SEC Issues Staff Report On Off-Balance Sheet Arrangements, Special Purpose Entities and Related Issues

The staff took a broad approach to the scope of the report by including a review of a range of topics with potential off-balance sheet implications, including: consolidation issues, transfers of financial assets with continuing involvement, retirement arrangements, contractual obligations, leases, contingent liabilities and derivatives, as well as a discussion of special purpose entities (SPEs).

The report identifies several goals for those involved in the financial reporting community, including efforts to:

• discourage transactions and transaction structures motivated primarily and largely by accounting and reporting considerations, rather than economics;
• expand the use of objectives-oriented standards;
• improve the consistency and relevance of disclosures; and
• focus financial reporting on communication with investors, rather than just compliance with rules.

The report provides recommendations for certain changes in accounting and reporting requirements, each of which complement one or more of the goals mentioned above:

• The staff recommends the accounting guidance for defined-benefit pension plans and other post-retirement benefit plans be reconsidered. The trusts that administer these plans are currently exempt from consolidation by the issuers that sponsor them, effectively resulting in the netting of assets and liabilities in the balance sheet. In addition, issuers have the option to delay recognition of certain gains and losses related to the retirement obligations and the assets used to fund these obligations.
• The staff recommends that the accounting guidance for leases be reconsidered. The current accounting for leases takes an “all or nothing” approach to recognizing leases on the balance sheet. This results in a clustering of lease arrangements such that their terms approach, but do not cross, the “bright lines” in the accounting guidance that would require a liability to be recognized. As a consequence, arrangements with similar economic outcomes are accounted for very differently.
• The staff recommends the continued exploration of the feasibility of reporting all financial instruments at fair value.
• The staff recommends that the Financial Accounting Standards Board continue its work on the accounting guidance that determines whether an issuer would consolidate other entities – including SPEs – in which the issuer has an ownership or other interest.
• The staff believes that, in general, certain disclosures in the filings of issuers could be better organized and integrated.

The Securities and Exchange Commission announced the release of a staff report on June 15th prepared by the Office of the Chief Accountant, the Office of Economic Analysis and the Division of Corporation Finance on off-balance sheet arrangements, special purpose entities and related issues. The report was prepared pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002. As required by that Act, the report has been submitted to the president, the Committee on Banking, Housing and Urban Affairs of the Senate, and the Committee on Financial Services of the House of Representatives. The staff report includes an analysis of the filings of issuers as well as an analysis of pertinent U.S. generally accepted accounting principles and Commission disclosure rules. The report describes the staff's study, details its findings, and provides recommendations. Notably, the report prominently identifies leasing as a key focus and a high priority for an FASB project.