FEI Committee on Corporate Reporting (CCR), SEC Chairman, Others Write Congress On Standard-Setting

On Nov. 5, 2009 FEI's Committee on Corporate Reporting (CCR) submitted a letter to Rep. Barney Frank and Rep. Spencer Bachus, Chair and Ranking Member, respectively of the House Financial Services Committee. The FEI CCR letter noted: "concer[n] with recent proposals that would place accounting standards oversight under the jurisdiction of a new oversight board."

One such proposal that could impact oversight of accounting standard setting is HR 1349, sponsored by Rep. Ed Perlmutter (D-CO). HR 1349 would amend the Securities Act of 1933 to remove the SEC's oversight role over FASB, and assign that oversight role instead to a Federal Accounting Oversight Board, consisting of the banking regulators, Chairman of the SEC and Chairman of the PCAOB.

As reported earlier this week, Rep. Perlmutter may offer an amendment on the Financial Stability Improvement Act (the bill relating to systemic risk regulation, to be reported as H.R. 3996) to incorporate language from HR 1349.

Following are additional points in the FEI CCR letter:

• Acting on such proposals to realign oversight of the Financial Accounting Standards Board (FASB), could change the objectives of financial reporting, harm U.S. capital formation, and potentially politicize the process of setting accounting standards.
• We respectfully request that accounting standards oversight should remain under the jurisdiction of the U.S. Securities and Exchange Commission, which is responsible for fair, objective, and transparent reporting for those who invest in our public companies.
• We urge you to reject any efforts to place accounting standard setting under a new oversight board and continue to support independent accounting standard setting in the United States.

SEC Chairman States Views
SEC Chairman Mary L. Schapiro sent a letter to Rep. Frank and Rep. Bachus yesterday, reports Steve Burkholder of BNA, in his article entitled SEC Chief Schapiro Cautions Lawmakers on Proposals to Widen Oversight of FASB, Here are some highlights from Burkholder's article:

• The chairman of the Securities and Exchange Commission is warning key congressional lawmakers at work on financial regulatory reform that efforts to change oversight of accounting standard-setting could harm the capital markets by undercutting investors' trust in financial reporting and diluting the mission of the rulemakers.
• In sternly worded letters dated Nov. 5, Mary Schapiro wrote to the chairman and ranking minority member of the House Financial Services Committee to state that she is “deeply concerned about the possible consequences” of the potential changes.
• ‘‘It is critical that Congress preserve the independence” of bodies such as the Financial Accounting Standards Board, Schapiro wrote ...[adding]..."[W]hile active engagement and dialogue with a broad spectrum of interested parties improves accounting standards, diluting the mission of the standard-setters does not,” the SEC chairman continued. “Accounting should be about accounting, and not about anything else.”

CII/CAQ/Chamber Letter
As previously reported, other groups that have filed letters against formation of an FAOB include a joint letter of the Council of Institutional Investors, Center for Audit Quality, and U.S. Chamber of Commerce. See, e.g. CAQ Wants Congress to Preserve SEC Oversight of FASB (webcpa.com) . Here are some highlights from the CII/CAQ/Chamber letter:

• In adopting the Sarbanes-Oxley Act of 2002, Congress recognized the benefits of having
  accounting standards set by an independent body and established a process for the establishment and oversight of financial reporting policy. In doing so, Congress designated the Securities and Exchange Commission (SEC) as the primary agency with oversight over accounting standard setting, given the important role accounting standards play in the Commission’s mission to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.
• By placing the FASB under the jurisdiction of a structure charged with managing systemic risks to the financial markets, accounting rules will be viewed though the narrow lens of a few large companies from specific industries, rather than considerate of the applicability of financial reporting policies to over 15,000 public companies.
• Procedure, appropriate oversight and independence are important to ensure the legitimacy of the standards-setting process, and to protect the goals of transparency, relevance, and usefulness in financial reporting that are critical to the success of the U.S. capital markets.

