Speech by SEC Staff:
"A Vision for the 21st Century"
U.S. Securities and Exchange Commission
1998 Twenty-Sixth Annual National Conference on
Current SEC Developments
December 9, 1998
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any publication or statement by its employees. The views expressed herein are those of Mr. Schuetze and do not necessarily reflect the views of the Commission or the other staff of the Commission.
I want to thank Mr. Herz for that kind introduction. It read just the way my mother drafted it.
Let me tell you about the conversation I had with Mr. Herz leading up to my speech this morning. Robert asked if I believed in the U.S. Constitution, and I said yes. Then he asked if I believed in the Bill of Rights, and again I said yes. Then I was asked if I believed in the First Amendment which guarantees free speech , and I replied yes. He said, "Fine, I want you to come give us a free speech."
I also want to thank the AICPA, an organization that I am proud to be a member of, for the opportunity to once again participate in this outstanding conference.
Before I begin, I have to remind you that any remarks you hear during this conference from me or anyone from my Office are only those of the speaker, and do not necessarily reflect the views of the Commission or others on the staff.
I’d like to follow up on some of the Chairman’s earlier remarks. He has called for a partnership of representatives of financial management, business executives, public accountants, attorneys and others. It is only through the diligent and determined efforts of such a partnership that we will all achieve the broader and greater goal of investor protection. Furthermore, it is only through these efforts that we will protect and enhance the transparency in financial reporting that cause our markets to be the envy of the world.
I would like to commend those here today that contribute on a daily basis to quality financial reporting in the U.S. First, there is the staff of the SEC. These dedicated professionals serve our government for compensation sometimes well below their peers in the private sector, while diligently and constantly reviewing filings, getting out comment letters within 30 days, and working with those of you in industry and the public accounting firms. Several times since my return to the Commission, regulators from other countries have indicated to me that they believe there is no securities regulator in the world that is the peer of the SEC. If that is the case, then I believe much of the credit should go to the SEC staff.
Second there are those of you who are the auditors for corporate America, or as the U.S. Supreme Court describes you, the "Public Watchdogs." I do believe the majority of you, when faced with a tough call, make the right decision. Certainly, these tough calls require people who can withstand pressure.
Finally, there are those in the audience who are members of financial management. I personally found the last couple of years in my career as a CFO to be as equally rewarding as the years I spent in public accounting. However, the press articles this past year have been critical of the roles played by CFOs, controllers, and their staffs in a number of alleged spectacular financial fraud cases. A recent informal survey of a small group of CFOs highlighted part of the issue when it showed two thirds of the respondents had been pressured by other senior executives to misrepresent financial numbers. While auditors face client pressures, I believe the pressure faced by financial management can be equally great. Yet, I have found the vast majority of those in financial management who find themselves in the pressure cooker do not succumb to the dark side, but rather join the forces of investor protection in the preparation of quality financial reports.
To all of you who do it right, let me just say on behalf of the Commission and its staff, thank you.
However, we certainly must realize that in today’s world, nothing remains the same. Things change and evolve, sometimes at a slower pace over a course of years, sometimes overnight.
Our profession [that of the auditor] was given a very special franchise by Congress when, in 1933, it required not only that public companies have audits of their books, but also that those audits be done by independent auditors with the highest level of integrity and objectivity. We were, in essence, placed in a very unique role in our public markets. We are indeed different. Attorneys, underwriters, analysts -- none of these were given the level of public trust that I personally believe the public accounting profession received. Earning the privilege to join the ranks of CPAs is indeed a special honor.
Yet, it is an honor that can melt away as quickly and as surely as the snow will go this coming spring time. It is an honor that must cause us to constantly adjust to the changing times we live in, while still remembering why we have this unique role; we have it because of the trust and confidence investors place in all of us gathered in this room today.
How then do we go about maintaining this trust and our special role as we move into the future? Certainly, the AICPA has its Vision Project underway to guide the profession toward the future. And many businesses today have continuous, ongoing reviews of their strategies, goals, and mission statements. Along similar lines of thinking, I would like to share with you what I think are some key and critical areas that the profession must address if it is to maintain its current status and role in our capital markets. In essence, here are my thoughts on a vision for the profession for the 21st Century. They are things I expect the staff will be devoting significant energy to as we move forward.
