SEC Committee Unveils Suggestions

A blue ribbon panel tasked with recommending ways to improve financial reporting and reduce complexity unveiled a number of its preliminary recommendations, including cutting down on industry-specific accounting guidance, “chunking” similar information in the financial statements, and making interactive data reporting mandatory for the largest companies as soon as next year.

The 17 members of the Committee to Improve Financial Reporting met Nov. 2 to discuss dozens of preliminary recommendations based on the reports of the group’s four subcommittees. None of the recommendations were voted on at the meeting.

Among other things, the substantive complexity subcommittee recommended that Generally Accepted Accounting Principles and any exceptions included in GAAP should be based on activities, rather than industries.

Pozen

The group also said the Financial Accounting Standards Board, which sets U.S. accounting standards, should analyze all existing industry-specific guidance and determine whether, and to what extent, it should be retained. Committee Chairman Robert Pozen, chairman of MFS Investment Management, called industry-specific guidance “a very concrete example of unnecessary complexity.”

Pozen said industry guides that just elaborate and detail GAAP “would be acceptable,” but added that guidance in conflict with generalized GAAP is “most problematic.” In other cases, such as revenue recognition, Pozen said a lack of general standards has led to “tremendous disparity.”

While Michael Cook, former CEO of Deloitte & Touche, acknowledged “some pretty bad accounting masquerading … under the heading industry practice,” he warned the group to “proceed with caution,” since there’s a “very real need” for such guidance in some areas.

The sub-committee also recommended grouping information by measurement attribute, which it described as “chunking” similar information in the financial statements, an idea that was well-received by all of the panel members.

Jonas

It also suggested a potential moratorium on any new standards that would expand fair value reporting requirements until implementation issues are resolved. However, Moody’s Investor Services Managing Director Gregory Jonas warned that a moratorium in that case “could turn out to be a funeral.”

A sub-committee on audit process and compliance was asked to consider a “tiered audit opinion,” which would provide varying levels of attestation based on the uncertainty of a measurement. Cook, chair of that sub-committee, said the group would give it “due consideration,” but suggested that might be a task more suited to a separate Treasury committee that is studying the viability of the audit profession.

Meanwhile, a standard-setting sub-committee recommended greater user participation in the standard-setting process, through more representation on the bodies involved in the process, such as the Financial Accounting Foundation and FASB.

Additionally, the sub-committee said FASB should be the primary issuer of authoritative accounting guidance, and that any registrant-specific guidance that comes from the SEC should be subject to a due process. The group also suggested a formal agenda committee be formed to provide input on the standard-setting agendas of FASB, the Emerging Issues Task Force, and the SEC.

In addition, it said more field testing and cost benefit analysis should be done during the development of a standard, and a post-implementation review should be conducted two or three years after a new standard is put in place.

Rebuttable Presumptions

Some of the more controversial proposals came from the audit process and compliance sub-committee, which is looking at developing a framework for professional judgment that could potentially serve as a safe harbor to alleviate auditor concerns about being second-guessed.

Cook noted that the “real challenge will be the frame of reference, the standard against which we believe professional judgment should be made.”

“We have eliminated two possibilities,” he quipped. “We have eliminated perfection and ‘anything goes.’ Everything between [those] is still on the table.”

That committee also suggested a sliding scale for evaluating the materiality of errors based on quantitative and qualitative considerations. For example, errors that amount to less than 5 percent would generally have a rebuttable presumption that they’re not material, while errors over 10 percent would have a rebuttable presumption that they are material.

A preliminary recommendation that the SEC should make reporting in eXtensible Business Reporting Language mandatory for the largest companies as soon as 2008 stirred debate among some members. In its report, the sub-committee on delivering financial information stated that, while there are challenges to full implementation of XBRL, “those challenges can be effectively addressed.”

Varian Chief Financial Officer and Treasurer Edward McClammy said the idea reminded him of how regulators grossly underestimated the cost and effort involved with implementing Sarbanes-Oxley Section 404.

“I don’t think small or mid-sized companies have the bandwidth to take this on,” McClammy said. Several members suggested that XBRL reporting be phased in slowly, starting with the largest companies first.

John White, director of the SEC Division of Corporation Finance and an observer to the committee, noted that SEC Chairman Christopher Cox has asked the staff to prepare a recommendation—“think proposed rule”—on interactive data reporting in the spring, with a final recommendation expected in the fall. The SEC has said that it will eventually make XBRL mandatory; the question is how soon. Adoption so far hasn’t been widespread.

The group is also exploring the possibility of companies providing short summary reports, perhaps in the form of a management letter to shareholders, to provide financial information to retail investors, in addition to the annual report. However, members raised questions about liability and whether there’s a need for another report. After discussing the issue, Pozen noted, “We may need to rethink whether summary reports as contemplated would be useful.”

The committee will hold its next open meeting Jan. 11. The group will make its final recommendations to the SEC next summer. All of the sub-committee reports and other related resources can be found in the box above, right.