Speech by SEC Staff:
|The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Turner and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.|
Thank you very much for that glowing introduction, Professor Dietrich. It seems like just yesterday that you were our Academic Fellow at the SEC, and now I am proud to see you here on your new home turf, where Ohio State is once again hosting the Accounting Hall of Fame and Association of Accounting Historians.
It is just this kind of rotation, or evolution if you will, of our best and brightest from the Halls of Academia, to the Halls of 450 Fifth Street (that’s the SEC Headquarters, for the uninitiated), to the Hall of Fame and its many practitioners who have been so honored, that makes our system of accounting the greatest in the world. It is this partnership that has worked so well in serving our shared mission of setting and putting into practice accounting and auditing standards. And it is with a shared vision that we must move forward, on to even more meaningful reporting for the 80 million investors in our nation’s securities market.
Before I go on, I must give you the official disclaimer that the views I express before you today are solely my own, and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission’s staff.
Today, you have honored not only Hall of Fame inductee Charles W. Haskins, but also many others who have served with distinction in the field. And of course, my personal favorite portion of the program: "The SEC’s Chief Accountants-Their Issues, Policies and Impacts: 1976-2000." It is indeed an occasion to mark with pride, that this is the 50th Anniversary of the Accounting Hall of Fame. In keeping with this theme, I would like to reflect briefly on the past traditions of our profession. But it is also the importance of a Vision for the Future that I will focus on together with you tonight.
They say the 50th Anniversary is the Golden One. And so it has been with the Accounting Profession in the years since its Hall of Fame was founded, and the preceding years when the profession was in its infancy. Although we tend to have some spirited debates from time to time, much has been achieved.
The beginning of the 20th Century saw the profession coming together, stressing uniformity of accounting principles as a starting point. Indeed, the Federal Reserve Board issued a standard called "Uniform Accounting" in 1917.
But uniformity is clearly not enough. And some uniformly bad practices, together with non-uniform manipulations and shady disclosures, contributed with other bad faith dealings to the Stock Market crash. The crash caused countless numbers of people’s lives to be literally uprooted, much as a tulip tree in the midst of a tornado, when their hard earned money was swept away. The resulting lack of confidence in the markets went quickly from a trickle down of fear, to a torrential downpour of tears.
When the dust settled, the Securities Acts of 1933 and ’34 were passed by Congress, and the SEC was born. With a distinct mandate to protect investors, the SEC was granted the statutory authority to set accounting standards. However, the Commission chose, and rightly chose, I believe, to leave standard setting in the hands of those closest to the business, and closest to practice, albeit the Commission still retains and exercises its statutory right to directly set such standards.
Indeed, the SEC issued Accounting Series Release, or ASR, No. 4 in 1938, which gave indirect, de facto recognition to the Committee on Accounting Procedure (or "CAP") of the American Institute of Accountants (the precursor to the AICPA), by stating that "In cases where financial statements filed with this Commission…are prepared in accordance with accounting principles for which there is no substantial authoritative support, such financial statements will be presumed to be misleading or inaccurate despite disclosures contained in the certificate of the accountant or in footnotes to the statements provided the matters involved are material…"
This was the clarion call to the accounting profession to not only continue to step up to the plate, but to swing a bigger bat as "the" source of "substantial authoritative support". And so the American Institute of Accountants further empowered CAP. It appeared that much of the energy of the American Institute of Accountants was spent on maintaining autonomous authority over setting standards, while it fell short on resolving certain conceptual issues.
Indeed, we still faced the problem: should standards follow practice, or should practice follow standards? It’s not unlike the tail wagging the dog! The eagerly anticipated Sanders, Hatfield and Moore study of the late 1930’s, "A Statement of Accounting Principles," was roundly criticized as lacking in substantive recommendations. Andrew Barr, a member of this Hall of Fame and a former Chief Accountant, said at the time, "A better title for their statement would have been "A Statement of Accounting Practices," with a footnote referring to Professor Hatfield’s book for a statement of principles." (emphasis added)
Around this time, the American Accounting Association, or AAA, stepped up to the plate as well, and in 1940 we saw the ground-breaking Paton and Littleton Monograph, "An Introduction to Corporate Accounting Standards," focusing on the entity theory and the matching concept for income determination.
