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Keynote Address before the 2017 Journal of Accounting and Public Policy Conference – “The Interaction between Regulatory Institutions and Accounting: A Public Policy Perspective”

Wesley R. Bricker, Chief Accountant

College Park, Maryland

June 9, 2017

The Securities and Exchange Commission (“SEC” or “Commission”), as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect the views of the Commission, individual Commissioners, or of the author’s colleagues upon the staff of the Commission.

Introduction

Good afternoon and thank you for the kind introduction and the invitation to address the sixth annual Journal of Accounting and Public Policy (JAPP) Conference, hosted by the Robert H. Smith School of Business at the University of Maryland.

Before I continue, let me remind you that the views expressed today are my own and not necessarily those of the Commission, the individual Commissioners, or other colleagues on the Commission staff.

Let me also express a word of gratitude to the entire Office of the Chief Accountant team for their work in providing advice to the Commission regarding accounting and auditing matters arising in the administration of the federal securities laws.  I also want to acknowledge Ying Compton, Eric Weisbrod, Mikhail Pevzner, and Mark Jacoby for their valuable assistance in preparing me to make today’s remarks.

I also want to take the opportunity to provide an organizational update of particular relevance to today’s audience.  I am pleased to say that Ying Compton recently joined OCA as our Senior Accounting & Economic Advisor.  With a Ph.D. in accounting from the Massachusetts Institute of Technology (MIT) and valuable experience in academia and other roles at the Commission, Ying leads our work in connecting accounting, auditing, and economics research to accounting, auditing, and professional practice matters.  Ying also coordinates the OCA academic fellowship program.  Her roles reflect the value that OCA places on the academic community’s enduring contribution to high quality, credible financial reporting that underpins the functioning of our capital markets.

Accounting Research

With that introduction in place, I am particularly pleased to speak to you today on the conference theme of “The Interaction between Regulatory Institutions and Accounting:  A Public Policy Perspective”

The research that each of you as accounting researchers do on the effects of economic events on the process of accounting and the effects of reported information on economic events has made (and will continue to make) significant contributions to accounting practice.  Your research comprises a broad range of areas, such as financial accounting, management accounting, auditing, and taxation. 

This conference encourages research that can advance the Commission’s mission of protecting investors; maintaining fair, orderly, and efficient markets; and facilitating capital formation. 

It can also contribute to the work of the Office of the Chief Accountant (OCA).  OCA is responsible for establishing and enforcing accounting and auditing policy to enhance the transparency and relevancy of financial reporting, and for improving the professional performance of public company auditors in order to ensure that financial statements used for investment decisions are presented fairly and have credibility. 

By preparing and ultimately sharing research that is relevant to accounting and auditing matters arising in the administration of the federal securities laws, your academic findings can better inform the Commission’s policymaking.

Academic Perspectives within OCA

Academic fellows and academic research are integral to our work in OCA.  For over two decades, accounting academics have been integrated into our staff as academic fellows.  We currently have fellows serving in the accounting and professional practice groups, which are our two largest functional areas from across our four areas of accounting, professional practice, international affairs, and the office of the chief counsel and enforcement liaison.

Academic fellows play an integral role in our accounting standard setting oversight and consultation processes. As part of their academic fellowship, fellows reach beyond traditional academic accounting research to also contribute to the research by practicing accountants in resolving consultation matters for companies and auditors. Current and recent fellows, for example, participate as members of the accounting group topic and consultation teams on areas such as revenue recognition and financial assets.  

Academic fellows also contribute to analysis of data by systematically applying statistical and logical techniques to describe, condense, and evaluate data.  This work contributes to OCA’s ability to use data in discovering useful information and supporting decision-making in monitoring financial reporting trends and themes used in, for example, in discharging our oversight of accounting standard setting activities.  

Similarly, academic fellows in the professional practice group conduct archival research by examining data collected by other researchers or available from data repositories in contributing to policy matters, such as internal control over financial reporting and in OCA’s oversight of the PCAOB standard setting activities. 

More generally, by working side by side with practice accountants in our office, academic fellows contribute to the diversity of thought needed in resolving the complex accounting, audit, and professional practice issues addressed by OCA.  As I mentioned before, Ying Compton also serves as our in-house accounting and economic advisor, providing in-depth expertise in analyzing the costs and benefits of accounting and auditing regulation, among many other areas.

Academic research also permeates the activities of other divisions and offices of the Commission. For example, the largest single component of the SEC’s Division of Economic and Risk Analysis (DERA) is Ph.D. financial economists. DERA’s role includes integrating financial economics and rigorous data analytics into the core mission of the SEC.  The Division is involved across the entire range of SEC activities, including policy-making, enforcement, and examination.  OCA interacts closely with DERA in all aspects of our activities.  

