(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.)

House Holds Hearings on FASB Reform Bill

A bill to reform accounting standards was recently the subject of hearings before the House Commerce Committee. The measure provides underlying principles to guide the Financial Accounting Standards Board (FASB) in setting accounting standards to provide greater transparency in the financial reports of public companies. It requires FASB to address existing inadequacies in the rules governing off-balance-sheet accounting, revenue recognition, and mark-to-market accounting. H.R. 5058, the Financial Accounting Standards Board Act is supported by senior House leaders, and was introduced by Rep. Cliff Stearns, Chairman of the Subcommittee on Commerce, Trade and Consumer Protection.

According to Commerce Committee Chairman Billy Tauzin, the Act makes important improvements to financial reporting. The bill introduces the benefits of a principles-based accounting system into the current rule-based system by requiring FASB to check the accounting standards against the principles of transparency and comprehensibility. It also requires FASB to draft a primary standard that must be used to ensure that the application of accounting rules complies with those same principles of transparency and comprehensibility. Any deviation in the application of a rule from the principles articulated in the bill must be explained and justified.

While supportive of some provisions in the draft bill, FASB Chairman Edmund L. Jenkins said other provisions would impair both the reality and appearance of FASB independence, and thus have a negative impact on the credibility and quality of financial information. Chairman Jenkins supports draft provisions addressing FASB's process. But he opposes provisions addressing FASB's technical activities. He believes it is inappropriate and potentially harmful to consumers and the capital markets for Congress to mandate the subject matter, the content, or the timing of the board's technical decisions or standards.

Expanding on this general theme, Mr. Jenkins said requiring FASB to transmit a report containing an evaluation of the compliance of financial statements with accounting standards would be beyond the board's authority, and the cost of such an evaluation would likely be far beyond the board's limited resources. FASB also has concerns about draft requirements mandating both the development of standards addressing certain specific issues and the completion of certain projects on the board's current agenda within specified time periods.

In FASB's view, those provisions restrict its ability to make objective decisions on technical matters and, therefore, compromise the ability of FASB to produce high-quality standards. Mandating the development of standards addressing specific issues inevitably means that FASB cannot develop standards addressing other specific issues that might have a higher priority in terms of consumer need, emphasized Chairman Jenkins, and mandating completion of agenda projects within specified time periods would likely shortcut FASB's open due process on those projects. In order to comply with the artificial deadlines, he continued, the resulting standards may have to be issued without the benefit of a full opportunity for open discussion and analysis of constituent views.

In addition, he warned that both mandates would have an adverse impact on FASB's goal of converging financial accounting and reporting standards around the world. To ensure convergence, the FASB, the IASB, and other national accounting standard setters must have significant flexibility over their respective agendas and the timing of projects so that common projects and issues can be addressed concurrently.

Finally on this point, the FASB chief feared that mandating the development of standards addressing certain specific issues would create a dangerous precedent. For example, the provisions could lead to future congressional or governmental mandates that certain specific accounting issues not be addressed, which he viewed as a clear threat to FASB's independence.

Separately, Chairman Jenkins assured the committee that FASB would not oppose provisions to transmit reports containing an assessment of FASB's resources, or the progress made on the projects included on FASB's technical agenda. Similarly, FASB supports the draft's clear statements on the authority of FASB standards, as well as the general principles for promulgating and revising standards and objectives for conducting the FASB's activities. He noted that those provisions of the bill contain language essentially the same as language in FASB's mission statement and conceptual framework.

Professor John C. Coffee, Jr. of the Columbia Law School queried how one would get to the more principled based system of accounting contemplated by the bill. While the specified standards are useful, he observed, they omit the critical concept that drives the United Kingdom's more principled system. Noting that U.K. GAAP requires auditors to report a true and fair view of an enterprise's financial condition, he suggested that similar language could be incorporated into the Act as a guiding instruction. Arguably, he continued, there is already a notion of fair presentation in U.S. law similarly requiring the auditor to fairly present the company's financial position, but he added that the idea will be resisted by the industry, absent a legislative statement.

According to Professor Bala G. Dharan of Rice University's Jesse H. Jones Graduate School of Management, the bill's primary strengths are providing FASB an independent legal basis for existence and moving the standard-setting process toward a principles-based approach. Trying to achieve these goals will, however, require addressing several key implementation issues, of which the most daunting is a clear delineation of the roles of FASB and the SEC in the development of accounting standards. Since the SEC already has the statutory authority to develop and enforce accounting standards, Professor Dharan emphasized the importance of including provisions reconciling any newly-recognized statutory role of FASB to issue accounting standards with existing SEC authority.

The second, and related, implementation issue is the development of a viable, long-term funding mechanism for the activities of FASB so that its current dependence on selling its own rules to fund its operations is eliminated. If the FASB were to have additional public responsibilities to set accounting standards and periodically report to Congress on the implementation of standards by corporations, said Professor Dharan, a funding plan to execute these public responsibilities must be addressed as well.