Wednesday, December 9, 2009

FASB Chairman Calls For 'Decoupling' GAAP and RAP

In remarks at the AICPA's national conference on current SEC and PCAOB developments, FASB Chairman Robert H. Herz called for:

a greater decoupling of bank regulation from U.S. GAAP reporting requirements. Doing so could enhance the ability of both the FASB and the regulators to fulfill our critical mandates. We can continue to work with independence and an unwavering dedication to market transparency; at the same time the bank regulators can utilize their authority to take whatever actions are required to keep the financial system stable and healthy.

In an oblique reference to the Perlmutter-Lucas amendment which passed the House Financial Services Committee in November as part of its systemic risk bill (still subject to consideration by the full House, with the Senate separately considering its own bill), Herz noted:
in the past year there have been calls from certain parties to change the objectives of financial reporting and the approach to accounting standard setting in the U.S. The focus of these calls, not surprising in a time of severe financial crisis, has been on the accounting for financial instruments and reporting by financial institutions.... I was pleased to note that the House Financial Services Committee, within the context of its recent markup of the systemic risk regulator bill, seemed to confirm the point that accounting standards should continue to be set through an independent process...

... During the markup of the systemic regulator bill, Chairman Frank noted that accounting principles should not be viewed to be so immutable that their impact on policy should not be considered. I agree with that, and I think the Chairman would also agree that accounting standards should not be so malleable that they fail to meet their objective of helping to properly inform investors and markets or that they should be purposefully designed to try to dampen business, market, and economic cycles.

Some may view Herz' remarks as hearkening to a return to the 'GAAP-RAP' era in which differences between regulatory accounting principles set forth by bank supervisory agencies differed to a greater extent from U.S. GAAP than the limited differences in practice today. In some cases, certain bank regulators have also raised this issue, resulting in some backlash, as noted by Tom Beisner of CPA firm The Whitlock Company in his March 9 post, Accounting for Loan Losses - GAAP vs. RAP - Not Again!

At the AICPA conference, Herz distinguished between the role of accounting standard-setters and the role of banking regulators as follows:

Our focus as accounting standard setters is on the communication of relevant, reliable, transparent, timely, and unbiased financial information on corporate performance and financial condition to investors and the capital markets. ...

The mandate of the Federal Reserve and other banking regulators relates to ensuring the safety and soundness of banks and the overall stability of the financial system... .that’s not to say that the accounting standards we set for the benefit of investors cannot also serve the needs of regulators. Usually they do....But it may not be possible to find common ground in every case, not because we aren’t communicating, but because our different missions take us down different roads.

For example, while investors might benefit from seeing bank assets such as tradable securities and even loans reported at “fair value,” regulators might deem cost accounting as the proper way of valuing certain assets for the purpose of assigning capital reserve requirements...

Handcuffing regulators to GAAP or distorting GAAP to always fit the needs of regulators is inconsistent with the different purposes of financial reporting and prudential regulation.

My two cents (I remind you of the disclaimer on the right side of this blog): Taking a cue from blogger Prof. David Albrecht of The Summa, who sometimes takes to referencing philosophical principles, I believe the FASB Chairman makes a very valid point that the purposes of accounting standard setting (i.e. in communicating "relevant, reliable, transparent, timely and unbiased information," as noted by Herz) and the purposes of systemic regulation (ensuring the safety and soundness of banks and the overall financial system, as noted by Herz) are distinct.

Thus it would be a false syllogism of sorts for people to say:

1. accounting (e.g. fair value accounting) causes procyclicality
2. procyclicality causes systemic risk, therefore
3. systemic risk regulators should oversee accounting

However, I believe that the fact that banks and their regulators may appear to be more vocal in criticizing, e.g. certain fair value GAAP requirements or other accounting standards is not entirely (partially or principally, perhaps, but not entirely) due to concern about the impact on bank capital requirements, but also due to legitimate concern in line with the core foundational issues of accounting standard-setting as articulated by the FASB Chairman: i.e., the relevance, reliability, transparency, timeliness, and freedom from bias of the reported information that results from a particular accounting standard.

Separately, on the fair value front, Matthew Lamoreaux of the Journal of Accountancy notes in his article, FASB Defends Fair Value, Calls for Separation From Banking Regulation, that:
On Monday, the AICPA’s Accounting Standards Executive Committee (AcSEC) issued a comment letter to FASB in which the committee indicated that it favors an approach that would measure “many but not all” financial instruments at fair value. The AcSEC letter cited a 30-year fixed rate mortgage loan held to maturity as an example of a financial instrument that should not be measured and recorded on the balance sheet at fair value.

In my view, it doesn't necessarily come down to an either-or choice between staying true to the principles of accounting standard setting or staying true to the mission of bank regulators, rather, it comes down to a focus on those core issues of accounting standard-setting (relevance, reliability, transparency, timeliness, and freedom from bias), and how varying views of constituents are weighed and balanced by the standard-setter in reaching a decision on an accounting principle.

As stated by SEC Commissioner Elisse Walter, in a separate speech at the AICPA conference:

The FASB's deliberative process has fostered strong financial reporting and promoted broad acceptance of our accounting standards. That process includes important safeguards for all users of financial statements, including obtaining feedback from groups such as individual investors, institutional investors, lenders, analysts, auditors, financial statement preparers, regulators, academics, and various other parties. These processes are designed to ensure that the competing interests and demands of the various groups are carefully and independently identified and balanced. Those transparent processes, in turn, are essential to ensuring that accounting standards remain current while promoting credible, comparable financial information.

Herz closed his remarks by thanking constituents for taking an active role in the standard-setting process by providing feedback to the boards (the FASB and IASB), noting:

Our attempt to bridge the divide on fair value is unlikely to stem continued criticism from certain parties, but my hope is that all interested parties will respect our process and choose to participate in it...

I know that most of you at this conference agree that we should aspire to financial reporting that’s geared to providing relevant, “decision useful,” and transparent financial information to investors and the capital markets, based on accounting standards established through an open and thorough due process that strives to be as independent, objective, and neutral as possible. So whether it’s the FASB or the IASB, it’s absolutely critical that these basic tenets underpinning accounting standards, standard setting, financial reporting, and our capital markets be preserved and protected. Our thanks to the many organizations and individuals that have been working hard to ensure that this continues to be the case through their strong support and participation in our activities.

There's a lot of thoughtful material covered in Herz' 18-page speech beyond what's cited above; for a more complete understanding, read the full text of Herz' speech.

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