GAO

United States General Accounting Office

Report to the Ranking Minority Member, 

Subcommittee on Financial Institutions, 

Committee on Banking, Housing, and 

Urban Affairs, U.S. Senate

June 2001 SECURITIES AND 

EXCHANGE 

COMMISSION

Reviews of 

Accounting Matters 

Related to Public 

Filings

GAO-01-718

Page 1 GAO-01-718 Securities and Exchange Commission

June 14, 2001

The Honorable Robert F. Bennett

Ranking Minority Member

Subcommittee on Financial Institutions

Committee on Banking, Housing, and Urban Affairs

United States Senate

Dear Senator Bennett:

This report responds to your request that we review how the Securities

and Exchange Commission’s (SEC) Office of the Chief Accountant (OCA)

resolves accounting issues submitted by companies that have or are

contemplating publicly traded securities. As agreed, this report describes

the (1) number and types of accounting-related inquiries and written

submissions that are presented by companies and their auditors and those

that are presented through requests for consultation services from SEC’s

Division of Corporation Finance (DCF), (2) SEC’s procedures for

reviewing and deciding on accounting issues, including the controls in the

SEC’s process to ensure consistency when dealing with these accounting

issues, and (3) views from SEC registrants, the accounting profession, and

SEC officials regarding how well the process is working.

The primary mission of the SEC is to protect investors and maintain the

integrity of the securities market. The Securities Act of 1933 requires that,

prior to the offering or sale of securities, the issuer must register the

securities offering with the SEC by filing a registration statement. The

registration statement must contain financial and other material

information concerning the securities and the issuer. Following the

securities’ registration, the Securities Exchange Act of 1934 requires that

the issuer make periodic filings disclosing its financial status and changes

in condition. For example, issuers must file annual reports containing

financial statements, which are required to be prepared in conformity with

generally accepted accounting principles (GAAP) and audited by

independent public accountants. The SEC reviews selected issuers’ filings

for compliance with accounting and disclosure requirements. During fiscal

year 2000, the SEC received over 14,000 registrants’ filings. Also, under the

Securities Act of 1934, the SEC has specific authority to establish

accounting and reporting standards as part of its mandate to administer

and enforce the provisions of federal securities laws.

United States General Accounting Office

Washington, DC 20548
Page 2 GAO-01-718 Securities and Exchange Commission

As the SEC’s principal advisor on accounting and auditing matters, OCA

resolves issues arising from the SEC’s review of registrants’ financial

statements and disclosures. OCA also reviews registrants’ accounting

issues through prefiling inquiries from the registrants themselves.

Registrants submit issues that generally involve unusual, complex, or

innovative transactions and, in many instances, for which no clear

authoritative guidance exists. During calendar year 2000, OCA received

113 new submissions and carried over 21 submissions from the prior

calendar year for a total caseload of 134 written submissions during the

year. Of these, OCA closed 116, leaving 18 submissions that were carried

over to calendar year 2001. Examples of the type of accounting issues

frequently reviewed include business combination issues, such as the

application of the pooling versus purchase methods of accounting, and

complex issues surrounding revenue recognition and financial

instruments.

OCA has published procedures that are publicly available for dealing with

the registrants on accounting issues. In December 1999, OCA issued

Protocols for Registrant Submissions to the Office of Chief Accountant.

They address the submission of accounting matters by registrants to OCA

for oral and no-name inquiries, written submissions, meetings with SEC

staff, and correspondence with SEC staff regarding registrants’

understanding of SEC staff’s positions. OCA has also documented formal

internal procedures for reviewing and resolving registrants’ accounting

issues. These internal procedures contain key controls, which are

designed to help ensure consistency in its process for dealing with

registrants’ accounting issues.

The representatives from SEC registrants and the accounting profession

whom we spoke with conveyed a range of experiences, both positive and

negative, with regard to the SEC’s handling of accounting issues. Some

common concerns were expressed regarding the SEC’s decision-making

process on accounting issues. Specifically, registrants and their auditors

told us that the SEC’s process for handling accounting issues and the basis

for its positions are not always apparent. Representatives cited the need

for additional transparency of the SEC’s internal processes. OCA officials

explained their internal procedures to us and stated that they would

consider providing additional information to registrants and their auditors

regarding the SEC’s internal process for its review and decision-making on

accounting matters.

Results in Brief
Page 3 GAO-01-718 Securities and Exchange Commission

In addition, representatives from the registrants and the accounting

profession expressed concern about the difficulty in tracking the variety of

sources used by the SEC in determining acceptable accounting practices

and financial reporting methods for filings. Registrants and their auditors

stated that many of these sources are in addition to, and outside of, the

private sector standard-setting process and are not subject to due process.

OCA officials stated that these sources are available in the Code of Federal

Regulations and on their external Internet Web site. OCA also said that

private publishing firms, such as Commerce Clearing House, Inc. (CCH)

publish documents that contain all SEC rules. With regard to the SEC’s

issuance of interpretive guidance without due process, the SEC officials

stated that all SEC guidance can be tied to existing GAAP and, therefore,

does not represent new GAAP. The SEC officials said that the staff’s

interpretive guidance describes new fact patterns appearing in industry

and provides guidance for handling these new types of cases under

existing GAAP.

We are making recommendations that focus on information provided by

OCA to registrants and the accounting profession. Specifically, we are

recommending that the SEC make public additional information that

explains its current policies and procedures for reviewing and deciding on

accounting issues. Also, because of the differing views, we are

recommending that the SEC officials meet with representatives of the

registrants and the accounting profession regarding the methods for

disseminating the variety of SEC’s rules and interpretive guidance and the

method for communicating OCA’s final position on accounting issues.

