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Take Shelter: The Perfect Storm is Rising Over XBRL Quality and Corporate Liability

Merrill Disclosure Solutions | November 14, 2013

XBRL Quality Series - The Perfect Storm Heading

The need to verify the quality of your XBRL submissions has ballooned substantially. Now that the training wheels are off for filers and full liability for XBRL-tagging errors is a reality, a crackdown on inadequate XBRL may be imminent. The age of full liability for errors in XBRL financial disclosures is no longer a future possibility: it has arrived. As of September 30, 2013, more than 7,300 public companies in the United States are facing the likelihood of SEC action if their filings are inaccurate because of poor quality in their XBRL tagging.

Take Shelter - The Perfect Storm Is Rising Over XBRL Quality And Corporate Liability

Three factors leading toward a perfect storm.

Three circumstances are converging, making it imperative for companies to ensure that their preparation of XBRL files immediately complies with SEC rules:

Issue One

The liability safe harbor that existed during the first two years has expired for most filers, who are now exposed to SEC or other legal action for disclosures inaccurately made in XBRL.

Critical Issue Two

The US House Committee on Oversight and Government Reform is pressuring the SEC to crack down on the types of XBRL errors that have pervaded many corporate filings to date.

Critical Issue Three

The SEC has developed an analytical tool, the Accounting Quality Model (“AQM”), that searches XBRL-tagged financial statements and automatically flags anomalies for further investigation.

Filers now carry full liability for the quality of their XBRL filings

What does full liability mean for filers? For a start, companies must comply with the SEC's XBRL requirements to be eligible for using short-form registration statements, such as Forms S-3 and S-8. However, the loss of eligibility to use these forms is perhaps the least of the worries faced by filers that fail to comply with the XBRL rules. Companies risk the spectre of lawsuits or SEC comment letters if their XBRL tagging and instance documents are inaccurate. Even for filers still in the limited liability phase (such as IPO companies, for which limited liability ends on October 31, 2014), the SEC could still take action, depending on the circumstances. Limited liability applies only to filers that make a good-faith effort to comply with SEC rules and that promptly correct any failures when they become aware of an error.

XBRL Quality Series - The Perfect Storm - Callout 1

For a long time now, the SEC has been calling out common mistakes in XBRL tagging - and urging filers to be certain they are not continuing to make errors. The SEC staff periodically publishes its observations on common XBRL mistakes. (See the May and June 2012 issues of Dimensions.) In the view of Commission staff, companies should now have both the tools and the awareness to make compliant filings.

Dr. Suzanne Morsfield

“For those who have not taken ownership of their XBRL, the limited liability provisions expire and the XBRL has the same liability as the financial statements,” cautions Matthew Slavin from the SEC's Division of Economic and Risk Analysis, speaking at a March 2013 XBRL And Financial Analysis Conference. Independent experts outside the SEC agree. “If you don't take your XBRL filing as serious as your HTML filing, you are asking for a lawsuit,” warns Suzanne Morsfield, Director of Research at Columbia Business School's Center for Excellence in Accounting and Security Analysis, at the same conference.

Congressional concern over XBRL mistakes puts pressure on the SEC

Some members of Congress are pressuring the SEC to get tough on XBRL mistakes in corporate filings. The loudest and loftiest voice so far has been that of Rep. Darrell Issa (R-CA), chair of the House Committee on Oversight and Government Reform, who expressed his views in a thunderous letter to the SEC in September 2013. Asserting that “the SEC's interactive data filings still contain significant errors, which lead to skepticism about usability of the data,” the letter continues:

Errors in the data and deviations from the designated taxonomy reduce the value of the data, necessitating additional effort to utilize the data for automation. Utilization of the data is limited by concerns of reliability, but the SEC has not issued even one comment letter on any of the more than 1.4 million errors identified.

In conclusion, Rep. Issa insists that the “revolutionary improvements” in financial reporting presented by the use of XBRL “will only occur as the SEC integrates structured data into its existing review processes, enforces the quality of data submitted under the Interactive Data Rule, and articulates a vision for the transformation of its whole disclosure system from inaccessible documents into structured data.”

