---

As part of its drive to enhance disclosure in Management's Discussion and Analysis of Financial Conditions and Results of Operations ("MD&A"), the Securities and Exchange Commission (the "SEC") on November 4, 2002 proposed rules under Section 401(a) of the Sarbanes-Oxley Act of 2002 (the "Act") for mandatory disclosure in MD&A of off-balance sheet arrangements, contractual obligations and contingent liabilities and obligations (the "Proposed Rules"). Existing MD&A rules already require disclosure regarding certain off-balance sheet arrangements and other contingencies. However, the Proposed Rules (i) seek to lower the threshold triggering disclosure of off-balance sheet arrangements, (ii) require that such disclosure be set apart in a designated section of MD&A, and (iii) require additional disclosure relating to aggregate contractual obligations and contingent liabilities.

Section 401(a) requires the SEC to issue rules providing that periodic reports "shall disclose all material off-balance sheet transactions, arrangements, obligations (including contingent obligations), and other relationships of the issuer with unconsolidated entities or other persons, that may have a material current or future effect on financial condition, changes in financial condition, results of operations, liquidity, capital expenditures, capital resources, or significant components of revenues or expenses."

In addition to providing for the disclosure required by Section 401(a), the Proposed Rules also codify recent statements of the SEC calling for improved MD&A disclosure in the area of liquidity and capital resources. While Section 401(a) does not require the SEC to adopt a disclosure requirement regarding contractual obligations and contingent liabilities and commitments, the SEC believes that aggregated information about such items in a single location would improve the disclosure of a company's liquidity and capital resources. [1] In addition, although the Act only requires disclosure of off-balance sheet arrangements in periodic reports, the Proposed Rules would also apply to disclosure in registration statements under the Securities Act of 1933.

The Proposed Rules would require a reporting company to provide in its MD&A (1) a comprehensive explanation of its off-balance sheet arrangements, (2) an overview of its aggregate contractual obligations in a tabular format and (3) an overview of its contingent liabilities and commitments in either a textual or tabular format. As noted above, only the first item is required by the Act.

The impact of the Proposed Rules will be most significant for companies that have entered into one or more of the following transactions:

• securitizations;
• hedging transactions;
• certain types of structured leasing transactions;
• off-balance sheet research and development arrangements;
• certain types of financing transactions using unconsolidated subsidiaries or other affiliates;
• arrangements involving keepwells, guarantees or other financial support; and
• transactions with special purpose entities providing liquidity, market or credit risk support for the company.

Although the Proposed Rules are still subject to change before becoming effective, we have been informed that the SEC staff is already focusing its attention on disclosure in this area as part of the review of registration statements and periodic reports.

Off-Balance Sheet Arrangements

Definition

The Proposed Rules define the term "off-balance sheet arrangement" as any transaction, agreement or other contractual arrangement to which an entity that is not consolidated with the reporting company is a party, under which the company (whether or not a party to the arrangement) has, or in the future may have:

• any obligation under a direct or indirect guarantee or similar arrangement;
• a retained or contingent interest in assets transferred to an unconsolidated entity or similar arrangement;
• derivatives, to the extent that the fair value thereof is not fully reflected as a liability or asset in the financial statements; or
• any obligation or liability, including a contingent obligation or liability, to the extent that it is not fully reflected in the financial statements (excluding the footnotes thereto).

Although Section 401(a) of the Act does not make this distinction, the proposed definition would only apply to contractual arrangements. This means that a company would not be obligated to disclose an off-balance sheet arrangement until there was an unconditionally binding definitive agreement, subject only to customary closing conditions or, if there were no such agreement, until settlement of the transaction.

Obligations or liabilities that are not considered to be fully reflected on the face of financial statements include:

• obligations that are not classified as liabilities according to generally accepted accounting principles ("GAAP");
• contingent liabilities that, as of the date of the financial statements, are not probable or, if probable, are not reasonably estimable; or
• liabilities as to which the amount recognized in the financial statements is less than the reasonably possible maximum exposure as of the date of the financial statements. [2]

The last item includes contingent liabilities that are only partially accrued under GAAP, but excludes liabilities recorded at fair value as of the date of the financial statements. For instance, where a company estimates a range of losses and then accrues its best estimate within the range, the contingent obligation would fall within the scope of the proposed definition as long as there is a reasonable possibility of losses in excess of the amount accrued. On the other hand, where a company estimates the expected present value of a liability and records that as the fair value, the liability is considered to be fully reflected in the financial statements and therefore outside the scope of the proposed definition. Liabilities, such as derivatives and recourse obligations, that a company is required to recognize at fair value would be outside the scope of the proposed definition, even though the fair value of the liabilities may increase in the future.

The definition of "off-balance sheet arrangement" encompasses arrangements between a company and an entity conducting off-balance sheet activities, as well as arrangements between that entity and third parties and between the company and third parties.

Many off-balance sheet arrangements involve the use of special purpose entities ("SPEs"), structured in such a way as to not require the reporting company to consolidate the SPE into its financial statements under GAAP. The SEC notes that accounting standard setters in the United States are currently reevaluating the accounting guidance for consolidation of SPEs. [3] The SEC indicates that it believes disclosure of off-balance sheet arrangements involving SPEs is vital to investor understanding, regardless of whether consolidation of such entities is required.

Disclosure Threshold

The existing MD&A disclosure standard is whether information is "reasonably likely" to have a material effect on financial condition, changes in financial condition or results of operations. The SEC interprets the "may" language ("may have a current or future material effect") in Section 401(a) of the Act as requiring a lower threshold for disclosure. The Proposed Rules would require disclosure of off-balance sheet arrangements under circumstances where management concludes that the likelihood of the occurrence of a future event and its material effect is higher than remote; in other words, where it "may" have a current or future material effect.

