NOTE: We are in the process of importing the archived blog posts from our previous server (the FEI blog goes back to 2004) . This post contains all of February, 2008. If you have any questions, please send an email to firstname.lastname@example.org and put in Subject line: Question.
Feb 29, 2008
Leap of Faith
This being the first Leap Year Day celebrated by the FEI blog (we were launched Sept. 3, 2004), I thought I’d open today's post by giving a shout-out to everyone with birthdays or anniversaries on February 29, that once every four year phenomena. Since we generally provide you with links to news of the day, you may find the Honor Society of Leap Year Babies to be of interest, they are a group that has been advocating for an Act of Congress to put Leap Year Day officially on the calendar. Their recent press release noted: “Birthday club Makes No Endorsement in Primary Races; Compressed Schedule Threatens to Overshadow Leap Day.”
Also in today’s “Leap of Faith” category, some may put the FAF’s recent announcement on the restructuring of FAF, FASB, and GASB governance. As we reported earlier this week, the most controversial of these changes is the reduction in size of the FASB board.
However, this is not just a leap of faith; as suggested by the CFA Institute in their press release earlier this week, the FAF will likely “monitor the effectiveness” of the changes to FASB’s structure and governance, particularly “ the reduction in the number of FASB members and the new powers of the chair in determining the board’s agenda,” to “ensure that communication with its constituents is transparent and collaborative and supports the FASB’s ability to address investors needs.”
Another item potentially for the leap of faith category, based on discussion at PCAOB’s SAG as we reported yesterday, may be the proposed Professional Judgment Framework of the SEC Advisory Committee on Improvements to Financial Reporting (CiFIR).
But, CiFIR's recommendations aren't being left as a leap of faith, your comments are wanted as evidenced by the fact that the SEC posted CiFIRs recommendations contained in the Progress Report in a Request for Comment, with comments due March 31. Comments letters as well as testimony at CiFIR’s March 13-14 meeting) will be considered as the SEC and other organizations move forward in considering implementing CiFIR’s recommendations.
Separately, PCAOB has its own proposal out for public comment, on Engagement Quality Review, with comments due May 12.
Last but not least, don't forget COSO! Watch for COSO's Exposure Draft on Monitoring Internal Control, expected out toward the end of March or April.
1:46 PM by Edith Orenstein
Feb 28, 2008
SAG Members Warn CIFIR Professional Judgment Framework Could Become Litigation Trap
Members of the Public Company Accounting Oversight Board’s (PCAOB’s) Standing Advisory Group (SAG) warned during their meeting on Feb. 27, 2008 that a Professional Judgment Framework (PJF) recommended by the SEC Advisory Committee on Improvements to Financial Reporting (CiFIR) could become a litigation trap that could lead to enhanced, not reduced liability.
Some SAG members observed that the PJF represented common sense principles which could raise the bar of financial reporting by requiring express consideration of applicable accounting standards, alternatives, and investor needs, in addition to requiring related documentation. However, some SAG representatives questioned the extent to which the PJF would enhance the quality of financial reporting, particularly when weighed against potential related litigation risk.
In related action, as we previously reported, the SEC posted a Notice containing a Request for Comments (see FEI summaries of CiFIR’s 12 recommendations and PJF), and other material contained in CiFIR’s Progress Report submitted to the SEC. The Request for comments was also published in the Federal Register today, and the comment deadline is March 31, 2008.
The PCAOB SAG discussed CiFIR’s proposed PJF – designed to be used by preparers of financial statements to support their judgments - from the standpoint of the PJF’s potential impact on auditors, and whether a similar PJF should be developed to substantiate auditors’ judgments. The SEC has announced CiFIR will meet on March 13-14 in San Francisco, to obtain additional feedback on its recommendations.
Other matters discussed at the PCAOB SAG meeting included whether the PCAOB should promulgate new rules on audit supervision similar to the broker-dealer supervision model of the SEC, and related language in Section 105 in the Sarbanes-Oxley Act empowering the PCAOB to discipline an audit firm and associated persons for failure to supervise personnel. A number of SAG members noted that audit firms, particularly large audit firms, have a matrix model of supervision, e.g. by industry, geography and specialization, rather than a strictly hierarchical model, and noted significant differences between the audit supervision model and the broker-dealer model.
Additionally, the SAG discussed Global Quality Control Practices of international audit firm networks, with an eye toward whether Appendix K in the PCAOB’s interim standards, originally promulgated by the AICPA’s SEC Practice Section (SECPS) as SECPS Member Firms With Foreign Associated Firms That Audit SEC Registrants, needs to be retained or changed in light of the movement toward convergence of international accounting and audit standards. SAG members encouraged the PCAOB to continue its joint inspections approach with peer regulators in other countries, and a number of SAG members suggested the PCAOB retain Appendix K at this time as international audit networks continue to strengthen their global audit quality controls.
Chief Auditor Tom Ray announced the next meeting of the SAG will be held June 25-26, 2008; they will decide closer to the date if it will be a two day or one day meeting.
FEI members can see complete Highlights of the SAG meeting in a summary that will be posted on http://www.financialexecutives.org/ later today. We will share some highlights below on the SAG's discussion of CiFIR's PJF.
SAG Discussion of CiFIR Professional Judgment Framework (PJF)
Two CiFIR members, Ed Nusbaum, CEO and Executive Partner, Grant Thornton, and Greg Jonas, Managing Director, Moody’s Investors Service (and a new member of the SAG), presented CiFIR’s Professional Judgment Framework (PJF).
Putting the PJF in historical perspective, Nusbaum noted the SEC’s 2003 Report to Congress on use of a principles-based accounting system said that a move to objectives-based (or principles-based) standards will require a change in behavior regarding professional judgment.
[Specifically, Section III. I. i. of the SEC’s 2003 report said: “One consequence of continuing to move to an objectives-oriented regime is that preparers and auditors would be called upon to exercise professional judgment in a different way than is currently required… Preparers would need to resist the temptation to challenge auditors by demanding written guidance in order to accept an auditor's judgments... [and] auditors would need to be weaned away from the check-list mentality… auditors will, in some cases, be faced with the prospect of having the rules-based security blanket removed.”]
Nusbaum also noted a predecessor advisory committee, the SEC Advisory Committee on Smaller Public Companies, issued a ‘protocol safe harbor,’ although he emphasized his committee (CiFIR) is not recommending a safe harbor per se.
“Our subcommittee [CiFIR’s Audit Process and Compliance Subcommittee] concluded that a carefully considered framework that sets forth a strong process that can be expected to result in well reasoned and supportable professional judgments and one that specifies that the judgment process must result in an answer that conforms to GAAP would improve the quality of preparer judgments,” said Nusbaum, “and make it more likely that preparer judgments would be respected by auditors and regulators, particularly where competent and informed professionals might reach different conclusions.”
He added, “It is very important to me and our committee that nothing in there would preclude questioning the work of preparers,” and that there is nothing in the PJF to preclude preparers from reversing judgments that are not deemed reasonable.
Nusbaum noted he was initially skeptical about the PJF, but became a major supporter as he realized, “I really thought it would improve the judgments made by preparers, and improve the process we as auditors go through, and the behaviors and processes of regulators.”
“When I discussed this with our own Professional Standards people, they were a little skeptical at first,” he added, “because they realized this might require us to do more work, and more documentation, and our preparers, our registrant clients to do more work.”
Jonas walked through the PJF (see FEI summary of PJF), and noted CiFIR has five goals for the PJF:
improve quality and reliability of reporting related judgments (he noted some misjudgments have been at heart of very important financial reporting failures)
improve investors’ lack of confidence in judgments in financial reporting, confidence that has been undermined by some financial reporting failures
establish criteria for judgments and thereby reduce uncertainty about the characteristics of sound judgments (he added, “it’s kind of you know it when you see it, maybe you can do better than that, we think we can”)
enable principles based standards – which necessarily rely more on judgment
improve preparers and auditors confidence that regulators will respect well reasoned judgments
Jonas reiterated CiFIR did not recommend a safe harbor, and that it will not stop auditors or regulators from asking questions about judgments.
Investor representatives and academics on the SAG, including Barbara Roper, Cynthia Richson, and Joe Carcello, questioned if the PJF would enhance financial reporting, and how it would benefit investors.
“I think most reasonable people would look at the composition of the Pozen committee [CiFIR is also referred to as the Pozen committee, for its chair, Robert Pozen],” said Carcello, “and the kindest way I can say it is, it is a bit skewed to the corporate community, whereas composition of the Treasury committee [Treasury’s Advisory Committee on the Auditing Profession or ACAP, co-chaired by Arthur Levitt and Don Nicolaisen] is more balanced.” Carcello added, “I think if the recommendation [for a PJF] came out of that group [Treasury’s ACAP] with no dissenting voices, I think it would be hard to criticize it; it would be viewed as a recommendation that strong investor advocates are in favor of.”
Jonas responded to the question of why a PJF is needed, observing, “Precious little guidance [is available] that helps people decide when they’ve made a good judgment.” He added, “given the importance of judgments, I think we can make genuine progress in raising the bar.” Further, he noted, “I think some of this can be taught, I don’t think judgments need to be purely instinct.” Therefore, he added, “More consideration and work on this topic is time well spent. “
“I come to this with an investor perspective,” said Jonas. "In my experience, when people get their heads in those 12 areas [outlined in the PJF], they make damn good judgments; I think we made progress in articulating what constitutes what makes a good judgment.”
Roper, of the Consumer Federation of America, stated, “The best I can say of this proposal is it is hopelessly naïve.” She acknowledged, “It will provide good companies a basis for making better judgments.” However, she warned, “That same approach for companies that are not inclined to [use good judgment] .. are fudging, it will give them a set of tools to say their approach is acceptable, and will make it harder for auditors to challenge them.”
Referring to the potential impact of the PJF on auditors and regulators, she said, “It is not enough to let people ask questions, they have to be able to say no.” She added, “I want auditors at public companies to have all the tools at their disposal to someone engaging in overly aggressive accounting.” Roper said she believes the PJF “seems to dismiss the notion of bad judgment, you can document the heck out of it and come up with really bad judgment, and bad judgment seems to fall into the category of ‘things we’re going to respect.’”
Although Jonas and Nusbaum said CiFIR is not recommending a safe harbor, Roper countered, “It was absolutely clear it is inextricably linked in minds of the (CiFIR) committee that it be linked to litigation and regulatory action, although not formally linked, it is naïve to suggest it isn’t very much a part of a proposal designed to include [that].” Roper added, “I want issuers and auditors sweating bullets whether they get things right or not.
Preparer ReactionPreparer representatives appeared cautiously optimistic about the PJF, with some reservations.
Arnie Hanish, Chief Accounting Office at Eli Lilly, said, “I might be the first one here to speak in favor of this, or at least to support it to some degree. From my perspective, as I read this section, which is an accounting framework, I viewed this as a reasonable framework, to me it was very common sense, I could try to analogize it to the Ten Commandments, that these are common sense kinds of principles that you would undertake to try to come up with judgment.”
“From my perspective, when I read this [PJF],” continued Hanish, “it enables the debate - it wouldn’t certainly eliminate the debate - and I think it would clearly provide the auditors with sufficient substance to suggest, has there been a thorough enough review and analysis of relevant literature.”
“The judgments are only as good as the analysis,” added Hanish, “and two rational people after reviewing data and literature can certainly come to different conclusions, but I don’t see where this offends at least me as a preparer to have a framework where I can engage in debate with my auditor over principles and judgments.”
He asked for clarification of PJF’s discussion on material issues or transactions, saying, “I can see that here is where we as preparers can get into significant debate [with auditors] as to what are those material issues or transactions are that would ‘needs to be disclosed,’ and to what degree those assumptions and conclusions need to be provided in our filings.”
Nusbaum responded, “The part you pointed out is that the analysis has to be in accordance with existing disclosure requirements.” He added CiFIR did not want to add to existing disclosure requirements. “I hate to say it, but I think we’re punting, asking SEC and FASB to consider this down the road, its all about changing behavior with the hope disclosure will improve,” said Nusbaum.
Another preparer representative, David Julian, EVP and Chief Operating Officer-Finance, Wachovia said, “I’d have to agree with others that most if not all aspects are common sense, from preparer point of view, there are 3 groups of folks:
those making sound judgments, probably applying aspects of this framework
those making not so sound judgments, regardless of framework will probably find way to make those judgments
in the middle, those who this framework may help make good judgments
Julian added, “the preparer might fear, when something is published in rules as something to think about, very quickly it becomes a rule, and informal or formally the firms or others make rules around it, and [I am] concerned about the burden that places on the majority of folks already applying this… to help the middle group, that I’m not convinced is the larger part of the problem.”
Xerox VP and Chief Accounting Officer Gary Kaburek said, “As the proposal stands now, it is workable,” calling it, “a really good first step.” He said the PJF “appropriately recognizes judgments are what we do every day, looking at rules, guidelines, frameworks for almost everything else, I think we should proceed down this route.” Kaburek said “It will be useful in organizing management’s thought process; this framework will more consistently bring companies to think about what subject matter experts say, think outside the box.” He added that like FASB’s codification, “putting all this in one place is a good thing. Whether or not this should be codified and at what level, I leave that to the SEC to decide.” “The one concern I would have on workload,” he added, “there are judgments that are routine, well established, and there are extraordinary judgments; I would like to focus the rule if there will be one, on extraordinary judgments, the disclosable events of the period.”
