On August 22, 2017, Stephen Deane, CFA, Investor Engagement Advisor, Office of the Investor Advocate, gave a speech addressing two proposed updates issued by FASB in 2015 (one that would apply to GAAP and the other that would apply to FASB’s Conceptual Framework) that refer to materiality as a legal concept, or rather rely on courts to provide the definition of materiality. FASB held a public roundtable on the proposed updates in March 2017, but they still remain under consideration.

In the proposed updates, FASB cited the Supreme Court’s definition of materiality in the context of the federal securities laws (i.e., information is material if there is a substantial likelihood that the omitted or misstated item would have been viewed by a reasonable resource provider as having significantly altered the total mix of information). In contrast, FASB’s current definition of materiality, as provided in Concepts Statement Number 8 (“Con 8”), states that information is material if omitting it or misstating it could influence decisions that users make on the basis of the financial information of a specific reporting entity. Although FASB described its proposed updates as clarifications to make them consistent with U.S. law and not intended to change any specific disclosure requirements, investor groups have expressed concerns, including that the proposals were based on the mistaken premise that investors were suffering from an overload of information, the proposals would shift decision-making from accountants to lawyers, and that the Supreme Court’s definition of materiality arose in the context of alleged securities fraud and thus may not be suitable in the context of accounting standards.

Mr. Deane described the Investor Advocate’s alternative approach proposed in a letter sent to FASB in July 2017. This alternative approach combines FASB’s prior definition of materiality in Concept Release Number 2 (“Con 2”) with SEC Staff Accounting Bulletin 99 (“SAB 99”). Mr. Deane noted that Con 2 essentially adopted the Supreme Court’s definition of materiality, but emphasized that “[m]ateriality judgments are concerned with screens or thresholds” and “[t]he more important a judgment item is, the finer the screen should be.” Mr. Deane noted that SAB 99 approvingly references Con 2 for “stat[ing] the essence of the concept of materiality” and then links the Con 2 definition to the Supreme Court’s definition and provides a helpful framework for evaluating materiality decisions in preparing or auditing financial statements, emphasizing that companies must take into account quantitative factors as well as qualitative factors and offering examples of how misstatements of relatively small amounts that come to the attention of auditors could have a material effect on financial statements. As a result, this alternative approach would harmonize FASB’s concept of materiality with the Supreme Court’s definition and the SEC’s approach as well as the PCAOB’s auditing standards, while responding to investor demands for a framework or guidance on how to apply the definition of materiality by drawing on the exposition and illustrative examples in SAB 99 and Con 2. If the SEC were to move forward with its disclosure effectiveness initiative, as is expected, any changes to disclosure requirements and guidance regarding required disclosures would likely address the concept of “materiality.” A copy of the speech is available at: https://www.sec.gov/news/speech/deane-speech-rulemaking-process.