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Disclosure in Management's Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

May 6, 2003

MEMORANDUM

To:   Our Clients and Friends
From:   Olshan Grundman Frome Rosenzweig & Wolosky LLP
Date:   May 6, 2003
Re:   Disclosure in Management's Discussion and Analysis about Off-Balance Sheet Arrangements and Aggregate Contractual Obligations

The Securities and Exchange Commission (the "SEC") has adopted final rules to implement Section 401(a) of the Sarbanes-Oxley Act (the "Act"), which requires public companies to disclose all material off-balance sheet transactions that will have a current or future effect on financial condition, results of operations, liquidity, capital expenditures or capital resources.  [1]  Public companies must now provide in Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") a detailed explanation of off-balance sheet arrangements in a separately captioned subsection of MD&A and tabular disclosure of certain contractual obligations on an aggregate basis.  The new rules, which became effective April 7, 2003, prescribe amendments to Item 303 of Regulation S-K, Item 303 of Regulation S-B, Item 5 of Form 20-F and General Instruction B of Form 40-F applicable to financial statements for periods described in the penultimate paragraph of this memorandum.  The amendments to Item 303 of Regulation S-K apply equally to foreign private issuers and U.S. public companies.  [2]

Definition of "Off-Balance Sheet Arrangements"

The definition of off-balance sheet arrangements is designed to include the methods through which companies typically structure off-balance sheet transactions or otherwise incur risks of loss that are not fully apparent to investors.  Off-balance sheet arrangements include any contractual arrangements to which an unconsolidated entity is a party, under which the registrant has:

  • Any obligation under certain guarantee contracts;
  • A retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement that serves as credit, liquidity or market risk support to that entity for such assets;
  • Any obligation under certain derivative instruments; or
  • Any obligation under a material variable interest held by the registrant in an unconsolidated entity that provides financing, liquidity, market risk or credit risk support to the registrant or engages in leasing, hedging or research and development services with the registrant.

Disclosure Threshold

Item 303 of Regulation S-K still requires general disclosure of off-balance sheet arrangements and other contingencies.  New paragraph (a)(4) of Item 303, however, now calls for a separately captioned subsection of MD&A that discusses any off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on a 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.  Disclosure of off-balance sheet arrangements can be avoided only if there is no reasonable likelihood of either the occurrence of an event or the materiality of its effect.  [3]  Such disclosures must be provided in registration statements, proxy statements and periodic reports for which MD&A is required as well as filings containing financial statements for interim periods, such as quarterly reports on Form 10-Q.

Required Disclosure

The new rules require a registrant to disclose material facts and circumstances that provide investors with a clear understanding of a registrant's off-balance sheet arrangements and their material effects.  The registrant must disclose the following to the extent necessary to understand a registrant's off-balance sheet arrangements and their material effects on the registrant's financial condition, changes in financial condition, revenues and expenses, results of operations, liquidity, capital expenditures and capital resources:

The nature and business purpose of the arrangement;

  • The importance to the registrant of the liquidity, capital resources, market risk support, credit risk support or other benefits provided by the arrangement;  [4]
  • The financial impact, including revenues, expenses and cash flows of the company arising from the arrangement, the obligations or liabilities of the company arising from the arrangement that are or are reasonably likely to become material, and the triggering events that could cause them to arise;
  • The nature and amount of any interests retained, securities issued and other indebtedness incurred by the registrant in connection with the arrangement; and
  • Any known event, demand, commitment, trend or uncertainty that will or is reasonably likely to result in the termination or material reduction in the benefits of the arrangement, and the course of action that the registrant has taken or proposes to take in response. [5]

These disclosures should provide investors with insight into the overall magnitude of a registrant's off-balance sheet activities, the specific material impact of the arrangements on a registrant and the circumstances that could cause material contingent obligations or liabilities to come to fruition.  Disclosure is required to the extent material and necessary to investors' understanding of:

  • The amounts of revenues, expenses and cash flows of the registrant arising from the arrangements;
  • The nature and total amount of any interests retained, securities issued and other indebtedness incurred by the registrant in connection with such arrangements; and
  • The nature and amount of any other obligations or liabilities (including contingent obligations or liabilities) of the registrant arising from the arrangements that are, or are reasonably likely to become, material and the triggering events or circumstances that could cause them to arise.

