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U.S. Securities and Exchange Commission

Speech by SEC Staff:
We're Good But We Can Be Better

Remarks by

Lynn E. Turner

Chief Accountant
U.S. Securities & Exchange Commission

Public Interest Section
American Accounting Association

August 12, 2001

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 for that kind introduction. I am honored to have this opportunity to address the Public Interest Section of the American Accounting Association. Your efforts to instill in the young minds of our future accountants the sense of integrity, ethics and professionalism are vitally important to maintaining our credibility with the public we serve. I want to personally thank you for your efforts.

I started getting ready for today by looking up what the Accounting Exemplar Award is. The website said "The Public Interest Section attempts each year to identify individuals whose career in accounting exemplifies notable contributions to professionalism and ethics in accounting education and/or practice. The person receiving the award will be someone making these notable contributions by serving as a role model and/or making significant contributions to the accounting profession in a manner that serves the public interest."

I can assure you, this is the single highest award you could have conferred upon the Chairman. I say that because public service has been a guiding light to Arthur, like a beacon along the rocky coastline. It started with his parents, Arthur Levitt, Sr., who served as the Comptroller of the State of New York, and his mom, who was the consummate public servant as a teacher in the public school system. Arthur himself served for two years in the Air Force, for four years as Chairman of the New York Economic Development Corporation, as a member of the base closing commission, and most recently as the longest serving Chairman in the history of the U.S. Securities and Exchange Commission. And during his tenure, Arthur made sure investor protection was the top priority of the Commission and its staff.

Many of you in the audience are no doubt aware of some of Arthur's initiatives, such as his efforts to promote plain English in documents provided to investors, to defend the independence of the Financial Accounting Standards Board (FASB), to strengthen the independence and resolve of auditors, to bring about audit committees who ask the tough questions, and to improve the quality and transparency of financial reporting around the globe. But there is more to the man than that. He has a zeal and passion like I have never known before for the individual American who invests in the U.S. capital markets. When he was leaving the Commission, it was important to him that his last major event was a chance to once again spend time at one of his countless town hall meetings with investors. And I recall that in one of our meetings on the Hill, when a Senator challenged how the proposed auditor independence rules might affect the accounting firms, Arthur without flinching immediately shot right back why this issue was so important to investors. He never forgot whom he had sworn to represent when he took the job.

Former Chairman Levitt asked that I send his regrets that he could not be here in person today to accept this award. He greatly appreciates it and it is an award and honor he kindly accepts.

In light of the various initiatives we worked on with the accounting profession during the former Chairman's tenure, I was asked if I would provide you some of my thoughts on the "State of the Profession" today, where we stand and where we are headed. I will tell you I am headed for a mountain lake at about 9,000 feet with a fishing pole - but in the meantime, let's take inventory.

International Accounting

Lets start with the topic of international financial reporting. A lot of people start by talking about international accounting standards. But the issue is really much more complex and difficult than that.

In the past three years, we have seen the fruit begin to grow from the seeds of an effort to establish a new International Accounting Standards Board (IASB). That board is based on the model of:

  • an independent, technically competent group of individuals,

  • whose mission is to represent and promote greater transparency and quality in financial reporting for the worldwide investing public, and

  • who will work in partnership with national standard setters.

It was a tough set of negotiations to accomplish this, one that could not have been accomplished without the help of the people such as former SEC Chairman Ruder, Tony Cope and Edmund Jenkins of the FASB, Sir David Tweedie, securities regulators such as Howard Davies of the United Kingdom, Michel Prada of France and Andrew Sheng of Hong Kong, and the leadership of the American Institute of Certified Public Accountants (AICPA), just to name a few.

The staff of the Commission has provided the new IASB with a list of the major reconciling items between U.S. generally accepted accounting principles (GAAP) and the accounting standards used in other countries. We hope that the cooperative partnership between the IASB, FASB and other national standard setters will result in the eventual elimination of the reconciliation through the private sector standard setting process and development of higher quality standards, as opposed to the need for governmental rulemaking. I have every belief today that the standard setters around the globe can and will accomplish this undertaking.

