A new one-liner in the cultural vocabulary was introduced when the hit comedy, “No Sex Please, We’re British,” opened in London in 1971.
Today’s plea – with the Securities and Exchange Commission’s proposal to inflict an analytic structure upon the making of accounting and audit judgments – would be “No Standards Please, We’re American.”
On February 14 the SEC presented for public comments the interim progress report of its Advisory Committee on Improvements to Financial Reporting – here – which among its suggestions was that the Commission should adopt a “judgment framework” in the accounting area, and that the country’s audit regulator, the Public Company Accounting Oversight Board, should do the same for audit judgments.
Responses to the SEC are due the end of this month. Meanwhile, the PCAOB sponsored a panel discussion on February 27 by its Standing Advisory Group – summarized here by Edith Orenstein of Financial Executives International.
The signal achievement of this day-long effort was that the competing interests in the debate managed at the same time to expose both the hazards and the vacuity of the whole idea.
As co-presented to the PCAOB group by a managing director of Moody’s – yes, the credit rating agency – the notion is this:
• Preparers of financial statements would be assisted by yet more pages of codified bullet points, in choosing and applying among the myriad of alternatives for selecting and implementing accounting standards, quantifying estimates, evaluating evidence and all the rest.
• Auditors, likewise, would be similarly enlightened across the spectrum of judgments required to choose audit procedures, to evaluate the likelihood and impact of fraud and other risks, to conduct audit sampling, to evaluate controls and – layering the irony – to assess management’s own judgments.
Wait.
In the century and a half since the emergence of independent accounting early in the Victorian era, preparers of financial statements and their auditors have been striving get their judgment processes right. So who are these bureaucrats, with their presumption of assistance?
This is, after all, the same SEC that was caught flat-footed over the pervasive extent of executive options back-dating. The same PCAOB that in its sixth year has no more than a pilot program for constructive engagement with non-US regulators and inspection beyond the samples taken within its own borders. And the same Moody’s whose involvement in the subprime mortgage fiasco, along with the other major credit ratings agencies, finds them to be central in the still-spreading credit markets turmoil.
Put another way, taking advice on the process for judgment-making from this crowd could be viewed like hiring Noah to give flood-control advice to the city of New Orleans.
As for the parody that passes for debate, the self-interested and antagonistic participants are circling the topic and each other like stray and wary dogs around a hydrant.
The accounting firms at the PCAOB’s table gave cautious endorsement to the framework idea, despite the obvious hazard: By getting it right they would obtain no more credit, safeguard or protection than is available today under existing guidance. Instead, they would only have one more procedure to get wrong, and therefore increase their already debilitating litigation exposure.
The large accounting firms remain muzzled on their fragile and threatened state, unwilling out of either fear or denial to acknowledge the shockingly low litigation impact that would cause their disintegration (which I've calculated and discussed here).
As a result, they are inhibited from insisting that the only realistic usefulness of yet more regulation on the exercise of their judgments would be under a “safe harbor” within which they could explore and apply new modes of working.
But on the other hand, investor advocates among the profession’s critics make plain the political reality that no adjustments in the American legal liability framework that entraps the auditors today are about to be forthcoming.
Exposing the sterility of the discussion, even the regulators themselves are in full self-protection mode, making clear that nothing in the application of the suggested framework process would inhibit the SEC or the PCAOB from examining and criticizing the judgments made by issuers or auditors.
For British theatre-goers the farce of “No Sex Please” ended when the nightly curtain came down. Because a new "judgment framework" would offer benefits that range from elusive to non-existent, would impose costs of extra work and documentation that are extensive, and would inflict potential litigation hazards that are considerable, the farce now playing out in Washington deserves a closing notice.
For other aspects of the PCAOB’s meeting last week, see my friend Francine McKenna at Re:The Auditors -- here.
I couldn't have said it better myself. Really, I couldn't have...
Posted by: Francine McKenna | March 06, 2008 at 11:54 AM