AUG 26, 2017

A Test for Trump's SEC Chief


President Donald Trump’s new head of the Securities and Exchange Commission, Jay Clayton, will soon face a choice about how much transparency to require of companies that issue shares to the public. We hope he’ll come down on the side of sunshine.

For most public companies, preparing financial statements isn’t just simple arithmetic. Questions such as how to value a hard-to-sell investment or when to recognize revenue from a long-term contract aren’t always open-and-shut, and can have a big impact on reported earnings -- and hence on the stock price. Yet companies often provide scant information on these judgments.

To give investors a clearer picture, more than 100 countries have recently adopted or promised to adopt a new requirement: When outside auditors report on companies’ accounting, they must provide details of any significant issues that required back and forth with the company to resolve. If, for example, they make management alter a valuation or take a special interest in the possibility of corruption, they must say so. The idea is both to provide useful insight and to encourage auditors to press management on questionable choices.

The U.S. was once at the vanguard of the reform: In 1978 and 2008, two separate commissions -- consisting of investors, accountants and corporate executives -- recommended the same changes that the rest of the world is putting into practice. But nothing happened. This time, as before, critics argue that the added reporting would be unduly costly, create legal liability, and possibly reveal information that management doesn’t want disclosed.

Those criticisms don’t stand up. Auditors typically make notes on such matters for their own purposes; preparing them for publication would cost next to nothing. If auditors had reported significant issues at Enron, Lehman Brothers and a long list of other companies, they might have avoided serious legal consequences. And so far as investors are concerned, more information is better.

The Public Company Accounting Oversight Board has issued a rule that would bring the country into line with the international standard. All that remains is for the SEC to ratify it -- usually a formality, but perhaps not in current circumstances. At stake is the reputation for good governance that has made America a magnet for investors and an attractive place to list a public company. Clayton has said he cares about this. If so he should approve the rule.

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