INDEPENDENCE OF ACCOUNTING STANDARD SETTERS
Speech by SEC Chairman:
Remarks before the AICPA National Conference on Current SEC and PCAOB Developments by
Chairman Christopher Cox
U.S. Securities and Exchange Commission
Washington, DC
December 8, 2008
Note: Selected comments from Chairman Christopher Cox’s speech are the basis for this case. Good morning to all of you, and let me add my welcome to the AICPA’s National Conference on Current SEC and PCAOB Developments. It is a pleasure to join you at this Conference once again. And while the Conference topics this year are focused as always on the cutting edge issues that concern you in your practice, more than ever before the subjects that you’ll cover this week are of great importance to our nation and the economy as a whole.
From issues such as fair value measurement, to the future of international accounting and reporting, to corporate governance and MD&A and the SEC’s coming interactive data revolution, the Conference agenda is truly cutting edge and consequential. As leaders in your profession, I am especially grateful that you have taken the time to be here, in order to carry forward this important work and to help confront these challenges that concern not only our nation’s economy but the world’s. I want you to know that the Securities and Exchange Commission is a strong supporter of your efforts, and that’s why not only I, but also a range of top staff from the SEC, including our Chief Accountant, Conrad Hewitt; John White, the Director of the Division of Corporation Finance; Linda Thomsen, Director of the Division of Enforcement; and Jim Kroeker and Paul Beswick, our Deputy Chief Accountants, will be participating with you in this event.
The timing for the presentations you will hear could not be more critical. And since the issues you are addressing in your daily work go far beyond the normal conference agenda, to the very core of the financial turmoil in our financial system, it’s fitting that the people who will be speaking are leading the efforts to help investors and markets manage through that turmoil with sound and consistent accounting standards.
The AICPA’s 121 year history, dating back to 1887, makes this one of the oldest professional organizations in the country. From the founding of the American Association of Public Accountants, as it was then called, with a membership of only a few hundred to your more than a third of a million members today, the accounting profession has been vital to our nation’s economic health and prosperity.
Americans have always entrusted you with great responsibility, both individually and as a profession. And through thick and thin you have maintained their confidence.
Even in the post–Sarbanes Oxley, post–Enron environment, accountants have continued to enjoy a solid reputation among the public, and among business decision makers. That’s a testament to your integrity and professional competence. Business executives—your clients—give you a favorability rating of 95%. At the SEC, where we’re focused on investor protection, we’re most impressed that investors give you a favorability rating of 97%. That’s as close to perfect as you’re likely to get in this life. None of this means that anyone in this room can afford to be complacent. You have a reputation, and a future, to protect. Together, we’ve all got to remain vigilant.
The role of the accounting profession, at its core, is parallel to that of the SEC. We both have the goal of ensuring full and accurate financial information is reported by companies. And in fact, given that the AICPA’s history dates back even further than the SEC’s, it was left for accountants to handle the Panic of 1884 on their own when this market crash hit the country. Like the current global financial turmoil, America’s Panic of 1884 was also precipitated by a credit crisis. When New York’s national banks refused to lend any additional money and began calling in their loans from borrowers in the West and South, at a time when the nation didn’t have the central bank policy levers that are used today, it caused a dramatic spike in interest rates. One contemporary commentator noted that loans at the time ‘‘commanded three percent interest and commission per day on call’’—or a staggering annualized compound interest rate of several hundred thousand percent. Although the aftermath of the panic was less serious than some other economic shocks, nearly 11,000 businesses failed in 1884 alone.
In those the early days of organized accounting in America, the profession was small. A quarter century before, city directories listed just 14 accountants offering services to the public in New York City, four in Philadelphia, and one in Chicago—a far cry from AICPA’s 350,000 members today. As one who formerly taught federal income tax, I’m obliged to point out that what really sparked the growth of the accounting profession in the early 20th century was the ratification of the 16th Amendment to the Constitution in 1913. The adoption of a federal income tax suddenly gave rise to the new field of tax preparation. Accountants quickly asserted their authority in this new field—in competition with law firms, of course, which also touted their expertise.
But the defining moment for the nascent field of modern accounting came in the aftermath of the Great Depression. As some of the largest and most profitable companies in the world fell victim to the crushing financial impact, much of the blame was directed at members of the accounting profession, who were accused in court and in the press of negligence, incompetence, and fraud. In hindsight, we know that the fault did not lie so much with the practitioners of accounting, but with the lack of objective and widely accepted accounting standards. In the absence of industry wide standards, accountants were forced to make ad hoc determinations across a range of business situations. Ten companies in the same industry could, and often did, use ten different standards. Clearly something had to change, and AICPA led the charge.
This history is directly relevant to us today, when accounting standard setting is at the center of the debate over how banks and financial firms got into—and how they can get out of—the current financial turmoil. It was to solve the problem of accounting improvisation that in 1939, AICPA created its own rule making body, the Committee on Accounting Procedure, to help set industry wide standards on contentious issues. The industry also accepted government licensing for CPAs, who were made responsible—and personally liable—for the auditing of publicly traded companies.
The Committee on Accounting Procedure was a huge improvement on the lack of process and procedure that had existed before. But because it dealt with standards on an issue by issue basis as they arose, rather than offering a comprehensive framework for all accounting standards, there was still more work to be done. To address those concerns the AICPA replaced the Committee on Accounting Procedure, 20 years after it was formed, with the Accounting Principles Board, and gave it a broader mandate. It is from the opinions of the Accounting Principles Board between 1959 and 1973 that much of U.S. GAAP has evolved. The Accounting Principles Board, in turn, was succeeded by a fully independent Financial Accounting Standards Board in 1973, under the oversight of the SEC.
