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Speech by SEC Staff:
The State of Financial Reporting Today:
An Unfinished Chapter III

Remarks by

Lynn E. Turner

Chief Accountant
U.S. Securities & Exchange Commission

Glasser LegalWorks
Third Annual SEC Disclosure & Accounting Conference
San Francisco, California

June 21, 2001

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statements by any of it 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.

I want to thank you for the generous introduction and for the opportunity to speak at this prestigious conference.

As I looked through the schedule of presentations and list of presenters, I was impressed by the quality of the conference. Nonetheless, as the keynote, I am obligated to tell you the views I express this morning are my own, and do not necessarily represent the view of the Commission, the Commissioners, or my colleagues on the staff.

I always enjoy working with a group of sharp legal minds. I recently saw an ad by a law firm in the Wall Street Journal, which said:

"Our lawyers communicate by cell phone, fax, email, video conference and the occasional telepathic vibe".

Now, it's that telepathic vibe part I really like, and always did suspect was the case with many of my colleagues from the Bar! It is something we always wished for in the auditing profession.

The American Investor

But since I don't have telepathic powers, let me share with you some important facts that are relevant to much of what you will hear today. Share-ownership 2000, using 1998 data, reports there were 84 million shareholders, representing 43.6 percent of the country's adult population. That is a 21 percent increase from the number of 69.3 million just three years earlier and a 61 percent increase from 52.3 million in 1989.

These stockholders come from all walks of life, young and old, rich and not so rich. Over one in five stockholders is under the age of 35, and one in eight is over the age of 65. And interestingly, half of those stockholders have income of less than $57,000 and only 18 percent have family incomes that exceed $100,000. Indeed, the average stockholder today is the average American who lives next door, is your aunt or uncle, a close friend or family member.

So what does this information tell us? It tells us that average Americans today, more than ever before, are willing to place their hard earned savings and trust in the U.S. capital markets. They are willing to do so because those markets provide them with greater returns and liquidity than any other markets in the world and because they have confidence in the integrity of those markets. That confidence is derived from a financial reporting and disclosure systems that has no peer. A system built by those who have served the public proudly at organizations such as the Financial Accounting Standards Board ("FASB") and its predecessors, as well as the stock exchanges, the auditing firms and the Securities and Exchange Commission ("SEC" or "Commission"). People with names like J.P. Morgan, William O. Douglas, Joseph Kennedy, Arthur Levitt and in the accounting profession, names like Spacek, Haskins, Touche, Burton, and Montgomery.

But when the integrity of the markets is lost, as has occurred on more than one occasion; and when investors in turn lost their confidence and trust in those markets, that pool of available funds can dissipate as quickly as a lake whose dam has burst, with devastating effect on the lives of American investors. That is why we must be ever vigilant for leaks in the dike.

Has Quality Improved?

Often I am asked, "Lynn, do you really think the quality of financial reporting today is as good or better than it was in, say, 1990?" It is a good question that all of us in this room should be asking. It occurred to me, though, that it really should be a three part question:

  1. Is the quality of the product we produce for our customers, the investing public, higher today than what it was ten or twenty years ago,
  2. Has that quality continuously improved as much as it could have, and
  3. What grade would investors give us on the quality of our product?

Important, Successful Accomplishments

Let's first take stock of our accomplishments and respond to the questions of whether the quality of financial reporting has improved.

I entered the accounting profession in July 1976, twenty-five years ago. The FASB was barely three years old, and had only issued 13 standards. The Auditing Standards Board or ASB, was relatively young and had only issued 13 standards. Audit committees, which were recommended by the SEC beginning in the 1940's, were more a novelty than reality and there was no formal system for reviewing the quality of firms' controls to ensure effective audits.

