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The SEC flexes its muscles in response to a power play.

The Future of Private Sector
Standard Setting

An Interview with Arthur R. Wyatt
By James L. Craig, Jr.

The FEI recommended changes to the way FASB sets accounting standards. The SEC reacted by making suggestions of its own--more "public interest" trustees on the Financial Accounting Foundation, the parent organization of FASB. Arthur Wyatt, a former FASB member and retired partner from a large accounting firm, looks behind these events and gives his thoughts as to what actually happened and what the long-term effect is likely to be.

Arthur Wyatt, as past chairman of the International Accounting Standards Committee, past member of the FASB, and past member and chair of the AICPA's Accounting Standards Executive Committee, is a strong proponent and champion of private sector standard setting. Retired from Arthur Andersen LLP and teaching at the University of Illinois, he continues to be a thoughtful observer and sometimes outspoken critic of developments in the profession. He strongly believes accounting principles should be just that--broad concepts of general applicability, not detailed rules to be followed in cookbook detail. The SEC has just enlisted him as a consultant on international accounting standards matters.

Managing editor James Craig traveled to the campus of the University of Illinois in Champaign-Urbana to discuss the recent actions of the SEC and apparent settlement over the makeup and appointment of the Financial Accounting Foundation (see the accompanying sidebar for

The CPA Journal: What is your view of what happened? Why all of a sudden did the SEC want to stick its nose into the makeup of the Financial Accounting Foundation? The FAF is not a standard setter.

Arthur Wyatt. To understand what happened, we have to go back and look at the events leading to the establishment of the FASB and related organizations. Those events beginning in the 1970s were driven by a number of concerns over the performance of the Accounting Principles Board--among them concerns about the independence of its members (almost all were partners in CPA firms) from their clients, concerns that as a part-time volunteer group it wasn't devoting the time and energy the job required, concerns about inadequate research and staff resources, and concerns that, in general, its performance was beginning to deteriorate.

A blue-ribbon committee was established to develop a whole new structure for standard setting. It came up with a scheme that would provide input from all interested parties, but have a number of checks and balances so that no one group could unduly influence the process. The board of trustees of the Financial Accounting Foundation was to be comprised of representatives of industry, public accounting, academia, and financial analysts and other user groups. It was felt each would bring its own perspective to the table and work to protect its own interests thereby establishing a balance and a check against undue influence by any one group.

CPAJ: Who provides funds to the FAF? What, in fact, does the FAF do?

Wyatt: The trustees have basically two duties: appoint FASB and GASB members and raise money. The money comes from contributions--the large accounting firms and industry. The large firms all contribute the same amount, and there is a limit on how much any one corporation can contribute. Also the board gets a significant amount of revenue--I think about half--from the sale and licensing of its work product. Just recently the SEC offered to make a significant contribution--reported to be $500,000--to the foundation to provide funds for a full time GASB board. At the present time, only the chair is a full time GASB member. The FAF refused the contribution on the basis that it might give rise to questions or concerns about the exercise of too much influence over the GASB.

CPAJ: Sorry for the diversion. Back to your background analysis.

Wyatt: We have had almost 20 years experience. Experience has shown--

* the academics have no power base and are not a force in the process. There is an academic member of the FASB and an academic on the FAF, but they are not powerful enough to counter the influence of other groups.

* the analyst, user community has not sought to be a major player in influencing standard setting. Individual analysts have participated in projects and been helpful to the FASB. But it has no central focal point from which to exert influence.

* with the reduction in the number and a huge increase in the size of the largest firms, they have become less professional organizations than they are large commercial enterprises. I don't mean that necessarily in a negative way; it is a descriptor of what they have become. Back in the 50s and 60s, they were partnerships of professionals. Today, with revenues of some approximating $10 billion a year, they, by necessity, are organized and managed like commercial conglomerates. With their increase in size and diversity of interests, they have become less able to speak in any unified way about specific accounting issues.

* the preparer community, on the other hand is fairly well organized through the Financial Executives Institute (FEI). The preparers have been very helpful to the FASB by participating in field studies and otherwise testing proposals. But they have used their power base to get various concessions. It began in the 80s at about the time Roger Smith of General Motors was chairman of the Business Round Table. GM was at the height of its stature and influence in the business community. It was powerful and, at times, a little arrogant with the use of that power. There were efforts by the preparers to get the FASB to be more responsive to what industry favored rather than what the board's mission was--to develop accounting standards independently without regard to individual consequences as long as they faithfully represented the true nature of the business transactions.

