[House Hearing, 111 Congress]
[From the U.S. Government Publishing Office]





                   ACCOUNTING AND AUDITING STANDARDS:
                 PENDING PROPOSALS AND EMERGING ISSUES

=======================================================================

                                HEARING

                               BEFORE THE

                    SUBCOMMITTEE ON CAPITAL MARKETS,

                       INSURANCE, AND GOVERNMENT

                         SPONSORED ENTERPRISES

                                 OF THE

                    COMMITTEE ON FINANCIAL SERVICES

                     U.S. HOUSE OF REPRESENTATIVES

                     ONE HUNDRED ELEVENTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 21, 2010

                               __________

       Printed for the use of the Committee on Financial Services

                           Serial No. 111-139







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                 HOUSE COMMITTEE ON FINANCIAL SERVICES

                 BARNEY FRANK, Massachusetts, Chairman

PAUL E. KANJORSKI, Pennsylvania      SPENCER BACHUS, Alabama
MAXINE WATERS, California            MICHAEL N. CASTLE, Delaware
CAROLYN B. MALONEY, New York         PETER T. KING, New York
LUIS V. GUTIERREZ, Illinois          EDWARD R. ROYCE, California
NYDIA M. VELAZQUEZ, New York         FRANK D. LUCAS, Oklahoma
MELVIN L. WATT, North Carolina       RON PAUL, Texas
GARY L. ACKERMAN, New York           DONALD A. MANZULLO, Illinois
BRAD SHERMAN, California             WALTER B. JONES, Jr., North 
GREGORY W. MEEKS, New York               Carolina
DENNIS MOORE, Kansas                 JUDY BIGGERT, Illinois
MICHAEL E. CAPUANO, Massachusetts    GARY G. MILLER, California
RUBEN HINOJOSA, Texas                SHELLEY MOORE CAPITO, West 
WM. LACY CLAY, Missouri                  Virginia
CAROLYN McCARTHY, New York           JEB HENSARLING, Texas
JOE BACA, California                 SCOTT GARRETT, New Jersey
STEPHEN F. LYNCH, Massachusetts      J. GRESHAM BARRETT, South Carolina
BRAD MILLER, North Carolina          JIM GERLACH, Pennsylvania
DAVID SCOTT, Georgia                 RANDY NEUGEBAUER, Texas
AL GREEN, Texas                      TOM PRICE, Georgia
EMANUEL CLEAVER, Missouri            PATRICK T. McHENRY, North Carolina
MELISSA L. BEAN, Illinois            JOHN CAMPBELL, California
GWEN MOORE, Wisconsin                ADAM PUTNAM, Florida
PAUL W. HODES, New Hampshire         MICHELE BACHMANN, Minnesota
KEITH ELLISON, Minnesota             KENNY MARCHANT, Texas
RON KLEIN, Florida                   THADDEUS G. McCOTTER, Michigan
CHARLES A. WILSON, Ohio              KEVIN McCARTHY, California
ED PERLMUTTER, Colorado              BILL POSEY, Florida
JOE DONNELLY, Indiana                LYNN JENKINS, Kansas
BILL FOSTER, Illinois                CHRISTOPHER LEE, New York
ANDRE CARSON, Indiana                ERIK PAULSEN, Minnesota
JACKIE SPEIER, California            LEONARD LANCE, New Jersey
TRAVIS CHILDERS, Mississippi
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
STEVE DRIEHAUS, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan
DAN MAFFEI, New York

        Jeanne M. Roslanowick, Staff Director and Chief Counsel
 Subcommittee on Capital Markets, Insurance, and Government Sponsored 
                              Enterprises

               PAUL E. KANJORSKI, Pennsylvania, Chairman

GARY L. ACKERMAN, New York           SCOTT GARRETT, New Jersey
BRAD SHERMAN, California             TOM PRICE, Georgia
MICHAEL E. CAPUANO, Massachusetts    MICHAEL N. CASTLE, Delaware
RUBEN HINOJOSA, Texas                PETER T. KING, New York
CAROLYN McCARTHY, New York           FRANK D. LUCAS, Oklahoma
JOE BACA, California                 DONALD A. MANZULLO, Illinois
STEPHEN F. LYNCH, Massachusetts      EDWARD R. ROYCE, California
BRAD MILLER, North Carolina          JUDY BIGGERT, Illinois
DAVID SCOTT, Georgia                 SHELLEY MOORE CAPITO, West 
NYDIA M. VELAZQUEZ, New York             Virginia
CAROLYN B. MALONEY, New York         JEB HENSARLING, Texas
MELISSA L. BEAN, Illinois            ADAM PUTNAM, Florida
GWEN MOORE, Wisconsin                J. GRESHAM BARRETT, South Carolina
PAUL W. HODES, New Hampshire         JIM GERLACH, Pennsylvania
RON KLEIN, Florida                   JOHN CAMPBELL, California
ED PERLMUTTER, Colorado              MICHELE BACHMANN, Minnesota
JOE DONNELLY, Indiana                THADDEUS G. McCOTTER, Michigan
ANDRE CARSON, Indiana                RANDY NEUGEBAUER, Texas
JACKIE SPEIER, California            KEVIN McCARTHY, California
TRAVIS CHILDERS, Mississippi         BILL POSEY, Florida
CHARLES A. WILSON, Ohio              LYNN JENKINS, Kansas
BILL FOSTER, Illinois
WALT MINNICK, Idaho
JOHN ADLER, New Jersey
MARY JO KILROY, Ohio
SUZANNE KOSMAS, Florida
ALAN GRAYSON, Florida
JIM HIMES, Connecticut
GARY PETERS, Michigan






                            C O N T E N T S

                              ----------                              
                                                                   Page
Hearing held on:
    May 21, 2010.................................................     1
Appendix:
    May 21, 2010.................................................    31

                               WITNESSES
                          Friday, May 21, 2010

Goelzer, Daniel L., Acting Chairman, U.S. Public Company 
  Accounting Oversight Board (PCAOB).............................    12
Herz, Robert H., Chairman, Financial Accounting Standards Board 
  (FASB).........................................................    10
Kroeker, James L., Chief Accountant, U.S. Securities and Exchange 
  Commission.....................................................     8

                                APPENDIX

Prepared statements:
    Kanjorski, Hon. Paul E.......................................    32
    Goelzer, Daniel L............................................    34
    Herz, Robert H...............................................    59
    Kroeker, James L.............................................    96

              Additional Material Submitted for the Record

Kanjorski, Hon. Paul E.:
    Written statement of the Independent Community Bankers of 
      America....................................................   109
Goelzer, Daniel L.:
    Written responses to questions submitted by Representatives 
      Bachus, Garrett, and Jenkins...............................   115

