financial transparency and reform: dodd-frank, ifrs, and xbrl

7/27/2019 Financial Transparency and Reform: Dodd-Frank, IFRS, And XBRL

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Financial Transparency and

Reform: Dodd-Frank, IFRS, andXBRL

David Blau, George Mason University School of Public Policy, November 2013



Financial Regulation in the United States

The first regulation in securities markets was motivated by the fear that companies would, in the

absence of government oversight, manipulate financial information as needed to increase the value of

their issued securities, and obtain investor financing, at the detriment of the public investor. After the

stock market crash of 1929, the United States government felt it needed to restore trust in corporate

America. The Securities Act of 1933 required that companies that wished to obtain equity financing by

“issuing” (selling) a security (piece of ownership) had to file financial statements that adhered to a set

of guidelines.1 Generally Accepted Accounting Principles (GAAP), the accounting standards and rules

by which companies must issue their financial statements to prospective investors, took on added

importance because of the need for specific rules to minimize the opportunity for management

manipulation of financial information motivated by their self-interest in reported economic position.

The Banking Act of 1933, also known as the Glass-Steagal Act, prohibited commercial banks

from most securities trading and most affiliations with securities firms. Oversight of these regulations

fell under the responsibility of the newly created Securities and Exchange Commission (SEC), tasked

with protecting investors, maintaining fair, orderly, and efficient markets, and facilitating capital

formation.2

The American Institute of Certified Public Accountants (AICPA) was the only rule-making and

oversight body for accounting rules, which it developed out of common professional practices. This

continued until 1973, when the SEC established the Financial Accounting Standards Board (FASB).

1 Carpenter, David H.; Murphy, M. Maureen (2010a), "Permissible Securities Activities of Commercial Banks Under the

Glass –Steagall Act (GSA) and the Gramm-Leach-Bliley Act (GLBA)", Congressional Research Service Report (R41181),

retrieved February 10, 2012.

2 Ibid.

http://assets.opencrs.com/rpts/R41181_20100412.pdf










The FASB is now the main rule-making body, and whenever there is an AICPA rule that the FASB has

not since contradicted, it can be treated as equally authoritative. Laws enacted by Congress or

pronouncements by the SEC are given equal authority.3

The AICPA retained some critical oversight roles after 1973. These included financial

statement auditing: performing a set of empirical tests as an independent third party to verify the

accuracy of financial information, often in statements on which public retail investors would rely to

make investment decisions. This continued until accounting scandals at large, publicly-traded

American companies Enron and WorldCom motivated the passage of the Sarbanes-Oxley Act of 2002.

Sarbanes-Oxley created the Public Company Accounting Oversight Board (PCAOB), tasked with

oversight of financial statement auditing, placing it under government oversight for the first time.4

The Great Recession

Repressed interest rates, the housing mandate by the Federal Housing Administration, and

pernicious mortgage lenders like Countrywide contributed to an explosion of underserved home

mortgage loans. The Gramm-Leach-Bliley Act of 1999 repealed the Glass-Steagal Act, and allowed

blending of the line between commercial retail banking and securities trading.5 As a result, banks were

able to securitize these mortgages, creating a tradeable commodity based on the value of a collection of

“slivers” of underlying home mortgage loans dependent on mortgage payments for their value, and

then to use investor capital to speculate on these highly-volatile investments. Credit default swaps

were another speculative financial innovation, essentially providing insurance against mortgage-backed

3 “The Hierarchy of Generally Accepted Accounting Principles: Statement of Financial Accounting Standards No. 162,

Financial Accounting Series.” Financial Accounting Standards Board. May 2008. pg. 1-2

4 “About the PCAOB.” http://pcaobus.org/About/Pages/default.aspx Retrieved August 15 2013.

5 Johnson, Simon and Kwak, James. 13 Bankers: The Wall Street Takeover and the Next Financial Meltdown. (New York:

Vintage Books, 2010). pg. 89

http://pcaobus.org/About/Pages/default.aspx





securities, and also widely-held and highly-volatile. When interest rates inevitably rose, defaults

accelerated, and the investments depreciated quickly.6 However, such investments were not explicitly

covered under the disclosure requirements of the current regulatory structure: Generally Accepted

Accounting Principles (GAAP), the Securities and Exchange Commission (SEC), and legislation

passed by Congress, including the Sarbanes-Oxley Act.

Credit rating agencies, responsible for rating the financial stability of mortgage lenders and

mortgage-backed securities as well as larger financial institutions that invested in these securities,

received revenue from the mortgage lenders and banks for other services, in a clear conflict of interest.7

They continued to rate these institutions and investments as safe, even as their value plummeted.

Eventually, the truth came out as to how worthless these positions were, and banks with large

investments in them experienced a panic that led to the Great Recession.8 Economic crisis decreases

national competitiveness and adversely affects both the US trade balance and the aggregate activity of

world trade. Financial reform is a trade issue, among other things.

