Friday, August 29, 2008

DOJ Revises Charging Guidelines on Privilege; Some Say Legislation Still Necessary

Deputy Attorney General Mark R. Filip announced yesterday (Aug. 28) that the Department of Justice (DOJ) has revised its charging guidelines - formally known as the Principles of Federal Prosecution of Business Organizations - to enhance the protection of attorney-client privilege. The guidelines, enhanced under then-Deputy Attorney General Larry Thompson, and subsequently revised by then-Deputy Attorney General Paul McNulty, were heavily criticized by the bar for eroding attorney-client privilege and interfering with the right to legal defense by crediting companies with 'cooperation" for waiving attorney client privilege and withholding legal defense fees.

As outlined in DOJ’s press release, supplemented by Filip’s remarks, the revised guidelines will:
state that credit for cooperation will not depend on the corporation’s waiver of attorney-client privilege or work product protection, but rather on the disclosure of relevant facts,
prohibit prosecutors from asking for what the old guidelines designated as “Category II” information (i.e. non-factual attorney-client privileged communications and work product, such as legal advice) with two exceptions, which Filip said are “well-recognized in existing law,”
instruct prosecutors not to consider a corporation’s advancement of attorneys’ fees to employees when evaluating cooperativeness,
make clear that the mere participation in a joint defense agreement will not render a corporation ineligible for cooperation credit, and
provide that prosecutors may not consider whether a corporation has sanctioned or retained culpable employees in evaluating whether to assign cooperation credit to the corporation.

The revised guidelines “will be committed for the first time to the United States Attorneys Manual, which is binding on all federal prosecutors within the Department of Justice… [and] will be effective immediately," stated DOJ's press release.

The American Bar Association (ABA) and the Association of Corporate Counsel (ACC) issued statements yesterday (
ABA statement; ACC statement) praising DOJ's action, but reiterating their position that legislation is needed to give permanence to these actions, and to provide a government-wide solution, since DOJ's action does not impact similarly criticized policies at the SEC and other agencies.

Legislation (the Attorney-Client Privilege Protection Act) has passed the House, but is pending in the Senate, reintroduced by Sen. Arlen Specter in July.
Specter’s statement issued yesterday said: “The revised guidelines are a step in the right direction but they leave many problems unresolved so that legislation will still be necessary. For example, there is no change in the benefit to corporations to waive the privilege by giving facts obtained by the corporate attorneys from the individuals in order to escape prosecution or to have a deferred prosecution agreement. The new guidelines expressly encourage corporations to comply with the waiver and disclosure programs of other agencies including the SEC and EPA. Legislation, of course, would bind all federal agencies and could not be changed except by an Act of Congress.”

Federal Appeals Court Upholds Judge Kaplan’s Decision in KPMG Tax Case
Also yesterday, as reported in “
U.S. Pares Its Arsenal in White-Collar Crime Fight" by Evan Perez and Amir Efrati in today’s Wall Street Journal, "the Second Circuit Court of Appeals dealt what could be a final blow to a case that was once billed as the U.S. government's biggest criminal-tax prosecution. The court upheld a ruling by New York U.S. District Court Judge Lewis A. Kaplan, who had dismissed charges against 13 former partners and employees of KPMG LLP because prosecutors, who were weighing charges against the firm, pressured the firm to cut off payment of the employees' legal fees."

A lawyer for one of the KPMG defendants - Michael Madigan of Orrick, Herrington & Sutcliffe, defending John Lanning, former head of KPMG's tax practice - was quoted in a New York Times today (“
U.S. Lifts a Policy in Corporate Crime Cases" by Jonathan D. Glater and Michael M. Grynbaum) saying: "This decision is a watershed event that is going to go down as one of the most important decisions in the last 20 years in the criminal justice system."

Separately, issues of waiver of privilege relating to disclosures made to auditors by companies remain an issue as well. The 'Treaty' struck between the American Bar Association and the AICPA decades ago may be more tenuous today, as noted in various comment letters on FASB's Exposure Draft to amend disclosures of contingencies under FAS 5. We covered some of these issues in our article in Financial Executive Magazine in Sept. 06, “
Has Privilege Lost its Reward?”

FEI's Committee on Taxation (COT) and Committee on Corporate Reporting (CCR) filed an amicus brief in the Textron case, which addresses matters concerning the review of attorney-client, tax practitioner-client, and work product privileges with regard to tax accrual workpapers, and discusses when those privileges could be overcome. Matt Miler, FEI's Director of Tax and Economic Policy reported earlier this week, "Oral arguments in the Textron appeal are going to be held on Sept. 5 in Boston." See this
FEI summary for details on the Textron case and a link to FEI’s amicus brief. Matt is coordinating FEI efforts in this area and can be contacted at or by telephone at (202) 626-7804. If you received this blog post from ‘a friend’ you can sign up here to get the blog by email.

Thursday, August 28, 2008

On the Road Again: SEC Approves Release of IFRS Roadmap

The SEC voted on Aug. 27 to release for public comment a proposed IFRS Roadmap – outlining milestones that would form the basis of an SEC decision to be made by 2011 on whether to mandate the use of IFRS by public companies in their SEC filings beginning in 2014. As noted in SEC’s press release, there will be a sixty day comment period on the proposal. Separately, the SEC also voted on a number of items impacting Foreign Private Issuers and cross-border business combinations, as noted in this SEC press release.

As described further in the Opening Remarks of SEC Chief Accountant Conrad Hewitt, Division of Corporation Finance Director John White, and Chief of the Office of International Corporation Finance of Corp Fin, Paul Dudek, as part of its IFRS Roadmap, the SEC is proposing to permit early adoption of IFRS by a limited number of companies that meet a two-pronged test, and seeks comment on two alternatives for the number of years of reconciliation from U.S. GAAP to IFRS that would be required of the early adopters. (‘Alternative a’ would be one year of reconciliation in an audited footnote consistent with IFRS 1, First Time Adoption of IFRS; ‘Alternative b’ would be three years of unaudited reconciling information for the same three years as the audited financial statements included in the SEC filing.) Dudek said the SEC currently estimates 110 companies would be eligible for early adoption.

Hewitt noted the Commission’s proposal was responsive to the request of constituents to provide a date certain, White noted the proposal for early adoption was aimed at enhancing comparability for those in an ‘IFRS industry’ on a limited basis, and Dudek outlined the milestones in the proposal, as well as the eligibility criteria for early adopters.

Additionally, “the proposal considers whether [any mandatory requirement for IFRS] should be staged from 2014 to 2016 depending on the company size (large accelerated filers – 2014; accelerated filers – 2015; non-accelerated filers – 2016),” as noted by Christine DiFabio, Vice President, Technical Activities, of FEI, who provides details from the SEC meeting in this FEI summary. (Summary can be downloaded by FEI members only, see info on FEI membership).
Commission Duty-Bound To Determine What Role IFRS Should Play In U.S. Noting that, “Today, all of Europe and nearly 100 countries around the world require or permit the use of IFRS,” with that number expected to increase, SEC Chairman Christopher Cox said in his opening remarks, “The increasing worldwide acceptance of financial reporting using IFRS, and U.S. investors increasing ownership of securities issued by foreign companies that report their financial information in IFRS make it plain that if we do nothing, and simply let these trends develop, with each passing year, comparability and transparency will decrease for U.S. investors and U.S. issuers.

“To help fulfill its statutory missions of protecting investors and facilitating capital formation,” continued Cox, “the Commission is duty-bound to determine what role IFRS should play in U.S. capital markets, including whether it should be available for use in the future by U.S. public companies.”

Cox also observed, “the increased use of IFRS around the world is a fairly recent phenomenon,” observing “the majority of companies that are currently reporting financial results based on IFRS have only been doing so for a few years.” He added, “This relatively limited history is an important reason that the United States needs to continue to support the work of the IASB, and the foundation that oversees it, the IASCF.” He described five items the SEC deems to be ‘keys to the success of IFRS”:

  • “the standards are created in the interests of investors – that has to be their overarching purpose”
  • “the standard setting process be transparent”
  • “the standard setter must be independent – that means independent from special pleaders, from the political process, from favored industries or industry players, and from national or regional biases
  • “the standard setter must be accountable – this means ensuring that IFRS actually meets the needs of investors and other stakeholders, and that they are updated in a timely way, and
  • “it’s vitally important that all of the stakeholders themselves participate in the standard setting process in order to ensure the continued success of IFRS.

“The proposed roadmap is cautious, and careful,” said Cox, noting, “it’s a proposed multi-year plan, that sets both the basis for considering the mandatory use of IFRS by U.S. issuers, and several milestones, that if achieved, could lead to the use of IFRS in the U.S.”