However, there is one thing that does bother me a lot as we start this new era in the setting of global standards. Already the IASB has received correspondence that says that if the IASB adopts a standard that is more rigorous than a U.S. standard, say, for example, in the area of business combinations or stock option accounting, then the writer would propose that the company use U.S. standards. I find this disappointing as it means that there are some out there who believe we should have standards based on the lowest common denominator (or some would say based on what gives them the answer they most desire) rather than international standards that are the "best of breed." However, I am not surprised. I always wondered if some of those advocating the use of international standards failed to recognize and give appropriate credit to the fact that we in the U.S. have the world's largest, most liquid capital markets because we do in fact have the "best of breed" financial reporting today. This in turn has provided companies with capital at the lowest possible cost that has been used to generate jobs and an improved global economy.

But ultimately, it will be the market that determines whose product works the best. I hope the IASB avoids the race to the "bottom" with its product, as some have recommended. I also hope that those people whose foresight seems myopic and shortsighted, who believe that no standard should be any "tougher" or more rigorous than what we establish in the U.S., realize they are really saying, "Let's be done with the IASB now that it appears they are going to develop higher quality standards, and just look to the FASB for standard setting."

International Auditing and Enforcement

But moving beyond the topic of international accounting standard setting, we quickly come to the thorny issue of enforcement of those standards. For without proper application and enforcement of the standards, we have no standards to start with.

As I traveled to various countries during the past year, one thing I have learned is that many countries, including many of the major developed countries in the world, do not have enforcement mechanisms and processes that ensure financial reporting is in compliance with the applicable home country, IASB (or it's precursor, the International Accounting Standards Committee, or IASC) or other accounting standards. They often do not have a timely review process, an enforcement body, or a substantive independent disciplinary process. This was an issue raised in responses from many of those who commented on the SEC's international concept release. My travels have borne out what their letters said. That is, until there is quality enforcement and application of international accounting standards, it is still too early to move to them for use in the world's capital markets.

In addition, we have the data from the annual reports on compliance with IASC standards that have been prepared by David Cairns, former secretary general of the IASC. I recommend you take a look at this data as well as that in his recent midyear update. The updates are available (and information regarding ordering the annual report is available) at: http://www.cairns.co.uk/survey_updates/survey_updates.asp. It demonstrates that IASC standards are not being fully complied with and, as a result, users of those financials are not seeing financial reporting based on the IASC standards but rather some short of convoluted hybrid.

I am hopeful that international securities regulators, international financial institutions and the accounting profession can find a path to a solution that results in higher quality international auditing. Currently the International Organization of Securities Commissions (IOSCO), the U.S. Auditing Standards Board (ASB), and the International Auditing Practices Committee (IAPC) are all working on projects to improve the quality of audits. In addition, the Panel on Audit Effectiveness (O'Malley panel) made a number of recommendations that the accounting profession must be willing to embrace and implement globally. In particular, I think it is important we all find ways to:

  1. Improve the quality of corporate governance and audit committees internationally.

  2. Establish an international oversight body for the accounting profession that is independent of the profession, adequately funded, with the necessary oversight, review and disciplinary powers. The establishment of this body should go through the same process as was used for the new IASB. This process includes the publication of a draft exposure document for public comment by an appropriately constituted body of the various stakeholders in financial reporting, a public comment period, and the adoption of a final organizational constitution whose goal is to provide investors with confidence in the numbers.

  3. Assess whether their current regulatory schemes provide for high quality financial reporting and transparency. I applaud the World Bank for making significant contributions toward this issue. I also commend PricewaterhouseCoopers for their pioneering start on such a project with the publication of their Opacity Index.

However, here in the U.S., the Commission staff continues to have difficulty in gaining access to foreign auditors' work papers on a timely basis when there is a question about the propriety of the financial reporting done by a foreign filer or a foreign subsidiary of a U.S. company. The U.S. firm almost invariably argues the foreign portion of the audit was done solely by a foreign affiliate of the firm that they have no control over (even though both market themselves to the public using the same brand name) and cannot require that the work papers be produced to those in the U.S. requesting them. This was a concern and question raised by the Commission in its international concept release, and ultimately I believe the Commission will have to take one of the possible alternatives listed in that release in order to properly protect the interests of investors.

