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Posts Tagged ‘Regulation’

J. Edward Ketz is my round tuit.  ???  A round tuit is anything that unlocks your sense of inertia, allowing you to start working on some task that has been delayed far too long.

An example helps.  Have you, like me, ever been nailed for procrastinating?  All the time.  It probably followed this thought, “I’ll get a round tuit when there’s a free moment.”  But everything else doesn’t get done and there’s no free time, so you never get a round to it.

Ed is my round tuit.

On February 25, 2010, the Securities and Exchange Commission (SEC) released a formal Commission Statement in Support of Convergence and Global Accounting Standards.

I never got around to reacting.  Yesterday (March 29, 2010), Ed Ketz published his reaction, “The Iffiness of IFRS“.  It’s better than anything I can  write (anything Ed writes is always better than anything I can ever write, just take it for truth).  Better late than ever, here are my personal reactions.

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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).

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There’s quite a discussion going on over at AECM now, centered around whether or not corporate disclosures via XBRL tagged data will be audited, and therefore receive some sort of assurance blessing.

One professor whom I respect a great deal is arguing that it is in the best interest of companies to make the best and most honest disclosures as they seek to raise capital, and it is in the best interest of auditors to associate themselves with only those companies that make the best and most honest disclosures via XBRL (and presumably via financial statements, also).

To which I say:  hogwash!

I’ve seen enough corporate reporting shenanigans, and auditor “nod-and-wink” assurance, that I have concluded that there are indeed sufficient incentives in place for corporate agents to try to game the system by mis-reporting financial results. I don’t see why, if there is substantial non-compliance with GAAP, that XBRL tagging would be a refuge of purity.   Moreover, there are incentives in place for auditors to fail to object to minor transgressions.   Some of the times, the incentives are sufficiently large so that auditors fail to object to major transgressions.  I guess I don’t see why assurance on XBRL reporting will be any different.

I certainly don’t trust corporate executives or auditors, as classes, to properly exercise “professional” judgment. Oh, proper judgment may be exercised more than half the time of the time, but given the risk averse nature of many investors, it is enough for a few bad apples to give the rest a bad name.   It is the many examples of bad reporting and bad auditing (while admittedly in the minority) that are enough to destroy trust.

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It is said frequently by politicians, SEC and other regulators, journalists and special interests that the accounting standard setting process should and must be insulated from politics.  As I explain in this essay, this runs counter to everything we understand about accounting theory.  For decades it has been taught in every graduate accounting program in the country that accounting standards have economic consequences.  As a result, I contend it is natural and predictable that competing economic interest attempt a political solution to proposed accounting standards.

This is an important issue at this time, because they are proposing major changes in the accounting regulatory landscape that run counter to this conventional wisdom of the financial reporting and capital market world.

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Stop!  Don’t move in inch!  Stop!  Hold the presses!

Even if the U.S. adopts IFRS, there is a chance that U.S. GAAP will survive and thrive.

Come again?

If IFRS implementation is anything like SOX implementation, then there is a chance that U.S. GAAP will survive.

It is so obvious, not even Captain Obvious is talking about it.  The rationale for my conclusion starts with a history lesson on SOX.
The Sarbanes Oxley Act of 2002 was passed in the immediate aftermath of (1) the dotcom burst bubble, (2) a huge recession, (3) the WTC terrorist attack, (4) dozens of  accounting scandals such as WorldCom and Enron, and (5) Washington’s perceived need to save the country from itself through increased regulation.  It is said that George H.W. Bush later so regretted his part in SOX’s passage, that he pushed IFRS as a way of making it up to corporate America (IFRS is a gift offering because of itse earnings management capabilities).

Here’s what corporate America thought of SOX.

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Edith Orenstein, in her exceedingly well done FEI Blog, quotes SEC Chief Accountant James Kroeker as saying:

Kroeker outlined six general areas that the SEC would have to “carefully consider … fully understand and address” regarding the potential use of IFRS by U.S. companies.  He added that this list is not all-inclusive. The six areas are:

  1. U.S. Investor understanding of and perspectives on IFRS;
  2. The development and application of IFRS for use as the single set of globally accepted accounting standards for U.S. issuers;
  3. The impact on the U.S. regulatory environment;
  4. Preparer considerations, including, among other matters: changes to accounting systems, changes to contractual agreements, corporate governance considerations, and litigation contingencies;
  5. Human capital readiness; and
  6. The role of the FASB in achieving the goal of a single global standard.

