pluck (noun)
the trait of showing courage and determination
in spite of possible loss or injury
Mary Schapiro has President Obama's backing
Mary Schapiro, recently confirmed chair of the SEC, responded to written questions posed by Senator Carl Levin (D-Michigan). Her comments show considerable insight into the workings of government regulation. Some are controversial. I believe they reveal a seasoned regulator who pretty much has things correctly figured out. I’m posting parts of her response that deal with accounting (after all, that’s all I care about). Very briefly, she discloses:
- She’s satisfied with the current relationship between the SEC and the FASB–that is, the FASB should continue to make rules free of political interference, even from Congress.
- She does not believe fair value accounting was a significant factor in the recent financial crisis. In other words, the accounting rule did not cause the crisis.
- She is not ready, at the current time, to delegate U.S. standard setting to the IASB.
- She believes that the series of annual exemptions should cease and that SOX 404 internal control requirements should be applied to small publicly reporting companies.
- She does not believe that inspection and regulation of foreign auditing firms should be delegated to foreign government regulators.
OK, all of this sounds great. It’s good enough to gain the benefit of the doubt.
The controversial statements are (1) she’s backing off from IFRS, and (2) she’s willing to lay onorous SOX provisions on smaller companies that probably can’t afford to implement them.
9. What is your view of the relationship between the SEC and the Financial Accounting Standards Board (FASB)? What is your view on whether Congress should legislate accounting rules?
Response: The SEC needs to diligently oversee the FASB to ensure that accounting rules are keeping pace with innovations in the markets and the needs of investors of clear, usable financial 4reporting. I believe that FASB needs to be shielded from outside economic and political pressures, and that they and not Congress should write accounting rules.
10. The SEC recently issued a report supporting the existing mark-to-market valuation rules, but recommending some improvements. What is your view of the current mark-to-market valuation rules?
Response: We know that certain banks were not presenting investors with the full picture of their financial health, utilizing off-balance sheet vehicles and other accounting methods. This was a disservice to investors as the integrity of the numbers is critical to their making smart investment decisions and to the smooth functioning of our markets. While there are a lot of different views on whether mark-to-market accounting contributed to this crisis, my personal view is that it was not a significant factor. As Chair, I will read the recent SEC report on this matter fully, talk with other regulators, and get their views as we move forward.
11. Do you believe U.S. banks have fully applied mark-to-market valuations to the structured finance transactions on their books, including asset-backed securities, credit default swaps, and CDOs? Do you believe inaccurate valuations are currently impeding U.S. credit markets? If confirmed, what actions would you take to insure accurate book valuations for U.S. banks?
Response: I am not in a position at this time to opine on whether US banks fully and appropriately applied mark to market valuations. See above.
12. Current SEC Chair Christopher Cox has indicated that he thinks the SEC should allow U.S. publicly traded companies to use international financial reporting standards (IFRS) issued by the International Accounting Standards Board (IASB) instead of U.S. generally accepted accounting principles (GAAP) in their financial statements.
a. Do you believe the Sarbanes-Oxley Act allows the SEC to delegate the development of U.S. accounting standards to the IASB? If confirmed, would you try to advance such a proposal?
b. Section 404 of the Sarbanes-Oxley Act requiring auditors to review a company’s internal controls has still not be applied to publicly traded small businesses. If confirmed, would you allow Section 404 to take effect for small businesses without additional delay?
Response: When it comes to international accounting standards, it’s critical that these standards are converged in a way that does not kick off a race to the bottom. American investors deserve and expect high standards of financial reporting, transparency, and disclosure — along with a standard-setter that is free from political interference and that has the resources to be a strong watchdog. At this time, it is not apparent that the IASB meets those criteria, and I am not prepared to delegate standard-setting or oversight responsibility to the IASB.
Regarding, SOX 404, accurate, robust, and easy-to-understand financial reporting — and the internal controls that guarantee it — are critically important to investors and to the efficient functioning of our markets. Right now, we have a system where some issuers are complying with 404 and others are still exempt from it. It’s time that we bring uniformity to the system so that investors know what to expect from companies, while being sensitive to the needs of small businesses. I look forward to working with the small business community in making sure they have the tools they need to comply with 404.
13. What is your view of FASB’s accounting standard requiring stock option compensation to be treated as an expense on corporate financial statements? If confirmed, would you support efforts to change this standard? If so, what changes would you support?
Response: No, I would not support changing this decision.
15. What is your view of the relationship between the SEC and the Public Company Accounting Oversight Board (PCAOB)?
Response: In addition to its oversight responsibilities, the SEC should ensure that the PCAOB has what it needs to enforce the rules of the road for auditors.
16. Chairman Cox has indicated that he thinks the PCAOB should stop inspecting auditing firms in other countries and instead delegate its inspection authority to foreign oversight bodies where those firms are located. Do you believe the Sarbanes-Oxley Act allows the SEC to make this delegation? If confirmed, would you try to advance such a proposal?
Response: No, I do not; and no, I will not.
Debit and credit – - David Albrecht
We seem to be missing the salient point. IASB standards are nonsense. They are currently applied in Australia and I can assure you the output after applying IASB standards is absolute nonsense. A friend of mine is an audit partner with Deloitte. He’s on the verge of changing careers. His reasoning. Virtually everyday he has to explain to clients why they need to be disclosing items in a certain way in their financials. The problem is he doesn’t believe it either pr understand the logic. I suggest the US holds on to their standards for grim death. IASB standards won’t help. They will make the problem far worse!
Thank you for your insightful and useful comments. I’m tempted to make the argument that, without 404, esp. in these perilous times, investors will penalize companies and eventually drive their stock prices so low that they will be de-listed, their need for access to public capital markets notwithstanding. Certainly I would never invest my hard-earned shekels in such a company. But I know better than to generalize from a sample of one, plus the data are not on my side, so I’ll leave it at that. For now.
