After I left the SEC, Executive Enterprise Institute signed me up to produce and chair various SEC and financial reporting courses. Our collaboration is still going strong, and they have given me lots of exposure to guest speakers, many of whom have played significant roles in capital markets regulation. Without wishing to make comparisons to others I have been privileged to meet, I distinctly remember James Doty, the new PCAOB chair, for his energy as a speaker, positive outlook, genuinely friendly demeanor, and openness to other points of view.
But, just because somebody is a genuinely nice fella, it doesn't necessarily mean he will lead the PCAOB as investor advocates believe it should be led. I decided to write this post after reading blogger Francine McKenna, who suspects that the SEC has sold investors down the river with the appointments of the three new board members. Francine's inculpatory evidence against Jim is that he did good business defending accountants and auditors in court. As you will see from reading this post, I am actually quite hopeful that Jim will follow in the footsteps of Charles Niemeier, former PCAOB chair, who himself did quite well in the same line of business. As with Niemeier (fomer enforcement chief accountant), I would expect that Doty's performance while at the SEC (former general counsel) is a better gauge of his fitness to lead the PCAOB.
Doty at the SEC – In His Own Words
The world has changed a lot since the early 90's, when Jim was the general counsel. The SEC brand had not yet been tarnished by partisan politics of the past ten years, and ignominious asleep-at-the-switch billions of dollars blunders. Jim Doty provided his personal take on his time at the SEC in a comprehensive interview sponsored by the SEC Historical Society. It could be the best glimpse we have at Doty's regulatory and financial reporting philosophies; so, what follows are a few snippets from the interview, mixed in with my own observations.
Derivatives – Doty thought very highly of Richard Breeden, who had indeed accomplished a great deal as SEC chair; and in the areas where Breeden failed to achieve his objectives, history has proved him tragically correct. For example, Breeden was strongly in favor of enhanced derivatives regulation, and he wanted to coordinate equities and derivatives regulation by merging the CFTC and the SEC; but, he ran into opposition from his own (Republican) party.
"[Breeden] saw, clearly, the need to do it [regulate derivatives]. He saw the fact that so much of the market's activity was shifting into this area that you couldn't monitor and determine capital requirements." [page 22]
And here we are, 20 years later, with bankers still insisting that we should measure capital adequacy under GAAP. (Kindly see my post on this vexing problem.)
Corporate governance –
"Richard believed, even then I think, that it was wrong for management to be self-perpetuating. People were tinkering with and considering proposals that looked like direct [proxy] access [to nominate board members], what we're now looking at." [p. 25]
Fair value – Breeden recognized that mark-to-market accounting for loans was the logical accounting policy response to the S&L crisis, and Doty is still singing the same tune:
"Regulatory accounting principles had been identified by everybody as having something to do with the failure of the system that had been in place to regulate the federally-insured depository institutions that were S&Ls. Richard very much believed in mark to market accounting and transparency. He believed that the volatility that occurred as a result of that transparency was better than the potential for serious misunderstanding and misstatement that occurred with historic cost accounting for financial instruments. He was in a very difficult position because he was also talking to Japanese, Mexican, European, and British regulators." [p. 34, italics supplied]
Nothing much has changed there! Elsewhere in the interview, Doty readily acknowledged that lack of high quality accounting standards for financial institutions played a significant role (although not the only role) in the banking debacles to come.
The status of GAAP – Against immense political pressure, Breeden held the line on compliance with GAAP by foreign issuers, while at the same time liberalizing other requirements to enable foreign companies to raise capital in the U.S.:
"[Breeden] also, of course, said, 'First of all, we're not going to abandon GAAP. If you're Deutsche Bank [sic, Daimler-Benz?] and if you want to offer your securities and list them on the New York Stock Exchange, you'd better provide a footnote that reconciles your earnings and your reserves to GAAP.' He, of course, was exactly right." [page 34, italics supplied]
And as to adoption of IFRS, Doty concludes the interview with this observation about Mary Schapiro:
"If you want to look at one that Richard Breeden was talking about … look at mark to market accounting, and look to GAAP and the principles-based accounting, and look at Mary [Schapiro], who's undergoing all these political pressures now, dealing with all these pressures, and what's she doing with IFRS? She's saying, of course, globalization is a fact of life: you can't be against harmonization, reconciliation and one uniform system accounting, but we're not there yet. We don't know what it is. Of course, she's right. They can't. They can't allow (or require) all companies to go to IFRS when there's Taiwanese IFRS and Milanese IFRS and Argentinean IFRS." [p. 48, italics supplied]
Will Jim Doty Walk the Talk?
The PCAOB's formative years occurred while any small deviation from the party line as enunciated by Christopher Cox would not be tolerated (a true definition of 'political correctness'). Once again, the case of Charlie Niemeier is instructive, as he was the first government official to deliver a tour de force critique of the SEC's misguided plans to jettison GAAP in favor of IFRS. While there is nothing to suggest that Doty will need to be as confrontational with the current SEC administration, I hope (and predict) that he will, like Breeden, seek to leave his mark on financial reporting. It would be too easy to be a caretaker chair, merely overseeing incremental improvements to the practice of auditing without declaring any sense of larger purpose. For that, Doty should start with a forceful articulation of his vision for financial reporting, and the role auditors should be expected to play in a more investor-friendly system. Jim should be able to come up with about 80 percent of the necessary ingredients from his recent interview with the SEC Historical Society.
We know what Jim Doty stands for, and he has demonstrated that he knows how to play the role of regulator with conviction. Here's hoping for a repeat performance.