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On January 22, 2002, the Securities and Exchange Commission (the "Commission") issued a release (the "Release") in response to a petition filed by the Big Five accounting firms seeking interpretive guidance about MD&A disclosure obligations relating to:
While the Release contains suggestions and reminders about the form and substance of MD&A disclosures, it does not, according to the Commission, create new or modify existing legal requirements. According to the Commission the purpose of the Release is to "suggest steps that issuers should consider in meeting their current disclosure obligations."
The Commission re-states in the Release – with some detail and specificity – that the purpose and goal of MD&A disclosure is "to provide in one section of the filing, material historical and prospective textual disclosure enabling investors and other users to assess the financial condition and results of operations of the registrant, with particular emphasis on the registrant's prospects for the future." While much of what is discussed in the Release is not new, at least from the standpoint of required disclosure, what is new is the emphasis the Commission appears to be placing on using the MD&A to pull all of the various disclosures together in an effort to provide an accurate picture of the registrant. The Commission emphasizes that "disclosure is mandatory where there is a known trend or uncertainty that is reasonably likely to have a material affect on the registrant's financial condition or results of operations." Even though the Release imposes no new requirements, it seems fairly clear that, given recent events, the Commission is likely to examine closely registrants' financial disclosures to determine compliance with the Commission's interpretative guidance.
We have summarized the Release below. You may view a copy of the Release at http://www.sec.gov/rules/other/33-8056.htm.
Liquidity and Capital Resources
The Commission reminds registrants that MD&A disclosure about liquidity and capital resources should not be overly general and suggests registrants consider describing the sources of liquidity and the circumstances that are likely to affect those sources. The Commission indicates that simply disclosing the sources of liquidity (e.g., "Our principal source of liquidity is operating cash flows.") is not adequate disclosure. Rather, registrants should describe the sources and the risks related to the availability of such sources. The Commission points out that the standard for identifying circumstances that could materially affect liquidity is whether a particular trend or uncertainty is "reasonably likely" to affect liquidity. The Commission believes this is a lower threshold than "more likely than not".
"Off-Balance Sheet" Arrangements
With respect to "off-balance sheet" arrangements, the Commission points out that registrants "need to provide disclosures concerning transactions, arrangements or other relationships with special purpose entities and other persons that are reasonably likely to affect materially liquidity or the availability of or requirements for capital resources." In addition, the Commission points out that the extent to which the registrant relies on such entities for liquidity should be described fully and clearly.
Registrants should consider the need to include information about the business purpose and activities, the economic substance, the key terms and conditions, the relationship with the registrant, and the registrant's potential risk exposure with respect to off-balance sheet arrangements. The Commission states that the relative significance of such arrangements to the registrant's financial position should be clear from the disclosure and such disclosure should not simply be a recitation of the terms of the transaction or "similar boilerplate."
Contractual Obligations and Commercial Arrangements
The Commission believes that investors would find it beneficial if information about contractual obligations and commercial commitments were provided in a single location so that a "total picture" of a registrant's obligations would be readily available. The Commission suggests that registrants should use schedules — presumably within MD&A — to show the amount of such obligations as of a particular balance sheet date. The Release contains examples – as to form – of such schedules, all of which should be accompanied by footnotes describing, among other things, material provisions or contingencies that create, increase or accelerate liabilities.
Disclosures About Non-Exchange Traded Contracts
The Commission expressed its concern about the lack of transparency and clarity with respect to disclosure of trading activities involving commodity contracts (e.g., weather, service capacity, energy storage, bandwidth capacity) that are accounted for at fair value but for which a lack of market price requires use of fair value estimation techniques.
The Commission suggests that registrants involved in such trading activities should consider supplementing their MD&A disclosures with additional statistical and other information about such business activities and transactions. The Commission encourages registrants to consider furnishing (and quantifying to the extent practicable) certain specific information about such contracts. The Release sets forth the type of information that each registrant should consider and an example of the format for the form of such disclosure.
"Related Party" Transactions
The Commission further suggests that registrants consider whether investors would better understand their financial statements if the MD&A included a description of all material transactions involving related persons. Once again, the Release contains suggestions from the Commission about the type of information which should be included.
The Commission also suggests that registrants should consider the need for disclosure about parties that fall outside of the technical definition of "related parties," but with whom the registrant has a relationship that enables such parties to negotiate terms of material transactions that may not be available from other, more "clearly" independent, parties on an arm's-length basis, such as perhaps a former executive. The Commission seems to indicate that in certain circumstances investors may not be able to understand the registrant's reported results of operations absent a clear explanation of such arrangements and relationships.
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Our corporate securities practitioners are well-versed in these topics and would be glad to consult with you about compliance with the Release, or about any other disclosure issues. In addition, for over 25 years, our securities litigators have represented companies, Big Five accounting firms, and other defendants in some of the largest and most highly publicized accounting-related cases and SEC proceedings ever filed. As a result of this experience and our close relationship with the Big Five firms, we bring insight into best practices being employed by both issuers and accountants.
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Tim Hoxie Rich Peers Neal Brockmeyer Alan Jacobs Dave Wilson |
Guy Molinari Leslie Davis Simon Luk Scott Benner |
