Re:Balance -- Jim Peterson

GAAP/IFRS Convergence: The SEC's Roadmap is a Highway Leading Nowhere

For two reasons I’ve taken a while to step into the fray about the prospects for convergence between Generally Accepted Accounting Principles in the United States and the International Financial Reporting Standards.  

First, it was an honest and necessary but also dreary and time-consuming task to plow through the entirety of the SEC’s statement of February 24, “In Support of Convergence and Global Accounting Standards” – here.

Second, it was a toss-up which was more enervating: to slog through all 68 pages of the SEC’s turgid and repetitive bureaucratic prose, or to contemplate whether anyone thoughtful in that agency really believe in a highly-uncertain timetable that at its most optimistic extends more than halfway through this decade. 

Although the G-20 declared in Pittsburgh last September that global standard setters should complete their convergence project by June 2011 (here), the SEC gives itself all of next year even to be positioned to consider a determination whether to give more support to convergence, much less when or how. Depending on a new staff-level Work Plan that supplants the famous “Roadmap” of 2008 (here), the SEC projects that presently-undefined steps in implementation may be taken no earlier than 2015 or 2016.

The merits of convergence are debated across the spectrum, from industry sycophancy (here and here) to David Albrecht’s professorial patriotism (here) to Tom Selling’s sour challenges to its lack of intellectual substance (here) to the playful irreverence of Going Concern (here).

For me – I am agnostic on this point. First, the whole issue of whether convergence ought to happen is largely academic – because the complexities and judgments within either GAAP or IFRS themselves render the outcomes too challenging and non-comparable for any users except the dedicated experts.    

But second, there are understandable reasons, based entirely on process, why the SEC’s program for convergence has more qualifiers than this month’s NCAA basketball tournament. 

On the European side of the Atlantic, conspicuous on the personal roadmap of IASB Chairman David Tweedie is the stop sign of his June 2011 retirement. Now a lame duck, Tweedie has combined intellectual rigor and prickly Scottish wit, but his ability to achieve harmony among his constituents has been frustrated by the evident limitations on his diplomatic skills.

Disparate nationalistic players in Europe have shown the ability to evade, frustrate and maneuver around attempts at cross-border unification and cooperation at many levels:

• ·      The French bankers, abetted by no less an accounting expert than President Jacques Chirac, led years of lobbying to prevent the applicability of a single international auditing standard on derivatives accounting (here).
• ·      The Swiss judiciary continues to provide home-court advantage in frustrating the on-going efforts of the American IRS to obtain personal data on alleged tax evaders (here).
  
• ·      And eight years on from the passage of Sarbanes/Oxley, the SEC has officially permitted the PCAOB to bail for another three years (here) on its supposed mandate to inject itself into the inspection and oversight of ex-US accounting firms, unable to penetrate the European rules on privilege, privacy and confidentiality.

While on the American side, the SEC’s guidance-writers did not have a great winter:

• ·      Their late-January pronouncement on disclosure of the implications of climate change (here) was a cheerleading exercise in vacuity – see here.
• ·      On the subject of short-selling, the SEC voted 3-2 on February 24 to re-instate an uptick rule (here), but only for shares dropping more than ten percent – a debatable exercise in cosmetics at best, that will impose obnoxious compliance costs while substituting the vacillations of motion for the reality of progress. 
  
• ·      And on the subject of convergence, the flabbiness of a schedule measured in geological time makes clear that compared to a real roadmap, the agency’s navigators couldn’t find first base with a compass and a guide dog.

So on one side, the Europeans can waffle and jawbone the convergence process for as long as it suits – while the SEC's political dithering only kicks the can down the road, far past the tenure of any present office-holders. Which means that the absence of accomplishment half-a-decade from now will become the responsibility of a whole new set of map-readers.   

It’s all enough to speculate how Robert Frost’s 1916 poem, “The Road Not Taken,” would sound, if written by an observer of the GAAP/IFRS process:

Two roads converged in a wood.

And sorry I could not see the forest for the trees,

Long I stood in the undergrowth.

……

I shall be telling this with a sigh

Somewhere ages and ages hence:

Two roads never converged

And that has made absolutely no difference.

 

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The SEC Turns Up the Heat on Climate Change -- Or Just More Gas?

The Securities and Exchange Commission in Washington voted by 3-2 last week to issue an “interpretive release” aimed at public company disclosures of the impact of climate change – ranging from new regulations and legislation, to changes in economic trends or physical risks (here).

Yet another layer of mandated environmental platitudes?

In her announcement speech, Chairman Mary Schapiro disavowed any intent to “create new legal requirements or modify existing ones,” and stated (her emphasis) that the Commission is “not making any kind of statement regarding the facts as they relate to the topic of ‘climate change’ or global warming’.” 

Further pounding down another nail of obvious banality, she noted that “it is neither surprising nor especially remarkable for us to conclude that of course a company must consider” possible events which “under our traditional framework” it must evaluate and disclose if material.

So the SEC’s cheerleading on climate change will be right there with the influence of the pom-pom girls on the outcome of the Super Bowl.

The SEC has been in rehabilitation mode since the prior administration, for everything from being caught out by Bernie Madoff’s spectacular Ponzi scheme to its virtual absence during the credit crisis. (see Andrew Ross Sorkin’s thoroughly engaging “Too Big To Fail” (Viking Penguin 2009), for the shared view that the then-Chairman was a clueless and ineffectual lightweight.)

The agency’s October 8, 2009 strategic plan has been followed by an outpouring: creation of a division for Risk, Strategy and Financial Innovation (November 5), borrowing of “cooperation incentives” from the toolkit of serious criminal prosecutors (January 13), and re-shuffling of bodies and titles within the Division of Enforcement (also January 13). Here then, the appearance of another release du jour. 

Or so it seems – because it can hardly be justified on the substance. Rather than real regulation, it’s the Potemkin façade of illusion – animated by the same optics-oriented spirit that inflicted on the user community the costs, disruptions and distractions of the Sarbanes/Oxley law. 

With details still to come, the SEC’s release offers four so-called “triggers’ whose impact could lead to disclosure – legislation and regulation, international accords, indirect consequences of regulation or business trends, and physical impacts of climate change – each of which would already have been unexceptionally viewed as an appropriate disclosure category under pre-existing guidance.

