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Last Thursday, SEC Chair Chris Cox delivered a speech on the future of IFRS – including a public policy oversight body that would oversee the IASB trustees (the speech notes that the IASC Foundation will consider a new monitor as part of its ’08 Constitution review). This is an important topic that I could literally blog about every day. But, to be honest, I’m not following it as closely as I probably should because I’m only human and there are still so many other developments to cover.

From reading comment letters, etc., I understand one considerable concern is the lack of a strong IFRS enforcement mechanism. The amazing circumstances of the fraud at Société Générale are often held up to illustrate the point of how easy it is for a company to break international accounting rules, get away with it, have its independent auditors bless it, with no major regulatory ramifications (read this Floyd Norris column and an Accounting Onion blog for more). Also held up is the fact that the IASB standards have not been enforced in the past. Finally, there have been concerns raised about how the FAF recently has managed the FASB.

So there are these – and many other – issues to deal with, but it’s clear that the globalization of accounting standards is something that is inevitable. We just need strong regulators – and ones that work together. This will be quite a feat to pull off since there are many cultural obstacles and regulatory differences among jurisdictions. But it is happening – here is a February statement from IOSCO urging companies to clarify which accounting standards they use. IOSCO is the organization whose members are comprised of securities regulators from around the world and who will be a key player in this movement.

Is IFRS Compatible with US-Style Corporate Governance?

This blog below from Tom Selling’s “The Accounting Onion” is several months old, but still interesting and relevant reading:

I just finished reading a brief, highly readable and interesting article by a Columbia Law School professor, John C. Coffee, Jr., entitled “A Theory of Corporate Scandals: Why the U.S. and Europe Differ.” The purpose of this post is to piggyback on his framework to also provide an explanation for the difference in basic approaches between U.S. GAAP and IFRS; and most importantly, why political pressure to trash U.S. GAAP and adopt IFRS should be resisted.

How and Why, According to Coffee, U.S. and European Scandals Differ

Coffee’s thesis is that corporate governance of majority-owned corporations (predominant in Europe) should be fundamentally different than corporate governance of corporations that lack a controlling shareholder group (predominant in the U.S.). It’s not necessarily because there are fewer incentives to rip off other shareholders, but the feasible means to do so will differ.

Scandals in Europe involving majority-owned corporations usually do not feature an accounting manipulation. First, financial reporting is less important to the majority owners because they rarely sell shares; and if they do, they usually receive a control premium that is uncorrelated with recent earnings (and generally larger than control premia in U.S. transactions). Second, fraud is more easily accomplished by misappropriation of the private benefits of control: authorization of related-party transactions at advantageous prices, below-market tender offers, are prime examples. Any trading that takes place between minority owners has less to do with recent earnings reports, and more to do with an assessment of how minority shareholders will be treated by controlling interests.

In dispersed-ownership corporations, managers do not possess private benefits of control. Moreover, a significant portion of manager’s compensation may be in the form of stock options or other forms of equity. Therefore, stock price can have a significant effect on a manager’s compensation, providing them with strong incentives to manipulate accounting earnings.

The Implications for Accounting

Professor Coffee’s thesis is that differences in ownership patterns have important implications for the selection of gatekeepers: auditors, analysts, independent directors, etc. His observations and recommendations are interesting, but I want to advance a related thesis, namely that different ownership patterns call for different types of accounting regimes.

It stands to reason that accounting should be difficult to manipulate, if it can be used to rip off shareholders. Thus, the evolution of U.S. GAAP can be seen as a response to the need for specific rules that minimized the role of management judgment because of their strong self-interest in the reported earnings and financial position. This has occurred in part because U.S. gatekeepers have shown themselves to often lack sufficient resolve or power to prevent management from under-reserving, overvaluing, or just plain ole making up numbers. U.S. managers effectively control the “independent” directors and auditors; and prior to Regulation FD, analysts bartered glowing assessment in exchange for tidbits inside information. Without empowered gatekeepers to prevent accounting fraud, we have had to place our hopes on very inflexible accounting rules, and sheriffs like the SEC and private attorneys to catch the cases where management has attempted to surreptitiously cross the bright line.

Thus, it should be self-evident that IFRS-style accounting, replete with gray areas, would be a gift to U.S. managers. Outright fraud would be replaced by more subtle means of “earnings management,” rendering the SEC and private attorneys much less potent. Is it any wonder why U.S. corporations and their auditors are practically begging to have IFRS available to them?

In short, it would be a grave mistake to adopt IFRS in the U.S. simply because it seems to work well elsewhere. As corporate ownership patterns in Europe change, it may well be that IFRS may evolve to look more like U.S. GAAP. Only after that occurs may it make more sense to have a single worldwide financial reporting regime.

Imagine if Enron Had Applied IFRS

One of the scapegoats of the Enron scandal was “rules-based” U.S. GAAP. The libel was that Andrew Fastow was a mad genius, capable of walking an accounting tightrope by creating complex special-purpose entities (SPEs). But, GAAP wasn’t the culprit in the Enron scandal. Frustrated Fastow was only able to get the accounting treatment he needed past the auditors by hiding from them side agreements that unwound critical provisions requiring the new investors to have a sufficient amount of capital at risk in the SPEs.

The enduring legacy of the libel is the erroneous conventional wisdom that GAAP is responsible for Enron; and what’s more, Enron et. al. might not have happened if our financial reporting system were more like IFRS. More likely, if IFRS had been the basis of accounting for Enron instead of GAAP, it might have taken longer to discover the fraud, or to pin the blame for the fraud where it belonged.

Neither GAAP nor IFRS are principles-based, but GAAP certainly has more rules and bright lines. At least there seems to be some method to the madness, but it would be nice if more of the rules were based on sound principles.

Peggy Foran: Moving On Up

Congrats to my good friend Peggy Foran, who is leaving Pfizer after a long stint to become General Counsel of Sara Lee (here is the press release). At Sara Lee, Peggy will be surrounded by friends – including Helen Kaminski, who will be speaking at our upcoming webcast: “E-Proxy’s First Season: Lessons Learned.”

As many of you know, Peggy is one of the most prolific persons in our profession. Besides being a very kind soul, Peggy has an incredible background, having worked a number of interesting jobs over the course of her long career. One of the reasons why Peggy is so knowledgeable is that she is a tireless networker. Being an avid networker myself, I am amazed at how much more Peggy is able to do – and Peggy uses her network, always asking probing questions to become even better at what she does. Now that Peggy is entering the executive suite, I hope we haven’t seen the last of her at the many events that she graces today!

– Broc Romanek