CPAJ: If the preparers were beginning to flex their muscles as early as the 80s, why all of a sudden do we have a problem here in 1996?

Wyatt: The efforts to influence standard setting on the part of the preparers has ebbed and flowed with the issues. There were other evidences in the past--the pensions and post-retirement benefits projects are examples. Preparers claimed the western world as we know it would come to an end if they had to accrue for the benefits they are committed to pay their employees after retirement. FASB survived those challenges in the past.

The proverbial straw occurred recently with the FASB's project on stock-based compensation. The search for the right accounting solution became very politicized. Those that would be most affected by FASB's proposals were start-up companies--companies who attracted talent by offering stock-based compensation because their operations were not yet yielding sufficient cash flows to pay high salaries. They objected vociferously to having to record a current expense for the stock options that they gave to employees.

As luck would have it, these same start-up growth companies had been working as part of a coalition with the large accounting firms and others in the battle for reform in the securities litigation area. Start-up companies were being sued at the drop of a hat over short-term glitches in stock prices, and large CPA firms were being sued whenever their deep pockets could be a source to fund securities litigation awards. The start-up companies and the large CPA firms had a common goal: appropriate relief from unreasonable liability arising out of Federal securities laws and regulations.

And so when the stock-based compensation debate began to heat up, the start-up companies turned to their partners in battle, the accounting firms, for help. The accounting firms, uniformly urged the FASB to back off. I would not offer a judgment as to what is more important to the profession--proper accounting for stock-based compensation or relief from unreasonable and onerous liability from securities laws. That is not an issue for this discussion. But what is important is that we no longer have the checks and balances within the FASB and related organizations that existed at the time of their formation. The public accounting firms no longer represent a unique perspective. They tend to align more with the business community and business interests.

CPAJ: So far you have not mentioned the role of the FEI in the shifting of the balance of power.

Wyatt: It made a move in early 1996 when it was requested, as were all interested groups, to make recommendations for improving FASB's procedures. They issued a letter recommending a reduction in the number of FASB members and more outside input on setting the FASB's agenda. In my view, the recommendations would have served to increase the relative power of the preparer community. The SEC's reaction to the letter was predictable. It is important to note that under the various Federal securities laws, the SEC has the authority to establish accounting principles for public companies. It has, however, been content to leave that responsibility to the private sector. The last thing it would agree to, however, would be to allow an increase in influence over FASB's activities by the group--the preparers--the SEC is regulating through various securities laws.

CPAJ: The FEI's attempts were that obvious?

Wyatt: The FEI move was pretty patently an effort to gain control of the standard setting process. There is a theory in economics called the "capture" theory. It is the theory that those being regulated ultimately will find a way to capture the regulatory process and use it to their own advantage. I am not knowledgeable enough to know whether that theory holds up very often, but we do have evidence of the theory at work here. Over the life of the FASB, in my opinion, the FEI has worked to gain more and more influence, without recognizing it was going to do itself in by overreaching. The SEC was not about to allow the takeover or capture to occur.

CPAJ: SEC Chair Arthur Levitt enters the picture. His recommendations and the response of the FAF went back and forth in the financial press.

Wyatt: Levitt's response was to urge (if not to insist) that the makeup of the trustees be changed to bring more individuals that would represent the public interest rather than constituent groups. The original idea of FAF was to protect the public by having checks and balances among the constituent groups. But as it evolved, the only interest that was of any great moment was the preparers. The auditors would not stand up often enough against their clients' interests. The other groups had no power. The basic premise was not operative.

CPAJ: Levitt's idea makes sense.

Wyatt: In some ways it is easier said than done. Getting the right "public interest" people is not easy. There are relatively few people who both understand the process and do not have a taint of some kind because of prior experience. Once you get past people like Charles Bowsher, recently retired Comptroller General, David Ruder, former chair of the SEC, and Manual Johnson, from the Federal Reserve Board, there are not a whole lot of people out there who would be interested in getting involved and bring to the process the independence the SEC prefers.

CPAJ: Do you think we have an end to the power struggle and will the SEC settle for this and not seek to exercise more control later?

