Make All Voices Count in Debates on Accounting

Among the most enjoyable parts of the six years I spent at the Securities and Exchange Commission were the intelligent discussions on how to resolve difficult financial reporting issues. Although many people think of accounting as a boring profession with little conflict, those of us in the profession know that important issues almost always result in mixed views. Good debates on these issues repeatedly have resulted in better reporting, whether the topic is one company’s accounting for one transaction, what principles should be embedded in a new accounting standard, or how to revise SEC rules and regulations.

Amongst the least enjoyable parts of the six years I spent at the SEC were the discussions and debates that devolved into finger pointing and accusations. Rather than just argue the issues, it seems we sometimes feel the need to denigrate those who disagree with us—the equivalent of negative campaigning, I guess. Instead of accepting that smart professionals could, in good faith, simply have different ideas about what will work best, we decide that those with different views are liars, willing to cheat the system or sacrifice integrity for their own benefit. Or perhaps they are power hungry, and care more about winning than what is right. Or, when we’re feeling more generous, that they just aren’t smart enough to be in the debate.

Jumping to conclusions about the motives or qualifications of those with different views is an excellent way to forestall potentially useful discussion, and to polarize positions even further. Unfortunately, I’ve seen it repeatedly over the past few years, and the frequency seems to be increasing. Read on, and you’ll probably see at least one situation that rings familiar.

You and Your Auditors

I hear preparers explain their auditors’ actions all the time as if the auditors are motivated by something other than just trying to do a good audit. “They’re just trying to run up fees” and “they’re only concerned about protecting themselves, not about our accounting” are common claims. A popular fallback: “They just don’t understand the business.”

I’ve found it to be far more common that the auditor has developed a reasonable concern about whether the accounting is appropriate. Unfortunately, management’s initial frustration, fueled by the assumption of conflicting motives, often leads to a strained relationship that doesn’t do the company any good.

Investors and the SEC

In the fall of 2006, the SEC overhauled executive compensation reporting requirements. In the initial package, the fair value of stock options was required to be included in the Summary Compensation Table when granted, but a late December update changed things so that the value would be reflected over the vesting period. Many investor-advocates believed the SEC had caved to pressure from issuers and announced the change in late December in the hopes investors wouldn’t notice.

As sure as they were about the SEC’s motives, they were wrong. Many of us had believed all along that option value should be reflected over time, consistent with the financial statement expense, particularly because the fair value of options was already reported based on the grant date in another table. The commissioners didn’t come around to that view until after the rules were published. By that time, late December was as fast as the fix could be processed.

The change was nothing more than a technical amendment to align compensation reporting with accounting. But many believed that the SEC was not appropriately concerned with investor interests, and therefore saw evil motivations that in fact weren’t really there. Their reaction was not helpful in future meetings and discussions.

Issuers and the SEC Staff

Have you ever thought that the SEC staffer writing a comment letter about your financial filings has it in for you? That you must have unfairly landed on a SEC blacklist of troublemakers, because that could be the only explanation for the harsh treatment you were receiving? Or have you found yourself thinking that the SEC staffers are arrogant or uninformed when they refuse to acknowledge the reasonableness of your conclusions?

The next time you find yourself jumping to the conclusion that the other side of the debate is populated by fools or liars, remember that they think the same thing of you.

In virtually all cases, this is wrong. Even if you don’t see it, the SEC staff has come to its views in good faith, and is not just out for a pound of flesh. I promise that your discussions with them will be more productive if you assume they are acting in good faith.

Of course, many would point out that the SEC staff is guilty of assuming the worst about issuers in some instances. If fair-value estimates are higher than the staff believes proper, the company was hiding losses; if the estimates are lower, the company was taking a big bath so that future periods would look better. If an error was made, it must have been intentional rather than an honest mistake. And if requested information isn’t quickly available, it must be because the company is trying to hide something. Even when I know there was no evil intent, convincing the SEC staff sometimes seems like an impossible task. At best, it results in wasted time chasing down unimportant issues.

FASB

One reason these negative debates worry me so much is that the Financial Accounting Standards Board has just issued a number of important proposals, and I am concerned that the attempt to reach reasonable solutions will be hindered by distrust and disrespect.

For example, FASB’s proposal to require expanded disclosure of loss contingencies is unpopular with issuers, lawyers, and many others. Some believe FASB is trying to destroy attorney-client privilege. Others say FASB doesn’t care if its proposals will cripple companies’ ability to defend lawsuits. Even those who say that FASB’s goal is noble also argue that because disclosures can’t help win the case and could possibly hurt, the project must be dropped.

The thinking seems to be that the possibility of harm to a company’s position in litigation outweighs investor concerns—that investor concerns should be considered a secondary priority here, even if information for investors is the whole point of financial reporting in the first place. On the other side, some suggest that companies just want to keep bad news from the market, and are using the possibility of harm to their case as a smokescreen to hide behind.

The truth is that investors are understandably dissatisfied with the disclosures they have been getting on contingencies and that companies have genuine concerns about impairing their defenses, and FASB has been working to find a way to improve disclosures with as little effect on litigation proceedings as possible. Its efforts would have a better chance at succeeding if there weren’t so much distrust and claims that the other side’s views are unimportant or irrelevant.

I’m more concerned about what will happen as FASB attempts to reach a solution on accounting for financial instruments. The prospects of a healthy debate are looking shaky already. I’ve read comments that suggest that anybody opposed to more use of fair value is just trying to help companies lie. Other constituents have sent FASB some pretty inflammatory comments, including several that question the Board’s intelligence and one which calls FASB Chairman Bob Herz an embarrassment to the human species.

Of course, the Board itself is somewhat bitterly divided, just as it has been throughout the years on the topic of fair value. The current proposal was passed by only a 3-2 margin. It is widely believed that the swing vote was outgoing FASB Chairman Bob Herz, one of the few people I’ve seen over the years who consistently resisted the temptation to assume the other guys were motivated by the wrong goals. I don’t know what precipitated his resignation (announced in August), but it certainly wouldn’t surprise me if he were tired of the lack of civility that so many participants in the standard-setting process have exhibited.

Can’t We All Just Get Along

My point, of course, is that we shouldn’t be so sure that the people we debate lack integrity or intelligence. Going in with that assumption always hinders the discussion, and in my experience it usually turns out to be an unwarranted assumption.

The next time you find yourself jumping to the conclusion that the other side of the debate is populated by fools or liars, remember that they think the same thing of you. And just as you know that your conclusions are based on due consideration, professional analysis, and experience, they know that their conclusions are similarly grounded in logic and intelligence. If we give each other the benefit of the doubt, maybe we can get to acceptable solutions quicker and with a little less pain.