Academic journal article Accounting Horizons

Viewing the 1996 FAF Restructuring as Policy Making without a Formal Due Process

Academic journal article Accounting Horizons

Viewing the 1996 FAF Restructuring as Policy Making without a Formal Due Process

Article excerpt

SYNOPSIS: In 1996, a major financial reporting controversy emerged, escalated, and was resolved without substantial exposure or a formal due process. Specifically, a committee of the Financial Executives Institute (FEI) sent a letter to the chair of the Financial Accounting Foundation (FAF) asserting that the Financial Accounting Standards Board (FASB) "process is broken and in need of substantive repair." When Securities and Exchange Commission (SEC) Chair Arthur Levitt determined that neither FAF nor public accounting leaders were dealing with the FEI proposals to his satisfaction, he acted to defeat this perceived threat to FASB's independence, focusing on the composition of the FAF In response, the FAF trustees resisted because they viewed his intervention as a threat to FASB's independence. When the trustees did not voluntarily change, Levitt proposed reconsidering Accounting Series Release No. 150, which designates FASB as the sole source of GAAP for SEC filings. Eventually, Levitt prevailed. This paper describes this intervention as a case of policy making without a formal due process and adds to the already weighty evidence that accounting standards are political.


In July 1996, the business media received a press release (FAF 1996c) that made this announcement:

Norwalk, CT and Washington D.C., July 8,1996--The Financial Accounting Foundation (FAF) and the Securities and Exchange Commission (SEC) today announced that they have reached agreement for a change in the composition of the Foundation's board. Specifically, the FAF will add two new At-Large positions, fill two existing At-Large vacancies, and reduce the number of members appointed by sponsoring organizations by two....The FAF selected the new At-Large Trustees in consultation with the SEC.

Anyone who considered this news to be innocuous misjudged one of the greatest crises in the life of the Financial Accounting Standards Board (FASB) because it described the outcome of perhaps the most significant exercising of oversight by the Securities and Exchange Commission (SEC) over FASB's affairs. Despite its importance, this intervention has not been widely understood.

By analyzing the events leading up to this restructuring, this paper adds to the abundant evidence that standard setting and generally accepted accounting principles (GAAP) are limited by their political nature. Although it is well known that compromises occur in standard setting, this episode is unique because it involved two institutions with oversight powers over FASB. Even though both wanted to protect the board's powers, they strongly disagreed over what change, if any, was needed.


This paper relies heavily on letters exchanged between the participants. Other sources include speeches, journalistic reports, and direct communications. Some events are also described in Miller et al. (1998) (hereafter, MRB). Because of space limitations, the texts of 11 cited documents are not included herein but are available at the web site


According to MRB (177-193), the role played by corporate executives in FASB's process has been controversial because some within this constituency have tried to gain domination and control its output. Most of Van Riper (1994) describes this hypothesis and his supporting evidence.

A concern has been expressed that this group is least entitled to shape the outcome. Nonetheless, fairness dictates that its members have a role in the process because their behavior is modified the most by new standards. However, their participation carries the risk that their influence may frustrate the public's interest in greater market efficiency. MRB (177-193) assert that growing preparer dominance between 1986 and 1995 did produce this result.

One defense against domination is the FAF, which is supposed to shield board members against various political pressures. …

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