On May 14, 2008, the SEC voted to propose its long-awaited XBRL rule, requiring companies to provide the information contained in financial statements, notes and accompanying schedules in a format amenable to interactive search and analysis. The XBRL data tag information would be presented in an exhibit to the filing, leaving the disclosure and formatting standards currently in use for all other sections of filed reports available as they are today. For liability purposes, the new exhibit would be considered to be “furnished” instead of “filed” with the Commission.
The proposed rule is undeniably a centerpiece of Chair Cox's tenure at the SEC. But despite all the attention and promotion lavished upon it, the milestone rule proposal comes five years after the commencement of the voluntary XBRL filers project, and has at least three more years to go to full implementation. And, the vision of a better future with XBRL is still foggy: despite slick demos of the types of analyses one can undertake with XBRL-formatted data, it is tough to see how much more can be done than what has already been made available with tools provided by third-party data providers.
Garbage In, Garbage Out
Well, maybe that's unfair, but I couldn't think of a better subtitle. What is true, however, is that the SEC has failed to recognize, or at least acknowledge, that they can influence XBRL's cost-benefit equation not just by how information is formatted in electronic filings, but how having XBRL should change what information is provided by filers. Here are just two examples from recent history where the SEC can do much to help investors at very little cost, and for which XBRL is an ideal application. In my humble opinion, the added information itself is worth much more to investors than mere improvements in data formatting:
Reconciling information for long-lived assets — The SEC used to require schedules of fixed assets by categories that contained information about the events that changed their carrying amounts. But, during the Reagan era, when the costs of compliance with disclosure requirements (especially by smaller companies) were seen to be holding back the growth of the economy, these schedules were eliminated on the dubious grounds that they were not used by investors. In contrast, IFRS has long required a reconciliation of beginning and ending carrying amounts for each class of PP&E and intangible, showing at minimum the following: additions, disposals, effects of business combinations, revaluations, depreciation, effect of foreign exchange on translation (IAS 16 and IAS 38).
Whatever you want to say about IFRS, this disclosure requirement is real sunlight. If the FASB and SEC truly cared about investor protection and having capital markets that set the standard for the rest of the world, they should feel shame that these basic disclosures do not exist in our rules and regulations. As proof of that point, it's a safe bet that if these disclosure had been required of U.S. companies, WorldCom might not have happened! (See my earlier post on the blown WorldCom audit for further explanation.)
Unhide the hidden reserves — A second example can be found in the SEC's abandoned proposal to require specific reconciliations of numerous "valuation and qualifying accounts" that are only vaguely specified in Rule 12-09 of Regulation S-X, and therefore, widely ignored. The proposal was added at the end of Arthur Levitt's tenure as chairman, and was a logical extension of his battle against earnings management. The proposed list of reconciliations are so basic and reasonable, that they bear repeating here:
- Allowance fo doubtful accounts and notes receivable
- Allowance for sales returns, discounts, and contractual allowances
- Unamortized premium or discount
- Excess of estimated costs over revenues on loss contracts
- Inventory valuation allowance
- Valuation allowance for deferred tax assets
- Liabilities for exist and employee terination costs
- Liabilities for costs of discontinued oeprations
- Liabilities for environmental remediation costs
- Contingent income and franchise tax liabilities recorded pursuant to FAS 5
- Product warranty liabilities
- Probable losses from pending litigation
I would love to have Chair Cox explain why this important and basic proposal has fallen through the cracks during his term and the terms of the other Bush appointees.
Now that we are going to eventaully have XBRL, it is going to be even more difficult to argue that investors will not benefit significantly from these detailed disclosures – not just by having more and better information to analyze, but to have disclosures that can deter fraud. Sunlight is free; auditors are not.
I have already given you my most important thoughts regarding XBRL, but I also think that the current plan for phase-in will take way too long. Large Accelerated Filers (approximately 500 companies) are to provide the required exhibits beginning with the fiscal periods ending on or after December 15, 2008. Accelerated Filers, constituting the significant majority of SEC registrants, would begin complying one year later, and all remaining filers in the third year.
For each phase-in group, there would be a one-time, 30-day grace period for late filing of the first required exhibit containing the interactive data. Notes and schedules accompanying the financial statements during the first year may be “block tagged”, meaning that each financial statement footnote or schedule would be tagged individually as a block of text. Beginning with their second year of compliance, filers would be required to tag the detailed disclosures within the footnotes and schedules; a second 30-day grace period would apply to the first filing in which full tagging of notes and schedules is required.
My recommendations — Shorten the phase-in period to two years. Require all accelerated filers to comply in the first year, and don't allow them to block tag. Everyone else should come in during the seocnd year. If that's seen as too strenous, I would not mind lengthening the proposed grace periods to 60 days, and allowing "smaller public companies" to block tag in their first year.
As exciting as the prospect of interactive data covering all public companies may be to investors, it sure seems as if the SEC is largely going it alone on this project. So, perhaps the slow progress is not just the SEC's fault, but for the sake of investors, they need to crack a whip, not a wet noodle. Only 75 companies agreed to participate in the pilot program even after the SEC offered volunteer companies expedited reviews of public offerings in exchange for joining the pilot group. Auditors have also been unusually quiet as well. As Jack Cieselski pointed out (as reported in CFO.com), "auditing firms should be leading the parade on the subject of providing assurance on the quality of XBRL preparation." Instead, their unison cheerleading has been aimed at two bigger prizes: the big pile of money that will be theirs should they motivate the SEC to shove investors off a cliff by adopting IFRS, and the mother lode of liability reform to shield them when the next accounting scandal tsunami inevitably crashes onto the beach.