United SEC Votes to Propose Pulling Back Drapes on Debt
By KARA SCANNELL And MICHAEL RAPOPORT
The Securities and Exchange Commission unanimously voted to propose rules to help investors spot companies that slash their debt before quarterly reports, a practice called "window dressing."
The new disclosure rules will help in more effectively evaluating companies' financial risks, said SEC Chairman Mary Schapiro. She called the information "critical to assessing a company's prospects for the future, and even the likelihood of its survival. This principle was borne out during the recent financial crisis."
The move follows heightened focus on financial window dressing. A report in March by a bankruptcy-court examiner said Lehman Brothers Holdings Inc. used an accounting strategy to remove debt from its balance sheet to make it look healthier than it was.
In a separate series of investigative articles, The Wall Street Journal has detailed how a group of 18 large banks as a group have consistently lowered a key type of debt at the end of each of the past six quarters, reducing it on average by 42% from quarterly peaks. The short-term borrowings—known as repurchase agreements or "repos"—are used to fuel bigger trades by banks. The banks have said they aren't doing anything improper.
All repos and other short-term borrowing would be covered by the new rule, which will almost certainly pass following a 60-day comment period.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter and daily averages, while other companies would disclose the maximum month-end level within the quarter and monthly averages.
All repos and other short-term borrowing would be covered by the new rule, which is subject to a 60-day comment period and requires a second vote before becoming final.
Under the proposed rule, all companies would have to disclose not only how much debt they have at the end of the quarter but also average and maximum figures during the quarter. Banks and other financial institutions would have to disclose the maximum on any given day within the quarter, while other companies would disclose the maximum month-end level within the quarter.
Companies also would have to explain the business purpose behind the borrowing, the importance of the borrowing to the company's liquidity and capital, and any meaningful fluctuations between the average and maximum levels compared with the quarter-end level.
Small companies, generally those with market values of less than $75 million, would be exempt from some requirements.
As an example, Ms. Schapiro pointed that out retailers rely on short-term borrowing to finance inventory throughout the year. "If those borrowings are repaid by year-end, the year-end disclosure may not fully inform investors of the importance to the company of this type of borrowing," she said.
Commissioner Luis Aguilar, a Democrat, supported the proposal but said enforcing the rules is essential. "Rules have not been enough to end attempts to dress up the balance sheet. It is essential to accompany principles and rules with tough enforcement," he said.
Separately, the SEC said it also would consider whether to issue guidance about current disclosure requirements related to liquidity and funding levels.
Laura Corsell, a partner at Philadelphia law firm Montgomery McCracken and a former SEC staff attorney, said the need for new disclosure rules targeting window dressing is a reflection of how "things move very fast in the markets that we're in now."
Write to Kara Scannell at email@example.com and Michael Rapoport at Michael.Rapoport@dowjones.com