Yesterday, we wrote: “Tomorrow – more about this accounting scam that threatens to destroy accountability in finance.” And we intend to keep that promise.
TRUST: THE KEY TO FINANCIAL TRANSACTIONS …
On September 15, 2008, I wrote a blog entry titled, “Can you trust the accounting profession? (Updated) where I made the following points:
The companies that brought us to this financial disaster, did so with the complicity of accounting rules and accountants.
Represented by allegedly the best and brightest …
All of the major enterprises and financial institutions that have crashed and burned have had name-brand accounting and legal support.
Enron, master of the off-balance-sheet transaction, had Arthur Andersen (which did not declare bankruptcy and was not dissolved as commonly thought – but which lives on in the form of four limited liability companies ironically named Omega Management I-IV.)
And illustrated the current state of affairs with a hoary joke.
An old accounting joke begins …
The president and the chief financial officer are interviewing the remaining big accounting firms to select their auditor. The president confesses that he has no idea what makes a good auditor as the chief financial officer reassures him that he knows how to select the best auditor from the sharp-looking and knowledgeable candidates.
The CFO slowly walks up to each candidate and whispers in their ear. The CFO listens intently to what each person says in response. Suddenly, the CFO announces he has chosen the auditor and dismisses the rest of the candidates.
The president asks the CFO what he was whispering. The CFO replied that he had simply asked each candidate what the sum of two plus two was. Baffled, the president could not understand how such an elementary question could have an impact on the CFO’s decision. Professing disbelief, the president asked how this simple question could make a difference when the answer was know to all to be four.
“It wasn’t the answer that I was looking for,” replied the CFO. I just waited until one candidate exclaimed, “What do you need for performance this quarter?”
And pointed out the inherent conflict of interest between the accounting profession and commerce.
Purchased opinions …
And herein lies the cause of most financial debacles. A fudging of the numbers to meet the needs of the managements that hired them. A definite disregard and disrespect for the accounting profession in order to maximize the income of the accounting firm trying to overcome the blandishments of its competitors.
And noted the situation was exacerbated by the rule-makers who set the accounting standards.
Aided and abetted by the rule-makers …
In many ways, the accounting profession is a mix of law and accounting rules which, like all endeavors involving licensed professionals, are complex enough to allow both sides to exert a position in order to allow the professionals on both side to collect their professional fees.
And pointing my finger at the Financial Accounting Standards Board and the Securities Exchange Commission.
Enter the rule-makers: FASB …
“The Financial Accounting Standards Board (FASB) is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public's interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. It was created in 1973, replacing the Accounting Principles Board and the Committee on Accounting Procedure of the American Institute of Certified Public Accountants. The FASB's mission is "to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors, and users of financial information” <Source>
What is the basis of accounting?
Hiding the truth …
The goal of accounting is to provide a regulatory framework which allows enterprises to fairly and accurately present their financial information to their regulators, investors, management and others who may make decisions based on the information presented. In essence, the two-fold goals are accuracy and transparency.
And it is now going to get worse …
Set against the current financial crisis, with complex rules and complicit accounting rules, the situation is about to become immeasurably worse.
The Securities and Exchange Commission is going to allow major firms to switch to the International Accounting Standard which will introduce chaotic confusion to the entire accounting profession and further obscure previous transactions which may turn out to be criminal.
According to the International Herald Tribune, the international version of the New York Times …
“The U.S. Securities and Exchange Commission moved Wednesday to allow some large American companies to begin using international accounting standards as early as next year and to require all American companies to do so by 2016.”
“The commission voted unanimously to propose for comment a ‘road map’ for conversion, with eventual adoption depending in part on revised provisions for financing of the group that writes the international standards.”
“The adoption of international accounting standards by the United States would move the world toward one set of standards. This should make it simpler for investors to compare companies operating in differing regions and make it easier for companies to raise capital in whatever market seems most attractive.”
The intersection between intention and reality …
“While there is widespread agreement that one set of worldwide standards would have advantages for investors, there are concerns about the transition and about just how uniform the accounts really will be. U.S. companies and auditors will have to learn new accounting rules that as yet are not taught by many American colleges.”
“The European Union has asserted the right to approve or modify each standard issued by the International Accounting Standards Board and allowed banks to ignore part of one standard. In an attempt to deal with that issue, the SEC has said that it will accept filings using international standards only if they comply fully with the standards as issued by the board.”
Shenanigans are still permissible …
“There would also be the question of uniform application of the rules. Early this year, the French regulator evidently approved a decision by a French bank, Société Générale, which moved losses from a scandal from 2008, when they occurred, to the previous year. That move outraged some members of the international accounting board as well as some international regulators, but nothing was done about it.”
Compared to FASB rules, the International Standard is incredibly lax …
“If the road map is eventually adopted, the result will be a wholesale change in American accounting rules. While the international board and the U.S. board are working to bring convergence of the rules, there remain differences between them, as well as entire areas on which the international rules are silent.”
