Comment: FASB Edicts Should Not Be Above Agency, Court Review

This country's system of setting accounting rules reminds me of the story about a man who was pulled over for speeding in a small town. Convinced he had not been driving too fast, the man asked the sheriff if he could appeal the ticket. Looking over his sunglasses, the sheriff responded, "You're in luck: I'm also the county judge. Appeal denied."

The extrajudicial procedures of the Financial Accounting Standards Board aren't much different.

FASB is the private-sector body that develops accounting standards that are required to appear on the financial statements of all publicly traded U.S. companies. It also decides whether public complaints about those rules merit a change in the standards. Not surprisingly, FASB usually determines that it was right all along.

These standards are important. At their worst, they can require U.S. public companies to present information that private or overseas businesses don't have to disclose.

Moreover, these standards don't operate in a vacuum; rather, they apply in a highly reactive market. In the most recent round of controversy at FASB, the board persisted in pushing through a derivatives and hedging rule that Federal Reserve Board Chairman Alan Greenspan said could "discourage prudent risk management activities" at some companies. If accounting standards end up causing companies to shy away from appropriate strategies to manage their risk, then something is seriously wrong.

The most distressing thing about how these accounting standards are developed is that the Securities and Exchange Commission enforces them, despite the fact that they have not met the agency's strict administrative procedures.

Public companies that fail to comply with FASB's accounting rules find themselves facing a presumption that they are in violation of federal securities laws. Why should the SEC be able to enforce rules that have not met the same good administrative procedures that apply to other SEC rulemaking?

Currently, it's not clear that aggrieved companies would even have standing to assert a legal challenge to the SEC's enforcement of FASB standards - no matter how good their case. We need to make it clear that persons who are adversely affected by FASB accounting standards are entitled to their day in court.

Recently, I asked the Congressional Research Service to review FASB's processes, and it found only one other example of a government agency, such as the SEC, delegating its congressionally conferred authority to a private body, such as FASB. In 1985, the Nuclear Regulatory Commission issued a policy statement that effectively adopted nuclear plan personnel training standards developed by the "Institute for Nuclear Power Organizations." Ultimately, however, a federal court determined that this "policy statement" did not meet the requirements of federal law.

The SEC is fond of saying that it maintains oversight over accounting standards. This implies that the investing public - indeed the whole country - can rest assured that the SEC will use its power, when necessary, to strike down FASB-created rules that are contrary to the public interest.

If a FASB standard is truly the right way to go, then the SEC should be counted on to carry out its public duty to ensure that the standard becomes a part of public reporting requirements. If it isn't the right way to go, the SEC should stop it dead in its tracks.

It's time for FASB to stop hiding behind the false argument that SEC oversight and possible court review of FASB standards would prompt a political firestorm and cause the standard-setting process to grind to a halt, with every company that disagrees with a rule muscling the SEC to disapprove it. Given the SEC's distinguished 64-year history, that's a ridiculous argument to make.

These procedures, by the way, assure a healthy deference for agency determinations, so why the fuss over making the SEC go through the same process for approving accounting standards that FASB would continue to develop? Besides, it's got to be true that the SEC's adjudicatory process in deciding whether to accept a FASB standard would be a less political situation than if aggrieved companies continue to come to Congress to address their concerns.

If the accounting industry and FASB can point to a single example of an SEC rule or order anywhere in the agency's history that was the result of political pressure being applied by special interests, then I would like to know about it.

Ten weeks after I introduced HR 3165, the Financial Accounting Fairness Act, which would do no more than subject FASB accounting standards to the same administrative procedures the SEC itself must follow, I still await the airing of a single good reason why FASB should alone be exempt from accepted government processes.

The simple fact is that even highly technical private-sector accounting standards should comply with the same solid administrative procedures that are well known throughout government.

Just as we wouldn't tolerate a justice system that didn't provide for trial by jury, so we shouldn't settle for a system of developing accounting standards that is alone excused from the procedures of government and exempt from court review.

Rep. Baker is chairman of the House Banking Committee's capital markets subcommittee.

For reprint and licensing requests for this article, click here.
MORE FROM AMERICAN BANKER