Archive for the ‘Accounting’ Category
PCAOB’s Constitutionality
posted by Lawrence Cunningham
The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board to set standards and supervise the public auditing profession. A pending Supreme Court case will consider whether the result is constitutional under the Appointments Clause and separation of powers principles. The DC Circuit thought it was good enough, seeing the Board as a subsidiary of the Securities and Exchange Commission.
Thanks to Donna Nagy, a diverse group of law professors (including me) join an amicus brief challenging that stance. We emphasize that we believe that the idea of the Board is appealing but the design Congress chose is flawed. A copy of the brief is available here.
August 4, 2009 at 10:11 am
Posted in: Accounting, Administrative Law, Constitutional Law, Uncategorized
Print This Post
One Comment
New Accounting Book Coming
posted by Lawrence Cunningham
Earlier this summer, teachers using my accounting textbook received an update highlighting developments for use in Fall classes. Changes will appear in the forthcoming fifth edition, due out in time for Spring classes.
I’ve completed and submitted the manuscript and am now finishing revisions to the Teacher’s Manual and PowerPoint slides. The wonderful publicity department at West, my publisher, will release some version of the following squib on the book:
Cunningham’s Introductory Accounting, Finance and Auditing, adopted at some 70 schools in its 12-year history, presents accounting, finance and auditing using clear narrative with extensive illustrations. It balances accessibility with rigor.
Pedagogical features that make it easy to use include a coherent layout, complete set of PowerPoint slides, comprehensive Problems and Solutions, intriguing Conceptual Questions and International Comparisons plus a Glossary, Bibliography, Index and Teacher’s Manual.
The fifth edition adds material on international accounting and other hot topics. It can be used as the primary book for a one-, two- or three-credit accounting course or to supplement business associations, corporations or corporate finance courses.
Fleshing that out a bit, changes from the fourth to fifth edition are far less extensive than changes made from the third to the fourth edition in 2005. No major overhaul is undertaken and no new chapters are added.
But I have made several pedagogical improvements, added materials on international financial reporting standards (IFRS), and updated a few discrete accounting and auditing topics. The main results are as follows. Read the rest of this post »
August 3, 2009 at 1:57 pm
Posted in: Accounting
Print This Post
No Comments
Copyright to Private Standards Government Embraces
posted by Lawrence Cunningham
Under what circumstances do privately-generated standards lose copyright protection by virtue of governmental approval, mandate or adoption of them? The law on this subject remains unsettled, with a few somewhat conflicting federal circuit court decisions and no Supreme Court direction. The issue is when standards become functional law so that, under principles of justice dating to Roman times, they must be freely accessible to the public.
Interest heats up after a firm based in California asks people to scan works that have been referenced in the Code of Federal Regulations for inclusion in the firm’s free standards database. This is a bold move for the firm to undertake and a potentially risky one for those responding to its request. My 2005 Michigan Law Review piece offered a framework for resolving these problems; the following abstracts it a bit and applies it to the California firm’s request. Read the rest of this post »
June 24, 2009 at 12:42 pm
Posted in: Accounting, Intellectual Property
Print This Post
No Comments
Treatment Differences in US / International Accounting
posted by Lawrence Cunningham
Amid continuing enthusiasm for the US to abandon its traditional accounting standards in favor of those set by an international body in London, insufficient attention is paid to differences in how the two treat particular questions and what those different treatments reflect about political realities.
In late August 2008 on this blog, I asked whether readers were aware of lists or charts illustrating treatment differences between US and international accounting standards. Comments and other research yielded modest results. The relevant literature tends to focus on differences in bottom lines between the two systems, not treatment differences.
This gap led Bill Bratton (Georgetown) and I to believe that a list or chart of treatment differences, with contextual analysis, would be useful to the literature (in both accounting and in law). As a result, Prof. Bratton and I prepared a contribution for the Virginia Law Review, commenting on a related paper by Jim Cox (Duke).
Our piece is now available here. The chart of treatment differences appears as the Appendix, at pp. 17-26. The preceding pages synthesize how these differences reflect deeply divergent philosophical and political realities, despite widespread talk of how the two standards are convergent.
