Who Do You Believe? Getting the Numbers Right

Who Do You Believe? Getting the Numbers Right

The average taxpayer takes little notice of the Securities and Exchange Commission (SEC), especially its rules governing the reporting of financial statements by corporations and businesses. Such arcane stuff is of interest only to bankers, accountants, stock market entrepreneurs and such, not to ordinary folk. But corporate financial reports are enormously important in determining the worth of a company’s stock and consequently the investment decisions of investors, banks, insurance companies, fund managers, etc. --- decisions which lie at the very core of our nation’s economic stability. Remove such rules and the transparency by which outsiders can judge the real value of a company’s stock, and all bets are off in the market place. That is essentially where the US was in 1929 when our whole edifice collapsed.

Before the stock market crash of 1929 there was little support in the business or political worlds for regulating the securities market. That view change dramatically when $50 billion in new securities sold in the 1920s fell to a worth of only $25 billion almost overnight. Restoring confidence in the stock market was a major thrust of Franklin Roosevelt’s administration and led to legislation establishing the SEC in 1934 with Joseph P. Kennedy (President John Kennedy’s father) as the first Chair.

The SEC was an outgrowth of Roosevelt’s New Deal and was intended to save capitalism in spite of itself. The aim was to restore confidence of investors by providing more reliable information and clear rules of honest dealing. While self-discipline of the industry was the ideal, Roosevelt believed it could be achieved only with an agency looking over the shoulders of those self-regulators, ready to take action if the rules were not properly enforced. The new rules were based on 2 common sense notions which, astonishingly, had not been in effect previously: 1. Companies offering public securities for investment dollars must tell the truth about their business and the risks involved; and 2. Those who sell and trade securities must treat investors fairly and honestly by putting investors’ interests first. Gradually, Wall Street powers and brokerage firms came to realize that they had far more to gain from public confidence than from the unbridled practices of the past.

Confidence in the Market was finally restored and all was relatively well until the shocking failure of Enron and the accompanying fallouts leading to failures of leading accounting firms, the wholesale loss of employee benefit and retirement plans, and reports of various corporate rip-offs at the expense of investors, all rivaling the unbridled, big business excesses of the Gilded Age. These developments led to the Sarbanes-Oxley Act of 2002 which expanded the role of the SEC by requiring enhanced corporate responsibility and financial disclosures to combat corporate and accounting fraud. Now the SEC is proposing to change the accounting rule for corporate financial reports which critics say will undo much of the impact of Sarbanes-Oxley.

What is being proposed sounds innocent enough: that the SEC allow American companies to opt out of using US accounting standards in favor of a single international standard. Why? To facilitate global business transactions and dealings around the world. Most observers agree that there is a sound case for using a single standard rather than requiring international firms to bear the expense and inconvenience of preparing different reports and meet different accountability standards for each country in which they do business. A single international rule for such requirements makes sense. The problem is in how and when it is done. Currently, the two standards are different. Although the international and American accounting bodies have promised to work out their differences there has been little of no progress over the last 5 years. Many experts believe that a process needs to be in place for assuring that the standards are reconciled BEFORE changing to the international system.

So why not go ahead with allowing companies the option of which system to use while the relevant US and international standards folks work out their differences thereby providing immediate help to international business? Bankers, financial marketers, security industries and the administration strongly support going ahead. The Bank of New York Mellon says it would harmonize accounting standards worldwide, help solidify cross-border acquisitions, improve investment flows, benefit US financial institutions, and enhance the competitiveness of US firms. PriceWaterHouseCoopers touts the international standards as desirable because they allow the exercise of more professional judgment, are less complex and contain fewer rules. The Treasury Department has repeatedly urged that efforts to allow companies to report under international rules be stepped up. A White House spokesman says of the SEC proposal: "We certainly have a positive view.”

Opponents have a different view. They believe that the administrations’ interest in pushing the issue is a way of defanging some of the post-Enron changes in Sarbanes-Oxley. James Cox, a corporate finance expert at Duke University Law School labels the proposed new rule another example of “deregulatory belt-tightening” that have been pushed under the guise of globalization. Cox points out several disparities between the two systems that do not work in favor of individual investors such as the fact that companies that file under the international system have 6 to 7 percent higher earnings than they do when they report under the US standards. This can allow firms to appear healthier than the really are. Moody’s Investors says that “allowing US companies the option of following (international rules) could have a chilling effect on accounting standard setting” concluding that “There are too many flaws in both (systems) to take the foot off the standard setting accelerator.” The Conference of State Bank Supervisors warns that the SEC proposal could well reduce the need to pursue convergence with the US system since they will have achieved their goal and have less incentive to compromise. The National Association of State Boards of Accountancy believes that until convergence between the two systems is achieved, the “public interest would not be served” by allowing the options to use either system.

Although the Chair of the SEC, Christopher Cox, has promised that the major shift being proposed is not imminent: “I don’t see this as happening for many years,” other are unconvinced. They have heard this administration say one thing while doing another too many times. Senator Reed of Rhode Island believes the proposal is motivated by the impending end of the Bush administration rather than to find a good policy: “This is a race to get it done, not to get it done right.” He described the proposal as “one way to weaken the provisions enacted after Enron under the rubric of competitiveness and globalization.” Law Professor Lawrence Cunningham of George Washington University and author of the most widely used book on accountancy for law students calls the proposed change a “leap of faith rich with paradox and irony.” Under the law, the SEC can adopt the proposed rule by vote of the full commission which will then become the governing authority for the securities industries. Currently Republicans hold a 5 to 3 majority of the seats on the Commission.

Are the proposed new rule a needed boost for international businesses that would free them from burdensome oversight and petty accounting rules; or is it another attempt to fudge the numbers in favor of corporate interests at the expense of the public? Could it be what Garrison Kieller calls another “classic Republican story –lax regulation, lavish salaries to executives, financial bungling and rescue by the tax payers.” Given the administration’s record to date, I know who I believe. What about you? .