The SEC’s IDEA: What to do…

So far, I’ve attempted to suggest that the SEC’s new IDEA system will be the logical continuation of disclosure-based regulation, taking into account the capabilities of rather more modern technology than the "paper under glass" arrangements that today’s EDGAR system (and the majority of other disclosure systems in use around the world) utilise ie: ASCII, HTML and PDF. It’s logical, but disruptive in a slow and steady kind of way. Yesterday, we went through some trends that follow from the IDEA platform, including the inevitable pressure, market as well as regulatory based, for additional markup; the way that markup will probably find its way onto web sites; the possibilities that a SOA platform like the IDEA one provides for new applications, public and private; and the importance of XBRL extensions.

So what? Well, here are a few suggestions for preparers, as well as for consumers of various sorts.

Issuers and Preparers

It will take time for the SEC’s new approach to take hold. File all of this as "Important, but not yet Urgent".

  1. Make tagging a robust process

    If you are thinking, today, in terms of tagging the financials and hoping that no-one much will look at them in that format, think again. There will be more and more requirements to tag corporate performance information. This means that companies should be talking with their BI and performance reporting vendors, to work out how they can incorporate the process of tagging into the close and into the normal reporting processes. You’ll quickly discover that they are mostly still in the development stages, but they will appreciate your input and statement of requirements. Think about whether you want your auditors involved (at this stage it is not mandatory, but that will change), and start talking to them about what they would do and how it will help your reporting. At present there are a very small number of shops looking at the way that XBRL can become an asset to enterprise reporting. But they are clearly on the right path.

  2. Review the way that your peers are reporting in XBRL

    Companies will want to make sure that their XBRL-based disclosures conform to industry norms (if they don’t want to get complaints from analysts and investors, that is). This will be a balancing act. Every company wants to be as comparable as is necessary, and no more. Inside industry bodies, or just informally, examine the way that others are using XBRL and which tags are being used in specific circumstances. There will be various industry-specific disclosures that are probably not in the official taxonomies – suggest that they get added. There will be other situations in which it makes sense to create industry extensions – agreed sets of industry tags that might involve non-GAAP concepts,or be too specialised to be incorporated into the official GAAP framework. These kinds of horizontal extensions can be referenced by members of that industry inside their instance documents. Hopefully, XBRL-US will act as an independent broker to make this kind of collaboration work in the US. Internationally the EBR consortium, working together with a number of other similar groups around the world, are also keen to help.

  3. Start discussing your tagging decisions with your analysts.

    Honestly, if you speak to your analysts today, more than half of them are likely to look at you with a puzzled look. However, that is changing quickly, and investment firms of all sorts are either making plans to use XBRL internally, or working with (or waiting for) their market data providers to fill the channel. As soon as their own systems are up to speed (unlikely to be before the middle of 2009) they will start providing you feedback. Get on the front foot. Be specific.

  4. Treat your extension taxonomy as a corporate asset

    Your extension taxonomies tell the world the things that are different about you. IDEA and similar platforms in other countries will make that information very accessible to analysts and investors, so think it through yourselves. Having well thought out, consistent and complete extension taxonomies will become a crucial part of external reporting.

Infomediaries and Portals

IDEA is either a big new opportunity or a big new threat, depending on the way you view things. In contrast to the preparers, this is both urgent and important.

  1. Add value

    This is too obvious to dwell on really. If the data that, today, is difficult to obtain and organise is suddenly freely available, infomediaries that are in that business today need to move upstream, or ensure that they can add still-difficult-to-access data to the freely available sort. Those in the business already know that, although many, over the years, have vacillated about what to do in this field.

  2. Gear up

    You need to be able to consume XBRL metadata and data and incorporate it into your systems. Generically. By which I mean: make sure that your infrastructure can handle lots of different taxonomies. We’ve seen a few that hard code dependencies to specific taxonomies or worse, specific versions of taxonomies. Think bigger. Think in terms of being able to consume XBRL messages from lots of (hopefully interoperable) services around the world, not just IDEA. That means APIs, quite possibly XML databases, and mapping and cross-mapping mechanisms. Y’all shout out if you need help now.

