As chairman of the Financial Accounting Standards Board (FASB), Robert Herz is the most influential accountant in America. Now, more than a year into his second five-year term, Herz will oversee one of the most extensive changes to the U.S. accounting system since the days when accountants wore green eyeshades and pocket protectors. In late August, the Securities and Exchange Commission laid out a timetable for adoption of International Financial Reporting Standards (IFRS) that would put the United States on track to follow a more principles-based accounting system that reduces complexity and paves the way to a global standard. Herz has already pursued a feverish agenda at FASB and has shown that he is unafraid to take on controversial topics such as fair value and accounting for stock options.
How is FASB funded and where does it derive its authority from?
Our funding changed under Sarbanes-Oxley. Previously, we received voluntary contributions from large auditing firms through the American Institute of Certified Public Accountants and from companies. SOX put an end to that because there were concerns about conflicts of interest. We are now funded through an accounting support fee that mutual funds and public companies pay. That’s worked very well because it is a secure source of funding; it’s something we can depend on.
FASB sets standards for public, private, and nonprofit entities. For public companies, it’s really a delegated responsibility from the SEC. SOX provided that the SEC should designate a standard-setting body, and in turn, it formally assigned FASB to that role for public companies.
What was the impetus for a move toward a global accounting standard?
Before joining FASB, I was on the International Accounting Standards Board (IASB). In 2002, we met with our friends in the IASB in Norwalk, Conn., where FASB is headquartered, and put together the Norwalk Agreement, which was a framework to work together to develop global accounting standards. Most of our major projects since then have been accomplished together with a mixed staff. We’re looking to produce common standards and to work together to identify common high-quality solutions.
How has it progressed and what is the outlook for IFRS?
Last year, the SEC lifted the requirement for reconciliation to generally accepted accounting principles (GAAP) for foreign filers that use IFRS. That was step one. We look at this as a road map. At some point if there’s enough progress, the next set of issues is whether to allow U.S. companies to use IFRS and switch from GAAP.
The next step was for the SEC to put out a proposal on that, which it did in late August. That proposal, now in a comment period, would allow a limited group of major U.S. companies to begin voluntarily using IFRS as early as 2009, with a decision in 2011 whether to require the use of IFRS for all filers in 2014, 2015, or not until 2016.
To what extent is it a choice to move to a ‘principles-based’ from a ‘rules-based’ approach?
Our GAAP is much older and more mature and has much more detail and guidance. But there is a misunderstanding on this. Our system has principles, too, and not surprisingly, IFRS has some rules. There’s no doubt our accounting system has been influenced by our regulatory and legal systems, but IFRS reflects a need to have much broader application across the world. But it is not purely one or the other. There’s always been a sentiment in our country that every question should get an answer. We’re trying to move away from that.
What will be some of the biggest changes with the adoption of IFRS?
You have to train people differently…try to understand the principles and get the facts and apply judgment. It also requires changes by the regulators. It might be staggered, like [SOX Section] 404—big companies first. There is an issue of what to do with private companies. Should private companies move to IFRS and, if so, when? Should there be some kind of slimmeddown version of IFRS? It’s about two things: coming to a single set of standards, but also achieving a higher quality so there is improvement. Both sides need to adopt the advice that used to be given to the father of the bride—you’re gaining a sonin- law, not losing a daughter.
What could keep it from happening?
There are a variety of potential hurdles. Clearly, there are all the philosophical questions, which we have been talking about. Secondly, there is the question of IASB’s financing—to address that, they’ve been trying to put in place a fee structure that would provide some funding. Another challenge would concern the overall timeliness of our decisions and execution with respect to issues that we believe require prompt attention. We sometimes have moved quickly on issues, which may not always be possible on an international basis, so that will need to be addressed. All these matters are not only doable in principle, but frankly, we are satisfied that as we speak there’s progress being made on all these fronts.
There’s also constituent politics that needs to be dealt with, and while we believe that this is the right way to go to achieve high-quality standards across the globe—transparency for cross-border capital flows—there is a disproportionate cost depending on company size. The major international companies and auditors support it, and investors support it, as long as FASB is involved and remains independent, but some smaller companies say there might be little gain for the pain. That’s part of the issue.
There has been some controversy around fair-value accounting, in light of the financial meltdown. Give us your take on this situation.
It may feel like a new issue—certainly the credit crisis has placed a new light on the subject—but investors and companies should recognize that we have always had to mark down assets in down markets. The problem we have now is a market problem. We have many financial assets with little or no liquidity, and this is caused or exacerbated by the lack of transparency or infrastructure. I have a lot of sympathy for the very significant challenges in valuing assets in such conditions, but most investors have told us they support the use of fair value and appreciate the new disclosures relating to Level I, II, and III assets. Do markets overreact? Yes, absolutely. Yet it turned out, so far with hindsight, that the market has been a good predictor of problems. But the pending government “bailout” program to buy illiquid assets may change the whole dynamic, hopefully for the better.
What does the future hold for you and how have you viewed your time at the helm of FASB?
My term is five years. You can only do two terms. I’m going into my seventh year, so I will have served my full term in 2012. I would hope that my legacy is that I scored on three fronts: improvement, simplification, and convergence, and the trick is to try to do all three simultaneously.
I would hope that we have improved standards and that we have, or are now moving toward, simplification and convergence. The mission’s a great mission. It’s important to capital markets and to the economy. I would also add on a personal note that I meet all sorts of interesting people all over the world. It’s very satisfying.