Viewing the 1996 FAF restructuring as policy making without a formal due process.

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.

INTRODUCTION

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.

THE SOURCES

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 http://www.uccs.edu/~fafletters.

THE INITIAL PROBLEM

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. In fact, that defense mechanism can fail if the trustees try to shape the standard-setting process through FASB member appointments and reappointments. (1) To hinder this maneuvering, the FAF Rules of Procedure (FAF 1998, 42) prohibit trustee interference in the standard-setting process.

Exhibit 1 summarizes the January 1996 structure of the FAF. The sponsoring organizations appointed electors who elected 13 trustees, who then chose three other at-large trustees.

The first section of Exhibit 2 identifies the sponsoring organization, name, affiliation, and position of the trustees serving in January 1996 (FAF 1996a). The second section presents the author's groupings into constituencies. The preparers included two governmental trustees who held positions requiring them to prepare and distribute public financial statements. The public group included a professor, a mayor, and an individual serving on several corporate boards. (2)

A relevant piece of the contemporary context was FASB's issuance of Statement of Financial Accounting Standards No. 123 (FASB 1995) in the preceding October containing compromises that board members admitted were designed merely to close the bitter debate over stock-based compensation and keep standard-setting authority in the private sector (FASB 1995, paras. 60, 62). These circumstances may have encouraged some preparers to believe they had sufficient power to gain control over the FAF and the FASB. Another relevant element was the fact that FASB's Chair, Dennis Beresford, was in the last 18 months of his second term. The process for selecting his replacement would thus influence the board's future for five or ten years.

Therefore, the stage was set for a controversy over the issue of whether preparers were sufficiently strong to control FASB. Initially, the two antagonists were the Committee on Corporate Reporting (OCR) of the Financial Executives Institute (FEI) (3) and the SEC.

THE OPENING GAMBIT

Several members of the CCR forced the issue by proposing a substantial restructuring of FASB and its processes, possibly because they were both dissatisfied with the existing situation and confident they had enough power to bring about their desired changes. A letter dated January 19, 1996, was sent by P. Norman Roy, president of the FEI, to J. Michael Cook, chair of the FAF and CEO of Deloitte & Touche (Roy 1996). Roy sent duplicates to Beresford, Karl von der Heyden (Chair of the Financial Accounting Standards Advisory Council), and Arthur Levitt (Chair of the SEC). (4)

According to Cook (2000), this letter followed up on a meeting that occurred in his office on January 5, 1996. The third paragraph stated: "In fact, FEI believes that the FASB process is broken and in need of substantive repair." These words show that the goal was significant change, not a moderate fine-tuning.

This opening salvo was followed by a numbered list of two statements and ten proposals about FASB's structure and process. One would have imposed strict time limits on deliberations, thereby changing FASB members' ability to pursue issues to their satisfaction. Another resurrected an old proposition for reducing the number of FASB members from seven to five. (5) A third asserted that FASB's open process inhibited the board's ability to resolve issues quickly. In contradiction, the fourth called for a sunset review that would inhibit fast action by loading up the agenda with previously resolved issues.

The CCR also revived a proposal for taking FASB's agenda out of the board's hands. (6) Their boldness may reflect confidence that the trustees would be sympathetic. The next proposal suggested that the FASB chair be given more power, perhaps reflecting OCR's expectation that it could choose Beresford's successor. Another reflected OCR's distrust of FASB's research staff by implying that board members should be able to hire like-minded personal staff assistants who would be more helpful than permanent staff members whom the OCR perceived to be biased and unduly influential.

The final item vented CCR's frustration with the outcome of FASB's process by saying:

Over the years, the business community has often expressed its view that the pronouncements of the Board reflect an implicit anti-business bias in that they do not recognize business reality and are not responsive to the valid concerns that business has raised. The business community believes that this is a real problem. (Roy 1996)

This statement revealed their deep feelings. These polarizing words not only offended FASB but also alarmed Levitt about the direction OCR would go if it could. In any case, the first shots were fired, and the battle would soon be joined, although the initial skirmishes were mostly out of the public arena.

LEVITT ENTERS THE FRAY

Even though Roy's (1996) letter was not addressed to the SEC. a short letter from Levitt (1996a) dated February 7 revealed that the two of them had already discussed the proposals. Levitt also defended FASB against the charge that it was unresponsive to preparers' needs. In a statement that became a leitmotif, he said that "the Board must be responsive to the broad public interest" (Levitt 1996a). He also emphasized that his priorities ranked investors and the public well above any other constituents, including OCR. Levitt then asserted that oversight power gave the SEC jurisdiction over FASB's affairs. He emphasized that he would not ignore threats to its independence, with pointed references to its agenda and due process.

