[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]



 
  ACCOUNTING FOR BUSINESS COMBINATIONS: SHOULD POOLING BE ELIMINATED?

=======================================================================

                                HEARING

                               before the

                            SUBCOMMITTEE ON
                    FINANCE AND HAZARDOUS MATERIALS

                                 of the

                         COMMITTEE ON COMMERCE
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             SECOND SESSION

                               __________

                              MAY 4, 2000

                               __________

                           Serial No. 106-100

                               __________

            Printed for the use of the Committee on Commerce



                     U.S. GOVERNMENT PRINTING OFFICE
64-765 CC                    WASHINGTON : 2000




                         COMMITTEE ON COMMERCE

                     TOM BLILEY, Virginia, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     JOHN D. DINGELL, Michigan
MICHAEL G. OXLEY, Ohio               HENRY A. WAXMAN, California
MICHAEL BILIRAKIS, Florida           EDWARD J. MARKEY, Massachusetts
JOE BARTON, Texas                    RALPH M. HALL, Texas
FRED UPTON, Michigan                 RICK BOUCHER, Virginia
CLIFF STEARNS, Florida               EDOLPHUS TOWNS, New York
PAUL E. GILLMOR, Ohio                FRANK PALLONE, Jr., New Jersey
  Vice Chairman                      SHERROD BROWN, Ohio
JAMES C. GREENWOOD, Pennsylvania     BART GORDON, Tennessee
CHRISTOPHER COX, California          PETER DEUTSCH, Florida
NATHAN DEAL, Georgia                 BOBBY L. RUSH, Illinois
STEVE LARGENT, Oklahoma              ANNA G. ESHOO, California
RICHARD BURR, North Carolina         RON KLINK, Pennsylvania
BRIAN P. BILBRAY, California         BART STUPAK, Michigan
ED WHITFIELD, Kentucky               ELIOT L. ENGEL, New York
GREG GANSKE, Iowa                    TOM SAWYER, Ohio
CHARLIE NORWOOD, Georgia             ALBERT R. WYNN, Maryland
TOM A. COBURN, Oklahoma              GENE GREEN, Texas
RICK LAZIO, New York                 KAREN McCARTHY, Missouri
BARBARA CUBIN, Wyoming               TED STRICKLAND, Ohio
JAMES E. ROGAN, California           DIANA DeGETTE, Colorado
JOHN SHIMKUS, Illinois               THOMAS M. BARRETT, Wisconsin
HEATHER WILSON, New Mexico           BILL LUTHER, Minnesota
JOHN B. SHADEGG, Arizona             LOIS CAPPS, California
CHARLES W. ``CHIP'' PICKERING, 
Mississippi
VITO FOSSELLA, New York
ROY BLUNT, Missouri
ED BRYANT, Tennessee
ROBERT L. EHRLICH, Jr., Maryland

                   James E. Derderian, Chief of Staff

                   James D. Barnette, General Counsel

      Reid P.F. Stuntz, Minority Staff Director and Chief Counsel

                                 ______

            Subcommittee on Finance and Hazardous Materials

                    MICHAEL G. OXLEY, Ohio, Chairman

W.J. ``BILLY'' TAUZIN, Louisiana     EDOLPHUS TOWNS, New York
  Vice Chairman                      PETER DEUTSCH, Florida
PAUL E. GILLMOR, Ohio                BART STUPAK, Michigan
JAMES C. GREENWOOD, Pennsylvania     ELIOT L. ENGEL, New York
CHRISTOPHER COX, California          DIANA DeGETTE, Colorado
STEVE LARGENT, Oklahoma              THOMAS M. BARRETT, Wisconsin
BRIAN P. BILBRAY, California         BILL LUTHER, Minnesota
GREG GANSKE, Iowa                    LOIS CAPPS, California
RICK LAZIO, New York                 EDWARD J. MARKEY, Massachusetts
JOHN SHIMKUS, Illinois               RALPH M. HALL, Texas
HEATHER WILSON, New Mexico           FRANK PALLONE, Jr., New Jersey
JOHN B. SHADEGG, Arizona             BOBBY L. RUSH, Illinois
VITO FOSSELLA, New York              JOHN D. DINGELL, Michigan,
ROY BLUNT, Missouri                    (Ex Officio)
ROBERT L. EHRLICH, Jr., Maryland
TOM BLILEY, Virginia,
  (Ex Officio)

                                  (ii)