  3. Give as well as receive

    Services like IDEA will be the catalyst for a lot of applications that can consume XBRL. Some of them will be owned by your clients. Others your partners. Start considering delivering some of your offerings in the same format, via complimentary services.

Investment Houses

  1. Get your hands dirty

    This interactive doodah, XRB..XBRL stuff is here to stay. If your investment technology group doesn’t understand it and in some detail, then you’ll need to get them to learn. Not just them either. Your analysis teams need to understand the idea of markup, the tricks, the traps, the common errors. The ways that, if they were so inclined, a company might seek to use the technology to be less comparable. You’ll want ways to classify extension concepts that issuers publish. Relevant? Only interesting in terms of a company timeseries? Useful and needs to be mapped somewhere else? You’ll need the wherewithal to instantly transform the layout and calculation decisions contained in a company’s filing into your own, preferred view.

    And (sorry) you’ll need to be patient, as corporate finance functions and their providers come to grips with what they need to do, what works and what doesn’t. But don’t fall behind. This is a curve you want to get out in front of. The SEC’s proposed rule calls for XBRL versions of accounts to be filed as exhibits concurrent with the EDGAR text versions.

    The only way to learn this stuff is to do it. Technologists that want to get up to speed very quickly can do so by participating in one of the technical or best practice working groups of the consortium.

  2. Develop a feedback loop

    Analysts and Investors that are consuming XBRL documents will need to develop ways to provide feedback to companies that are publishing them. Be nice people! Everyone has a learning curve here. You’ll be very well placed to point out inconsistencies in markup and extension decisions. No doubt you’ll be listened to.

So there you go. Free advice. You all know what that’s worth.

On a serious note, although dressed up as PR and even though nothing really new was announced by the SEC, count me, at least, as one observer who thinks that the regulator has come up with a very important IDEA.

The SEC’s IDEA: Reading the tea leaves…

Yesterday, I said that the SEC is probably onto something with its IDEA announcement. They are moving, in a very public, very clear and pretty determined manner towards a new era for disclosure based regulation. It’s interesting to see the number of articles that take a very different, rather more skeptical view. The adversarial nature of the relationship between companies, lawyers and the Commission clearly isn’t going to disappear any time soon. But if you take the broad view, then the IDEA announcement is more than mere marketing (although it is that too). It’s a stake in the ground about the way that disclosure-based regulation will work for the next decade or two.

And it’s more of the same, just in electronic form.

More of the same with a vengeance, that is. Changing the focus of disclosure onto the internet will have significant repercussions for many of today’s actors. Here are a few fuzzy predictions.

  1. If it moves, tag it

    XBRL, or interactive data, involves wrapping definitions around information, with XML tags, or (strictly) elements. The information can be a single number, a paragraph of text, a picture or chart, or any combination of these.

    IDEA will drive the SEC and every other regulator, to require information to be marked up in this way. Today the focus is on financial statements. In five years’ time, it will likely include a much wider range of information, including prospectus documents and proxy statements covering information like compensation and related party dealings. Regulators will undoubtedly extend their requirements to also cover specialist disclosures such as those made about Oil and Gas reserves, pharmaceutical approvals, lending covenants and risk transfers. They won’t necessarily be asking for more information. But there will be an ongoing balancing act, not to mention conflict, between questions about liability and the burden that additional structured disclosures impose on Issuers on the one hand, with the utility that such structured information provides to the market overall on the other. Presumably, given recent market turmoil and the opaque nature of a range of financial instruments, the playing field is going to be tilted towards disclosure for quite some time.

  2. Market markup

    Those tags are going to end up everywhere. Markets will rely on them and ask for more. Where? Earnings releases for a start. Macro-economic data. Yes, governments themselves will need to get down and dirty mapping their own statistical disclosures to appropriate tags. Industry and corporate metrics: national and regional car sales, home loan approvals, airline miles flown. If you compile valuable information and today distribute it in a press release or on a web site in text, PDF, HTML or even Excel format today, you’ll be doing the same thing, but in XBRL tomorrow.

    Even the markets themselves will get in on the act, as research information (especially estimates) that are today distributed to investors and analysts in PDF and HTML will get tagged and shipped out as interactive data, for use and assimilation into other people’s systems, models and ideas.

