Treasury Releases Restatements Study

Earlier today, the U.S. Treasury Department released its study of restatements: “The Changing Nature and Consequences of Public Company Financial Restatements .“ Authored by Prof. Susan Scholz of the University of Kansas, the study was commissioned as part of Treasury’s Capital Markets competitiveness initiative.

Highlights noted in a related press release issued by Treasury:

• Financial restatements grew nearly eighteen-fold from 90 in 1997 to 1,577 in 2006 with acceleration in restatement activity occurring in 2001 before the implementation of the Sarbanes-Oxley Act
  
• Restatements associated with fraud and revenue declined after 2001. Fraud was a factor in 29 percent of all 1997 restatements, but only 2 percent of 2006 restatements. The proportion of revenue-related restatements also decreased from 41percent in 1997 to 11 percent in 2006
  
• Market reactions to the restatements dampened over the decade study period, while the number of restatements grew. Market reaction to financial restatements tended to be more negative when the restatement involved fraud or revenue errors.
  
• Restating companies are typically unprofitable even before the restatement. In the year prior to announcing a restatement, more than half of restating companies reported a net loss.
  

U.S. Treasury Secretary Henry M. Paulson said, “The information in this study should complement the work underway at the Securities and Exchange Commission and the Financial Accounting Standards Board to improve financial reporting for investors.”

Treasury’s press release adds: “Treasury did not ask the study’s author to develop policy recommendations. The study was intended to inform federal regulators and advisory committees, such as the SEC’s Advisory Committee on Improvements to Financial Reporting.

The goal was to take a clear look at figures often used when discussing U.S. companies’ competitiveness and investor confidence in financial reporting.”

We plan to provide further highlights and commentary on the Treasury study later this week.

Treasury Briefing Today on Restatements Study

The U.S. Treasury Department announced yesterday that it will hold a briefing for the press at 11:30 a.m. EDT today (April 9) on the restatements study it commissioned as part of its capital markets initiative.

As announced last fall, the study is being conducted by Prof. Susan Scholz of the University of Kansas. As noted in that announcement:

"Numerous studies have pointed to a significant increase in the number of financial restatements during the past few years. Many reports attribute the growing number of restatements to increased management and auditor focus on accurate financial reporting due to the mandates in the Sarbanes-Oxley Act and greater financial reporting review and enforcement by financial regulators.

"However some studies suggest that while some financial restatements are clearly material, immaterial financial restatements might pose significant and unwarranted challenges to the capital markets. Immaterial restatements might unnecessarily harm investor confidence by calling into question the credibility of company management, auditors, and the financial reporting system as a whole.

"Professor Scholz will examine the factors triggering public company financial restatements, describe public company financial restatements, analyze the impact of public company financial restatements upon investors and the capital markets, and evaluate the significance of public company financial restatements. The study will focus on restatements from 1997-2006. Treasury intends to make the study's results public by early 2008."

Treasury did not specify in yesterday's announcement if the study will actually be released today, presumably it is close to being released. Actually, a close reading of last fall's announcement (highlighted above) indicates just that the "study's results" will be made public, not necessarily that the full study will be released to the public, so we will see.

Of note in yesterday's announcement was the title of the Treasury study was given as: "The Changing Nature and Consequences of Public Company Financial Restatements."

Although this is a new study, the title if nothing else has parallels to some prior studies Prof. Scholz has published, some of which were coauthored with then-USC professor (and now, SEC Deputy Chief Accountant) Zoe Vonna Palmrose. One such study cited in the working bibliography of Treasury's Advisory Committee on the Auditing Profession (ACAP) is entitled: "The Circumstances and Legal Consequences of Non-GAAP Reporting: Evidence From Restatements," by Palmrose and Scholz, published in 2004.

Not only is Treasury ACAP (and Treasury in general) interested in the study's results; the SEC Advisory Committee on Improving Financial Reporting (CiFIR) is also following this issue, and a number of the recommendations in its progress report (released by the SEC for public comment, on which comments were due March 31) are aimed directly and indirectly at reducing unnecessary restatements and providing more transparency around restatements.

We will provide an update on Treasury's restatements study in a blog post later today or tomorrow, including a link to the study if it is released.