Since 1976, I believe the accounting profession, the business community, and the SEC have taken steps to improve the quality of financial reporting. Perhaps some of the more notable achievements have included:

  • Receiving the final recommendations of the "Cohen Commission" (1977), the "Treadway Commission" (1987), the Special Report by the Public Oversight Board (1993), the Jenkins Committee (1994), the 1996 U.S. General Accounting Office (GAO) Report - "THE ACCOUNTING PROFESSION Major Issues: Progress and Concerns," the "Blue Ribbon Panel on Improving the Effectiveness of Audit Committees" (1999), and the most recent Report of the Panel on Audit Effectiveness (O'Malley Panel) (2000). Each of these reports made a significant number of recommendations to the accounting profession, private sector standard setters, and the Commission on ways to enhance the quality and credibility of our product - financial reporting.

  • Improvements in audit committees - brought about initially by new NYSE listing requirements in the late 1970's and followed up with the new rules of the NYSE, NASD, SEC and ASB in 1999 and 2000.

  • The creation of a newly written Charter in 2001 for the Public Oversight Board ("POB") giving it greater oversight and review powers.

  • New requirements effective in 2000 for timely auditor review of all quarterly financial statements filed with the Commission.

  • Issuance of SEC staff interpretive guidance on some of the more troublesome financial reporting issues - materiality, loss accruals and asset impairments, and revenue recognition (1999).

  • Appointment of the first three public members to the AICPA's 20 member Disciplinary Committee, the Professional Ethics Executive Committee (2000).

  • Restructuring of the International Accounting Standards Committee (IASC) into an independent body of technically competent professionals, with oversight by a board of trustees led by former Chairman of the Federal Reserve Board, Paul Volcker (2001).

Because of these accomplishments, I believe that the transparency and quality of financial reporting today is better than what it was twenty-five, or even ten, years ago. And investors owe a debt of gratitude to those who have led the efforts to make these changes.

However, we must consider whether our accomplishments have achieved the goals and recommendations set forth for the profession in the various reports I mentioned earlier.

In addition, we must ask ourselves, what grade would investors give us?

The Ever-Appearing Mole

Let me note that dealing with financial reporting issues is like playing the "mole" game at the arcade. One issue pops up and no sooner have you knocked it down, then another pops up. It takes a constant, vigilant effort on the part of the entire accounting profession and the SEC to stay ahead or even abreast of the issues that confront us.

Changing and Challenging Times

No doubt, the times we live in today are perhaps more challenging than ever. Consider these points:

  • Articles in Business Week and CFO Magazine in 1998 cited surveys of CFO's who admitted they had been pressured to inappropriately manage the numbers, and had chosen to do so in a surprisingly high number of cases.

  • An article in the June 2001 Harvard Business Review entitled "The Earnings Game: Everybody Plays, Nobody Wins," which states, "The earnings game is now so common-place that it can sometimes seem like a collective agreement to believe the unbelievable.... Companies have a variety of techniques for making earnings appear out of thin air." It goes on to state: "Why would investors buy stock on the strength of earnings they know are nothing but smoke and mirrors? Part of the explanation can be found in the well-known `greater fool' phenomenon: in a generally rising market, an investor will buy a stock on the strength of earnings he knows to be vaporous, assuming that he will find a greater fool to buy the stock from him at a higher price."

  • Restatements have been increasing in the past few years, topping 230 in 2000 based on a study by Arthur Andersen and a study by Financial Executives International puts the number at 156. And with this increase in the number of restatements has come staggering investors losses totaling tens of billions, aggregating by some estimates to be more than $100 billion in the past six to seven years. And while some in the profession argue that 150 or 230 restatements in one year and $100 billion in losses over the last several years are not significant in relation to 10,000 to 12,000 actively traded public companies and a total U.S. market capitalization of $16 trillion, I don't think the average U.S. investor is going to buy it.

