Federal Register / Vol. 66, No. 242 / Monday, December 17, 2001 / Notices 65013

1See, e.g., Accounting Principles Board Opinion

No. 22, ‘‘Disclosure of Accounting Policies’’ (Apr.

1972); AICPA Statement of Position No. 94–6,

‘‘Disclosure of Certain Significant Risks and

Uncertainties’’ (Dec. 1994).

2The underlying purpose of MD&A is to provide

investors with ‘‘information that the registrant

believes to be necessary to an understanding of its

financial condition, changes in financial condition

and results of operations.’’ Item 303(a) of Regulation

S–K [17 CFR 229.303(a)]. As we have previously

stated, ‘‘ ‘[i]t is the responsibility of management [in

MD&A] to identify and address those key variables

and other qualitative and quantitative factors which

are peculiar to and necessary for an understanding

and evaluation of the company.’ ’’ Securities Act

Rel. No. 6835 (May 18, 1989) [54 FR 22427]

(quoting Securities Act Rel. No. 6349 (Sept. 28,

1981) [not published in the Federal Register]).

3See Codification of Statements on Auditing

Standards, AU § 380, Communication with Audit

Committees or Others with Equivalent Authority

and Responsibility (‘‘SAS 61’’). SAS 61 requires

independent auditors to communicate certain

matters related to the conduct of an audit to those

who have responsibility for oversight of the

financial reporting process, specifically the audit

committee. Among the matters to be communicated

to the audit committee are: (1) Methods used to

account for significant unusual transactions; (2) the

effect of significant accounting policies in

Continued

For the Commission, by the Division of

Investment Management, under delegated

authority.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–30977 Filed 12–14–01; 8:45 am]

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE

COMMISSION

[Release Nos. 33–8040; 34–45149; FR–60]

Accounting Policies; Cautionary

Advice Regarding Disclosure

AGENCY: Securities and Exchange

Commission.

ACTION: Cautionary advice regarding

disclosure about critical accounting

policies.

SUMMARY: The Securities and Exchange

Commission is issuing a statement

regarding the selection and disclosure

by public companies of critical

accounting policies and practices.

FOR FURTHER INFORMATION CONTACT:

Robert A. Bayless, Special Assistant to

the Chief Accountant, 202–942–4400.

SUPPLEMENTARY INFORMATION: As public

companies undertake to prepare and file

required annual reports with us, we

wish to remind management, auditors,

audit committees, and their advisors

that the selection and application of the

company’s accounting policies must be

appropriately reasoned. They should be

aware also that investors increasingly

demand full transparency of accounting

policies and their effects.

Reported financial position and

results often imply a degree of

precision, continuity and certainty that

can be belied by rapid changes in the

financial and operating environment

that produced those measures. As a

result, even a technically accurate

application of generally accepted

accounting principles (‘‘GAAP’’) may

nonetheless fail to communicate

important information if it is not

accompanied by appropriate and clear

analytic disclosures to facilitate an

investor’s understanding of the

company’s financial status, and the

possibility, likelihood and implication

of changes in the financial and

operating status.

Of course, public companies should

be mindful of existing disclosure

requirements in GAAP and our rules.

Accounting standards require

information in financial statements

about the accounting principles and

methods used and the risks and

uncertainties inherent in significant

estimates.1 Our rules governing

Management’s Discussion and Analysis

(‘‘MD&A’’) currently require disclosure

about trends, events or uncertainties

known to management that would have

a material impact on reported financial

information.2

We have observed that disclosure

responsive to these requirements could

be enhanced. For example,

environmental and operational trends,

events and uncertainties typically are

identified in MD&A, but the

implications of those uncertainties for

the methods, assumptions and estimates

used for recurring and pervasive

accounting measurements are not

always addressed. Communication

between investors and public

companies could be improved if

management explained in MD&A the

interplay of specific uncertainties with

accounting measurements in the

financial statements. We intend to

consider new rules during the coming

year to elicit more precise disclosures

about the accounting policies that

management believes are most

‘‘critical’’—that is, they are both most

important to the portrayal of the

company’s financial condition and

results, and they require management’s

most difficult, subjective or complex

judgments, often as a result of the need

to make estimates about the effect of

matters that are inherently uncertain.