Kroeker noted, “I expect that you will hear more from us on this topic in the near term.”

James Kroeker

It is so depressing to hear James Kroeker speak of #2 and #6, as it reveals the SEC’s continued fixation on a single global set of accounting standards.

A global accounting standard is both unwise and misguided.  I’ve explained why many times.  However, just in case today is the day Mr. Kroeker checks out my blog, I’ll explain it again.

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A lawsuit challenging the consitutionality of the Sarbanes Oxley Act of 2002 (SOX) is scheduled for review by the Supreme Court on Monday, December 7.

Key provisions of SOX are under attack. It is possible that SOX will be either voided or scaled back in the near future, threatening the very existence of the Public Company Accounting Oversight Board (PCAOB). The PCAOB was created by SOX for its implementation and administration. I hope the PCAOB is able to survive. We need it. Here’s why.

In reaction to (1) many scandals, most notably WorldCom and Enron, and (2) a decades long history of ineffective auditing by the Big 8-7-6-5 auditing firms that contributed to the scandls, Congress passed SOX to help clean up financial reporting in the USA. Did it nead cleaning up? Most certainly. At that time the US clearly had the best accounting standards (rules companies follow as they prepare financial statements) in the world. But some companies were in non-compliance and audit firms were not forcing companies to comply.

The key provisions of SOX are:

  1. Responsibility for the accuracy of financial statements clearly is placed on corporate executives. The CEO is required to sign a statement that the financial statements are correct. Violations leading to convictions result in jail time.
  2. Corporations had to secure an audit of their internal controls, and append the resulting auditor’s opinion to the financial statements. The intention was to give investors some assurance as to whether or not the internal controls were functioning well enough to ensure accurate data from which the financial statements would be prepared. No more GIBO (garbage in, garbage out). Generally accepted audit standards and various SEC provisions already had established that internal controls were to be present.
  3. A PCAOB (Public Company Accounting Oversight Board) was established (appointed by the SEC) to police the auditors. This policing took the form of annual inspections of the big boys, three year inspections of the smaller firms.

SOX should be retained because of these three provisions. Each of them is essential for U.S. capital markets.

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Occasionally, I’ve been sending e-mails over to AECM about rising European discontent with respect to IFRS.  I’ve been regularly poo-pooed as a result.  After all, I’m an anti-IFRS guy and am thought to be creating rumors of imaginary IFRS difficulties in an attempt to delay American adoption of IFRS.  But I simply read a lot (especially European publications Accountancy Age and Financial Times).  There have several stories quoting EU and member-state politician concerns over the IASB’s IFRS.

WSJWell, the bad news has jumped the pond, to be reported in the venerable Wall Street Journal.  I refer specifically to three stories by Simon Nixon in the Heard on the Street column:

Similar stories appear in European newspapers.  If accurately reporting reality, it all leads one to conclude that there is a reasonable possibility that the EU will back away from IFRS to either (1) modified IFRS, or (2) unique European GAAP.  If either were to happen, wouldn’t it have an impact on IFRS consideration in the U.S.? I would hope so.

In Paris Mounts the Barricades, Nixon concludes, “French minister Christine Lagarde plans to lobby other G-20 finance ministers meeting in Scotland on Friday (Nov. 6?) to accept greater political control of the standard-setting process.”  Later in the article, Nixon says:

Paris’s real objection is to the IASB itself, which it believes is too focused on investor interests and not sufficiently accountable to politicians. Never mind that the G-20 in Pittsburgh specifically endorsed the independence of standard-setters. Never mind the G-20 also endorsed efforts by the IASB to improve its accountability by establishing a monitoring board and consulting more widely with stakeholders such as regulators. Ms. Lagarde’s objective is a greater role for national governments.

Consistent with Shyam Sunder’s brilliant analysis, such an objective is rational, natural and to be expected.