U.S. Accounting Standard Setting

Let me get closer to home and discuss our own U.S. accounting standard setter, the FASB. As the market has clearly demonstrated, and as is often acknowledged globally, the FASB is the undisputed "champion" among global accounting standard setters today. They have developed the highest quality standards and have done so because they are independent and have attracted some of the best minds in the profession. I think we all owe a tremendous debt of gratitude to those in the profession who have agreed to serve for several years at the Board. Unfortunately, sometimes I am embarrassed by the grief they receive from the very people who benefit greatly from the product of the FASB, especially in view of the success they have achieved.

Everyone must continue to work hard to defend the independence of the Board. And investors, who typically sit on the sidelines like a third string player, must get more engaged and join the standards setting effort. They cannot continue to let others carry the water for them! Battles have ensued during the past ten years over the topics of stock options, derivatives and business combinations. And the next battle over fair value accounting is quickly gaining steam among certain industry participants, such as financial institutions.

I hope the American Accounting Association (AAA), as it has so eloquently done in the past, will continue to defend the independence of the Board. I hope more of its members will raise their voices in that effort. Too often I see other organizations or individuals say they agree that the independence of the Board is important, as they proceed on their way to Capitol Hill to lobby against some proposal the Board has issued. It is important that we give the Board the chance to go through its full process, where all constituents get a full and fair hearing, and the result is financial reporting that reflects the economics of the business, not compromised, complex solutions and standards that are the result of individual agendas.

At the same time we need to continuously improve our standard setting process. For example, the accounting profession often asks the Commission to look to the FASB to establish accounting standards. And typically the Commission, as well as others, has done so. But I want to point out some things some of you might have forgotten. In 1975, when the SEC issued its Accounting Series Release No. 268 on preferred stock, it asked the FASB to undertake a project to provide guidance on when an equity instrument is in reality a liability and should be reported as such. Later on in the 1970's, the Cohen Commission recommended the Board require disclosure in the footnotes of all the items that have a material impact on the comparability of the numbers from period to period. This no doubt would be helpful in dealing with the "pro forma" earnings numbers today. In the 1970's the Board also issued a Discussion Memorandum on materiality and an Invitation to Comment on accounting for service transactions, including revenue recognition. In the early 1980's when my son was born, who now has graduated from high school, the Board took on a project on consolidations. In 1985, over fifteen years ago, the Commission asked the Board to develop guidance on financial instruments and special purpose entities. And in 1998 the Commission asked the Board to better define liabilities so as to address abuses in restructuring charges.

But today, decades after some of these requests were made, there has been either no or too little guidance forthcoming in a timely fashion. I do not believe investors should have to wait so long for answers. The Commission can wait only so long before it must act to protect those it serves.

I hope the Board is able to find a way to manage its projects so as to deliver a product to investors in a more timely fashion. At the same time, as a former executive, I fully understand the Board has limited resources. I urge its trustees to reach out to those who benefit the greatest from its fine work, including large institutional investors and other market participants such as the stock exchanges, and who traditionally have "played but not paid." It is important the FASB has the resources necessary to carry out its mission.

At the same time, I believe the cooperative efforts of the IASB and national standard setters may bring more resources to the table, so to speak. For example, the SEC staff recently requested the IASB to undertake a project on accounting for revenue recognition. I am pleased the IASB has responded in writing and said they would do so. They will be able to leverage off the discussion paper recently issued by the Accounting Standards Board in the U.K. I hope the FASB is able to join as a partner in this project and investors will receive a final product delivered on a timely basis.

A subset of the FASB that has worked well since its creation in 1984 is the Emerging Issues Task Force (EITF). It has provided timely and useful guidance for many practice issues and contributed to quality reporting by narrowing alternatives and improving the consistency and comparability of financial statements. With the fast pace of today's business world it is doubtful that the profession could have kept up without the efforts of the EITF.