Auditor CommentsThe Big Four audit firm representatives on the SAG generally supported the PJF, although they said further consideration should be given to improving disclosures for investors, not only by applying PJ to the existing disclosure framework as CiFIR had recommended.
Liz Gatineer, Director of Quality Control, at audit firm Stegman & Co. said, on the one hand, “I think, what could be the harm in giving guidance to make more well reasoned, informed judgments.”
However, she added, “The question is, have you walked me into a documentation trap, where I made a well reasoned judgment, but there is a documentation trap in the 12 buckets… Now I have to somehow explain I used judgment in not using the judgment framework, that’s going to be a tough sell, it’s going to somehow be what we are evaluated against.” She warned, “I would caution we end up not creating another set of problems.”
Gaylen Hansen, an audit partner, and member of NASBA’s board of directors, said, “Any time you shed light on a process in arriving at conclusions is important.”
“At the same time, I’m thinking, perhaps any time in our profession that we have an issue of significance, a framework supposedly is going to solve our problems for us.
Hansen continued, “I’m wondering, and Cynthia [Richson] alluded to it, if you look at Rule 203 of the AICPA’s Code of Prof Conduct, it says, if there is a conflict with GAAP that ends up with a misleading answer, you pursue that, and burden of proof is on the auditor to document conclusion different from GAAP.”
“The thing that perplexes (me is) that, FASB in looking at GAAP hierarchy proposed to rescind that rule, (Rule 203). Last time I looked, it’s still there,” said Hanson, but “it seems we’ve almost gone full circle where we wanted to get rid of this and want it back.”
Nusbaum said that he would bring the Rule 203 issue back to his CiFIR subcommittee to consider.
Becker, Turner Warn PJF Could Increase LitigationDavid Becker, an attorney with Cleary Gottlieb and former General Counsel of the SEC, said the PJF may enhance liability, not reduce it, warning that it may be taken as a cookbook approach that may complicate defense of reasonable judgment.
He noted by way of analogy his experience in helping develop SAB 99 on materiality when he served as general counsel at the SEC, what it was meant to do, and how it has been interpreted in practice. “Lynn Turner and I when we were at SEC were part of an effort to introduce a certain degree of intellectual rigor into the making of materiality judgment. In doing SAB 99, I came to SEC with background as defense lawyer, and the number of times I have heard people explain “it’s my judgment” – (and people ask, all right, well, what does that mean, and people say ‘it’s my judgment’) and the idea is to insert into that a framework for thinking about it, and for going thru a process so that what’s called judgment is not merely taking refuge in the ineffable, but the end result of a serious process, I think that’s a good thing.”
Becker added, “I have a little skepticism as result of SAB 99 experience about how this will work in practice. We did SAB 99, the principal point was, ‘this is not a bright line, this requires the exercise of judgment, and your judgment should be informed by the following factors.’ And, the text and subtext was, ‘and if you do exercise judgment this way, it will be respected.’
“Speaking only for myself to be sure,” he continued, “part of this was to stem what seemed to be a tide of very loose materiality judgments, but it was written in a way that was intended to constrain the discretion not only of preparers and auditors but regulators as well, in simply saying, ‘nah, that’s material.”
Becker then said of SAB 99, “I don’t think it has been taken quite the way I would have hoped it was taken on all sides, that instead of saying this is a matter of judgment and these are the things you have to look at, instead I think it has been taken more as a cookbook with a more complicated recipe than used to be there before.”
Moving more directly to CiFIR’s PJF, Becker said, “And I would worry, for those who want to move to a more principles based system, and I have some questions about what exactly that is, but I would worry that the problem is not principles based or lack of principles based rules, but do you have principles based humans out there, so no matter how you put it, it’s going to be taken by preparers, by auditors and by regulators as a more complicated recipe for doing what people already do, and that perversely this becomes something of a litigation trap, that, even if you have a safe harbor that says ‘if you do these things, there will be no liability,’ - and frankly, if it’s the case that this produces better accounting decisions, I don’t mind having a safe harbor, I might want to wait and see before I put a safe harbor into effect - but what happens, is that by proceduralizing the decision-making somewhat, you then have grounds for enhanced liability, so that, even if the judgment is defensible, if the documentation is crappy, you may find yourself with more complicated legal proceedings, having lawyers prepare documentation." Given the additional work for lawyers, he then joked, "Well, never mind, I’m in favor of it."
Lynn Turner, former Chief Accountant at the SEC and a member of Treasury’s ACAP, said, “Actually I find myself agreeing with some things Greg [Jonas) has talked about,” adding, “I do think there were a lot of poor judgments at the heart of many of the failures, and I agree with him, there should not be a safe harbor.”
However, Turner noted, “it is not going to be in best interests of the profession, in part, for the exact reasons David Becker pointed out earlier. We have heard input over at the Treasury committee, from very well known former senior officials besides David, people who have been actively involved in that role at the SEC and Corp Fin, who have clearly indicated to us that this business judgment rule, rather than driving down litigation, will actually turn out to be the very basis for litigation and will in fact drive the amount of litigation against the firms up, and certainly that’s one of the factors we are weighing and looking at there, and we’re still going thru that process, but it does raise some serious questions. As I think about it, I don’t think you (CIFIR) thought about that.”
“The other thing is, on the safe harbor, its clear it got teed up, but if members of your committee don’t support the safe harbor, your report would be much more transparent if in fact you noted members don’t support the safe harbor, I think that would be of great interest to investors,” added Turner.
“Going to the question Tom Ray teed up about the elements [of the framework], I was listening to Arnie [Hanish] saying this thing is like the ten commandments, I agree, this is very much like the Ten Commandments, of course we know how well people follow those, which gets us back to litigation all over again,” said Turner.
He added, “But, when you go thru and you just look at these 10 factors or 9 factors and documentation - by the way, on Enron, there was plenty of documentation, in fact one audit partner said there was so much documentation he disagreed and got pulled off the audit, we know documentation hasn’t always been the problem.”
Turner ran down the nine points in the PJF and said most of them come directly out of existing auditing standards.
“So when I look at the elements [of the PJF],” said Turner, “there’s nothing here that isn’t already out there, common sense, I turn around and say, does the profession really need a rule to turn it around and say, go look at GAAP, go make sure you’ve got all the facts, and make sure you’ve analyzed them, that’s all this says, and if you’re going to turn around and hang yourself with litigation by going to this, I’ve got to say, who in their right mind would turn around and do this?
FEI members can see further details on the remainder of the SAG meeting in a summary to be posted later today (Feb. 28) on http://www.financialexecutives.org/. If you received this FEI blog post from 'a friend' and would like to receive emails of our blog posts real time, enter your email address here.
9:49 AM by Edith Orenstein
Feb 26, 2008
FAF Votes To Reduce Size of FASB Board; PCAOB Proposes Tightening of Engagement Quality Review
Two big news items today (Feb. 26): the Financial Accounting Foundation (FAF), parent of the FASB, announced the FAF Trustees voted to reduce the size of the FASB board from seven members to five, effective July 1, 2008, and approved other changes to the FAF, FASB and GASB’s structure and governance. Separately, the PCAOB voted to release a proposed auditing standard for Engagement Quality Review (EQR) – also called concurring or second partner review – which will tighten the current standards for EQR. Further details are below.
FAF Vote Confirms Reduction in Size of FASB Board; Other Changes
The changes to FAF, FASB and GASB structure and governance announced by the FAF today are virtually identical to those proposed by the FAF in December, with the exception of required competencies of members of the FASB board. Unlike the December proposal, which was more of a ‘quota’ approach in proposing that the FASB board include one preparer, one auditor, one financial statement user, one academic, and one ‘at-large’ member, today’s announcement says the FAF’s by-laws will be amended to require generally that: "The Members of the FASB shall, in the judgment of the Trustees, have knowledge of and experience in investing, accounting, finance, business, accounting education and research and a concern for the investor and the public interest in matters of investing, financial accounting and reporting."
The only other change evident in today’s FAF announcement vs. the December proposal which I noted was a moderate change regarding the earlier proposal that the FASB and GASB chairs be given the power to set their respective board agendas. Like the December proposal, the chairs will be given the authority to set their agendas and prioritize projects, but this will be referred to as a 'leadership agenda process,' requiring ‘appropriate consultation’ (presumably, with their other board members).
Perhaps the most controversial change in governance approved by the FAF, to reduce the size of the FASB board from seven to five members, remains unchanged from the FAF’s December proposal. A total of 59 comment letters were filed, and the FAF states in its press release that it used the comment period to “liste[n] to the views of various constituents and government officials.” As previously reported, FEI’s Committee on Corporate Reporting (CCR) and Committee on Private Companies (CPC), in comment letters filed with the FAF earlier this month, noted concern with the proposed reduction in size of the FASB board; a number of former FASB board members noted similar concerns.
PCAOB Proposes Tightening of Engagement Quality Review (EQR) Standard
In another corner of the regulatory world, at its board meeting earlier today (Feb. 26), the PCAOB announced that it voted to release for public comment a proposed auditing standard to tighten the requirements for auditors to conduct an Engagement Quality Review (EQR) – commonly referred to as a concurring partner or second partner review – by requiring all registered audit firms to conduct EQRs for all engagements conducted under PCAOB standards.
Although driven by a requirement in the Sarbanes-Oxley Act, the proposal goes beyond the requirements of the act, as explained below. A press release notes there will be a 75 day comment period (ending May 12, 2008) on the proposed standard and related amendments.
Listed below are some highlights from the discussion of the EQR proposal during today's (Feb. 26) PCAOB open board meeting.
EQR can provide ‘tangible enhancement to audit quality’
PCAOB Chairman Mark Olson noted EQRs can provide “a tangible enhancement to audit quality,” and said the PCAOB “thoroughly looked at existing practices, input from the Standing Advisory Group (SAG) and inspections, and concluded we can further improve the concurring partner process.”
Chief Auditor Tom Ray told the board, “Well-performed EQRs are an important element in establishing a basis for investor reliance on audits.” He added, “EQRs conducted contemporaneously with audit engagements may identify and correct a problem before the engagement is completed.”
Board Member Bill Gradison said, “Far too often, concerns were expressed by [PCAOB’s] inspection team, about quality of reviews, particularly when [a] firm itself identified a client as higher than average risk, but very little evidence that the engagement reviewer structured work to take into account heightened concern about risk identified by the firm itself.”
Board member Charles Niemeier called the proposal, “a significant step” by providing “a mechanism to find and correct audit problems before the audit report is issued.” Over the past five years, said Niemeier, the PCAOB has found numerous audit deficiencies. “A thoughtful EQR reviewer who has access to the same information we do as part of these inspections would be even better for investors, leading to correction of deficiencies before investors rely on the audit.”
Board member Dan Goelzer noted four improvements arising from this proposal, including its risk-based approach, consistency with Congress’s direction (in the Sarbanes-Oxley Act) to require the EQR reviewer to approve issuance of the audit report, not simply to conduct an EQR, the change to a “knows or should know” expectation of the reviewer vs. current requirements that simply say “nothing has come to the attention” of the EQR reviewer, and improvements to required documentation of the EQR.
Goelzer asked a number of questions relating to how the proposal differed from the explicit requirement in the Sarbanes-Oxley Act and how the proposal differed from similar standards of the International Audit and Assurance Standards Board (IAASB), as detailed below.
Small audit firms and audit firms of all sizes – not only firms previously part of SECPS – will require EQR
Under current standards (i.e., PCAOB’s “interim standards” or predecessor standards of the AICPA adopted by PCAOB when PCAOB was formed), only those registered audit firms (firms registered with PCAOB) that previously belonged to the AICPA’s SEC Practice Section (SECPS) are required to conduct an EQR.
As explained to the board by Chief Auditor Tom Ray: the Sarbanes-Oxley Act required PCAOB to establish a standard for EQR, and required the standard be applicable to all registered audit firms, not only those previously registered with the SECPS.
Board member Bill Gradison said it would be a “great improvement to close the SECPS loophole” (discussed further below) and require all registered audit firms to have an EQR.
Chairman Olson observed, “I understand many firms have procedures for a concurring partner review in place, and will only need to modify procedures.” However, he noted, “Firms that were not members of SECPS will need to invest resources to build a concurring partner review.”
Smaller firms will generally be among those firms needing to conduct an EQR for the first time. Recognizing smaller firms may have a limited number of partners to conduct the EQR, and further recognizing that smaller and even some larger firms may have limited numbers of partners with specialized expertise necessary for certain EQRs, the PCAOB proposal would allow personnel other than partners and other than members of the firm in question to conduct the EQR. Independence rules will apply to the EQR reviewer, however, as well as a requirement that the reviewer must be objective.
Scope of proposal broader than IAASB standard by requiring affirmative approval, risk-based approach
Board member Goelzer asked how the proposal differed from similar standards of the International Audit and Assurance Standards Board (IAASB).
Deputy Chief Auditor Greg Scates responded to Goelzer that one of the principal differences between the PCAOB’s proposal and the IAASB’s standard is that the IAASB only requires the EQR to consider “no matters have come to their attention” that the engagement was not performed in accordance with standards of the PCAOB.
“In contrast,” explained Scates, “the [PCAOB’s] proposal provides that the EQR must not provide concurring approval of issuance [of the audit report] if:
the engagement team failed to obtain sufficient competent evidence;
the engagement team reached an inappropriate conclusion on the engagement;
the audit report is not appropriate under the circumstances; or
if the audit firm is not independent of the client.”
