Cleary Gottlieb Steen & Hamilton

August 2, 2002

Jonathan G. Katz, Secretary
Securities and Exchange Commission
450 Fifth Street, N.W.
Washington, D.C. 20549-0609

Re: File No. S7-16-02-Disclosure in Management's Discussion and Analysis ("MD&A") About the Application of Critical Accounting Policies

Dear Mr. Katz:

We are submitting this letter in response to the request of the Securities and Exchange Commission (the "Commission") for comments on the Commission's proposed disclosure requirements regarding the application of critical accounting policies.1 We appreciate the opportunity to comment on the matters discussed in the Proposing Release.

I. Introduction

The Commission is right to require focused disclosure about judgments that have a material impact on financial presentation. Financial statements may appear to be precise and objective, and to promise continuity from one period to the next, but in reality, they turn on judgments and estimates and are subject to rapid change. If the new disclosure requirements work, they will benefit investors by highlighting elements of judgment and uncertainty, and by forcing companies to think through and defend the estimates they make.

The proposed requirements could, however, backfire. The resulting disclosure will not benefit investors if it is too long, complex, confusing or mechanical. Nor will it improve transparency if it places disproportionate emphasis on accounting estimates, as compared to the other important subjects to which a quality MD&A must devote attention. We believe that these are real risks, which the Commission should address by modifying the proposal. First, as we discuss in Part II of this letter, we believe that the Commission should allow companies more flexibility in how they address the sensitivity of their critical accounting estimates. Second, as discussed in Part III, we propose the following five additional significant modifications:

  1. Require that the notes to the financial statements identify critical accounting estimates.

  2. Make the definition of "critical accounting estimate" simpler and more consistent with the accounting and auditing literature.

  3. Delete the proposed disclosure about discussions with the audit committee.

  4. Encourage companies to develop responsive disclosure by strengthening protections from liability.

  5. Phase in the new rules slowly, and provide for the Commission to review the resulting disclosure and adjust the rules accordingly.

Finally, attached as Annex A to this letter, we have provided brief responses to several of the issues about which the Commission requests comment in the Proposing Release.

Our proposals aim to ensure that the Commission's initiative leads to a successful evolution in disclosure practices. The subject is difficult; it requires a discussion that cuts across several disciplines; and the issues vary widely for different companies. We expect that the evolution of enhanced disclosure practices will take several years in which companies will experiment, and in which new disclosures will be examined by investors, analysts, other companies and the Commission staff.2

II. The rules should allow more flexibility in discussing sensitivity to changes in critical accounting estimates

Paragraph (3)(iii) of the proposed rules requires, for each critical accounting estimate, a quantitative discussion of the sensitivity of financial results to changes in the estimate. It also establishes two methodologies from which a company must choose, both of which require the company to quantify how much variation is reasonably possible.

Developing good disclosure on critical accounting estimates will be difficult, and by far the most difficult part will be addressing sensitivity. We agree that the MD&A discussion should address the sensitivity of the financial results to changes in a critical accounting estimate, but we feel strongly that the Commission should revise this paragraph so that companies have more flexibility in how to do so.3 We believe that companies will find that different kinds of estimates involve different kinds of analysis and can best be addressed by different kinds of disclosure. Specifically, the rules (a) should permit an unquantified discussion if that is the most effective way to explain sensitivity, (b) should not prescribe any particular methodology and (c) should not require that the company give precise numbers for necessarily imprecise concepts like "reasonably possible near-term changes" or "the range of reasonable possibilities."

We propose that paragraph (3)(iii) should read as follows:

Discuss how overall financial performance and, to the extent material, the line items in the financial statements would change if the registrant used different estimates that the registrant reasonably could have used in the current period, or if reasonably possible near-term changes in the estimate occur.

This could be accompanied by an instruction reading as follows:

In response to paragraph (c)(3)(iii) of this section, you should provide information sufficient for an investor to understand the sensitivity of the financial statements to reasonable alternative estimates or to reasonably possible near-term changes in estimates. This information should include a quantitative analysis where that is the most effective practicable method of illustrating or defining the sensitivity.

Under our proposal, it will often be appropriate to use specific figures to illustrate the sensitivity of an estimate. The Commission's proposed rules, however, would require a company to give specific figures for how much near-term change is "reasonably possible" or for the upper end of the range of "reasonable possibilities." In many cases, there is no basis for doing so, because these are not mathematically precise expressions. Giving numbers in answer to such questions, a company can easily compound the problem of false precision that prompted the present rule proposal. For each estimate, the company will provide alternative numbers, and investors will effectively be invited to rely on them as representing the outer limit of the reasonably possible.4

We are not persuaded that the Commission's more specific requirements will produce better disclosure than the more open language we propose, and we think there is a good chance that they will elicit weaker disclosure. Some companies will give figures that are self-serving or unjustifiably optimistic; others will be unnecessarily conservative to protect themselves against being proven wrong in the future; and still others will give data that is too voluminous or technical for investors to understand or evaluate. We believe the more flexible rules will reduce these risks. After companies have developed some experience in applying the rules, the Commission should review disclosure practices, and perhaps at that point it will be able to propose, at least for some types of estimates, specific methodologies that are both workable and produce effective disclosure.