 
                        ACCOUNTING AND AUDITING
                      STANDARDS: PENDING PROPOSALS
                          AND EMERGING ISSUES

                              ----------                              


                          Friday, May 21, 2010

             U.S. House of Representatives,
                   Subcommittee on Capital Markets,
                          Insurance, and Government
                             Sponsored Enterprises,
                           Committee on Financial Services,
                                                   Washington, D.C.
    The subcommittee met, pursuant to notice, at 10:05 a.m., in 
room 2128, Rayburn House Office Building, Hon. Paul E. 
Kanjorski [chairman of the subcommittee] presiding.
    Members present: Representatives Kanjorski, Sherman, 
Perlmutter, Foster; Garrett, Royce, and Campbell.
    Chairman Kanjorski. This hearing of the Subcommittee on 
Capital Markets, Insurance, and Government Sponsored 
Enterprises will come to order.
    Pursuant to committee rules, each side will have 15 minutes 
for opening statements. Without objection, all members' opening 
statements will be made a part of the record.
    I yield myself 5 minutes.
    Good morning. Since the start of the financial crisis, we 
have done much work to understand its root causes and to pass 
robust reform legislation, initially in the House, and 
yesterday in the Senate, that will end the era of ``too-big-to-
fail'' financial companies; reform credit rating agency 
operations and regulations; and implement a broad array of 
sorely-needed measures that will better protect innocent Main 
Street investors from unscrupulous Wall Street operators.
    In debating these matters, accounting and auditing issues 
have surfaced more than once. As a result, the House-passed 
Wall Street Reform bill includes my reforms aimed at responding 
to the Madoff fraud by better regulating the auditors for 
broker-dealers. This legislation also contains my provisions 
designed to enhance the ability of security authorities to 
coordinate foreign and domestic investigations and to improve 
the ability of the Public Company Accounting Oversight Board to 
collect from and share information with foreign entities.
    The bill additionally includes a provision by Congressman 
Lee of New York providing for an annual accounting transparency 
hearing, like the one we are having today.
    It further incorporates a provision by Congressman Miller 
of California to create a financial reporting forum for 
regulators.
    Finally, Congressman Adler and Capital Market's Ranking 
Member Garrett, both of New Jersey, amended the bill to exempt 
small public companies from the Sarbanes-Oxley Act's 
requirements for external audits of international control, a 
provision which continues to concern me.
    At today's hearing, we will doubtlessly re-examine each of 
these matters as well as the pending Supreme Court case on the 
process for appointing members of the Public Company Accounting 
Oversight Board. We will also continue to explore whether or 
not accounting and auditing standards helped to contribute to 
the financial crisis. Decisions to move problematic assets off 
of their balance sheets allowed some companies to hide the real 
nature of their financial health. Moreover, the recent court-
appointed examiner's report of the Lehman Brothers' bankruptcy 
highlighted the troubling Repo 105 practice that some companies 
may use to embellish their financial viability and inaccurately 
portray leverage. These practices, motivated purely by short-
term self-interest, are not literary works to be admired; 
rather, they are fictional stories based on half truths that 
have no place in our capital markets.
    Accounting standards and those that apply them ought to 
portray a company's financial condition candidly and in a way 
that investors can readily understand. Today, we will also 
explore what progress regulators and standard setters have made 
to simplify our reporting framework and produce books that 
investors want to read.
    We will further examine how to improve accounting 
transparency, decrease regulatory burdens, and address old 
issues, like auditor concentration, and newer ones, like 
converging accounting rules.
    The financial crisis demonstrated just how interconnected 
our economic fortunes are. Capital now moves across 
international borders at lightning speed, as investors 
diversify their portfolios and take advantage of opportunities 
both here and abroad. Investors, therefore, need to have access 
to timely, accurate financial information that allows them to 
make apples-to-apples instead of apples-to-oranges comparisons 
at similar companies around the world.
    While we have moved quickly on converging global accounting 
standards, we must also proceed carefully to ensure that these 
rules produce high-quality results for investors. America's 
markets and its financial reporting framework are among the 
most developed in the world because of the independence of 
standard setting and enforcement. To protect the credibility of 
our markets and to instill investor trust, we must ensure that 
any new international system continues to adhere to the core 
principles of independence, transparency, and accuracy.
    In closing, I look forward to hearing from today's 
witnesses on the state of accounting and auditing regulations, 
the progress they have each made in improving standards and 
enforcement, their priorities, their coordination efforts, and 
the challenges they now or may soon face. I thank each of them 
for coming and look forward to their testimony.
    I now recognize the gentleman from New Jersey, the ranking 
member, Mr. Garrett, for 5 minutes.
    Mr. Garrett. I thank the chairman for this important 
oversight hearing today.
    Thank you to all the witnesses who are here today.
    With all the changes occurring in our regulatory structure, 
I look forward to all your testimony, the reason being that 
accountants and auditors do play a crucial role within our 
financial markets of ensuring that investors basically have the 
appropriate and reliable information.
    I would like, though, to begin my comments by mentioning 
the current case that is before the Supreme Court to determine 
the constitutionality of the Public Company Accounting 
Oversight Board, the PCAOB, that was created by the Sarbanes-
Oxley Act, or SOX.
    Let me be clear, I believe that the PCAOB, as currently 
established, is unconstitutional. I believe it is in direct 
violation of the appointments clause. And I believe that when 
the Supreme Court ruling is delivered, maybe as early as next 
week, they will agree with me on that point.
    Several Congresses ago, I started a caucus in the House 
called the Constitution Caucus, and one of the goals of that 
caucus is to educate other Members of Congress about the 
constitutional limitations on congressional actions in 
legislation. Too many times, Members of this body simply 
abdicate their responsibility to examine each law and determine 
whether it adheres to the Constitution or not.
    Our Founding Fathers expressly stated that it is incumbent 
on all three branches of government, not just the Judiciary, to 
examine and determine the constitutionality of each law before 
them. So no Member of Congress should ever pass legislation and 
say, we will just let the courts decide if this is 
constitutional or not. Each Member must look at each law and 
determine for themselves if the legislation is within the 
confines of the Constitution. Maybe if more Members had done 
this, for example, with the health care bill, we wouldn't have 
passed a basically unconstitutional monstrosity like the House 
and Senate did.
    So, partly in response to my concerns on the 
constitutionality of PCAOB, I introduced legislation 3 years 
ago, we called it the Amend Misinterpreted Excessive Regulation 
in Corporate America Act, which basically came out to be the 
AMERICA Act. And one provision in the AMERICA Act just simply 
attempted to fix the appointment clause at the heart of the 
current Supreme Court case by requiring that the PCAOB, the 
Board, be appointed directly by the President and confirmed by 
the Senate. If you think about it, had more of my colleagues 
focused on this issue then, perhaps we would not have had to 
engage in this very long and drawn out and also costly legal 
battle that is going on across the street.
    And when you consider the constitutionality of the PCAOB, 
it has been given question for a number of years, I am not sure 
why we are giving this same body additional powers and 
authorities until this is determined. We marked up legislation 
affecting the PCAOB in November of 2009, and less than a month 
later, the Supreme Court was hearing arguments as to whether or 
not the entity should even exist.
    I believe it is prudent before Congress gives different 
entities more powers, that we make sure that those entities are 
operating in a manner in accord with the Constitution.
    Now, another issue from the Sarbanes-Oxley law currently 
being debated as part of the financial regulatory reform 
package is whether to permanently exempt small businesses from 
the costly independent auditor attestation of management 
internal controls. Now, I know my good friend here, Chairman 
Kanjorski, and I differ on this topic, but during this economic 
downturn, where thousands of small businesses across the 
country are really struggling just to make payroll, I don't 
really see how adding one more costly, burdensome regulation--
which at best has dubious benefits--will help improve the 
number of jobs in the country or improve the economy.
    And so I will repeat my comments from yesterday by stating 
that this is one of numerous ways we can help small businesses 
without creating another TARP program or throwing another $30 
billion at deficit spending.
    In regards to the Financial Accounting Standards Board, 
FASB, I look forward to hearing how the changes and additional 
guidance you have provided to fair accounting so far have 
worked. I would also like to explore in greater detail with 
both FASB and the SEC the recent changes to the securitization 
rules and 166 and 167 and regulation A-B and the potential 
impact that those new rules, when you combine them and couple 
them with the new proposals, will basically have on the 
availability of the cost of credit.
    I am also very interested in learning further on the 
progress, as some of you have talked about, of international 
convergence of accounting standards. I believe this is a 
critical long-term goal for international competitiveness, and 
I want to make sure that we are moving forward, as I think we 
will probably hear, on this expeditiously.
    So, again, I want to thank the chairman for holding this 
oversight hearing. I think general oversight hearings with 
government regulators are very informative; they allow us as 
Members to discuss a wide range of issues. We are going to do 
another such hearing next week with the FHFA, and later on in 
June with the SEC and Chairman Schapiro. I do look forward to 
those.
    And once again, I thank the members of the panel before us.
    I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Garrett.
    I will now recognize the gentleman from California, Mr. 
Sherman, for 5 minutes.
    Mr. Sherman. I thank the chairman for holding these 
hearings. Due to my flight schedule, I may not be here to the 
very end, but I recognize the importance of these hearings.
    The chairman comments on the action taken by the Senate. I 
have been informed that the Senate passed the bill without 
passing the manager's amendment. If that is true, then section 
210(n)10 remains a phony limit on the amount that the FDIC can 
borrow of taxpayer funds in order to help the creditors of 
defunct financial institutions. I am confident that anyone who 
voted for the bill in the Senate really intended the manager's 
amendment to be part of it, and I am confident that those 
limits, which are so important to the bailout versus nonbailout 
question, will be dealt with.
    These hearings are on auditing standards and accounting 
principles. I will leave to others the discussion of the 
auditing standards and the discussion of section 404, because 
accounting principles are so important.
    Corporations dedicate their focus to showing higher 
earnings per share. He who controls the rules controls the 
behavior of corporate America. The FASB, therefore, has the 
highest ratio of anonymity-to-power of any entity in the 
business world.
    I have been one of the loudest voices in Congress for the 
independence of the FASB, not because I was convinced they were 
doing a great job, but because I thought they could do better, 
and I wasn't so sure that Congress would be helpful. And I was 
also told again and again, don't worry, international standards 
are on the way, and they will solve all the problems.
    Mr. Herz, we will get the international standards when you 
and I get hair.
    And so, we do have to take a look at whether the accounting 
standards make any sense from an accounting theory standpoint.
    Accounting theory would tell you that two companies should 
be comparable and that companies that are virtually identical 
should have identical results, notwithstanding superficial 
differences, and yet we still have one company to choose LIFO 
and another company to choose FIFO. Why? Because accounting 
theory isn't as important as just keeping everybody happy: Let 
the business world do what they want; investors, figure it out 
on your own.
    We dealt with some non-optional requirements with stock 
options, and I think that may have been a step in the right 
direction. As to mark-to-market, these much ballyhooed rules 
don't really give you comparability, because if one bank 
invests in a $100 million loan on a shopping center which they 
hold for their own portfolio, they made the loan the old 
fashioned way, and another invests in $100 million worth of 
collateralized debts, collateralized by shopping centers, 
perhaps identical shopping centers, the two would be treated 
differently under this rule. And yet, all the shopping centers 
are down in value, not just the ones where the debt happened to 
be securitized.
    But the biggest problem the FASB has is the desire to go 
with the verifiable rather than the relevant, the desire to 
make it easy on the auditor rather than useful for the 
investor. And the best example of this, and by far the most 
harmful act that nobody ever talks about, is FAS 2, which 
requires the write-off of all research expenses; penalizes 
those companies that choose to do research, while we in 
Congress are providing large benefits to those same companies, 
and while I think most people agree that the success of America 
depends upon the research done in the private sector. This 
isn't good accounting. Good accounting says you are supposed to 
capitalize research expenditures that provide useful results.
    Why do we have FAS 2? Because good accounting theory would 
require accountants to distinguish between useful and useless 
research projects. That is difficult. That is like eliminating 
the strike zone in baseball and saying every pitch is a strike 
because the umpires don't want to be second-guessed as to their 
ball and strike calls. The fact is, for us to be penalizing 
those corporations that engage in research, making them write 
off the money they spend, providing higher earnings per share 
to those companies that choose not to do research, and to do 
this, not only in the high-tech sector where I think investors 
may be savvy enough to adjust for it, but in the rest of our 
economy where research is also important, is the most harmful 
thing that has been done to our economy that nobody knows 
about.
    So I look forward to going back to good accounting, when it 
comes to research, instead of adopting a system that is easy 
for the umpire and terrible for everyone in the ballpark.
    I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Sherman.
    I now recognize the gentleman from California, Mr. 
Campbell, for 3 minutes.
    Mr. Campbell. Thank you, Mr. Chairman.
    I am one of the two CPAs on the committee here, along with 
my California colleague, Mr. Sherman.
    I remember when I was first getting my certificate and 
accounting was a very nice, steady thing, boring, and one of 
the three of your organizations didn't even exist. We would 
have probably never had this hearing because nobody would have 
cared and nobody would have come, but unfortunately, I guess 
that is not the case anymore.
    And accounting, as my colleague, Mr. Sherman, pointed out, 
for many entities and many things is now under a great deal of 
scrutiny and under the spotlight.
    One thing we do not, any of us, want this to yield is that 
we up here in Congress start to dictate accounting standards. 
That is the worst possible result we could ever get to because 
we will politicize them, and we will not make judgments on the 
basis of proper accounting, good accounting, any kind of 
reasonable judgement; we will make them on the basis of what 
groups here are powerful and what ones are not, and have 
different accounting standards for the same companies that are 
different sizes or in different States or with different 
treatments. We don't want to go there, and we don't want to be 
there.
    But because of the focus on accounting, it means that FASB 
and other organizations will need to be more responsive and I 
think quicker in response to things that have happened out 
there.
    A few things that I would like to talk about is, one thing 
we do deal with are reporting standards for public companies 
and also banking regulations. And a couple of things I will 
mention in my short time here that hopefully will come out over 
time is, I am, for example, supportive of going from quarterly 
financial statements to every 6 months financial statements, 
and other things that we might do in order to try and reduce 
volatility in the markets.
    My colleague, Mr. Garrett, mentioned harmonization with 
international accounting standards. I would like to hear what 
you all think is happening or can happen and so forth on that 
because we shouldn't be having situations where two 
international companies based in different countries have 
completely different accounting reporting on the same 
fundamental results.
    What is going to happen if--the banking sector is far from 
being out of the woods and far from being out of the problems 
of 2008--banking regulations start diverging from accounting 
regulations? If some of the things that we do and are looking 
at in terms of reserves and so forth diverge from accounting?
    And also, I wondered about financial statements and 
financial reporting in general. It hasn't changed a whole lot 
since when I took the exam some years ago, decades ago, but yet 
markets today are using a whole lot of other measures and 
metrics to evaluate the performance of companies than the 
traditional three financial statements that we have been 
putting out for decades and decades. Now, much of that 
information may be derived from audited results, and I 
understand that, but should we be taking a look at what we are 
auditing and what we are reporting, given the realities of the 
market today?
    I yield back. Thank you, Mr. Chairman.
    Chairman Kanjorski. Thank you very much, Mr. Campbell.
    I will now recognize Mr. Sherman for 5 seconds to clarify.
    Mr. Sherman. I misspoke in a way when I said the manager's 
amendment had not been adopted by the Senate. They adopted the 
first manager's amendment. They failed to adopt the second 
manager's amendment, and we can breathe a little easier.
    I yield back.
    Chairman Kanjorski. Only an accountant would want to 
correct--
    Mr. Sherman. It is an occupational hazard, Mr. Chairman.
    Chairman Kanjorski. I now recognize the gentleman from 
Colorado for 2 minutes.
    Mr. Perlmutter. And it will be much shorter than that.
    I just appreciate you all being here today. We tangled a 
little bit the last time you all were here.
    And I just want to say thank you to--working with various 
people, various parties, various industries in helping us move 
through a very difficult time for this country financially.
    And I would say to my friend, Mr. Campbell, I agree, for 
the most part, the accounting profession, there are a lot of 
objective kinds of things, two plus two equals four. We have 
come through a time, though, where there was some subjective 
analysis that had to be involved. And I just appreciate the 
willingness of the Board, of the different agencies for looking 
at bigger picture and, quite frankly, helping us get through 
very difficult periods. So I look forward to your testimony, 
and appreciate you being here today.
    Thank you. With that, I yield back.
    Chairman Kanjorski. Thank you, Mr. Perlmutter.
    I now recognize the gentleman from Illinois for 3 minutes.
    Mr. Foster. Thank you, Mr. Chairman.
    In the wake of the financial crisis that we went through 
and the largest destruction of wealth in human history, of 
approximately $17.5 trillion of household net worth in the last 
18 months of the previous Administration, a lot of attention 
has focused on the procyclical versus countercyclical effects 
of accounting standards. And much of the attention has focused 
on providing relief after the bubble has burst.
    I think it is more important to adopt countercyclical 
accounting standards that actually suck energy out of the 
bubble on the way up. And it seems to me that the key principle 
there is to treat skeptically the value of recently appreciated 
assets. We are going to have a workshop next month at the 
American Enterprise Institute, which will include Alex Pollock 
and Mark Zandi, two frequent witnesses in front of this 
committee, on preventing the next real estate bubble, which I 
think is the single most important thing we have to do.
    We are going to look, first, among other things, 
specifically at proposals to calculate the loan-to-value for 
mortgages using not simply the current market price but the 
current market price deflated by the amount that real estate 
has gone up regionally in the last several years. And if that 
had been in place, I think it is very clear that that would 
have just sucked all the energy out of these enormous real 
estate housing bubbles that we have gone through and that have 
been the big dog in destroying net worth. So that is one of the 
specific things I would like to hear your reactions on.
    Second, the PCAOB I found to be a very interesting model as 
the possible way forward for the oversight of the rating 
agencies. I think, frankly, that there is no satisfactory 
solution to the conflict of interest in the rating agency 
models. The PCAOB was an attempt to deal with similar conflicts 
of interest in the accounting business, and I would be very 
interested in people's general reaction on how effective that 
approach has been because it is, to my mind, the best stab at 
that. And I was partly successful in getting amendments into 
the regulatory reform bill.
    The third issue has to do with the high-frequency 
accounting standards for firms, especially large trading firms, 
where things can fluctuate on a day-to-day or hour-to-hour or 
even minute-to-minute basis. You are not going to be able to 
just publish reports that continuously update, but we are going 
to need to have some mechanism of looking over the shoulder of 
these large firms with very high volatility to understand and 
to give investor confidence that there are at least systems in 
place so that there is good real-time monitoring of these, and 
that is different than just publishing a report every 6 months 
or a year. Anyway, those are what I see are the big issues 
here, and I look forward to your testimony.
    Chairman Kanjorski. Thank you very much, Mr. Foster.
    Are there any other members who desire time? If not, we 
will move to our panel.
    Thank you for appearing today before this subcommittee. 
Without objection, your written statements will be made a part 
of the record. You will each be recognized for a 5-minute 
summary of your testimony.
    And, first, we have Mr. James Kroeker, Chief Accountant, 
U.S. Securities and Exchange Commission.
    Mr. Kroeker.