The requirement for the EQR reviewer to affirmatively approve issuance of the audit report before it is issued goes beyond the PCAOB’s current (interim) requirements, and is derived from Section 103 of the Sarbanes-Oxley Act, which requires the EQR to provide “concurring approval” in the issuance of an audit report, as noted in PCAOB’s press release.
Ray added the PCAOB’s proposal that the EQR perform a risk assessment and certain specific procedures set forth in the PCAOB’s proposal go beyond the IAASB’s standard.
Goelzer said, “One would hope the process wouldn’t have to be substantially different if one is complying with the international standards or our standard.”
Ray replied, “An EQR reviewer is not asked to perform auditing procedures or evidence gathering procedures or a re-audit, but to look at the work and judgments that have already been performed.” Therefore, fundamentally, he said, the process under the PCAOB’s EQR proposal should be similar to that under IAASB standards.
Ray added he added he believes the larger firms already incorporate a risk-based component into their EQR, and that the costs of larger firms EQR may not go up substantially to adopt the PCAOB’s proposal.
Proposal goes beyond what is required by Sarbanes-Oxley Act, broadens scope of engagements requiring EQR
Goelzer also asked PCAOB staff to describe the scope of audit engagements covered by the proposal, and whether that scope goes beyond the Sarbanes-Oxley Act’s requirements for EQR.
In terms of scope, Goelzer said, “I think we’re talking about: integrated audits [of internal control and the financial statements], audits, review of unaudited quarterly statements and SEC Regulation Asset Backed Security (ABS) reports, and a report on remediation of internal controls under Auditing Standard No. 4,” said Goelzer. “Is there anything else currently that this [proposal] would be subject to?” he asked.
Scates responded that audits of issuers are the primary reports covered by the proposal, but added, “There could be some others [other types of reports] that the engagement team may be requested by the client to perform, they may be asked to perform special reports in connection with their principal lender or others, and those special reports would also be subject to the review.”
“Do I understand correctly, that in this regard," asked Goelzer, "we’re going beyond what Sarbanes-Oxley requires; that if we simply implemented the statute, it would only be the financial statement audit, either the integrated or financial statement only?”
“Yes, we are going beyond that,” replied Scates, adding, “but we think this is expectation of the public, that the public would expect this, for any auditor to perform this type of function in order to provide any type of opinion on the financial statements, or in connection with a review.”
Goelzer also asked about the proposals requirement relating to reissuance of the auditors’ report.
Ray explained auditors are required to perform certain subsequent events procedures in connection with including their consent to include their earlier audit report, e.g., in a registration statement filing under the ’33 Act.
“We hear a lot from issuers about difficulty of getting consent when there’s been a change in auditor, now do we need consent from prior auditor and prior auditors’ EQR? How will this effect consent process?” asked Goelzer.
Ray responded, “I wouldn’t look at this as another step in addition to firm having to provide consent… I wouldn’t expect the standard to add any additional burden” with respect to requirements relating to predecessor auditors.
Auditor independence rules
Goelzer also asked if the EQR reviewer comes from a different firm, if the reviewer’s firm has to be independent of the client.
PCAOB General Counsel Gordon Seymour responded, “Most of the independence rules including restrictions on nonaudit services are implemented through SEC rules.” He added, “I don’t want to speak for the SEC,” and noted in addition to the specific rules, a general standard of independence always applies.
“All that said,” Seymour continued, the EQR reviewer would be considered part of the audit engagement team and become subject to the SEC’s independence rules. However, he added, in his view, the reviewer’s firm (if a different firm from the firm that conducted the audit engagement being reviewed) would not necessarily be considered part of the audit engagement team (for purposes of the auditor independence rules).
The proposal is expected to be posted on the PCAOB website on Feb. 26, and as noted above, there will be a 75 day comment period ending May 12, 2008.
PCAOB SAG Meets Wed. Feb. 27
More PCAOB happenings are expected on Wed. Feb. 27, as PCAOB convenes a meeting of its Standing Advisory Group (SAG) to discuss the SEC Advisory Committee on Improvements to Financial Reporting (CiFIR)’s proposed professional judgment framework, accounting firms and auditors responsibility to supervise, global quality control practices, and emerging issues. Check back to FEI’s blog tomorrow or Thursday for a summary of the SAG meeting; you may want to check out the webcast of the all-day SAG meeting yourself, it’s always very interesting to hear the diverse panel of experts on the SAG.
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5:57 PM by Edith Orenstein
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Feb 22, 2008
Sarbanes-Oxley: The Next Generation: COSO Readies Exposure Draft on Monitoring Internal Control; IMA Paper; Welytok Book
The Sarbanes-Oxley Act, particularly Section 404 on internal controls, remains in the collective mind-set as large public companies and their auditors are in the midst of publishing their fourth in a series of annual reports on internal control effectiveness this 10-K season. Under the SEC’s phase-in approach, smaller public companies entered their first year of management reporting on internal control this year, and on Feb. 1, were granted a ‘stay’ or delay on the requirement to have their auditor conduct an audit of internal control and file a related report on their findings until years ending on or after Dec. 15, 2009. Part of the reason for this further delay, said the SEC, was to allow time for the SEC to conduct its own study of the costs and benefits of reporting on internal controls under the new guidance issued by the SEC and PCAOB in 2007: SEC’s management guidance, and PCAOB’s ‘top-down’ oriented Auditing Standard 5 (AS5), replacing the more prescriptive AS2.
Meanwhile, further guidance and calls for additional guidance are emanating from various corners, including the Committee of Sponsoring Organizations of the Treadway Commission (COSO), the Institute of Management Accountants (IMA), and from JD/CPA Jill Gilbert Welytok, author of “Sarbanes-0xley For Dummies.”
COSO Readies Exposure Draft on Monitoring Internal Control
Readers of this blog will note we’ve been telling you, as recently as Nov. 07, why you should care about COSO and its upcoming guidance on Monitoring Internal Control, particularly if your company is required to report under (or voluntarily applies) Sarbanes-Oxley Section 404, since the SEC and PCAOB recognize COSO’s Internal Control-Integrated Framework as a suitable, generally accepted internal control framework to use as a reference point in reporting on the effectiveness of internal control.
COSO evolved from the Treadway Commission formed in the 1970s to study factors leading to fraudulent financial reporting and make recommendations to improve the reliability of financial reporting. The founding organizations that sponsored the Treadway Commission and COSO are the American Accounting Association (AAA), the American Institute of CPA’s (AICPA), Financial Executives International (FEI), the Institute of Internal Auditors (IIA) and the Institute of Management Accountants (IMA).
In our Nov. 07 post we told you COSO published a Discussion Document – a precursor to an Exposure Draft of proposed guidance – on Monitoring Internal Control, and shared with you the comment letter filed by FEI’s Task Force on Monitoring (TFM), which supported the COSO project, but cautioned against issuing overly prescriptive guidance.
Two important updates have been made to the COSO website regarding the Monitoring project. First, the website currently states the Exposure Draft on Monitoring Internal Control is ‘coming soon.’
“Plans are that the Exposure Draft will be out by the end of March,” COSO Chairman Larry E. Rittenberg, Ernst & Young Professor at the University of Wisconsin, shared with us. Although COSO has not yet formally determined the length of the comment period, Rittenberg said he believes it is likely to be a 60 day comment period, with final guidance anticipated by mid-2008.
New material that will appear in the Exposure Draft vs. last fall’s Discussion Document will include practical examples and implementation guidance based on interviews Grant Thornton – the firm leading the drafting of COSO’s Monitoring guidance, under the oversight of a broad-based project task force – has conducted. In addition, conceptual material will be carried forward from the Discussion Document, including revisions for comments received last fall.
If you want to get up to speed on COSO’s Monitoring project in anticipation of release of the Exposure Draft, check out COSO’s website for the earlier Discussion Document and comment letters filed. (Note: additional comments were filed by some parties by online-response form only, which are not posted to maintain confidentiality of the online commenters. The 17 ‘hard copy’ comment letters received by COSO which have been posted represent a wide variety of COSO’s diverse constituents.)
IMA Advocates For Accounting Control Assessment Standards
Earlier this month, IMA issued a press release announcing formation of a Finance, Governance, Risk and Compliance (FGRC) research practice, and concurrently announced the release of a discussion paper on: “Accounting Control Assessment Standards: The Missing Piece in the Restatement Puzzle.” (A link to IMA’s discussion paper appears in the press release, we had trouble opening the link to the IMA paper this morning, we’ll update this post to let you know if the link has changed.)
As noted in IMA’s press release, “The paper explores the high incidence of cases in which management and their external auditors attest to having an effective system of internal controls, but later issue a material financial restatement relating to an internal controls breakdown.”
Specifically, IMA’s paper: “asserts that while accounting complexity is a driver of financial restatements, the system of internal controls and lack of practical risk-based standards is also an important driver of material financial restatements and is the “missing piece” in reducing the frequency of financial restatements to an acceptable level.”
One of the primary recommendations in IMA’s paper, foreshadowed in this Dec. 6, 2007 Statement of IMA President and CEO Paul Sharman in testimony before a subcommittee of the SEC Advisory Committee on Improvements to Financial Reporting (CiFIR), is a need for the establishment of “Generally Accepted Control Principles” (as referenced in the Dec. 07 statement) or “Accounting Control Assessment Standards” as referenced in the title of the IMA paper. IMA posits such standards – which would presumably go beyond COSO’s internal control guidance – would assist in reducing the number of restatements. Another point raised in IMA’s paper relates to the need for global convergence of control standards.
Jeff Thomson, IMA Vice President, Research Applications and Development, said, “[O]ur own research during the past three years and an assessment of 25 large accelerated filers in this paper suggest that sub-optimal internal control systems, standards and guidance are major causes for material financial restatements.” He added IMA’s paper was “developed to stimulate debate and more comprehensive research.”
IMA's paper adds to thought pieces and research out there on what the causes of restatements are. As referenced in IMA's press release cited above, some restatements have been attributed to complexity of financial reporting, not necessarily control weaknesses per se. The SEC Advisory Committee on Improvements to Financial Reporting (CiFIR) has looked at issues like materiality as relates to restatements, and the Treasury Advisory Committee on the Auditing Profession (ACAP) may have some interest in this as well. Treasury is also conducting its own independent study on restatements, as previously reported.
COSO Chairman Larry Rittenberg, not commenting on IMA’s paper directly, told us, “COSO is engaged in a strategic planning process,” and among the issues being addressed, “COSO is looking at global convergence as one thing on the horizon.”
Welytok’s New Book: Sarbanes-Oxley for Dummies: 2nd Edition
You know you’ve lived thru Sarbanes-Oxley when you see “Sarbanes-Oxley for Dummies: 2nd Edition,” being published. (The book is published by Wiley; FEI and its research foundation offer select Wiley books for sale in our bookstore; you can purchase the book here.)
Some of you may recall the famous photo of SEC Chairman Christopher Cox holding up a copy of “Sarbanes-Oxley for Dummies” (the first edition) when he testified at a hearing of the House Financial Services Committee on the Impact of Sarbanes-Oxley on Sept. 19, 2006. (If we find a live link to that photo by AP photographer Lawrence Jackson we’ll be sure to update this post.)
Author Jill Gilbert Welytok, who holds a JD, CPA, LLM and Masters in Computer Science, shared with us via email some highlights from the second edition of her book, “Sarbanes-Oxley for Dummies,” and her take on major developments that took place between publication of the first and second editions.
An entirely new section in the second edition of Welytok’s book addresses, “What’s New for Non-Accelerated Filers,” and a new section in the Appendices includes selected sections from PCAOB’s Auditing Standards No. 5 (AS5).
As in the initial edition of her book, Welytok continues to provide a very readable, plain English walk-through of the entire Sarbanes-Oxley Act, not only Section 404. She also continues to provide a number of quick-read “Top Ten” lists, including “Ten Governance Tips from Sarbanes-Oxley Lawyers,” “Ten Ways To Avoid Getting sued or Criminally Prosecuted Under SOX,” “Ten Tips for an Effective Audit Committee,” and “Ten Things You Can’t Ask an Auditor to Do After SOX.”
Welytok’s “Top Ten Places to Get Smart About SOX” range from a SOX-online website that includes a “Dear Mrs. Sarbox” advice column (for real!) to websites of the AICPA, COSO, FEI, SEC, PCAOB, InsideSarbanes-Oxley, Candela Solutions, Compliance Week, and a Sarbanes-Oxley Forum (and, she adds, “Don’t Forget Wikipedia!”) Welytok also continues to state (pg. 181): "A great way to keep up with what other companies are doing with respect to SOX is to become a member of Financial Executives International."
We asked Welytok to share with us some highlights relating to Sarbanes-Oxley that took place between publication of the first and second editions of her book.
“More companies realize that Sarbanes-Oxley either does not apply to them (i.e. they are not publicly traded) and that Sarbanes-Oxley does not require them to do ridiculous things like revamp e-mail responses,” said Welytok. She noted that for companies falling outside the explicit scope of Sarbanes-Oxley, the provisions can be used as a ‘common sense good governance guide.’
Welytok also shared with us her view of the most important aspect of Sarbanes-0xley. “After the initial years of compliance and concern over 404 audits Sarbanes-Oxley has faded into the general fabric of accounting procedures and corporate law,” she noted.
However, she added, "Its [the Sarbanes-Oxley Act's] most important legacy is the creation of the Public Accounting Oversight Board (PCAOB), which meant essentially, that the audit profession lost its right to be a self-governing profession.”