Let me now turn to how your work contributes to our mission.

Integrating Academic Research in Rulemaking and Oversight Activities

Academic research is valuable in providing theories, testable hypotheses, and evidence that help us to understand issues we frequently encounter in our work.  For example, we often talk about decision usefulness to investors of accounting information, and in assessing decision usefulness, academic research can provide empirical evidence based on market reactions to certain information, changes in company liquidity, and differences in how different types of investors react to certain information.  These types of findings are identified and shared among the academic and professional staff in OCA and also contribute to the work of the financial economists in other offices and divisions at the SEC.

As you may be aware, the SEC staff performs economic analyses as part of rulemaking activities, both when recommending proposals for new rules and later when recommending final adoption of rules.  The economic analysis draws upon similar theories and methodologies as academic research, especially the analysis of the economic consequences of regulation.  There are differences too, of course, with one being that the SEC staff’s analysis is performed before a rule becomes effective, and so focuses on likely economic effects. 

SEC staff guidance on economic analysis in rulemaking lays out four basic elements: 

  1. Justification for the rule (for example, a market failure);
  2. The baseline (i.e., the current state of the market) against which the effects of the regulation should be measured;
  3. Alternative regulatory approaches (to allow the Commission to meaningfully compare the proposed action with reasonable alternatives);
  4. Analysis of the economic effects, including the benefits, costs, and effects on efficiency, competition, and capital formation, of the rule and reasonable alternatives.

As I’ve mentioned, economists from the Commission’s Division of Economic and Risk Analysis are involved from the earliest stages of rulemaking activities; economic analyses thus inform decisions on the scope and requirements of a rule.[1] 

Areas of Interest for Future Academic Research

During today’s conference, participants will present papers on a broad range of informative topics, such as the impact of disclosure exemptions for Emerging Growth Companies (EGCs).[2] While some of the topics covered today may not directly relate to financial reporting, public attention to non-financial reporting topics is increasing, given the potential relevance of such information to investors. 

With the integration of academic research throughout our work, I encourage additional research examining the interaction between regulatory institutions and accounting.  In doing so, I encourage researchers to consider the broad role of the Commission when examining the impact of accounting and audit standards in U.S. capital markets.

Recognizing that there are a number of fruitful and unique research topics from across the accounting domain, let me suggest or reinforce several topics for continued emphasis in accounting research. 

Financial accounting areas

The first broad area is financial accounting research.  This area comprises, in part, the relevance, reliability and quality of accounting information, accounting standard setting and application, and financial statement analysis.

One topic for further research is the impact of non-authoritative application guidance from staff of standard setters, accounting firms, industry groups, and other stakeholders in shaping financial reporting. Research of the impact of accounting standard setting often focuses on the accounting standard, which is a vital component for financial reporting.  But, the role of non-authoritative guidance has received little attention in the academic literature.

The SEC staff fosters appropriate application of accounting standards through communications with companies, auditors and others in various formats, such as: 

  • staff accounting bulletins, which reflect the Commission staff's views regarding accounting-related disclosure practices;[3]
  • staff announcements, which reflect the Commission staff’s views concerning accounting technical matters made at FASB public meetings;[4] and
  • speeches, which reflect individual staff member views about a wide range of topics concerning the state of the markets and the regulatory agenda.[5]

Collectively, these SEC staff communications are intended to elaborate on, and be consistent with, the authoritative guidance contained in U.S. GAAP.

The SEC staff also encourages companies and their auditors to consult with OCA on accounting, financial reporting, and auditing concerns or questions, especially those involving unusual, complex, or innovative transactions for which no clear authoritative guidance exists as well as on issues regarding auditor independence.[6]

Academic research can inform standard setting and application activities by examining the ways in which various stakeholders communicate their views on the application of accounting standards and the effects of those communications.  These communications might be especially relevant in the coming years as companies implement, and ultimate apply, the FASB and IASB’s recently issued standards for contracts with customers, leases, financial instruments, and credit losses.

The recently issued expected credit loss standards issued by the FASB and the IASB also offer additional opportunities for academic research.  The FASB’s current expected credit loss (CECL) model requires that the full amount of expected credit losses be recorded for all financial assets measured at amortized cost, whereas the IASB’s approach in IFRS 9 requires that an allowance for credit losses equal to the 12-month expected credit losses as defined in IFRS 9 be recognized, until there is a significant increase in credit risk when lifetime expected credit losses are recognized.  

