As chairman of the Investor Protection, Entrepreneurship and Capital Markets Subcommittee of the House Financial Services Committee, Rep. Brad Sherman plays a key role in setting the agenda for Congress’ capital markets legislation and oversight of financial regulators and standard-setters.
In a wide-ranging interview with Accounting and Compliance Alert, the California Democrat discusses the GameStop and Archegos fallout, the problems with the FASB’s delayed credit-losses standard, and hope for a compromise on the upcoming PCAOB audit inspection reckoning that threatens to delist Chinese companies traded on U.S. exchanges, among other topics.
[Editor’s note: The Q&A was edited for length and clarity.]
On implementation of the Holding Foreign Companies Accountable Act, a measure signed into law late last year that will delist companies whose auditors cannot be inspected by the PCAOB for three consecutive years. Sherman sponsored the companion bill in the House:
“The purpose of the bill was not to punish China….it’s not even to deny Chinese companies access on their equal terms with U.S. companies to U.S. stock markets, it’s just to say ‘hey, we’re not going to let you avoid the laws that we impose on our own companies.’ We protect our investors with the PCAOB. If we were going to relax those rules, maybe it should be for some U.S. company that’s at least going to maybe get more capital than they deserve because their accounting statements are not quite as good as they ought to be, but at least they are going to build factories here and employ people. We under-protect investors to over-provide capital to Chinese companies.”
On whether the Biden administration’s tougher China posture will make a compromise with the PCAOB more difficult:
“I think it strengthens the hand of the PCAOB, ultimately where we should have a deal. But it should be a deal where the PCAOB has access to all the accounting work papers on the same basis as they have with Canadian companies, British companies, American companies. Yes, I want a deal, I want a deal that fully protects American investors. The fact is [Senate bill sponsor Sen. John] Kennedy and Sherman et. al beat Wall Street. That doesn’t happen very often. It happened because China is not terribly popular on either side of the aisle…We’ve been working on this for a long time, this was not easy. And yes, not all of Wall Street, but elements of Wall Street were on one side, and Kennedy and Sherman were on the other side. For a long time we were losing. I didn’t expect that bill to become law last year, we got it through at the very end.”
“I don’t know if we can delay it further, most of the big banks have waved the white flag. That doesn’t mean the small banks will or should. As CECL’s being evaluated based on ‘oh is it good for lending, is it good for the banks, is it good during the COVID crisis,’ and that’s all important, and it is bad for the banks, bad for the economy, bad for the borrowers ¬ but it’s also terrible accounting. And the answer out of [FASB headquarters in] Norwalk, Connecticut every time they do something that’s terrible, is ‘oh, but that’s what the stock analysts wanted.’ Stock analysts want accountants to predict the future. Why would you settle for a perfect document describing the past when instead you could demand a document that predicts the future? CECL is now an attempt to predict the future of loans based off events that have not occurred. And to do that, only predicting bad events that have not occurred but not good events that have not occurred. And it gives you completely false information. The proof of it is that if you have two banks that are identical in every way, they are across the street from each other, and on December 31 one of them throws a big holiday party, does absolutely no business, and the other one across the street makes $50 million worth of good loans, just as good as all the loans they made during the rest of the year…the partying bank will have higher earnings-per-share. Because they goofed off. They wore funny hats and drank spiked punch. Is that how you make money, is that what a successful business is? Making goods loans loses you money, according to CECL.
On whether a long-standing budget rider barring the SEC from making corporate political spending disclosure rules will survive the current appropriations process:
“I can’t imagine such a rider will be in this year’s appropriations bills. That rider will not be there. And of course, last year’s SEC might not have issued the regs anyway, but this year’s SEC will…I expect that the appropriators in both houses and the new [SEC] chair [Gary Gensler] will be supportive of appropriate disclosures so that shareholders know what political causes their companies are paying for. It is, after all, their money.”
On Archegos Capital Management, a family office that imploded in March, which had relied on derivatives known as total return swaps to make heavily leveraged bets:
“We cannot allow Archegos to be a family office issue. Maybe it’s a family office issue, but it’s mostly a margin issue. Something that will affect dozens of rich families is the family office issue. Something that affects everybody with a Robinhood account, or is thinking about having a Robinhood account, is the margin issue. How much margin are we going to allow, and should we have different policies for the big and the small on that issue? Traditionally we allow 1:1 margin. You want to buy $1,000 worth of shares, you got to have $500. But not if you’re rich. And it’s not just family offices. You can be sure that these banks wouldn’t have cared at all whether Archegos was a family office or a hedge fund…if hedge funds can get 7:1, and family offices can get 7:1, should Robinhood customers get 7:1? Or put another way, if our markets need to make sure it’s only 1:1, shouldn’t we apply that even when somebody says this ‘oh this isn’t margin, this is a total return swap. Look into my eyes, see the watch going back and forth, it’s not margin, it’s a total return swap.’ Come on, if margin rules should be 1:1, they should apply to somebody even if they want to use a different name.”
On whether payment-for-order-flow should be prohibited, or better disclosed, following the GameStop volatility in late January, a controversy that partly focused on commission-free trading platform Robinhood and Citadel Securities, which serves as a market-maker for Robinhood:
“I’m fairly aggressive, and I kind of look first for the prohibitions…you can prevent Citadel from paying 15 cents to Robinhood to secure your order flow, but can you prevent citadel from paying $15 billion to Robinhood to buy the company and get virtually all their order flow? If we’re going to payment for order flow, I got to know whether you get around that by having the broker-dealer and the market maker be part of the same company…[On disclosure], what I want to know is how much price improvement I get, either after the fact tell me what you got me…or just as well, publish every month your total price improvements for all your customers as a percentage of the value of the transactions that you handle: ‘Last month we did $12 billion of transactions, we created $1 million worth of price improvements.’ That would allow me to go to the broker that gets me the best deal. And if it’s a broker that charges me commission but gets great price improvement, fine. If it’s a broker that says no commission, but it’s crappy price improvement, maybe that’s the best deal. But when you say no commission on this transaction, they are basically saying we saved you $10, we saved you $50, we saved you $100 on this transaction by not charging you a commission. That’s only half the story, what did you do on the price improvement side? And so I think if we let people know that whether their broker is buying or selling on an exchange, buying or selling with a market-maker, or buying and selling internally with their own market-making operation, no matter how they do the work, no matter how they get paid internally for the work, the issue for me is what kind of price improvement do they get. I think that disclosure of price improvement puts everybody on the same footing.”
On the five-decade old SFAS No. 2, a FASB standard on accounting for research and development costs:
[SFAS No. 2] is responsible for many thousands of deaths and massive under investment in research. A terrible impediment to us competing with China. The president gave a speech talking about how important it is to do research…and yet [SFAS No. 2] punishes every company that engages in research. It’s really bad accounting, and it was done because in the 1970s it was thought to be more convenient. And it continues to be done because the voters of the country can’t find Norwalk on a map. You have a government agency in Norwalk that has found a way to exercise government power, to collect tax revenue, and to avoid any responsibility for what they do.”
[Editor’s note: A FASB spokesperson responded that “The FASB is not a government agency. It is an independent, private-sector, not-for-profit organization recognized by the U.S. Securities and Exchange Commission as the designated accounting standard setter for public companies.”]
This article originally appeared in the May 17, 2021 edition of Accounting & Compliance Alert, available on Checkpoint.
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