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Former and Current SEC Officials Discuss State of Financial Reporting

Panelists at the SEC Historical Society's discussion on the current financial reporting model agreed that it is time to move toward a new model that more effectively meets the needs of investors. Panelists also discussed the challenges of moving from a rules-based system of accounting standards to principles-based standards, and the increasing use of fair value in financial statement measurements.

SEC Chairman Christopher Cox welcomed the panelists to the Historical Society's seventh annual meeting, which coincided with the 72nd anniversary of the founding of the SEC. Accounting is a hot topic, he said, with an increasing focus on the level of complexity in today's financial statements. There are over 2,000 separate pronouncements in accounting issued by numerous bodies. While the pronouncements were born out of the desire to protect investors, Cox said the result has been unnecessary complexity and added costs. Efforts are underway to simplify accounting standards, according to Cox. He said the effort will be a long one, but one worth making.

Fair Value Accounting

Robert Kueppers, the deputy CEO of Deloitte & Touche LLP, moderated the panel discussion. The first topic he raised with the panel was the increasing use of fair value accounting and whether it was the right direction for the benefit of investors. Pat McConnell of Bear, Stearns & Co. said that fair value is good for investors and is absolutely necessary for making asset allocation decisions. However, she noted that the move to fair value accounting is not universally welcomed. McConnell recommended a review of the Chartered Financial Analysts Institute's recently issued paper on a new business reporting model that proposes a "re-do" of basic financial statements.

Lawrence Salva, with Comcast Corp., said the mix of fair value and historical cost accounting has created such a hybrid model that it is almost incomprehensible. He proposed a moratorium on the introduction of any more fair value accounting in the primary financial statements, or at least a slow-down. Accountants need to retool their minds to think like valuation specialists, he explained, which is a very different thought process.

Aulana Peters, a former SEC commissioner who is an audit committee member on several boards of directors, did not share the opinion that the movement to fair value should be slowed down. However, she acknowledged concerns with how it is audited. It will take some time for auditors to ramp up, she said, and there may currently be a dearth of valuation expertise, but she expressed complete faith that the profession will learn how to audit the information.

Donald Nicolaisen, a former SEC chief accountant, also expressed faith in the auditing profession. The concerns arise where there is little trading information, he said, and auditors must rely on good faith and judgment. Fair value has tremendous relevance, but historical cost also has some meaning, he said, since it is used in tax transactions.

Kueppers raised the "relevance versus reliability" debate with respect to fair value accounting. He asked if the mixed attribute model breeds complexity. Kueppers pointed to the hedging exception which he said created a lot complexity and confusion. Salva agreed that complexity was the crux of his concern. We are in the middle of an evolution towards fair value, he said, but some will fight vehemently for exceptions to the rules. It is very difficult to provide essential information in the financial statements with the current mixed model.

Kueppers asked whether audit committees understand the complexities of fair value accounting. Peters advised that such issues are presented to the committee and the committees sometimes have to struggle with the issues. She said that regulators must respect management's decisions unless they are definitely wrong.

Principles-Based Standards

The challenges of attempting to move from the current rules-based accounting standards to principles-based standards are enormous, in the panelists' view. It took many years to get where we are today, Nicolaisen said, and it will take a really long time to get to principles-based accounting. One problem is that FASB has to write standards that have acceptability. If the standard would impose a significant change, he said, it gets dragged out for a very long time. By the time it is introduced, it has very little impact because the industry has already dealt with it --corrected and made adjustments for it, compensated for it and made deals --all of which results in enormous complexity. In a rules-based society, the rules are written "after the horse is already out of the barn," according to Nicolaisen.

Salva agreed that it would take a really long time to achieve principles-based accounting. He noted that many people in the profession today did not grow up in a principles-based environment so all they know is following rules. When accounting questions arise with the SEC staff, Salva suggested that two questions should be asked: did the company get the accounting right and if not, how bad was the error. Restatements used to be reserved for the most egregious cases, he said.

McConnell said that FASB goes astray in its standard-setting when it puts in exceptions and options. A principles-based standard should rely on a single measurement attribute, she said. Otherwise, there is no avoiding the exceptions and options. Peters said she is neutral on the issue, but suggested that the U.S. keep track of what is going on abroad. The IASB has touted international financial accounting standards as being principles-based, she noted, but reports in the foreign press suggest that companies are in an uproar and no one knows what to do with them.

Changes to Financial Statements

Kueppers suggested that the real challenge of principles-based standards is to change behavior. He echoed Salva's remark that an entire generation has grown up with rules only. He asked the panelists if financial statements have reached a point where they are no longer meeting the needs of investors and whether it is time for a fresh look. Nicolaisen said it is time to move forward with innovative thinking to find a way to do things better. Technology has to be part of the answer, he said, and has to make it better, faster and cheaper.

Peters agreed wholeheartedly that the time has come for a new financial reporting model. She noted that XBRL technology may provide a tool for changing the format of financial reporting. Kueppers asked whether XBRL might be "a huge deal," and whether it merits a Presidential commission to explore further. He asked the panelists whether the XBRL effort should be global in focus.

McConnell said that any revamping of the financial statements must definitely be done on a global basis in order to establish a common starting ground. XBRL is already being developed on a global basis, she added. She has been told that IFRS is easy to apply using the XBRL format. Nicolaisen raised concerns about the diplomacy and politics associated with a global initiative, such as whose system you use and how you use it. He believes the initiative is headed in a good direction and emphasized the importance of the private sector taking the lead. A better product will sell itself, in his view.

Peters said that change does not always occur through consensus and that there is nothing wrong with the U.S. taking the lead. If the accounting profession puts out a good product, it should be easy to sell and will eventually become global, she said.

Acting chief accountant Scott Taub said everyone must have the right mindset to ensure that financial reporting in the future serves the public interest. He quoted numerous past chief accountants on their views about the objectives of financial reporting. Today, there are too many compromises, according to Taub. He emphasized the importance of transparency over predictability and the needs of investors over companies, accountants and regulators.

A good and knowledgeable accountant knows when he or she is abusing the accounting literature, Taub said. Practitioners are often reluctant to use their best judgment out of fear of litigation. They often seek safe answers that may not be best for investors. Many blame the SEC for their reluctance to rely on their own best judgment out of fear of being second-guessed. Taub acknowledged that the SEC should not object to well-founded business judgments.