American Bankers Association Testimony
Another point of view is held by the American Bankers Association, which shared its views on this matter within broader testimony at an Oct. 29 hearing of the House Financial Services Committee. Following are some highlights from ABA President Edward Yingling's testimony:

• A Systemic Risk Oversight Council could not possibly do its job if does not have oversight authority over accounting rulemaking. This is a major deficiency in the draft legislation.
• The Financial Accounting Standards Board (FASB) should continue to function as it does today, but it should no longer report only to the Securities and Exchange Commission (SEC). The SEC’s view is simply too narrow.
• Accounting policies contributed to the crisis, as has now been well documented, and yet the SEC is not charged with considering systemic and structural effects. Moving oversight to the systemic risk council, which includes the SEC, will address this problem.
• Accounting policy is arcane and difficult, but it was a critical factor in turning a bubble and a recession into a full-fledged panic. If Congress does not address this issue as part of reform, it will not have addressed one of the significant causes of the problems .

Mark-up Continues Today

As shown here, the House Financial Services Committee was slated to continue its markup of the systemic risk bill beginning at 1pm today.

FASB, IASB Reaffirm Convergence By June, 2011

Earlier today, FASB and the IASB announced the release of a 23-page joint statement which reaffirms their commitment to improve IFRS and U.S. GAAP, and to bring about their convergence through completion of the major convergence projects outlined in the FASB-IASB Memorandum of Understanding by June, 2011. The joint statement outlines plans and milestone targets that will guide completion of the major projects by the June, 2011 target date. The major convergence projects include:

• Financial Instruments
• Consolidations
• Derecognition
• Fair Value Measurement
• Revenue Recognition
• Leases
• Financial Instruments with the Characteristics of Equity
• Financial Statement Presentation
• Other MoU Projects
• Other Joint Projects

Strive to Align Project Timetables
In response to concerns voiced about 'leapfrogging' - i.e. when one of the two boards gets ahead of the other on a joint convergence project- the joint statement notes:

We will strive to avoid creating timeline differences like those that have complicated our efforts to improve and align standards for financial instruments and other areas. If such differences do arise, we will work together to eliminate differences between standards as soon as practicable by drawing stakeholders’ attention to each others’ proposals and reviewing our own requirements with a view to addressing differences on a timely basis.

In addition, the joint statement expresses the boards' commitment to: "Fundamental first principles about the purposes of accounting standards and the process by which the standards are determined, as set out in the statement of the Monitoring Board of the International Accounting Standards Committee Foundation, issued on 22 September 2009."

"Single Set," "Common" Set of Standards
It is interesting to note that the FASB-IASB joint statement speaks in some places of converging to a 'single' set of standards, and in other places of converging to a 'common' set of standards. To some, these terms can mean a world of difference. However, the terms are often used interchangably by many different parties. For example, here are some excerpts from the joint statement:

We are redoubling our efforts to achieve a single set of high quality standards within the context of our respective independent standard-setting processes.

Our goal is to develop together common standards that improve financial reporting in the US and internationally and that foster global comparability. Achieving such improvements is consistent with the objectives of the IASB that are set out in the Constitution of the IASC Foundation. It also fulfils the responsibility the FASB has under US law and the Securities and Exchange Commission’s 2003 Policy Statement to consider, in developing standards, whether international convergence is necessary and appropriate in the public interest and investor protection.

Presumably, once a set of 'common standards' is acheived, the next step would be to officially adopt one set (again, presumably, IFRS, which is used in over 100 countries) as the 'single' global standard. FASB Chairman Robert Herz said as much in remarks at various conferences and Congressional hearings in 2007 and 2008. For example, in testimony before the Senate Banking Committee, Securities Subcommittee, in October, 2007, Herz said:

[W]e agree with the Securities and Exchange Commission that a widely used single set of high quality international accounting standards for listed companies would benefit the global capital markets and investors. The ultimate goal, we believe, is a common, high-quality global financial reporting system that can be used for decision-making purposes across the capital markets of the world.

However, achieving the ideal system requires improvements and convergence in various elements of the infrastructure supporting the international capital markets, including a single set of common, high-quality accounting standards, a well-funded, global standard-setting organization, and a global interpretive body to handle guidance and implementation issues.

Improvements are also needed in disclosure requirements; regulatory, enforcement and corporate governance regimes; auditing standards and practices; and education of capital market participants.

Herz first acknowledged that the likely, ultimate 'single' set of accounting standards would one day be an improved version of IFRS, in remarks he gave at an FEI Global Convergence Conference in Sept., 2007, as noted by Marie Leone of CFO.com in Sweeping Away GAAP, 9.28.07.

