MD&A Disclosure on Off-Balance Sheet Arrangements and Aggregate Contractual Obligations.

On January 22, 2003, the SEC adopted final rules under the Sarbanes-Oxley Act relating to the disclosure of off-balance sheet arrangements and known contractual obligations. The new rules amend requirements for management discussion and analysis disclosures in registration statements, periodic reports and proxy or information statements that are required to include financial statements. The full text of the final rules can be found at http://www.sec.gov/rules/final/33-8182.htm.

The final rules are effective for fiscal years ending on or after June 15, 2003. However, earlier compliance is encouraged and can be expected by many companies given the SEC's prior guidance on this subject.

"Off-Balance Sheet Arrangements"

In defining the term "off-balance sheet arrangement" ("OBSA"), the SEC sought to capture the means by which companies typically structure off-balance sheet transactions or otherwise incur risks of loss that are not fully transparent to investors. For the purpose of the new rules, an "off-balance sheet arrangement" means any transaction, agreement or other contractual arrangement to which an entity unconsolidated with the company is a party and under which the company has:

Any obligation under a guarantee contract having specific characteristics identified by reference to FASB Interpretation No. 45 (Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others (November 2002)), such as a standby letter of credit that guarantees payment of a specified financial obligation, a contract requiring payment to an indemnified party based on the failure of another entity to perform or an indemnification agreement that contingently requires payments to the indemnified party based on changes in an underlying related to an asset, liability or equity security;

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 such entity for such assets;

Any obligation, including a contingent obligation, under a contract that would be accounted for as a derivative instrument but is indexed to the company's own stock and is classified in stockholders' equity in the company's statement of financial position; or

Any obligation, including a contingent obligation, arising out of a variable interest defined by reference to FASB Interpretation No. 46 (Consolidation of Variable Interest Entities (January 2003)) in an unconsolidated entity that is held by, and material to, the company, where such entity provides financing, liquidity, market risk or credit risk support to, or engages in leasing, hedging or research and development services with, the company.

Disclosure Requirements

As originally proposed, the rules would have required disclosure of OBSAs where the likelihood that they would have a material effect was "higher than remote." This unusually low standard was rejected following extensive commentary. Under the rules as adopted, companies are required to discuss in a separately captioned section of their MD&A's OBSAs that either have, or are reasonably likely to have, a current or future effect on the company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that are material to investors.

The new rules will require disclosure of the following specified information to the extent necessary to an understanding of the company's OBSAs and their material effects, and such other information that the company believes is necessary for such an understanding:

The nature and business purposes of the company's OBSAs;

The importance to the company of such OBSAs for the company's liquidity, capital resources, market risk, credit risk support or other benefits;

The financial impact and exposure to risk; and

Any known event, demand, commitment, trend or uncertainty that implicates the company's ability to benefit from its OBSAs.

The new rules will not require disclosure of an OBSA until an unconditionally binding definitive agreement, subject only to customary closing conditions, exists or, in the absence of such an agreement, when settlement of the transaction occurs. Contingent liabilities arising out of litigation, arbitration or regulatory actions will not be considered OBSAs.

Tabular Disclosure of Contractual Obligations

In a further departure from traditional disclosure, the rules require a tabular disclosure of all contractual obligations.

Under new Item 303(a)(5) of Regulation S-K, companies will be required to disclose in a tabular format the amount of payments due under specified contractual obligations, aggregated by category of contractual obligation, for specified time periods. A company may disaggregate the specified categories of contractual obligations by using other categories more suitable for its business; however, the table must include all of the obligations that fall within the following specified categories: long-term debt, capital lease obligations, operating leases, purchase obligations, other long-term obligations reflected on the company's balance sheet and total contractual obligations. The estimated payments amounts are to be broken down into four time periods: less than one year, one to three years, three to five years and more than five years. With the exception of purchase obligations, the categories of contractual obligations are defined by reference to accounting pronouncements under GAAP. "Purchase obligations" is not defined by reference to GAAP. However in the accompanying release, the SEC said, "The definition of 'purchase obligations' is designed to capture the company's capital expenditures for purchases of goods or services over a five-year period." Thus, it appears that only capital items were intended to be included. The rule itself is not, however, so limited. Rather, it states as follows:

"As used in this Item . . ., the term purchase obligation means an agreement to purchase goods or services that is enforceable and legally binding on the company that specifies all significant terms, including: fixed or minimum quantities to be purchased; fixed, minimum or variable price provisions; and the approximate timing of the transaction."

Therefore, a much broader set of obligations will be required to be quantified and included in the table.

