Accounting & Tax

Did Complexity Give Rise to Scandal?

''Conformity to hundreds of technical rules became not a shield to protect investors, but a sword to be wielded against them,'' maintains SEC chair...
Stephen TaubDecember 5, 2005

Keep it simple.

This was a major theme of the message delivered by Securities and Exchange Commission Chairman Christopher Cox in a speech Monday during an AICPA conference in Washington, D.C.

Cox stressed the need for greater clarity and transparency, asserting that the recent accounting scandals were made possible in part by the sheer complexity of the rules. “Criminal conduct could be concealed in a thicket of detail,” he explained. “Conformity to hundreds of technical rules became not a shield to protect investors, but a sword to be wielded against them.”

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One reason for the complexity, said Cox, was pressure from different constituencies, and he acknowledged the “inescapable fact that the complexity of modern financial transactions often calls for a commensurately detailed set of regulatory requirements.”

He added, however, that “the sheer accretion of detail has, in time, led to one of the system’s weaknesses — its extreme complexity. Convolution is now reducing its usefulness. In business, academia, and the regulatory community, the question is being seriously asked whether preparers and auditors can produce the transparent financial information that our capital markets require.”

Cox said that in an effort to simplify accounting rules, the Financial Accounting Standards Board is reassessing specific standards “in major areas where rules fail to provide transparent information.” In addition, FASB is trying to codify all of the existing literature and establish a single source for all GAAP material. To do that, Cox noted, “FASB is trying to contain the proliferation of new pronouncements from multiple sources.” He also stressed that the movement toward “plain English” is “just as important in accountancy as it is everywhere else where investors are concerned.”

In his speech, Cox also expressed concern about the dearth of competition among the major accounting firms. Big Four firms audit 80 percent of U.S. public companies, he observed, and their audit clients account for 99 percent of all U.S. public-company annual sales.

The chairman elaborated that because of geographic demands or industry specialization, a company may have only one realistic choice if it want to change auditors. Cox also observed that in some cases, because of auditor-independence rules, a company that uses one or more of the Big Four for non-audit services may find itself in a position where it simply can’t consider changing auditors at all.

Cox also thanked the assembled attendees for “promoting the use of Extensible Business Reporting Language, or XBRL. I completely agree with you that XBRL will do for business reporting what bar coding did for product distribution,” he added.

Elaborated Cox: “The interactive data that this initiative will create will lead to vast improvements in the quality, timeliness, and usefulness of information that investors get about the companies they’re investing in. Interactive data will give SEC analysts better tools to detect fraud. It can make it easier, less expensive, and less time consuming for companies — and their accountants — to comply with SEC reporting requirements. It is not mere wishful thinking that with interactive data, it would be possible for a significant part of the 404 work to be automated.”

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