It offers a fair question: where the carbon set-offs will be found, for the acres of forest and tankers of jet fuel that will be consumed and emitted, to support all the round-tables, seminars and symposia, expensive legal opinions and auditor box-ticking, that will enable registrants to react to this latest burst of regulatory hot air.

What might be some of the new language, on top of disclosures that are already vaporous enough?

•  “The company safeguards its portfolio of exotic derivatives in an eco-friendly black box, which is regularly re-valued by marking to a market that is completely organic.”
• “While the company’s internal control structure may not prevent our shopping-addicted CFO from stealing us blind, we are pleased that our corporate credit card accounts are now settled by paperless invoicing.”
  
• “Any facilitating payments made to public officials by our off-shore subsidiaries will be delivered in brown paper bags made of no less than 60% recycled material.”

Kidding aside, validation of the importance of climate change is plain from its prominence in the marketing of each of the Big Four (here, here, here and here) – so nearly identical and undifferentiated as to be products of the same publicity shop.  

The accountants had best be ready, because the financial and reporting issues around climate change will become real – from the complexities sure to arise when the inventive wonks in the derivatives markets develop exotic ways to re-package emissions permits for speculative purposes, to the management and audit issues of identifying and controlling pollution sources for purposes of permit measurement and compliance.

But for now, with the SEC already fully occupied with credibility-stretching issues, it is hard to see its exercise in non-substantive flag-waving as anything more than a needless contribution to the already-elevated level of Washington’s noxious fumes.  

 

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Previewing 2010 -- And a Note of Thanks

As the old year winds down to the winter solstice and all those rituals by which we mark the holiday season, a brief look ahead.

Depending on reckoning, the New Year will either end an old decade or begin the next one. Whichever, here are a few events that will feature in 2010 among the on-going challenges to the global structure of large-company assurance:

• The Supreme Court in the US may well declare the PCAOB to have been illegally constituted (here or here). If so, predictable spasms of re-enactment and ratification by the SEC cannot successfully encompass such issues as the viability of pending investigations, the legitimacy of past inspection reports, or the need to re-register all the foreign accounting firms.

In the context of those issues of contention, the legislative mischief to be wrought by a Congress offered a blank page on which to re-debate the Sarbanes/Oxley law can scarcely be imagined.

• The fits and starts of accounting standards convergence will have no more traction than a pig on roller skates. The announced retirement of Sir David Tweedie as head of the IASB (here) will take one prickly personality off-stage, but will not solve the antagonisms among competing country and industry level interests. And as the scope of complexity and judgments within both GAAP and IFRS figure to be as significant as those between reporting systems, the achievability of comparability and comprehension will remain as elusive as ever. 

• Attempts to impose liability on the large accounting firms’ international structures will continue apace. The success of BDO International in confining the Bankest verdict in Miami to the Seidman firm alone (here) means that if that $521 million exposure becomes enforceable, BDO may need to find a new US member firm – a tactic painful enough for that organization but which none of the Big Four could achieve under like conditions.

Flashpoints for structural threats will include the Madoff-related feeder funds litigations, concentrated in the US but also spread around the world, and PwC’s exposure on Satyam.  And with PwC’s Indian partners on Satyam about to observe their first full year of local imprisonment, that network's attempts to extract itself from class action exposure in the American court system (here) raise the interesting question whether submission to Indian justice is really a preferred strategy.

• Tempting as it might be to be lured into the speculation about identifying which of the Big Four firm is most likely to disintegrate under the combined pressures of litigation and government threat, in 2010 or otherwise (here), I will decline – since the determining factor is the unpredictable timing of the cases themselves. Specify the judges’ scheduled trial dates for the 25 biggest cases hanging in Damoclean fashion over the large firms – and only then would I be able to offer a view.

• More broadly, strategic decision makers in the world of financial information will continue to confront the volatility of government conduct – an under-recognized factor in their overall risk assessment methodologies.
  

The reactive nature of public officials has been marked in recent years by an ad hoc cascade of unpredictable and unintended consequences – ranging in scope and scale from the back-of-envelope bank bail-out schemes to the bonus supertax in the United Kingdom to the first-ever invention in Dubai of a default-driven debt reorganization scheme of uncertain application or reliability.

So life in the forthcoming year will not be boring. 

Meanwhile, in this space, Re:Balance observes its second birthday. Launched in January 2008, this venture was the evolution from “Balance Sheet,” the column I had the six-year privilege and good fortune to write for the International Herald Tribune.

The challenges have been fascinating, starting with the anxiety-inducing migration from old-style print. No less than the accounting firms, the IHT itself -- like the other newspapers -- pursues its fading struggle in search of a sustainable niche business model. While in the world of rapidly mutating media platforms, the near-term impact of the likes of Twitter, Facebook and Kindle will continue at a dizzying pace to re-define the information landscape.  

It has been most gratifying over these two years, both to participate in community with an expanding group of smart and incisive commentators, and to experience steady growth in readership and especially in subscribers.

For these opportunities, I thank you all for your interest, your insights and your inputs.

Merry Christmas -- best holiday wishes -- and a healthy, peaceful and prosperous New Year to all. 

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Global Convergence of Accounting Standards? In Whose Lifetime?

A senior member of the fraternity of pundits touchingly spoke, recently, about one effect of the passage of time: “The older I get,” he said, “the more care and respect I have for the phrase “not in my lifetime…’.”

There’s a grain of sense -- however frustrating it is, that decent respect for the elderly means that we have to pay attention to the superannuated, however unwilling they are to surrender their microphones. Truth to tell, there is usually an inverse relationship between advancing age and advanced intelligence -- examples would be gratuitous but readily available on request – suggesting a requirement that pontificators come with staleness warnings or prominent display of a sell-by date.

That said, there is a recent media flurry around the long-dated estimate for convergence to a single set of global accounting standards – centering on the dialog between the Financial Accounting Standards Board in the United States, responsible for GAAP in that country, and the International Accounting Standards Board, responsible for IFRS as now mandated in the European Union and adopted to varying degrees in 100+ countries around the world.

The recent G-20 meeting in Pittsburgh was the context for a leaders’ statement by the great and the good, calling for completion of a convergence project in 2011 – a date also targeted for the US SEC’s decision to require IFRS adoption (for a helpful review of the state of play, see Edith Orenstein’s FEI Blog.)