Increased transparency and open communications are fundamental for an

effective working relationship between the registrants, the accounting

profession, and the SEC.

In commenting on a draft of this report, the SEC expressed appreciation

for the constructive nature of the recommendations and said that it had

begun considering ways to implement them. The SEC described its

planned actions to create more transparency for SEC processes for

making decisions on accounting issues and highlighted the availability of

its current guidance and positions on accounting issues. The SEC also

pointed out that many of the accounting cases it deals with are unique.

The American Institute of Certified Public Accountants (AICPA) said that

the recommendations made in our report, if properly implemented, would

provide an opportunity to promote improved transparency of the SEC

processes and communications among registrants, the accounting

profession, and the SEC. The AICPA provided additional suggestions for

specific discussion topics related to OCA’s procedures and
Page 4 GAO-01-718 Securities and Exchange Commission

communications with registrants. The SEC’s and the AICPA’s written

comments have been reprinted in appendixes I and II, respectively.

The primary mission of the SEC is to protect investors and maintain the

integrity of the securities market. The Securities Act of 1933 requires that,

prior to the offering or sale of securities, the issuer must register the

securities offering with the SEC by filing a registration statement.1 The

registration statement must contain financial and other material

information concerning the securities and the issuer. Following the

securities’ registration, the Securities Exchange Act of 1934 requires that

the issuer make periodic filings disclosing its financial status and changes

in condition. For example, issuers must file annual reports containing

financial statements, which must be prepared in conformity with GAAP

and audited by independent public accountants. During fiscal year 2000,

the SEC received over 14,000 registrants’ filings. The SEC reviews selected

issuers’ filings to ensure compliance with accounting and disclosure

requirements. The SEC has enforcement authority under federal securities

laws to take legal action against companies that do not comply with the

securities laws.

SEC’s critical role to protect investors’ interests has been made even more

challenging with the significant changes in the global economy and capital

markets over the past few years. The current business environment is

characterized by a globalized, highly competitive economy; explosive

growth in the development and use of technology; expansion in the

number of public companies; and the unprecedented growth and in some

cases subsequent decline in the market value of those securities.

Furthermore, growth in equity values has placed tremendous pressure on

public companies’ management to reach earnings or other performance

targets and to meet or exceed the earnings expectations of the security

analysts and investors. Missing these targets may cause a significant

decline in a security’s market value and reduce management’s

compensation in those cases when it is tied to achieving target earnings

and/or stock market prices. Several major instances of misstated earnings

have resulted in massive declines in the values of the affected companies.

Recently, the SEC has become increasingly concerned with the

 1

Not all offerings of securities must be registered with the SEC. For example, private

offerings to a limited number of persons or institutions, offerings of limited size, intrastate

offerings, and securities of state and federal governments are exempted from registration

requirements.

Background
Page 5 GAO-01-718 Securities and Exchange Commission

inappropriate use of GAAP and the resulting effect on reported earnings

and, in some cases, has required companies to restate their earnings.

The SEC’s DCF oversees the disclosure of information, which is required

by federal securities laws, to the investing public. DCF’s staff routinely

reviews the disclosure documents filed by public companies with SEC and

consults with OCA to resolve issues arising from the review of registrants’

filings. OCA is the SEC’s principal advisor on accounting and auditing

matters. OCA also reviews registrants’ specific accounting treatment of

complex issues as a result of prefiling inquiries from the registrants

themselves. OCA encourages registrants to consult on those financial

reporting and auditing issues that involve unusual, complex, or innovative

transactions for which no clear authoritative guidance exists.

As the SEC’s principal advisor on accounting and auditing matters, OCA

provides rulemaking and interpretation initiatives that supplement private

sector accounting standards and provide implementation guidance for

financial disclosure requirements. OCA provides general interpretive and

accounting advice through interpretive releases and letters, staff

accounting bulletins, responses to telephone inquiries, speeches, and

active participation with the standard-setting bodies.

Under the Securities Exchange Act of 1934, the SEC has specific authority

to establish accounting and reporting standards as part of its mandate to

administer and enforce the provisions of the federal securities laws. Soon

after its creation, the SEC decided to rely on accounting standards

established in the private sector as long as such standards had substantial

authoritative support. Since 1973, the Financial Accounting Standards

Board (FASB) has been the designated organization in the private sector

that establishes standards for financial accounting and reporting. The SEC

officially recognizes GAAP standards established by FASB as

authoritative. As such, the SEC requires compliance with GAAP in the

presentation of financial statements. FASB’s deliberations are open to the

public, and its standards are subject to public exposure and comment

prior to issuance. The SEC is involved in establishing accounting

standards through the oversight of, and close working relationship with

FASB, and other professional standard-setting bodies. The SEC is also

involved in establishing accounting standards through the adoption of

rules and publication of interpretive guidance. Rules and interpretive

releases, such as in the Codification of Financial Reporting Policies and
Page 6 GAO-01-718 Securities and Exchange Commission

Regulation S-X2 of the SEC, have an authority similar to pronouncements

by FASB for SEC registrants. The SEC staff issues Staff Accounting

Bulletins that represent interpretive guidance and practices followed by

DCF and OCA in administering the disclosure requirements of the SEC.

The SEC has relied on generally accepted auditing standards (GAAS)

promulgated by the AICPA’s3

 Auditing Standards Board (ASB) as the

standard for independent audits. ASB’s deliberations are open to the

public, and its standards are subject to public exposure and comment

prior to issuance.

