SEC Staff Suggests MD&A Disclosures on Structured Investments and CDOs

In an open letter to the chief financial officers of banks and other entities that have investments in structured investment vehicles or collateralized debt obligations, the SEC staff identified a number of disclosure issues that they may wish to consider in preparing the Management's Discussion and Analysis section of upcoming annual reports on Form 10-K or 20-F.

With regard to the off-balance sheet arrangements disclosure required by Item 303 of Reg. S-K, the companies should consider disclosing a number of items for structured investment vehicle or CDOs for which the firm has material exposure. The firms should disclose categories and rating of assets, as well as the weighted-average life of assets that the off-balance sheet entity holds. Also to be disclosed are the forms of funding and the weighted-average life of the funding that the off-balance sheet entity holds. Any material difficulties the off-balance sheet entity experienced in issuing its commercial paper or other financing during the period should also be disclosed, as well as material write-downs or downgrades of assets.

The staff would also like to see disclosure of the maximum limit of the losses to be borne by any first loss note holders. In addition, affected companies should detail the types of variable interests they hold in the off-balance sheet entity.

The SEC staff also favors the detailed disclosure of the company’s obligations under the liquidity facilities. In doing so, the CFOs should consider whether there are triggers associated with the obligations to fund and whether there are any terms that would limit the firm’s obligation to perform.

Further, any obligations under the facilities and their material terms should be disclosed, such as the duty to purchase commercial paper the off-balance sheet entity issued. Investors should be informed if there are any other liquidity providers, and if so, how the company’s obligation ranks with the other liquidity providers.

Companies should consider disclosure of whether they purchased commercial paper or other securities issued by any off- balance sheet entities that they manage, and whether any agreement required them to make those purchases. If not, companies should discuss their reasons for the purchase. Similarly, companies should disclose if they provided or assisted the off-balance sheet entity in obtaining any other type of support, or whether it is their current intention to do so.

Further, the potential impact on debt covenants, capital ratios, credit ratings, or dividends should be disclosed if it is necessary to consolidate the entity or significant losses are incurred associated with the entity.

To the extent that companies have identified consolidation and variable interest entities as a critical accounting policy, they should consider discussing in their filings the scenarios where they would have to consolidate the off-balance sheet entity and their expectation of the likelihood of such a consolidation. The companies should also disclose the frequency of which they reconsider, and the typical triggers which require them to reconsider, whether they are the primary beneficiary of the entity.

Finally, the SEC staff reminded the CFOs of the Item 303 requirement to discuss any known trends or uncertainties that they may reasonably expect to have a material favorable or unfavorable impact on income from operations, liquidity and capital resources. In this regard, financial officers need to consider, to the extent material in light of their particular facts and circumstances, disclosing the amount of any material loss expected to be realized as a result of the firm’s involvement with any material off-balance sheet entity.