The recent Securities and Exchange Commission settlement with Gibson Greetings Inc. underscored that regulators expect full disclosure of derivatives risk from end users as well as traders.

In the Oct. 11 settlement, the commission ruled the company and two former financial officers - chief financial officer Ward Cavanaugh and treasurer James Johnsen - broke federal securities laws in connection with derivatives purchased from BT Securities, a subsidiary of Bankers Trust New York Corp.

Without admitting to or denying the commission's findings, the company consented to an order to cease and desist from similar violations. The settlement said the company's derivatives activities amounted to "trading or speculation," and that the company failed to mark the instruments to their market value at least quarterly.

The settlement also said the company failed to disclose the nature, terms, and risks associated with these activities, and did not maintain adequate books, records, and internal controls on these instruments.

"The general theme seems to be an extension of what has been going on in the dealer market," said Stephen Frank, an attorney with Emmet, Marvin & Martin. "That is, that end users should know what they are doing and be able to convey that information to investors."

Robert Lecky, a senior adviser with Ferrell Capital Management in Greenwich, Conn., said the case also shows the need for strong internal controls.

"You have to have the internal process that segregates those who have the line responsibility for managing the risks of the firm from those people who need to review any transaction before it is booked," he said. "Even if you have these kinds of controls in place and you book the transaction and you don't have to constantly mark it to market for accounting reasons, you should still do so from a business perspective."

By closely monitoring the value of derivative instruments, he said management will receive early warnings about factors that might hurt the value of an instrument or the entire portfolio.

Leslie Rahl, a principal with Capital Market Risk Advisors, said maintaining the kind of discipline that regularly marking to market provides could have prevented or mitigated some of the "most spectacular losses" of the past 18 months. She said this kind of discipline is needed whether management is considering derivative or cash instruments, and even if the company is making money on its activities.

"Just because you're making lots of money doesn't mean you can sit there and pat yourself on the back," she said. "Unexpected gains are an equally important warning signal that you may be taking on too much risk."

While chastising Gibson for not updating the value of its derivatives instruments on a quarterly basis, the commission did take note of the company's annual valuation by taking a swipe at BT Securities.

The commission said the Bankers Trust subsidiary "misled" Gibson on the mark-to-market values provided for these instruments at the end of both 1992 and 1993.

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