Oust the SEC as Sole Accounting Watchdog?

Are you ready for the FAOB? New House bill would install instead a five-member oversight board made up of heads of Treasury, the Fed, FDIC, and PCA...
Marie LeoneMarch 10, 2009

Politics are creeping into accounting once again. This time it’s through a proposed law that would replace the Securites and Exchange Commission as the sole overseer of accounting standards, and turn that role over to a high-level group that would let bank regulators have a say in approving accounting rules.

The bill, which would sharply widen the government’s oversight over how accounting rules are applied, was introduced Friday. Under HR 1349 — the Federal Accounting Oversight Board Act — the SEC would cede its accounting-oversight powers to a newly created board. According to the bill, drafted by Colorado Democrat Ed Perlmutter and Oklahoma Republican Frank Lucas, the FAOB would comprise five top regulators: the Secretary of the Treasury, the chairman of the Federal Reserve, the chairman of the SEC, the chairman of the Federal Deposit Insurance Corp., and the chairman of the Public Company Accounting Oversight Board.

Currently, the Financial Accounting Standards Board operates under the aegis of the SEC, which has budget approval power over FASB as the main U.S. accounting standard setting organization. In addition, the SEC has the ability to nominate and interview trustees of the Financial Accounting Foundation, FASB’s parent, and the organization that nominates and approves the five FASB members. Under the arrangement proposed in the bill, FASB would remain, but would be under the new FAOB instead of the SEC.

Drive Business Strategy and Growth

Drive Business Strategy and Growth

Learn how NetSuite Financial Management allows you to quickly and easily model what-if scenarios and generate reports.

Regulatory reform, including accounting rule revisions, has been a theme in Washington of late. Today, in a speech to the Council on Foreign Relations, Fed chairman Ben Bernanke called for a review of accounting rules that affect the way companies value assets, according to a report in the New York Times. However, the report noted that Bernanke said he did not support suspending fair-value accounting rules. Later this week, members of a House subcommittee are scheduled to discuss the merits of the Perlmutter-Lucas bill during a hearing on the financial crisis.

Code for Tampering with Fair Value
The new bill would stipulate that when approving accounting rules, the FAOB must consider, among other things, how standards create systemic risk exposure to the American public, financial markets, and global financial markets. The board must also make sure that accounting rules “handle illiquid and liquid assets differently.”

Further, the bill states that if another federal financial regulatory agency determines that an accounting rule “has an adverse effect on the safety and soundness of the entities [it regulates], the health of the United States financial system, or the economy, [it] may request authorization from the FAOB to review such standard.” What’s more, the FAOB would have the power to determine whether the rule should continue to be applied or be removed on either a temporary or permanent basis, which could strip FASB of its rulemaking and rule revising role.

These provisions seem to be code for tampering with fair-value accounting rules, which critics have blamed for exacerbating the current credit crisis. Indeed, fair-value accounting forced companies to take huge writedowns on the value of some financial instruments that were exposed to risks associated with the subprime meltdown. However, many investor groups say that fair-value accounting helped reflect the true economic value of the instruments, and in many cases helped to expose risky investments sooner.

However, the architects of HR 1349 contend that the proposed law, which also includes an expansion of government oversight to include a broader view of the economy, gives “FASB the tools it needs” to be flexible enough to respond to changes in the markets, says Leslie Oliver, a spokesperson for Perlmutter.

An Echo of the Bankers’ Views
According to a statement released by Perlmutter’s office, the bill would give regulators greater ability to judge the value of assets being held to maturity. “Arbitrarily decreasing capital levels of financial institutions puts our communities at risk by causing some financial institutions to show an artificial undercapitalization which prevents them from lending money to business and individuals,” said Perlmutter in the statement.

That view of accounting, and more specifically fair-value accounting, has been echoed by bankers since the credit crisis went into overdrive last year. For example, in April 2008, during the debate over whether fair value accounting should be applied to financial instruments that are held to maturity, American Bankers Association president and CEO Edward Yingling characterized mark-to-market accounting in illiquid markets as “pouring gasoline on the fire.”

