Materiality: No, the SEC did not write SAB No. 99

Corporate Counsel serves up a mostly excellent article, Securities Law Disclosure Checklist for Alleged (or Confirmed) Misconduct. It outlines disclosures that public companies should consider regarding alleged misconduct by employees, directors, or officers (e.g., “accounting improprieties, disclosure failures, criminal or civil actions involving the company and/or management, scandalous personal indiscretions, threatened disciplinary actions, fraud, false statements, or omissions, bribery or forgery”).

I say “mostly excellent” because, while the checklist is comprehensive and helpful to both companies and prospective whistleblowers, it unfortunately perpetuates the oddly popular myth that SEC Staff Accounting Bulletins (a.k.a. “SABs”), like SAB No. 99 dealing with materiality, are promulgated by the SEC and, therefore, are binding legal rules:

“In Staff Accounting Bulletin 99, the SEC also noted. . .” blah, blah, blah.

The SEC noted no such thing. As each and every SAB bears explicit witness, SABs are not binding partly because the SEC specifically disavows each of them with this preface:

The statements in the staff accounting bulletins are not rules or interpretations of the Commission, nor are they published as bearing the Commission’s official approval. They represent interpretations and practices followed by the Division of Corporation Finance and the Office of the Chief Accountant in administering the disclosure requirements of the Federal securities laws.*

Under the Fifth Amendment and the Administrative Procedure Act, so-called legislative regulations can only come into being through due process development that includes public notice and opportunity to comment. If the SEC were to so decide, it might be able to sneak by with interpretative regulations, thanks in no small part to the Supreme Court’s 2015 decision in Perez v. Mortgage Bankers Assoc. So far, however, on a number of important disclosure topics, including materiality and revenue recognition, the SEC has studiously avoided promulgating any regulations at all.

Thus, left to their own devices, SEC staff have taken the easy way out, engaging in a form of extra-legal self-help by drafting SABs, which they cook up behind closed doors with zero input from financial market constituents (investors and registrants). This is why SABs are called “Staff Accounting Bulletins.”

The distinction between legitimate SEC rules and ersatz SABs is not trivial. Rules that emerge from the crucible of notice and comment would undoubtedly differ significantly from the contents of the SABs, Wanda Wallace observed in 2007.** Investors and SEC registrants need and deserve better, legitimate regulatory guidance than the SABs. Meanwhile, the SEC should get no credit for binding regulations it has not drafted.

* See, e.g., SAB No. 99, See also Kurt S. Schulzke, Wink, Wink, Nudge Judge: Persuading U.S. Courts to Take Accountants Seriously in Federal Securities Cases with Help from the U.K. Companies Act, 16 Tenn. J. Bus. L. 231, 267 (2015) ,  (noting the disturbing appearance of this SEC mythology during Jeff Skilling’s Enron trial and in other securities cases); Kurt S. Schulzke, Gerlinde Berger-Walliser & Pier Luigi Marchini, Lexis Nexus Complexus: Comparative Contract Law and International Accounting Collide in the IASB–FASB Revenue Recognition Exposure Draft, 46 Vand. J. Trans. L. 515, 524 (2013) (similar).

** Wanda A. Wallace, Commentary: With or without due process?, ACCT. TODAY, Nov. 26, 2007, n.p. (decrying multiple SABs for their negative impact on the quality of financial information).


Happy Fourth, America!

Happy Fourth! Just watched The Perfect Game, a remarkable movie based on a true story that captures the American dream at its best. America’s game — yes, baseball — played (mostly) by the rules. Immigrant* underdogs win through sheer grit, pluck, and faith against enormous odds.

*Technically speaking, the kids in this story were not yet immigrants. But some of them later played professional baseball in the United States and most likely became immigrants at that time.


Michael Mann v. Ken Cuccinelli: Is Academic Freedom a License to Lie?

