[Federal Register Volume 67, Number 17 (Friday, January 25, 2002)]
[Notices]
[Pages 3746-3751]
From the Federal Register Online via the Government Publishing Office [www.gpo.gov]
[FR Doc No: 02-1899]


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SECURITIES AND EXCHANGE COMMISSION

[Release Nos. 33-8056; 34-45321; FR-61]


Commission Statement About Management's Discussion and Analysis 
of Financial Condition and Results of Operations

AGENCY: Securities and Exchange Commission (``Commission'').

ACTION: Commission statement.

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SUMMARY: The Commission today is issuing a statement regarding 
Management's Discussion and Analysis of Financial Condition and Results 
of Operations. The release sets forth certain views of the Commission 
regarding disclosure that should be considered by registrants. 
Disclosure matters addressed by the release are liquidity and capital 
resources including off-balance sheet arrangements; certain trading 
activities that include non-exchange traded contracts accounted for at 
fair value; and effects of transactions with related and certain other 
parties.

FOR FURTHER INFORMATION CONTACT: Questions about this statement should 
be referred to Jackson Day or Robert Bayless, Office of the Chief 
Accountant (202 942-4400) or Paula Dubberly, Division of Corporation 
Finance (202 942-2900), Securities and Exchange Commission, 450 Fifth 
Street, NW., Washington, DC 20549-1103.

SUPPLEMENTARY INFORMATION:

I. Background

    On December 31, 2001, the Commission received a petition from the 
accounting firms of Arthur Andersen LLP, Deloitte and Touche LLP, Ernst 
& Young LLP, KPMG LLP, and PricewaterhouseCoopers LLP.\1\ The petition, 
which was endorsed by the

[[Page 3747]]

American Institute of Certified Public Accountants, requested that the 
Commission issue additional interpretive guidance regarding Item 303 of 
Regulation S-K, Management's Discussion and Analysis of Financial 
Condition and Results of Operations,\2\ Item 303 of Regulation S-B, 
Management's Discussion and Analysis or Plan of Operations,\3\ and Item 
5 of Form 20-F, Operating and Financial Review and Prospects \4\ 
(collectively, ``MD&A'' or ``the MD&A rules'').\5\ The petition 
requested that additional guidance be provided to public companies 
preparing their annual reports for the fiscal year just ended.
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    \1\ The petition is posted on the Commission's web page 
(www.sec.gov) under Regulatory Actions, Petitions for Rulemaking.
    \2\ 17 CFR 229.303.
    \3\ 17 CFR 228.303.
    \4\ See 17 CFR 249.220f.
    \5\ The accounting profession has made previous petitions to 
improve MD&A disclosure. See, e.g., Securities Act Release No. 6711 
(April 17, 1987), Concept Release on Management's Discussion and 
Analysis of Financial Condition and Results of Operations, 52 FR 
13715; and Securities Act Release No. 6835 (May 18, 1989), 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations; Certain Investment Company Disclosures, 54 FR 
22427.
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    The petition identified three areas of concern regarding disclosure 
in MD&A:
     Liquidity and capital resources, including off-balance 
sheet arrangements;
     Certain trading activities involving non-exchange traded 
contracts accounted for at fair value; and
     Relationships and transactions with persons or entities 
that derive benefits from their non-independent relationship with the 
registrant or the registrant s related parties.
    Generally, we believe that the quality of information provided by 
public companies in the three areas identified in the petition should 
be improved. Because many companies are currently preparing disclosures 
for fiscal 2001 annual reports, the Commission believes it is 
appropriate to issue this statement so that public companies can 
consider the petition and this statement in preparing year-end and 
interim financial reports and other disclosures made after the issuance 
of this release.
    While the Commission intends to consider rulemaking regarding the 
topics addressed in this statement and other topics covered by MD&A, 
the purpose of this statement is to suggest steps that issuers should 
consider in meeting their current disclosure obligations with respect 
to the topics described. This statement does not create new legal 
requirements, nor does it modify existing legal requirements.

