March 2001, Meeting Highlights

Ernie Baugh

John Gerdener

Wendy Hambleton

Jay Hartig

Chris Holmes

Jim Ledwith

Bob Rouse

Roy Van Brunt

John Wolfson

Bill Yeates

Mary Jane Young

 Lynn Turner, Chief Accountant

Andrew Bailey, Academic Fellow

Bob Burns, Chief Counsel

Sam Burke, Associate Chief Accountant

Carina Canedo, Professional Accounting Fellow

Andrew Hubacker, Assistant Chief Accountant

Mike Kigin, Associate Chief Accountant

Shelly Luisi, Associate Chief Accountant

Michael Pierce, Professional Accounting Fellow

 Division of Corporation Finance

 Robert Bayless, Chief Accountant

Jennifer Roddy, SECPS

David Cace, Richard A. Eisner & Co.

Gary Illiano, Grant Thornton

Louay Khatib, Ernst & Young

Scott Pohlman, McGladrey & Pullen

 We have been urged to consider the need for greater transparency of all equity compensation plans, whether or not the plans have received security holder approval. Some market participants have expressed concern that a growing number of employee stock plans escape security holder scrutiny because they are not submitted for approval. Disclosure of the overall number of securities of a registrant authorized for issuance under employee stock option plans then in effect is sometimes available indirectly through the registrant's financial statements included in its annual report to security holders. However, this disclosure is not consistently available in any one location or format, may not include information disaggregated for each plan, and may not include stock options granted to non-employees.

 We are proposing amendments that would require registrants to disclose, at least annually, information about the total number of securities that have been authorized for issuance under each equity compensation plan in effect as of the end of the last completed fiscal year, whether or not the plans have been approved by security holders. This disclosure would be set forth in a tabular format

• in the registrant's proxy statement whenever the registrant is seeking security holder action regarding a compensation plan; or
• in the registrant's annual report on Form 10-K in years when the registrant is not seeking security holder action regarding a compensation plan.

 These amendments would require disclosure in a registrant's proxy statement or annual report on Form 10-K or 10-KSB of the following information:

• the number of securities authorized for issuance under each equity compensation plan of the registrant in effect as of the end of the most recently completed fiscal year;
• the number of securities issued pursuant to equity awards made during the last completed fiscal year, plus the number of securities to be issued upon the exercise of options, warrants or rights granted during the last completed fiscal year, under each plan;
• the number of securities to be issued upon the exercise of outstanding options, warrants or rights under each plan; and
• other than securities to be issued upon the exercise of outstanding options, warrants or rights, the number of securities remaining available for future issuance under each plan.

 This information would be provided without regard to whether the equity compensation plan was previously approved by a registrant's security holders. Registrants would be required to identify, either in the table or through a narrative statement, which of the equity compensation plans, if any, was adopted without security holder approval. They also would be required to provide a brief, narrative description of the material features of each plan adopted without security holder approval during the last completed fiscal year.

 The comment period ends April 2, 2001.

 Lynn Turner also recommended that the staff's 2000 Audit Risk Alert Letter be reviewed for additional information regarding the staff's position on various disclosures. This letter is posted on the SEC website at http://www.sec.gov/info/accountants/staffletters/audrsk2k.htm. He noted that some of the concerns raised in this letter have become even more relevant given current market factors.

 Mr. Turner made the following additional observations relative to adequate disclosures:

• OPEB Accruals. Increases in the trend in health care costs have given rise to concerns about the adequacy of OPEB accruals. Preparers and auditors should review the assumptions that are being used to calculate the OPEB obligation in light of these trends. Adequate disclosures should be provided in MD&A on the impact of such costs on current operations and future trends.
• Restructurings and Layoffs. The staff has reviewed a number of filings in which disclosures describing recent restructurings and employee layoffs were deficient. For example, the number of actual employees laid-off is required to be disclosed but was missing in some filings. Registrants should adhere to the guidance in Staff Accounting Bulletin (SAB) No. 100 and EITF Issue No. 94-3, Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity (Including Certain Costs Incurred in a Restructuring when making such disclosures.
• Impairments. The staff has reviewed a number of recent filings in which impairment losses were recorded. In their reviews, the staff asked registrants a number of questions relating to the business environment around the time the impairment was recorded (e.g., top ten customers, revenue streams, cash flow data, employment records, etc). In reviewing the data received, the staff found evidence that the impairments actually occurred before they were recorded. Registrants should take steps to ensure that impairment losses are recorded on a timely basis and that adequate disclosures are provided.

