Wriston, Walter B.
The Solution to Scandals? Simpler Rules
In today's toxic atmosphere, politicians are racing with each other to pass new laws to "solve" the recent spate of corporate misdeeds. The fundamental American right to a presumption of innocence has been discarded by the media, and almost anyone can allege an accounting irregularity and drive the market cap of the accused company into single digits.
Talking heads on TV and radio, and distinguished members of our Congress, routinely talk about "cooked books" with little or no knowledge of accounting. When President Bush recently suggested that all accounting decisions are not always black and white, he was attacked as if he had made an obscene statement, when in fact he was dead right.
Scholars will recall that in the beginning, the Roman empire operated with laws recorded on just 12 tablets which every school child had to memorize. Over time, as laws proliferated, the 12 tablets grew to some 3,000 brass plates stored in the capital and read by nobody. American accounting rules have outdone in a few years what the Romans took 13 centuries to produce.
Everybody is in on the act. The Financial Accounting Standards Board has, at last count, enshrined generally accepted accounting principles into three volumes comprising some 4,530 pages. Some of the FASB rules run to over 700 pages on how to book a single transaction. It should surprise no one that two skilled accountants, looking at the booking of the same transaction and using their knowledge of the same rules, come out with different results.
It happens all the time in legal matters. Learned judges hearing the same testimony and reading the same briefs often render split opinions of 5-4 or 2-1. It is rare that they are castigated by the media or Congress for failing to agree unanimously, but in the accounting profession a difference of opinion is often reported as if a fraud has been committed.
Congress, which suddenly has become expert on the nearly 5,000 pages of rules governing private-sector accounting, prevents our own government from using GAAP. The reasons for this hypocrisy is clear. If GAAP were used by the federal government, the reported surplus last year of $170 billion would have to be reported as a deficit of $580 billion. Off-balance-sheet financing, a la Enron, is more the rule than the exception in government.
While GAAP accounting is the accepted norm in the U.S., except of course by the government itself, others overseas have slightly different ideas of how the books should be kept -- ideas which emphasize broad principles rather than lots of picayune rules. Since we are all the product of the environment in which we operate this should surprise no one.
With the plaintiff's bar pouring money into the coffers of Congress, the pressure to pass laws destroying the concept of a limited liability corporation, which has fueled the expansions of our economy, is immense. The number of companies that have been destroyed by the asbestos suits grows every day. All of this public noise has led to an attempt to write a rule for everything.
Sir David Tweedie, the retiring chairman of the International Accounting Standards Board, testifying before Congress on Feb. 14, explained, "Companies want detailed guidance because these details eliminate uncertainties about how transactions should be structured. Auditors want specificity because these specific requirements limit the number of difficult disputes with clients and may provide a defense in litigation. Securities regulators want detailed guidance because these details are thought to be easier to enforce."
While this rationale makes sense on one level, it fails on another. It engenders a mindset among accountants, auditors and managers to ask the wrong question: "Is it legal?" instead of "Is it right?" High-priced lawyers and skilled merchant bankers can often find a way through the thicket of regulations because human ingenuity is such that it is impossible to cover every possibility.
Many years ago, James Madison foresaw the problem and wrote in "The Federalist Papers": "It will be of little avail to the people that laws are made by men of their choice, if the laws be so voluminous that they cannot be read, or so incoherent that they cannot be understood . . . that no man who knows what the law is today can guess what it will be tomorrow." It can be argued that we have now arrived at that point in the accounting profession.
The alternative to this rule-based approach is one pursued by IASB. In the words of Sir David: "Put simply, adding the detailed guidelines may obscure, rather than highlight, the underlying principle. The emphasis tends to be on compliance with the letter of the rule rather than on the spirit of the accounting standard."
"Our approach," Sir David explains, by contrast, "requires both companies and their auditors to exercise professional judgment in the public interest. Our approach requires a strong commitment from preparers to financial statements that provide a faithful representation of all transactions and a strong commitment from auditors to resist client pressure. It will not work without those commitments."
Sir David's bottom line: "There will be more individual transactions and structures that are not explicitly addressed. We hope that a clear statement of the underlying principles will allow companies and auditors to deal with those situations without resorting to detailed rules."
Indeed, IASB has just 34 standards, and instead of thousands of pages, most are expressed in memos of a few dozen pages. This view of how accounting should be regulated is rapidly gaining acceptance in Europe; indeed all companies resident in the European Union will have to be in compliance by 2005. In the meantime, in America, FASB continues to crank out reams of paper, and is falling further and further behind what is happening in the rest of the world.
Is it not possible to have an understandable global accounting system for a global market? Sooner rather than later the world will require it. In fact our corporate "scandals" show that it is long overdue here.