The stimulus package for the accounting profession …
“While it is often said that the international rules are based on standards, and the U.S. ones on rules, the differences are more in degree than nature. Still, in many cases the international rules will require more professional judgment from auditors.”
“The major accounting firms have broadly endorsed the move, saying that the United States should not isolate itself as most countries move to international standards.”
Why am I concerned?
On any number of occasions we have seen that the Wall Street Wizards, with their rocket science financial engineering, create natural and synthetic derivatives which require sophisticated computer programs to analyze their actual worth … as well as requiring a willing counterparty to purchase this often illiquid paper. The ability to hide these specious securities were aided and abetted by the accounting rules which set forth the criteria for keeping these particular transactions off the main entity’s balance sheet. According to the accountants, a perfectly legitimate maneuver; and one which permitted the parent organization to hide overwhelming risk and contingent liabilities that greatly exceeded the organization’s net worth. This allowed organizations to hyperextend themselves out of sight of the shareholders, security analysts, ratings organizations, consumers, and most importantly, the regulators who should have stopped this practice before the company became technically insolvent.
IAS 39: The fight over derivatives and accounting for hedged risk …
(July 31, 2008) IASB amends standard to give additional guidance on the designation of a hedged item
“The International Accounting Standards Board (IASB) issued today Eligible Hedged Items (an amendment to IAS 39 Financial Instruments: Recognition and Measurement).
The amendment clarifies how the existing principles underlying hedge accounting should be applied in two particular situations.”
“The International Financial Reporting Interpretations Committee (IFRIC)∗ asked the IASB to provide additional guidance on what can be designated as a hedged item. The responses to an exposure draft of proposed guidance (published in September 2007) indicated that diversity
in practice existed, or was likely to exist, in the designation of:
(a) a one-sided risk in a hedged item, and
(b) inflation in a financial hedged item.” <Source>
Example of a moving target …
Notice that the October 13, 2008 Amendment to IAS 39 was effective July 1, 2008. For members of the public who may be considering a particular investment, it is unlikely that this item will be flagged as it might be simply reported as “prepared under existing IAS standards.”
And it’s getting worse …
According to the Washington Post …
“Accounting Standards Wilt Under Pressure”
“World leaders have vowed to help prevent future financial meltdowns by creating international accounting standards so all companies would play by the same rules, but the effort has instead been mired in loopholes and political pressures.”
“In October, largely hidden from public view, the International Accounting Standards Board changed the rules so European banks could make their balance sheets look better. The action let the banks rewrite history, picking and choosing among their problem investments to essentially claim that some had been on a different set of books before the financial crisis started.”
“The results were dramatic. Deutsche Bank shifted $32 billion of troubled assets, turning a $970 million quarterly pretax loss into $120 million profit. And the securities markets were fooled, bidding Deutsche Bank's shares up nearly 19 percent on Oct. 30, the day it made the startling announcement that it had turned an unexpected profit.”
Credibility: surely you jest …
“The change has had dramatic consequences within the cloistered world of accounting, shattering the credibility of the IASB -- the very body whose rules have been adopted by 113 countries and is supposed to become the global standard-setter, including for the United States, within a few years.”
Political manipulation of accounting standards acknowledged…
“Sir David Tweedie, chairman of the IASB, acknowledged that the body needs more protection from political manipulation before it can claim that it has become the global gold standard.”
“Tweedie said he nearly resigned over the rule change demanded by European politicians. ‘I was so frustrated by the whole thing,’ he said. ‘All the time when we are trying to build a global accounting system, and we are pretty close to it, and then suddenly out of left field this thing appears. It's just absolutely exasperating.’"
Why is the SEC moving forward?
“U.S. standards have been set by the Financial Accounting Standards Board since 1973. ‘Right now, there is no credibility,’ said Robert Denham, chairman of the Financial Accounting Foundation, which oversees the FASB. ‘If we are going to have global accounting standards, my view is that is not going to work if the IASB is going to be jerked around by the European Commission. That is the very real risk that is posed by the EC coercion and the IASB's response.’"
Can you trust people like Treasury Secretary Paulson, Fed Chairman Bernanke and SEC Chairman Cox to protect us from the type of manipulation that led to the current crisis?
“The episode exposes how small, incremental changes in arcane accounting rules can affect billions of dollars in market value and corporate profitability. In turn, the money at risk raises the political stakes, as desperate companies begin to lobby political leaders to insist on changes that normally would come about only after a careful discussion and evaluation by experts.”
Our system is far from perfect, but it is still “our” system …
“For years, there has been a disconnect between U.S. and international accounting rules. With the history of corporate litigation in the United States, U.S. standards tend to be exact and explicit, making it easier for companies to defend themselves in court.”