The milestones described by Corp Fin’s Dudek were in many ways analogous to the points referenced by Cox noted above. Specifically, Dudek mentioned the SEC will look at, among other things:

  • improvements in the accounting standards
  • the accountability and funding of the International Accounting Standards Committee Foundation;
  • improvement in the ability to use interactive data for IFRS reporting; and
  • education and training in the United States relating to IFRS, among investors, auditors and others.

Two Pronged Test To Determine Eligibility for Early adoption
The eligibility requirements for early adoption of IFRS by U.S. issuers fall into a sort of two-pronged test:
(1) Comparability: if a company is in an ‘IFRS industry’ – i.e. if IFRS is used as the basis of financial reporting more often than any other basis of accounting by the 20 largest public companies in that industry (as measured by market cap on a global basis, and
(2) Limitation: if the company is among the 20 largest public companies in its industry on a global basis.

The Need for Education
Commissioner Elisse Walter noted that regarding education and training, “a lot of it is not within our control,” and asked, “what plans do we have [so] that we can feel comfortable the accounting expertise is out there, auditors are out there?”

Hewitt said professors have indicated to him “all of a sudden [they are] starting to get interested” in IFRS, “starting to add appendices to textbooks, seriously planning within the next two years to teach students” about IFRS. He acknowledged that on the investors side, there is no question there needs to be more training.

Wayne Carnall, Chief Accountant in the Division of Corporation Finance, observed, “While university education is a very important part of the process, most people graduating school today will not be signing [audit] reports or certifications under [Sarbanes-Oxley Section] 302 for 20 odd years, it’s the people doing the work today [that need] to be able to learn IFRS.”

“A good example is what happened in Europe," said Carnall. "It was a challenge, but not an impediment to moving forward.” He added, If Europe can do it, I’m confident we can do it.”

NOTE: To help identify and address the multitude of issues that will arise from the move to IFRS in the U.S., FEI was one of the charter members of the
Corporate Roundtable on International Financial Reporting (CRIFR). See also FEI’s Statement on SEC’s IFRS Roadmap.

Driver’s Ed
Maybe some folks will listen to Willie Nelson’s
On The Road Again as background music for reading SEC’s proposed IFRS Roadmap. Although some of the lyrics would seem to speak to the ‘old days’ – e.g. “Insisting that the world keep turnin' our way…” … other lyrics may inspire the move to one set of global accounting standards – a move predicted for a number of years now by the SEC, FASB, IASB and others:

“On the road again
Goin' places that I've never been
Seein' things that I may never see again,
And I can't wait to get on the road again.”

On the education front, as we noted earlier this week, KPMG is hosting a webcast at 11am EDT Aug. 28 on the IFRS roadmap developments, see

And, learn more about IFRS at FEI’s upcoming conferences: Current Financial Reporting Issues (CFRI - FEI’s annual conference covering a range of SEC, PCAOB, FASB and IASB Developments), Nov 17-18, NYC, and “IFRS: Strategies for Adopting a Single Set of Standards,” sponsored by Deloitte, Nov. 19 in NYC. Further info on our upcoming conferences can be found on under Networking Events.

FASB To Release Proposed Changes to Going Concern, Subsequent Events
Separately, on the FASB front, FASB voted on Aug. 27 to release for public comment its proposed standards on going concern and subsequent events. These two projects were launched mainly to move the topics from auditing literature to accounting literature (i.e. by placing them into FASB's Codification). However, after agreeing on one change at the Aug. 27 meeting versus previous deliberations - specifically, to determine a going concern based on the IFRS 1 requirement of looking at 'all available information' - which board member Larry Smith noted would be a significant change from U.S. auditing literature - the board decided to release the proposed standards (possibly in the form of a proposed FSP) on going concern and subsequent events for a 60 day comment period, rather than simply include them in the codification and rely on comments from the 'verification phase' of the codification. The board reaffirmed its prior decisions on subsequent events, as described in the
board handout. See FASB's Summary of Decisions Reached at the board meeting, posted in FASB's News Center. If you received this blog post from ‘a friend’ you can sign up here to get the blog by email.

Wednesday, August 27, 2008

IFRS Insights; Update on FAS 5 on Contingencies; COSO

With the SEC slated to vote on Aug. 27 whether to propose an IFRS roadmap laying out if and when U.S. public companies will be permitted – or required – to file with the SEC using International Financial Reporting Standards (IFRS) instead of U.S. Generally Accepted Accounting Principles (U.S. GAAP), we thought we’d provide, as promised, some highlights from SEC's IFRS roundtable held earlier this month.

As noted in SEC’s press release announcing the Aug. 4 roundtable, the focus was, in part, on “the performance of [IFRS] and U.S. [GAAP] during the recent period of market turmoil.” And, as noted in the FEI summary posted earlier this month (accessible to FEI members only), SEC Chairman Christopher Cox summed up themes at the conclusion of the roundtable, including, among other things, that “IFRS kept Special Purpose Entities (SPEs) on the balance sheet to a far greater extent than did U.S. GAAP,” that, “Fair Value is presenting challenges for both sets of standards,” and “Not only convergence, but improvement is needed in both [sets of] standards, in areas such as reductions in the value of a company’s own debt, which anomalously results in companies showing more phantom income - the more their business is doing worse.”

In brief, the parts of SEC’s Aug. 4 roundtable which I found most interesting, and perhaps most telling in advance of the Aug. 27 vote, were the remarks of SEC Deputy Chief Accountant
Julie Erhardt, who, for the past four years, has served as the primary liaison in the Office of the Chief Accountant working on International matters. With the perspective of familiarity with Corp Fin’s reviews of IFRS filings, and involvement representing the SEC in various international groups including IOSCO, Erhardt responded to two criticisms of a potential U.S. move to IFRS floated by investor representatives on the panel: an alleged reduction in comparability under the more principles-based IFRS, and an alleged inflation of earnings under IFRS.

On the comparability front, in response to a question from Commissioner Elisse Walter, panelist Tom Robinson of the CFA Institute said, “One thing that would help things along [would be] if regulators put in place a system to ensure uniform application of the standards as they exist, and currently that’s not in place.”

Erhardt responded, “[To] Tom, you talk about uniform application… arguably, despite all the best efforts of the 3,000 people at the SEC, we don’t have every U.S. issuer [lined up] like a tin soldier in their filings, and the cost of getting either 6,000 of us to ride herd a little closer, or standards that are twice as thick to provide for every eventuality - it seems like there’s a cost there; and doubling the size of the standard to get more prescriptive is then what people call complexity.” She continued, “it seems like this is a classic tradeoff type question,” and asked Robinson, “do you have a suggestion, how do you see this uniformity thing going forward, is it – they’re lined up like tin soldiers, or is it just a little more meat on the bones of IFRS?”

Robinson responded, “John [White, Director of the Division of Corporation Finance] said earlier over 100 countries permit or require IFRS - some permit, some don’t require, and those that require IFRS oftentimes don’t require IFRS as adopted by the IASB, and there’s a lot of differences there, so if we can get at least get that level of uniformity, where the regulators around the world agree that it is going to be one set of high quality standard that we’re going to follow, and not have every jurisdiction tweaking the standards - that just adds another degree of inconsistency within that set of standards.” He continued, “even though you’re right, within the U.S. we may not have perfect consistency, comparability among companies, at least they are following U.S. GAAP to some degree.”

Erhardt noted, “IOSCO went on record in November, saying, if you’re not doing IFRS as issued by the IASB, you need to be clear about what your framework is, so I think we’re singing out of the same hymnal in that regard - that I understand; the lining up at all the detailed level seems like a different discussion.”

Separately, in response to remarks of panelist Jeff Mahoney of the Council of Institutional Investors, Erhardt challenged some studies that allegedly showed an earnings advantage to switching to IFRS.

Mahoney noted, “My friend Jack Ciesielski has done great deal of work, identified two dozen areas of significant differences, [including] pension, OPEBs (other post-employment benefits), share-based compensation, derivatives.” Mahoney noted that Ciesielski (one of the panelists at FEI’s June 5 IFRS conference) “… has pointed out these differences [are] very significant, in many cases, not all, would result by higher earnings [in a] median amount of 6.5%.” Additionally, Mahoney noted Ciesielski’s studies have shown “a lot of legacy differences, resulting from differences in asset bases, [that] will linger quite a long time; U.S. investors will have to deal with those differences, including business combinations, revaluing other long-term assets, R&D, other intangible assets; in most cases, but not always, IFRS because of legacy differences will exceed U.S. earnings by 4.3%.”