Notably, Levitt declared his intent to take an active role in the controversy by sending his letter to 13 others, including SEC commissioner Steven Wallman, four prominent FEI members, A. A. Sommer (the head of the Public Oversight Board), Barry Melancon (president of the American Institute of Certified Public Accountants [AICPA]), and the chief executives of the Big 6 accounting firms. As described in a June 6 speech, Levitt had already conferred with some of these people to determine whether they intended to defend FASB:

I met with the CEOs of the Big Six accounting firms and the Trustees of the FAF and urged them to speak up in support of the FASB... Unfortunately, every new assault on the FASB was met with silence. (Levitt 1996d)

These words strongly suggest that Levitt's letter was motivated by these unsatisfactory replies.

Normally, SEC involvement in financial reporting matters is spearheaded by the Chief Accountant, in this case Michael Sutton, who described his views of the controversy in a February 15 speech:

The Commission's Chairman has made it clear that he would oppose any initiative, by any group, that would compromise the FASB's effectiveness or the fact or perception of its independence. I fully support the Chairman's position. (Sutton 1996)

The fact that Levitt was leading instead of Sutton reflects his high priority for this issue.

COOK WRITES TO ROY

Cook (1996a) replied to Roy on February 12, 1996, after both were informed of Levitt's support for FASB. According to Cook (2000), he sent this letter as a routine courteous response to constituents because he did not yet fully grasp the intensity of Levitt's anxiety.

In fact, Cook's letter fanned the controversy by not acknowledging Levitt's concerns, especially in failing to rebut Roy's pejorative claim that "the FASB process is broken and in need of substantive repair." Instead, Cook innocuously referred only to the CCR's "views about the structure and effectiveness" of FASB and thanked Roy for "continued support" of the board's "continuing independence." In addition to not rejecting CCR's proposals, Cook said that FAF had discussed "several" of the proposals at its February 1 meeting and promised Roy that CCR's "views will be considered further." Perhaps thoughtlessly, Cook merely sent Levitt a copy of his letter without calling.

Like Sherlock Holmes, who noticed in the story "Silver Blaze" that the dog did not bark when the racehorse was stolen, Levitt was alarmed by Cook's apparent indifference to his stern letter to Roy of just a few days before (Levitt 1996a). Inadvertently, Cook's diplomatic letter motivated Levitt to turn up the heat. (7)

EVENTS OF THE NEXT TWO MONTHS

After this public airing of views, the controversy went below the surface for two months where it was addressed in several meetings that eventually caused Cook and the trustees to replace the CCR as antagonists to the SEC chair. When Levitt concluded that they were not addressing his concerns, he went public with another letter.

LEVITT ISSUES AN ULTIMATUM

Levitt's (1996b) April 22 letter to Cook escalated the controversy while trying to build a broader-based consensus to support his plan for restructuring the FAF to give the trustees more power for turning aside threats. The first sentence declared Levitt's "strong commitment to safeguard and strengthen the independence of the Financial Accounting Standards Board," thus framing the issue as the question of whether the trustees would rebuff the CCR proposals. He described his objective and opinion of those proposals with these words: "to ensure that the FASB continue[s] to be free of undue influence from special interest groups" (Levitt 1996b). Levitt did not see OCR as constituents with minor complaints; rather, they were a "special interest group" trying to exert "undue influence."

Levitt then said that his goal was to "promote the public interest and improve financial reporting and disclosure" while observing that FAF was not suitably structured to respond because it lacked "sufficient public representation" (Levitt 1996b).

He next revealed that he had asked the FAF to create a plan to produce a majority consisting of "individuals with strong public service backgrounds who are able to represent the public interest, free of conflict." His words show that he believed the present trustees were unsuitable.

Levitt changed his tone for two paragraphs by describing similar changes in other regulated areas but ended the interlude by confirming the issue's high importance and reasserting that financial reporting is crucial to the capital markets and reminding the FAF that his concerns were "well grounded" and deserved the trustees' close attention.

