Speech by SEC Commissioner:
Remarks at the Financial Executives International 2002 Conference:
Current Financial Reporting Issues
Commissioner Cynthia A. Glassman
U.S. Securities and Exchange Commission
New York Hilton Hotel
November 5, 2002
Thank you, Phil, for that kind introduction. Financial Executives International has been and I'm sure will continue to be an important advocate for integrity in financial reporting, and a key partner with the SEC in our work on behalf of investors. That is why Chairman Pitt, who was unable to be here this morning, asked me to speak on behalf of the SEC - to let you all know how much we appreciate your assistance in our important work.
I should note that these remarks, as always, represent my personal views and do not necessarily reflect the views of the Commission.
Approximately one year ago, the corporate malfeasance and financial mismanagement at Enron was just coming to light. By now, we're all painfully familiar with the spate of high-profile corporate failures, which have eroded confidence in our capital markets and in the honesty and integrity of those who serve them. These scandals were years in the making and are a sad reflection of the "feel good" culture of the 1990s.
In the year since, there has been a revolutionary change in the way that our markets are being regulated, that public companies are disclosing the results of their operations, and that the accounting profession performs its assigned public responsibilities. I commend Financial Executives International and Phil Livingston for holding this conference on Integrity in the Bottom Line. In my view, integrity is the bottom line.
As executives responsible for the collection and dissemination of financial information, you play a critical role in our market-based economy. Capital flows to opportunity everywhere, and information - particularly financial information - is the critical currency for investors seeking returns and for companies seeking capital to grow. To be sure, some financial executives helped perpetuate the scandals that we are now cleaning up. You need only turn on the TV or open the newspaper to see one case after another against financial officers, like those against officers of Enron, WorldCom, Adelphia, and Rite Aid, and unfortunately, a long list of others. These cases unquestionably send an important deterrent message to public company officials. But we need to do more than simply deter bad conduct. We must incent good conduct. Top of the line conduct must be the norm in American business. In short, we need you to do better. Only then will we be able to restore investor confidence.
The vast majority of corporate executives are honest managers. But bad corporate managers have made stricter regulation necessary for all. The Commission has sought to improve regulations, not simply add more regulations. We are working hard to solve the long-standing problems that the recent scandals have brought to light. And to all corporate managers, I must say quite frankly, if you're not part of the solution, you're part of the problem.
I'm pleased that FEI is part of the solution. Over the past year, FEI has responded in a forthright and responsible manner to our calls for suggestions and ideas on ways we can strengthen our corporate disclosure system and improve corporate accountability. Your thoughtful efforts represent a significant step in addressing major concerns raised by recent events.
Our corporate governance system requires that corporate leaders be faithful to the interests of shareholders and act with both ability and integrity. Most of the problems we've seen recently result from a failure of company executives to honor their fiduciary duties. Some of the problems also resulted from a failure of communication between government and the private sector. To restore public confidence in the integrity of senior corporate managers, companies must demonstrate a strong commitment to the development and enforcement of rigorous corporate governance standards. They also have to be ready and willing to come to the SEC with their questions and their problems. In our view, the best way to protect investors is to prevent problems before they arise.
No set of rules can stop venal actors determined to put personal interests ahead of those of the companies they manage; but there are a number of ways corporate disclosure can be improved to deter breaches of fiduciary duties and to increase transparency. The Commission is working to make disclosures more meaningful and intelligible to investors. In particular, financial statements must be clear and informative and not overload investors with information that is not meaningful. This should be your mindset too. Investors deserve comprehensible financial reports that they can easily and quickly interpret and understand.
Technology will play a critical role in the process of furnishing information to investors. The Internet can disseminate information quickly, and can provide concise disclosure information without sacrificing the wealth of information available to investors. I encourage you to use technology to put user-friendly information into investors' hands more promptly.
Now I want to touch on some of our recent initiatives, because so many of them affect financial executives.
This past summer, the SEC took unprecedented steps to restore investor confidence and establish true accountability among corporate leaders. In June, we first required CEOs and CFOs to personally certify-in writing, under oath, and for publication-that their most recent reports filed with the Commission were both complete and accurate. In August, we adopted rules requiring CEOs and CFOs to certify the contents of quarterly and annual reports. Officers who make false certifications face personal liability. By demanding sworn certification of past financial statements, the SEC got executives' attention. Now, with new rules requiring sworn certification of all future statements, executives are on notice that they had better know not just the bottom line, but how the company got there.