The paper’s abstract reads as follows:
April 13, 2009 at 11:29 am
Posted in: Accounting
Print This Post
4 Comments
As If Accounting
posted by Lawrence Cunningham
Do reasonable Americans today regard housing markets, credit markets, stock markets or collectibles markets to reflect accurately the fair value of their homes, corporate bonds/equity and collectibles? My guess is that a large number could honestly and in good faith say “no, that they do not,” whether correctly or incorrectly. Many might say instead that at least some of these markets are at least periodically distressed (or even inactive in the case of collectibles and some housing markets) and that related prices, if any, “really represent distressed sales.”
If so, according to the logic of new accounting rules the country’s independent accounting standard setter adopted last week, valuation of these items may not accurately be ascertained by using recent comparable home sales or trading prices for corporate debt and common stock or auction sales of collectibles. Instead, they could be ascertained by reference to the owner’s own judgments about what those assets would sell for in an “orderly transaction” and “active market.”
The accounting body (the Financial Accounting Standards Board) last week gave analogous authorization to corporate America (and FASB’s London-based counterpart is being pressured to follow suit). In its plain English version of these new rules, FASB says they are designed “to figure out fair values when there is no active market or where the price inputs being used really represent distressed sales.” FASB continues: “The objective is to reflect how much an asset would be sold for in an orderly transaction (as opposed to a distressed or forced transaction) .”
April 6, 2009 at 2:49 pm
Posted in: Accounting
Print This Post
3 Comments
The Great Repression
posted by Lawrence Cunningham
Amid contending descriptions of the prevailing economic crisis, and candidates for causes and responses, I nominate The Great Repression and, in doing so, point out how unconscious exclusion of painful realities from the conscious mind caused the crisis and continues to infect policy responses to it.
No consensus appears on what to call the prevailing economic crisis, let alone diagnostics of its causes or prescriptions for cure. It’s not yet so severe to warrant Great Depression II or so mild to be called a mere recession. As something in between, some are tempted to call it a Great Recession.
People seem agreed that an asset price bubble, especially in housing, manifested crisis, but disagree on exact culprits. Consumers and businesses respond by curtailing borrowing and spending, but government’s responses are exactly the opposite.
All candidates for culprits ultimately involve false stories that people—citizens, business people, regulators and politicians alike—told themselves. Exemplars: the American dream of home ownership can be made available to all; housing prices tend inexorably upward; massive current borrowing can be repaid from future assumed prosperity; financial risk can be diversified, hedged, securitized away by carving up underlying financial instruments; regulators can let market participants self-monitor and self-correct; and politicians can safely respond to citizen appetites by sustaining all these false beliefs.
April 6, 2009 at 8:23 am
Posted in: Accounting
Print This Post
23 Comments
Silver Lining and Lesson Department
posted by Lawrence Cunningham
A compressed portrayal of US failures evident in the current crisis may arise from the following list of representations:
(A) firms: Countrywide, Fannie Mae, AIG, Citigroup, Moody’s, Lehman Brothers, General Motors;
(B) industries: mortgage origination, mortgage finance, insurance, commercial banking, rating agencies, investment banking, automobile manufacturing and finance;
(C) regulators: state mortgage, insurance and banking overseers; Federal Housing Finance Agency; Securities and Exchange Commission and Commodity Futures Trading Commission; Federal Reserve, Treasury, Office of Comptroller of the Currency; Federal Deposit Insurance Commission;
(D) lawmakers: Congress, Congress, Congress, Congress, Congress.
What representations do not appear on this list? Deloitte Touche et al, the auditing industry, and the Public Company Accounting Oversight Board. Three cheers.
March 6, 2009 at 1:24 pm
Posted in: Accounting
Print This Post
No Comments
Forms May Fail Big Four Auditing Firms
posted by Lawrence Cunningham
A common form of business organization designed to limit liability of participants may have failed the four largest auditing firms, according to a judicial opinion last week refusing a motion for summary judgment based on the design. The case, involving claims by defrauded investors in the Italian company, Parmalat, seeks to hold liable affiliates of the Italian accounting firm found culpable in the fraud, Deloitte S.p.A. The court refused to dismiss the latter’s US affiliate, Deloitte Touche LLP, and the Swiss entity that unites them, Deloitte Touche Tohmatsu.
