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Comment Letters on Materiality Proposal Expose Sharp Divide Between Investors, Companies

The FASB is proposing that materiality be considered a legal concept for deciding what information should be in financial statement footnotes. Several companies have told the FASB that they like the proposal, although audit firms seem less sure. For their part, investors have sharply criticized the proposal and believe it will deny them important information for making informed investment decisions.

The feedback has been mixed on the FASB’s proposal to offer companies more leeway in determining the information that should be in their financial statement footnotes by clarifying the use of the legal concept of “materiality.”

Companies and professional organizations say the proposal will make increasingly lengthy financial statements less costly and burdensome to compile. Their views contrast sharply with investors and consumer groups who say the plan will strip away the information for making informed investments or contributions to not-for-profits.

Proposed Accounting Standards Update (ASU) No. 2015-310, Notes to Financial Statements (Topic 235): Assessing Whether Disclosures Are Material , calls for the legal concept of materiality to be the basis by which businesses and not-for-profit organizations decide when to include information in their footnotes. The FASB’s goal with the September proposal was to allow businesses and organizations to stop bogging down their footnotes with extraneous information they believe is not meaningful for investors.

At the same time it issued Proposed ASU No. 2015-310, the FASB released Proposed Amendments to Statement of Financial Accounting Concepts (CON) No. 2015-300, Conceptual Framework for Financial Reporting Chapter 3: Qualitative Characteristics of Useful Financial Information , to offer amendments to the accounting board’s Conceptual Framework, the set of guidelines for writing U.S. GAAP.

Comments for both documents were due by December 8, 2015.

The FASB’s Conceptual Framework describes materiality as a concept that “could influence decisions that users make on the basis of the financial information,” although the term is not defined in U.S. GAAP. Proposed ASU No. 2015-310 refers to the U.S. Supreme Court, which in 1976 ruled that information is material if a reasonable investor would consider it important in an investment decision.

The responses from investors to the FASB proposals were particularly harsh. At an SEC Investor Advisory Committee (IAC) meeting on October 15, several investors and securities analysts said the FASB is proposing to give businesses too much leeway on judgment calls about the information they make public.

This criticism continued in the comment letters, with the Consumer Federation of America and Americans for Financial Reform jointly chastising the FASB for characterizing the proposal as a “benign” change to clarify materiality and help businesses improve the effectiveness of their disclosures. Instead, the proposal will deny investors useful information.

“There is no question in our mind that the proposed change would be seized on by some companies to justify reducing the amount of information they provide to investors and other users of financial reports,” the groups wrote.

R.G. Associates Inc., an investment research business led by Jack Ciesielski, also criticized the proposal.

“There seems to be a certain strain of paternalism present in these proposals, something along the lines of: ‘Investors can’t handle immaterial disclosures, and we have to find a way to let preparers reduce them.’ This is contrary to the experience of many investors: If a disclosure doesn’t merit their attention, they’ll pass it by. Most of the time, investors want more disclosures, not less,” the firm wrote on December 7.

A group of public interest organizations, including US PIRG and GreenPeace, said the FASB proposal will reduce the amount of information available to investors.

“In general, more disclosure is better than less disclosure,” the groups wrote in a December 6 letter. “Finance-based problems stem from a lack of disclosure, from ‘reduced volume,’ such as Enron, World Com, the Madoff Ponzi scheme and many others. We are unaware of any groundswell of investors petitioning the SEC for less information.”

In contrast, Financial Executives International (FEI), which represents major companies, was one of the proposal’s strongest supporters. The group has long been vocal about what it calls “disclosure overload” and the burdens companies face in compiling financial statements.

The organization “strongly supports the board’s efforts to help issuers eliminate immaterial information by formalizing and reinforcing the capabilities they already have available to them to make these changes,” FEI wrote.

Responses from individual companies were mixed, however. Ford Motor Co. agreed that the application of materiality generally is, and should continue to be, evaluated in the context of the legal definition. But Ford said the inclusion of the phrase “materiality is a legal concept” may set an expectation that additional legal analysis is required when a company needs to decide whether information can be left out of the footnotes because it is immaterial.

“To avoid these unintended consequences, we encourage the board simply instead include the legal definition of materiality.”

Comcast Corp. said it supported the plan.

“First, we do not believe the proposed changes to the definition of materiality are any different than how the concept of materiality is applied today by public companies in the United States,” the media and technology company wrote. “Second, we believe the proposed clarification that the omission of immaterial disclosures is not an accounting error would be a helpful clarification that is consistent with the overall objective of making disclosures more decision-useful for the average investor.”

Several groups, including audit firms, were concerned about referencing a legal definition in U.S. GAAP.

Calling materiality a legal concept could increase the amount of effort and documentation needed for businesses to justify all disclosures omitted due to materiality, or planned to be omitted based on the guidance elsewhere in the proposal, the American Council of Life Insurers wrote.

The American Accounting Association, an academic organization, had similar concerns.

“The determination of materiality in GAAP has long been based on both quantitative and qualitative factors as determined by professional judgment. Financial statement preparers and auditors must determine whether the magnitude and qualitative characteristics of information would influence the decision of a reasonable person relying on the financial statements,” the association wrote.

No single definition of materiality can be relied on in every circumstance, which is problematic for professionals preparing or auditing financial statements for organizations that span multiple legal jurisdictions, the organization wrote.

KPMG LLP said it did not support the proposal. It expressed several concerns about it, including the decision to incorporate a legal concept in financial reporting. This could push companies and auditors into making legal determinations in their accounting and auditing decisions, the firm wrote. It is also unclear how the U.S. Supreme Court’s definition of materiality would apply to U.S. GAAP financial statements prepared and used solely in a foreign country.

“We understand that the Supreme Court definition is broad-based and subject to ongoing interpretation by litigants and the courts. We believe that leaving a fundamental concept in the accounting literature to legal interpretation would result in less consistency in financial reporting than the FASB would achieve by making it an accounting definition. We also believe it could impede on preparers’ and auditors’ ability to discuss materiality in a meaningful manner,” the audit firm wrote.

Deloitte & Touche LLP also disagreed with defining materiality as a legal concept.

“Referring to materiality as a legal concept may be construed as requiring someone within the legal profession to make, or be involved in making, materiality judgments on the grounds that only a person with such credentials would have the requisite knowledge and education,” Deloitte wrote. “We believe that as a result, such ‘legal concept’ language potentially exposes preparers and auditors to additional scrutiny from regulators or legal consequences for failure to involve the legal profession in making materiality assessments when historically, such involvement has not occurred and has not been deemed necessary.”

Deloitte also was concerned about a statement that information not disclosed to investors because it is deemed immaterial could affect “close call” judgments about whether to include a piece of information in a financial statement. Companies may err on the side of excess and include immaterial information because they do not want to meet documentation requirements to justify its exclusion and the lack of a prohibition against including immaterial information.

“If these types of other barriers cannot be overcome, the proposed amendment… might not have the desired effect on disclosure effectiveness and therefore may not be worth pursuing,” Deloitte wrote.

The FASB started examining disclosures in 2009 as part of what then-FASB Chairman Robert Herz described as an effort to reduce “disclosure overload.” Businesses complained about compiling increasingly lengthy financial statements, with footnote disclosures being one of the main culprits. Others said companies included too much unhelpful, boilerplate information in the footnotes, which makes it harder to get at important facts. Investors and analysts, however, have told the FASB that footnote disclosures contain valuable information, even if they have to dig for it, and they have advised the accounting board to not slash its disclosure requirements. If some changes are deemed necessary, they prefer that the board make its existing disclosure rules produce more useful information for investors.

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