Risk & Compliance

SEC Committee Tackles Second-Guessing

An advisory group is asking the commissioner to tell companies how to temper nitpicking by auditors and rulemakers.
Sarah JohnsonJanuary 11, 2008

A committee tapped to cut complexity in financial reporting will ask the Securities and Exchange Commission to help companies defend their accounting interpretations against second-guessing by regulators and auditors.

If the SEC takes up the committee’s recommendations, the regulator would weigh in on what may be one of the highest barriers to a shift to a more principles-based accounting system: the possibility that adding leeway to corporate interpreters of generally accepted accounting principles could spawn a wave of lawsuits.

Skeptics of the movement to allow the widespread use of international financial reporting standards in the United States, for example, believe the litigious environment in this country must change before that could happen. The global standards are said to be principles based.

Spurred by fears of securities lawsuits, excessive scrutiny by auditors, and an overall lack of respect for a professional’s choices, more and more rules have crept into U.S. accounting standards, members of the SEC’s Advisory Committee on Improvements to Financial Reporting (CIFR) say. “Those who evaluate judgments should evaluate the reasonableness of the judgment, and should not base their evaluation on whether the judgment is different from the opinion that would have been reached by the evaluator,” a CIFR subcommittee wrote in its recommendation for the SEC guidance.

Such a policy statement would not mean that SEC registrants’ judgment would automatically be accepted. Rather, it would give companies more support in their decisionmaking and improve the likelihood that an auditor or regulator would accept their choices, according to the CIFR. Committee members say they don’t know whether it’s within the SEC’s purview to craft such a safe harbor.

To be sure, CIFR isn’t suggesting that its proposed framework would diminish auditors’ or regulators’ rights to question management’s judgment or ask for corrections. Instead, the framework would organize management’s steps for coming up with and documenting an accounting decision — providing it with a way to show it did what was needed to reach an appropriate judgment. Under the CIFR’s proposal, managers would have to show that their thought processes involve good faith. They could do that by demonstrating that they had considered the relevant accounting literature, alternative estimates, and input from experts.

James Quigley, chief executive officer of Deloitte Touche Tohmatsu and a CIFR member, thinks the recommendation is the most important one supplied by the committee, which is due to provide its final report to the SEC by August. A professional-judgment framework designed by the SEC could discourage the current “complexity in the system and defensive financial reporting,” he said during Friday’s CIFR meeting. “We may be wasting our time with this report if we can’t have something like this,” he added.

Appointed last summer by the SEC, the CIFR’s members — 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. At its third open meeting on Friday, the committee voted to perfect the wording of some of its proposals for formal presentation to the SEC, possibly as early as February.

The CIFR also hopes the SEC will encourage the Public Company Accounting Oversight Board to create its own framework for professional judgment, similar to the one statement the commission will issue.