II. Regulation S-K. Item 303. Management's Discussion and Analysis 
of Financial Condition and Results of Operations (MD&A)

    Paragraph (a) of Item 303 of Regulation S-K identifies a basic and 
overriding requirement of MD&A: to ``provide such other information 
that the registrant believes to be necessary to an understanding of its 
financial condition, changes in financial condition and results of 
operations.'' The Commission has explained this requirement on a number 
of occasions. In 1987, we said:
    The Commission has long recognized the need for a narrative 
explanation of the financial statements, because numerical 
presentations and brief accompanying footnotes alone may be 
insufficient for an investor to judge the quality of earnings and the 
likelihood that past performance is indicative of future performance. 
MD&A is intended to give the investor an opportunity to look at the 
company through the eyes of management by providing both a short and 
long-term analysis of the business of the company.\6\
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    \6\ Securities Act Release No. 6711 (April 17, 1987), Concept 
Release on Management's Discussion and Analysis of Financial 
Condition and Results of Operations, 52 FR 13715.
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    And, as we said in 1989, ``[t]he MD&A requirements are intended to 
provide in one section of a 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.'' \7\
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    \7\ Securities Act Release No. 6835 (May 18, 1989), Management's 
Discussion and Analysis of Financial Condition and Results of 
Operations; Certain Investment Company Disclosures, 54 FR 22427, 
22438 (footnote omitted).
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    Disclosure is mandatory where there is a known trend or uncertainty 
that is reasonably likely to have a material effect on the registrant's 
financial condition or results of operations.\8\ Accordingly, the 
development of MD&A disclosure should begin with management's 
identification and evaluation of what information, including the 
potential effects of known trends, commitments, events, and 
uncertainties, is important to providing investors and others an 
accurate understanding of the company's current and prospective 
financial position and operating results.\9\
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    \8\ Securities Act Release No. 6835 (May 18, 1989), Management's 
Discussion and Analysis of Financial Condition and Results of 
Operations; Certain Investment Company Disclosures, 54 FR 22427, 
22429 (``Required disclosure is based on currently known trends, 
events, and uncertainties that are reasonably expected to have 
material effects. * * * In contrast, optional forward-looking 
disclosure involves anticipating a future trend or event or 
anticipating a less predictable impact of a known event, trend or 
uncertainty.'').
    \9\ See Instructions to Item 303 (``The discussion and analysis 
shall focus specifically on material events and uncertainties known 
to management that would cause reported financial information not to 
be necessarily indicative of future operating results or of future 
financial condition.'').
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    Investors have become increasingly concerned about the sufficiency 
of disclosure regarding liquidity risk, market price risks, and effects 
of ``off-balance sheet'' transaction structures. Also, many readers of 
financial statements have cited a lack of transparent disclosure about 
transactions with unconsolidated entities and other parties where that 
information appeared necessary to understand how significant aspects of 
the business were conducted.
    Accordingly, the Commission is reminding companies of the 
requirements of MD&A as they relate to (1) liquidity and capital 
resources, including off-balance sheet arrangements; (2) certain 
trading activities involving non-exchange traded contracts accounted 
for at fair value; and (3) relationships and transactions on terms that 
would not be available from clearly independent third parties on an 
arm's-length basis. This statement suggests steps that companies should 
consider in meeting their disclosure obligations.
    We also want to remind registrants that disclosure must be both 
useful and understandable. That is, management should provide the most 
relevant information and provide it using language and formats that 
investors can be expected to understand. Registrants should be aware 
also that investors will often find information relating to a 
particular matter more meaningful if it is disclosed in a single 
location, rather than presented in a fragmented manner throughout the 
filing.

A. Disclosures Concerning Liquidity and Capital Resources, Including 
``Off-Balance Sheet'' Arrangements

    Paragraphs (a)(1) and (a)(2)(ii) of Item 303 of Regulation S-K set 
forth certain requirements for disclosures about ``Liquidity'' and 
``Capital Resources.''
    (1) Liquidity. Identify any known trends or any known demands, 
commitments, events or uncertainties that will result in or that are 
reasonably likely to result in the registrant's liquidity increasing or 
decreasing in any material way.
* * * * *
    (2)(ii) Capital Resources. Describe any known material trends, 
favorable or

