(The news featured below is a selection from the news covered in the Federal Securities Report Letter, which is distributed to subscribers of the Federal Securities Law Reports.)

Treasury Official Says GAAP Technical Compliance Is Not Enough

Peter R. Fisher, Treasury Undersecretary for Domestic Finance, told Congress that the "true culprit" in the growing gap between capital markets and accounting disclosure is an ethic in boardrooms and auditing firms that too often equates Generally Accepted Accounting Principles compliance with adequate disclosure. This ethic sets the bar too low, he declared, and encourages corporate executives to prepare, and auditors to certify, financial statements that may meet GAAP technical requirements but fail to provide investors with a realistic picture of a firm's condition. Testifying before the House Financial Services Committee, the Treasury official said that a company's CEO and its auditors must be made accountable for disclosing the information that a reasonable investor would find necessary to assess the company's value.

The Bush administration has made clear, and the SEC has recently re-affirmed, that mere compliance with GAAP is not enough. According to Mr. Fisher, each investor should have access to a true and fair picture of the company, in plain English, and should be promptly informed of critical events that affect the condition of the company. Companies should not be able to hide behind technical GAAP compliance, he asserted.

Recently, SEC Chairman Harvey Pitt sounded a similar theme when he stated that present-day accounting standards are cumbersome and offer far too detailed prescriptive requirements for companies and their accountants to follow. That approach encourages accountants to "check the boxes," reasoned the chairman, and to ascertain whether there is technical compliance with applicable accounting principles.

But according to Chairman Pitt, the first principle should always be the one Circuit Judge Henry Friendly articulated four decades ago in U.S. v. Simon (1969-70 CCH Dec. ¶92,511 ). In rejecting the auditors' claim that criminal charges were foreclosed because the financial statements literally complied with GAAP, Judge Friendly held that, if literal compliance with GAAP creates a fraudulent or materially misleading impression in the minds of shareholders, the accountants could, and would, be held criminally liable.

Similarly, the Federal Reserve Board reserves the right to apply its own "sound interpretation" to the application of generally accepted accounting principles to special-purpose vehicles, according to newly-appointed Governor Mark W. Olson. In recent remarks at the University of Miami School of Law Sixth Annual Institute on Mergers and Acquisitions, he noted that the Federal Reserve Board has exercised this right and will continue to do so when necessary to ensure the transparency of an institution's risk profile and financial condition through the accuracy of its financial statements.

Furthermore, in appropriate circumstances, when the Federal Reserve Board finds that a banking organization has effectively retained the substantive risks of assets it has transferred to a special-purpose vehicle, the bank will have to consolidate those assets in financial statements prepared in accordance with GAAP.

At a minimum, he proclaimed, these statements must satisfy GAAP. But the central banker reiterated that the Federal Reserve Board will apply its own sound interpretation of those accounting principles based on a careful consideration of the underlying facts and circumstances and the economic substance of the transactions. Adding his voice to the sentiment, IASB Chairman Paul Volcker recently told the European Commission that too often the emphasis is on finding ways to meet the letter of the technical accounting requirements at the risk of violating the spirit.