December 9, 2002
Mr. Jonathan G. Katz, Secretary
Re: File No. S7-42-02
Dear Mr. Katz:
We at PricewaterhouseCoopers LLP appreciate the opportunity to comment on the Commission's Proposed Rule: Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments (the "proposal(s) or the "proposed rule(s)".
We support the Commission's overarching goals to enhance the transparency surrounding off-balance sheet arrangements, contractual obligations and contingent liabilities and commitments. We believe that the proposed rules are indeed consistent with many of the concepts embodied in the Sarbanes-Oxley Act of 2002 (the Act) and other broader initiatives aimed at restoring investor confidence, namely the Commission's Statement about Management's Discussion and Analysis of Financial Condition and Results of Operations (FR-61) issued in January 2002.
We believe the increased clarity of disclosure requirements relating to off-balance sheet arrangements is necessary, since the current MD&A disclosures requirements only cover the disclosure of those types of arrangements indirectly. For example, disclosure is required for the following: (i) information necessary to an understanding of the registrant's financial condition, changes in financial condition and results of operations and (ii) any known trends, demands, commitments, events or uncertainties that will result in, or that are reasonably likely to result in, the registrant's liquidity increasing or decreasing in any material way.
However, we believe that the current threshold applicable to other MD&A disclosure items should be applied to off-balance sheet arrangements, rather than establishing a new threshold. We believe that lowering the disclosure threshold to "more than remote" would significantly increase the amount of disclosure a registrant would have to make, and distract the reader from important disclosure determined by the registrant, in good faith, to be reasonably likely. The objective of the disclosure should be to provide investors with sufficient information and transparency about arrangements that are reasonably likely to affect the registrant's financial position, result of operations and cash flows.
In FR-61, the Commission reminded registrants that "reasonably likely" is a lower threshold than probable, and we believe that using this threshold is still appropriate. While we note the use of the word "may" in the Sarbanes-Oxley Act, we do not believe that the intent was to further lower the threshold and thereby overwhelm the reader with information that may not be useful to an understanding of the issuer's operations if it is not at least reasonably likely that there will be an impact on the registrant. We believe there needs to be a balance between providing relevant, useful and understandable information to investors and information overload.
In addition, we believe that the disclosure requirements for commitments should be limited to commercial commitments as is currently the case in FR-61. Commercial commitments would be intended to include lines of credit, guarantees, and other potential cash outflows resulting from a contingent event that requires registrant performance pursuant to a funding commitment. We believe that absent this restriction, the disclosure would include a wide range of commitments such as for example environmental liabilities. Disclosure of this information could be potentially damaging and may inadvertently indicate that a company is conceding an issue that is still subject to negotiations.
In the attachment to this letter, we have expressed our views on many of the specific questions that appear in the Release. Our responses should be considered in conjunction with the general comments expressed above.
We appreciate the opportunity to express our views and would be pleased to discuss our comments or answer any questions that the staff may have. Please do not hesitate to contact Jay P. Hartig at 973-236-7248 regarding our submission.
Attachment - Responses to the detailed questions
Off-Balance Sheet Arrangements
We believe that the proposed definition is appropriate. The more focused definition included in the proposed rule, in contrast to the broader definition in the Act, is warranted to avoid an overload of information for investors and to focus on the specific areas where additional disclosure is needed. We would, however, suggest that the Commission clarify that obligations under pension plans or similar arrangements should be excluded from the definition of off-balance sheet arrangements, similar to the rationale followed by the FASB in FIN 45, Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (FIN 45). FIN 45 indicates that those items not within the scope of FAS 5, Accounting for contingencies, are also not within the scope of FIN 45.
We also concur with the proposed exclusion from the definition of off-balance sheet arrangements of contingent liabilities arising out of litigation, arbitration or regulatory actions (not otherwise related to off-balance sheet arrangements), and encourage to Commission to make that clear in the final rule. The Commission may also consider providing examples of the types of contingent liabilities that would be excluded.