Meanwhile in furtherance of the accounting profession’s party line, Ernst & Young’s global chief Jim Turley is quoted (in the Going Concern blog), flogging a single set of standards as “imperative.”

The chorus for convergence is not singing in unison. No critic is more trenchant or persistent than Tom Selling (The Accounting Onion) – although in an era of commentators’ ranting for ratings, sound reasoning and intellectual rigor have limited weight.

It matters much more that the reluctant Europeans will likely have their way. The Financial Times reports – here – that Henri de Castries, chief of French insurance giant AXA, views the setting of standards as “a matter of political sovereignty” and that French finance minister Christine Lagarde has put it to EU financial services commissioner Charlie McCreevy to “’ensure the safeguard’ of European public interest.”

Which sounds entirely like dressed-up cover for another version of the European capacity for protracted refusal to yield up national autonomy – foreshadowing a de facto continuation of country-based “mark to management” accounting, however pious the leaders’ pronouncements in favor of convergence.

Not that it may matter all that much, in a financial reporting world where comprehension and comparability are already elusive.

A generation ago, one of my then-colleagues – the world’s expert on accounting for complex financial instruments – maintained a list, on which he always included one entirely fictitious product. His standard wager of a full year’s bonus was that even a knowledgeable practitioner would not find the bogus item – and he never found a taker.

In practice today, he would say that there is already so much slack, judgment and overnight obsolescence in the tough issues of recording and reporting, even within single systems – whether the best-in-class among the major countries’ local GAAP or under IFRS itself – that the prospects for true convergence at any level of detail will remain perpetually elusive.

Add in the politically-motivated local vetoes being retained by the likes of the recalcitrant French, exemplified by the spirit of M de Castries and reflected in the measurements of European progress over spans of geological time: the deeply-embedded antagonisms and resistance recall the lesson from high-school geometry, that parallel lines only converge at infinity.

If only for these purposes, how delicious it would be if Ernst & Young were AXA’s auditors in France. Armed with the opposing attitudes of their bosses, if the client’s chief financial officer and the audit engagement partner were put to a debate on convergence, which one would emerge alive?   

One thing for sure – considering that the footnote in AXA’s 2008 annual report that sets out its choices and description of accounting principles already runs to sixteen pages (here): for anyone tempted to estimate a future date on which AXA might issue financial statements under a single converged set of globally-applicable accounting standards, it would be a safe bet to go with “not in our lifetime.”

 

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Evil Accounting Spirits on the Loose -- A Scary Halloween in Germany

With the mist beginning to clear after the American elections, it’s time to observe how countries differently observe the holiday known to some as Halloween.

In the US, children canvas their neighbors for candy – a ritual seemingly designed to benefit pediatric dentists, aerobic instructors and obesity consultants.

In France, Toussaint mainly presents an excuse for a ten-day school holiday. While in Germany, the souls of the dead supposedly walk the earth on Allerheiligentag until released when the church bells chime.

This season in Germany was particularly uneasy for the departed spirits of dependable financial reporting, transparent governance and stable market regulation, with ominous implications for the elusive goal of global convergence toward good-quality reporting and compliance standards.

All Hallows Eve saw Deutsche Bank report quarterly net income of € 414 million – thanks only to the bank’s avoidance of € 845 million in asset write-downs made possible by the reclassification of € 25 billion of loans originally intended for onward sale. The change was enabled by the success of the European banks in lobbying the accounting regulators for relief from the “mark-to-market” rules for impaired loans, if permissibly treated instead as “held to maturity.” 

Doubtless a precursor to similar ghoulish accounting by equally motivated banks across Europe, the D Bank move will only be credibly testable over the collection life of the underlying loans – assuming of course that the bank itself is around that long. Investors are essentially being asked to take on considerable faith the ability of bank management to wave the wand of reclassification and stir up ultimate value out of a witches’ cauldron incapable of valuation by more rigorous standards.

Among others, Tom Selling at The Accounting Onion has inveighed against the readiness of the International Accounting Standards Board to rationalize such witchcraft. Deutsche Bank’s eager adoption in practice is a signal that the IASB's accommodationism will unloose malign spirits across the accounting landscape.

The same week saw Porsche’s trick-or-treat on the hedge funds, who were caught by the extent of its option-based creeping take-over of Volkswagen. Plunging short the ordinary shares of VW and long its preference shares, a herd of funds are said to be squeezed as much as € 20 billion by their self-inflicted need to cover with a free float of less than 6%.

Meanwhile the financial sorcery of Porsche chief Wendelin Wiedeking, by which the company made three times more last year in options trading than it did building cars, has him the highest-paid warlock in the German corporate coven.

Shed no tears for the hedge funds who walked into Porsche’s strategy. But do be concerned for the wrong-footed German regulators, who will be scrambling to plug the loopholes that permitted the stealth accumulation of control over VW by way of cash-settled options not disclosable under BaFin’s presently porous rules.

And it cannot be reputation-building for Deutsche Börse, that it reacted to the run-up in VW’s stock price, reaching fully 27% of the Dax-30 index, by making a one-time adjustment to put a 10% cap on the company’s weighting.

The very essence of a credible index – stability of constituent components and adjustments that are infrequent, predictable and transparent – is traduced by such ad hoc fiddling.

These recent events in Germany remind investors and other financial information users of an inevitability: creative and agile corporate chieftains will run ahead of their slower-witted over-seers. When regulation comes too late and standard-setting yields to pressure, it’s no surprise that the nightmares are real: creepy things lurk in dark corners, never to be reached by the disinfectant of sunshine.

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"Where were the Auditors?" In this Crisis, Nobody Asks - Because Nobody Cares

In the rural America of my youth, the ultimate symbol for feckless optimism was the farm boy discovered in the barn early on Christmas morning, digging in the manure pile, crying out that, “With all this horse-shit around, there must be a pony under here somewhere.”