                            C O N T E N T S

                               __________
                                                                   Page

Testimony of:
    Bible, Peter R., Chief Accounting Officer, General Motors 
      Corporation................................................    89
    Dooley, Hon. Calvin M., a Representative in Congress from the 
      State of California........................................    62
    Goodlatte, Hon. Bob, a Representative in Congress from the 
      State of Virginia..........................................    59
    Hoffman, Gene, Jr., President and CEO, EMusic.com............    98
    Jenkins, Edmund L., Chairman, Financial Accounting Standards 
      Board......................................................    69
    Lewis, William Frederick, President and CEO, Prospect 
      Technologies...............................................   102
    Powell, Dennis D., Vice President, Corporate Controller, 
      Cisco Systems..............................................    80
Material submitted for the record by:
    American Business Conference, letter dated May 3, 2000, to 
      Hon. Michael Oxley.........................................   134
    Biotechnology Industry Organization, letter dated May 4, 
      2000, enclosing statement for the record...................   130
    Jenkins, Edmund L., Chairman, Financial Accounting Standards 
      Board, letter dated May 23, 2000, enclosing response for 
      the record.................................................   125
    National Association of Manufacturers, letter dated May 3, 
      2000, to Hon. Michael Oxley, enclosing material for the 
      record.....................................................   132
    Valuing the New Economy, a white paper presented by The 
      Merrill Lynch Forum........................................   136

                                 (iii)

  


  ACCOUNTING FOR BUSINESS COMBINATIONS: SHOULD POOLING BE ELIMINATED?