We believe that a company should have to right to maintain confidentiality and protect shareholder interests, especially with regard to items such as tax reserves and litigation matters. The requirement for disclosure of contingent liabilities, including those arising out of litigation, are already addressed in FAS 5 and Financial Accounting Standards Board Interpretation No. 14 (FIN 14), as well as Item 103 of Regulation S-K. In accordance with FAS 5 and FIN 14, registrants often record liabilities at the low end of the range of outcomes when no single amount within the range is a better estimate than another while continuing vigorous defense tactics. In addition, the instructions to Item 103 already address various circumstances in which disclosure is or is not required.
We believe that the definition is appropriate.
We believe that the definition is adequate.
We believe it is appropriate to exclude preliminary negotiations. A requirement to include arrangements that are not unconditionally binding could be both economically damaging to the registrant and confusing to the investors. It would place an undue burden on registrants who would have to explain the changing terms of such agreements, or why an agreement was cancelled or even revoked.
No, we do not believe that the threshold is appropriate. See our answer to question 6 below.
We believe that the current threshold applicable to other MD&A disclosure items should be applied to off-balance sheet arrangements. We believe that lowering the threshold to "more than remote" would significantly increase the amount of disclosure a registrant would have to make, and would distract the reader from important disclosure determined by the registrant, in good faith, to be reasonably likely. The objective of the disclosure should be to provide investors with sufficient information and transparency about arrangements that are reasonably likely to affect the registrant's financial position, result of operations and cash flows. In FR-61, the Commission reminded registrants that, "reasonably likely" is a lower threshold than probable, and we believe that using this threshold is still appropriate.
While we note the use of the word "may" in the Act, we do not believe that the intent was to lower the threshold and overwhelm the reader with information that may not be useful to the understanding of the issuer's operations.
Yes, we believe that would be the case. While we strongly believe that off-balance sheet transactions warrant registrant specific tailored disclosures, we do not believe that they should be more prominent than the remainder of the MD&A disclosures.
No. See our answers to Question 6. We believe the Commission should maintain the existing disclosure thresholds. We further believe this would be an overload of information that may not be very meaningful to the reader.
We believe so, however, we are unable to support this at this point with empirical data.
We believe that the requirements would be adequate.
Yes, we believe that the requirements are appropriately tailored. We believe that the current MD&A requirements often resulted in boilerplate language, which did not yield a thorough and transparent disclosure, as would be the likely consequence if the proposed rules are adopted as drafted. We believe that the proposed rules will promote more consistency, comparability, and transparency in registrants' filings. We believe that the Commission adequately balanced the need for relevant and useful information with information overload. We note that while the proposal enumerates specific disclosure items regarding off-balance sheet transactions, those disclosures are only needed to the extent necessary to an understanding of a registrant's off-balance sheet arrangements and their impact on financial condition, changes in financial condition and results of operation.
Yes, we believe that a registrant should be able to monitor and provide disclosure about those arrangements as part of its risk management procedures.
No, we believe that the requirements are appropriate.
Contractual Obligations and Contingent Liabilities and Commitments
No, we believe that the current requirements are appropriate. However, the Commission may wish to remind registrants of its positions on liquidity and capital resources as explained in FR-61.
No, we do not believe that definitions are necessary. However, as stated in our cover letter we believe that commitments should be limited to commercial commitments as is currently the case in FR-61. Commercial commitments would be intended to include lines of credit, guarantees, and other potential cash outflows resulting from a contingent event that requires registrant performance pursuant to a funding commitment. We believe that if commitments are not restricted to commercial commitments, the disclosure would include a wide range of commitments such as for example environmental liabilities. Disclosure of this information could be potentially damaging and may inadvertently indicate that a company is conceding an issue that is still subject to negotiations.
In addition, we believe that the final rules should also clarify that the contractual obligation information to be included in tabular format should be consistent with current GAAP measurements and disclosure requirements. For example, unconditional purchase obligations should be limited to unconditional obligations that meet all of the characteristics stated in paragraph 6 of FAS 47, Disclosure of Long-Term Obligations (FAS 47). The disclosure would exclude normal, routine purchases that are outside the scope of FAS 47, paragraph 6.
We do not believe that the Commission should impose limits on the extent to which a registrant can adapt the table to its particular circumstances. The purpose of MD&A has been and should continue to be, to enable investors to see the company through the eyes of management. Not allowing flexibility in the way a company can tailor the disclosures would be antithetical to that principle. We further believe that the overall goal of this disclosure is to present aggregated information about contractual obligations and commitments in a single location so that a total picture can be easily understood.