  3. Joined-up thinking

    The architecture of the IDEA system, and many other, similar ones around the world will be service oriented, or SOA, based. This is a relatively new way of designing computer systems, but it gives rise to new capabilities as it is much easier for people to build on them. SOA allows so called "mash-ups" of information to be put together, using different data sources and different services that act on that information. Other countries will certainly develop similar systems. Expect, therefore, for infomediaries like ThomsonReuters, and FactSet, to facilitate the comparison of disclosures made by the same company in different countries, as well as international industry and peer comparisons that will make your head spin. They’ll be well placed to do that because they are good at making judgements about the comparability of different accounting rules across international boundaries. But expect others, including ratings agencies, new start-up players and the regulators themselves, to get in on the act.

  4. A galaxy of applications

    The free provision of company and mutual fund performance data and metadata in a searchable, organised format will greatly improve the capability of investors and other stakeholders to better understand different securities.

    Whether it is:

    • MSN Money, providing automated peer comparison tables to retail investors;
    • A large hedge fund looking for arbitrage opportunities; or
    • the SEC itself, sniffing through corporate filings, looking for anomalies and compliance violations or the illegitimate resurrection of a business following investor fraud;

    the scope and variety of applications are difficult to attempt to define.

    Some applications will be private, for the use of the SEC. Others will be private for the use of financial institutions, and trading houses. Others will be open to the world. Some will mash up information from multiple sources and some will, in turn, allow others to use (for free or for a fee) the information that they produce.

    There are some clear commonalities though. The IDEA platform will need to scale to service lots of different users of lots of different applications. Local staging, storage and transformation of data, including information unique to specific companies, will be the main technical challenge for application builders.

  5. One document. Different views.

    One aspect of XBRL that has a lot of people stumped is how to view it. Issuers are concerned about the way that the SEC viewer applications will represent their disclosures on a web page or in Excel. Here comes the XBRL consortium to the rescue. The Inline XBRL (iXBRL) specification lets you create a web page that looks and feels exactly the way you want it to, but that contains XBRL markup wrapped around every relevant fact. The markup is not generally visible to a human being, but can be immediately consumed by computers. One document, two different views. Inline XBRL lets preparers format their documents the way that they want to, including in a way that looks exactly like today’s regulatory filings. At the same time, the content that the regulators require, or the markets demand, must be machine readable and it is right there in the document. Next to all the tags that people are already familiar with, like <bold> and <italics> are some new ones that say <cash> and <AccountingPolicies>.

    IDEA and its counterpart services run by other securities regulators, companies registrars and exchanges will almost certainly receive and republish entire iXBRL documents that can be read by humans and computers alike, rather than just getting the raw, computer-readable information contained in an XBRL data document. This is important for any number of reasons, including one very good one: because the filings will just be web pages containing some specialised, if hidden, tags they will be searchable via ubiquitous systems like Google. Architected correctly, it will also keep the costs down.

  6. Metadata matters

    The important thing about XBRL is the X. It stands for extensible, an ugly, if descriptive word. XBRL has three layers:

    • A specification. Think of it as the alphabet and rules of grammar;
    • Taxonomies. These are loose-leaf dictionaries of terms that define specific concepts, using the alphabet set out in the specification and obeying its rules of grammar; and
    • Instance, or data documents, that use the words in the dictionary to communicate performance reports.

    Notice that taxonomies are "loose leaf" dictionaries. If the dictionary contains a suitable word, you need to use it. If it doesn’t, you need to add a new page to the dictionary, containing your new word and its definition. This is the idea of extensibility.

    Companies will use and no doubt abuse the idea of extensibility in XBRL for a year or two. It will settle down before long. All the extensions that apply to specific companies will need to be catalogued and referenced appropriately. Doing so will ensure the operation of the analytical "electronic applications" that will form part of IDEA, as well as external applications such as those run by portals like Yahoo Finance and Microsoft Money.

    Just as importantly, companies will need to treat their own extensions as an important corporate asset. They are very public statements about specific and important aspects of corporate disclosure.

What should actors on the disclosure stage be doing? Tomorrow there will be a few suggestions.

What’s the big IDEA?