Against the doubtful benefit of the rules as proposed, the Commission should weigh the very heavy burdens of the relatively mechanical quantification exercise its proposed rules would impose. This increased burden comes at a time when the Commission has also proposed to shorten reporting deadlines and mandate the audit committee's involvement in the MD&A process, and companies are developing and reviewing internal processes in response to fast-moving regulatory and legislative developments. In particular, updating a sensitivity analysis quarterly, and discussing it with the audit committee, would be extremely burdensome, particularly in light of the Commission's proposal to shorten deadlines for Form 10-Q filings.5 Unless the Commission modifies the proposal along the lines we suggest, we urge that the quarterly updating requirement be deleted or substantially softened.6

III. Five Suggested Modifications

A. The notes to the financial statements should identify critical accounting estimates

Rule 4-08 of Regulation S-X identifies matters that must be discussed in the notes to financial statements. Rule 4-08 should be amended by adding a new paragraph to require identification of critical accounting estimates in the notes to any financial statements subject to Regulation S-X as follows:

Critical accounting estimates. In a separate note or a separately captioned section of a general note, identify each accounting estimate that is a "critical accounting estimate" (as such term is defined in Item 303(b)(3)(ii) of Regulation S-B, Item 303(c)(2) of Regulation S-K and Item 5.E.2. of Form 20-F).

With respect to interim financial statements, this information would be covered by Rule 10-01(a)(5) of Regulation S-X, which provides that note disclosures may be omitted in interim financial statements if they would substantially duplicate the disclosure in the audited financial statements.

In adopting this amendment, the Commission should also:

One reason for our proposal is to prevent a divergence between the MD&A and the financial statements on which accounting estimates require disclosure. Paragraph 13 of SOP 94-6 requires that a company provide disclosure in the notes regarding certain estimates, based on the likelihood that they will change and whether the change would be material. The idea is essentially the same as that underlying the Commission's definition of critical accounting estimates, but the definition in SOP 94-6 is different in ways that are unnecessary and will only create confusion.9 The Commission's definition represents a desirable improvement on the definition in SOP 94-6, and we expect that, if the Commission amends Rule 4-08 as we suggest, the practice under SOP 94-6 will conform to the new definition even before an amendment to SOP 94-6 is adopted.

Another reason for our proposal is to try to foster a coordinated approach to the preparation of the new disclosures. We generally agree with the reasoning that led the Commission to propose that the descriptive disclosure on critical accounting estimates be included in MD&A.10 The identification of estimates and the determination of whether they are critical should, however, be part of the preparation of the financial statements, using the same concepts and subject to the same internal procedures and to the independent audit process.11 This will increase the level of rigor that is applied. This will also address the issue raised by the Commission in the Proposing Release of whether and how to involve a company's independent auditor in the preparation of the proposed disclosure in order to ensure its accuracy and reliability. 12

B. The definition of "critical accounting estimate" should be simpler and more consistent with the accounting and auditing literature

Paragraph (B) of the definition in paragraph 2(ii) of the Commission's proposal should be amended to read as follows:

(B) Different estimates that the registrant reasonably could have used in the current period, or reasonably possible near-term changes in the estimate, would have a material impact on the presentation of the registrant's financial condition, changes in financial condition or results of operations.

We believe the definition as amended accomplishes the Commission's goal of identifying instances where management's judgments have a material impact on the current period financial presentation. It would also avoid some terminological confusion within the rules and with other accounting literature. In particular:

C. The topic of discussions with the audit committee should be left to corporate governance initiatives

The Commission should delete from its proposed rules paragraph (c)(3)(v), which requires disclosure about whether management has discussed the critical accounting policies disclosure with the audit committee. Corporate governance is currently the subject of a broad and promising public discussion, and one part of that discussion is the role of the audit committee in reviewing periodic disclosures. Indeed, since the Proposing Release was issued, the Corporate Accountability and Listing Standards Committee of the New York Stock Exchange has proposed that the audit committee charter should specifically include discussing the quarterly and annual MD&A with management and the independent auditor.17 As a result, the Commission and others will have the opportunity to consider, in the proper context, the involvement of the audit committee in reviewing MD&A. In addition, existing accounting literature already requires auditors to discuss accounting estimates with the audit committee.18 We believe that at some companies the audit committee already reviews and discusses with management at least the annual MD&A, and that many other companies will consider adopting the practice even if the New York Stock Exchange does not adopt the recommendation. Against this background, it would be untimely for the Commission to introduce a special disclosure rule about discussions with the audit committee, applicable to a very small subset of the matters audit committees should be discussing.