                              ----------                              


                         THURSDAY, MAY 4, 2000

                  House of Representatives,
                             Committee on Commerce,
           Subcommittee on Finance and Hazardous Materials,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:08 a.m., in 
room 2123, Rayburn House Office Building, Hon. Michael G. Oxley 
(chairman) presiding.
    Members present: Representatives Oxley, Tauzin, Gillmor, 
Cox, Largent, Ganske, Lazio, Shimkus, Bliley (ex officio), 
Towns, DeGette, Barrett, Luther, Markey, Rush, and Dingell (ex 
officio).
    Also present: Representatives Eshoo and Crowley.
    Staff present: Brian McCullough, majority professional 
staff; David Cavicke, majority counsel; Linda Dallas Rich, 
majority counsel; Shannon Vildostegui, majority professional 
staff; Robert Simison, legislative clerk; and Consuela 
Washington, minority counsel.
    Mr. Oxley. The subcommittee will come to order. The Chair 
recognizes himself for an opening statement.
    I would like to begin by reaffirming my belief in FASB as 
an independent private sector entity is best suited to set 
accounting standards. Few would want politicians without 
accounting expertise making highly technical accounting 
decisions. From time to time, however, FASB considers an issue 
which has broad public policy implications best brought to 
light through congressional hearings such as this. In such an 
instance, the Congress has a responsibility to foster open 
dialog on the issue. That is precisely why I have called this 
hearing today.
    FASB proposes eliminating the use of pooling as a proper 
method of accounting for business combinations as well as 
making changes to the treatment of goodwill. Many of the same 
arguments have circulated for years both for and against 
pooling accounting as the treatment of goodwill. The debate has 
little changed. What has changed, however, is the context of 
the debate. In the information economy, the magnitude of the 
implications of eliminating pooling accounting has increased 
dramatically. Intangible assets of knowledge-based companies 
often account for most of the company's value or ability to 
generate revenue in the future.
    Central to this debate is the information available to 
investors under each accounting method. Arguably, the benefits 
the elimination of pooling accounting will provide varies. The 
question we must answer is whether the information is better, 
more accurate, and as useful under purchase accounting as the 
information provided under the current pooling method of 
accounting for these transactions.
    The recording of goodwill is a good example of the 
different treatment intangibles receive under pooling and 
purchase accounting. Some argue pooling accounting distorts 
book value because it does not amortize goodwill. The values of 
the two companies are simply combined. Others argue purchase 
accounting artificially reduces stated income by requiring 
goodwill write-off without a negative economic event to support 
it. In fact, I can understand how many intangible assets 
appreciate rather than depreciate over time.
    Distinct from which method is more accurate is the issue of 
whether requiring a shorter amortization period for goodwill or 
even require the write-off of goodwill and other intangibles 
will actually make mergers and acquisitions uneconomical for 
businesses. I suspect mergers will continue. However, the 
possibility that such a rule change would artificially slow 
economic growth without providing any marginal benefit gives me 
pause.
    Though I do not begin to have a solution to this debate, I 
do urge those central to this debate to consider all of the 
options. Perhaps we need to further examine the changing nature 
of assets which is driving our economy. We need to consider 
whether eliminating pooling accounting is a negative economic 
impact that could diminish the competitiveness of U.S. 
businesses. Finally, we must evaluate whether the proposed 
changes will actually provide investors with more useful 
information about a company.
    Today we will hear from those closest to the debate. I 
thank our panelists for appearing today and look forward to 
hearing what each has to say about this important issue.
    The Chair's time has expired. I recognize the ranking 
member, the gentleman from New York, Mr. Towns.
    Mr. Towns. Thank you, Mr. Chairman, for holding this 
hearing.
    A number of concerns have been raised about the elimination 
of pooling as a method of accounting for business combinations. 
Eliminating pooling accounting, it is argued, could slow the 
pace of business combinations and hinder the growth of high-
tech industry then by reducing the number of jobs its industry 
creates. High-tech companies in particular say that with 
pooling accounting, many of the mergers in the high-tech 
industry which have boosted our economy and the stock market 
might not have ever happened.
    As a New Yorker and the ranking member of this Subcommittee 
on Finance, I am concerned about the potential adverse effects. 
On the other hand, a number of other companies, investors, 
consumer groups and accounting experts argue that pooling is 
flawed, that it distorts financial reporting, and that it 
adversely affects the allocation of economic resources by 
creating an unlevel playing field for companies that compete 
for mergers and acquisitions.
    Still others have concluded that both the pooling method 
and purchase method of accounting for business combinations are 
flawed, and that we need to go back to, should go back to, the 
drawing board before moving forward.
    There has been some concern lately about traditional 
accounting. This is because intangible assets have replaced 
traditional bricks and mortar as the backbone of business 
today. Information, knowledge, and human capital are difficult, 
if not impossible, to value. They simply do not depreciate the 
same way tangible assets do. In fact, they often appreciate.
    We should not be forcing companies with mostly intangible 
assets to apply the accounting method which does not accurately 
reflect the value of their assets. It seems to me we should be 
moving toward a framework that more accurately reflects the 
value of companies in this information day and age.
    Consistency in accounting standards is a desirable goal and 
one that I support vigorously, but consistency will not be 
beneficial if investors cannot rely on the valuation that the 