Increasing the Level of Professionalism in Public Accounting and Financial Management
The press has published several articles this year with titles such as "Pick a Number, Any Number," "Accounting Abracadabra," "The Auditors Are Always Last to Know," and "Earnings Hocus Pocus, How Companies Come Up With the Numbers They Want." Perhaps even more of a concern was a loss by investors of over $20 billion dollars in a single instance that, according to the press, was due to a company publishing financial statements with errors of approximately half a billion dollars, including errors in the cash accounts.
The investing public has come to expect high quality in the financial reporting by companies in the U.S. capital markets. Investors also expect to receive financial statements that have been subject to independent, high quality audits that have been performed with a great deal of integrity and objectivity.
As I said earlier, I believe many members of the public accounting profession and financial management community live up to the expectations of the public markets. However, there is a great need today for leadership that can take financial reporting and auditing into the 21st Century. This leadership must be willing to challenge the status quo and look for new ways to make audits more effective, to improve upon our financial reporting model, to meet the expanding globalization of the capital markets, to protect and ensure the integrity and independence of our private standard setting process, and to meet the demands of ever changing technology. These leaders, in meeting these challenges, must:
- Be willing to put investors and professionalism first,
- Stand tall in the saddle when the temptation arises to meet an earnings forecast or do a business deal that conflicts with the needs of investors,
- Be willing to speak out on issues that will advance the needs of investors, even if they conflict with the desires of the profession,
- Have a vision of the future, anticipating change, and lead the profession in developing timely and effective responses to the changes, and
- Most importantly, understand that we will have our unique role only so long as investors perceive a need for it.
Such a leader was Leonard Spacek who in the 50s and 60s, to the chagrin of many members in public accounting, challenged the profession for not showing leadership and meeting the expectations of its largest constituency, the investing public. He demonstrated vision and an ability to challenge others around him to move to a higher level. In 1956, Spacek stated: "I find the most serious problems of our profession are caused by our own indulgence . . . . We must wait for the catastrophe, because we do not have a sufficiently strong or self-appraising accounting profession to right this public wrong -- before, not after, serious injury results."
While some leveled severe criticism at Spacek for his innovative thinking, ultimately his leadership resulted in positive changes. His leadership lead to necessary changes being made prior to a catastrophe.
As the Chief Accountant of the SEC, I am focusing on, and hope we may once again see, such leadership. I hope we will see leaders who understand and believe that sound decisions based on professionalism will be good for business, but not all business decisions are good for the profession.
Let me discuss what I believe are some examples of such leadership today. First, the "Big Five" accounting firms have stated to me that as of January 1999, each of them will require timely interim reviews of the financial statements of each public client, as a condition of acceptance of the company as a client. I applaud each of the firms for this important step. I challenge the rest of the profession to follow their leadership on this issue.
Second, the Chairman of Ernst and Young, Phil Laskaway, made a very significant speech this year on international accounting standards. Phil, who is also serving on the Blue Ribbon Panel on Audit Committees, called for not just minimum standards but rather for high quality international accounting standards that are so important to our global markets. It took a lot of courage and leadership to call for such standards, especially when making a speech in Europe.
The third example I will mention is one involving Louis Matusiak of the firm of Olive & Co. Lou took on the role of leading a new task force to develop new accounting guidance for the motion picture industry. A previous task force had been unsuccessful in developing guidance that responded to investor concerns regarding what many perceived as abusive accounting practices.
Lou certainly did not have to chair this task force, especially in light of opposition from some in the industry. Nonetheless, he answered the call and worked diligently to develop a new, higher quality standard that will serve the interests of investors. While some improvements still could be made to the exposure draft, it is a significant improvement to the existing standard.
Now, however, let me briefly touch on a few, and I believe somewhat limited, instances I have seen over the years as a member of the public accounting profession, a CFO, a member of the SEC staff, that would cause me to challenge our level of professionalism.
