inherently, mark-to-model refers to modeled prices, not to a mathematical equation based on observable, quoted market prices, such as a Black-equivalent option model used to value a European-style option on natural gas, expiring in 2 years.
2 E.g., a firm commitment to sell electricity generated by a specified power plant when economically feasible, where the power plant is anticipated to physically supply the electricity to the buyer, is within the confines of the normal operations of a company that owns and operates physical assets-not-withstanding the accounting distinction of what constitutes a "normal sale".