The SEC is being strongly encouraged to enforce a high standard of XBRL quality and it is in a better position to do so than some observers may realize. The SEC's command of XBRL analytics is becoming increasingly sophisticated, making it more likely that corporate filings with XBRL mistakes will be flagged and reviewed.

XBRL Quality Series - The Perfect Storm - Callout 2

Got XBRL errors? Meet the SEC's Accounting Quality Model

One of the SEC's most important projects in the XBRL area is the Accounting Quality Model (“AQM”), a quantitative analytics tool for reviewing financial statements, using XBRL tagged data as the source. This is the first significant, largescale, live use of XBRL data by the SEC. The AQM-which the business press has ominously nicknamed “RoboCop”- will search for financial statements that seem to contain anomalies and will automatically flag them for review by an examiner.

Craig M. Lewis

The AQM has been developed under the aegis of Craig Lewis, Director and Chief Economist at the SEC's Division of Economic and Risk Analysis. During an interview in the April 2013 issue of Merrill's publication Dimensions, Dr. Lewis, also a professor at Vanderbilt University, discussed details of the AQM and about the role of XBRL in this application. In a keynote address to the 2013 XBRL US National Conference in September 2013, Dr. Lewis explained that the AQM is a structured analytic model that “takes filer information and identifies outliers. In my initial vision for how this tool would be used, I saw it as a tool that could be primarily used by the Division of Corporation Finance to assist in their review process. I also think that it has applications for enforcement.”

XBRL Quality Series - The Perfect Storm - Callout 3

How can public companies avoid the AQM's eagle eye? “I would say, check your work,” Dr. Lewis told Dimensions in the April 2013 interview, and continued:

If you make a mistake in how you record an element, that would affect the score you get from the model and might make you more likely to be pulled up for a review - I would argue, correctly so. The model will tell the reviewer which factor was contributing to the score, and if one factor comes out and has a large impact on the score and can be traced back to a recording error in the XBRL data, you will be flagged because you made a mistake in providing us your XBRL data.

Shelter from the storm: careful preparation is key for liability prevention

Lou Rohman

The first line of defense for liability prevention is, obviously, to get the XBRL tagging right during the initial preparation of the filing. “Many steps are involved to make sure that the XBRL files are conveying the same message as the traditional financial statements, including proper tag selection, accurate structuring of those tags, and appropriate entry of amounts in the XBRL instance document,” observes Lou Rohman, Vice President of XBRL Services at Merrill Corporation. (See Liability For XBRL Filings in the August 2012 issue of Dimensions.)

Even more critical in preventing errors is realizing that there are many types of serious mistakes which cannot be detected by software. To find those problems, it is critical to have experts check over XBRL instance documents. It bears repeating: Many serious mistakes in XBRL cannot be detected by software alone. Since it is the filer that bears the eventual responsibility and culpability for accuracy, it is important that companies seek assurances about the quality of their tagging and verification of its accuracy. XBRL submissions in which Merrill is involved are all prepared or reviewed by consultants who are experienced CPAs with in-depth XBRL knowledge. These consultants understand the intricacies of XBRL and the SEC rules, and are able to apply that expertise to XBRL documents. Merrill's unique expertise allows filers to move forward with confidence, knowing that their XBRL filings do not contain the errors that are being received by the SEC.

Merrill experts work in teams, and each team has several seasoned members available to help. The team reviews each file to ensure that the tagging is consistent with the current XBRL taxonomy. The experts also investigate essential items, such as every calculation inconsistency to ascertain its validity; document their review at each stage, to ensure that common errors are detected; and provide training and education for personnel at the filer/company, equipping corporate staff with insight on how to accomplish quality XBRL documents.

Expect SEC action

It is of course impossible to say when the SEC will start singling out sloppy XBRL filers and issuing comment letters or taking other actions over poor XBRL quality. Nobody can predict the regulatory weather at the SEC. However, the clouds of a perfect storm over XBRL quality and corporate liability seem to be gathering. Now is the time for managers to seek shelter. No one wants to be the first executive whose name appears in headlines, called out by the SEC.


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