  • There has been a constant parade of press reports of alleged major financial frauds involving companies with household names. The restatements I previously mentioned are often reported by smaller companies, in part due to the fact that small companies make up the largest portion of public companies. But the Andersen survey noted that 15 percent of the restatements were by companies with revenues in excess of 1 billion dollars. Some of these companies have restated their financial statements for errors totaling hundreds or millions and even billions of dollars. Some of these companies have had to restate their financial statements more then once. And unfortunately, we at the SEC find out about the vast majority of these restatements the same way the investors do, we pick up the morning paper and read about the latest "surprise." In fact, the FEI survey noted only 21 of the 156 restatements were due to an inquiry by the SEC.

  • Often in these press reports the auditors say management fraud is the reason the errors were not detected during the audit or, in some cases, during a number of audits. But I ask you, "How can an auditor miss a billion dollars?" This is not pocket change! And keep in mind it is not just one auditor who missed the problem, but rather an entire experienced team that includes an engagement partner and a second experienced reviewing partner; both of whom probably have 12 to 30 years of experience, as well as, a manager with 6 to 12 years of experience. Quite often there also is a third SEC reviewing partner involved if the company is registering securities.

So ask yourself, what grade do you think the average American investor would give these auditors who missed a $100 million or a $1 billion error in the accounts. Better yet, what grade would your college professor have given you for such a miss?

  • I also have noted with concern the abuses of pro forma earnings announcements, which distract investors from the real GAAP earnings and recently made the front and editorial pages of Business Week.

  • Finally, some analysts' reports and recommendations are reported to be tainted by conflicts, to lack any correlation with overall movements in the market, and to be based more on a desire to market one's products rather than to provide sound investment analysis and advice to investors.

An Ice Cube or An Iceberg?

In light of these developments and statements by others, one of the most frequent questions I am asked is just how widespread are the problems with financial reporting? Is there more than what meets the eye? My experience as an audit partner, a CFO and business executive, and as a regulator tells me the answer to that question is yes. And to use an analogy - I wonder at times just how big is the iceberg below the waterline?

Working Together for Continuous Improvement

So should we chalk up the achievements of the past quarter century and say the improvements made to the quality of financial reporting are sufficient? Given the disturbing trends and cultures just highlighted I think not. Rather, we should continually move forward to strengthen the trust and credibility investors place in the accounting profession. We do not have to look far for ideas because there are recommendations that have been made over the past twenty-five years in the reports I have cited, which have not yet been implemented and would greatly enhance the quality of financial reporting. Let me cite some of those and other ideas.

Improvements for the SEC

Let me start with the recommendations for the SEC. First, the O'Malley Panel recommended we increase our enforcement efforts and we are doing just that. We created the Financial Fraud Task Force headed by Charlie Niemeier, from whom you will hear later on today. And while Charlie has only 25 accountants in Washington D.C. to investigate approximately 250 open cases, they have worked long and hard to bring cases such as those involving W.R. Grace and its auditors, as well as Livent, MicroStrategy, and the more recent Sunbeam case.

I encourage people involved with financial reporting to carefully read and consider the clear messages in the Sunbeam release. One message is that if management is going to rob Peter to pay Paul through such methods as "channel stuffing," you must disclose it to the company's shareholders. A second message is that if management is going to manage earnings through "Big Bath" charges or inventory write-downs only to generate profits in later periods, it is no longer an issue for the Chief Accountant but for the Division of Enforcement. And finally, if an engagements partner tries to "justify" overly aggressive accounting practices of a client, rather than standing his or her ground and requiring the proper adjustments, that partner may very well be charged with fraud.

I also encourage you to read the historic Andersen case, which is on the SEC's website at http://www.sec.gov/litigation/admin/34-44444.htm. The case provides a number of lessons including those related to:

  • The assessment of materiality;

  • The improper use of the "roll forward" method of assessing proposed audit journal entries;

  • Improper use of loss accruals, sometimes referred to as "reserves," to create income and manage earnings;

  • Improper establishment of loss accruals or reserves in accounting for acquisitions of businesses; and

  • The need for auditors to be critical skeptics who put getting the numbers right the first time, before their relationship with the client.