Mahoney also referenced a “Citigroup study,” which he said showed that, “if U.S. companies were given the option of IFRS… they estimate U.S. companies adopting IFRS would see an increase of about 23% in net income on average.” He added, “There is going to be burden shifting to us analysts, and like U.S. accountants, there are many U.S. analysts not very familiar with IFRS; some experts pointed out it will take more than three years before we have the kind of educational materials in place to retrain, reeducate - not just accountants, but others - to use IFRS in the U.S.”

Erhardt responded, “Needless to say, I’ve looked at some of that information myself, and I’m always struck by the comments about income, in two respects.”

“One is, it seems like… intellectually, one system can’t perpetually forever be higher than the other, at some time it all comes back to the cash you collected, accrual accounting isn’t that powerful,” observed Erhardt. “So, [for example] you might defer development costs under IFRS, which allows you to report higher income, but sooner or later those have to be amortized, which then in essence allows lower income; so, I think those studies are instructive, but I always like to look at the timeframes that they cover.

“And the second thing is,” she noted, “I don’t know if there is any information about equity, about the balance sheet, e.g. in IFRS, actuarial losses in the pension, IFRS says… if you’ll book that loss, and put that obligation on the balance sheet immediately when it happens, sort of the quid pro quo is, you don’t run the debit thru P&L [profit and loss or the income statement], you can charge it directly to equity, but it gets the obligation on the balance sheet right away; whereas U.S. GAAP - although I know its been amended now - US GAAP, it was the other way around: yes, you’ve got to put the debit thru the income stmt, ergo U.S. GAAP income is lower, but you don’t put the obligation on the books until ultimately its been amortized over a number of years through income, so it’s like a tradeoff, you can say U.S. GAAP income is lower than IFRS, but in the IFRS balance sheet the equity is lower, because they’ve actually shown what the obligation is sooner.”

Erhardt added, “I’m always curious, if you have access to more information I’d be glad to have it.. when they look at the full picture, the other part, the balance sheet as well, I think some of the tradeoffs, it’s just pick your poison in the accounting model, vs. one sort of perpetually leans one way or the other, we don’t have to do that now, but if there’s other aspects, if you’d send that along, I’d appreciate it.”

There were many valuable insights added by all the panelists. If I had to zero in on one panelist’s remarks as giving a general flavor for the panel, (with the exception of the investor representatives cited above) I’d cite KPMG partner Paul Munter, who said:

“Many, [and] I am one of those, that think we have to have a date certain to march towards to address education and training, systems issues… what that also speaks to is… it doesn’t necessarily mean you have to wait for convergence.”

He added, “the fact that there are differences doesn’t speak to which body of literature is higher quality - there are differences that in some cases you can argue IFRS is higher quality, in other cases argue U.S. GAAP is higher… the real question is, are IFRS a comprehensive body of literature and a high quality body of literature, in my own judgment, the answer to that is yes. I also think there are some potential benefits from a less mature body of literature, in that [IFRS] hasn’t had time to develop a lot of existing practices and implementation that in fact give you conflicting answers.”

From a regulator’s perspective, Paul Boyle, Chief Executive of the U.K. Financial Reporting Council, noted, “One of the highest profile tragedies was the bank known as Northern Rock, [which] made extensive use of securitizations.” He observed, “all the SPEs [were] fully consolidated, there was full disclosure of what they were doing, they just took a risk and it didn’t work out. We wouldn’t see that as a financial reporting difficulty, it was underlying business difficulty. Our sense is that, to the extent that there has been a loss of investor confidence in financial institutions … it has not been … due to a loss of confidence in financial reporting… To extent [there has been a] loss of confidence, [it has] more to do with investors understanding the numbers and not liking what the numbers tell them, [they] lost confidence in management to run [the] business with an acceptable risk/reward tradeoff.” He acknowledged, “There have been some surprises., things popped back on balance sheet, to some extent,” but he believes those companies “made a different business decision [reputational] to bring [those assets] back on the balance sheet.” Boyle said, “Perhaps there’s a new category of assets and liabilities we ought to disclose, the ‘just off balance sheet’ assets and liabilities.”

Corp Fin Chief Accountant Wayne Carnall, one of the moderators of the panel, likened that to “Broadway, off Broadway, and off-off Broadway.”

Read more details from the SEC’s Aug. 4 roundtable (including a discussion of placement of disclosure in MD&A vs. the audited footnotes) in our updated summary of “
additional highlights” (FEI members only).

For More Information...
KPMG's IFRS Institute will be featuring an audio-cast at 11am EDT on Thurs. Aug. 28 summarizing the decision reached at SEC's Aug. 27 open commission meeting and the implications for financial reporting in the U.S., check it out at

Read about Canada's experience in moving to adopt IFRS in Darla Sycamore's blog,
IFRS Canada: The Devil is in the Details. Sycamore is a member of FEI Canada and a Trustee of FEI Canada's Financial Executives Research Foundation; she writes her blog in her personal capacity.

And, here's a new blog that's come to my attention: see
Discussion Heats Up on IFRS by Travis Drouin in Moody, Famiglietti & Andronico's (MFA) blog.

Update on FAS 5
Last week, the Wall Street Journal published a letter to the editor from FASB Chairman Robert Herz, “
FASB Seeks To Inform Investors, Not Whack Companies,” in response to an earlier editorial published by the WSJ on FASB’s Exposure Draft, Disclosure of Certain Loss Contingencies, which will amend FASB Statements No. 5 and 141(R). As of today (Aug. 26) FASB has received 234 comment letters on the proposal; including comment letters filed by a number of FEI’s technical committees.

COSO Update
We previously reported that FEI’s Task Force on Monitoring filed its comment letter on
COSO’s Exposure Draft on Monitoring Internal Control Systems. COSO has since posted all comment letters received. The comment deadline was Aug. 15, and COSO is currently reviewing comments received with an aim toward issuing final guidance this year.

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Friday, August 22, 2008

SEC IFRS Roadmap Coming Aug. 27; Bernanke on Reducing Systemic Risk; PCAOB Ruled Constitutional - Will Starr's Team Appeal?

The SEC posted a Sunshine Act Notice this afternoon announcing it will consider proposing an IFRS Roadmap at an open commission meeting on Wed. Aug. 27. Specifically, the Notice states:
“The Commission will consider whether to propose a Roadmap for the potential use by U.S. issuers for purposes of their filings with the Commission of financial statements prepared in accordance with International Financial Reporting Standards ("IFRS") as issued by the International Accounting Standards Board. As part of the Roadmap, the Commission will also consider whether to propose amendments to various rules and forms that would permit early use of IFRS by a limited number of U.S. issuers.”

Other matters to be addressed at the Aug. 27 SEC open commission meeting include issues relating to foreign private issuers and cross-border business combinations.
Bernanke SpeechSeparately, in a speech earlier today on “
Reducing Systemic Risk” at the Federal Reserve Bank of Kansas City's Annual Economic Symposium in Jackson Hole, Wyoming, Federal Reserve Board Chairman Ben S. Bernanke called for further consideration of systemwide or ‘macroprudential’ oversight.

He drew critical distinctions between oversight focused on the safety and soundness of an individual institution, and oversight of the system as a whole, including:
“During a period of economic weakness, for example, a prudential supervisor concerned only with the safety and soundness of a particular institution will tend to push for very conservative lending policies. In contrast, the macroprudential supervisor would recognize that, for the system as a whole, excessively conservative lending policies could prove counterproductive if they contribute to a weaker economic and credit environment.
“Similarly, risk concentrations that might be acceptable at a single institution in a period of economic expansion could be dangerous if they existed at a large number of institutions simultaneously.
“[F]ormal stress tests, not at the firm level as occurs now, but for a range of firms and markets simultaneously…. might suggest that a sharp change in asset prices would not only affect the value of a particular firm's holdings but also impair liquidity in key markets, with adverse consequences for the ability of the firm to adjust its risk positions or obtain funding." He added, "Systemwide stress tests might also highlight common exposures and "crowded trades" that would not be visible in tests confined to one firm.”

In supporting further consideration of increased systemic oversight, Bernanke cautioned, “[T]his more comprehensive approach would be technically demanding and possibly very costly both for the regulators and the firms they supervise." He added, "the information requirements for conducting truly comprehensive macroprudential surveillance could be daunting indeed."

Additionally, he noted, “the expectations of the public and of financial market participants would have to be managed carefully, as such an approach would never eliminate financial crises entirely. Indeed, an expectation by financial market participants that financial crises will never occur would create its own form of moral hazard and encourage behavior that would make financial crises more, rather than less, likely.”