The SEC monitors the structure, activity, and decisions of not only FASB,

but also FASB’s Emerging Issues Task Force (EITF). EITF was formed in

1984 to provide timely financial reporting guidance on emerging issues

before divergent practices became widespread and entrenched. Task force

members are drawn primarily from public accounting firms but also

include representatives of industry. The Chief Accountant of the SEC or

his designee attends EITF meetings regularly as an observer and

participates in the discussions, but does not have a vote. If the group

reaches a consensus4

 on an issue, generally FASB takes this as an

indication that no further board action is needed. If no EITF consensus is

possible, it may be an indication that action by FASB is necessary. EITF

proceedings are documented in EITF Abstracts. The SEC staff and FASB

and EITF members work together in an ongoing effort to improve the

standard-setting process and to respond to various regulatory, legal, and

business changes promptly and appropriately.

 2

Regulation S-X contains the SEC’s principal accounting requirements, which govern the

form and content of financial statements filed by public companies with the SEC. It

addresses those areas in which GAAP standards are not explicit and there is a need for an

authoritative source for such requirements.

3

The AICPA is the national professional organization for certified public accountants

(CPA). Its primary mission is to provide members with the resources, information, and

leadership to enable them to provide valuable service to the public, employers, and clients.

To achieve its mission, the AICPA acts as an advocate for CPAs and establishes rules and

standards for the accounting profession.

4

A consensus of EITF is deemed to exist when not more than 2 of the 13 members disagree

with the suggested accounting approach. An EITF consensus is considered to be a GAAP

standard under SAS No. 69, The Meaning of “Present Fairly in Conformity With Generally

Accepted Accounting Principles” in the Auditor’s Report, which was issued by the AICPA

in 1992. The SEC staff questions registrants’ accounting practices that differ from an EITF

consensus.
Page 7 GAO-01-718 Securities and Exchange Commission

In carrying out its responsibilities, OCA works with the private sector

accounting profession, including the AICPA SEC Practice Section and the

AICPA SEC Regulations Committee. The AICPA SEC Practice Section is

part of the profession’s self-regulatory system, with a goal of protecting

the public interest by improving the quality of CPA firms’ practice before

the SEC. The AICPA SEC Practice Section establishes requirements for

member firms and has a program to monitor those requirements. Member

requirements include adhering to quality control standards and submitting

to a peer review of each firm’s accounting and auditing practice every 3

years. The AICPA SEC Regulations Committee is part of the AICPA SEC

Practice Section that acts as the primary liaison between the profession

and the SEC on technical matters relating to SEC rules and regulations.

The AICPA SEC Regulations Committee provides input to the SEC on

accounting and auditing matters and communicates important SEC

developments to its AICPA members. The AICPA SEC Regulations

Committee includes accounting firms that belong to the AICPA SEC

Practice Section as well as members from academia and industry.

To fulfill our objectives, we interviewed officials and professional staff

members from the SEC’s OCA. We reviewed relevant policies and

procedures, including the Protocol for Registrant Submissions to OCA

(effective December 1999) and OCA’s Policies for Handling Registrants

Matters (dated August 2000). We focused on the procedures and controls

employed by the SEC for resolving registrants’ prefiling accounting issues

and issues on filings in which DCF consults with OCA. To gain an

understanding of OCA’s procedures and the controls employed by the SEC

throughout the process, we reviewed OCA’s case files of written

submissions from registrants and their auditors. Although we reviewed

cases to gain an understanding of the SEC’s process and the related issues,

we did not perform testing to evaluate whether the SEC properly

implemented its procedures throughout its caseload, nor did we evaluate

the SEC’s final accounting positions on the cases that we reviewed.

We interviewed representatives from the AICPA’s SEC Practice Section

and SEC Regulations Committee, FASB’s EITF, and several CPA firms. We

also interviewed representatives from Financial Executives International

(FEI) and its Committee on Corporate Reporting. FEI is a professional

association of senior financial executives, with many members from SEC

registrant companies, which communicates its members’ views on

emerging issues to standard-setting bodies and legislators. We also

interviewed representatives from SEC registrant companies to obtain their

views on the SEC’s process for handling accounting issues.

Scope and

Methodology
Page 8 GAO-01-718 Securities and Exchange Commission

We conducted our work from December 2000 through May 2001, in

accordance with generally accepted government auditing standards. We

requested comments from the SEC, the AICPA SEC Practice Section, the

AICPA SEC Regulations Committee, and FEI. We received written

comments and technical comments from the SEC and the AICPA. FEI

advised us that they did not have official comments on this report. The

SEC’s and the AICPA’s written comments are discussed in the “Agency

Comments and Our Evaluation” section of this report and are reprinted in

appendixes I and II. We incorporated the technical comments provided by

the SEC and the AICPA throughout this report as appropriate.

OCA receives both prefiling and active filing accounting issues for review

through oral inquiries and written submissions from registrants and their

auditors and from DCF. Oral inquiries received by OCA involve broad

issues that are often not registrant specific. Registrants or their auditors

can call OCA to ask prefiling accounting questions. Oral inquiries and

OCA’s responses are considered informal and therefore not binding for a

subsequent filing. Oral inquiries are sometimes done on a “no-name” basis,

whereby the registrants or their auditors telephone OCA to ask questions

without giving their names. However, OCA encourages registrants or their

auditors to put accounting inquiries in writing to ensure a clear

understanding of the facts, especially those involving complex, unusual, or

innovative transactions for which no clear authoritative guidance exists.

Prefiling written submissions from the registrants and their auditors are

registrant specific, and OCA considers its position to be binding for

purposes of deciding whether a registration has complied with the SEC’s

accounting and disclosure requirements. OCA also receives inquiries

through consultations with DCF on issues related to filings from

registrants. Some of DCF’s inquiries are oral and others are considered

written inquiries when the issues are substantive and involve extensive

OCA’s review. Inquiries from DCF include questions relating to

(1) accounting issues and auditing matters that involve basic policies of

SEC, (2) auditor’s independence or qualifications, or (3) new, unusual, or

controversial accounting issues relating to a registrant’s financial

statement presentation.