     STATEMENT OF JAMES L. KROEKER, CHIEF ACCOUNTANT, U.S. 
               SECURITIES AND EXCHANGE COMMISSION

    Mr. Kroeker. Chairman Kanjorski, Ranking Member Garrett, 
and members of the subcommittee, I am Jim Kroeker, Chief 
Accountant in the Office of the Chief Accountant, which advises 
the Commission on accounting and auditing matters, and I am 
pleased to testify today on behalf of the Commission.
    One of the lessons from the financial crisis is that 
financial reporting plays a critical role in establishing, 
maintaining, and, in certain cases, rebuilding investor 
confidence. The objective of financial reporting is to provide 
decision-useful information for capital allocation. Market 
participants must be confident that the information they 
receive is neutral, it is reliable, and it portrays the 
economic results in an accurate and faithful manner.
    As the agency empowered to be the investors' advocate, the 
Commission is responsible for this reporting. To further ensure 
the integrity of this reporting, the Federal securities laws 
mandate that an independent audit by qualified professionals be 
performed.
    As more fully described in my written testimony, in 
discharging our responsibilities, we oversee the work of the 
FASB and the PCAOB, and we do that to monitor existing 
accounting and auditing standards for potential improvement, 
and to increase consistency in the application of those 
standards.
    Let me just outline from my written testimony some of the 
pending proposals and emerging issues in these areas. Let me 
turn first to what is often referred to as off-balance sheet 
accounting. Last year, the FASB issued standards relating to 
the accounting and the related disclosure with respect to what 
are often referred to as special purpose vehicles, which 
include many securitization structures. The new standards 
should enhance financial reporting by better portraying a 
company's risk exposure. Of course, we will continue to review 
the reporting practices to determine if companies are complying 
with their requirements, and we will continue to see whether 
further improvement is warranted.
    We are also focused on the Commission's ongoing 
consideration of global accounting standards and the 
convergence of U.S. GAAP and IFRS. The Commission is engaged in 
significant efforts toward the development of a single set of 
high-quality, globally accepted standards. These efforts are 
reaching a critical stage, and in February, the Commission 
directed my office to execute a work plan to evaluate the areas 
relevant to further incorporating IFRS into the U.S. financial 
reporting system. We will begin providing public progress 
reports on our work no later than October of this year.
    Another critical component to our consideration is 
convergence between the FASB and the IASB, which is further 
covered in my written testimony.
    Turning to auditing, PCAOB oversight of the auditing 
profession has provided clear benefits to financial reporting 
quality and to investor protection. As you may know, the PCAOB 
is currently facing a constitutional challenge before the 
Supreme Court, but we are hopeful that the PCAOB's 
constitutionality will be upheld so its important work can 
continue uninterrupted. If not, the Commission stands ready to 
issue any necessary guidance to provide continuity. If 
congressional action is needed, we will promptly provide 
technical assistance so changes can be considered as quickly as 
possible.
    Another challenge facing the PCAOB is the inspection of 
overseas auditors whose reports are filed with the Commission 
or who perform audit work for U.S. issuers. Access to these 
firms has been hampered by the PCAOB's inability to share 
information with their foreign counterparts. I would like to 
thank Chairman Kanjorski and this subcommittee for their 
leadership in including a provision to address this issue in 
the House regulatory reform bill.
    I would also like to thank the chairman and this 
subcommittee for another provision in the bill to address the 
important issue of PCAOB oversight of auditors of broker-
dealers. Clarifying the PCAOB's authority will improve audit 
quality and strengthen both investor protection and broker-
dealer compliance.
    In closing, a significant lesson from the recent crisis is 
the same one underlying the commitment to securities regulation 
over 75 years ago, that is, transparent financial reporting is 
critical when pressures are highest and investor confidence may 
be shaken by uncertainty.
    Thank you for the opportunity to appear today. I am happy 
to answer any questions that you may have.
    [The prepared statement of Mr. Kroeker can be found on page 
96 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Kroeker.
    Next we have Mr. Robert Herz, chairman, Financial 
Accounting Standards Board.
    Mr. Herz.

