Investor advocate’s office weighs in on FASB’s materiality debate

An SEC staffer in the agency’s Office of the Investor Advocate advised the FASB to refer to previous guidance from the market regulator and the accounting board as it rewrites U.S. GAAP’s concept of materiality.

“By drawing on the exposition and illustrative examples in [Staff Accounting Bulletin (SAB) No. 99, Materiality, (Topic 1.M)] and [Statement of Financial Accounting Concepts (CON) No. 2, Qualitative Characteristics of Accounting Information], a new document would respond to investor demands for a framework or guidance on how to apply the general definition of materiality,” said Stephen Deane, the investor engagement advisor to the SEC investor advocate, in an Aug. 22, 2017, speech to the Tulsa, Oklahoma, chapter of the Institute of Management Accountants. “This would be seen as encouraging informative disclosures, rather than trying to oversimplify or reduce them. This approach would also address concerns about devolving accounting decisions to lawyers.”

Deane’s recommendation to the FASB echoed an argument SEC Investor Advocate Rick Fleming made to the accounting board in a July comment letter.

The use of CON No. 2 and SAB No. 99 “would illustrate how to apply the general definition of materiality and make reasonable materiality judgments in various accounting contexts,” Fleming said. “This would include examples in which an item is small in magnitude but nonetheless important in the context of trends or other qualitative factors, such as turning a loss into a profit. This approach should be seen as encouraging disclosures of material items, rather than oversimplifying or reducing them. The revised language could also remove or alleviate concerns over encouraging excessive management discretion or devolving accounting decisions to lawyers.”

The advice from Fleming and Deane to the FASB comes at a somewhat sensitive time for the accounting board, which in September 2015 released Proposed CON No. 2015-300, Conceptual Framework for Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information, and Proposed Accounting Standards Update (ASU) No. 2015-310, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material. The proposals were issued as part of the board’s Disclosure Framework project to revise U.S. GAAP’s disclosure rules and, where possible, resolve some concerns about what the board called “disclosure overload.” In the past two years, the FASB has released a series of related proposals to revise specific disclosure requirements in U.S. GAAP, and in March it held a roundtable discussion to assess the progress on the effort and weigh the options for the next face.

During the roundtable, FASB members considered adopting a course similar to the one offered by Fleming and Deane, although with more of a focus on erasing the materiality language in CON No. 8, Conceptual Framework for Financial Reporting—Chapter 1, The Objective of General Purpose Financial Reporting, and Chapter 3, Qualitative Characteristics of Useful Financial Information (a replacement of FASB Concepts Statements No. 1 and No. 2), and replacing it with the CON No. 2 definition.

CON No. 8 was issued in 2010 partly to align the FASB’s and IASB’s Conceptual Frameworks, but in the years since then, the accounting boards have abandoned their work on international convergence. As the FASB proceeded to work on its framework independently, the U.S. board recognized that the language in CON No. 8 departed from the legal guidelines established by the Supreme Court’s 1977 decision in TSC Industries Inc. v. Northway Inc. The court said information was considered material in a fraud complaint if a reasonable shareholder would rely on it deciding how to cast a proxy vote.

The FASB’s 2015 proposals sparked a contentious debate that the board did not foresee. Companies have been urging the board for years to address the disclosure overload and their complaints that the FASB and SEC have too many requirements for the footnotes in financial statements and the narrative sections of regulatory filings. But many investors complained that the proposals were nothing more than a thinly veiled effort to scale back the amount of information they receive about companies. The FASB has defended its proposals, calling them an effort to simplify the materiality definition in U.S. GAAP and align it with the guidance from the SEC and PCAOB, both of which rely on the legal precedent established by the Supreme Court. Board members said they never intended to deny investors information they want or need for evaluating investments.

As Deane and Fleming noted, CON No. 2 and SAB No. 99 rely on the Northway ruling for their definition of materiality, and both advised the accounting board to return to them as it revised its definition.

“A fresh approach based on CON No. 2 and SAB No. 99 would satisfy FASB’s legitimate concerns to make its concept consistent with U.S. law,” Deane said.

A FASB spokesperson did not respond to a request for comment as this story was being written.