“A Declaration of (Accounting) Independence”

It’s a rare privilege to speak before a group that has done so
much to raise the profile and standing of business in the world
today.  As one of the largest business membership organizations
in the world, the Conference Board has been a consistent leader
in economic research and business education.

You are the world’s most frequently quoted private source of
business information.  Time after time, you have confronted the
most vexing issues facing our economy, and responded with
compelling insights and reasoned analysis.

Your extraordinary reputation was confirmed by the U.S.
Department of Commerce when it appointed the Conference Board
official custodian of the Index of Leading Economic Indicators --
a stewardship you have fulfilled with distinction.

Just as you seek to improve the relationship between business and
the general public, so the SEC tries to preserve trust between
businesses and investors.  The keystone of investor trust is
accurate financial information.  The ability to produce such
information depends in turn on high quality accounting standards.

Our nation is immensely fortunate to have an independent process
that sets those standards.  That process may be the single most
important reason why virtually everyone agrees that the American
financial reporting system is the world’s best.  I want to speak
to you today about the urgent need to keep that standard setting
process independent.

In Federalist Number Ten, James Madison describes perhaps the
most important safeguard for preserving a just government: “No
man is allowed to be a judge in his own cause, because his
interest would certainly bias his judgment, and, not improbably,
corrupt his integrity.”

Mindful of Madison’s maxim, Congress has often seen fit to
protect important public responsibilities from the powerful tides
of self-interest and political special pleading.  In many
instances, our elected representatives have ceded a portion of
their authority in an area to an independent body, for the common
good.

True statesmanship lies in recognizing that preserving the
independent decision making process can be far more important
than who wins, loses, or breaks even on any given issue.
Nevertheless, it sometimes happens that, after creating these
independent bodies, those who established them yield to pressures
by seeking to tamper with them and influence their operation.

Recent history is filled with examples of attempted interference
and pressure.  Consider the effort to reform entitlement
programs.   The need for reform has been clear for some time.  As
baby boomers retire, these programs will either face bankruptcy
or will “explode” the federal budget deficit.  Neither outcome is
tolerable.  More important, neither outcome is inevitable.

In 1994, President Clinton appointed a 32-member Bipartisan
Commission on Entitlements from both houses of Congress.  Yet any
hope of meaningful reform soon foundered.  Members of the
Commission were apparently unable to withstand the relentless
pressure of powerful interest groups.

The White House subsequently formed a 13-member commission
composed of private citizens ostensibly immune to such political
exigencies. While the commission made several recommendations, it
lacked the authority to make its proposals anything more than
exhortations.

Campaign finance reform is another area that cries out for
nonpartisan, independently crafted solutions.   Recent hearings
seem only to have highlighted the entrenched positions of the
political parties.  The urgent recommendations of various blue-
ribbon commissions have been acknowledged but not enacted.

Such a politically intractable problem may be most responsibly
approached by the formation of an independent body.  It is more
likely to reach an objective conclusion and, if empowered, to put
it into effect, because it is protected from political fire and
brimstone.

                          *     *     *

I like to think that James Madison would be proud of the
independent process we’ve established for regulating the
securities markets.  The Securities and Exchange Commission is an
independent agency with a strongly non-partisan tradition.

It is a rare day when we receive a call from the Oval Office.
The Commission deals with Capitol Hill far more frequently, and
this is proper.  We must be held accountable to the American
people for the tax dollars we receive, and the services we
provide in return.

While we must fight for our budget, on the whole, we are shielded
from the day-to-day push-and-pull of partisan politics.  This is
one of the key reasons why investors trust the SEC and the
markets we regulate.  They understand that we hold the interests
of investors supreme, above the special interests of any
political party or organized group.

Congress created the SEC to protect investors, and structured the
agency in a manner so that it could accomplish that objective.
Early on, commissioners debated whether the SEC should use its
authority to set uniform accounting standards, or instead, should
build upon the expertise developed by the profession itself.  The
conclusion reached nearly 60 years ago still makes abundant sense
to me today.