Last week the SEC announced plans to replace its EDGAR system for electronically filing financial disclosures with a new one. The replacement, called "IDEA" will use interactive data to power a range of electronic applications, some to be provided by the SEC, others by the private sector. The Commission says that it will be working quite quickly but that it will take five years to bed down. What will it look like? What should preparers and users expect? What are the challenges? Where are the opportunities? Over the next few days I’ll provide a few half-educated guesses.

Today though, a little history. Financial crises are soon followed by new types of regulation. It was the Wall Street crash of 1929 and resulting Great Depression that gave rise to the disclosure based regime that is widely (although not universally) used around the world.

In 1933, President Franklin D Roosevelt, in announcing the formation of the SEC’s immediate predecessor, set out a new way of thinking about regulation. Prior to the creation of the SEC, the regulators themselves examined drafts of company public statements. They were attempting to judge their veracity and reliability. There was a significant onus on the government itself to ensure that scams, rumours and plain bad information were not publicised and traded on. The crash brought about a rethink.

In signing the 1933 legislation into law, Roosevelt introduced the idea of corporate transparency. He said:

“Of course, Federal Government cannot and should not take any action which might be construed as approving or guaranteeing that newly issued securities are sound in the sense that their value will be maintained or that the properties which they represent will earn a profit.

There is, however, an obligation upon us to insist that every issue of new securities to be sold in interstate commerce shall be accompanied by full publicity and information, and that no essentially important element attending the issue shall be concealed from the buying public.

This proposal adds to the ancient rule of caveat emptor, the further doctrine "let the seller also beware." It puts the burden of telling the whole truth on the seller. It should give impetus to honest dealing in securities and thereby bring back public confidence.”

(See H.R.Rep. No. 85, 73 Congress, First Session 2 (1933) for the quote and the Financial History of the United States for a fascinating insight into the pressures, for and against, the new approach that Congress weighed up.)

Since the formation of the SEC, the US, and the majority of other securities markets, have relied on a positive obligation on those seeking investment from the public to provide honest statements about their businesses and not to omit material information from such statements. These obligations are backed by lawyers and their investor clients that are willing to enforce them (the obligation is to show that nothing material has been omitted, which is difficult to prove) and by the markets themselves – stocks that seem to lack full transparency tend to be punished in terms of growth and valuation as a multiple of earnings.

Transparency (mostly) works. The fact that the Commission is concentrating on the use of technology to improve a proven recipe, rather than throwing out the current system should be welcome. The regulatory tide has not yet risen too high, despite some of the wilder pressures that these agencies are under, given the impact of the current credit crunch.

So, at a macro level, the IDEA announcement is merely reinforcing disclosure-based securities regulation.

We should also take away the fact that XBRL and the idea of structured, computer readable performance reporting is now completely embedded within the SEC. Anyone that has been hoping, or betting, for something else, should think again.

The fact that IDEA is being presented as a platform is also important. Infomediaries, portals and investment houses of all sorts should be thinking about how to incorporate the use of the platform into their development plans.

It would be particularly surprising if the SEC was the only securities regulator, companies registrar or exchange around the world that came to the conclusion that a platform of the sort described last week is the right IDEA for the future of disclosure-based regulation.

Tomorrow, a few predictions through a cloudy crystal ball.

More and more XBRL initiatives.

It’s all XBRL, all of the time. Another announcement from the SEC this week, as well as encouragement for European interactive data, this time from the European Parliament.

As expected, the SEC is proposing that all mutual funds in the US provide a range of information, covering investment objectives, investment strategies, risks, historical performance and costs, starting with registration statements, in XBRL format from 1 January 2010. Once again, the Commission is proposing that all such filings are simultaneously posted to fund web sites.

Full details will be posted on the SEC web site soon. For the moment, read the press release here.

