Merrill Lynch  
John Fosina
First Vice President
Corporate Controller
(212) 449-8618
Esther Mills
First Vice President
Accounting Policy
(212) 449-2048
ML & Co., Inc.
4 World Financial Center
New York, New York 10080

July 31, 2002  

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

Re:  Proposed Rule on Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies - File No. S7-16-02

Dear Mr. Katz:

On behalf of Merrill Lynch, we are pleased to submit this letter in response to the Commission's request for comments on the Proposed Rule: Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies, Release Nos. 33-8098 and 34-45907 (the "proposal"). We appreciate the additional time afforded by the Commission to comment on these important accounting matters.

As a leading underwriter and distributor of securities for our corporate clients, as well as a frequent issuer of securities, we are keenly aware that transparent and reliable disclosure of material information is essential to market liquidity and investor confidence in public markets. Accordingly, we fully support the Commission's efforts to improve the transparency and quality of financial reporting and restore trust and confidence in the capital markets.

For the large majority of registrants, the use of estimates and assumptions and the application of judgment is an inherent part of the business model, and accordingly, such estimates and assumptions form an underlying part of the financial statements. We therefore believe that a thorough discussion of the areas in which estimates are a significant component of the amounts reported in the financial statements is critical to a reader's understanding of the financial statements and his ability to make informed investment decisions. As a result, we fully support the proposal to require a complete discussion of where and how critical estimates affect the financial statements, including the identification of the segments of the business affected, and the controls and procedures that govern the selection of such estimates by management.

However, we do have concerns regarding the second element of the proposal, namely, the requirement to provide quantitative information regarding the impact of changing those estimates using a number of different scenarios. We believe it should be the objective of financial reporting to present financial information in the manner which will be most clear and comprehensible to readers. We are concerned that the proposal set forth will result in the disclosure of accounting scenarios that will not provide any more meaningful information to investors but may, in fact, cause considerable confusion regarding financial reporting.

Investor Confidence in Reported Earnings
By requiring registrants to present different accounting scenarios in the financial statements, the proposal could be perceived by the marketplace as an acknowledgement by the Commission that reported earnings are merely one possible point in a range of possible outcomes. In essence, the Commission would be requiring registrants to provide readers of financial statements with a variety of potential outcomes, so that the readers can decide for themselves what earnings should be. We believe that such an approach will actually create more confusion among investors as they attempt to determine which set of assumptions are the "right" ones. This effort could ultimately undermine, rather than restore, investor confidence in financial reporting. It is the responsibility of management to make determinations regarding estimates based on its experience and judgment, and it is the goal of Management's Discussion and Analysis (MD&A) to look at a company through the eyes of management. We believe that reporting accounting sensitivities regarding estimates and assumptions rejected by management would be inappropriate and would run contrary to the objectives of MD&A.

On a more fundamental level, we do not believe that the proposed quantitative disclosures address the most important issue facing investors today - the recent breakdown of investor confidence in reported earnings and the lack of faith in the reliability of an auditor's opinion. Making estimates and assumptions has always been a normal part of the process in compiling financial statements. We believe the root cause of a number of recent accounting scandals has been a combination of financial fraud, a lack of adequate internal control procedures, and a breakdown in the audit process, rather than a lack of disclosure related to accounting estimates. We do not believe the proposed quantitative disclosures would have prevented the types of financial misstatements that have recently occurred. Accordingly, we believe that investors' concerns would be better addressed by the Commission by focusing on identifying and implementing appropriate reforms to restore credibility to the audit process, by increasing the Commission's scrutiny of financial statements, and by ensuring that perpetrators of financial fraud are investigated and brought to justice.

We also encourage the Commission to support the development of broad-based accounting principles that focus on accurately capturing the economic substance of a transaction. Recently issued accounting standards have adopted an overly detailed rules-based approach that emphasizes form over substance. The end result is an exhaustive set of guidance and interpretations that encourage a "check-the-box" approach to the application of accounting standards. We strongly advocate a move back to a conceptual approach that will focus on the economic substance rather than the form of a transaction, one that will continue to require the use of judgment by preparers and auditors in applying the principles in practice. The proposal to provide a robust qualitative discussion of critical accounting estimates would greatly complement a principles-based approach.