Tabular Disclosure of Contractual Obligations

New paragraph (a)(5) of Item 303 requires registrants [6] to include in MD&A a table disclosing known contractual obligations, both on- and off-balance sheet, as of the latest fiscal-year-end balance sheet date. [7]  Registrants must disclose the amounts of payments owed under contract, aggregated by specified type, for the time periods noted below.  Registrants may disaggregate these specified categories of contractual obligations using other categories, but must include all obligations of the registrant that fall within the five categories specified in the following table:

 

PAYMENTS DUE BY PERIOD

Contractual Obligations

Total

Less than 1 year

1-3 years

3-5 years

More than 5 years

[Long-Term Debt]

         

[Capital Lease Obligations]

         

[Operating Leases]

         

[Purchase Obligations]

         

[Other Long-Term Liabilities Reflected on the Registrant's Balance Sheet Under GAAP]

         

Total

         

This table must appear in proxy statements and in periodic reports and registration statements covering full fiscal-year periods.  Rather than including the table in quarterly reports, registrants may disclose material changes outside the ordinary course of their businesses by including a discussion of any relevant changes in Form 10-Q.

Statutory Safe Harbors

Any responsive disclosure, other than of "historical facts," will constitute "forward-looking statements," and therefore will be entitled to the benefits of the safe harbor for forward-looking information.  Within the context of off-balance sheet arrangements, the "meaningful cautionary statements" element of the statutory safe harbor will be satisfied if a registrant satisfies all of its off-balance sheet arrangement disclosure requirements.

Effective Dates

The new rules pertaining to off-balance sheet arrangements apply to filings that include year-end financial statements for fiscal years ending on or after June 15, 2003.  The contractual obligations table must be included in filings that include year-end financial statements for fiscal years ending on or after December 15, 2003.

____________________

These are only brief descriptions of the SEC's new rules.  This memorandum provides general information only and does not constitute legal advice that may be applied to any particular situation.  Please contact the Partners in our Corporate Department for further advice and assistance.


[1] See SEC Release No. 34-47264 at http://www.sec.gov/rules/final/33-8182.htm.

[2] Foreign private issuers are not required to file quarterly reports and therefore will not be required to update their MD&A disclosure more frequently than annually, unless they file a registration statement that must include interim period financial statements and related MD&A disclosure.

[3] The SEC prescribed the following analysis to determine whether a particular arrangement requires disclosure:

    Management should identify and critically analyze off-balance sheet arrangements;

•    Management should objectively assess the likelihood of the occurrence of any known trend, demand, commitment, event or uncertainty, such as performance under a guarantee or recognition of an impairment, that could affect an off-balance sheet arrangement:

•    If management concludes that the known trend, demand, commitment, event or uncertainty is not reasonably likely to occur, then no disclosure relating to the off-balance sheet arrangement is required in MD&A; but

•    If management cannot determine that the known trend, demand, commitment, event or uncertainty is not reasonably likely to occur, then it must assume it will come to fruition and provide disclosure relating to the off-balance arrangement unless it determines that a material effect on the company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources is not reasonably likely to occur.

[4] These disclosures should provide investors with an understanding of the importance of off-balance sheet arrangements to the registrant as a financial matter.

[5] A registrant must disclose, for example, any material contractual provisions calling for the termination or material reduction of an off balance sheet arrangement.  The disclosure should address factors that are reasonably likely to affect the registrant's ability to continue using off-balance sheet arrangements that provide it with material benefits.  If a registrant's credit rating were to fall below a prescribed level, some off-balance sheet arrangements may require the registrant to purchase the assets or assume the liabilities of an unconsolidated entity.  In addition, a change in a registrant's credit rating could either preclude or materially reduce the benefits to the registrant of engaging in off balance sheet arrangements.  In such cases, the registrant will have to disclose known circumstances that are reasonably likely to cause its credit rating to fall to the specified level and discuss the material consequences of the drop in the ratings.  The registrant must also discuss the course of action that it has taken or proposes to take in response to a termination or material reduction  in the availability of an off-balance sheet arrangement that provides material benefits.

[6] Small business issuers (SB filers) are exempt from making such disclosures.

[7] Contingent liabilities and commitments need not be disclosed.

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