The New York Stock Exchange has also proposed disclosure by foreign private issuers of the differences between their corporate governance practices and those applicable to U.S. issuers.19 We think that is more appropriate than the Commission's approach, which treats foreign private issuers as though they were subject to one small piece of the U.S. corporate governance requirements.

D. Companies should be protected from liability to stimulate better disclosure

The disclosures on critical accounting estimates will require management to wrestle with difficult questions about the probability and the materiality of different future outcomes. Management will also be trying to reconcile two contradictory imperatives: on the one hand, doubts about whether a matter is material should usually be resolved in favor of disclosure, a principle that is particularly reflected in Staff Accounting Bulletin No. 99.20 On the other hand, disclosure must be selective, because the proliferation of items weakens the impact of those that are the most significant.21

The Proposing Release properly encourages companies to approach the disclosure intelligently and creatively. We believe, however, that the risk of liability will chill open, thoughtful, balanced disclosure. It will incline companies to two drafting strategies that run counter to the Commission's objectives: limiting forward-looking information and including too many estimates as critical. Because the proposed rules call for highly speculative, forward-looking disclosure, the Commission can foster the evolution of better disclosure by providing strong safe harbor protection for forward-looking statements relating to critical accounting estimates.

The Commission should delete proposed Instruction 2, which merely calls attention to the existence of the statutory and regulatory safe harbors,22 and add a new, numbered paragraph within its proposed rules, providing explicit safe harbor protection under the Private Securities Litigation Reform Act of 1995.23 This would be modeled in part on the safe harbor in the market risk disclosure rules under Item 305(d) of Regulation S-K and Item 11(d) of Form 20-F.24 We propose the following text:

A safe harbor of this kind must refer to clearly identified portions of the required disclosure. In order to facilitate this, the first two subparagraphs of paragraph (c)(3) under the Commission's proposal should be reorganized so that:

The cross-references in our proposed language set forth above assume that this reorganization has been made, so that the safe harbor applies to the forward-looking discussion only. We also believe that this reorganization would make the order of ideas in the rules more logical.

Even with a safe harbor covering forward-looking statements, companies will still be concerned about liability to private litigants arising from omissions-particularly with respect to the determination that a specific estimate is not a "critical accounting estimate" requiring disclosure and with respect to the forward-looking discussion that the rules require. The Commission should consider how it can reduce the risk of liability for omissions in private actions under the Securities Act of 1933, the Securities Exchange Act of 1934 and Rule 10b-5 by using its exemptive authority and adding provisions in the proposed rules similar to Rule 102 of Regulation FD.26

E. The new rules should be phased in slowly

The Commission should implement its new rules on critical accounting policies in stages. Disclosure practices will evolve, and the Commission and its staff should build in a chance to react to that evolution and to adapt the rules accordingly. In effect, the Commission has adopted this approach in its initiatives in this area to date, by issuing its cautionary advice,27 observing the resulting disclosure, and then issuing the Proposing Release. The Commission should consider the following measures to continue this iterative process and ensure that its initiative leads to a successful evolution in disclosure practices.

The Commission should also consider establishing a pilot program with certain companies29 or applying the rules to larger companies first.30 This could provide an opportunity for many companies to build on the experience of others, and possibly for the Commission to modify the rules after some experience has been gained in applying it.

* * *

We thank you for the opportunity to comment on the Proposing Release. We would be happy to discuss with you our comments or any other matters that you feel would be helpful in your review of the proposal. Please do not hesitate to contact Nicolas Grabar or Leslie N. Silverman in New York (212-225-2000) or Edward F. Greene in London (44-20-7614-2200) if you would like to discuss these matters further.

Very truly yours,

CLEARY, GOTTLIEB, STEEN & HAMILTON

cc: The Honorable Harvey L. Pitt, Chairman
The Honorable Cynthia A. Glassman, Commissioner
The Honorable Paul S. Atkins, Commissioner
The Honorable Jerome Goldschmid, Commissioner
The Honorable Roel C. Campos, Commissioner
Alan L. Beller, Director, Division of Corporation Finance
Robert K. Herdman, Chief Accountant, Office of the Chief Accountant
Anita T. Klein, Senior Special Counsel, Division of Corporation Finance

RESPONSES TO REQUESTS FOR COMMENT

For reference within this Annex, we have numbered the Commission's requests for comment. Where we have no comment to any of the requests for comment in a particular section of the Proposing Release, we have not included those requests for comment.

