Deloitte & Touche LLPDecember 9, 2002 Mr. Jonathan G. Katz
RE: Release No. 33-8144; 34-46767
Dear Mr. Katz: Deloitte & Touche LLP is pleased to respond to the Securities and Exchange Commission's (the "Commission") request for comments on its proposed rule regarding Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments (File No. S7-42-02). I. Introduction We strongly support the goals of the President of the United States, the United States Congress, and the Commission to improve the quality and transparency of financial reporting. Many provisions of the Sarbanes-Oxley Act of 2002 (the "Act") will serve to effect positive changes. We are committed to assisting the Commission in the adoption of responsible rules to effect changes that serve to positively impact the quality of financial reporting and help to restore investor confidence in our capital markets. One element of the implementation of the Act is the Commission's proposed rule concerning disclosure about off-balance sheet arrangements, contractual obligations and contingent liabilities and commitments, consistent with Section 401(a) of the Act. The objectives of the proposed rule are to improve the transparency of registrants' off-balance sheet arrangements and to provide financial statement users with aggregated information about the nature and magnitude of registrants' contractual obligations and contingent liabilities and commitments. These objectives are consistent with those of the Commission Statement that was issued in January 2002 regarding improved disclosures within Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") (the "January 2002 Commission Statement").1 At that time, we, along with the other large accounting firms, petitioned the Commission to issue the additional interpretive guidance contained in that statement. We believe that the proposed rule will promote more consistency, comparability, and transparency in registrants' filings. Accordingly, we support the issuance of rules governing required MD&A disclosures in this area. Our comments below are provided in response to the requests for comment and are intended to present our views on the key aspects of the proposal and to address certain specific areas in which we believe the proposed rule could be modified or clarified in order to better meet the Commission's stated objectives. In summary, we believe that the Commission should (1) develop a clearer definition of the term "off-balance sheet arrangement," (2) apply its current "reasonably likely" threshold to disclosure of off-balance sheet arrangements, (3) provide a definition of the term "contractual obligations," (4) use a different term than "contingent liabilities and commitments" and provide a definition of that new term, and (5) provide additional guidance to registrants in the form of comprehensive examples of items that do and do not fall within the scope of these definitions. II. Off-Balance Sheet Arrangements A. Off-Balance Sheet Arrangements Covered Under the Proposal We agree that investors and other financial statement users would benefit from enhanced disclosures about registrants' relationships with unconsolidated entities that result in financial exposures that are not reflected in the financial statements. However, the proposed definition of "off-balance sheet arrangements," while intended to be more focused and narrow than the language included in Section 401(a) of the Act, is somewhat confusing, and therefore it is difficult to ascertain how broadly it should be applied. We also do not believe that the proposed definition will require disclosures that are responsive in all instances to the rule's objectives, or to the objectives of Section 401(a) of the Act. We believe that a clearer definition should be developed that better advances the Commission's intentions. The proposed rule defines the term "off-balance sheet arrangement" as:
Any transaction, agreement or other contractual arrangement to which an entity that is not consolidated with the registrant is a party, under which the registrant, whether or not a party to the arrangement, has, or in the future may have: The definition begins with language defining such arrangements as "...any transaction, agreement or other contractual arrangement to which an entity that is not consolidated with the registrant is a party, under which the registrant...has, or in the future may have..." certain financial exposures. We believe that this definition should be modified to clarify the types of unconsolidated entities with which registrants may be involved that would be subject to the disclosure requirements. Presumably, the Commission is most concerned with registrants' potential exposures to non-independent, limited purpose entities, which are often referred to as structured finance or special purpose entities. However, registrants also may have potential obligations and exposures to many other types of unconsolidated entities in the normal course of business, such as cost or equity method investees, or counterparties to contracts that are substantive operating enterprises. It is not clear whether the Commission intends for registrants' relationships with these types of entities to be included in the definition of "off-balance sheet arrangements." If these types of entities are intended to be included, we believe the proposed definition is too broad. Further, the proposed definition includes potential exposures from certain obligations to an unconsolidated entity and retained or contingent interests in assets transferred to an unconsolidated entity, regardless of whether these items are "fully reflected in the financial statements." However, the proposed definition excludes potential exposures from derivatives with an unconsolidated entity and obligations, including