Yet, the EITF also is subject to some of the same concerns expressed thirty years ago with respect to the FASB's predecessor, the Accounting Principles Board. For example, questions have been raised regarding whether the votes of members on the task force are influenced by the positions of their clients or other constituents. For example, on one issue involving revenue recognition, the task force reached a consensus. Then, based on a memo provided to us by an industry group, we understand the EITF accounting firm members were heavily lobbied and at their next meeting reversed their earlier position. In the end, this issue affected only about 20 reporting companies when it was addressed in Staff Accounting Bulletin (SAB) 101. During the debate on another issue, the client of one of the task force members sat in the gallery, passed notes to the members, and then went up to the table and discussed the issue with the members. This highlights the competitive pressure on the members, especially those from accounting firms.

On another occasion, in February 1999, the staff met with the leading technical partners of the Big Five accounting firms and asked them to compile a list of the accounting issues related to dot-com companies that were arising at the time, and also being reported on in the press. In August, when a response had not materialized and further delay would only further exacerbate the concerns over the numbers being provided to investors, the SEC staff undertook an effort to catalog the list of issues and present it to the EITF for their consideration, leading to criticism that the SEC staff was "controlling the agenda." Needless to say, I found to be interesting a recent letter from the profession encouraging the SEC staff to be more proactive in sending issues to the EITF, particularly in light of the criticism we seem to receive whenever we send issues to the EITF.

It also needs to be highlighted that when the EITF was created in 1984 and received the support of the SEC staff, it was comprised of the senior partner in charge of the firm's national office, as well as leading CFO's. Today, some of the people who sit around the table are no longer at a comparable level within their firms. This has raised the question of whether there has been an increase in the use of "tentative" conclusions, in part, due to the changes in who is at the table.

One of the national office partners that recently served on the EITF, at his last meeting, strongly urged the group to develop simpler, more practical and operational answers. At a conference the other day, I heard an EITF member describe guidance developed by the EITF on equity instruments with beneficial conversion terms to be the most complex answer known on earth to man. The thought that ran through my mind was why limit it to the single planet, I think it has got to be the most complex answer in the universe, one worthy of Einstein's consideration.

The bottom line to all of this is that the EITF serves a very useful purpose, and at the Commission we appreciate its contributions to improving the quality of financial reporting and continue to support it. But it is faced with some valid concerns and questions that should be considered in the context of how it can continue to improve what it does. A couple of considerations might be that the EITF be reviewed periodically, and that it adopt as part of its mission not only the elimination of alternatives but also the selection of the highest quality alternative based on the characteristics that the FASB has established in its Concept Statements. These concepts include representational faithfulness, consistency, verifiability and comparability.

The Saga of the Dot.Gones - "Our Financial Reporting Model Is Not Broken"

Now let me hit the changer and go to a tune on another record. But it is a record that is broken, should be removed from your collection and thrown away. It is a record that began to play about ten years ago and which has gotten way too much airtime. It is the tune labeled "Our Financial Reporting Model is Broken."

Folks, as Jack Bogle, the well-respected founder of the Vanguard Funds has said, perhaps it was the markets that were wrong and not the model. He couldn't be more right.

I believe the 90's will be remembered in history as a period much like the roaring twenties. Both were periods of new technologies; cars and radios in the twenties, advances in electronics and the internet in the 90's. But in both cases "irrational exuberance" eventually subsided and, when it did, investors paid a price. In the 1920's it resulted in a market melt down into the early thirties and investors did not really return to the markets until after World War Two. Yet to-date, we have been fortunate and been able to avoid such a dramatic outcome.

I believe this is in part due to the greater transparency we have in financial reporting today than they had seventy years ago. We have numbers that come closer to reflecting the results of the business, and the accounting profession has upgraded the quality of audits.

But many market participants, including analysts, investors, investment bankers, auditors and others, got carried away. The press has reported on:

  1. Analysts' conflicts and the lack of quality analysis and recommendations,

  2. The question of "Where were the auditors?"

  3. The use of hypothetical pro forma numbers that reflect everything but bad stuff and which are used to justify higher multiples in the market,

  4. Pressures on management to make the numbers,

  5. Management who managed the numbers rather than the business, and

  6. Investors who failed to do their own homework before investing.

I think all of these factors contributed in some fashion to the rise and subsequent drop in the markets. I think as Jack said, they contributed to the markets probably being wrong.