 Mr. Turner added that the Commission's Enforcement Division staff have been sensitized to this issue and are aware of the staff's position.

 He added that auditors should consider the O'Malley Panel's observations in assessing the risk of material misstatement arising from fraudulent financial reporting in connection with the performance of procedures required by Statement on Auditing Standards (SAS) No. 82, Consideration of Fraud in a Financial Statement Audit.

 Robert Bayless added that this year, DCF is screening proxies filed in preliminary form primarily to determine whether the disclosures are there. Next year the staff will provide additional guidance and will perform more extensive reviews.

 The staff is particularly interested in the communications and training that firms have done with their international affiliates regarding the new independence rules, especially as they relate to the performance of bookkeeping services. In addition, CFOs of registrant companies need to ensure that their foreign subsidiaries are not retaining their external auditors for bookkeeping services in a manner that violates the new rules.

 He emphasized that he expects auditors and registrants to address this issue immediately to ensure they are in full and absolute compliance with the rules.

 Background: Prior to the recent revisions of Item 302, quarterly financial data was not required to be presented by registrants that did not meet certain defined criteria in Item 302 (A)(5)

 Revised Item 302 A (5) states that the requirement to present quarterly financial data "applies to any registrant, except a foreign private issuer, that has securities registered pursuant to sections 12(b) (15 U.S.C. § 78l(b)) (other than mutual life insurance companies) or 12(g) of the Exchange Act (15 U.S.C. § 78l(g)). "

 Item 302 A (1) states that quarterly financial data should be provided "for each full quarter within the two most recent fiscal years and any subsequent interim period for which financial statements are included or are required to be included by Article 3 of Regulation S-X."

 Discussion: There are no special transition provisions related to the recent revisions of Item 302. Accordingly, even though a registrant was not required to present quarterly data in 1999, it would appear that the registrant's Form 10-K for the year ended December 31, 2000 should contain quarterly data for two years, i.e., both 1999 and 2000.

 Additionally, U.S. generally accepted auditing standards [CSAS AU 722. 38] indicate that when the financial statements to which the quarterly financial information relates have been reported upon by an independent auditor, the auditor also must review the quarterly data. The auditor's review should comply with the standards in Statement on Auditing Standards 71, "Interim Financial Information". Accordingly, in the above fact pattern, it would appear that both the 1999 and 2000 quarterly data presented as supplemental data under Item 302 should be reviewed by the auditor.

 Staff Comment: We agree with this analysis of the requirements of Item 302 and GAAS. (Note that the response to Question 2 in SAB 6.G.1.c became obsolete upon the amendment of Item 302.) The staff will consider requests for no-action in unusual circumstances that prevent compliance with the rule without unreasonable cost or effort.

 Background: Prior to the recent revisions of Item 302, quarterly financial data was not required to be presented in an IPO. The Committee is aware of several instances in which the staff commented that quarterly data is required under the revised rules. The proposal and final release do not indicate that the SEC intended to extend the requirement for quarterly financial data to initial public offerings.

 Item 302 A (5) states that the requirement to present quarterly financial data "applies to any registrant, except a foreign private issuer, that has securities registered pursuant to sections 12(b) (15 U.S.C. § 78l(b)) (other than mutual life insurance companies) or 12(g) of the Exchange Act (15 U.S.C. § 78l(g)). "

 Discussion: Because a company in its initial registration does not have securities registered, it would appear that they are exempt from the requirement to present quarterly financial data. Based on conversations with Division of Corporation Finance staff, it appears they agree that quarterly financial data is not required in initial registrations. Is this an appropriate characterization of the staff's view?

 Staff Comment: We agree with this analysis of the requirements of Item 302 in an initial registration statement. After the initial registration statement is declared effective, the registrant must comply with Item 302 in any Exchange or Securities Act document that calls for that disclosure.

 Bacgkround: Company A has a retained deficit and positive capital surplus. It also has preferred stock that requires an annual dividend payable in either cash or stock. The Company, as in the past, plans to distribute common stock as the required dividend on its preferred stock. Should the dividend should be accounted for at:

1. the fair value of the common stock being issued with a charge (increase) to retained deficit or
2. the par value of the common stock issued with a charge to capital surplus.

 Legal counsel to Company A had advised that, under appropriate state law, a retained deficit does not preclude the issuance of the common stock dividend as the dividend could be declared from available capital surplus.

