Securities and Exchange Commission: Reviews of Accounting Matters Related to Public Filings
Published: 2001-06-14T00:00:00

Fast Facts:

Highlights:
section_title: Why GAO Did This Study
paragraphs: This report reviews the Securities and Exchange Commission's (SEC) resolution of accounting issues submitted by companies that have or are contemplating publicly traded securities.
section_title: What GAO Found
paragraphs: Companies are required by law to register their securities with SEC by filing a registration statement. This statement must contain financial and other information on the securities and the issuer. SEC's Office of the Chief Accountant (OCA) is responsible for providing guidance to companies to ensure that they comply with the reporting requirements of the law. Generally, registrants submit issues to OCA for which there is no authoritative guidance. These issues tend to involve unusual, complex, or innovative transactions. Some of the accounting issues frequently reviewed include business mergers and issues surrounding revenue recognition and financial instruments. Representatives of registrants and the accounting profession have had both positive and negative experiences with SEC's handling of accounting issues. Several representatives expressed concerns over the transparency of SEC's decision making process and SEC's use of accounting sources outside of generally accepted accounting procedures.

section_title: Letter
paragraphs: 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.
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.
subsections: section_title: Background
paragraphs: 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 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 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 Regulation S-X 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’s 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 consensus 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.
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.
section_title: Scope and Methodology
paragraphs: 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.
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.
section_title: Accounting-Related Inquires to OCA
paragraphs: 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 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).
section_title: OCA’s Procedures and Controls for Reviewing Accounting Matters
paragraphs: 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:   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.
subsections: section_title: Key Steps From the SEC’s Published Protocols
paragraphs: 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   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.
section_title: Key Steps From the SEC’s Internal Procedures Document
paragraphs: 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.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.
section_title: Views of Registrants, Their Auditors, and the SEC
paragraphs: 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.
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.
subsections: section_title: Transparency of OCA Policies and Basis for Decisions
paragraphs: 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 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.
section_title: The SEC’s Response
paragraphs: 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 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 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.
section_title: Sources Used by the SEC to Make Decisions on Accounting Issues
paragraphs: 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 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 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.
section_title: The SEC’s Response
paragraphs: 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.
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.
section_title: Current Relations Between the SEC and the Accounting Profession and Registrants
paragraphs: “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 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.
section_title: Conclusions and Recommendations
paragraphs: 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   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   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.
section_title: Agency Comments and Our Evaluation
paragraphs: 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.
subsections: section_title: SEC Comments
paragraphs: 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 additional details can be found in OCA’s written comments, which have been reprinted in appendix I.
section_title: Comments From the AICPA SEC Practice Section and the AICPA SEC Regulations Committee
paragraphs: 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.
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.
section_title: Appendix I: Comments From the Securities and Exchange Commission
section_title: Appendix II: Comments From the American Institute of Certified Public Accountants
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