Registrants are currently developing implementation plans and accounting policies for application of the expected credit loss standards.  Researching the anticipated effect of the expected credit loss approach compared to today’s incurred loss model under various scenarios could contribute to the level of understanding by companies, investors, and others about the quality of accounting information from the two accounting approaches. For example, studies comparing the simulated performance of these models based on historical data with varying assumptions could produce information that may help inform implementation and application decisions.

Also, there may be further fruitful opportunities for accounting research on the application of international accounting standards. For example, a recent study published in JAPP examines changes in earnings attributes for foreign private issuers that report using international accounting standards.[7]  The Commission’s criteria for accepting financial statements from foreign private issuers without reconciliation to U.S. GAAP includes that such financial statements are prepared in accordance with IFRS as issued by the International Accounting Standards Board (“IASB”).[8]  Possible areas for further research include monitoring financial reports issued from jurisdictions that have not endorsed IFRS as issued by the IASB, or have done so in only a partial manner, in contributing to an understanding of the similarities and differences in financial reporting attributes and outcomes. 

Governance and controls

The second broad area is governance and controls research, which comprises, in part, the processes and structures implemented by the board and management to inform, direct, manage, and monitor the activities of a company’s credible financial reporting.  Areas of particular contribution include the means of promoting appropriate ethics, tone and values within a company; oversight of performance management and accountability; communicating information among the board, management, and internal auditors and external auditors; and controls to manage risk and increase the likelihood that that objectives and goals will be achieved. 

In this regard, the is value in furthering the existing research in the role of internal control over financial reporting (ICFR) in reducing the risk of material misstatements in financial statements.  ICFR research may be poised to progress beyond initial exploration of the role of material weakness disclosures in capital markets, and explore deeper and more complex issues that underlie causes and consequences of potentially ineffective ICFR.  This may necessitate moving beyond traditional database-driven research towards hand-collected data and perhaps even field studies.  Some published work has already proceeded down this route, but additional research input may be fruitful, as ICFR continues to be a key topic on the staff’s agenda. 

In light of the several new accounting standards taking effect in the coming years, I encourage researchers to examine the role of internal control over financial reporting in the implementation of new accounting standards.  In particular, papers could address the question of how different approaches to internal control over financial reporting certification and disclosures contribute to higher or lower incidence of material accounting misstatements with the new accounting standards over time.  

Moreover, I encourage researchers to advance the understanding of the role of audit committees in fostering effective internal control over financial reporting, and the factors that strengthen or weaken audit committees’ effectiveness. Audit committees serve an important function in our financial reporting system.  

The vital role of audit committees, members’ education, and minimum thresholds for expertise of its members in financial reporting and disclosure is a well-researched area.  Particularly after the Sarbanes-Oxley Act of 2002, academic research on audit committees has flourished, and studies consistently find that independence and expertise of audit committees are associated with enhanced financial reporting quality.  However, there continues to be interest in further ways to advance the consistency in effectiveness of audit committees in corporate governance for companies of all sizes. 

In July 2015, the Commission issued a Concept Release on “Possible Revisions to Audit Committee Disclosures.”[9]  The release sought input on understanding the types of disclosures about audit committees’ work related to the audit committees’ oversight of the external auditor that might be beneficial to investors. In this regard, an area where academic research might be of interest is further work on the characteristics and skills of audit committee members that contribute to their effective oversight of financial reporting. 

Studies could also examine the types of information that are informative to audit committee members in their oversight roles.  For example, academic research finds that book-to-tax differences can be a source of insight to potential earnings manipulation.[10],[11]  Would more attention by some audit committees on the disclosures of book-to-tax differences already in the financial statements facilitate additional insight and understanding of management’s financial reporting? 

Auditing

Turning now to a third area, audit research covers audit standard setting, audit standards, audit methodology, auditor independence, and judgment and decision making of individuals such as investors, managers, and audit professionals. 

The PCAOB employs economists, researchers, and analysts to further the PCAOB’s work in establishing auditing and related professional practice standards for registered public accounting firms to follow in the preparation and issuance of audit reports.  PCAOB staff conducts economic analysis, research, risk assessments, and other data analysis to inform PCAOB activities, including standard setting, inspection, enforcement, and other oversight activities. They also identify and analyzes audit and financial reporting risks and trends to inform PCAOB oversight activities, including its risk-based inspection program.  

In that context, the PCAOB identifies areas for audit research, in part, through an annual conference that encourages the submission of papers about all aspects of financial statement auditing, as well as the impact of regulation and oversight.[12]  

Investment decision-making   

A fourth area for research is in the area of advancing an understanding of the flow and uses of financial reporting information, given the continuing changes from technology and capacity for data analytics.  In doing so, it is vital to continue to understand information about the segments, disparate interests and financial reporting information needs of both professional and individual investors.  Studies could also examine the nature of information sources, decision styles, and implications for the accounting, audit and disclosure within the financial reporting process.   