If sustained after further fact resolution, the result would expose Deloitte US to crushing legal liability—and likewise expand the liability exposure of the other three large auditing firms that use similar structures (Ernst & Young; KPMG; and PriceWaterhouseCoopers). That, in turn, could increase the risks that one of those four firms may soon fail, which would make it difficult or impossible for many large publicly-listed companies to find outside auditors as required by federal securities laws. Ultimately, this could mean US federal governmental takeover of the traditional process of private audits of listed companies.
At issue in the Parmalat securities case against Deloitte is the standard structure that the four large auditing firms use. They operate as networks of scores of member firms organized as separate legal entities in jurisdictions where they practice. They enter into agreements that enable identifying members with the global brand name and practice of a global firm. These structures are designed to promote a recognizable professional identity while insulating each member from the others’ liabilities. The delicacy of the balance appears in how the court last week questioned its liability limiting efficacy.
February 3, 2009 at 7:27 am
Posted in: Accounting, Corporate Law, Securities
Print This Post
No Comments
Hello Ms. Schapiro
posted by Lawrence Cunningham
The Senate on Thursday confirmed President Barack Obama’s nomination of Mary Schapiro as Chair of the Securities and Exchange Commission. In Ms. Schapiro’s written answers to questions posed by Senator Carl Levin, she indicates a refreshingly sharp break with many policies of her predecessor, Chris Cox.
Differences appear on numerous particular subjects. These reflect a general orientation to re-dedicate the agency to its primary mission of investor protection. Examples from Ms. Schapiro’s letter follow (with full text available here from Investment News):
1. Corporate Governance. Ms. Schapiro favors (a) rules letting shareholders (at least significant, long-time holders) nominate candidates for corporate boards of directors; and (b) rules allowing shareholders to express advisory opinions and votes on executive compensation .
2. International Accounting. Ms. Schapiro, unlike Mr. Cox: (a) does not believe that the International Accounting Standards Board meets US legal criteria and is not prepared to delegate authority to it; and (b) believes that US authorities must oversee foreign auditing firms auditing financial statements of companies with securities listed in the US.
3. Internal Controls. Ms. Schapiro, unlike Mr. Cox, would enforce laws requiring internal controls as to small and large public companies alike.
4. Accounting. Ms. Schapiro also believes in: (a) maintaining the independence of the US accounting standard setter, the Financial Accounting Standards Board; (b) cracking down against abuses of off-balance sheet accounting; and (c) continuing the requirement that stock options be accounted for as compensation expense.
5. Regulatory Scope. Ms. Schapiro favors: (a) regulating hedge funds; (b) strengthening capital requirements for securities brokers; and (c) strengthening regulation of rating agencies.
So far so great.
January 24, 2009 at 3:20 pm
Posted in: Accounting, Securities Regulation
Print This Post
No Comments
Satyam Fraud’s Systemic Regulatory Implications
posted by Lawrence Cunningham
From a systemic regulatory standpoint, the Madoff Ponzi scheme remains of limited significance, especially compared to the latest exposed fraud case, at the large Indian software company, Satyam Computers Services Ltd., whose shares trade on the New York Stock Exchange (in the form of American Depository Receipts, or ADRs). Its CEO released a letter yesterday disclosing an elaborate, and apparently simple, billion-dollar fraud that went undetected by the firm’s outside auditors, an India affiliate of PriceWaterhouseCoopers (PWC).
The Satyam fraud presents serious questions about systemic regulatory efficacy, particularly concerning auditing and audit firm oversight. True, it may seem outlandish that Madoff was able to use a rinky-dink auditing firm to review the books of a fund commanding billions of dollars in assets and it may be that even such small auditing firms of even private funds require as much regulatory supervision as larger auditing firms auditing public enterprises.
But the Satyam scandal presents a far more serious problem. Unlike Madoff, the company has shares listed in the United States. Also unlike Madoff, it was audited by a foreign affiliate of a large US auditing firm, PWC, whose operations apparently were outside the scope of review undertaken by the US auditing profession’s regulatory overseer, the Public Company Accounting Oversight Board (PCAOB).
Pending additional information from the newly-revealed fraud, of course, a couple of preliminary issues may prove to be lessons of the Satyam fraud. First, if foreign companies list securities in the United States, their financial statements need to be audited by a firm whose activities are subject to regulatory oversight in the United States.