Levitt then dropped a bombshell by delivering an ultimatum that the trustees replace some of themselves with new members and demanded the power to approve specific appointments. Significantly, he added:

The FAF's prompt response will avoid the necessity of the Commission pursuing a direct solution to the concerns I have raised through amendments to Accounting Series Release (ASR) No. 150. (Levitt 1996b)

His willingness to amend ASR No. 150 (SEC 1973) raised the stakes to an unprecedented level by threatening the SEC's endorsement of FASB as the only authoritative source of GAAP. Levitt went on to encourage Cook to change voluntarily and asked the trustees to act at their next meeting, only eight days away. This time frame suggests that he thought the trustees had discussed his concerns and would be able to respond that quickly; Cook (2000) denies that this demand had been previously delivered.

This communication took the SEC/FASB relationship into new territory. Levitt's claim for approval of trustee appointments was probably unjustified as an oversight power and eventually faded from the scene. However, later events revealed that he held this kind of power informally.

As a footnote, Levitt's cordial greeting ("Dear Michael") and signature (simply "Arthur") contradicted the letter's gravity. Perhaps Levitt was signaling his hope for an amicable resolution. (8) In any case, the die was cast, and the next question was whether the trustees would accede or resist an intrusion they considered to be unwarranted.

ROY RAISES A WHITE FLAG

Eight days after Levitt's April 22 letter, Roy distributed a press release (FEI 1996) that is noteworthy for its lack of substantive comment on the struggle. The opening paragraph asserted that FEI had "actively and constructively" participated in taking U.S. GAAP to higher levels. Roy cautiously and ambiguously supported Levitt by echoing his words but did not describe any actions that FEI would take:

FEI agrees with SEC Chairman Arthur Levitt Jr. that accounting standard-setting must function in the public interest. We believe that oversight by a balanced Financial Accounting Foundation Board of Trustees most effectively prevents domination of the process by any special interest and ensures that all constituencies are represented. Our mutual goal is financial reports that best serve the needs of investors and other users, and we are ready to work with the Chairman in furthering this goal. (FEI 1996)

Although ambiguity often surrounds political statements, it appears that Roy was trying to mend fences while saving face and extracting the FEI from the now titanic struggle after realizing that the controversy had escalated to the point that he had nothing to gain. (9) If so, then the release was a white flag that vainly invited a peaceful resolution.

JOHN DINGELL WEIGHS IN

Given the depth of Levitt's feeling, he sought support from other corners, including Congress, as evidenced in a May 15 letter to him from Congressman John Dingell (1996). It began by stating his belief that there was a plan to "undermine" the FASB's independence and continued by reciting the authority for the SE C's involvement in the dispute. Dingell also asserted his own jurisdiction in this political territory. He then culminated his offer of support with this request:

I commend your efforts to carry out your statutory mandate for the protection of investors, and respectfully request a full report on this matter at your earliest convenience. That report should include: a list and description of the current make-up of the FASB and the FAF; your assessment of whether there is adequate representation of the public interest on these bodies; your assessment of whether, in particular, the majority of FAF trustees are free of conflicts with constituent interests so as not to compromise the independence and fairness of their decision making; your assessment of any reforms to FASB proposed by FAF; a description of any and all conversations and/or meetings between SEC and FAF officials on these or related matters; and any recommendations you deem appropriate for maintaining the integrity of private-sector self-regulation in this area. (Dingell 1996)

The final paragraph said: "If there is any way that I can be of assistance to you in this matter, please do not hesitate to contact me." This open-ended support strengthened Levitt's already strong hand by giving him the weapons of Dingell's personal persuasion, public hearings, and legislation to appropriate federal funds for FASB to counterbalance contributions from preparers. To avoid delay, Levitt deferred an official response to Dingell until midsummer, when he sent him a copy of the July 8 press release with a covering letter.

THE ESCALATION CONTINUES

Despite this powerful support for Levitt, the trustees soon took the controversy to a higher level by issuing a press release on May 21 covering separate letters from Cook to Roy and to Levitt (FAF 1996b). The release expressed the trustees' view that Levitt had overreached and that he was interfering with their ability to exercise their own oversight:

The FAF is responsible for funding, selecting the members of, and overseeing the Financial Accounting Standards Board, the Governmental Accounting Standards Board, and their respective Advisory Councils. (FAF 1996b)

Because the trustees had engaged Kekst & Co., a public relations firm known for its aggressiveness in fighting hostile takeovers (Andrews 1996; Ketz and Miller 1996), it is fair to surmise that their uncharacteristically harsh tone was created by these experts.

