Pozen is chairman of MFS Investment Management and was
recently appointed chairman of the new SEC Advisory
Committee on Improvements to Financial Reporting
(CIFiR). He recently answered questions from the
* Mr. Pozen’s comments do not
necessarily reflect the views of the committee, other
committee members, the SEC or its staff.
What is the ultimate goal of CIFiR, and how
will you measure progress toward achieving
Pozen: The SEC
established CIFiR in order to develop recommendations
to reduce unnecessary complexity in the financial
reporting system and make financial reports more
useful to investors. We will measure progress
initially by whether we can produce by August 2008 a
set of sensible and doable recommendations in those
two areas. We are aiming at taking practical steps
forward, rather than revolutionizing the reporting
We are formulating proposals that can
be implemented by the SEC, FASB or PCAOB, while
staying away from any proposal that would require
legislative action. Over time, we will measure the
success of the CIFiR on whether a significant portion
of our recommendations are actually adopted by these
organizations and prove to be effective.
Why have prior efforts to address complexity
in financial reporting failed, and why do you
believe that your fate will be different?
Pozen: One of our
objectives is to reduce “unnecessary” complexity, not
all complexity. If we can understand the reasons for
complexity, we will have a better chance of making
effective proposals. For example, are financial
reports complex because the transactions are complex
or because we allow too many industry exemptions and
Second, this is a
committee set up by the SEC, with the support of other
boards, that together have the power to change the
financial reporting rules. The SEC has asked for
recommendations because it wants to improve financial
reporting. By contrast, many prior efforts were
sponsored by business, nonprofit or academic groups
that did not necessarily have the power to change
financial reporting rules.
Your charter is set to expire Aug. 2, 2008.
Is a year enough time for such a gargantuan task?
Is it possible you will make recommendations to
the SEC in less than 12 months?
Pozen: We are trying
to generate a relatively modest number of
recommendations (for example, 10 to 15) that can be
implemented by the SEC or FASB or PCAOB within a
reasonable time frame. As discussed above, we are not
aiming at bringing about a totally new concept of
financial reporting; rather, we are trying to improve
upon the existing system for financial reporting.
We intend to submit a set of such recommendations
to the SEC by Aug. 2, 2008. However, the SEC can
provide us with an extension of a few months if
needed. On the other hand, we may make some interim
recommendations before Aug. 2, 2008, to expedite the
How do you reconcile the need for long-term
sweeping changes with the need for recommendations
that can have a short-term impact?
Pozen: As mentioned
above, we will be concentrating on making proposals
that are sensible and doable within a reasonable time
frame. Nevertheless, some of these proposals could
involve what might be seen as sweeping changes—for
example, delivering financial information in different
packages appropriate for different types of investors.
Other proposals might be the first step down a
road toward sweeping changes—for example, suggesting
an income statement that more clearly and effectively
distinguishes between realized and unrealized
Do you intend to coordinate your work and
recommendations with the Treasury Department’s
Advisory Committee on the Auditing Profession? If
so, how will the two committees coordinate their
work and recommendations?
Pozen: In addressing
compliance with financial reporting rules, we will be
aware of the legal liabilities and sustainability
challenges confronting the audit profession. However,
we will not make proposals in these areas since they
will be the focus of the work of the U.S. Treasury
We have an observer from the U.S.
Treasury who will sit in on the meetings of the CIFiR.
At the same time, the staff of the CIFiR will monitor
the progress of the U.S. Treasury committee. It is too
early to tell exactly how the recommendations of both
committees will be coordinated.
How do you combine rules-based instructions
with the principles-based look at the economic
substance of the business?
Pozen: Much of the
debate on a principles-based vs. rules-based approach
is not constructive. In a good financial reporting
system, both principles and rules have important roles
First, principles must be articulated
in order to guide the writing of rules. Second,
principles allow rules not to be written in certain
areas—just apply the principles. Third, we can have
rules that are designed to implement the general
principles covering a transaction, but we can say that
principles take precedence over those rules if the
precise application of those rules to a transaction
leads to a misleading picture for investors. This
third point shows how rules-based instructions can be
combined with a principles-based look at the economic
substance of a transaction.
Is the quality of audits a concern when
implementing more principles-based financial
Pozen: When we move
away from rules and toward a principles-based system
of financial reporting, we face certain inherent
limitations. Principles require auditors to exercise
more judgment, so there is inevitably a higher degree
of subjectivity in accounting for a particular
transaction. As a result of such subjective judgments,
there may be less comparability among multiple audits
of similar transactions.
limitations of a principles-based approach must be
weighed against the disadvantages of relying
exclusively on detailed rules. Such reliance may
encourage issuers and their auditors to redesign
transactions primarily to avoid a brightline test.
Similarly, rigid adherence to detailed rules can
sometimes limit the auditor’s ability to ascertain the
economic substance of a transaction. Again, we need an
appropriate combination of principles and rules.