The reasons for creating a non governmental body are completely familiar to us today—to be fair and objective, based on expert analysis and judgment, and free of both political and business influence so that accounting standards could be applied consistently across all situations in thousands of different companies. Those reasons for independent private sector standard setting are as relevant and important today as they ever were.
Since then, Congress has consistently restated its purpose in providing the SEC with oversight responsibility for the FASB’s independent standard setting activities. In the Sarbanes Oxley Act of 2002, the Congress recognized the importance of having an independent standard setting process in order to facilitate accurate and effective financial reporting, and to protect investors. In the Emergency Economic Stabilization Act of 2008, the Congress described the SEC’s role as ensuring that accounting standards work in the public interest and are consistent with the protection of investors.
In creating the first body to set such standards, AICPA and the accounting profession helped America emerge from its darkest economic hour, and you and your peers set down a structural foundation for the economic growth and success of the past 70 years. Now we find ourselves in another economic crisis, and once again the role of accounting standards and the accounting profession is being challenged. As we respond to these new challenges, we must continue to protect the independence of the standard setting process.
If we learned one painful lesson from the events of the 1930s, and from the more recent scandals of the S&L crisis in the 1980s and Enron, WorldCom, and the rest in the 1990s and the first part of this decade, it is how vitally important it is to protect the independence of accounting standard setters and ensure that their work remains free of distortions from self serving influences. That priority must also be reflected in any regulatory reform undertaken by the next Congress and the new administration. Accounting standards setting should remain an independent function, and regulatory oversight of the independent private sector standard setter should not become entangled with the competing priorities of evaluating and addressing systemic risk. Accounting standards should not be viewed as a fiscal policy tool to stimulate or moderate economic growth, but rather as a means of producing neutral and objective measurements of the financial performance of public companies.
Accounting standards aren’t just another financial rudder to be pulled when the economic ship drifts in the wrong direction. Instead they are the rivets in the hull, and you risk the integrity of the entire economy by removing them.
There are those who say that independent standard setting is important, and who will agree that private sector standard setting is preferable to ensure that the process is not detached from reality— but who nonetheless say that while these things are true in ordinary times, these are not ordinary times. Therefore, they argue for setting aside the normal approach to standard setting, which identifies issues for consideration, gives the public exposure documents, includes outreach efforts, and then solicits comments on the exposure documents, and finally considers all of the resulting comments in finalizing and issuing new accounting standards. All of that, they say, should be set aside and replaced with a quick fix, whether the standard setters agree or not.
This view gives short shrift not only to the principle of independence, but also to the credibility of the standard setting process and investor confidence in it.
The truth is that the value of independent standard setting is greatest when the going gets tough. The more serious the stresses on the market, the more important it is to maintain investor confidence. A few years ago, during the consideration of a particularly contentious and important accounting rule, the then Comptroller General, David Walker, wrote a letter on this very point to the Chairman and Ranking Member of the Senate Banking Committee, who were then Richard Shelby and Paul Sarbanes. ‘‘[T]he principle of independence,’’ he said, ‘‘both in fact and in appearance, is essential to the credibility of and confidence in any authoritative standard setting processes.’’ And about the FASB’s role as the SEC’s designated independent private sector standard setting body, the GAO had this to say:
This time tested and proven deliberative process has served to strengthen financial reporting and ensure general acceptance of the nation’s accounting standards. This process is especially important given the complexity and controversial nature of some accounting standards. The established process that the GAO was referring to includes important safeguards for all users of financial statements, including obtaining feedback from groups such as financial statement preparers, auditors, individual investors, institutional investors, lenders, creditors, professional analysts, and various other parties. These processes are designed to ensure that the competing interests and demands of the various groups are carefully and independently balanced. And that, in turn, is absolutely essential to ensuring that accounting standards promote transparent, credible, and comparable
financial information.
None of this is to say that standard setters can or should turn a blind eye to the events in the world around us; or ignore the valid criticism and input of leaders in business, politics, and academia; or endlessly debate and deliberate instead of act when action is required. To the contrary, that is what the transparent process is for. It is meant to achieve results, and to keep standards current. Standards must keep pace with the real world to stay relevant, and they must be refined over time to better address weaknesses, as we have recently seen with the problems in valuing assets in illiquid markets. I believe it is critical that FASB complete its analysis of the SEC’s request for expeditious improvement in the impairment model in FAS 115, made formally last October, in accordance with its established independent standard setting process. As we have learned, illiquid markets bring new challenges to the measurement of fair value that could not have been fully appreciated in past years. These challenges have brought into focus the need for further work on improving the tools that companies have at their disposal to achieve transparent, decision useful financial reporting. Transparency is the cornerstone of world class financial reporting. Transparent and unbiased financial reporting allows investors to make informed decisions based on a company’s financial performance and disclosures. A clear, concise, and balanced view into the companies that participate in our capital markets is fundamentally important to those who choose to invest in our markets. Informed decision making results in efficient capital allocation.
Required
a. ‘‘Accounting standards should not be viewed as a fiscal policy tool to stimulate or moderate economic growth, but rather as a means of providing neutral and objective measurements of the financial performance of public companies.’’ Comment.
b. Letter of David Walker, then Comptroller General (in Part).
‘‘This time tested and proven deliberate process has served to strengthen this financial reporting and ensure general acceptance of the nation’s accounting standards. This process is especially important given the complexity and controversial nature of some accounting standards.’’ Comment.