TOO LITTLE, TOO LATE

The letter from Cook to Roy (Cook 1996b) was intended to be a public statement showing that the FAF was resisting the original CCR proposals. Finally, the trustees had responded in the way that Levitt had sought four months earlier. However, the only specific CCR proposal that the trustees addressed was turning FASB's agenda over to a committee, which was perhaps the least likely to be implemented:

The Trustees have specifically considered and rejected your recommendation that agenda control be taken from the FASB and placed in the hands of an independent, third-party organization. In our view, this is not consistent with an essential concept underlying today's standard-setting process, that is, that standard setting is exclusively the province of an independent FASB. (Cook 1996b)

Cook then segued to a statement that the trustees would resist any effort that:

impairs, in fact or appearance, the independence of the FASB, or subjects it to undue influence from any group or body, or impairs its ability to issue timely accounting standards it deems to be in the public interest. (Cook 1996b)

This phrasing shows that both parties believed they were resisting inappropriate intrusions; to Levitt, the intruder was CCR, while the trustees thought it was Levitt.

This letter was clearly "too little, too late" because of the certainty that the controversy would not have arisen if Cook had originally responded to Roy with a message like this one back in February. However, he had not, and this belated effort did not console Levitt.

THE TRUSTEES' LAST STAND

Cook's May 20 letter to Levitt was his first public rejection of Levitt's demands for restructuring (Cook 1996c). The opening paragraph confirms that he had more than one meeting with Levitt and the SEC staff. Like a prizefighter shaking the opponent's hand before a match, Cook claimed a shared "commitment to safeguarding the independence of the FASB and to ensuring that the FASB not be unduly influenced by any particular group or body."

Cook noticeably changed his tone in the second paragraph by using words that provoked Levitt even further. Despite Levitt's previous firm language and Dingell's support for a major restructuring, Cook characterized the SEC chair's concerns merely as "a perception that the composition of the FAF Board of Trustees somehow prevents it from sufficiently supporting the FASB." Cook's decision to use the condescending words "perception" and "somehow" reflected the vast distance between their positions. Cook then kicked the controversy up a notch by saying. "We emphatically do not agree" (Cook 1996c). The third and fourth paragraphs claimed that Levitt had misinterpreted their previous silence as acquiescence and Cook cited his May 20 letter to Roy (Cook 1996b) as proof that FAF was capable of saying "no" to its critics.

Cook used the sixth paragraph to assume control over the controversy and its resolution by declaring that FAF was ready to appoint two new "At-large public Trustees," apparently with the hope that Levitt would be mollified. However, that olive branch was compromised by Cook's observation that the two previous at-large trustees were chief financial officers. (10) The third sentence dismissed the notion that a sponsoring organization would willingly reduce its representation and used the Securities Industry Association (SIA) as an example. Cook then discouraged Levitt's intervention by saying, "[w]e do not believe it would be appropriate to.. .provide for.. .a controlling majority of the Trustees to be 'public interest' Trustees, as defined by you" (Cook 1996c). His message was that the FAF was competent to decide for itself and that Levitt's interference was unmerited. Cook asserted that Levitt's definition of public trustees was too restrictive and then contested Levitt's previously unpublished view that he did not consider the governmental trustees to be public members. Cook also rejected Levitt's proposal for separate trustee boards for FASB and GASB and then struck at the chink in Levitt's armor by arguing that his previous demand for power to approve trustee appointments contravened the basic concept of private sector standard setting.

Cook also put a different perspective on the relationship between FAF and the SEC chair. Whereas Levitt approached the controversy from the point of view that the commission's duty was to exercise active oversight of the FAF/FASB system, Cook asserted that Levitt could only expect the FAF to receive his inputs and then communicate their decisions to him. Specifically, he said, "We will continue to consider your concerns and will keep you informed as we develop our strategic plan" (Cook (1996c.). (11) Cook closed the letter by claiming the trustees were acting in accordance with the vision of the Wheat Committee (actually, the Wheat Study Group), implying that Levitt was not.

If the trustees intended this letter to make Levitt lose heart and back down from the controversy, they soon discovered that it did not work.

LEVITTS QUICK ANSWER

Levitt wasted no time responding to Cook with a letter dated May 21 (Levitt 1996c). Because this letter carries the same date as the FAF press release, he must have prepared it very shortly after receiving Cook's letter. Like Cook, he began with an obligatory handshake but quickly attacked Cook's allusion to the Wheat Study Group by stating that FASB must have "unassailable independence in fact and in appearance." He plunged on: "I continue to believe that the FAF would be publicly recognized as independent--in fact and appearance--if it were comprised of a majority of independent members." He parried Cook's claim that his plan for restructuring would endanger the system by saying, "Our goal is not to undermine private sector standard setting--but to strengthen it" (Levitt 1996c).