We've also adopted amendments to accelerate the filing deadlines for quarterly and annual reports. These changes will be phased in over three years, ultimately requiring annual reports to be filed within 60 days and quarterly reports within 35 days. These shortened deadlines were long overdue as the existing deadlines were set more than 30 years ago. Thoughtful comments, such as those from the FEI, were key in striking the best balance between companies' need for adequate preparation time and investors' need for more timely information.
Similarly, we've adopted rules that accelerate filing deadlines for corporate insiders to report transactions in their company's securities, including transactions with the company. These deadlines decreased to only two days - from periods of up to 410 days.
In the past few weeks we have proposed several important rules to implement the requirements of Sarbanes-Oxley. Again, we encourage your comments on these rule proposals so we can implement the best final rules possible.
- First, we proposed rules requiring disclosure of whether a company has a code of ethics for senior financial officers and standards for immediate disclosure of substantive changes in that code.
- Second, we proposed a rule requiring that a public company disclose whether its audit committee has at least one member who can accurately be described as a "financial expert."
- Third, we proposed rules covering improper influence on audits to prevent financial statements from being rendered misleading.
- Fourth, we proposed new rules and amendments regarding the use of pro forma financial information. We also proposed requiring that public companies file with the Commission earnings announcements and releases.
- Fifth, we proposed rules that would require companies to provide in their "Management's Discussion and Analysis" section of the Commission filings a discussion of off-balance sheet arrangements. In addition, in keeping with our year-long focus on improving MD&A disclosure, we proposed including clear disclosure of contractual obligations and contingent liabilities and commitments.
- Finally, we proposed new rules that would prohibit an issuer's directors and executive officers from engaging in transactions in equity securities of their companies during a period when employees cannot do the same in their pension funds.
Several of these proposals are of particular interest to FEI, and many will directly affect the responsibilities of financial executives.
In addition to these various rulemaking efforts, we have just finished a record-breaking year for enforcement actions. Our "Real Time Enforcement" initiative aims to improve our protection of investors by moving faster, in real time, to bring enforcement actions. Some of the milestones we met as a result of the work of the Enforcement Division for fiscal year 2002, which ended September 30th, include that:
- We filed a record 163 actions for financial reporting and issuer disclosure violations, approximately 46% higher than we filed in fiscal year 2001 and 58% higher than in fiscal year 2000. Overall, we filed a record 598 enforcement actions, approximately 24% more than in fiscal year 2001, and 19% more than in fiscal year 2000.
- We sought to throw 126 unfit officers and directors out of corporate boardrooms for good. That is about 147% more than we sought in fiscal year 2001 and 232% more than in fiscal year 2000. As the President stated in his Ten-Point Plan, corporate officers and directors, and especially CEOs and CFOs, must personally assume responsibility for compliance with our full disclosure laws. The ouster of unfit officers and directors is a critical tool to ensure that officers and directors "get it," get that their mission is to safeguard the interests of shareholders. It is also vitally important to prevent any corporate wrongdoers from getting a second chance to injure investors.
- The Commission filed 48 Temporary Restraining Orders, seeking immediate relief to prevent irreparable harm to investors - up approximately 55% from fiscal year 2001 and 45% from fiscal year 2000.
- And, we have brought more subpoena enforcement actions than in previous years and supported an extraordinary number of criminal prosecutions.
We're proud of real-time enforcement and the staff dedication that makes it possible. The SEC was in court with fraud charges against WorldCom within 24 hours of the company's restatement, and we won a freeze on executive bonuses and departure compensation within 72 hours. That meant more money in the till for investors and creditors. And we're doing that in dozens of cases.
We've also come up with some creative approaches to old problems. Using our long-existing authority to obtain affirmative statements from companies under investigation, we've required public companies to provide the public on a "real time" basis with critical information on the nature of financial frauds or other difficulties. We invoked this authority informally last October, to press Enron to report publicly and quickly the circumstances that led to its restatement, and we formally issued an order requiring the same thing when WorldCom's fraudulent financial reports became known.