  Commission Request for Comment Cleary Gottlieb Response
  Scope of the Proposals  
1. We solicit comment with regard to broadening the scope of our proposals to achieve a more expansive objective. In general, we believe the proposals are very demanding and should not be broadened at this time. Some broader objectives might appropriately be considered after experience has been gained applying the new requirements.
(a) Should we require additional MD&A disclosure specifically regarding the effects of a change by a company from one accounting policy to another acceptable (and preferable) accounting policy under GAAP? This might be an appropriate broadening to be undertaken at a later date.
(b) 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? No. It would be very burdensome to require companies to maintain parallel accounting applying different approaches.
(c) What costs would companies incur if they had to prepare disclosure about the effects of alternative accounting policies that could have been chosen but were not? No comment.
(d) Beyond a company's initial adoption of those policies, should we require disclosure in MD&A regarding a company's reasons for choosing, and the effects of applying, accounting policies used for unusual or innovative transactions or in emerging areas? This might be an appropriate broadening to be undertaken at a later date, but only in cases where there is no clear treatment of the transaction under generally accepted accounting principles.
(e) Similarly, should we require companies to disclose in MD&A the effects of accounting policies that a company could have adopted, but did not adopt, for unusual or innovative transactions or in emerging areas? See our response to question 1(b).
(f) Should we require more disclosure by companies about their process of making estimates, or in other areas of discretion relating to recognition and measurement in financial statements? If so, please describe in detail. No. See our response to question 1.
(g) Should we require in MD&A a discussion of the impact of a company's choice among accounting methods under GAAP that are used in the company's industry (for example, the completed contract and the percentage of completion methods of accounting for construction-type contracts)? Should we require that type of disclosure only where a company uses a method under GAAP that is not generally used by other companies in the industry? No. See our response to question 1(b). In addition, it would not be appropriate or feasible for a company to make disclosures about the accounting policies applied by other companies in its industry.
  Proposed Disclosure About Critical Accounting Estimates  
2. We seek comment on the proposed definition of critical accounting estimates.  
(a) Is the definition appropriately tailored? See Part III.B of our letter.
(b) Does the definition capture the appropriate type and scope of accounting estimates?
(c) Is the definition appropriately designed to identify the accounting estimates that require management to use significant judgment or that are the most uncertain? If not, what other aspects descriptive of that type of estimate should be included?
(d) Is the definition appropriately designed to identify the accounting estimates involving a high potential to result in a material impact on the company's financial presentation?
(e) Would it be difficult for a company to discern which of its accounting estimates require assumptions about highly uncertain matters? If so, how could the proposal better target them?
(f) Should we consider setting a minimum percentage impact on results of operations in the second criterion of the definition, or would that be unnecessary because the proposed definition would not capture changes that have an insignificant impact? It would be unnecessary.
(g) How many accounting estimates would a company typically identify as critical accounting estimates under the proposed definition? No comment.
(h) Would a company with multiple segments have a greater number of critical accounting estimates than a company without multiple segments? If so, please provide an explanation. Often, because accounting issues may be specific to one segment. Also, the materiality threshold for determining if an estimate is critical may be lower for a company with multiple segments, since the company would likely evaluate the effects of an estimate on each segment.
(i) Should we establish a maximum number of accounting estimates that may be discussed as critical accounting estimates (e.g., seven)? If so, what should the maximum number be and what criteria should be applied to set the number so as to strike the appropriate balance between information truly useful to investors and overly extensive disclosure of marginal use? If a maximum were set, should the number of segments a company has be considered? See Part III.D of our letter, particularly note 21.
(j) 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? No.
3. We request comment on the proposed identification and analysis of changes.  
(a) Are there some types of critical accounting estimates or some circumstances where the proposed disclosure relating to sensitivity would not be meaningful or otherwise helpful to investors? If so, which estimates or what circumstances? See Part II of our letter.
(b) In addition to the two choices we propose for assuming changes relating to the critical accounting estimates to analyze sensitivity, are there others that we should permit? Should we require instead that all companies use the same method? If so, which one?
(c) Should we require a company to use whichever of the two proposed choices demonstrates the greatest impact on the company's financial presentation?
(d) Are there circumstances under which a company should be required to demonstrate sensitivity using both of the proposed choices?
(e) Are there any critical accounting estimates for which neither of the two choices for selecting the assumed changes would be appropriate?
(f) Will companies be able to select appropriate changes in their most material assumption or assumptions, or should we provide further guidance?
(g) 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?
(h) Conversely, would any changes we standardize not be equally meaningful to measure sensitivity, or equally probable, for various accounting estimates, industries and companies, and thus reduce the value of any disclosure about sensitivity?
4. We solicit comment on the proposed disclosure of past material changes in critical accounting estimates.  