The following comments dealt with: (1) Cook's original letter to Roy (Cook 1996b), (2) Levitt's dissatisfaction with the rebuff to the CCR, and (3) his insistence that the trustees see things his way:

I am encouraged by your recent response to the FEI letter of several months ago and I am prepared to continue our discussions regarding a credible selection process that is broadly accepted as independent.

I favor consensus solutions, and remain optimistic that we will work together to address quickly these difficult issues. In the meantime, I expect that the FAF and FASB will defer independent action on these matters.

Although I am hopeful that we both recognize our mutual interests and will find ways to resolve them satisfactorily, you must understand that the Commission takes its statutory responsibility quite seriously and we are required to take whatever steps necessary to discharge our mandate.

He thus made it clear that he would consider the controversy resolved only if the FAF's structure was changed. In summary, Levitt was not even slowed down by the trustees' salvo, much less stopped. He considered the stakes to be worth fighting for, and he let them know that he still held the high hand. After this letter, the struggle went almost entirely out of the public eye. (12) After only six weeks, the impasse would be broken.

THE DENOUEMENT

When the process was completed in July, Levitt won on two issues. First, the trustees converted two sponsoring organization positions into at-large seats. Because of Levitt's concern that preparers and auditors dominated the FAF, the sacrificed positions came from the FEI and ATCPA, a fact that surely frustrated CCR because it was so far from what they had set out to accomplish six months earlier. Second, Levitt persuaded the trustees to appoint four specific individuals who met his criteria. However, he lost on three other issues. As mentioned earlier, he failed to win separate trustee panels for the FASB and GASB, and he ended up agreeing to classify two of three governmental trustees as public members. He also did not get veto power over trustee selections; however, this power could not have been legitimately granted by the trustees. Despite this loss, the outcome established that this particular SEC chair did indeed have the de facto power to approve appointments.

Perhaps the biggest issue was the search for Beresford's successor, which was not resolved until Edmund Jenkins was appointed in July 1997. Levitt's impact on this choice was confirmed by both Cook (2000) and Levitt (2000).

The public announcement of the restructuring occurred in a joint press release issued simultaneously by the SEC and the FAF (1996c). (13) The role of the SEC in the restructuring was acknowledged by the release's title, "FAF and SEC Reach Agreement on Changes in Composition of Accounting Foundation." After stating that the two organizations "reached agreement for a change in the composition of the Foundation's board," the release described new trustees John Biggs, Manuel Johnson, and David Ruder, and disclosed Charles Bowsher's tentative election upon his retirement from the General Accounting Office. This sentence understates Levitt's impact: "The FAF selected the new At-Large Trustees in consultation with the SEC." The evidence in the preceding pages proves that the trustees really considered the SEC's role to be an unwelcome intrusion rather than a simple helpful consultation.

The release also stated that the FAF would amend its bylaws to reflect the structural changes. (14) The sixth paragraph quotes Cook, who put a positive spin on both the restructuring and the new appointees by saying:

The change in the composition of the Foundation Board provides a strong basis for the Foundation's continuing support of the FASB and the GASB and their essential role in private sector accounting standards setting and the efficient functioning of our economy and capital markets. (FAF 1996c)

This support is not perfectly consistent with Cook's previous communications. On the other hand, Levitt surely restrained his enthusiasm in this quote:

In all, I believe these changes serve to enhance the FAF, maintain the FASB and GASB as the private-sector standard setters and protect the integrity of American accounting standards. (FAF 1996c)

Although Levitt had won, he refused to gloat.

THE OUTCOME

The basic effect of the restructuring was to reduce the number of sponsored trustees to 11, while increasing the at-large seats to five. Of course, this new structure did not necessarily ensure the permanency of Levitt's achievements. In particular, future trustees could decide that at-large members do not have to be public representatives in accordance with Levitt's definition. (15) They also have discretion to adopt different criteria for identifying suitable public representatives. Furthermore, the FAF's bylaws do not define a process that allows a nontrustee to hold trustees accountable for any action or inaction. Although these possibilities are and will be constrained by SEC oversight, the nature of that constraint depends on the future composition of the commission and its leadership.

The trustees who were serving one year after CCR's letter are listed in the first section of Exhibit 3 (FAF 1997). The lower section summarizes the impact of the resolution: auditors lost one position and dropped from 28.57 percent in 1996 to 18.75 percent; preparers lost two and fell from 42.86 percent to 25 percent; users retained their seat but declined from 7.14 percent to 6.25 percent; and the public increased from three to eight trustees, thus raising its proportion from 21.43 percent to the 50 percent minimum that was Levitt's goal. Altogether, seven new trustees came onto the FAF in the year after the controversy started. Any CCR members who had believed in January that they had a solid footing for gaining control of the standard-setting process were surely disappointed by this outcome.

