Remarks Before the 2012 AICPA Conference on Current SEC and PCAOB Developments
Paul A. Beswick
Acting Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission
Dec. 3, 2012
As a matter of policy, the Securities and Exchange Commission disclaims responsibility for any private publication or statement of any SEC employee or Commissioner. This speech expresses the author's views and does not necessarily reflect those of the Commission, the Commissioners, or other members of the SEC Staff.
Good morning and thank you Melanie (Dolan) for the kind introduction, and thanks once again for the invitation to share my views at the annual AICPA National Conference on Current SEC and PCAOB Developments. This year I am particularly glad to be here in person to actually deliver my remarks.
I need to start, as always, by reminding you that for me and for all of the SEC staff speaking at this conference, the views expressed are each speaker's own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.
International Financial Reporting Standards
To begin, I thought I would spend a few moments on IFRS.1 On July 13th of this year, the staff published its final report on the IFRS Work Plan.2 Later this morning, Jenifer Minke-Girard will summarize our findings from the final report. Since the publication of the final staff report, the staff has continued to receive feedback on this critical issue from a number of stakeholders. The consideration of incorporating IFRS may be the single most important accounting determination for the Commission since the determination to look to the private sector to establish accounting standards in the 1930's.3 We understand individuals' interest in this topic and the potential uncertainty that may exist, but the staff is working to ensure that the Commission is properly informed on the issue. Obviously, we will work with our new Chairman and our existing Commissioners on determining the next steps in this process. So please stay tuned.
Financial Reporting and the Scope of the Financial Statements
I would like to turn to my next subject, and I must admit this one started out a little under the radar; however, I think it is a critically important issue. Over the past several years, the FASB4 has been working on three projects that address disclosures in the financial statements: the Liquidity and Interest Rate Disclosures, Going Concern, and Disclosure Framework projects.5 As the FASB has solicited feedback, a common issue has emerged. That issue is: what is the type of information that should be included in a set of financial statements, as opposed to the type of information that should be included in a broader set of financial reporting? For simplicity's sake, for the purpose of this speech, when I refer to "financial reporting," I am referring to the entirety of a company's Form 10-K or equivalent filing. A corollary issue is, for the disclosures that the FASB is considering for financial statements, what consideration should there be to creating overlap with existing financial reporting requirements outside the financial statements?
Now I have to confess something. I enjoy reading about the history of how accounting standards and financial reporting have evolved over the years. I know that sounds bad, or at least maybe a little sad. But it is relevant here, because I have learned from this reading that this is not the first time that this issue has been raised.
So I think it might be helpful to highlight some examples in SEC history when this issue has been discussed, in fact it has come up on several occasions.
The modern notion of Management's Discussion and Analysis, or MD&A, originated with the Securities Guides and the Exchange Act Guides. Securities Act Guide 22 was issued in 1968, and it was amended when Exchange Act Guide 1 was added in 1974.6 These Guides reflected the need for information outside the financial statements that would provide some additional narrative explanation of unusual conditions as well as conditions that might indicate that previous results may not be indicative of the future.
In 1977, the SEC's Advisory Committee on Corporate Disclosure recommended that the Commission encourage expanded disclosure of so-called "soft information," meaning forward-looking and analytical information, including projections of future company performance.7 In this context, the Committee recommended that the Guides be revised to give registrants broader latitude over the information to be included, and to explicitly recognize two separate aspects of management analysis: quantitative analysis (e.g., variance analysis); and discussion of historical facts.
In 1980, the Commission issued four related proposals to modernize the Commission's accounting and disclosure requirements, including a new integrated Form 10-K, which incorporated "an entirely restructured management's discussion and analysis" which was proposed to be lifted out of the Guides and placed into Regulation S-K.8 As adopted later in 1980, the new MD&A required a discussion of liquidity, capital resources, and results of operations, and, for each of these, disclosure of trends, events, and uncertainties.9
Fast forward to 2003, when the Commission issued interpretive guidance on disclosure in MD&A, including on liquidity and capital resources. This release had a substantial amount of information about MD&A's requirements and relationship with financial statements, including the following:
The purpose of MD&A is not complicated. It is to provide readers information "necessary to an understanding of [a company's] financial condition, changes in financial condition and results of operations." The MD&A requirements are intended to satisfy three principal objectives:
- to provide a narrative explanation of a company's financial statements that enables investors to see the company through the eyes of management;
- to enhance the overall financial disclosure and provide the context within which financial information should be analyzed; and
- to provide information about the quality of, and potential variability of, a company's earnings and cash flow, so that investors can ascertain the likelihood that past performance is indicative of future performance.10
And finally more recently, in 2010, the Commission issued interpretive guidance on the presentation of liquidity and capital resources disclosures in MD&A, as well as on the contractual obligations table disclosures.11 In that release, the Commission reiterated that "MD&A requires companies to provide investors with disclosure that facilitates an appreciation of the known trends and uncertainties that have impacted historical results or are reasonably likely to shape future periods." The Commission also provided guidance about how companies should disclose funding and liquidity risk management, particularly for banks.