(a) Is sufficient disclosure of these changes already required under current MD&A requirements? Arguably yes, but a more specific requirement is appropriate.
(b) Is a three-year period the most appropriate period of time over which investors should consider changes? If not, why would a shorter or longer period be more appropriate? Because MD&A currently offers comparisons over a three-year period, three years is the most appropriate period, subject to the phase-in period suggested in Part III.E of our letter.
(c) Would requiring disclosure over a longer period, such as five years, make it easier for investors to identify trends? If so, over how many years should we phase in a longer period requirement?
(d) Should we mandate a standardized format for quantitative disclosure about past changes in critical accounting estimates (e.g., a chart illustrating the dollar value of the change from the prior year for each year showing the impacted line items and other effects in each year)? No. In order to avoid boilerplate and to achieve disclosure that is tailored to a specific company, the Commission should allow companies more flexibility for this disclosure.
5. We request comment on the proposed disclosure about discussions between senior management and the audit committee regarding the development, selection and disclosure of critical accounting estimates.  
(a) To what extent does senior management currently discuss critical accounting estimates with the audit committee of the board of directors and the company's auditors? See Part III.C of our letter.
(b) Would the proposed requirement provide useful information to investors?
(c) Would the proposed disclosure be a catalyst for discussion between audit committees and senior management? Could it chill discussions?
(d) Is there other related disclosure that should be required for the benefit of investors?
(e) Should we require that companies disclose any unresolved concerns of the audit committee about the critical accounting estimates or the related MD&A disclosure? No. Requiring this disclosure would chill audit committee discussions and activity.
(f) Should we require disclosure of any specific procedures employed by the audit committee to ensure that the company's response to the proposed disclosure requirements is complete and fair?
(g) Should we consider requiring disclosure of whether the audit committee recommends the disclosure be included in the MD&A, which is akin to the disclosure required in the Item 306 audit committee report? See Part III.C of our letter.
(h) Instead of the proposed disclosure, should we amend Item 306 of Regulation S-K and Regulation S-B to require that the audit committee report disclose whether the audit committee has reviewed and discussed with senior management the development, selection and disclosure regarding critical accounting estimates?
(i) If we were to amend Items 306 in this manner, should we also expand them to include the discussions about critical accounting estimates between senior management and the audit committee as one of the bases for the audit committee's recommendation to include the financial statements in the annual report? No.
(j) Should we expand Items 306 to require disclosure of whether, based on an audit committee's review of and discussions about the MD&A, the audit committee recommended to the board of directors that the MD&A be included in the company's annual report? See Part III.C of our letter.
(k) Should we expand Items 306 to require disclosure of whether the audit committee has reviewed and discussed the entire MD&A disclosure (current and proposed) with management and/or the auditors?
(l) 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? No. Requiring such disclosure would chill audit committee discussions.
6. We request comment regarding identification of the segments affected and the proposed additional disclosure of the critical accounting estimates on a segment basis.  
(a) Should we provide more guidance for determining the circumstances that warrant segment disclosure? No.
(b) Should we require the additional segment discussion only when more than one segment is affected? No comment.
  Auditor Examination of MD&A Disclosure Relating to Critical Accounting Estimates  
7. We solicit comment with respect to independent auditor examinations of the proposed MD&A disclosure regarding critical accounting estimates.  
(a) Should we require that the critical accounting estimates disclosure in the MD&A undergo an auditor examination comparable to that enumerated in AT §701? No. See Part III.A of our letter, particularly note 12.
(b) Would these engagements significantly improve the disclosure provided in MD&A?
(c) In practice, when companies engage auditors to examine the MD&A pursuant to AT §701, does it elicit a higher quality of disclosure than when auditors consider only, as currently required, whether an MD&A is materially inconsistent with the financial statements?
(d) If we were to require examinations by auditors of part or all of MD&A disclosures, should we also require that a company file, or disclose the results of, the auditor's reports? Yes.
(e) If we do not require auditors' examinations of MD&A disclosure but an auditor nonetheless examines MD&A disclosure on critical accounting estimates, should we require that the auditor's report be filed or the results be disclosed? No.
(f) What would be the relative benefits and costs of a requirement for an auditor examination with respect to the critical accounting estimates portion of the MD&A? See Part III.A of our letter.
(g) Should we require an auditor "review" under standards comparable to AT §701, as opposed to an auditor "examination" of the critical accounting estimates MD&A disclosure?
(h) Do current requirements relating to what an auditor must consider make an examination or review of the proposed MD&A disclosure under standards comparable to AT §701 unnecessary?
(i) If we do not require auditor examination or review, are there other steps we should take to help ensure the quality of disclosure in this proposed section of MD&A?
  Quarterly Updates  
8. We solicit comment on the quarterly updating requirement for U.S. companies.  
(a) Are there some accounting estimates or material assumptions or methodologies that would normally be considered by companies only on a less frequent basis than quarterly? If so, which ones? Should they be omitted from the quarterly updating requirement on that basis? Yes.
(b) Is the scope of the disclosure required in a quarterly update appropriate? If not, what should be added or omitted? See Part II of our letter, particularly note 6 and the accompanying text.
  Proposed Disclosure About Initial Adoption of Accounting Policies  