But any real progress toward conceptual grounding within CAP was not to be. As one of the original inductees into this Hall of Fame, George O. May, recognized in 1952, "accounting income was on its way to becoming a political, not an economic concept".
It was time for a new standard setter to arrive.
Enter the APB. In June 1957, the American Institute of Accountants renamed itself the American Institute of CPA’s, or AICPA. And in October 1957, the AICPA’s new president, Alvin R. Jennings, called for the reorganization and strengthening of the AICPA’s standard setting process. Jennings was truly one of the stalwarts of the profession in standing up and making this case.
In 1959, the AICPA’s Accounting Principles Board, or APB was born. The APB was challenged to succeed where the CAP could not, in reducing the number of alternative accounting methods. And even more importantly, the APB was expected to develop conceptually correct standards, not just a reflection of existing practice, and not just standards driven by political expediency without regard to economic reality.
The APB was spurred on by Leonard Spacek, one of its original members, who very deservedly was inducted into the Hall of Fame a quarter century ago. In words that still ring true today, Spacek said in an address to the AICPA’s Annual meeting in 1960: "Accountants must supply the reasoning underlying the applications of accounting principles and be able to explain why they produce fairness in financial statements." (emphasis added)
With its emphasis on developing the "right" answers, the AICPA put a new thrust on research, and opened a new Accounting Research Division. Major new foundational efforts arose from the first few Accounting Research Studies, or "ARS", that were published. Virtually all the authors of the ARS’s have been inducted into the Hall of Fame. People like Maurice Moonitz, who authored ARS 1, "The Basic Postulates of Accounting," and Robert Sprouse, who with Moonitz authored ARS 3, "A Tentative Set of Broad Accounting Principles for Business Enterprises." Unfortunately, as we know, ARS 3 was published with what amounted to a de facto "disclaimer" by the APB, that "The Board believes…that while these studies are a valuable contribution to accounting thinking, they are too radically different from present generally accepted accounting principles for acceptance at this time." So much for being forward-thinking, and putting quality first. It reminds me of the saying that unless you try to do something beyond what you have already mastered, you will never grow.
However, in fairness, let’s recognize the fact that the APB took on some brutal battles. Issues like:
business combinations, which had been debated for 30 years
The APB wasn’t successful on every issue, but did advance the ball.
And there were certainly other people on the APB who stood out as giants in our field, people like: Phil DeFliese, Joseph P. Cummings, and Oscar Gellein, to name just a few.
But, an inability to continue to move forward on a conceptual framework and define objectives of financial reporting, rather than just reiterate existing practice, in addition to a concern about responsiveness to contentious issues of the day, resulted in the APB’s demise. AICPA President Marshall Armstrong commissioned two studies in January 1971, including the Trueblood Study Group, which reviewed the objectives of financial statements and the technical problems in achieving those objectives, and the Wheat Committee, which recommended a new standards board be formed, one in which all members were full-time, fully independent members, ultimately becoming what was to be known as the Financial Accounting Standards Board, or FASB.
In forming the FASB, many people came together and created this new standard setter.
And the SEC, in ASR 150, reaffirmed the policy set forth in ASR 4, stating that the Commission would recognize FASB Statements and Interpretations as having, and contrary statements as lacking, broad authoritative support. Of course, some of you in this room probably remember that at that time, the Commission was sued by one firm in the profession, for its position of looking to the private sector. Now that same firm writes me letters saying any new standard must be done in the private sector. How times have changed!
Through its full-time, independent members, diligent and thoughtful due process, outstanding leadership, and most importantly, commitment to the investing public, the FASB became recognized worldwide, as the standard setter with NO PEER AND NO EQUAL. It is clearly the premier standard setter.
Importantly, the FASB was able to do what their predecessors had not, in establishing a Conceptual Framework. They made, and continue to make, significant progress in continuing to advance the ball in this regard.
And, just as they say imitation is the highest form of flattery, we would say the creation of an international standards organization (the IASC) which is modeled very much after the structure of the FASB, is also a testimony to a process and system that works, and works well.
