The SEC Rules

Five years after Sarbanes-Oxley, the SEC is flexing its regulatory muscle as never before.

This is the second of a three-part series examining the state of accounting five years after passage of the Sarbanes-Oxley Act.

If Enron made accounting sexy and the Sarbanes-Oxley Act made it lucrative, the current power struggle over rule-setting makes it both compelling and consequential. Accounting may ultimately come down to numbers, as math does, but the rules that govern how those numbers are added, subtracted, and classified are hardly fixed. The standards by which assets, liabilities, debt, taxes, and the other components of corporate finance are reported are subject to constant revision. Indeed, one could argue that accounting is every bit as dynamic as the economy that it describes.

The same was not supposed to hold true for the entities that make the rules, however. As former Federal Reserve chairman Paul A. Volcker noted several years ago, “competent professional standard-setters” play a vital role in guaranteeing that accounting rules possess “consistency, coherence, and credibility.”

Volcker made those remarks at a time when Congress was weighing in on the debate over whether and how companies should expense stock options. That was (and remains) a significant issue, but today the battle has shifted. Rather than coalescing around a single point of contention, the struggle for control now extends across the entire accounting landscape. The debate is hardly academic. Accounting determines both Corporate America’s reality and its perception on the part of investors, competitors, and other stakeholders. Whether, for that reason, it should be regarded as a public-policy issue or insulated from public-policy debate is at the heart of the contest.

The key players in this battle are the Securities and Exchange Commission, which has largely focused on enforcing the rules; the Financial Accounting Standards Board (FASB), a panel of accounting experts that has written much of the existing accounting rulebook; the Public Company Accounting Oversight Board (PCAOB), a regulator created to oversee audit firms; the American Institute of Certified Public Accountants (AICPA), a professional organization with membership that includes sole practitioners as well as CPAs in industry; the public accounting firms; and the business lobby.

The catalyst, of course, is the Sarbanes-Oxley Act of 2002. Not only did it mandate the creation of the PCAOB, but in an effort to create greater accountability in financial reporting it sought to more clearly define the roles of all accounting rule-makers.

Five years later, the SEC has emerged as the clear winner in that reshuffling. While the commission has always had nominal jurisdiction over FASB, and was granted clear jurisdiction over the PCAOB under the terms of Sarbox, only recently has it begun to exercise its sway over both. Under the energetic leadership of Christopher Cox, who was appointed in June 2005 by President Bush, the SEC is letting the accounting world know that it is calling the shots.

This creates plenty of uncertainty for businesses on at least two counts. First, the SEC is led by political appointees, raising the specter of a boom-and-bust cycle for business-friendliness. (Not that it’s terribly predictable: despite his GOP roots, Cox has not appeared to bow to corporate wishes as much as many had anticipated.) Second, the SEC’s push for a single set of global, principles-based accounting standards may achieve its stated aim of benefiting both businesses and investors by ushering in a clearer and simpler financial-reporting regime — but not without mandating an overhaul of current practices that will make the changes wrought by Sarbox seem trivial.

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