The Commission noted that professional accounting bodies existed
in the private sector whose mission was to serve the public
interest.  It decided to look to these private entities to
provide leadership in establishing and improving accounting
standards.  SEC staff would oversee the overall process.  And the
Commission retained ultimate legal authority over the content and
presentation of financial statements.

Accounting standards are, of course, the foundation of fairness
in financial reporting.  Without such rules, the investor would
stand unprotected, uninformed, and unaware of misleading or
deceptive disclosures by those who may seek to distort financial
reality.

All of us understand that new rule proposals will often be
perceived negatively by the businesses that will be subject to
them.   We also know to expect that, in at least some instances,
the temptation to try to influence or derail the rules will be
enormous.  If the decision-making process that creates these
rules is not independent and is not protected from undue
influence, the standards are bound to lose their credibility and
legitimacy.

It is compellingly clear to me that the objectivity and fairness
of standard-setting can only be guaranteed if the process is
insulated from political agendas, special interests, and
bureaucratic convenience.  If that independence is compromised,
or perceived to be compromised, we would pay a heavy price in
declining investor confidence in the markets.

The Financial Accounting Standards Board has filled the role of
impartial standard-setter admirably for a quarter century.  As
you know so well, these same years have witnessed an astonishing
evolution and expansion in the techniques of raising capital in
our markets.  In a climate where change has become a constant,
the FASB has consistently sought to ensure the accuracy of
financial information, protecting the basic rights of the
investor and strengthening public confidence in our markets.
Resolute enforcement of these standards by the SEC is, in large
part, responsible for the flourishing markets we see today.

Nonetheless FASB critics are working hard in Washington to limit
its independence.  They sometimes take the ironic tack of arguing
that the Board is anti-business.  To me, that’s like suggesting
the College of Cardinals is anti-Catholic.

It is hard to imagine a more accomplished group of capitalists
and free market advocates than the roster of past and present
trustees of the FASB’s parent, the Financial Accounting
Foundation.  Included in this group are

*    the former Vice Chairman of the Federal Reserve and Co-
  Chairman of Johnson Smick International, Manuel Johnson;

*    Michael Cook, the Chairman and CEO of Deloitte & Touche, and
Nicholas Moore, Chairman and CEO of Coopers & Lybrand, firms
formerly part of the Big Six but soon to be part of what we will
no doubt call the Fabulous Five;

*    Philip Duff, President and CEO of Van Kampen American
Capital, one of the nation’s largest mutual fund complexes; and

*    Thomas Jones, an Executive Vice President at Citicorp.
The trustees choose who will serve five-year terms on the FASB
board, and this group too is one that has served American
businesses with great distinction.

If anyone doubts the huge difference that accounting standards
can make, consider the example of Daimler-Benz.  In 1993, it
became the first German company to register securities in the
United States.  Under German accounting standards, Daimler had
reported a profit of 168 million Deutschmarks in 1993; under more
telling American standards, the company reported a loss of almost
a billion Deutschmarks for the same period.  It’s as if two
different cameras, aimed at the exact same object at the exact
same time, produced completely different pictures.  I don’t think
there is any question that American accounting standards provided
a sharper, more focused and more accurate snapshot of Daimler
than did their German counterparts.

Closer to home, in 1992, the FASB required companies to record
retirement health benefits as liabilities.  This was an
undertaking that, at the time, may have been more controversial
than the derivatives proposal.  As a result of this new standard,
the balance sheet of General Motors, for example, revealed for
the first time its liability for its retirees’ health care costs.

Without the new standard, total shareholder equity at GM would
have been reported as $27 billion.  With the new standard,
shareholder equity was actually shown to be $6 billion -- a huge
difference in value that investors had the right to know.
Ironically, many of the corporate officers who complained about
this standard have now conceded that it has produced much
important and useful information.