But there is another very important lesson for both audit partners in the field as well as those in the consulting chain. And that is, when the auditor is aware that the client is using overly aggressive accounting practices the auditor cannot take an approach that attempts to "rationalize" or support such accounting in an effort to avoid forcing a correction of the accounting. This case sets a clear-cut precedent that in such a case, the Commission will not hesitate to unrelentingly pursue and charge the individual auditors with fraud, censure and fine them. And we will pursue the firm itself.

In the past, the Cohen Commission (1978), the Treadway Commission (1987), GAO (1990), AICPA (1993), POB (1993), Financial Executives International (FEI) (2000), have strongly recommended that the SEC adopt a requirement for management reports on internal controls. As the Cohen Commission report states, "Users of financial information have a legitimate interest in the condition of the controls over the accounting system and management's response to the suggestions of the auditor for correction of weaknesses." I've been an investor, an audit partner, an educator, a business executive, and now a regulator, and based on what I have learned from those experiences, I couldn't agree more. I believe it is time we deal with these recommendations forthrightly, and I have asked the staff to work on a draft proposal we can present to the next Chairman for his consideration.

A more recent recommendation for the Commission to consider came in the May 28, 2001 edition of Barron's. The article, in discussing earnings releases, appropriately stated:

    "There's a flavor of performance measurement for practically every company that doesn't look too hot when measured in old fashioned earnings. The dot-coms were notorious for their promotion of "pro forma" earnings; ultimately, what passed for performance turned out to be a pipe dream. That didn't stop firms in other industries from adopting their own pro forma earnings management. The corporate architects of financial reporting are now building their own Tower of Babel."

Barron's is right in noting pro formas are often used by companies with performance and business issues to mask their real earnings. In fact, the Washington Post has aptly defined pro forma earnings as "hypothetical" earnings.

But Barron's goes further and recommends that in this day and age of electronic commerce, we need to consider updating the rule governing the filing date of interim financial statements in Form 10-Q. Others, such as the well-respected financial analyst Jack Ciesielski, also have recommended a change be made. They recommend that the Form 10-Q be required to be filed when, or approximately when, the press release announcing earnings is made. This could be done in a couple of different ways. One would be to leave the current 45-day filing requirements in place, but if an earnings press release is done, then the Form 10-Q would have to be filed when the release is published. While some would undoubtedly argue, as they have in the past to avoid change, that this might delay earnings releases, I have not seen an abundance of press releases that provide much of a base for any meaningful in-depth financial analysis. A second approach would be just to say the Form 10-Q must be filed within a prescribed number of days, say three to seven days, of the earnings press release. This should be possible as we are now seeing large international conglomerates such as AOL Time Warner provide their financial statements to investors as an attachment to their press releases. Companies who provide such information on a more timely basis to their investors are clearly demonstrating leadership in improving the dissemination of data to investors.

Improvements for the Accounting Standard Setters

First let me say that I believe we have the preeminent accounting and financial reporting in the world due to the quality of work performed by FASB and its predecessors, and the AICPA's Accounting Standards Executive Committee. They have the type of jobs where they get mountains of criticism and sands of praise, and no doubt have to call their moms periodically to see if someone still loves them. And our support for an independent FASB is unwavering. Let me state unequivocally, investors are grateful for what the Board has accomplished.

But again, improvements can and should be made. First, it has taken too long for some projects to yield results necessary for high quality transparency for investors. For example, in the mid 70's the Commission asked the FASB to address the issue of whether certain equity instruments like mandatorily redeemable preferred stock are a liability or equity. Investors are still waiting today for an answer. In 1982, the FASB undertook a project on consolidation. One of my sons who was born that year has since graduated from high school. In the meantime, investors are still waiting for an answer, especially for structures, such as special purpose entities (SPEs) that have been specifically designed, with the aid of the accounting profession, to reduce transparency to investors. If we in the public sector and investors are to look first to the private sector we have the right to expect timely resolution of important issues.