“With all these caveats,” Bernanke concluded, “I believe that an increased focus on systemwide risks by regulators and supervisors is inevitable and desirable. However, as we proceed in that direction, we would be wise to maintain a realistic appreciation of the difficulties of comprehensive oversight in a financial system as large, diverse, and globalized as ours."

Separately, Bernanke called on Congress to authorize further powers for the Fed, including “granting the Federal Reserve explicit oversight authority for systemically important payment and settlement systems.”

Bernanke likened the role of settlement and payment mechanisms to that of the ‘hardware’ of the financial system infrastructure. He noted efforts are already underway in which the Fed, the Federal Reserve Bank of New York, and other authorities are working in cooperation with public and private sector entities on such issues as centralizing clearing and settlement of credit default swaps and certain other derivatives.

He also called for strengthening “the associated ‘software’ of the infrastructure, which he said “includ[es] the statutory, regulatory, and contractual frameworks and the business practices that govern the actions and obligations of market participants on both sides of each transaction.”

Noting that, “In the overwhelming majority of cases, the bankruptcy laws and contractual agreements serve this function well,” he observed in certain rare circumstances, “the standard procedures for resolving institutions may be inadequate.” Specifically, “In the Bear Stearns case, the government's response was severely complicated by the lack of a clear statutory framework for dealing with such a situation.”

To mitigate such situations from arising in the future, the Fed chief repeated his call (made previously in a July speech on "Financial Regulation and Financial Stability”) for Congress to consider establishing a statutory framework for resolution of failing nonbank entities. Such an effort, said Bernanke, could potentially be led by the U.S. Treasury Department, “in consultation with the appropriate supervisors, to intervene in cases in which an impending default by a major nonbank financial institution is judged to carry significant systemic risks.” He acknowledged, “The implementation of such a resolution scheme does raise a number of complex issues, however, and further study will be needed to develop specific, workable proposals.”

Bernanke gave a clinical assessment of such a resolution program. “A statutory resolution regime for nonbanks, besides reducing uncertainty, would also limit moral hazard by allowing the government to resolve failing firms in a way that is orderly but also wipes out equity holders and haircuts some creditors, analogous to what happens when a commercial bank fails. “ He added such a regime would mitigate the perception of a nonbank institution being ‘too big to fail.’

Additionally, Bernanke observed that the topic of procyclicality in capital regulations and accounting rules has generated attention among regulators and elsewhere. Additional highlights from Bernanke's speech can be found in this FEI summary. (Summary can only be downloaded by FEI members; see info on FEI membership.)

PCAOB Receives Favorable Court Ruling on Constitutional Challenge
In other news, the
PCAOB issued a statement noting the Court of Appeals ruled today in their favor in a case involving a challenge to the PCAOB’s Constitutionality. The SEC issued a related statement as well.

Washington Post’s David Hilzenrath notes in his article, “
Appeals Court Upholds Sarbanes-Oxley Act,” “The U.S. Court of Appeals for the District of Columbia Circuit rejected a challenge to the heart of the [Sarbanes-Oxley] act, the creation of a nonprofit board to set auditing requirements and police the accounting firms that audit public companies.”Hilzenrath notes, “Today's 2-1 decision by a three-judge panel can be appealed to the full court of appeals or directly to the U.S. Supreme Court, neither of which is obligated to consider the case. “

The case was filed by audit firm Beckstead & Watts in conjunction with the Free Enterprise Fund, and their legal team includes former U.S. solicitor general Kenneth Starr.The 2-1 court ruling, with one judge (Kavanaugh) dissenting, is also discussed in the article, “Sarbanes-Oxley Audit Panel Upheld by Appeals Court,” by Ian Katz and Cara O’Reilly on If you received this blog post from 'a friend' and would like to receive the blog by email, enter your email address here.

Thursday, August 21, 2008

SEC Announces EDGAR to be Succeeded by IDEA; Lutz Speaks on 21 Cen. Discl. Project

The SEC announced at a press conference earlier today (see related press release) that they have "unveiled the successor to the agency’s 1980s-era EDGAR database, which will give investors far faster and easier access to key financial information about public companies and mutual funds. The new system is called IDEA, short for Interactive Data Electronic Applications. Based on a completely new architecture being built from the ground up, it will at first supplement and then eventually replace the EDGAR system. The decision to replace EDGAR marks the SEC’s transition from collecting forms and documents to making the information itself freely available to investors to give them better and more up-to-date financial disclosure in a form they can readily use."
The press release noted the tie-in of the IDEA platform to SEC's proposal earlier this year that companies file financial statements using interactive data in the form of eXtensible Business Reporting Langauge (XBRL). (See related FEI comment letters on SEC's XBRL proposal filed on Aug. 1 by FEI's Committee on Finance and Information Technology and FEI's Committee on Corporate Reporting.)
SEC Chairman Christopher Cox said today, "IDEA’s launch represents a fundamental change in the way the SEC collects and publishes company and fund information – and in the way that investors will be able to use it.”
Lutz Speaks on SEC's 21st Century Disclosure Initiative
Also speaking at today's SEC press conference was Dr. William Lutz, who is leading the SEC's previously announced 21st Century Disclosure Initiative.
“If I were in Hollywood pitching this disclosure project to a producer or head of a studio,” said Lutz, he would describe the project as 'financial disclosure meets the matrix.’

Specifically, Lutz noted that developments in technology, in the U.S. and around the world, have enabled many processes in routine life, from renewing drivers licenses to credit cards, to be done online, with no paper forms required. He compared the existing EDGAR system, the forms based system, to a Model T car, which he said was “reasonable, reliable, dependable, and got you there… but we don’t want to drive a Model T today.”

Using the ‘matrix’ analogy, Lutz said, “Forms are nothing more than a way of collecting information or data; once that data is entered into (the) matrix or cyberspace, all kinds of things happen to it.”

“What we’re going to do is not get rid of the forms,” noted Lutz, adding, “the forms will simply die.” The 21st century disclosure project, said Lutz, “will start from scratch, what if the SEC started today, what would it look for,” and how would it want it provided, to make it useful for investors..

“My team is going to lay out a plan for how the SEC can achieve that,” said Lutz, “and then we get to hand it off to an advisory committee, and I get to go home and let someone else do the hard work.”

Note re: updates: I did not catch the beginning of the SEC press conference today when they focused on the move from the EDGAR platform to IDEA; I will update this post periodically with further details later, or add links to other published summaries, e.g.:
"The SEC's Big IDEA? An FTAlphaville liveblog," posted by Stacy-Marie Ishmael (SMI) of the Financial Times, including live blogging coverage by SMI as well as Francine McKenna of Re: The Auditors and Dominic Jones of IR Web Report.
"Financial Data 'on Steroids,'" by Christopher Twarowski, Washington Post Aug. 19. "A Midsummer Review of Recent XBRL Developments," by Bob Schneider, Hitachi Data Interactive Blog, Aug. 15. This post predates today's announcement, but provides many useful links to XBRL-related information. Also filed under Updates: Even the SEC’s press release issued today had almost an interactive-type element, by means of a taped voice-over intro that pops up when you open the press release. (The commanding voice sounded to me at first like that of Erik R. Sirri, Director of SEC’s Division of Trading and Markets; a reader subsequently told me they believe it was Ethiopis Tafara, Director of SEC's Office of International Affairs.) ] If you received this blog post from 'a friend' and would like to receive FEI's blog by email, enter your email address here.

Monday, August 18, 2008

Board Role Focus Of FEI Comments To COSO On Monitoring Internal Control

In a comment letter filed on Aug. 15, 2008, FEI’s Task Force on Monitoring (TFM) urged the Committee of Sponsoring Organizations of the Treadway Commission (COSO) to revise the proposed description of the role of the board of directors in its Exposure Draft entitled, “Guidance on Monitoring Internal Control Systems,” by clearly stating the board’s role is one of oversight, and by better distinguishing the board’s role with respect to internal control from that of management. The FEI TFM letter was signed by TFM Chair Rick Brounstein, CFO of NewCardio, Inc. Brounstein and FEI Senior Advisor and Former President Michael P. Cangemi, FEI's representative on the COSO board, represent FEI on COSO's monitoring project task force.

“Companies should endeavor to establish controls that would prevent and detect potential fraud perpetrated by senior management, all the way up to the CEO,” said the FEI TFM letter on COSO's ED. Additionally, “In conducting its oversight role, the board should be proactive in seeking information from management, particularly on critical matters, in considering management’s assertions, and seeking information from other sources as appropriate. Importantly, the board should review all such information with requisite skepticism,” noted the FEI TFM letter.