So where do I think that this brief, and I really mean brief, history lesson leaves me? Well, I believe that one could begin to draw some conclusions about the type of the information that should be included in other parts of the financial reporting package as compared to the financial statements. However, I believe that a healthy and robust dialogue could greatly contribute to this debate. Therefore, it is my intent for OCA along with staff in other offices and divisions to hold a roundtable in the upcoming months as the first step in considering this issue. We plan initially to focus on whether this issue should be further explored (including, for example, whether there any perceived disclosure gaps today), and what are the critical decision points regarding this issue of the dividing line between what should appear in financial statements versus the broader financial reporting package. For example, do liability or auditing considerations impact how people think about this issue? The participation of both the FASB and the PCAOB12 will be integral to these efforts. In addition, I believe it will be important to pull together individuals from the accounting profession, preparers big and small, the legal community, and other regulators to provide their views on this important matter.
Now I would like to turn to a significant part of the FASB's and the IASB's (collectively the "Boards") standard setting agenda, and that is the convergence projects. When I refer to the convergence projects, I am focusing on revenue, leases, and financial instruments. I tend to put the insurance project in a different category because, as a number of people have commented, US GAAP currently has a fully developed insurance standard, while IFRS does not. For the other three projects, both sets of standards have existing literature that the Boards are seeking to improve.
I acknowledge that there is a certain amount of standard-setting fatigue. On some level that is understandable, as the Boards have been working on these projects for the better part of a decade. I am hopeful that the Boards are in the final stages of completing these projects.
As the Boards work through the remaining issues on the convergence projects, I am encouraged about the level of convergence in the revenue and leases projects that Boards have achieved to date. When thinking about the status of the financial instruments project, I think some perspective is important. As I frequently mention, 18-24 months ago it was called almost unthinkable by some that the Boards would be able to reach substantive agreement on classification and measurement. Yet today the Boards are a lot closer than probably many would have guessed.
During the same period, however, the Boards have diverged on the impairment aspect of the project. Regarding the next steps and potential way forward, I think it is important for both Boards to expose their models for public feedback to see if there is a way to reconcile the two views. It is also important that the exposure period for the documents be similar so that interested parties can have the benefit of both Boards' thinking and can provide feedback to both Boards concurrently. This is one area were the profession can be particularly helpful. Your feedback on the exposure documents and participation in the field-testing can improve the quality of any final standard. From our perspective, some of the areas we are focusing on are whether principles are clearly articulated, whether the standard can be implemented for all sizes of entities, and, most importantly, whether the standard provides clear and understandable information to investors.
As we move forward on the convergence projects I thought I should highlight three other matters.
First, Is the Glass Half Empty or Half Full
As you can imagine, there are a number of groups and individuals who share their views with the SEC staff on the current decisions reached by the Boards in the convergence projects. The discussions tend to focus on the areas where the groups or individuals disagree with the decisions reached by the Boards. In many cases, these decisions are converged. Sometimes, this is unfortunate because it fails to recognize all of the hard work by the Boards in these areas and ultimately fails to acknowledge that the finalization of these projects will improve financial reporting for the benefit of investors.
Second, Implementation Matters
In some ways, coming up with a converged standard by the Boards is the "easy" part. I know what I just said might sound like heresy, but also reflect on the role of the securities regulator and our role in implementation. This effort will be more complex because these are converged standards. If the goal of all these efforts is a single set of high-quality global standards, keeping implementation consistent is of paramount importance. On this front, I can say we are making progress. At the staff level, we have increased our efforts to work with other securities regulators across the globe. I expect we will continue to increase our efforts with our counterparties across the globe in the upcoming year.
Finally, First to Press Isn't Always the Best Thing
I am already getting the sense from some trade organizations and others that they are trying to be the "first to press" with their implementation guides to the individual convergence projects. I would caution everyone to be thoughtful and deliberative in their approaches to non-authoritative implementation guides. As you know, they are by their nature non-authoritative. Further, given the significance of these projects, one of things we have been thinking about along with the FASB is whether there might be a way to take a more holistic approach to implementation guidance and how it is issued. In fact, if you have specific suggestions, we would certainly love to hear them.
Auditor Independence and Consultancy Practices
Now turning to a subject that is near and dear to my heart: auditor independence. As a profession, accountants have a duty to act with integrity, objectivity, and high ethical standards. This is a hallmark of our profession. Revenue and profit pressures at an accounting firm can give rise to conflicting incentives, but the accountant's obligation to the public trust cannot change.
Keeping that in mind, I continue to observe some accounting firms actively growing consultancy practices. Some of this is anecdotal, but I can tell you that OCA is occasionally asked about transactions involving accountants that are expanding their non-audit service practices. Some of the expansion relates to businesses that are fairly removed from the accountant's professional mandate to perform quality audits. For instance, we are aware that accountants have been acquiring businesses that provide project management, system architecture design, and other IT infrastructure services. At a minimum, these transactions can raise transitional issues with respect to compliance with the auditor independence rules. However, in my mind, more important is how the accounting firm views its non-audit services practice, and whether this results in the accounting firm devoting the appropriate resources to its audit and attest practice.