Second, there are a number of areas where significant improvements can still be made in the quality of accounting standards. Since we now have "two horses" to carry the load in the race towards higher quality financial reporting, the FASB and International Accounting Standards Board (IASB), I hope we see initiatives and progress on:

  • The development of fair value accounting.

  • A rigorous, practical impairment test that results in declines in value being reported to investors during the periods the declines actually occur; as opposed to the current standards that yield nothing more than one time overnight "Big Bath" charges that try to sell the investor on the story line that such losses occur within solely the 90 day quarter or when the CEO changes. In one press release I read, management announced a multi-billion dollar writeoff and explained how business had slowed so dramatically. But when I looked at the Form 10-Q for the previous quarter, which had been filed just a month earlier, it lacked a clear picture that would provide investors with sufficient information about what was about to happen and sufficient information about what was about to happen and the ability to see what was happening to the business through the "eyes of management."

  • The accounting for financings otherwise known as leases.

  • A rigorous revenue recognition standard that is responsive to the fact that the single largest cause of restatements, the single largest issue in SEC enforcement cases, and the issue that has and continues to result in the greatest losses for investors, is improper revenue recognition. To avoid adding another reconciling item for what is often the largest item in financial statements around the globe, I believe the IASB should take on this project and work in close partnership with the national standard setters such as the FASB. The FASB, IASB and other national standard setters need to develop a comprehensive, not piecemeal standard, for revenue recognition. This is a global issue that requires a global solution. Appropriate global auditing standards for revenue recognition also need to be developed in light of this being the number one cause of restatements. But in the end, any final accounting and auditing standard must be based on research of past problems, provide adequate investor protection with respect to those problems, and be responsive to the concerns I just mentioned.

Third, the Cohen Commission recommended in 1977 that the FASB amend APB No. 20 to require a standard note to the financial statements covering accounting changes and requiring, not just recommending in certain instances, disclosure of all changes that materially affect interperiod comparability, including "changes in accounting estimates." The lack of such disclosures in the Waste Management, Sunbeam and W.R. Grace cases contributed to an inability of investors to understand and analyze the companies' reported results. I strongly believe, as did the Cohen Commission, that disclosure of all material items affecting comparability would assist investors in better understanding what has affected the numbers they are analyzing. It also would put sunlight on some of the issues affecting financial reporting that have been relegated to the "dark room."

Finally, I note that in the late 1980's the FASB issued SFAS No. 96 ("Accounting for Income Taxes") that was almost immediately superceded by SFAS No. 109 ("Accounting for Income Taxes"). Then in the 1990's the Board issued SFAS No. 121 ("Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of"), which is now being rewritten. In addition, SFAS No. 125 ("Accounting for Transfers and servicing of Financial Assets and Extinguishments of Liabilities") had inherent issues that required amendments in SFAS No. 140 ("Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, a replacement of FASB Statement No. 125"). SFAS No. 133 ("Accounting for Derivative Instruments and Hedging Activities") resulted in SFAS No. 138 ("Accounting for Certain Derivative Instruments and Certain Hedging Activities") before the original standard even became effective.

I do give the FASB credit for the willingness to review a standard it has recently issued. I believe such a review should be an expected practice for all standards five years after they are issued with a report card being issued upon the completion of the review. In addition, I believe it would greatly enhance the quality and credibility of standards if they clearly articulate how to improve financial reporting and meet each of the FASB's characteristics for quality financial reporting.

At the same time, I challenge whether there has been sufficient field-testing of the operationality and practicality of some standards when they are in their development stage. I wonder if "how to" or other types of implementation issues raised in comment letters have been adequately thought through and addressed. I believe the need for some of these prompt amendments highlight this concern. This is also a comment that has been applicable to IASB standards such as the recent standard for agriculture. Having come from a farm, I wonder if that project was driven by "technical accounting experts" who lacked sufficient time behind the wheel of a tractor. I strongly encourage the Board to take the necessary steps to improve its standard setting efforts in this regard. As the United Kingdom's Accounting Standards Boards noted in a recent comment letter, extensive testing greatly contributed to the success of its Financial Reporting Standards No. 11, "Impairment of Fixed Assets and Goodwill."

