The Securities and Exchange Commission’s advisory Committee on Improvements to Financial Reporting (CIFR) voted unanimously on Friday to move forward with its proposal to require a new “executive summary” in annual and quarterly reports filed with the SEC.
As proposed, the executive summary would be a plain-English description of a reporting company’s business, financial condition, and operations. It would take a “layered approach” that stresses the most important information but then cross-references the location of fuller discussions elsewhere in a 10-Q or 10-K.
The proposed form of the summary, which was described at the committee meeting as “a roadmap for investors to understand a company’s business,” will, however, undergo several revisions. They include the removal of a number of required disclosure items and clarification of the executive summary’s relationship to the management discussion & analysis section of financial reports.
While the proposal considered on Friday would require companies to provide a digest of GAAP, non-GAAP, and nonfinancial key-performance indicators as well as a summary of business outlook, it is likely that the final proposal will be less prescriptive. “There may be too much detail on what should and what shouldn’t be included,” said G. Edward McClammy, CFO of Varian Inc. “Leave it up to the SEC.”
Several committee members questioned the usefulness of such an additional financial-reporting requirement and discussed the possibility that it would be redundant with parts of the MD&A. “I don’t have a lot of enthusiasm about this,” said J. Michael Cook, former chairman and chief executive of Deloitte & Touche. “Where did this come from? Who really thinks we need this?”
But Greg Jonas, managing director of Moody’s Investors Service, said the executive summary would resemble “an elevator speech” — a quick overview — and “could be an outstanding idea if done well.”
In particular, committee members expressed concerns that the summary would just add boilerplate language. “I am concerned that the average company won’t have the resources to do this in such a well-stated fashion,” said Dennis Beresford, executive professor of accounting at the University of Georgia, referring to a sample summary provided by Microsoft Corp. “The lawyers will get [hold] of it, and it will become very problematic.”
In other action, the committee unanimously approved the first part of its recommendations to curb the complexity of financial information at a meeting.
The first section deals with “substantive complexity” in financial statements and discusses how to better recognize the estimation and assumptions that go into documents that appear to be very precise and systematic.
The group said that some of the most critical areas of complexity in U.S. GAAP can be improved upon; among them are the “mixed-attribute model,” which blends fair-value and historical-cost accounting; the lack of a “holistic” approach to disclosures; the use of certain bright lines; and exceptions to certain principles.
However, Robert Pozen, the group’s chairman, resisted discussion of the minutiae of answers to the currently contentious question over how far fair-value financial reporting, which values assets at the market for them at the present time, should go. “It’s not possible for our group to resolve the whole debate over fair value and historical cost,” Pozen, chairman of MFS Investment Management, said. (Historical-cost accounting is based on the original monetary values of a company’s assets and liability.)
Among the committee’s suggestions is a plan to strengthen the “infrastructure” that supports the use of fair value before making such financial reporting more widespread. That would include better education and training for preparers and auditors on valuation methods.
The committee also suggested that the SEC and the Financial Accounting Standards Board work together to rescind duplicate disclosure requirements. It also recommend that the use of bright lines be removed from financial statements where possible.
Further, the CIFR suggested that exceptions to GAAP should be based on specific business activities and not be granted to entire industries. Currently such industries as insurance, oil and gas, cable television, and casinos operate under versions of GAAP tailored to them. The CIFR contended that this increases complexity because it makes it hard to compare different types of companies and because many companies are so diverse that it’s impossible for them to fit neatly into a single industry category.