Peeling away financial reporting issues one layer at a time

The Financial Accounting Foundation Has Outlived Its Usefulness (As if it Ever Was)

Let’s pretend that we could decide anew how accounting standards for U.S public companies should be promulgated.  Who would want the operations to be run by the Financial Accounting Foundation?  Are there other options?

When it was established in 1972, there were three important features of the FAF.  The first two are explicit: to appoint and oversee the FASB (which it still does), and to cover the cost of the FASB’s operations principally through fund raising.

The third feature is less apparent, but the most critical.  The FAF’s board was, and largely continues to be, stacked with plutocrats of finance and industry, who when selecting a new FASB member, operate even more mysteriously than a papal conclave.

For example, when a discussion on the AECM listserv was had on the topic of the most recent FASB appointment (more on that later), Dennis Beresford, a former FASB chair, stated that the FAF “…runs its selections for FASB Board members by the Chairman of the SEC who would have an effective veto right if she were not satisfied with the Trustees’ selection… I am personally aware of this veto having been exercised once.”

I would be surprised if any of the more or less 700 academics on the listserv was aware of that before Denny’s statement.  Knowing and trusting Denny, I have no doubt of its veracity; but why is it that only a privileged few are permitted to have knowledge of this process?

Actually, it seems, a very privileged few.  I did have an opportunity to ask one other source with first-hand knowledge of the inner workings of the accounting sausage factory, and he is also not aware that anything like this actually happened or was part of an established protocol.

Moreover, I don’t think that enough people fully appreciate that the FAF acts with impunity to appoint FASB members whose collective decisions essentially create established law to be followed by all public companies in the U.S.  If an SEC commissioner should be publicly vetted by Congress, then why shouldn’t it be the same for an FASB member?

One doesn’t need to have a lot of experience with not-for-profit organizations, especially ones that depend on large gifts, to predict how the FAF was going to operate when it was granted its franchise four decades ago.  In return for their largesse, top donors would want to influence what the organization produces.  To quote General Motors’ CEO at the time, Roger Smith, “You know, when we did this Wheat study [the Wheat Committee recommended the establishment of the FASB], I ordered chicken salad.” [As told by Donald Kirk, one of the original members of the FASB.]

That quotation serves to vividly illustrate that the FAF has one feature that distinguishes it from all other not-for-profits: those large donors who serve on the board of trustees are also major constituents: the accounting profession, the audit clients of the major firms and the financial services industry.  Imagine if the President of the U.S. invited the most significant donors to his re-election campaign from the defense industry to take a seat on the National Security Council.  Frankly, I don’t see much difference.  One could conceivably argue with me over the quantity of chicken salad (a pejorative I have used in no fewer than 10 posts, by the way) that the FASB has actually dished out over the years, but it can’t be denied that Smith and his co-architects of the FAF expressly intended to deliver standards to special interests that would be nothing if not tasty and easy to chew.     

It seems that the drafters of S-Ox recognized that conflicts between the FAF and the public interest existed, which they attempted to at least mitigate by creating an independent source of funds for the FASB’s standard setting activities – an “accounting support fee” that is essentially a tax on SEC filers.  But, the old boy network that is the FAF stayed, and here is a sampling of what they have wrought since their hides were spared:

2008In one fell swoop, and against the protestations of practically everyone, the FAF shrank the FASB to five members in order to minimize any dissent and truncate due process while adopting IFRS.  It also revised the FASB’s voting rules to require only a simple majority to pass a new standard; and it vested all power to set the agenda with the FASB’s chair.  Fortunately, their high-handed gambit failed miserably.

2010 – Out of frustration with the lack of progress on adoption of IFRS, and fear that the FASB might vote to require fair value measurement for bank loans, the FAF fired the FASB chair and undid the reduction in number of board members.  In a second fell swoop, it created three new positions so as to stack the board with new members who could be reliably counted on vote down fair value for bank loans; and promoted to chair the board’s staunchest fair value opponent.

2013 –  The new FASB chair — like his predecessor and numerous other extant and former board members — had been programmed, vetted behind closed doors and plucked from the ranks of FASB staffdom. He has a long track record of catering to the accounting establishment.  His wife, incidentally, is a Big Four partner.

A little while later, the FAF anointed Jim Kroeker —who some months earlier had resigned his position as SEC Chief Accountant and yet another FASB staffer at one time — to the FASB.  No one whom I have asked can cite for me one significant accomplishment of Mr. Kroeker’s while in a leadership position at the SEC.

But, Mr. Kroeker did demonstrate on numerous occasions that, when called upon to obfuscate, he could be trusted to do so.  As deputy chief accountant, he participated in the charade to cover up the incompetence of his superior, a political appointee of Christopher Cox.  But more important, when Mr. Kroeker took over the hot seat, the overwhelmingly negative feedback on convergence with IFRS continued unabated throughout his three-year term; yet with great aplomb he acted throughout as if the war was being won, even though every battle had been lost.  The last public report to come out of the Office of the Chief Accountant to mark financial reporting’s lost decade finally acknowledged that the barriers to IFRS adoption were insurmountable.  It was so poorly constructed and in so many respects such a humiliation, that Mr. Kroeker shamefully timed the issuance of the report for his last day at work – leaving others to answer the inevitable questions about the mess that had been created under his watch.

Oh well.   So, why didn’t Congress restructure the FASB, perchance to look just like the PCAOB, when it had the opportunity?  I see two possibilities.  First, Congress had enough of a fight on its hands against the accounting establishment to create the PCAOB, and to put it under the wing of the SEC.  To wage war on two fronts might have risked defeat for other accounting portions of S-Ox.

Second, Congress clearly, and by a wide margin, misjudged the potential for the IASB to contribute to a solution (instead of creating new problems).  They expected that the role of the FASB would have been diminished by now.  But, if anything, due to the passivity of the SEC when it comes to accounting matters, the power of the FAF and FASB may have actually been strengthened.

After a lost decade of attempted convergence with IFRS, it seems that we’re back to square one.  We (the public interest) remain saddled with a system under which we must rely on the FAF to correct the problems with financial reporting that helped bring us Enron, Worldcom and the 2008 financial crisis.

Based on its track record, the term “trustee” seems sadly misplaced.

1 Comment

  1. Reply ron todd September 4, 2013

    Nice article.

    I think you are complaining about something that can not be fixed. Their behavior appears in all respects to be what one would expect from normal human group iteration.

    No reason to quit complaining, a few of old folks like to know what is really going on.

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