Friday, March 9, 2012

Essay on Should SEC replace FASB?

Essay on Should SEC replace FASB?

Should SEC replace FASB?
Originally established to enforce the Securities Exchange Act of 1934, the Security Exchange Commission (SEC) is a governmental body which focuses on protecting investors in US securities by setting codes of conduct to ensure transparency, relative safety and efficiency for traders.

An essential element in this process is to provide the investors clear and accurate information regarding public companies. In this context, financial reporting rules are being developed and implemented. The SEC has gave this assignment to a private body, the Financial Accounting Standard Board (FASB), whose main product are the Generally Accepted Accounting Principles, or GAAP, which serve as the basis for auditing and reporting activities in the US.

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The FASB is an NGO which receives trust from the authorities and therefore has great responsibility. However, it is dominated by the major accounting firms (known as the “Big Eight”) and therefore, as some would claim, serves as a channel to promote their interests. The result is what can be perceived as cumbersome, slow and rather expansive accounting regulations. Simply put, by obliging companies to follow the GAAP, the FASB is an instrument by the hands of the big accounting firms to keep and increase their clientele and their profits. Thus, by relying on the FASB to set the rules, the SEC, a representative body, is giving away power that should belong to the public, presumably trusting an organization which focuses much more on developing accounting processes than to emphasize disclosure and the quality of information given to the investor.

The classical case of Enron is a good example for that. Following the FAS 157 methodology, known as mark to market, the SEC authorized (and still does, although to a lesser extent) Enron to report theoretical earnings in its statements. In this case, the company and its accounting firm have crossed the line between “creative” accounting (which naturally increase companies’ market value but may create a bubble) and fraud. Some critics would also say that FAS 157 has created an extremely unfair market valuation that boosted the recent sub-prime crises. Therefore, the somewhat passive approach of the SEC regarding accounting policies was not very helpful to minimize the crises, just as happened with Enron. Critics of the FASB do not need much more than a blink on the financial newspapers to find accounting scandals, restated reports and rough mistakes, which contributes to a greater volatility of markets, at least in the short run. Naturally, they will blame the gatekeeper for setting the wrong standards or not enforcing them properly.

On the other hand, it is not so clear that a governmental body will better serve those causes. Even if the FASB is dominated by the firms, it is a safe to assume that these firms are much more connected to the players in the market than the federal government. In addition, as happens sometimes with legislation, there is a risk that a governmental body would set rules that are impossible to enforce. Cooperation with the professional bodies is vital; without it rules would not be implemented. The result may be a cause in reporting which will harm the market and its players.

Moreover, the FASB is aware of the criticism on it and seems to improve its work and remain relevant. Issues such as valuation of intangible assets (e.g., intellectual property) and the accounting implications of complicated contracts demand the involvement of top professionals. Some other issues, in particular those which influence the daily work of the accountant (e.g., timeliness of accounting processes) must be guided by the bodies who actually perform the tasks.

In conclusion, I would not rush to assume that replacing the FASB with the full control of the SEC. Bad experiences in the past and present prove that the contemporary methods are not sufficient to protect and improve financial markets. Nevertheless, one should not expect perfection and should bear in mind that every system will always leave loopholes; some of those may be quite hazardous.

Therefore, power should be divided between the two bodies. By promoting a system with more checks and balances and through continuous dialog between the industry and the state, the SEC and the FASB can build a comprehensive and safer environment for investors.
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