Statement regarding MD&A

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ACTIO N MEMO RAND UM January 16,20 02

TO:

The Commission

FROM:

Office of the Chief Accountant

SUBJECT:

Comm ission Statement Regarding MD&A

RECOMMENDATION:

Ar

That the Comm ission publish a statement substantially in the form of Attachment A to suggest steps that issuers should consider in meeting their disclosure obligations with respect to MD& A while preparing year-end and interim financial reports and disclosures in other filings made after the issuance of this release, and to ask for comment on future possible rulemaking.

ACTION REQU ESTE D BY:

January 17,20 02

SUNSHINE ACT STATUS:

Serratim

REGULATORY FLEXIBILITY ACT STAUS:

Not applicable.

PAPERWORK REDUCTION ACT STATUS:

Not applicable.

NOVEL, IMPO RTAN T OR COMP LEX ISSUES:

Explanation of risks and uncertainties surrounding (a) off balance sheet financing structures, (b) trading activities involving nonexchange traded contracts accounted for at fair value, and (c) the effects of transactions with related and certain other parties.

OTHE R OFFICES OR Fredrickson) DIVISIONS CONSULTED: Office of the General Counsel (David Division of Corporation Finance (Martin Dunn) Division of Investment Management (Dave Smith) Division of Enforcement (Steve Cutler) PRIOR COMMISSION ACTION:

None.

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PERSONS TO CONSULT:

Office of the Chief Accountant x4400 Robert Herdman x2892 Robeli Bayless x4425 Robert Burns

Background

I.

accounting firms of On December 31, 2001, the Commission received a petition from the KPMG LLP, and Arthur Andersen LLP, Deloitte and Touche LLP, Ernst & Young LLP, the American Institute of PricewaterhouseCoopers LLP. The petition, which was endorsed by nal interpretive Certified Public Accountants, requested that the Commission issue additio sion and Analysis of guidance regarding Item 303 of Regulation S-K, Management's Discus S-B, Management's Financial Condition and Results of Operations, I Item 303 of Regulation 20-F, Operating and Discussion and Analysis of Plan of Operations, 2 and Item 5 of Form 3 rules"). The petitioners Financial Review and Pro;,pects (collectively, "MD& A" or "the MD&A quickly as they are requested that this additional guidance be provided to public companies and attached a proposed currently preparing their annual reports for the fiscal year just ended, interpretive release. ure: The petition identified three areas of concern with regard to MD&A disclos s; ement arrang • liquidity and capital resources, including off-balance sheet accounted • certain trading activities involving non-exchange traded contracts for at fair value; and" " benefits from • relationships and transactions with persons or entities that derive their non-independent relationship with the registrant or the registrant's related parties. firms in their joint The petition is one of several actions contemplated by the accounting Corporation. The press release of December 4,200 1 responding to the demise of Enron recommended petitioners indicated that, following issuance by the Commission of the rules to establish new interpretive guidance, they expect to petition the Commission to adopt petition. The firms minimum disclosure requirements for the three areas identified in the consistent and indicated that the objective of that rulemaking would be to promote more comparable disclosure by registrants.

II.

Discussion of Petition and Possible Commission Actions

financial and Generally, the staff agree that the petitioners have identified areas of the Commission rules, and operating risk that warrant disclosure that is completely responsive to petitioners' that is presented in a clear and understandable style and format. The 17 CFR 229.303. 2 17 CFR 228.303. 3 See 17 CFR 249.220f. I

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lReProdU'CEiCi irom-the" Unclassiiied f Declas"sified Holdings of the National Archives I.

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er, the staff is not recom menda tions appear to be though tful and constr uctive . Howev MD& A rules at this time. recom mendi ng that the Comm ission issue an interpr etation ofthe ent sugges ting steps Instead, the staff is recom mendi ng that the Comm ission issue a statem MD&A , and solicit ing public registrants should consid er in meetin g their obliga tions regard ing that the Comm ission statem ent comm ent on those steps and the petitio n. We recom mend further been filed, by a rule be follow ed before May 30th, 60 days after 2001 annual reports have achiev e consis tency and propos al that would elicit more targete d disclo sure that could better ners. compa rabilit y in the three import ant areas identif ied by the petitio MD& A rules. Some Many of the recom mende d disclo sures are alread y requir ed by the only in particu lar of the recom mende d disclo sures are requir ed by the MD& A rules Other recom menda tions circum stance s, and would not be expect ed in filings more genera lly. that may be beyon d the may be charac terized as "best practic e," elicitin g detaile d disclo sure would be very useful to presen t requir ement s of MD&A . The staff believ es the disclo sures Comm ission issued a investors. Disclo sure in curren t filings would likely impro ve if the ing their 200 1 annual statem ent at this time, when a majori ty of public compa nies are prepar reports. n that disting uishes Howev er, the staff canno t compl ete so quickl y a review of the petitio by existin g securit ies laws and betwe en those recom mende d disclo sures that are legally requir ed n to identif y the off-ba lance regula tions and any that are not. In additio n, terms used in the petitio within the scope of the sheet structures, comm odity trading activit ies, and related parties Devel opmen t of useful guidan ce appear to require crispe r definit ion to be fully effecti ve. ission 's articul ation of Comm definit ions will not be easy. Furth@r, the staff recogn izes that the drawn becaus e of its any interpr etation of long-s tandin g MD& A rules must be carefu lly did not observ e that implic ations for possib le enforc ement action s agains t compa nies that etation . interpr etation in their disclo sure prior to public ation of the interpr - to issue a The course of action recom mende d by the staff in this memo randum the key object ive of drawin g statem ent, rather than an interpr etation - is intend ed to accom plish public compa nies, while attenti on to the recom menda tions so that they will be consid ered by ntive impro vemen ts to the allowi ng Comm ission resour ces to focus directly on develo ping substa e of the draft statem ent in Comm ission 's disclos ure rules in the three identif ied areas. The purpos er in meetin g their disclos ure Attach ment A is to sugges t useful steps that issuers should consid legal require ments, or makin g obliga tions. This draft statem ent explic itly disclai ms creatin g new existin g rules. The statem ent any comm ent on any disclos ure that alread y is or is not requir ed by s these areas of import ant also alerts the public to the Comm ission 's intenti on to further addres menda tions and the disclos ure, and invites comm ent genera lly on the petitio ners' recom Comm ission 's statement. 4

n. That The Comm ission has receiv ed one comm ent letter on the firms' petitio firms and plans to expand its comm enter, Dyneg y Inc., applau ded the "proac tive efforts " of the ission , from Rober t D. Letter to Jonath an G. Katz, Secret ary, Securi ties and Excha nge Comm Presid ent, Dyneg y Inc., dated Doty, Execu tive Vice Presid ent, and Micha el R. Mott, Senior Vice Januar y 8, 2002.

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y asked by this proposal." However, Dyneg ired des y arit nul gra the et me "to existing disclosures ted for at fair -exchange traded contracts accoun non ing ard reg nt me uire req re losu that the disc rises engaged in the to any industry, or require all enterp value eliminate references specific those re, regardless of the significance of losu disc the e vid pro y ustr ind rgy merchant ene tives acknowledged the on with the staff, Dynegy representa sati ver con -up ow foll a In . ons rati 10 years, ope energy contracts with terms beyond on lds yie ing vid pro t rke ma ing absence of a trad similar handicap to ncial trading activities that faced a fina er oth y ntif ide dily rea not ld and cou contracts. estimating fair values of long-term

Ill.

Recommendation

ommends that the Office of the Ch ief Accountant rec For the reasons discussed above, the ement. Commission issue the attached stat

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