OCA receives various types of accounting-related inquiries through the

processes described above. OCA tracks written submissions but does not

track oral inquiries. OCA provided the following caseload information on

written submissions and DCF consultations for calendar year 2000: OCA

received 113 new submissions during calendar year 2000 and carried over

Accounting-Related

Inquires to OCA
Page 9 GAO-01-718 Securities and Exchange Commission

21 submissions from 1999 for a total caseload of 134 written submissions

for calendar year 2000. Of the 134 cases, OCA reported that it closed 116

cases, leaving 18 cases that were carried over to calendar year 2001.

Approximately 38 percent of the 113 written submissions received by OCA

came from DCF. The registrants and their auditors submitted the

remaining 62 percent of the cases to OCA.

According to OCA, the written submissions it receives involve issues that

are complex and involve significant judgment. Examples of the type of

accounting issues frequently reviewed include business combination

issues, such as the application of the pooling versus purchase methods of

accounting and complex issues surrounding revenue recognition and

financial instruments. OCA’s position on these accounting issues can have

a significant impact on a company’s reported earnings and financial

condition and a correspondingly large impact on the stock value of a

company. The following represents the breakdown by type of the 113

submissions received by OCA during calendar year 2000:

• business combinations (29),

• revenue recognition (25),

• financial instruments (19),

• capital accounts (11),

• consolidations and equity method (9),

• stock compensation (4),

• auditor’s independence (2),

• deferred income taxes (3),

• foreign reporting issues (2),

• financial statement presentation (3), and

• asset impairment, accounting changes, leasing, earnings per share,

contingencies, and interest capitalization (1 each).

Because of concerns regarding the communications between auditors and

the SEC, the AICPA issued a “best practices” guide in 1996 for member

firms’ communications with SEC staff in order to promote effective,

efficient communications among SEC staff, registrants, and their auditors.

The AICPA provided this document to the SEC, which in turn issued its

Protocols for Registrant Submissions to the Office of Chief Accountant in

December 1999. The SEC protocols are available to the public on the

SEC’s Web site and the AICPA’s Web site; they set out the formal

procedures for registrants’ inquiries to the SEC on accounting matters.

The protocols cover the following:

OCA’s Procedures and

Controls for

Reviewing Accounting

Matters
Page 10 GAO-01-718 Securities and Exchange Commission

• oral and no-name inquiries,

• written submissions from registrants on prefiling accounting issues,

• meetings with SEC staff, and

• correspondence with SEC staff regarding registrants’ understanding of the

staff’s position on an accounting issue.

The SEC’s protocols cover the process for submitting accounting issues to

OCA for review, conducting meetings with the SEC, and closing out issues

with the SEC. The protocols do not include information about the internal

process that SEC uses for its review and decision-making on registrant

accounting matters. The protocols also do not provide information on the

SEC’s procedures for dealing with issues on filings in which DCF consults

with OCA on accounting issues.

In December 1999, OCA began to document its internal procedures for its

review of registrants’ accounting matters and its procedures for dealing

with issues on filings in which DCF consults with OCA on accounting

issues. Completed in August 2000, these written internal procedures

include key steps and controls in the SEC’s process for dealing with

registrants’ accounting issues. These internal procedures have not been

made available to registrants or the accounting profession. The following

are OCA’s key steps and controls as described in the protocols and SEC’s

current internal procedures.

• OCA requires registrants to submit standard, comprehensive information

for written submissions so that OCA can fully understand the issues. The

required information is listed in the protocols, and includes the following:

• a clear description of the accounting, financial reporting, or auditing

questions;

• all facts that may influence a decision as to the proper accounting

treatment for the transaction;

• the accounting treatment proposed by the registrant and the basis for

that conclusion, including an analysis of all the relevant accounting

literature, as well as all alternatives considered and rejected; and

• a statement regarding the conclusion of the registrant’s auditor on the

proposed accounting treatment.

• Upon resolution of an issue, the SEC protocols state that the registrant

should prepare and send a letter to the SEC describing the registrant’s

understanding of the SEC staff’s position.

Key Steps From the SEC’s

Published Protocols
Page 11 GAO-01-718 Securities and Exchange Commission

• OCA maintains teams of experts specializing in specific accounting issues,

and individual issues are referred to the appropriate team of experts.

• OCA’s teams of experts are to follow various prescribed steps for

resolving each issue, which can include researching the accounting

literature, researching the disposition of prior cases, and consulting with

internal and external subject matter experts, including representatives

from FASB and representatives from the “Big 5” accounting firms.5

• If a majority of the team dealing with an issue disagrees with the

registrant’s proposed accounting treatment, the decision is to be discussed

with the team leader and a Deputy Chief Accountant and/or the Chief

Accountant before communicating with the registrant.

• All issues that are not clearly answered by the accounting literature or

staff precedents or are unusual, novel, or controversial are to be discussed

with a Deputy Chief Accountant. A Deputy Chief Accountant discusses

issues with the Chief Accountant where deemed appropriate.

• The Chief Accountant is to be notified if previous SEC staff positions are

being reversed or if a registrant would be required to restate its financial

statements. In such situations, the SEC staff must first obtain the approval

of a Deputy Chief Accountant, and then must discuss the case with the

Chief Accountant before notifying the registrant of its decision. The Chief

Accountant may overturn the decision of the SEC staff if he becomes

convinced that it is the best course of action.