The European Parliament, acting at this stage in committee, has voted on a range of measures related to the simplification of company law, accounting and auditing. Experienced euro-tea-leaf readers assure me of the significance of this passage in the motion that was passed on Wednesday, and let’s face it, it has something for everyone:

Stresses that auditing of accounts and disclosure requirements for publicly traded companies are vital to the sound functioning of the internal market, and that new technologies such as electronic reporting formats (e.g. XBRL) should make it possible to meet disclosure requirements economically, efficiently and swiftly; welcomes, with a view to the simplification of the First and Eleventh Company Law Directives, the aim of reducing disclosure requirements; however, underlines that, as with other simplification measures, disclosure requirements should be reviewed on a case-by-case basis by means of concrete, individual simplification measures based on thorough impact assessments; suggests that exemptions for SMEs and micro-entities should focus on reducing administrative burdens and costs, but should not jeopardise justifiable information needs;

Followed by this one:

Agrees that it should be made easier for companies to register and to prepare, file and
publish statutory information; recommends that the preparation, filing and publication of
statutory information should be effected electronically by way of an interoperable
Business Register; strongly promotes the use of new technology such as XBRL;
emphasises that such information should be easily accessible for investors, creditors,
employees and public authorities throughout the European Union;

You can get all the details here..

The SEC Announces. Straight up, with a twist

The SEC’s proposed ruling came out on Wednesday, pretty much in line with what we expected. The bottom line is that all companies will be required to file,including all foreign filers that prepare using IFRS. There is a healthy three-year transition period, with only the largest 500 or so companies coming first. However, there are a couple of surprises in the announcement that are worth thinking about.

Note that there will be another proposed ruling, covering investment funds, next week.

Straight up

Most of the proposed changes are in line with the recommendations of the CIFR Committee. Three year transition, starting with the largest companies. No audit obligation initially – that deserves a blog entry all of its own. At
this early stage of the implementation, accounts in XBRL format will be provided as an additional exhibit and will be "subject to liability similar to that of the voluntary program and, as a result, would be subject to only limited liability". It’s not entirely clear what this means. The voluntary phase has seen materials furnished to the EDGAR system, instead of filed, which means that the liability imposed on companies is fairly minimal. They didn’t say that in the statement on Wednesday, but presumably it will be something similar to "furnished" even if the Staff has decided that wording is inappropriate. In any event, like the audit requirement, I expect that the liability arrangements will have to change over the next 2-3 years, but it is the right thing to do initially.

Here’s an excerpt from the speech given by James Lopez of the Commission, setting out the way that the SEC proposes to phase in the requirements for filing, for all SEC registrant companies.

  • In year 1, the proposed rules would apply only to domestic and foreign large accelerated filers that use U.S. GAAP and have a worldwide public float above
    $5 billion, which we estimate would cover approximately 500 companies.

  • In year 2, all other domestic and foreign large accelerated filers using U.S. GAAP would be subject to interactive data reporting.

  • In year 3, all remaining filers using U.S. GAAP, including smaller reporting companies, and all foreign private issuers that prepare their financialstatements in accordance with IFRS as issued by the IASB, would be subject to the same interactive data reporting requirements.

For all those foreign filers that thought they might not have to worry about XBRL for a while – take note! If you prepare your financials in US-GAAP, XBRL comes early. Note also that the SEC will be encouraging early adoption by companies. Until the analysts start telling companies that the XBRL makes their lives easier, I would be surprised to see very many firms rushing to take them up on that.

The Twist

There were two parts to the announcement that I didn’t expect and would suggest are worth concentrating on. The first is that the Commission is requiring that, as well as providing their XBRL quarterly and annual filings in interactive data as a supplementary exhibit, they propose that companies publish the XBRL materials on their corporate web sites – simultaneously with the provision of those materials to the SEC.

If, like me, you interpret what the SEC is doing with XBRL as acting as a large and particularly effective (and in many respects, a self-interested) catalyst for bringing financial reporting into a new and far more usable era, this move should be read in the same way. In fact, if you heard about Eddy Wymeersch’s speech in Eindhoven last week, you might think that the SEC is contemplating a fairly radical step. Lighting a fuse under a lot of today’s received wisdom. Mr Wymeersch is the Chairman of CESR, the European umbrella body for Securities Regulation. In a speech to the XBRL conference last Wednesday, he suggested a distributed storage mechanism – specifically, company web sites – could be used to facilitate XBRL-based reporting, a step which he described as an essential building block for full and fair pan-European disclosure. Interesting.