Nixon concludes with, “Instead of tighter convergence on accounting, that would lead to fragmentation, which is in nobody’s interest.”  Mr. Nixon, you are wrong. It  is in France’s national interest to manage its own economy and be responsive to its own citizens.  You see, having accounting standards that promote national interests is important to every country in the world.

In New Proposals … Meet Resistance, Nixon describes new a new IASB standard on financial instrument valuation as an improvement, but only partly effective.  He says,

But before further progress can be made, the IASB must overcome a bigger obstacle:  French resistance to the current watered-down standard. …  Demands for political control of standard-setting appear to be gathering support in Europe.

He concludes with:

“This is worrying.  Standard-setting must be independent if it is to command investor confidence.  Global convergence is too important a goal to let slip.”

Mr. Simon, I wish you knew something about accounting and international finance.  It has been shown, time and time again, that global convergence of accounting standards leads to a grossly sub-optimal economic result.  You see, capital markets are mostly local or national.  Let’s say that an American company with $100 million in sales were to float its IPO.  Its costs to raise capital are much less if it only markets its securities to American investors.  Marketing its stock to European investors would incur prohibitively huge transaction costs and be exposed to currency fluctuation losses.  Moreover, international investors would largely be reluctant to participate in the offering, fearing that any potential investment returns would be wiped out by foreign currency fluctuations.

Finally, in EU’s Go-Alone Approach, you report (or more accurately, your analysis leads you to conclude):

The decision to appoint a low-key Belgian as president, the European Union’s newly created top job, and an obscure unelected British official as foreign-policy chief is a blow for the 27-member bloc’s global ambitions. … France and Germany now look free to decide Europe’s two top economic jobs, which become vacant in January.  The European commissioners for competition and the single market have real power to shape Europe’s economic destiny.  …

If French and German nominees end up holding these economic posts, investors should brace for a shift in EU policy. Important dossiers await the new commissioners, including financial-system overhaul, sensitive state-aid decisions on banks and auto makers, and a revamp of bank-accounting rules. France, for example, wants greater political control of accounting standards, threatening to undermine the Group of 20 industrial and developing nations’ goal of convergence.

European developments should have us all jumping for joy.

Many European observers agree with you.  This gives me reason to jump for joy, and it should for you too.

All of this isn’t too surprising.  Why?  Ten months ago the European Union offered to completely fund all future IASB operations.  As discussed in E.U. Bids to Buy IASB, this was attempted because the E.U. (and your respected Charlie McGreevy) desired to own the IASB, lock stock and barrel.  After being rebuffed, it isn’t surprising for me to hear that the E.U. wants to go it alone.  I’ve been predicting it.

Mr. Nixon, your stories are too biased, promoting one side of a very controversial issue.  Unless placed on the editorial page, readers expect stories to have more meat and less opinion.  Please tone it down.

Debit and credit –  – David Albrecht

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A letter from three former SEC chairmen, printed in today’s Wall Street Journal, is today’s big news.   I am referring to:   “Don’t Let Banks Hide Bad Assets:   In times of distress, there’s always pressure to change accounting standards,” by Roderick M. Hills, Harvey L. Pitt, and David S. Ruder,”  The Wall Street Journal, November 19, 2009.

Independent accounting standards have helped make American capital markets the best in the world. In making financial decisions, investors rely heavily upon the integrity of corporate financial reports prepared in accordance with accounting standards established by the independent Financial Accounting Standards Board (FASB). That board is supervised by the Securities and Exchange Commission (SEC).

Now, the Obama administration is on the verge of transferring accounting standards responsibility from the SEC to a systemic risk regulator. Such a radical move would have extremely negative consequences for our capital markets.

Although there may be good reasons for establishing different regulatory capital standards for financial services firms, those reasons cannot justify dispensing with the FASB’s accounting standards. Acting in accord with powers given to it by the Sarbanes-Oxley Act, the SEC has formally recognized the FASB as the definitive standard-setting body, capable of “improving the accuracy and effectiveness of financial reporting and the protection of investors.”

The SEC treats accounting standards adopted by the board as authoritative. If the SEC has concerns about, or disagrees with, accounting standards promulgated by the FASB, it can refuse to give them deference.

As I blogged yesterday, it is a fact of life that accounting standards frequently have economic consequences.  It is government’s responsibility to adjudicate between competing economic interests.