Wyatt: I think the result--eight constituency trustees and eight public interest trustees on FAF--is healthy. It may be only a stopgap. It will provide time for an overall review of the fundamental foundation upon which the structure was based. It was initially well conceived based upon the conditions that existed at the time. I hope each of the new trustees will take the time to come to understand the background of the standard setting process and to be an active player in the process. Clearly the SEC would like to keep accounting principles standard setting in the private sector. It is also clear that most of the nonregulatory players would also like to keep the process in the private sector.

The CPAJ: What about FASB itself? To what extent was it a contributor to the palace insurrection?

Wyatt: The board has a tough job. It doesn't take up many things that are not controversial. Right now there is not a huge audience out there that is applauding what it has been doing. It has to be pretty sure before issuing a standard that it has a solution that will work. Field testing becomes necessary and desirable but adds to an already time consuming process. As a result, the board is regularly criticized for being too slow. I personally think there are things the board can do to speed up the process. For example, they have been working on the financial instruments project for ten years. This is not nuclear physics. But, on balance, I have no great criticism of the board. They have done a reasonably good job and reached reasonably good conclusions. The financial reporting process in the U.S. remains far superior to that in any other country. Users of financial reporting in the U.S. have the best financial information in the world upon which to make their decisions and to make our capital system work.

Having said that, I think the board has suffered from a lack of support from FAF's trustees, suffered in the sense that a fair amount of energy has been expended in trying to deal with initiatives of the trustees that the board feels are inappropriate. That certainly was the case when I was a board member.

CPAJ: What exactly do you mean by that?

Wyatt: It has been my observation, first as a board member and later just as an observer, that there has been a movement among the trustees to reduce the influence of the accounting firms and increase the influence of the preparer community. Also in the 80s we saw an attempt by the trustees to perform an oversight role over what FASB was deliberating. This was never envisioned. The trustees are supposed to raise money, appoint board members, and replace trustees. They are not supposed to become involved in any way in what the board decides. It is not an oversight role. A good deal of time, especially of the FASB chair, is spent dealing with diversionary issues raised by the trustees. This is unfortunate. The board has enough on its plate without having to deal with what I consider to be political issues flowing from the trustees.

Some of the fallout from this is visible in the difficulty the trustees have had in finding replacement board members.

CPAJ: Why is that? The pay is reasonably good.

Wyatt: The compensation is fine. Individuals are being asked to take on a responsibility for which they really have had no experience or training. They are taking on the role of a regulator, and not everyone is comfortable in such a position. There is not a whole lot of satisfaction after working on a project for years to have 90% of those out there tell you you've done a dumb job--taking too long to come up with an unworkable solution. It is difficult to convince high caliber people to undertake the responsibilities. With all the power grabbing going on and special interest pressures, why would anyone want to subject themselves to such a hassle?

CPAJ: The term of Dennis Beresford as chair will expire next year? What is your thinking about a replacement for him? Will there be difficulties?

Wyatt: In spite of what I have said, there are a number of very good candidates that I can think of who have a strong public interest that might make good chairman. People such as Ed Jenkins and Michael Sutton. Their careers have been impeccable, and they have already contributed to the profession in leadership roles. It may be with the changes Arthur Levitt has accomplished that the FAF will be able to attract people it might not otherwise have been able to. The ability to attract a leader into the chairmanship position will show the restructuring has worked.

CPAJ: How do you view the job that Mr. Beresford as done as chair?

Wyatt: At the time of his appointment, his firm was the most critical of the FASB--it was a constant critic. He was their chief spokesperson on accounting issues. He took the position, therefore, with some handicaps, with some of his colleagues on the board being concerned about his commitment to set high quality accounting standards. No new mission or broad vision was apparent. But the board has accomplished a lot during his leadership. They have dealt with some of the toughest issues to face the board--post retirement benefits, financial instruments and derivatives, stock-based compensation, etc. But it is time for new leadership and it will be interesting to see what develops.

CPAJ: Getting back to the problem, do you have any overall observation?

Wyatt: I think the designers of the way the FAF and FASB are structured did a thoughtful job in attempting to encourage all interested parties to have the avenue to express themselves while at the same time providing safeguards against any one viewpoint being predominant. The problem is that the checks and balances haven't worked anywhere near as well as was contemplated.

CPAJ: The user community has to be a big disappointment. They are the major reason for the demand for sophisticated financial reporting. Yet they have remained as noncombatant observers on the sidelines.

