30 Oct 2008
The profession in the United States might think its day of reckoning came and went in 2002. But those who thought that the Sarbanes Oxley Act was the final word in regulation may be in for a rude surprise.
Both Barack Obama and John McCain have pledged to put what remains of Wall Street’s financial institutions under a close watch. And not since Franklin Delano Roosevelt entered the White House in 1933 have the American people appeared so keen to see it happen.
The only sure outcome of the current credit crisis is that the 30 year trend in America towards deregulation is over.
An increased appetite in Washington for regulating the financial markets could have a number of effects on accountants.
Experts speculate that an Obama presidency might have the effect of stalling the US’s shift towards international financial reporting standards, as the new president confronts the unwelcome prospect of allowing foreign control of how US companies draw up their balance sheets. The opposition of Obama’s Democratic Party to limiting litigation against accountants who cook the books will probably grow even more aggressive in response to shareholder anger.
Any proposals to limit liability would be expected to meet renewed scepticism. ‘I would caution the accounting profession to recognise that when people start looking for scapegoats, anybody could be found,’ says Harvey Pitt, former chairman of the Securities and Exchange Commission and now CEO of the consulting firm Kaloram Partners. ‘No sector of our financial markets will escape scrutiny.’
So far, of course, it is the Wall Street bankers who are the main target of public anger. And as credit contracts, the populist rhetoric of both McCain and Obama have expanded.
In speeches, McCain, the Arizona Republican senator who likes to claim he is outside the establishment, has struck out against bankers’ greed. Obama, the Ivy League educated and bookish Democratic senator from Illinois, has cast himself as standing up against ‘welfare for Wall Street’.
As bankers sustain criticism, some US financial commentators have tried hard to redirect some blame towards fair value principles. ‘The people who are being painted as the villains are saying that none of this would have happened unless you had forced us to value what’s in our portfolio as if we had to sell it tomorrow,’ says Fleischman, who is now a senior counsel in Linklaters’ New York office. ‘They want to pin the whole tail on the donkey of the accounting profession.’
Increasingly, fair value accounting has come under fire, with critics saying that it needlessly weakened balance sheets. Proponents say that a departure from fair value principles would further prevent lending between banks and make it impossible for investors to gauge the health of a financial institution.
US legislation passed in October that authorised the $700bn bailout plan contains a provision that explicitly grants the SEC authority to suspend fair value. Given that the SEC already had the authority, the new provision is ‘just covering with a handkerchief something already covered with a bedspread’, according to John Coffee, a law professor at Columbia University, Obama’s alma mater. The debate over fair value has spilled out into newspapers and magazines, and even into the presidential race.
McCain, in speaking to a group of Hispanic business owners in southern California back in March, suggested that fair value was fuelling the credit crunch.
‘It is time to convene a meeting of the nation’s accounting professionals to discuss the current mark-to-market accounting systems,’ he declared. ‘We are witnessing an unprecedented situation as banks and investors try to determine the appropriate value of the assets they are holding and there is widespread concern that this approach is exacerbating the credit crunch.’
At the beginning of October the SEC and Financial Accounting Standards Board gave some flexibility to companies to deviate from fair value accounting and use their own models, as opposed to current market information, when trying to value distressed assets for which no willing buyers exist.
A senior economic adviser to McCain, Douglas Holtz-Eakin lauded the regulatory decision. Sadly, McCain’s remarks about fair-value appear to be the first and only serious discussion by either candidate of accounting principles in the presidential race.
The only economic issue over which the candidates routinely wade deep into details are their plans to cut taxes.Neither Obama nor McCain has experience in the business world.
McCain was elected to the Congress in 1982, a year after retiring from the Navy. His wife is the heiress of an Arizona beer distribution company. In the Senate, McCain’s main interest has been foreign affairs. He admitted last year that ‘the issue of economics is not something I’ve understood as well as I should.’
Before election to the Senate, Obama taught for more than a decade at the University of Chicago Law School, which is known for specialising in the study of the intersection of law and economics. But the classes Obama taught focused on constitutional law, voting rights and racial issues.
‘We don’t know what would happen with either of these folks,” says Neal McGarity, spokesman for the FASB, referring to what a McCain or Obama presidency would mean for the profession.
‘The big question,’ said Wayne Landsman, an accounting professor at the University of North Carolina Business School, ‘is whether the US is, after the election, going to be committing to IFRS.’
In August the SEC proposed a roadmap that would require all US public companies to file financial statements using IFRS in 2014, with the convergence between IFRS and the US GAAP relieving multinational companies from having to keep two sets of books.
‘I had thought the train had left the station, but I wouldn’t bet on it now,’ says Landsman on the likelihood of convergence.
While Obama has not addressed the issue, accounting experts speculate that the Democrats pro-regulatory stance could make an Obama administration wary of ceding control away from US regulators. ‘It would be a lot harder to sell to the American people that the people who set accounting standards, even though the SEC has input in the process, is a group who meets every once in a while over in England,’ says Fleischman. ‘It just doesn’t sound right to Americans.’
Others also speculate that Obama’s pro-labour posture against free trade could be viewed as a signal that he could be reluctant to converge the US GAAP and IFRS. ‘Obama appears to be much more an American firster, with a more insular view of the world that resonates fairly well with labour,’ says James Cox, a law professor at Duke University. ‘It’s unlikely that the Obama administration would embrace the mantra of the Chamber of Commerce.’
However, at least one former SEC commissioner, Roel Campos, has been reported to be advising the Obama campaign. Campos, now a Washington lawyer, was pro-convergence.
In the unlikely event...
And a McCain administration should the current opinion polls be reversed and he wins might be inclined to oppose convergence if IFRS is identified as being more strongly committed to fair value.
‘Let’s look at the political reality. As a talking point this anti-fair value thing has come up,’ says Landsman said. ‘It’s perceived that the IASB is more wedded to fair value accounting than FASB. If that perception carries the day politically, you can imagine the backlash.’
Another key issue is litigation. And commentators are predicting that in the next administration, proposals to put ceilings on penalties that litigants can win in US courts for suing accountants and auditors are unlikely to gain ground.
Juries in America are fond of big verdicts. In one recent case, a jury in New Jersey state court ordered KPMG to pay nearly $32m over the firms’ failure to find fraud in the books of a company that made collectible statuettes. Last year, a Miami court ordered BDO Seidman to pay a Portuguese bank more than £300m in another suit.Democrats, who have a chance of sweeping Congress in the coming elections, are highly unlikely to erect laws preventing such kinds of damages being hoisted in corporate defendants in the current climate.Before the current financial meltdown, the accounting industry won a major victory this January when the US Supreme Court made it much more difficult for shareholders to include accountants and other secondary players, such as lawyers, as defendants in most shareholder litigation.
But a Democratic Congress could seek to change the securities fraud law to explicitly make accountants liable even in instances where there were no publicly issued statements.
‘This will be a climate in which Main Street doesn’t like Wall Street,’ said Prof Coffee of Columbia University. ‘Even very de-regulatory people do not like investment banks today. The idea of suing them and suing their friends is not as unpopular as it was two years ago.’
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