• Whenever a team leader discusses the resolution of a matter with a

registrant or the registrant’s auditor, at least one other team member is

required to be present.

• Once a decision is reached, the SEC is to document the decision in a

memorandum for its files. The memorandum is to include relevant

background information and facts of the case, the question raised, and

alternate accounting treatment(s) that were considered but not accepted.

• A registrant may appeal the staff’s position to a Deputy Chief Accountant,

the Chief Accountant, or the Commission.

The representatives from SEC registrants and the accounting profession

with whom we spoke with said they had a range of experiences, both

positive and negative, with the SEC’s handling of accounting issues. Some

of the representatives we spoke with expressed common concerns

regarding the SEC’s process for deciding on accounting issues.

 5

The “Big 5” accounting firms are Andersen LLP, Deloitte & Touche LLP, Ernst & Young

LLP, KPMG LLP, and PricewaterhouseCoopers LLP.

Key Steps From the SEC’s

Internal Procedures

Document

Views of Registrants,

Their Auditors, and

the SEC
Page 12 GAO-01-718 Securities and Exchange Commission

Specifically, we were told that the SEC’s process for handling accounting

issues and the basis for the SEC’s position is not always apparent to the

registrants and their auditors, and representatives cited the need for

additional transparency in the SEC’s internal processes. In addition, the

representatives we spoke with expressed concern about the difficulty in

tracking the variety of sources used by the SEC in determining acceptable

accounting and financial reporting. According to these representatives,

many of the sources used by the SEC are in addition to, and outside of, the

private sector standard-setting process.

Representatives and members of the SEC registrant and accounting

profession we spoke with did not identify any specific problems with the

SEC protocols issued in 1999. The protocols deal with the process to be

followed when submitting accounting issues or questions to the SEC.

However, the representatives expressed concern that OCA’s process for

handling the issues is not clear, and registrants and their auditors are often

unsure of how the SEC reached its decisions and on what basis.

Representatives suggested that additional transparency regarding the

SEC’s process would help them to understand how issues are being

handled and resolved by OCA.

Representatives of registrants and the accounting profession expressed a

need for additional information regarding the following:

• general status information, including time estimates for resolving issues

and status of the review;

• how accounting issues are assigned to SEC staff members;

• how OCA consults with standard-setting bodies and other large accounting

firms, including how OCA ensures that information presented in these

consultations is unbiased and how the results of consultations are used in

resolving issues;

• the SEC’s approval processes for determining whether registrant

restatements are necessary;

• how OCA coordinates with DCF, including how OCA and DCF minimize

duplication of information requested from the registrants and auditors;

and

• OCA’s final position on accounting issues.

The representatives we spoke with also stated that registrants and

auditors who have only occasional dealings with OCA would especially

benefit from additional transparency regarding SEC’s procedures for

deciding on registrant-specific accounting issues. The representatives said

Transparency of OCA

Policies and Basis for

Decisions
Page 13 GAO-01-718 Securities and Exchange Commission

that large corporations and their auditors who are involved in frequent

SEC registration filings have over time established effective working

relationships with SEC staff and can often obtain information on SEC

procedures through their frequent dealings with the SEC. The

representatives also said that other registrants and auditors who have not

developed ongoing working relationships with the SEC have greater

difficulties working through the process, and additional information about

OCA’s process would be beneficial.

Also, many registrants said they believe that because they do not

understand OCA’s process, they must rely too heavily on their external

auditors, even though the application of accounting methods is ultimately

the registrants’ responsibility. There is the perception that only the major

accounting firms are aware of OCA’s process and that it is almost

mandatory to have these accounting firms lead the effort for them. While

registrants would want to consult with and have the support of external

auditors, registrants said that if they better understood OCA’s processes,

they might be able to take the lead in the process without having to rely so

heavily on their external auditors. In addition, many of the representatives

from the AICPA, who have considerable experience in dealing with OCA,

expressed uncertainty about OCA’s process and said they saw a need for

additional information.

Representatives said that they are reluctant to appeal OCA’s staff

decisions to the Chief Accountant, Deputy Chief Accountant, or the

Commission for three reasons. First, registrants have the impression that

the SEC staff’s supervisors have reviewed the matters prior to

communicating with registrants and their auditors, and are in support of

the staff’s positions. Second, registrants have the perception that, in the

appeal process, the SEC may open other accounting issues. Finally, the

appeal process also adds to the registrants’ time and cost. Representatives

estimated that it can cost from $25,000 to $100,000 for legal and

accounting fees to bring an issue to OCA, and appeals would add to this

cost. Representatives told us that only a few decisions have been appealed

and that the SEC’s initial decisions were not changed through the appeal

process.

OCA representatives referred to OCA’s written procedures for internal

processing in response to the concerns of registrants and their auditors.

OCA officials stated that they would consider making public some

information regarding their internal procedures for handling registrants’

matters, as well as explanations of the key steps and communications that

The SEC’s Response
Page 14 GAO-01-718 Securities and Exchange Commission

should occur between the SEC and the registrants throughout the process.

At the same time, SEC officials also stated that certain information relating

to the staff’s internal policies requested by the registrants and their

auditors would not be provided.

OCA officials provided the following responses to the specific issues

raised by the representatives of the registrants and the accounting

profession whom we spoke with in preparing this report.

• OCA officials stated it would be difficult to provide registrants with an

estimate of how long it will take to review and rule on issues because this

process is not completely within the SEC’s control. The SEC staff often

will request additional information from the registrant after receiving an

initial written submission. However, registrants do not always respond to

these requests for additional information promptly or the registrants’

circumstances may change, thereby changing the scope of the issues.