Wyatt: The user community is not organized to be a strong political force. Those in it are very individualistic, many with their own black box of techniques to help develop unique perspectives of the capital markets. They have been very helpful to the board, but when you try to pin them down as to how they use the information available to them, you don't get concrete answers. They want more information, but they view what they do with the information as proprietary. We are beginning to see, through the work of the Association for Investment Management and Research, some organized commentary on what the investment research community views as meaningful and important. But this effort does not compare with the capabilities of the FEI to influence. That organization is an experienced lobbyist. AIMR has not felt the need to put forth a unified, organized front when it comes to accounting standards.

CPAJ: The FEI is not that large an organization. I think its membership numbers would pale compared to the that of the AICPA. And yet people like Motorola vice president Ken Johnson have been very visible as FEI spokespersons, and critics, of accounting standards.

Wyatt: The FEI has some very powerful and influential members. They get some of that power from the size and importance of the companies they represent. I know Ken Johnson very well--he was a student of mine. I spoke with Ken last winter before the FEI letter on restructuring FASB was released. He read a draft of the letter to me and asked for my reaction. I said it was an open invitation to the SEC to cut back on the influence of the preparer community. It was a takeover letter. "Oh no. That's not our objective at all," was Ken's reaction. I do not know what the motives of FEI actually were. I do know that FEI's proposals were interpreted as an attempt to give it more control over FASB's work. It turns out the FEI leadership may now regret having sent the letter. The chair of the SEC, Arthur Levitt, saw a threat and reacted decisively.

CPAJ: The FAF's reaction as seen in its chair Michael Cook's response was strange in some respects. In effect, it said the FAF did not plan to change its makeup except to appoint two public members to two open at-large seats.

Wyatt: His letter was not the kind you would have expected from the accounting profession sector. I can only conclude that the other constituents--perhaps the FEI and other preparers--had a strong say in the response. Or perhaps the change in character of the large firms from professional partnerships to commercial ventures has changed the way they react. We cannot reverse the clock. Those large firms are what they are. But we do need statesmanlike leadership from the practicing profession to step in in instances such as this to protect the fabric of the institutions against undue influence by any one group or, for that matter, any other similar threat.

The changing nature of the profession has not, in my opinion, weakened firms' independence on individual engagements. There is no evidence that firms are not objectively and independently dealing with individual clients at any level different from what they have done in the past. Perhaps in light of the huge legal settlements, they may be even tougher than they used to be when dealing with clients individually. However, when it comes to a firm speaking out on broad issues from a public interest perspective, the accounting firms no longer seem willing to do so. It appears that their commercial concern about the reaction of any significant pocket of clients that has a strongly held view has closed off significant potential leadership. Examples of this are the stock-based compensation project, and, it can be seen in the past in the comment letters of firms on the post retirement benefits proposals.

CPAJ: Speaking of the stock based compensation issue, and the so-called cave-in of FASB to those objecting to the proposed accounting, do you think that this has resulted in any permanent damage to the authority of FASB and pronouncements it issues?

Wyatt: I don't think there has been any long-term damage. But I think, as a result of the reversal, the industry people felt it was the time to make a move to gain greater control over the process. That's why we have the initiative that took place earlier this year. But the industry folks did not anticipate the reaction the SEC would have.

CPAJ: How would you evaluate the performance of the FAF in dealing with this issue and in doing the job it is supposed to do?

Wyatt: I am somewhat disappointed with the representatives of the accounting profession that are on the board of trustees. They have not been as supportive of the board in its efforts to resolve sensitive issues as they should have been. Instead of deflecting some of the criticism, they joined the critics. This has been counterproductive. I don't think they've spent the time to get a real understanding of what the board is all about. Only recently have the trustees had any substantive role in interviewing board candidates. And even today, they seem to drive away potential candidates rather than attract them. In the years prior to my acceptance of a position on the board, I had been asked three times to serve. Yet over that period the trustees never interviewed me or attempted to learn of my view on accounting standards. The only time I met with the trustees was after I resigned. While the trustee role has changed somewhat, the trustee group really has not had a positive influence on the standard-setting process.

CPAJ: The solution that we have--more public interest trustees on FAF--coupled with new leadership from a new chair, may be what is needed to get the whole process back on track and preserve accounting standard setting for the private sector. Do you agree?