Even before new rules are considered,

however, we believe it is appropriate to

alert companies to the need for greater

investor awareness of the sensitivity of

financial statements to the methods,

assumptions, and estimates underlying

their preparation. We encourage public

companies to include in their MD&A

this year full explanations, in plain

English, of their ‘‘critical accounting

policies,’’ the judgments and

uncertainties affecting the application of

those policies, and the likelihood that

materially different amounts would be

reported under different conditions or

using different assumptions. The

objective of this disclosure is consistent

with the objective of MD&A.

Investors may lose confidence in a

company’s management and financial

statements if sudden changes in its

financial condition and results occur,

but were not preceded by disclosures

about the susceptibility of reported

amounts to change, including rapid

change. To minimize such a loss of

confidence, we are alerting public

companies to the importance of

employing a disclosure regimen along

the following lines:

1. Each Company’s Management and

Auditor Should Bring Particular Focus

to the Evaluation of the Critical

Accounting Policies Used in the

Financial Statements

As part of the normal audit process,

auditors must obtain an understanding

of management’s judgments in selecting

and applying accounting principles and

methods. Special attention to the most

critical accounting policies will enhance

the effectiveness of this process.

Management should be able to defend

the quality and reasonableness of the

most critical policies, and auditors

should satisfy themselves thoroughly

regarding their selection, application

and disclosure.

2. Management Should Ensure That

Disclosure in MD&A Is Balanced and

Fully Responsive

To enhance investor understanding of

the financial statements, companies are

encouraged to explain in MD&A the

effects of the critical accounting policies

applied, the judgments made in their

application, and the likelihood of

materially different reported results if

different assumptions or conditions

were to prevail.

3. Prior To Finalizing and Filing

Annual Reports, Audit Committees

Should Review the Selection,

Application and Disclosure of Critical

Accounting Policies

Consistent with auditing standards,

audit committees should be apprised of

the evaluative criteria used by

management in their selection of the

accounting principles and methods.3

65014 Federal Register / Vol. 66, No. 242 / Monday, December 17, 2001 / Notices

controversial or emerging areas for which there is

a lack of authoritative guidance or consensus; (3)

the process used by management in formulating

particularly sensitive accounting estimates and the

basis for the auditor’s conclusions regarding the

reasonableness of those estimates; and (4)

disagreements with management over the

application of accounting principles, the basis for

management’s accounting estimates, and the

disclosures in the financial statements. Id.

1 15 U.S.C. 78s(b)(1)

2The MBS Division is the successor to The

Participants Trust Company, which was merged

into DTC effective August 31, 1998.

3These rules are currently in Annex A of DTC’s

Rules.

4The Commission has modified the text of the

summaries prepared by DTC.

5The Fedwire system of the Federal Reserve

Board is currently used for, among other things, the

issuance and settlement of U.S. Treasury securities

and mortgage-backed securities guaranteed by the

Federal Home Loan Mortgage Corporation

(‘‘FHLMC’’) and the Federal National Mortgage

Association (‘‘FNMA’’).

6The Conversion Plan is available online at

<www.frbservices.org> and at

<www.bondmarkets.com/regulatory>. A copy of the

Conversion Plan is also attached as Exhibit 2 of

DTC’s filing [DTC Important Notice No. 1483 (Feb.

15, 2001)], which is available through the

Commission’s Public Reference Section or through

DTC.

Proactive discussions between the audit

committee and the company’s senior

management and auditor about critical

accounting policies are appropriate.

4. If Companies, Management, Audit

Committees or Auditors Are Uncertain

About the Application of Specific

GAAP Principles, They Should Consult

With our Accounting Staff

We encourage all those whose

responsibility it is to report fairly and

accurately on a company’s financial

condition and results to seek out our

staff’s assistance. We are committed to

providing that assistance in a timely

fashion; our goal is to address problems

before they happen.

Dated: December 12, 2001.

By the Commission.

Margaret H. McFarland,

Deputy Secretary.

[FR Doc. 01–30978 Filed 12–14–01; 8:45 am]

BILLING CODE 8010–01–P

SECURITIES AND EXCHANGE

COMMISSION

[Release No. 34–45146; File No. SR–DTC–

2001–14]

Self-Regulatory Organizations; The

Depository Trust Company; Notice of

Filing of Proposed Rule Change

Relating to the Closing Down of the

Mortgage-Backed Securities Division

of The Depository Trust Company

December 10, 2001.

