SEC proposes tighter debt-disclosure rules for companies
Friday, September 17, 2010; 9:51 PM
The Securities and Exchange Commission on Friday proposed cracking down on tactics financial companies might use to conceal how much debt they have.
The measure is a response to concerns among regulators that firms - mostly notably defunct Wall Street giant Lehman Brothers - have used accounting trickery to mislead investors. Lehman hid nearly $50 billion in short-term borrowing, making it seem much less leveraged than it was in the months before it collapsed, according to a March report by the firm's bankruptcy examiner. The Lehman bankruptcy helped fuel the 2008 financial crisis.
The proposal would require that all companies tell investors more about their short-term borrowing in quarterly financial disclosures. Financial companies would face even tighter disclosure requirements. Companies often fund their operations with short-term loans lasting between one and 30 days, obtained through a variety of markets.
SEC Chairman Mary Schapiro said the agency is concerned that, in the days before filing quarterly financial disclosures, companies might be "window dressing" by undertaking transactions that temporarily reduce their debt load.
The agency is proposing that companies tell investors more about their debt throughout the year, not just immediately preceding a disclosure filing. "With this information, investors would be better able to evaluate the company's ongoing liquidity and leverage risks," Schapiro said.
The agency also approved a proposal for more guidance, requiring companies to be honest with investors about their debt levels.
The regulator's actions are, in part, a reaction to its own failings. The SEC supervised Lehman's debt levels in the years before the investment bank collapsed. But the regulator failed to grasp that the firm was masking its debt, according to the report by the bankruptcy examiner.
SEC Commissioner Luis Aguilar, though voicing support for the proposal, said requiring financial firms to tell investors the truth is not enough.
"Individuals and entities will always have incentives to dress up the balance sheet," he said. "Rules on the books are not enough - they have to be enforced. Otherwise, the commission will always be approving new rules after the latest crisis."
Lehman used an accounting technique known as "Repo 105" to sell assets in its portfolio to other firms in exchange for cash, while agreeing to buy the assets back. These repurchase agreements, in essence, represented short-term loans to Lehman from other firms, who used the assets as collateral. But Lehman counted the repurchase agreements as sales, so it would seem like it was borrowing less money than it actually was.
This legerdemain may have misled Lehman's investors, but regulators have not alleged that the tactic was illegal. Still, such a finding could come; the SEC is investigating Lehman Brothers' use of "Repo 105."
The agency has ordered several other firms to clarify their accounting around repurchase agreements, but it has not invalidated the approach. And at times, Schapiro said, it is appropriate.