The Financial Accounting Standards Board (FASB) is made up of seven members, six of whom are either ex-partners of major accounting firms or former high-ranking financial executives of their clients.

Unfortunately, there is no effective ombudsman or meaningful representation on the accounting standards board for tens of millions of small investors that entrust their life savings to the U.S. capital market.

However, this was not the intention of Congress when the Securities and Exchange Commission (SEC) was established in the 1930s.

The SEC has always had the power to directly set accounting standards and require their enforcement by public companies.

Why The SEC Doesn’t Do Its Job

From the very beginning, the SEC abdicated its power to set accounting standards, giving this job to the private sector.

It has claimed that the private sector is better prepared to handled the technical aspects of the task.

However, after more than seventy years, the SEC certainly has had time to hire those who know enough about accounting to set rules that protect the investing public.

This picture (from the Securities and Exchange Commission Historical Society) shows Joe Kennedy, a market manipulator with no expertise in accounting, as the first SEC Chairman in 1934.

The investment market was, of course, considerably different in 1934 than today.

Only about five percent of Americans owned stocks and most, by today’s standards, were relatively sophisticated, buying and selling securities for their own account.

Issuers were still dominated by owner-managers engaged in raising capital to build factories, intent on earning money to pay cash dividends to shareholders.

This was well before the rise of workers’ capitalism and the mass marketing of open-end mutual funds.

Institutional investors, with interests that conflicted with those of the ultimate investors, did not yet hold majority voting rights in public companies.

In the 1930s, the era of millionaire accountants was far distant. Most accounting associations had been established only twenty or thirty years before.

It was still early days in the transformation of the job of bookkeeping into an accounting ‘profession’.

The image of accountants as modest, self-effacing individuals with green eyeshades and independent views was closer to reality in the 1930s than today.

Big Accounting and Small Investors

Today, the clients that provide the profits of the big accounting firms are giant international companies that issue stocks and bonds in the capital market and the market intermediaries that make money from stock buybacks, takeovers, mergers and other business for these issuers.

It is virtually impossible to become a senior partner of a major accounting firm without developing, even unintentionally, a strongly-held bias towards the points of view of the issuers of securities and market intermediaries.

After all, senior partners of accounting firms are not rewarded for their profound understanding of accounting, but rather for their ability to expand the number of hours billed to large corporations that directly help partners become millionaires.

The interests of the issuers of securities are quite different from those of small investors who own these securities.

It is a fact that public accountants, the SEC, and the FASB are generally more on the side of the issuers than that of the public that they are presumed to serve.

What This Has To Do With Capital Flows

Accounting practices and standards have a profound effect on capital flows, measured in hundreds of billions and even trillions of dollars.

The rise of the buyback-option movement, which directed trillions of dollars away from cash dividends into blatant market manipulation condoned by the SEC and papered over by the FASB, would never have occurred if the accounting standards boards were looking out for the interests of small, long-term investors, holding life savings for retirement, rather than for those of corporate executives seeking to get rich quick with stock buybacks that divert company profits to an elite group of option holders. (See essays on “Buybacks and Options“)

The misreporting of pension fund liabilities by public companies has persisted for two generations, and could not have gone on for so long without the decision of the FASB to “go slow” (very slowly indeed) when correcting practices that resulted in obvious misrepresentations of the true financial position of major public companies.

(See: “Why Pension Funds Support Buybacks“.)

In both cases, while the FASB fox was guarding the henhouse, the SEC ‘watchdog’ was looking the other way.

The role of the FASB in the U.S. capital market is, for all intents and purposes, set in stone and it is unlikely that reforms in accounting disclosure that truly benefit small investors will occur any time soon.

This entry was posted on Sunday, April 2nd, 2006 at 12:39 pm and is filed under Corporate Managers, Individual Investors, Government Officials, Bankers, Brokers, Fund Managers. You can follow any responses to this entry through the RSS 2.0 feed. Both comments and pings are currently closed.

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