Samuel Lowenberg - Independent Journalist biography articles articles

Called to account on derivatives

Legal Times  May 4, 1998, Monday

If the devil is in the details, the fudging is in the footnotes. So says the Financial Accounting Standards Board (FASB), the little-known organization that is authorized by the Securities and Exchange Commission to set accounting standards for publicly held companies, known as Generally Accepted Accounting Principles. The FASB's latest rule has the business community in an uproar. The rule requires that companies include derivative holdings--financial vehicles valued at billions of dollars in the economy as a whole--as assets and liabilities in their balance sheets when they file financial statements with the SEC. Currently, the complex financial devices are nestled in footnotes at the back of annual reports.

Companies are loath to include derivatives in their balance sheets, as this can make what would otherwise appear to be a successful company look considerably less well off.

So an informal coalition of banks, business groups, and Wall Street traders is lobbying Congress to pass legislation to overturn the rule. And senior executives from the nation's top companies and banks have written to the FASB asking it to hold up the rule, which is in its final stages of preparation and is slated to take effect in fiscal 2000.

The bills, sponsored by Sen. Lauch Faircloth (R-N.C.) and Rep. Richard Baker (R-La.), would do more than reverse this FASB rule. They would also permanently curtail the FASB's power and put it directly under government supervision. Both bills are awaiting subcommittee action.

"Good accounting rules should be created in an open--and accountable--process, " Baker, chairman of the House Banking Committee's securities subcommittee, wrote in The New York Times.

"That is not how it works today."

The FASB is a private-sector organization in Norwalk, Conn., set up in 1973 to write accounting rules on everything from how to compute stock options to how to account for mergers and acquisitions. Composed of accountants, businesspersons, and academics, the board devises its rules with input from the financial community. But the FASB's real impact stems from its symbiotic relationship with the SEC--which doesn't formally adopt the FASB's rules but polices them.

FASB officials say its rule-making process is even more rigorous than the one most federal agencies go through. But critics say the process does not give aggrieved parties sufficient opportunity to air their complaints. They want the SEC to formally adopt FASB rules to allow for better review.

"No one really takes responsibility for the economic impact of accounting standards," says Paul Salfi, who is lobbying on the issue for the American Bankers Association, along with Donnas Fisher, who directs the ABA's tax and accounting division. He says if banks follow the proposed rule for accounting for derivatives and hedging, it will create distortions in their income statements and balance sheets.

FASB project director Jeffrey Mahoney disagrees, saying that the rule-making process is very flexible and open. He points out that the FASB had 140 public meetings on the derivatives project in the last six years.

Mahoney argues that the corporations' lobbying push is simply an attempt to escape uncomfortable regulations and to politicize the rule-making process. "With the federal government involved, special interest groups can manipulate the process," says Mahoney.

"If enacted, the Baker legislation would essentially kill the FASB altogether and get the derivatives and hedging standard delayed or watered down or killed."

Mahoney and the FASB's chairman, Edmund Jenkins, have registered to lobby to fight the business groups.

Derivatives, which first gained popularity in the go-go 1980s, are commonly used but little understood. Companies and banks often use them to hedge against market risks such as sudden changes in interest rates. But they can also be used recklessly, to make fast profits from risky bets.

Financial derivatives came to the attention of regulators after major losses by the likes of the Procter & Gamble Co. and Gibson Greetings Inc. Perhaps the best-known horror story occurred in 1994 in Orange County, Calif., where speculations in derivatives by the treasurer cost the county $1.7 billion.

One company that says it would be adversely affected by the FASB's rule is the Hershey Foods Corp. The change would force Hershey, a publicly traded company,to disclose its hedging activities in cocoa futures to its main competitors--the Swiss company Nestle and the privately held Mars--who are not bound by FASB rules.

To make sure that nobody forgot what was at stake, somebody put Hershey's Kisses in members' chairs at a House Banking Committee hearing on the issue last October. Hershey's lobbyists on the issue, Robert Rosenbaum and Martha Cochran of Arnold& Porter, denied responsibility.

Also pushing the legislation is the International Swaps and Derivatives Association, which has hired James Butera of Butera & Andrews and Donald Moorehead of Patton Boggs, the former chief minority counsel to the Senate Finance Committee.

ISDA board member Mark Brickell, a J.P. Morgan bank official, has been flying to Washington to talk to members about the issue. The U.S. Chamber of Commerce is also pushing for an FASB overhaul.

Against this onslaught, the only organization that has publicly taken the FASB's side is the American Institute of Certified Public Accountants. "We are very much in favor of the rule-making process remaining in the private sector," says AICPA lobbyist Tom Higginbotham.

"I really don't think it does much good to bring the rule-making process close to the Congress and subject it to political pressures and considerations." Both the SEC and the Federal Reserve have reportedly taken sides behind the scenes. The SEC is in favor of retaining the current system because it already has final authority over the FASB, but it wants to keep the organization independent of outside influence. And Fed Chairman Alan Greenspan has written three letters to the FASB objecting to the rule, according to The Washington Post.

An SEC spokesman declines comment on the pending legislation.A Fed spokesman did not return a call.

The broader of the two bills, sponsored by Baker, would bring the FASB under direct SEC supervision, and require FASB rules to be put forth for public comment and to be open to review in federal court. (FASB fans say its actions are already subject to federal court review.)

Sen. Faircloth's bill deals specifically with banks. It would exempt banks from FASB rules unless banking regulators determine that a bank's earnings and risk-management practices would not suffer.

Supporters of the current legislation admit that their chances are slim, but hope they can persuade FASB to reconsider. We are trying to make the point that the current process is flawed," says a Hill aide.

By Sam Loewenberg