Let the "Condorsement" Games Begin

The SEC has finally conceded that its efforts to adopt IFRS have failed. Damage control has begun in earnest, but the ship is still taking on water.

The SEC took a tentative poke at the problem last May with the publication of a Staff Paper, Exploring a Possible Method of Incorporation (with emphasis, supposedly, on "exploring"). Once upon a future time, the staff fantasized, it will be possible that financial statements prepared in accordance with U.S. GAAP will simultaneously comply with IFRS as issued by the IASB. Known informally as 'condorsement', the paper describes the staff's wishful thinking in the form of three "convergence" phases and a final "endorsement" phase.

Convergence Phase I — Would somehow complete the few surviving MoU convergence projects by the end of this year, but even those have since been shot full of enough holes to push the timeline out by at least another year. The SEC will not acknowledge this, but everyone pretty much agrees that the decade-long effort to converge U. S. GAAP and IFRS has been marked by many more failures than successes.

Convergence Phases II and III — Would take an additional 5 to 7 years and require the FASB to formulate plans for merging active IFRS projects into U. S. GAAP. If FASB-style "due process" can't get it all done, someone is supposed to be able to figure out a way to pick up all the pieces.

Endorsement — Simple math combined with the most obvious lessons learned from recent history leads to the inescapable conclusion that the "endorsement" phase can't even begin for at least another decade. At that point, the FASB is supposed to get hog tied; it will not be allowed to do anything except for figuring out how to fit new IFRSs into the GAAP codification.

The Staff Paper Fizzles instead of Sizzles

Except for the Big Four (I'll be getting to that later) and perhaps a few large companies, the Staff Paper has gone over like a lead balloon. To start, the handpicked investor panel at July's SEC Roundtable on IFRS provided only tepid encouragement, and the smaller public companies panel could barely be held back from strangling the SEC staff; all they saw in IFRS was a lot of incremental cost and zero incremental benefit. Other federal regulators exercised political restraint, but the representative of the state boards of accountancy condemned the SEC's for its foolhardy quest for a holy grail -- which not everyone believes is so holy -- in no uncertain terms.

It is quite possible that the failure of the Roundtable to drum up support for IFRS adoption may have also moved the IASB itself to go negative shortly thereafter. In an August 3 public conference call discussing the IASB's agenda, Ian Mackintosh, vice chairman of the IASB, was asked whether the IASB will continue to develop projects jointly with the FASB. With surprising frankness, he sent a strong signal that our favored nation status could be revoked:

"It depends on what decision is made in the United States on adoption, or convergence, or incorporation of IFRS. I would have thought … that we would continue to work jointly with FASB on those four major projects I mentioned before. But I wouldn't have thought … that we would work jointly with them on new projects. I think we are in a situation where we have a global constituency; every country has its right to a place in the process."

In some respects, all Mackintosh has done is echo the sentiments expressed some months ago by EU Commissioner Charlie McGreevy and the IASB's John Smith, as they attempted to ratchet up the pressure on the U.S. to abandon GAAP – lest it forfeit any future say on IFRS. But, whatever the motivation, Mackintosh is clearly not happy with the SEC's condorsement fantasy; and to add insult to injury, apparently, the SEC failed to consult with the IASB beforehand. Perhaps Mackintosh chose to inflict public humiliation on the SEC as payback for the slight.

The Big Four Tries to Pick up the Pieces

Given the Roundtable bashing and the Mackintosh lashing, the SEC may not have been at all surprised by E&Y's recent defection from the IFRS adoption bandwagon, as expressed in their belated comment letter on the Staff Paper:

"Ideally, we would like to see a single set of high-quality accounting standards used throughout the world, including the US, without modification. However, we unfortunately are not convinced this worthy goal can be practically achieved at this time. … Few nations are willing to sacrifice their accounting standard-setting sovereignty, particularly for issues they view as important to their local capital markets and economies. We doubt constituents in the US will be more willing to make this sacrifice. Therefore, some form of endorsement process seems necessary and the creation of a 'US flavor of IFRS' inevitable. [italics supplied]

There's that word "inevitable" again!

"Inevitable" means that something will undoubtedly come to pass, doesn't it? E&Y used to say that IFRS adoption is inevitable; and now they would have the SEC believe that a mutually exclusive proposition, namely a "US Flavor of IFRS", is the new "inevitable." I'm not surprised by the tactic, but I could certainly have wished for somewhat more inventive rhetoric to digest.

Of course, that's not the only curious statement in the comment letter:

"Although we support the approach described in the Staff Paper, we believe it is unlikely that method would allow US issuers (following a transition period) to assert compliance with IFRS as issued by the IASB." [italics supplied]

On the one hand, it's a relief to finally see the day when even E&Y has conceded that IFRS adoption is a virtual impossibility; but on the other hand, E&Y is also saying that the SEC should proceed as if IFRS adoption were to actually take place!

Methinks the method to E&Y's madness lies in their latest policy recommendations. First, E&Y would still like to see the FASB hog tied:

"[W]e hope the FASB would make changes to its legacy standards only to converge with IFRS."

Second:

"We would support voluntary adoption of IFRS as issued by the IASB by US issuers."