Second, the fraud implicates the Securities and Exchange Commission’s recent enthusiasm for the concept of mutual recognition. This refers to a policy allowing foreign firms, especially brokers but potentially also companies and auditors, to access US securities markets without regulatory oversight here, so long as they are subject to comparable regulatory oversight at home. (I have questioned this policy before.)
Third, there is some possibility that audit failures by foreign affiliates of US auditing firms could expose the US firm to crushing legal liability. This could lead to the dissolution of one of the four remaining large US auditing firms (see my post here). Should that occur, with only three such firms standing, the country would face an additional blow to its system of corporate finance, with attendant adversity for the real economy and citizens.
January 8, 2009 at 7:45 am
Posted in: Accounting
Print This Post
10 Comments
Spreading Blame in Ponzi Scheme
posted by Lawrence Cunningham
When word of Bernard Madoff’s alleged $50 billion Ponzi scheme broke last Friday, my systemic worry was whether the fund was audited by a prominent auditing firm. Public revelation of an auditor’s involvement in such a fraud would almost certainly destroy it. Cf. Arthur Andersen amid Enron (2002).
If one of the four very largest auditing firms (Deloitte, Ernst, KPMG or PWC) were involved, the world would face an additional crisis by reducing from 4 to 3 the number of auditing firms capable of auditing most global companies. Indeed, such added crisis could occur if one of the next three largest firms (BDO Seidman, Grant Thornton or McGladrey Pullen) were implicated in such a fraud.
Fortunately, Madoff’s vehicle was not audited by one of those 7 firms (it was apparently audited by a storefront neighborhood accountant). Yet there is continuing fallout from this fraud that, some assert, does implicate one of the large 7 firms. In a putative class action lawsuit filed yesterday, New York Law School is suing investment advisor, Ezra Merkin, and his outside auditor, BDO Seidman.
December 17, 2008 at 11:20 pm
Posted in: Accounting
Print This Post
One Comment
KPMG-BCE: Auditor Conflict in Huge LBO Deal?
posted by Lawrence Cunningham
As one of the largest leveraged-buy out deals in history verges on collapse, much attention is being paid to a central condition in the agreement, the target’s solvency; little attention has been given to conflicts of interest facing the firm, KPMG, deciding whether the condition is met.
The deal is a $28 billion LBO for BCE, Canada’s largest telecom firm. A principal lender in the proposed deal is Citigroup, the struggling commercial bank. BCE has made clear it wants the deal to close as scheduled on December 11; Citigroup, like other lenders amid the current financial crisis, may prefer that it does not.
The agreement contains a condition to the lenders’ obligation to close that BCE shall have obtained an opinion from KPMG, or another public accounting firm, attesting to the solvency of the post-LBO company. This may be difficult to deliver, given the considerable debt being used in the LBO and terrible market and economic conditions.
Trouble is, KPMG is the outside auditor for both BCE and Citigroup, presenting it with a potential conflict of interest. One arm of KPMG may wish to bless the deal, to promote favorable relations with BCE, while another may wish to scotch it, to promote favorable relations with Citigroup.
December 1, 2008 at 2:53 pm
Posted in: Accounting
Print This Post
3 Comments
SEC Schizophrenic on Global Accounting
posted by Lawrence Cunningham
With surprising absence of fanfare, the Securities and Exchange Commission released over the weekend a 165-page document outlining its delayed and long-awaited proposals for how the US might switch from using its own generally accepted accounting principles to new international financial reporting standards. The release bears a schizophrenic quality. It offers one unsurprising and one surprising proposal.
The unsurprising portion reflects what the Commission reluctantly came to accept last summer: the US is not ready for such a switch and is not likely to be until 2014 at the earliest. Accordingly, the release principally outlines the many obstacles to such a switch and lays out milestones that would have to be met before considering such a radical move.
The surprising portion contemplates allowing selected US issuers voluntarily to make the switch as early as the year after next—2010. This radical proposal would be limited to US issuers whose industry uses IFRS as the basis of financial reporting more than any other set of standards. The release struggles to explain why this special approach for such issuers overcomes the many obstacles facing other US issuers.
