SEC Advisory Committee on Improvements to Financial Reporting

By Cydney Posner

You may have heard that the SEC has formed an Advisory Committee on Improvements to Financial Reporting (CIFiR). The Committee’s objective is to examine the U.S. financial reporting system with a view to providing specific recommendations regarding reduction of unnecessary complexity and increasing usefulness of that system to investors. Upon conclusion of the Committee’s work, it will provide to the Chairman of the SEC written recommendations regarding how to improve the financial reporting system in the U.S., which may include recommendations that involve the FASB, the PCAOB and other appropriate organizations. Note that the SEC implemented a number of the recommendations of its Advisory Committee on Smaller Public Companies, and this Committee's report may likewise have substantial impact.

The Committee will consider the following topics:

• the current approach to setting financial accounting and reporting standards, including (a) principles-based v. rules-based standards, (b) the inclusion within standards of exceptions, bright lines and safe harbors, and (c) the processes for providing timely guidance on implementation issues and emerging issues;
• the current process of regulating compliance by registrants and financial professionals with accounting and reporting standards;
• the current systems for delivering financial information to investors and accessing that information;
• other environmental factors that may drive unnecessary complexity, including the possibility of being second-guessed, the structuring of transactions to achieve an accounting result and whether there is a hesitance of professionals to exercise judgment in the absence of detailed rules;
• whether there are current accounting and reporting standards that do not result in useful information to investors or that impose costs that outweigh the resulting benefits; and
• whether the growing use of international accounting standards has an impact on the relevant issues relating to the complexity of U.S. accounting standards and the usefulness of the U.S. financial reporting system.

One subcommittee will study the sources of substantive complexity, including the complexity that may result from the tension between principles and rules and from competing principles, as well as from conflicts between the objectives of preparers and users, industry-specific exceptions and the availability of alternative principles. Interestingly, comments submitted by former SEC Chief Accountant, Walter P. Schuetze, argue that principles-based standards almost never work and that it would be "a grave mistake for standard setters or regulators such as the Commission to attempt to set standards based on principle." He instead recommends the adoption of "fair value" reporting, which would require that all assets and liabilities, not just financial assets and liabilities, be reported in the balance sheet at fair value.

Another subcommittee will consider the standard-setting process, including the GAAP hierarchy. U.S. GAAP has been developed formally by many recognized organizations, such as the SEC, the FASB, the EITF and the AICPA, as well as more informally through, for example, the SEC comment process, FAQs, interpretive guidance and even private organizations and firms that publish educational material or enforce standards firm wide. These various contributors may lead to increased complexity.

A third subcommittee will study the current process of regulating compliance with the accounting and reporting standards and other environmental factors that drive unnecessary complexity, including the possibility of being second-guessed, the structuring of transactions to achieve an accounting result and whether there is a hesitance on the part of professionals to exercise professional judgment in the absence of detailed rules. In particular, the subcommittee will consider the reasons underlying the significant increase in restatements, including whether the increased volume of restatements makes it more difficult for securities analysts and other users of financial information to determine the significance of a restatement and whether it could lead to an environment where users of financial reports begin discounting the importance of restatements (for example, if restatements are viewed to be routine). In addition, the subcommittee will consider the role of preparer and auditor judgment as it relates to the reduction of bright lines and prescriptive application guidance, including whether it would be useful to provide more latitude in standards while requiring more disclosure about the alternatives that were considered and why the selected alternative was applied. The subcommittee may also look at how legal risks faced by audit firms and registrants influence their behavior in preparing and auditing financial reports, including their willingness to exercise judgment and to show flexibility in applying accounting rules.

A fourth subcommittee will consider the current system for delivering financial information to investors and for accessing that information, including tiering and data tagging, as well as the use of press releases and websites. The last subcommittee will look at whether the growing use of international accounting standards has an impact on the relevant issues relating to complexity of U.S. accounting standards and the usefulness of the U.S. financial reporting system.