Is Accounting Regulation Being Dismantled?

Implications: Can the SEC protect investors without regulation? 

Analysis: “The mission of the U.S. Securities & Exchange Commission (SEC) is to protect investors, maintain fair, orderly and efficient markets and facilitate capital formation.” [From the SEC’s web site]  As part of their mission, the SEC seeks to assure that “all investors have access to certain basic facts about an investment prior to buying it, and as long as they hold it.” In part, these “certain basic facts” are communicated through the financial reporting process.   However, some are questioning whether the SEC is moving away from their mandate to protect investors through regulation.  

For example, William Donaldson, the former Securities & Exchange Commission chairman said Wednesday that the regulatory pendulum has swung too far toward deregulation, criticizing the movement toward "vague, principles-based" (International Financial Reporting Standards, IFRS) financial reporting.   He also argued that as soon as the Sarbanes-Oxley Act of 2002 restored investor confidence, "there began a concerted effort to roll back" the new finance and accounting rules. 

In my article of January 24, 2008 titled "Will IFRS be required soon?” I wrote that one of the primary supporters of a move to a "vague, principles-based" financial reporting, i.e.  IFRS, is coming from the world's largest accounting firms.  They issued a paper titled "Principles-Based Accounting Standards," which argued strongly in favor of IFRS.  The American Institute of Certified Public Accountants (AICPA) also appears to support adoption of IFRS.  

In my view, International Financial Reporting Standards (IFRS) appear "Principles-Based" because they are so incomplete.  As others have suggested, I believe that given time, IFRS will be as rule burdened as Generally Accepted Accounting Principles (GAAP). 
 
IFRS are far from “high quality” nor are they “comprehensive.”  Many accounting experts would argue that IFRS are of lower quality especially in the area of their disclosure requirements and need significant improvement.  Further, they are by the IASB’s own admission incomplete.   For example, the International Accounting Standards Board (IASB) has not yet addressed the issue of revenue recognition.  

As is well known, the SEC in November 2007 eliminated the requirement that foreign registrants reconcile their financial statements to Generally Accepted Accounting Principles (GAAP) in their SEC filings.  Almost simultaneously, the Commission issued a concept release, which would allow U.S, public companies to choose between preparing their financial statements on the basis of IFRS or GAAP. 

I share the view of Financial Accounting Standard Board (FASB) chairman that such a “two-GAAP system for U.S. public companies would just add immense cost and complexity to our already complicated system.” [“Change Agent,” Journal of Accountancy, February 2008, p.32].  In addition, financial statements across companies would not be comparable with some using IFRS and others using GAAP.  Without comparability, financial statements would cease to be useful. 
 
Unfortunately, some believe that the SEC will quickly move to allow U.S. companies to choose between IFRS and GAAP.  For example, former SEC chairman Donaldson said, “He expects the SEC to move swiftly to allow domestic U.S. companies to have the choice of using International Financial Reporting Standards or the Generally Accepted Accounting Principles they use now.  But regulators, he said, have a long way to go in resolving the differences between the principles-based and rules-based systems.” 

If the SEC does indeed allow U.S. companies to adopt IFRS, there will be little if any need for resolving the differences between IFRS and GAAP because the primary motivation for convergence has been the push by the SEC to do so.  Everyone recognizes the need for “common, high quality financial reporting across the global capital markets.” [Change Agent, p. 32]. Presumably, the Financial Accounting Standards Board would either cease to exist or just become the standard setter for non-public companies and not-for-profit entities.

It is not clear why the SEC seems to be in favor of IFRS rather than GAAP.  It is apparent that unlike the FASB, the IASB is not independent, nor is it well resourced or properly funded in a broad-based and secure way. Also, it has no oversight responsibility, nor do they have the means to provide oversight.  As a result, financial reporting as we know it would not be regulated. 
 
I ended my previous article with the following two questions, which still need to be answered:  
    1.  "Why is it that in just a few short years has the Commission  
         (SEC) decided to shift  the responsibility for developing global
         standards to a foreign body?” 

    2.   “Is this just another example of regulation being dismantled?"    

Donaldson suggests that perhaps the deregulation advocates are “naïve” and that financial regulation is as basic as the need for “stoplights on a highway.”  Under GAAP, the red light means stop.  However, under IFRS, the red light may not mean anything because the IASB hasn’t considered it yet. 
 
Confusingly however, the SEC says “As our nation’s securities changes mature into global for-profit competitors, there is even greater need for sound market regulation” [SEC website].  Certainly, letting the market decide which accounting standards companies can follow is anything but “sound market regulation.” 
 
Can this move toward deregulation be stopped?  Maybe, but it will not be easy because it has the support of the major players in the accounting industry.  Ultimately, analysts and the investors they represent will have to demand that the SEC protect investors as it was meant to do.  Otherwise, there will be little need for the SEC either.