CESR finds US GAAP Equivalent to IFRS; EU's McCreevy, ECOFIN Talk Fair Value; SEC Updates 8-K Interps

On March 31, the Committee of European Securities Regulators (CESR) issued its final advice to the European Commission on the equivalence of U.S., Japanese, and Chinese GAAP to IFRS. CESR found U.S. GAAP to be equivalent to IFRS, and Japanese GAAP to also be equivalent to IFRS, (subject to the progress of convergence laid out in the “Tokyo Agreement”). CESR deferred its decision on equivalence of Chinese GAAP until a later date, since 2007 is the first year of reporting under the new Chinese GAAP.

CESR Advice More Principles Based Than 2005 Proposal
Based on our reading of CESR's advice issued last week, they appear to have given up the previously proposed requirement contained in their 2005 advice that equivalence of U.S. GAAP be contingent on companies providing 'remedies' in the form of 'rectifying disclosures' to explain significant differences between U.S. GAAP and IFRS. (FEI noted concern with the 2005 proposal’s ‘remedies’ in a joint comment letter filed by FEI’s Committee on Corporate Reporting (CCR) and Globalization Oversight Committee (GOC).

CESR appears to have taken a more principles based - or in their words, 'holistic' - approach to determining equivalence of these 3rd country GAAPs to IFRS, vs. their approach in 2005. CESR notes their approach follows on that laid out in the EU's Dec. 07 determination of the 'equivalence mechanism", which is focused on the general state of convergence efforts and the continued progress on formally laid out convergence efforts like FASB-IASB's MOU which was updated in 2006, rather than being focused so heavily on a standard-by-standard comparison. However, for informational purposes, CESR attaches as an appendix to its advice issued March 31 an updated version of its standard by standard comparison for major differences between U.S. GAAP and IFRS, as it was requested to provide that info by the EU.

The next step is for the European Commission to consider CESR's advice and make a formal determination by mid-2008 on the equivalence of U.S. and the other GAAPs to IFRS.

For other IFRS news see our post yesterday, including a link info about FEI’s upcoming conference on June 5 in NYC: “The World Is Moving To IFRS: Are You?”
McCreevy, ECOFIN on Fair Value and Current Market Turmoil

In other international developments, in an article entitled, "European Finance Ministers Seek Fair Value Accounting Review," Joe Kirwin reports in today’s BNA Daily Report for Executives that fair value accounting as may relate to volatility in credit markets was a subject of discussion at informal meetings of ECOFIN (the Economic and Financial Affairs Council of the European Union) earlier this month.

Additionally, BNA’s Kirwin notes that EU Internal Markets Commissioner Charlie McGreevy (himself a chartered accountant) testified before a committee of the European Parliament on April 1 that fair value accounting issues and other accounting issues (consolidation accounting and risk disclosure) needed to be addressed regarding the recent market turmoil. McCreevy testified, ”There is a growing debate on whether fair value and mark to market measurements may have aggravated the crisis by bringing pro-cyclicality in financial statements. I want to make it clear that I believe that there are some real accounting issues and anomalies to examine, including the interface with the Capital Requirements Directive, such as the consolidation of special purpose entities or the measurement and information disclosed on risk exposures.” He added, “Clearly, these and other issues –such as the impact of mark to market valuation when markets generally become illiquid and irrational- must be thoroughly analysed.”

More About Fair Value Accounting and Subprime
As we noted yesterday, NYT’s Floyd Norris recently criticized those who are blaming accounting standards as being among the ‘scapegoat’ for the current market turmoil.

Perhaps in part to combat the scapegoating which Norris refered to, the CFA Institute is presenting a panel discussion on Thurs. April 10 in NYC, their press release is entitled, “Journalists Invited to Hear Investor Perspective on Fair Value (“Mark To Market”) at CFA Institute Centre for Financial Market Integrity Roundtable.” FASB’s Russell Golden is among the panelists.

Additionally, the Director’s Roundtable is holding a Conference on April 11, 2008 in NYC entitled, “A National Conference on Historic Challenges Arising From Fair Value and Other New Accounting.” Panelists include FASB Chairman Robert Herz, attorney Michael Young of Willkie Farr (who we noted previously wrote this article on “Fair Value Accounting and Subprime,” and others.