9. We seek comment on the proposed disclosures related to initial adoption of accounting policies.  
(a) Would the proposed disclosures about initial adoption of accounting policies provide useful information to investors and other readers of financial reports? Yes.
(b) Are there particular situations involving the initial adoption of a material accounting policy for which we should require additional disclosure? If so, what are those situations and what additional disclosure should we require? No.
(c) Should we require companies to disclose, in MD&A or in the financial statements, the estimated effect of adopting accounting policies that they could have adopted, but did not adopt, upon initial accounting for unusual or novel transactions? No. See our response to question 1(b).
(d) What would be the costs for companies to prepare disclosure about the effects of alternative accounting policies that could have been chosen but were not? No comment.
(e) Would investors be confused if companies presented disclosure of the effects of acceptable alternative policies that were not chosen? Yes.
(f) Should we require in MD&A a discussion of whether the accounting policies followed by a company upon initial adoption differ from the accounting policies applied, in similar circumstances, by other companies in its industry, and the reasons for those differences? Please explain. If such a discussion should be required, please identify the specific disclosures companies should make. No. See our response to question 1(g).
(g) Would a company know the policies applied in similar circumstances by other companies in its industry? If not, would auditing firms or other financial advisors be able to assist companies in determining whether their accounting policies generally diverge from industry practices?
  Disclosure Presentation  
10. We solicit comment on the disclosure presentation aspects of the proposals.  
(a) Should the proposed disclosure be presented in a separate section of MD&A or should we require that it be integrated into the other discussions of financial condition, changes in financial condition, results of operations and liquidity and capital resources when the proposed disclosure is closely related to an aspect discussed in those separate sections of MD&A? In order to give companies the flexibility to develop appropriate, tailored disclosure, the Commission should not require presentation in a separate section of MD&A.
(b) Should other requirements relating to the language and format be added to the requirement for clear, concise and understandable disclosure? If so, what requirements? No. The Commission's plain English rules will apply to the proposed disclosure as they do to the rest of the MD&A.
  Application to Foreign Private Issuers  
11. We request comment regarding the proposed MD&A disclosure of the application of critical accounting policies as it relates to foreign private issuers.  
(a) Should we apply different standards for foreign private issuers with respect to the proposed MD&A disclosure? See Part III.C of our letter.
(b) Are there specific items of the proposed disclosure that would be less appropriate for foreign private issuers? If so, what should substitute for that disclosure?
(c) Should we consider applying an updating requirement to the proposed critical accounting estimates disclosure for foreign private issuers that do not file quarterly reports? If so, what should trigger that updating requirement? No.
(d) Are there reasons to distinguish this aspect of MD&A disclosure when foreign private issuers otherwise may not prepare MD&A-equivalent disclosure on a quarterly basis?
  Application to Small Business Issuers No comment.
  Application of Safe Harbors for Forward-looking Information  
12. We request comment regarding the application of safe harbors for forward-looking information to the proposed MD&A disclosure. See Part III.D of our letter
(a) Is there any need for further guidance from the Commission with respect to the application of either the statutory or rule safe harbors?
  General Request for Comment  
13 We also solicit comment on the following general aspects of the proposals:  
(a) Is the additional information elicited by the proposals useful to investors, other users of company disclosure and readers of a company's financial statements? If not, how can it be improved to achieve that goal? See our letter.
(b) In addition to the requirements we propose, are there particular aspects of critical accounting estimates or their development or impact that the proposals should specifically require companies to address? If so, what are they?
(c) In addition to the requirements we propose, are there particular aspects concerning a company's initial adoption of an accounting policy that the proposals should specifically require companies to address? If so, what are they? No.
(d) Is disclosure necessary concerning the procedures that management follows in selecting its critical accounting estimates? If so, what additional disclosure should be provided? No.
(e) Is additional disclosure or regulation necessary or appropriate concerning the role of the audit committee in discussing the critical accounting estimates and the disclosure about them that management drafts? See Part III.C of our letter.
(f) In addition to the proposed disclosure, should we adopt a specific requirement that a company must provide any other information that is needed to make the proposed disclosure reflective of management's view of the critical accounting estimates and the initially adopted policies being discussed? No.
(g) For critical accounting estimates of fair value, should we mandate the example in FR-61 as part of these rules? If yes, do other areas exist for which that type of detailed disclosure would be appropriate? No.
(h) If the proposed disclosure would involve competitive or other sensitive information, are there any mechanisms that would ensure full and accurate disclosure while reducing a company's risk of competitive harm? The proposal in Part II of our letter would help to address this issue.
(i) Are there some aspects of the proposed disclosure that should be retained while eliminating other parts of the proposed disclosure? We solicit comment on the desirability of adopting some sections of the proposed rules, but not all sections.
  Paperwork Reduction Act No comment.
  Cost-Benefit Analysis No comment.
  Effects on Efficiency, Competition and Capital Formation No comment.
  Initial Regulatory Flexibility Analysis No comment.
  Small Business Regulatory Enforcement Fairness Act No comment.