contingent obligations, to an unconsolidated entity that are "fully reflected in the financial statements" as assets or liabilities. A liability that is recorded at its fair value in the financial statements as of the date of the financial statements is considered to be "fully reflected" under the proposed rule. It is unclear why certain exposures are and other exposures are not included within the proposed definition of "off-balance sheet arrangements." As noted in the "Discussion of the Proposed Rules" section of the proposal, the fair value of a liability recorded in the financial statements at any point in time may be materially different from the amount at which the liability is ultimately settled, because the estimation of the fair value of the liability would reflect the probabilities of all possible outcomes. A fair value measurement would not result in the recording of a registrant's maximum potential exposures and, therefore, potentially material exposures to unconsolidated entities are excluded from the proposed definition of off-balance sheet arrangements. Conversely, obligations under a direct or indirect guarantee or "similar arrangement" are subject to the proposed definition, notwithstanding the fact that such obligations may be recorded at fair value in the financial statements. These inconsistencies should be reconciled or resolved in the final rule. As an alternative, the proposed disclosure requirements could apply to all "off-balance sheet arrangements," as more precisely defined, regardless of whether a registrant's potential exposures to such arrangements are recorded in the financial statements at fair value. The disclosure requirements could then be based on a maximum potential exposure approach, with certain practicability exceptions, similar to that taken by the Financial Accounting Standards Board ("FASB") in the recently issued Interpretation No. 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. 2 An approach such as this would, in our view, be more responsive to the objectives of the proposed disclosures; that is, to provide investors with quantitative and qualitative information about certain exposures that are not reflected in the financial statements. In addition, the proposed definition of off-balance sheet arrangements includes several undefined terms that may have different meanings in different contexts. For example, is the term "derivatives" intended to conform to the definition in generally accepted accounting principles ("GAAP"),3 or is it intended to have a broader or narrower meaning? Specific guidance on the intended meaning of these undefined terms (such as derivatives and contingent obligation or liability) would be helpful for registrants in complying with the final disclosure rules. In order to address some of the conceptual and practical concerns that we have with the proposed definition, we believe that the Commission could benefit from the progress that the FASB has made,4 and define an off-balance sheet arrangement as follows: An unconsolidated entity in which the registrant has an ownership interest, or with which the registrant has a contractual relationship or other involvement. Through its relationship with the entity, the registrant provides financial support to the entity, and has potential exposure to losses as a result of the entity's operations. The rule could then provide examples of common means through which financial support is provided to unconsolidated entities, such as loans, leases, management or other service contracts, firm purchase commitments or purchase options, guarantees of debt or asset values, retained beneficial interests in transferred assets, and derivative instruments. The rule could also clarify the types of unconsolidated entities in which registrants may be involved that would be subject to the disclosure requirements, which presumably would include special purpose entities; that is, entities for which it is not possible to establish a controlling financial interest through ownership of voting interests.5 If the Commission intends for the proposed disclosures for off-balance sheet arrangements to be more broadly applicable (that is, beyond special purpose entities), we believe that the rule should be based upon, or reconciled to, the requirements of FASB Interpretation No. 45. In other words, the final rule should either require that the disclosures required by FASB Interpretation No. 45 be carried forward into MD&A, or be limited to potential exposures that are not already addressed by this Interpretation. For example, the Commission could require MD&A disclosures for guarantees that are exempted from the initial recognition and measurement and disclosure provisions of FASB Interpretation No. 45 or otherwise reconcile the scope of its disclosure rule to the scope of the accounting and disclosure requirements of GAAP. If the scope of the final rule is different than the scope of the accounting and disclosure requirements of GAAP and no clear explanation or reconciliation of the differences is provided, the competing and inconsistent disclosure regimes may only serve to further confuse financial statement users, undermining the Commission's intent. B. Proposed Disclosure Threshold In the proposing release, the Commission requests comment on the threshold that should govern disclosure of off-balance sheet arrangements. The Commission has proposed applying a "higher than remote" standard, under which disclosure would be required whenever management concludes that the likelihood of a future event resulting from an off-balance sheet arrangement and the likelihood that the event will have a material effect, are "higher than remote." We believe the proposed disclosure threshold would require highly speculative judgments and would be