Our study of the Financial Accounting Standards Board's 40-year history shows us it has been politically dominated one way or another for virtually its entire existence. The two exceptions we see are a seven-week period in 2002 and only recently in 2013. We think that everyone, especially the board's members, must understand that it is now more free than ever to resolutely fulfill its social responsibility to help create more efficient capital markets through improved financial reporting.
Our analysis shows it has endured through four political phases.
THE FORMATIVE YEARS
FASB was founded in 1973 as recommended in the Report of the Study on the Establishment of Accounting Standards. Reflecting the politics of the time, the board was placed under the wing of the American Institute of CPAs and the eight largest CPA firms. For example, the institute selected the Financial Accounting Foundation's trustees, at least five board members had to be CPAs, and the firms funded most of FASB's operating costs.
This arrangement created at least an impression that the board was independent of the corporate managers it was regulating. It worked because the CPA profession was perceived as independent of and dominant over its clientele, in large part because of now- antiquated genteel relationships between the firms. Specifically, ethics rules kept auditors from approaching others' clients or submitting fixed-amount bids for engagements. Professional courtesy also required new auditors to consult their predecessors. As a result, unhappy clients had nowhere to turn.
The downside was that the board produced cautious standards in this era, including SFAS 2 that writes off research & development, and SFAS 12 that applied lower-of-cost-or-market to investments in marketable securities.
In the mid- to late-1970s, this arrangement crumbled in the wake of hearings by Senator Lee Metcalf and Representative John Moss and a determined effort by the Federal Trade Commission that eliminated these provisions of the Code of Conduct because they were deemed anticompetitive.
As we see it, FASB's vulnerability was intensified when the profession's dominance over its clientele gave way to dependence.
A LONG DARK PERIOD
Left on its own, the board tried to stay independent but that grew ever more difficult as the large audit firms competed instead of cooperating. One manifestation was an explosion of "opinion shopping" engagements designed to woo away others' clients with accommodating interpretations of GAAP. This seemingly caused the firms to withhold support for FASB's proposed changes in order to avoid offending their clients.
Perhaps the most troubling situation in this era was that most of FASB's funding came from corporate contributions, but that wasn't the only problem.
Starting in the early 1980s and continuing through the 1990s was non-stop harping from the Financial Executives Institute and the Business Roundtable that the board didn't understand how the business world works and that it was even "anti-business." They made efforts to bring FASB under control, including a behind-the-scenes roundtable scheme to take over the Financial Accounting Foundation by appointing statement preparers to a majority of trustee positions. Another sought to turn FASB's agenda over to an outside committee dominated by management, and still another demanded more board seats for preparers. With the hope of inhibiting the board's ability to make progress, they also successfully pushed for restoring the original supermajority voting rule in 1990.
SEC Chair Arthur Levitt strongly defended FASB's independence in 1996 after he sniffed out that a majority of FAF trustees were auditors and managers; he was also suspicious about the public members' backgrounds. After private arm-twisting and a threat to rescind ASR 150 (the commission's 23-year old endorsement of FASB), Levitt completely rebuilt the FAF board to have a majority of public-oriented members. However, FASB's independence remained precarious because of its reliance on corporate donations.
Although the board tried to do its best, we think its dominated position led to compromised standards, including SFAS 87 on defined-benefits pensions, SFAS 95 on cash flow statements, SFAS 115 on investments, and SFAS 123 on stock options.
50 DAYS OF FREEDOM
Sarbanes-Oxley was enacted on July 30, 2002, and created a new world by first requiring the SEC to designate a standard-setting body with characteristics that fit FASB to a T and then levying a mandatory fee on public companies to fund that body's budget. These provisions conclusively established the board's authority and at last eliminated its need for contributions from managers.
After nearly 30 years, freedom seemed to be at hand. Alas, it was not to be.
CONVERGENCE
On Sept. 18, 2002, only 50 days later, FASB and the International Accounting Standards Board entered into "The Norwalk Agreement" that expressed their mutual commitment to produce joint standards and move toward converged global standards. There was a big catch, however: Most of the IASB's funding was (and still is) provided by contributions from U.S. corporations and accounting firms!
We think the agreement was attractive to FASB's leaders because it would extend their influence around the world. It must have appealed to the IASB's leadership because it endorsed their legitimacy.
The two organizations worked well together, albeit slowly, when they produced some standards and a new piece of a joint Conceptual Framework.
Higher-level politics took over in 2008 when SEC Chair Christopher Cox ended his lame-duck term by proposing to supplant FASB and GAAP with the IASB and IFRS. The final proposal wasn't released until after the presidential election guaranteed he would be replaced by a Democrat. Only the naive believed that his pet project would be championed by the new SEC chair, Mary Schapiro.
Schapiro soon indicated that the plan would be studied carefully, which was an understatement because the studying lasted nearly four years. By the end of 2012, it was evident the idea was unworkable because of an impasse. On the one hand, the SEC cannot justify sacrificing its current control over reporting standards by turning standard-setting authority over to an international body it cannot influence or readily call on for assistance. On the other hand, the IASB is politically unable to subjugate itself under the commission's oversight and administration. These obstacles simply could not be overcome.
During 2009-2012, however, those points were not widely understood, and almost everyone tried to jump on the train they thought had already left the station. The AICPA, for example, began offering CPE courses about IFRS and added IFRS-related questions to the CPA Exam. The four largest CPA firms went all out, with one giving money to faculty who integrated international standards into their curriculum and then vowing to recruit at only those schools that taught IFRS.
Perhaps the most ardent proponent was the IASB itself. For example, its then-chair, David Tweedie, came to New York and made a video for the AICPA in which he warned that the U.S. would lose its four board seats if the SEC didn't adopt. Advocates also persuaded the G-20 to recommend creating global standards, and then trumpeted that result without explaining that the recommendation was 14th on the group's priority list or that many of its members had not adopted IFRS themselves.
Even though the boards continue working together as amicable professional colleagues with similar but different responsibilities, most of their unfinished joint projects are inactive, and we've concluded that this political era of convergence has ended.
FREEDOM TO REFORM
We're convinced that FASB has finally achieved the independence promised by its founders in 1973. Here are six factors that have set FASB free:
- It no longer depends on contributions.
- It enjoys the SEC's uncompromised designation.
- Its trustees understand their protective role.
- It can resolve issues without a consensus with the IASB.
- It has a mechanism for working with private companies.
- It has seven highly and broadly experienced board members who are at the peak of their careers without being, we think, so senior that they're unwilling to create authentic reform.
It's no surprise to our regular readers that we're pleased about this situation because we strongly advocate for transforming financial reporting in general and financial accounting standards in particular.
THE OPEN ROAD BECKONS
Specifically, we see that the capital markets demand greater quantities of much more useful information than ever before, yet practice in the U.S. and elsewhere is stuck in the 20th century mode of begrudgingly providing limited amounts of outdated, compromised and otherwise incomplete data only once every three months. Our most detested anachronism is systematic depreciation that U.S. accountants embraced when Andrew Jackson was president.
To our friends at FASB, we point to the wide, straight and almost smooth highway in front of them, in contrast to the bumpier roads they traveled when they had to get along with their self-serving critics by compromising away usefulness. Therefore, we encourage today's board members and staff to make sound decisions based on pursuing what they know is right for the capital markets, even though it isn't popular.
At the very least, they owe it to themselves and all other FASB veterans who wanted to reform financial reporting but couldn't because of stifling political conditions. In fact, they owe it to all of society.
Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.
