Kudos to The Economist for summarizing in slightly more than one-third of a page the critical issues that will determine the future of financial reporting. Leading off:
"Despite the departures of Sir David [Tweedie, IASB] and Mr Herz [Robert, FASB], big accounting firms and their clients still expect convergence of standards to top the agenda of their successors…"
In other words, investors, small accounting firms and small businesses, not so much, if it all. That's practically a known fact.
Another interesting fact, as reported by CFO.com, is that a panel of experts created by the FASB and AICPA have recommended that a standard setter apart from the FASB should be responsible for setting the accounting standards for private companies – irrespective of their size. The "elephant in the room" is reported to be that private companies don't wish to be burdened by the recent spate of fair value rules.
But, I wonder if the panel's sponsors haven't been double-crossed by the outcome; for such a re-organization provides yet one more reason not to adopt IFRS. The establishment of a separate standard setter for private companies will permit the FASB to focus more closely on the mission given to it by the SEC: to create accounting standards suitable for financial statements contained in public company filings to the Commission. I don't know how the SEC, whose raison d'etre is public companies, will be able to get around the fact that an IASB with a less-focused mission should somehow be expected to do a better job than a more sharply-focused FASB.
All Fair Value, All the Time
"The most controversial issue in that process [of convergence] is how to report financial assets… Mr Herz firmly backed fair value, arguing that doing otherwise made financial trickery easier."
Yes, that's the whole point: if wisely implemented, fair value measurement of loans deprives management of the opportunity to manipulate their earnings and measures of financial solvency. I give The Economist full marks for stating it so bluntly, because few other publications seem capable of tackling the issue even tangentially. One of the reasons I so enjoy reading The Economist is that their broad readership permits them to provide independent views without concern for biting the (banker's) hand that feeds it.
"[However,] opponents think that revaluing seldom-traded assets during market meltdowns makes banking crises more likely and more severe."
As I have stated often, the FASB made a critical error by specifying that "fair value" should be an "exit price" as opposed to an "entry price." Exit prices are indeed very difficult to estimate when markets suddenly become illiquid, because you can't "command" somebody to purchase some toxic financial instrument at your asking price, even though you might think that it's a "fair" price. On the other hand, it should be much more straightforward to estimate how much someone would be willing to sell an asset for, even in an illiquid market. It's always easier to buy something than to sell it.
Stacking the FASB Against Fair Value
"Mr Herz's empty seat at FASB will be filled by an insider, FASB's technical director [Russell Golden]. … Mr Herz broke a 2-2 tie to vote for the reporting-standards proposal that leant heavily towards fair value. … The "big four" accounting firms … not to mention companies of all types with international reach, are on IASB's side [i.e., amortized cost accounting for loans and debt]. Many think, therefore, that Mr Herz's departure may allow for a consensus-seeker to emerge as his replacement."
How Bob Herz came to be fired remains a mystery. The Economist reports that he resigned for "undefined personal reasons," but CFO.com conducted a lengthy interview with Bob, and discussion of the circumstances that led to his departure from the FASB were clearly out of bounds for the interviewer. So, I say he was fired for reasons we can only guess at – and that's what I'm going to do. Unless I'm told otherwise, I am going to assume that his handling of the congressional flap over financial instrument accounting and his pro-fair value stance must have exasperated the trustees of the Financial Accounting Foundation enough to fire him.
And, lest you conclude that the FAF is not attempting to stack the Board against fair value, here are a few more things you should know about Herz's replacement, Russell Golden.
First, "insider" doesn't fully describe the culture from whence Golden comes. As with far too many FASB staff members, Golden came to the FASB straight from the Big Four, where he was a technical partner who presumably lobbied the Board and its surrogates for the accounting rules his firm, Deloitte, proponed. Until the Board expands to seven members from the current five, he will join two other former staff members on the Board, Leslie Seidman and Lawrence Smith. These two, not coincidentally, are also the two dissenting members to the FASB's fair value exposure draft. If Golden votes with Seidman and Smith on fair value, as I fully expect he will, all pretense of an investor-focused FASB will be abandoned, as the Board's position on fair value will have turned on a dime.
Second, Golden has a track record of catering to the Accounting Establishment. Notwithstanding, CFO.com reports that "Golden says he considers his point of view to be less that of an auditor and more of someone with an 'open mind' about improving financial reporting, which includes balancing investor concerns with the cost of improvements to prepares and auditors." – I simply don't see any evidence of that in Golden's past actions.
To take just a couple of examples that I have written about recently, Mr. Golden presided over the EITF and its agenda when that Big-Four-dominated group came up with consensuses on Issues 10-D and 10-F: both are unapologetic sops to special interests, and shouldn't even have been put on the EITF's agenda. Then, there is the infamous FASB Staff Position that broadened the use of other comprehensive income for keeping declines in market value off the income statement. The Board's meeting minutes indicate that the Board was leaning toward limiting the new 'get out of jail free card' to debt securities, but the Golden-led Staff recommended that equity securities be included in its scope. The Staff ultimately prevailed on the three Board members who voted for the FSP.