As for your comments about the debt writedown, I’m willing to mud-wrestle with you on that one, sir. I certainly agree with what you said. However–and here’s the point I think is being overlooked–I believe that public policy should resonate with the average American, investor or not, whether s/he, in this case, owns a share of stock or not. If/when it doesn’t, then, as you rightly noted, we’re headed down a slippery slope.
I, for one, don’t think it is rocket science to point out the sheer nonsense that a credit downgrade results in a pop to a company’s P&L. In contrast to your comment, I don’t think that Citigroup’s debt was at all ‘forgiven’. No how, no way. They’re still on the hook for it. But the downgrade makes it appear as if they’re not. That, in my view, is at least as bad, and arguably much worse, than the sheer lack of logic I noted in the first place.
Again, thank you for a fine blog. And thank you for the serious and grave questions you and your colleagues are raising about IFRS. The way I put it is, “If you think the United Nations is a wonderful and effective organization, then you’re gonna love IFRS and IASB!”
I respectfully disagree with your comments about SOX 404 and smaller companies. There are 80+ years of empirical data from Morningstar/Ibbotson that show us quite clearly that smaller companies are, on balance, much riskier than bigger ones. In my experience advising and appraising such companies–not under Sec. 404 because we don’t provide any services in that arena–their internal controls are usually meager, at best. If there is a sector for which 404 should be mandatory, it is the small companies, not the big ones, at least in my view. In fact, if any companies s/b exempted from 404, it’s the GEs, Microsofts, and IBMs of the world. They need 404 about as much as Britney Spears needs another drink.
If 404 is indeed ‘onerous’ (your word), then perhaps these companies never should have come public in the first place. In my mind, they can either get with the 404 program or go private. They can’t have it both ways, and they’ve been having it both ways for far, far too long. Time to fish or cut bait. No more delays, no more extensions. We’ve indulged their whining about cost and complexity long enough.
404 was and is critical to trust in public markets. The CPA community, led by the rum-dumbs @ AICPA, totally abdicated its responsibilities. It failed to self-regulate responsibly. American investors got slapped with Enron and then Worldcom. Well, any profession that fails to self-regulate the way it should is going to get the heavy, expensive, over-reacting hand of the federal government. So be it. We deserve it. I’m a CPA, incidentally.
Over 230 years ago, Adam Smith wrote about the need for trust in markets. In the late ’90s and into this new century, trust went up in smoke. We’re now facing another crisis. I respect Chairwoman Schapiro, but I respectfully disagree w/her on one key issue: I believe that SFAS 157/159 had one heckuva lot to do w/the current crisis. No, it didn’t cause it–the fools on Capitol Hill did that. But it certainly poured gasoline on a bonfire. Anyone who doesn’t think so probably can rationalize how Citibank in Q3/2008 absorbed a credit downgrade, wrote down its debt by $1.5 billion. . .and got a $1.5 billion spike on its P&L.
That’s absurd. Only a bunch of bean-counters would say that makes sense. My creditworthiness goes down, and my profit goes up? American investors will never buy such poppycock, nor should they.
Thanks for a great blog.
There are often many sides to a story, and you’ve written one.
I agree with pretty much everything you wrote WRT 404 as applied to small businesses. Instituting such a program by a small company means a significant investment in fixed cost. Without additional investment to pay for it, a small company would be forced out of business. The problem is that the smaller companies are undercapitalized. At least, I think that’s the problem. Being undercapitalized, they just can’t handle the source of funds for 404 expenditures.
Should they be forced to incur it? No and yes. You’ve made a good argument for yes. Here’s the no argument. Smaller comanies provide a benefit to society because they provide additional economic competition, and this additional competition helps us all in the long run. To require them to make 404 expenditures makes us just that much more of a big business country, and it stifles innovation and entrepreneurial activities. But they need public company access to capital markets in order to exist. Without this access, they never get sufficient resources to compete at all. The argument goes that it is in society’s long range interest to cut them some slack. At th current time I agree with cutting them some slack, unless there is a way to create proportionate 404 compliance (some but not all).
Now, for the other matter, a write-down of debt. I think you are co-mingling two different events. You have the bad operating results (most definitely a loss) and being excused from making debt payments. Having bad operating results is generally accounted for correctly (accountants are pretty good at recording having spent too much money, or in writing down assets). However, having at one time been on the hook for X dollars, and then being told that you have been forgiven some or all of the debt obligation is a good thing for the company being excused..
What accounting has tried to do is to be disciplined in where items go on the income statement. There are actually three parts to the income statement: (1) income/loss from operations, (2) interest revenue/expense, gains/losses, and taxes, (3) unusual one-time items such as discontinued operations and early extinguishment of long-term debt. I’d go so far as to say that early extinguishment of all debt (short-term or long-term) should be classified as an extra ordinary item, but that’s all. A knowledgable observer should be able to tell the difference between operating income and what comes after it.
This brings us to an area were there are some philosophical differences among accounting theorists. This is, the role of comprehensive income. Comprehensive income serves as means for storing long-term gains and losses from asset fair valuation so they don’t flow through the income statement until a later time. Some theorists are revolted by the notion of using comprehensive income, and want all gains and losses run through the income statement. Of course, this distorts income if your focus isn’t on operating income only. Now, perhaps an argument can be made that any gain from debt write-down should be made to permanently by-pass the income staement in favor of copmrehensive income. I can see this relating to public policy, and I might even support the idea if I thought about it for a while.
But tying more and more accounting rules to public policy is a slippery slope.