In what Chairman Christopher Cox termed "a second front in an all-out war on complexity in financial reporting," the Securities and Exchange Commission has formed a Committee on Improvements to Financial Reporting and called on it to formulate specific ways "to reduce complexity and all its costly burdens."The committee will have a year to search for solutions that have eluded standard-setters and regulators for decades. While fears of litigation have led to complex and detailed rules-based standards, a growing demand for simplicity has inspired calls for less specific standards that are based more on principles.
At the committee's first meeting, in August, Cox noted that the country's financial reporting system provides excellent information, but that it is useless if it can't be understood.
"We can't say that we've achieved our investor protection objectives ... if the information is provided in a way that isn't clearly understandable to the men and women who use it to make decisions," Cox said, later adding, "When it comes to financial statements, most investors today would probably find themselves agreeing with Mark Twain when he said, 'The more you explain it, the more I don't understand it.'"
The primary agenda item of that first meeting was a discussion paper authored by committee chairman Robert C. Pozen, who is chairman of MFS Investment Management, an investment concern that manages roughly $170 billion in assets.
The paper considers the current approach to setting reporting standards; the process of regulating compliance; the current system for delivering financial information; whether the burden of some accounting and reporting standards outweighs the benefits; the impact and potential of international reporting standards; and factors in the business environment that necessitate the complexity of accounting standards.
Calling the first meeting "very productive" and praising the "significant thought" that the committee's members brought to the meeting, Joseph Ucuzoglu, senior advisor in the Office of the Chief Accountant, expressed the SEC's hope that the committee will yield useful recommendations.
"We're interested in receiving practical recommendations, many of which can hopefully be implemented in the near term," he said. "The group we have assembled is well-positioned to advise the commission on the information needs of investors."
The committee is indeed well-positioned. Members include former Financial Accounting Standards Board chair Denny Beresford; former Federal Reserve Board governor Susan Bies; Deloitte Touche Tohmatsu chief executive officer James H. Quigley; CFA Institute president and CEO Jeffrey J. Diermeier; Moody's managing director Greg Jonas; Microsoft chief financial officer Christopher Liddell; Grant Thornton CEO Edward E. Nusbaum; and 10 others representing audit committees, brokers, attorneys, investors, credit-rating agencies and banking regulators.
The impact of complex, rules-based accounting standards has been causing an increasing number of problems in financial reporting. In 2006, 10 percent of public companies had to restate prior reports due to errors. The complexity of standards and the difficulty of knowing how to recognize, measure and report certain transactions are commonly blamed for the problems.
SEC chief accountant Conrad Hewitt said that the number of restatements was "alarmingly high," and that restatements caused by unintentional errors in accounting were obscuring the seriousness of a few other restatements. He called on the committee to be creative in their research and recommendations: "I suggest that maybe you want to think outside the box."
Pozen called on the committee to produce specific, useful, workable recommendations that would not need congressional legislation to put them into effect.
The committee will look not only at standards, but at how new technologies, such as interactive data and XBRL, can address an array of problems.
The committee has been asked to produce its recommendations by August 2008.
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