“However,” noted FEI TFM, “the wording in COSO’s ED as currently written implies that if internal audit is not present, or even potentially in situations when it is, that the board must directly engage in ‘monitoring’ senior management in the same manner that senior management monitors other functions at the company. We do not see this as practical or as being within the bounds of the oversight role of boards.”

A similar observation was made in the comment letter filed by the Center for Audit Quality (CAQ) –
affiliated with the AICPA. Referencing paragraph 24 in the COSO ED, the CAQ comment letter said, “The statement is made … that the board has ultimate responsibility for determining whether management has implemented effective internal control. We suggest that it … emphasiz[e] that the Board’s role is one of oversight and not actual implementation.” (emphasis added). Read more about CAQ’s letter further below.

As highlighted in this FEI summary, FEI TFM urged COSO to remain consistent with major listing standards, such as the NYSE Listed Company Manual. Additionally, FEI TFM noted that, based on informal discussions with research staff at the National Association of Corporate Directors(NACD), citing usage from the NACD Blue Ribbon Commission series, as well as informal discussions with legal experts Marty Lipton of Wachtell, Lipton, Rosen & Katz and Ira Millstein of Weil, Gotshal & Manges LLP, they (NACD research staff, Lipton and Millstein) concurred that it would be preferable for COSO to retain use of the word ‘oversight’ to describe the role of the board within its monitoring guidance - consistent with COSO’s description of the role of the board in COSO’s 1992 framework as being ‘governance, guidance and oversight’ - vs. describing the role of the board as ‘monitoring,’ given the specificity with which ‘monitoring’ is described in this guidance.

The FEI TFM letter added, “blur[ring] the line between management’s responsibility to establish and monitor internal controls, and the board’s oversight responsibility… can become particularly troublesome for independent board members… [and] may threaten the very independence of independent board members which is central to the control environment.”

“Deputizing board members as ‘senior, senior managers’ is not the right approach; board oversight is the right approach,” said FEI TFM.

COSO’s Guidance Can Improve Quality of Monitoring, FEI TFM Says
The FEI TFM letter commended COSO for forming a broad-based project task force on the monitoring project, and noted the dedication of the Grant Thornton team leading the drafting of the guidance under the auspices of the COSO project task force.

“We believe COSO’s monitoring guidance has the potential to improve the quality of monitoring at some companies, reinforce effective monitoring already in place at other companies, and enhance understanding of the role of monitoring among issuers, auditors, board members, investors and others,” said FEI TFM. “Additionally, we believe the guidance goes a long way toward COSO’s stated goal of not only improving monitoring, but helping companies to better leverage - or ‘take credit’ for – their monitoring activities, to help reduce unnecessary testing and other procedures that are performed, often in clusters at or near year-end, to assess the effectiveness of internal control. These benefits can accrue to both public and private companies in reaching an optimal mix of company and auditor work, including with respect to assertions under Sarbanes-Oxley Section 404 and applicable AICPA standards.

“However,” continued the FEI TFM letter, “we note that the ultimate cost-benefit and potential value-add in applying COSO’s monitoring guidance will vary based on company facts and circumstances. Additionally, particularly in light of the fact that the guidance was not ‘field tested’ or cost-benefit tested per se, the ultimate cost-benefit will depend on COSO maintaining guidance that is principles-based and practical, and not cause inconsistencies with existing layers of regulation companies are subject to, including SEC, PCAOB, AICPA and major listing standards.” The letter concluded, “[T]he ultimate success of the guidance will depend on the commitment of all parties (including companies and auditors) to maximize efficiency and effectiveness.” For complete details, see the FEI TFM comment letter.

Final Guidance on Monitoring Expected by Year-End; Comment Letters Being Posted
FEI is one of the five sponsoring organizations of COSO, along with the American Accounting Association, the American Institute of CPAs, the Institute of Internal Auditors, and the Institute of Management Accountants.

The Exposure Draft (ED) on Monitoring Internal Control released by COSO in June, on which comments were due August 15, focuses on providing additional guidance on monitoring, one of the five core components in COSO’s 1992 Internal Control-Integrated Framework. The five components are: (1) control environment, (2) risk assessment, (3) control activities, (4) monitoring, and (5) information and communication. After its review of comment letters on the ED, COSO plans to issue final guidance on monitoring internal control by year-end 2008.

FEI’s and CAQ’s comment letters responded to all 33 questions posed by COSO in ED.
Notable in CAQ's comment letter is the fact that CAQ copied all five SEC commissioners and the chief accountant, and all five PCAOB board members and the chief auditor, on its comment letter.
Comment letters received by COSO will be posted on COSO’s website, [Note: COSO currently has comment letters posted on last year's Discussion Document on Monitoring, (a precursor to the ED) and is in the process of posting comments received on this year's ED on Monitoring, on which comments were due Aug. 15.] Besides the FEI and CAQ letters (links provided from FEI's and CAQ's websites, respectively) noted above, additional comment letters are generally sent by other members of COSO’s sponsoring organizations and by major audit firms, as well as some state societies of CPAs and others. (Note: although we currently do not see a comment letter to COSO posted on the New York State Society of CPAs website, NYSSCPA also does a thorough job of sending comment letters to a variety of organizations on various proposals – see NYSSCPA comment letters.)

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Wednesday, August 13, 2008

GAO Tax Study Released; Private Cos Request Exemption From FIN 48; COSO Deadline This Week

Yesterday (Aug. 12) the U.S. Government Accountability Office released a report updating its earlier studies on differences in reported tax liability of Foreign Controlled Domestic Corps (FCDCs) vs. U.S. Controlled Domestic Corps (USCCs). See GAO report.

As noted by Jesse Drucker in the Wall Street Journal today, “Corporate Tax Reporting Draws GAO Scrutiny,” the report found that “At least 23% of large U.S. corporations don't pay federal income taxes in any given year… [and] at least 60% of all U.S. corporations studied -- which also includes many smaller companies -- reported no federal income-tax liability during the period studied, 1998 to 2005.” [Note: This data can be found in Table 1 of the GAO report, on printed page 23 (pdf page 27) of the report.]

Drucker emphasizes the fact that the GAO study “didn't reach any conclusions about why so many corporations reported no tax liability,” noting prior research has focused on the gap between book (i.e. GAAP) and tax income. However, the impetus for this particular study was not the broad topic of book vs. tax income, but the topic of transfer pricing, as noted in the final paragraph of Drucker’s article, in which he describes transfer pricing as, “the method that companies use to allocate costs and revenue between different tax jurisdictions.”

The transmittal letter to Senators Carl Levin and Byron Dorgan in GAO’s report states: “In response to your long-standing concerns about whether foreign-controlled U.S. corporations are abusing transfer prices and avoiding U.S. income tax, we compared the tax liabilities of foreign- and U.S.-controlled companies incorporated in the U.S. in three prior reports.”

Although GAO found “FCDC’s and USCCs differed in age, size, and industry,” they noted it was not possible to isolate the impact of transfer pricing among various tax and non-tax related variables. Additionally, “As agreed, we did not attempt to determine whether corporations were abusing transfer prices. Nor did we attempt to determine the extent to which this abuse explains any differences in the reported tax liabilities of FCDCs and USCCs.”

GAO made an observation which I believe is important to keep in mind generally, concerning potential limitations on the ability of research reports to isolate causative factors for observed results. GAO states: “Researchers have used direct and indirect methods to estimate the extent to which transfer pricing abuses explain the differences in reported tax liabilities… In some of these studies, statistical methods are used to explain as much of the difference in reported tax liabilities as can be explained by the nontax characteristics and the remaining unexplained difference is identified as the upper limit of the difference that could be explained by transfer pricing abuse.” GAO cites some of these studies in footnote 4 of its report, and continues, “However, how close this upper limit estimate is to the actual effect of transfer pricing abuse depends on how many of the important nontax characteristics have been included in the first stage of the analysis. As noted above, data are unavailable for some important nontax characteristics.”

FEI Committee on Private Companies, Backing Request of FASB-AICPA’s PCFRC, Asks That Private Companies Be Exempted From FIN 48

In other tax news, FEI’s Committee on Private Companies, standards subcommittee, filed a comment letter with the Financial Accounting Standards Board yesterday (Aug. 12) asking that private companies be exempted from FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (FIN 48

The FEI letter backs a similar request made on May 30 by the Private Companies Financial Reporting Committee (PCFRC), a joint committee of the FASB and American Institute of Certified Public Accountants chaired by Judith O’Dell.

“For the record, we wish to support the position that [the FASB-AICPA PCFRC] committee has taken to ‘exempt private companies from all the requirements of FIN 48,” states the FEI Committee on Private Companies letter, signed by standards subcommittee chair William Koch.