Valuation of Financial Instruments
We note that regulatory and investor concern has focused largely on the inappropriate valuation of certain less liquid financial instruments. Merrill Lynch continues to believe that fair value, properly reported, represents the most accurate and complete picture for all financial instruments, and is superior to carrying financial assets and liabilities on a historical cost basis. With particular regard to valuation of less liquid financial instruments subject to management estimation, we do not believe that providing a sensitivity analysis for all material critical estimates will provide any additional assurance that the valuation of these instruments is appropriate. We believe that investors would be better served by ensuring that registrants establish well-articulated valuation policies and procedures which are 1) overseen by an independent valuation group that has demonstrable support from company management; 2) validated by the external auditors; and 3) in the case of regulated financial institutions, overseen by the appropriate regulatory authorities.

We believe that providing a sensitivity analysis is particularly problematic in the context of fair value of financial instruments, especially for institutions that hold a diverse portfolio of products such as complex and/or long-dated derivatives, less-liquid credit positions, and private equity securities, where numerous assumptions and inputs are considered in determining valuation. Unlike the example disclosure provided in the proposal, which assumes a homogeneous population with minimal and fairly straightforward inputs, sensitivity analysis for a complex and diverse portfolio of financial instruments is more difficult due to the sheer number of inputs, their inherent complexity (e.g., volatility, liquidity, interest rate risk, yield curve risk, credit spread, currency, and correlation factors), and their varying degrees of interdependency. Specifically, the effect of a change in a particular input cannot necessarily be extrapolated to a change in the value of the financial instrument in its entirety, because the change is calculated independent of changes in other assumptions. In other words, the relationship of the change in a single assumption to the change in fair value may not be linear. For example, in estimating the value of a mortgage-related financial instrument, a decline in the value of interest rates could have an effect on the assumed rate of prepayment speeds; thus, both changes should be taken into account when presenting information regarding possible changes in estimates of fair value. Complex instruments may have a number of multi-dimensional inputs and assumptions, and disclosing the impact of changing the assumptions may require the application of path-dependent options or complex Monte Carlo simulations. Additionally, such types of instruments typically have associated hedges which also would need to be taken into account with a different set of assumptions.

As a result, we believe that any attempt to present this information to the reader will result in either a relatively simplistic analysis (showing the effect on fair value of changing one input at a time) that could ultimately be misleading, or a highly complex analysis that will prove at best bewildering to the average investor, as well as costly and difficult to implement. Though the proposal states that overly technical terminology will not satisfy the proposed requirements, the reality is that the valuation of less liquid financial instruments can be a highly technical process; a discussion of all the elements underlying that process will therefore necessarily result in highly technical disclosures.

Industry-Specific Approach Recommended
Although we believe that expanded qualitative disclosure of estimates and accounting policies would provide the most useful information to investors, if quantitative data is mandated, we would urge the Commission to provide flexibility in terms of the method of disclosure, rather than requiring a particular quantitative approach or choice of approaches. Currently the proposal allows a choice of two methods of sensitivity analysis. However, as this proposal would affect registrants across all industries, we believe it is important to allow a registrant to communicate data regarding critical accounting estimates to investors in a manner that is most meaningful in the context of its particular business and industry. Therefore, if specific guidance is offered as is currently proposed, we would encourage the Commission to take an industry-specific approach. For example, in the case of the financial services industry, we believe that the combination of the regulatory environment in which we operate and the predominantly mark-to-market nature of our financial statements warrants separate consideration from businesses operating in non-regulated environments with a historical cost basis of accounting. We would encourage the Commission to work with our industry to develop an approach that is suitably tailored for the financial services industry.

With respect to the financial services industry, we offer the following thoughts for consideration. In a complex portfolio of financial instruments, there will be many instruments that trade in liquid markets and that are marked using readily available market prices; other instruments are marked-to-model, but the inputs to the model are directly observable in the market, or the instruments are priced with reference to comparable financial instruments whose parameters can be directly observed. As the valuation of both of these types of instruments do not involve the use of significant estimates, we would conclude they fall outside the scope of the proposal and are therefore not subject to its requirements.