How can more principles-based standards work
in the United States if preparers and auditors
have a constant fear of being second-guessed by
regulators and in litigation?
Pozen: The threat of
second-guessing is a significant constraint on the use
of principles- based standards in the United States.
No one wants to exercise judgment and later be sued on
that judgment call. One big advantage of rules is that
they offer a degree of legal comfort—if an issuer or
auditor follows a rule, that would be an important
defense in the
event of litigation.
regulators decide to move toward a more
principles-based system, they will probably have to
give more deference to the judgment exercised by
preparers and auditors in applying those principles.
This could be implemented, for example, through the
adoption by the SEC and the PCAOB of a rule permitting
a defense based on good faith judgment or reasonable
choice among alternatives.
auditors may also have to stand ready to supply
enhanced disclosures about their significant
judgments. However, it is less predictable how the
courts would react to the judgment calls made by
preparers or auditors in applying a principles-based
How do you balance the need for uniform,
firm-wide audit procedures and the use of
auditors’ professional judgment?
Pozen: In order to
promote quality control, audit firms have increasingly
turned to firm-wide audit procedures. If these
procedures are expressed as detailed rules, they are
easier to follow and enforce on a firm-wide basis.
They also help to reduce audit costs.
audit firms could establish presumptive rules that
could be overridden by the judgment of the engagement
partner. The engagement partner could be required to
consult in advance with the national expert or,
alternatively, include in his or her audit workpapers
the rationale for deviating from the presumptive role.
Such procedures allowing for judgment would require
different types of training programs by audit firms.
The number of restatements has increased
dramatically over the last several years. Do you
think more restatements are being made on issues
that are not material to investors? If so, how can
this be changed?
Pozen: The committee
will be examining why the number of restatements has
increased so much over the last few years. This
increase may be related to various factors. For
example, some claim that many restatements have
resulted from speeches or letters from government
officials with new views of existing accounting
standards. Others claim that restatements have risen
because everyone involved in the audit process is more
concerned about potential liabilities. Still others
attribute the increase in restatements to a more
rigorous examination of financial controls by
management and auditors.
Yet there are clearly
a number of restatements that had no material impact
on stock prices and were generally viewed by investors
as technical in nature. In such situations, the
committee will look at whether it is possible to
correct accounting errors prospectively, rather than
through restatements of prior financials.
Given the importance of the new joint
conceptual framework, do you believe FASB should
consider postponing the issuance of new guidance
until the new conceptual framework is complete and
can be applied to its most complex standards? Why
or why not?
Pozen: The new joint
conceptual framework is important and should provide a
consistent foundation for the adoption of specific
standards. However, it would seem impractical to halt
the issuance of all new guidance until the new
conceptual framework can be completed, which could
take several years.
A better approach may be
to postpone the issuance of certain standards that
would be most heavily impacted by the new framework,
while allowing the issuance of other types of guidance
to go forward. This choice should also be influenced
by the degree to which new guidance on a particular
set of issues is needed in the commercial markets.
Does the current mixed attribute system,
which uses both historical cost and fair value,
contribute to the complexity of the system? Do you
think that the move toward more fair value
measures will reduce complexity?
Pozen: The current
mixed attribute system does contribute to complexity
by using both historical cost and fair value methods.
The rules for when fair value may or must be utilized
have been the source of considerable misinterpretation
and potential for gaming. And investors may be
confused by an income statement combining realized and
Yet it is probably not
desirable or feasible to move totally to a fair value
approach or to stay totally on historic cost. We will
be looking for ways to clarify the rules on the use of
fair value. In addition, we will consider better
disclosure to investors about the assumptions
underlying fair value estimates and the qualitative
differences among income components.
How do you think technology such as XBRL
might be used to reduce complexity and make
financial reporting more useful?
Pozen: XBRL is a
technology that involves tagging of specific items of
information, including those in financial reports of
public companies. For example, XBRL would allow
investors to obtain a comparative array of selected
items for all companies in an industry, such as the
ratio of research spending to gross revenues. Thus,
XBRL should provide financial information from SEC
reports in a more useful format for sophisticated
On the other hand, XBRL may be less
helpful with regard to “softer” information items,
like those in the management discussion and analysis.
Such information items tend to be less standardized
among companies and, therefore, are less amenable to
comparative analysis through XBRL.
How do you envision the financial reporting
model would include nonfinancial indicators such
as key performance indicators and other Enhanced
Business Reporting measures?
Pozen: The committee
will be looking at how public companies and investors
communicate with respect to non-GAAP measures of
financial performance. In this effort, the committee
will review the development of key performance
indicators and Enhanced Business Reporting measures.
Many of these indicators and measures go beyond
information items in SEC filings.
much of this type of communication between public
companies and investors occurs in press releases that
accompany the filing of a 10-K or 10-Q with the SEC.
The committee will seek to understand the role of
press releases and how they might be incorporated into
the financial reporting system.