(The news featured below is a selection from the news covered in the Federal Securities Law Reporter, which is distributed to subscribers of SEC Today.)

Glassman Calls for Fewer Bright-Line Tests In Accounting

In remarks at a recent conference at the University of Southern California's Leventhal School of Accounting, Commissioner Cynthia Glassman discussed the complexity of financial reporting and accounting standards. She believes that accounting standards have become overly prescriptive and provide too many bright-line tests that are vulnerable to financial engineering. Many constituencies have asked for, and received, bright-line tests in virtually all areas of financial reporting, according to Glassman. Preparers or parties to a transaction may then structure the transaction so that it achieves the desired accounting treatment, even though it may obscure the principles underlying the accounting standard, she said.

Glassman singled out hedge accounting as one example where some companies have altered the way they otherwise hedge their financial risk for the sole purpose of meeting the shortcut criteria outlined in FAS 133. FAS 133 may have resulted in the unintended consequence of impeding optimal risk management, she explained. Glassman said that reporting requirements and accounting standards should not drive business practices. Instead, the business reality of a transaction should determine how it is reported.

Lease accounting is another example in which companies could take advantage of the bright-line aspects of the standards to make a financed purchase look like a rental contract, according to Glassman. She noted that a cottage industry has sprung up to address leasing issues, largely based on the accounting standards. She said that similar problems exist with revenue recognition, pensions, and allocation and impairment testing related to purchase accounting.

Glassman advised that prescriptive accounting rules may also create legal problems for preparers and issuers, both through the potential for overly aggressive accounting to take advantage of the complexity, or through honest mistakes that may lead to restatements or securities law violations.

Glassman supports the FASB initiative to codify all of the accounting literature that constitutes generally accepted accounting principles in one place. She suggested that the initiative be expanded to include the literature issued by all of the standard setters, including the SEC, in order to clarify and rationalize accounting standards.

Standard setters should work to ensure that accounting standards are principles-based and objectives-oriented, she added. Glassman also proposed that standards encourage management to disclose key performance indicators and other relevant information. Management should concentrate on the best way to manage the company, not manage the numbers, she said.

The SEC should simplify its rules and streamline its regulatory scheme, in Glassman's view. It should identify and eliminate obsolete and duplicative regulations, rationalize definitions, update regulatory thresholds and consolidate forms, she said. The SEC should take advantage of advances in Internet and communication technology, according to Glassman, including the use of interactive data. Glassman is convinced that the use of interactive data could make the information that registrants file with the SEC more useful to investors and other global market constituents.

Cox Remarks on Section 404

In recent remarks at the Harvard Business School Global Leadership Forum, Chairman Christopher Cox advised that the SEC and the PCAOB are working together to make Sarbanes-Oxley Act section 404 more efficient and cost-effective. The SEC plans to issue guidance to help management in its assessment of internal controls over financial reporting.

The SEC is working with the PCAOB to propose revisions to Auditing Standard No. 2 to ensure that auditors concentrate on areas of higher risk. The standard should spell out what role, if any, the auditor should play in evaluating a company's assessment of its internal controls, according to Cox. He explained that the goal is to significantly reduce the compliance costs of section 404 while improving investor protection. This undertaking will help conform the SEC's and the PCAOB's rules to those of other high-standards countries, he said.