SEC Investor Advisory Group to FASB: Materiality Is Material
In a strongly worded letter to the Financial Accounting Standards Board (FASB), the Investor Advisory Committee (IAC) at the US Securities and Exchange Commission objected to the Board’s proposals to “clarify” materiality, saying it would make matters worse for investors. The letter was posted to the IAC’s web page on the SEC website late last week, at the conclusion of the Committee’s first meeting of 2016.
According to Kurt Schacht, JD, CFA, managing director of Standards and Advocacy at CFA Institute and chair of the IAC, the FASB’s proposed change in definition would make it difficult for investors to be confident that the information they are using to determine the appropriateness of an investment alternative is comprehensive. This reduced trust in financial statements may lead to higher risk premiums for issuers, and less-efficient capital markets, if permitted to go through.
Calling the proposal a “significant and substantive alteration to the current definition” of materiality, the IAC contends the FASB’s proposals would give companies more flexibility in determining when to make disclosures. This, the IAC said, was unacceptable.
“The changes set out in the Proposals are not, however, clarifications but entail a significant and substantive alteration to the current definition,” the IAC wrote in its letter. “The approach taken in the Proposals is explicitly designed to reduce disclosure and in doing so has the potential to adversely affect the quality of financial disclosure.”
Under current FASB guidance, materiality relates to information that “could influence decisions that users make on the basis of the financial information of a specific reporting entity.” It is further described as “an entity specific aspect of relevance based on the nature or magnitude or both of the items to which the information relates in the context of an individual entity’s financial report.”
Through its Proposed Amendments to Statement of Financial Accounting Concepts No. 8, the FASB proposes to change the definition by following the lead of the US Supreme Court in its application of the term when considering anti-fraud provisions of US securities laws. Under that definition, information would be considered material “if there is a substantial likelihood that the omitted or misstated item would have been viewed by a reasonable resource provider as having significantly altered the total mix of information.”
IAC members speaking at Thursday’s meeting contended that while subtle, the change in definitions would have a profound effect on companies’ and auditors’ views about when to consider something material.
CFA Institute has submitted comment letters on the FASB’s materiality proposals, expressing the importance of investors and preparers coming to a common definition of materiality. Finding common ground on the underlying disclosure issue is an essential first step in reaching consensus on the need for a change in the definition of materiality.
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