For some interesting reading on the practical aspects of convergence, see Convergence Doesn't Necessarily Mean the Same, also by Leone, published Nov. 5 in CFO.com, in which she quotes D.J. Gannon of Deloitte and other experts.

Relevant, Transparent, Neutral and Comparable
Appendix B of the joint statement, Shared Goals, Values and Principles, will likely be very significant, taking on perhaps an almost equal role to the Conceptual Framework of the two boards.

The phrase 'relevant, transparent, neutral and comparable' is emphasized, in the context that:

[I]t is critically important to achieve high-quality, globally converged financial reporting standards that provide relevant, transparent, neutral, and comparable financial information, regardless of the geographical location of the entity.

High-quality accounting standards are those that foster the provision of relevant, transparent, neutral, and comparable financial information.

Some may view the only critical missing factor in that list of four factors as 'reliability,' although the decreasing emphasis on 'reliability' in favor of 'transparency' and 'relevance' has been happening for some time now in the boards' proposals to amend the conceptual framework.

FASB's Mission Statement (as described in the April 2009 edition of Facts About FASB) continues to emphasize relevance and reliability:

To accomplish its mission, FASB acts to [i]mprove the usefulness of financial reporting by focusing on the primary characteristics of relevance and reliability and on the qualities of comparability and consistency.

My two cents (I remind you of the disclaimer which appears in the right margin of this blog): The tipping of the scales with what some may perceive as more weight on relevance than reliability within the emerging revised conceptual framework, and statement of goals in today's joint statement, reflects the view of some that information about what an asset is worth today, based on what a market participant or third party would say, is more important to investors (i.e. more 'relevant') than a value based on some other valuation methodolog(ies), which may be more reliable. (Keep in mind, third party information for a nonliquid financial instrument, or a formerly liquid instrument in a disorderly or inactive market, can, in theory, be a quote from a broker who is giving a reference price, but may not necessarily actually want to buy and hold the item.) Caught in the middle, however, are preparers and auditors (not to mention members of the boards' of directors) who have legal liability for the information provided in financial reports, who may prefer keeping the historic balance between relevance and reliablity.

One Paragraph Statement By SEC Chairman
A one paragraph statement was issued by SEC Chairman Mary L. Schapiro, in recognition of the FASB-IASB joint statement, in which she said:

I am greatly encouraged by the commitment of the IASB and the FASB to provide greater transparency to the standard setting process and their convergence efforts. I believe that these efforts will result in improved financial information provided to investors.

Although brief, Schapiro's statement may help pave the way for the SEC to, as Schapiro said at a conference in September: "... speak a little later this fall about what our expectations are with respect to IFRS."

UPDATE: Regarding the status of the SEC's proposed IFRS Roadmap, Reuters' Emily Chasan reports that at a New York State Society of CPAs conference on Nov. 5, SEC Deputy Chief Accountant Julie Erhardt explained that, while commenters on the roadmap generally concurred on moving to a single set of accounting standards, there was no one clear view on how to get there. Read more in Chasan's article, Lack of Accounting Rules Consensus Vexes SEC.

G-20 Finance Ministers Meet This Week
The issuance of the joint statement by IASB and FASB, noting support of the G-20 - specifically, the G-20 Progress Report issued on Sept. 25, which "call[s] on our international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process; and complete their convergence project by June 2011" - comes one day ahead of the 10th anniversary meeting of the G-20 Finance Ministers and Central Bank Governors, set to take place in St. Andrews, Scotland Nov. 6 and 7. Following are some early reports relating to this week's G-20 Finance Ministers meeting:

A Deluge of G20 Meetings (FT, Nov. 4)
G-20 Will Discuss 'Bubble-Building,' Meirelles Says (Bloomberg, Nov. 3)
France Sets New Bonus Rules for Banks Ahead of G20 (DJ Newswire, Nov. 5)
Big Bank 'Living Wills' Gain Traction in G20 (Globe & Mail, Nov. 5)
Strauss-Kahn Sees G-20 Adopting Timeline, Method on Imbalances (Bloomberg, Nov. 4)

Learn More About IFRS
Learn more about IFRS at FEI's IFRS Boot Camp Nov. 18 in NYC sponsored by Deloitte. Or come to the two-day IFRS conference offered by Executive Enterprises Institute, cosponsored by FEI, Nov. 9-10 in Chicago, or Dec. 2-3 in Las Vegas. And, if you want to get an update on all the hot issues currently in the mix on the financial reporting scene, its not too late to sign up for FEI's 28th Annual Current Financial Reporting Issues (CFRI) conference, Nov. 16-17, at the Marriott Marquis in NYC. Francine McKenna of Re: The Auditors will be among press covering the event, we look forward to seeing you there!

