Business Day

FASB Proposes to Curb What Companies Must Disclose

Fair Game

By GRETCHEN MORGENSON    JAN. 2, 2016

Accounting rule makers are not generally known as flame-throwers. But with a new proposal, the Financial Accounting Standards Board has lobbed a miniature Molotov cocktail into the usually staid world of audit standards, upsetting investor groups and experts in the field.

The proposal would effectively change the definition of materiality, a mainstay of corporate financial disclosure that determines what a company must tell investors about its operations and results.

On its surface, that sounds tame enough. But bear with me: If you own stock in corporate America in any form, you need to understand what FASB is thinking of doing.

For decades information was deemed material if it could influence decisions made by users of financial statements, a.k.a. current and prospective shareholders or lenders.

But now, accounting standard-setters have proposed a new meaning for material information, one that some investors say will give far more discretion to companies in deciding what to disclose in their financial statements. The trouble with more discretion, the critics say, is that it usually means less information.

Officials at the standards board said the change was intended to align accounting standards with Supreme Court rulings and literature from the Securities and Exchange Commission.

Under FASB’s proposal, materiality will become a strictly legal concept identical to the definition cited by the Supreme Court in securities fraud cases. In the new framework, information would be considered material if it was likely to be seen by a reasonable person as significantly altering the total mix of facts about a company.

In practice, investors say, that change will not only set too high a bar for what is material information, it will also effectively outsource to lawyers what is better left to auditors: disclosure decisions on accounting matters.

Amy Borrus, interim executive director at the Council of Institutional Investors, said the new disclosure rule would directly harm investors. “This is not a simple matter of clarification,” Ms. Borrus said. “FASB’s proposal would be a sweeping change that would make financial statements much less valuable as a source of information for investors.”

Of course, the concept of materiality in financial disclosures has always been somewhat fuzzy. Companies and their auditors routinely make judgment calls on what is or is not material information about how their businesses operate.

Say, for example, a company is about to lose a customer that generates 5 percent of its sales. That would be material to investors if the customer’s departure meant the company would breach covenants on its debt — essentially, promises made to its lenders.

But the loss of revenue might not be material if the company’s remaining client base is diversified and financially sound, and its cash flows remain healthy.

Some investors questioned why FASB decided to move on this issue at all. “It’s not apparent that there was a need to do this,” said Jack T. Ciesielski, publisher of The Analyst’s Accounting Observer and a critic of the FASB proposal. “I think it’s what the corporate side wants.”

In materials describing how its proposal came about, FASB suggested that it was intended to improve the effectiveness of financial statements by reducing the amount of immaterial information in them. FASB also said that with the proposal, it was “trying to promote the use of discretion” by those preparing financial statements.

But few investors seem to agree that financial filings today contain a flood of irrelevant information. In a report, Mr. Ciesielski called disclosure overload a “paper bogeyman” and a myth.

He added in an interview, “The S.E.C. and FASB always talk about redundant disclosures, but really there are very few.”

FASB published its proposal last September and, as is its custom, asked for comments. The deadline was Dec. 8, and some 71 letters came in on the proposal.

Among those expressing support for the change were corporations that said the shift would reduce complexity and excess information in financial statements.

On the other side of the debate, Bruce T. Herbert, chief executive of Newground Social Investment in Seattle, rejected this argument in a letter to FASB.

“While the proposed changes on definitions of ‘materiality’ are written as if they are minor technical reforms designed to reduce the inclusion of marginally useful information in corporate filings,” he wrote, “we feel in reality they are misdirected, and send an entirely wrong message to the corporate community — that less disclosure is better — when in fact, the opposite is true.”

Some auditors were also critical of the proposal. “Leaving materiality as a ‘legal concept’ is a significant flaw, which will appear to subordinate the judgment of the preparer and auditor to any attorney, regardless of their capacity or area of expertise,” wrote Peter S. Kennedy, audit director at Cover & Rossiter, certified public accountants and advisers, in a letter to FASB.

Marc Siegel, a FASB member, said the board had not expected to receive the blistering criticism from investors that it did on the proposal.

“We were surprised by the feedback,” Mr. Siegel said in an interview conducted in late 2015. “When it generated a lot of controversy, we committed to slow down, take in this feedback and do a round table on it, probably sometime in the second quarter of next year.”

An excellent idea, said Sandra J. Peters, head of financial reporting policy at the CFA Institute, an organization with 135,000 members that promotes excellence in the investment profession. In an interview, she said that while preparers of financial statements may think financial filings contain reams of unnecessary information, investors do not.

A recent survey of CFA members showed that three-quarters of them did not “currently observe the inclusion of obviously immaterial information in disclosures”; the report also noted that investors and other users of financial statements “have lower materiality thresholds than preparers and auditors.”

“If we think financial statements are full of immaterial information,” Ms. Peters said in an interview, “let’s put them on the table and say ‘Preparers, what do you think are immaterial?’ and ‘Investors, what do you think are immaterial?’”

She added, “We need to come to a common ground about what are we trying to solve.”

FASB, are you listening?

A version of this article appears in print on January 3, 2016, on page BU1 of the New York edition with the headline: Board Hurls a Bombshell Into Auditing.

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