consistent approach provides.
    On that note, Mr. Chairman, I yield back.
    Mr. Oxley. The Chair recognizes the chairman of the full 
committee, the gentleman from Richmond, Mr. Bliley.
    Chairman Bliley. Thank you. I commend you, Mr. Chairman, 
for holding this hearing today.
    The draft rule proposal issued by the Financial Accounting 
Standards Board will have a significant impact not only on 
high-tech and other companies, but also on our economy. I 
commend the FASB's work in seeking to ensure that accounting 
rules provide an accurate and fair picture of a company's 
financial status.
    In this instance, important questions have been raised as 
to whether the Board's proposal would actually do that, or 
whether it would, on the contrary, make it more difficult for 
investors and creditors to understand the true status of a 
company that has resulted from a business combination.
    It is not an easy job to get companies to clarify their 
financial status. The job has become increasingly difficult. 
Bricks-and-mortar assets share the same balance sheet as 
creativity, innovation and other intellectual assets. High-
tech, biotech, financial, and other companies thrive on these 
intangible values. Measuring these intangible values is very 
difficult, and I recognize that FASB does not have an easy job 
to do.
    An accounting framework that functions effectively in this 
new economy is an important goal we must achieve. There are 
good arguments both for and against the FASB proposal. Hundreds 
of comment letters were received, and the FASB heard from 
witnesses at hearings in California and New York. I am 
interested to know how this information has been received.
    I am concerned by claims that FASB's proposal does more 
harm than good. If the proposed changes have a negative effect 
on our economy, then these changes become a public policy 
matter that Congress must consider. I hope that is not the 
case, but I do not think the picture is clear enough at this 
time to advocate the changes contemplated in the FASB proposal.
    I look forward to hearing the views of our witnesses today, 
and I hope that we can begin to answer these important 
questions.
    Thank you, Mr. Chairman.
    Mr. Oxley. I thank the gentleman.
    The Chair recognizes the gentleman from Massachusetts Mr. 
Markey.
    Mr. Markey. Thank you, Mr. Chairman, very much. Thank you 
so much for having this very important hearing here today so we 
can air out the concerns that I think many of the people who 
are right now representing new economy districts such as mine, 
the concerns which are being raised by many of the companies 
which we represent.
    The critics of FASB raise concerns that purchase accounting 
may fail to accurately value some of the mergers. These 
concerns have been particularly intense among many of the new 
economy companies whose worth may be less a function of their 
physical assets, earnings, or capital, and more a product of 
intellectual property or other more intangible assets and 
goodwill.
    Some have advocated that eliminating pooling would 
discourage many new e-commerce startup companies from doing a 
merger because of the cost purchase accounting would impose on 
such a transaction.
    Today, Mr. Chairman, you have wisely invited Ed Jenkins as 
well as a very distinguished panel of corporate leaders with 
varying perspectives on FASB's proposal to eliminate pooling. I 
greatly respect Ed Jenkins. I admire Ed Jenkins. I think he is 
an excellent head of FASB, and I welcome him here today.
    I am going to be particularly interested in hearing 
constructive ideas on options that FASB may or should consider 
to address in terms of their concerns that had been raised 
about the impact of purchase accounting on the new economy, and 
at the same time assuring that investors get the full and fair 
disclosure which they deserve. I think this is an excellent 
forum to have that discussion in.
    Obviously, we are, as a Nation, in a transformation that is 
reflected in the earliest stages by particular east coast and 
west coast congressional districts, but without question, it is 
time for us to have this important discussion.
    Mr. Chairman, since we are on the subject of accounting, I 
would also suggest to the Chairman that we consider holding a 
further oversight hearing on another issue affecting the 
accounting profession, the disturbing conflicts of interest 
arising from the fact that some firms wish to simultaneously 
serve as consultants to or business partners of companies that 
they are also auditing simultaneously.
    This practice is very disturbing to me. When my brother 
John was graduating from Boston College as one of the 
outstanding finance majors, I asked him why he was not an 
accounting major instead. He said to me, well, the finance 
majors play the game, and the accountants keep score. In this 
new era, accountants want to play the game and keep score at 
the same time, and it does build in tremendous conflicts that I 
believe this committee should look at.
    I know that you, Mr. Chairman, and several other members of 
the majority have recently written to Arthur Levitt on this 
subject, criticizing him as he tries to clamp down on such 
practices, and I would hope that we could have a public hearing 
on that issue as well so that we can discuss the propriety of 
accountants also having financial interests in the firms they 
are allegedly auditing for public consumption. I think that 
would be important.
    I look forward to this hearing. It is a central issue in 
the development of the new economy. I thank everyone who has 
come here today. I think it is going to illuminate the 
understanding of the subcommittee.
    Mr. Oxley. The gentleman from Illinois Mr. Shimkus.
    Mr. Shimkus. Thank you, Mr. Chairman. I will be brief. I 
have only been a Member for 4 years, two terms. I have never 
seen a submission of testimony this large before. It gives 
members a great excuse, those who have not covered it prior to 
the hearing. If more hearings would have this type of 
documentation, I would have better excuses for not doing all my 
homework, Mr. Chairman.
    Mr. Oxley. There are pictures in there, though.
    Mr. Shimkus. We appreciate pictures.
    I do have great respect for FASB, too. I understand the 
complexity of trying to determine market value in a new era of 
services, information services, and how do you value that. I am 
here to listen and learn. I thank my colleagues for appearing, 
and also the members of the next panel.
