SEC Chairman Arthur Levitt, Concerned That The Quality of Corporate Financial Reporting Is Eroding, Announces Action Plan to Remedy Problem

In a major address on
the state of accounting delivered today at New York University,
Securities and Exchange Commission Chairman Arthur Levitt
expressed concern that the quality of financial reporting in
corporate America is eroding and he presented an action plan that
calls on the entire financial community to remedy the problem.

     Chairman Levitt said, “Increasingly, I have become concerned
that the motivation to meet Wall Street earnings expectations may
be overriding common sense business practices.  Too many
corporate managers, auditors, and analysts are participants in a
game of nods and winks.  In the zeal to satisfy consensus
earnings estimates and project a smooth earnings path, wishful
thinking may be winning the day over faithful representation.”

     He added, “As a result, I fear that we are witnessing an
erosion in the quality of earnings, and therefore, the quality of
financial reporting.  Managing may be giving way to manipulation;
Integrity may be losing out to illusion.”

Suspect Accounting Practice and the Pressure to “Make Your
Numbers”

     Chairman Levitt cited five accounting practices that
companies employ to manage their earnings:  “big bath”
restructuring charges, creative acquisition accounting, “cookie
jar reserves,” “immaterial” misapplications of accounting
principles, and the premature recognition of revenue.

     Chairman Levitt outlined the pattern that earnings
management creates:  Companies try to meet or beat Wall Street
earnings projections in order to grow market capitalization and
increase the value of stock options.  Companies’ ability to do
this depends on achievable earnings targets from analysts.  And
analysts need constant guidance from companies to frame those
expectations. Auditors, who want to retain their clients, are
under pressure not to stand in the way.
                                
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Levitt Accounting Speech News Release
September 28, 1998
Page 2

Action Plan

     Chairman Levitt said, “This is a financial community
problem.  It can’t be solved by a government mandate:  it demands
a financial community response.  Therefore, I am calling for
immediate and coordinated action:  Technical rule changes by the
regulators and standard setters to improve the transparency of
financial statements; enhanced oversight of the financial
reporting process by those entrusted as the shareholders’
guardians; and nothing less than a wholesale cultural change on
the part of corporate management and Wall Street.”

     Specifically, Chairman Levitt called for the following
actions:

   --SEC will formulate and augment new and existing accounting
   rules and interpretations covering revenue recognition,
   restructuring reserves, materiality, and disclosure;
   --NYSE and NASD will sponsor a “blue ribbon” panel to improve
   audit committee performance -- to be co-chaired by John
   Whitehead and Ira Millstein;
   --FASB will prioritize current standard setting projects,
   particularly those relating to the definition of
   “constructive” liability;
   --The AICPA’s Auditing Standards Board will give greater
   guidance heightening auditors’ scrutiny of problematic
   accounting practices during audits;
   --The Public Oversight Board has a proposal to create a panel
   to review the effectiveness of recent changes in the audit
   process;
   --The SEC Enforcement Division and Corporation Finance
   Division will vigorously identify and pursue accounting
   fraud;
   --Corporate management and Wall Street need to undergo a
   wholesale cultural change, rewarding those who practice
   greater transparency and punishing those who don’t.