Proposed Disclosure

Under the Proposed Rules, a company would have to disclose, in a separate section of its MD&A:

• the nature and business purpose of the off-balance sheet arrangements;
• the significant terms and conditions of the arrangements, to the extent material to an understanding of the proposed disclosure (including the terms of arrangements under which the company may have a direct or contingent obligation even though it is not a party);
• the nature and amount of the total assets and total obligations and liabilities (including contingent obligations and liabilities) of an entity in which off-balance sheet activities are conducted;
• the amount of revenues, expenses and cash flows arising from the arrangements;
• the nature and total amount of any interests retained, securities issued and other indebtedness incurred; and
• the nature and amount of any other obligations or liabilities (including contingent obligations or liabilities) of the company arising from the arrangements that are, or may become, material and the triggering events or circumstances that could cause them to arise.

Under the Proposed Rules, a company would also have to provide an analysis of:

• the material effects, either individually or (for common or similar effects) in the aggregate, of the off-balance sheet arrangements and resulting obligations and liabilities on the company's financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures and capital resources;
• the degree to which the company relies on off-balance sheet arrangements for its liquidity and capital resources or market risk or credit risk support or other benefits; and
• the effects of a termination or material reduction in the benefits of off-balance sheet arrangements, including any contractual provisions calling for the termination or material reduction of any off-balance sheet arrangements.

The SEC noted that there are some transactions that are referred to as "off-balance sheet arrangements" but do not fall within the scope of the definition. For example, a company may securitize financial assets without providing any recourse or credit support to the SPE holding the assets, so that there is no contingent liability of the company. The definition also excludes some arrangements that are already subject to MD&A disclosure requirements, for example "contingent liabilities arising out of litigation, arbitration or regulatory actions (not otherwise related to off-balance sheet arrangements)." If disclosure of such an arrangement is required under another provision of MD&A, a company would be able to choose whether or not to provide such disclosure in the new section discussing off-balance sheet arrangements.

Contractual Obligations

Under the Proposed Rules, the company (other than a small business issuer) would have to disclose, in a tabular format, its contractual obligations aggregated by type, for at least the periods specified in the table below. A company would be permitted to use either the provided categories or other suitable categories. The disclosure could be placed anywhere in the MD&A that the company deemed appropriate. A company would not be required to include the table of contractual obligations in its quarterly reports, but could instead limit disclosure in such reports to a discussion of material changes. The Proposed Rules do not define "contractual obligation," although the SEC has requested comments on this point. 

Contractual Obligations	Payments due by period
	Total	Less than 1 year	1-3 years	3-5 years	More than 5 years
[Long-Term Debt]
[Capital Lease Obligations]
[Operating Leases]
[Unconditional Purchase Obligations]
[Other Long-Term Obligations]
[Total Contractual Obligations]

Contingent Liabilities and Commitments 

Under the Proposed Rules, a company (other than a small business issuer) also would have to disclose, in either tabular or textual format, the expected amount, range of amounts or maximum amount of contingent liabilities or commitments that are expected to expire in less than one year, from one to three years, from three to five years, and more than five years. The disclosure could be placed anywhere in the MD&A that the company deemed appropriate. A company would not be required to repeat the required textual disclosure in its quarterly reports, but could instead limit disclosure in such reports to a discussion of material changes. 

The contingent liabilities or commitments would be aggregated by type in a manner that is suitable for the company's business. Examples of contingent liabilities or commitments that would be covered under the proposals are lines of credit, standby letters of credit, guarantees and standby repurchase obligations. The disclosure would be required to address, in footnotes to the table or in the text, provisions of contingent liabilities that create, increase or accelerate obligations, and other pertinent data. 

Application to Foreign Private Issuers

The proposed MD&A disclosure requirements would apply to foreign private issuers that file annual reports on Form 20-F or Form 40-F. Because Section 401(a) of the Sarbanes-Oxley Act does not distinguish between foreign private issuers and U.S. companies, the SEC has stated that it believes Congress intended the new disclosure requirements to apply equally to foreign private issuers, including Canadian companies that file reports on Form 40-F. The SEC noted that, under the Multijurisdictional Disclosure System, the MD&A disclosure provided by Canadian issuers is generally that required under Canadian law. However, the SEC has proposed supplementing the Canadian disclosure requirements with the same disclosure items for off-balance sheet arrangements proposed for U.S. companies. 

Although the New Law requires the off-balance sheet disclosure to apply to quarterly reports as well as annual reports, since foreign private issuers do not file "quarterly" reports, the proposed rules would not apply to Form 6-K reports. However, the SEC has requested comments on whether the disclosure requirements should apply to Form 6-K reports that included quarterly financial statements.

Safe Harbor for Forward-Looking Information

Some of the disclosure required by the Proposed Rules would involve forward-looking information. In order to encourage companies to provide the analysis necessary for investors to understand the impact of off-balance sheet arrangements, the SEC has included within the Proposed Rules a safe harbor for forward-looking information. The proposed safe harbor would explicitly apply the statutory safe harbor protections (Sections 27A of the Securities Act and 21E of the Exchange Act) to forward-looking information that would be required to be disclosed by the Proposed Rules. 

The SEC has stated that the proposed safe harbors are designed to remove possible ambiguity about whether the statutory safe harbors would apply to some of the new MD&A disclosure. The proposed safe harbor would specify that, except for historical facts, some of the disclosure would be deemed to be a "forward looking statement" as that term is defined in the statutory safe harbors. Under the proposed MD&A safe harbor, all of the conditions of the statutory safe harbors would need to be met.

Anticipated Timeframe for Adoption

The deadline for public comment on the Proposed Rules was December 4, 2002. The Act mandates that final rules be adopted no later than January 26, 2003.