It is also valuable to examine the nature of delivery innovations in financial reporting, such as the role of analysts and data aggregators in the dissemination of structured and non-structured data in the capital markets.[13]  Academic research could examine the role of other parties, among other areas, in conforming the form, format, prominence, and distribution of financial statement data to investors and analysts.

Reporting of other information

A final and fifth area that I’ll mention is reporting of information other than the financial statements, such as non-GAAP measures and non-financial metrics. The staff monitors compliance in this area to foster disclosure practices consistent with Commission rules.  For example, last year, staff in the Division of Corporation Finance updated its Compliance and Disclosure Interpretations (C&DIs) in the area of non-GAAP reporting.[14]  Since then, the staff has observed changes in some registrants’ disclosure practices in response to this new guidance. Academic research may deepen an understanding of the determinants and consequences of both non-GAAP measures and non-financial metrics as well.

Closing

Finally, let me reiterate the importance of academic input into our work.  Beyond conducting research, I encourage academics to provide input through the comment process on policy proposals by regulators and standard setters.  The Financial Accounting Standards Committee of the American Accounting Association (“AAA”), the Standards Committee of the Auditing Section of the AAA and some individual accounting academics over the years have written a number of such letters, which have contributed to the discussion over proposed policies and standards. 

As I mentioned earlier, an academic fellowship is a direct way by which academia can impact financial accounting and auditing regulation.  Academic fellows not only serve as internal experts on research and economic analyses; they also keep us educated as to current trends in academic literature.  This helps us ensure that our policy work is based on the most up-to-date evidence.

Conferences such as this one very much help us in our work.  Thank you for your time, and please enjoy the remainder of the conference.


[1] Similar to SEC rulemaking, the PCAOB is committed to economic analysis in its standard setting, and its staff guidance on economic analysis follows the same basic approach as the SEC’s.  

[2] See Section 103(a)(3)(C) of The Sarbanes-Oxley Act of 2002, as amended by Section 104 of the Jumpstart our Business Startups Act (“JOBS Act”).  Section 104 of the JOBS Act also provides that any rules of the Board requiring mandatory audit firm rotation or a supplement to the auditor's report in which the auditor would be required to provide additional information about the audit and the financial statements of the issuer (auditor discussion and analysis) shall not apply to an audit of an EGC.

[6] See also Financial Reporting Release No. 60, Cautionary Advice Regarding Disclosure About Critical Accounting Policies (December 12, 2001), which encourages public companies to consult with the Commission's accounting staff if companies, management, audit committees or auditors are uncertain about the application of specific GAAP principles related to "critical accounting policies." This document provides guidance as to the recommended form and content of correspondence when consulting the Commission's accounting staff in OCA.

[7] See Hansen, B., Pownall, G., Prakash, R., and Vulcheva, M., Earnings changes associated with relaxing the reconciliation requirement in non-U.S. firms’ SEC filings. Journal of Accounting and Public Policy 33(5): 424 – 448 (2014). Available at http://www.sciencedirect.com/science/article/pii/S0278425414000520.

[8] See SEC Rule Release Nos. 33-8879; 34-57026, Acceptance from foreign private issuers of financial Statements prepared in accordance with international financial reporting standards without reconciliation to U.S.GAAP, available at https://www.sec.gov/rules/final/2007/33-8879.pdf.

[9] SEC Release No. 33-9862; 34-75344 File No. S7-13-15; available at: https://www.sec.gov/rules/concept/2015/33-9862.pdf.

[10] See, for example, Hanlon, M. (2005). The persistence and pricing of earnings, accruals, and cash flows when firms have large book-tax differences. The Accounting Review80(1), 137-166.

[11] See, for example, Maydew, E. L. (1997). Tax-induced earnings management by firms with net operating losses. Journal of Accounting Research35(1), 83-96.

[12] See PCAOB’s 2017 Conference on Auditing and Capital Markets and Call for Papers, available at https://pcaobus.org/EconomicAndRiskAnalysis/CEA/Pages/2017-conference-auditing-capital-markets-papers.aspx.

[13] See Julie A. Erhardt, Deputy Chief Accountant, U.S. Securities and Exchange Commission, Remarks at the 2016 AICPA National Conference on Current SEC and PCAOB Developments (Dec. 5, 2016), available at  https://www.sec.gov/news/speech/erhardt-2016-aicpa.html.