My series of meetings last week started with the investment officer of a large hedge fund. Over an extremely dour martini he volunteered his list of those responsible for the nightmares still spreading from the credit markets through the entire world economy:

•    Homebuyers whose aspirations overreached their ability to pay.
•    Mortgage lenders piling up immediate fees for unsustainably aggressive products with neither rational underwriting nor retained risk.
•    Bankers made rich beyond reason by packaging subprime mortgages and other exotic products into slices too complex and obscure to be comprehensible.
•    Ratings agencies whose imprimatur was the key to worldwide distribution of these previously unknown instruments.
•    Investors so graspingly eager that they bought uncritically into the triplet myths of a never-ending real estate boom, ring-fenced exposures and fail-safe yields.
•    And the regulators and politicians whose laisser-faire enabled the entire fiasco.

I waited for him to include the auditors – scapegoats inevitably tagged for blame in every scandal’s aftermath. And waited.

And was still waiting, later that day, when my other friend the insurance executive laid out the precisely identical cast of miscreants  -- with the same unexpected omission.    

In this non-scientific sample, despite the raging furor over accounting standards for fair value and the world-wide lobbying for relief from mark-to-market requirements, nobody was pressing the question, “Where were the auditors?”

There will be days of reckoning to be sure: the Big Four all face new mega-claims -- gratuitous to recite, because taken from the familiar roster of failed financial institutions.

But instead of hauling the auditors into their hearing rooms, the grand-standing politicians are making sport with such fallen executives as Richard Fuld of Lehman and Martin Sullivan and Robert Willumstad of AIG.

My two highly knowledgeable friends both distinguish earlier waves of corporate malfeasance: In this era of turmoil so extensive and widely supported, the accountants didn’t cause the problems in the first place, and in the second, they’re not important or influential enough to provide a fix. 

The value to users of large-company audits began to deflate in earnest in the 1980’s, during the piratical recapitalization of corporate America led by the likes of Ivan Boesky, Michael Milken and Henry Kravis. An unobserved non-event back then, when the predators would lose a deal and lick their wounds and go on to the next deal, was the total absence of claims against auditors.

The simple reason was that no disappointed raider could be bothered to assert reliance on audited financial statements – no such claim would have been credible, when those reports attracted only yawns in the due diligence rooms before being tossed aside.

The trend continued at century’s turn, during the dot-com boom, when stock prices became completely unhinged from traditional financial reporting – when price/earnings ratios were irrelevant to IPO’s and hot after-markets, because flotations did not even require revenues, much less the rigor of real earnings.   

And today, unbidden, the accountants are unheard in the public debates on the causes, accountability and solutions for the credit market debacle. Even on fair value, their predictably rational and sensible position (here) puts them, as customary, on the opposite and futile political side from the forces of influence – unable to stop or even deflect the overwhelming rush to satisfy the world’s bankers specially pleading for the authority to “mark-to-fantasy”.

There are ominous long-term implications in the accountants’ slide to marginalization. Balance sheets loaded with toxic assets that are “marked-to-whatever” will suffer for credibility under the noses of skeptical investors, who know full well that the pile of manure is still fermenting somewhere.

In the same way, the fundamental issue of trustworthiness – on which the entire value of the auditors’ franchise perilously rests – is put under scrutiny when they are effectively sidelined for want of influence and capacity to persuade.

Which marks a shift in the debate on the continuing viability of the profession’s future. Whether the Big Four are “too big to fail” or “too fragile to survive,” it increasingly appears that – if the auditors are so insignificant that they are being ignored, even to be criticized -- then they are “too irrelevant to matter.”

Sad as it is, that bodes ill.

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Don't Like "Mark to Market"? How About "Mark to Congress"?

With the chaos in Washington over legislation to bail out Wall Street, looking like nothing so much as the stateroom scene in the Marx Brothers’ “Night at the Opera,” it’s remarkable that only now have the poor accountants shown up.

Should politicians be entrusted to write accounting standards? With the Securities and Exchange Commission already leading the way – here -- relief is proposed of the obligation to “mark to market” the toxic waste on institutional balance sheets – the accumulated tranches of subprime mortgages, credit default swaps and other creative derivatives now freezing up the financial markets. 

The idea is that the otherwise imminently sensible Statement 157 of the Financial Accounting Standards Board – and its cognates in Europe, if French President Nicholas Sarkosy and UK Conservative leader David Cameron have their way – would be eased to allow companies to apply their own judgment – such as it may be – in valuing financial holdings that nobody understood or could properly value from the time they were invented and launched into the stream of commerce in the first place.

And why not? The injection of politics into accounting rules has a long and sorry history – from the technology industry’s perfervid opposition to expensing stock options, to Enron’s lobbying for permissive rules on special purpose entities, to the French-led revolt of European banks against the use of “mark to market” rules for derivatives.

So should Congress be trusted to meddle with the intricacies of financial instruments valuation -- in the same way that they railroaded the Sarbanes/Oxley law in the summer of 2002? What they accomplished then, in an exercise in unintended consequences, was to inflict immense cost and disruption on corporate governance, poison the relationships between issuers and auditors, and entrench a bureaucracy at the PCAOB whose principal achievement is its own perpetuation, while – as today's turmoil makes clear -- conspicuously failing to instill corporate virtue by either fiat or paperwork.

Can it be sensible to relieve the holders of locked-up financial instruments of the obligation to confront the reality of their distressed values – when the wreckage extending from Bear Stearns through Merrill and AIG to Washington Mutual and Wachovia is eloquent testimony that the bankers were and remain clueless as to legitimate and reliable valuations? To do so is to perpetuate an environment instinct with hazard, to reduce the already doubtful quality of financial information available to investors, and to foist off to the future the ultimate reckoning in further barrels of red ink.

The rationale that “mark to market” need not be applied so long as the mysterious paper will be held to either maturity or at least a restored and active market suffers two reality checks:

First, this year’s cascade of institutional failures makes questionable any assumption that a particular holder will survive long enough to see its portfolio restored. And second, with the depths of the American recession still unmeasured both in real estate and across the spectrum of household consumption, there is no currently realistic estimate of the ultimate write-offs still to be taken.

All else aside, it’s likely not to work. How can trust and confidence be restored, when financial statement readers will sniff out the bags of garbage still rotting on the balance sheets – whatever their new names or mythified valuations? Reducing rigor and transparency in the name of management judgment leaves the keys to the henhouse in the hands of the foxes.

There is one glaring irony in the “mark to market” discussion – namely the late-arriving opposition of the large accounting firms themselves to the easing of the rules – here. As usual their position is rationally argued and intellectually sound – and as appears usual, they appear to lack both friends and influence.