  STATEMENT OF ROBERT H. HERZ, CHAIRMAN, FINANCIAL ACCOUNTING 
                     STANDARDS BOARD (FASB)

    Mr. Herz. Chairman Kanjorski, Ranking Member Garrett, and 
members of the subcommittee, thank you for inviting me to 
participate in today's hearing.
    The FASB is an independent private sector organization 
whose mission is to establish standards of financial accounting 
and reporting for U.S. nongovernmental entities. Those 
standards are recognized as authoritative Generally Accepted 
Accounting Principles, or GAAP, by the SEC for public 
companies, and by the American Institute of Certified Public 
Accountants for other entities.
    GAAP is essential to the efficient functioning of the U.S. 
economy because investors, creditors, donors, and other users 
of financial reports rely heavily on credible, transparent, 
comparable, and unbiased financial information to make their 
resource allocation decisions.
    An independent standards-setting process is the best means 
of ensuring high-quality accounting standards since it relies 
on the collective judgment of experts informed by the input of 
all interested parties through a thorough, open, deliberative 
process.
    However, we also fully appreciate that the FASB does not 
operate in a vacuum. The FASB is accountable in two important 
ways: first, by engaging in robust due process in setting 
standards, including wide consultation with stakeholders; and 
second, by being subject to oversight conducted in the public 
interest by both the Financial Accounting Foundation's Board of 
Trustees and by the SEC.
    Our very extensive process involves public meetings, public 
roundtables, visits to interested parties, and of course the 
exposure of our proposals for public comment. We meet regularly 
on both a formal and informal basis with the SEC and the PCAOB 
and their staffs, and with bank regulators. FASB and FAF also 
regularly brief Members of Congress and their staffs on 
developments. Indeed, a number of FAF trustees and FASB Board 
members will be meeting with Members of Congress next week.
    Over the past year, the FASB had acted vigorously to 
improve U.S. GAAP, especially by addressing reporting issues 
emanating from or highlighted by the financial crisis. The 
standards we issued in 2008 and 2009 made improvements to U.S. 
GAAP in a number of areas, including: the valuation of 
financial assets, especially in inactive markets; 
securitizations and other involvements with special purpose 
entities; accounting and disclosure for impairments, credit 
default swaps, and other derivatives; and for financial 
guarantee insurance. In these and other standards we have 
issued in recent years, we have focused on communicating clear 
objectives and principles supported by a sufficient level of 
implementation guidance.
    The FASB has also reduced complexity in the U.S. financial 
reporting system through the launch last July of the Accounting 
Standards Codification. The codification will benefit everyone 
in the financial reporting system by replacing the previous 
myriad of separate accounting pronouncements with an easily 
accessible, topically organized online research system which 
also links in the XBRL U.S. GAAP financial reporting taxonomy.
    During the past year, we have made good progress working 
with the International Accounting Standards Board on projects 
aimed at improving both U.S. GAAP and international financial 
reporting standards, and achieving convergence between those 
standards. Many of these projects are nearing their exposure 
draft stage.
    On some of the projects, I believe the Boards are on track 
to both make the desired improvements to U.S. GAAP and IFRS and 
achieve convergence, while on other projects, achieving 
substantial convergence is proving to be quite a challenge. Let 
me be clear, we are committed to and are making every effort to 
foster convergence between U.S. GAAP and IFRS, but consistent 
with our mandate under Sarbanes-Oxley, we must also ensure that 
the resulting standards represent improvements that are in the 
best interests of U.S. investors and other users of U.S. GAAP 
information. My written testimony also details our extensive 
efforts regarding the private company and not-for-profit 
sectors.
    I have also been asked to comment on financial arrangements 
that companies may employ to manage their financial position 
near the end of a reporting period, presumably including 
arrangements such as the so-called Repo 105 transactions 
engaged in by Lehman Brothers. As I explained in a letter to 
the committee last month, the FASB does not have any regulatory 
or enforcement powers, but we do work very closely with the SEC 
and stand ready to take any additional standard-setting actions 
that may be appropriate as they obtain further information 
concerning the practices of financial institutions.
    In conclusion, the demands on accounting standard setters 
that stemmed from the financial crisis, together with the goals 
of continuing to improve U.S. GAAP and achieving convergence 
between U.S. GAAP and IFRS, have made this past year one of the 
more challenging in the FASB's 37-year history, and I expect 
that the coming year will also be equally as challenging.
    I thank you again, and I would be pleased to respond to any 
questions.
    [The prepared statement of Mr. Herz can be found on page 59 
of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Herz.
    And finally, we will hear from Mr. Daniel Goelzer, Acting 
Chairman, U.S. Public Company Accounting Oversight Board.
    Mr. Goelzer.

 STATEMENT OF DANIEL L. GOELZER, ACTING CHAIRMAN, U.S. PUBLIC 
           COMPANY ACCOUNTING OVERSIGHT BOARD (PCAOB)