The table of contractual obligations must be prepared substantially in the form prescribed by the new rules, must contain information as of the latest fiscal year end balance sheet date and should be accompanied by footnotes describing the material terms and other material information to the extent necessary to an understanding of the timing and amount of the contractual obligations set forth in the table. Unlike the disclosure about a company's off-balance sheet arrangements, companies will be permitted to place the tabular disclosure of known contractual obligations in an MD&A location it deems appropriate.

Significantly, the SEC did not adopt a new disclosure requirement for contingent liabilities and commitments, as it had originally proposed. However, it did note in its release that it would continue to assess the costs and benefits of such an MD&A disclosure.

Other Matters Covered by the Release

The SEC's release recognized that some of the disclosures required by the new rules may overlap with GAAP disclosure requirements. To avoid unnecessary repetition, the new rules permit a company to include within its MD&A section cross-references to clearly identified information contained in the footnotes to the company's financial statements.

The new rules, when effective, will supersede guidance provided by the SEC in its January 22, 2002 statement on disclosure of off-balance sheet arrangements, as well as its guidance in the same statement on disclosure of the table of contractual obligations; however, all other guidance in such statement will remain in effect. Companies having fiscal years that end before the effective date of the new rules will be expected to continue to follow the SEC's January 22, 2002 guidance.

Foreign private issuers will not be exempted from the new disclosure rules in their Form 20-F or 40-F filings. However, the new rules will not apply to Form 6-K reports filed by foreign private issuers with the SEC. Therefore, a foreign private issuer's MD&A disclosure will not need to be updated more than once annually, unless it files a Securities Act registration statement that must contain interim period financial statements and related MD&A disclosure.

Safe Harbor Protection

Because the new rules will require disclosure of forward-looking information, the new rules provide a safe harbor against private legal actions for such information. The safe harbor protection expressly applies the statutory safe harbor protections of Sections 27A of the Securities Act and 21E of the Exchange Act to forward-looking information required to be disclosed by the new rules. Safe harbor protection will be afforded where: (1) a forward-looking statement is identified as forward-looking and is accompanied by meaningful cautionary statements that identify the important factors that could cause actual results to differ materially from those in the forward-looking statement; (2) a forward-looking statement is not material; or (3) a plaintiff fails to prove that a forward-looking statement was by or with the approval of an executive officer of the company who had actual knowledge that it was false and misleading. Because the safe harbor under the new rules is predicated on the statutory safe harbor protections, managements should consider the terms, conditions and scope of those statutory protections in drafting their disclosures (and should consider these new MD&A disclosure requirements in drafting their forward-looking statements language).

Implications of the New Rules

Given the current environment and the requirement that senior management personally certify as to, among other things, compliance with the securities laws and the adequacy of systems of internal accounting and disclosure controls, managements should put in place procedures to capture the information required to be disclosed by the new rules. The nature and complexity of these procedures will necessarily vary from one company to another. However, they will include in virtually all circumstances:

a careful review of the company's businesses to catalogue the types of transactions that could predictably give rise to required disclosures;

where applicable, the preparation of a set of assumptions to be used to estimate future payment obligations; and

compliance with the company's internal financial information collection and consolidation process.

Since the SEC has said that all management assessments of the likelihood of the occurrence of any known trend, demand, commitment, event or uncertainty that could affect an off-balance sheet arrangement, must be "objectively reasonable," the fact that, for example, a certifying officer under Section 302 of the Sarbanes-Oxley Act who acted in good faith and subjectively believed an estimate to be correct may not be enough if it could be said that his/her estimate was unreasonable or not based on reasonable procedures. By definition, this will be determined using 20/20 hindsight.

In light of the personal certifications required of CEOs and CFOs under the Sarbanes-Oxley Act and related requirements, most companies are examining and refining their SEC report preparation processes and documenting these processes. While the specific content of the disclosure controls process will vary from company to company and is beyond the scope of this summary, procedures typically being considered include:

review and establishment of a time/responsibility checklist;

documentation of the financial/reporting and disclosure processes;

evaluation of these procedures (a required part of the CEO/CFO certificates under Section 302 of the Sarbanes-Oxley Act); and

creation of a disclosure committee for this purpose and the conduct of review sessions not unlike due diligence sessions in respect of filings under the Securities Act of 1933.

These procedures necessarily will vary widely. Many companies are fine-tuning these procedures in the current environment and are considering additional measures such as formally involving outside accounting and legal advisors, obtaining so-called sub-certifications (certification from operating management and executives having corporate staff functions to back up the CEO/CFO certifications) and the like. These procedures will need to be modified to reflect the new MD&A requirements under the SEC's latest release.

The foregoing is a highly condensed and generalized discussion of some key provisions of recently adopted rules. Application of the rules to particular circumstances will require further, detailed consideration and may be affected by subsequent administrative, judicial and other interpretation.

Jones Day

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