The first involves the less than rigorous and proper implementation of accounting standards. Every once in a while I have seen circumstances where GAAP has not been followed and a practice has developed that is inconsistent with the written literature. In a recent conversation with a national office partner about such a situation, the partner noted what the literature required, but indicated he felt the practice that had developed was not that egregious. This is disturbing in that one of the first auditing standards requires each of us to follow the standards set by the profession. It does not discuss the notion of a CPA assessing whether a violation of a standard is egregious or not.
Another situation was the result of deliberate action by a CFO. This action involved the CFO causing an error to be recorded in the financial statements, contrary to the advice of his Company’s auditors. His rationale was that the error, which was not the result of a problem in systems but rather a "hard" adjustment for which the data had to be accumulated, was not material, even though it was in the tens of millions.
A final example I’ll cite came out of a meeting I held with financial analysts. They pointed out that the financial statements they rely on do not always include the disclosures required by consensuses for EITF Issues 94-3 and 95-3 and by Regulation S-X in the Schedule for Valuation and Qualifying Accounts. Notwithstanding this lack of compliance with GAAP, the auditors still issued an unqualified opinion.
Perhaps, a recently retired vice president of the AICPA, in responding to a question regarding a shift in emphasis to the trade association aspects of the AICPA from its professional and self regulatory aspects, said it best:
"It is extremely important that the AICPA maintain a proper balance among the business interests of maintaining a financially viable organization, its member service aspects, and its role as a self regulator and professional society . . . . At times, I do sense a "lack of "respect" and "understanding" on the part of some of our leaders -- staff and members -- for the technical, professional aspects of the AICPA. . . . I hope that its leaders can bring the three forces into sync as it moves forward in these very demanding times."
My strong belief, hope, and vision for the 21st Century is that a professional, whether in public accounting or in financial management, is an individual who strives to achieve a level of doing things right, to perform to best of his or her ability, and to be proud of each effort and accomplishment. A professional in public accounting is a person who views their career as more than a job to do for eight hours a day. Rather, it involves the exercise of reasonable judgment and professional care to ensure that investors are better served and our capital markets adequately protected. In the future, the profession must achieve -- not just strive for -- the highest level of professionalism. It must put investors beyond clients and self interests. It must maintain trust and confidence. We must be the "Olympic Athlete" of the business community. We must be a profession, not a trade organization.
Let me switch briefly from my vision of leadership and professionalism to the auditing process we have today.
Personally, I wonder if the audit process has kept pace with the quickly evolving and changing ways we do business. I probably do not have to point out to most of you, the changes in communication and data gathering and dissemination that have occurred since I last spoke at this conference just eight years ago. The use of email, the internet, and technologies with faster and wider transmission capabilities, has exploded.
In this room, we have a generation who went through college with limited or no exposure to computers. There is another generation here who, how can we forget, learned computers using punched cards. Then there is the first generation who had to buy a personnel computer for college. And today, even my daughter is adept at using the internet to send me emails.
Today’s students, tomorrow’s investors, are going to require faster, more timely dissemination of quality information, on a global basis. And tomorrow in fact may be here now. Consider for example, a large well-known European company that has never had a U.S. style audit, but has 17% of its stock held by U.S. investors. Could it be that investors, through various means of communication and information gathering and dissemination available today, are willing to forgo the traditional U.S. audit? What are the implications of such investor decisions to the quality and efficiency of our capital markets?
I must also note that while auditing firms hire some of the brightest graduates from our universities, I wonder if these new staff, who typically have zero to six years of auditing or business experience, and who perform more than 80% of the audit work, have an adequate understanding and knowledge of both auditing procedures and business operations to dig deep enough into a complex business, its operations, and the resulting numbers.
To address this concern, the pob has announced the creation of a committee to investigate the effectiveness of audits. Never before has a committee comprised of such distinguished individuals, a majority of whom are from outside the auditing profession, undertaken such an important task. This panel, comprised of a former CEO of one of the major accounting firms, a former executive of AMEX, two former SEC Commissioners, representatives of the academic community, and a ceo from industry, are expected to complete their study in the next twelve months. This committee, which we have asked to operate in the sunshine in order to increase the public input, is extremely important. I look forward to their deliberations and recommendations.
