SEC Authority

Suppose Congress authorizes an agency to promulgate standards. The agency delegates that authority. Congress later enacts laws preserving the agency’s promulgation authority but strictly limiting its delegation power to organizations meeting stated criteria. Suppose the agency then delegates the function to an organization lacking those criteria. May the agency do so?

The SEC plans to do exactly that. It has congressional power to set accounting standards and has delegated that to FASB, a private domestic standard-setter for whom the later statute is tailor made. The SEC instead wants to delegate this authority to IASB, an international organization lacking many of the requirements. Congress has raised doubts about the SEC’s statutory authority to take this position but SEC officials have testified before Senate committees that it has the authority. It seems illegal and irresponsible for the SEC to take this position as (somewhat technical) analysis below explores.

Despite SEC flexibility to recognize accounting standard setters, dating to the 1930s, the Sarbanes-Oxley Act in 2002 (SOX) imposed boundaries. It listed criteria that any SEC delegate must possess for the SEC to recognize it as a US accounting standard setter. The delegate must: (1) be a private entity; (2) have a board serving the public interest, a majority of whose members are independent of the accounting profession; (3) be funded by Congressionally-levied fees; (4) have procedures to consider promptly, by majority vote, accounting changes; (5) consider the need to keep standards current and converging internationally; and (6) be approved by the SEC based on ability to aid the SEC in discharging its responsibilities to protect investors under US securities laws.

These statutory requirements were designed for FASB, including to induce one adjustment to it. The adjustment was shifting from funding by private donation to the funding mechanism the statute required (levies on US listed companies). With that adjustment made, FASB applied to the SEC for recognition in 2003, and the SEC approved it. The SEC noted that such recognition is permitted under SOX only when a standard setter can assist the SEC in meeting requirements of US federal securities laws, including to protect investors under US law. The SEC opined that FASB’s overseer, the Financial Accounting Foundation (FAF), met this and other SOX requirements.

Although IASB adopted governance attributes that the SEC had suggested in the late 1990s, it lacks some of the traits that SOX requires. Of the criteria listed in SOX, IASB meets the first two—it is a private entity with a majority of trustees independent of the accounting professions. It clearly lacks two others and it is uncertain whether it meets the remaining two.

SOX requires simple majority to approve new standards but IASB uses a super-majority rule. This is non-trivial. The voting rule influences the standard setting process and the probability that the body will have the capacity to respond quickly and independently to emerging accounting issues. The reason SOX included the simple majority voting rule requirement traces to debates and changes over the years in the voting rule FASB used.

IASB is not funded using the SOX mechanism. It relies on private donations from a small number of corporations, auditing firms and others. Private funding can create real or apparent conflicts, if donors contribute believing the board will return the favor by passing accounting standards they prefer. SOX’s funding provision eliminated that problem for FASB. Establishing independent and stable funding for IASB is vital. Despite this fundamental point, the SEC seemed at first unaware of it and later indifferent to it.

IASB may or may not meet two other SOX criteria. It is uncertain whether it promptly considers new standards. It did so in the early 2000s. But after numerous countries and the EU began recognizing its standards, the costs of shifting from national accounting standards to international ones appeared daunting to many companies. (The costs would be higher if, during the transition, companies also had to contend with continuing changes and updates.) As a result, IASB announced a policy to suspend adopting new standards for a number of years.

Perhaps the most nettlesome SOX criteria for IASB to grapple with is SOX’s quintessentially domestic character. SOX requires standard setters to assist the SEC in its duties by “improving the protection of investors under the securities laws.” Can IASB commit to protecting investors under US securities laws? Its mission is to produce standards of general applicability globally. Being responsive to international needs may lead IASB to subordinate US needs, including of US investors.

A final issue is whether the SEC is authorized to delegate powers to bodies even if they lack the stated criteria. The SEC claims this authority; an elementary analysis of the statutory language and purpose concludes that the SEC’s position is untenable. The statute provides that the SEC “may recognize, as ‘generally accepted,’ for purposes of the securities laws, any accounting principles established by a standard body” that possesses the stated attributes. The statute adds: “Nothing in this Act . . . shall be construed to impair or limit the authority of the Commission to establish accounting principles or standards for purposes of enforcement of the securities laws.”

The SEC appears to believe that this latter provision means it can recognize standard setters not meeting the criteria stated in the former. A more faithful reading of the literal language is that the latter provision reserves pre-existing SEC authority to establish accounting standards and the former narrowly addresses its power to delegate that authority to others. This reading of the literal language is strengthened by a purposive understanding. The stated attributes express public policy values that would be rendered meaningless under the SEC’s interpretation. It is fortified by observing how SEC delegation to IASB would represent a non-trivial relinquishment of US sovereignty to an international non-governmental organization.

Despite all this, the SEC appears prepared to recognize IASB before summer’s end and before this fall’s elections bring new leadership to Washington and the Commission, who will then inherit the fallout.

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