burdensome to issuers and investors because it would result in overly voluminous disclosure of information that is of questionable relevance to investors. The proposed standard appears to go beyond the requirements of the Act, and it is inconsistent with the existing standard for disclosure of prospective information in MD&A, as set forth in Item 303(a) of Regulation S-K and interpreted by the Commission. Rather than adopting a new, more speculative standard, we believe the Commission should apply its current, "reasonably likely" standard to elicit an appropriate level of disclosure about these arrangements. The proposed standard, by contrast, is overly inclusive and would require disclosure of extraneous information about future events that, by definition, are unlikely to occur. This information would be of limited use to investors and could have the effect of obscuring information about future events that are of greater significance to a registrant's financial condition and results of operations because they are much more likely to occur. The Act directs the Commission to promulgate rules mandating disclosure about material off-balance sheet transactions that "may" have a material current or future effect on various aspects of a company's financial condition. Although the Commission interprets the use of the word "may" in the Act as "suggesting a lower disclosure threshold" for prospectively material information relating to off-balance sheet arrangements, the statutory language does not appear to mandate this interpretation. In interpreting the language of the Act, the Commission relies on two "long-standing probability thresholds used in financial disclosure" to conclude that a future event should be disclosed unless management determines that the occurrence of the event and the materiality of its effect are "remote" or, stated another way, "outside of the realm of reasonable possibility." According to Statement of Financial Accounting Standards ("SFAS") No. 5, a future event is "reasonably possible" if the chance of the future event occurring is "more than remote but less than likely," and it is "remote" if "the chance of the future event . . . occurring is slight." Because the common usage of the word "may" connotes possibility or probability, we do not believe that the disclosure required under the Act extends to future events that have only more than a "slight" chance of occurring and producing a material effect on a company's financial condition and results of operations. A "higher than remote" standard would therefore expand the reach of the statutory provision to off-balance sheet arrangements that the language of the Act does not appear to cover. The Commission's proposals would also establish a lower disclosure standard than the existing "reasonably likely" threshold that otherwise applies to disclosure about known trends, events and uncertainties in MD&A. For this reason, it is overly inclusive and would result in a proliferation of disclosure about future events that have only more than a slight chance of occurring. It is also inconsistent with the guidance set forth in the January 2002 Commission Statement in which the Commission articulated its views on disclosure about off-balance sheet arrangements and cautioned that management "should provide the most relevant information." The proposed disclosure standard is particularly problematic in view of the Commission's existing guidance on disclosure about known trends, events and uncertainties and the two-prong test articulated in the Commission's 1989 interpretive release for determining when disclosure is required. Under the test, where a trend, event or uncertainty is known to management, management must first assess whether it is likely to come to fruition. If management determines that it is not "reasonably likely" to occur, then no disclosure is required. If management cannot make that determination, it must evaluate the consequences of the known trend, event or uncertainty, on the assumption that it will occur, and assess whether it is reasonably likely to have a material effect on financial condition or results of operations. MD&A disclosure is required unless management can determine that a material effect is not reasonably likely. Applying the Commission's two-prong test to off-balance sheet arrangements, as the Commission now proposes, may have untenable consequences. Unless management can determine that a future event resulting from an off-balance sheet arrangement is "remote," it must proceed on the assumption that it is not remote, assess the likelihood that the event will have a material affect, and make disclosure unless the likelihood of a material effect is remote. Lowering the disclosure threshold from "reasonably likely" to "higher than remote" will require management to speculate about the possible ramifications of off-balance sheet arrangements, the likelihood that those ramifications will materialize in the future, and the effects that they will have on a company. Moreover, unless management can determine that a future event resulting from an off-balance sheet arrangement is "remote," it will be required to conduct a materiality analysis. As a result, if adopted, the Commission's proposals would increase the number of materiality determinations that registrants and their management would have to make. Because materiality determinations involve difficult judgments, this would a substantial burden on registrants with limited corresponding benefit to investors. Off-balance sheet arrangements are just one of many items that can affect a registrant's financial condition and results of operations. Imposing a lower disclosure threshold that is specific to these arrangements would unduly emphasize their importance at the expense of other events