FEI's Koch adds, “The purpose of this letter is to point out that there is a very salient and relevant argument that was not mentioned in Ms. O’Dell’s letter. We wish to emphasize that the vast majority of private companies are pass through organizations, and as such, the bulk of the income tax attributable to the income of the firm is paid by the owner and not by the firm. Therefore, we believe that the requirement to spend accounting and auditing effort on the minor portion of tax that is paid by the firm on behalf of the owner is requiring the firm to spend limited resources on an issue that should not be given such a level of importance.” Further details can be found in the FEI Committee on Private Companies’ letter.

Earlier this year, FASB issued FSP FIN 48-2, deferring the effective date of FIN 48 for certain nonpublic entities “to the annual financial statements for fiscal years beginning after December 15, 2007.”

COSO Comment Deadline Aug. 15
As a reminder, the deadline for comments on COSO’s Exposure Draft, “Monitoring Internal Control Systems,” is Aug. 15. The Exposure Draft can be found on COSO’s website, FEI’s Task Force on Monitoring (TFM) commented on the earlier Discussion Document (DD) released by COSO last year on this project (see comment letters on 2007 DD - note these are letters on last year's DD, not this year's Exposure Draft), and FEI TFM is planning to file a comment letter on the 2008 Exposure Draft later this week. Your views count - as noted in the COSO Chairman's letter accompanying the 2008 Exposure Draft, a number of changes were reflected in the 2008 Exposure Draft based on comments received on the 2007 Discussion Document.
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Monday, August 11, 2008

Counterparty Risk Management Policy Group Releases Report

On August 6, the Counterparty Risk Management Policy Group (CRMPG - technically, CRMPG III) released a report: “Containing Systemic Risk: The Road to Reform."

As noted in CRMPG’s press release, its recommendations (summarized in CRMPG’s Executive Summary) are laid out according to " five 'Core Precepts,' which the Policy Group regards as relatively simple, readily understandable and forward-looking standards upon which the management of large integrated financial intermediaries must rest. The precepts are:

Precept I: The Basics of Corporate Governance
Precept II: The Basics of Risk Monitoring
Precept III: The Basics of Estimating Risk Appetite
Precept IV: Focusing on Contagion
Precept V: Enhanced Oversight"

CRMPG's report was the subject of an article in the Aug. 7 WSJ, “Debt Market Fix? Try 60?” by Jon Hilsenrath and Serena Ng, which notes, “The group, co-chaired by Gerald Corrigan, a Goldman Sachs managing director and former president of the Federal Reserve Bank of New York, laid out 60 proposals, including that banks be forced to account for more assets on their balance sheets, face tougher standards for selling complex debt instruments, accelerate overhauls of the credit-default-swap market, and implement tougher standards for managing their own risk and liquidity.”

WSJ’s Hilsenrath and Ng added, “The group… includes representatives from nearly every big U.S. bank and broker. It has issued reports in past years -- most notably one in 2005 -- that weren't fully embraced by Wall Street. The 2005 report included warnings about the workings of the collateralized-debt-obligation market, which subsequently experienced a boom and bust that has cost Wall Street hundreds of billions of dollars in write-downs and losses.”

Friday, August 8, 2008

FEI Files Comment Letters On FASB Proposal Amending FAS 5, Contingencies

Earlier today (Aug. 8, 2008) a number of Financial Executives International’s (FEI’s) technical committees filed comment letters with the Financial Accounting Standards Board, voicing concern on FASB's proposal to change disclosures of contingencies, including litigation contingencies, set forth in FASB’s Exposure Draft, Disclosure of Certain Loss Contingencies – an amendment of FASB Statements No. 5 and 141(R).
As noted in a cover letter signed by Christine DiFabio, Vice President, Technical Activities at FEI, the following letters were included in FEI’s comment letters on FAS 5:
A joint letter of FEI’s Committee on Corporate Reporting (CCR) and Committee on Government Business (CGB); and
A letter from FEI’s Committee on Private Companies (CPC)
The joint letter submitted by FEI’s Committee on Corporate Reporting (CCR) and Committee on Government Business (CGB), signed by CCR Chair Arnold Hanish and CGB Chair Dale Wallis, notes, “CCR and CGB (“the committees”) are very concerned about the implications the ED will have, if finalized in or near its present form, on the accounting and disclosures of loss contingencies related to litigation; particularly the prejudicial effects these changes will have on ongoing and threatened litigation.”
The high level of concern regarding FASB’s proposal to change contingency disclosures is evident in the fact that financial executives representing 31 member companies signed onto the CCR-CGB letter, as shown on Exhibit I to the letter.
The separate letter filed by FEI’s Committee on Private Companies (CPC) was signed by William Koch, chair of CPC’s Standards Subcommittee.
FASB is posting comment letters received on its FAS 5 proposal here ; as of 2pm EDT Aug. 8, there were 69 comment letters posted, dated thru Aug. 7, 2008; it is not unusual for a rush of comment letters to come in on the deadline day (today).
Yesterday, we noted some highlights from comment letters filed by the American Bar Association, Association of Corporate Counsel, and Willkie Farr’s Michael Young.

Thursday, August 7, 2008

Legal Community Raises Alarm On FAS 5, Contingencies: Comment Deadline Aug. 8

The legal community has raised the alarm about proposed changes to disclosure requirements for litigation and other contingencies in FASB’s Exposure Draft (ED): Disclosure of Certain Loss Contingencies-An Amendment of FAS 5 and Statement 141R (the FAS 5 ED.) The comment deadline to respond to FASB’s proposal is tomorrow (Aug. 8); see comments filed. (OpEd in today’s WSJ: “FASB’s Lawyer Bonanza”.)

The Association of Corporate Counsel’s (ACC) comment letter states: “The proposed amendments have generated a greater response from our membership, in a shorter period of time, than any other single issue within memory.” They add: “The proposed amendments dramatically alter the disclosure requirements of certain loss contingencies in current FASB 5 (“FAS 5”), including lawsuits…. In our view, and the view of our membership, the quality of the information that would result from the proposed amendments would not warrant the harm that they would inflict on companies and their shareholders.”

Here are some points from ACC’s letter:

Forcing the extensive and detailed disclosures mandated by the proposed amendments in a far broader range of cases than FAS 5 now requires will cause serious harm to the disclosing companies and their shareholders.

The proposed disclosures create a substantial risk of waiver of the attorney-client privilege and work-product immunity, with catastrophic consequences to the corporation.
Underestimating a large loss will be painted as a professional failure laid at the feet of lawyers who are forced to provide concrete estimates about remote and undeveloped matters. Bad numbers could also create new potential liability for the company whose stakeholders relied on mistaken estimates.
[U]nder the new rule, the financial statement consequences of a suit with huge potential losses, albeit a low likelihood of prevailing, will inflict immediate injury on the company and its shareholders. A sophisticated plaintiff may be able to exploit that problem by threatening a suit and then withdrawing it in exchange for an unjustified and extortionate settlement.

Because the proposed amendments would damage the companies ACC members represent, they necessarily injure those who have invested in these companies – a principal constituency that FASB seeks to protect.

Even if the disclosure of litigation-related loss contingencies were a serious systemic problem, it is extremely doubtful that compelling companies and their lawyers to quantify litigation risks would yield more accurate financial statements. As every trial lawyer knows, litigation anywhere in the world — but especially in American courts and before American juries— inherently is unpredictable. The reaction of a single juror or the impact of a single ruling can have a dramatic and unanticipated impact. Indeed, it is highly doubtful that any company or lawyer who ever lost a billion-dollar case expected that result -- they were presumably surprised by the extent of the negative outcome. Had they expected to lose or to lose so badly, they surely would have settled.

In this instance, requiring the losing lawyer or company to have produced a more precise description of the outcome would not have provided more accurate disclosure to investors.

Not only will these expanded disclosures compromise the litigation of existing claims, but they threaten to spark claims of their own. …by compelling the disclosure of significant detail regarding the circumstances of the claim, the factors that may affect the result, the most likely outcome, and the anticipated timing for resolution, the proposed revisions invite Monday morning quarterbacking. Parties who purport to have relied upon these litigation disclosures and predictions will use them as the basis for claims of their own.

The American Bar Association’s (ABA) comment letter states: “We have a number of serious concerns regarding the Exposure Draft’s approach to disclosure of non-financial liabilities, particularly those involving litigation.” They add, “We are particularly concerned with its requirements to provide current quantitative disclosures of estimates of possible losses and qualitative disclosures about the likely future course of events in pending claims without regard to whether a reasonable basis exists for making such estimates and predictions,” and conclude, “we urge the Board not to adopt the proposed amendment to FASB Statements 5 and 141(R).”

