Association for Financial Professionals

December 9, 2002

Jonathan G. Katz
U.S. Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, DC 20549

Re: File No. S7-42-02

Dear Mr. Katz:

The Association for Financial Professionals (AFP) welcomes the opportunity to comment on the Securities and Exchange Commission's (SEC) proposed rule Disclosure in Management's Discussion and Analysis (MD&A) About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments. The proposal implements Section 401 of the Sarbanes-Oxley Act of 2002. The Act requires that quarterly and annual reports contain specific disclosures about material off-balance sheet arrangements, obligations (including contingent obligations), and other relationships with unconsolidated entities that may have a material current or future effect on the financial statements and liquidity of the company. This proposal defines the terminology, establishes a threshold for disclosure, and provides required items to be disclosed in the MD&A.

AFP supports reasonable disclosure of off-balance sheet arrangements and contingencies that could represent significant current or future liabilities. The SEC needs to be concerned, however, about the total effect of all of the SEC's new and proposed rules, including the amount and sensitivity of required disclosures. This proposed rule provides an illustration of the collective effect. Each required MD&A disclosure item on off-balance sheet arrangements taken individually provides information that could be useful to an investor making a detailed comparison of companies. However, the sheer magnitude of the required information, and required management assessment of probabilities, could be overwhelming. We strongly recommend that the SEC consider the cumulative effects of all proposed disclosures, when issuing final rules in several areas that are still outstanding.

The membership of AFP includes approximately 14,000 financial executives employed by over 5,000 corporations and other organizations. Our members represent a broad spectrum of financial disciplines; their organizations are drawn generally from the Fortune 1000 and middle-market companies in a wide variety of industries, including manufacturing, retail, energy, financial services, and technology.

Cumulative Effect of the SEC's New and Proposed Rules

The SEC has proposed twelve new reporting and disclosure rules in the past nine months, many prompted by the Sarbanes-Oxley Act. Several of the proposed disclosure rules include accelerated filing deadlines. Each proposal taken individually may provide benefits to investors and analysts. In addition, most of the proposals have provisions that could be implemented without major disruptions to companies. However, the collective effect of all the rules and proposals may not be beneficial and will impose a tremendous cost on corporate America.

Under the twelve proposals, five involve quarterly and annual reporting of financial statements on Forms 10-Q and 10-K. Four involve current reporting on Form 8-K and Form 4 (for insider transactions). Under the proposals, companies will be required to disclose detailed, and possibly sensitive, information on accounting estimates in the MD&A section of quarterly and annual reports. In addition, companies will have to disclose on Form 8-K several events not previously reported, such as material agreements not made in the ordinary course of business, terminations of significant business relationships, and creation of a material direct or contingent financial obligations. The proposal also decreases the filing deadline for Form 8-K from fifteen business days after the event occurred to two business days.

Further, under a provision of the Act, company management will be required to assess and report on overall internal controls and the external auditor will be required to attest to management's report. While the Act requires annual overall internal control reporting, the SEC's proposed rule will require quarterly assessments and reporting on internal controls.

In addition to the pending proposed rules, several new rules have been finalized. Chief executive officers and chief financial officers must certify annual and quarterly reports, in addition to assessing and reporting on the effectiveness of disclosure controls. Insider trading must be reported within two business days; the previous deadline allowed up to 45 days after the trades occurred. Beginning in 2003, the filing deadline for Form 10-Ks will be accelerated by 15 days, from 90 days after fiscal year end to 75 days. In 2004, the deadline will be 60 days after fiscal year end.

AFP's Position on This Proposed Rule

This proposal provides definitions of off-balance sheet arrangements, contractual obligations, and contingencies; establishes a threshold for disclosure; and provides required items to be disclosed in the MD&A. AFP generally agrees that certain items should be disclosed about off-balance arrangement but has concerns about the volume and sensitivity of required disclosures.

There is a proposed three step process that triggers the required disclosures.

  1. Management must identify arrangements not on the balance sheet and assess whether chances are remote that an event could occur that would trigger a liability or contingent liability.

  2. If management concludes that chances are not remote, then it must determine if the potential effect is material.

  3. If the potential effect is material, then management must disclose the arrangement in the MD&A.

Required disclosures

If the off-balance sheet arrangements pass the proposed disclosure threshold tests, then management's MD&A disclosure must contain several detailed items. Companies must report the business purpose, significant terms and conditions, interests retained, securities issued, and debt incurred. Companies must also show the assets, liabilities, revenues, expenses, cash flows, obligations and contingent liabilities related to the arrangement. In addition, companies must disclose obligations and contingent liabilities that may become material and the triggering event.

Companies also must provide certain analyses in the MD&A that are supported by specific details, data, and management estimates. There must be an analysis of the extent that company relies on the arrangement for liquidity and capital resources, market or credit risk support, or other benefits. There also must be an analysis of the material effects, such as gains or losses from sales of assets to special-purpose entities in current and prior periods and reasons for any changes. Companies must also discuss the effects, or potential effects, of a termination or material reduction in the benefits of off-balance sheet arrangements. Companies also must provide insight into the impact and proximity of potential risks from the arrangement.

We do not believe that it would substantially benefit users of financial instruments to have the lengthy disclosures required under the proposal, especially when much of the disclosure could be based on information that is highly uncertain, or based on management's estimates. The proposed rules could result in voluminous disclosures of information about potentially multiple off-balance sheet arrangements that could inadvertently mask, rather than clarify, information in the financial statements. Also, as we stated in our July 19, 2002, letter to the SEC on disclosure of accounting estimates in the MD&A, certain information that companies use in determining accounting estimates could be company sensitive and should not be available to competitors and others.

The goal of corporate disclosure should be to provide transparency for investors. We strongly recommend that the SEC consider the effects on investors and companies of all the proposed disclosures when issuing rules in several areas that are still outstanding. The SEC should consider the cumulative costs and burdens for companies of any new requirements. Further, new rules should not require an amount of information and/or a level of detail that will be overwhelming and possibly obfuscating for investors.

We commend the SEC for its efforts to implement the Sarbanes-Oxley Act provisions in a timely manner and improve the quality of financial reporting by public companies. We appreciate the opportunity to comment on the proposed rule and urge your consideration of our recommendations. If you have any questions, please contact Gregory Fletcher, AFP's Director of Financial Accounting and Reporting, at (301) 961-8869.


Alvin C. Rodack, CCM
Associate Treasurer
The Ohio State University
AFP Government Relations Committee
  James R. Haddad, CCM
Vice President, Corporate Finance
Cadence Design Systems, Inc.
AFP Financial Accounting and Investor Relations (FAIR)
Task Force