My interest goes beyond technical compliance with the rules, which of course is very important. I also question whether accountants' expanding practices into areas unrelated to their primary competencies weakens public trust. I'm disheartened when I read an article in the press that raises questions about the propriety of non-audit services that accountants provide to their audit clients. It is firmly rooted in the independence principles that independence is needed in both fact and appearance. As you all know, perception is reality, and negative perceptions can undermine investor confidence in audits.
I am also concerned that expanding into businesses that have little relevance to the accountant's primary competencies probably does little to promote audit quality, and it has the potential to distract a firm's leadership and other personnel from providing appropriate attention to their audit practice. Such expansion runs the risk of damaging the accountant's reputation. I'm hopeful that my comments today will help to encourage a degree of reflection when firms are faced with decisions about growth that undoubtedly will shape the public's long-term views of their firm and potentially of the entire profession.
Internal Control Over Financial Reporting
We stand here today 10 years after the enactment of the Sarbanes-Oxley Act. Increased attention on internal control over financial reporting, or ICFR, was an important element of that Act. As you know, the Act had two provisions in this regard: Section 404(a), which required disclosure of management's assessment of the effectiveness of its ICFR; and Section 404(b), which required auditors to audit and report on the effectiveness of these controls. I believe there can be no question at this point that investors have benefited from improvements in the reliability of financial reporting due to the increased focus on ICFR since the passage of the Sarbanes-Oxley Act.
My message today is simple. Let's not lose ground. Let's stay focused on the importance of ICFR. It's important to remember that management and auditors both have important responsibilities with respect to ICFR, regardless of whether or not the company is exempt from Section 404(b). Furthermore, it's important to recognize that the benefits to reliable financial reporting are dependent upon the ongoing commitment by management to maintaining effective ICFR. Brian Croteau, OCA's Deputy Chief Accountant for our Professional Practice Group, will be providing some additional thoughts on this topic, including how the completion of COSO's project to update its internal control framework may provide some opportunities that are consistent with the ongoing focus I've mentioned.
Auditor's Reporting Model
Now let me turn to the auditor's reporting model - a topic that has generated much discussion around the world. For years, investors have relied on the standard auditor's report for the auditor's opinion on the financial statements of a particular company. The model we have today, which has been in existence since the 1940s, is often referred to a "pass/fail" model.
Many people believe this model is clear and direct and makes reports easy to compare. They also believe that any modifications made today to the standard auditor's report are easily recognizable. However, as with many things in life, the merits of this model have been debated and changes have been considered. Over the last 70 or so years, groups such as the Cohen Commission,13 the Treadway Commission,14 and an advisory committee on the audit profession formed by the U.S. Department of the Treasury,15 have deliberated changes to both the auditor's responsibilities and the form of the auditor's report. More recently, standard-setters such as the PCAOB and the IAASB,16 and regulators such as the United Kingdom's Financial Reporting Council and the European Commission, have considered changes to the auditor's reporting model.
Ideas being considered could impact both the content and form of the auditor's report. Some have called for the content of the auditor's report to be expanded to provide what they describe as more relevant, tailored, and useful information, and others, while expressing appreciation for the pass/fail model, have indicated that the form of the report is too boilerplate and does not convey the significant judgments made by the auditor in forming the audit opinion. In considering these matters, I believe the PCAOB is taking a careful and deliberate approach. Over the last two years, the PCAOB has conducted significant outreach to investors, preparers, auditors, audit committee members, regulators, and standard-setters; has issued a concept release; and has held a public roundtable.
So where does this leave us? I'd say that careful examination of potential changes to the auditor's report, in and of itself, is a good thing. I know you'll be hearing more about this project during this conference and in year ahead, and I encourage you to provide your input as the PCAOB proceeds.
In closing, I would like to share a quote from President Theodore Roosevelt, one of my favorite past presidents, from a speech he delivered at the Sorbonne, in Paris, France on April 23, 1910:
It is not the critic who counts; not the man who points out how the strong man stumbles, or where the doer of deeds could have done them better. The credit belongs to the man who is actually in the arena, whose face is marred by dust and sweat and blood; who strives valiantly; who errs, who comes short again and again, because there is no effort without error and shortcoming; but who does actually strive to do the deeds; who knows great enthusiasms, the great devotions; who spends himself in a worthy cause; who at the best knows in the end the triumph of high achievement, and who at the worst, if he fails, at least fails while daring greatly, so that his place shall never be with those cold and timid souls who neither know victory nor defeat.
The reason I am highlighting this quote is because I grow worried about an unfortunate trend to highlight only when individuals are criticized for failing to do their job. However, it is not lost on me that that there are literally tens of thousands of hard working and dedicated accounting professionals who show up to work every day and do their job well. It is unfortunate that we do not have better mechanisms to highlight their successes. So let me try one here today. Thank you. Investors are better protected for your efforts.
Thank you for your time today, and enjoy the rest of the conference.