The other bit that I didn’t expect was that the SEC is proposing that companies provide XBRL versions of the notes to the accounts, initially in the form of block tagging, which is quite coarse-grained mark-up, but then in companies’ second year of interactive data disclosure, in full: in a very fine-grained manner. To be clear, that means that initially, companies will be free to mark up entire sections of their notes to the accounts with tags that are more or less headings. They will identify the Pension note, for instance, which often runs to pages and pages, as just one block of text and numbers. After a year of doing that, corporates will need to drill down to all of the detail, tagging sections of text and individual numbers that appear within the Pension note, as well as all the other notes to the accounts.

Some commentators have suggested that this will be very burdensome. I happen to think that the next generation of tagging tools, which I expect to be available
before too long, will take most of the pain out of the process. I think that the SEC is trying to ensure that XBRL can eventually replace traditional filings, and, in any event, by ensuring that notes are tagged in detail, they are guaranteeing that the markets will get their hands on the structured data that they really want.

By the way. Once you’ve tagged your financial statements in detail, what’s th marginal cost to publish an earnings release (i.e. market moving data) in that format? What do analysts really, really want in a structured form? Don’t say I didn’t warn you.

A balancing act

The SEC’s announcement is a pretty nuanced one. They’ve approached the topic with a lot of determination from the outset, and they’ll need to keep it up for several more years. However, it really will alter the way that companies think about disclosure and the manner in which those disclosures are analysed. I don’t suppose it will be plain sailing, but it’s a journey that is well worth taking. Sometimes, notwithstanding the tight-rope walk between competing interests that needs to be carefully judged, real leadership, like that which Chairman Cox is displaying here, pays off in a big way. I’m betting this will be one of those times.

Join us today to discuss XBRL next steps…

Register now to listen in later today to a Webinar hosted by FSN, covering "What you should do now" as XBRL heads for mandation in the US and other markets.

Financial systems guru Gary Simon and I will discuss the issues and answer questions posted by attendees. A short sharp thirty minutes. Gary is always worth listening to. You can make your own minds up about yours truly!

IROs shouldn’t look for new jobs just yet…

I see that Dominic Jones is at it again… providing Christmas Cheer to the Investment Relations community. His take on XBRL? It’s unstoppable and will put Investor Relations Officers with a financial background out of a job. I wouldn’t be too sure.

In fact, I think it might have the opposite effect. Why? Let me try and calm a few nerves.

Interactive data makes it easier for analysts and investors to do their work and to do it more thoroughly, but it doesn’t change accounting. Wherever GAAP (or IFRS if you are this side of the pond) provides you flexibility, that flexibility still exists. XBRL doesn’t force you into template reporting.

Companies will still disclose their financials within the accounting rules in force. In other words, the game associated with disclosure will continue: companies that want to be compared to their peers will do their best to make comparison easy. Companies that don’t, will do their best not to. All within the rules you understand.

Of course, some things will change. Companies will largely operate rationally and use the technology in a way that maximises their capacity to communicate with investors and analysts. Specifically that will mean that companies will do two things.

Firstly, In addition to face financials, companies will disclose in XBRL format at least those notes that are "analyst friendly". They might be mandatory of course. The notes to the accounts that everyone knows that analysts want to use in their models: Leasing notes, pension notes, off-balance sheet instruments such as securitized assets or captive finance operations. This is the stuff that analysts use to adjust the published financials in order to make the accounts more comparable with other companies. They are going to do it anyway, let’s make it easy for them. Not providing this type of information in XBRL will simply make it harder to analyse the accounts – making it more attractive to analyse someone else’s.

I imagine that financially savvy IROs will spend a lot of time (a) making sure that these types of XBRL disclosures are being done right and (b) trying to ensure that they are being interpreted correctly.

Secondly, IROs will help their finance teams ensure that the key performance measures contained in the company’s investment messaging are reflected in the accounts. Wherever possible by way of extension taxonomies. If you can link the President’s message about growth in China with compelling performance data that proves the point, you are going to want to. In XBRL. Analysts will happily suck up that information and include it in their models. IROs are going to be involved in helping structure the way certain disclosures are captured in company-specific extension taxonomies. It’s a direct link to investors. Use it.