    With that, Mr. Chairman, I yield back my time.
    Mr. Oxley. The Chair is now pleased to recognize the 
ranking member of the full committee, the gentleman from 
Michigan Mr. Dingell.
    Mr. Dingell. Mr. Chairman, thank you for that courtesy.
    Mr. Chairman, I commend you for holding this hearing. It is 
a valuable one, and it will be a useful device in achieving the 
best judgments as to what should be done on the matters under 
consideration.
    Mr. Chairman, there is probably no stronger defender of the 
Financial Accounting Standards Board, or FASB, and the 
independent setting of accounting standards than I have been 
over my congressional career. I say this even though I don't 
always agree on every last detail on every accounting standard 
that FASB has set.
    Making us happy, however, is not their task. Their job is 
quite a different one. That is to promulgate standards of high 
quality that do not favor any particular interest group and 
maintain the credibility of our financial reporting system.
    They have an even greater responsibility, and that is to 
see to it that our accounting system reports truthfully, 
factually, fairly, and correctly to all involved, to the 
companies, to the shareholders, to the regulators and everybody 
else.
    Where we have not seen that happen, and I have seen several 
instances in this committee, including some railroad mergers 
where the reporting of the accounting system was not reliable, 
major scandals and major troubles occurred.
    The unparalleled success of our capital markets are due in 
no small part to the high quality of the financial reporting 
and accounting standards promulgated by FASB. I would note that 
this is very much in contradistinction to what we have seen 
with regard to some of the foreign accounting systems and some 
of the standards that are promulgated through their mechanisms, 
referring very specifically to countries in and around the 
Pacific Rim and in Asia.
    If I have any criticism of FASB, and I would note that I 
do, it is that they seem to have a political tin ear and to 
make a lot of powerful enemies. Their decisionmaking process is 
supposed to be neutral and thorough and open and informed, and 
it is all of that.
    They do have a tough job to do. I respect that, and I 
welcome them here today, as I do all of our witnesses.
    On the substance of this hearing, I have not made up my 
mind as to what is the right answer. I am not an accounting 
expert. I would note that my experience in accounting is 
bottomed somewhat on the practice of law and the fact that I 
once took a mail order course in accounting to understand what 
I was dealing with when I addressed this particular subject in 
the practice of law.
    The 1970 compromise by the FASB to allow both purchase and 
pooling accounting for business combinations has been highly 
controversial, strongly dissented from, and showed serious 
fault lines during the merger boom of the 1980's.
    After several years of deliberation and debate, at the 
urging of affected parties, FASB has issued an exposure draft 
that proposes replacing the pooling of interests method with 
the purchase method for almost all business combinations.
    Currently companies can use pooling if they meet 12 
criteria. I suspect if there is a criticism of what has 
happened heretofore, it has been that the industry has gotten 
the assumption, correctly or incorrectly, from FASB that they 
have arrived at a decision that this is what is going to occur, 
and that nothing further is going to be done on the matter. I 
think that is unwise, and certainly politically so.
    Under the purchase method, an acquiring company records the 
value of the acquired company at the cost it actually paid. 
Under pooling of interests, the combining companies simply add 
together the book value of their assets, leaving investors with 
no way to determine what price was actually paid or tracking 
the acquisition's subsequent performance.
    In an example cited at page 5 of FASB's prepared remarks 
involving a $10 billion transaction that was accounted for 
under the pooling method, the book value of the company being 
acquired was only $500 million. The acquisition was reported as 
$500 million in the financial statements of the acquired 
company, and $9.5 billion in value simply disappeared. Where 
did it go?
    Despite no real change in cash-flows, the pooling method 
also creates a false measure of increased earnings, say its 
critics. Dramatically different results are produced by the two 
accounting methods, making it difficult for investors to 
compare companies, or indeed even to understand whether or not 
the accounting system is producing a reliable and truthful 
result. This will have another curious result, and that is 
possible serious competitive advantages or disadvantages.
    High-tech companies and financial institutions oppose the 
FASB proposal, saying if pooling is eliminated or curtailed, it 
will destroy their industries, the M&A market, the stock 
market, and the U.S. economy. It seems every time anybody has a 
bad case, they come in and make these charges. The Congress and 
everybody else is supposed to panic.
    It may well be that this is the case. If that is so, then 
maybe we had better take a hard look at these high-tech 
companies and see whether they have any real viability at all.
    Other companies such as General Motors, whose chief 
accounting officer will testify today, the respected rating 
agency Moody's Investors Service, and the Council of 
Institutional Investors, the Consumer Federation of America, 
and other groups representing investors and consumers support 
the FASB proposal.
    Me, I think that we probably ought to just support the 
gathering of the truth and seeing to it that accounting, 
accounting standards, and things of this kind tell us the 
truth. Perhaps maybe if we get that, we will have accomplished 
our purpose in this particular matter.
    In May 1999, a study by Goldman Sachs concluded that the 
proposed accounting standards will not have a material adverse 
impact on future business consolidations, although the study 
identified some industries that might be adversely affected.
    I would ask unanimous consent, Mr. Chairman, that that be 
inserted in the record.
    Mr. Oxley. Without objection.
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    Mr. Dingell. I also note that most foreign countries 
prohibit pooling or allow it only as an exception.
    For example, the United Kingdom and the International 
