Regulation: a help or hindrance to business growth?

• Author: Cheney, Glenn Alan
• Position: FEI@75 - Financial reporting

It's more coincidence than cause and effect, but Financial Executives International and substantial financial regulation were born at just about the same time. Thus, they share a history of about 75 years.

But the first inklings of regulation appeared a little earlier--during the economic woes of the end of the 19th century. An "irrational exuberance" in the stock markets, fed by a boom in railroad profits, faltered when the market learned of fraudulent financial statements. For the first time, the New York Stock Exchange demanded independent audits of public company books. The books were about all that got audited in those days. The simple math. The classic image of the accountant in green eyeshades poring over a ledger exemplifies the proto-audit of the 1890s. The auditor never thought to, say, verify inventory. It wasn't required.

The economy recovered some, but in the early 1900s it stumbled again. The federal government responded with antitrust laws and the establishment of the Federal Reserve, the central bank that Alexander Hamilton had advocated shortly after the American Revolution. The Fed issued a bulletin on financial reporting by banks, including, for the first time, accounting rules developed by the accounting profession. In a national atmosphere of renewed confidence in financial reports, the economy recovered.

Then, the 1920s saw an unprecedented boom, a so-called "New Economy," based on then-new technologies--radios, automobiles and airplanes. As car manufacturers blossomed--with over 2,000 of them--the base of an economic bubble inflated, with not much more than irrational exuberance (quite similar, in fact, to the 1990's "dot-com" explosion, with its brand of new technologies). Then came Black Tuesday, down went Herbert Hoover and along came Franklin Roosevelt and the country's first substantive financial regulation, a desperate attempt to instill public confidence in public companies and stock markets.

So, the era of substantive financial regulation began in reaction to the stock market crash of 1929 and the Great Depression that followed. Herbert Hoover's government was reluctant to use regulation to solve the country's economic woes, but by 1932 it was obvious that something had to be done.

In that year, financial executives, believing they might improve the situation through better accounting and accountability, established The Controllers Institute of America, predecessor of Financial Executives International (FEI). In the gloom and pessimism of a collapsed economy, the organization grew as it grappled with accounting, economics and something new to American business: regulation of the way they reported corporate financial conditions.

The first of these new regulations came in an avalanche following the election of FDR. The Emergency Banking Act provided for inspections of federal banks. The Glass-Steagall Banking Act established even more regulation. The Securities Act of 1933 and the Securities and Exchange Act of 1934 created the U.S. Securities and Exchange Commission (SEC) and mandated independent audits. Initially, the SEC intended to establish the same regulation system that the Federal Reserve had set up for banks, with government examiners conducting audits. But after testimony before Congress by members of the audit profession, it was decided that the private sector was better suited for the job.

Financial officers of public companies recognized the need for new rules, but questioned the SEC's required solutions. The Editorial Comment in the June 1934 issue of The Institute's magazine, The Controller, would echo through the century: "The excessive cost of preparing reports, statements and questionnaires for various government and state agencies is claiming the attention of controllers, on whom this increasing burden is falling." In the same issue, Judge William L. Ranson, of Whitman, Ransom, Coulson & Goetz, corporation lawyers of New York City, argued, "Today it often seems that the primary task of the managers of an enterprise must be to conduct and record its transactions so as to comply with a multitude of complex requirements and regulations, imposed by all manner of public authority; then, if any time or energies are left, for production and selling, the enterprise is fortunate."

The comments fed into a consequent question: Who should set accounting standards--the accounting profession or the SEC? The SEC deferred, leaving the task to the private sector. At the same time, however, the commission established the position of chief accountant--giving that person ability to set accounting policy and, if necessary, override standards set outside the SEC.

New regulations hardly ended The Depression era, but the stock market began to rise, apparently buoyed by increased confidence. By 1937, however, the market stumbled again.

In 1939, an SEC investigation of massive fraud at McKesson & Robbins revealed inexcusable auditor negligence. Within the year, the profession formed the Committee on Accounting...