Sarbanes-Oxley Exemption Passes Congressional Committee

Earlier today, the House Financial Services Committee approved an amendment that would exempt small public companies from the provisions of Sarbanes-Oxley Section 404b. The Garrett/Adler amendment, offered by Rep. Scott Garrett (R-NJ) and Rep. John Adler (D-NJ), was approved in the HFS Committee today by a vote of 37-32, as part of the Investor Protection Act (IPA). The Committee voted in turn, by a vote of 41-28, to approve the IPA. (See: Financial Services Committee Approves Investor Protection Act. )

As noted in Adler's Nov. 3 press release, the Garrett/Adler amendment would not only exempt small businesses (with less than $75 million market cap), but would require the SEC, together with the GAO, to conduct a study directed at reducing the burden of Sarbox 404b on companies with market cap between $75 million and $250 million. Additionally, the amendment calls for the study to "consider whether reducing the compliance burden or a complete exemption for these companies will encourage them to list on exchanges in the United States in their initial public offerings."

The ultimate impact of the Garrett/Adler amendment will depend on whether it remains in the IPA when voted on by the full House of Representatives, and whether it will be included in the Senate’s version of the bill and ultimately signed into law.

Background
Sarbanes-Oxley Section 404a requires a management report on internal control. Companies of all sizes currently provide the management report on internal control. Sarbanes-Oxley Section 404b, the target of the Garrett/Adler amendment, requires an external audit of internal control. Small public companies (non-accelerated filers, generally defined by the SEC as companies with less than $75 million market cap) have not yet been subject to the Sarbox 404b requirement. As described in SEC's Oct. 2 press release issued concurrently with SEC's Sarbox cost-benefit study, the SEC granted a final deferral of the effective date of Sarbox 404b for small companies, extending the deadline to annual reports for fiscal years ending on or after June 15, 2010. See related Final Rule.

Rationale Behind The Garrett/Adler Amendment
Garrett's Oct. 28 press release explained:

Although reforms were made in 2007 to relax the guidelines for smaller companies, businesses of all sizes still report excessive compliance costs, as noted in an SEC report from September 2009. In summarizing survey responses from businesses regarding the benefits of Section 404 compliance, the SEC wrote, “[A] majority felt that the costs of compliance outweighed the benefits. This was especially true among smaller companies.

Garrett's initial proposal, cosponsored with Rep. Carolyn Maloney (D-NY) was withdrawn, as was an earlier version of Adler's amendment. According to a report in today's WSJ, Small Business Gets Break in House Financial Overhaul Bill, by Kara Scannell and Damien Paletta:

[White House Chief of Staff Rahm] Emanuel negotiated with Mr. Adler to avoid a more damaging amendment that would have exempted firms already covered by Sarbanes-Oxley, those with market caps of less than $700 million, [House Financial Services Committee Chair Barney] Frank told reporters....

"It's odd that I should be defending the White House," Mr. Garrett said. Mr. Adler said he spoke with White House Chief of Staff Rahm Emanuel three times recently about giving small businesses relief.

House Financial Services Chairman Barney Frank (D., Mass.) and Rep. Paul Kanjorski (D., Pa.) both oppose the amendment, as do left-leaning consumer-advocacy groups.

SEC Chairman Mary L. Schapiro reportedly filed a letter with the House Financial Services Committee on October 16, indicating that she “opposes an exemption,” as reported by Zachary A. Goldfarb in today's Washington Post, Small Public Companies Win Exemption from Audits. However, it is not clear if Schapiro's views changed in light of modifications made over the past week to the earlier versions of the amendments; WSJ's Scannell and Damien reported today that: "SEC Chairman Mary Schapiro said earlier this week that she didn't oppose a move, but 'I don't want to just pass the problems around the map." In related news, see also Frank Seeks House Vote in December on Financial Measures, by Michael R. Crittenden of the WSJ.