Accounting Standards Committee permit pooling only when both 
companies are the same size or the acquiring entity cannot be 
identified. Canada is considering a proposed standard much like 
FASB.
    As the managing director of corporate finance at Moody's 
noted in his comment letter to FASB, ``Moody's supports the 
objectives of accounting standards setters to improve the 
harmonization of accounting standards globally, and welcomes 
FASB's proposal to eliminate the pooling of interests method. 
We believe that a single method can improve analytic 
efficiency, especially in cases where a single transaction or 
essentially identical transactions would produce dramatically 
different accounting results, and thus enhance the ability of 
cross-border capital participants to compare, easily and 
accurately, alternative investments.''
    As I said at the beginning, I have not made up my mind on 
the FASB proposal. It raises a lot of questions, including 
those relative to the treatment of goodwill and the valuation 
of intangible assets. The FASB is in the process of sifting 
through better than 400 comment letters, along with the 
testimony it received in its public hearings, and is 
redeliberating all the issues.
    I urge the Board to proceed cautiously and carefully in 
weighing the costs and benefits to try to achieve the greatest 
possible good. I would also urge my friends in the high-tech 
industry to work with FASB to develop a compromise or an 
approach that eliminates current biases and distortions and 
meets the legitimate concerns of all parties. On that note, I 
look forward to today's testimony on this important and complex 
matter.
    Mr. Chairman, I again commend you and thank you for calling 
this hearing.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from California Mr. Cox.
    Mr. Cox. Thank you, Mr. Chairman. Thank you for holding 
this hearing today. It is obvious from the comments of the 
members of our panel thus far that it is very important for us 
to examine FASB's current proposal to eliminate pooling.
    As a member of this subcommittee and a former securities 
lawyer, I am anxious to hear from our witnesses on their 
perceptions of the consequences, both intended and unintended, 
of FASB's decision to eliminate the pooling method for mergers.
    I would not expect that Congress would want to legislate 
specific financial accounting rules for reporting companies, 
although that is clearly Congress's prerogative. I do believe 
it is important that several important concerns that have been 
raised about the current exposure draft have a complete airing 
in Congress. I also believe it is important that FASB's process 
be both deliberative and transparent.
    The purpose of the 1933 and 1934 acts is full and fair 
disclosure in order to build and maintain confidence of the 
public in our capital markets. Congress in the 1933 and 1934 
acts made it plain that the standards of financial reporting 
and financial statements issued under these acts are defined 
pursuant to congressional authority. I prefer to see this 
authority exercised through delegation to the SEC and to the 
FASB.
    When, as in this case, the consequences of a change in the 
rules go far beyond a determination of the quality of publicly 
disclosed financial information and would, in addition, have a 
potentially significant impact on the entire economy, Congress 
cannot abdicate its responsibility. So we are doing today the 
minimum, I think, that is required of us. We are beginning a 
hearing process.
    Many questions remain as to why FASB is eliminating pooling 
at this time and in this way. Our current reliance--our current 
national reliance on pooling and purchase as the two means of 
accounting for goodwill intangibles is as reliable as a two-
legged stool. What FASB appears to be proposing here, rather 
than an examination of how better to account for intangibles, 
is to cut out one of the two legs of the stool, giving us a 
one-legged stool.
    I would hope that in this hearing process we can go beyond 
the exposure draft and examine some of the questions that our 
experience over the last 20 years has raised for us, because 
over that last 20 years market-to-book value ratios have 
increased threefold because of intangible assets.
    As it has been pointed out by many of our colleagues here 
this morning, ideas and intangible assets are an enormous part 
of today's economy not because these things are illusory, but 
because they are very real and more important than some of the 
things that go into making book value a hallowed and very 
reliable method of accounting for many, many years.
    I think Congress needs to keep our focus. Ideas and 
intangibles are driving this economy, and we are responsible, 
much more than FASB, to ensure that we do not derail the 
economy in the United States.
    A recent U.S. Department of Commerce study found that the 
Internet economy is alone responsible for 35 percent of the 
real economic growth in the United States in the last 5 years. 
So I am interested in our witness's views as to how FASB's 
proposal to eliminate pooling will impact capital flows in this 
sector of our economy.
    Last, Mr. Chairman, I would observe that the pooling method 
has been around for decades. It makes it puzzling, therefore, 
to me to understand why FASB is changing the rules at this 
particular time.
    Not very long ago, in 1994 when already I had been in 
Congress for 6 years, the AICPA, the American Institute of 
Certified Public Accountants, through its Special Committee on 
Financial Reporting, addressed this very topic. This Special 
Committee on Financial Reporting of the AICPA included among 
its members the current FASB Chairman Mr. Jenkins.
    Here is what their report said, the report from Mr. Jenkins 
and his colleagues just a few years ago: ``While it is true 
that some users prefer the purchase method and some prefer the 
pooling method, most also agree that the existence of the two 
methods is not a significant impediment to users' analysis of 
financial statements. A project to do away with either method 
would be very controversial, require a significant amount of 
FASB time and resources, and in the end, is not likely to 
improve significantly the usefulness of financial statements.''
    So I would like to know why Mr. Jenkins has changed his 
view and what has happened in just these last few years to turn 
that statement on its head.
    FASB does not make its decisions in a vacuum. The 
accounting rules it adopts can and in this case surely will 