Welytok emphasized, “The creation of the PCAOB and change in culture and expectations in the audit profession has driven corporate practices more than any other aspect of the law. Companies know that their auditors will audit. Not all companies are even required to have audits, but since Sarbanes-Oxley, when auditors are used, they must be scrupulously independent and not get involved or negotiate the presentation of financial data on which the public relies. This has impacted the accounting profession in general and has been a tremendous check-and-balance for the management in reporting to its Board.”
9:20 AM by Edith Orenstein
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Feb 20, 2008
SEC Posts CiFIR (Pozen Committee) Report for 30 Day Comment Period
Yesterday (Feb. 19), the SEC posted this Request for Comments on the Progress Report of the SEC Advisory Committee on Improvements to Financial Reporting (CiFIR, also called the Pozen Committee for committee chair Robert Pozen.) The comment period will end 30 days after the Request for Comments is published in the Federal Register (which normally follows posting on the SEC website by a couple of days if not same day.) CiFIR’s progress report is attached to the Request for Comments.
As we reported last week, upon receipt of CiFIR’s Progress Report, SEC Chairman Christopher Cox issued a statement calling the progress report “an important step toward making financial information more useful for investors and reducing unnecessary complexity.”
He added, “I thank the Committee members for their diligent work to date and look forward to additional proposals and recommendations as the Committee continues its important work over the next few months.”
As to how CiFIR’s recommendations will be used, Cox stated, “I have asked the SEC's professional staff to analyze the report and its proposals, and to provide recommendations to the Commission for possible consideration later this year.”
Additional information is available in FEI’s summary of CIFiR’s 12 Proposals and FEI’s summary of CIFiR’s proposed professional judgment framework. (Note: these summaries were prepared based on CIFiR’s Feb. 11 draft progress report, minor wording changes were made to the final progress report.)
Also as we reported last week, the PCAOB’s Standing Advisory Group (SAG) is scheduled to discuss CIFiR’s proposed professional judgment framework at its Feb. 27 meeting. I made some personal observations on that framework in an earlier post, and welcome comments/reactions/observations of others to be posted on this blog, or if you prefer you can share your thoughts by email.
9:26 AM by Edith Orenstein
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Feb 19, 2008
Canadian Securities Regulators Concept Release Suggests Eliminating U.S. GAAP Option,as Canada AcSB Confirms IFRS by 2011
Last week (Feb. 13), Canada’s equivalent to the U.S. FASB – the Canadian Accounting Standards Board (AcSB) announced it has confirmed the move from Canadian GAAP to IFRS, tentatively announced in 2006, will take place as planned, as of January 1, 2011.
Scope: The AcSB says the change will effect “listed companies and other profit-oriented enterprises that are responsible to large or diverse groups of stakeholders,” and that “Private companies (non-publicly accountable enterprises), and not-for-profit organizations are not required, but are permitted, to adopt IFRS in 2011.” (See additional details on private companies further below.)
Comparative for 2010 required: Technically, the adoption of IFRS by listed companies in Canada will need to take place ‘as of’ one year prior, to provide comparative financial statements, as noted in the AcSB announcement and in an article written by Peter Menyasz in the Feb. 15 edition of BNA’s Daily Report for Executives, “Canada Accounting Standards Body Says For-Profits Must Use IFRS Starting in 2011.”
The readiness to apply IFRS to companies financials for 2010 was one concern highlighted in a comment letter filed by FEI Canada’s Committee on Corporate Reporting in October, 2007. Another issue noted in their comment letter was the uncertainty over whether the U.S. would permit IFRS for U.S. domestic filers, and whether Canada would continue to accept U.S. GAAP from cross listed (i.e., U.S. SEC listed and Canadian listed) companies.
Regarding the status of consideration of IFRS in the U.S., we previously reported SEC Chairman Cox has stated in a number of speeches so far this year he intends to have the SEC create a ‘roadmap’ this year on use of IFRS by U.S. filers.
Canadian Securities Regulators’ Concept Release, “Tentatively Concludes” to Eliminate Option of Filing in U.S. GAAP
Separately, regarding the status of continued acceptance of U.S. GAAP by cross listed issuers in Canada, the Canadian Securities Regulators (technically, the Canadian Securities Administrators or CSA) announced on Feb. 13 the issuance of a Concept Release (CSA Concept Paper 52-402) on “Possible Changes to Securities Rules Relating to [IFRS].” Issues addressed in the Concept Release include use of IFRS by Canadian domestic filers before the Jan. 1, 2011 changeover date, and continued acceptance by Canadian Securities Regulators of U.S. GAAP by cross listed filers who file with the SEC in U.S. GAAP.
Cross-listed filers who currently file in U.S. GAAP in Canada as well as with the SEC should take note that Canada’s Concept Release (Concept Paper) tentatively concludes:
“CSA staff believe that, on balance, the factors discussed above support eliminating our current provisions relating to the use of US GAAP by domestic issuers. Specifically, CSA staff's tentative conclusion is that we should not allow a domestic issuer to use US GAAP for a financial year beginning on or after January 1, 2009, with the exception that a domestic issuer filing US GAAP financial statements in Canada for its most recent financial year ending on or before December 31, 2008, could continue doing so for five years (i.e. 2009 to 2013).” [UPDATE 1: The comment deadline on the CSA IFRS Concept Release (Concept Paper) is April 13, 2008.]
As an aside, check out the Ontario Securities Commission (OSC) website, look familiar?
FEI IFRS Conference June 5: "The World Is Moving To IFRS - Are You?"
[UPDATE 2: If you found this FEI blog post on IFRS of interest, we invite you to attend our IFRS conference on June 5, 2008 in New York City: "The World is Moving to IFRS - Are You?" An FEI conference is a great opportunity to network with your peers and come away with solid information from top experts in the field. Visit the link to the event periodically as we update it with more details on speakers and agenda.]
What About Private Companies?
For private companies, see also: “Global Warming in Financial Reporting Standards” by KPMG Canada, which notes three models under consideration for private company financial reporting in Canada, once publicly accountable companies move to IFRS: (1) Development of a set of Canadian accounting standards for private businesses. This model might be similar to the existing model, or could be a simplified version, reflecting the perceived reduced information needs of users of the financial statements of privately owned businesses, (2) Adoption of the proposed international standard for small and medium-sized entities. This model is based on IFRS but modifies the reporting requirements, where appropriate, for the requirements of the small and medium-sized business community, and (3) Adoption of a version of IFRS that continues the Canadian practice of providing "differential reporting" options for companies based on the information needs of their shareholders.
In addition, see the comment letter filed by FEI Canada in Oct. 2007 on the AcSB's Invitiation to Commen on Financial Reporting by Private Enterprises.
9:49 AM by Edith Orenstein
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Feb 15, 2008
Regulatory Roundup: SEC XBRL Financial Explorer Released; PCAOB SAG Meeting Feb. 27; FASB Guidance Issued
Earlier today, the SEC announced the release of an interactive tool called the “Financial Explorer,” which the SEC says will, “help investors quickly and easily analyze the financial results of public companies.” Yesterday, the PCAOB announced the next meeting of its Standing Advisory Group (SAG) will take place on February 27. Separately, the FASB posted two final FASB Staff Positions (FSPs). Details follow.
SEC’s XBRL “Financial Explorer” Tool Released
The Financial Explorer launched today is the third in a series of tools relating to eXtensible Business Reporting Language (XBRL) made available on the SEC’s website. The earlier tools released include the SEC’s Executive Compensation viewer and the Interactive Financial Report viewer, all of which are available to the public at http://www.sec.gov/spotlight/xbrl/xbrlwebapp.htm .
SEC Chairman Christopher Cox noted in today’s announcement: “XBRL is fast becoming the universal language for the exchange of business information and it is the future of financial reporting.” He added, “With Financial Explorer or another XBRL viewer, investors will be able to quickly make sense of financial statements. In the near future, potentially millions of people will be able to analyze and compare financial statements and make better-informed investment decisions. That’s a big benefit to ordinary investors.”
David Blaszkowsky, Director of SEC’s Office of Interactive Disclosure, added, “Financial Explorer will help investors analyze investment choices much quicker. I encourage both companies and investors to visit the SEC Web site, try the software, and get a first-hand glimpse of the future of financial analysis, especially for the retail investor.”
For more news on XBRL, see the February 2008 Update issued by XBRL-US.
PCAOB Announces Feb. 27 SAG Meeting
The PCAOB released the agenda for its Feb. 27 Standing Advisory Group (SAG) meeting. Agenda topics (including links to briefing papers posted so far) will include:
Panel Discussion - CIFiR Proposal Relating to Judgments Made by Financial Statement Preparers and Auditors
Accounting Firms' and Auditors' Responsibility to Supervise,
Panel Discussion - Global Quality Control Practices, and
FASB Releases Final FSPs On….
Yesterday, FASB issued two final FSPs:
FSP FAS 157-1, “Application of FASB Statement No. 157 to FASB Statement No. 13 and Other Accounting Pronouncements That Address Fair Value Measurements for Purposes of Lease Classification or Measurement under Statement 13.”
FSP SOP 07-1-1, “Effective Date of AICPA Statement of Position 07-1.” SOP 07-1-1 is, "Clarification of the Scope of the Audit and Accounting Guide Investment Companies and Accounting by Parent Companies and Equity Method Investors for Investments in Investment Companies.”
We previously posted about FASB’s discussion when they voted on Feb. 6 to issue the two FSPs.
11:49 AM by Edith Orenstein
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Feb 14, 2008
SEC Chairman Asks Staff to Provide Recommendations After Studying CIFiR Report;Senate Banking Hearing on Economy Begins
Earlier today, SEC Chairman Christopher Cox, upon receiving the Progress Report of the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR), issued a statement saying he has asked SEC staff to review the report and it’s proposals, and to provide recommendations to the Commission for possible consideration later this year. He also noted his thanks CIFiR members for their diligent work, and looks forward to additional proposals and recommendations as it continues its work over the next few months. (CIFiR is scheduled to disband, according to its charter, on Aug. 2, 2008.) For additional background, see our earlier post summarizing CIFiR's Feb. 11 meeting.
Separately, as we told you earlier this week, the Senate Banking hearing on "The State of the U.S. Economy and Financial Markets" (video via C-SPAN) just began (shortly after 10am EST Feb. 14), featuring testimony from SEC Chairman Chrisopher Cox, Treasury Secretary Henry M. Paulson, and Federal Reserve Board Chairman Ben S. Bernanke. Perhaps some of the following topics will come up, noted in today's papers:
"A Labyrinthine Path to Justice: FBI, SEC Join Complex Probe of Housing Crisis," by Carrie Johnson in today's (Feb. 14) Washington Post. Johnson reports, "FBI officials said yesterday that they are conducting criminal investigations of 16 companies, while their partners at the [SEC] are probing nearly two dozen more. Those federal investigations follow subpoenas from attorneys general in at least four states and class-action lawsuits that target home builders, lenders, credit-rating agencies and the banks that packaged groups of mortgages into securities." Johnson also quotes FBI section chief Sharon E. Ormsby saying: "These are going to be complex investigations," and that 'policing mortgage and credit-related fraud is the "number one priority" of the FBI's financial crimes unit."
"Worried Bankers Seek to Shift Risk To Uncle Sam," by Damien Paletta in today's (Feb. 14) Wall Street Journal. Paletta reports: "One proposal, advanced by officials at Credit Suisse Group, would expand the scope of loans guaranteed by the Federal Housing Administration. The proposal would let the FHA guarantee mortgage refinancings by some delinquent borrowers....Another plan gathering support seeks to make it easier for banks to write off part of the unpaid balance on loans that exceed a property's value, people familiar with the matter said. If that happens, homeowners would owe less, and they might be able to refinance their loans and avoid foreclosure." Paletta says the government is open to considering proposals which it may not have in the past. He quotes FDIC Chair Sheila Bair saying, "Everybody is looking at everything... The door is not closed on anything."
10:22 AM by Edith Orenstein
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Feb 14, 2008
Foreign Filers:The SEC Giveth,The SEC Taketh Away;FASB on Pension Disclosures;FEI 'Respectfully Disagrees' With FAF Proposal
The SEC voted yesterday to propose a package of amendments to the rules for Foreign Private Issuers (FPI). As part of this package, the SEC will give FPIs the opportunity for to provide all-electronic filings (and take away the requirement for paper filings) with the SEC. At the same time, SEC is proposing to take away some time from the current six month filing deadline for FPIs to file annual reports on Form 20-F, by proposing to shorten that deadline to 90 days for large accelerated and accelerated FPIs. (Smaller FPIs would have 120 days in the proposal.) There will be a 60 day comment period on the proposals, commencing after publication in the Federal Register. Further details are in SEC's press release.
FASB Moving on Pension Disclosures, Bankruptcy Issue
On the FASB front, FASB voted yesterday to move ahead on the proposed amendment of FAS 132R, “Employers’ Disclosures about Pensions and Other Postretirement Benefits.” Staff said these amendments, to come in the form of a proposed FSP, are aimed at being responsive to users’ requests for more disaggregated information, and to incorporate some of the disclosures from FAS 157, Fair Value Measurement.
The proposed amendments to FAS 132R, as detailed in the board handout, would (1) provide a principle for disclosing categories of plan assets and specific examples of categories that an employer would provide in complying with the principle, (2) require further disclosure of categories or subcategories for concentrations of risk in plan assets, and (3) require certain disclosures about fair value measurements of plan assets similar to FAS 157.