But notwithstanding my comments or other criticism you might hear of the FASB standards, we have to keep in mind that their standards such as SFAS No. 133 on accounting for derivatives have made a significant improvement in the quality and transparency of information investors are receiving. Those who argue that SFAS No. 133 should be rescinded must have short memories. We cannot afford to forget the losses investors suffered in the early and mid 90's and the headlines involving household names such as Gibson Greetings, Inc., Bankers Trust, Kidder, Peabody Group, Inc., Procter and Gamble Co., and international companies such as Metallgesellschaft. Investors were negatively affected because they were unable to see the losses totaling tens and hundreds of millions of dollars, even billions, that had been incurred by these companies as a result of derivatives. And even today, as companies have adopted SFAS No. 133, we are seeing adjustments that exceed a billion dollars. Investors have the right to this transparency. While some argue the cost is too great, I ask, what has been the cost to investors of being "blind" to such numbers? We can only wonder why is it that some companies want to keep their investors "in the dark"?

For example, an initial review of the filings of 881 of the Fortune 1000 companies showed 501 or 57% disclosed they did not have a material impact from SFAS No. 133. However, there were 32 with an impact greater than $100 million, of which 8 were greater than a billion dollars.

A chart summarizing the impact of the adoption of SFAS No. 133 is as follows:

Net Impact Fortune

$0 - $10 million 316   415   731
$10 - $50 million 76   18   94
$50 - $100 million 19   5   24
$100 - $500 million 19   2   21
$500 million-$1 billion 3   -   3
$1 billion and up 8   -   8


441   440   881

A review of some of these changes may call into question just how compliant registrants were with the former standards, SFAS No. 52 ("Foreign Currency Translation") and SFAS No. 80 ("Accounting for Futures Contracts"). In fact, in one meeting some time ago with one of the professional committees, I asked why it did not appear that there was compliance with the standards with respect to certain intercompany derivative transactions. The response from one of the committee members was that, quite frankly, absent the SEC enforcing the standards, no other regulator or auditor would. I appreciated the frank and open response but, quite frankly, maybe that is why the documentation requirements set forth in SFAS No. 133 are necessary!

A subset of the FASB that has worked well since its creation in 1983 is the Emerging Issues Task Force. 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 is also subject to some of the same concerns expressed thirty years ago with respect 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, only 20 out of 234 active reporting companies were affected by this issue 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 1983 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 periodically reviewed and 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, including representational faithfulness, consistency, verifiability and comparability.

Investors Deserve Real Analysis From Real Analysts

Let me switch for a moment to the issue of how analysts are serving investors. An article in the Financial Times dated March 20, 2001, emphasized a recurring theme I quite often hear today. That article's title? "Shoot All the Analysts." Now it could have said shoot just some, or shoot a few, but no, the editor said shoot them all. Unfortunately, this demonstrates that all analysts are being "tainted" by the actions of those who fail to serve the public interests of investors.

But rather than becoming caught up in the emotion of the article, I thought one should try to obtain some facts. I did obtain some facts that I would like to share with you.

First as of April 2, 2001, based on approximately 26,000 analysts' recommendation, I found1:

  1. 7,657 or 29.8% recommendations of strong buy

  2. 9,740 or 37.9% recommendations of buy

  3. 7,961 or 31.0% recommendation of hold

  4. 81 or 0.3% issued recommendations for strong sale.

I understand some also use the terminology "outperform" for hold but based on these studies I am not sure who the companies are outperforming!

