SEC adopts new disclosure rules for derivatives.

The Securities and Exchange Commission approved rules requiring companies to reveal more about their accounting policies for derivatives in the footnotes of financial statements. The rules also require new disclosure of information about the risk of loss from market rate or price changes that are inherent in derivatives and other financial instruments.

SEC Chairman Arthur Levitt, Jr., told reporters the rules build on generally accepted accounting principles and give investors tangible, quantifiable information about derivatives and their potential consequence for a company's financial position.

Effective dates

Small companies and registered investment companies are exempt from the new requirements. The rules, which will be phased in over the next few years for quantitative and qualitative disclosures, are effective for filings after June 15, 1997, for banks, thrifts and companies with market capitalization over $2.5 billion. Large commercial companies with December 31 yearends must comply by December 31, 1997.

What companies must do

In general, the rules require enhanced descriptions of accounting policies for derivatives in financial statement footnotes and quantitative and qualitative disclosures about market risk outside the financial statements. The rules also remind registrants to supplement existing disclosures about financial instruments, commodity positions, firm commitments and other anticipated transactions with related disclosures about derivatives.

The rules allow companies providing quantitative market risk information to choose from three methods of presentation.

* Tabular presentation of fair value information and contract terms relevant to determining a company's future cash flows, categorized by expected maturity dates.

* Sensitivity analysis of the potential loss in future earnings, fair values or cash flows of market risk sensitive instruments due to hypothetical changes in interest rates and other rates or prices.

* Value at risk disclosures of potential loss in future earnings, fair values or cash flows from market movements, including their likelihood of occurrence.

Stephen M. Swad, SEC deputy chief accountant, told the Journal that the three alternatives should help quell the concerns of companies that the disclosures would reveal proprietary information or put them at a competitive disadvantage. He also said the SEC provided the alternatives because there was no single way to disclose such information on the financial statements. According to Swad, the tabular presentation offers companies the simplest way to comply. The other two methods require companies to summarize their market risks.

The cost to companies

The SEC estimated that complying with the new rules could cost U.S. companies $40 million. Swad said most of the costs related to the requirement to provide the quantitative information about market risk. He said the SEC estimated that compliance would take about 80 hours per company. The companies that initially must comply--larger entities, banks, thrifts, broker-dealers and financial institutions--already are managing this risk because it is their primary business risk, according to Swad. "These companies manage the risk in ways that conform with many of the disclosure requirements, so their costs are not expected to be significant," said Swad. He also said compliance costs should not be as high for companies that have one debt instrument or a few swaps.

Accounting for derivatives

The SEC rules address only footnote disclosure. The Financial Accounting Standards Board, which issued its derivatives exposure draft in June, is dealing with the accounting issues. "The thrust of the FASB project is in recognition and measurement and not just footnote disclosure," said FASB Project Manager Robert Wilkins. When final, the FASB project will completely void FASB Statement no. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments. "Our final statement will include certain disclosure requirements, but they will be far different from what the SEC has done," said Wilkins.