The proposed FSP is expected by March 7, and the board agreed on a 45 day comment period. The proposed effective date will be fiscal years ending after Dec. 15, 2008. The board vetoed the staff recommendation for retrospective adoption, voting instead for prospective adoption, but asked staff to seek comment on that point in the proposed FSP.
Separately, also at yesterday's FASB meeting, the board agreed to amend AICPA SOP 90-7, “Financial Reporting by Entities in Reorganization Under the Bankruptcy Code,” to remove the requirement in the SOP for entities applying fresh-start reporting to early adopt new accounting standards that would result in a change in accounting principle in the emerging entity’s financial statements within 12 months following emergence.
FEI 'Respectfully Disagrees' With FAF Proposal To Reduce Size of FASB Board
FEI’s Committee on Corporate Reporting (CCR) and Committee on Private Companies (CPC) each filed comment letters in response to the Financial Accounting Foundation’s proposal (the "FAF proposal") to restructure the FAF, the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). The FAF oversees the two standard-setting boards.
The CCR letter, signed by CCR Chair Arnie Hanish, and the CPC letter, signed by CPC standards subcommittee chair Bill Koch, each supported the FAF engaging in an analysis of how it may improve the FAF’s and FASB’s governance, and the standard-setting process.
However, both of the FEI letters also raised significant concerns about the FAF’s proposed reduction in size of the FASB board from seven members to five, and about the FAF’s proposed simple majority voting (vs. super-majority voting) requirement, particularly in light of the proposed reduction in size of the board. See also these highlights from the FEI letters.
9:34 AM by Edith Orenstein
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Feb 12, 2008
SEC's Cox, Treasury's Paulson, Fed's Bernanke to Testify to Senate Banking;AIG's $4 Billion Loss; More Hope?;Lerach and Lincoln
SEC Chairman Christopher Cox, Treasury Secretary Henry M. Paulson, and Federal Reserve Board Chairman Ben S. Bernanke are scheduled to testify at a hearing of the Senate Banking Committee this Thursday on, “The State of the U.S. Economy and Financial Markets.” Concurrent with the Senate hearing, the House Financial Services Committee will hold a hearing on, “The State of the Bond Insurance Industry.” Panelists for the House hearing are not yet listed.
This Valentine’s Day treat follows on the heels of a plethora of negative economic news splashed throughout today’s papers, including a $4 billion mortgage-related asset writedown at AIG related to the value of credit default swaps.
A new initiative announced today (Project Lifeline) by the U.S. Treasury-encouraged “Hope Now” alliance was panned by Senate Banking Chair Chris Dodd.
In other news, former class action king William Lerach was sentenced to two years in prison.
As I write this, on Feb. 12, the birthday of our 16th President, Abraham Lincoln, I was wondering what Lincoln would have said about today's challenges, like the housing crisis and perhaps Lerach’s situation. Read more below and find out.
AIG’s $4 Billion Loss Amidst Material Internal Control Weakness; Related Audit Literature
AIG had previously estimated a writedown relating to mortgage backed assets and derivatives of $1 billion, but disclosed the step-up in the writedown yesterday (Feb. 11), along with the fact that a material weakness in its internal control was identified by its auditor, PricewaterhouseCoopers (PwC). Further details are in: “AIG is Forced to Write Down Mortgage Links” by Liam Pleven and David Reilly in today’s Wall Street Journal. Susan Mangiero also wrote about this saga in her Pension Risk Matters blog, in a post entitled, “AIG Auditors 1, Traders 0 – Round 1.”
Regarding the intersection of accounting and auditing in the AIG-PwC matter, WSJ’s Pleven and Reilly note, “The accounting firm’s actions are in line with a push by auditors to force companies to use market value for securities they hold even if there is little trading going on.” They add, “The practice is at odds with executives who say they believe that it would be better to look to the long-term value of securities rather than at distressed prices being thrown out by markets that in many cases have ceased functioning.”
If you’re looking for auditing and regulatory literature behind the “push by auditors to force companies to use market value” for thinly traded securities, discussed by WSJ’s Pleven and Reilly, here’s a place to start: “Center for Audit Quality (CAQ) Issues White Papers on Illiquidity in the Markets” (Oct.3, 2007), and “PCAOB Issues Staff Audit Practice Alert on Fair Value” (Dec. 10, 2007).
Regulatory guidance specific to modifications of subprime mortgages under a framework adopted by the American Securitization Forum in furtherance of the U.S. Treasury Department – encouraged “Hope Now” alliance of mortgage servicers, investors and lenders in working out solutions for struggling subprime borrowers came in the form of this letter from SEC Chief Accountant Conrad Hewitt issued to FEI Committee on Corporate Reporting Chair Arnold Hanish and CAQ Professional Practice Executive Committee Chair Sam Ranzilla. The letter said the SEC will not object to continued off-balance sheet treatment of certain modifications, even for mortgages securitized under a Qualified Special Purpose Entity (QSPE) structure, under FAS 140, which deals with sales and transfers of assets.
Project Lifeline Announced by Hope Now Alliance and Six Mortgage Servicers is Not Enough, Says Dodd
Earlier today (Feb. 12) U.S. Treasury Secretary Henry M. Paulson announced a new initiative led by Hope Now, in which six of the largest mortgage servicers have joined together in support of an initiative called “Project Lifeline” to workout troubled mortgages that are 90 days past due. Significantly, Project Lifeline will apply to any mortgage holder, not only subprime mortgage holders, said Paulson. Specifically, as noted in this Overview, Project Lifeline will “giv[e] homeowners a simple “step-by-step” approach that, if followed, may enable them to “pause” their foreclosure for 30 days while a potential loan modification is evaluated.”
Senator Chris Dodd, Chair of the Senate Banking Committee set to host Paulson, Cox and Bernanke later this week, responded to the Project Lifeline initiative by calling it “a step in the right direction,” but saying it “will not stem the tide of the millions of foreclosures we are facing in the coming months.”
“We need bold ideas to address these problems,” said Dodd, “whether it is along the lines of the Homeownership Preservation Corporation I've suggested, or whether we can use existing entities like the Federal Housing Authority or Government Sponsored Enterprises such as Fannie and Freddie to get to the same goal. Regardless, it's clear we need to move faster and more aggressively to combat this problem and keep Americans in their homes.”
In other news, indicted class action lawyer William Lerach, who plead guilty to kickbacks paid to plaintiffs to bring cases, was sentenced yesterday (Feb. 11) to two years in prison, as noted by Professor Peter J. Henning in the White Collar Crime Prof Blog.
See also: “Closing Argument: Mr. Lerach Mulls Time Behind Bars” – subtitled: “Guilty but Defiant, The Plaintiffs' Lawyer Kicks Back in La Jolla,” by Peter Lattman, in today’s Wall Street Journal.
In honor of former President Abraham Lincoln’s birthday (Feb. 12), we thought we’d see what sage advice he would have had about today’s challenges, like the subprime market and some of the shadier sides of the plaintiff’s bar.
On the topic of housing, Lincoln said in 1864, as noted in “Abraham Lincoln’s Famous Quotes” gathered by G. Stolyerov II, published in the online community, Helium, “Property is the fruit of labor...property is desirable...is a positive good in the world.” He added, “Let not him who is houseless pull down the house of another; but let him labor diligently and build one for himself, thus by example assuring that his own shall be safe from violence when built."
Lincoln, widely admired as one of our greatest Presidents not only for truly pulling himself up by the bootstraps from humble beginnings, but also for his great leadership and sense of fairness in advocating against slavery and for our country to be unified, practiced law before he became President, as noted in “The Law Practice of Abraham Lincoln,” and more fully described in “Historical Introduction: the Lincoln Legal Papers Project,” both part of “The Model Editions Partnership-Historical Editions in the Digital Age” initiated at the University of South Carolina.
Perhaps another one of Lincoln’s quotes could have helped lawyer Lerach, the now dethroned king of class action law as some have come to refer to him.
"Discourage litigation,” said Lincoln in 1850, as cited in “Abraham Lincoln’s Famous Quotes” “Persuade your neighbors to compromise whenever you can. Point out to them how the nominal winner is often a real loser - in fees, expenses, and waste of time. As a peacemaker the lawyer has a superior opportunity of being a good man. There will still be business enough."
About this Blog…
Now, I hope I don’t get emails from mobile device users saying that this posting interrupted their enjoyment of American Idol (which I too am a fan of, as I have noted in this blog in the past.) If it did, maybe you’d be interested in: “Survey Shows Americans Increasingly Addicted to Mobile Email,” posted by Ed Hardy on Brighthand.com in August 2007, about an AOL-Opinion Research Corporation survey which found: “Fifty-nine percent of people emailing from portable devices are checking email in bed while in their pajamas; 53% in the bathroom; 37% are checking email while they drive; and 12% admit to checking email in church.” Additionally, the survey said, “Forty-three percent of email users with portable devices say they keep the device nearby when they are sleeping to listen for incoming mail.”
With that in mind…. You may be interested in knowing that we normally post once a day to the FEI blog, usually in the morning, but occasionally later in the day (or evening). If you received this post from ‘a friend’ and would like to receive emails of our blog posts real time, enter your email address here.
9:33 PM by Edith Orenstein
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Feb 11, 2008
CIFiR Votes To Issue Draft Progress Report To SEC, Will Seek Public Comment
Moments ago the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR, also called the Pozen committee for chair Robert Pozen) voted to release its progress report containing 12 ‘developed proposals’ (and additional ‘conceptual approaches’ and ‘matters for further consideration’ that are not yet ‘developed proposals’) by issuing it, in the next few days, to the SEC Chairman. SEC staff told the committee the report will be posted on the SEC website and published in the Federal Register for public comment (they did not say what the comment period would be).
There were minor changes to the report voted on today, (a 'revised' draft progress report was posted today by the SEC, marked for some, but not all, revisions) and SEC staff said the report (including all edits, for typos as well) should be posted within a few days.
The report will include the dissenting statement of Peter Wallison (dissenting statement is included in the Draft Progress Report, plus this addendum) to the committee’s XBRL recommendation. However, the committee voted against a proposed amendment presented by Wallison. Wallison was concerned that the committee’s recommendation that the SEC mandate XBRL over the long term, require XBRL to initially be furnished, not filed, and require it not have auditor assurance until further info about cost of that assurance were available, would unduly restrict the SEC.
CIFiR member Jeff Diermeier asked the SEC staff present if CIFiR’s recommendation regarding XBRL would in any way restrict the SEC.
Corp Fin Director John White responded, “I don’t think there are any restrictions here, I do think we could move more quickly, and very well [may].”
CIFiR’s next meeting will be March 13-14 (we understand it will be a full committee meeting held in San Francisco); [CORRECTION, we originally posted the March meeting would be held in NYC] Pozen also mentioned CIFiR currently plans to meet in July in New York City. Further details on future meetings will be forthcoming.
The final report due in August, said Pozen, will include a review of the progress report, an update on any discussions with FASB, SEC or PCAOB staff, and may incorporate changes to the recommendations based on comment letters or testimony received on the progress report. It will also include any additional developed proposals that may result from further development of what are currently described in the progress report as ‘conceptual approaches’ and ‘matters for further consideration”
3:25 PM by Edith Orenstein
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Feb 11, 2008
Observations on SEC CIFiR's Professional Judgment Framework
In reading the discussion of the Professional Judgment Framework contained in the Feb. 11 Draft Progress Report (DPR) of the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFiR or the ‘Pozen Committee’ for its chair, Robert Pozen), scheduled to meet later today to vote out issuing the DPR to the SEC and likely for public comment, I made six observations.
As background, CIFiR recommends that the SEC (and PCAOB) recognize a professional judgment framework applied by auditors and preparers, so as not to necessarily have a knee-jerk reaction that if one person’s (e.g. an auditor vs. preparer, or a regulator vs. auditor/preparer) judgment differs, that their judgment is necessarily the one and only ‘correct’ judgment. Thus, CIFiR recommends: (in ‘developed proposal 3.4’):
The SEC or its staff should adopt a judgment framework for accounting judgments.
The SEC or its staff should also encourage the PCAOB to consider similar action with respect to auditing judgments.
Careful consideration should be given in implementing any framework to ensure that the framework does not limit the ability of auditors and regulators to ask appropriate questions regarding judgments and take actions to require correction of unreasonable judgments.
The proposed framework applicable to accounting-related judgments would include the choice and application of accounting principles, as well as the estimates and evaluation of evidence related to the application of an accounting principle.
CIFiR also takes the initiative in outlining in the DPR what such a professional judgment framework would look like, by defining a nine component list of items that demonstrate professional judgment, and referencing recommendations for contemporaneous documentation.
Following are my six observations on CIFiR’s proposed professional judgment framework.
1. Not a Safe Harbor
The DPR states: “Some have proposed that a “safe harbor” be developed that protects the exercise of judgment in accordance with a specified framework. That approach would seem to provide greater support to auditors and preparers than a statement of policy.” The DPR continues, “However, it is unclear to us whether a legal or regulatory safe harbor (i.e., an effective legal or regulatory defense based on conformity with the framework) could be adopted by the SEC or whether it would require changes to existing statutes.”