Should the proposed rules state that no disclosure is required with respect to the issuance of notes, drafts, acceptances, bills of exchange or other commercial instruments with a maturity of one year or less issued in the ordinary course of the registrant's business?
No. We believe it is useful to the investor to have a complete understanding of a company's obligations and contingencies. In fact, these items will likely require a cash outflow within a very near term and therefore could have a very significant effect on short-term liquidity.
Location of disclosure
We believe that the disclosure should be presented in separate MD&A section. We understand from the release that a registrant may place the tabular and textual disclosure of known contractual obligations and contingent liabilities and commitments in an MD&A location that it deems to be appropriate, while requiring the proposed disclosures regarding off-balance sheet arrangements to be set apart in a designated section of MD&A. We believe that the tabular disclosure on contractual obligations and contingent liabilities and commitments should also be presented in a separate section. We believe that a distinct presentation of each section would layer the MD&A, which would enable investors to easily obtain the desired information, just as the Commission's proposed disclosure of critical accounting estimates will be set apart in a separate section which will permit readers to easily locate the discussion.
To facilitate the layering of MD&A, should we amend the MD&A rules to require separate captions for the required discussions of results of operations, liquidity and capital resources?
Yes, we believe that the reader of the financial statements would benefit from such segregated disclosure.
Other MD&A Disclosures
We believe that the various requirements included in FR-61, but not specifically required by the Sarbanes-Oxley Act should be incorporated into this rulemaking. However, the task at hand is really to achieve the quality of reported data and improved understandability, and not to increase the volume of MD&A gratuitously. If the SEC believes that the current disclosures have not met the spirit of the rules, it should express its views though the CorpFin comment process.
See answer to question 20.
Should we codify the factors that we identified in our January 2002 Commission statement for management's consideration in identifying the trends, demands, commitments, events and uncertainties that require disclosure with respect to liquidity and capital resources? Are there other factors that should be included in such a codification?
See answer to Question 20.
Application to Foreign Private Issuers
Subject to our other comments about this proposal, we believe the proposed rules should be equally applicable to foreign private issuers as domestic issuers with the exception of companies that file under the Multijurisdictional Disclosure System (MJDS) - see comments below. Historically, with respect to disclosures included in management's discussion and analysis, market risk, etc, the Commission has required foreign private issuers to disclose information that is substantially similar to that required by domestic companies.
While not commenting on the continuation of the MJDS, we believe that the requirement to disclose such information is inconsistent with the principles of the MJDS system. Securities Act Release No. 6902 that established MJDS states that qualifying Canadian companies can meet the Commission's reporting requirements by providing disclosure documents prepared in accordance with the requirements of the Canadian securities regulatory authority. The concept is that with the exception of the requirement to provide reconciliation to US GAAP, the document filed with the SEC is simply a wrap of the document submitted to the Canadian regulators that has been prepared in accordance with the Canadian requirements. By requiring this disclosure, the Commission would be deviating from the fundamental principle of the establishment of MJDS. Since the adoption of the MJDS system over ten years ago, the Commission has made far more significant changes to the reporting requirements that apply to foreign private issuers without modifying the MJDS system.
See comments above.
Should we exempt Form 6-K reports from the scope of the proposed rules, as proposed? Or should we apply the proposed rules to Form 6-K reports that include quarterly financial statements?
We agree with the proposed exemption for Form 6-K reports for the reasons stated in the proposed rule.
Safe Harbor and Forward-Looking Information
No, the information proposed to be disclosed in more factually based.
We believe that the statutory safe harbors are sufficient.
See our response to Question 20 on the codification of the different factors and requirements included in FR-61.
See our response to Question 20 on the codification of the different factors and requirements included in FR-61.
We concur with the proposed exclusion from the definition of off-balance sheet arrangements of contingent liabilities arising out of litigation, arbitration or regulatory actions (not otherwise related to off-balance sheet arrangements), and encourage the Commission to make that clear in the final rule. The Commission may also consider providing examples of the types of contingent liabilities that would be excluded.
We have no additional comments.