have a significant impact on our economy.
    Mr. Chairman, I thank the committee for holding this 
hearing on this important issue, and I look forward to hearing 
from our witnesses.
    Mr. Oxley. The gentleman from Illinois Mr. Rush.
    Mr. Rush. Thank you, Mr. Chairman.
    Mr. Chairman, I look forward to today's hearing on U.S. 
accounting rules for business combinations.
    This discussion is certainly a timely one. Today we have 
seen an unprecedented increase in market activity, which has in 
turn fueled the booming economy that we currently enjoy. Within 
the midst of such growth, there has also been a market increase 
in mergers and acquisitions.
    This brings us to the problem at hand. The pooling of 
interests versus the purchase accounting method is intriguing 
for several key reasons. Before we have the pooling method, 
which reflects the uniqueness of the high growth economies in 
that today the merging of two high-tech companies does not 
necessarily involve the acquisition of depreciating machinery 
or office furniture.
    Instead, in today's high-tech market, ideas themselves have 
value, and over time that value increases. However, this 
accommodation for this new asset apparently comes with a price. 
That price is transparency. While I am certainly in favor of 
measures which sustain and encourage market growth, I remain 
mindful that the United States has been at the forefront in 
encouraging transparencies of markets worldwide. I am of the 
belief that we should be consistent in our support of that 
policy on the domestic front.
    Aside from this public policy concern, I am at present most 
concerned that when the economic climate in this country is not 
so robust, fiscally weak companies which undergo mergers will 
use the pooling method to, if you will, sucker in unwary 
investors.
    There is little doubt in my mind that we need uniformity in 
the merger and acquisition information made available to the 
weekend warrior who signs onto E*TRADE or any other of the 
assortment of easily accessible trading venues. But it is 
important that in protecting the average investor, the very 
factor which has encouraged such high market participation is 
not damaged.
    I am confident that with a sober discussion and analysis by 
FASB and others, there can be some reasonable compromise which 
will result in clear and uniform means by which investors can 
make crucial decisions. At the very least, there should be some 
examination of whether requiring the purchase method across the 
board will, as many argue, deliver a severe blow to our surging 
economy.
    The challenge is up to the financial pundits to strike this 
important balance. I certainly hope that we and they will meet 
this important challenge.
    Mr. Chairman, I yield back the balance of my time.
    Mr. Oxley. The gentleman from New York Mr. Lazio.
    Mr. Lazio. Thank you, Mr. Chairman, for holding the 
hearing. I want to thank you for assembling a great list of 
witnesses, including our colleagues and Mr. Jenkins, the FASB 
Chairman Mr. Jenkins.
    I want to make mention of a couple of things. First of all, 
the gentleman from Michigan made reference to a factual setting 
which, ironically or coincidentally, is the same involving AOL 
and NetScape, the merger affecting the--the $900 billion 
merger, only $500 million of which was accounted by tangible 
assets.
    That merger would likely never have occurred if they were 
forced to use purchase accounting because of the write-down of 
$9.5 billion over 20 years under purchase accounting. The 
economy would have been deprived of the synergy of that merger, 
like many others, Travelers and Citi and several others who may 
well have foregone the option of merging if they were forced to 
use purchase accounting.
    There are some who argue that we need to have a single 
accounting method, we need to have harmony with our 
international neighbors. First of all, even among our 
international neighbors, and including the U.K., there are 
situations where pooling is allowed.
    Second of all, why should we harmonize if we are not 
harmonizing based on the right principles? Why should they not 
harmonize with us if we have the superior model? If our economy 
is making all of the right moves, and the synergies that are 
being created by our combinations through IT and biotechnology 
are leading the world, why shouldn't they be following us?
    There are people who say, why is it that we shouldn't use 
purchase accounting, because you can identify the value of the 
transaction better through purchase accounting? Hogwash. The 
market determines the value of mergers and acquisitions. In the 
end, the market knows far more than any accounting method and 
any law that we can create. We need to have some trust in them.
    There are some people who say that the purchase method is a 
superior method for giving investors more information. Some 
would argue that the information is less relevant, that 
increasingly the market is looking for cash-flow valuations and 
not economic value analysis, neither of which rely on 
accounting methods.
    There are people who say investors cannot tell how much is 
invested in a particular transaction, and they cannot track any 
subsequent performance. Again, the value in the end is 
determined by the market. Under any methodology, investors 
often find it very difficult to track subsequent performance 
based on individual combinations.
    Some people say we should have one accounting method 
because companies who are merging should have only one 
accounting method. Why should they? Businesses even within the 
same sectors are often using maybe different accounting methods 
for different purposes, including inventory and depreciation 
and other costs.
    In a May 2 letter from the Financial Accounting Foundation, 
which funds FASB and helps support its members, they opined 
something that I am concerned about. I will quote briefly, if I 
can: ``at the present time, a few constituents are 
unfortunately encouraging Members of Congress to intervene in 
the independent private sector standards-setting process. While 
full public debate of the technical merits of a proposed 
standard is encouraged and appropriate, we do not believe that 
the standard-setting process should be subject to governmental 
intervention when appropriate and extensive due process 
procedures have been followed by the FASB.''
    I would say, first of all, that I hope this does not have a 
chilling effect in terms of people who want to express their 
