The March 2010 "Dear CFO" Letter

On March 29, 2010, the SEC Division of Corporation Finance ("Division") released a "Dear CFO" letter addressing securities repurchase transactions ("repos"), securities lending transactions, and other transactions where financial assets have been transferred subject to repurchase obligations. The Division issued the letter following the issuance of the Report of the Examiner for Lehman Brothers Holdings which discussed how Lehman accounted for certain repo transactions as "sales" when repos are more typically accounted for as "financings."

The letter can be found at (http://sec.gov/divisions/corpfin/guidance/cforepurchase0310.htm )

Accounting Inquiry

The SEC staff is questioning selected registrants about the use of sale accounting for repurchase transactions. The staff wants to know:

  • Were repurchase transactions entered into and structured as sales solely to reduce leverage metrics and ratios at the end of reporting periods, and not for a sound business purpose?
  • Did those repurchase transactions qualify under the authoritative accounting literature for the use of sale accounting, and did companies document their accounting judgments?
  • Did repurchase transactions accounted for as financings differ significantly from those accounted for as sales?
  • Which specific counterparties were used for sales accounting transactions?

Disclosure Inquiry

The SEC staff is also asking registrants to explain the lack of disclosures about financial asset repurchase transactions. The comments indicate that the staff is concerned that companies may have entered into these transactions just to dress up the balance sheet. While the accounting may be technically correct, the staff may be concerned that the disclosures are not adequate.

Release of Comments

The staff normally uses the "Dear CFO" letter vehicle to suggest enhancements to registrant disclosures in an industry. This release is unique because it represents a Division comment letter issued to a number of large institutions requiring a response to questions about both accounting and disclosure. Thus, the staff has deviated from its policy of not releasing its comment letters until 45 days after a review is completed.

This release of the text of comments while reviews are still in progress demonstrates that the SEC is taking the findings of the Report of the Examiner for Lehman Brothers Holdings very seriously.

Possible Future SEC Actions

The Division will likely compare and contrast the responses it receives from various institutions to identify disparate accounting methods for identical transactions and possible deficient disclosures about registrant use of repurchase transactions and their impact on financial statements. Based upon the responses to its questions, the Division presumably will determine whether individual companies should be asked to revise their disclosures and possibly restate their financial statements. It may expand the reviews of repo transactions beyond the initial registrant group.

The information gathered about the financial statements and the related disclosures in response to the comment letters may also provide a basis for the SEC Enforcement Division to investigate potential violations of the securities laws.

In addition, if the repo transactions were structured solely to achieve an accounting outcome at period-end and had no economic substance, the Enforcement Division might also investigate the counterparties to the repo transactions for possible aiding and abetting of violations of the securities laws.

Given the attention that repo accounting and disclosures have received, the PCAOB may follow with investigations of auditing procedures employed by independent auditors.

FTI has experts available to answer questions about accounting for transfers of financial assets (including repurchase transactions), meeting SEC accounting and documentation standards, and providing comprehensive disclosures about transfers of financial assets.

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