Here are some points from ABA’s letter:

- The quantitative and qualitative disclosures called for by the Exposure Draft would inevitably require reporting entities to turn to their lawyers for information if they are to act responsibly, but the kind of speculation and estimation contemplated by the Exposure Draft goes beyond what lawyers can do in a professionally responsible way even if they are willing to risk the possibility of privilege waivers by advising on the disclosure process. As a result, reporting entities often would be left to engage in their own speculation and estimating with the attendant uncertainties and potential exposure to additional liability… predictive information often will turn out to be incorrect because of the uncertainties inherent in litigation. This inevitably will increase the exposure of companies and their management to further litigation, including litigation of a type that Congress has sought to discourage in the Private Securities Litigation Reform Act as burdensome and abusive.
- The additional exception permitting omissions in “rare” circumstances when aggregation is not a solution does not adequately mitigate the prejudice because the minimum required disclosure will frequently still contain prejudicial information of the types described above. Moreover, the standard provides no guidance as to who will ultimately determine whether a particular case presents the “rare” circumstance justifying omission of the information, but concern about getting that judgment wrong and about the consequences of doing so will surely limit its use.
- Even if disclosures can be crafted that preserve the privileges in most cases, two consequences of the Exposure Draft are foreseeable: (i) there will be a substantial increase in litigation over privilege matters and communications between reporting entities and their counsel relating to these disclosures and (ii) reporting entities may feel inhibited in their ability to communicate freely with counsel about these disclosures fearing that such communication may lead to loss of privilege. Neither of these would be a desirable result.
- Because of the numerous subjective factors that go into an assessment of a lawsuit, as well as the possibility of critical factors that are not presently known, auditing quantitative disclosures about litigation will be very challenging. To the extent that the reporting entity’s judgments and estimates are based on privileged communications between a disclosing entity and its counsel, auditors may feel obliged to seek privileged information from counsel or the company in order to test the disclosures. Even where the reporting entity has not relied on its counsel for the estimates, counsel representing the entity in the matter is likely to be a useful source of information to test those assertions. In either case, disclosure of privileged information to an independent auditor could lead to loss of the privilege. At the least, the need for the auditor to audit the information is likely to put strains on the “Treaty” between the American Bar Association and the AICPA that has governed lawyers’ responses to auditors’ inquiries since the 1970s. … As the United States Supreme Court said in Upjohn Co. v. United States 449 U.S. 383, 393 (1981) “an uncertain privilege…… is little better than no privilege at all”. The loss of the protections of the attorney-client privilege and work product doctrine for this type of detailed analysis will often be extraordinarily detrimental. Once the privilege is lost, the subject of the once privileged communication becomes fair game for discovery in the litigation. The reporting entity’s adversaries will be given a potential roadmap to victory since the privileged information will reveal counsel’s assessment of the strengths and weaknesses of the reporting entity’s litigation position
- This is one of those unusual situations where the potential harm to reporting entities and their shareholders from the required disclosures outweighs the potential benefits to investors and other users of financial reports.
- The Exposure Draft fails to take into account certain basic aspects of the adversarial system of justice in the United States and threatens to put reporting entities at a serious disadvantage in that process.

The FAS 5 Changes and the "Preeminence" of Investors
The last two points raised in ABA's comment letter, cited above, speak to the need for FASB to balance the many sometimes divergent interests in the system to achieve a state of fairness.
Similar points were made in Willkie Farr attorney Michael Young's comment letter. Young is highly regarded for being an expert on securities law and recently rotated off FASB's Advisory Committee, FASAC. Young states [we format with bullets for emphasis]:

“At the risk of stating the obvious, what is really going on here - at least insofar as the exposure draft is applicable to loss contingencies arising from litigation - is a fundamental difference between two cultures.
- One is the culture of financial reporting and its commendable commitment to transparency.
- The other is the culture of our adversary system of justice which necessarily balances the objective of transparency against prejudice to litigants seeking to have their day in court."

Young continues, "It should not be surprising, therefore, that commentators on this exposure draft can offer such differing, but wellintentioned and genuinely held, views.”He adds, “I believe that the two cultures may be reconcilable for purpose of FAS 5,” and states, “if improvement is warranted, I would suggest that the Board seek a middle ground that both seeks to accommodate the objectives of users while preserving the ability of preparers to have their day in court without undue prejudice." See his comment letter for his detailed recommendations on how FASB can achieve this balance.

On the subject of balance, Professor Tom Selling, in his Accounting Onion blog, discussed his views on investor 'preeminence' as that term is used in the final report of the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR). (He cites our earlier post which noted footnote 15, one of the last additions to CIFIR's final report, amplified that ''preeminence' as that term is used is not necessarily that investors' views 'trump' all other interests, but that investors views should be given 'greater weight." )

Personally, I believe the footnote is an attempt to reflect the necessary balancing of all interests - a balancing recognized as fundamental to standard-setting going back to FASB Concepts Statement No. 2, Qualitative Characteristics of Accounting Information (CON 2), which included cost-benefit among the necessary characteristics to consider, noting in para. 140:

"The burden of the costs and the incidence of benefits fall quite unevenly throughout the economy, and it has been rightly observed that “ . . . the matter of establishing disclosure requirements becomes not only a matter of judgment but also a complex balancing of many factors so that all costs and benefits receive the consideration they merit. For example, a simple rule that any information useful in making investment decisions should be disclosed fails as completely as a rule that says disclosure should not be required if competitive disadvantage results.” The problem is to know how to accomplish that “complex balancing.”

The FAS 5 proposal, on which comments are due tomorrow, will surely be an opportunity for FASB to exercise the "complex balancing" referenced in CON 2 above. Willkie Farr's Young noted in his letter: "I have every confidence that the Board will rise to the challenge.”

Wednesday, August 6, 2008

FASB Retains November Effective Date For Disclosures Of Credit Derivatives, Other Guarantees

FASB voted earlier today (Aug. 6) to retain the effective date stated in its proposed FASB Staff Position (FSP) No. FAS 133-b and FIN 45-c, Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45. (Proposed FSP, comment letters.) That proposed effective date is fiscal years and interim periods ending after Nov. 15, 2008.
The board noted some commenters on the proposed FSP had requested that FASB delay the effective date of the upcoming final FSP to coincide with the effective date of FAS 161 on derivatives disclosures; however, FASB voted to retain the original effective date, as noted above, due to strong investor interest in getting timely information on Credit Default Swaps and certain other guarantees. The vote was 3-2, with FASB Chairman Robert Herz and FASB Board Members Tom Linsmeier and Larry Smith voting to retain the effective date; and FASB Board Members Leslie Seidman and George Batavick voting to defer the effective date.
FASB will also clarify in the final FSP that interim disclosure information pertaining to companies’ fourth quarter will be required to be provided under this FSP as well as under FAS 161. Staff noted they received some questions whether 4th quarter disclosures would be required, since companies don’t file a 4th quarter “interim” report (e.g. for public companies, a 10-Q) per se, but file only an annual report (10-K) at year end. The clarification to be provided in the FSP will note that disclosures required by FAS 161 and by this FSP will need to be provided for 4th quarter as well (e.g. to be included in 10-K). The likely language for this clarification is noted in para. 10 of today’s board handout.
The board authorized the staff to proceed in drafting a pre-ballot draft of the FSP.
FASB staff member Bob Bhave said he would expect to have the final FSP ready for release (following board vote on ballot draft) in mid- to late-September. Board member Larry Smith said “I would encourage staff move as quickly as possible considering the decision just made” [i.e. on retaining the effective date].
Additional highlights from today’s FASB meeting can be found in this FEI summary (FEI members only).

