Beyond economics: the U.S. recognition of international financial reporting standards as an international subdelegation of the SEC's rulemaking authority.

• Author: Barney, Jacob L.

ABSTRACT

A final rule promulgated by the Securities and Exchange Commission (SEC) in 2008 allowing foreign private securities issuers to prepare SEC-required financial disclosures under international financial reporting standards (IFRS) as promulgated by the International Accounting Standards Board (IASB) is a highly significant event for U.S. and global capital markets. However, surprisingly few questions have been asked regarding the SEC's legal authority to take such an unprecedented step.

This Note assesses the recent SEC action with regard to IASB from two perspectives--traditional administrative law, with particular emphasis on delegations by government entities to private parties, and international law, with particular emphasis on the ability of a national government to delegate some portion of its sovereignty to international bodies. This Note concludes that the SEC does not currently possess the authority necessary to recognize IASB as an official accounting standard-setter, and that Congress must take the lead on any proposed agency action which would function as an international delegation of authority.

TABLE OF CONTENTS I. INTRODUCTION II. THE HISTORY OF ACCOUNTING RULEMAKING UNDER U.S. SECURITIES LAWS A. The History of the SEC and Its Role as Accounting Standard-Setter B. The History and Standard-Setting Procedures of FASB C. The History and Standard-Setting Procedures of IASB III. SUBDELEGATION A. General Limitations on the Ability of Government Branches and Agencies to Subdelegate Their Authority to Private Parties 1. Delegation and Subdelegation in Administrative Law 2. U.S. Telecom Ass'n v. FCC: Legal Limitations on Subdelegation B. Recognition of Industry Standards Established by a Nongovernmental Entity as a Form of Subdelegation 1. Recognition of Externally Created Accounting Standards as a Subdelegation of the SEC's Authority a. "Passing of Power". b. Previous Scholarly Work c. Comparisons to Other Delegations 2. Delegation vs. Incorporation C. Specific Limitations on the SEC's Ability to Subdelegate Accounting Rulemaking Authority IV. INTERNATIONAL DELEGATION A. Constitutional Limitations on Delegations of Power to International Organizations B. Policy Considerations Regarding International Delegations 1. Accounting as an Expression of National and Financial Forces a. National Forces b. Financial Forces 2. The Effect of Accounting System Choice on Capital Formation V. RECOMMENDATIONS AND PROPOSALS FOR FUTURE ACTION A. A Path Forward for Congress B. Judicial Review of the SEC's Recognition of IFRS VI. CONCLUSION In the U.S. capital markets many ... are anxious to capitalize on the benefits of having a widely used set of accounting standards accepted and in place. I am excited about this opportunity, but I also want to make sure we get it right. (1) I. INTRODUCTION

The prevailing regime of financial accounting and reporting for publicly held companies in the U.S. is currently undergoing significant changes. Almost since its inception, the U.S. Securities and Exchange Commission (SEC) has "outsourced" its statutory authority to promulgate financial accounting rules (2) applicable to companies that must make financial disclosures under the federal securities laws. (3) The SEC currently recognizes the Financial Accounting Standards Board (FASB) as the organization empowered to promulgate such accounting rules. (4) Although several organizations have been recognized by the SEC as officially establishing generally accepted accounting principles (GAAP) since the 1930s, (5) all of these organizations (in their role as standard-setters) have worked exclusively toward the goal of establishing rules and practices for U.S. companies--or, at least, for those companies wishing to access U.S. capital markets. (6)

Recently, however, the SEC has considered allowing companies, both foreign and U.S.-based, to disclose financial information in accordance with the International Financial Reporting Standards (IFRS) promulgated by the International Accounting Standards Board (IASB). (7) In 2006, the SEC began allowing foreign-based securities issuers to file with the SEC financial statements prepared in accordance with IFRS and containing a conversion or "reconciliation" from IFRS to U.S. GAAP (8) (as opposed to financial statements prepared entirely in accordance with GAAP). SEC Chairman Christopher Cox publicly stated that he wanted the SEC to "eliminate, by 2009 at the latest, the SEC requirement for foreign private issuers to reconcile IFRS-based financial statements to US GAAP." (9) However, in the most recent and arguably most important development in the U.S. shift toward the use of international accounting standards, the SEC promulgated a final rule in January 2008 that allowed foreign private securities issuers to file IFRS-based financial statements with the SEC without including a reconciliation to U.S. GAAP. (10) This development comes despite the fact that many in business and academia hold reservations against recognizing IFRS without a corresponding IFRS-GAAP reconciliation. (11)