 Discussion: One firm discussed this fact pattern with the SEC staff several years ago. In that situation (with facts identical to the above), the SEC staff took the position that the stock dividend should be recorded at par with a charge to capital surplus. The staff objected to treating the stock dividend as a charge to retained earnings at fair value. Although documentation of the basis for the staff's view is not available, one argument favoring this view is legal counsel's conclusion that the divided could be declared from available capital surplus.

 ARB 43 indicates that when the stock dividend is not in substance a stock split, companies should charge the fair value of the stock dividend against retained earnings.1APB No. 29 indicates that dividends-in-kind are recorded at the fair value of the assets transferred. However, the literature does not address the accounting when retained earnings are in a deficit position.

 Would the SEC staff object to accounting for a stock dividend in the above situation at fair value with a charge to retained earnings? Would the staff permit charging the stock dividend at par value to paid in capital?

 Staff Comment: A significant fact in the question is that the stock dividend is payable to holders of preferred stock, rather than common stockholders. In this circumstance, we believe the dividend should be accounted for at fair value on a basis consistent with APB No. 29, with a corresponding decrease of income or increase of loss applicable to common shareholders. This accounting is appropriate to reflect the transfer of value (a new residual interest) to a class other than the common shareholders. However, we believe all stock dividends payable to common stockholders when retained earnings are in a deficit position should be accounted for by capitalizing only the stock's par value from paid in capital. Registrants are also advised to consider FRR 214 when there are pro rata stock distributions to shareholders.

 Background: Under SAB 5-J, if a company becomes substantially wholly owned, the acquirer's cost should be pushed down and reflected as a new cost basis in the company's financial statements. Generally, the SEC staff will not require or object to push-down accounting when a minority interest of greater than 5 percent but not more than 20 percent exists.

 This question considers the fact pattern where an owner acquires sufficient ownership of an existing registrant so that push-down accounting is permitted but not required. At the time this level of ownership is reached, the registrant elects to not apply push-down accounting. Later, although there has been no change in ownership, the registrant decides it would rather apply push-down accounting.

 Discussion: We are not aware of any SEC staff guidance on this question. SAB 5-J indicates that the SEC staff encourages the use of push-down accounting. This might indicate that the later application of push-down accounting is an improvement in reporting that is permitted. We note that if the company in question was not a registrant at the time of the change in ownership, it could restate its financial statements to apply push-down accounting in connection with an initial registration of securities.

 On the other hand, the rationale for applying push-down accounting is that the parent has acquired the ability to control the form of ownership of the entity. The evaluation of whether the parent has this ability could be viewed as question of facts, the answer to which dictates whether push-down accounting should be used. Under this line of thinking, if not applying push-down accounting at the acquisition date was proper, a subsequent change in facts would be needed for push-down accounting to become permitted.

 Staff Comment: We believe that push-down accounting is applied on the basis of the specific facts and circumstances at the time of the transaction. If the determination was proper at the acquisition, we believe no subsequent change by a registrant is permitted. We are unsure of how a subsequent change of facts would justify a change in the original determination. This position does not override the special exemption for an initial public distribution described in paragraph 29 of APB 20.

 Background: A number of registrants have acquired power plants from utilities. Often, all of the power plant's output has historically been transferred to the seller's transmission and distribution operations. Sometimes, the power plant has had a small amount of third party revenue. After the transaction, the buyer will sell the plant's output to third parties. Sometimes it will continue to provide power to the seller.

 For purposes of reporting significant acquisitions under the SEC's rules, whether the power plants are businesses or assets is not clear. Rule 11-01(d) states that this evaluation should consider whether there is sufficient continuity of the acquired entity's operations prior to and after the transaction so that disclosure of the prior financial information is material to an understanding of future operations. It also states that a registrant should consider whether the nature of the revenue-producing activity of the acquired component will remain generally the same as before the transaction.

 Discussion: A number of registrants have concluded that it is not necessary to provide financial statements of acquired power plants in their SEC filings. They have written to the SEC staff to discuss the reasons for their conclusions, and the staff has not objected to excluding the power plants' financial statements. Registrants' reasons for concluding power plants' financial statements weren't necessary have included the following:

• The power plant is not a business under Rule 11-01(d) because the operation lacks third party revenue and/or because there are planned changes in operations after the purchase.
• In a registration statement, the filing often contains a significant amount of historical and/or projected operating information about the power plant and this information, in the view of registrants, is sufficient to meet the needs of investors.

 Should each of these fact patterns be pre-cleared? Is there general guidance that would be useful in reaching appropriate conclusions absent pre-clearance?