Third, and this is the whopper, one Tracey C. Golden is a highly-placed partner at Deloitte. I had heard that Russell Golden's wife works for the Big Four, and I guess this is she. The conflict of interest for Mr. Golden must be obvious, but since the Financial Accounting Foundation seems to have not given it much consideration, I'm compelled to spell it out:
- If (as The Economist reports) Deloitte wants the FASB to converge with the IASB on loan and debt accounting, it is highly probable that this is also what Mrs. Golden wants;
- If Deloitte wants to augment its book of business by assisting US companies in a mandated conversion from US GAAP to IFRS, then it is highly probable that Mrs. Golden wants IFRS and GAAP to converge wherever possible;
- If Deloitte gets what it wants out of the FASB, then Mrs. Golden stands to become significantly wealthier, and so does Mr. Golden.
It may be no small thing for the Technical Director of the FASB, who has no formal vote, to be in a position to gain from the outcome of an FASB vote; but one might conceivably take comfort in the belief that voting members of the FASB will mitigate both the fact and appearance of a conflict of interest on the part of its Technical Director. It's quite another thing, however, when the fate of the most consequential exposure draft in the history of the FASB has a nontrivial probability of being decided by the single vote of Tracey Golden's husband.
So Far, So Bad
I'll concede at the outset that I was not in possession of the inside skinny on Russell Golden's imminent appointment to the Board until after I wrote my post, but his appointment certainly feeds into my concern that the FAF might do whatever it takes to ensure that fair value would be defeated, and in so doing put IFRS adoption back on track – despite the many voices against it.
At the same time the FAF announced the Golden appointment, it published a Q and A with chair John Brennan to address the process by which the FAF would fill the remaining Board positions. Mr. Brennan was 'asked' only three questions; and I will dare to venture that his response to the last question was the entire motivation for issuing that document:
Q. What are the selection criteria for the new board members? Some internet bloggers [emphasis supplied] have recently speculated that new board members could be selected based on their views about "mark to market" accounting as it pertains to current proposals out for public comment.
A. Let me state unequivocally that FASB members are not selected based, in whole or in part, on their views on any technical accounting issues. In fact, it would not only be inappropriate to select FASB members based on those views, it is against the very core and spirit of the FAF. I would also add that such behavior would be against our by-laws, which emphasize the independence of the FASB with respect to standard-setting matters.
That said, we are looking for some very special qualities in our FASB members, and that includes a strong passion for the mission, great depth of experience and demonstrated knowledge of financial accounting and reporting, and an appreciation of the varying needs and interests of all the FASB's constituents. …
Since I could find no other "speculating" bloggers besides yours truly, I am going to assume that Mr. Brennan was responding to my post.
Mr. Brennan, despite what you have stated "unequivocally," I don't believe it is possible to select Board members without regard to their views on "technical accounting issues," especially at this critical juncture. Do you mean to say, for example, that just because some trustees may have read my blog posts, which express my point of view on numerous current financial reporting issues, I should be automatically disqualified from consideration? Or, do you mean to say that the trustees have both the intellectual capacity and purity of motive to utterly disregard what they actually know of my views? Or, to take another example, if you were to offer a Board seat to a current technical partner of one of the Big Four, could you possibly disregard her firm's formal position on fair value, which she might have drafted herself?
Mr. Brennan, financial reporting has become a huge mess. Even former Board members say so (see here and here). Untold amounts of wealth and the livelihoods of innocent, hardworking Americans have been destroyed by the self-serving actions of executives managing to the rules of GAAP instead of the long-term interests of their shareholders. The FASB should have foreseen, on numerous occasions, that recipes for made up numbers would be abused; and if they did foresee abuse, they must have rationalized that problem away somehow. If you don't believe me, I can provide you with the name of an FASB staff member (originally from a Big Four firm) who told me that value-destroying abuses of accounting rules should be of no concern to the Board.
Restocking the Board from the pipeline of Accounting Establishment candidates will not fix the many problems with GAAP and the inexorable erosion in the public trust in financial reporting coming from the waves of accounting scandals that have rocked our economy in the decades since the FASB was formed. Moreover, the situation is not helped by high-minded assertions that every reasoning person knows cannot be anything more than a pretense for obscuring the real agenda. Reasonable people understand that the views of potential Board members are, and should be, important to you and your FAF colleagues – no matter what may be set forth in the FAF's by-laws. I am simply asking the FAF to recognize that more convergence with IFRS will not fix the mess that accounting is in; it will only make matters worse.
Finally, Mr. Brennan, you will have my application for one of the open Board seats by the end of the week. Each of the four former Board members whom I am privileged to know well enough to ask, have graciously given me permission to use them as references. Three members of ITAC, and two former SEC chief accountants have done the same, and one volunteered that it was a privilege for him to serve as a reference.
I hope that you will give both my views and my application serious consideration.