And so we have had many golden moments in the past 50 years and more of accounting standard setting and practice. But we are now at a point in time when the QUALITY of the numbers counts more than ever, and the QUALITY of financial reporting is more critical and more important than ever before.
In just the past few years, we saw the effect of the Asian markets crisis, and the liquidity crisis at Long Term Capital Management, which were felt around the world. And while I don’t want to sound like Yogi Berra who uttered that well known phrase "Déjà vu all over again," we need to act now, not after another crisis or failure, from which recovery may be all the more difficult than in decades past.
And so, let’s move from our focus on the past, to talk about the CHALLENGES that confront the profession today, right here, right now.
And I believe the future is now. As Oliver Wendell Holmes stated: "…The great thing in this world is not so much where we stand, as in what direction we are moving…we must sail sometimes with the wind and sometimes against it, but we must sail, and not drift, nor lie at anchor."
And with that, let me address four oceans that lie ahead with both challenges and opportunities.
The accounting profession has been granted a unique franchise through the Securities Laws requiring audited financials and the SEC’s recognition of the private sector standard setters as providing substantial authoritative support for the accounting used in financial statements filed with the Commission. I urge the profession to keep the public good uppermost in their minds. The obligation to investors must be first and foremost. Remember that the P in CPA means Public! And in order to create the kind of standards envisioned by leaders like Spacek, and through the FASB’s Conceptual Framework, we must put investors first.
Investors need transparency. They need to see the results of the business through a clear glass, not a rose colored glass, not through a kaleidoscope of unnecessary or misleading complexity, not through the eyes and words of a novelist, but through straight, nonfictional reality. And the words and numbers chosen to be disclosed are of tremendous import to the investor in predicting future performance. Nothing less will do.
The profession needs to focus on the quality of the numbers, and quality of information going to the public, not just the acceptability of the numbers. In our information age, power is information and power resides with those who have information at their fingertips. They say that over 80% of CEO’s today use their systems as competitive weapons. Given that change, we need to identify quality information that will provide useful information with predictive value to investors, and we need to make it available in a consistent, comparable and relevant fashion.
I believe the FASB does have the opportunity to improve the quality and transparency of the financial reporting used in our capital markets.
For example, most of us had to fly into this conference, yet few if any of us flew on an airplane included in any airline’s financials statements. Leonard Spacek noted this problem decades ago and yet we still have not succeeded in solving this part of the numbers game. How can we look the public in the eye and say we really do have the public’s interest in mind, when such a cloud hangs over the product we opine upon?
Or what about a company that acquires entities many times smaller, and says it’s a uniting of stockholders interests and a pooling as opposed to an acquisition. Does that really make economic sense? Show me the Chief Executive Officer who went into such a transaction with an opening line for the target of "I’m not interested in buying your business, I just want to unite our interests!" Senator Gramm, while he raised many questions, recognized the problem with this, in his opening statement at a Senate Roundtable on Goodwill earlier this year, in which he said, "The basic problem with pooling accounting is that when two companies merge, or one acquires another, by simply looking at book value, you create a balance sheet that in no way reflects the reality of the new company…"
Each and every accounting standard must truly reflect the economics of the underlying transaction, and the financials as a whole must truly reflect the underlying economics of every transaction. That was the intention of FASB’s Conceptual Framework, and is near and dear to every one of us, especially investors.
I believe the FASB has looked to their conceptual framework in developing new standards and I commend them for that. I believe that other standard setters such as AcSEC and the Emerging Issues Task Force should also do the same. In that regard, I believe that it would be useful for both the FASB and AcSEC to provide an analysis of each newly issued accounting standard by discussing in the appendix to the standard, how the qualitative characteristics of the conceptual framework, such as relevance, representational faithfulness, reliability and verifiability, neutrality, comparability and consistency, are achieved through the guidance in that standard. Such an approach should help convey to investors, as well as preparers of financial statements, how the quality of financial reporting has been improved. It would also serve as an initial report card on the quality of the standard.
Now, I’ve heard for the past twenty-five years people say that the FASB does not listen. That just isn’t true. Look at the standards they have issued and they all reflect changes made from the exposure drafts as a result of thoughtful comments they have received.
