STANDARDS BEARER
A heavyweight in financial and accounting reform weighs in on what's coming Asia's way as the US market puts its house in order.
By Abe De Ramos

Paul Volcker's second career is shaping up to be as influential as his first. Until recently, his claim to fame rested primarily on his tenure as US Federal Reserve Board chairman from 1979 to 1987, when his tight money policy broke the back of the double-digit inflation that doomed Jimmy Carter's quest for a second term. But although Volcker's performance prepared the way for the US's economic turnaround and longest-ever bull market, his star was eventually outshone by that of his successor at the Fed, Alan Greenspan.

Now, as Greenspan's own star has dimmed as the internet bubble has burst, the 75-year-old Volcker has reemerged as a beacon of integrity in the business world. After leaving the Fed, he served as chairman and CEO of investment firm James D. Wolfensohn Inc. from 1988 to 1996, and became a professor (now emeritus) at Princeton University, his alma mater. Then, in 1996, he was chosen to chair the committee overseeing the restitution by Swiss banks to Holocaust victims. The committee's investigation ultimately uncovered thousands of accounts that probably belonged to victims of Nazi Germany.

In 2000 Volcker accepted the invitation of Arthur Levitt, then chairman of the Securities and Exchange Commission, to head the Oversight Board of the International Accounting Standards Committee. The board was charged with bringing IAS rules into greater harmony with US Generally Accepted Accounting Principles. Levitt gave Volcker the job despite the latter's blunt comment that it was "arrogant" for the US to believe that everyone should report in GAAP.

It was in part this reputation for bluntness and independence that landed him his next post. In one of the oddest footnotes to the Enron scandal, Arthur Andersen CEO Joseph Berardino hired Volcker to serve as chairman of a committee to reform Andersen. Such was Volcker's clout that Andersen agreed to adhere to any recommendations he made. Although this extraordinary initiative was abandoned quickly as Andersen fell apart, Volcker survived with his own reputation not just unscathed but even enhanced. So it was no surprise when SEC chief Harvey Pitt, shortly before his own downfall, called on him to head the new Public Company Accounting Oversight Board (PCAOB) mandated for the accounting industry by the Sarbanes-Oxley Act of 2002 (or "the Sarbanes Act," as Volcker called it during a recent Association for Financial Professionals conference, "since Sarbanes did 90 percent of the work"). Volcker declined Pitt's offer, citing concerns about the time demands of the job.

Abe De Ramos, executive editor of CFO Asia, recently sat down with Volcker for a far-reaching conversation about how the demands on his time have been influenced by the events of the past two years - and how those events have changed both the climate for corporate governance and the prospects for international accounting standards.

What influenced your decision to take the role of chairman of the board of trustees of the International Accounting Standards Committee?

I'm a sucker for punishment. It came out of the blue. I had some interest in international accounting standards in a general way, and I had no idea that this group was working on it. But Arthur Levitt, then the head of the SEC, called me up one day and invited me to chair the oversight board. It sounded interesting, so I did it.

What progress have you made?

Well, the board has been reorganized and re-appointed. We have a new board in place and it's working. We're now beginning to issue standards, and the first ones, particularly the standard on accounting for derivatives, will be very controversial. I wish this didn't have to be so, but it's perhaps inherent in the business. [See box, Explosive Standards] Where the real progress has been made is in thinking, in the general environment. All the scandals have been a big help in one sense, because they have challenged the traditional American view that if you want international standards, use our standards, we've got the best and brightest. The Americans are more cooperative, there's now more public understanding of the need for international standards.
There has also been progress in a concrete sense. Good cooperation has been forged between the US Financial Accounting Standards Board (FASB) and the IASB. The two bodies announced in September a joint effort to get together, clarifying some of the differences and diminishing them. Bob Herz, the new head of the FASB, came from the IASB, which is a reflection of some mutual sympathy. We have a big work program because with Europe and some other countries wanting to adopt international standards, by law, in 2005 … you want to be prepared and companies want to know where they stand by 2004. We're already in 2003, so there's a lot of work to be done in the next year or 15 months or so.

But as far as the FASB and IASB are concerned, they also have a 2005 goal. Is that workable?

That goal is not a coincidence. You will not have a complete set of international standards that everybody's agreed to in 2005 … so what they're doing is getting as much convergence as possible on a group of standards. There's an international standard, a US standard, and other countries have standards too. They're not 100 percent apart anyway, but they have a lot of differences.

And then there are other standards, new standards, that we're working on now, like expensing stock options. This is a new standard. We're working on a standard for derivatives, and other standards including pension accounting, but that's further off. There are other big areas of accounting convergence that are further off. The view is to make as much progress as possible where both sides already have standards, and get that ready for 2004, so people know where they stand.

The FASB-IASB agreement makes it appear that the US will compromise US GAAP. Is this true? Where will resistance come from?

It's much more the case now than it would have been a year or two ago. I would not have done this if I did not think that the US was sympathetic with it - and some people in the US are not - but the SEC at the time of my appointment to IASC said it was. Well, the SEC will have a new leader soon. [William Donaldson, a former investment banker and chairman of the New York Stock Exchange, was appointed by President George Bush on December 10 to succeed Harvey Pitt, who resigned on November 5]. I don't know what the new chairman will do, but the SEC has been supportive up to now. The interesting thing is I think the FASB itself is supportive. Every individual in the FASB may not be equally enthusiastic, but they have come to the conclusion that there are enough problems in this area, political and otherwise, and it may be easier to work out some of them internationally rather than domestically. They were subject to very heavy political influence, and I don't think they liked it.

