From somewhere in the back of the room came the question: "Why are we all principles-based at conferences like this, and when we get back home, it's all rules. How do we break the cycle?"
The query momentarily stumped the otherwise highly engaged panel of experts who were assembled yesterday to speak at the AICPA's conference on international financial reporting standards. Then Deloitte CEO James Quigley broke the silence. Giving credit to the lone lawyer on the panel -- Michael Young of Willkie Farr & Gallagher -- Quigley said the answer was provided earlier in the session.
"I think Michael broke the cycle for us," said Quigley, noting that an obsession with rule compliance doesn't trump economic substance with respect to accounting treatments. "Conformity to rules doesn't necessarily get you off the hook if [the accounting treatment] doesn't have a lot of substance," opined Young.
Indeed, the panel admitted that professional judgment, which is more often used in applying so-called principles-based accounting standards than rules-based standards, can be second guessed by regulators. However, Young, who has spent 25-years litigating accounting cases, pointed out that in a case based on a principle, it's "really hard" to prove that executives or directors acted in bad faith.
Key to any good defense of an accounting judgment is documenting "good faith" attempts. If there's a tough judgment call, executives and boards should talk it out and document the discussion, advised both Young and Quigley.
"The law is, in its own slow, slow way, coming to appreciate the importance of judgments, and the law is going to have to come to grips with the fact that if it doesn't, it will stand as a significant impediment to the evolution of financial reporting," argued Young. "And I think that slowly but surely judges are starting to get that."
Why are principles-base standards considered more virtuous than a rule-based system, anyway? Young explained that rules have sharp edges that you can aim for. So companies can convolute deals and structures to stay within rule thresholds. Principles have fuzzy edges, so you have to aim for the center, and "there may be no better protection than that," mused Young.
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