What people too are often saying when they argue that the FASB does not listen, is that the FASB did not give them the answer they wanted, that they did not "obey". In those cases, I challenge both the constituent and the FASB to sit back and say, does the standard faithfully represent the economics of the events and transactions being reported on, in a consistent, comparable and verifiable fashion? For example, are those airplanes on the balance sheet of the company that is flying them and getting all the benefits from them?
The Business Roundtable said it very well in a recent comment letter they sent to the SEC:
"We believe the following:
And let me also address the point some people argue today, that the "New Economy" is rendering historical financial statements no longer relevant. That just could not be further from reality. Reporting on the actual results management has achieved is just as relevant today as when the "new economy" meant moving from the covered wagon to a model T, from the telegraph to the telephone, or from the telephone to the internet. Investors and the markets react to that information. Just ask the CEO or CFO who failed to meet the market expectations and fell short of their budget or plan. Does "here today and gone tomorrow" come to mind? Try to tell those executives that the historical results lacked relevance and were meaningless. Perhaps as Jack Bogle, founder of Vanguard has stated, "while that seemingly omnipotent master 'the stock market' may be telling the profession that the…model of reporting doesn't work anymore, please don't write off too hastily the possibility that the model may be right and the market wrong."
Let me move on to another opportunity for our profession to better serve investors. Today we are in an information age, where information means power and value to those who have it. And with the advancements in electronics and communications, people are creating, demanding and using more information than ever before.
Our capital markets and investors should also be able to benefit from how these advancements can enhance our financial reporting models. As a former CFO, I full well know the power of the information that systems can generate today. I firmly believe that there is information that can make capital allocation and our markets more efficient, and result in them maintaining their competitive leadership.
For example, information such as backlog, revenues per employee, percentage of revenue dollars spent on research and development, marketing and capital expenditures, the utilization rate and capacity of a manufacturing plant, the amount of revenues generated from new products introduced in the year or from the top ten customers, the number of design wins, and the size, nature and type of patent portfolio all can aid investors in knowing the value being created in a business.
We need to consider disclosure of Key Performance Indicators, or KPI’s. Every analyst and company know KPI’s tremendous predictive value for investors, and I firmly believe that the profession needs to find a way to bring this into our disclosure system as a starting point – there may be other predictive information as well.
I believe companies should be given the latitude to do this, and as a starting point, identify 10-12 key items to investors that should be required to be disclosed, consistently over time. I believe each company should be given the choice of the items to be disclosed. These are likely to be the items already disclosed to or calculated by the registrants’ analysts. I believe investors and the markets will challenge the company who plays games with the items selected.
The AICPA has been a strong proponent of increasing the amount of information that should be disclosed to the public and investors. I believe the soon to be published report sponsored by the AICPA and FASB on the business reporting model will highlight much of that information. However, I believe the AICPA also must provide guidance to ensure that such public disclosures, meet the qualitative characteristics of high quality financial information. And to meet that test, I believe the AICPA should sponsor, through their standard setting process with oversight by the FASB, a task force that will provide common definitions for disclosures that are proposed such as EBITDA, statistical ratios, and other non-GAAP financial performance measures.
There is no question that Fair Value can also provide useful information and I am a staunch believer we need to continue to move toward greater use of Fair Values in Financial Statements. But in doing so, we need to devise models and methodologies that will insure Fair Values are reported in a comparable, and consistent manner for similar transactions, and similar instruments.
As noted in the Chairman’s recent speech to the AICPA Council, we are looking to the AICPA for leadership in developing models that will result in comparable, consistent Fair Value reporting. The AICPA as well as some of its members have developed a significant volume of guidance and training materials for consultants who provide valuation services. The AICPA also sponsors a major conference on valuations. Given this institutional knowledge that has been developed, it is only appropriate that the AICPA bring together the appropriate constituents to focus on providing similar guidance on valuation models and methodologies for their members who serve the public investors, the independent accountant, as well as preparers of financial statements. Those constituents should include valuation experts, accounting standard setters, auditors, preparers and regulators.
This guidance would serve a useful purpose in improving the consistency and comparability of the information provided to investors. Today fair value information that must be reported includes items such as the fair values of financial instruments that must be determined pursuant to Statement of Financial Accounting Standards (SFAS) No. 107, the values of purchased assets and liabilities reported in accordance with APB No. 16, the values of impaired assets including loans that are recorded at their fair value pursuant to SFAS No. 121, or the intrinsic value of stock options accounted for in accordance with APB No. 25.