Wyatt: Yes, it may do the trick. The quality of the new trustees is beyond reproach. If the new trustees will spend the time to understand the background of accounting standard setting and its vital role in the efficient functioning of our capital markets, they will be able to bring insights and balance to the process. They must work hard, however, to be effective in dealing with the existing entrenched interests. If this gets coupled with a new FASB chair with the right leadership qualities and sufficient stature, accounting standard setting will be able to confidently move forward into the next century.

CPAJ: Thank you for your views and insights. *

Arthur R. Wyatt, PhD, CPA, is retired from Arthur Andersen LLP and an adjunct professor of accounting at the University of Illinois. He is past chairman of the International Accounting Standards Committee, past chairman of the American Accounting Association, former member of the FASB, and past member and chairman of the AICPA Accounting Standards Executive Committee. He presently serves as a consultant to the SEC on international accounting issues.

It all began somewhat innocently. The Financial Accounting Foundation, the body responsible for funding the operations and choosing the members of both the Financial Accounting Standards Board (FASB) and the Government Accounting Standards Board (GASB), was seeking recommendations to improve the standard setting process. Quite naturally, the Financial Executives Institute (FEI), a major representative of the financial statement preparer community, responded with recommendations directed toward improving the work of FASB. The FEI called for more involvement by FASB's constituents, greater use of task forces, a third-party group to set FASB's agenda, and a smaller number of FASB members. In the meantime, certain very visible and outspoken members of the FEI were expressing their concerns about the FASB's search for "theoretical accounting purity" instead of the practical effects of what they are trying to do. These comments and recommendations, coupled with the FASB's well publicized retrenchment on accounting for stock-based compensation because of heat from corporate executives, seem to have led SEC chairman Arthur Levitt to examine the basic organization of FASB and its safeguards from pressures from special interest groups. In April 1996, Mr. Levitt, seeking to ensure the independence of standards setting, expressed his view in a letter to the FAF and in public statements that the trustees of the Financial Accounting Foundation should be more representative of the public interest and that nominations to the position of trustee should be subject to some sort of SEC approval.
The FEI immediately issued a press release strongly supporting the existing makeup of the FAF.
The Government Finance Officers Association's (GFOA) executive board voted to oppose the move of chairman Levitt to restructure the makeup of FAF's trustees. The GFOA and the National Association of State Auditors, Comptrollers, and Treasurers nominate candidates for three of the 16-member FAF board of trustees. Levitt initially had indicated that he did not think the FAF trustees from state and local governments were bona fide representatives of the public interest.
On May 20, 1996, J. Michael Cook, president of the FAF board of trustees issued a letter that "emphatically" disagreed with Levitt's position that the composition of the FAF board somehow prevented it from sufficiently supporting the FASB.
Cook went on to state that the FAF would proceed promptly to appoint two at-large public trustees. The two positions were open and were most recently held by officers of a major industrial corporation and a major bank. Cook stated, however, that the FAF did not think it was appropriate to eliminate any sponsoring organization from nominating individuals for election to the FAF nor to have the SEC approve, in substance, nominations to the FAF.
Amidst all the posturing, discussions among the various groups continued, and on July 8, 1996, additional changes to the makeup of the sponsoring organizations were announced. The AICPA and the FEI each agreed to give up one of their nominees, releasing them to become public interest appointments. In addition the SEC accepted the position that the three nominees of the governmental group would be considered to be in the public interest category. The end result, satisfactory to the SEC, is that the FAF's trustees line up eight in the public interest and eight representing constituent groups. (See table.)

The foundation consists of 16 trustees nominated for election by the following sponsoring organizations representing the indicated constituencies. The before and after is before and after the agreement with the SEC as to the makeup of the trustees by constituency.
The FAF appoints the members of the Financial Accounting Standards Board, the Government Accounting Standards Board, and the advisory councils to those two standard setting bodies.
* Considered to be public members.

Organization Before After
AICPA--public accounting 4 3
Association for Investment
Management and Research--
users of financial statements 1 1
Financial Executives Institute,
Institute of Management Accountants,
and Securities Industry Association--
preparers of financial statements 4 3
American Accounting Association--
educators 1 1
Government Finance Officers
Association and the National
Association of State Auditors,
Comptrollers, and Treasurers--
government 3 3*
At large 3 5*
Total 16 16

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