    Mr. Goelzer. Thank you.
    Chairman Kanjorski, Ranking Member Garrett, and members of 
the subcommittee, I appreciate the opportunity to appear before 
you today on behalf of the Public Company Accounting Oversight 
Board.
    Congress created the Board in 2002 to provide rigorous, 
independent oversight of public company auditors. I would like 
to summarize how we discharge our responsibilities and how the 
Board has responded to issues raised by the financial crisis. I 
also want to mention some challenges we currently face.
    The Board has four basic functions:
    First, no accounting firm may prepare, or substantially 
contribute to, an audit report for a company that files 
financial statements with the Securities and Exchange 
Commission without first registering with the PCAOB. There are 
currently about 2,500 Board-registered accounting firms, in 87 
countries.
    Second, the Board conducts a continuing program of 
inspections of registered firms' public company auditing, 
including reviews of individual engagements and evaluations of 
firms' systems of quality control. Since 2003, the Board has 
performed more than 1,300 such inspections and reviewed aspects 
of over 6,000 audits, including 173 non-U.S. inspections.
    Third, the Board has broad authority to sanction firms and 
associated persons that violate applicable laws and standards. 
The PCAOB has announced the resolution of 31 enforcement 
proceedings. These cases do not, however, fully reflect the 
Board's enforcement activity since they do not include ongoing 
investigations and contested disciplinary proceedings which 
are, by statute, nonpublic.
    Fourth, the Board sets the professional standards for 
public company auditing. The Board has an active program to 
update and strengthen the auditing standards. Our standards-
setting agenda is appended to my written testimony.
    I want to turn next to the financial crisis. The financial 
crisis affected our work in three basic ways.
    First, our inspections program is designed to focus on 
difficult audit issues. We are currently reviewing the results 
of the recent inspection cycles and intend to prepare a report 
on findings related to the impact of the financial crisis on 
auditing.
    Second, this inspection experience has also informed 
several ongoing standards-setting projects, including risk 
assessment, use of specialists, and auditor communications with 
audit committees. In addition, the Board's chief auditor has 
issued a series of Practice Alerts on crisis-related audit 
issues.
    Third, the enforcement staff has opened several 
investigations related to audits of public companies involved 
in the financial crisis. As I have noted, these matters are 
non-public.
    Before closing, I want to mention three challenges we 
currently face. First, we are not able to conduct inspections 
in the European Union, Switzerland, or China. Significant audit 
work on which investors in SEC-reporting companies rely occurs 
in these countries. One of the obstacles, particularly in the 
EU, has been the Board's inability to share confidential 
inspections and investigation information with foreign audit 
oversight authorities.
    Section 7602 of the Wall Street Reform Act, passed by the 
House last year, would correct this problem. The Senate 
financial services bill contains a similar provision. 
Hopefully, enactment of the information-sharing provisions will 
allow EU inspections to go forward.
    The second challenge relates to overseeing auditors of 
securities broker-dealers. While such auditors must register 
with the PCAOB, we currently lack any authority over their 
work. Both the Reform Act and the Senate financial services 
bill would extend Board inspections, enforcement, and standard-
setting to audits of broker-dealers. That would close the gap 
between broker-dealer auditor registration and Board authority 
over these firms.
    Finally, there is a pending challenge to the Board's 
constitutionality. That litigation, now before the U.S. Supreme 
Court, deals principally with the way in which Board members 
are appointed and the circumstances under which we could be 
removed. I expect the Court to issue its decision within the 
next few weeks.
    The PCAOB won in the District court and in the Court of 
Appeals, and we hope the Supreme Court will reach the same 
result. If the PCAOB does not prevail--and the decision 
requires a legislative change--I would urge Congress to act 
quickly to fix whatever structural problems the Court 
identifies. The need for investor protection through 
independent oversight of the auditing profession is as great 
today as in 2002 when the Board was created.
    My written statement covers these topics in greater detail, 
and I would ask that it be made a part of the record. I would 
be happy to answer any questions.
    Thank you.
    [The prepared statement of Mr. Goelzer can be found on page 
34 of the appendix.]
    Chairman Kanjorski. Thank you very much, Mr. Goelzer.
    I thank the panel for their testimony, and I suspect we 
have some questions here from our panel.
    Not to be facetious, Mr. Kroeker, I ask the question: Why 
do I get the feeling, sometimes, that we are playing a game of 
cops and robbers, waiting always behind the fact to find out 
what happened and then to close ``loopholes'' or take 
positions?
    The Repo 105 problem, was that not observed and was that 
not evaluated at some point to be an attempt to avoid 
transparency, and if that were the case, does the SEC not have 
the authority, in conjunction with these other entities, to 
propound rules to prevent that from happening? Rather, if you 
do not have that authority, why was that not requested of the 
Congress for additional authority?
    All these questions predicate on the fact that when I talk 
to my constituents, they are not nearly as sophisticated as you 
all are, but they do not understand why we are always catching 
up, playing the game of catch up, as opposed to why we do not 
have a system that prevents some of this abuse. Maybe you can 
give me--
    Mr. Kroeker. I suspect, in some respects, it goes back to 
the issue of, are we going to continually be playing cops and 
robbers? It goes back to human nature in that when a standard 
is put in place, there are very ingenious people who work to 
design around that.
    One of the things that the SEC did coming out of the post-
Enron reforms was to do a study on accounting standards 
themselves, recommending the proper balances to come up with an 
objectives-based standard; that is, we shouldn't lean too 
heavily on only principles by which you can circumvent the 
principle or try to circumvent the principle by creative 
structuring. But if you lean too heavily on a rules-based 
system, we have seen the outcome of people saying, well, the 
rule didn't catch me, if you will, suggesting an optimal 
balance, in our view, of sufficient specificity of the 
objective of the standard, coupled with guidance that would 
help you operationalize that in practice. A number of the 
FASB's recent standards I would characterize in that vein, 
their standard on business combinations, their relook at off-
balance sheet accounting and Statements 166 and 167 that dealt 
with off-balance sheet and securitization accounting, providing 
a clear objective of the standard.
    So I suspect that, in some form, it will be human nature 
for some small minority to try and escape that, but the second 
piece of that question then is, do we have the authority? And 
yes, we do have the authority.
    And important in my mind or my way of thinking, an 
important element of ensuring that the conduct doesn't 
continue, is enforcing standards where standards are already in 
place as opposed to suggesting that the standard itself should 
change if the standard is clear.
    Chairman Kanjorski. Well, in enforcing those standards, are 
we remiss in giving you certain authority? Let us say an 
accounting firm purposefully concentrates on avoidance for the 
purpose of changing leverage or giving a false impression of a 
company's financial condition--and that is quite apparent from 
what went on, nothing is 100 percent, but the high probability 
is up in the 90 percentile--do you have the power to say, 
``Look, if you persist in that type of operation, we are not 
only going to put some conditions on the company, or 
potentially fines or what can be levied, but we are going to 
bar you from practicing, that you are just not going to be 
allowed, for a given number of years, or we are going to fine 
you individually as an accounting firm?'' It just seems to me 
we are constantly chasing--I use the term ``cops and 
robbers''--to the level of real frustration.
    I am trying to think of the operation down there in the 
South, the guys putting the accounts offshore, Stanford 
Financial. That was observed for a number of years, what he was 
doing, and that it was putting in jeopardy investors and 
citizens. When I talk to those groups, they just thought it was 
clearly something that government regulation had addressed and 
would not allow to happen. Now, that was not under the SEC, 
that was under bank regulators and others that would have the 
authority there, but it seems to me people just said, ``Well, 
it is not a clear case for us to get involved in, so we are not 
going to get involved in it.''
    I guess the question I am asking you is: Is there something 
we can put in this reform bill now that makes it so clear that 
we are just not going to take it anymore, not just for creative 
accounting, but also for fraudulent accounting, for avoidance 
of truth, and injury to the average investor? Is there 
something we can do here?
    Mr. Kroeker. Well, we do have authority, including 
authority of barring accountants from appearing and practicing. 
We have used that authority with respect to firms, I believe, 
since the 2002 era, about 66 times against firms and multiple 
of that against individual accountants. I can certainly think 
more fully and get back to you if there are more specifics.
    Chairman Kanjorski. I would appreciate that.
    I am going to take 1 more minute, even though I am over 
time. It violates what I call the ``bastard rule.'' I want to 
lead in with that because it sounds as if I am assuming that 
all accountants do not do their job. The fact is that most 
accountants and most business executives do the right thing, 
want to do the right thing, want to engage in fairness in their 
businesses. However, if you have an element of 3 or 5 percent--
those are my ``bastard violators''--you almost get forced into 
doing the same thing they did, or you are going to be at a 
decided disadvantage after a while. We have to find a way of 
getting them out of the system, so join me in my ``bastard 
hunt,'' if you will.
    Mr. Kroeker. I agree.
    Chairman Kanjorski. The gentleman from New Jersey.
    Mr. Garrett. Thank you. And I thank the panel again.
    You may have heard, if you were listening to the hearing 
that we had the other day, I gave an example of a company in my 
district that manufactures products for our troops overseas. 
The company has a $3.5 million market cap, they have about 30 
employees, the CEO, the CFO, and the COO work basically in the 
same room, if you will. And they told me weeks or a month ago 
that if they don't receive a permanent exemption from the 
404(b) requirements, they will have to pay upwards to $100,000 
by the end of the second quarter to get things up and working 
to be in compliance. So that is only 4, 5, 6 weeks away.
    So, in light of where the economy is right now, I guess the 
short question is, what do I go back to tell them, that it is 
better that they spend about $100,000 to be in compliance with 
a little tiny company like them with 404(b) as opposed to using 
$100,000 to hire another employee or two or make sure their 
stuff is up to snuff with regard to what they are sending 
overseas to our troops?
    Mr. Kroeker. The objective of the auditors opining on or 
giving an opinion with respect to 404 wasn't to put in place a 
costly or non-beneficial requirement. And investors that I 
speak to almost unanimously, both with respect to individual 
companies, but as well as the financial system as a whole, 
indicate that they receive significant benefit from knowing 
that there is increased quality to financial reporting. It goes 
back to the 1977 Foreign Corrupt Practices Act where an 
integral part of strengthening financial reporting is strong 
internal controls.
    That doesn't mean that the cost should be disproportionate. 
The SEC, working with the PCAOB, has taken a number of steps to 
reform the costs going back to the outset of 404 and what we 
have heard--
    Mr. Garrett. You have to admit, $100,000, when you are 
dealing with little tiny company, a $3.5 million mark cap 
company, it is a lot of money. So I just don't know where, when 
you are talking about the transparency that you are trying to 
get with a little company like this, does the cost really meet 
the benefits? Isn't there some level that maybe the cost 
exceeds the benefits when you are getting down to this size? 
That is not talking about when you talk about the GMs of the 
world--or who knows whether GM--I guess we have a whole 
different situation with GM, let's see how well it worked with 
them, right?
    Mr. Kroeker. Again, the confidence that the individual 
investor has when they put their money at stake in a company of 
that size, we hear from them, that they take tremendous 
confidence, not just from the GAAP financials, but the process. 
And I appreciate that obviously there is then balancing that 
tradeoff between what are the costs and what are those 
benefits?
    Mr. Garrett. Well, someone just mentioned to me, with 
regard to the SEC itself, with regard to their own internal 
control requirements, that GAO has certain internal audit 
requirements. Is it the case that the SEC has not met their own 
requirements that set those audits?
    Mr. Kroeker. The GAO does effectively the equivalent of 
404(b), the auditor opinion--
    Mr. Garrett. How did the SEC do?
    Mr. Kroeker. We did have a material weakness. And the 
process by which we looked at our own controls, and the GAO 
taking an independent look at that, has actually caused a 
significant increase in our internal focus on financial 
