Bankers and other financial industry players who hoped the financial crisis might prompt a suspension of fair-value accounting found their hopes disappointed today. Although improvements in guidance and auditing practices are needed, investors still consider fair-value accounting useful and meaningful, said Securities and Exchange Commission chairman Christopher Cox at a conference of the American Institute of Certified Public Accountants.
Cox’s remarks were a clear indication that the SEC’s report to Congress will not recommend suspending FAS 157. “Accounting standards aren’t just another financial rudder to be pulled when the economic ship drifts in the wrong direction,” said Cox. “Instead they are the rivets in the hull, and you risk the integrity of the entire economy by removing them.”
Included in the $700 billion bailout package Congress passed in October was a requirement that the SEC study the impact of fair-value accounting. The final law also reiterated the SEC’s authority to suspend FAS 157 — the accounting standard that defines how fair-value measurements should be made — if the SEC determined that to be in the best interests of the nation. Cox said the SEC’s report would be delivered on January 2.
Cox’s full remarks follow:
Thank you for that kind introduction. 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; 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 that 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, 4 in Philadelphia, and 1 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 upon 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.
To address these issues of fair value accounting on a timely basis, the SEC’s Office of the Chief Accountant and the Division of Corporation Finance have been working with FASB staff continuously over the past year. Together they have publicly addressed issues including disclosure of fair value measurements of hard-to-value assets in inactive markets, consolidation of off-balance sheet entities, and the accounting treatment of bank support for money market funds. Staff from the SEC and the Financial Accounting Standards Board have also worked together in recent weeks to provide clarifications of existing fair value measurement guidance in the current environment.
Since our October letter, we have encouraged the FASB to address issues including impairment, the convergence of IFRS and U.S. GAAP on this and related topics, and the treatment of so-called EITF 99-20 securities including CDOs and other structured instruments. As you will hear from Bob Herz and others later today, the FASB is working diligently on these issues, and is mindful of the importance of providing guidance in time for the preparation of annual reports at the end of this year.
Simultaneously with that effort, the SEC is currently conducting a study on mark-to-market accounting that was mandated by the Emergency Economic Stabilization Act. Under the terms of the Act, our study must be completed by January 2, 2009. We are working on it, as the statute requires, in consultation with the Secretary of the Treasury and the Board of Governors of the Federal Reserve System.
Under the Act, the study has six areas of focus: The effects of mark-to-market accounting standards as provided in Statement Number 157 of the FinancialAccounting Standards Board on a financial institution’s balance sheet; the impacts of such accounting standards on bank failures in 2008; the impact of such standards on the quality of financial information available to investors; the advisability and feasibility of modifications to such standards; alternative accounting standards to those provided in FASB Statement Number 157; and the process used by the Financial Accounting Standards Board in developing accounting standards.
Although the study is still ongoing, we have already completed two public roundtables that brought together a wide range of experts, analysts, and other interested parties to discuss the issues involved, including representatives from the major accounting firms, banks, insurance companies, think tanks, and academia.
In consultation with those experts, and many of the people in this room, as well as through the input received from the comment process and Commission research on these important issues, the professional staff have shaped much of the study’s direction and outlined its likely conclusions.
Although the study is not complete, the current direction indicates a number of preliminary findings that I would like to share with you this morning.
First, for many financial institutions, investments marked-to-market through earnings on a quarterly basis represent a minority of their total investment portfolio. A larger portion of investment portfolios consists of available-for-sale securities or loans. As you know, investments in loans and available-for-sale securities are not marked-to-market through earnings each period. Rather, these securities are subject to (in some cases, difficult) judgments on other-than-temporary impairments.
Second, most investors, and many others, agree that fair value is a meaningful and transparent measure of an investment for financial reporting purposes. Financial reporting is intended to meet the needs of investors. While financial reporting may serve as a starting point for other users, such as prudential regulators, the information content provided to investors should not be compromised to meet other needs.
Third, accounting standards have served our capital markets well, but we must endeavor to continue to develop robust best practice guidance for auditors and preparers — particularly for fair value measurements of securities traded in inactive or illiquid markets. Education efforts and the development of application guidance must provide a path for auditors and preparers to reach a common ground on these difficult issues.
The work we have already done suggests that the accounting standard setters could improve upon the existing security impairment models. Investors have also clearly indicated a view that the current concept of mark-to-market accounting increases the transparency of financial information provided to investors — but that in inactive or illiquid markets, additional guidance would be useful to promote reasonable application of the standards.
We expect to release the final results of the SEC study as mandated by Congress by January 2. I am sure that other speakers at this Conference may provide additional details while going into more depth on our preliminary findings.
Beyond our work on mark-to-market accounting, we are also working with regulators and accounting standard setters in other countries to coordinate our responses to the challenging issues we are facing today. In my role as Chairman of the IOSCO Technical Committee, I have been coordinating closely with our fellow securities and accounting regulators in the world’s major capital markets to support accounting standards which afford investors transparency, maintain market integrity and facilitate capital formation. In that connection, the Commission has been strongly supportive of the joint work of the IASB and FASB to address these accounting considerations. Their objective is, as it should be, to develop and maintain high quality standards that provide transparency to investors.
