Investment Counsel Association of AmericaDecember 10, 2002 Via Electronic Filing Mr. Jonathan G. Katz
Re: Proposed Rule: Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments; Release Nos. 33-8144; 34-46767; File No. S7-42-02 Dear Mr. Katz: The Investment Counsel Association of America1 appreciates the opportunity to submit comments related to the Commission's proposed amendments to the Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") to require more substantial disclosure of off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of an issuer.2 ICAA members collectively manage trillions of dollars in assets for institutional and individual investors, and rely heavily on the financial materials of issuers. The information presented in an issuer's MD&A is of critical importance to our members for evaluating the issuer's overall financial condition and making appropriate investment decisions on behalf of their clients. The Proposal will improve the transparency of an issuer's off-balance sheet arrangements and other obligations and liabilities. We strongly support the Proposal and believe it will result in the disclosure of a more complete and accurate picture of the overall financial condition of issuers.3 The Proposal implements Section 401(a) of the Sarbanes-Oxley Act of 2002, which directs the Commission to adopt rules requiring an issuer to disclose in each annual and quarterly financial report filed with the Commission "all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons that have, or may have, a material effect on financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources."4 In addition to meeting the requirements of Section 401(a) of the Act, the Proposal would also require issuers to aggregate information about contractual obligations and contingent liabilities and commitments in a single location in the MD&A. We have the following comments and recommendations: 1. Definition of "Off-Balance Sheet Arrangement" The term "off-balance sheet arrangement" is defined in a more focused manner in the Proposal than in Section 401(a) of the Act. The Proposal defines an off-balance sheet arrangement to mean "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: (i) any obligation under a direct or indirect guarantee or similar arrangement; (ii) a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement; (iii) derivatives, to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements; or (iv) any obligation or liability, including a contingent obligation or liability, to the extent that it is not fully reflected in the financial statements (excluding the footnotes thereto)."5 The Commission has requested comment as to the scope of the proposed definition of off-balance sheet arrangements. We believe the proposed definition will be more effective than the language in Section 401(a) of the Act in guiding issuers in complying with the disclosure requirement, and will aid investors and the securities markets in developing expectations about the material presented. The Commission has requested comment as to the appropriateness of applying its existing policy of excluding preliminary negotiations from MD&A disclosure to off-balance sheet arrangements.6 We support the Commission's decision to apply its existing standard of excluding preliminary negotiations to the Proposal. In addition to possibly jeopardizing completion of the transaction, such disclosure has the potential to be misleading to investors and the securities markets. 2. Materiality Threshold We are concerned that the Proposal introduces a dual materiality standard for prospective information in the MD&A that may be confusing to investors. Currently, a registrant has a duty to disclose prospective information in its MD&A where a "trend, demand, event, commitment or uncertainty is both presently known to management and reasonably likely to have future material effects on the registrant's financial condition or results of operations."7 The Commission proposes to interpret the legislative mandate in the Act as requiring a lower disclosure threshold for prospective material information related to off-balance sheet arrangements.8 Accordingly, the proposed disclosure of off-balance sheet arrangements would be required if management determines either that the arrangement is material in the current period or that it may become material in the future. Disclosure would not be required for off-balance sheet arrangements where the likelihood of either the occurrence of an event, or the materiality of its effect, is remote.9 The Commission has requested comment as to the use of the proposed "remote" disclosure threshold for prospective material related to off-balance sheet arrangements in conjunction with the "reasonably likely" threshold for other prospective information in the MD&A. We are concerned that a dual-materiality standard for prospective information in the MD&A could be confusing to investors. We also agree with the Commission's concern that a difference in threshold could attribute undue prominence to information about off-balance sheet arrangements in relation to other significant information.10 Moreover, we are concerned that the use of the "remote" standard could result in voluminous information and overwhelm the reader. We believe that the proposed definition of the term "off-balance sheet arrangement" will result in sufficient new disclosure of prospective information under the "reasonably likely" standard, and that the "remote" standard is unnecessary. 3. Contractual Arrangements and Contingent Liabilities The Proposal would require issuers to aggregate information about their contractual obligations and contingent liabilities and commitments in a single location in the MD&A. While this aspect of the Proposal is not required by the Act, the Commission believes it is important for improving the transparency of the circumstances surrounding an issuer's liquidity and capital resources.11 The Proposal would require tabular disclosure about contractual relationships and either tabular or textual disclosure about contingent liabilities and commitments.12 We support the proposed expanded disclosure related to an issuer's contractual obligations and contingent liabilities and commitments. We believe the proposed disclosure is consistent with the Commission's prior initiatives aimed at improving corporate disclosure and our comments with respect to these initiatives.13 We agree with the Commission that the proposed requirements would provide investors and the securities markets with a more complete context for assessing the relative role of off-balance sheet arrangements. We believe the proposed tabular format for contractual relationships will simplify information for the reader and enhance the opportunity for comparison among issuers, but recommend that the issuer have the flexibility to supplement the information in the table with a narrative discussion. We recommend modifying the requirement for disclosure about contingent liabilities and commitments to require tabular disclosure to the extent possible, together with supplemental narrative disclosure. The Commission has asked whether it should adopt definitions for the terms "contractual obligations" and "contingent liabilities or commitments."14 We believe broad definitions of these terms, together with disclosure examples would help issuers in preparing the information and investors in anticipating the scope of the material to be included in this section. 4. Presentation The Proposal would allow an issuer to present the tabular and textual disclosure related to known contractual obligations and contingent liabilities and commitments in a location the issuer deems appropriate. The proposed disclosure about off-balance sheet arrangements, however, would be provided in a separate designated section of the MD&A. The Commission has requested comment regarding the proposed presentation for these disclosure requirements.15 The presentation of the off-balance sheet arrangements should be clearly identified. While a separate section may not be necessary, off-balance sheet arrangements should be properly labeled to alert the reader of the nature of the material. We support the Commission's initiatives to make the MD&A and other Commission filings easier for the reader to understand and follow. Moreover, we continue to support with respect to MD&A disclosure: (i) enhanced discussion of line items of financial statements; (ii) more detailed discussions of recurring extraordinary charges; and (iii) greater disclosure related to trends that management evaluates in making decisions about its business.16 We appreciate the opportunity to comment on this important development and would be pleased to provide any additional information. Sincerely, KAREN L. BARR
cc: Harvey L. Pitt, Chairman
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