The Dodd Frank Wall Street Reform and Consumer Protection Act

The Congressional response, the Dodd Frank Wall Street Reform and Consumer Protection Act

(Dodd-Frank), signed into law July 21, 2010, is the largest overhaul of the regulatory apparatus for the

financial system since the Great Depression. Its stated objectives are, “To promote the financial

stability of the United States by improving accountability and transparency in the financial system, to

6

Mason, Joseph. “The Summer of 2007 and the Shortcomings of Financial Innovation.” Journal of Applied Finance, Vol.18, No. 1, Spring/Summer 2008. This paper provides a thorough, readable, technical background of the causes of the

financial crisis. pg. 12

7 United States Senate, Permanent Subcommittee on Investigations, Committee on Homeland Security and Government

Affairs. “Wall Street and the Financial Crisis: An Anatomy of a Financial Collapse” (April 13, 2011) Retrieved January 15,

2013. http://www.hsgac.senate.gov//imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf?attempt=2

8 Mason, Joseph. “The Summer of 2007 and the Shortcomings of Financial Innovation.” pg. 12

http://www.hsgac.senate.gov/imo/media/doc/Financial_Crisis/FinancialCrisisReport.pdf?attempt=2





end ‘‘too big to fail,’’ to protect the American taxpayer by ending bailouts, to protect consumers from

abusive financial services practices, and for other purposes.”9 Dodd-Frank is comprised of sixteen

“Titles” (sections).

Dodd-Frank at a Glance10

Bold: Critical Issue to Monitor

Italics: New Regulatory Agency

Title Name What does it do?

Title I Financial Stability Creates the Financial Stability Oversight

Council and Office of Financial Research,tasked with oversight of all financial regulatory

agencies and chaired by the Secretary of theTreasury. Is the expansion of the regulatory

apparatus the solution?*

Title II Orderly Liquidation Authority Increases FDIC insurance from $100,000 to$250,000. Establishes a new fund within FDICfor liquidation of troubled financial institutions.Expands the definition of “Covered Financial

Companies” eligible for liquidation.

Establishes approval process in Bankruptcycourt of Delaware for placing banks intoreceivership. Overall, this increases the

availability of bailout funds. Does this

increase the moral hazard that contributed

to the last crisis?

Title III Transfer of Powers to the Controller, the FDIC, andthe Fed

Abolishes the Office of Thrift Supervision,spreading its responsibilities between the Boardof Governors of the Federal Reserve, the FDIC,

and the Office of the Comptroller of theCurrency.

Title IV Regulation of Advisers to Hedge Funds and Others Increases the disclosure requirements forRegistered Investment Advisors (including but

not limited to Hedge Funds). Narrows thedefinition of “accredited investor” (one not

requiring full disclosure, because of a presumption of financial knowledge).

Title V Insurance Establishes the Federal Insurance Office withinthe Department of the Treasury, tasked with

oversight of the insurance industry.

Title VI Improvements to Regulation Establishes the “Volcker Rule”: banks may not

speculate with investor capital. How will

allowed/forbidden entities and investmentsbe strictly defined? How will positions be

monitored and enforced? Will this hinder

banks’ abilities to invest, hedge, and deliver

9 United States Congress. (2010). The Dodd Frank Wall Street Reform and Consumer Protection Act. H.R. 4173. Retrieved

November 18, 2012 from http://www.sec.gov/about/laws/wallstreetreform-cpa.pdf

10 Ibid.

http://www.sec.gov/about/laws/wallstreetreform-cpa.pdf






returns?

Title VII Wall Street Transparency and Accountability Previously over-the-counter “swaps” and

derivatives, like credit default swaps, arerequired to pass through a regulated exchange.

Can the government require disclosure of

public and private data from private

exchanges to data warehouses? Who can

apply to be a data warehouse, and are they

allowed to profit from the data? (both arequestions in a lawsuit from the Chicago

Mercantile Exchange Group) Title VIII Payment, Clearing and Settlement Supervision Tasks the Federal Reserve with establishing

uniform risk management requirements for“systemically important payment, clearing, and

settlement activities.” What will the

requirements be? What will the penalties

and enforcement mechanisms be? What

effects will they have on return, and will they

effectively reduce risk?

Title IX Investor Protections and Improvements to theRegulation of Securities

Aims to prevent regulatory capture within theSEC with the creation of the Office of the

Investor Advocate. Increases enforcementremedies, disclosure requirements for asset-

backed securities and credit rating agencies, andnumerous other provisions. Does creating

another capture-able agency eliminate the

threat of regulatory capture?*

Title X Bureau of Consumer Protection Creates the Consumer Advisory Board .

Regulates consumer financial products andservices, with enforcement authority.

Title XI Federal Reserve System Provisions One-time Audit of the Federal Reserve byGovernment Accountability Office, new

position of Vice Chairman serves as riskcontroller, more explicit standards for entities

regulated by Federal Reserve roughly outlined, but largely to be determined. Given the

expansion of scope and funding for the

regulatory apparatus, should there be a

mechanism for regular audits (oversight) of

the Federal Reserve, not just a one-off? With

regards to the Fed’s standards for regulated

entities, see questions for Title VIII. Can

these standards be crafted to address the

questions raised by Title II?