In contrast to a ‘safe harbor,’ CIFiR states, “Another approach is for the SEC and the PCAOB to issue policy statements that describe a framework for the exercise of professional judgment and state that auditors, the SEC or the PCAOB, as applicable, would take into account the implementation of the framework in evaluating a judgment made by a registrant or an auditor.” “The SEC has utilized similar frameworks in the past with success,” says CIFiR, specifically citing the framework contained in “the [SEC’s] “Seaboard” report (October 23, 2001) on the relationship of cooperation by a company to taking action in an enforcement case and the SEC’s framework for assessing the appropriateness of corporate penalties (January 4, 2006).”
Although the DPR presumes “regulators would strongly support the principles of this framework,” the framework would not tie the hands of auditors or regulators – i.e. would not necessarily be a safe harbor. The DPR states: “the mere completion of the process outlined in the framework in making a judgment would not prevent an auditor and/or regulator from asking appropriate questions about the judgment or asking companies to correct unreasonable judgments.A new paragraph added to CIFiR’s Feb. 11 DPR, replacing a similar sentence that previously appeared in the Jan. 11 DPM, states: “It is unclear to us whether, as a matter of regulatory strategy, this judgment framework should be implemented through a safe harbor or policy statement. We leave to the SEC and its staff the resolution of these difficult issues
2. Framework would need to be ‘fully’ implemented to gain support of auditors, regulators; a ‘rigorous process’
CIFiR states: “While not an automatic defense of the registrant’s or auditor’s judgment, a framework would provide more support to registrants and auditors that the applicable regulator would be likely to accept a judgment made if the registrant or the auditor had fully implemented the framework.” Also, CIFiR states, “The framework is likely to enhance the quality of judgments by providing incentives to follow a rigorous process for making accounting and auditing judgments. The increased use of this rigorous process should, in turn, provide more comfort to investors about the quality of accounting judgments made in connection with financial statements.” Note the term: ‘fully’ implemented the framework, (and the term ‘rigorous process’), and consider the word ‘fully’ vis-à-vis the nine-point checklist and disclosure requirements contained in CIFiR’s professional judgment framework. I wonder what former SEC Commissioner Joe Grundfest, a member of CIFiR, (and maybe a member of its Audit Process and Compliance Subcommittee) thinks about use of the word ‘fully’ in the DPR’s description of how CIFiR’s professional judgment framework should be applied? Grundfest was very good at pointing out how a single term in PCAOB Auditing Standard No. 2 (AS2) - the standard for internal control audits criticized as being too prescriptive, replaced last year by AS5 – was the focal point of the problem with AS2. In his paper on “Fixing 404,” Grundfest highlighted the fact that the term “more than remote” used to define material weaknesses in internal control was too low of a threshold. I wonder if he fully agrees with use of the term ‘fully’ above, which would seem to imply the need to comply with all nine components in the checklist proposed by CIFiR, and the related documentation requirements. Also, how does the word ‘fully’ impact the ability of auditors and regulators to apply their own ‘professional judgment’ based on materiality of a particular issue for which the preparer’s judgment is being questioned – say, if 8 of the 9 points in the checklist were followed?
And, do all the points in SEC’s Seaboard memo or the SEC’s corporate penalty policy cited by CIFiR have to be ‘fully’ implemented for companies to get ‘credit’ as far as potential enforcement proceedings? Maybe some lawyers can share their insights on this point by posting a comment to this blog post or emailing me their thoughts to share.3. Judgment needs to be applied by company personnel who are “Appropriately… objective”
Another major question about potentially overly prescriptive terminology in CIFiR’s professional judgment framework which I would pose for consideration, relates to the terms “appropriate” and “objective” in the first sentence appearing under the subheading “The Concept of Professional Judgment” in the framework. Specifically, the sentence says: "Professional judgment, with respect to accounting matters, should be the outcome of a process in which a person or persons with the appropriate level of knowledge, experience, and objectivity form an opinion based on the relevant facts and circumstances within the context provided by applicable accounting standards.” I wonder how prescriptively the assessment of the ‘appropriate’ level of knowledge, experience and objectivity’ will be applied to initial judgments made in the field real time at the transaction level, or if it will appear to require ‘objective’ internal auditors (which not all companies, particularly small companies, have) or 3rd party consultants to come in at the transactional level who are deemed “objective.” (Although, engagement of a third party would not always be required, as footnote 60 in CIFiR’s DPR states: “In many cases, input from professional experts would include consultation with a preparer’s independent auditors.”)
However, the wording of the sentence cited above regarding appropriate knowledge, experience and objectivity sounds like it may have been lifted from an auditing standard (and possibly, and internal audit standard) as to characteristics an independent auditor (who by definition is supposed to be objective) should bring to an audit, rather than a standard aimed at preparers.
Some may sense déjà vu on this point relating back to PCAOB’s proposed standard on use of work of others, which was ultimately dropped and instead addressed directly in AS5, as well as some of the language in COSO’s Discussion Document on Monitoring Internal Control. (COSO is presently working toward release of the next phase document on Monitoring – an Exposure Draft.)
On balance, some of the above concerns may be partially blunted by the fact that CIFiR also states in the Feb. 11DPR: “In applying the components of the framework, it would be expected that the amount of documentation, disclosure, input from professional experts, and level of effort in making a professional judgment would vary based on the complexity, nature (routine versus non-routine) and materiality of a transaction or issue requiring judgment. “
4. Lack of contemporaneous documentation would ‘complicate’ matters
CIFiR also points out in the Feb. 11 DPR in a paragraph in the professional judgment section that begins with the bold word, “Documentation,” that although they recommend ‘contemporaneous’ documentation take place, “The lack of contemporaneous documentation may not mean that a judgment was incorrect, but would complicate an explanation of the nature and propriety of a judgment made at the time of the release of the financial statements.” What does ‘complicate’ mean in the above cite? Some may ask if ‘complicate’ implies adding hours or dollars to the audit, or may imply other things with respect to regulatory review/action. 5. No diversity in practice, harder to defend an alternative
With regard to selection of accounting alternatives and estimates, point number 7 of CIFiR’s nine proposed components of a professional judgment framework cites to footnote 61 in the DPR which states: “If there is not diversity in practice, it would be significantly harder to select a different alternative.” I wonder if this would be problematic particularly for new types of transactions for which there is a limited known universe of practice, and also even for more established transactions where more than one answer may be deemed a reasonable alternative.6. “Analysis” of the transaction, and “Thorough review and analysis” of relevant literature require
It will be interesting to see how people will interpret what is required by an ‘analysis’ of the transaction (point 1 in CIFiR’s proposed nine component framework) and a ‘thorough review and analysis’ of relevant literature (point 3 in their framework) require.
The points above are my personal observations only. In sum, preparers and others may want to focus very carefully on the specifics of CIFiR’s proposed nine component framework and related documentation requirements in evaluating the potential benefits or drawbacks of CIFiR’s proposed professional judgment framework contained in its Feb. 11 Draft Progress Report (DPR).
9:24 AM by Edith Orenstein
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Feb 8, 2008
SEC's Cox Says Rulemaking Coming on IFRS, XBRL, Credit Rating Agencies; Risk Assessment Staff To 'More Than Double'
In a speech earlier today, SEC Chairman Christopher Cox gave some of his most direct comments yet - using the 'r' word (rulemaking) and the 'p' word (proposal) - on upcoming initiaves relating to IFRS, XBRL, and Credit Rating Agencies. His remarks were given at the Practicing Law Institute's (PLI's) 'SEC Speaks' conference. Specifically, Cox said:
IFRS: “In 2008, the Division of Corporation Finance and the Office of the Chief Accountant, led by Wayne Carnall and Julie Erhardt, will formally propose to the Commission an updated "roadmap" that lays out a schedule, and appropriate milestones on which the schedule will be conditioned, for continuing the progress that the United States is making in moving to accept IFRS in this country.”
XBRL: “In 2008, following years of evaluation and experience through the SEC's voluntary XBRL pilot program, the Commission will consider a rule for the use of interactive data by U.S. reporting companies that will parallel efforts already underway in other countries.”
Credit Rating Agencies: “The Division of Trading and Markets, under the leadership of Tom McGowan and Mike Macchiaroli, will lead the way with proposals for new, more detailed rules under the new Credit Rating Agency Reform Act that respond directly to the shortcomings we have seen through the subprime experience. Among the proposals that the Commission may consider in the spring are rules that would require credit rating agencies to make disclosures surrounding past ratings in a format that would improve the comparability of track records and promote competitive assessments of the accuracy of past ratings. In addition, the Division may propose rules aimed at enhancing investor understanding of important differences between ratings for municipal and corporate debt and for structured debt instruments.”
Cox also referenced a recent speech by Corp Fin Director John White, which details Corp Fin’s financial reporting initiatives planned for 2008 (FEI summary here).
Among areas being looked at by enforcement, Cox indicated enforcement actions – including relating to accounting and disclosure - may be forthcoming relating to the current subprime crisis. He noted the formation of the Subprime Working Group (also called Subprime Task Force) within the Commission.
“The subprime crisis and its still-unpredictable consequences present immediate problems for both the United States and global markets,” said Cox. “We've already launched an initiative in this area to investigate possible fraud or breaches of fiduciary duty involving collateralized debt obligations. Among the issues confronting us this year will be determining whether bank holding companies and securities firms made proper disclosure in their filings and public statements of what they knew about their CDO portfolios and their valuations. We'll determine whether brokers carefully followed suitability requirements when they sold complex debt-related derivatives that shortly afterward went bad. And in this area, as elsewhere, we'll be investigating whether unscrupulous insiders used non-public information to bail out of these securities or to sell them short, in violation of the securities laws. Our subprime working group, led by Cheryl Scarboro, is well underway with these investigations.”
He added, “There are also significant accounting questions in the subprime area, such as when off-balance sheet CDO-related liabilities will be forced back on to a sponsor's balance sheet. For these reasons, the Office of the Chief Accountant is also a key member of the [Subprime] Task Force.” In addition, he noted, “The adequacy of public company disclosure surrounding these issues is a key focus for the Division of Corporation Finance, and so they too are important participants. We've had to rely heavily on the expertise of the Division of Investment Management as well on questions including the impact on money market funds, and the Office of the General Counsel is consulted on a daily basis on close questions of law in each of these areas. Each of the heads of these Divisions and Offices is therefore also a member of the SEC's Subprime Task Force, which is truly an ambitious organizational response to the entire spectrum of subprime issues.”
Risk Assessment Staff to be "More Than Doubled"
Additionally, Cox noted the SEC plans to "more than double" professional staff devoted to risk assessment in support of the Commissions surveillance and enforcement efforts.
Specifially, he said, "This coming year will also see the inauguration of a major initiative to knit together the agency's resources in another area: the identification of market risks and dangerous illegal practices before they metastasize into truly lethal consequences for investors. This year, the Office of Risk Assessment — an important addition to the Commission's structure under the leadership of former Chairman Bill Donaldson — will be significantly expanded to provide resources and analytical support to the Divisions of Enforcement, Trading and Markets, Investment Management, and Corporation Finance, as well as the Office of the Chief Accountant and the Office of Compliance Inspections and Examinations. Our 2008 management plan will more than double the professional staff devoted to the vital function of looking around the corners and over the horizon, so that the SEC's efforts will not always be focused on the money that got away, and the lessons of the last major scandal. With the brainpower of nine men and women and the latest quantitative and analytical surveillance tools, the significantly expanded Office of Risk Assessment will help direct agency resources to where they can do the most preventative good."
Additional details can be found in Cox’s speech.
2:48 PM by Edith Orenstein
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Feb 8, 2008
An Extraordinary Book: Worldcom Whistleblower Cynthia Cooper's 'Extraordinary Circumstances;' Update On Treasury ACAP
Today (Feb. 8) is the official publication date of an extraordinary book for anyone interested in corporate intrigue, financial reporting and auditing, and fraud detection: WorldCom whistleblower Cynthia Cooper’s book: “Extraordinary Circumstances,” published by Wiley. FEI is proud to offer sales of Cooper’s book through our Financial Executives Research Foundation (FERF), where you can order the book here.
What’s great about this book is it’s not just for people who are trained in accounting, auditing or securities law, but is a parable for all professions and roles in life about when to ask questions and not walk away from something that doesn’t seem right.
Not everyone is as brave as Cooper, who spends significant time in her book not only unraveling the tale of WorldCom’s fraud and her role in detecting and ‘outing’ it, but also the personal toll it took on her life.
“I had done what I believed was right,” says Cooper, “but there’s an emotional and physical price.”
Cooper had shared some of this tale as a keynote speaker at FEI’s Current Financial Reporting Issues Conference (CFRI) in November. For the whole story, read her book, I highly recommend it.
Update on Treasury ACAP
We told you earlier this week the Treasury Department posted the written statements provided to its Advisory Committee on the Auditing Profession (ACAP) which met on Feb. 4. The webcast was posted a couple of days ago.
AccountancyAge has a good summary of some highlights of the Feb. 4 ACAP meeting in the article: “Levitt Committee Mulls Audit Changes in U.S.” by Penny Sukhraj.
9:13 AM by Edith Orenstein
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Feb 7, 2008
SEC To Consider FASB Funding, FPI Matters Next Week; FASB Grants Partial Delay of Fair Value Std; FEI-Baruch CFO Outlook Survey
In a Sunshine Act notice issued yesterday, the SEC announced it will meet on Feb. 13 to decide on a package of proposals relating to foreign private issuers (FPIs), including “change the deadline for annual reports filed by [FPIs],” and “revise the annual report and registration statement forms used by [FPIs] to improve disclosure.”
