Are You “Reasonable”?

The SEC's accounting anti-complexity committee will revisit its suggestions for warding off second-guessing from regulators and auditors.
Sarah Johnson and Marie LeoneMay 1, 2008

More than halfway through its year-long project to cut complexity in financial reporting, a Securities and Exchange Commission advisory committee plans to rethink some of the recommendations it has sent to the regulator.

At its Friday meeting, the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFR) will consider what it means to make a reasonable judgment, according to SEC chief accountant Conrad Hewitt, who observes the meetings.

One of CIFR’s subcommittees — the so-called “substantive complexity” group — wants to back away from the concept of creating a professional judgment framework. Under CIFR’s initial recommendations, such a framework would outline how companies come up with and document their accounting decisions.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

The idea is to curb the constant second-guessing by regulators and auditors — which proponents argue is the only way for the U.S. financial reporting system to ever fully adopt more principles-based accounting standards.

CIFR, however, may decide that a “framework” isn’t the right way to go about that change — particularly if it means judgments will be put up against a checklist or that the guidelines “could be used as a shield to protect unreasonable judgments,” the subcommittee wrote in a paper for the Friday meeting.

CIFR’s first round of proposals alarmed investor groups, who feared the plan would lead to changes of the SEC’s nearly 10-year-old materiality guidance, which companies rely on to calculate an error’s effect on financial statements. But during a financial reporting conference at Baruch College in New York on Thursday, Hewitt tried to dispel such fears.

The SEC’s chief accountant said there would not likely be any wholesale changes to the definition of materiality. The SEC will only consider materiality through the eyes of investors, he noted.

CIFR will also discuss issues related to international financial reporting standards, a topic it has thus far avoided. The SEC is currently contemplating whether to allow U.S. companies to use IFRS rather than U.S. GAAP after it gave some international companies the same choice last year.

CIFR’s chairman, Robert Pozen, has hinted that there may be other topics up for grabs. In an op-ed article in the Wall Street Journal earlier this week, Pozen, who also chairs MFS Investment Management, suggested what companies should disclose about their securitized loans.

In a securitization, a bank or mortgage lender sells the future proceeds of a mortgage loan to a trust, which then pools them with other loans and issues bonds backed by the loan payments. Pozen wrote that regulators should “require someone to ‘own’ the securitization process as well as require more disclosures about who will bear the losses from the assets underlying the securities.”

The committee — made up of current and former CFOs, professors, securities lawyers, investor advocates, and audit firm executives — have been working on ideas for simplifying the U.S. financial-reporting and standard-setting systems for a formal report to be issued to the SEC in August.

The committee has a full-day hearing scheduled for Friday to go over its comments made to its midpoint progress report. Its agenda includes representatives from Citigroup, KPMG, Council of Institutional Investors, American Express, and others. Financial Accounting Standards Board chairman Robert Herz, who has observed the meetings since they began last August, is also expected to speak.

Case Study: How Edgewood Tahoe’s CFO Saved 500 Jobs From the Ashes