Remember: XBRL provides more relevant, accurate information in a machine readable format. Better numbers. More data means deeper, more sophisticated models that take into account aspects of company operations that today are often ignored. Expect the sell and buy-sides to have more questions, not less.

Oh, and of course, there will be a pretty lengthy transition period as the investment world gets XBRL-savvy. Two to three Christmases yet before anyone should even begin to contemplate new careers. By that time they might find that they are busier than ever.

Dominic is dead right on part of his message. Should IROs learn to be better communicators and get web savvy, perhaps doing away with their boilerplate web sites? For sure. More on the latter point early in the New Year.

Happy Holidays.

By the way. Not sure what an extension taxonomy is? Visit the great new XBRL-US site to learn.

Review the Future

It’s been a while – the XBRL world is hectic at present, to say the least. This post first appeared a week ago on the Hitachi Blog, run by Bob Schneider and Wilson So (a must read if you are not already subscribed). I’m concerned about the assurance framework for XBRL at the moment, and that’s what this post is all about. You can read more about the topic in a downloadable whitepaper, titled Assurance Considerations for Interactive Data.

Fresh back from the latest international XBRL conference in Vancouver, I think the writing is on the wall. The SEC’s Voluntary Filing Program (VFP), the sandbox that lets registrants furnish their quarterly and annual financial statements in XBRL format in a low risk, low pressure environment to the EDGAR system, is going to close down. Why? Because it is going to be replaced, with mandatory XBRL filings for large corporations toward the end of 2008 or early 2009. All other registrants will follow before long.  The immediate message that all SEC registrants should take away is that now is the right time to participate in the VFP: while it’s still available, still low risk, still low pressure.

Mandatory XBRL filings will undoubtedly involve (no doubt with a short transition) explicit or implied assertions about the accuracy and utility of the financial information contained in them. 

That’s why it is important that financial executives, regulators, and auditors alike work together to determine how XBRL documents can be independently reviewed.

The SEC’s efforts are creating a domino effect, with securities regulators around the world either monitoring what is happening or implementing their own programs. Increasingly, policymakers are seeing this development as a question of national competitiveness. For an admirable analysis of this phenomenon, read the keynote speech made to the conference by Peter Wallison, who serves on the Pozen Committee of the SEC.

Japan’s Financial Services Agency is moving to mandatory XBRL-based disclosures, including the equivalent of earnings releases (made through the Tokyo Stock Exchange) for all listed companies as early as April 2008. One-quarter of Japanese companies are participating in a pilot program – that’s fully 1,000 listed companies.

Contrast this with the few dozen companies, or less than 1% of EDGAR filers, that have participated in the SEC’s VFP program so far. Perhaps the VFP will become substantially more popular at the point that it is crystal clear mandatory filing is on the way, but at present it looks as though the US market is letting slip a great opportunity to get comfortable with this technology. Let me repeat: It’s not too late! Sign up now.

It won’t be very long before it is those documents – the bar-coded financial disclosures – that will be the primary materials consumed by financial market systems to help analysts and investors make decisions about the best way to invest. This is vastly more sophisticated than today’s processes that rely on slow and inaccurate re-keying of a subset of the financial information published by companies.

Is the American market ready? Well, the framework is not far away. Thanks to a Herculean effort by XBRL-US, the new US GAAP taxonomies have just been completed in draft. Public review of these taxonomies is well under way. The software situation is beginning to shake out. The education process for CFOs and IROs has a long way to go, but it is accelerating quickly.

However, there is one area that still really seems to need a kick along: audit and assurance.

While there are a number of committees working on this issue within the audit profession, and the regulators are examining the issues actively, this is an area that needs rapid attention from preparers as well as the broader audit profession. Not just in the US (in fact, all the action is currently stateside) but internationally as well.

First, there needs to be acceptance of something fundamental: XBRL disclosure will require (a small amount of) additional review, above and beyond today’s audit. Suggesting that this step is unnecessary would be a serious disservice to the investing public as well as the professional financial markets. Publishing information in XBRL is more complicated than transforming an existing report into PDF or HTML. It isn’t like today’s EDGARising of existing reports into a specific layout. It involves management making decisions about which "tags" they need to use for which concepts. It is like having a supermarket of goods without bar codes that need to be labelled correctly.