Change in 20-F Filing Deadline for FPIs May Be Proposed
Corp Fin Director John White foreshadowed upcoming actions regarding FPIs in his remarks at the Securities Regulation Institute last month. After listing a number of rule changes pertaining to FPIs the SEC may pursue, including the definition of FPIs, White said: “Another… area where change may be warranted, is the annual report filing deadline for foreign issuers. In this regard, the Commission has sought comment on advancing the six-month Form 20-F filing deadline several times since the late 1970s, most recently in connection with the IFRS proposing release.”
Presumably, the SEC is considering tightening up the six month deadline for 20-Fs, to bring it closer to the deadline for U.S. co’s to file their 10-Ks.
White noted in his remarks, “Though I cannot predict what may be proposed here, much less adopted, I will note that when the accelerated filing deadlines for U.S. issuers were implemented a few years ago, they were phased in gradually — I would think that a similarly measured approach could be appropriate here.”
We summarized key points from White’s speech on Corp Fin’s agenda for 2008 here.
SEC To Consider FASB Annual Support Fee
Another matter on the SEC’s open meeting agenda Feb 13, states the Sunshine Act Notice, will be review of the FASB’s annual accounting support fee, as required under Section 109 of the Sarbanes-Oxley Act. Additional matters are also listed on the notice.
FASB Votes To Finalize Its Partial Delay of FAS 157, Fair Value Measurement
FASB voted at its board meeting yesterday that staff can proceed to draft a final FASB Staff Position (FSP) based on proposed FSP FAS 157-b, the partial deferral of the effective date of FAS 157, Fair Value Measurement, for certain nonfinancial assets and liabilities. The board agreed the deferral will apply to public and private companies, and approved what the staff described as nonsubstantive drafting changes to the proposed FSP. Staff will provide the board with a written ballot on the final FSP.
FASB’s vote was responsive to earlier requests from three FEI committees (Committee on Corporate Reporting (CCR), Committee on Small and Mid-Size Public Companies, and Committee on Private Companies standards subcommittee), and others, to provide this delay.
In related action, FASB also discussed comments received on proposed FSP FAS 157-a, the scope out of leasing (FAS 13) from FAS 157. The board agreed staff can proceed to a ballot draft on the final FSP. As shown in the board handout, a number of comment letters on the proposed FSP asked for clarification of the scope of the proposed FSP with respect to certain other standards, specifically FAS 144 (Impairment or Disposal of Long-lived Assets), FAS 146 (Costs Associated With Exit or Disposal Activities), and FIN 21 (Accounting for Leases in a Business Combination) - and by extension FAS 141 and 141(R) (Business Combinations). The board agreed that this particular FSP should not scope out the leasing implications from those other standards (other than FAS 13), although the board may consider at a future date whether to add a project relating to FAS 141R in connection with this discussion.
FASB Votes To Finalize Guidance on Investment Companies
Also at yesterday's board meeting, FASB discussed proposed FSP SOP 07-1-a, “Effective Date of AICPA Statement of Position 07-1” (SOP 07-1), relating to Investment Companies.
FASB voted that the final FSP will essentially indefinitely defer the effective date of AICPA SOP 07-1, but will allow early adopters to continue to apply it, and will also give early adopters the option to rescind their adoption. The final FSP will not allow any other entities to adopt AICPA SOP 07-1 at this time. FASB also voted to add the following requirement to the final FSP: “If a parent that early adopted the SOP chooses not to rescind its early adoption, an entity consolidated by that parent that is formed or acquired after the parent’s adoption of the SOP must apply the provisions of the SOP in its standalone financial statements.” Staff will continue to work on wording regarding the effective date of the FSP.
Economy Top Election Issue, Says FEI-Baruch Survey; CFOs Back Recommendations To Stop Quarterly Earnings Guidance; Some Favor Semi-Annual Financial Reporting
The CFO Outlook Survey for 4th quarter 2007, released January 30, conducted jointly by Financial Executives International (FEI) and Baruch College shows CFO confidence in the economy plummeted to a level 19% lower than a year ago, and almost three-quarters of the CFO’s said the economy is the number one issue to them when evaluating U.S. Presidential candidates.
Among other items of interest, 81% of CFOs reported they support recommendations of various committees studying competitiveness and others to discontinue quarterly earnings guidance (i.e., estimates or forecasts).
Separately, 60% of CFOs said they would support a move to semi-annual (the U.K. model) vs. quarterly reporting (the U.S. model).
Both of those concepts have been raised to address concerns about an overly short-term focus of investors and others on financial results (vs. a long-term focus), which some have said also pressures companies toward earnings management.
Detailed CFO Outlook survey results and archived results are available at http://www.cfosurveys.com/. You can also listen to a podcast of the Baruch Business Report featuring John Elliott, Dean of Baruch’s Zicklin School of Business, and Terrence Martell, Saxe Professor of Finance and International Business in Baruch’s Zicklin School of Business, discussing the implications of the survey results.
10:24 AM by Edith Orenstein
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Feb 6, 2008
SEC 'Complexity' Committee Posts 'Draft Progress Report" To Be Voted on Feb. 11, With a Dozen Rec's; Treasury ACAP News
Yesterday (Feb. 6) the SEC's Advisory Committee on Improvements to Financial Reporting (CIFiR) - also referred to as the ‘complexity committee’ or the ‘Pozen committee’ for its chair, Robert Pozen - posted CIFiR’s Draft Progress Report on which CIFiR will vote February 11 whether to issue the report to the SEC. The Feb. 11 Draft Progress Report contains a dozen recommendations (‘developed proposals’ or formal recommendations), as well as additional ‘conceptual approaches and matters for future consideration’ which it will continue to discuss before making formal recommendations.
The 12 recommendations in CIFiR's February 11 Draft Progress Report are virtually identical to those that appeared in their January 11 Draft Decision Memo, which were unanimously adopted by CIFiR except for the recommendation regarding mandating eXtensible Business Reporting Language (XBRL), on which there was one dissenting vote (Peter Wallison of the American Enterprise Institute, who is a member of the board of XBRL-US). The February 11 Draft Progress Report includes a separate statement from Wallison on that point.
Upon a quick review, the only differences I noted in the wording of the recommendations in the two draft reports (January 11 Draft Decision Memo vs. February 11 Draft Progress Report) are:
there is one less ‘developed proposal’ listed (former developed proposal 3.5) regarding encouraging the SEC to accept a certain level of diversity in practice particularly on new Generally Accepted Accounting Principles (GAAP), and remainder of that proposal regarding post-adoption review of new standards has been incorporated into another developed proposal. Thus, there are 12 proposals total, vs. 13 in the earlier draft.
additionally, there are some wording changes to the developed proposal on mandating XBRL, specifically, the February 11 version inserted the word ‘over the long term” immediately after recommending that the SEC mandate XBRL.
If upon further review I note additional significant differences in the way the recommendations appear in the two versions of CIFiR's draft report I will update this post.
Treasury ACAP Posts Written Statements From Feb. 4 Meeting
Separately, the Treasury Department's Advisory Committee on the Auditing Profession (ACAP) has posted the written statements received by those testifying at its Feb. 4 meeting at USC. In spite of the recent claim in a GAO report there is not a need to address audit firm concentration and competion - in part due to a lack of consensus on how to deal effectively with the issue, a variety of views were stated on this issue in the written statements presented to ACAP.
9:13 AM by Edith Orenstein
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Feb 4, 2008
Christopher Cox, Cartographer: SEC Chairman Says Roadmaps to U.S. Adoption of IFRS, XBRL Coming in 2008
In remarks before the European-American Business Council (EABC) on Feb. 1, SEC Chairman Christopher Cox - who prior to coming to the SEC served as a member of Congress and in the private practice of law - made known his interest in cartography.
Specifically, he announced: “This year, the Commission will consider how we will map the future for U.S. firms and International Financial Reporting Standards [IFRS].”
Also slated for the Cox Global Positioning System (GPS), shall we call it, will be XBRL. “In the coming months," he told EABC, "the Commission will consider laying out a roadmap for the adoption of interactive data by U.S. reporting companies.” Cox added the SEC’s roadmap for interactive data – specifically, eXtensible Business Reporting Language (XBRL) – “will parallel efforts in other countries that are helping make our capital markets truly global and interconnected.” [In related news, XBRL-US, author of the U.S. GAAP XBRL taxonomies (data tags), announced its 2008 board members. Congratulations to FEI member Taylor Hawes, Controller Global Platforms and Operations, Microsoft, who is among the new members of the XBRL-US board! Hawes currently chairs FEI's Committee on Finance and Information Technology (CFIT).]
Cox' remarks about the SEC's IFRS and XBRL initiatives were part of his acceptance speech on receiving the EABC’s Atlantic Leadership Award. The co-recipient of this year’s award was European Union Internal Markets Commissioner Charlie McCreevy.
A third initiative this year, which Cox termed “the most significant initiative … when it comes to building a common U.S.-EU capital market,” will be the continued “pursuit of mutual recognition of high quality securities regulation.”
Specifically, as noted in this press release issued by the SEC on Friday, Cox and McCreevy have: “agreed that the goals of a mutual recognition arrangement would be to increase transatlantic market efficiency and liquidity while enhancing investor protection.”
The benefits of mutual recognition of EU and U.S. (SEC) securities regulation, continues the press release, “would have the potential to facilitate access of EU and U.S. investors to a broader and deeper transatlantic market, increase the availability of information about foreign investment opportunities, promote greater diversification of securities portfolios, significantly reduce transatlantic trading and transaction costs, and increase oversight coordination among regulators.”
“Without prejudice to their respective domestic processes," adds the announcement, "Chairman Cox and Commissioner McCreevy jointly mandated their respective staffs to intensify work on a possible framework for EU-US mutual recognition for securities in 2008.”
Props to Rachel McTague and Richard Hill who noted Cox’ speech in their article, “SEC Chairman Cox Says Agency Has Placed Accounting Convergence on Agenda for 2008,” in today’s BNA Daily Report for Executives.
FEI June 5 Conference: “The World Is Moving To IFRS – Are You?”
Have you noticed the SEC in the last six months or so has subtly changed the way it highlights its IFRS roadmap efforts by changing the reference in the “Spotlight” bar (on the lower left-hand side) of the SEC's homepage of http://www.sec.gov/ from “International Financial Reporting Standards” - which sounds like something other than ‘domestic’ or U.S. oriented – to “Global Accounting Standards” - which sounds like something we can all sit around the global campfire together and sing about? [Maybe its time to bring back “I’d Like to Teach The World To Sing in Perfect Harmony” – which was the #1 hit song in the U.K. and #7 in the U.S. back in 1971 (according to wikipedia). Some of our readers may recall the song was originally written as a commercial for Coca Cola, and if you’re really nostalgic see this cite by the Library of Congress, or the website of The New Seekers, The song was perhaps an early precursor to Band-Aid’s “Feed the World” in 1984 and USA for Africa’s “We Are The World” in 1985.]
Getting back to 2008 and the rapid movement toward one set of global accounting standards… part of the reason why SEC Chairman Christopher Cox stated in his Feb. 1 remarks that the SEC will “map the future for U.S. firms and IFRS” this year, is because, as noted separately by Wayne Carnall, Chief Accountant in the SEC’s Division of Corporation Finance, during the SEC’s Dec. 17 roundtable on IFRS, “IFRS is used in 100 countries around the world, by some of the largest corporations in the world, I dare say probably half of the global Fortune 500 is using IFRS, [and] a large portion of those companies have subsidiaries in the U.S.” Additionally, the Chairman of the U.S. Financial Accounting Standards Board (FASB), Robert Herz, has also stated publicly – beginning with his remarks at FEI’s Global Financial Reporting Convergence Conference in September, 2007, and continuing in various venues, including in testimony before the Securities subcommittee of the Senate Banking Committee in November, 2007, that the one set of global standards the world is moving to is IFRS - and that he would endorse a move to IFRS in the U.S., under certain circumstances, including sufficient consideration for infrastructure issues applicable to the IASB and global interpretations, enforcement and oversight, as well as sufficient consideration for transitional issues in the U.S. Herz has been a strong proponent of establishing a roadmap with a date certain for implementation of IFRS in the U.S., as noted here.
Where does your company (or audit firm, or you as an investor or other interested party) stand, in this time of increasing globalization and the potential movement to IFRS in the U.S.? Would you like to find out more about IFRS to help you decide whether or not (if the SEC permits IFRS as an option) or when to move to adopt it (prior to any potential mandatory date, if it is mandated)?
Continuing to show a leadership role in educating its members and other interested parties on IFRS, Financial Executives International (FEI) is hosting a conference on IFRS June 5, 2008 in New York City. FEI's June 5 conference, “The World Is Moving to IFRS – Are You?” will provide the opportunity for you to learn more about the major differences between IFRS and U.S. GAAP, advantages and challenges in reporting in IFRS, and how world-class companies have made the move, or plan to make the move, to IFRS. Additionally, there will be a status update from SEC staff on their IFRS roadmap for potential adoption of IFRS in the U.S. A second day ‘deep dive’ with more detailed instruction on IFRS may also be added (separate registration fee required). Check back to the above link on FEI’s website for updates as more details are added regarding this conference, or feel free to contact me if you have any questions about the program.
Welcome new readers…
We always welcome new readers to the FEI Financial Reporting Blog. If you received this post from ‘a friend’ and would like to receive our blog emails real-time, just enter your email address here. (Or you can elect to receive our posts via RSS feed.) A sample of our posts from last week follows.
