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Editor: Eric C. Chaffee
Univ. of Toledo College of Law

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Monday, August 4, 2008

SEC Advisory Committee Releases Report on Financial Reporting

The SEC Advisory Committee on Improvements to Financial Reporting presented to the SEC its final report containing 25 recommendations to make financial information more useful and understandable to investors.  Last year Chairman Cox created the Advisory Committee to make recommendations on reducing unnecessary complexity in the U.S. financial reporting system and making financial reports clearer and more understandable to investors.

The SEC already has acted on two earlier recommendations made by the Advisory Committee. On May 14, the Commission formally proposed requiring all U.S. companies to provide financial information using interactive data beginning as early as next year. On July 30, the SEC approved new guidance to public companies to address their concerns about how to comply with the securities laws while developing their Web sites to serve as an effective means for disseminating important information to investors.

The Committee's report provides practical proposals to improve financial reporting in five main areas:

Increasing the usefulness of information in SEC filings
Enhancing the accounting standards-setting process
Improving the substantive design of new standards
Delineating authoritative interpretive guidance
Clarifying guidance on financial restatements and accounting judgments

Among other things, the Committee noted in the first area that many individual investors find company filings with the SEC to be overly complex and detailed. Thus the Committee recommended the inclusion of a short executive summary at the beginning of a company's annual report that would describe concisely the main aspects of its business and its key performance metrics.

In the second area, the Committee called for more investor participation in accounting standard setting by increasing investor representation on the FASB and Financial Accounting Foundation (FAF).

In the third area, the Committee noted that the underlying objectives of certain accounting standards are sometimes obscured by dense language, detailed rules, and numerous exemptions. The Committee recommended a different approach to the substantive design of standards. For example, the Committee called for improved rules on off-balance sheet accounting and fewer situations where alternative accounting standards exist for the same transaction. The Committee recommended that companies provide better disclosure to investors about what portion of their earnings constitutes cash or accrued income based on historic cost accounting and what portion represents unrealized gains or losses based on fair value estimates.

To reduce the proliferation of U.S. GAAP, the Committee said it strongly supports FASB's efforts to complete the codification of all authoritative accounting literature into one document. The Committee said that others such as audit firms may still publish their views on accounting issues, but they should be labeled as non-authoritative. In this fourth area, the Committee also called for a clearer delineation of functions on interpreting accounting standards — with the FASB taking the lead on broad issues and the SEC on registrant-specific issues.

In the fifth area, the Committee recommended increased correction of accounting errors and more disclosures about those corrections to investors. However, the Committee warned that the correction of every accounting error should not automatically result in a lengthy process of restating financial statements for several prior years. The Committee said that in the "dark period" during restatements when companies generally cease filing current financial reports, companies usually do not provide investors with much information. Thus, the Committee said it believes that restatements of prior years should be undertaken for the correction of accounting errors that are material to current investors.

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