The SEC and Some Sort of Ostrich Syndrome

The U.S. government bears the societal responsibility for establishing accounting standards.  In its structure of economic regulation, the task for creating accounting standards is fixed on the Securities and Exchange Commission.  For seventy years the SEC has passed on its responsibilities, instead relying upon private U.S. organizations.   This has been called the Ostrich Syndrome (aka Head-in-Sand).  Now, the SEC proposes to rely upon a private international organization (IASB).  I call this the Some Sort of Ostrich Syndrome (aka Head-Where-It-Doesn’t-Need-to-Be).

Six weeks ago, in Economic Consequences and the Political Nature of Accounting Standard Setting (Jan. 6, 2010), I wrote:

Not only does the federal government have the authority to determine accounting standards (the Securities and Exchange Act of 1934 affirms it), but it has the responsibility to do so.  This is because accounting standard setting is an integral part of the economic regulatory system of the U.S. And maintaining a stable and sound economy is a basic underpinning of national security.

As determined by legal statute, the Securities and Exchange Commission is to determine the accounting standards for use by companies that engage in the regulated capital markets of the United States (Securities and Exchange Act of 1934).  The Sarbanes-Oxley Act of 2002 reaffirms it.

Although it has never been legally tested (to my recollection), the SEC has reliance upon private U.S. organizations (first the AICPA, then the FASB) has long been viewed as acceptable, because the SEC has overseen their standards.  In two well-publicized instances it has voided such rules.

Never-the-less, relying upon a private standard setter has not produced very good results.  Professor Arthur Acevedo of The John Marshall Law School says, ” The SEC’s failure to establish accounting principles and constant reliance on private standard setters has contributed to the manipulation and exploitation of GAAP by corporations and their auditors.” (“The Fox and the Ostrich: Is GAAP a Game of Winks and Nods?“, which everyone should read.)  Acevedo goes on to explain,

Yet, for all of its social and economic importance, establishing accounting standards has been the subject of limited federal and virtually no meaningful state regulation. Several reasons explain this phenomenon.  First, intense pressure from an accounting profession resistant to government regulation has until recently, been successful. Second, scarce government resources have not been sufficiently allocated to handle the ever-increasing complexity of accounting issues. Third, the deferential posture adopted by both legislators and courts has created within the accounting profession, a culture of entitled noninterference.  Finally, a common misperception exists among many individuals, including lawyers and politicians, that accounting is a rudimentary number-crunching exercise.

Yes, we all know the practical ramifications of thousands of “exploitation(s) of GAAP by corporations and their auditors”.

A couple of months ago, Jim Peterson of re: Balance suggested that in today’s world, the audit opinion has no value and is, therefore, unneeded.  I think, though, the problem with financial reporting is further upstream.  Financial statements in today’s world have little value because the accounting standards are sometimes irrelevant  They are irrelevant because sometimes the FASB has not created a rule that properly draws a line between interests of investor versus corporation.  Although the FASB says it creates unbiased accounting standards, in reality it creates biased accounting standards that all to frequently are not biased to protect investor interests.

And now the ultimate crony, the SEC, is proposing having the IASB establish the accounting standards for the U.S.  And there is to be no U.S. government oversight.  Because IFRS are not optimized for the U.S. economy and are designed to protect corporate interests, financial statement manipulation will become rampant in the U.S. under IFRS (much more so than it is today).  This move will produce a disaster of such magnitude that having one’s head up you know where might be the only protected place for it.

With respect to accounting standard setting, the SEC is ignoring its responsibilities.  It is safe to say that the SEC most definitely has its head elsewhere than where it needs to be.

Debit and credit – - David Albrecht