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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 

( 

(II) 

HOUSE COMMITTEE ON FINANCIAL SERVICES 

BARNEY FRANK, Massachusetts, Chairman 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

KEITH ELLISON, Minnesota 

RON KLEIN, Florida 

CHARLES A. WILSON, Ohio 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

BILL FOSTER, Illinois 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

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 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

RON PAUL, Texas 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

ADAM PUTNAM, Florida 

MICHELE BACHMANN, Minnesota 

KENNY MARCHANT, Texas 

THADDEUS G. McCOTTER, Michigan 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

CHRISTOPHER LEE, New York 

ERIK PAULSEN, Minnesota 

LEONARD LANCE, New Jersey 

JEANNE M. ROSLANOWICK, Staff Director and Chief Counsel 

(III) 

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

PAUL E. KANJORSKI, Pennsylvania, Chairman 

GARY L. ACKERMAN, New York 

BRAD SHERMAN, California 

MICHAEL E. CAPUANO, Massachusetts 

RUBE ́ N HINOJOSA, Texas 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

CAROLYN B. MALONEY, New York 

MELISSA L. BEAN, Illinois 

GWEN MOORE, Wisconsin 

PAUL W. HODES, New Hampshire 

RON KLEIN, Florida 

ED PERLMUTTER, Colorado 

JOE DONNELLY, Indiana 

ANDRE ́ CARSON, Indiana 

JACKIE SPEIER, California 

TRAVIS CHILDERS, Mississippi 

CHARLES A. WILSON, Ohio 

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 

SCOTT GARRETT, New Jersey 

TOM PRICE, Georgia 

MICHAEL N. CASTLE, Delaware 

PETER T. KING, New York 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

JUDY BIGGERT, Illinois 

SHELLEY MOORE CAPITO, West Virginia 

JEB HENSARLING, Texas 

ADAM PUTNAM, Florida 

J. GRESHAM BARRETT, South Carolina 

JIM GERLACH, Pennsylvania 

JOHN CAMPBELL, California 

MICHELE BACHMANN, Minnesota 

THADDEUS G. McCOTTER, Michigan 

RANDY NEUGEBAUER, Texas 

KEVIN McCARTHY, California 

BILL POSEY, Florida 

LYNN JENKINS, Kansas 

(V) 

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 

(1) 

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. 

2 

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 applesto-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. 

3 

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 SuVerDate Nov 24 2008 17:35 Sep 24, 2010 Jkt 058049 PO 00000 Frm 00009 Fmt 6633 Sfmt 6633 K:\DOCS\58049.TXT TERRIE
4 

preme 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 

5 

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 anonymityto-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 

6 

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. 

7 

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. 

8 

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-tominute 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 realtime 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 

9 

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 

10 

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 

11 

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 

12 

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 

13 

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 brokerdealers. 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, 

14 

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 objectivesbased 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 

15 

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 

16 

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 deal- ing 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, 

17 

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 

18 

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? 

19 

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. 

20 

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. 

21 

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. 

22 

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 

23 

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 

24 

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 standardsetting folks are all about the transparency and disclosure and just 

25 

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. 

26 

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 

27 

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. 

28 

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? 

29 

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. 

30 

The panel is dismissed. 

And this hearing is adjourned. Thank you, gentlemen. 

[Whereupon, at 11:50 a.m., the hearing was adjourned.] 

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A P P E N D I X 

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