Title XII Improving Access to Mainstream FinancialInstitutions

Provides for various incentives to lend to lower-income consumers. Is this consumer credit

mandate similar to the one that contributed

to the last crisis? Title XIII Pay it Back Act Reduces funds available for Troubled AssetRelief Program by $225 billion to $475 billion.

Title XIV Mortgage Reform and Anti-Predatory Lending Act Within the Bureau of Consumer Protection,establishes uniform standards for data collection

by underwriters of mortgage loans, and thatmortgage originators only lend to borrowers

likely to repay their loans.

Title XV Miscellaneous Provisions Various reports ordered, including oneffectiveness of Inspectors General.

Title XVI Section 1256 Contracts Ensures that derivatives brought onto exchanges



by Title VII are exempt from Sec. 1256treatment under the IRS, which would have

meant tax penalties for hedging (riskmanagement).

*: these questions are related to each other (Title I and IX) and will be discussed below

Dodd-Frank is the product of the view that the regulatory failure of the last financial crisis is the

result of a lack of a sufficiently coordinated and robust framework. Whether this is true or not, it fails

to address the issue of regulatory capture, that regulators will be captured by the interests of the

industry they are supposed to regulate, making their efforts at reform simply kabuki to get reelected, or

reappointed, or hired by the same entities they are supposed to regulate after they leave the regulatory

agency.

The stock market crash in 1929 and the Great Depression inspired the Securities Acts and the

creation of the SEC. The AICPA maintained its chief rule-making authority until the creation of the

FASB in 1973. It still maintained its oversight of auditing of financial statements of publicly-traded

companies until the Enron and WorldCom scandals and the bursting of the dotcom bubble inspired

Sarbanes-Oxley and the creation of the PCAOB in 2002. The regulatory apparatus has a tendency, like

some generals, to (perhaps sometimes wittingly) want to fight each war like the previous one.

Legislation motivated by the most recent crisis addresses well the causes of the previous meltdown, but

fails to anticipate the causes of the next one. The only way to do that would be for financial

information to be far more timely, robust, and cheap than it is now, and to be more publicly available.

Regulatory capture is more likely, and more likely to be dominant, in a traditionally self-

regulated, highly-skilled market, which perfectly describes the market for accounting and financial

information.11 Regulation was long the sole domain of the AICPA, a private professional society.

Kenneth Button notes the work of George Stigler and Richard Posner; that the limitation of regulation

11 Button, K.J. “Cost Recovery in Transport: An Introduction.” Journal of Transport Economics and Policy Vol. 39 (3), pg

250.



in these markets is that it is frequently captured by the industry under regulation, “the regulatory body

that had a vested interest in avoiding excessive confrontation. The industry had control over cost

information, and there was no incentive to keep costs down when any increase could be passed on to

customers.” In the case of the accounting industry, these cost increases could be passed to consumers

initially indirectly, through encouraging investment in overvalued securities; and later directly, through

bailouts. “Combating this was difficult for the authorities who, in any case, had minimal incentive to

be too robust in their application of the rules because the appearance of high complexity (or “really

tough” reform) justified larger bureaucracies.”12

Dodd-Frank justifies a larger bureaucracy through highly complex rules, but does nothing to

guarantee robust application or enforcement of those rules. Referring again to the airline industry,

Button remarks, “In some cases workers or suppliers of inputs further exploited this because they knew

there was no incentive for management to fight input cost increases.”13 This can be applied to the

moral hazard of financial institutions making risky bets with meaningless cost information, because

they knew they would be bailed out. It also illustrates, through a pointed example of asymmetric

information, how inefficient the market for financial information is. The central question is how to

enable regulators to regulate efficiently and effectively. How can they have real-time access to

transparent data, cheaply, while making that data available to the entire public, including those lacking

technical backgrounds in accounting, finance, or information technology? Open government data in

this area is critical to educated and active democratic participation, and acts as a necessary check for

12 Ibid. pg. 50

13 Ibid. pg. 50



the public against corruption.14 The answer is decreasing the costs of providing and obtaining accurate

and timely financial information.

What Are Our Competitors Doing? Comparable Legislation in the European Union, United

Kingdom, and China

For the most part, developed countries are attempting to institute changes to financial regulation

very similar to Dodd-Frank. In the European Union (EU), the European Market Infrastructure

Regulation moves swaps onto regulated exchanges. The Markets in Financial Instruments Directives (I

and II) provide for oversight of derivatives and investor protections. The Capital Requirements

Directive and Legislation (CRD IV) is similar to the Volcker Rule. In the United Kingdom, the

“Vickers Report” is essentially the same as the Volcker Rule.15 In China, regulators are instituting

capital adequacy ratios in line with their own version of Basel III, and providing for more investor

protection.16

According to the World Bank’s “Financial Sector Assessment for China,” published on

November 14, 2011, the regulation of China's financial system still needs to be improved "to ensure it

is suited to the challenges posed by a rapidly evolving financial sector." The report suggests that a

14 See Bertot, John C., Jaeger, Paul T., Grimes, Justin M. “Using ICTs to Create a Culture of Transparency: E-Government

and Social Media as Openness and Anti-Corruption Tools for Societies.” John C. Bertot, Paul T. Jaeger, Justin M. Grimes.