The events of recent months have underscored the importance of financial disclosure and transparency not only in the United States but in markets around the world. The growing use of International Financial Reporting Standards in the world’s markets, and its current position as the most widely used set of accounting standards in the world, give U.S. investors a major stake in seeing to it that IFRS are high quality and consistently applied. Two-thirds of U.S. investors own foreign securities, directly or through funds, and so the SEC is likewise extremely interested in ensuring that IFRS are truly high quality and consistently applied across jurisdictions. Whatever the future of IFRS for U.S. issuers, retail and institutional investors alike in our country are relying upon IFRS today.
Improving investor confidence in global capital markets requires that investors be able to more easily compare issuers’ disclosures, regardless of what country or jurisdiction they come from. A single set of high-quality standards would be a particular boon to emerging markets, because investors could have greater confidence in the transparency of financial reporting.
Since March of last year, the SEC has held three roundtables on IFRS, including one that looked at the relative performance of IFRS and U.S. GAAP during the subprime crisis. As you know, a year ago, the Commission issued a concept release on allowing U.S. issuers to prepare financial statements using IFRS. After a great deal of public comment and analysis, that in turn led, just last month, to the Commission’s publication of a proposed Roadmap that could lead to the use of IFRS by U.S. issuers beginning in 2014, if the Commission believes it to be in the public interest and consistent with the protection of investors.
The proposed Roadmap is cautious and careful. It is a multi-year plan that lays out both the basis for considering the use of IFRS by U.S. issuers, and several important milestones that would have to be achieved first.
In order for IFRS to fulfill the promise it holds to be a uniter of the world’s capital markets and a powerful tool for investors everywhere, there are a handful of principles that are critical to its success. Every one of us here today needs to see to it that these principles are applied.
First, the standards must be crafted in the interest of investors. That has to be their overarching purpose. We all know that a business’s financial reports are relied upon by many other people for many purposes. Financial statements are used by the managers of the business as an important tool in making decisions. They are relied upon by many outside parties, such as commercial lenders who extend credit to the business. And of course financial reports are important to analysts of all kinds for purposes that go far beyond investing, as for example when economists use them as a basis for reporting about an industry’s size and other aggregate statistics. But above all, a public company’s financial reports represent a direct communication between the company and its investors. And from the investor’s standpoint, accounting standards should promote both clarity and comparability.
In these respects, both the IASB and the IASC Foundation, its governing body, are working hard to ensure that investors’ interests remain the primary concern in the continuing development of IFRS. This is particularly important today, as the IASB reviews its standards in light of the experience of the recent market turmoil.
This focus on the investor’s interest in global comparability is also evident in the aggressive support of the IASC Foundation for eXtensible Business Reporting Language — a priority shared by AICPA. In the same way that IFRS might someday soon make financial statements understandable to investors anywhere on earth, the 30 different spoken languages that will someday soon be embedded in XBRL data tags attached to public company financial statements could let any investor read an IFRS or U.S. GAAP financial statement from any country in his or her own native language. That objective will be significantly advanced if, as expected, the Commission later this month finalizes our proposed rule to provide investors with all public company financial reports in interactive data format.
The second principle for the success of IFRS is that the standard setting process must be transparent. That is essential not only to maintain investor confidence, but to ensure the integrity and quality of the standards. Open due process is necessary so that investors and the many others who participate in our capital markets can be assured that their views will be thoughtfully considered.
Third, the standard setter must be independent. It cannot be said often enough that effective standards require a dispassionate arbiter, both in this country and around the world. That means the standard-setter must be independent from special pleaders, from the political process, from favored industries or industry players, and from national or regional biases. An independent standard setter is best positioned to develop unbiased standards that foster investor confidence and transparency.
The standard setter must also be accountable. Just as the FASB’s process must make U.S. GAAP accountable to the needs of investors, issuers and the markets, so too must the IASB ensure that IFRS actually meet the needs of investors and other stakeholders, and that they are updated in a timely way.
And finally, just as with U.S. GAAP, it is vitally important that all of the stakeholders themselves participate in the standard setting process in order to ensure the continued success of IFRS. The current dialogue among securities regulators over IFRS development is an essential ingredient in its steady progress.
As IFRS gain acceptance, the ultimate question remains whether IFRS will in fact function as the single set of high-quality, global accounting standards that the world has been seeking for so long. At least, when it comes to satisfying investors’ concerns, there is no question of the attractiveness of the promise of a truly global accounting standard. The only real question is not whether this is good for investors, but how quickly both the accounting standards and the process by which they are established and developed can be globally recognized as world-class.
In coming years, a new SEC Chairman will look back at the events taking place today and offer his or her own perspective to a future AICPA conference, much like this one. Although none of us can predict how the economy and the markets will unfold, I do have one prediction of what will likely turn up in that future Chairman’s remarks. I am confident that you will hear once again what I am telling you now: That your industry provides critical infrastructure for the economy. And, just as a previous generation of accountants helped this country emerge from the Great Depression, your leadership will have helped us emerge from the current crisis. Thank you for the important vocation you have chosen, and for the extraordinarily meaningful work that you do for the benefit of our economy. On behalf of the thousands of men and women of the SEC whose mission it is each day to protect investors and the integrity of our markets, let me say that we are proud to be your partners.