Friday, July 11, 2008

SEC's Complexity Committee Agrees On Report

Earlier today (July 11), the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR) passed all recommendations in its Draft Final Report unanimously, with some editorial changes described below. [NOTE: a 10 page summary appears in the Compendium of Recommendations in the Executive Summary of the 180-page report.] CIFiR will meet by teleconference on July 31 to vote on issuing its final report to the SEC (i.e., incorporating editorial changes agreed to today).

SEC Chairman Christopher Cox thanked the entire committee for its work, in particular chair Robert Pozen and the subcommittee chairs, noting it was ‘pretty remarkable’ to see so much ‘fire power’ … ‘assembled in a room with no windows in a basement in Washington, DC. ” He added a press conference would be held on August 1 (to announce delivery of the final report from CIFiR to the SEC).

CIFiR’s focus, reiterated Cox, was “on making financial reporting [more] useful to investors and broader markets.” He noted, “Lord knows we need that more than ever right now, when a great deal of turmoil in the market is from people not understanding where the risk is.” Cox added, “we all have in common a thorough commitment to making sure information which drives the markets is presented in the most useful, accurate and clear fashion.”

Importantly, Cox noted the SEC has already moved on some of CIFiR’s recommendations and others may see action soon. Specifically:

  • The SEC has already moved forward on CIFiR’s interactive data (XBRL) recommendation, noted Cox [i.e. by issuing a proposed rule in May, on which comments are due August. 1].
  • “We’re close to doing something on your corporate website recommendation,” noted Cox, referring to CIFiR’s recommendation 4.2, which states: “The SEC should issue a new comprehensive interpretive release regarding the use of corporate websites for disclosures of corporate information, which addresses issues such as liability for information presented in a summary format, treatment of hyperlinked information from within or outside a company’s website, treatment of non-GAAP disclosures and GAAP reconciliations, and clarification of the public availability of information disclosed on a reporting company’s website.”
  • Additionally, Cox indicated the SEC is ‘close to doing something’ on a handful of CIFiR’s other recommendations, “including your judgment recommendation.” This refers to CIFiR’s Recommendation 3.5, which states: “The SEC should issue a statement of policy articulating how it evaluates the reasonableness of accounting judgments and include factors that it considers when making this evaluation.” The recommendation continues, “The PCAOB should also adopt a similar approach with respect to auditing judgments.” CIFiR suggests that SEC, in developing its ‘statement of policy,’ consider a list of 11 ‘factors to consider in evaluating the reasonableness of judgments” which are provided on pdf pgs 105-106 (printed page numbers 100-101) of the Draft Final Report.These factors remain unchanged from the 9 in CIFiRs Feb. 14 Progress Report, with 2 additional factors being moved up to the ‘factor’ list previously in the paragraph below it. Such an SEC ‘statement of policy’ enumerating ‘factors’ is meant to be akin in concept to the approach in SEC’s ‘Seaboard’ memo enumerating how the SEC may give ‘credit’ to companies in enforcement proceedings based on certain factors of ‘cooperation,’ including potentially not charging the company.
Among the dozen or so editorial changes agreed to at today’s meeting with respect to CIFiR’s Draft Final Report, some of the more prominent ones include:

  • softening the language relating to materiality, correction of errors and restatements, by potentially removing the reference to ‘large’ errors potentially not being material, and focusing instead on qualitative and quantitative judgments generally
  • adding/clarifying language about comparability still being a desired goal. This clarification would be in response to investor concerns about a potential rise in noncomparability under principles-based vs. rules-based or bright line standards. The clarification may emphasize that use of a principles based framework, when applied with professional judgment (i.e. under CIFiR’s recommendation that SEC issue a ‘statement of policy’ in evaluating judgment) may result in more genuine comparability. [Observation: it was pointed out during CIFiR’s discussion about comparability that factor #8 in their 11 point list of “factors to consider in evaluating the reasonableness of judgments’ states the SEC should (if SEC adopts this list of factors) consider:
  • “The preparer’s consideration of known diversity in practice regarding the alternatives or estimates.” Importantly, footnote 159 that appears at the end of factor 8 states: “If there is not diversity in practice, it would be significantly harder to select a different alternative.” We pointed out in our post on CIFiR’s Feb. 14 progress report, Observations on CIFiR’s Professional Judgment Framework, that there could be unintended consequences from this language, particularly the footnote, in effectively disallowing a different treatment if one can not identify that there is already a diversity in practice. This could lead to the question – what if there is no diversity- but everybody is ‘wrong’? Would this language discourage companies from breaking away from established practice, if the company believes reasonable alternatives are preferable?]
  • deleting a reference to CIFiR ‘supporting’ FASB’s derivatives project, and referring to the project more generally
  • deleting a reference in rec. 1.2 to “litigation and regulatory developments,” which Linda Griggs said “sounds like we are trying to weigh in on [FASB’s proposed changes to FAS 5” on contingency disclosures, which, she added, “the bar is extremely concerned [about]” regarding attorney-client privilege and other issues.
  • clarifying references to recommended changes in the financial statements based on different types of activities (e.g., investing, financing) and differing nature of components of income such as fair value changes vs. core operating earnings, to make such references generic as to the goal of such aggregation, rather than supporting specific categories including those in the FASB-IASB’s current project on Financial Statement Presentation.
  • clarifying that SEC and FASB should work together to determine if existing accounting rules need amending or if existing disclosures need updating or to be removed. It was noted that the SEC’s 21st Century Disclosure Project examining SEC disclosure requirements holistically was recently announced and is referenced in a footnote in CIFiR’s report.
Also of note, it was pointed out that the Draft Final Report has ‘elevated’ the discussion about stealth restatements to a bullet in Recommendation 3.2 which states: “To limit the likelihood of ‘stealth restatements,’ the SEC should revise the instructions to Form 8-K to state clearly that the form needs to be filed for all determinations of non-reliance on prior financial statements.”

CIFiR noted the phenomenon of ‘stealth restatements’ was noted in a GAO report on restatements issued in March, 2007. For further background, see the reference to ‘stealth restatements’ in SEC Corp Fin Director John White’s speech on Jan. 23, 2008.

Personally, if there ever was a committee that deserved a theme song, this one is it (I even thought of some possible theme songs once, maybe some readers have ideas too). For now, the committee known as the ‘Complexity’ committee in some circles, may have to settle for Avril Lavigne’s Complicated. On a more serious note, it has been intriguing to follow this committee’s deliberations, including its openness in incorporating suggestions of its committee members that may not have been on the particular subcommittees drafting the recommendations (such as the editorial changes CIFiR members suggested today, listed above), even as it moves toward its final report. Some of these strengths may prove to be a useful model for the Financial Reporting Forum (FRF) which it recommends to serve as an advisory committee to advise and promote coordination among the FASB, SEC (within bounds of what’s allowed by the federal advisory committee act, as noted by SEC staff today) and PCAOB. FASB Chairman Robert Herz explained a broad-based advisory model was successful in some other countries, including the Financial Reporting Council (FRC) model in the U.K. (wouldn’t you know they’ve got their own Complexity project?)

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