Banks are currently trying to use the political arena and the Congressional branch of government to influence accounting rules.  Specifically, I am referring to an amendment sponsored by Representative Ed Perlmutter (D-CO) to the Financial Stability Improvement Act, currently being considered by the House Financial Services Committee.

Although I do not favor the bank position on fair value accounting, I applaud their attempt to use Congress to influence accounting standards.

Why?  The SEC has two relevant policies. First, any country adopting IFRS should use them lock-stock-and barrel. Second, it endorses the notion of one universal set of global accounting standards, and is poised to announce the adoption of IFRS for U.S. reporting.

It seems to me that the SEC is about to abdicate its responsibility and role, in oversight of accounting standards. If the SEC continues along its intended path, there will be no U.S. governmental control over accounting standards. Oh, there is the hope that the SEC can influence the IASB. Europe has that same hope. Last week we saw that several countries in Europe have concerns over the lack of European control over the IASB, and continued use of IFRS in Europe is a little doubtful.

Well, if the SEC is anxious to get out of the business of overseeing accounting standards (and adjudicating competing economic interests), then it seems reasonable to me that it is in the self-interest of concerned economic interests in the U.S. to preserve a governmental solution to oversight of accounting standards. As I blogged yesterday, any nation that cedes control over some aspect of its economy to an extra-national body is incredibly stupid. Today I add that it is brainless, dazed, deficient, dense, dim, doltish, dopey, dull, dumb, foolish, futile, gullible, half-baked, half-witted, idiotic, ill-advised, imbecilic, inane, indiscreet, insensate, irrelevant, laughable, ludicrous, meaningless, mindless, moronic, naive, nonsensical, obtuse, out to lunch, pointless, puerile, rash, senseless, shortsighted, simple, simpleminded, slow, sluggish, stolid, stupefied, thick, thick-headed, trivial, unintelligent, unthinking, and witless (synonyms supplied by thesaurus.com).

Consequently, I do not think it a bad thing the banks are appealing to Congress.

Now we have three previous Chairmen of the SEC speak out on the issue.   Their position is that the SEC role in determining accounting standards should not be overridden. They cite the pre-eminence of U.S. capital markets and attribute it in part to American accounting standards.   At first glance, this seems like a defense of continuing the status quo of FASB-SEC working partnership. I mean, if it isn’t broken, why fix it?

But that isn’t what they mean. There is no more vocal proponent of IFRS than Harvey Pitt, now writing for Compliance Week. Ruder has been interested in the U.S. adopting IFRS for decades.

What these three previous chairmen of the SEC mean is that the Perlmutter proposal upsets the applecart of the inexorable march toward IFRS in the United States.  The SEC has no intention of letting anything get in the way of that.

Why can’t these guys say what they mean?  Oh, they’re politicians.

It could very well be that the Perlmutter proposal is the last opportunity to derail IFRS adoption in the U.S.  Defeat of his proposal would clear the way for an SEC announcement that the U.S. has adopted IFRS.

To be continued.

Debit and credit – – David Albrecht

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Finally, some hard hitting rumor reported as news on Thursday, July 30.  According to Jesse Westbrook and Ian Katz of Bloomberg, Mary Schapiro has narrowed down Chief Accountant finalists to two:  James Kroeker (accounting firm candidate with ties to Clifford Cox and Robert Herz) and independent Jack Ciesielski.

I’ve talked with Westbrook before, and he has been following the chief accountant for many months. Westbrook also reported Niemeier’s candidacy.  I suspect that these rumors are fairly square on.

This is an interesting development from early June when I reported on leaks that there were five finalists.  On June 4, I supplied more information about each candidate in Thoughts About Candidates For Chief Accountant.

James Kroeker, acting Chief Accountant, and Wayne Carnall, chief accountant of the SEC’s Division of Corporation Finance, are both in-house candidates and IFRS proponents, the issue of the day, year and decade.  That Kroeker remains as finalist is an endorsement of his performance as acting chief.   He seems to have done well in discussions with Congress as he defended fair value.  He was chief architect of an SEC report that concludes fair value accounting did not cause the recent financial mess.