In addition to the above, there also may exist less liquid instruments that are priced using management's best estimate of fair value, or which are marked to model, where inputs to the models and/or the models themselves are subject to significant estimation. If the level of estimation has a material effect on the financial statements, we believe a thorough discussion of this class of instruments is warranted, including a description of how fair value is arrived at and the nature of the markets in which these instruments trade. However, we are not convinced that a sensitivity analysis for each of the individual inputs for these instruments would be the most meaningful information for investors. Rather, we believe that a discussion of the risk profile of this category would prove more meaningful. Such a discussion could include, for example, information regarding risk scenario analyses, inventory turnover, or information from other risk management tools that are employed by management in its assessment of its business.

In addition, we noted that some of the sample disclosures included a discussion of how estimated input factors compared to actual results. We would be concerned if such a discussion were the express expectation of the Commission, as many factors which influence the valuation of financial instruments will be macroeconomic and beyond the control of management. Looking back, it may be difficult if not impossible to differentiate between the change in value due to a change in the market versus a change in the accounting estimate. Moreover, the accuracy of matters such as interest rates or economic conditions would be fully reflected in subsequent completed accounting periods and already must be discussed in MD&A, which would render this type of discussion superfluous.

Estimation of Loss Accruals
We further note that the proposal could also require quantitative disclosures related to estimates of legal, tax, and other reserves of a confidential nature, if those estimates are deemed to have a material effect on the financial statements. We believe that the additional information proposed related to these estimates may, in certain cases, be very harmful to investors. In particular, with respect to legal reserves, the required disclosures may make transparent to persons with whom the company is engaged in actual or potential litigation 1) the company's own assessment of the merits of the claims against it, and 2) the company's estimated exposure for such claims. Company shareholders - the most important beneficiaries of public disclosures - would not welcome rules and disclosure that would undermine the company's position in both litigation and negotiations. We believe shareholders would have similar concerns with respect to disclosure of information regarding other reserves for which the ultimate determination is based on negotiation with third parties.

Registrants are currently subject to Statement of Financial Accounting Standards (SFAS) No. 5, Accounting for Contingencies, with regard to accounting for and disclosing legal and tax contingencies, and other reserves for potential losses. We believe that those rules strike the proper balance between providing meaningful disclosure to financial statement users while permitting companies to guard against disclosure of confidential information that might harm a company's ability to achieve minimization of liabilities. Accordingly, in keeping with the goal of the proposal to provide more meaningful information to investors, we suggest that the Commission consider removing disclosure of confidential items such as legal reserves from the scope of the proposal.

Number of Critical Accounting Estimates
Regarding the definition of what constitutes a critical accounting estimate, we believe that it is likely that a large conglomerate that operates in a variety of different industries could easily have a considerable number of critical accounting estimates that could far exceed the three to five that is suggested by the Commission, especially if the assessment must be done on a segment-by-segment basis. Accordingly, we believe that it would be inappropriate for the Commission to limit the total number of critical accounting estimates that a company should disclose. Additionally, we believe that it would be helpful if the Commission were to acknowledge in the final proposal that for complex corporations that have a large number of segments, there could be one or more critical estimates per segment, though the ultimate determination of this would be made by management using its reasonable judgment.

We also request that the Commission reconsider its proposal to require disclosure of changes in critical accounting estimates over the past two years for the initial year of implementation. We struggle to find the relevance in recreating this financial scenario information for periods that have already occurred, particularly when the accuracy of previous estimates would have already largely been borne out by events in subsequent periods. We also believe that it will be especially difficult to comply with in the initial year of application if the Commission proceeds with the accelerated filing deadlines for 10-K and 10-Q filings. We therefore strongly encourage the Commission to revise its proposal such that implementation of these new requirements would be mandated on a prospective basis only.

Safe Harbor Protections
If the current proposal is adopted as drafted, we believe the Commission should provide explicit safe harbor protection for any new disclosures on critical accounting estimates. We believe that these disclosures are essentially forward-looking in nature and should therefore be protected; however, it would be helpful if the Commission could clarify this explicitly so that there is no confusion regarding this point.