You need to put the bar code for Heinz tomato soup on the Heinz tomato soup can, not the (similar-looking) Heinz potato soup can. Just as in the grocery store, once you’ve selected your bar codes the first time around, the process becomes much easier next time. And, as you’ve guessed, if you can get the manufacturer (in this case, the consolidation or ERP system) to put the bar codes on at source, everything becomes easier again. Whichever way the bar codes are applied, the information that has been marked up this way gains hugely important utility and gives rise to a wide range of efficiencies. Investors are going to rely on these tagging decisions, so they need to be reviewed by someone independent.

To be clear, this isn’t a huge area. There have been a few suggestions from frankly rather badly informed pundits that XBRL assurance will amount to another Sarbanes-Oxley. That is probably a bit mischievous.

What’s really involved? Auditors (and investors) are concerned with identifying areas of risk that might introduce material misstatements into financial statements as a whole. XBRL introduces a small number of new types of risk. First, there is a pretty wide range of basically technical issues that need to be tested. Examples include determining whether the correct date and the correct currency have been associated with concepts being disclosed. Most of these tests can be automated, in part or in full.

While management no doubt can run through these kinds of tests, it would be best if an independent expert also conducted these reviews.

More substantively, there are a number of areas that require professional judgement from an independent expert. These relate to decisions about the manner in which financial statements are marked up, or tagged. Since XBRL encourages companies to create extension taxonomies (i.e., customized definitions about financial concepts being disclosed by particular companies), this is not quite the same as choosing between bar codes of tomato and potato soup. But the analogy is not a bad one. Specific areas that require professional judgment include:

  • Determining whether a company has chosen the correct tag to mark up a specific disclosure.
  • Determining whether a company has correctly decided to extend a taxonomy with a custom definition.
  • Deciding whether a company has associated the right values with its chosen tags.

(As mentioned in the introduction, a lot more detail, some examples, and some tentative recommendations can be found in the white paper I’ve prepared on this topic.)

So what needs to be done? The business community needs to accept that a small incremental piece of audit work is part of interactive data. It is likely to involve some small additional costs at the outset which should be more than offset by a range of savings in the short term.

The "assurance supply chain" community (i.e., the audit profession, its regulators, and its clients) need to identify the tests that should be applied to draft XBRL versions of financial statements. Work needs to be done with securities regulators as well as software vendors to make sure that anything that can be fully automated is automated. And the audit profession and its regulators need to agree on an audit or assurance standard that will govern this kind of work. Most important, auditors then need to be educated in the new procedures. If this education process is not in full swing by the summer of 2008, the "assurance supply chain" might have failed the investors and analysts that it serves.

Please make Tony Fragnito very welcome

It’s a very real pleasure to welcome Tony Fragnito to the XBRL consortium. Tony started in his new role as CEO on Monday, although he attended the international conference last month where he was introduced to the deep end of the pool. Tony brings a formidable set of skills and terrific experience in managing associations. His initial statements about priorities and improvements to the professional capabilities of XBRL International are a breath of fresh air.

Beer from Munich

A month has passed since the Munich XBRL conference and for some reason the slides have not yet been posted. I’ve had a few requests for my talks, so here they are.

Michael Ohata and I gave a joint talk about XBRL International, with my section on the background to and current priorities of the Standards Board. I’m going to write some more about that elsewhere in the near future, but for the moment, here are the slides (PDF).The bottom line is that while we have a terrific community, we still need more volunteer experts who are responsible for XBRL technology inside their own shops, simultaneously working inside the consortium to help improve the level of testing and review that is conducted on modules that cover requirements such as versioning, formula and rendering.

Ralf Frank (who is the very articulate MD of the DVFA) and I co-chaired a day and a half long session on External Reporting. The track brought together professionals that work with business reports from a number of perspectives (exchanges, analysts, infomediaries, credit ratings agencies and the audit profession). I spoke about managing expectations in an XBRL-enabled world. Today the first thing that investors see (and that the entire process is geared around) is EPS. The day you get an entire earnings release marked up in XBRL you can do a lot more analysis than has ever been possible in the past. Sorry about the lack of beer – but I got your attention, didn’t I? Drop me a line if you want to discuss, disagree, or explore.