A group of Democratic senators has written to the chair of the Securities and Exchange Commission urging the SEC to require more complete and accurate corporate accounting disclosures, especially of off-balance sheet transactions.
The group of six senators, led by Banking Committee member Robert Menendez, D-N.J., wrote to SEC chair Mary Schapiro, noting a series of incidents in which corporations concealed their debts and financial weaknesses. They pointed to Lehman Brothers use of Repo 105 repurchase transactions to hide its debts. They requested that the SEC use its existing rule-making authority from the Sarbanes-Oxley Act to require full disclosure of off-balance sheet activity.
Besides Menendez, the group of letter signers also included Senators Edward Kaufman, D-Del.; Carl Levin, D-Mich.; Diane Feinstein, D-Calif.; Barbara Boxer, D-Calif.; and Sherrod Brown, D-Ohio.
Rather than relying on carefully staged quarterly and annual snapshots, investors and creditors should have access to a complete real-life picture of a companys financial situation, wrote the senators. The SEC was founded on the premise that when investors and creditors have full and accurate information about companies finances, they can allocate capital effectively. But when companies use accounting gimmicks to mislead investors and creditors, capital markets malfunction. As we attempt to recover from the latest meltdown, we hope that, in addition to aggressively investigating and prosecuting past misconduct, you will put in place these new rules that will make it harder for companies to mislead investors and creditors in the future.
They noted that the Sarbanes-Oxley Act gave the SEC the power to require reporting of off-balance sheet activities, but that hasnt stopped companies from hiding their debts.
While the SEC did issue rules on off-balance sheet activity pursuant to Sarbanes-Oxley, we are troubled that despite these rules, widespread off-balance sheet accounting arrangements allowed large financial firms to hide trillions of dollars in obligations from investors, creditors, and regulators, they said.
In addition to Lehmans use of Repo 105, the senators cited Citigroup, which reportedly kept $1.1 trillion worth of assets off its books in various financing vehicles and trusts that were used to handle mortgage-backed securities and issue short-term debt. State Street shareholders, they noted, saw their investment value drop by 60 percent in a single day when hidden off-balance sheet conduits sustained heavy losses under credit turmoil in January 2009.
Neither of these companies adequately disclosed the risks posed by their off-balance sheet activities to investors, the senators wrote. Had they done so, investors and creditors might have made better decisions.
They want the SEC to use its existing authority under Sarbanes-Oxley to require that companies write detailed descriptions of all their off-balance sheet activities in their annual 10K reports, not just those that are reasonably likely to affect the firms financial condition, as the regulations currently state.
Companies should also explicitly justify why they have not brought those liabilities onto the balance sheet, said the senators. Complete disclosure of all off-balance sheet activities is particularly crucial for the largest and most interconnected companies, including both banks and non-banks. Additionally, we also urge the SEC to encourage the Financial Accounting Standards Board to improve financial reporting rules for all types of off-balance sheet activities and to monitor FASBs efforts to prohibit off-balance sheet financing.
They are also urging the SEC to pay particular attention to the large market for repurchase agreements.
We are concerned by both the risks of using short-term funding for longer-term holdings and that firms may be engaging in these transactions with the intent to hide their true debt and risk levels, they wrote.
They cited not only Lehmans use of Repo 105 transactions, but also a recent Wall Street Journal article that identified 18 banks, including Goldman Sachs Morgan Stanley, J.P. Morgan Chase, Bank of America, and Citigroup, which understated the debt levels used to fund securities trades by lowering them an average of 42 percent at the end of each of the past five quarterly periods.
Those who engaged in fraud in the past must be held accountable under our existing securities fraud statutes, they wrote. But we must also look forward. In order to prevent this from happening in the future, we urge the SEC to require disclosure of period end and daily average leverage ratios in quarterly and annual reports. This would provide useful information to investors and creditors to assist their decision-making processes.
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