Government Information Quarterly, Vol. 27, 2010, pg. 264-265. “Transparency ultimately serves to keep government

honest—“Good government must be seen to be done.” In terms of international practices in transparency, the Internet

has greatly reduced the cost of collecting, distributing, and accessing government information. As a result of these

capacities, recent years have seen trends toward using e-government for greater access to information and for promotionof transparency, accountability, and anti-corruption goals… In each of these areas, the provision of information to citizens

and the ability of citizens to monitor the activities of the government play an important role, both key areas in which e-

government and other ICTs can be used to battle corruption. The influence of culture often makes social change the

largest challenge in openness and anti-corruption initiatives.”

15 Shearman and Shearman. (2012). Dodd-Frank, UK, EU & other Regulatory Reforms. Retrieved December 9, 2012 from

http://www.shearman.com/dodd-frank/.

16 Lakyara. (2012). Financial Regulation in China After Upcoming Leadership Transition. Retrieved December 9, 2012 from

http://www.nri.co.jp/english/opinion/lakyara/2012/pdf/lkr2012130.pdf .

http://www.shearman.com/dodd-frank/


http://www.nri.co.jp/english/opinion/lakyara/2012/pdf/lkr2012130.pdf






permanent Financial Stability Committee be established in China to consolidate supervision across the

industries, which Dodd-Frank does for the US. It also recommends that Chinese regulatory agencies

have access to increased resources as their responsibilities expand, implying that the current regulatory

structure in China needs expansion. In China, there are rules providing for client confidentiality that

could make it difficult to comply with the US plans for registering every swap transaction.17 This

raises an additional critical issue: how to deal with jurisdictional synchronization with the various

requirements of Dodd-Frank with countries with differing regulation. Chinese banks lack a legal

framework underpinning banks' activities. Surveillance has been established, but more attention needs

to be paid to illegal investment activities, hedge funds, and private equity funds, according to the World

Bank report. An inferior financial regulatory system can have adverse effects on attracting foreign

investment, because of a lack of confidence in corporate governance and arms-length. The latter area,

according to this report, is one where the US will likely maintain competitive advantage relative to

China in the near-term.

IFRS versus GAAP: One Small Piece of a Plan for US Competitiveness in Financial Regulation

The most striking difference between financial regulation in the US and in other countries,

including China, is between GAAP and the International Financial Reporting Standards (IFRS), a

different set of accounting rules required for submission of audited financial statements of publicly-

traded companies. Where GAAP is a rules-based system, IFRS is more principles-based. In GAAP,

specific rules adopted by the AICPA or FASB are interpreted literally. Requirements are specific and

court decisions rely on literal interpretation of the rule. The GAAP approach to ensuring investors’

rights have been preserved has been to have legal requirements for regulatory compliance be

17 Financial Sector Assessment Program. (2011). China Financial Sector Assessment . Retrieved November 25, 2012 from

http://www.worldbank.org/content/dam/Worldbank/document/WB-Chinas-Financial-SectorAssessment-Report.pdf .

http://www.worldbank.org/content/dam/Worldbank/document/WB-Chinas-Financial-SectorAssessment-Report.pdf





interpreted as strictly as possible, in order to prevent management manipulation of financial

information given to investors. The flaw, illustrated by the most recent financial crisis, is that

transactions for which there is no law or rule specifically naming them are exempt from these

requirements. Unlisted transactions not explicitly covered by specific rules from the AICPA, FASB,

PCAOB, or SEC are not the responsibility of those regulatory agencies. The legislative process and

regulatory agencies have not been able to keep pace with new financial innovation, and the result is the

failure of the preexisting regulatory apparatus to anticipate the financial crisis.

IFRS is a more principle-based system than GAAP. Emphasis is placed on abstract objectives,

rather than specific rules. As a result, IFRS is simpler than GAAP, with less emphasis on explicitly-

covered transactions. GAAP is more than 25,000 pages, while IFRS is 2,500 pages. Guidelines in

IFRS are more easily applied to a variety of situations. Because it prioritizes basic goals of clarity,

veracity, and most of all, versatility, without requiring that a specific transaction type be named, IFRS

can lead to more stringent reporting requirements for unlisted transactions. This allows the regulatory

framework to adapt to new financial innovation to require accurate and fair disclosure and oversight,

without the need to pass a new accounting pronouncement as quickly as new types of securities are

being invented. The SEC has proven that keeping pace with financial innovation is difficult for them,

and thus the political and practical appeal of an incorporation of IFRS standards into the US system is

clear.

