Full Disclosure

By Thomas Brom
     
      The Gnomes of Norwalk
      Sometimes the man behind the curtain isn?t a man, but a committee. And sometimes the committee really does have power, and chooses to demonstrate it. Such is the case with the Financial Accounting Standards Board (FASB)?an independent, private group nicknamed the ?Gnomes of Norwalk? (Connecticut). The latest occasion was a fascinating confluence of events precipitated by the great pension crises of ?05. Traditionally, pension funding and pension accounting operate on separate tracks. But this year they converged. In August, President Bush signed the nearly 1,000-page Pension Protection Act of 2006, which sets a funding target of 100 percent for defined-benefit plans. A month later FASB issued a new pension-accounting standard, FAS No. 158, which requires companies to record the funded status of retirement plans on their balance sheets rather than in footnotes, as had been permitted previously. For public companies, the changes take effect at the end of the fiscal year ending after December 15, 2006.
      The meaning of these changes has kept the readers of sheep entrails busy all year. Some say they portend the demise of defined-benefit plans, already on life support for employees and retired workers in the steel, auto, and airlines industries. Others focus on the impact full pension funding and transparent accounting might have on reported earnings?and on stock valuations.
      FASB?s new accounting standard, which moved from exposure draft to final release in just eleven months, is the most unpopular of the changes. A study by Mercer Human Resource Consulting found that among the 235 letters FASB received during the comment period, the unfavorable outnumbered the favorable 4 to 1. Board members faced withering criticism from companies and actuaries at a June roundtable. Moody?s Investors Service predicted that the new standard ?will significantly increase? total liabilities and reduce shareholders? equity for many nonfinancial corporations?especially those with defined-benefit plans. Yet FASB Chairman Robert H. Herz was adamant in its defense, testifying before the Senate Banking Committee that the change would ?increase the transparency, completeness, and usefulness of financial statements for shareholders, creditors, employees, retirees, donors, and other users.?
      So what?s going on here? ?It?s basically a drag-and-drop exercise, from the footnotes to the financials,? says Jack T. Ciesielski, publisher of The Analyst?s Accounting Observer in Baltimore. ?But the standard has produced a lot of angst?companies are kvetching about estimating projected benefit obligations when it?s not even on the table.?
      According to Ciesielski, the new accounting standard reflects a power shift within FASB from the preparers of financial statements?public corporations and auditing firms?to the users of financial statements?capital markets, analysts, and investors. Ciesielski has seen the shift from the inside. He served on a FASB advisory council from 1997 to 2000 and was appointed to the emerging-issues task force by Herz in 2003 to increase user representation.
      ?It?s fair to say there?s tension between the two groups,? Ciesielski says. ?The difference is knowing versus being told about a company?s financial condition. ?It?s ?trust me,? versus ?trust and verify.? ?
      That tension within FASB, founded in 1973, is longstanding. FASB?s seven-member board is appointed by the 16 trustees of the Financial Accounting Foundation (FAF). To become a foundation trustee you must be nominated by one of a handful of sponsoring organizations, divided roughly into financial statement preparers and statement users.
      ?The sponsoring organizations just accepted each other?s nominees,? says Paul B. W. Miller, a professor of accounting at the University of Colorado, Colorado Springs, who worked in the SEC chief accountant?s office as an academic fellow in 1987?88. ?It was like a social club, in which members agreed not to blackball anyone who is recommended by other members.? For most of FAF?s history, Miller says, the board had been heavily influenced by the Business Roundtable and the American Institute of Certified Public Accountants.
      All that changed in 1993 with the Clinton administration?s appointment of Arthur Levitt?a champion of the users of financial statements?as SEC commissioner. In July 1996 Levitt faced down FAF Chairman J. Michael Cook, then CEO of Deloitte & Touche, over the issue of independent FAF trustees. He achieved a compromise that produced an expanded board evenly divided between dedicated and public-interest seats.
      Levitt?s victory immediately bore fruit, producing user-friendly standards for the accounting of derivatives and intangible assets. The Sarbanes-Oxley (SOX) Act of 2002 then changed the game fundamentally. SOX created the Public Company Accounting Oversight Board, and through it funded FASB?s budget by levying fees on all public companies in proportion to their market capitalization for the preceding year.
      ?The great divide continues,? Miller says. ?Public companies still believe that capital markets depend on financial statements alone, and that if you manage those statements everything will be fine. They ignore the obvious: What capital markets don?t know, they will either pay analysts to find out or they will discount?which only raises the cost of capital.?
      Ciesielski says the real battle on pension accounting, still to come, will be fought between users advocating a projected-benefit obligations formula and preparers advocating an accumulated-benefit obligations formula, which does not account for future salary increases. ?Management remains committed to having financial statements be a scorecard that they control,? Miller says. ?It?s a uniform attitude, like syrup on a pancake.?
      So the gnomes bicker endlessly about transparency in financial statements. What they do, however, has a huge effect in the larger world. Ciesielski writes in his weblog that the ?rejiggering of balance sheets to show pension and other post-employment benefits more clearly? could be the hot fourth-quarter accounting topic for chief financial officers. ?That?s likely to lead to ?minimizing? behavior by companies: pension plan freezes, pension benefit reductions, and/or health care benefit cutbacks.? And that?s major social change?all produced behind the curtain.

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