The news release states that the committee "will study the causes of complexity and recommend to the SEC how to make financial reports clearer and more beneficial to investors, reduce costs and unnecessary burdens for preparers, and better utilize advances in technology to enhance all aspects of financial reporting."

Christopher, you know as well as I do that complexity is not the central problem of financial reporting. It is the lack of integrity. Any investor who has real money in the game would prefer complex, truthful financial statements to simple ones riddled with deceit, including those with the white lies of exaggeration and omission.

The chairman named a stellar group of 17 individuals to this committee, including Denny Beresford, Michael Cook, Edward Nusbaum, and James Quigley. Unfortunately, they mostly represent the interests of preparers and auditors. Only four members represent the interests of the investment community; they are Jeffrey Diermeier (CFA Institute), Scott Evans (TIAA-CREF), William Mann (Motley Fool), and the committee chair Robert Pozen (MFS Investment Management).

I would have thought that an agency that purportedly looks after investors would have selected more investor-friendly professionals to examine these issues. The other members are quite capable, but they represent interests that at times may compete with investors -- especially managers and directors who are evaluated by these disclosures.

Chief Accountant Conrad Hewitt spoke at the committee's first meeting on Aug. 2 of this year. He begins with the same claptrap as Cox, "… it has become increasingly apparent to me that the current system has become overly complex." If Cox and Hewitt insist on spinning the agenda this way, they at least should acknowledge the two major causes of the complexity in financial reports: (1) the complexity of today's transactions especially those involving financial instruments and (2) the purposeful obscuring of reporting the economic substance of transactions so that the management team looks better than it otherwise would either in the current report or in future reports.

Hewitt later at least acknowledges that there are several classes of investors with varying needs. He calls them individual investors and market analysts and other investment professionals. I still prefer the terms in academic literature: naïve and sophisticated investors; after all, some individual investors are quite sophisticated and some investment professionals are not quite as sophisticated as they claim to be. Hewitt correctly points out that their needs are different, but incorrectly specifies what those differences are.

Hewitt postulates that naïve investors "may be interested primarily in summarized, plain-English reports that are easily understandable." I would refer him and committee members to the writings of Bill Beaver, accounting professor at Stanford, beginning with his 1973 article in Journal of Accountancy, "What Should Be the Objectives of the FASB?" I shall quote it at length because Professor Beaver challenged this seemingly popular perspective so lucidly.

"The FASB [and I would add SEC] must reconsider the nature of its traditional concern for the naïve investor. If the investor, no matter how naïve, is in effect facing a fair game, can he still get harmed? If so, how? The naïve investor can still get harmed, but not in the ways traditionally thought. For example, the potential harm is not likely to occur because firms use flow-through v. deferral for accounting for the investment credit. Rather, the harm is more likely to occur because firms are following policies of less than full disclosure and insiders are potentially earning monopoly returns from access to inside information. Harm is also likely to occur when investors assume speculative positions with excessive transactions costs, improper diversification and improper risk levels in the erroneous belief that they will be able to ‘beat the market’ with published accounting information.

"This implies that the FASB should actively discourage investors' beliefs that accounting data can be used to detect overvalued or undervalued securities. This also implies that the FASB must not attempt to reduce the complex events of multimillion dollar corporations to the level of understanding of the naïve, or, perhaps more appropriated labeled, ignorant investor. We must stop acting as if all -- or even most -- individual investors are literally involved in the process of interpreting the impact of accounting information upon the security prices of firms."

In short, an SEC advisory committee that researches today's financial reporting system may be useful, but not if it focuses primarily on complexity. Professor Beaver correctly pointed out that many investors lose when insiders, such as managers and directors, earn monopoly profits from acting on information that others are not privy to. In my words, the investment community loses when managers and directors act without integrity by failing to fully and accurately disclose the results of corporate operations. If the SEC advisory committee wants to do something useful, it should focus on how to add integrity to the financial system so that investors are really facing a fair game.

This essay reflects the opinion of the author and not necessarily the opinion of The Pennsylvania State University.