STIRRING THE REGULATORY POT: FRANK VIEWS FROM A FASB HAND

Larry Smith, who has been working in the Norwalk, Conn., offices of the Financial Accounting Standards Board since 2002, has a reputation for technical expertise—and for not being shy about saying what’s on his mind.

Plain-spoken directness, combined often with humor and sometimes tinges of civil resignation when he’s on a losing side in a vote, color his comments around the big FASB meeting room table. He has sat there as a board member since 2007.

In a recent noteworthy speech, Smith, a former long-time auditor at KPMG, was even more candid, departing from his usual, more constrained speech-making style, as he acknowledged to me. He called the last 15 minutes of his Sept. 21 speech “final reflections” as his FASB gig winds down.

Smith drew on his time spent at the board, including as a technical staff director, and offered in the nine months-plus remaining “until they kick me out of my office in Norwalk,” some frank views and advice for people who care about the future of financial reporting.

Key Takeaways.

A key message Smith sent in his speech is that although FASB has completed some landmark standard-setting that promises improvements in financial reporting (not the least of which is the fact that accounting rules used globally “are closer than they used to be,” he said), the board of the future faces some significant challenges that require work with other regulators and rulemakers.

“And some of those challenges cannot be solved by FASB on its own, for they relate to challenges created in how financial information is being reported,” he said.

Along those lines, he nominated the use of non-GAAP measures as a topic that should be addressed jointly by accounting rulemakers and regulators such as the Securities and Exchange Commission. This year the SEC has targeted the improper use of non-GAAP measures in earnings and other releases for a crackdown, including by the commission’s enforcement staff.

‘Anti-GAAP’ and Boards, Agencies Working in Concert.

Here are some of the high points of Smith’s words at the recent banking conference of the American Institute of CPAs, in Washington:

“The length of financial reports in the U.S. is out of control,” a situation marked notably by a large volume of footnote disclosures;

  • Ignoring the increased “professionalization and specialization of investors” poses “greater challenges to the FASB” in terms of the types and focus “of standards it should be issuing in the future”;

  • On financial reporting that departs from generally accepted accounting principles, a concern beyond that – the use of what he and others call “anti-GAAP measures,” or “measures different from GAAP because the issuer disagrees with the GAAP measure”—“is a concern that needs to be addressed”; and

  • A suggestion that “the auditor could issue a simple report” on the information that investors are actually usingthat is, to apply internal controls to “the amounts, etc. appearing in the package of information provided to investors before the financial statements are filed.”

     

    One, Semi-Annual Interim Report?

On the last modest proposal above, Smith acknowledged that the bankers and others in his audience wouldn’t relish prospects of such a change. He went on to suggest what the SEC could do to alter the schedule for filing required reports:

“And let’s think out of the box a little more—and this one some of you actually may like if we find that the regulatory filings are really just of confirmatory value, perhaps the SEC can consider loosening the timing of the required filings to take some of the pressure off the system, or go even further and just require one, semi-annual interim report.”

Smith noted that such changes would raise other questions. Those include, he told bankers and bank auditors:

 

  • “Will ‘standards’ be necessary to address whether there should be required minimum information that is included in those investor packages?”

  • “If yes, what should that information be?”

  • “Are all non-GAAP measures that meet current SEC rules acceptable, or are more stringent rules required?” 

 Non-GAAP:  FASB Should Look at ‘Big Picture.’

“The proliferation of non-GAAP disclosures should cause the FASB to step back and look at the big picture to see what, if anything, can be done to address the fundamental cause of their use,” said Smith, the former chairman of FASB’s Emerging Issues Task Force. “I have not always been of that view.”

He noted that members of the FASB’s main advisory council have told the board “not to worry, that the use of non-GAAP disclosures was not a reflection of shortcomings or failures in GAAP. After all, we live in a country where freedom of speech is fundamental.

“My concern is that there are ‘non-GAAP measures’ being reported that, on their surface, appear to be comparable measures, when in fact there are differences in their composition which in turn makes comparisons difficult,” Smith added.

Caution against Saying ‘Heck with GAAP.’

He then described the “anti-GAAP” situation, providing examples of how companies currently don’t apply or might simply not apply the accounting principles because the outcomes run counter to what they’d like to see presented in a best-light report of earnings.

Smith cited, for example, one unnamed tech company that present its earnings excluding charges stemming from stock compensation, “and it justifies that practice because  GAAP permits the use of different methodologies to calculate the amount of stock compensation,” he said.

“I’m sorry, but to me, there’s a difference in presenting a ‘non-GAAP” number that excludes certain infrequent or unusual charges from presenting an ‘anti-GAAP” number that just says the heck with GAAP,” said the FASB member.

Smith said he is encouraged by the SEC staff’s recent guidance, issued in the spring, “that may result in a reduction of ‘anti-GAAP’ reporting measures.” However, he voiced concern about “the lack of comparability that may exist between ‘non-GAAP’ measures that have captions that appear very similar.”

Four Legs of a Stool: FASB, SEC, PCAOB and ASB.

Again, an important conclusion from his speech is that because of the challenges facing those who write the accounting standards and check that they are applied properly (auditors and regulators), FASB alone can’t resolve issues that may be or could grow into problems.

“It’s time for the various parties”—the SEC, the Public Company Accounting Oversight Board, the AICPA’s Auditing Standards Board and the FASB—“to put their heads together to critically evaluate how entities are disseminating financial information, what users [i.e., investors] use to make investment decisions and how those decisions are made and whether changes to our existing financial reporting system are warranted,” he said.

Smith called the commission and three boards a four-legged stool that makes up the U.S. financial reporting system. “All four legs must work together to address those issues,” he said.

He then seemed to lament that the financial statements, by the description of former chairman of Deloitte & Touche LLP, seem to be the caboose on the financial reporting train. The metaphor implies that “all of the important cars precede the caboose” and there is little interest in what financial statements contain by the time they are issued. 

 First Task for Regulators, Rulemakers.

“I don’t have the answers,” Smith said, “for I haven’t concretely defined just what the fundamental problems are. That would be the first issue this group would need to attack.

 “But I think it’s time for the various regulators/standard-setters to collectively think out of the box,” he said.

Watch this space and Bloomberg BNA news columns for more on “anti-GAAP” measures, and comments on Smith’s views from regulators and other actors in the financial reporting system.

 

Continue the discussion at Bloomberg BNA Accounting LinkedIn.

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