The Failures of SEC and FASB

In the US, the legal and regulatory framework ensuring the reliability of accounting information has been around since the establishment of the AICPA and its predecessors dating back to 1887. The AICPA committee began by formally establishing accountancy in the United States as a profession through educational requirements, a code of professional ethics, licensing status and, most importantly, setting generally accepted accounting principles for financial statement accounting. 

Until the 1970s, the AICPA held a virtual monopoly in this field. In the 1970s, however, it transferred its responsibility for setting generally accepted accounting principles (GAAP) to the newly formed Financial Accounting Standards Board (FASB). Though widely used, the lack of enforcement of AICPA was deemed to be it's major drawback,  as the Wall Street Crash has been attributed to wide-spread accounting fraud, insufficient disclosures and false information. This lead to the creation of the SEC in 1933. 

The goal of the SEC in financial accounting was to ensure improved disclosure and protect investors. However, with the collapse of Enron and WorldCom,  the legal framework faced intense pressures for redevelopment. This resulted in the passage of the Sarbanes-Oxley law that established increased securities regulation and the Public Company Accounting Oversight Board (PCAOB) to maintain audit independence, enforce compliance and regulate the auditing environment. In response to Arthur Andersen shredding implicating documents, tampering was recorded as a criminal offence and  auditing firms were required to maintain seven years of records relevant to their audits. Furthermore, internal controls were mandated to promote enhanced disclosures of off-balance sheet transactions
and pro-forma figures, such as with the use of SPEs and mark-to-market accounting in Enron , with senior executives taking individual responsibility for the accuracy of financial reports.

The developments in the legal and regulatory frameworks are commendable, however several limitations pose a threat to the effectiveness of the the SEC and FASB. These threats consequently transpire into large-scale accounting fraud, such as the AIG Scandal in 2005, Lehman Brothers Scandal in 2008 and Autonomy Scandal in 2012. The main limitation of the legal system stems from timeliness and adequacy of investigations, insufficient persecution and lax protection for whistleblowers. Though, the SEC budget has doubled since the SOX act was enacted the
investigation process has remained fairly constant, relying primarily on informal inquiry and witness testimonials. 

While tips are vital towards the timely uncovering of  financial statement frauds, the subpar witness protections fails in providing an incentive for compelling witnesses, particularly those not involved in the fraudulent reporting. For example, executives , Timothy Belden and Ken Rice, both involved in the accounting scheme avoided jail time and gained protection for their unethically earned fortune while neutral whistleblower, Sherron Watkins of Enron and Cynthia Cooper of WorldCom, were publicly shamed. Therefore, the SEC should seek to provide adequate compensation and/or protection to whistleblowers or divert the majority of funding towards technical forensic investigation such as data-mining, artificial intelligence and latent semantic indexing. In addition, the benefits derived from fraudulent accounting to the perpetrators, often outweighs the cost. For example, the SEC failed to prosecute Lehman Brothers citing lack of evidence and the CEO of AIG faced no criminal charges with the proceedings focused mainly on negotiating monetary fines. 

The main limitation of the regulatory system stems from the flexibility within GAAP and the effects of politics in the standard-setting process. As a principle-based accounting standard, US GAAP tends to be more susceptible to aggressive reporting decisions, in comparison to rule-based accounting standard. This is evident in the choices in accounting for goodwill, recognition of special purpose entities, treatment of loans and conditions for capitalization that were extensively manipulated by Enron and WorldCom towards the interest of the executives. The interaction of private-interest groups in the accounting standard process also dilutes the true-and-fair notion that FASB frameworks claims to uphold. For example, Enron and its auditor, Arthur Andersen, were given permission to use mark-to-market accounting in 1992 after extensive lobbying efforts.

The SEC and FASB claim to be responsible for protecting investors from mishaps in the capital markets. However, numerous studies and evaluations indicate limited improvements in investor protection particularly with regards to the increase in regulation and compliance cost. The points above provide a non-exhaustive summary of the limitations of the legal and regulatory organizations in the US, further improvements include educating the public about securities markets , warning investors of fraud and stock market scams and limiting the relationship between publicly-traded companies and Wall Street.