SEC Adopts New Disclosure Rules for Derivatives
T he Securities and Exchange Commission approved rules requiring companies to reveal more about their accounting policies for derivatives in the footnotes of financial statements. The rules also require new disclosure of information about the risk of loss from market rate or price changes that are inherent in derivatives and other financial instruments.
SEC Chairman Arthur Levitt, Jr., told reporters the rules build on generally accepted accounting principles and give investors tangible, quantifiable information about derivatives and their potential consequence for a companys financial position.
Small companies and registered investment companies are exempt from the new requirements. The rules, which will be phased in over the next few years for quantitative and qualitative disclosures, are effective for filings after June 15, 1997, for banks, thrifts and companies with market capitalization over $2.5 billion. Large commercial companies with December 31 yearends must comply by December 31, 1997.
What companies must do
In general, the rules require enhanced descriptions of accounting policies for derivatives in financial statement footnotes and quantitative and qualitative disclosures about market risk outside the financial statements. The rules also remind registrants to supplement existing disclosures about financial instruments, commodity positions, firm commitments and other anticipated transactions with related disclosures about derivatives.
The rules allow companies providing quantitative market risk information to choose from three methods of presentation.
- Tabular presentation of fair value information and contract terms relevant to determining a companys future cash flows, categorized by expected maturity dates.
- Sensitivity analysis of the potential loss in future earnings, fair values or cash flows of market risk sensitive instruments due to hypothetical changes in interest rates and other rates or prices.
- Value at risk disclosures of potential loss in future earnings, fair values or cash flows from market movements, including their likelihood of occurrence.
Stephen M. Swad, SEC deputy chief accountant, told the Journal that the three alternatives should help quell the concerns of companies that the disclosures would reveal proprietary information or put them at a competitive disadvantage. He also said the SEC provided the alternatives because there was no single way to disclose such information on the financial statements. According to Swad, the tabular presentation offers companies the simplest way to comply. The other two methods require companies to summarize their market risks.
The cost to companies
The SEC estimated that complying with the new rules could cost U.S. companies $40 million. Swad said most of the costs related to the requirement to provide the quantitative information about market risk. He said the SEC estimated that compliance would take about 80 hours per company. The companies that initially must complylarger entities, banks, thrifts, broker-dealers and financial institutionsalready are managing this risk because it is their primary business risk, according to Swad. "These companies manage the risk in ways that conform with many of the disclosure requirements, so their costs are not expected to be significant," said Swad. He also said compliance costs should not be as high for companies that have one debt instrument or a few swaps.
Accounting for derivatives
The SEC rules address only footnote disclosure. The Financial Accounting Standards Board, which issued its derivatives exposure draft in June, is dealing with the accounting issues. "The thrust of the FASB project is in recognition and measurement and not just footnote disclosure," said FASB Project Manager Robert Wilkins. When final, the FASB project will completely void FASB Statement no. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments . "Our final statement will include certain disclosure requirements, but they will be far different from what the SEC has done," said Wilkins.
DIRECT: Major Benefits for Journal Readers
Now theres another good reason for keeping up with the Journal . American Institute of CPAs members can earn up to 24 continuing education credits per year by reading selected Journal articles, completing four quarterly study guides and passing four quarterly examinations.
An annual subscription costs $159. For information or to order, call 1-800-862-4272 and select option #1.
I In a letter to the General Accounting Office, Shirley S. Chater, the commissioner of the Social Security Administration (SSA), said the current format of the SSAs personal earnings and benefit estimate statements (PEBES) was not user-friendly and that the SSA would begin work on content and design changes this year.
Chater was responding to a December GAO report recommending that the SSA revise the current benefit statements to improve design and simplify explanations. According to the report, SSA Benefit Statements: Well Received by the Public but Difficult to Comprehend , PEBES will be sent to 123 million people each yearalmost every U.S. worker aged 25 and olderby the year 2000. In 1995, Congress required the SSA to send the statements to all workers who had reached age 60. The six-page statements supply workers with information about their yearly earnings on record at the SSA as well as information on their eligibility for Social Security retirement and estimates on survivor and disability benefits.
In the report, the GAO said that PEBES failed to clearly communicate to taxpayers the complex information needed to understand the SSAs programs and benefits. The GAO said the statements made it difficult for taxpayers to locate and understand important information, such as who in a taxpayers family is eligible for Social Security benefits and how much these family members could receive.
Chater told the GAO that the SSA had set up a workgroup, chaired by the associate commissioner for program benefits policy, to examine the specific problem areas the GAO had identified and to recommend several alternative formats.
T he Securities and Exchange Commission proposed a rule that would mandate plain English disclosure in prospectuses. The proposal would require companies to make the front and back cover pages, summary and risk factor sections of prospectuses more readable for the general public.
In 1996, the SEC began the pilot program in which participating companies agreed that the new prospectuses would not disclose proprietary business and financial information.
The SEC wants investors, financial analysts, brokers and other users of prospectuses to comment on the proposal and provide additional ways to improve readability. The SEC said mandating plain English would both help investors and market professionals and lessen the misunderstandings that lead to costly lawsuits. "We need to acknowledge that disclosure is not disclosure if it doesnt communicate," said SEC Chairman Arthur Levitt, Jr.
Writing in Plain English
The Securities and Exchange Commission listed plain English principles to help furnish investors with readable disclosure documents. They include using the active voice, shorter sentences and everyday language and avoiding legal jargon. Here is a before-and-after example:
The rule also would revise the current requirements for highly technical information in the front of prospectuses and would detail the clarity required in the entire document. The SEC also released A Plain English Handbook: How to Create Clear SEC Disclosure Documents , which explains where and how information should be disclosed. it includes before and after examples.