The controversy over marking securities to market provides
perhaps the most dramatic example of how accounting standards can
make a difference.  Prior to 1993, securities often were carried
on balance sheets at their historical cost, regardless of their
current value. That’s like always keeping your watch set to the
time you first bought it -- it doesn’t help you get to work on
time.  Under the historical cost standard, for example, the
American S&L industry showed a positive net worth of $36.2
billion in 1980.  This was at a time when Congress was
considering whether to deregulate the thrift industry.

S&L assets consisted more of loans than securities, but the key
point still applies.  S&Ls were not required to mark those assets
to market.  The industry had pressured its regulators and
received a special exemption from complying with generally
accepted accounting principles.  The resulting positive net worth
for the industry in fact was an elaborate fiction.  Many of the
loans were in default, and undercollateralized to boot.  Had S&Ls
been required to mark those assets at their actual fair market
value, the industry’s real condition would have been evident -- a
collective negative net worth of between $78 and $118 billion.  I
can’t say whether Congress would have refrained from deregulating
the industry had these figures been widely known.  But we would
have approached the question of deregulation with our eyes wide
open.  And I can say that fact, by itself, would have given us a
better chance of averting the S&L crisis.

Considering these examples and their impact on investors, the
case for the independence of the accounting standard-setting
process would seem clear.

Almost from its inception, the FASB and its pronouncements have
been criticized by corporate interests. There’s nothing wrong
with criticism -- much of it is necessary and expected -- indeed,
it’s what I used to do when I was on the corporate side.  A frank
dialogue between those who make the rules and those who must
abide by them is healthy.  Part of the responsibility of the
rulemakers is to be certain that the independent decision-making
process not become an insulated or unresponsive one.

Responsiblity cuts both ways, however.

Recently, some groups have ceased to offer constructive criticism
to the FASB, focusing instead on attempts to undermine the Board
and its independent decision-making process.

One of this nation’s leading bankers recently suggested taking
standard setting out of the private sector’s hands.  He wants to
assign the responsibility to government officials -- the same
people so often derided as bureaucrats.  I don’t know about you,
but I find this argument rich with irony.  Here, after all, is a
bank CEO -- urging the government to immerse itself in the
details of technical accounting rules that are important to the
bank’s business.

I wonder if the theory is government officials would develop
better rules because they are much more reasonable, practical,
thoughtful, and flexible than their rigid, insulated and
unresponsive brethren in the private sector.  I am looking
forward to the next great idea: maybe somebody will suggest that
Congress start setting interest rates.

The latest skirmish about accounting standard setting was set off
when the FASB proposed that companies measure and disclose their
derivatives exposure. This is an issue that has particular
poignancy for me.

Those of you with businesses sensitive to interest rate movements
no doubt recall the events of 1994.  Americans saw millions of
their investment dollars vanish as major derivatives positions
went sour when interest rates spiked upward.  Enormous losses at
well-known companies such as Eastman Kodak, Gibson Greetings, and
Procter & Gamble shocked many investors because they seemed to
have so little to do with sales of film, greeting cards, and soap
powder.   The problem was not just that the losses were large,
but that they happened so suddenly and took so many knowledgeable
analysts by surprised.  Upon further study, it became clear that
the risks companies took in derivatives were not adequately
described in annual reports and other disclosure documents.
Indeed, sometimes they weren’t described at all.  Obviously,
there were serious shortcomings in the guidelines for derivatives
accounting and disclosure.

Derivatives were propelled into the headlines.  Each new loss
brought forth calls to the SEC to restrict their use -- including
from powerful members of Congress on both sides of the aisle.
Leading newspapers called for the SEC to take action.  But the
Commission resisted calls for more regulation.  We chose instead
to focus on how to ensure that derivatives and their potential
risks could be more meaningfully communicated to American
investors.

After three years of inquiry, the Commission adopted market risk
disclosure rules that will provide a reasonable amount of
information to investors at a reasonable cost to companies.  At
the same time, the FASB proposed a framework for derivatives
accounting, a proposal that was the culmination of a decade’s
worth of study and research.  That is the proposal that has since
come under such heavy fire.