Pursuant to section 19(b)(1) of the

Securities Exchange Act of 1934

(‘‘Act’’),1 notice is hereby given that on

July 24, 2001, The Depository Trust

Company (‘‘DTC’’) filed with the

Securities and Exchange Commission

(‘‘Commission’’) the proposed rule

change as described in Items I, II, and

III below, which Items have been

prepared by DTC. The Commission is

publishing this notice to solicit

comments on the proposed rule change

from interested persons.

I. Self-Regulatory Organization’s

Statement of the Terms of Substance of

the Proposed Rule Change

The proposed rule change concerns

the closing of DTC’s Mortgage-Backed

Securities Division (‘‘MBS Division’’).2

To accomplish this, DTC plans to close

the MBS Division’s transaction

processing system and to amend DTC’s

rules to delete the MBS Division’s

rules.3 The securities formerly services

by the MBS Division will remain

eligible for processing on DTC’s main

processing system to the same extent

that other Fedwire securities are

currently processed at DTC although the

issuance and the majority of clearance

of these securities will be moved to the

Fedwire system.

II. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

In its filing with the Commission,

DTC included statements concerning

the purpose of and basis for the

proposed rule change and discussed any

comments it received on the proposed

rule change. The text of these statements

may be examined at the places specified

in Item IV below. DTC has prepared

summaries, set forth in sections A, B,

and C below, of the most significant

aspects of such statements.4

A. Self-Regulatory Organization’s

Statement of the Purpose of, and

Statutory Basis for, the Proposed Rule

Change

The purpose of the proposed rule

change is to obtain Commission

approval of DTC’s closing the operations

of its MBS Division. Currently, among

other things, the MBS Division issues

and settles mortgage-backed securities

that are guaranteed by the Government

National Mortgage Association

(‘‘GNMA’’). However, GNMA wishes to

transfer the settlement of these

mortgage-backed securities to the

Fedwire system of the Federal Reserve

Board.5 GNMA plans to convert its

securities to Fedwire by the end of the

first quarter of 2002.

GNMA announced its plans to move

its securities to Fedwire in May 2000.

The conversion plans were developed in

consultation with a task force organized

by The Bond Market Association

(‘‘BMA’’) that consisted of

representatives from broker-dealers,

custodial banks, GNMA, the Federal

Reserve Banks, the Mortgage Bankers

Association, DTC, and the BMA. The

force formed a GNMA Conversion

Subcommittee to develop a conversion

plan and implementation schedule. In

February 2001, the subcommittee issued

its Conversion Plan.6

The conversion is taking place in

phases over a series of weekends

beginning October 6, 2001, and is

scheduled for completion by March 31,

2002. During this period, different

classes of GNMA securities will be

moved electronically from the MBS

Division to Fedwire in accordance with

delivery instructions provided to the

MBS Division by the MBS Division’s

participants. Other securities issued and

settled on the books of the MBS

Division, namely securities guaranteed

by the Department of Veterans Affairs

and a limited number of FNMA and

FHLMC securities which are

collateralized by GNMA securities, will

also move to Fedwire at some time

during the GNMA conversion or

immediately after on dates to be

determined.

Shortly after the completion of the

payment of principal and interest with

respect to securities last converted to

Fedwire, DTC will close the transaction

processing system of the MBS Division,

return the MBS Division participant

fund deposits to the MBS Division’s

participants, and amend DTC’s rules to

delete the rules that apply to the MBS

Division. After the conversion, FNMA

securities will remain eligible for

processing on DTC’s main system in the

same manner as other Fedwire

securities are currently processed at

DTC. Fedwire securities processed at

DTC must be deposited and withdrawn

free of payment over Fedwire to and

from DTC’s Fedwire account. Once

deposited at DTC, Fedwire-eligible

securities will be processed among DTC

participants subject to DTC’s rules and

procedures without additional

restrictions.

In connection with the conversion of

GNMA securities to Fedwire, DTC

considered expanding its processing to

permit GNMA securities to be delivered

versus payment into and from DTC’s

Fedwire account subject to regulatory

approval. DTC solicited comments from

its participants, but fewer than a dozen