Reporting Complexity; Cox on Proxy Access; More

An advisory committee tasked with recommending ways to improve the U.S. financial reporting system and to reduce unnecessary complexity for companies faced its first challenge at its inaugural meeting: deciding which of the myriad financial reporting issues it can reasonably tackle in a year.

That’s how long the 17-member panel, which met for the first time on Aug. 2, has to deliver its recommendations to the Securities and Exchange Commission.

Pozen

As members of the Advisory Committee on Improvements to Financial Reporting hashed out which issues to address, its chairman Robert Pozen, also chairman of MFS Investment Management, noted: “We cannot possibly address every issue in financial reporting … but we can focus on areas where we think we can make substantial improvements.” Pozen said he hopes the group’s recommendations will be “focused,” and, “be doable, easy to adopt, and not require legislation.”

White

To that end, John White, director of the SEC’s Division of Corporation Finance, which proposes a large number of new rules to the SEC, urged the committee, “Please give us something we can do in a realistic and practical way.”

Several attendees at the meeting said the current, record-breaking number of restatements underscores just how complex financial reporting truly is. SEC Chief Accountant Conrad Hewitt noted that almost 10 percent of U.S. public companies restated their financial statements in 2006—“an alarmingly high number.”

Pozen agreed. He described auditors and preparers of financial statements as “a group of people trying very hard to get it right” and then soberly added, “When that many people try that hard and have that high an error rate, it’s not good.”

Pozen said one benchmark of his committee’s success will be whether the number of restatements falls in future years. As part of that effort, the committee will consider the findings of a separate Treasury Department study of restatements expected early next year.

Beresford

Advisory committee member Dennis Beresford—also formerly chairman of the Financial Accounting Standards Board, and a member of the audit committee at multiple companies—noted that past efforts to simplify financial reporting have met with “relatively modest” results. Beresford urged the group to deal with “the relevance of current and proposed [Generally Accepted Accounting Principles] rather than just its complexity.”

What Comes Next

The advisory committee’s primary focus will be the needs of investors. While it will also consider the needs of auditors, the group won’t make specific recommendations on auditor liability, since a separate Treasury committee on sustainability of the audit profession is examining that issue.

A discussion paper, drafted by Pozen that may be issued for comment, outlined five areas of focus:

Substantive complexity: the various causes and effects of complexity on accounting and reporting standards;

Standards setting: how accounting standards are adopted and subsequently interpreted;

Audit and compliance processes: how the audit process occurs; how financial statements are reviewed by the Division of Corporation Finance; how the Public Company Accounting Oversight Board inspects audit firms; and how the SEC enforces rules against violators;

Information delivery: how to deliver information to investors in formats and packages more appropriate for their needs, and how the XBRL data language can help in that effort;

International coordination: The SEC released a proposed rule in June to allow foreign issuers in the United States to file financial statements in International Financial Reporting Standards without reconciling the numbers to U.S. GAAP; it also promises a concept release on whether domestic filers should be allowed the same choice of IFRS.

Pozen suggested the group concentrate on the first four areas, and wait on international coordination until public comments on the SEC’s IFRS proposals arrive in the next few months.

Cox Talks to Lawmakers on SOX, Proxy Access

Responding to a threat of legislative action, Securities and Exchange Commission Chairman Christopher Cox repeated to lawmakers last week his promise to have a rule in place on shareholder access to the proxy in time for the upcoming proxy season.

Dodd

During a July 31 hearing to examine the state of the securities market, where lawmakers peppered the former California Congressman with questions on a wide range of topics—including its dueling proposals on shareholder access—Senate Banking Committee chairman Chris Dodd, D-Conn., warned that the issue of proxy access is one where he “might express interest legislatively” if the SEC “can’t come to a conclusion.”

“I appreciate … the extra encouragement, but as I stated, we will do a rule, and we’ll have it in place this fall,” Cox responded.

As Compliance Week has previously reported, on July 25 the SEC published two conflicting proposals on proxy access, and Cox served as the swing vote for each; the other commissioners split along party lines. Democrats support a proposal to permit the inclusion in the proxy statement of shareholder-proposed bylaws on how directors are nominated in the company’s proxy materials. Republicans supporting a plan that would block proxy access and reaffirm the SEC’s 1990 interpretation of the federal proxy rules.

Cox

Cox said he personally believes the proposal favoring access (also known as “the longer proposal”) has “much merit.” Some banking committee Democrats fretted that the proposal’s requirement that shareholders own at least 5 percent of company stock to propose proxy-access changes is too high. Cox, however, defended the threshold and questioned whether a group that can’t meet the 5 percent mark to put forward a bylaw proposal would be able to get the majority of shareholders needed to approve it. Improved, more expansive electronic communication among shareholders might also “be a way to put together a five percent group that doesn’t exist today,” he added.

On another subject, Cox also said that the SEC staff is developing a proposal on mutual recognition of foreign stock exchanges and securities, based on input gathered during a June roundtable on the topic. Cox said he expects the staff to complete initial work by the fall. Mutual recognition would permit foreign exchanges and broker-dealers to provide services and access to U.S. investors under an abbreviated registration system, provided that they’re supervised in a jurisdiction that provides oversight substantially comparable to U.S. oversight.

Five Years Post-SOX, Being Public Still Isn’t Cheap

Another year, another mixed bag of hope and gloom for companies in the post-Sarbanes-Oxley world.

According to the fifth annual study by law firm Foley & Lardner, “The Cost of Being Public in the Era of Sarbanes-Oxley,” overall SOX compliance costs drifted downward in fiscal 2006. But out-of-pocket costs for companies—audit fees, steeper board compensation, and legal fees, primarily—still marched upward at double-digit rates.

The study reports that average compliance costs for companies with less than $1 billion in annual revenue have increased more to approximately $2.8 million since SOX’s enactment in August 2002, for a 171 percent overall increase from fiscal 2001 to 2006.

Out-of-pocket costs associated with SOX compliance rose 13 percent last year for public companies with annual revenue of less than $1 billion, and 12 percent for companies with revenues exceeding $1 billion.

On average, external audit fees increased 271 percent in fiscal 2001 to 2006 for companies with less than $1 billion in revenue. Fees for those companies increased 4 percent from 2005 to 2006 alone.

While some experts predicted external audit fees would decrease after the initial implementation of Section 404 audits, as auditors became more efficient in conducting them, study director and Foley Partner Tom Hartman says the results don’t support that prediction. He notes that external audit fees have been the only cost to increase every year since SOX was passed.

In fiscal 2006, audit fees represented more than 47 percent of out-of-pocket costs associated with compliance for companies with less than $1 billion in revenue, and 60 percent for companies with $1 billion or more.

Average audit fees leveled off for companies of all sizes in 2006, with relatively modest year-over-year increases of 5 percent for Standard & Poor’s small-cap companies, 4 percent for S&P midcap companies, and 6 percent for S&P 500 companies.