[[Page 3748]]

unfavorable, in the registrant's capital resources. Indicate any 
expected material changes in the mix and relative cost of such 
resources. The discussion shall consider changes between equity, debt 
and any off-balance sheet financing arrangements.
    A registrant's liquidity and capital resources are closely aligned. 
Disclosures about each are likely to be affected by many of the same 
facts and circumstances. And off-balance sheet financing arrangements 
often are integral to both.\10\ Management should consider all of these 
items together, as well as individually, when drafting disclosures 
responsive to the MD&A rules.
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    \10\ See Securities Act Release No. 6835 (May 18, 1989), 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations; Certain Investment Company Disclosures, 54 FR 
22427, particularly Section III.C.
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1. Liquidity Disclosures
    MD&A disclosures should not be overly general. For example, 
disclosure that the registrant has sufficient short-term funding to 
meet its liquidity needs for the next year provides little useful 
information. Instead, registrants should consider describing the 
sources of short-term funding and the circumstances that are reasonably 
likely to affect those sources of liquidity.
    For example, a registrant that identifies its principal source of 
liquidity as operating cash flows may need also to disclose the extent 
of the risk that a decrease in demand for the company's products would 
reduce the availability of funds. That risk might arise, to further the 
example, where customer demand is reasonably likely to fluctuate in 
response to rapid technological changes. Similarly, if commercial paper 
is a principal source of liquidity, the registrant should consider the 
need to disclose how this facility could be adversely affected by a 
debt rating downgrade or deterioration in certain of the company's 
financial ratios or other measures of financial performance. The 
discussion should be limited to material risks, and, as with MD&A 
generally, should be sufficiently detailed and tailored to the 
company's individual circumstances, rather than ``boilerplate.''
    If the registrant's liquidity is dependent on the use of off-
balance sheet financing arrangements, such as securitization of 
receivables or obtaining access to assets through special purpose 
entities, the registrant should consider disclosure of the factors that 
are reasonably likely to affect its ability to continue using those 
off-balance sheet financing arrangements.\11\ Registrants also should 
make informative disclosures about matters that could affect the extent 
of funds required within management's short- and long-term planning 
horizons.
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    \11\ ``The scope of the discussion should thus address liquidity 
in the broadest sense, encompassing internal as well as external 
sources, current conditions as well as future commitments and known 
trends, changes in circumstances and uncertainties.'' [Securities 
Act Release No. 6349 (September 28, 1981)].
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    Registrants are reminded that identification of circumstances that 
could materially affect liquidity is necessary if they are ``reasonably 
likely'' to occur. This disclosure threshold is lower than ``more 
likely than not.'' Market price changes, economic downturns, defaults 
on guarantees, or contractions of operations that have material 
consequences for the registrant's financial position or operating 
results can be reasonably likely to occur under some conditions. 
Material effects on liquidity as a result of any reasonably likely 
changes should be disclosed pursuant to Item 303(a).
    In 1989, the Commission identified two assessments management must 