Because the SEC’s process depends to a certain extent on the nature and

timing of responses from the registrants, SEC officials stated that they

would be unable to provide definitive time estimates for handling written

submissions. The SEC did, however, state that often a sense of urgency or

a specific deadline exists with regard to resolving an accounting issue, due

to a pending transaction. In those cases, SEC officials said the SEC staff

and the registrants work very closely and interactively to resolve the issue

based on the timing needs of the registrants.

• Accounting issues are assigned to OCA professional staff members who

work in teams in specialized areas. Under OCA procedures, assigned OCA

staff generally calls the registrant within 3 days of receiving the issue with

follow-up questions or to schedule a conference call involving the

registrant and its auditors. Through this communication, the registrant

also becomes aware of the specific SEC staff members assigned to its

case, and OCA is able to determine whether the registrant has certain

timing needs for resolving the issue. Also, the SEC provides a list of staff

names by specialized work area at the annual conference sponsored by the

AICPA SEC Regulations Committee.

• In researching a specific accounting issue, OCA staff members sometimes

consult with standard-setting bodies and the other accounting firms. OCA

staff members may prepare a “white paper” detailing the facts of the case.

The paper generally summarizes the issue and basic facts that are specific

to the registrant and poses the one, key accounting question relevant to

the case. The paper does not identify the registrant. An OCA official

responded that the registrants and their auditors might be concerned that

the facts presented to the standard-setting bodies may be biased by the

staff members. However, OCA representatives emphasized that it is the
Page 15 GAO-01-718 Securities and Exchange Commission

responsibility of the Chief Accountant and a Deputy Chief Accountant to

ensure that the issues and facts are fairly presented and that OCA does not

advocate a certain position.

• The SEC’s internal procedures require that the Chief Accountant be

notified if a registrant will be required to restate its financial statements. In

such situations, the SEC staff must first obtain the approval of a Deputy

Chief Accountant and then must discuss the case with the Chief

Accountant before notifying the registrant of its decision. The Chief

Accountant may overturn the decision of the SEC staff if he becomes

convinced that it is the best course of action.

• In reviewing registrants’ filings, DCF sometimes requests assistance or

consultation services from OCA to resolve difficult accounting issues.

Some of DCF’s inquiries of OCA are oral and, if the questions are easily

resolved, do not involve further interaction with the registrant. According

to SEC officials, in cases in which additional information is needed from

the registrant, both the DCF staff member reviewing the filing and an OCA

staff member are present when the registrant is called for additional

information. This internal procedure helps to ensure continuity and

prevents or minimizes any duplication of information requests between

DCF and OCA. Depending on the issues, OCA staff may also have further

follow-up questions on previously submitted information from the

registrant if it was unclear.

• After OCA staff members complete their review, OCA provides an oral

response to the registrant along with an explanation of the basis for OCA’s

position and then documents its decision in a memorandum for its files.

The SEC asks the registrant to provide a letter documenting the

registrant’s understanding of OCA’s position. This procedure is set forth in

the SEC’s protocols and is intended to ensure that the registrant clearly

understands OCA’s position and the basis for its decisions. However,

registrants do not always respond to OCA’s request, especially when they

disagree with SEC decisions. Although the SEC does not provide written

responses to registrants’ issues, it issues its staff accounting bulletins as a

way to communicate broad issues to the registrant community.

Representatives of the registrants and the accounting profession

expressed concerns that the SEC is using a variety of sources in addition

to the authoritative standards and interpretations issued by the private

sector standard-setting bodies as criteria for making decisions on

accounting issues. Representatives expressed concern about the variety of

SEC interpretive guidance, which they believe is being used by the SEC in

its decisions on accounting issues. Many of the representatives we spoke

with stated that it is becoming increasingly difficult to keep track of the

Sources Used by the SEC

to Make Decisions on

Accounting Issues
Page 16 GAO-01-718 Securities and Exchange Commission

variety of guidance being issued and used by the SEC, especially for the

smaller accounting firms with limited resources. The representatives we

spoke with cited the following guidance being used by the SEC as criteria:

• SEC Financial Reporting Releases;

• SEC Accounting and Auditing Enforcement Releases;

• SEC Staff Accounting Bulletins;

• SEC Frequently Asked Questions (FAQ) documents;

• SEC announcements at EITF meetings (such SEC announcements become

part of public record, and some believe that this is setting new rules

through the announcement process);

• DCF Outline of Current Issues and Rulemaking Projects, which contain

pending rulemaking, recent rule adoptions, current disclosure issues on

mergers and acquisitions, significant no-action and interpretive letters, and

accounting issues;

• speeches by SEC staff members and commissioners;

• letters to the AICPA, EITF, and others to express SEC staff positions,

including interpretations of other SEC formal interpretive guidance;

• highlights of joint meetings of SEC staff and AICPA SEC Regulations

Committee and International Practices Task Force; and

• comment letters—for example, SEC staff positions are sometimes

identified only as comments arise, and the SEC staff position is applied for

the first time in a registrant review environment.

Registrants told us that rulemaking is coming from various places—the

SEC, FASB, and EITF. The registrants want to know what is expected for

fair presentation and disclosure so that they can comply. However, they

said that the criteria being used by SEC are sometimes unclear, even to

their auditors. The members of the accounting profession we spoke with

said that they assist their clients in determining what is acceptable

reporting under GAAP, but they too are often uncertain as to what the

SEC’s position will be in the matter. Consequently, they often bring such

issues to the SEC, not for the purpose of inquiring what is acceptable

under GAAP, but for the purpose of determining whether their application

of the accounting standards will be acceptable to the SEC.

