Securities and Exchange Commission: Reviews of Accounting Matters
Related to Public Filings (14-JUN-01, GAO-01-718).
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. Companies
are required by law to register their securities with SEC by
filing a registration statement. This state must contain
financial and other information about 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. Examples of the type of
accounting issues frequently reviewed include business mergers
and issues surrounding revenue recognition and financial
instruments. Representatives of registrants and the accounting
profession have conveyed both positive and negative experiences
regarding 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.
-------------------------Indexing Terms-------------------------
REPORTNUM: GAO-01-718
ACCNO: A01199
TITLE: Securities and Exchange Commission: Reviews of Accounting
Matters Related to Public Filings
DATE: 06/14/2001
SUBJECT: Securities regulation
Reporting requirements
Accounting standards
Accounting procedures
Decision making
Information disclosure
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GAO-01-718
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- X 2 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 3
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 4 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 Effectiveness 6 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
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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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