reporting.
    Mr. Garrett. So we are asking this little company to try to 
meet some standards that the SEC can't meet. Now, of course, 
the different is the SEC gets all the money they need basically 
to do so, and this little company here is just--I don't want to 
say they are holding on, that would make them sound like they 
are not doing well, I think they are doing okay.
    You can see how the CEO of a company like this might say, 
``Hey, it doesn't seem right. The SEC can't even meet its 
standards, and yet they are coming in and saying that we are 
supposed to meet a standard that they can't even meet.'' Do you 
see the problem I have in discussions with folks like that?
    Mr. Kroeker. The standard, itself, is an opinion on 
controls, the same as the opinion, taking a self-look at 
controls, the SEC internally reported a material weakness and 
the GAO agreed, so it is the same assessment that we are asking 
companies to do.
    Mr. Garrett. But they just can't do it.
    Just in the time that I have left, so we have the 
discussion with regard to trying to look at companies with 
regard to SIBs outside, these may be one of the areas we had 
problems with these in the past, where the companies actually 
had controls of the SIBs in the past, and say that they should 
all be on their own balance sheet, right? And that is a good 
thing? One word answer.
    Yes. You are nodding yes. And so if that is a good thing, 
if we want to have transparency and openness and what-have-you, 
shouldn't we really be doing the same thing for the Federal 
Government? Don't we have an entity right here with the GSEs, 
Fannie Mae and Freddie Mac where you basically have an entity 
where the CBO says these are entities out there that are 
actually controlled by the Federal Government right now, and 
for all honesty and transparency, if we were to treat the GSEs 
like we are trying to treat all these public companies, 
wouldn't they have to bring the GSEs on to our budget? If you 
applied your rules to how we run our system?
    Mr. Herz. I have not done that exact analysis, but the 
criteria are, if, essentially in layman's terms, that if you 
are running the show and you have significant skin in the game, 
then it is on your books.
    Mr. Garrett. We control it. We fund it. We decide who is in 
charge of it, and there is one other criteria.
    Mr. Herz. Under our standards, that is the approach.
    Mr. Garrett. I see my little red light is on, but thanks 
for the nod and thanks for the ``yes.''
    Chairman Kanjorski. Thank you, Mr. Garrett.
    Now we will hear from Mr. Perlmutter for his 5 minutes.
    Mr. Perlmutter. Thank you. And again, I appreciate you 
being here, and I have to smile, Mr. Herz, I think you were a 
master of understatement when you said you had gone through a 
few challenges over the last 18 months. I think the accounting 
industry, pretty much every industry has been stressed to the 
max. And again, I do want to compliment the industry, the 
profession, the Board as a whole because this has been a heck 
of a time for this country. But as Americans do, they roll up 
their sleeves, they move forward, they deal with the problem 
and do the best job they can. And so I just want to start with 
that. You and I may not agree on some things from time to time. 
Mr. Garrett and I often don't agree. But we do agree on the 
point that he was making about his company and that the burden 
of some of the accounting measures to smaller organizations 
sometimes can just be too much. I know we here in the Congress 
need to consider that, and I would ask that you three do, as 
well.
    Now, Mr. Goelzer, my question to you is Madoff, okay, who 
is watching? You can have lots of people looking over 
everybody's shoulder and it goes on and on and on and on. But 
in that instance, what repercussions, who is the policeman for 
the accountants who apparently said okay, year after year to 
the statements that were coming out of the Madoff organization?
    Mr. Goelzer. Mr. Madoff's auditor was not registered with 
the PCAOB and was not required to be registered with the PCAOB 
because at that time, the SEC had exempted broker-dealer 
auditors from PCAOB registration so we had no contact 
whatsoever with them. My understanding is that they should have 
been subject to peer review, that is, a review by, under an 
industry-run system, by another firm. But they misled the AICPA 
as to whether they were conducting audits and therefore they 
weren't subject to peer review.
    Mr. Perlmutter. You said, ``at that time.'' Is there now a 
new regulation in place? Or is that kind of accounting still 
exempt?
    Mr. Goelzer. Yes, the SEC's exemption that caused auditors 
of broker-dealers not to be registered with us expired at the 
end of 2008, shortly after the Madoff events became public. As 
a result of that, we picked up another probably 550 firms 
registered with us. All auditors of broker-dealers are now 
required to be registered with the PCAOB.
    The difficulty is we have no other authority over them. We 
can't inspect their work. We can't write standards for how 
their work is performed. Perhaps, most importantly, we couldn't 
bring an enforcement action, if the Madoff situation repeated 
today. Mr. Madoff's firm would be registered with us, but we 
wouldn't be able to take any action.
    Mr. Perlmutter. Now that they are registered with you, you 
are basically telling me you can't do anything, but they are 
registered with you?
    Mr. Goelzer. I am telling you exactly that. However, 
fortunately, from our perspective, the financial services 
legislation that the House passed, thanks to this committee, 
includes an amendment that would give us authority--
inspections, enforcement, and standard setting authority--over 
these now registered with us as broker-dealer auditors.
    Mr. Perlmutter. Do you know if the Senate version has that? 
Because I don't know.
    Mr. Goelzer. Yes the Senate has a slightly, a somewhat 
different version of it. But from a big picture standpoint, yes 
it does. And this is very important to us because we are 
concerned about the fact that the public might perceive that we 
have some responsibility now for these firms, particularly in 
light of the Madoff situation when, in fact, we simply 
currently lack the capacity to do anything with them.
    Mr. Perlmutter. Mr. Chairman, I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Perlmutter.
    The gentleman from California, Mr. Campbell.
    Mr. Campbell. Thank you, Mr. Chairman.
    I wanted to focus a little bit on rules versus principles 
based accounting which was touched on a moment ago. We have 
increasingly moved to rules based accounting in part, I 
believe, because of litigation risk and because of the desire 
of accounting firms to have a--and the accounting industry to 
have a safe harbor, a place they know they can go and not have 
litigation.
    But that has resulted in some very, very, very complex FASB 
pronouncements and so forth. I have one, I should have brought 
it. I have a KPMG summary of the stock option pronouncement 
which is about this thick. And I actually took a seminar on 
that, 8 hours on that. And it was the beginning seminar. There 
were 3 more days on that, if you wanted to do the rest of it.
    What do each of you feel about rules versus principles 
based accounting? And should we be moving in one direction or 
the other and how do we get there?
    I will start with you, Mr. Kroeker.
    Mr. Kroeker. My reaction would be that you need to find a 
balance between the two. We should have a system that has a 
clear objective of the standard, but it goes to your opening 
remarks that one of the objectives of financial reporting is to 
have some degree of consistency as well, and so part of the 
reason I think that the accounting profession seeks bright 
lines is to ensure to some degree that the objective of the 
standard is prepared or that the filings are prepared with a 
relative degree of consistency so that companies that are 
engaging in similar activities can be compared on a comparable 
basis.
    Mr. Campbell. Mr. Herz?
    Mr. Herz. I wholeheartedly agree with Jim's comments.
    And I believe we have been writing our standards with that 
focus in mind in recent years. I worked for some time in the 
profession in the U.K., and I'm also a chartered accountant, 
and that is at one extreme, the consolidation standard.
    Mr. Campbell. They are very much principles-based aren't 
they?
    Mr. Herz. They are principles-based, but to the point where 
some believe almost anything goes.
    On the other hand, we in the past have had standards with 
lots of facts and very detailed implementation guidance, and I 
think the balance is somewhere in between starting with the 
articulation of clear objectives and principles.
    Mr. Campbell. So would you say that right now you are too 
far towards the rules based and that there is, we need to come 
back?
    Mr. Herz. We are currently doing a lot of our major 
projects together with the international board so what we are 
trying to do, is to write common standards. And when you are 
writing common standards essentially for major parts of the 
world, not just the United States or Europe, but other parts of 
the world that use IFRS or companies, a lot of companies, for 
example, in Japan use U.S. GAAP. You have to find those that 
kind of balance across those varying societies and economies 
and the like.
    Mr. Campbell. Mr. Goelzer, would you like to comment?
    Mr. Goelzer. Sure. We don't have any responsibility for the 
accounting standards. So I will answer as to the auditing 
standards, although I think the answer would be about the same. 
We try to take what I would call an objectives-based approach 
when we set auditing standards, and each of our standards now 
includes at the beginning a statement of what the objective is.
    We are charged with enforcing these standards also, so I 
think it is important to us that they be written in a clear and 
precise enough way that when we do an inspection or bring an 
enforcement case, we can make a determination about whether the 
standard was followed.
    Mr. Campbell. Let me ask this, because my time is starting 
to run out. As we harmonize with IFRS and so forth and have 
these joint--and if we were to move to more of this balance, 
the risk is that our litigation system is very different from 
that in the U.K. and in other countries.
    We cannot go to a big three, okay, with Sarbanes-Oxley, you 
physically can't exist if we go to a big three.
    Are we putting our accounting firms at risk with our 
current litigation system if we move two more principles based 
which I agree with you guys, I think we should, and are there 
changes we need to make in our litigation system to enable this 
to happen and harmonize with the international accounting 
standards but to make the litigation risk not so great if the 
accounting firms complied with what we ask them to do? Whomever 
wants to comment?
    Mr. Kroeker. I agree with the sentiment that going from 
four to three would not be a good idea, would not be a good 
thing. In terms of the litigation system itself, it is a 
recommendation out of the Committee on Improvements to 
Financial Reporting, an SEC advisory committee, actually 
recommended guidance on how firms and how the SEC might look at 
judgment in a system that has less prescriptive guidance. And I 
am a big supporter of the idea that if a firm exercises, a 
company or an audit firm, exercises reasonable judgment, 
documents that in the context of what would be useful 
information to investors, that would go a long way for them and 
then defending, in any context, the subsequent result of that 
judgment.
    Mr. Campbell. Thank you. I yield back.
    Chairman Kanjorski. Thank you very much, Mr. Campbell.
    Now, the gentleman from Illinois, Mr. Foster.
    Mr. Foster. Thank you. I would like to start by thanking 
the ranking member for his concern over the liabilities of the 
GSEs. And of course, had we recognized all of those liabilities 
at the time that they were taken over by the previous 
Administration, people would realize, of course, that our 
financial situation inherited by the current Administration 
was, in fact, far worse than once recognized.
    But I would like to ask first perhaps of Mr. Goelzer is the 
state of play of countercyclical concerns and the definition of 
accounting practices, how seriously is that being incorporated 
into the next generations?
    Mr. Goelzer. I really think I would have to defer to my 
colleagues on that since we really have no jurisdiction over 
the accounting and disclosure principles. We have to enforce 
them as they write them.
    Mr. Herz. Well, the accounting standards involve 
measurements in reporting the underlying economic situation 
including the financial condition of the reporting companies, 
and therefore the goal is to report economic reality, not to 
adjust it through policy.
    I believe that good accounting can be countercyclical in 
that it gives evidence of an early warning of additional risk, 
additional leverage, those kinds of things.
    But I think it is then up to regulators and policymakers to 
take that information and do what they need to do in order to 
manage the economy and the markets.
    Mr. Foster. So you are not seeing big changes in accounting 
standards, it is not regularly incorporated as one of the 
desired aspects of any--
    Mr. Herz. We are trying to kind of tell it like it is 
rather than to take numbers and adjust them for policy matters. 
But other people can do that and then take the right policy. 
But I think they need to start with the numbers, the right 
numbers.
    Mr. Foster. Yes, Mr. Kroeker?
    Mr. Kroeker. I would agree with Chairman Herz's remarks 
that the objective of financial reporting ought to be neutral, 
unbiased, and unvarnished reporting of the economic 
circumstances. They are, as a group of standard setters, both 
the IASB and the FASB looking at, for example, loan loss 
provisioning and whether or not being more forward looking if 
you will on the credit cycle would be useful information, would 
that be unbiased and useful information to investors.
    And as part of that project, the objective isn't outcomes-
based in that it would be less procyclical, but would investors 