make where a trend, demand, commitment, event or uncertainty is known:
    1. Is the known trend, demand, commitment, event or uncertainty 
likely to come to fruition? If management determines that it is not 
reasonably likely to occur, no disclosure is required.
    2. If management cannot make that determination, it must evaluate 
objectively the consequences of the known trend, demand, commitment, 
event or uncertainty, on the assumption that it will come to fruition. 
Disclosure is then required unless management determines that a 
material effect on the registrant's financial condition or results of 
operations is not reasonably likely to occur.\12\
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    \12\ Securities Act Release No. 6835 (May 18, 1989), 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations; Certain Investment Company Disclosures, 54 FR 
22427, 22430.
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    The Commission further reminded registrants that each final 
determination resulting from the assessments made by management must be 
objectively reasonable, as viewed at the time the determination is 
made.\13\
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    \13\ Id.
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    To identify trends, demands, commitments, events and uncertainties 
that require disclosure, management should consider the following:
     Provisions in financial guarantees or commitments, debt or 
lease agreements or other arrangements that could trigger a requirement 
for an early payment, additional collateral support, changes in terms, 
acceleration of maturity, or the creation of an additional financial 
obligation, such as adverse changes in the registrant's credit rating, 
financial ratios, earnings, cash flows, or stock price, or changes in 
the value of underlying, linked or indexed assets;
     Circumstances that could impair the registrant's ability 
to continue to engage in transactions that have been integral to 
historical operations or are financially or operationally essential, or 
that could render that activity commercially impracticable, such as the 
inability to maintain a specified investment grade credit rating, level 
of earnings, earnings per share, financial ratios, or collateral;
     Factors specific to the registrant and its markets that 
the registrant expects to be given significant weight in the 
determination of the registrant's credit rating or will otherwise 
affect the registrant's ability to raise short-term and long-term 
financing;
     Guarantees of debt or other commitments to third parties; 
and
     Written options on non-financial assets (for example, real 
estate puts).
2. Off-Balance Sheet Arrangements
    Registrants should consider the need to provide disclosures 
concerning transactions, arrangements and other relationships with 
unconsolidated entities or other persons that are reasonably likely to 
affect materially liquidity or the availability of or requirements for 
capital resources. Specific disclosure may be necessary regarding 
relationships with unconsolidated entities that are contractually 
limited to narrow activities that facilitate the registrant's transfer 
of or access to assets. These entities are often referred to as 
structured finance or special purpose entities. These entities may be 
in the form of corporations, partnerships or limited liability 
companies, or trusts.
    Material sources of liquidity and financing, including off-balance 
sheet arrangements and transactions with unconsolidated, limited 
purpose entities, should be discussed pursuant to Item 303(a).\14\ The 
extent of the registrant's reliance on off-balance sheet arrangements 
should be described fully and clearly where those entities provide 
financing, liquidity, or market or credit risk support for the 
registrant; engage in