*   *   *   *   *

We appreciate the opportunity to provide our comments on these matters, and support the Commission's effort to improve the quality and transparency of financial reporting. We have included our thoughts on other selected issues solicited for comment by the Commission in the Appendix of this letter. We hope the Commission will consider these points as it moves forward with its proposal. Please call John Fosina or Esther Mills if we can be of assistance to you during your deliberations or if you wish to discuss any of the points outlined above.



/s/ John Fosina
John Fosina
First Vice President
Corporate Controller

/s/ Esther Mills
Esther Mills
First Vice President
Accounting Policy

Alan L. Beller, Director, Division of Corporate Finance, SEC
Robert K. Herdman, Chief Accountant, SEC
Annette Nazareth, Director, Division of Market Regulation, SEC

Thomas H. Patrick, Executive Vice President and Chief Financial Officer, Merrill Lynch



Response to Selected Questions Solicited for Comment

Should we require in MD&A a discussion of the impact that alternative accounting policies acceptable under GAAP would have had on a company's financial statements even when a company did not choose to apply the alternatives?

We strongly oppose this proposal. Providing quantitative information regarding the impact of changes in estimates under different scenarios for different accounting alternatives would result in a minimum of four scenarios (assuming two estimates for each of two accounting policies) and potentially even more scenarios for an investor to consider, which would result in even further confusion for investors.

Should we expand the definition to include MD&A disclosure of volatile accounting estimates that use complex methodologies but do not involve significant management judgment? Should we do so only when the underlying assumptions or methodologies of those estimates are not commonly used and therefore not understood by investors?

If the Commission proceeds with this proposal, we believe it should clarify what is meant by a "volatile accounting estimate that does not involve significant management judgment," since it would seem on the surface that an estimate would necessarily involve the use of management judgment. In any event, we believe that the fact that an estimate is complex should not in and of itself be grounds for disclosure. We believe this proposal would only add further confusion and clutter to the financial statements.

Should we require a company to use whichever of the two proposed choices demonstrates the greatest impact on the company's financial presentation? To enhance an investors' ability to compare the sensitivity of various companies' financial statements to changes relating to a particular type of accounting estimate, should we standardize the changes that companies must assume for various types of estimates? If so, what should they be and why? For example, should we set a specified percentage increase and decrease to assume (e.g., a 10% increase and decrease), or a presumptive increase and decrease, provided that degree of change is reasonably possible in the near term?

As stated in our letter, although we believe that expanded qualitative disclosure of estimates and accounting policies would provide the most useful information to investors, if quantitative data is mandated, we would urge the Commission to provide flexibility in terms of the method of disclosure, rather than requiring a particular quantitative approach. As this proposal would affect registrants across all industries, we believe it is important to allow a registrant to communicate data regarding critical accounting estimates to investors in a manner that is most meaningful in the context of its particular business and industry. We believe a company should assume changes in estimates that reasonably could occur, and those amounts would differ among companies.

If any of a company's accounting policies diverge, to its knowledge, from the policies predominately applied by other companies in the same industry, should we require that the company disclose, possibly in connection with the audit committee report, whether the audit committee has had discussions with senior management about the appropriateness of the accounting policies being used? When such discussions have taken place, should we require that the company disclose the audit committee's unresolved concerns about the divergent accounting policies being applied? Prior to the adoption of our proposals, to what extent would a company know that its accounting policies diverge from those of other companies in its industry?

We believe that for certain areas that involve critical estimates, such as less liquid financial instruments, there are different equally justifiable models and policies for valuing instruments (e.g., discounted cash flows, comparables approach, etc.), most of which are already disclosed in the Summary of Significant Accounting Policies footnote. Different companies may be exposed to different risks and management may have differing views on the best way to address those risks, some of which represents proprietary information. Furthermore, it may be difficult to discern what a competitor's accounting policy is for a particular item, as what is significant for one company may not be so for another and therefore may not be disclosed in the financial statements. Assuming there is full transparency in the marketplace, however, if a company's accounting policies diverge from industry practice, we believe that a discussion regarding this policy is warranted, which would include the company's rationale as to why its choice was deemed appropriate by management.