In July 2007, the SEC established the Advisory Committee on Improvements to Financial Reporting to recommend ways to reduce the complexity of financial reporting and provide more useful information to the investing public. The Advisory Committee has developed a host of proposals over the past year — from ending industry-specific guidance to requiring companies to submit their financial statements with electronic-tagging technology. One proposal of particular interest is to limit corporate financial restatements to those involving “meaningful” reporting errors.
The number of restatements filed with the SEC increased from 116 in 1997 to 1,876 in 2006. Nearly 10% of public companies issued restatements in 2006 — which the SEC’s Chief Accountant in August 2007 described as “an alarmingly high number.” The Advisory Committee has stated that too many decisions to restate are made without full consideration of whether a reasonable investor would consider the error meaningful, and thus material. The result, according to the Advisory Committee, has been a significant number of “unnecessary” restatements.
The Advisory Committee has proposed three principles for determining when a restatement is necessary. First, those who evaluate the materiality of an accounting error should make the decision to restate based on the perspective of the reasonable investor. Second, decision-makers should consider how the error affects the total mix of information that is available to the reasonable investor. Third, decision-makers should apply a “sliding scale” of quantitative and qualitative factors: the higher the quantitative significance of an accounting error, the stronger the qualitative factors must be to conclude that the error is immaterial, and vice versa. These principles, taken together, could reduce the number of restatements, especially for small or stale corrections or corrections for highly technical accounting reasons.
The Consumer Federation of America, a consumer-advocacy group, has criticized the Advisory Committee, and warned at a two-day public meeting in March 2008 that the proposal “would weaken the materiality standard and provide less transparency about the reporting of financial statement errors.” The Advisory Committee nonetheless confirmed at the March 2008 meeting that it would continue to pursue its recommendation. The Advisory Committee is expected to make a formal recommendation to the SEC in August 2008. The fall SLEW newsletter will report on that recommendation and the SEC’s response.