In 2008, the SEC identified the areas designated as high-priority in the process of reconciling

US GAAP with IFRS. These included the classification and measurement of complex financial

instruments. Standards development began, but was considered less critical, in insurance contracts,

consolidation of separate corporate entities, financial statement presentation, and financial instruments



with equity-like characteristics, all of which are relevant to the recent financial crisis.18 In this 2008

report, the SEC argued that compliance would be more effective after IFRS convergence. If financial

statements are more comparable across countries, the US remains competitive with other countries for

attracting foreign investment. Firms will thus be able to raise capital more cheaply.

19

However; in 2012, convergence had not moved much further. SEC Chief Accountant James

Kroeker, who oversaw the SEC’s two-year study to provide a plan for convergence, resigned the day

before the report for this study was released. The plan shows reluctance to implement IFRS treatment

on a number of issues. Part of the reason for the lack of progress is illustrative of the drawbacks of

IFRS. The gap between treatment on gains and losses on derivatives (relevant to the most recent

financial crisis in monitoring bank positions in CDO's and similar instruments) in IFRS and GAAP is

particularly large.20 IFRS allows for more creative management manipulation of financial results than

GAAP in certain situations. This is because, while IFRS avoids the need to cite specific transactions,

more interpretation is allowed in crafting one’s own financial results. Comparability for a more casual

investor could be adversely affected. Dr. Teri Yohn of Indiana University testified to Congress that

investors prefer GAAP to IFRS, and that IFRS provides greater opportunities for earnings

management.21 The initial political appeal of IFRS following the financial crisis has disappeared.

Unfortunately, no simple political false dichotomy where GAAP represents the greedy American Wall

Street bankers, and IFRS is the way of the new progressive international community, applies.

18 PriceWaterhouseCoopers. (October 2011). IFRS and US GAAP: Similarities and Differences. 19 Ibid.

20 Selling, Tom. (November 18 2012). The IASB’s Stages of Grief. The Accounting Onion. Retrieved December 9, 2012

from http://accountingonion.typepad.com/theaccountingonion/2012/11/the-iasbs-stages-of-grief.html.

21 Yohn, Teri. (October 24 2007). International Accounting Standards: Opportunities, Challenges, and Global Convergence

Issues. Retrieved November 29, 2012 from

http://grovesite.com/GSLibrary/Downloads/download.ashx?file=sites/4/7280/212568/TYohn10242007.pdf.

http://accountingonion.typepad.com/theaccountingonion/2012/11/the-iasbs-stages-of-grief.html






A blend of the two approaches is most appropriate. The SEC has been trying to achieve this

without much success. The only area where IFRS treatment is clearly preferable is in the area of these

unlisted transactions, especially those that pose a risk to the greater economy. But how does the SEC

detect which unlisted, unknown transactions are dangerous to the economy as a whole? IFRS would

provide for oversight only after the problem had become painfully clear. It is only one piece of a

solution. Analyzing the differences in treatment between the two systems is an important task for

regulatory awareness. The problem of synchronization of regulatory approaches across countries is a

big one. The World Trade Organization does not provide for a global accounting authority. Even

IFRS, used in a number of countries, is adapted to suit each country’s needs and is as a result not

perfectly comparable to each of its own variations.

The issue is how to ensure that reported financial and accounting data accurately represent

economic position. How can we make that data available in real-time, at a much cheaper cost, to

regulatory agencies and the public, to provide transparency into the financial positions of not just

financial institutions, but all publicly-traded companies, and the regulatory agencies themselves? The

critical mass of a crisis can be the key to reform and improved competitiveness. How can the US

government best promote democratic accountability, critical to competitiveness and the public trust

required for a democratic system to function? Government’s relationship with civil society will be

important. Authoritarian mandates without consideration of the political marketability of the message

will fall on deaf ears. A successful approach has to be embraced by all stakeholders, investors,

consumers, private firms, and the government. Such a technology that satisfies these myriad

requirements already exists, and is being used much more widely in China and Japan, by all

stakeholders, than in the US.



The Root of the Problem: The Financial Reporting Process, and the Solution: Extensible

Business Reporting Language (XBRL)

Financial reporting today consists largely of paper documents. PDF and paper submissions for

regulatory filings do not easily permit interchangeability across one another, and cannot be

automatically read by computers. This even applies to many electronic formats, because these formats

are proprietary, and derive much of their value (and cost) from their incompatibility with other file

types. Data must be re-entered manually each time into a consistent format, be it for regulatory

purposes, internal private firm or government agency efficiency, or evaluation by the public. The data

entry of the report may need to be repeated several times. The potential for manual error grows with

each repetition of the process. There is a resulting time lag needed to disseminate financial data for

regulators to ensure compliance, and for the public to view it. The manual dissemination of the

financial data away from its format in order to make it more widely usable also removes meaningful

context, the supporting information, from that data. Determining “how and why” for a number

involves going back to the original document and hoping that enough information was bundled with it

and is not locked into the originating program, far away from the end-user.