The best evidence of this is perhaps the dot.coms that I now call the Dot.Gones. Many of these came to market with financial statements that a few years ago would not have supported a public offering. Remember when it used to take three years of profits and at least thirty to fifty million in revenues to go public? Well the dot.gones did not measure up to such fundamental "rules of thumb" in the markets and so people decided to ignore them. Yes, the valuations the dot.gones achieved were wildly different than book values reported in the "broken financial model." Yes, those financials did not show an asset reflective of the tremendous value the market ascribed to the "new technology" of this industry. But I ask you, in the long run, which one turned out right?

It "Ain't Broken" But It Can Be Improved

The key point I want to make is that these are all lessons we can, and should, learn from. Hopefully, we will not get into the scenario portrayed in the movie "Ground Hog Day" and we will find solutions before we wake up only to make the same mistakes again.

I do believe one of those solutions is that we need to enhance an already good financial reporting model. Any product needs updating periodically and I think that is true with the disclosure of financial information today. I believe we need to:

  1. Require that management report to investors on their internal accounting controls. These controls are critical to quality financial reporting and investors have a right to understand whether management thinks those controls are working effectively or not. If management is nervous about having to make such disclosures, then I suggest investors may be just as nervous about the numbers they are getting. Many corporations already provide management reports to their stockholders today, but they remain in the minority. This would place the third leg of the three legged stool discussed in the report of the Blue Ribbon Panel on Improving the Effectiveness of Audit Committees (with audit committees and auditors being the other two legs) firmly where it needs to be to support quality financial reporting.

  2. Have companies pick their ten or twelve most critical key performance indicators and disclose them to investors, along with how they define and calculate them. For starters, I would build flexibility for experimentation into the system and let the companies choose which indicators they disclose but require they be consistently disclosed on a comparable basis, unless there is a valid reason for changing. For financial institutions, the disclosures recommended by the "Shipley Group" also should be required if companies fail to provide them on a voluntary basis as recommended.

  3. Accelerate the date of the filing of the Form 10-Q to achieve timelier financial reporting and address some of the abuses in "pro forma" earnings announcements. I also believe the FASB should act promptly on the recommendation of the Cohen Commission that a footnote to the financial statements should disclose those items that affect the comparability of the information provided to investors.

  4. I believe the FASB should do a periodic review of its standards after they are issued. I found the reviews the SEC staff performed of the implementation of SAB 101 and SFAS 133 to be useful and informative. Having an evaluation performed of your work is a necessary element of any quality management system. As such, I believe the Board should evaluate its standards after they have been in place for, say, five years and see if they are achieving the desired results or need further work to ensure transparency and quality financial reporting. If you are uncomfortable with evaluations on your efforts, then there is often an underpinning reason that is not always good.


Part of the charge of the Public Interest Section of the AAA involves professionalism and ethics. These are important to all of us in this room.

A recent commentary in BusinessWeek stated that auditors' reports today have about as much credibility as analysts' reports. I take great exception to that statement. But what I think and what you think doesn't really matter in the court of public opinion. What matters is what the public thinks, and its confidence in the credibility of our work.

Yet the level of restatements, massive financial frauds, and concerns with the quality of the numbers being reported in the press will erode that confidence if allowed to continue. Even people in the profession are asking why are we more focused on branding a consulting image such as XYZ or Cognitor rather than the internationally recognized name of CPA? Why when we are having difficulties with getting the accounting right, are we shortchanging the accounting section of the CPA examination and cutting back on the testing of accounting skills? And why are our disciplinary and quality control processes not identifying these issues on a timely basis, and more importantly, the solutions needed to fix them? Why do the public and regulators have to take the lead in initiating action on issues so vitally important to our profession, U.S. capital markets and the public?

The profession has over the years risen to the occasion when problems have surfaced and our credibility tested and I believe we can do it again. We need to find solutions. We need to become more transparent in what we do. And we need to remember that our customer is the investing public.

If we build the public a quality product that works as advertised in the window, without gimmicks or hidden strings attached or recalls, and that is built upon the familiar and trustworthy CPA brand name, then our profession has nothing to worry about. It is what has created trust and confidence in our profession in the past and it must continue to be what we remain focused on. I hope that with your efforts we can continue to build a product that the public is willing to buy from the Certified Public Accountant.

Thank you.


Modified: 08/17/2001