“FASB Issues Guidance Delaying FIN 48 For Pvt Cos;Up Next: Partial Delay FAS 157;Former FASB Board Mbrs Weigh In on FAF Proposal
“SEC Proposes One Year Delay in Sarbox404(b) Audit For Small Co's; Treasury ACAP, SEC CIFiR To Meet; Chamber's 2nd Cap Mkts Summit”
“PCAOB Adopts AS6, 'Evaluating Consistency of Financial Statements; Agrees To Move GAAP Hierarchy From Audit to Accounting Stds’”
“Lone Trader Socks It To SocGen With $7 Billion Fraud - Or Did He? And -Atkins, McKenna on Supreme Court's Stoneridge Decision”
1:12 AM by Edith Orenstein
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Feb 1, 2008
FASB Issues Guidance Delaying FIN 48 For Pvt Cos;Up Next: Partial Delay FAS 157;Former FASB Board Mbrs Weigh In on FAF Proposal
Earlier today (Feb 1), FASB issued final guidance on the deferral of the effective date of FIN 48 (Accounting for Uncertainty in Income Taxes) for private companies. Highlights of this, and other recent (e.g., FASB’s vote this week on the Mortgage Banker’s Association Request re: FAS 114) and upcoming FASB actions (e.g., finalizing a proposed delay of FAS 157, Fair Value Measurement) are noted below, as well as a reminder that comments are due Feb. 10 on proposed changes to FASB’s governance and structure recommended by trustees of the Financial Accounting Foundation (FAF).
FASB Releases Final FSP FIN 48-2, Deferal of Effective Date of FIN 48 For Pvt Co's
In a month known for Valentine’s, FASB started it off with a bang by releasing final guidance on the deferral of the effective date of FIN 48, Accounting for Uncertainty in Income Taxes, for private companies. The guidance comes in the form of FASB Staff Position No. FIN 48-2, "Effective Date of FIN 48 for Certain Nonpublic Enterprises," (FSP FIN 48-2).
Key points in FSP FIN 48-2 include:
The FSP applies to nonpublic enterprises subject to the provisions of FIN 48 unless that nonpublic enterprise is a consolidated entity of a public enterprise that applies U.S. GAAP, or has issued a full set of U.S. GAAP annual financial statements prior to the issuance of this FSP using the recognition, measurement, and disclosure requirements of FIN 48.
The FSP defers the effective date of FIN 48 for nonpublic enterprises included within this FSP’s scope to the annual financial statements for fiscal years beginning after December 15, 2007.
When effective, FIN 48 should be applied as of the beginning of the enterprise’s fiscal year.
FASB notes this deferral does not change the effective date of FSP FAS 13-2, which relates to leveraged leases and cross references FIN 48.
Issuance of the final FSP deferring the effective date of FIN 48 for private companies followed quickly from FASB's vote last week on this matter, which in turn followed quickly on the close of the comment period on the related proposal (proposed FSP FIN 48-b), on which a total of 48 comment letters (interesting coincidence, FIN 48 and 48 comment letters…) were filed. (As we previously noted in our summary of the comment letters, nine of the 48 letters were variations on a form letter by Blue Cross Blue Shield entities.)
Financial Executives International (FEI) was among those constituents that had an impact on FASB's decision to clarify and broaden the scope of private companies that would qualify for the proposed delay and to modify the effective date, through the comment letter sent by FEI's Committee on Private Companies (CPC) standards subcommittee.
FASB To Decide on Final Guidance on Partial Deferral of FAS 157, Fair Value Measurement
In other news, FASB is scheduled to decide on another proposed delay of a standard next week. This relates to the proposed ‘partial’ delay of the effective date of FAS 157, Fair Value Measurement. FASB announced it has put on its agenda for discussion at next week’s board meeting comments received on proposed FSP FAS 157-b, “Effective Date of FAS 157;” FASB will decide whether to issue the proposed FSP as final and any necessary changes based on its discussion of comment letters.
FASB had recommended in proposed FSP FAS 157-b a limited scope deferral, only with respect to: “nonfinancial assets and nonfinancial liabilities - except those that are recognized or disclosed at fair value in the financial statements on a recurring basis (at least annually).”
Mortgage Banker’s Association Request Turned Down
Separately, at this week’s FASB board meeting, the board concurred with its staff’s recommendation not to add a project to its agenda concerning a request by the Mortgage Banker’s Association (MBA) to permit accounting for Troubled Debt Restructurings (TDR) under FAS 5 (Accounting for Contingencies) vs. as currently required under FAS 114 (Accounting by Creditors for Impairment of a Loan).”
FASB’s vote on the MBA request was detailed in, “FASB Rebuffs Mortgage Bankers' Request For Relief From Statement 114,” in the Jan. 31 edition of BNA’s Daily Report for Executives. Writer Lyda Phillips noted that FASB board member Leslie Seidman said at the meeting that FAS 114 is “very clear when a lender adds a concession ... that a loss recognition threshold has been triggered…[and] is explicit that the only loans that are scoped out are those at fair value." Further details are on the last seven pages of this week’s FASB board handout.
Comment Deadline Approaching on Proposed Changes To FASB Governance, Structure
Those who follow FASB developments (particularly ‘stakeholders’ including investors, creditors, public and nonpublic companies, auditors and others) should consider commenting on the Financial Accounting Foundation’s (FAF’s) “Proposed Changes to Oversight, Structure, and Operations of the FAF, FASB, and GASB.” As a reminder, the comment deadline on the FAF proposals is February 10.
We previously summarized the 11 recommendations contained in the FAF proposal here; possibly the most controversial of which are to reduce the size of the FASB board from seven members to five and to move agenda-setting decisions from the FASB board to the chair.
Typically, the bulk of comment letters on any FASB or regulatory proposal flood in at or around the comment deadline; it can sometimes be helpful to see the thinking of those who file comment letters early in the process. So far (as of Feb. 1), FASB has received 12 comment letters, including some from former FASB chairmen and board members. We have gathered a few highlights from the comment letters, including some strong opinions from a number of former FASB board members about the proposed reduction in size of the board.
8:49 PM by Edith Orenstein
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Feb 1, 2008
SEC Proposes One Year Delay in Sarbox404(b) Audit For Small Co's;Treasury ACAP, SEC CIFiR To Meet;Chamber's 2nd Cap Mkts Summit
Earlier today (Feb. 1) the SEC announced “the four-member Commission unanimously proposed on Jan. 31, 2008, the one-year extension of the Section 404(b) auditor attestation requirement for smaller companies that SEC Chairman Christopher Cox had previously announced in testimony before the House Small Business Committee in December 2007…Under the proposed extension, the Section 404(b) requirements would apply to smaller public companies beginning with fiscal years ending on or after Dec. 15, 2009.” There will be a 30 day comment period on the proposed rule (30 days after it is published in the Federal Register). UPDATE: The proposed rule has been posted on SEC's website here.
The extension of time applies only to smaller public co’s external audit of internal controls required by Sarbanes-Oxley Section 404(b). Smaller public co’s had to begin complying with Section 404(a) – the management report on internal control – beginning with year-end 2007 (in their soon to be filed 10-Ks).
The SEC explained it was granting this extension since its professional staff has formally embarked on a cost benefit study of Section 404(b) for smaller companies.
SEC Chairman Christopher Cox said,“The study will give us the opportunity to ensure that the investor protections of Section 404 are implemented in the way that Congress intended, and do not impose unnecessary or disproportionate burdens on smaller companies."
“Real World” Cost-Benefit Data to Be Studied; Completion of Study Expected by Late Summer/Early Fall
The SEC announcement emphasized they will be conducting a study of “’real world’ cost and benefit data from a broad array of companies currently complying with Section 404 under newly-issued guidance for companies and auditors.”
A two-pronged approach will be taken by the SEC on its cost study:
a Web-based survey of companies that are subject to Section 404; and
in-depth interviews including companies that are just now becoming compliant.
Timing: Since the Section 404 reports are done on an annual basis, filed in Form 10-K, complete data for the current year will not be available until March or April “at the earliest,” noted the SEC.
Observation: Although data will be in from the larger public companies (accelerated filers) and smaller public companies that implemented the SEC’s new management report guidance, and – for the larger companies’ (and any small companies that are early adopters of) 404(b) audits, will reflect the auditors’ approach under PCAOB’s streamlined AS5 (the improved guidance for internal control audits which replaced AS2) - it has become increasingly difficult to parse out the portion of audit fees applicable to the internal control audit required by Section 404(b) vs. the rest of the financial statement audit. This difficulty in separately pricing the Section 404(b) audit relates to the fact that auditors have increasingly tended toward quoting an integrated audit fee – in line with the fact that the audit of internal control and the audit of the financial statements is supposed to be an ‘integrated’ audit. Another challenge facing this SEC study will be the fact that auditors may not have quoted the cost of the 404(b) audit to their small bus clients yet, given that the requirement for small co's to have an internal control audit will not kick in under the proposed extension until 2009. Whether the fact that it is the SEC calling for the data will help bring estimates out sooner (and whether those estimates will ultimately align with the quotes auditors give smaller clients in their engagement letters) remains to be seen; it probably couldn’t hurt. It is worth noting that the SEC acknowledges that sufficient data to conduct the study may not be available until March or April “at the earliest.”
Private sector studies of cost, benefit of 404
A number of private sector studies of the costs and benefits of 404 have been provided by Financial Executives International (FEI), whose studies going back to 2004 are available here. Other studies of the estimated impact of the cost and benefit of Sarbox 404 have been conducted by AeA (formerly the American Electronics Association), the U.S. Chamber of Commerce (in conjunction with the Institute of Management Accountants (IMA) and the American Stock Exchange (Amex)), CRA International (commissioned by the Big Four audit firms), Foley & Lardner, Compliance Week, Audit Analytics, and consulting firm Lord & Benoit.
There has been some variability and questions raised about trend lines within and among some of those studies, particularly relating to extrapolations and assumptions for smaller companies that have not yet become fully engaged in the 404(b) audit process, and only recently were required to file their 404(a) management reports. For example, the Lord & Benoit study, which concluded the cost of 404 for smaller companies would, on average, be less than the SEC’s much maligned original cost estimate of about $93,000, relied in part on earlier data from Audit Analytics, which we have discussed previously in this blog.
Recently, CFO.com published an article entitled, ”Sarbox Stings Small Biz, But How Much?” citing a study by RAND Corporation. The complete results of the RAND study are contained in a chapter in a larger publication that can be purchased, and are summarized in this RAND Research Brief: “Do the Benefits of Sarbanes-Oxley Justify the Costs? – Empirical Evidence in the Case of Small Firms”
Although the RAND study concluded, “The evidence offers qualified support for the view that SOX, at least initially, had a number of negative effects on small firms,” it also noted there could be numerous factors explaining some of the results of the surveys it reviewed.
One finding cited by RAND was that: “almost all studies that did distinguish between large and small firms found that SOX sometimes reduced the latter’s value.”
Tellingly, the authors of the RAND study acknowledged that they “concluded that SOX has had a mixture of negative and positive effects on small firms, but which effects will prove more significant in the future is, as yet, unknown.”
Sarbanes-0xley 404 has been but one development impacting accounting and auditing in recent years. The broader subject of accounting and auditing and related impacts on competitiveness are being addressed by two federal advisory committees (at the Treasury Department and SEC) which are scheduled to meet again soon (detailed below). Accounting and auditing is also one of the primary topics to be addressed at the U.S. Chamber of Commerce’s 2nd Capital Markets Summit, also noted further below.
Treasury ACAP To Meet Monday Feb. 4
The U.S. Treasury Department’s Advisory Committee on the Auditing Profession (ACAP), co-chaired by Arthur Levitt and Don Nicolaisen, announced its next meeting will be Monday Feb. 4 at 1:30 p.m. PACIFIC time. NOTE: This meeting will be held at the University of Southern California, and, like all ACAP meetings, will be open to the public. The agenda published in the Federal Register says the meeting will “consist of hearing oral testimony from witnesses and considering written statements that those witnesses have filed with the Advisory Committee… focus[ing] on the issues impacting the sustainability of the auditing profession, including issues mentioned in the [Working] Discussion Outline, which was presented at the initial meeting of the Advisory Committee on October 15, 2007.”
SEC Advisory Committee To Meet Feb. 11
Separately, the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR), chaired by Bob Pozen, announced it will hold a telephonic meeting on Feb. 11, beginning at 2pm, and it will be webcast.
The SEC says the agenda for CIFiR’s Feb. 11 meeting will include: “(1) discussion and deliberation of a draft progress report with developed proposals, conceptual approaches and currently identified future considerations based on the Committee’s deliberations of the Draft Decision Memorandum presented at its January 11, 2008 meeting in the areas of substantive complexity, standard setting, audit process and compliance and delivery of financial information; (2) a vote on a proposal to publish the Committee’s draft progress report in final form to the Commission and for public feedback; and (3) a discussion of next steps and planning for the next meeting.”
U.S. Chamber To Hold 2nd Capital Markets Summit
The U.S. Chamber of Commerce recently announced it will hold its 2nd Capital Markets Summit on March 26, 2008. Topics will include: Securities Litigation and Reform, Attorney-Client Privilege, the Subprime Mortgage Crisis, and Accounting and Auditing. A detailed agenda is forthcoming and will be posted on the Chamber's website.
2:15 PM by Edith Orenstein
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