[[Page 3749]]

leasing, hedging, research and development services with the 
registrant; or expose the registrant to liability that is not reflected 
on the face of the financial statements. Where contingencies inherent 
in the arrangements are reasonably likely to affect the continued 
availability of a material historical source of liquidity and finance, 
registrants must disclose those uncertainties and their effects.
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    \14\ Securities Act Release No. 6835 (May 18, 1989), 
Management's Discussion and Analysis of Financial Condition and 
Results of Operations; Certain Investment Company Disclosures, 54 FR 
22427, at III.C.
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    Registrants should consider the need to include information about 
the off-balance sheet arrangements such as: their business purposes and 
activities; their economic substance; the key terms and conditions of 
any commitments; the initial and ongoing relationships with the 
registrant and its affiliates; and the registrant's potential risk 
exposures resulting from its contractual or other commitments involving 
the off-balance sheet arrangements.
    For example, a registrant may be economically or legally required 
or reasonably likely to fund losses of an unconsolidated, limited 
purpose entity, provide it with additional funding, issue securities 
pursuant to a call option held by that entity, purchase the entity's 
capital stock or assets, or the registrant otherwise may be financially 
affected by the performance or non-performance of an entity or 
counterparty to a transaction or arrangement. In those circumstances, 
the registrant may need to include information about the arrangements 
and exposures resulting from contractual or other commitments to 
provide investors with a clear understanding of the registrant's 
business activities, financial arrangements, and financial statements. 
Other disclosures that registrants should consider to explain the 
effects and risks of off-balance sheet arrangements include:
     Total amount of assets and obligations of the off-balance 
sheet entity, with a description of the nature of its assets and 
obligations, and identification of the class and amount of any debt or 
equity securities issued by the registrant;
     The effects of the entity's termination if it has a finite 
life or it is reasonably likely that the registrant's arrangements with 
the entity may be discontinued in the foreseeable future;
     Amounts receivable or payable, and revenues, expenses and 
cash flows resulting from the arrangements;
     Extended payment terms of receivables, loans, and debt 
securities resulting from the arrangements, and any uncertainties as to 
realization, including repayment that is contingent upon the future 
operations or performance of any party;
     The amounts and key terms and conditions of purchase and 
sale agreements between the registrant and the counterparties in any 
such arrangements; and
     The amounts of any guarantees, lines of credit, standby 
letters of credit or commitments or take or pay contracts, throughput 
contracts or other similar types of arrangements, including tolling, 
capacity, or leasing arrangements, that could require the registrant to 
provide funding of any obligations under the arrangements, including 
guarantees of repayment of obligors of parties to the arrangements, 
make whole agreements, or value guarantees.
    Although disclosure regarding similar arrangements can be 
aggregated, important distinctions in terms and effects should not be 
lost in that process. The relative significance to the registrant's 
financial position and results of the arrangements with unconsolidated, 
non-independent, limited purpose entities should be clear from the 
disclosures to the extent material. While legal opinions regarding 
``true sale'' issues or other issues relating to whether a registrant 
has contingent, residual or other liability can play an important role 
in transactions involving such entities, they do not obviate the need 
for the registrant to consider whether disclosure is required. In 
addition, disclosure of these matters should be clear and individually 
tailored to describe the risks to the registrant, and should not 
consist merely of recitation of the transactions' legal terms or the 
relationships between the parties or similar boilerplate.
3. Disclosures About Contractual Obligations and Commercial Commitments
    Accounting standards \15\ require disclosure concerning a 
registrant's obligations and commitments to make future payments under 
contracts, such as debt and lease agreements, and under contingent 
commitments, such as debt guarantees. Disclosures responsive to these 
requirements usually are located in various parts of a registrant's 
filings. We believe investors would find it beneficial if aggregated 
information about contractual obligations and commercial commitments 
\16\ were provided in a single location so that a total picture of 
obligations would be readily available. One aid to presenting the total 
picture of a registrant's liquidity and capital resources and the 
integral role of on- and off-balance sheet arrangements may be 
schedules of contractual obligations and commercial commitments as of 
the latest balance sheet date. Examples that could be adapted to the 
registrant's particular facts are presented below.
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    \15\ See, e.g., Statement of Financial Accounting Standards Nos. 
5, Accounting for Contingencies, 13, Accounting for Leases, 47, 
Disclosure of Long-Term Obligations, and 129, Disclosure of 
Information about Capital Structure.''
    \16\ Commercial commitments are intended to include lines of 
credit, guarantees, and other potential cash outflows resulting from 
a contingent event that requires registrant performance pursuant to 
a funding commitment.