that are more likely to have a material impact on a registrant. C. Proposed Disclosure About Off-Balance Sheet Arrangements The proposed rule would require certain disclosures about off-balance sheet arrangements. Disclosure of specific enumerated items, to the extent necessary for an understanding of the effects of the arrangements on financial condition, changes in financial condition, revenues and expenses, results of operations, liquidity, capital expenditures, and capital resources, would be required in a separate section of MD&A. Proposed disclosure items include, but are not limited to: nature and business purpose; significant terms and conditions; nature and amount of total assets, total obligations and liabilities (including contingencies) of the off-balance sheet entities; amounts of revenues, expenses and cash flows of the registrant arising from the arrangements; nature and amount of any interests retained, securities issued and other indebtedness incurred by the registrant; and nature and amount of any other obligations or liabilities (including contingencies) of the registrant arising from the arrangements and the triggering events or circumstances that could cause them to arise. Disclosure of the degree to which a registrant relies on off-balance sheet arrangements for its liquidity and capital resources or market risk or credit risk support would also be required. After the definitional or "scope" aspects of the proposed rule are resolved, we believe that the items required to be disclosed regarding off-balance sheet arrangements in the proposed rule will improve the transparency and quality of such disclosure by enhancing investors' understanding of a registrant's uses of off-balance sheet arrangements, the reasons for entering into such arrangements, and a registrant's potential exposure to losses resulting from these arrangements. The proposed disclosures are consistent with those contained in the January 2002 Commission Statement. We believe that the proposed requirement to disclose the nature and business purpose of registrants' off-balance sheet arrangements will be particularly helpful for financial statement users. The vast majority of off-balance sheet transactions are entered into for legitimate business purposes, and meaningful discussions of the nature and business purposes of these transactions will, in our view, help "clear the air" and restore investor confidence. However, to promote consistency, and to ensure compliance with the Commission's intent, the Commission should consider providing, in the text of the proposed rule or elsewhere, examples of disclosure best practices for common off-balance sheet arrangements, developed from the recent disclosures made in response to the January 2002 Commission Statement. In addition, we believe any final rule should clarify the periods for which certain quantified disclosures should be provided. For example, we believe disclosure of financial information (such as the amount of total assets, obligations and liabilities of the off-balance sheet entities, and revenues, expenses and cash flows of the registrant arising from such arrangements) should only be required as of the latest balance sheet date and corresponding latest fiscal year. III. Contractual Obligations and Contingent Liabilities and Commitments The proposed rule would require registrants, other than small business issuers, to include tabular disclosure about contractual obligations and either tabular or textual disclosure about contingent liabilities and commitments in MD&A. The disclosure would include information about a registrant's known contractual obligations and contingent liabilities and commitments, encompassing both on- and off-balance sheet arrangements, as of the latest balance sheet date. Registrants would be required to disclose the amount of contractual obligations (for example, long-term debt, capital lease obligations, operating leases, unconditional purchase obligations, and other long-term obligations) and the expected amount, range of amounts or maximum amount of contingent liabilities and commitments that are expected to mature or expire in less than one year, from one to three years, from three to five years, and more than five years. Many of the disclosures required under the proposed rule regarding contractual obligations and contingent liabilities and commitments are already required to be disclosed in the footnotes to the financial statements pursuant to existing authoritative accounting literature and Commission rules and regulations. For example, a lessee is required to disclose, in the footnotes to its financial statements, future minimum lease payments as of the date of the latest balance sheet presented in the aggregate and for each of the five succeeding fiscal years.6 Notwithstanding the disclosure requirements under GAAP and other Commission rules and regulations, due to the fragmented nature of these accounting and disclosure requirements, we agree that investors and other financial statement users would benefit from the disclosure of aggregated information regarding registrants' contractual obligations and contingent liabilities and commitments within MD&A. We believe that the proposed tabular disclosure, accompanied by appropriate explanatory footnotes or narrative discussions, for contractual obligations and tabular or textual disclosure for contingent liabilities and commitments would improve transparency of a registrants' short- and long-term liquidity and capital resource needs and demands. However, in order to generate the most meaningful disclosure for financial statement users and filter out superfluous information, we believe that the final rule should provide a definition of the term "contractual obligations," use a different term than "contingent liabilities and commitments" and provide a definition of that new term, and provide examples of the types of items that meet these definitions. For example, a contractual obligation could be defined as an obligation to pay cash or to provide goods, services or other assets to specified or determinable entities on demand, at specified or determinable dates, or on the occurrence of specified events, that is based on a legally binding, enforceable written or oral agreement.7 As an alternative, contractual obligations subject to the disclosure rules could be limited to legally binding, enforceable obligations under which the registrant would be required to pay cash upon settlement (that is, cash obligations). Examples of representative contractual obligations that meet this definition, such as borrowings, lease obligations, and firm purchase commitments could then be provided in the instructions to the final rule. A clear definition of this term would assist registrants in distinguishing the types of obligations that are required to be disclosed from those that are not subject to the disclosure requirements (such as constructive or other obligations that meet the definition of liabilities under GAAP, but are not "contractual obligations"). In any event, we believe that disclosure of contractual obligations required by the final rule to be presented in the table should be limited to those disclosures that are already required by GAAP. That is, the final rule would require summarization in one place of the disclosures about contractual obligations that are currently required by GAAP but dispersed throughout the footnotes to the financial statements. Under the proposal, registrants (other than small business issuers) would have to provide disclosure about "contingent liabilities and commitments." We believe the Commission should consider using a different term than "contingent liabilities and commitments," define that new term, and provide examples of items that are subject to the disclosure requirements. The term "contingent liabilities and commitments" is generally considered to be a loss contingency accounted for under SFAS No. 5. SFAS 5 broadly defines a loss contingency as "an existing condition, situation, or set of circumstances involving uncertainty as to possible loss." This definition would appear to include items that the Commission did not intend to include in the proposed disclosure. For example, contingencies such as product warranty obligations, environmental or tax contingencies, potential obligations arising from pending or threatened litigation, and contingent consideration in a purchase business combination would all appear to represent "contingencies," but we do not believe these items should be within the scope of the proposed disclosure requirements. Consistent with the January 2002 Commission Statement, the Commission could consider using the term "commercial commitments" instead of "contingent liabilities and commitments." Examples of commercial commitments in the Commission Statement include lines of credit, guarantees, standby letters of credit, and standby repurchase obligations. Since these examples are the same as those cited in the proposed rule for contingent liabilities and commitments, we believe such a change in terminology is consistent with the scope of the proposed disclosures and would promote clear, consistent and meaningful disclosure. Once the current term "contingent liabilities and commitments" is appropriately renamed, the Commission should provide a definition of that term. The January 2002 Commission Statement defined commercial commitments as "...potential cash outflows resulting from a contingent event that requires registrant performance pursuant to a funding commitment." In addition, the Commission should clarify whether the proposed disclosure requirements are intended to elicit disclosure regarding contingent liabilities and commitments that are settleable by the registrant with assets other than cash, such as by the issuance of the registrant's own equity shares. We believe the tabular presentation should only focus on cash obligations and commitments. However, contractual or other commitments that involve the issuance of debt or equity securities that expose the registrant to risk of loss should also be discussed through narrative, qualitative disclosure. While we agree that the Commission's MD&A disclosure rules currently are and should continue to be sufficiently flexible to permit an insightful discussion within the context of a registrant's unique business environment, a lack of sufficient clarity related to the intended scope of the proposed rules could lead to unintended consequences. That is, absent clarity, registrants may revert to high-level, boilerplate discussions and inadvertently omit important information. Another unintended consequence of the use of ambiguous terms in the final rule could be that registrants mix important information with unimportant information, resulting in disclosure overload and an obfuscation of the relevant details. For these reasons, we believe the final rules should provide more clarity and specificity in defining the terms off-balance sheet arrangements, contractual obligations, and contingent liabilities and commitments. In addition, to promote consistency, and to ensure compliance with the Commission's intent, the Commission should consider providing, in the text of the proposed rule or elsewhere, examples of disclosure best practices for contractual obligations and contingent liabilities and commitments. Such disclosure examples should also address practical implementation issues and questions identified upon the issuance of the January 2002 Commission Statement. For example, while GAAP contains disclosure guidance