The heaviest hammer against financial fraud, of course, is criminal prosecution and serious jail time. The new Corporate Fraud Task Force, established by President Bush, is the latest step in what has been a remarkable run of coordinated enforcement efforts between the SEC and federal criminal authorities. This year, even before the Task Force was put in place, approximately 75 criminal actions by 17 different U.S. Attorney's Offices and the Department of Justice were taken with our assistance for securities related offenses or obstruction of justice in our investigations. By the end of the fiscal year, these figures had grown to 259 and 30, respectively. And under Sarbanes-Oxley, the hammer against financial fraud is now even heavier.
While at times the immediate tasks that we are facing seem daunting, we have not lost sight of longer-term goals and initiatives that we plan to undertake. As I mentioned at the outset, the rules we have proposed are meant to provide better - not just more - disclosure for investors. In order to give investors more usable information, I favor simplifying financial statements, and converting them into simple and precise English. This is a lot harder than it sounds, but the goal here is for investors to be able to pick up a financial statement and understand, almost instantly, what the true financial position of a company really is. At present, we are some distance from that type of financial reporting. Nature abhors a vacuum, and unfortunately this void, instead of being filled by mandated, simplified financial statements, has been filled in many cases by so-called pro forma financials.
Investors who are anxious for current, simplified and comprehensible financial reporting, unfortunately, are more likely to rely upon a company's "pro forma" disclosures than the same company's meticulously prepared, mandated GAAP financial disclosures. This is why we provided cautionary advice to companies and investors last December about the use of pro forma financial information, and that's why Sarbanes-Oxley addressed the same subject.
Again, this is an area where FEI has been out in front. As you know, earlier this year, FEI drafted a best practices statement on pro forma profit figures. I want to offer my own analogy to help us think about pro formas. The analogy is this: think about how sports scores are reported. After the game is over, it's the final score that gets reported. There are no adjustments to account for scores that could have been, but for "one time events" such as injuries, bad officiating or missed shots. The sportscasters don't deduct points from the home team to account for home field advantage, nor do they add points to the visitor's score. They just tell it like it is.
But, while they may have a legitimate use in some circumstances, in too many cases companies seem to use pro formas to adjust the score. They say, in effect, "Well, if we didn't have this one-time charge, our results would have been x and we actually would have made money." This is equivalent to a football team saying, "Well, if we hadn't fumbled the ball in the red zone, we would have scored a touchdown and won the game." Nice try, but you lost. And some companies even have the audacity to take such "one-time" charges every single quarter. The clever ones always take different one-time charges. This is equivalent to a football team saying, "Well, we lost one game because of the fumble in the red zone; we lost another game because the other team blocked a field goal, which has never happened to our field goal kicker before; and another game we lost because our quarterback got injured on a late hit." The list goes on.
There is something about sports that is universally appealing to our sense of fairness. Sports are played in the open, for all to see. It is obvious whether there is the proverbial "level playing field." Also, in sports there are clear rules and there are officials who enforce them. And, more and more these days, there are procedures to appeal an official's call and these appeals are handed down in minutes, not years. There is a clear beginning and end to a game. Afterwards, you have a clear result. Also, with sports, there is something about cheating that sets our teeth on edge. When people violate the integrity of the game, it is unforgivable. And leagues and teams and fans alike show no mercy.
The truths that we can see so clearly in sports are also apparent in the corporate world. I hope this analogy helps you to think about some of the problems with financial reporting today. Granted, the final score does not always tell the whole story. That's why the box score also shows other statistics, which are often telling, such as turnovers or fouls or field goal percentage.
We still have more work ahead of us - including additional rules to meet the requirements of Sarbanes-Oxley. I know the SEC is up to the task. I am certain of that because of our excellent staff and their dedication. We are tremendously proud of them for going above and beyond the call of duty in what has been a trying year for the agency. They have worked long and hard hours to address a record number of corporate failures and to put the rules and systems in place to ensure that investors and our markets have more protection from such failures.
More than 53% of American households participate in our securities markets, and while we need to improve Americans' financial literacy -- one of my key concerns -- we also need to improve what they are reading. Financial statements must be clear and informative. If we could get to a point where the financial results of public companies were as easy to understand as box scores and the sports page, then America's investors would be well served. And then maybe everybody would read the financial pages first instead of the sports section! (In the interest of full disclosure, I start with the Style section.)
To accomplish much, if not all, of the initiatives I have discussed today will require private groups like FEI and its individual members to step up. The government did not create the problems that we are facing today and we cannot resolve all of them on our own. The private sector must make the most important inroads. While government can improve the way we govern, the private sector must respond too, and forcefully, or our efforts will have been in vain.