Jack Ciesielski, candidate for SEC's chief accountant

Jack Ciesielski, candidate for SEC's chief accountant

Jack Ciesielski beat out Charles Niemeier as the anti-IFRS candidates (that is, U.S. should not adopt IFRS).  Both have impressed with the quality of their research on IFRS and other issues.   I suppose Jack’s ascendancy is not surprising given that Charley has been a lightening rod, but I still love Charley.  We owe him much gratitude for his 2008 speech that enticed hundreds of thousands of U.S. accountants to come out of the woodwork and declare their opposition views to IFRS.

Jack Ciesielski has written at length about the perils of U.S. adoption of IFRS, at least as currently formulated and with its current structure.  His Analyst’s Accounting Observer is a great resource.

Both remaining candidates are fair value proponents.

Who will win out?  I don’t really know Mary Schapiro, and it’s her call.  She faces a great deal of pressure from Barak Obama and Paul Volcker to appoint someone who will implement G-8 recommendations.  Kroeker is this person.  On the other hand, she seems to have an independent streak and a mind of her own.   Both qualities could lead her to support the anti-IFRS candidate.

The country does not need a big four Chief Accountant.  Kroecker would triumph the preparers of accounting information over the users.  He has ties to the foul Christopher Cox.    Foxy John Kroecker will eat us all hens for supper.

If Mary Schapiro is true to her stated prinicples, she will act to protect investors and appoint Jack Ciesielski.

Why has this taken so long?  Schapiro has been under intense pressure not to appoint an anti-IFRS person.  But, she has resisted, because the U.S. adoption of IFRS is clearly the wrong thing to do.  Had Kroeker not done such a fine job in the fair value defense, I suspect that Ciesielski would already have been appointed.

Over and out – – David Albrecht

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In a report issued Wednesday, June 17, the Obama administration touched on its vision for regulation of financial reporting in the U.S.  Not yet possessing statutory authority, Financial Regulatory Reform is more a statement of strategy and intention with respect to regulation of banks and all matters related to financial markets in the U.S.

muddyfootprints2It has Paul Volcker’s muddy footprints all over it.  Shame.

I see two provisions affecting accounting.  The first, from page 11:

The accounting standard setters (the FASB, the IASB, and the SEC) should review accounting standards to determine how financial firms should be required to employ more forward-looking loan loss provisioning practices that incorporate a broader range of available credit information. Fair value accounting rules also should be reviewed with the goal of identifying changes that could provide users of financial reports with both fair value informationand greater transparency regarding the cash flows management expects to receive by holding investments.

Quite simply put, fair value reporting by banks of financial assets is reaffirmed.  However, bank desires to avoid recognizing losses in declines in value should also be accommodated. Nice work if you can get it (and you can get it if you try).

The kicker is on pages 19-20 (with more detail provided on pages 86-87):

J. Improve Accounting Standards

1.  We recommend that the accounting standard setters clarify and make consistent the application of fair value accounting standards, including the impairment of financial instruments, by the end of 2009.

2.  We recommend that the accounting standard setters improve accounting standards for loan loss provisioning by the end of 2009 that would make it more forward looking, as long as the transparency of financial statements is not compromised.

3.  We recommend that the accounting standard setters make substantial progress by the end of 2009 toward development of a single set of high quality global accounting standards.

The G-20 Leaders agreed that the accounting standard setters should make substantial progress toward a single set of high quality global accounting standards by the end of 2009. The IASB and FASB have engaged in extensive efforts to converge IFRS and U.S. Generally Accepted Accounting Principles (GAAP) to minimize or eliminate differences in the two sets of accounting standards. Last year, the IASB and FASB reiterated their objective of achieving broad convergence of IFRS and U.S. GAAP by the end of 2010, which is a necessary precondition under the SEC’s proposed roadmap to adopt IFRS. Currently, the SEC is considering comments submitted on its proposed roadmap that sets forth several milestones that could lead to the eventual use of IFRS by all U.S. issuers.

Does Paul Volcker want the U.S. to move to IFRS?   Why yes, bears shit in the woods.  Obama and Volcker wishing it, however, does not mean that it will happen.  I hope someone in the Obama administration finds a brain.  And soon.

Debit and credit – – David Albrecht

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