 Staff Comment: This summary is generally correct, but pre-clearance may continue to be wise in many circumstances. The staff's analysis considers all the factors identified in Rule 11-01(d). Planned changes in operations may or may not affect the relevance of historical information, depending on the nature of those changes. Generally, the absence of third party sales is a persuasive indicator that historical information would not be meaningful. However, determinable market prices directly attributable to a commodity (such as posted oil prices for a producing property) may permit the preparation of meaningful historical financial information.

 Background: Regulation S-X Rule 4-08(g) calls for summarized financial information of investees to be presented if the investees are significant on an aggregated basis. The Rule states that the information may be presented on an individual or group basis. However, the rule does not state that a registrant should present summarized information for investees that are individually significant separately from the information for investees that are individually insignificant.

 Discussion: On occasion, the SEC staff has asked registrants to present summarized data for investees that are individually significant separately from the data for investees that are individually insignificant. Is this a common staff practice that should be communicated to registrants?

 Staff Comment: We believe that Rule 4-08(g) permits the aggregation of all investees, whether individually significant or not, in most circumstances. However, in some circumstances, aggregation can be misleading or suppress important information. For example, the staff may request that investees in different businesses be aggregated separately. Separate information also may be requested for Individual investees that are very significant quantitatively or qualitatively.

 Background: When a registrant's equity method investee is 20% significant under the investment test or the income test of Rule 1-02(w) of Reg. S-X, Rule 3-09 requires the registrant to include audited financial statements of the investee in its Form 10-K. The Staff Training Manual (III.A of Topic 2) states that "the financial statements required should be for the same annual audited periods as required by Rule 3-01 and 3-02." It also indicates that "financial statements are not required for periods prior to the registrant's ownership of the investment." (emphasis added)

 Discussion:

 Year of acquisition - In the year a registrant acquires a significant investee, it is unclear whether the registrant should include audited investee financial statements for the entire year or just for the period of ownership. Obtaining audited investee financial statements from the date of acquisition may be impractical since the registrant does not control the investee. Conversely, audited investee financial statements that cover an entire fiscal year may not be meaningful when the registrant owned the investment for only a short time. Will the staff permit the inclusion of investee financial statements for the entire year in lieu of financial statements from the date of acquisition?

 Year of disposition - Rule 3-09 and the guidance above raise the question of whether Rule 3-09 investee financial statements should continue to be provided after a registrant has disposed of its investment in the investee. The investee's financial statements could be necessary because either (a) current year income from the investee is significant to the registrant or (b) the investee was significant in prior years. The potential need to provide these financial statements raises both practical and relevance issues.

 By disposing of its investment, the registrant moves from a position of significant influence to one of no influence. Therefore, the registrant may be unable to require the former investee to provide audited or unaudited financial statements. This problem becomes even more difficult if the investee's financial statements should cover only the period through the disposition date.

 It is also unclear whether investors need investee financial statements when the registrant no longer owns the investment. Presenting summarized financial information for the investee pursuant to Rule 4-08(g) might be sufficient. This approach would be similar to the approach an investor uses after it disposes of a consolidated investee that is reported as a discontinued operation under APB 30. (Paragraphs 8 and 18 of APB 30 require information which is similar to the information called for by Rule 4-08(g).) It seems inappropriate to require more information for an equity method investee that has been sold than is required for a consolidated investee that has been sold. Will the staff permit presentation of summarized information (Rule 4-08(g)) in lieu of full audited financial statements of the investee in the year of disposition? If not, will the staff permit financial statements of the investee for the entire year in lieu of financial statements through the date of disposition?

 Staff Comment: The staff will favorably consider the kind of relief described in this question if the registrant determines that the financial statements specified by the rule cannot be obtained without undue difficulty or cost. However, if the investee is sold near the end of the most recent year, the staff may be more reluctant to waive the requirement if the investee is very significant quantitatively or qualitatively during that year. In this circumstance, the staff will consider, among other things, the significance of the registrant's participation in the investee's business, whether similar investments comprise a significant part of the registrant's business, and whether significant intercompany transactions have occurred.

 Background: FASB Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, changes the accounting for financial asset transfers and liability extinguishments that occur after March 31, 2001, while leaving the accounting for previous securitizations and extinguishments unaffected, except in certain circumstances. The standard also requires new disclosures about securitized financial assets and retained interests in securitized financial assets in financial statements for fiscal years ending after December 15, 2000.

 Regulation S-X, Article 10-01(a)(5), requires disclosure in an interim period of new accounting principles and practices, details in accounts that have changed significantly in amount or composition, and other significant changes that have occurred since the end of the most recently completed fiscal year. When a new standard is adopted in an interim period, the staff has interpreted this requirement to mean that all disclosures prescribed by the standard should be included in the interim financial statements, in addition to any transitional disclosures required by the standard.