The current financial reporting process involves several stages of costs that add no value. These

contribute greatly to both the oft-cited “costs of compliance” for firms, as well as the costs of oversight

responsibility for regulatory agencies. The requester of information must gather, document, and format

its requirements before sending. After sending, there is a need for clarification for the responder from

the requester. Eventually, this back and forth leads to the responder gathering data from disparate

sources with varying levels of detail, verifying and reconciling that data, summarizing and formatting it

before sending it to the requester. The process can be repeated several times back-and-forth for the

same original request as manual processes and systems do not interface, making reconciling

compliance a clumsy task. Financial reporting requirements have been a series of disconnected one-to-



one transactions, where for each new reporting requirement, the process must be repeated. Many

agencies have their own systems for submission of required information, but then convert it manually,

negating any advantage of automation.22

The inability of the SEC to anticipate the risk of bank positions with mortgage-backed securities

was partly because ensuring accurate and timely compliance of financial statements had grown too

complex and time-consuming using paper documents with their limited manpower and budget. The

SEC provides the most direct link between the inability of organizations, be they regulatory agencies or

private companies, to quickly assess accurate financial information, and the damage that failure causes

to the economy and public trust, but there are other examples. The Internal Revenue Service estimates

that the tax gap is roughly $350 billion per year. The most recent estimate dates from 2001. The ten-

year delay in estimates is due to the difficulty in processing disparate formats of data and in obtaining

an accurate picture of corporations’ true economic position and accounting data.23

XBRL

Extensible Business Reporting Language (XBRL) is a standard for electronic formatting of

financial data. XBRL makes financial data more trustworthy and timely. XBRL is a universal open-

source language, as opposed to proprietary software. XBRL is a standardized means of representing

financial and accounting data, creating a unified framework for that data as it moves from system to

system. Creators of the XBRL standard have sought input in its development from a wide range of

stakeholders, including those who could be sensitive to such disruptive change. Encouraging the

collaboration of those stakeholders is critical to encouraging diffusion of the standard, which is critical

22 Financial Information Sharing Subcommittee: American Council for Technology and Industry Advisory Council (February

2007). Transforming Financial Information: Using XBRL in Federal Financial Management . Retrieved December 9, 2012

from http://www.xml.gov/documents/completed/iac/xbrlwhitepaper.pdf .

23 Internal Revenue Service. (2011). The Tax Gap. Retrieved December 2, 2012 from http://www.irs.gov/uac/The Tax-

Gap.

http://www.xml.gov/documents/completed/iac/xbrlwhitepaper.pdf



http://www.irs.gov/uac/The%09Tax-Gap








to the US reaping its benefits. Academics, PriceWaterhouseCoopers and Microsoft, government

agencies, the Organization for Economic Cooperation and Development and the AICPA have all been

instrumental in establishing XBRL as a standard, and any interested individual can offer input.24

XBRL development is an example of a new evolution of civil society; the organic communities of the

open-source online space, where participation and insight into the development of the technology is

free to anyone. Global collaboration has been much more productive and communal in XBRL than in

IFRS or regulation. The goal of XBRL is the democratization of accurate, real-time information, and

ensuring that it more clearly represents economic position. This is the key to making regulators more

effective and efficient. It would help restore public trust if applied to the financial system and to

governmental accountability.

XBRL attaches semantic meaning, like business reporting unit, location, and chart of account

type within the general ledger taxonomy, the most critical accounting definitions, to numerical data.

XBRL embeds the meaning and importance behind an accounting number into any format, according

to a common “dictionary.” The “metadata” contained in the semantic meaning contains descriptive

labels, definitions, and links to authoritative guidance. This gives automated systems context, allowing

programs to automatically sort data by type, like industry or revenue, across datasets, rather than

viewing them as no more than a string of digits (which requires manual reentry). This makes it easier

for organizations to obtain and use data from one another quickly, which in turn makes it easier to

quickly verify the accuracy of the data. In XBRL, the most useful economy of scale comes from

increasing the productivity of information processing, which results in a massive decrease in the costs

of information, a welcome improvement to the current financial reporting process.

24 Kernan, Karen. (2009). The Story of Our New Language: Personalities, Cultures, and Politics Combine to Create a

Common, Global Language for Business. American Institute for Certified Public Accountants. Retrieved November 18,

2012 from http://dx.doi.org/10.1080/10196780500303029.