In introducing new standards, do you think there will be geopolitics involved? Will Americans be saying: "Why don't you guys in Europe do it first, and then we'll follow?"

You don't want to go that way. You want a standard that everybody is sure is okay. The US hasn't said it would accept anything; the presumption is that for the time being, the US isn't suddenly going to say we'll adopt international standards, but will go along with it by starting to make its own standards conform. It will still call it US GAAP, but if it becomes virtually identical to international standards, you have no problem. But the first job is to get them as close as possible, that's what the US is trying to do now.

Europe will adopt international standards, but it reserves the right to reject any standard it doesn't like. The law that says it will adopt international standards also says that if there's some particular standard that the technical people, the policy people, object to, it could be rejected. If they reject one, what happens could prove an interesting question. If that rejection happens very often, you've defeated the purpose of introducing a set of rules to be accepted on an international basis.

Going back to stock options. If the goal is to have an international standard to expense stock options, doesn't it follow that there also has to be a standard on the way stock options are valued, particularly the issue of volatility?

The standard that is being proposed [by the IASB] does not require a particular method of expensing, just some guidelines on how it should be done. It doesn't say you must do it exactly this way. The proposal requires companies to do it, and within a certain framework, but there's more than one way to do it within that framework. You could get differences between companies and differences between countries.

Here's my point of view, independent of the IASC. When I look at stock options, I get more and more convinced that the basic trouble is not whether you expense or not, but that they're a bad instrument, period. They're so subject to abuse, I'd want to get rid of them. There ought to be better ways of compensating people. There are better ways of compensating people.

So I want to discourage the use of stock options. Expensing them would somewhat discourage it. But the primary question to ask is: what should be the accepted best practice? What should stockholders insist upon? If a company is going to grant stock options, I would like to see some damn good reasons for why that particular company finds it desirable to use an instrument that demonstrably is so subject to abuse.

In your view, what accounting standards or issues can the US adopt from the IAS?

The much-debated underlying philosophical issue is how much emphasis to put in a general statement of principles as opposed to very detailed explanations as to how the principles are supposed to be applied. There's no doubt that the opinion in the international area, particularly that of David Tweedie who chairs the IASB, is to go for principles. Now that is not a unanimous feeling. There is more sympathy for that in the US than there used to be, but it's certainly not unanimous among everybody in FASB. The chairman, yes, but not necessarily all of them.

But if you did a poll of accountants, or chief financial officers in the US, their views would be quite split. And the fear is if you don't have a so-called black line, if you don't let accountants and CFOs know exactly what the rule requires, it could leave the door open for excessive legal activism. Also, the possibility that some measure could be deemed as malfeasance after the fact scares everybody, so they want a very clear rule.

What do you think are the weaknesses of the typical board structure in America?

The most important single structural change is to encourage the deployment of non-executive chairmen. The advantage is you have a better degree of oversight over the CEO.

There's always talk about how the independent directors, when they get together, are not being directly influenced by the chief executive or the management, so they'll have a free discussion among themselves. That's very important. But I think that when they meet the only way to have truly free discussion is to have a non-executive chairman who determines the agenda. That way they're not entirely at the mercy of the priorities and information of the chief executive himself. In extraordinary times, it becomes really important - like if the company isn't doing well, or where there's some question of whether you want a new chief executive, or you have to pick a new chief executive.

I know from when I was a regulator, when something goes wrong and you want changes made, who do you talk to? You talk to the chief executive. But he's the problem, or might be the problem. If you can't talk to the chief executive, who will you talk to? There should be somebody who understands he has that responsibility.

The Economist suggested that CFOs should report to audit committees.
I sympathize with that. But where do you find the people to spend all their time, and have the experience to serve on an audit committee? You don't have those people on an ordinary board. You have competent people who don't have the time, and people who have time but aren't competent. My idea is to elect the members of the auditing committees separately. That means you wouldn't be just voting for a slate of general purpose people, but would have to have some indication of who's going to be on the auditing committee, and what his or her experience and background is. In order to be credible, people who have the right kind of experience have to be nominated.

What do you mean by separately?

Well, I mean one of two things. You could say you have an auditing committee, but it's not part of the board. It's separate, but reports to the board. The other way is to just have ordinary board members, but with designated auditing committee board members. When you're voting for 12 members of the board of directors, you say these three people are going to be on the auditing committee, and vote for them.

The typical reaction I get from auditing and accounting people is, it sounds like a good idea. The typical reaction I get from CEOs, and to some degree from directors, is, well, we don't want to divide up the responsibility, and a good auditing committee member wants to be familiar with all the operations, and that kind of familiarity requires him sitting on the board generally. .

What should the CFO's relationship be with the committee?

The CFO should report to the chairman of the board as his or her first priority and report to the auditing committee as a secondary duty. The auditor or controller, I would say, should report to the auditing committee as a primary duty, and report to the chairman of the board secondarily.

Do you regard the US SEC as in crisis?

All the government has lost is prestige, but the SEC had a lot of prestige, moral authority and integrity. It's still got integrity, but has lost some of its resources. One of the things that the Sarbanes-Oxley bill did was to authorize a big increase in expenditures - small in terms of the total budget - but big for the SEC. That was important, and the Bush administration has refused to provide the funds that are authorized. They need more money and higher salaries.

Abe De Ramos is Executive Editor, Hong Kong, for CFO Asia.