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As reflected in this letter from SEC Commissioners Atkins and Glassman to the US Senate Committee Chair on Appropriations, tense relations among the Commissioners continue to fester. The letter starts by stating:

“In voting on whether to send the attached Staff Report on the Exemptive Rule Amendments of 2004: The Independent Chair Condition as required by Consolidated Appropriations Act, 2005, we dissented. We do not believe that the staff report adequately responds to the questions directly posed in the Act. Unfortunately, we were not given at any point in the process an opportunity to provide constructive input on what we would consider a responsive report.”

In my many years following the SEC, I have never seen such disharmony at the SEC’s highest level; if anything, relations among the Commissioners typically were so good that Commission meetings were quite routine and bordered on monotonous. I can’t imagine what closed Commission meetings are like these days! By the way, the Commissioners have not moved to Station Place yet – which is what the new HQ is being called – so they are still on the 6th floor of 450 5th St.

Conflicts of Interest and Dicey Engagements

We have posted the transcript for the DealLawyers.com webcast: “Conflicts of Interest and Dicey Engagements.” I found this to be a fascinating program and some members have pointed out the timeliness of the program in light of the Goldman Sachs conflicts controversy surrounding the NYSE/Archipelago transaction. It was interesting to note this piece in the New York Times last Sunday that even challenged the “back-up” fairness opinions given by others because of ties they had to Goldman.

SEC Guidance May Change How Companies Gauge Accounting Errors

As reflected in my notes from PLI’s “SEC Speaks,” SEC Deputy Chief Accountant Scott Taub talked about a potential summer project that could change how companies determine when accounting errors are large enough to warrant adjusting the company’s books. This project is interesting because it bears on the ongoing “materiality” debate.

Yesterday, the WSJ ran this article on the topic – below is an excerpt:

“Companies currently may choose between two different methods, a process the SEC accountants hope to standardize by calling for companies to use both methods, booking an error if either method shows it to be substantial. The idea was recommended in an academic paper to be published this summer.

Although the shift would require companies to revisit previously issued financial results, SEC accountants are expected to allow companies to use a one-time “catch-up” for past errors rather than roil markets with restatements.

The shift could be difficult and even “ugly,” cautioned Scott Taub, SEC deputy chief accountant, but SEC accountants won’t recommend”grandfather” treatment for companies that would protect them from having to correct prior problems found to be material under a two-pronged approach. Taub’s comments were made at an “SEC Speaks” conference last month at which he gave the usual disclaimer that he was speaking for himself, not the SEC.

Companies can’t ignore “material” errors large enough to matter to investors, typically those exceeding 5% of net income. While companies must consider quantitative and qualitative factors, they have a choice of two methods to quantify if errors are big enough to be material.

Since results can vary depending on which method is used, companies are supposed to pick one approach and stick with it. Companies rarely – if ever – divulge which method they use, which critics say gives executives too much leeway to engineer results.

A 2000 panel on audit effectiveness recommended regulators settle on one method to avoid confusion. Yet the choice isn’t clear-cut since there are instances where one method would indicate an error is material while the other method wouldn’t.

The cumulative or “iron curtain” approach compares the total amount of a misstatement at the end of the current period to net income, while the current-period or “rollover” approach compares the amount of misstatement added in the current period to net income. The “rollover” method, thought to be more prevalent, recognizes that prior errors may be offset or reversed in the current quarter or year while the “iron curtain” approach doesn’t allow that.

Under the “iron curtain” method, a company that overstated inventory by $100 million in 2003 and by $150 million in 2004 would tally a $150 million error in 2004. Under the rollover method, the company would calculate it at $50 million. The $100 million difference could make the mistake material under one method but not the other.

Auditors may be influenced by which method is used. Academic researchers questioned hundreds of accountants at Big Four firms and found just 23% would ignore an error that is relatively large under the iron curtain method while 70% would do so when the rollover method showed the effect was near zero.”