The early days of the SEC were marked by the increasingly difficult common-law development of accounting precedents – case by case. The notion of disclosure as acceptable alternative to correction had been painfully stretched in the Northern States Power case.
The securities laws gave the SEC the clear authority – if not mandate – to make rules and regulations governing registrant financial statements, including methods to be followed in the preparation of accounts. In the 1930s, a broad-based body of generally accepted accounting principles was embryonic, at best, and Chief Accountant Carman Blough had argued that the SEC had neither the time nor resources to develop accounting standards.
But an elegant solution was soon devised. In April 1938 a still-divided Commission issued an “administrative policy” for financial statements in Accounting Series Release No. 4, centered on the notion of whether there was substantial authoritative support for accounting practices.
If financial statements were prepared in accordance with principles for which there was no substantial authoritative support, the SEC would presume that the statements were misleading or inaccurate, despite disclosures. If the Commission differed with a registrant on an accounting practice, disclosure in lieu of correction would be accepted only if there were substantial authoritative support for the registrant’s practice and the SEC’s position had not been expressed previously in an official release, including opinions of its Chief Accountant. Registrants could no longer attempt to cure accounting deficiencies with disclosure.