My two cents
I remind you of the disclaimer that appears in the right margin of this blog, above the blogroll. I am not going to comment on the exemption provision in the Garrett/Adler amendment, only on the provision calling for GAO and the SEC to perform a cost study. Some may question why a new cost study on Sarbox is required, when the SEC just released its cost-benefit study in September (SEC study).

Cent one: I would submit that the cost-benefit study called for under the Garrett/Adler amendment may add some valuable information. For example, there could be benefits from adding an independent party (GAO) as co-head of a cost study on Sarbox, as compared to the SEC's study published in October, in which the SEC alone studied the cost-benefit of implementation of its own rules, and those of the PCAOB (which the SEC, in turn, is responsible for approving.)

One could contrast this with the decision of Congress last year, in the Emergency Economic Stabilization Act, to call upon solely the SEC (and not GAO) to conduct a study of the impact of the fair value accounting rules, given that the SEC is responsible for oversight of the FASB that issued those rules.

Additionally, although the SEC's cost-benefit study does a good job of detailing assumptions underlying its methodology - including difficulties in obtaining certain data - it is possible further work could be done with alternative assumptions and information.

Here are some verbatim excerpts from the SEC study:

For Section 404(b) compliant companies, the largest cost component is internal labor costs— which can comprise more than 50 percent of the total compliance cost—followed by the estimated portion of total audit fees attributed to ICFR (404(b) audit fees), outside vendor fees, and non-labor cost (see Table 8). [pdf pg 7, printed pg 9, SEC study]

It is important to note that the estimates of internal labor costs presented in this report are based on an assumption about a reasonable hourly rate. The rate adopted for internal labor is $121 per hour, consistent with the rate quoted as of September, 2008 for a junior accountant cited in a report on salaries prepared by the Securities Industry and Financial Markets Association (SIFMA), to which the Commission frequently refers in its rulemakings. This is at the low end of cost estimates that are provided in the SIFMA report for accounting and related services, and above the rate of $50/hour (or $100,000 for 2000 hours) that is assumed in a series of Financial Executives International (“FEI”) reports of survey findings relating to the costs of compliance with Section 404 that date back to 2005. Although our assumed rate is within the range of reasonable estimates for evaluating the overall costs of compliance, it is not intended for use in estimating the cost to an individual company. [pdf pg 14, printed pg 12, SEC study]

Overall, on average, respondents provided estimates of audit fees that are lower than what is reported by Audit Analytics. This is consistent with the disparity between the relatively broad definition of audit fees that applies in SEC filings from which Audit Analytics collects data and the comparatively narrow definition of audit fees provided in the survey questionnaire. Moreover, the differences are significant among the medium ($75-700 million) and larger (>$700 million) companies only, precisely where the broad definition of audit fees adopted for the purpose of SEC’s filings is most likely to lead to a discrepancy relative to the narrower definition in the survey. [pdf pg 37, printed pg 35, SEC study]

The evidence on the experiences of larger companies may be useful in evaluating the extent to which additional improvements to the implementation of Section 404(b) should be undertaken before it becomes applicable to non-accelerated filers. Notwithstanding, it is important to highlight that the analysis in this report is not designed to provide compliance cost estimates for companies that have yet to comply with the relevant requirements of Section 404. [pdf pgs 3-4, printed pgs 1-2, SEC study]

Based on the above, it is possible that further analysis could be done using alternative assumptions or methodology.

Cent two: However, an alternate view could be that the cost study under the Garrett/Adler amendment, aimed at considering the impact on companies with between $75 million and $250 million market cap, could potentially undo compliance by companies that are already required to comply with Sarbox 404b, and presumably may have already integrated the 404b internal control audit into their preexisting financial statement audit.

This could be viewed by some as raising different issues than the exemption of smaller companies with less than $75 million market cap (which have yet to be required to comply with 404b) as set forth in the remainder of the Garrett/Adler amendment. As noted in some of the articles linked above, although some parties favor exemptions, some strongly object to exemptions. For additional views on this topic, see Jim Peterson's Nov. 1 post in his Re: Balance blog.