Peeling away financial reporting issues one layer at a time

Will the SEC Sneak IFRS in Through the Back Door?

I have been hearing rumors that the SEC is getting ready to come out with its IFRS adoption plan any time now. Richard Breeden, a distinguished former SEC chair, and now the head of a $2 billion international investment fund, stated that if the SEC were to adopt IFRS, "it would be the darkest day in the history of the SEC."*  Like it nor not, though, there is no denying that it will be the most radical and riskiest change to accounting standards since the establishment of the federal securities laws in 1933.

The latest indication of what could be in store for us is set forth in the May 26, 2011 SEC Staff paper, Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers: Exploring a Possible Method of Incorporation, informally referred to as the "condorsement" proposal. To the staff's credit, it finally conceded that a complete abrogation of U.S. GAAP in favor of IFRS as established by the IASB has absolutely no chance of succeeding.

 But, seemingly out of thin air, it now proposes a very curious restructuring: the FASB would retain its title as the standard setter for U.S. GAAP, but it would be emasculated. It would be prohibited from adding any new project to its agenda, unless it would be to endorse an existing IASB standard, or to work with the IASB on one of a project of the IASB's own making. In this way, the FASB's activities would be limited to only incorporating IFRS standards into the FASB's Accounting Standards Codification over just a few years' time. Hardly anyone feels that this is realistic, or shall I say, "justifiable."

 The Back Door Gambit

 "Justifiable" is a key word, because I believe that the SEC is planning to proceed with a condorsement policy without adequate evaluation of the costs and benefits. This is because the new proposal is deviously structured such that it could be implemented without any rulemaking by the Commission itself. This is especially alarming in light of a recent court ruling which makes clear that the Commission must accompany all rulemaking with a rigorous, reasonably complete and unbiased evaluation of costs and benefits.

 If IFRS adoption were to take effect, by a process that circumvents rulemaking, then that by itself would make for "the darkest day in the history of the SEC." And, indeed, it now seems that IFRS could only be possible without rulemaking; because the Staff has absolutely no idea how it will be able to conjure a justification with more than a snowball's chance in hell of passing muster in a court of law.

  •  The CFA Institute, representing over 100,000 investment professionals worldwide has expressed similar concerns regarding the SEC's obligation to reasonably consider all of the pros and cons of IFRS adoption. In a recent comment letter, the Institute reminds the SEC Staff that it hasn't done much homework at all. In fact, as we sit here going on two years after the announcement of that work plan, little has yet to be been done to:
  • Define what "high quality standards" means, and whether IFRS standards measure up;
  • Address whether the IASB has made needed improvements to its infrastructure and governance;
  • Specify an enforcement mechanism for IFRS; and
  • Specify how endorsement of IFRSs would actually take place (and by implication lead to the ambitious goal of generating financial statements that simultaneously comply with US GAAP and IFRS).

 "I should add to the Institute's concerns that the staff work plan provides no indication whatsoever as to how the SEC will assess the economic benefits of IFRS adoption – either quantitatively or qualitatively. The DC District Court's decision explains in no uncertain terms that rulemaking must be accompanied by a clear-eyed assessment of benefits, yet nothing in the Staff's planning documents indicate that such an analysis is in process, or will ever be produced.

Send in the Shills

Yet, despite the fact that the SEC clearly has no intention of honoring its word, and there is overwhelming opposition to IFRS adoption, many fear that the decision to pre-empt real answers to these threshold questions is soon at hand. Earlier this month, Hans Hoogervorst and Harvey Goldschmid, IASB chair and CAQ board member, respectively, attempted to provide momentum to the Staff's condorsement proposal with keynote speeches at the IFRS Foundation/AICPA Conference in Boston. Their unqualified exhortations to the SEC to move ahead on IFRS adoption is exactly what one would have expected from the most visible paid promoters of IFRS at a conference jointly produced and staged by the two most active and powerful IFRS lobbying groups. The biased conclusions of Messrs Hoogervorst and Goldschmid were synthesized from an admixture of vague generalities, selective use of the facts, cherry picking of academic research, and biased speculations. (These are not empty accusations; I'll be discussing these in detail in posts to follow.)

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The real answers to IFRS adoption questions are in the details. I am certain that we are never going to get those details that the public is entitled to from the SEC or the special interests that only want to line their pockets at more expense to shareholders and investors.

If IFRS gets shoved down the throats – without formal rulemaking – of the thousands of corporations that want this whole thing to go away, and the millions of investors who deserve better, then the next thing to do is to call for Mary Schapiro's resignation.

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*As reported to me by Lynn E. Turner, former SEC Chief Accountant, who two years ago attended the semiannual meeting of the Council for Institutional Investors in Los Angeles where Mr. Breeden spoke and made this statement. Among other reasons, Mr. Breeden believes US GAAP provides him and his portfolio managers with better data.

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