As we noted in our March 24 post on “Today’s Market and Accounting, Legal Issues,” a plethora of articles have been written on the subject of fair value accounting and subprime, and we provided a link to a summary of 14 articles, 7 on each side of the fence on the issue of accounting aiding transparency vs. accounting needing to be revised.

I also noted one piece of analysis missing from most of the articles written as of March 24, was to consider the possible role of guidance on valuation in illiquid markets issued in fall 2007 by the Center for Audit Quality (CAQ – affiliated with the AICPA), and the extent to which that guidance may have driven a more conservative approach than FAS 157 itself (and potentially more conservative than the SEC’s subsequent guidance issued in late March contained in SEC’s “Sample Letter Sent to Public Companies on MD&A Disclosure Regarding the Application of SFAS 157 (Fair Value Measurements).”

A number of people (including NYT’s Floyd Norris and Credit Suisse’ David Zion) have written recently about whether the SEC’s guidance interpreted FAS 157 or not, Zion states the consensus seems to be it did not, and that the SEC's guidance was consistent with FAS 157. But the question remains – in considering issues of how fair value accounting has been implemented during the recent market turmoil - on bringing together not only FAS 157 and the SEC’s recent guidance (sample letter) but also the guidance issued by CAQ - and in the international arena, guidance issued by a coalition of international audit firms last fall. Some may sense a déjà vu factor in considering the CAQ guidance issued by the audit community on applying FAS 157 in illiquid markets, and another set of guidance issued by the auditing profession in the form of a control framework issued by nine audit firms collectively in interpreting PCAOB’s Auditing Standard No. 2 (AS2). The PCAOB noted in its ‘4010’ report on initial implementation of AS2 (see “Use of Judgment,” pg 17) that the internal control framework issued by the nine audit firms “may have driven auditors' decision-making process unduly toward simplistic quantitative thresholds and away from the qualitative evaluation that may have been necessary in the circumstances.” [On this point, it is also interesting to note EU Internal Market Commissioner McCreevy's remarks cited above about the need to consider "the impact of mark to market valuation when markets generally become illiquid and irrational." ]

More generally, the process by which interpretive guidance is issued is among the subjects that SEC’s complexity committee (CiFIR) has been looking at.

The other observation I noted on March 24 is there has been an age-old debate over whether accounting could, or should, reflect economics, and whether accounting could, or should influence economics or be neutral. Members of CIFiR have noted accounting standards do not necessarily reflect the economics of a transaction; even if accounting reflects the economics at inception of a transaction, there can be a divergence between accounting and economics over the life of an asset (liability).

Proponents of fair value accounting are trying to close the gap between accounting and economics, and sometimes, as noted in IASB's recent discussion paper on Reducing Complexity in Reporting Financial Instruments and FASB's related Invitation to Comment, promote fair value as a simplification method. Where the rubber meets the road is in fair valuing nonfinancial assets (liabilities) and thinly traded or nontraded financial assets (liabilties), and in considering issues of reliability and auditability for resulting fair values, as well as relevance. The PCAOB SAG has discussed this issue as well.

SEC Updated 8-K Interps
In other SEC news, props to Broc Romanek of TheCorporateCounsel.net blog who noted on April 4 “Corp Fin Revises Its New Form 8-K Interps” and provided followup info yesterday. See the updated SEC FAQ’s on Form 8-K posted by SEC on April 3.

The interps not only update, but also bring together a large volume of prior interpretive material found in various sources, as stated by the SEC: “These interpretations replace the Form 8-K interpretations in the July 1997 Manual of Publicly Available Telephone Interpretations, the June 13, 2003 Frequently Asked Questions Regarding the Use of Non-GAAP Financial Measures and the November 22, 2004 Form 8-K Frequently Asked Questions. Some of the interpretations included here were originally published in the sources noted above, and have been revised in some cases. The bracketed date following each interpretation is the latest date of publication or revision.” Separately, Jenny Anderson reports on the SEC in today's New York Times,” A Fear That the Market’s Watchdog is Losing Its Bite.”