have better information if they were aware earlier in the 
credit cycle of loan losses?
    Mr. Foster. The next thing I would like to bring up is a 
lot of the uncertainties you have surround the valuation of 
structured financial products and SFX securities things like 
that. And as you are probably aware, there is an SEC initiative 
to encourage or mandate the publication of key underlying 
information on these, including in the case of mortgage-backed 
securities, you would have the ZIP codes, the credit scores, 
the income history and all this sort of thing, as well as the 
waterfall code that actually specifies the behavior of the 
tranches and so on, and this, in principle, will make things 
much more transparent.
    And I was wondering, do you view that as something that is 
realistically going to be incorporated into the whole 
accounting and valuation game in a much more transparent way? 
Are you optimistic that is really going to lead to sort of a 
more objective analyses of the also values of different 
tranches of these?
    Do you view that as an experiment that might or might not 
work on a fundamental game changer in the valuation of these 
complex financial products?
    Mr. Kroeker. Right now, it is a proposal by the SEC, so we 
will obviously be informed by the feedback that we get. But I 
hope that it is a significant improvement in terms of price 
discovery so that would then flow through all the financial 
reporting.
    Mr. Foster. Mr. Herz?
    Mr. Herz. Yes, I have been fairly strong and vocal on this 
subject. Accounting and reporting by companies was 
significantly challenged during the crisis essentially because 
we had markets for which there were not the necessary 
infrastructures and that included the markets for certain 
asset-backed securities. It is very hard to properly value 
something or provide for anticipated credit losses when there 
is no price discovery, when the effect of the waterfall and the 
condition of the collateral is not known.
    So it took people with great sophistication, and a lot of 
labor intensity to be able to parse through a lot of these 
structures in order to then better understand what they had and 
then to value them. So I'm a big supporter of trying to put in 
what is the necessary infrastructure in order to, not just for 
my selfish point of view, but for the whole system to be able 
to do the better reporting.
    Mr. Foster. Thank you. I guess my red light is on, so I 
will yield back.
    Chairman Kanjorski. Thank you, Mr. Foster.
    Now, we will hear from the gentleman from California, Mr. 
Royce.
    Mr. Royce. Thank you. I am going to ask Mr. Herz a 
question, and it goes to an issue which in IFRS standards, 
international standards, frankly, would have handled the Lehman 
situation a lot differently than we did. Under IFRS, Lehman's 
leverage ratios would have shown up as much higher. It would 
have been harder for them to continue the overleveraging, as I 
understand it, than they did under the U.S. standards. And FAS 
166 amended certain aspects of disclosure related to the 
classification of assets under FAS 140, requiring an 
institution to disclose all of its continuing involvement with 
transferred financial assets.
    These amendments were related to Lehman Brothers' use of 
Repo 105s to take assets off the books at the end of the 
reporting period, and thereby, of course, disguise the true 
leverage that was afoot. Lehman officials even referred to 
these transactions as balance sheet ``window dressing.''
    You wrote a letter to the committee on April 19th, and you 
mentioned that the accounting guidance for Repos has not 
changed since 1997. And I guess my question is, should FAS be 
considering amending the standards governing the use of Repo 
transactions in light of the use of Repo 105s by Lehman and 
other financial institutions, and, at the end of the day, I 
guess, to what extent would moving toward IFRS address this 
problem? Did the Europeans see something coming that we just 
failed to miss in terms of our accounting of it?
    Mr. Herz. A couple of points. We are not an enforcer or a 
regulatory agency, but in that letter, I did indicate some 
points as to whether or not the Repo 105 transactions actually 
qualified as sales under U.S. standards. And again, without all 
the facts, I could not tell. But the SEC has been doing an 
extensive information gathering process of the practices of 
major financial institutions with regard to Repos and security 
lending and the like. And to the extent that those reveal 
practices like that, we stand very ready to change the 
standards.
    Mr. Royce. And just to get back to the bottom line, to what 
extent would moving toward IFRS address this problem?
    Mr. Herz. It is not clear to me whether under IFRS they 
would have appeared as financings or sales either. We have a 
joint project with the international board on the subject of 
derecognition which includes these kinds of items. And the goal 
has been to harmonize our standards there. There are many other 
current differences in the way financial institutions balance 
sheets are reported as between U.S. GAAP and IFRS including 
issues as to whether master netting agreements are sufficient 
to net derivatives and various other things which we are also 
exploring harmonizing.
    Mr. Royce. I appreciate that. Now let me ask Mr. Kroeker a 
question as well, and this goes to the testimony that we had 
from Mr. Markopolos here who noted that for a number of years 
he tried to warn individuals from within the SEC about the 
Madoff Ponzi scheme.
    And he found an ally in the Boston branch with industry 
experience in the SEC. But his problem was that he could never 
get beyond the New York office, I guess, because as he says, 
folks in Washington simply couldn't comprehend the case, 
certainly the people in New York who held the case couldn't 
comprehend it, and he often noted the overlawyering at the SEC.
    I know Ms. Schapiro is attempting to address this failure.
    But I'm concerned that this won't be enough that the basic, 
if you look back over the years, the focus of the SEC, the way 
it has been overlawyered by those who have informed me that 
there isn't the technical knowledge about markets in the SEC to 
really uncover things like the Ponzi schemes that are out 
there, has always been a problem institutionally.
    Could you comment on that?
    Mr. Kroeker. Let me comment from my perspective on 
accounting and auditing. Our office is approximately 50 people. 
The vast majority are folks who were practicing either as 
accountants or as auditors. So from that perspective, our 
office is, again the vast majority are auditors, but to the 
heart of whether we can be more forward looking, what market 
practices are out there, I think we have taken significant 
steps. Just as one example, we are hiring a deputy within the 
Office of the Chief Accountant whose job it will be to monitor 
market practices, to look at new standards that have been put 
in place.
    Mr. Royce. Just very quickly, the SEC official in Boston 
who did understand it had been a portfolio manager, he had been 
a trader, he had that experience in the market, and I think it 
is that kind of hiring at some point that has to be addressed.
    I understand the British had the same problem with the FAS, 
so I just raise it again.
    Mr. Kroeker. I agree.
    Mr. Royce. Thank you very much, Mr. Chairman.
    Chairman Kanjorski. Thank you very much Mr. Royce.
    Does the gentleman have any further questions? I do have an 
additional question. Do you want to take additional time?
    Okay, if I may, in your opening remarks, Mr. Goelzer, you 
referred to the section 7602 fix that we have added to allow 
transmittal of information, investigative findings, between 
foreign entities and the American entities, and you indicated 
that fixes the E.U. problem, but you caution that it does not 
fix the China problem. While we are now going from the House 
and the Senate to conference, I am curious as to whether or not 
you have structured in your own mind what would fix the China 
problem, so that we could include it in the Act when it comes 
back. What should we do?
    We anticipate there will be a problem, or there is 
potentially a problem, and we have not done anything about it. 
What do you suggest we do?
    Mr. Goelzer. I appreciate the question because it is a very 
difficult issue. I don't think I have an answer as to what 
Congress could do to fix the problem with China.
    Let me say, as to the E.U., the ability to share 
information would let us essentially resume the negotiations 
with them, and I am hopeful it would open the door to 
inspections. They have raised other issues with us that will 
also have to be resolved.
    With respect to China, I think the best hope we would have 
at the moment is that as we bring all of the rest of the world 
into our inspection system, China will not want to be an 
outlier and will feel an incentive to negotiate with us and 
open the doors there also. I can certainly assure you that if 
we see any kind of legislative action that would help us with 
China, I will let you know. But at the moment, I don't see 
anything that would address the situation.
    Chairman Kanjorski. Well, if we do not address it--are you 
suggesting it would require some treaty arrangement with China?
    Mr. Goelzer. I don't believe that any of these foreign 
auditor access issues we have should require treaties. I think 
it is simply a matter of negotiation and understanding between 
ourselves and the audit oversight body or other governmental 
authorities in each country.
    Chairman Kanjorski. Are we not one step away from a China 
disaster or China meltdown if we don't do something?
    Mr. Goelzer. I think it is a very serious problem. I think 
there is much that is unknown to us about the quality of 
financial reporting in China and the quality of auditing in 
China, and there are an increasing number of Chinese-based 
companies that are in our markets. So yes I think it is a 
substantial risk to U.S. investors.
    Chairman Kanjorski. Does anyone else have any opinions on 
that? Mr. Herz, Mr. Kroeker?
    Mr. Kroeker. As it relates to--
    Chairman Kanjorski. There is a provision in the reform 
regulations which are pending that allows, where it was 
disallowed before, for a transmittal of investigative 
information between the United States and foreign powers. We 
have now vitiated that, and Mr. Goelzer's opinion is that takes 
care of our problem with the E.U., but he indicated it does not 
take care of the problem with China.
    Do you recognize that there may be a problem with China, 
and do you have any helpful hints?
    Mr. Kroeker. Yes, one I agree, and a second provision that 
could be helpful is a provision that is in the House regulatory 
reform bill on section 106 of Sarbanes-Oxley that would give us 
greater ability to subpoena work papers from foreign audit 
firms. So I think that would be of assistance as well.
    Chairman Kanjorski. Does that allow retribution if they do 
not respond to our subpoenas?
    Mr. Kroeker. It allows greater access, as I understand it, 
in serving a subpoena to and then enforcing a subpoena related 
to access to foreign work papers.
    Mr. Goelzer. If I could just make one brief additional 
point. I do want to be clear that we do have existing authority 
to deregister foreign firms or any firm that doesn't cooperate 
in an inspection with us. And I don't want to take that off the 
table as a solution. Obviously, it would have significant 
ramifications if there were any foreign country where no 
auditor in essence was registered in the United States. But in 
terms of our existing authority, that is sort of the ultimate 
step that we could take.
    Chairman Kanjorski. Thank you, Mr. Goelzer.
    The gentleman from New Jersey.
    Mr. Garrett. Thank you. So what I hear in general here and 
other places as well from you folks is that the accounting 
standard-setting folks are all about the transparency and 
disclosure and just making sure that the information is out 
there, right, and then that it is the regulators' job to deal 
with it, to mitigate and reconcile the applications of it, and 
that is the regulators' job to do it.
    So we have the Financial Service Reform bill that is going 
through right now and that has a risk retention element to it, 
right? It mandates 5 percent on each loan or bond issue be held 
on. And so some folks look at that and say, hey, if you put 
that 5 percent risk retention aspect on it, that is going to 
sort of tighten down credit availability even further than with 
the market are today.
    So with that whole issue out there looming right now, is it 
even more important than ever before that you have, I think 
your words have said, a decoupling of the accounting rules from 
what the regulators are putting in place, if you wanted to make 
sure that we still have some availability of credit 
availability going forward?
    Mr. Kroeker. As I understand it, there already is that 
flexibility to decouple prudential supervision and the measures 
used by bank supervisors from accounting--accounting as set by 
the FASB as the starting point, but they have the flexibility 
to decouple so as I understand it that already exists. But I do 
think that it calls for continuing coordination between the 
FASB, the SEC, prudential supervisors as we do already, we meet 
no less than a quarterly basis at the senior staff level with 
bank supervisors, and my staff is talking to their staffs on a 
real-time continuous basis.
    Mr. Garrett. And I see you want to chime in on this. I 
guess the question, where we were before all this happened was 
whether or not that decoupling, to use that expression, really 
was occurring or not. Mr. Herz?
    Mr. Herz. It occurred to a certain degree, for example, the 
bank regulators have traditionally chosen to not factor in 
unrealized gains and losses on debt securities into their 
computations of regulatory capital even though for GAAP 
reporting it does affect the amount of stockholders equity that 
is reported. In our changes in statements 166 and 167, we did 
involve them, kept them very well apprised as we were going 
along in the development of those, they did factor them into 
the stress tests last year, and then they followed up late last 