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                                                              Payments due by period
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     Contractual obligations                        Less than 1
                                       Total           year          1-3 years       4-5 years     After 5 years
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Long-Term Debt
Capital Lease Obligations
Operating Leases
Unconditional Purchase
 Obligations
Other Long-Term Obligations
Total Contractual Cash
 Obligations
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    The preceding table could be accompanied by footnotes to describe 
provisions that create, increase or accelerate liabilities, or other 
pertinent data.

[[Page 3750]]



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                                                             Amount of commitment expiration per period
                                   Total amounts ---------------------------------------------------------------
  Other commercial commitments       committed      Less than 1
                                                       year          1-3 years       4-5 years     Over 5 years
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Lines of Credit
Standby Letters of Credit
Guarantees
Standby Repurchase Obligations
Other Commercial Commitments
Total Commercial Commitments
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B. Disclosures About Certain Trading Activities That Include Non-
Exchange Traded Contracts Accounted for at Fair Value

    The Commission is concerned that there may be a lack of 
transparency and clarity with respect to the disclosure of trading 
activities involving commodity contracts that are accounted for at fair 
value but for which a lack of market price quotations necessitates the 
use of fair value estimation techniques. These contracts may be indexed 
to measures of weather, commodities prices, or quoted prices of service 
capacity, such as energy storage and bandwidth capacity contracts. 
Companies engaged to a material extent in trading activities \17\ 
involving these contracts should consider providing disclosures in MD&A 
that supplement those required in the financial statements by 
applicable accounting standards. Investor understanding and financial 
reporting transparency may depend on additional statistical and other 
information about these business activities and transactions. That 
information should include any contracts that are derivatives involving 
the same commodities that are part of those trading activities (for 
example, energy derivatives that are part of energy trading activities 
\18\).
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    \17\ Companies that may find the suggested disclosures 
particularly valuable are those engaged to a material extent in (a) 
energy trading activities as defined in Emerging Issues Task Force 
Issue 98-10 (EITF 98-10), Accounting for Contracts Involved in 
Energy Trading and Risk Management Activities, (b) weather trading 
activities as defined in Emerging Issues Task Force Issue No. 99-2, 
Accounting for Weather Derivatives, or (c) non-exchange traded 
commodity trading contracts that are marked to fair value through 
earnings and are part of analogous trading activities (for example, 
nonderivative trading contracts on pulp, bandwidth, newsprint, and 
so on).
    \18\ Emerging Issues Task Force No. 98-10 (September 23, 1999) 
identifies factors that distinguish energy trading activities from 
other activities that involve the purchase or sale of energy.
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    The Commission reminds registrants that accounting standards 
require disclosures in financial statements of material energy trading 
and risk management activities.\19\ Discussion in MD&A of material 
trends and uncertainties arising from those activities is also 
required. Information about these trading activities, contracts and 
modeling methodologies, assumptions, variables and inputs, along with 
explanations of the different outcomes reasonably likely under 
different circumstances or measurement methods, should be considered 
for inclusion in management's discussion of how the activities affect 
reported results for the latest annual period and subsequent interim 
period and how financial position is affected as of the latest balance 
sheet date. The Commission recently issued cautionary advice 
encouraging companies to include in their MD&A full explanations, in 
plain English, of their ``critical accounting policies,'' the judgments 
and uncertainties affecting the application of those policies, and the 
likelihood that materially different amounts would be reported under 
different conditions or using different assumptions.\20\
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    \19\ Emerging Issues Task Force Issue 98-10 (September 23, 
1999), Accounting for Contracts Involved in Energy Trading and Risk 
Management Activities.
    \20\ Financial Reporting Release No. 60, Cautionary Advice 
Regarding Disclosure About Critical Accounting Policies (December 
12, 2001) 66 FR 65013.
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    Consistent with that advice, registrants should consider the need 
to furnish information, quantified to the extent practicable, that does 
the following:
     Disaggregates realized and unrealized changes in fair 
value;
     Identifies changes in fair value attributable to changes 
in valuation techniques;
     Disaggregates estimated fair values at the latest balance 
sheet date based on whether fair values are determined directly from 
quoted market prices or are estimated; and
     Indicates the maturities of contracts at the latest 
balance sheet date (e.g., within one year, within years one through 
three, within years four and five, and after five years).
    An example of this disclosure in the form of a schedule is provided 
below.

Fair value of contracts outstanding at the beginning of the period--
xxxxxx
Contracts realized or otherwise settled during the period--xxxxxx
Fair value of new contracts when entered into during the period--xxxxxx
Changes in fair values attributable to changes in valuation techniques 
and assumptions--xxxxxx
Other changes in fair values--xxxxxx
Fair value of contracts outstanding at the end of the period--xxxxxx

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                                                       Fair value of contracts at period-end
                                 -------------------------------------------------------------------------------
      Source of fair value                                                          Maturity in
                                   Maturity less   Maturity 1-3    Maturity 4-5     excess of 5     Total fair
                                    than 1 year        years           years           years           value
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Prices actively quoted..........
Prices provided by other
 external sources...............
Prices based on models and other
 valuation methods..............
----------------------------------------------------------------------------------------------------------------


[[Page 3751]]

    In addition, issuers should consider the need to disclose the fair 
value of net claims against counterparties that are reported as assets 
at the most recent balance sheet date, based on the credit quality of 
the contract counterparty (e.g., investment grade; noninvestment grade; 
and no external ratings).
    Registrants should also consider their disclosure obligations 
regarding risk management in connection with the trading activities 
discussed above. Registrants should consider whether they should 
provide fuller disclosure regarding the management of risks related to, 
for example, changes in credit quality or market fluctuations of 
underlying, linked or indexed assets or liabilities, especially where 
such assets are illiquid or susceptible to material uncertainties in 
valuation.

