Constellation
Energy Group

December 11, 2002

Mr. Jonathan G. Katz
Secretary, U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609

RE: File No. S7-42-02

VIA ELECTRONIC MAIL

Dear Mr. Katz:

I am writing to provide comments on Release Nos. 33-8144 and 34-46767, Proposed Rule: Disclosure in Management's Discussion and Analysis About Off-Balance Sheet Arrangements, Contractual Obligations and Contingent Liabilities and Commitments. We support the SEC's efforts to implement the requirements of the Sarbanes-Oxley Act of 2002 (the Act) in a timely and effective manner, and we concur with the objective of the Act and the Proposed Rule of improving disclosures in these areas. It is in that spirit that we offer our comments. Our comments relate to the threshold for off-balance sheet disclosures and the definition of off-balance sheet arrangements under the proposal.

Threshold for Disclosure of Off-Balance Sheet Arrangements

Summary

The proposed rule states that the disclosures it would prescribe are not required for off-balance sheet arrangements where "the likelihood of either the occurrence of an event, or the materiality of its effect, is remote." It notes that this threshold is lower than the "reasonably likely" standard applied elsewhere in MD&A based upon an interpretation of the language of Section 401 (a) of the Act. The Act states, in part, that disclosure should be required for arrangements that "may have a material current or future effect." The proposal requests comment as to whether this threshold is consistent with the language of the Act, whether the "reasonably likely" standard should be applied instead, or whether the current MD&A rules should be amended to apply the threshold in the proposed rules to all of MD&A.

We recommend that the final rules adopt the "reasonably likely" standard currently applicable under existing MD&A rules rather than the "remote" standard in the proposed rules. We believe that the existing MD&A standard is consistent with the language of the Act and appropriately balances the benefits of added disclosure with the potential confusion created by excessive disclosure volume and inconsistency within the MD&A section. We explain the reasons for our view below.

Discussion

We believe that the "reasonably likely" standard applied in MD&A works well in eliciting appropriate disclosure and discussion of actual results of operations, financial position, and known trends. We do not believe it is necessary to apply a different standard to off-balance sheet arrangements than to the discussion of those which are presented in the financial statements, and we believe that applying two different standards within MD&A will confuse readers. We believe that applying the existing MD&A standard for disclosure of off-balance sheet arrangements will result in appropriate disclosure in a manner consistent with the rest of MD&A.

With regard to the language of the Act, we believe that requiring disclosure of an off-balance sheet arrangement that is reasonably likely to have a current or future material effect is an appropriate interpretation of the Act and is consistent with its requirements to disclose arrangements that "may" be material. We observe that the language of the Act does not employ technical accounting terms, and we note that the proposed rule itself acknowledges that it diverges from the specific language of Section 401(a) in certain respects in order to assure that focused, relevant disclosures are provided consistent with the intent of the Act. We believe that such an approach is appropriate here as well.

We also believe that the application of a lower threshold for disclosure of off-balance sheet arrangements would be a detriment, rather than a benefit, to MD&A disclosure. We are concerned that, with such a low threshold (and notwithstanding the safe harbor provisions of the proposal), registrants may be unwilling to limit disclosure of off-balance sheet arrangements that are not likely to be material. This unintended but practical response may occur because of the uncertainties of the business and economic environments, the increased scrutiny of such arrangements, and the threat of adverse consequences in the event of an adverse impact from a good-faith decision to omit disclosure. As a result, we believe that this lower threshold will result in a substantial increase in disclosure of arrangements that may not be material, producing increased disclosure volume while potentially sacrificing both relevance and the ability to focus on arrangements that are likely to be material.

Finally, if the final rule retains the proposed lower threshold for disclosure of off-balance sheet arrangements, for the reasons set forth above in support of using the existing "reasonably likely" standard, we recommend that the remainder of the existing MD&A rules should not be amended to adopt a lower disclosure threshold. Further, we recommend that the final rule include additional guidance regarding the application of the remote standard in order to assist registrants in providing disclosures consistent with the intent of the Act.

Definition of Off-Balance Sheet Arrangements

Summary

The proposed rules define off-balance sheet arrangements potentially subject to disclosure as "any transaction, agreement or other contractual arrangement…under which the registrant…has, or in the future may have" one or more of several potential obligations or transactions, including any obligation or liability, whether contingent or not. Further, one group of those potential obligations or transactions is "derivatives, to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements…"

We recommend three modifications to the definition of off-balance sheet arrangements to ensure that the final rule is appropriately focused and leads to improved disclosure rather than simply an increased volume of disclosure covering routine transactions. For the reasons set forth below, we are concerned that the proposed definition of off-balance sheet arrangements is overly broad and that the text of the proposed rule regarding derivatives does not clearly reflect the explanatory commentary in the proposal.

Discussion

We believe that the proposed definition of an off-balance sheet arrangement will encompass virtually every executory contract entered into by an entity as well as transactions (e.g., loss contingencies or environmental obligations) that already are subject to effective disclosure requirements. When combined with the proposal's low disclosure threshold as discussed earlier, this definition is likely to produce extremely voluminous disclosures about routine business transactions, some of which may be duplicative. We are concerned that the additional disclosures that could result would be unlikely to add to reader knowledge and understanding and, by their sheer volume, may actually detract from readers' ability to focus on matters that are most critical. We do not believe that such an outcome would be beneficial to readers of financial reports. Therefore, we recommend that the definition of an off-balance sheet arrangement be appropriately circumscribed in order to avoid the need to evaluate and disclose routine transactions entered into in the normal course of business.

Additionally, the text of the proposed amendment includes within the definition of an off-balance sheet arrangement "derivatives to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements." As presently drafted, this would incorporate all derivatives designated as normal purchases and normal sales and accounted for on the accrual basis under Statement of Financial Accounting Standards No. 133, Accounting for Derivative Instruments and Hedging Activities. However, the proposal's commentary on this part of the definition cites as an example "derivatives that are classified as stockholder's equity under GAAP." Further, in explaining how to apply the proposed disclosure threshold, the proposal directs registrants to review only "equity-linked or -indexed derivatives."

While it appears that the proposal intends to focus on equity-linked or -indexed derivatives, the text of Item 303(a)(4)(iii)(C) in the proposed rule would result in contracts meeting the technical definition of a derivative but that were entered into in the normal course of business being considered off-balance sheet arrangements for potential disclosure, even though such contracts would be covered by other accounting and disclosure requirements related to loss contingencies. This would substantially increase the potential volume of disclosures, particularly if the lower disclosure threshold in the proposal is retained. We recommend that the portion of the text of the proposed rule defining off-balance sheet arrangements be revised to clarify that it refers only to equity-linked or -indexed derivatives.

Finally, we believe that the final rule should clarify that, in consolidated financial statements, a parent's guarantee of a consolidated subsidiary's debt to a third party would not be included in the scope of the final rule because, from the perspective of the consolidated reporting entity, the parent's guarantee of a consolidated subsidiary's debt is a guarantee of the consolidated entity's own future performance in making payments on the consolidated debt. This principle was included in the Financial Accounting Standards Board's (FASB) recently published Interpretation No. 45, Guarantor's Accounting and Disclosure requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. In order to avoid any doubt as to whether the proposed disclosures are intended to include such arrangements, and in order to provide consistency with the FASB's interpretation, we recommend including such a clarification in the final rule.

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We appreciate the opportunity to provide our views on these important matters.

Very truly yours,