Let me begin by noting that this is an oversight hearing. We held an earlier oversight hearing on March 4 of this year. At that time, we looked at the proposed derivative disclosure rule of the Securities and Exchange Commission (SEC), and we looked at the exposure draft that the Financial Accounting Standards Board (FASB) had issued. We received testimony from a broad, representative cross section of people.
What we did not have at that time was an opportunity to hear from FASB because, at that point, FASB was in the process of reviewing comments on the exposure draft. They were not prepared to testify at that time. Today is an opportunity for us to complete the hearing that we had on March 4, by receiving testimony from three representative participants in the derivatives markets and then receiving testimony from Edmund Jenkins, the Chairman of FASB.
Let me note that after our March 4 hearing, this Subcommittee issued a report. We thought this was an important subject. I think that report is relatively well known. We raised some concerns about the FASB proposal.
The main point that I would like to emphasize today is straightforward. The principles that are established by FASB make up what is called GAAP accounting, generally accepted accounting principles. The chief problem with the FASB proposal before us today is that there is no general acceptance of this principle. So my concern is not with any specific date at which we would implement the rule. My concern is being sure we get it right, that we have a rule that is generally accepted as a sound, wise accounting principle.
There have been questions raised about whether or not Congress intends to intervene in the process of setting accounting standards. Let me assure you that if Senator Dodd and I had decided to intervene, we would have intervened. What we have done is simply seek to gather the facts, and we have sought to give people an opportunity to express their views.
Now let me say this about FASB. I am concerned about what is happening at FASB. I am beginning to be concerned that there might be an infection of the accounting equivalent of political correctness. Financial standards are the last place on earth into which you would think political correctness would find its way, but I say in all earnestness that I am convinced that there is reason to be concerned that FASB is infected. Let me just give you a couple of examples.
A few years ago, we had a rash of protests concerning employee stock options. Employee stock options are particularly important to small developing companies, as a way of attracting top-flight management. There was a public outcry, at least from some quarters, about what they called obscene rates of return, the obscene earnings of some of these executives. We had a bill introduced in Congress by several of our colleagues that would have required that these stock options be charged against current earnings.
I believe that any intermediate accounting student who was making a B or better in any accounting course in any major university in America, if given the problem of determining how to account for stock options, would make the decision that they should be recognized as a possible dilution of ownership. I do not think any student in any accounting class at any major university in America, who was making a B or better, would conclude that stock options should be charged against current earnings. But yet we had an effort by FASB to require that very treatment as a general accounting standard.
Second, we had the fiasco wherein an elected official in Orange County, California, was engaged in an activity that was nothing short of speculation and clearly illegal, who ended up on the short end of derivative purchases, and as a result produced the bankruptcy of Orange County. We had a hue and outcry against derivatives. We had an effort in many quarters to end the trading of derivatives. It became a hotly debated topic in the country. Now FASB has a new rule about derivatives, and I will talk about that more in just a moment.
And there is one additional example, although I will have to say that this may have come from SEC Chairman Arthur Levitt, and I will have more to say about him in a moment. I refer to an effort to increase the number of so-called public members on the FASB and on its parent board, the Financial Accounting Foundation (FAF), so that we do not leave accounting standards in the hands of people who have a knowledge of accounting, so that we can get a broader, more public perspective on accounting standards, so that accounting standards take into account public service needs. Maybe that does not sound like the accounting equivalent of political correctness to you, but it certainly does to me.
The last thing I want is for Congress, or any arm of government, to get into the business of setting accounting standards.
Now let me turn to Arthur Levitt, the Chairman of the SEC. I think it is fair to say that Arthur Levitt has had a good relationship with me, with Senator Dodd, and with this Subcommittee. But that good relationship is about to come to an end. The idea that the Chairman of the SEC is going around this country, directly or indirectly discouraging business people from coming before the Congress, and not to exercise their First Amendment rights to petition the government, is absolutely outrageous and unacceptable.
How are we going to know what is happening in the country unless people who are actively participating in what is happening come before the Congress and tell us. The idea that we have the head of the SEC giving speeches to the American Institute of Certified Public Accountants and speeches to the Economic Club of Detroit, telling business people not to come to Congress to complain about the SEC and its decisions or FASB and its decisions, is totally unacceptable.
I want to make it clear we are not going to tolerate that. People have a right to be heard. People have a right to express their views, particularly before the Congress.
Now I understand that Chairman Levitt is today again somewhere in the country denouncing Congress, sharply attacking Congress and the banking industry for intervening in the independent process by which accounting rules are written. I do not think that Mr. Levitt has proposed that the SEC have no power to intervene. Does he want us to take that power away? Yet it seems to me that if anybody has intervened in the FASB standard-setting process, it has been the SEC. It has been the SEC that has pushed this notion of placing more public members on the FASB and the FAF. It is the SEC that has pushed FASB again and again to move ahead quickly without any national consensus with regard to the derivatives accounting standard.
So if anyone is subject to the criticism of intervening or tampering or being heavy-handed in the accounting standard setting process, it is the SEC and Arthur Levitt. It is not the Congress or this subcommittee.
Now let me conclude, before I wear out the patience of my colleagues here, by talking a little bit about derivatives. Derivatives are complicated instruments. Fundamentally, derivatives are instruments whereby people try to deal with risk. And the concern that those who have questions about the new proposal that FASB has put forward is not that we are trying to measure the risk. The concern is that risk is so difficult to measure. It is hard to look at both sides of the transaction with any degree of precision.
I think there is very legitimate concern that if all we are doing by the FASB proposal is looking at the instrument that is used to manage risk, but we are not looking at the risk itself, then far from producing a clearer financial picture, we will produce a financial picture that is cloudy. In the process, we will induce companies to avoid use of a vehicle that allows them to reduce risk, and they will be encouraged to do so in order to avoid having to show on their balance sheets a partial picture of the risks that they face. These are legitimate concerns.
I have long looked for a way of explaining financial derivatives to people, and to do so by the use of terms familiar to them. I always try to be careful about these analogies, because someone is liable to claim that I do not know the difference between fire insurance and life insurance and derivatives. But if I were going to try and explain this to my mother, the basic problem and something she would understand is that this financial derivative accounting issue is like a situation where she wants to borrow some money from the bank. The bankers look at her income and they look at her expenses, including payments for fire insurance and life insurance, and they conclude that she does not have enough money to borrow what she wants to borrow. But if she would stop paying for fire insurance and life insurance she would reduce her expenditures, and then she would qualify.
Now part of the problem we have in accounting for derivatives is very much akin to that problem. It is true that paying for fire insurance and paying for life insurance represent an outlay, but the risk of your house burning down, losing one's principal asset, also represents an exposure for the bank. And the basic problem we have in accounting for derivatives is that we want to account for derivatives but we want to be sure that we are looking at the whole risk picture.
The point today, though, is that if we are going to have generally agreed upon principles of accounting, which is the whole focus, the whole purpose of GAAP, then it is important that they be agreed upon.
I think that FASB does a great job in what they do when they allow a consensus to form, and then using wisdom and experience and expertise they mold that consensus into a general principle of accounting. But I think they get off the road and into the ditch when they try to force a consensus where there is not one, when they try to impose standards that people all across the country, in many different situations, believe are harmful to them.
After all, it is not as if the people who are going to use these standards are not the beneficiaries of the standards. The very people who would benefit from good accounting standards in many cases are the ones who have expressed concerns with the FASB proposal.
These are the statements that I wanted to make as we started our hearing today.
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