Of course, the substance of any criticisms must be assessed and
weighed carefully.  But we are in a situation today in which the
notional amount of derivatives outstanding worldwide has reached
$70 trillion -- a figure that is nearly 10 times our gross
domestic product.  Accounting has simply failed to keep pace with
this exponential growth.

The FASB believes that the truest and most relevant picture of a
company’s derivatives position is fair value.  Zero is most
certainly not fair, although that is how many derivatives are
reported today.  My lifetime of work in the securities industry
tells me that the FASB has gotten this about right.  Their
proposal is a thoughtful and reasonable solution that meets the
test of significantly improving current practice. That said,
however, I am not really here to persuade you of the rule’s
technical merits.  I am here instead to defend the independence
and the validity of a standard-setting process that is needed and
wanted by investors, and crucial to the future health of our
markets.

Few fully appreciate the careful and painstaking deliberations
that led the FASB to propose the rule.  A decade of study;
thousands of hours of staff time reviewing hundreds of comments
and analyzing dozens of alternatives; field tests; and more than
one hundred open meetings and public hearings.  It is extremely
significant to me that, as a result of this process, the FASB
modified its proposal.  Those changes led companies like General
Motors, McDonalds, and Berkshire Hathaway -- and institutional
investors like T. Rowe Price, Vanguard, and the nation’s largest
pension fund, TIAA-CREF -- to declare their support for the rule.

Ironically, the FASB’s responsiveness in making these changes is
now cited by opponents as reasons for further delay.  Other
critics have suggested that further study is necessary before the
FASB races ahead with its proposal -- a proposal preceded by 10
years of study and debate.

These delaying tactics are inconsistent with the way the standard-
setting process should be conducted.  The SEC, the accounting
profession, and the business community acted wisely and
selflessly in forming the FASB as an independent body that could
objectively set accounting standards.

The FASB is an outstanding example of an independent institution
that has worked as intended, largely free from political
interference.  It made a carefully considered but difficult
judgment about how to account for derivatives.  However, it now
faces some of the same attacks on its authority and legitimacy
that have stymied efforts to reform other complex issues, like
entitlements and campaign finances.     Hearings are being held
on Capitol Hill.  The SEC has traditionally resisted its power to
second-guess a FASB rule.  Now Congress, under pressure from some
in the business and banking community, is thinking of intervening
in this non-partisan process and second-guessing us both.

That effort may bring us to a troubling crossroad.  There’s no
going halfway on this.  It’s not enough to respect FASB only when
its decisions go in your favor.  And it’s not acceptable to claim
the process is unfair every time they do not.

The true test of a democratic institution is whether it is
respected even by those who disagree with its decisions.  If we
don’t abide by FASB’s decisions when they go against our
interests, then we will seriously undermine, and ultimately
destroy, the institution.

I say to you today that that is too high a price to pay. The
value of FASB’s independence is incalculable.  If investors don’t
trust the numbers in a company’s financials, we’ve lost more than
dollars -- we’ve lost a measure of hope.

We have to work hard not to allow a process to be undermined that
has, time and again, proven to be a unique source of rational,
unbiased judgment.  Let past efforts to reform entitlements and
campaign finances serve as warnings: we tamper with independent
processes at our peril.

The FASB is not immune to criticism and change.  But there is a
world of difference between advice and intimidation.

Changes that would make the Board more responsive to critical
issues are absolutely welcome.  Changes that would undermine its
independence are not.

In protecting FASB’s autonomy, the Congress and the SEC should be
stewards of a profound trust, the covenant between citizens and a
government sworn to protect them and keep them fully informed.
Our capital markets must remain among our nation’s most
spectacular achievements -- not only in their accomplishments,
but also in their fairness.

Those markets, and investors’ confidence in them, are a rich
legacy we have inherited, but do not own.  They are a national
asset we hold in trust for our children, and for generations of
Americans to come.

On behalf of those future generations, we must preserve that
trust, and even expand it.  That means working together to
improve FASB’s process, by all means; and working together to
preserve FASB’s independence, by any means.

Thank you again for the honor and privilege of joining you here
this evening.