AAA Annual Meeting Taking Place in Anaheim This Week

FEI’s blog would like to give a shout-out to all our colleagues participating in the American Accounting Association (AAA) annual meeting this week in Anaheim, CA. AAA is the professional association for accounting professors. We understand AAA may have a record number of participants in the annual meeting this year; no surprise with the heightened interest in accounting among students, professors, and others.
With the accounting profession faced with a shortage of PhDs to meet rising enrollments, and challenged by an accelerating rate of change, programs at AAA’s annual meeting are geared toward meeting these and other challenges, including the move to International Financial Reporting Standards (IFRS). (Note: later today, we will be posting highlights from SEC's IFRS-GAAP roundtable held Aug. 4.)
FEI has helped promote AAA’s programs to increase the number of professionals in becoming “professionally qualified” (PQ) to teach at the college level – to supplement those deemed “academically qualified” (AQ) to teach by means of holding a PhD. Programs like AAA's one day PQ programs, and AACSB’s week-long Bridge Program, are aimed at helping offset the shortage of PhDs in accounting, and providing more professors with practical experience. See our related articles here, here and here.
Separately, a related effort was announced July 30 by the audit profession, “Doctoral Scholars Program in Accounting Created by CPA Profession - $15 million to Help Fill Shortage of Accounting Professors.”
AAA’s immediate Past President, Gary John Previts of Case Western Reserve University, is a member of FEI, and a member of the U.S. Treasury Department’s Advisory Committee on the Auditing Profession (ACAP). (See some of our past coverage of ACAP’s deliberations relating to the education aspect of the audit profession’s human capital here.) AAA’s new President is Sue Haka of Michigan State University.
FEI Senior Advisor and former President & CEO Michael P. Cangemi is participating in a roundtable session at the AAA conference today with leaders of major organizations, including the AAA, AICPA, AGA, FEI and IMA, in a session entitled “Critical Issues in Accounting Education: Synergies for Accounting Organizations.” The leadership summit panel, coordinated by AAA Executive Director Tracey Sutherland, will take place during the 10:15 am concurrent sessions today.
Cangemi is also participating in a session entitled “Developing a Better Understanding of the Relationship between IT and an Organisation's Value,” one of the 2:30 pm concurrent sessions today. The panel, coordinated by Robert Hodgkinson of the Institute of Chartered Accountants In England and Wales (ICAEW), also includes Kevin Kobelsky, Baylor University, and Paul Miranti, Rutgers Business School.
Accounting Professors and Assoc. Professors, Deans and Ass't Deans take note: FEI has a special membership category for you, with discounted annual dues. By joining FEI, you will receive all the high quality, practical reports issued by the Financial Executives Research Foundation (FERF), the research foundation affiliated with FEI, as well as our award-winning magazine, Financial Executive, and our weekly e-newsletter, FEI Express. (Note: CPE credit is available for some of our magazine articles and FERF reports, as well as our conferences.) FEI membership also entitles you to reduced rates at our conferences, including our annual Current Financial Reporting Issues (CFRI) conference Nov. 17-18, 2008 in NYC (featuring the Chairmen of the SEC, FASB and IASB), our annual Summit Conference in the Spring, our Women in Financial Leadership Conference Sept. 17 in NYC, and much, much more. If you have any questions about FEI membership, feel free to contact me or Nancy Ehlers in our membership department

Monday, August 4, 2008

SEC Ready To Roll with All Five Commissioners in Place; Pozen Committee Report Issued

With all five commissioners now in place upon last week’s swearing in of Commissioners Luis Aguilar and Troy Paredes, and the July 9 swearing in of Commissioner Elisse Walter - joining Chairman Christopher Cox and Commissioner Kathleen Casey - the SEC is ready to roll on issues like IFRS and the 25 recommendations contained in the final report of its ‘complexity’ committee.

SEC released the list of panelists for today’s 1pm EDT roundtable (which will be webcast): Roundtable on Performance of IFRS, U.S. GAAP During Subprime Crisis. It will be interesting to see if SEC provides an update on expected timing of release of its “IFRS Roadmap,” following on last year’s Concept Release, as to whether U.S. companies should be given the option – or be required – to report their financial statements in SEC filings in IFRS instead of U.S. GAAP. (Further background in SEC's "Spotlight on Global Accounting Standards/IFRS" webpage.)

Recommendations of ‘Complexity’ Committee (aka 'Pozen Committee' aka 'CIFiR')
At a press conference on Aug. 1, Robert Pozen, chair of the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR), formally delivered a copy of CIFiR's Final Report to SEC Chairman Christopher Cox. The report contains 25 recommendations to improve the usefulness of, and reduce complexity in, financial reporting.

Timing of Implementation of CIFIR Rec's
The SEC has already implemented two of the recommendations contained in CIFiR’s Progress Report released earlier this year, noted Cox (re: SEC’s XBRL proposal – on which the comment deadline was Aug. 1 - and last week’s Interpretive Release: Guidance on Use of Company Websites).

Going forward, said Cox, “I’ve asked the commission staff to immediately begin analyzing the balance of the proposals with a view to presenting [them for consideration of] the commission.”

Asked how long he thought it would take to implement some of CIFiR’s recommendations, Cox replied, “I don’t know that the commission will be able to address all the recommendations by year end, but we will certainly start immediately.”

He added, “I’m sure a lot of that will continue into 2009,” and noted “the process for … proposal is not different than on other SEC rulemakings; once a proposal is voted on by the commissioners, it would be exposed for public notice and comment for a month, two months, [or] three months.” The next step, noted Cox, is, “those comments are collated and weighted,” and “the final recommendation goes back to the commission for action.” All in all, he said, “that process tends to take about six months.”

Observing where we are in the calendar now, Cox said, “You can figure the normal gestation period would take us into spring of next year for any recommendations we would bring up right away.” He added, “There are some recommendations in here that might be more tractable than others, might be more susceptible to immediate action, simply because they build on work the staff has been doing here for a long time,” however, others may take longer.

Highlights from CIFIR Report: Fair Value (FV), Quasi-GAAP
Certain recommendations in CIFiR's report are addressed to the Financial Accounting Standards Board and the Public Company Accounting Oversight Board; FASB Chairman Robert Herz and PCAOB Chairman Mark Olson also participated in the press conference.

Asked to give some highlights from the report, Pozen singled out one item from each of the four chapters in the report (standard-setting, substantive complexity, audit process and compliance, and delivering financial information), among the items he highlighted were CIFiRs recommendations relating to Fair Value (FV).

“[There is an] important conceptual debate whether FV or historical cost (HC) is the appropriate way to go.” He continued, “we were not able to solve the debate ... but we took the view that we could make the distinction a lot clearer and we could educate investors about the different quality of earnings and the different aspects of them,” such as how much is from core earnings are, and how much from unrealized profit or loss based on FV estimates. “While we had pressures from both sides,” (i.e. pro- and con-FV), said Pozen, “we did not yield to either pressure.” Instead, given they believe the ‘mixed attribute’ system (i.e. some items measured at FV, others at HC or still other measurements) would be with us for some time, CIFIR accepted that reality and made a recommendation to provide more transparency to investors as to which components of income were measured by which attributes.

FASB Chairman's Remarks
Also present at the press conference announcing release of the CIFiR report was FASB Chairman Robert Herz, who observed, “There are people who love FV, people who hate FV, and people in the middle.”

He added, “I think generally the recommendations are congruent with where we’re headed.” He noted one of CIFiR’s recommendations is that FASB “be ‘judicious’ with further expansion of FV while we deliberate the measurement phase of the conceptual framework project with the international folks.”

Additionally, Herz noted that CIFIR’s recommendation “that there be a better articulation in financial statements from those things that derive from ongoing activities, (e.g. core earnings) and other things” is tied into the FASB-IASB project on Financial Statement Presentation. FV is not the only thing being addressed in that project, noted Herz, adding the project will “try to construct a better set of financial statements that would much more clearly show these kinds of differences.”

Another significant proposal released by CIFiR, said Pozen, was “if there is an industry wide issue that comes up at the SEC, we should try to move that to FASB and have the sort of notice and process [i.e. public notice and comment period] FASB is good at.”

“There is a tendency on the registrants’ part, if some comment is made by [an SEC] staffer [e.g., in communicating with the registrant on their filings] that there is a broader rule. If we can divide what’s industry applicable and have some kind of notice and process and at same time give guidance on registrant issues, [it would be a] significant step forward.”

Separately, Pozen noted, “we support the excellent work of FASB in trying to codify all of accounting literature into one volume, this hopefully will reduce the amount of quasi-GAAP that runs around the world, and everyone will know what’s authoritative.”

Regarding audit firm guidance, the SEC’s press release issued Aug. 1 noted, “The Committee [CIFIR] said that others such as audit firms may still publish their views on accounting issues, but they should be labeled as non-authoritative. … the Committee also called for a clearer delineation of functions on interpreting accounting standards — with the FASB taking the lead on broad issues and the SEC on registrant-specific issues.”

Additional highlights from the press conference can be found in this press release. The full list of 25 recommendations is provided in the compendium of recommendations in the executive overview section of CIFiR’s final report. We provide further details from the press conference in this FEI summary. (FEI members only.) If you received this blog post from ‘a friend’ you can sign up for the FEI blog by emailing and putting in subject line: Sign Up.

In other news, the SEC formally announced on July 31 that Deputy Chief Accountant Zoe-Vonna Palmrose is leaving the SEC to return to teaching at USC.