Representatives of the registrants and the accounting profession express

concerns that the SEC staff is using sources other than standards and

guidance that have been through due process for determining what is

acceptable financial reporting. They believe that the SEC staff defines

acceptable accounting and reporting requirements through its interpretive

guidance, without going through a formal due process under rulemaking.

Due process provides a public forum for affected parties to comment on
Page 17 GAO-01-718 Securities and Exchange Commission

the impact of new standards or rules on particular industries and

businesses. Registrants and external auditor representatives expressed

concern that this process has resulted in the SEC staff setting GAAP as

criteria for determining what is acceptable accounting and financial

reporting for purposes of registrants’ filings. As stated in the background

section of this report, the SEC has specific authority to establish rules

governing the financial reports of public companies and to ensure fair

financial reporting.

OCA officials provided the following responses to the specific issues

raised by the representatives of the registrants and the accounting

profession whom we spoke with in preparing this report.

OCA officials acknowledged that, in its review of accounting and

disclosure issues, the SEC staff uses a variety of sources, including SEC

Financial Reporting Releases, SEC Accounting and Auditing Enforcement

Releases, SEC Regulation S-X, Staff Accounting Bulletins, answers to

FAQs, speeches, and letters. As stated in the AICPA’s Statement on

Auditing Standards, No. 69, The Meaning of “Present Fairly in Conformity

with Generally Accepted Accounting Principles in the Independent

Auditor’s Report”, the SEC’s rules and interpretive releases have an

authority similar to pronouncements of FASB for SEC registrants. SEC

rules, communicated through issuance of SEC Financial Reporting

Releases, are approved through the Commission. Staff Accounting

Bulletins, answers to FAQs, speeches, and letters are staff positions that

act as interpretations of existing GAAP. Most registrants and their auditors

have found them to be useful sources in their filings to the SEC.

OCA officials stated that SEC has made these materials readily available.

Commercial publishers, such as Commerce Clearing House, Inc., publish a

loose-leaf document covering federal securities laws that contain the

Codification of Financial Reporting and Policies, Regulation S-X, and the

Staff Accounting Bulletins. The SEC’s rules and releases are included in

the Code of Federal Regulations by topic index and are published weekly

in the SEC Docket. In addition, the Staff Accounting Bulletins, answers to

FAQs, speeches, and letters are posted on the SEC’s Web site. The SEC

officials also stated that the SEC began posting speeches and letters on its

Web site after members of the accounting profession requested that they

be published to aid the registrants and their auditors in understanding the

SEC’s positions for administering SEC disclosure requirements.

The SEC’s Response
Page 18 GAO-01-718 Securities and Exchange Commission

With regard to the concern from the registrants that the SEC is using

interpretive guidance, such as Staff Accounting Bulletins, to set GAAP

without due process, the SEC officials stated that Staff Accounting

Bulletins are interpretive guidance and do not represent new GAAP. SEC

staff, through speeches, describes new fact patterns appearing in industry

and provides guidance for handling these new types of cases under

existing GAAP. Also, the SEC published answers to FAQs as a guide to

registrants and their auditors in submitting filings to the SEC. The Staff

Accounting Bulletins and speeches can be tied back to existing accounting

literature and are meant to be communicated to everyone. If an issue is

unclear, OCA will send the issue to EITF for resolution. The SEC officials

believe that, since the interpretive guidance is not new GAAP, it is not

subject to due process.

The Panel on Audit Effectiveness6

 reported that the relationships between

the SEC and the accounting profession are stressed. The strained

relationships were described in The Panel on Audit Effectiveness Report

and Recommendations, August 31, 2000, as follows:

“While one would expect occasional tensions, the current relationship between the

profession and the SEC seems under unusual stress. The Panel views this situation as

counterproductive to continued improvement in financial reporting, which is a shared goal

of both the profession and the SEC. The Panel believes that this important relationship

must be restored to its historic level of candor, trust, and respect.”

Many of the comments we heard from the registrants’ representatives,

representatives from the accounting profession, and SEC officials over the

course of our work are consistent with the conclusions of the Panel on

Audit Effectiveness regarding the stressed relationships between the

registrants, their auditors, and the SEC. In fact, representatives from the

accounting profession and registrants stated that they believe that

tensions between registrants, the accounting profession, and the SEC have

been higher during the past few years than during any recent period.

An OCA official stated that the relationship between the industry and the

SEC has ebbed and flowed throughout the years depending on economic

 6

The Panel on Audit Effectiveness was formed at the request of the SEC to

comprehensively review the conduct of the audits and the governance of the profession.

The Public Oversight Board appointed an eight-member panel of leaders from the

accounting profession.

Current Relations

Between the SEC and

the Accounting

Profession and

Registrants
Page 19 GAO-01-718 Securities and Exchange Commission

and business events and the related issues with the Commission. He stated

that tension should exist between the SEC and the companies it regulates,

but it is a “constructive tension,” which has evolved and has made the U.S.

markets work well. He also stated that FEI has been conducting a study on

the quality of financial reporting. In this study, there have been a large

number of restatements in recent years, some were a result of the SEC’s

actions, but most were from registrants, and auditors’ actions. He stated

that the impact of financial reporting is greater today than ever before.

An effective working relationship between the registrants, the accounting

profession, and the SEC is important for ensuring that investors are

protected and that the integrity of the securities market is maintained. This

working relationship would benefit from increased transparency of OCA

procedures in resolving accounting matters, especially for those

registrants and auditors who have infrequent dealings with OCA. Due to

the common concerns expressed by representatives of registrants and the

accounting profession and SEC’s recognition that additional information

would be beneficial, we recommend that the Chairman of the SEC direct

the Chief Accountant to implement procedures to improve the availability

of information to registrants regarding OCA’s process for deciding on

accounting issues. Such procedures would include expanding the

protocols or issuing additional public information to explain the SEC’s

current policies and procedures for handling registrant’s matters,

including

• general communications to registrants and auditors about the status of the

reviews,

• assignment of accounting issues to SEC staff members,

• how the SEC conducts its consultations with other accounting firms and

FASB, and how the results of such consultations are considered in its

decisions,

• the SEC’s approval process for determining when registrant restatements

are necessary,

• coordination between DCF and OCA, and

• when decisions are considered to be final.