____________________________
1 SEC Release Nos. 33-8098; 34-45907; International Series Release No. 1258 (May 10, 2002). We refer to this release as the "Proposing Release."
2 A close parallel is the development of the disclosures on market risk sensitive instruments required by Item 305 of Regulation S-K and Item 11 of Form 20-F (which we refer to in this letter as the "market risk disclosure rules"). There the Commission adopted a new, universal requirement to cover a complex area in which there was no clear template for good disclosure. In adopting disclosure requirements for critical accounting policies, the Commission should consider some lessons of its disclosure requirements for market risk sensitive instruments. Three of our proposals (Parts III.A, D and E) mirror what the Commission did for the market risk disclosure rules. Two others (Part II and Part III.B) are intended to avoid one signal weakness of the market risk disclosure rules, which is that overly specific rules can produce mechanical, rather than thoughtful, disclosure.
3 Moreover, it is the sensitivity analysis that will most often present the risk of the competitively harmful effects that the Commission highlights in a request for comment.
4 The examples provided in the Proposing Release illustrate this problem. Betascott Company (Example 3) quantifies the impairment that would result if its estimated future cash flows were 10% lower. It does not characterize or explain the 10% figure. Surely the variables that go into the estimate of future cash flows are far too complex and independent for any specific figure to stand for the range of reasonable variation. The $30 million impairment loss accordingly illustrates the sensitivity, but there may be no basis for saying it is "reasonably possible" and a $50 million loss is not.
5 SEC Release Nos. 33-8089; 34-45741 (Apr. 12, 2002). The Commission's proposal is unclear as to whether the audit committee disclosure must be updated quarterly. In Part III.C below, we propose to delete the audit committee disclosure. In any event, however, we propose that the decision regarding updating should be left to the audit committee, subject to its charter, rather than mandated.
6 Our proposal to include critical accounting estimates in the notes to the financial statements (discussed in section III.A below) would reduce the need for a specific provision requiring quarterly updating of the disclosure. Under our proposal, Rule 10-01(a)(5) of Regulation S-X would require disclosure of any new critical accounting estimates in the notes to the interim financial statements.
7 AICPA Statement of Position No. 94-6, Disclosure of Certain Significant Risks and Uncertainties (Dec. 1994) ("SOP 94-6").
8 Statement of Auditing Standards ("SAS") No. 61, Communication with Audit Committees (Apr. 1988), at paragraph 8.
9 The main conceptual differences between the Commission's proposed definition and SOP 94-6 are: (a) SOP 94-6 refers to changes but not to alternative estimates and (b) SOP 94-6 turns on a "reasonably possible" standard, while the Commission's definition turns on a "reasonably likely" standard. SOP 94-6 also confusingly borrows the terminology of "future confirming events" from Financial Accounting Standards Board Statement of Financial Accounting Standards No. 5, Accounting for Contingencies (Mar. 1975) ("SFAS No. 5").
10 Part III.A of the Proposing Release, text accompanying note 39.
11 See Codification of Statements on Auditing Standards (including related Auditing Interpretations) ("AU") § 342, Auditing Accounting Estimates.
12 In addition, our proposal would enable underwriters to benefit from auditor expertization, in the case of the audited financial statements, and "cold comfort," in the case of the unaudited, interim financial statements, with respect to critical accounting estimates. Part III.E of the Proposing Release suggests the possible approach of requiring an independent auditor examination or review the proposed MD&A disclosure in accordance with the Attestation Standards set forth in Codification of Statements on Standards for Attestation Engagements ("AT") § 101 Attest Engagements and AT § 701 Management's Discussion and Analysis. We think that such an examination or review would not result in a significant improvement in the MD&A disclosure warranting the additional burden and expense. In our experience, an auditor examination or review of the MD&A is uncommon for that reason.
13 See, e.g., AU § 342, paragraph 14; AU § 312, Audit Risk and Materiality in Conducting an Audit, paragraph 36.
14 See, e.g., SFAS No. 5, paragraph 3.
15 See, e.g., SOP 94-6, paragraph 7.
16 Reasonably likely is also used twice in paragraph (3)(i) of the Commission's proposed rules. In the fifth sentence, "reasonably likely to occur" should be changed to "reasonably possible." In the last sentence "why the accounting estimate is reasonably likely to change from period to period" should be changed to "why near-term changes in the accounting estimate are reasonably possible." See note 25 below setting forth our proposed new language in full.