SUMMARY AND CONCLUSIONS

When the SEC issued ASR No. 150 endorsing the FASB as the source of GAAP, it could justify this unusual delegation of rule-making authority only by retaining strong oversight. In the ensuing two decades, SEC oversight had been scrupulously subtle, even restrained, to ensure that standard setting was perceived to be independent. This placid relationship was altered in 1996 when SEC chair Arthur Levitt grew alarmed at the confluence of three factors: a shell-shocked FASB, an aggressive preparer constituency, and FAF trustees who were unwilling to stand up. Levitt's risk in breaking from the past was outweighed in his mind by the even greater risk that the FASB would be unable to enhance financial reporting standards.

He faced an uncharted downside because he would not be guided by an established due process that described mechanisms for formally notifying the public, holding hearings, soliciting comments, and enacting the desired change.

The greatest blame for this urgent situation surely resides with the CCR, whose initial letter to Cook created a pejorative tone by claiming FASB was "broken and in need of repair." The situation was exacerbated by CCR's decision to let Levitt learn of their demands merely by sending him a copy of the letter. Their likelihood of success was surely hindered by this failure to communicate directly.

Further, the initial responses to OCR by Cook and to Levitt by other significant leaders were so neutral that Levitt feared that there was total agreement with the plan to put the FASB in what he later described as "leg irons." Only when his February 7 letter forced the issue did the FAF undertake a public response. However, Cook committed the same error of merely sending Levitt a copy of his letter of February 12 instead of addressing his concerns directly. Because this letter did not describe any open due process for the trustees to apply when dealing with the CCR proposals, Levitt feared that the FAF would accede to the FEI in closed-door sessions. This possibility heightened his concern over a diminished FASB as the end result.

Without a due process of his own, Levitt created a back channel with numerous personal contacts. Not being guided by formal policies, he followed his instincts and aggressively pursued the change that he believed was needed. A key step was ensuring his support from Congressman Dingell, who offered Levitt an opportunity to raise and discuss the issues in a public forum. Levitt declined. Perhaps he felt that success was within his grasp; it is also possible that he did not want to lose time preparing for, conducting, and then responding to evidence provided at the hearings. The clock on Beresford's term was running out, and Levitt feared any delay that might hasten the appointment of a new FASB chair who would acquiesce to OCR and its agenda.

On the other side, the trustees were obviously offended by Levitt's assault on FASB's independence. Their defensive response is, of course, understandable in light of the freedom they and their predecessors enjoyed during the previous 23 years. When Levitt continued pressing, their desperation increased to the point where they engaged Kekst & Co. to help fight an apparent hostile takeover. They failed to understand that Levitt's position as SEC chair gave him all the trumps; his control over ASR No. 150 severely limited their options.

To the mutual credit of the antagonists, they eventually conceded that the others had valid points and took the issues out of the public arena. They went on to reasonable compromises and a workable solution. Levitt was the clear winner by getting four new trustees and reducing the default positions filled by the AICPA and FEI.

Since the July 1996 compromise and press release, no public complaints about FASB have approached the intensity of those in the initial letter to Cook from Roy. This silence does not necessarily mean that dissatisfaction has disappeared; rather, it may reflect the fact that the FEI leadership and other preparers learned the limits of their power to intimidate FASB. The biggest issue still remains open--the question of whether the restructuring led to new accounting standards that put more useful information in financial statements.

In closing, it may very well be true, as Cook (2000) has suggested, that this episode is a case of "all's well that ends well." The road to ending well was not smooth, but it was the best that could be expected when no one had a clear map outlining a due process for reaching the destination.

