Peeling away financial reporting issues one layer at a time

What’s Going to Happen to Financial Reporting in 2011?

I predict that 2011 will be a year full of sound and fury, but signifying nothing to advance the cause of high quality financial reporting. You can take it to the bank – by which I mean any one of the banks fighting accounting reform tooth and nail.

If History is Any Guide, Watch Out!

If you are inclined to think that accounting is headed for a better place, then I implore you to consider recent history, as devastatingly portrayed by one of the most successful and smartest investors of our time, Charlie Munger. In an interview published in Spring 2009 (video here; magazine version here) with former SEC Commissioner Joseph Grundfest, Munger laid much of the responsibility for the current economic problems at the feet of the accounting profession:

"I would argue that a majority of the horrors we faced would not have happened if the accounting profession were organized properly. In other words, they have a position from which, if they behaved intelligently and correctly, they could prevent a huge amount of all that's wrong with the system. And they fail utterly, time after time, after time.

"And they are way too liberal in providing the kind of accounting the financial promoters want. They have sold out … Compared to what could reasonably be with intelligence and honor, the accounting profession is a sewer." [emphasis supplied]

… "Enron never could have happened if they hadn't changed the accounting rules, and what we have now is just a bigger, widespread Enron."

… "Idiot bubbles blessed by accountants are terrible for the whole civilization."

I happened upon the Munger interview more or less coincidentally with the recent news that the Financial Accounting Foundation promoted Leslie Seidman to chair of the FASB. "Probably more than others on the board, she brings a preparer's [italics supplied] perspective to the table," said a gratified pharmaceutical executive in the CFO.com report of Seidman's appointment. Substitute "banker" for "preparer" and you'll have an even better idea of what we're in for with Leslie Seidman as chair. In an interview she gave to Floyd Norris, Seidman has already announced that bankers will be awarded the loan accounting they so desperately covet.

Can the Reputation of Accounting Get Any Lower?

Continuing on the theme of coincidences, I also commend to you a series of brief commentaries in the online version of NYT that fits right in with Munger's complaint. "What's Wrong with Accountants?" is a must read with many provocative nuggets, but I'll confine myself to just the one for now; Columbia law professor John Coffee's commentary on Lehman's now infamous "Repo 105" device for dressing up its balance sheet with the apparent acquiescence of Ernst & Young:

"[In response to the Repo 105 affair,] the S.E.C. only issued a quiet release in September that requires greater corporate disclosure of 'short-term borrowings.' That was a modest step at best, and, by only providing 'interpretive guidance' for the future, the S.E.C. seemed to accept implicitly that 'window dressing' is not fraud. … [U]ntil the S.E.C. returns to its former view that a public statement can be both technically accurate and materially misleading, investors are at risk."

"Strong public enforcement is the best answer, because other alternatives simply will not work. … [T]here are only four global accounting firms … and none wish to compete on the basis of their relative integrity." [italics supplied]

Although Munger's criticisms of accounting standards setters are devastating and accurate, Coffee's point is that the ultimate responsibility for the fundamental weaknesses in our system of financial reporting, lies with the SEC and the bank regulators.

I agree with Coffee, and from a reading of the entire interview, I am confident that Munger would agree with him as well. No matter how one may have felt about the wisdom of outsourcing accounting standard setters to groups of individuals who themselves have vested interested in the rules they set, there have been numerous points in SEC's history when that financial reporting policy should have been seriously reassessed. Although lip service has been given from time to time, a serious reconsideration has never happened.

As for what we can expect from the current SEC leadership, Munger must be highly pessimistic. Mary Schapiro may have a record of integrity and effectiveness in some other areas of capital markets regulation, which I understand less well, but her past performance clearly indicates neither sufficient interest nor acumen for accounting. None of the other Commissioners for that matter have yet to stick their necks out or say anything profound on accounting matters either.

I wonder if the SEC even had much to say to the FAF about the appointment of Leslie Seidman? It appears that with the SEC standing idly by, the FAF's new scheme to stack the board away from fair value accounting and toward IFRS adoption (as I have already predicted) is effectively in place. Two newly-created, over-compensated Board seats remain unfilled, but this will be a largely perfunctory exercise. It's not that there aren't some great candidates whom Charlie Munger could not accuse of lacking intelligence or honor, but it's a sure thing that they will be either passed over or appointed as a mere token to investor interests once the majority voting bloc has been signed, sealed and delivered.

As for my own application, which I reluctantly announced in the interests of full disclosure, I will be sending a notification to FAF that I am withdrawing my name from consideration. For what it's worth, I am not aware that FAF did anything with my application other than to acknowledge receipt. I am also unaware of any attempt on their part to discuss my application with any one of my references.

The next time a spot on the board opens up, I'll be sure to ask Charlie Munger for permission to list him as a reference.

1 Comment

  1. Reply Independent Accountant January 3, 2011

    Tom:
    I have concluded fixing the accounting industry is not going to happen. It’s hopeless. I sympathize.

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