Peeling away financial reporting issues one layer at a time

If You Think GAAP is Opague, Try SEC Staff Interpretations!


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SEC reporting? 
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The securities laws give the SEC broad power to create regulations to implement the pertinent statutes.  The political appointees of the Commission, in turn, allow their staff to publish "interpretations" of the regulations.  These have accumulated to a mountain of technical detail dispersed over obscure documents that only an expert can hope to find, much less divine the need for. 

One wonders whether the system (such as it is) exists to protect investors, or to secure employment for Commission staff after they leave the SEC?  Companies who must comply with the SEC’s disclosure rules pay a premium to SEC alumni who came to know the arcana first hand; and have street cred with the SEC staff by dint of their own contributions to the mountain when they themselves were SEC staff members.

A Recent Example to Illustrate the Point

By way of background:

  • SFAS 159 permits a company to account for financial assets at fair value, including investments that otherwise would be accounted for under the equity method (per APB 18).
  • Regulation S-X (the principle SEC regulation governing the form and content of financial statements in reports to the SEC), Rule 3-09 requires a company to provide separate financial statements of individual investees accounted for under the equity method, if the investee meets any one of the three quantitative tests of significance set forth in Rule 1-02(w) at the 20% level.
  • Rule 4-08(g) requires supplementary disclosures regarding the assets, liabilities (i.e., a highly condensed balance sheet), revenues and expenses (i.e., a highly condensed income statement) of all such investments in the aggregate if the Rule 1-02(w) significance test is met at the 10% level. 
  • APB 18 has similar disclosure requirements as Rule 4-08(g), but it lacks a specific significance test.  Moreover, the free election of SFAS 159 would obviate the APB disclosure requirements, since the investment would no longer be within the scope of APB 18.   

The two questions recently addressed by the SEC staff were: (1) whether the Reg. S-X disclosure rules still apply for investments elected to be accounted for at fair value under SFAS 159 that would otherwise be accounted for using the equity method; and (2) how significance should be determined (i.e., how Rule 1-02(w) should be applied) when the fair value option is elected. 

The staff’s answer to the first question is “yes.” If an investment is eligible to be accounted for under the equity method as set forth in APB 18, then Rules 3-09 and 4-08(g) apply by "analogy."  In other words the rule clearly states that the disclosure rules don’t apply to investments measured at fair value, but the staff is telling you to apply them anyway.  The Staff’s position on significance is that the ‘income test’ (one of three tests of significance) should be based on the change in the fair value reflected in the investor’s income statement—instead of the investor’s equity in the earnings of the investee as if the equity method had been applied. Again, the rule, as written, doesn’t give you a clue as to what you’re supposed to do–just do what the staff is telling you to do.

These SEC discloure rules, as written, were good rules, because they balanced abusive off-balance sheet accounting practices afforded by APB 18 (you can view my post on the equity method of accounting here).  Also, the questions the staff adressed are important, given recent developments in GAAP.  But, my point is this: if a disclosure rule should be updated, why doesn’t the SEC simply vote to modify the rule for all to know and plainly see? In fact, the only place you will find the Staff’s position is in an obscure AICPA publicationyou can’t even find it on the SEC’s website

Coincidentally, a recent GAO report to be released tomorrow — you can read what Gretchen Morgenson has to say about it here — has found significant problems with the SEC’s antiquated methods of policing insider trading violations.  I find it ironic that the SEC’s approach to updating many of its own rules also benefits a class of ‘insiders’ — current and future SEC alumni.   


Would you like your staff to learn more about
SEC reporting? 
Click here for a sample in-house training agenda!


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