EXHIBIT 2

FAF Board of Trustees January 1996

Trustees Nominated by Sponsoring Organizations

Sponsoring
Organization         Name                 Affiliation

AAA           Beaver, William H.     Stanford University
AICPA         Cook, J. Michael       Deloitte & Touche
              Madonna, Jon C.        KPMG Peat Marwick
              Rimerman, Thomas W.    Frank, Rimerman & Co.
              Weinbach, Lawrence A.  Arthur Andersen

AIMR          Austin, George E.      J. P. Morgan Investment
                                      Management, Inc.
FEI           Brown, Michael W.      Microsoft Corporation
              Jones, Thomas E.       Citicorp

Government    Kennedy, Stan          Kennedy Consulting
              Morris, Earle E., Jr.  State of South Carolina
              Soglin, Paul R.        City of Madison, WI
IMA           Parfet, William U.     MPI Research
SIA           Duff, Philip N.        Morgan Stanley Group

Sponsoring
Organization       Position

AAA           Professor
AICPA         Chairman and CEO
              Chairman and CEO
              Managing partner
              Managing partner--
               Chief Executive
AIMR          Managing director

FEI           Chief Financial Officer
              Executive Vice
               President
Government    President
              Comptroller General
              Mayor
IMA           Co-Chairman
SIA           Chief Financial Officer
At-Large Trustees Selected by Other Trustees

Name                      Affiliation       Position

Wriston, Kathryn D.  Various organizations  Director
Vacant
Vacant
Percentages

Constituency  Trustees                                     Number

Auditor       Cook, Madonna, Rimerman, Madonna                4
Preparer      Brown, Jones, Parfet, Kennedy, Morris, Duff     6
Users         Austin                                          1
Public        Beaver, Soglin, Wriston                         3
Vacant                                                        2
Total                                                        16

Constituency  Percentage

Auditor          28.57
Preparer         42.86
Users             7.14
Public           21.43
Vacant
Total           100.00
EXHIBIT 3

FAF Board of Trustees January 1997

Trustees Nominated by Sponsoring Organizations

Sponsoring
Organization  Name                   Affiliation

AAA           Weygandt, Jerry J.     University of Wisconsin

AICPA         Cook, J. Michael       Deloitte & Touche
              Rimerman, Thomas W.    Frank, Rimerman & Co.
              Weinbach, Lawrence A.  Arthur Andersen


AIMR          Marshall, Greta E.     The Marshall Plan

FEI           Jones, Thomas E.       Citicorp

Government    Morris, Earle E., Jr.  State of South Carolina
              Regan, Ned             The Jerome Levy
                                      Economics Institute
              Soglin, Paul R.        City of Madison, WI

IMA           Parfet, William U.     MPI Research

SIA           Duff, Philip N.        Morgan Stanley Group

Sponsoring
Organization  Position

AAA           Professor

AICPA         Chairman and CEO
              Managing partner
              Managing partner--
               Chief Executive

AIMR          Principal

FEI           Executive Vice President

Government    Comptroller General


              Mayor

IMA           Co-Chairman

SIA           Chief Financial Officer
At-Large Trustees Selected by Other Trustees

Name                 Affiliation              Position

Biggs, John H.       TIAA-CREF                Chairman and CEO
Bowsher, Charles A.                           Former Comptroller
                                               General of the U.S.
Johnson, Manuel      Johnson Smick            Co-Chairman
                      International
Ruder, David S.      Northwestern University  Professor
                      School of Law
Wriston, Kathryn D.  Various organizations    Director
Percentages

Constituency              Trustees               Number  Percentage

Auditor       Cook, Rimerman, Weinbach             3       18.75
Preparer      Jones, Parfet, Morris, Duff          4       25.00
Users         Marshall                             1        6.25
Public        Weygandt, Regan, Soglin, Riggs,
               Bowsher, Johnson, Ruder, Wriston    8       50.00

Total                                             16      100.00

Submitted: January 2002

Accepted: April 2002

(1.) MRB (183) hypothesize that FASB member Arthur Northrop was not reappointed in 1991, despite his willingness and unanimous support by the other members, because he may have failed to meet the preparer community's expectations. Van Riper (1994, 166) also comments on this event.

(2.) Categorizing Wriston is problematic in light of her associations with managers of Business Roundtable companies.

(3.) The organization is now known as Financial Executives International.

(4.) Although the letter contains no acknowledgement, an informal source reveals that one impetus for its preparation was Beresford's invitation to several representative constituent bodies to provide suggestions that might be helpful for FASB's first strategic review.

(5.) This structure change was again proposed in April 2002 by the FAF in response to criticisms related to the Enron crisis. The proposal was rejected in June 2002.

(6.) In 1988, SEC chair David Ruder promptly rejected a similar proposal that was presented to the commission by the Business Roundtable (MRB, 182).

(7.) The June 6 speech by Levitt (1996d) assessed the threat with these words: "[e]arlier this year, healthy criticism turned into withering attack. The FEI, a financial officers' group, issued a series of recommendations that would have put FASB in the corporate equivalent of leg irons."