Loosey-goosey and dependent on bought-and-paid for accounting professionals who are very rarely sent to jail …
“International rules rely on broad principles, giving companies greater leeway to make their own judgments. An extensive review of international accounting standards published last month by Moody's Investors Service found significant differences between two French companies on one key issue -- even though they used the same accounting firm.”
Economic war fought on an international battlefield …
“On Oct. 8, the leaders of France, Germany, Italy, Britain and the European Commission met in Paris to discuss the worldwide economic crisis. They issued a statement saying they were working together ‘within the European Union and with our international partners’ to ensure the safety and stability of the worldwide banking system. But buried within the statement was a sentence warning that European banks should not face a competitive disadvantage with U.S. banks "in terms of accounting rules and their interpretation.’ The leaders added ominously: ‘This issue must be resolved by the end of the month.’"
“At issue is an accounting standard known as fair value, or mark to market, in which companies disclose how much an asset could fetch on the open market. With the values of assets plummeting, banks were suddenly stuck with paper losses on assets they could no longer sell. With some critics saying the provision was forcing banks to take large write-downs, the SEC and FASB issued guidance in late September that companies could use their own internal models for assigning a value to assets -- in essence, a nod to the principles-based international rules.”
Hiding the obvious: obfuscation by accounting …
“But European officials smelled a rat. Under rare circumstances, U.S. companies are permitted to reclassify assets they were actively seeking to trade into long-term ‘loans,’ using an accounting rule that was considered weaker than the international equivalent. The international rules did not permit such transfers, and European officials feared that the new guidance was handing the Americans a competitive advantage.”
How the writer could have written this with a straight face is beyond me …
Unlike the U.S. board, the international board has no regulator like the SEC to help shield it from political pressure. So the IASB was at the mercy of the European Commission.
Like all other Bush Administrative Agencies, SEC Chairman Christopher Cox was and is a politician who was extremely sensitive to the political winds.
“But the IASB bowed to demands to let the firms backdate the accounting shift to the beginning of July -- something not permitted under U.S. rules.”
“In a recent report, Moody's wrote that the backdating provision could distort a bank's earnings and capital position, since "it allows managements to 'cherry-pick' selected assets" and "distort their economic reality," making it more -- not less -- difficult to compare global bank performance. “
" ‘The measure does not make much sense in the first place,’ said J.F. Tremblay, a Moody's vice president. ‘But the fact that a board can be influenced like that is not good news.’"
The noise you hear is the sound of the dollar turning over in its search for a politician’s pocket…
Again, our Administration, Congress and the Obama Administration-elect have promised the American people transparency in financial transactions.
THEY ARE FULL OF CRAP!
What can YOU do?
Concentrate on keeping your job, or better yet, starting your own business. Reduce your personal expenditures to a reasonable level which reduces anxiety over your financial affairs.
Invest in things which can be verified and which are not connected with securities or derivatives of unknown or suspicious value.
Demand your elected officials honor their promise of fiscal transparency. If the financial institutions and other organizations do not fully account for the funds which they have been loaned, dump the politicians and demand that their replacements seek the prosecution of those who have violated the law.
Accept my apology for a long and somewhat technical blog entry, but it is extremely important to know that our political leaders are complicit in manipulating our financial rules for personal and political profits. And that they are planning to weaken even those that we currently have – apparently for political purposes.
Be well and be safe.
The new financial battle flag …
Quote of the day: “It is the mark of an educated mind to be able to entertain a thought without accepting it.” -- Aristotle
A reminder from OneCitizenSpeaking.com: a large improvement can result from a small change…
The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane. -- Marcus Aurelius
“Nullius in verba.”-- take nobody's word for it!
“Beware of false knowledge; it is more dangerous than ignorance.”-- George Bernard Shaw
“Progressive, liberal, Socialist, Marxist, Democratic Socialist -- they are all COMMUNISTS.”
“The key to fighting the craziness of the progressives is to hold them responsible for their actions, not their intentions.” – OCS "The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." -- Marcus Aurelius “A people that elect corrupt politicians, imposters, thieves, and traitors are not victims... but accomplices” -- George Orwell “Fere libenter homines id quod volunt credunt." (The people gladly believe what they wish to.) ~Julius Caesar “Describing the problem is quite different from knowing the solution. Except in politics." ~ OCS
“The key to fighting the craziness of the progressives is to hold them responsible for their actions, not their intentions.” – OCS
"The object in life is not to be on the side of the majority, but to escape finding oneself in the ranks of the insane." -- Marcus Aurelius
“A people that elect corrupt politicians, imposters, thieves, and traitors are not victims... but accomplices” -- George Orwell
“Fere libenter homines id quod volunt credunt." (The people gladly believe what they wish to.) ~Julius Caesar
“Describing the problem is quite different from knowing the solution. Except in politics." ~ OCS