(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.)

Accounting Issues Take Center Stage in House Hearings

As the SEC conducts investigations of corporate accounting practices, and against the backdrop of a Commission proposal to recast the MD&A discussion to include critical accounting policies, a House subcommittee launched its own investigation into the efficacy of currently applied Generally Accepted accounting principles (GAAP). Testifying before the Capital Markets subcommittee, SEC Chief Accountant Robert K. Herdman emphasized that financial statements are often the captives of rule-based accounting standards that encourage a "check-the-box mentality" to financial reporting that eliminates judgments from the application of the reporting. As an example of rule-based accounting guidance, he cited FASB Statement No. 133 on accounting for derivatives.

Mr. Herdman testified that an ideal accounting standard is one that is principle-based and requires financial reporting to reflect the economic substance, not the form, of the transaction. He said that FASB Statement Nos. 141 on business combinations and 142 on goodwill appear to be steps in the right direction. He also indicated that an important benefit of principles-based standards is that it mitigates the opportunities to financially engineer around the rules.

It was clear from the testimony that the SEC and Congress remain committed to the current system of private-sector accounting standards setting. Full Financial Services Committee Chairman Michael Oxley praised the SEC for "wisely " working through private sector bodies to set standards, adding that it would be "sheer lunacy " to imagine that the federal government could dictate accounting principles. The chairman believes that, even after Enron, the SEC's collaboration with the private sector is the "best financial disclosure and reporting system in the world."

In the view of former SEC Commissioner Steven M.H. Wallman, the current scandals highlight how outdated GAAP really is. It is his position that the scandals would have been mitigated if companies had adhered strictly to GAAP, but would not have been avoided entirely. It is possible to adhere to the letter of GAAP while evading the spirit of fair presentation, he averred. Mr. Wallman called for reform of GAAP to provide more disclosure on the primary accounting judgments driving the financial statement presentation and to implement what the former commissioner calls "colorized accounting, " which is a reliability-based disclosure of different levels of information. He also believes that both the accounting profession and issuer community need to be reeducated as to the need for more goal-oriented accounting principles. The former SEC official also proposed requiring the equivalent of a concurring partner, but from a different auditing firm, to sign off on the primary accounting judgments and independently report to the company's audit committee.

FASB Chairman Edmund L. Jenkins called on auditors to end the practice of accepting "show me where it says I can't do this" accounting. Auditors must assure that the stated intent of the standards is followed and not accept "facile" arguments that the reporting is acceptable because the standards do not explicitly say that the reporting is unacceptable. Chairman Jenkins refuses to accept the implication that GAAP is the main contributor to the perceived lack of credibility of corporate financial reports. While acknowledging that GAAP should be improved, he emphasized that GAAP, when properly applied, produces the most transparent financial reports in the world.