With XBRL, a company can use one open-source technology for an entire audit trail, reporting

to any outside agency, internal management, forecasting and statistical analysis, including metrics on

business operation and social responsibility reporting, all from the same set of data. But, the key is that

the data has to originate with XBRL “tags.” Microsoft has already built the functionality into MS

Excel. XBRL filing data for all publicly-traded companies is available free of charge on the SEC's

EDGAR database, but requires knowledge of computer science techniques that automatically pull and

compile the data. Calcbench (Calcbench.com) and 9W (9Wsearch.com) are the initial startup

applications meant to enable anyone, including those lacking any technical computer science

background, to use the technology to view financial data from SEC filings much more quickly, with

built-in functionality for data analysis and business intelligence metrics, but these last two elements

remain underdeveloped. The next steps would be adoption of XBRL at such a widespread level that

cheap, real-time, automated updates of financial data would be enabled, along with analytics for fraud

detection for both corporations and government agencies, cost-benefit/net welfare analysis and social

metric reporting for government agencies and nongovernmental organizations, and other macro and

micro-economic research, including that to be gained by combining XBRL with other large data source

application programming interfaces.

XBRL allows for easier automated report generation and interpretation, reuse of individual

information on reports, and manipulation of report information, without the risk of losing the meaning

of the underlying format and context. Data for a given account is universally defined. For example,

information on cost of goods sold over time for a toy manufacturer would be included on credit risk

data as part of a loan application to a bank. The same data at an aggregate level could be automatically

grabbed by the bank from the initial data instance for a new report for Basel II risk capital purposes. If

the toy company is publicly-traded, bank data on the company should tie to the company’s financial

statements filed with the SEC. If not, this is an interesting point of inquiry, but the point is that XBRL



enables software to automatically detect this just from the initial filing. This enhances regulatory inter-

agency coordination. The bank could aggregate cost data with an XBRL query on the costs of all toy

manufacturing companies to which it has outstanding loans, to analyze credit risk and cost relationships

in that industry. Alternatively, any government agency could pull from that same original data point as

part of a query for analysis of changes in profitability for the manufacturing sector as a macro-

economic indicator. XBRL allows for all of this analysis from the same cheaply-produced single

instance of data. XBRL provides a grand bargain for the current politically polarized budget

wrangling. Auditing for Wall Street and government agencies can both be revolutionized by a single

more accurate, cheap, quick, and most of all, publicly available format.

The FFIEC: Hard Evidence of Dramatic Improvements in Financial Reporting

In a 2006 report by the Federal Financial Institutions Examination Council (FFIEC), which

includes the Federal Deposit Insurance Corporation (FDIC), the Federal Reserve System, and the

Office of the Comptroller of the Currency, XBRL improved government oversight and effectiveness in

ways that would apply to any organization, including private corporations and government agencies.

The FFIEC was the first organization in the US to implement XBRL on such a large scale.

XBRL led to dramatic improvements in accuracy, faster data inflow and access, increased

productivity and efficiency, and the ability to adjust the system to changes in regulation much more

quickly. Under the XBRL-based system, 95% of submitted data for financial reports from regulated

entities was accurate with regards to logical relationships, like that between income on the income

statement and income on the statement of retained earnings, as opposed to 66% under the prior system.

Mathematical accuracy increased from 70% under the old system, to 100% with XBRL. Staff

productivity also increased between 10 and 33% after implementation. Under the old system, banks



submitted their required reports an average of weeks after the end of each quarter. Using XBRL, they

submitted the next business day.25

The best way for the US government to ensure effective and efficient financial regulation, and

to prevent regulatory capture, is to make the data that is relevant to regulators cheap, public, and

available in real-time to any citizen.26 XBRL enables this, provided it is adopted widely enough to

ensure its positive network externalities.27 Adoption of XBRL ensures accounting data accurately

represents economic position, and can fix the financial reporting process. In China, both tax and

financial statement filings in XBRL are mandatory. The SEC, IRS, and FDIC have begun to adopt

XBRL for regulatory oversight, with the SEC recently mandating all electronic filings, but they lag

behind the equivalent agencies in China. The SEC also requires traditional paper formats, removing

much of the benefit of XBRL filing, because companies still retain all the costs of the old approach,

and have to recode data into XBRL if they have not overhauled all of their internal accounting systems.

While improving, company filings are still error prone. Companies are wary of the dollar and time

costs of the “tagging” process needed to make an average Excel spreadsheet or equivalent legacy

system into XBRL, and to simply be held to the inevitably higher standards for financial reporting and

economic results that will come with full implementation and adoption of the standard.28 This is

surprising, given the dramatic success of the FFIEC as a test case six years ago. So why has XBRL

25 Improved Business Process Through XBRL: A Use Case for Business Reporting. (2006). Federal Financial Institutions

Examination Council. Retrieved December 6, 2012 from http://www.xbrl.org/sites/xbrl.org/files/resources/1%20FFIEC-

White-Paper-31Jan06.pdf.

26 See Bertot, Peter et al.

27 Saloner, Garth, and Farrell, Joseph. “Working Paper: Department of Economics: Economic Issues in Standardization.”

Cambridge, Massachusetts. Massachusetts Institute of Technology, 1985. Retrieved November 21, 2011 from

http://dspace.mit.edu/bitstream/handle/1721.1/63537/economicissuesin00farr2.pdf?sequ nce=1.

