The nation's accounting rule makers took steps yesterday intended to make it harder for companies to hide debts and assets from their shareholders. At the same time, the Securities and Exchange Commission adopted rules aimed at changing other practices thrown into a harsh light by recent financial scandals.
The accounting group, the Financial Accounting Standards Board, adopted new rules for the accounting of special-purpose entities, which are usually created to buy certain corporate assets.
“A significant number of entities will be consolidated” into the financial statements of the companies that created them, said Edward W. Trott, a member of the board who led the effort. He said the new rules certainly would have forced consolidation of the entities used by Enron before that company collapsed.
Enron's collapse gave special-purpose entities such a bad name that the new rule even comes up with a new term, variable interest entity, or V.I.E., to describe such vehicles. They get that name because different investors in them have interests that will vary with the success of the enterprise.
Under the old accounting practices, auditors permitted companies to keep such entities off their balance sheets if an outside investor put up all the equity, so long as that equity amounted to at least 3 percent of the total assets.
The new rule creates a guideline of 10 percent, but says that the auditor must assess whether any level of equity capital is enough to support the enterprise, given the nature of its assets, or whether a guarantee from the sponsor, like Enron, is necessary for it to borrow the money it needs. If the auditor believes that the guarantee is in fact needed, then the sponsor will have to consolidate the entity on its balance sheet.
Even when companies are not required to consolidate an entity, more disclosures will be required concerning the maximum loss that the entity could cause.
Mr. Trott said that one strategy he expected companies to use was to seek multiple guarantees. In that case, if three companies provided the guarantees, none of them a majority, none of them would have to consolidate.
“The people who really want to not have a consolidated V.I.E. can accomplish that, but they will spread the risk to more entities,” Mr. Trott said. “And those parties will be providing more disclosures. I think this will improve financial reporting. Does it solve all the problems of consolidation? The answer is no.”
An earlier version of the proposed rule had a provision saying that if the equity owner operated a real business and consolidated the entity, then the company providing the guarantee would not have to do so. That was scorned by critics as a “rent a balance sheet” provision and it was removed from the final draft. Now that entity would still have to be consolidated by the company providing the guarantee if that would otherwise be appropriate.
The S.E.C. votes came on rules the commission was required to issue under the Sarbanes-Oxley law, passed last summer in response to a wave of corporate scandals. The rules set forth requirements for the way a company can issue “pro forma” earnings numbers and make clear that it is illegal to issue such figures in a misleading way. They also bar company executives from selling company stock at a time when employees in the company's 401(k) plan are barred from doing so.
The most contentious of the new rules concerns company disclosures on whether the audit committee of its board has a “financial expert” on it. An earlier version of the rule defined such an expert as a person who had been involved in auditing or preparing financial reports of a similar company. The new version expands that definition to include many other people with financial expertise.
The rule requires a company to identify the financial experts on its audit committee, or explain why it does not have any.
It also states that being identified as a financial expert will not expose a director to any additional responsibilities or possible legal liabilities.