WASHINGTON - Lost amid the clashes at the Securities and Exchange Commission over who knew what about William Webster's business dealings was another accounting-related debate that hits a lot closer to home for banks.
The SEC on Wednesday proposed to toughen its rules for disclosing off-balance-sheet items by all public companies. Though others have offered more sweeping reforms - such as a Financial Accounting Standards Board plan that would restrict the use of off-the-books partnerships - experts said the SEC plan threatens to complicate the operation of special-purpose entities and similar arrangements popular with banks.
"Banks that have standby letters of credit, swap agreements, reverse-repurchase agreements, and hedging devices will have to assess the disclosure requirements carefully," said V. Gerard Comizio, a partner in the corporate and financial institutions practice at Thacher, Proffitt & Wood.
The outcome may turn on whether the fractured five-member commission can decide how to define, oddly enough, the word "may."
The corporate accounting scandals of the last year have put a sometimes unflattering spotlight on banks' and other public companies' use of off-the-books entities. For example, lawmakers and news reports have asked whether Citigroup Inc. and J.P. Morgan Chase & Co. used special-purpose entities to help Enron disguise its debt.
In response to those concerns, the Sarbanes-Oxley Act directed the SEC to come up with disclosure requirements for off-balance-sheet arrangements that "may" be of material concern to the markets.
Under the SEC's proposal, companies would disclose any transactions meeting the materiality standard in the management's discussion and analysis section of public filings. They would also describe the nature of the arrangements, aggregate contractual obligations in a table, and provide an overview of contingent liabilities and commitments. Those steps, the SEC said, would give a "total picture in a single location" of off-balance-sheet exposure.
Though securities rules already require issuers to disclose off-balance-sheet arrangements that are "reasonably likely" to be material, the agency interpreted Sarbanes-Oxley as dictating a stricter standard. It plans to have the standard be transactions that have a "more than remote" chance of being material.
Whether the agency picks "more than remote," "reasonably likely," or something else, it still would have more to clarify. SEC and securities lawyers have fought for years over the meaning of the word "materiality."
"Reasonable and brilliant minds can disagree about the precise definition of materiality, so unless the SEC provides more guidance, it's going to be a tough standard for banks to apply," Mr. Comizio said. "I can see large banks struggling with when, where, and how to disclose."
The commissioners, at their meeting Wednesday, debated whether the proposal would have the unintended consequence of producing confusion rather than clarity.
"My freshman English professor would have loved the semantic discussion," Commissioner Paul Atkins said after he and his colleagues spent considerable time parsing "may" and other words. "One thing it does prove is that accountants, economists, and lawyers can't speak English."
Definitions aside, Commissioner Cynthia Glassman raised concerns about the risk of "information overload," and other commissioners elaborated on that point in emphasizing the need for public comment on the issue.
The industry should heed the call for input immediately, a banking lawyer said.
"People need to get their heads out of the foxhole on this issue and offer substantive comment to the SEC," said Michael McAlevey, a Washington-based partner in the capital markets group of the Alston & Bird law firm. Though generally supportive of more disclosure, he said that, "Depending on the standard used, the rules could impose a tremendous burden on reporting companies at a significant expense, and add a lot of pages" to public filings.
The SEC has yet to release the entire text of the proposal, which will answer some questions. Though banks should expect the additional disclosure burden, the costs that come with the additional disclosure, and the difficult task of deciding materiality, could it be worse?
That even greater threat is imminent. The Financial Accounting Standards Board in July issued a draft proposal that probably would force banks and other public companies to consolidate at least some items that previously were left off the financial statements. The board is scheduled to meet Wednesday and aims to issue a final rule by December.
