Peeling away financial reporting issues one layer at a time

For Whom Does the FASB Toil? (Not for Investors)

The FASB’s exposure draft on loan losses is a huge disappointment:

  • Investors will not be helped by this approach;
  • The numbers produced by the ED will be whatever the bank CEO wants;
  • The wording of the ED is so permissive and allows for so much judgment that the CEO can get the number from his/her OUIJA board.

The FASB is making a huge mistake.   [emphasis supplied] [available at:]

Amen.  And these are not merely the sentiments of some cranky ex-professor.  They are the unvarnished view of a former SEC Chief Accountant and charter member of the FASB: Walter Schuetze.  As is too often the case, the FASB has buried such against-the-grain sentiments deep under a pile of dross — i.e., the comment letters from financial institutions and the accountants who feed at their troughs.  Such is “due process” FASB style.

Were I back as staff at the SEC either as chief accountant or chief accountant of the enforcement division, I could not recommend to the Commission that it bring either an administrative proceeding or an action at law against any registrant or its auditor re loan losses.  It will be impossible to prove that the registrant did not follow GAAP. [underlining in original]

If there is only one thing more you should know about Walter, it is that he was the partner at KPMG almost solely responsible for insulating his firm from the fallout of the S&L crisis of the early 1990s.  He fought tooth-and-nail, and virtually alone, against accepting new banking clients; because he could not abide the thought that KPMG should be associated with loan valuations that bore no basis in reality.

The incurred loss model, which is the current standard, does not produce credible information in times of financial crisis as in 2008.  It is embodied in FASB Statement 5, which was issued in 1975, and which I signed [and co-wrote].  SFAS 5 was issued to stop insurance companies from establishing what they called “catastrophe reserves.” … That practice is much the same as might be established pursuant to the words in the ED.  It will not work; it will not produce useful, credible information.  [emphasis supplied — and see this earlier post on this problem.]

If there is one other thing you should know about Walter, it is that he resigned from the FASB before the end of his first term.  In a 2006 interview for the SEC Historical Society, he said he was unable to counter the immutable resistance of other board members to measuring equity securities at market value, even when closing prices were available for all to read in the WSJ. (Plus ça change…)

What will work is to take the fair value information now in the notes to the financial statements and move it into the basic financial statements.  That approach may not make bankers happy because the market place, not the bankers themselves, will be generating the numbers.  Bank regulators may not be happy because they want rainy-day reserves, which might be accommodated by the words in the ED, but they have the authority to require whatever they want in filings by banks with the authorities.  But, investors, who are the FASB’s audience, will be happy, and that is the only thing that should matter. [Underlining in original] …

In the end, investors who use bank financial statements will say that the FASB caved to the bankers.  The FASB’s credibility will suffer greatly. [emphasis added]

Looking at the hash that the FASB is slow-cooking on revenue recognition and leasing (I will, and I have — here and here) in addition to loan impairment, I’d say that the FASB’s credibility is already in serious jeopardy.  If a donkey is a horse created by a committee, then an Accounting Standards Update has come to be an accounting pronouncement created from focus group data.  

Why does the Board seem to think it has to subordinate its judgment to special interests instead of investors?  (That’s not just my opinion, it’s the opinion of several members of the Investor Advisory Committee who have contacted me over the years.)  I’ll give you two hints:

Hint #1—Board members are appointed by the Financial Accounting Foundation, an organization that should have been consigned to oblivion by the SEC once Sarbanes-Oxley created a mechanism to fund the costs of running the FASB.  Taken as a whole, the FAF’s trustees are  the personification of the special interests that deluge the Board with those “due process” comment letters.  FAF adamantly claims that the criteria for FASB member selection has nothing to do with a candidate’s views on specific accounting matters before the Board; but if you actually believe that, then perhaps you would be interested in buying the 100 acres of beachfront property I own on the moon.

Hint #2—As I mentioned, Walter blew off the FASB out of principle.  That’s rare.  The vast majority over the past four decades have stayed on the Board for as long as they could: two 5-year terms.  Comparing an FASB member’s average tenure to turnover rates at the SEC, or of government appointees in general ought to raise a red flag, but it’s clearly a taboo topic.

My point is that there is evidence to suggest that the FASB has come to exemplify a particularly distasteful form of regulatory capture more commonly observed in third world countries.  Contrary to practically every other kind of US bureaucratic leader, FASB members demonstrate by their lack of mobility that have no better place to go, and they leave only when they staying is no longer an option.  To this fact, add one other:  that FASB members are paid somewhere north of $500K per year plus benefits.  Usually, one accepts a pay cut to become a regulator; but not at the FASB.  Don’t make waves, and get another five-year term from the FAF.

If one concludes from the evidence that FASB members are appointed by agents of special interests, and that at least some FASB members are overpaid, then one must perforce ask: for whom does the FASB toil?  

Do FASB members toil in service of oligarchs or for investors and our economic security?

The answer to that question should also explain why Walter is whistling in the wind.


1 Comment

  1. Reply Joel Ungar June 2, 2013

    I continue to be disappointed with everything the FASB issues (ok one exception: the revisions to goodwill impairment testing weren’t horrible). Nothing every gets easier and we continue to issue financial statements that don’t contain good information.

    Not that I think IFRS is the response.

Leave a Comment