28 After all, that is the point of XBRL implementation in the first place.

http://www.xbrl.org/sites/xbrl.org/files/resources/1FFIEC-White-Paper-31Jan06.pdf







taken off in China (and Japan, for that matter), but not in the US? How do we encourage adoption

beyond SEC filing mandates?

Perhaps the financial crisis motivates the most democratically satisficing solutions, like a

regulatory overhaul, at the expense of political and institutional support for a cheaper, less politically

dramatic solution, that would actually produce the kind of uncomfortable change that occurs when the

books are truly open and accurate for both private entities and the government agencies that are

supposed to be watching over them. The business community also mostly ignores what could be a

profitable technology for its own operational synergy, because of fear of regulation and change.

Advanced data analytics and machine learning, integrated with a wealth of new, much cheaper, real-

time financial and economic data, would be powerful for both firms and government. While

implementing a standardized process comes with initial costs for firms that adopt the technology, the

benefits are simpler technology environments and lower costs over the long-term.29 China has

longstanding cultural traditions of Confucian faith in a strong central government, while distrust of

central government is endemic to the United States. Differences in governmental structure allow the

Chinese government greater authority to simply decree a mandate of universal adoption of the standard

beyond regulatory filings for publicly-traded companies. Forced adoption of the standard for internal

business reporting has helped China to ensure that firms realize (sometimes unforeseen) internal

financial data synergies, because they have no choice.

A technological standard for data interchange is only effective to the extent organizations use it.

The ability to automatically pull data that is easily reused and analyzed is contingent upon the data

originating in that format. As more adopters begin to transmit information according to the standard,

the value of adopting the standard oneself increases. The goal at this stage is to achieve critical mass,

29 See Saloner, Garth, and Farrell, Joseph. “Working Paper: Department of Economics: Economic Issues in

Standardization.”



where the fear of the inevitability of enough competitors using the standard would motivate everyone

to adopt the technology, ensuring the public good of cheap, accurate, timely financial data for

everyone.

It is important to monitor the critical questions raised by Dodd-Frank as the legislation is

implemented, as noted in Table 1, and to implement an IFRS-like approach to unlisted financial

innovations, and to continue to study the potential for convergence between IFRS and GAAP. There

are also a number of important steps to encouraging standardization of XBRL. Embracing XBRL

within the federal government for intra and inter-agency reporting would be an important first step

towards encouraging widespread adoption. The SEC currently requires issuers to file both paper and

XBRL-based financial statements. The option to file solely in XBRL should be available. The process

of tagging documents that originated in costly traditional paper filing formats would be cheaper and

quicker if companies did not have to transform existing data from paper to XBRL, because that data

originated in XBRL in the first place. The goal is to remove redundant steps. Companies can better

adjust to the shock and growing pains of reevaluating their own internal accounting information

systems architecture and processes in order to implement XBRL if they are not simultaneously required

to process everything by paper.

The SEC already uses XBRL data for economic analysis. The need for better insight into

government spending, and greater accountability for agency social goals, lends XBRL to use by any

agency for similar analysis. The US government should show the business community that it can be a

leader in innovation and reform, and implement internal audit systems based in XBRL for its own

operations, in order to engender the type of public trust and support it so desperately now needs.

Governmental audit and accurate agency reporting are flawed. Implementing XBRL to improve fiscal

responsibility and transparency in this area would comprise the needed concession from Democrats in

order to generate support from Republicans for similar reporting requirements for corporations. The



US government should also support small independent software developers using XBRL to create

paradigm-shifting, cheap alternatives to the current system of expensive, proprietary enterprise

resource planning (ERP) software, by making XBRL data and the tools to use it accessible for citizen

users with as wide-ranging a level of technical expertise as is possible. Expensive proprietary ERP and

similar software systems have expensive aftermarkets for implementation, which is the exact economic

case where government standardization creates the least inefficiency with its intervention, and can be

best rationalized.30 However, those ERP vendors and implementation “consultants” will fight

vigorously to protect the rents of proprietary systems lacking interchangeability, in long-term

implementation contracts ridden with regulatory capture.

Widespread adoption of XBRL is an investment in information infrastructure. The investment

is infinitely cheaper than the physical type. The returns of that investment, in the form of cost savings

in providing information, from anticipating; and maybe even preventing, financial crises; in providing

the first accurate government audits for agencies that may or may not be rife with corruption and

capture,31 in providing for more accurate social metric reporting to assess whether at-risk social groups

agencies intend to help are truly being helped, and in a new wealth of information to datamine, are

exponentially better. Information and information infrastructure are the areas where America should

focus on maintaining competitive advantage in the future. XBRL is critical to ensuring that domestic

and foreign consumers view US companies and governance with confidence.

30 See Saloner, Garth and Farrell, Joseph, “The Economics of Standardization.”

31 The important point is that there is no way to really know the extent to which this may or may not be true under the

current system, where audit for private firms and government agencies remains farce.

financial transparency and reform: dodd-frank, ifrs, and xbrl

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