November 17, 2008 at 11:05 pm
Posted in: Accounting, Securities Regulation
Print This Post
One Comment
Rescue Plan Relies on Accounting Finesse
posted by Lawrence Cunningham
Treasury’s latest plan to address the credit crisis by direct investment of $250 billion in US banks has politicians telling Americans one thing and firms telling investors another. Politicians tell Americans the investments are temporary, no threat to private market capitalism in a democracy; thanks to deals brokered by Treasury and the Securities and Exchange Commission this weekend, firms will tell investors the investments are permanent, necessary to account for them as increasing firms’ permanent capital and minimizing dilution of common stockholders.
The tension is finessed by imaginative design and classification of the two components of the government’s investment: preferred stock and warrants to buy common stock. As to the preferred stock, the solution is designing terms to exploit a gray area in accounting dividing debt from equity. Borrowed funds a firm must repay are debt (liability); permanent funds a firm need not repay are equity (capital). Preferred stock is a liability if the firm must repay it and equity otherwise.
Critical to the Treasury’s plan is boosting firms’ equity capital, which means making the securities look as permanent as possible. But if they look too permanent, that would impeach the political story. The result is a term sheet negotiated this weekend calling the preferred perpetual while incentivizing firms to repay it within five years, without an explicit obligation to do so. Examples include a spike in the dividend rate at year five from 5% to 9%, forbidding firms to pay dividends on common stock unless dividends are first paid on preferred and limiting firms’ right to repurchase common stock while the preferred is outstanding.
October 20, 2008 at 11:08 am
Posted in: Accounting
Print This Post
3 Comments
The Craziest Claims Yet about the Credit Crisis
posted by Jonathan Lipson
The credit crisis has provided ample opportunities for foolishness. Certainly California Republican Darrell Issa’s claim that the House bill would have been a “coffin on top of Reagan’s coffin” was an oddly necrophilic bunkmate to President Bush’s penetrating insight that “this sucker’s going down.”
But the prize for crazy claims about the credit crisis must go to former Dallas Fed President Bob McTeer, whose Monday post on the New York Times’ Economix blog claims that: (i) Wall Street banks were the real victims of the crisis; (ii) the real villains were minorities; and (iii) the only thing needed to fix the crisis is to change accounting rules.
I kid you not.
Let’s consider each in turn.
1. Banks are Victims
“[A]ll the focus on C.E.O. salary caps,” he writes “implied that the holders of illiquid mortgage-backed securities were the villains in this drama rather than the victims. They didn’t package the securities, or sell them; they bought them as an investment.”
October 3, 2008 at 12:52 pm
Posted in: Accounting, Bankruptcy, Corporate Finance
Print This Post
12 Comments
More on Accounting as Policy Lever
posted by Lawrence Cunningham
Debate intensifies on the topic of my Monday post: accounting as a policy tool. (David Zaring captures divergent views.) The intensity shows in today’s NYT column by Floyd Norris, a columnist noted for accounting acumen. I usually agree with Mr. Norris, but have quibbles with today’s column, excerpts of which follow (emphases added):
banks and legislators are pushing for a change in accounting rules to end mark-to-market accounting for financial assets. They are sure that market values are too low, so why not just assume they are really higher? That illogic has caught on [as (1) both of this week’s intervention bills encourage the SEC to consider suspending those rules, in a] push for bad accounting [and (2) the SEC this week issued a statement giving issuers considerable flexibility in measuring fair value amid distressed market conditions].
The American Bankers Association concluded that [the SEC] had slapped down auditors who were forcing banks to unreasonably reduce the value of assets no one was buying. . . . Auditors cringed, awaiting appeals of clients to let them value assets as they please. [Still, the SEC statement] could persuade Congress not to make things worse, and not really give the banks new permission to fudge their books.
It is possible, perhaps probable, that many mortgage securities are undervalued now, amid [prevailing] uncertainty and fear . . . [Pending legislation] calls for the government to buy securities from banks for more than current market value but less than the government hopes they will be worth someday. Whether it will succeed depends in part on whether banks conclude that other banks are solvent after the money arrives and the dodgy securities depart. . . .
Quibbles:
October 3, 2008 at 12:26 pm
Posted in: Accounting, Current Events
Print This Post
No Comments