And yet I hear from investors, analysts and other regulators that sometimes the values they see being reported on, quite frankly lack credibility. They question whether the numbers are in fact the "real" numbers that have been subjected to a rigorous examination by the auditor. As a result, it is now time for the profession to shore up the trust in these numbers, and reestablish the credibility of the information being reported.
I have heard analysts say, as we move toward Fair Value, that the first step should not be total desertion of historical cost financial statements. This view states that we should allow companies to continue to report historical cost financials, to allow us to measure the accountability of management for results in the past, and how well they did against plan and budget… and also have companies to report Fair Value numbers that give the ability to assess the results of management actions in terms of value. The choice between Fair Value and historical cost financial statements should involve assessing investor reaction to numbers that are measured in a consistent, comparable fashion. Perhaps consideration should be given to a process whereby historical cost and Fair Value numbers are reported side by side, at least for some period of time.
The standards developed by our profession should reflect the economics of the transaction, but not be so complex as to be impractical to put into place, to be verifiable, or incapable of being applied on a consistent and comparable basis.
That is what has happened with the leasing literature, which is so complex, it has been rendered virtually useless. I am encouraged that the G4+1 has started to address the leasing issue.
Statement of Financial Accounting Standards (SFAS) No. 121 on Impairment is another example of a Statement that is not practical. People in the profession have told me that SFAS No. 121 doesn’t work. They ask, how can impairment be assessed and measured, using 2 different methodologies? It has NOT resulted in consistent treatment, nor has it reflected economics and is nigh impossible to verify!
A simple practical standard that reflects economics, would be verifiable and result in comparability, would be one that:
Such a standard would not require subjective "indicators" of impairment. Companies would achieve comparable results based on fair value established in the marketplace with third parties and the results would have a much higher degree of verifiability than cash flow forecasts that lack any established guidelines and that require a "Vulcan mind meld" by the auditor to audit management’s intent.
I believe that high quality accounting standards must be practical and operational, not only in the literature, but in the real world. In fact, I believe we must be able to apply a "litmus test" to each new accounting standard: that it must be operational at all levels, from the CFO, controller and accounting staff who have to implement the standards in practice, to the auditors who have to attest as to whether the company has correctly applied the standards, to enforcement bodies such as the SEC and similar securities regulators around the globe, who are charged with reviewing financial filings and judging whether such filings follow the standard.
And the need for accounting standards to be practical in application applies across all industries, so that the CFO of a bank, the Controller of an airline, and the front-line accountant at a retailer all can understand and apply the accounting standard in a correct and consistent manner. Conceptually pure (or even impure, for that matter!) standards that are not verifiable, operational and practical just do not serve our investing public.
And so the future is NOW. We cannot wait another 20 years to make it happen.
My Vision for the future, is a world in which all of us in the profession work together as partners with the information needs of the investor as our first priority. We stress quality above all else, incorporating representational faithfulness as our backbone: that the information reported will faithfully represent the underlying economics of the transactions, and in turn the financial statements as a whole.
The Vision entails that we will strive together, all of us in this room, to continuously improve our standards and to make use, in a responsible fashion, all the power that the Information Age offers at our fingertips.
This Vision requires a strong and vibrant self-regulatory framework, where the interests of investors and the public are put first, and where the public has a real voice in ensuring high quality, effective self-regulation.
Finally, this Vision is one that can only be seen in Sunlight. The Vision of transparency will facilitate investors’ ability to see investment opportunities and performance with greater clarity, thereby enhancing their confidence in the markets, and solidifying the partnership of fair disclosure with over 80 million investors in our market.
80 million investors, who would have believed it? And remember when they thought you could not travel the world in less than 80 days? We know how fast we can fly, and how fast information flies, around the world now. The world has changed and continues to do so at record speed. My congratulations to all those who have been inducted into the Accounting Hall of Fame, and the many thousands of other leaders in our profession, who have earned the respect of investors worldwide, and will continue to move us further to an even higher plane of devotion to the public interest.
Thank you very much.