 Staff Comment: The disclosure requirements of the standard are set forth in paragraph 17a through 17g. We believe the disclosure requirements should be satisfied as follows, for non-calendar year registrants, in the interim period in which the standard is adopted:

 Disclosures that mirror existing disclosure requirements. Paragraph 17 b, c, d, e, and g(2) were previously required by Statement 107 and Statement 125. If a registrant failed to provide these disclosures in prior financial statements, it should correct this deficiency by providing the disclosures in the interim period in which Statement 140 is adopted. That is, the interim period which includes April 1, 2001.

 Disclosures for changes in accounting policy. Paragraph 17a(1), f(1) and g(1) require disclosure of the entity's accounting policies. If adoption of the standard changes a registrant's accounting for securitized financial assets, or if a registrant failed to include this disclosure in prior financial statements, it should provide the disclosures in the interim period in which Statement 140 is adopted. That is, the interim period which includes April 1, 2001.

 Transactions requiring disclosure. Paragraph 17a(2), a(3), f(2), and f(3) require disclosures related to certain transactions. If a registrant enters into material transactions in an interim period after the adoption date of the standard, it should provide these disclosures. The adoption date for the standard is April 1, 2001.

 Other disclosures. We recommend that registrants provide paragraph 17 f(4) and g(4) disclosures in the interim period upon adoption. That is, the interim period which includes April 1, 2001. Also, in certain instances, these disclosures may be needed in the interim period in order for existing information not be misleading, or may be necessary to satisfy requirements of Item 303 of Regulation S-K. Paragraph 17g(3) disclosures should be considered by registrants to supplement their market risk disclosure (Item 305 of Regulation S-K) for sensitivity analysis, if material.

 Background: FASB Statement 133, Accounting for Derivative Instruments and Hedging Activities, as amended by Statement 138, establishes for the first time a comprehensive accounting and reporting standard for derivative instruments and hedging activities. This standard is applicable to all fiscal quarters of all fiscal years beginning after June 15, 2000.

 Regulation S-X, Article 10-01(a)(5), requires disclosure in an interim period of new accounting principles and practices, details in accounts that have changed significantly in amount or composition, and other significant changes that have occurred since the end of the most recently completed fiscal year. When a new standard is adopted in an interim period, the staff has interpreted this requirement to mean that all disclosures prescribed by the standard should be included in the interim financial statements, in addition to any transitional disclosures required by the standard.

 Staff Comment: The disclosure requirements of the standard are set forth in paragraphs 44 and 45, with enhanced disclosures for reporting changes in the components of comprehensive income in paragraphs 46 and 47, and transition disclosures in paragraph 53. We believe the disclosure requirements should be satisfied as follows in the interim period in which the standard is adopted:

 Qualitative disclosures in paragraph 44. Disclosure is similar to what was required in Statement 119, modified for the updated rules on hedging. A registrant should enhance the Statement 119 disclosures provided previously to conform to paragraph 44 in the period of adoption.

 Quantitative disclosures in paragraph 45. Paragraph 45 disclosures are required for every reporting period for which a complete set of financial statements is presented (i.e., annual financial statements). In the interim period of adoption, we believe a registrant should provide all paragraph 45 disclosures in order to inform the reader of the impact of adoption of the standard.

 Disclosure of changes in the components of comprehensive income. Paragraph 53 requires disclosure in the year of adoption of the amount of gains and losses that are being reclassified into earnings during the 12 months following the date of adoption, which were associated with the transition adjustment recorded to AOCI. Therefore, although the components of OCI are not required to be disclosed under Article 10 of Regulation S-X, the paragraph 46 and 47 disclosures should be made in the interim period of adoption in order for the paragraph 53 disclosure to be meaningful.

 Transition disclosures. Registrants should provide disclosure of transition amounts as well as disclosure of any reclassifications made upon adoption under paragraphs 54, 55 (both related to securities) or 56 (mortgage servicing rights).

 Disclosure in subsequent interim periods. The qualitative disclosure should be updated when a registrant significantly changes its objectives for holding or issuing derivative instruments and/or strategies for achieving those objectives. Registrants should consider the paragraph 45 disclosures when complying with the requirements of Item 303 of Regulation S-K and Rule 10-01(a)(5) of Regulation S-X. Paragraph 46 and 47 disclosures about the impact of hedging on OCI should be provided if material events occur.