I also hope the profession will identify and find ways to respond to the quickly changing needs of investors and the technologies they use. I believe it is important we develop solutions that will provide for new ways to provide assurance on information included in changing financial reporting models, on a timely, if not real time, basis. Unfortunately, it has taken us 25 years to get to the timely interim reviews of quarterly financials we have today. Does any one in this room think we have another 25 years to take the next step? Remember what happened to the dinosaurs, Edsel, and Osborn computer.
A hallmark of the accounting profession is that it has been a self regulating organization for the most part, including disciplining of its membership. Often this regulation has come in the form of the Professional Ethics Executive Committee or the SEC Practice Section of the AICPA. In addition, the Public Oversight Board has also reviewed and provided critical evaluation of the quality control processes of the profession.
I believe that it is important today, as well as into the future, for the profession to continue to demonstrate to the public that it has the capability and desire to continue as an effective self regulatory organization. In order to do this, I believe the profession needs to benchmark its practices against those of other self regulatory bodies, to determine what are best regulatory practices. No doubt, areas for improvement of existing practices identified. For example, I believe best practices may include a more open process with in put from public participants and more timely resolution of open cases.
Once those practices are identified, I believe the AICPA and profession should determine an action plan that can be implemented in order to put in place those practices will be that are considered "best in class."
In an address to the AICPA, Board of Directors this year, the Chairman expressed his concern that the AICPA’s disciplinary mechanism lacked credibility and urged the AICPA to re-evaluate this process. The Chairman suggested that the AICPA consider alternatives to improve the timeliness and effectiveness of the disciplinary mechanism and also provide more disclosure and analysis of ongoing proceedings and actions. The Chairman also asked that the AICPA consider more public representation in this process. In addition, the SEC staff met with the Professional Ethics Executive Committee and re-iterated the Chairman’s concerns.
In response, the Committee has agreed to review its processes and compare those processes to other self-regulatory bodies and consider recommendations to improve that process. The SEC looks forward to hearing the Committee’s recommendations for improving this process. On a side note, I encourage each of you to provide any suggestions you might have for improving the disciplinary process to representatives of the Committee.
Supporting the Standard-Setting Process
No vision for the 21st Century would be complete without a discussion of the accounting standard setting process. Today this includes both the standard setting process within the United States as well as the process for establishing high quality international accounting standards.
I have found that when you put ten accountants in a room to discuss an accounting issue, even without the added pressure from analysts, budgets, boards of directors, or regulators, it is very difficult to get any sort of consensus. This is not dissimilar to what we see in the private sector standard-setting process today when the differing constituents of the Financial Accounting Standards Board ("FASB") and Accounting Standards Executive Committee ("AcSEC") provide their comments and viewpoints to the standard setters.
Not everyone agrees on the answers to each question, and in fact in the past, even I have had a different viewpoint on number of accounting standards. For example, despite the complexity of today’s business, I wish a number of our rules today could be simpler, more practical, and more operational.
Yet, notwithstanding my personal viewspoints on individual standards, I believe that our standard-setting process works very well. The lack of transparency and the magnitude of the problems that we are seeing in many of the global markets provide definitive support for the quality of our processes and the standards we have. Given this support of our "best in class" process, it seems counter-intuitive to question the effectiveness of our private sector standard-setting process.
Accordingly, I believe those in the financial community need to support, contribute in a meaningful way, and defend the integrity and independence of the private sector standard-setters, including the FASB. If we as a profession are to continue to set our own standards that have to date produced the best capital markets in the world, then our vision for the future must include support for all of our private standard setters.
I know some people have not always agreed with the FASB. In particular the FASB’s standards on stock compensation, derivatives, and its project on fair value have been a source of controversy for industry. However, this does not mean that the standard-setting process is broken.
I also frequently hear people call for broader general standards rather than a rule based approach. I also would like to see such standards. However, as long as our culture results in preparers asking their auditors "where in the literature does it say I can’t do that," and when as soon as a standard is released there are people in the profession working on structuring transactions to stretch the elastic band on reasonableness to the breaking point, broad general standards will not be possible.
