By Joseph Neu
The August 24 announcement that FASB Chairman Robert Herz is retiring in October, 21 months before his term expires, has sparked renewed speculation on the fate of fair value accounting and international convergence. Helping to fuel this speculation is the fact that the Financial Accounting Foundation (FAF), the FASB’s governing body, announced concurrent with Herz’s retirement that it was returning to a seven-member board format. The FASB operated with a seven member board until 2008, when the FAF decided to shrink the number to five. In both instances the move was cited as a means to aid international convergence.
According to the Accounting Onion, a blog on financial reporting, the international convergence aim now goes hand-in-hand with an effort to bend accounting back in the direction of historical cost, which the IASB has been more inclined to do of late. In this context, Mr. Herz’s retirement coupled with an expansion of the FASB board would allow the FAF to appoint enough new board members to tip it back toward the IASB—just like a typical internationalist conspiracy.
Beyond Conspiracies
Looking past conspiracies, Mr. Herz’s retirement will indeed impact future accounting standards, beginning with the proposed guidance on financial instruments and hedge accounting that will no longer have his imprint when it takes final form. Issued in May, the exposure draft is open to comment until September 30. Few firms that use financial instruments actively in their businesses are pleased with moving further in the direction of fair value now, as the ED proposes.
While Mr. Herz has been a strong proponent of fair value accounting and a principles-based approach, he has shown sympathy to those who correctly point out the practical limitations. And, contrary to many FASB critics, Mr. Herz does know something about the perspective of practitioners, including treasurers. We saw this first-hand when he served as a founding member of our advisory board from 1994 through 1999. Where he has not shown much sympathy is toward those who attempt to use the practical limitations (see “The Physics of Fair Value,” May 2008) as an excuse not to simplify financial reporting around core tenets.
Mr. Herz understood from the start that his tenure at the FASB would be challenged by the core tension in accounting standard-setting between establishing code-of-conduct type principles and bright-line rules.
“We could possibly develop some overarching principles which contain less escape hatches, to improve the understandability of the system and cut down on the ability to game it,” he said in an interview with International Treasurer at the time (see “Bob Herz: FASB, The New Frontier,” July 2002). But he also outlined an important caveat: “People who want to skirt the system can do it, principles or not. That’s fraud, and it is not our business to try and catch that.”
Bearing in mind that Mr. Herz became FASB chairman in the wake of the accounting scandals that led to SOX, it is an important lesson for the latest crisis: Accounting standards are not a replacement for good corporate citizens and regulatory enforcement. Thus the significance of Mr. Herz’s call for bank regulators to use something other than GAAP to measure regulatory capital in response to banker criticism of fair value.
A lack of resolve on regulatory enforcement may be why the US cannot wean itself from rules-based accounting. And international accounting even less so: “Enforcement is how you uncover the scandals. We [the US} detect more of them, and sooner. Overseas, they don’t turn as many rocks as we do,” as Mr. Herz also noted in 2002.
A failed Moon Shot?
When he joined the FASB, Mr. Herz said he thought of JFK’s Man on the Moon speech: “We choose to go to the moon in this decade and do the other things, not because they are easy, but because they are hard… because that challenge is one that we are willing to accept, one we are unwilling to postpone, and one which we intend to win…”
In the end, Mr. Herz may not have reached the moon, but he did ably defend the mission; i.e., pushing accounting standards away from serving those inclined to use them in earnings and balance sheet manipulation and toward fair principles, while also preserving the FASB’s independence. Not a bad legacy. And if you believe in conspiracy theories, you could argue that no one ever really made it to the moon anyway.