C. Disclosures About Effects of Transactions With Related and Certain 
Other Parties

    Statement of Financial Accounting Standards No. 57 (FAS 57), 
Related Party Disclosures, sets forth the requirements under GAAP 
concerning transactions with related parties.\21\ As noted in that 
standard, ``[t]ransactions involving related parties cannot be presumed 
to be carried out on an arm's length basis, as the requisite conditions 
of competitive, free-market dealings may not exist.'' \22\ Accordingly, 
where related party transactions are material, MD&A should include 
discussion of those transactions to the extent necessary for an 
understanding of the company's current and prospective financial 
position and operating results. In addition, Item 404 of Regulation S-K 
and Item 404 of Regulation S-B require disclosure of certain 
relationships and transactions with related parties.\23\
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    \21\ Statement of Financial Accounting Standard No. 57, Related 
Party Disclosures (March 1982). See also 17 CFR 210.4-08(k)(1), 
which states, ``Related party transactions should be identified and 
the amounts stated on the face of the balance sheet, income 
statement, or statement of cash flows.''
    \22\ Id., paragraph 3.
    \23\ 17 CFR 229.404 and 17 CFR 228.404, which require, with 
certain exceptions, disclosure of transactions or series of 
transactions in which the company was, or is to be, a party, the 
amount involved exceeds $60,000, and a director, executive officer, 
nominee for election as director, security holder of more than five 
percent of any class of the company's voting securities, or any 
member of the immediate family of any of such persons, had or will 
have a direct or indirect material interest. Required disclosures 
include the name of the person and the person's relationship with 
the registrant, the nature of the person's interest, the amount of 
the transaction(s), and, where practicable, the amount of the 
person's interest in the transaction(s). In addition, section 10A of 
the Securities Exchange Act of 1934, 15 U.S.C. 78j-1, requires that 
each audit of financial statements pursuant to that Act include 
procedures designed to identify related party transactions that are 
material to the financial statements or that require disclosure. 
Statement on Auditing Standards No. 45, Related Parties, published 
by the Auditing Standards Board and effective for periods ended 
after September 30, 1983, provides guidance on auditing related 
party transactions.
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    Registrants should consider whether investors would better 
understand financial statements in many circumstances if MD&A included 
descriptions of all material transactions involving related persons or 
entities, with clear discussion of arrangements that may involve 
transaction terms or other aspects that differ from those which would 
likely be negotiated with clearly independent parties.\24\ Registrants 
should consider describing the elements of the transactions that are 
necessary for an understanding of the transactions' business purpose 
and economic substance, their effects on the financial statements, and 
the special risks or contingencies arising from these transactions. 
Discussion of the following may be necessary:
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    \24\ Audit committees may wish to include a review of such 
relationships and transactions in their discussions with management 
and auditors, including a review of their terms and internal 
corporate and Board actions involving the transactions, prior to 
their recommendation that the financial statements be included in 
the company's Form 10-K. See generally, Regulation S-K Item 306, 17 
CFR 229.306, and Regulation S-B Item 306, 17 CFR 228.306.
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     The business purpose of the arrangement;
     Identification of the related parties transacting business 
with the registrant;
     How transaction prices were determined by the parties;
     If disclosures represent that transactions have been 
evaluated for fairness, a description of how the evaluation was made; 
and
     Any ongoing contractual or other commitments as a result 
of the arrangement.
    Registrants should also consider the need for disclosure about 
parties that fall outside the definition of ``related parties,'' but 
with whom the registrant or its related parties have a relationship 
that enables the parties to negotiate terms of material transactions 
that may not be available from other, more clearly independent, parties 
on an arm's-length basis. For example, an entity may be established and 
operated by individuals that were former senior management of, or have 
some other current or former relationship with, a registrant. The 
purpose of the entity may be to own assets used by the registrant or 
provide financing or services to the registrant. Although former 
management or persons with other relationships may not meet the 
definition of a related party pursuant to FAS 57, the former management 
positions may result in negotiation of terms that are more or less 
favorable than those available on an arm's-length basis from clearly 
independent third parties that are material to the registrant's 
financial position or results of operations. In some cases, investors 
may be unable to understand the registrant's reported results of 
operations without a clear explanation of these arrangements and 
relationships.

    Dated: January 22, 2002.

    By the Commission.
Margaret H. McFarland,
Deputy Secretary.
[FR Doc. 02-1899 Filed 1-24-02; 8:45 am]
BILLING CODE 8010-01-U