Following a review of annual reports filed last year by the 500 largest US corporations, the SEC is calling for better information on assumptions and estimates used to project how much a company will spend to fund its pension plan.
According to a summary report, the negative market returns of the last three years have resulted in large, unrecognized losses in the pension plans of many large firms – losses that are often not made transparent to investors, according to an information summary posted on the agency’s Web site.
According to the SEC, most of its pension-related comments dealt with the long-term expected return assumption for plan assets. The SEC asked companies about the basis for, and the reasonableness of, their expected return assumption, and, according to a notice posted on their Web site, also asked many companies to expand their MD&A to describe:
- The significant assumptions and estimates used to account for pension plans and how those assumptions and estimates are determined, specifically the method (arithmetic/simple averaging, or geometric/compound averaging) and source of return data used to determine the expected return assumption and the assumptions, estimates, and data source used to determine the discount rate;
- The impact that pension plans had on results of operations, cash flow, and liquidity, including the amount of expected pension returns included in earnings and the amount of cash outflows used to fund the pension plan;
- Any expected change in pension trends, including known changes in the expected return assumption and discount rate to be used during the next year and the reasonably likely impact of the known change in assumption on future results of operation and cash flows;
- The amount of current unrecognized losses on pension assets and the estimated effect of those losses on future pension expense; and
- A sensitivity analysis that expresses the potential change in expected pension returns that would result from hypothetical changes to pension assumptions and estimates.
The SEC expressed its concerns in writing to more than 350 firms; some firms were asked to amend their 2002 annual reports, but others were simply told to make changes in future filings.
Despite the pension concerns, management discussion and analysis - a required feature in annual reports - garnered more comments than any other topic from the SEC. Regulators want corporate executives to strike "boiler-plate" material, and instead provide more analysis of the company's finances, including:
- cash flow, and
Year-to-year changes and trends also received "insufficient attention" in many corporate annual reports, the SEC found.
The SEC also noted that many companies have continued to categorize as "temporary" for an extended period of time investments that have significant, unrealized losses. The SEC also called into question the disclosure of critical accounting policies, as well as the use of so-called pro forma accounting that doesn't conform to generally accepted accounting principles, or GAAP. Companies that use alternative, pro forma results were asked to remove them, and the SEC said it would keep a close eye on the practice to ensure compliance with new rules.
A summary of the SEC's findings is available online at http://www.sec.gov/divisions/corpfin/fortune500rep.htm .