The accountants have been demonized in the post-Enron era, and have failed to secure relief against the looming risk of catastrophic collapse of their franchise to audit large global companies.

But what they have not grasped is that a shift of accounting standards under the sanction of the Congress amounts to a “Get Out of Jail Free” card – a transfer of responsibility they could never achieve on their own.

For decades the accountants have been pilloried for their accommodation to their clients, in the courts and in the halls of the legislators. A suspension by law-makers of the “mark to market” requirements can no more relieve the consequences of past financial excesses than an attempted repeal of the law of gravity would enable pigs to fly.

But it would allow the accounting firms at last to hand back to the politicians the consequences of their folly.   

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If the Large Accounting Firms Stood Up for Themselves -- What Might they Say?

I was chided last week by a senior partner at one of the large accounting firms, who felt my views to be unhelpful to the strategy of liability reform.

The sensitivity was unsurprising, because the firm involved is among the most exposed to a litigation-driven catastrophic failure.

But with all the large firms holding hands together on the cliff edge, broad skepticism is entirely warranted. As they present their collective litigation exposure, it looks like a game of Russian roulette – only all the chambers are loaded, and the single variable is the bullet’s victim when the hammer next falls.

With the yawning chasm between their exposures and their resources, nothing is on the table by way of liability caps – whether in money or percentage terms – that is either (a) within the firms’ political reach, or (b) sufficient to enable their survival.

Just because they pursue a flawed strategy does not, however, make me the counsel of pessimism. The large firms have tools readily available for use – hence this update of a column first appearing in the International Herald Tribune:

Most of us experienced at least some childhood fear of the schoolyard bully. Fewer remember the adrenaline high of standing up, and the energy rush when the brave act of delivering a punch on the nose reordered the rules of the playground.

I was recently sympathizing with a just-retired senior partner of a Big Four firm. He was decrying the profession's miserable record against its critics - particularly over the bogus issue of whether auditors should perform non-audit services for audit clients. The debate was never fair, we agreed, because it was swamped by the flood of criticism that auditors could never exercise independent critical judgment when the corporate management under scrutiny was also paying the bills.

Because the critics ended up in control, the large firms sold or divorced from most of their consulting practices, failing to develop into the cross-disciplinary consulting and legal powerhouses they might have become.

According to my unhappy colleague, the auditors' problem was one of weapons. They had only the "nuclear option" - namely, complete withdrawal from the franchise of privately provided audits - which, at least to date, nobody believes they would ever use. So the firms were bullied into submission by aggressive regulators armed with nothing more than an ax to grind.

This is a thoughtful guy - smart enough to have extracted himself and his capital from his old firm before sky-high liability claims could gobble both of them up. But I think he is mistaken. The large firms have always had an arsenal of effective tactical weapons at their disposal. Here are a few:

•    In financial statements for international use, there could be explicit recognition of the significant cross-border differences in both accounting and auditing standards. The goal of converged, high-quality audit performance is desirable, and approaching, but far from accomplished. There are substandard country practices, which candor should disclose. Users were ill-served in the last decade when the accountants' effort to introduce an "explanation of cross-border differences" in the Asian markets was bluffed off the table by hostile regulators in Japan and Thailand.

•    The auditors could refuse to perform the lucrative but unmanageably risky reports on internal corporate controls required under Section 404 of the Sarbanes-Oxley law. As the engineering profession has known forever, any system designed for human operation has a non-zero likelihood of significant failure. So as a percentage of public companies have revealed horrific control breakdowns, the liability cost of Section 404 is yet to be reckoned.

•    Financial reporting could explicitly recognize the uncertainty of management estimates and expectations. The auditor's report could catalogue the areas that rely -- fallibly -- on the models, plans, probity and credibility of management: examples include the future performance of exotic financial instruments or loan portfolios, the recoverability of research expenses out of new-product success, or the achievement of post-merger cost reductions.

•    The auditor's report could draw an explicit line of materiality beneath which there is neither examination, evaluation nor auditor comfort. Although the audit sampling process cannot realistically go below some quantified level, whether in absolute or percentage terms, investors today are left in the dark as to what that is.

Regulator opposition to any of these would be expected - and rule changes would be required. But while the regulators have their place in professional oversight, it is past time for the firms to reclaim some turf. It makes no more sense that setting standards for the technically demanding processes of audit and financial reporting should be dominated by the political agendas of amateurs - however intelligent or well-meaning - than it would for the performance of cardiac surgeons or airline pilots.

It is the large firms, after all, who actually execute the large and risky audits. It is for them to force change in today’s hostile regulatory environment, and their failure to control the dialogue leaves them on the wrong end of the ongoing antagonism.

Unfortunately, the large firms have consumed their energy in the Sisyphean failure to attain liability limitations. Relieved of that limited strategic vision, they would see such timorous proposals as in the US Treasury Committee’s draft report – here – as popguns and peashooters against real tanks and artillery.

But like the chronic victims of the schoolyard, the large firms need the courage to stand up. Their franchise to provide large-company assurance is ever nearer to collapse -- so even if there is a little blood on the ground and some whining from the bullies, that is the requirement for their survival.  

These issues are important, and the dialogue is not well engaged. I encourage you to send your comments – and to share this address with your friends and colleagues – and if not a subscriber, to sign up at the Home page, where it is easy, free and non-commercial.

Accounting Standards Convergence -- Sometimes the Bear Eats You

For months now the trans-Atlantic regulators have kept up a complex choreography, hoping to converge the global standards for accounting, reporting and auditing corporate financial information.

It’s like watching a carnival performance of dancing bears – notable not that they’re so slow and clumsy, but that they dance at all.

The publicity machinery has been cranking:

First was the US Securities and Exchange Commission, announcing in November – here -- that it would start to accept the financial statements of non-US companies, as prepared in accordance with International Financial Reporting Standards – widely used around the world except in the US – only now without the reconciliation to US standards that has been so costly, disruptive and questionably useful.

Next followed EU internal markets commissioner Charlie McGreevy – here -- with a symmetrical plan for American companies to list in Europe using accounting principles generally acceptable in their home country – good old familiar US GAAP.