for long-term debt, capital lease obligations, operating leases, and unconditional purchase obligations8 required to be disclosed in the contractual obligations table, it is unclear what type of obligations are required to be disclosed in the "other long-term obligations" section of the table. Examples of "other long-term obligations" that require disclosure would be helpful. As stated above, we do not believe that any new disclosures about contractual obligations not currently required under GAAP should be required in the final rule. Although substantially all of the proposed disclosures for contractual obligations appear to be those already required by GAAP, the disclosures for contingent liabilities and commitments may exceed the requirements under GAAP, depending on how the Commission ultimately defines these terms. It is unclear whether the Commission intended for these disclosures to exceed the current GAAP required disclosures. In addition, we believe the Commission should consider whether the additional proposed disclosures on guarantees are necessary or should be modified in any way in light of recently issued FASB Interpretation No. 45, which requires certain disclosures to be made by a guarantor about its obligations under certain guarantees that it has issued. For example, the interpretation requires certain disclosures including the approximate term of the guarantee and the maximum potential amount of the future payments under the guarantee. While the Commission's proposed rule, requires disclosure of the expected amount, range of amounts, or maximum amount of guarantees that are expected to expire in less than one year, from one to three years, from three to five years, and more than five years. Other issues the Commission should consider clarifying in the final rule include:
IV. Application to Foreign Private Issuers These comments address the unique concerns facing foreign private issuers relating to the proposed rule. Confusion regarding the definition of "off-balance sheet arrangements" is exacerbated when considered in the context of a foreign private issuer whose financial statements are prepared in accordance with a comprehensive basis of accounting other than U.S. GAAP, as permitted by Form 20-F. For example, it is unclear whether the disclosure requirements of Item 5.E of Form 20-F are applicable when the arrangement is "fully reflected in the financial statements" prepared in accordance with a comprehensive basis of accounting other than U.S. GAAP, but may not be "fully reflected in financial statements" prepared under U.S. GAAP (i.e., considered off-balance sheet for U.S. GAAP purposes, but not for "home-country" GAAP purposes). In these cases, the Commission should consider the applicability of the proposed disclosure requirements. The Commission has asked whether foreign private issuer annual reports on Form 20-F should be exempt from the scope of the proposed rule. We believe the proposed rule should apply to both domestic issuers, other than small business issuers, and foreign private issuers that file annual reports on Form 20-F. Our comments regarding qualified Canadian issuers are detailed below. The Commission has historically maintained the same MD&A disclosure requirements for both domestic issuers and foreign private issuers. We support the disclosures required in MD&A and believe U.S. security holders need this information to make informed investment decisions, regardless of whether the issuer is domestic or foreign. In addition, exempting foreign private issuers' annual reports on Form 20-F from the scope of the proposed rule would raise questions regarding the basis for not omitting other MD&A disclosures currently required in Form 20-F. The Commission has asked whether the MJDS annual report filed for qualified Canadian issuers (that is, Form 40-F) should be exempt from the scope of the proposed rule. We understand the Canadian Securities Administrators ("CSA") is studying a number of initiatives arising from the Act, including an initiative related to the disclosure of off-balance sheet arrangements. As such, the Commission may wish to consider the outcome of possible actions by the CSA regarding MD&A requirements for Canadian issuers. Should the Commission consider those requirements and conclude that they are consistent with the Commission's proposed disclosure requirements, qualified Canadian issuers would be providing U.S. security holders with information equivalent to that provided by domestic issuers. Under such circumstance, the Commission should consider maintaining the current requirements under the MJDS and exempt Form 40-F from the scope of the proposed rule. Finally, the Commission asked whether Form 6-K reports that include quarterly financial statements should be exempt from the proposed rule. The underlying principle of Form 6-K is that when certain material information is made public or distributed to security holders in a foreign private issuer's home country, such information must be furnished to U.S. security holders. We believe that a requirement to update the proposed MD&A disclosures on a basis more frequent than annually (for example, via Form 6-K reports that include quarterly financial statements) would be inconsistent with that underlying principle, unless the disclosure of such updates is made public or distributed to security holders in the issuer's home country. Accordingly, we believe that such disclosures should be made only when they are made public or distributed in the issuer's home country. However, the Commission may wish to address separately, in connection with a larger project, the continuous filing requirements of foreign private issuers and the need for more frequent disclosure to U.S. security holders than those made under the