Yingling pointed out that fair value accounting is appropriate for financial instruments that are held for trading purposes. However, for assets and liabilities that are not based around short-term trading, or are held to maturity – such as loans, deposits, and receivables – fair-value measurement leads to income statement volatility (understatements and overstatements), according to both the ABA and its international counterpart, the International Banking Federation.

Oliver says that while fair-value is the most “prominent” accounting issue currently being debated, the bill was written to address more that just mark-to-market issues. In fact, she says that the bill is part of a “broader regulatory reform” effort being taken on by the Obama administration and others.

What’s more, the idea of creating a new board has been spurred by “looking at the reality of how the [accounting] rules played out during the economic downturn,” as well as examining how the SEC and FASB responded to the credit crisis, Oliver tells While “the idea of GAAP is great … one size doesn’t fit all,” she notes.

She also confirms that the bill will be one of the key items discussed on Thursday during a Congressional hearing held by the House Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises, of which Perlmutter and Lucas are members.

A Host of Opponents Likely
Opposition to the new board likely will come from investors, practitioners, and standard-setters that tout fair-value accounting’s transparency, and the current FASB’s independence. “Creating another new layer of governance is the wrong way to go,” says Peter Iannone, a director with CBIZ MHM, an accounting provider. “The board as described in the bill would put non-accounting business people in an oversight position over the most technical aspects of the accounting profession,” contends the accountant.

Iannone also believes the new board could thwart efforts by FASB and its overseas counterpart, the International Accounting Standards Board, to converge the two sets of standards into a single set of global accounting rules. “I do not believe that adding bankers and other to the mix at this time is going to make setting standards aimed at uniform presentation/consistency and reporting transparency easier,” asserts Iannone. “The SEC has failed the investing public, few would argue against that. Creating a new standards oversight board on top of the FASB does nothing to address that.”

Oliver insists that the new board is not meant to “hamstring” FASB in any way. This is not the first time, though, that politics have been seen by some as encroaching on FASB’s independence. For example, in April 2007, the SEC used its authority to hold up approval of FASB’s budget until the FAF agreed to give the regulator more say in the appointments of FASB members and FAF trustees.

The Options-expensing Battle
Perhaps the most notable instance of politics steering accounting policy was the battle over expensing stock options. Under intense pressure from Capitol Hill, FASB backed off from a 1994 stock options expensing rule. The heavy political pressure was seen as compromising not only the board’s position on expensing, but its very independence as a standard setter.

At the time, Congress claimed no desire to end independent standard-setting, and the lawmakers asserted that they were trying to aid the struggling economy by encouraging greater use of entrepreneurial incentives. But many observers said that FASB’s decision not to require options expensing may also have motivated executives to pump up their companies’ stock prices by whatever means necessary.

In fact, the widespread use of nonexpensed stock options is generally thought to have led to inflated stock-market valuations, excessive executive compensation, accounting frauds, bankruptcies, and the loss of approximately $5 trillion.

By the next decade, the massive stock-option backdating scandal underscored the problems with allowing the true cost of stock options to be removed from income statements, and by 2004, FASB passed FAS 123R, which required companies to expense stock options based on the fair value of the options on the grant date.

While it is unclear what position new SEC chairman Mary Schapiro will take — both the SEC and FASB declined to comment on the Perlmutter-Lucas bill — former SEC chairman Christopher Cox defended fair-value accounting last year amid calls by bankers to suspend the rules. After the SEC was directed by Congress to study the potential roll-back of fair value accounting, Cox announced in December that the regulator would not pull the plug on mark-to-market accounting. At an industry meeting that same month, Cox publicly stated that, “Accounting standards aren’t just another financial rudder to be pulled when the economic ship drifts in the wrong direction … Instead they are the rivets in the hull, and you risk the integrity of the entire economy by removing them.”