Third was the December 5 announcement by the US Public Company Accounting Oversight Board – here -- that starting in 2009, its inspections of non-US audit firms would move toward fuller reliance on the inspection and enforcement regimes of that agency’s counterparts in other countries.

And lately, inputs from the US Chamber of Commerce – here – to the SEC’s Advisory Committee – here -- have been extolling the necessity of integrated global standards and principles.   

A theme played for years, the case for convergence has stayed consistent -- that the use of common standards promotes strong globalized capital markets, supports investor comprehension and confidence, and fuels economic growth.

But the background has changed since the time the Americans were calling the tune: When convergence was first seriously sounded, corporate listings were migrating to the New York Stock Exchange, the Euro-to-be was predicted to be a regional form of play money, and the extensible hegemony of accounting principles as issued in the US was taken for granted. Little wonder the Europeans were mostly unenthusiastic wallflowers at the party.

And then? Still shadowed by the darkening gloom of the Enron era, the American-led scandals around executive options and subprime mortgages have showed the limits on its capacity for regulatory detection and deterrence. London became the center of the IPO market, and the Euro is hovering around $1.55.

Europe ascendant has had its mis-steps, of course. The French-led opposition to unqualified EU endorsement of the standards for derivatives accounting showed the survival of its parochial difficulties.

And although the subprime contagion started in and primarily affects American markets and institutions, it extends from the regional German banks to the funding of villages in northern Norway, while the Bank of England stubbed a toe against the collapsed mortgage lender Northern Rock and UBS showed the storied competence of Swiss bankers to be as holed as its cheese.

Back in the USA, while the London bankers merrily stole the lunch of their New York counterparts, the SEC’s readiness to accept IFRS-based financial statements – half a decade after Sarbanes-Oxley -- now rings as an effort to protect against market-share erosion. And fair-value accounting has become the target of choice for blame-shifting to evade the dysfunctions of the bankers’ black-box valuation models.   

At the same time, the PCAOB’s readiness to “increase its level of reliance on non-US oversight systems” needs to be translated out of agency obfuscation into real English. If so, a candid statement from Chairman Mark Olson would read like this:

    "Since 2002 we haven’t made a dent in achieving the legislatively-imposed mandate to inspect and oversee the 800 non-US audit firms forced by the law to register with us. We will never solve the foreign law prohibitions or find the competent resources to do this ourselves. We have no realistic choice but to devolve our responsibility over to the authorities of 86 other countries, although they mostly have neither real track records of success nor the resources to get there. Whether any progress is actually made or even measurable will not be known for many more years to come."         

Meanwhile, taking a look at the PCAOB’s record at home, Sarbanes-Oxley has neither restored virtue to financial reporting nor unsprung the auditors from the limits on their performance:

•    The subprime-triggered chaos across the capital markets originated with and is traceable to the confessed failure of the players to understand, value, control, account for or report on entire balance sheets full of complex financial instruments. What leadership role does an audit regulator deserve, having sat that one out?

•    The academics’ confident proclamations of a year ago, that the level of US securities class action litigation was enjoying a structural reduction, now yields to the reality: case filings are back up to Enron-era levels, with the very large and rapidly-expanding group of subprime-based cases still comprising only a fraction.

So let’s wait a bit to evaluate the extent and effect of whatever convergence may actually be achieved within our lifetime.

Or, to invoke the ursine advice of the 17th century French fabulist La Fontaine, “don’t sell the bearskin until you’ve killed the bear.”

What the Wine Sellers Buy -- A Metaphor for Understanding Subprime

The credit crunch spreads – from tapped-out holders of adjustable-rate mortgages, to specialty insurers desperate to preserve their ratings, to the leaders of Citigroup and Merrill Lynch on begging-bowl fundraisers in Asia and the Middle East, to a swell of big-number litigation enough to enrich the lawyers world-wide.

And as spring foretells the release of the finest French wines, my wine-collecting friend in Paris confronts a crunch of his own. 

He prefers his tangible cellar of fine vintages over a portfolio of financial derivatives. But he has learned that – as with countless investors ranging from holders of the Bear Stearns subprime funds to pension funds and village treasurers and any number of other yield-chasing funds and institutions -- he has an uncomprehended and volatile commodities market exposure.

Like the small investors who clamored to share the sexy returns of the hedge funds, my friend ventured beyond his retail wine shop. Going to an internet wine vendor in 2006, he bought a quantity of a fine Bordeaux 2005, then being offered en primeur – that is, an advance sale just after the harvest but two years before the wine would be ready for retail sale.

In simpler times, the wine makers would sell perhaps half of their production en primeur – only to sophisticated professionals – in a direct form of forward contracting that both financed inventory and mitigated price volatility.

But the en primeur market then became open to individual players. Buyers of the 2005 vintage made the leap of faith that as this wine is even now being released for delivery, they will actually receive the specific wine contracted for, rather than some poorly made or inferior substitute.

Additionally, though, my friend faces a huge market exposure.

Namely, the vendor – who is said to have made some € 10 million of advance sales – is now exposed as were Bear Stearns or Merrill or Citi, who had sold highly-leveraged investments in hard-to-price slices of the subprime mortgage sector. Instead of locking in a contract with the vineyard for the necessary physical supply, at the time it took its customers’ deposits, the vendor reportedly chose to wait and play the fluctuating secondary market.

That is, like the bankers who sold the mortgage-based derivatives on the assumption that ever-rising housing prices would bail out all the dodgy mortgages, the wine-seller assumed an ability to cover its needs at delivery time, perhaps even hoping that a soft market might give it a windfall.

Here arises the problem of unexpected risk and uncontrollable price volatility in an underlying commodity. Holders of subprime paper were whacked by collapsing real estate values, unpredicted under their black-box pricing models. Just as with killing frost in the orange groves or warfare in the oil fields – serious re-pricing has hit the wines of 2005. With the publicists touting 2005 as a vintage for the century, the entire Bordeaux market took a major upward spike. Prices for my friend’s particular wine are up over 60%, and the very top wines have shot up 300% in less than a year.

Again as with the subprime sector, my friend has learned to his bewilderment that he is in an unraveling commodity hedging operation -- the vendor’s naked delivery problem being piled onto a whole structure of risks.