(8.) According to Cook (2000), Levitt's use of "Michael" instead of "Mike" made him feel that he had been called on the carpet.

(9.) As reported by Cook (2000), this release was a surprise. In his words, "No one knew it was coming."

(10.) When these two were trustees, preparers occupied 50 percent of the FAF seats.

(11.) The author previously summarized this statement as saying, "In other words, 'Don't call us, Mr. Chairman, we'll call you'" (Ketz and Miller 1996, 17).

(12.) Levitt (1996d) lifted the veil on his plan for restructuring the FAF early in June. Specifically, he said that he wanted to have some sponsoring organizations relinquish seats so that additional at-large trustees could be elected without expanding FAF's size.

(13.) A quote from this release was presented in the opening paragraph of this paper.

(14.) This action did not occur until nearly two years later (FAF 1998, 42-44).

(15.) The foundation's rules describe at-large positions as follows: "The remaining members of the Board of Trustees shall be members at large...and shall be individuals with business, professional, government, or other experience who, in the judgment of the Board of Trustees, can contribute to advancing the purposes of the Foundation" (FAF 1998, 43).

REFERENCES

Andrews, S. 1996. Gershon Kekst, the bidden persuader. Institutional Investor (March): 108-114.

Cook, J. M. 1996a. Letter to P. N. Roy. February 12.

-----. 1996b. Letter to P. N. Roy. May 20. The full text is available at: http://www.uccs.edu/~fafletters

-----. 1996c. Letter to A. Levitt. May 20. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 2000. Telephone conversation with author. October 25.

Dingell, J. D. 1996. Letter to A. Levitt. May 15. The full text is available at: http://www.uccs.edu/~fafletters.

Financial Accounting Foundation (FAF). 1996a. 1995 Annual Report. Norwalk, CT: FAF.

-----. 1996b. News: FAF trustees respond to Arthur Levitt. May 21. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 1996c. News: FAF and SEC reach agreement on changes in composition of accounting foundation: Appointing three new trustees to serve. July 8. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 1997. 1996 Annual Report. Norwalk, CT: FAF.

-----. 1998. Rules of Procedure. Norwalk, CT: FAF.

Financial Accounting Standards Board (FASB). 1995. Accounting for Stock-Based Compensation. Statement of Financial Accounting Standards No. 123. Stamford, CT: FASB.

Financial Executives Institute (FEI). 1996. News release: Financial Executives Institute supports strong, independent standards-setting process. April 30. The full text is available at: http://www.uccs.edu/~fafletters.

Ketz, E. J., and P. B. W. Miller. 1996. FAF reform plan emasculates FASB and must be stopped. Accounting Today (June 17-July 7): 14, 16.

-----, and -----. 1998. New revenue sources offer a better way to fund FASB. Accounting Today (April 6-26): 14, 29.

Miller, P. B. W., R. J. Redding, and P. R. Bahnson. 1998. The FASB--The People, the Process, and the Politics. Fourth edition. New York, NY: Irwin-McGraw Hill.

Levitt, A. 1996a. Letter to P. N. Roy. February 7. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 1996b. Letter to J. M. Cook. April 22. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 1996c. Letter to J. M. Cook. May 21. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 1996d. The guardians of financial truth. Speech before the SEC and Financial Reporting Institute, Pasadena, CA, June 6. The full text is available at: http://www.uccs.edu/~fafletters.

-----. 2000. Telephone conversation with author. May 10.

Roy, P. N. 1996. Letter to J. M. Cook. January 19. The full text is available at: http://www.uccs.edu/~fafletters.

Securities and Exchange Commission (SEC). 1973. Statement of Policy on the Establishment and Improvement of Accounting Principles and Standards. Accounting Series Release No. 150. December 20. Washington, D.C.: Government Printing Office.

Sutton, M. 1996. Remarks at the 1996 AICPA Conference on Current SEC Developments. Washington, D.C., February 15.

Van Riper, R. 1994. Setting Standards for Financial Reporting. Westport, CT: Quorum Books.

The author expresses appreciation to Messrs. J. Michael Cook and Arthur Levitt for their assistance in reviewing, commenting on, and correcting earlier versions of this manuscript. Thanks are also directed to the anonymous reviewers of the submitted manuscript. Any errors that remain are, of course, the author's responsibility. Data used in this paper is presented on a website, is available publicly, or consists of private communications with the author.

Corresponding author: Paul B. W. Miller

Email: pmiller@uccs.edu

Paul B. W. Miller is a Professor at the University of Colorado at Colorado Springs.