A recognition of the validity of IFRS in regards to the fulfillment of financial disclosure requirements under U.S. securities laws marks the first occasion upon which the SEC has given such recognition to international standards. This Note argues that the SEC's recognition of an international accounting standard-setter essentially acts as a further delegation, or subdelegation, of the rulemaking authority Congress originally vested in the SEC. (12) Recently, the U.S. Court of Appeals for the District of Columbia Circuit expressed concern about the validity of delegations of government power to foreign organizations, (13) and legal scholars have noted the complex issues and divergent interests inherent in such delegations. (14)

An assessment of the recognition of IFRS in the U.S. must necessarily extend beyond a purely economic analysis (15) and must also critically analyze the constitutional and political validity of recognition by a federal administrative agency of international standards in an area of law that previously had been strictly the domain of U.S.-based organizations. (16) This assessment can be broken down into two steps: (1) an analysis of the SEC's ability to subdelegate its authority to create accounting principles that are controlling under the federal securities laws; and (2) an analysis of the legality of and the policy considerations involved in delegating federal power to an international organization, either by one of the three main branches of the federal government or by an administrative agency in the form of a subdelegation. This Note concludes that though there are no specific constitutional limitations on the ability of the federal government to delegate authority to international organizations, there are two reasons why the SEC does not currently possess the authority necessary to recognize IFRS in the U.S.: (1) because the recognition of IASB as an authorized accounting standard-setter constitutes a subdelegation to a private party, and the SEC lacks the express statutory authorization required to make such a subdelegation; and (2) because Congress, and not an administrative agency, is the proper body to make delegations of authority to international organizations. (17) Therefore, this Note also asserts that in order to validly recognize IASB as an official accounting standard-setter in the U.S., Congress must grant the SEC explicit authorization to make that recognition. If Congress does not give such specific authorization, the SEC's recognition of IFRS is likely reviewable in federal court.

Part II of this Note provides a brief overview of the history of the SEC, its delegations of the accounting rulemaking power to various organizations (including FASB, the current U.S.-based standard-setter), and the history of FASB and IASB, including the procedures used by both organizations in promulgating new accounting standards. Part III places the SEC's outsourcing of accounting rulemaking in the context of subdelegation and discusses both explicit and inherent limitations on the SEC's ability to make such subdelegations. Part IV discusses constitutional and policy-related limitations on the federal government's ability to delegate its powers to international or foreign-based organizations, with a particular focus on the SEC and IASB. Part V applies the subdelegation and the international delegation frameworks to the current SEC-IASB relationship and makes specific recommendations, and Part VI concludes with a few general observations.

2. THE HISTORY OF ACCOUNTING RULEMAKING UNDER U.S. SECURITIES LAWS

   1. The History of the SEC and Its Role as Accounting Standard-Setter

      The Securities Exchange Act of 1934 (the '34 Act) (18) established the SEC after the stock market crash of October 1929, which "dramatized the need for federal intervention in establishing and maintaining higher standards of business conduct in the capital markets." (19) Indeed, one major cause of the crash was that government "proposals ... to require financial disclosure ... were never seriously pursued." (20) The first set of federal securities laws was passed as the Securities Act of 1933 (the '33 Act) and was for a short time administered by the Federal Trade Commission (FTC), (21) with the SEC taking over the FTC's securities-related duties upon the passage of the '34 Act (although not without some public backlash). (22) Among the powers conferred upon the SEC by the '33 and '34 Acts (as amended) are the powers to make "rules and regulations governing registration statements and prospectuses for various classes of securities and issuers," (23) to exempt certain classes of securities from federal reporting requirements, (24) and to make rules requiring disclosure of specific information from companies who wish to have their securities listed on a national securities exchange. (25)

      The SEC also has the authority...