At a simple level, the vendor generated two years of float for itself, by immediately cashing its customers’ checks. And although dealing frequently with Anglo customers investing dollars and pounds, the vendor could easily hedge any currency fluctuation exposure.

But like Bear Stearns or New Century Financial or Northern Rock or UBS today – or others in recent memory such as Long Term Capital Management or Amaranth – the wine vendor is hostage to externally-delivered pricing shocks.

With the vendor facing a massive and expanding loss, my friend has the entirely legitimate anxiety that when the time comes, it may be unwilling or unable to deliver.

While he waits, it has been brought home – for both the bankers’ one-time valuation geniuses and their management who blithely assured that their controls were all in good Sarbanes/Oxley order -- that market reality has a stubborn unwillingness to behave according to unprovable mathematical models. And there is a lesson for central bankers: one-time bailouts have a terrible tendency to be under-calculated, insufficient, and fraught with unintended consequences.

Time will tell. Come this summer, while the Bordelaise prepare to press the grapes of 2008, my friend may be preparing to press his legal rights.   

Meanwhile, shareholders and investors in subprime funds have enlisted their lawyers to assess whether their glasses are half-full, half-empty or only holding the bitter dregs.

Société Générale’s 2007 Annual Report – Jérôme Kerviel Is So Last Year

The recurring claim of French exceptionalism got a big boost early this month – at a price. Société Générale asserted that the only fair way to report its loss of € 4.9 billion, inflicted in January by junior trader Jérôme Kerviel, was as an event occurring in 2007.

Deep down in footnote 40 of SocGen’s massive annual report – to get the English version -- here – ou bien la VO Française ici – the bank discloses that Kerviel was in a net positive position of € 1.471 billion as of the end of 2007. His blow-up came on January 18, and the unwinding losses in the following days came to an eventual € 6.382 billion.

Over-riding the compelling guidance of the International Accounting Standards Board, that would book the effects of Kerviel’s mischief as they fell, would be rare enough under the UK’s high-level “true and fair view” rubric, much less under the American guidance of “present fairly in accordance with generally accepted accounting principles.”

But that didn’t stop the French bank – supported by its national banking and securities market supervisors, as well as the two Big Four accounting firms -- Ernst & Young and Deloitte & Touche -- who share responsibility for its audit.

There is at least behavioral history on the French side: for years the European practice of booking the effect of deliberate errors in the year of discovery rather than in the year of perpetration has avoided the litigation hazard of the American requirement to re-state erroneous financial statements for prior years.

And on the recent and highly political side, the French have been vocal and steadfast in resisting the international standard for marking financial derivatives to market – the infamous IAS 39 – arguing the difficulty of valuation models other than historical cost but also conveniently retaining the flexibility of corporate management to time their recording of results to suit their discretion.

SocGen’s tone-deaf approach starts with its footnote description of Kerviel’s trading “plain vanilla” financial instruments – a colloquialism lacking both a usable French translation and a common understanding in the industry. Nor is there any positive spin to the term, since the more ordinary Kerviel’s scope and job description, presumably the more effective SocGen’s oversight and control of his desk should have been.

As I am told by the technical accountancy wonks, SocGen may – just barely – have a straight-faced justification, that its year-end balance sheet should reflect the € 4.9 billion body blow that struck only three weeks later.

Fair enough, on a casual first glance. But the argument for evading a well-known body of international standards, under an exception so obscure and elastic that prior examples are virtually unknown, fails on three grounds – technical, strategic and political.

First, on the technical side. Moving around Kerviel’s impact cannot lessen its prominence or significance. As a post-closing event it is comprehensively discussed for three pages in the SocGen report. A pro forma balance sheet presentation right there would do as much for disclosure as the roll-back could.   

Even if it can be done, in other words, doesn’t mean that it should be.

Strategically, then, what’s the point? The known facts are so notorious that no one will be diverted or misled. Whether CEO Daniel Bouton survives – whether the bank itself survives – or how much the bank will ultimately pay out to the shareholders who are now at the courthouses with claims that the bank was running a “culture of risk” – none of these will be affected by the choice of years. So if SocGen can achieve no good for itself, what constructive purpose could there be in adopting a lightning-rod position?

And politically, the bank has succeeded only in setting back the global arguments for international accounting convergence, harmonization and improvement. If a “fair reporting” excuse can be made for Kerviel, there is no intellectually defensible line-drawing guidance by which investors can anticipate where the next similar exception will be invoked.

The size of the event can’t be a factor. A knock of € 4.9 billion is big, to be sure, but consistency in the reporting of small things is of little use if it’s the really worrisome big problems that qualify for revision and exception.

And with a French tradition to favor management’s opportunity to manage the timing of bad news, agreed by the supporting players, predictability of reporting at the global level is out the window.

So vive la difference – but let it be kept to matters of local impact only. 

Accounting and Audit Judgments -- Please, No More Standards!

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.

Accounting for Subprime -- Scoring the Scorekeepers

This audit season the skeletons just refuse to stay in the closets. Latest this month, but far from last, are AIG’s $4 billion loss estimate increase and Credit Suisse’s $2.85 billion write-down in its asset-backed securities.

Both examples read directly on a question put by a friend and regular reader -- a business school professor in Paris: “How much of the subprime thing is related to the accounting?”

Not that she needs my help with a lesson outline for her MBA students. But having been a guest in her classroom, I’m happy to offer. If I were teaching her class, I’d get there in three steps:

At the level of human behavior, subprime in its origins was first about the disconnect between incentives and risks: the mortgage originators took their fees immediately, but repackaged and laid off the future stream of payment obligations. Then the bankers, abetted by the ratings agencies, gamed the credit rating system by pushing untestable valuation models onto their credulous customers.

Second, as after-effect, subprime is now about legal responsibility. With the filing of new investor lawsuits back to Enron-era levels (for which, see the helpful running count being kept by the D&O Diary,here ),  the roster of defendants includes not only the banks and mortgage companies, but also the three dominant credit rating agencies and, at last count, three of the Big Four accounting firms.

But third, with the global harm extending from villages in the Norwegian Arctic to counties in rural Florida to bush hamlets in Australia, we should go back to basics: accounting principles and methods for the recording and reporting of transactions are as old and pervasive as trade itself.

As soon as commerce moved beyond one-to-one barter, conventions were required to quantify such inherently judgmental issues as the hazard of re-payment in future periods, the time value of money to change hands at a later time, or the transfer of performance to a third-party.