current periodic disclosure regime. V. Other Issues and Questions Considered A. Presentation of Proposed Disclosure The Commission has asked whether it should require that the proposed disclosures be presented in a separate MD&A section. The proposal currently requires a registrant to present disclosure about off-balance sheet arrangements in a separate section of MD&A. In contrast, management may place the disclosure about contractual obligations and contingent liabilities and commitments in an MD&A location that it deems most appropriate. We do not believe the Commission should require that the proposed disclosures be presented in a separate section of MD&A. Management of each registrant is best able to decide the location of the required disclosures and, therefore, registrants should have sufficient flexibility to provide an insightful discussion within the context of the registrant's unique business environment. While disclosure in a separate section of MD&A may be the most useful presentation for certain registrants with extensive off-balance sheet arrangements, a separate section may unnecessarily emphasize the importance of these items for a registrant who does not have material off-balance sheet arrangements. B. Other MD&A Disclosure The Commission has asked whether the MD&A rules should be further amended to require more specific disclosure about relationships and transactions with persons or entities that derive benefits from their non-independent relationships with the registrant or the registrant's related parties. We do not believe further rulemaking is necessary as existing disclosure requirements and practices, including SFAS No. 57, Related Party Disclosures, Item 404 of Regulation S-K, and the January 2002 Commission Statement, appear to adequately address this issue. In particular, the January 2002 Commission Statement, which recommends registrants provide disclosure necessary for an understanding of the transactions' business purpose and economic substance, their effects on the financial statements, and the special risks or contingencies arising from these transactions, provides useful guidance to registrants regarding appropriate MD&A disclosure for these types of transactions. C. Interim Period Disclosures Instruction 7 of the proposed amendment to Item 303(b) states that the registrant "is not required to include the table required by paragraph (a)(5) of this Item in a quarterly report on Form 10-Q." Instead, the registrant may disclose material changes by including a discussion of the relevant changes in quarterly reports. We believe that Instruction 7 to Item 303(b) should be revised to clearly indicate that registrants are not required in quarterly reports to include the table or repeat the other required textual disclosures that may be provided for contingent liabilities and commitments in annual reports. In addition, no similar guidance regarding disclosure required for off-balance sheet arrangements in interim reports appears to be provided in the proposed rule. The final rule should clarify that disclosure in quarterly reports about off-balance sheet arrangements generally should be limited to a discussion of material changes during interim periods, as with other MD&A requirements. D. Transition Issues The proposed rule does not provide for any transition period. The final rule should provide an appropriate period of time for transition. We believe this period of time should be relatively short (for example, for year-end and interim reports for periods ending on or after December 15, 2002) since the proposed disclosure requirements are generally consistent with the January 2002 Commission Statement. Periodic reports filed prior to the effectiveness of the rules may not contain all of the disclosures which will be required under the amended MD&A rules. If these periodic reports are incorporated by reference into registration statements, we do not believe that an amendment to the periodic reports to include the required disclosure would generally be warranted. Rather, any additional disclosures required could be included in the registration statement or the next Form 10-Q to be filed to eliminate the need to amend prior documents. VI. Conclusion We support improving the quality and transparency of disclosures about off-balance sheet arrangements and recognize the importance of providing investors with useful and understandable disclosure about these arrangements. Because off-balance sheet arrangements, by definition, are not reflected on the face of a registrant's financial statements, absent appropriate disclosure, investors might otherwise be unaware of these arrangements and their potential to impact a company's financial condition. We also support the proposal to provide an overview of a registrant's aggregate contractual obligations in a tabular format and contingent liabilities and commitments in either a textual or tabular format. However, we urge the Commission to consider our suggestions for modifications to or clarifications of the proposed rules to best accomplish the Commission's objectives. In summary, we believe that the Commission should (1) develop a clearer definition of the term "off-balance sheet arrangement," (2) apply its current "reasonably likely" threshold to disclosure of off-balance sheet arrangements, (3) provide a definition of the term "contractual obligations," (4) use a different term than "contingent liabilities and commitments" and provide a definition of that new term, and (5) provide additional guidance to registrants in the form of comprehensive examples of items that do and do not fall within the scope of these definitions. If you have any questions, please contact Robert J. Kueppers at (203) 761-3579.
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