Essentially, this latter recommendation, which quite predictably has now been echoed by the AICPA, repudiates the one and only rationale that has ever been proffered for adoption of IFRS: comparability of financial statements. Now, E&Y and the AICPA are saying 'pick a number.' If a free choice between IFRS and GAAP by foreign private issuers (FPIs) does not harm investor interests, they say, then it would also be appropriate to give domestic issuers the same freedom to choose.

Obviously, I think they're wrong. To begin with, the option given to FPIs to file financial statements in accordance with IFRS without a reconciliation to U.S. GAAP was highly controversial decision made during the Christopher Cox era. It cavalierly brushed aside the fact that it was strenuously opposed by investor interests. But even more important to evaluating E&Y's latest proposal, it has been established for decades that the criteria for FPI rulemaking are fundamentally different from those for domestic issuers.

Whereas disclosure adequacy is generally the paramount concern, the SEC has long recognized that FPIs are a special case. If the SEC were to impose the same disclosure requirements on FPIs, it could discourage many FPIs from offering their securities to U.S. issuers. That would harm investors, because they would be deprived of an opportunity to invest in foreign companies while enjoying the broad regulatory protections and lower costs afforded by U.S. markets.

Thus, if there was any rationale to allowing FPIs to choose between IFRS and U.S. GAAP, it was to accommodate the FPIs. And the fact remains that whatever the outcome, the decision to accomodate them ran the risk of lowering investor protections. Although E&Y and the AICPA would have us believe otherwise, none of this has anything to do with whether domestic issuers should be given a choice between IFRS and U.S. GAAP. 

I have, as you might have suspected, many other concerns with E&Y's recommendations:

• As Jack Cieselski pointed out in his early comment letter on the Staff Paper, the FASB will be prevented from adding items to its agenda that are of particular concern to U.S. investors. Is E&Y thinking that its voice counts for more at the IASB than at the FASB? The IASB independence problems are well known, and entirely consistent with that self-serving scenario.
• Getting back to the comments of the IASB vice chair, the 'condorsement' strategy that E&Y would like to see the SEC implement must be anethema to at least some IASB members. I imagine they are torn between taking our money, and telling us to take a hike. The EU wants to drive the bus, and China and India also want their say. But, are they ready to pay for the gas?
• How will accounting education (and the CPA exam) be affected if IFRS is merely optional? By the way things are headed, students eventually would have to master three sets of rules – public company U.S. GAAP, private company U.S. GAAP, and IFRS. I'm all for studying comparative accounting systems, but having to be tested on three systems will perforce crowd out real learning in favor of committing details to memory.
• The hundreds of FPIs, which include some of the largest banks in the world, are probably shaking in their boots, contemplating a condorsement plan where the U.S. would require of its domestic issuers compliance with IFRS plus additional disclosures. Instead of IFRS becoming the only game in town, it would once again look like the weaker of two regimes.  When will we finally get the message that the EU doesn't want us in their sand box?
• The courts have recently set the bar a lot higher for SEC-generated cost-benefit analysis in support of any new rulemaking. If the SEC had continued down the path of ultimately requiring adoption of IFRS, would they be capable of conjuring up a cost-benefit analysis that could actually survive a legal challenge? Methinks condorsement was cooked up in part to achieve de facto convergence without additional SEC rulemaking.

In summary, all I can say is, 'here we go again.'

Comments

[Warren D. Miller, CFA, CPA]

Great stuff, as always, Tom. Thank you for your insights.

I have a solution for the "three sets of rules" problem you raised. Why not have separate credentialing exams and, thereby, separate certificates and licenses for each set of rules, but with the restriction that a given individual can be licensed only in one set? That would force some hard choices. Doing otherwise, however, seems to me to be the accounting equivalent of allowing one doctor to specialize in cardiology, proctology, and ophthalmology. It's insane. But then, so is this whole one-size-fits-all IFRS thing. Haven't we learned from the gratuitous failure of the U.N., another seductive idea that would surely bring world peace? Good grief.

I believe that forcing individuals to make choices would point up the idiocy of the whole exercise. . .except to the likes of E&Y and AICPA, which, in reality, speak with one voice. AICPA is the puppet, E&Y is the puppeteer.

[Ken Kobylenski]

EY's muted support for a "US flavor of IFRS" contrasts with PWC's IFRS orthodoxy: "PwC believes that the SEC should continue working with the FASB and IASB to determine the best means of ultimately transitioning US companies to IFRS on a mandatory basis."

Since FASB did not roll over to the IASB this summer on the transparent presentation issue of Derivatives netting, it seems unlikely that US GAAP will ever be the same as IFRS, nor that US co's would welcome an option for "pure IFRS" if they can get a US GAAP brand of "almost IFRS, not quite" with exceptions to their liking.

[K O'M]

Something to remember is that from the perspective of the Big 4, the convergence project has already generated a fair amount of work, or at least the potential for it. Standards over leasing, revenue recognition, and financial reporting are substantially changed, so there is less risk for the firms to walk back from their previous stance and advocate for something less than full adoption of IFRS.

[Colin Davenport FCCA @Accountants in Birmingham]

Interesting article you have, I've been reading upon this. The SEC staff paper should incorporate the two most prevalent methods of IFRS incorporation.