A group of prominent Senate democrats recently called on Securities and Exchange Commission (SEC) Chairwoman Mary Schapiro to require fuller and more accurate corporate accounting disclosure.
Specifically, the group urged Shapiro to use her agency's existing authority to prevent instances where corporations conceal their debts and financial weaknesses. In its letter, the group of six Senators cited Lehman Brothers' use of an off-balance sheet "Repo 105" transaction to hide its debts and project a falsely positive portrait of its financial state.
"The Lehman Brothers use of the 'Repo 105' transaction is particularly troubling," said the letter. "According to the Lehman Brothers Examiner's Report conducted by Anton Valukas, Lehman took advantage of accounting rules to temporarily book a loan as a sale, and by carefully timing this transaction just before the release of its quarterly financial report, Lehman was able to deceive the public and regulators into thinking it was much better capitalized than it actually was." Such activity is apparently still rampant, as the letter referred to a Wall Street Journal article that showed a group of 18 banks had understated their debt levels by lowering them an average of 42% at the end of each of the past five quarters.
"Rather than relying on carefully-staged quarterly and annual snapshots, investors and creditors should have access to a complete real-life picture of a company's financial situation," said the letter, signed by Senators Robert Menendez (D-NJ), Edward Kaufman (D-DE), Carl Levin (D-MI), Diane Feinstein (D-CA), Barbara Boxer (D-CA) and Sherrod Brown (D-OH). "The SEC was founded on the premise that when investors and creditors have full and accurate information about companies' finances, they can allocate capital effectively. But when companies use accounting gimmicks to mislead investors and creditors, capital markets malfunction."
The Sarbanes-Oxley Act of 2002 gave the SEC the authority to require the reporting of off-balance sheet activities, but the agency has only issued rules on the subject, rather than definitively regulating it. In their letter, the Senators called on the Commission to require companies to write detailed descriptions of all their off- balance sheet activities in their annual 10k reports. Current regulations only require them to detail off-balance sheet activities that are "reasonably likely" to affect the firm's financial condition.
"Companies should also explicitly justify why they have not brought those liabilities onto the balance sheet," the letter added. "Complete disclosure of all off-balance sheet activities is particularly crucial for the largest and most interconnected companies, including both banks and non-banks."
Other requests made in the letter include for the SEC to encourage the Financial Accounting Standards Board (FASB) to improve financial reporting rules for all types of off-balance sheet activities and to monitor the FASB's efforts to prohibit off-balance sheet financing. "As we attempt to recover from the latest meltdown, we hope that, in addition to aggressively investigating and prosecuting past misconduct, you will put in place these new rules that will make it harder for companies to mislead investors and creditors in the future," said the Senators.
Jacob Barron, NACM staff writer