Does “academic freedom” include the right to falsify data in government grant applications? One might think so, to hear Rachel Levinson Waldman, senior counsel for the American Association of University Professors. She (and 810 Virginia professors) have objected to Virginia Attorney General Ken Cucinelli’s civil investigative demand or “CID” (shown below) that the University of Virginia produce documents and communications relating to $485,000 in government funds it received on behalf of then UVA prof Michael Mann (of Climategate Hockey Stick fame) for the study of global warming theories.

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SCOTUS to SEC on PCAOB: “Fire at will!”

With today’s SCOTUS decision in Free Enterprise Fund v. PCAOB, the Public Accounting Oversight Board (“PCAOB”) survives but with less swagger and self-importance than before.  This decision holding unconstitutional the “dual for-cause limitation” on the President’s ability to fire PCAOB members leaves the PCAOB’s form intact but downgrades its political independence. Continue reading

Utterly Ridiculous: Coast Guard Stops Oil-Sucking Barges for Life Vests

You can tell governance in the United States is upside-down when a mere Lt. Commander in the U.S. Coast Guard can force a state’s governor — in this case Louisiana Governor Bobby Jindal — to stand down barges saving the state’s coast line from an oil spill.  Not to mention that the spill itself is the proximate result of Coast Guard and other federal-government misfeasance. Continue reading

Not even WSJ reporters get FASB accounting standards. Why write more of them?

For an eloquent illustration of how accounting innovations like FAS 157’s “fair value” regime are way beyond even above-average American financial readers, try Michael Rapoport’s May 1, 2009 article entitled
New FASB Rule Aims to Clarify ‘Net Income’.

Rapoport, trying to capture the meaning of the new SFAS No. 160, stumbles over one of the most basic concepts in the accounting literature — that “minority interests” in consolidated financial statements reflect the fact that “parent” companies don’t really “own” 100 percent of the assets or income of “subsidiaries” except those they wholly own. Continue reading

Comments on FASB’s fair value amendment reflect FAS 157 distress

Lenders have been hammered by the pathologically procyclical impact of FAS 157’s mark-to-market regime.  Hardly surprising, therefore, that banks and credit unions came out in force to support the latest FASB “clarification” of FAS 157.  Some other commenters, mostly from the “analyst” community, emphatically disagree.

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Graham County Soil & Water: Can whistleblowers sue using state or county audits?

The federal False Claims Act (FCA) encourages private whistleblowers to sue, usually in partnership with the U.S. Department of Justice, to recover federal funds allegedly misspent by individuals, companies or local government agencies.

Rewards of blowing the whistle can be very substantial — up to 30% of the government’s recovery plus attorneys fees — but would-be whistleblowers must satisfy a number of stringent rules.  One of these is the so-called “public disclosure bar” of 31 U.S.C. § 3730(e)(4)(A) that bars most claims based on publicly available information the disputed definition of which is now before the U.S. Supreme Court in Graham County Soil & Water District, et al., v. U.S. ex rel Wilson (08-304). Continue reading

Not so fast, Johnathan Weil: Citigroup & the fair value illusion

Johnathan Weil called on Citigroup today to “properly confess” the “rot on Citigroup’s $2.1 trillion balance sheet.”  Weil is sure the rot is there because if it weren’t Citigroup “wouldn’t have needed last week’s government rescue [including] a new $20 billion investment by the Treasury Department, plus a guarantee covering about $306 billion of the bank’s assets against most losses.” I beg to differ.

The “rot” may well be an illusion created by poorly-drafted accounting principles applied in draconian fashion by auditors spooked by the specter of ruinous lawsuits.  Citigroup’s request for government assistance may well be an appropriate strategic response to the illusion.  In the market place, a good illusion beats a bad reality most any day.

Weil assumes facts not in evidence and arguably misapplies SEC regulations in demanding the Citi book losses now.  Under SEC rules, Citigroup would be obligated to “confess” losses on Form 8-K only if Citi’s board concludes that a material charge for impairment is required under generally accepted accounting principles.  If the board either has concluded that such a charge is not required or has not yet concluded that one is, no Form 8-K confession is called for. Continue reading