Let me make it a little more interesting by giving you the same statistics near the market peak on March 1, 2000:

  1. 10,025 or 35.8% of the recommendation were for strong buy

  2. 10,303 or 36.8% of the recommendations were for buy

  3. 7,430 or 26.6% of the recommendations were for hold

  4. 164 or 0.6% of the recommendations were for sale, and

  5. 56 or 0.2% of the recommendations were for strong sale

There is little change in the recommendations between the years. Yet there have been very fundamental changes in the capital markets, in the economy, and in the revenues and profits of many companies. As I mentioned earlier, Nasdaq hit a high of 5132 on March 10, 2000, and by April, 2001 had fallen approximately 3100 points. In the fourth quarter of 2000, a record 794 earnings warnings were issued. That was followed by a record 895 warnings in the first quarter of 2001. Yet in light of all of this, as the market began its downward shift a year ago, less than one percent of the recommendations were for sales. And today, after the markets and investors have lost trillions in market capitalization, just over one percent of the recommendations are for sale.

I believe this lack of quality research and reporting would lead Benjamin Graham, the pioneer of high quality securities analysis, to wince. Such research and recommendations no doubt lead investors to challenge the credibility of analysts. Don't you ask yourself, just how poor is the performance of the stock of the companies with "sell" recommendations?

Maybe the answer is in a study by four University of California professors, which concludes that the stocks most highly recommended by analysts in 2000 fell 31.2 percent below the performance of the stock market. Their least favorably recommended stocks out-performed the market by almost 49 percent.

You might have heard the concern expressed by others at the recent hearings on analysts held by Congress. I applaud the members of Congress for their interest in this topic and investor protection.

Just prior to the hearings, the securities industry announced the adoption of a new set of "best practices." However, on the same day, two of the largest well-known Wall Street securities firms were quoted in the Wall Street Journal as follows:

"A spokesman for [X, Inc.] said, "We're not implementing any new policies." A spokesman for [Y, Inc.] units said, "Nothing is going to change with us; everything is going to be status quo."

In light of the performance of analysts, such statements raise serious public policy concerns and issues. They also demonstrate that investors should have a healthy level of skepticism when reading analysts' reports and be very cognizant of the fact that undisclosed conflicts may affect and influence the research reports the analysts provide.

Establishing Accountability for Quality

Another issue that can affect the quality of financial reporting is the quality of the CFO and controller, and the attitude among other corporate executives toward the financial management or team and its vital role. I raise this issue because sometimes, perhaps too often, I hear the reference to "bean counters" and a notion that the CFO and controller don't add value as accountants and financial reporting experts. Well, just ask investors or audit committees of companies like Waste Management, MicroStrategy, Rite Aid, Cendant, Sunbeam, Oxford Health, McKesson HBOC, Livent, and the remaining companies who have had to do restatements, whether they think a CFO or controller is a valuable contributor to a business. CEOs and audit committees must foster a culture that recognizes and values the members of financial management and the skills and knowledge necessary for high quality internal controls and external financial reporting. However, I wonder if that is occurring today. As noted in the April 2000 edition of CFO magazine, ten years ago, CFO turnover in the Fortune 500 was about 12 percent per year, with retirement the major reason why someone left a company. In 1998, the figure was up to 26 percent, and research cited missing an earnings estimate for a quarter as a frequent cause. I find it interesting when it is noted that the "CFO" missed on expectations. What about the CEO, the COO, and the vice presidents of manufacturing, sales, marketing and product developments? Wasn't it really the business that all of these executives are responsible for managing that failed to achieve the necessary sales, cost levels and new product introductions and accordingly missed expectations?

I hope that in the future, audit committees are fulfilling their responsibilities and will see to it: 1) that there are people in the top financial reporting positions that have the requisite skills to ensure the proper books and records are maintained, 2) that reasonable assurance is provided by the company's internal controls, and 3) that undue internal pressure on financial management to "make the numbers" will not only not be tolerated, but also will result in swift and appropriate disciplinary action. Quite frankly, an audit committee that does less, in the event of an SEC investigation of financial reporting wrong-doings, may very well find itself having to explain how the wrongdoing happened under its oversight. If cases continue to be reported as they were in CFO magazine, which suggests CFOs and controllers left over disagreements with the company's financial reporting, one can only wonder how long it will be before such terminations become the subject of Form 8-K reporting requirements similar to those for the termination of auditors or directors.

