SEC Adopts Rules On Disclosure Of Off-Balance Sheet Arrangements And Aggregate Contractual Obligations

The Securities and Exchange Commission today voted to adopt amendments to implement the mandate of Section 401(a) of the Sarbanes-Oxley Act of 2002. Section 401(a) added Section 13(j) to the Securities Exchange Act of 1934, which requires the Commission to adopt final rules by Jan. 26, 2003, to require each annual and quarterly financial report required to be filed with the Commission, to disclose "all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses."

The amendments approved by the Commission will require a registrant to provide an explanation of its off-balance sheet arrangements in a separately captioned subsection of the "Management's Discussion and Analysis" (MD&A) section in its disclosure documents. The amendments also will require registrants (other than small business issuers) to provide an overview of certain known contractual obligations in a tabular format.

The amendments will include a definition of "off-balance sheet arrangements" that primarily targets the means through which companies typically structure off-balance sheet transactions or otherwise incur risks of loss that are not fully transparent to investors. The definition of "off-balance sheet arrangements" will employ concepts in accounting literature in order to define the categories of arrangements with precision. Generally, the definition will include the following categories of contractual arrangements:

• certain guarantee contracts;
• retained or contingent interests in assets transferred to an unconsolidated entity;
• derivative instruments that are classified as equity; or
• material variable interests in unconsolidated entities that conduct certain activities.

The amendments will require disclosure of off-balance sheet arrangements that either have, or are reasonably likely to have, a current or future effect on the registrant's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. That disclosure threshold is consistent with the existing disclosure threshold under which information that could have a material effect on financial condition, changes in financial condition or results of operations must be included in MD&A.

The amendments will require disclosure of the following specified information to the extent necessary to an understanding of off-balance sheet arrangements and their material effects:

• the nature and business purpose of the registrant's off-balance sheet arrangements;
• the importance to the registrant for liquidity, capital resources, market risk or credit risk support or other benefits;
• the financial impact and exposure to risk; and
• known events, demands, commitments, trends or uncertainties that implicate the registrant's ability to benefit from its off-balance sheet arrangements.

Consistent with the existing MD&A requirements, the amendments will contain a principles-based requirement that a registrant provide such other information that it believes is necessary for an understanding of its off-balance sheet arrangements and their specified material effects.

In addition, the amendments will include a requirement for registrants to disclose, in a tabular format, the amounts of payments due under specified contractual obligations, aggregated by category of contractual obligation, for specified time periods. The categories of contractual obligations to be included in the table are defined by reference to the applicable accounting literature. Registrants will be required to comply with the disclosure requirements for off-balance sheet arrangements in Commission filings that are required to include financial statements for the fiscal years ending on or after June 15, 2003. Registrants will be required to comply with the disclosure requirements for the table of contractual obligations in Commission filings that are required to include financial statements for the fiscal years ending on or after Dec. 15, 2003. Registrants could voluntarily comply with the new disclosure requirements before the compliance dates.