We found differences in views between SEC officials and representatives

of the registrants and accounting profession regarding the accessibility of

the variety of SEC rules and interpretive guidance, and methods of

communicating OCA’s positions on accounting issues. Therefore, we

recommend that the Chairman of the SEC direct the Chief Accountant to

Conclusions and

Recommendations
Page 20 GAO-01-718 Securities and Exchange Commission

• meet with representatives from the accounting profession and registrants

to determine how best to disseminate information on rules and

interpretive guidance and

• meet with representatives from the accounting profession and registrants

to determine how the SEC could provide additional written information on

the reasons for its decisions, especially when they involve complex and

unusual accounting issues.

We requested comments from the SEC, the AICPA, and FEI. We received

written comments from SEC’s Chief Accountant on behalf of the SEC’s

OCA, and the Chair of the AICPA SEC Practice Section on behalf of the

AICPA’s SEC Practice Section and the AICPA’s SEC Regulations

Committee. FEI advised us that they did not have official comments on

this report. The SEC’s and the AICPA’s written comments are discussed

below and reprinted in appendixes I and II, respectively. We also received

technical comments from both the SEC and the AICPA that we

incorporated throughout this report as appropriate.

The SEC’s Chief Accountant, commenting on behalf of the SEC’s OCA

expressed appreciation for the constructive nature of our

recommendations and stated that actions are being planned by the SEC to

implement our recommendations. Regarding our recommendation to

improve the availability of information to registrants about the OCA’s

processes for decisions on accounting issues, OCA plans to publish its

internal procedures, with minor modifications. In addition, the OCA plans

to publish an article, which will describe how accounting issues typically

flow through the SEC’s OCA. Regarding our recommendations that OCA

meet with representatives of the registrants and accounting profession to

determine (1) how best to disseminate information on rules and

interpretive guidance and (2) how the SEC could provide additional

written information on the reasons for its decisions, the SEC agreed that

discussions would be helpful and appropriate. OCA anticipates either

adding these issues to the periodic meetings with the AICPA’s SEC

Regulations Committee and other appropriate committees, or convening a

special meeting to discuss these two issues.

The SEC’s OCA also provided additional details on planned modifications

to its internal procedures for decisions on accounting matters, and its

outreach programs that inform the public of OCA’s decisions and positions

on accounting issues. In its comments, the SEC’s OCA also provided

information on the size of OCA’s staff and the scope of its workload. These

Agency Comments

and Our Evaluation

SEC Comments
Page 21 GAO-01-718 Securities and Exchange Commission

additional details can be found in OCA’s written comments, which have

been reprinted in appendix I.

In its written comments, the AICPA noted the critical role SEC plays to

individual investors who place their trust in the capital markets. The

AICPA also recognized that the SEC staff executes its critical mission

under difficult and challenging circumstances, including pressures that

result from market timing and limited resources. The AICPA stated that if

our recommendations were properly implemented, they could provide an

opportunity to promote improved transparency of the SEC processes and

communications among registrants, the accounting profession, and the

SEC. Related to our recommendations, the AICPA provided additional

suggestions for specific discussion topics regarding the SEC’s

communications with registrants about its procedures and its process. The

AICPA’s suggestions deal with the following areas:

• the SEC’s “white papers” used in its consultation process;

• timing of SEC responses;

• the SEC’s referrals of matters to the standard-setting bodies;

• the SEC’s approving official for restatements; and

• codification of SEC staff positions.

We believe that discussions between the SEC and the accounting

profession on the above issues would be constructive as part of the

meetings between the SEC, registrants, and the accounting profession.

Additional details can be found in AICPA’s written comments, which have

been reprinted in appendix II.

We are also sending copies of this report to the Acting Chairman of the

Securities and Exchange Commission, the Director of the American

Institute of Certified Public Accountants’ Professional Standards and

Services, and the President and Chief Executive Officer of Financial

Executives International.

Comments From the

AICPA SEC Practice

Section and the AICPA

SEC Regulations

Committee
Page 22 GAO-01-718 Securities and Exchange Commission

If you have any questions, please call me at (202) 512-2600 or Jeanette

Franzel, Acting Director, at (202) 512-9471 or contact her via e-mail at

franzelj@gao.gov. Key contributors to this report were Darryl Chang,

Charles Ego, Peggy Smith, and Meg Mills.

Sincerely yours,

Jeffrey C. Steinhoff

Managing Director

Financial Management and Assurance
Appendix I: Comments From the Securities

and Exchange Commission

Page 23 GAO-01-718 Securities and Exchange Commission

Appendix I: Comments From the Securities

and Exchange Commission
Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

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Appendix I: Comments From the Securities

and Exchange Commission

Page 35 GAO-01-718 Securities and Exchange Commission
Appendix II: Comments From the American

Institute of Certified Public Accountants

Page 36 GAO-01-718 Securities and Exchange Commission

Appendix II: Comments From the American

Institute of Certified Public Accountants
Appendix II: Comments From the American

Institute of Certified Public Accountants

Page 37 GAO-01-718 Securities and Exchange Commission
Appendix II: Comments From the American

Institute of Certified Public Accountants

Page 38 GAO-01-718 Securities and Exchange Commission (917630)
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