17 Report of the New York Stock Exchange Corporate Accountability and Listing Standards Committee 15 (2002) (the "NYSE Committee Report"). The board of directors of the New York Stock Exchange approved final rule recommendations on August 1, 2002; however, the text of the final rules is not yet available. In addition, the Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204, 116 Stat. 745 (2002), and the recent corporate governance proposals of the NASDAQ Stock Market, Inc., a summary of which is available at http://www.nasdaqnews.com/, have addressed corporate governance reforms generally and provisions related to audit committees in particular.
18 SAS No. 61 requires auditors to ensure that a company's audit committee is informed about the process used by management to formulate particularly sensitive estimates and about the basis for the auditor's conclusions regarding the reasonableness of those estimates. See SAS No. 61, at paragraph 8.
19 NYSE Committee Report, at 22. The New York Stock Exchange's final rule recommendations include this requirement. Press Release, New York Stock Exchange, NYSE Approves Measures to Strengthen Corporate Accountability (Aug. 1, 2002) (available at http://www.nyse.com/press/press.html).
20 Staff Accounting Bulletin No. 99 (Aug. 12, 1999) ("SAB 99").
21 The Proposing Release emphasizes only the second principle, to a degree we consider excessive. The Commission should acknowledge that management must reconcile two important objectives. We also do not think that the Commission should mandate a maximum number of critical accounting estimates, as suggested by one of the Commission's requests for comment. Rather, we think it is appropriate that a company decide for itself which and how many estimates fall within the definition of critical accounting estimates.
22 The Commission's proposal deletes Instruction 7 to Item 303(a) of Regulation S-K, Instruction 6 to Item 303(b) and Instruction 3 to Item 5 of Form 20-F. The Commission's proposed new Instruction 2 is styled as an instruction to the critical accounting policies disclosure, but the text appears intended to apply to the MD&A as a whole. Although we urge the Commission to adopt stronger safe harbor protection for forward-looking statements relating to critical accounting estimates than that contained in proposed Instruction 2, we agree that an amendment to the existing instruction may also be appropriate at this time. We propose the following text, which could serve as an instruction to all of Item 303 and to Item 5 of Form 20-F:
Registrants are required by various sections of this item, and are otherwise encouraged, to supply forward-looking information. If the terms and conditions of Section 27A of the Securities Act (15 U.S.C. 77z-2), Section 21E of the Exchange Act (15 U.S.C. 78u-5), § 230.175 of this chapter or § 249.3b-6 of this chapter are satisfied, forward-looking statements would be entitled to safe harbor protection. Registrants are encouraged to consider the terms, conditions and scope of the safe harbors when preparing disclosure.
23 Pub. L. No. 104-67, 109 Stat. 737 (codified in scattered sections of 15 U.S.C.).
24 The safe harbor in the market risk disclosure rules is discussed in the adopting release in Part III.B.3, text at notes 62-65, and Part VI.C.7, text at note 77. SEC Release Nos. 33-7386; 34-38223; International Series Release No. 1047 (Jan. 31, 1997) (the "Market Risk Adopting Release").
25 The subparagraphs as reorganized would read as follows (including the changes we propose above in note 16):
(i) Identify and describe the accounting estimate. Describe the methodology underlying the accounting estimate. Explain the significance of the accounting estimate to the registrant's financial condition, changes in financial condition and results of operations and, where material, identify the line items in the financial statements affected by the accounting estimate.

(ii) Describe the material assumptions underlying the accounting estimate. Discuss any known trends, demands, commitments, events or uncertainties that are reasonably possible and materially affect the methodology or assumptions described. Disclose, if applicable, why different estimates that would have had a material impact on the registrant's financial presentation could have been used in the current period. Describe, if applicable, why near-term changes in the accounting estimate are reasonably possible.

26 The Commission clarified in the adopting release for Regulation FD that Rule 102 was added to "remove any doubt that private liability will not result from a Regulation FD violation." SEC Release Nos. 33-7781; 34-43154 (Aug. 15, 2000).
27 SEC Release Nos. 33-8040; 34-45149 (Dec. 12, 2001).
28 The Commission did this in connection with the market risk disclosure requirements. Market Risk Adopting Release, Part I, text at footnote 21.
29 The Commission did this in connection with the amendments to Rules 421(b) and (d) under the Securities Act of 1933 (the "plain English rules"). SEC Release No. 33-7497; 34-39593; International Series Release No. 1113 (Jan. 28, 1998).
30 The Commission did this in connection with the market risk disclosure requirements. See General Instruction 1 to Item 305 of Regulation S-K.