Wednesday, March 11, 2009

Bill Would Take Accounting Oversight from SEC and Give it to New Board

By James Hamilton, J.D., LL.M.

Bi-partisan legislation creating a new Federal Accounting Oversight Board to oversee the application of financial accounting standards has been introduced by two members of the House Financial Services Committee, Rep. Ed Perlmutter and Rep. Frank Lucas. The new Board will include five influential members of the federal regulatory community, the Chair of the Federal Reserve Board, the Secretary of Treasury, the SEC Chair, FDIC Chair, and the PCAOB Chair. Currently only the SEC has oversight of accounting standard setting.

The new board is designed to fit into the regulatory reform legislation being readied by the Committee because its sponsors believe that a broader group of individuals with a view of the greater economy should be in charge of applying US GAAP. An amendment to Section 102(d) of Sarbanes-Oxley would provide funding for the Board through an assessment on registered accounting firms.

The bill, HR 1349, creates a framework to review the application of current and future GAAP under which regulators will have some discretion in applying accounting standards to take into consideration different types of assets and different types of market conditions. The bill also expresses the sense that regulators must have the tools to judge the value of assets being held to maturity. In the view of the members, arbitrarily decreasing capital levels of financial institutions puts communities at risk by causing some financial institutions to show an artificial undercapitalization which prevents them from lending money to businesses and individuals. At the same time, the legislation allows for investors to have data regarding the assets held by these financial institutions.

The bill instructs the FAOB to look beyond current accounting standards and balance sheets to consider broad national and international financial markets and economic conditions when applying GAAP. The Federal Accounting Standards Board (FASB) is an independent board with the authority to set GAAP. The legislation retains FASB as the accounting standard setter. It does not change GAAP, but does create an environment where FASB will have the tools and flexibility it needs to adjust GAAP for future economic conditions.

The legislation provides for discretion in the regulatory community to consider the overall condition of the financial markets in applying GAAP so the principles are not applied in a way that exaggerates or multiplies cycles in the markets. This provision appears to be designed to deal with what many commenters see as the pro-cyclacity effects of applying fair value mark-to-market accounting to illiquid securities.

More specifically, the legislation sets out a laundry list of factors that the Board must consider when approving accounting principles and standards, including how the standards impact both global and domestic systemic risk, as well as how the standards resolve questions surrounding illiquid securities. The Board mist also consider how the accounting standards should be applied to distressed markets.

More broadly, the Board must consider the accuracy and transparency of financial statements and the ability of both investors and regulators to accurately judge the current and long term financial condition of companies and financial institutions from their financial statements. Similarly, the Board must consider the extent to which accounting principles and standards can improve the usefulness of financial reporting by focusing on the characteristics of relevance and reliability and on comparability and consistency.

The bill generally encourages the Board to consult with the IASB, FASB and the PCAOB when carrying out its duties. Before approving an accounting standard, the Board must solicit input from a number of federal financial regulators, including the SEC and CFTC. In addition, the SEC , the Fed and other financial regulators who determine that an accounting standard or principle affects the safety and soundness of an entity they regulate or the health of the financial system in general may request authorization from the FAOB to review such accounting principle or standard for the agency, and, also, the FAOB must determine whether the standard or principle should continue to be applied or instead be removed on either a temporary or permanent basis.