year, or early this year with some guidance on the impacts that 
those new standards would have under their regulatory capital 
determinations, but they did provide a transition period for 
the regulated institutions to build the additional capital.
    Mr. Garrett. As long as you are still talking, with regard 
to the whole convergence issues which you touched on and some 
other people talked about, the G-20 has recommended 
procyclicality in accounting standards, accounting rules work 
together with the banking regulators to be less procyclical 
accounting, the ISAB has been working with the banking 
regulators, investors and others all on the one point and we 
haven't hit this too much today and that is on the one issue of 
mark-to-market, and that they have said they don't want mark-
to-market.
    You all take a contrary view, I guess you could put it. So 
can you just lay that out a little bit as to why we are taking 
a contrary view as to where the G-20, the banking regulators, 
and the investors are all on this issue.
    Mr. Herz. My understanding, the G-20, there is a group 
under the G-20, the Financial Stability Board which actually I 
meet with periodically as well. Obviously, being a Financial 
Stability Board, their first interest is in stability of the 
overall system. Our job, and I have absolutely nothing against 
and I am totally for stability, but our job is more 
transparency for investors to make the capital allocation 
process work better, so we work very closely with the banking 
regulators to try to understand their points of view.
    We work closely with investors to understand their points 
of view. We get the points of view of the companies, and we 
really try to square the circle in terms of meeting all of 
those different needs in ways. A lot of investors would like to 
see more information on the current values of the financial 
assets of institutions.
    Mr. Garrett. You have a slightly different role than some 
of those. Okay, thanks.
    Chairman Kanjorski. Thank you, Mr. Garrett.
    Mr. Campbell?
    Mr. Campbell. Thank you, Mr. Chairman. I want to follow up 
a little bit on something Mr. Garrett was on with you, Mr. 
Herz, on standard 166, 167. If there is a risk retention 
requirement, you have to keep 5 percent, bank sells off a loan 
into securitization, but they have to keep a slice of it, they 
have to keep 5 percent. Under 166, 167, that bank has to keep 
that whole loan on their--no? Okay. I am wrong. Talk to me.
    Mr. Herz. It really depends on what the 5 percent 
represents. If it represents the first loss, yes, the effect 
there is like being the equity participant in the transaction, 
they absorb the first losses. If it is more of a pro rata 5 
percent retention, that would not be deemed significant.
    Mr. Campbell. Okay. But if it is the first loss, then they 
do have to keep the entire loan on their books, right?
    Mr. Herz. Yes.
    Mr. Campbell. So this is the kind of place--and again as we 
do these prescriptive, very prescriptive accounting standards, 
this is the sort of thing where when you did that you probably 
weren't anticipating this sort of thing and there may be some 
other actions in the future where we have a lot of banks with a 
lot of debt that there may be various ways that that debt can 
be moved to other places but where they are going to have to 
keep a slice of it somewhere in order to make the whole 
transaction work but we are trying to make some of these banks 
a little more solvent than they are in the future.
    And this is where I think you can see that divergence where 
we may set up some banking regulation in order to try to make 
this thing work out and then you look at standard 166, 167 and 
you say, uh oh, but as far as the audited balance sheet of this 
bank, it is not going to improve it at all. Not a problem, and 
I'm curious for any of you, in that specific instance, not a 
problem, you guys can look at it and respond quickly or what?
    Mr. Kroeker. In that instance, I don't view it as a problem 
as you said you had, in Bob's example, and it is not 
prescriptive in the standard. The objective is if you have 
significant skin in the game, if you will, significant risk, 
and you have control, you need to consolidate. If it was 5 
percent first loss, you have the majority of the--let's say it 
is very high-quality assets, you might actually have most of 
the risk of those assets. And so I think that is the principle 
of standards, if you have in that fact pattern, if you have 
most of the risk of those assets, maybe they ought to be on 
your books, so not a problem, though, in terms of being able to 
respond quickly.
    Mr. Campbell. Part of it is if you have a $3 million loan 
you can lose $3 million in theory, and that is on your books 
and so forth. But if that loan goes somewhere else, and you 
have some tranche of it, that is first loss, but gives you a 
maximum $200,000 loss, let's just say, is that a different 
situation?
    Mr. Herz. Think of it in these terms. If you had a company 
and had some risk in it and you were the equity investor and 
the rest of the capital is provided by other people in the form 
of debt financing and you also ran the show, I think you would 
agree under longstanding accounting you would consolidate that 
entity. And so that is the basic analogy there.
    Mr. Campbell. But I guess, does it bother any of you if 
there is this divergence in transactions like I just described 
between the financial accounting standard and the way the 
banking regulators will treat the transaction?
    Mr. Herz. I think in an ideal world we would have the same 
reporting for financial reporting, for regulatory reporting, 
for tax reporting, but because they all start from different 
objectives sometimes that is not possible.
    Mr. Campbell. Okay. Mr. Kroeker?
    Mr. Kroeker. In the instance of 166 and 167, I think, as I 
understand it, as bank regulators have looked at those 
standards, they have actually indicated it will help them do a 
better assessment of risk and, in fact, a process like that 
went through or was included in the stress tests effectively 
taking FASB's new guidance and saying would we get a better 
identification of risk through these new standards?
    Mr. Campbell. Quick question for Mr. Goelzer, on my way out 
here, relating to something else. I mentioned before about the 
markets using different data than the traditional three 
elements of the financial statement. Are there things that we 
ought to be, are there, and a lot of that comes from audited 
data, but does it all? And are there things that we ought to be 
auditing, numbers that ought to be audited for public companies 
that are not currently being audited? Because the markets are 
using it.
    Mr. Goelzer. This is a hard question for me to answer in 
that form. I think from our perspective, the important thing 
would be that the scope of the auditors' responsibilities are 
clear and that if we are going to bring in additional 
information that is not currently part of the financial 
statements that it be information that is auditable, not solely 
dependent on judgments or management assessments that an 
auditor can't develop evidence to support an opinion on and 
that we have a chance to write a standard. As to what the sort 
of content would be of additional information brought under the 
auditing tenet, I think I would have to think about that a 
little.
    Mr. Campbell. Thank you, Mr. Chairman. Thank you.
    Chairman Kanjorski. Thank you very much, Mr. Campbell.
    The gentleman from California, Mr. Royce.
    Mr. Royce. Yes, thank you, Mr. Chairman. I am going to 
follow up on Mr. Garrett's and Mr. Campbell's lines of 
questioning here, because last week, we had FASB's Kevin 
Stoklosa submit testimony here that in many ways recognized or 
admits a certain dichotomy here, a certain problem when it 
comes to the impact or effect of this decision.
    He said that keeping assets on the books will better 
reflect financial institutions' exposures to risk, but may 
also, in his words, affect their ability to comply with the 
regulatory capital requirements and therefore affect the 
liquidity available to real estate in the United States to 
commercial real estate specifically, and one of the debates 
that we have had about the vicious circle that we have 
ourselves caught in is the fact that in many cases, you have 
performing loans, but banks aren't allowed to be banks right 
now.
    If the appraisal comes back and the value isn't what is 
necessary, regardless of the fact that it is a performing loan, 
and in the past, maybe you would keep it on the books, and you 
have to make that tough decision because the regulator is 
breathing down your neck.
    And at that hearing, you had several witnesses involved in 
the commercial real estate industry express their grave 
concerns over this accounting treatment. I guess we are just 
getting back to what is FASB's response to those concerns in 
this case raised and acknowledged by your technical adviser 
there, by Kevin in that hearing last week.
    At some point in time, do you give the banks the ability to 
work out some of these problems using their best judgment?
    And then I would also just ask the SEC's perspective there 
as well because you will have to deal, this will affect 
companies that you oversee as we become more and more rigid in 
terms of the way in which we define and control the ability of 
bankers to use their judgment, ultimately you oversee those 
firms. You might have a comment on this.
    So go ahead, please, Mr. Herz.
    Mr. Herz. Well, again, the goal of financial reporting is 
to reflect the underlying economic reality as best we can with 
the tools available and often requiring the necessary judgments 
of the companies and the auditors involved.
    We believe the new standard strikes the right balance in 
that area, the bank regulators seem to agree that for their 
purposes it does as well. Arguably, some of the problems that 
caused the crisis were too much free rein, too much liquidity, 
too many things that were improperly shown off the balance 
sheets and the risks not captured.
    Mr. Royce. Mr. Herz, I grant you all of that and I concur 
with that. But somehow when you get to point where you have 
performing loans which no longer make the test, you are in 
something of unchartered waters here when you notice that it 
begins to have this domino effect in communities and it is 
almost a self-fulfilling prophecy in that sense. If you don't 
roll over these performing loans because you don't make these--
the reality is they are performing loans at least for here and 
now, and that is sort of the dichotomy I think we are in. 
Right?
    Mr. Herz. I'm not sure those are elements of 166 or 167.
    Mr. Royce. But the further crimp on liquidity for 
commercial real estate compounds this problem where we already 
have this lack of liquidity and we just keep tightening the 
screws on that, and at the end of the day there isn't the 
capital there, and so the decision is made not to roll over the 
performing loan on the basis of the lack of it.
    Mr. Herz. Again, the capital requirements are things that 
the bank regulators determine. They have given some forbearance 
for a transition period related to our new standard, but they 
concluded that the new standards provide a better basis for 
them to make the capital determinations, but that is up to 
them.
    Mr. Royce. Let me ask the SEC quickly, and then I'm 
finished.
    Mr. Kroeker. I don't think banks should have greater 
flexibility in terms of keeping risk off-balance sheet, and it 
is probably a better question for bank regulators, but again, 
as I understand it, they have the flexibility then in terms of 
how they will respond if that risk is on balance sheet.
    Mr. Royce. The flexibility hasn't be used to our ability to 
discern it. But thank you very much.
    Chairman Kanjorski. Thank you very much, Mr. Royce.
    It is not surprising--this actually was an interesting 
commentary when I started out, I suggested that we who were not 
accountants could get bored to death, but quite frankly, I have 
really enjoyed the witnesses' testimony. I want to thank them. 
Also, I want to send this message to you: In the next several 
weeks or week, rather, we will be convening a conference on the 
Senate and the House bill as it presently exists, and 
obviously, there is a need to reconcile some differences and 
potentially to add some parts of the bill that may be missing. 
All three of you witnesses are in a peculiar and favored 
position to be able to help the committee, as we put the final 
bill together. If you see something lacking, I can assure you I 
am one telephone call away, and I am sure Mr. Garrett is one 
telephone call away. We are looking for the best expert help in 
structuring the finest enforcement bill we can put together to 
make sure--although we hear this all the time--that this will 
never happen again. I, for one, concede something is going to 
happen again, so we should not use that terminology, but that 
we could gain a great deal from the crisis of 18 months ago and 
certainly, put a piece of legislation in place that will 
forestall that type of activity from occurring again for many, 
many, many decades.
    Toward that end, I solicit your assistance and help and any 
of my staff who do not take your calls, you let me know, and we 
will have new staff in place, but I know they will, and we want 
to encourage you to take advantage of that invitation.
    With that, the Chair notes that some members may have 
additional questions for this panel which they may wish to 
submit in writing. Without objection, the hearing record will 
remain open for 30 days for members to submit written questions 
to these witnesses and to place their responses in the record. 
Without objection, it is so ordered.
    Before we adjourn, the following material will be made a 
part of the record of this hearing: a May 20th letter from the 
Independent Community Bankers of America. Without objection, it 
is so ordered.
    The panel is dismissed.
    And this hearing is adjourned. Thank you, gentlemen.
    [Whereupon, at 11:50 a.m., the hearing was adjourned.]
                            A P P E N D I X



                              May 21, 2010



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