So viewed, subprime and the credit market turmoil are all about the accounting, and nothing else. Fundamentally flawed assessments were made – whether out of venality or ignorance – about the quantification, timing and transferability of the risks associated with uniquely complex financial derivatives, and the collapse in their values as knowledge and experience eventually caught up.

So the accounting for mortgage-based assets and their off-spring should be seen as a proxy for the reckoning of financial reality in all aspects:

For a family buying its first home with an adjustable-rate mortgage, the expense entry for housing cost changes from rent to mortgage payment. Its balance sheet now has an asset, the house, with the associated mortgage debt as a liability. When a depressed housing market erodes any equity, and the payment escalates beyond the family’s means, the accounting confirms the reality – red ink and foreclosure.

An investment bank that sponsored and sold exotic tranches of financial products now has the task of re-assuming them back onto its balance sheet and marking their value to a collapsing market rather than a discredited black-box model, which means filling the accounting holes. Costly new rescue capital, opportunistically supplied to the likes of Citi and Merrill, Northern Rock and the monoline insurers, may provide a lifeline but dilutes or even destroys the prior shareholders.

As for investors – whether an individual shareholder of the banks or a pension or retirement fund that bought the exotic products – their losses may not yet be realized for accounting purposes, unless they have sold out the positions, but they can plainly feel the real-world loss of wealth, and unsurprisingly are taking advice from the plaintiffs’ lawyers.

As shown already by AIG and Credit Suisse, the accounting challenges pinpointed by the professor are fraught both for the financial institutions and also for any investor who heard the siren song of higher rates and traded off for unknown future risks.

That’s because the more candor and rigor are brought to this year’s audit process, the more stark will be the ultimate concession that the valuation models on which subprime was built were creatures of myth and unreality. And therein lies a ghastly liability implication -- that the well-controlled and smoothly operating systems required under Section 404 of the looming Sarbanes-Oxley law simply weren’t there.

In the end, to wrap up for the good professor’s class, the quality of accounting is an effect, not a cause – the level of its virtue and integrity is observable in a mirror held up to commercial society.

Or as first put in the early 1970’s by cartoonist Walt Kelly’s swamp philosopher, Pogo the possum, “We have met the enemy, and he is us.”   

Blackstone's Pre-IPO Accounting

Hindsight is so wonderful. A week after this column ran in the IHT, Blackstone pulled back from the proposed accounting treatment discussed here. In the circumstances it would be a shame to go back and re-edit the verb tenses.

It also brought its offering at $31, into the teeth of the subprime mortgage meltdown, and saw its price sag immediately below $22. For the company’s principals whose net worth expansion is measured in units with capital “B’”, little sympathy is indicated.

Private Equity Discovers the Value of Myth

Originally published in the International Herald Tribune on May 25, 2007

A timeless but troubling story lurks in the plans of Blackstone Group, the private equity giant, to raise $4 billion through an initial public offering.

Blackstone proposes, through the use of options accounting, to book as immediate profits the gains it estimates that will presumably be made once its transactions are ultimately wound up. In other words, as soon as it goes into a deal, Blackstone's 20 percent carried interest - that great profit engine of private equity - will be valued like a salable financial instrument, and recorded as an asset.

Noncash profits today, in eager anticipation of an undated and uncertain but rosy future, and investors - including the Chinese government - lining up to hurl their funds at the prospects. Sound familiar? Has everyone forgotten Enron, the creative energy trader that crashed, or the academics' darling among the trading models that flamed out, Long-Term Capital Management?

Generations ago, the investment maxim on Wall Street was "buy on the rumor, sell on the news." The lore in the bubble years of the 1990s then became, "Buy on the fantasy." All too often, the result was "hold till the debacle."

The lesson seems irresistible: The origins of the next wave of corporate misadventures will be a new set of compelling stories. After all, we have been eager to devour simplistic myths and fables ever since our ancestors gathered around the fires in front of their caves, to listen to tales spun by those hailed, rightly or wrongly, as the wisest men in the tribe.

Here's an example: Because I dislike shopping, I look increasingly to catalogs. One features clothing and accessories no different in quality or cost from a number of others, but its goods are promoted in seductive little vignettes that locate the wares in such modestly exotic locations as Mumbai, Portofino or West Egg. That's good enough for me.

Consumers willingly buy into a good story. Brands of premium ice creams are all as alike as Tolstoy's happy families, but think of the success of Häagen-Dazs - a word concocted from no known human language, but evocative of Danish quality. And think of two unknown guys from Vermont, Messrs Cohen and Greenfield - mythicized as Ben and Jerry.

We buy look-alike vehicles, by reference to wilderness spots those vehicles will never visit - Denali, Sierra, Tahoe, Kodiak. Again, why? Imagine a marketer trying to sell a 4x4 branded for its real venues - a Chevrolet Strip Mall, a Subaru Speed Bump, or that new luxury offering, the Cadillac Cul-de-Sac.

Financial products and services are subject to the same power of myth. The meltdown this year in the subprime mortgage-backed securities market destroyed a bubble built from two stories: first, that ever-increasing housing prices would forestall a reckoning for credulous but unqualified home buyers, and second, that the inverse relationship between bond coupon and default risk had somehow been suspended for equally credulous investors.

Neither proved true, but the crash in this industry segment has failed to dampen the appetite of a myth-driven market. No less a tale-spinner than Warren Buffett has warned of unsustainable returns for alternative investments. But, depressingly, it appears that the only information commanding attention is that conveyed in stories worthy of re-telling around the modern version of the prehistoric campfire.

So today, the story of Blackstone's IPO overrides two antagonistic realities: that the private equity funds are awash in the cash of ever-smaller investors, even while chasing deals that are bigger and richer but doomed to deterioration in quality and results.

Blackstone's circular approach to its profit picture - booking profits today based on a collective blind vote of confidence on a future bet, as a proxy for real results down the road - not only echoes the immediate past of Enron and LTCM. The same approach came to grief in the late 1960s for the investors in Bernie Cornfeld's Swiss-based Fund of Funds, which did the same in a wild bet on deep oil in the Canadian Arctic.

But memories are short, and if the stories are timeless, so are the failures to learn from the past.