We need to focus efforts on how to seek "continuous improvement" in the standard-setting process. As a businessman and former CFO, I know the need to seek continuous improvement in each process, to ensure the process provides world class results in a timely and effective manner.
However, we must come to realize we will not always agree on each issue, that due consideration and respect must be given to differing viewpoints; and that at the end of the day, if a reasonable answer is arrived at that we individually might disagree with, that disagreement in and of itself does not warrant the condemnation and destruction of our system.
I should note that chairman of the FASB has recently brought in a consultant to review the process the FASB uses in its projects with an eye toward making the process more timely and efficient. In addition, the Board with strong support and funding from its constituents, has commenced a project to examine the U.S. financial reporting model. I view these as two very positive steps indicative of a commitment to improving our standard setting.
Let me also comment briefly on the work of the Emerging Issues Task Force. I know this is a group that has provided valuable guidance on various accounting issues. However, from time to time there have been conflicts between this group and the staff of the SEC or FASB.
I believe that to work effectively to provide guidance that protects investors, the EITF must work in the manner as it was originally intended. That is, to identify accounting issues at the earliest possible date, as transactions initially are being structured or marketed, and to provide timely guidance on these issues. The system does not work well if the issues are surfaced initially by the SEC staff in reviews of filings, debated with a registrant and their accountants and, then the decision "appealed" to the EITF.
In recent weeks, I was reading some of the original documents leading up to the establishment of the EITF. This appeal process was not what anyone had in mind at that time. Accordingly, I hope we will see more timely identification and submission of issues to the EITF.
My vision for the future would result in my never having to answer any of these questions on accounting for emerging issues, as the EITF would have dealt with them first. However, if the staff needs to take a position on an issue to insure the interests of investors are protected, we will continue to do so.
International accounting and Auditing Standards
Let me switch for a moment from the challenges facing us in the United States to a more global issue -- that of harmonization of International Accounting and Auditing Standards.
we must all contribute to the future evolution of the international accounting and auditing standards, while at the same time assuring:
- A comprehensive set of standards;
- A set of high quality standards that result in transparency for the underlying economics of the businesses;
- That the final standards are rigorously interpreted and implemented.
This is no longer a project that public accountants and CFOs in America can ignore. It is very relevant to all of us.
I offer as an example the accounting rules for business combinations worldwide. Some people believe, and I think with some justification, that some of the standards used in other countries are of a higher quality than those currently used in the U.S. In addition, it is difficult for foreign filers to reconcile the differences between U.S. GAAP and the GAAP they use to report in their home countries. As a result, it makes all of the sense in the world for the FASB to work closely with other national standards setters to come up with global, harmonized standards. One potential outcome of harmonizing the various worldwide standards would be to eliminate the use of accounting alternatives and pooling accounting.
Accordingly, I encourage you to become engaged in the debate on international accounting standards. I actively am seeking the financial community’s perspectives on the issues and would certainly welcome your input on the tough decisions I will face shortly, such as:
- What will be the impact on U.S. filers if IASC standards are adopted?
- Do investors benefit from the information in the current U.S. GAAP reconciliation? Does this reconciliation provide a useful tool for "leveling" the competitive playing field for U.S. and foreign companies?
- Is there a sufficient infrastructure worldwide today, including quality international auditing and independence standards, to ensure the rigorous implementation of the IASC standards?
On this last question, I must mention the concerns that have been expressed by the World Bank with respect to the quality of audits in some foreign countries. They are concerned that if a major accounting firm uses its own name on the audit opinion of a foreign company’s financial statements, but has not applied rigorous audit standards indicative of a high quality audit, investors and lenders may be misled. I share the concern of the World Bank regarding this issue.
I want to close now and tell you a superstition about the ocean that one wave comes along greater than the others that came before it. It’s called the Ninth Wave. There is no greater force. It’s the power of the sea and the wind working together. To catch the Ninth Wave at the right time requires a special skill of timing. Today, we see such a powerful wave in our future. Our own Ninth Wave, bringing with it significant change. To benefit from this wave, we must prepare now so that when it’s our turn to mount it, we will be able to respond -- to catch the mighty Ninth with the best that is in us and ride it all the way to the top.