Bringing Education Current with the Times

I have discussed recommendations for standard setters, regulators and preparers. Let me shift for a moment to a group that all too often is missed in the equation. That is the educators and the all-important role they play.

The most valuable asset of the accounting profession and public accounting firms is the people who make up our organizations. Great people who are talented, well educated and motivated make for great organizations while "weak" people are nothing less than as the television show aptly calls it, the weakest link!

Accordingly, I give credit to the current leadership of the AICPA for its efforts to boost enrollment in our colleges and universities of the best high school students and its efforts to interest them in the accounting profession. It is important that accounting firms and industry provide support for this initiative. During the recent debate on auditor's independence we noted that the salary gap between the starting pay for accounting college graduates entering the profession, and those who chose other fields of study or employment opportunities in business, had grown very significantly over the past ten years. This salary differential sends the wrong signal to students about to choose a major field of study. Clearly, we need to correct this problem in addition to considering the level of investment going into those who choose to enter the accounting profession as auditors as well as the tools they need to perform effectively.

Today we also need to bring down the "silos" that still exist in the business colleges. Educators need to take concrete steps to change the all too typical dinosaur of an accounting curriculum that is based on the accounting silo. They need to stop competing with the finance, management, marketing or computer science "silos" and seek to integrate these programs in a broad-based accounting curriculum. Today, these ingredients need to be blended together to meet the student's and profession's needs.

Good auditors and financial managers need a broad spectrum of knowledge. For example, to be a good auditor today, you must understand marketing and distribution channels, how risk management is effectively and efficiently achieved through the use of various financial as well as managerial techniques to develop effective strategic and tactical plans. And of course, each of these areas of study are affected by the rapid change in technology.

Universities need to reflect these changes in their curriculum now. Certainly this will in all likelihood require more than what a student is able to learn in a four year program. Keep in mind, while many of us were in college, technology meant punched cards fed into a computer, management was done in an environment of paper and calculators, not in a real time on-line mode, and almost all of the financial instruments used today had not yet been created. In the past, we talked about interstate business and commerce, now it's the integrated global economies. In simple terms, this means we must also realize that if our new hires are to have the basic understanding they will need to be successful in their respective roles, they will need an enhanced course of study. The enhanced program must be both more broadly based in business, more integrated and still steeped in the accounting contribution unique to our discipline. At the same time, it is imperative that the basic skills taught in financial accounting and theory, income tax and auditing courses today, must continue as part of the curriculum. Accordingly, I do not believe this can all be accomplished in four short years. I believe we need advanced programs. The result will be students who leave the university with a better education, as compared to the body of knowledge new graduates had ten or twenty or thirty years ago. However, the accounting firms and business must be willing to compensate the students who invest in this greater body of knowledge.

I understand the AICPA is attempting to make changes in the annual CPA examination that provides a basis for licensure of certified public accountants. These changes are supposed to reflect the changes in business that I have just described. I support this effort. At the same time, those changes cannot come at the expense of the knowledge that an auditor and accountant must possess if they are to fulfill their most important role - the financial statement audit and the resulting protection of the individual investor. That is the role of preparing high quality financial statements and disclosures for the investing public. If testing of accounting and auditing skills is reduced, as some have proposed, then a serious public policy question is raised that states and others involved with licensure and the practice of public accounting will need to respond to quickly.


Let me close by again noting that the past quarter century has been productive and successful with improvements in the quality of financial reporting. But as with any business, continuous improvement is necessary to keep up with the fast pace and ever- changing challenges we face in our global economy. If the accounting profession is to receive an "A" for our efforts from investors, our customers, it will not come from the path of least resistance but from a passionate desire to serve society and the public. And that is why the vast majority of the accounting profession continues to take great pride in being called certified PUBLIC accountants.


1 Information from Thomson Financial/First Call.



Modified: 07/23/2001