first amendment right to speak to Members of Congress, 
especially when economic impact is taken into account; it seems 
to me, to this Member, more some of us at the podium than those 
in FASB, with all due respect, first of all.
    Second of all, I am concerned that the FAF and FASB say on 
one hand that their standard-setting process should be free 
from intervention by Congress, while on the other hand FASB is 
citing SEC staffing burdens as one of the reasons for 
eliminating pooling. Does that mean that it is wrong for us to 
inquire into FASB's process, but it is okay for the SEC to 
actually drive the process?
    Third, I am interested in hearing from FASB how they 
proceeded in considering the elimination of pooling. I want to 
compliment them and commend them on the notice and comment 
process, but I would much prefer if they look at purchase 
accounting first, figure out how it can be improved to account 
for all the intangible assets that companies possess, 
especially in the IT and biotech sectors. I am interested in 
hearing why purchase accounting cannot be retooled for the new 
economy, and then we can consider the use of pooling.
    I am hoping that FASB Chairman Ed Jenkins can touch on some 
of these when he testifies.
    Thank you, Mr. Chairman.
    Mr. Oxley. The gentleman's time has expired.
    The Chair is now pleased to recognize the gentlewoman from 
California, who is technically not a member of this 
subcommittee, although we hope perhaps that will change soon. 
We are glad to have her with us. The Chair recognizes Ms. 
Eshoo.
    Ms. Eshoo. Thank you very much, Mr. Chairman, first of all 
for extending your courtesy to me to join with your 
subcommittee today for this very important hearing, and I 
salute you for bringing this hearing into reality, because it 
is a discussion of an issue that we all believe, given the 
excellent opening statements of members of the subcommittee--it 
really is a hearing about our national economy, what has made 
it so, what has contributed to it, and the examination of the 
proposal that the FASB Board has brought about.
    When I first came to the Congress in 1993, I introduced 
legislation relative to an FASB proposal. It was legislation 
that respected the independence of the Board, but it also was 
legislation regarding the potential decision of the FASB Board 
to prohibit a method of accounting for the value of stock 
options.
    I believe that the conclusion that the FASB came to at the 
end of the 1994 was fortuitous because it was good for our 
national economy. It spoke to a method of offering stock 
options that I think has moved on to be very important for 
workers and for companies in our country.
    Back then I might say that you could count on one hand the 
number of Members that even knew what an FASB was. Today there 
are more and more Members that know and really look closely to 
what the FASB Board recommends. This hearing today again 
involves a potential decision of that Board, and I think that 
it is a proposal that needs to be examined very, very 
carefully.
    There have been some very important developments that have 
taken place since I first came here and was introduced. There 
was a different Chairman of FASB at that time and some 
different issues.
    Dennis Powell is going to be speaking today representing 
Cisco Systems. Since FASB made its stock option decision and 
its proposed standard on then business combinations, Cisco 
Systems has become one of the most admired, if not the most 
admired, businesses in America. I say this not just as an 
advertisement for Cisco. I think every member wants to examine 
very carefully what has given rise to what Cisco represents.
    We also have Gene Hoffman who is going to be testifying 
today, president of EMusic, an Internet digital music company. 
When I was making the case back in 1993 and 1994 about stock 
options, I don't think Gene Hoffman's business even existed.
    So these are not flukes of our national stage or national 
economy. As I respect the independence of FASB, I also believe 
that the Congress has a responsibility to weigh in about issues 
that affect or that we think could have a detrimental effect on 
our national economy.
    Mr. Lazio has spoken to and quoted the Financial Accounting 
Foundation's letter that is here before each member of the 
subcommittee. I, too, would like to underscore that. I think it 
is very important for people to weigh in with their opinions, 
but I have to tell you that I feel a certain rub, because I 
don't think they are just a few constituents. Even if they 
were, if there were just a few constituents, I was elected to 
give voice to my constituents.
    Members of the House of Representatives are very unique in 
that we enjoy, under the Constitution, direct representation. 
The Presidency does not enjoy that because the Vice President 
can move into the Oval Office based on the prerogatives of the 
Constitution. The members of the United States Supreme Court 
are appointed. If someone dies over in the U.S. Senate, or they 
decide to step down, there can be appointment. We and we alone 
under the Constitution of the United States of America enjoy 
direct representation, so if I die or step down or I am removed 
from office, there will be a special election held so that 
there will be a direct voice of the people of the 14th 
Congressional District of California.
    So while I welcome the comments of the Financial Accounting 
Foundation, I have to say that in paragraph 5, I think they 
have a little overstepped their interpretation or their view of 
Members of the Congress.
    Mr. Chairman, I really welcome this hearing today. Thank 
you for inviting me to join with the subcommittee for this 
hearing, not being a member of the subcommittee. I do hope to 
be a member in the next Congress. I was before the 
jurisdictions of the subcommittee were split in a previous 
Congress.
    I hope that the Financial Accounting Board representatives 
will attempt at least to make the case as to why we would blend 
with a European standard when we are the envy of the entire 
world relative to our economy, how the proposed standard really 
serves our national economy well, who has been hurt by the 
pooling accounting standard that you are making the 
recommendation about, and see how those voices that have 
weighed in and questions--if, in fact, FASB sees today a better 
and a newer way of approaching this.
    Some of my colleagues have suggested a compromise. I hope 
that you will cover that in your testimony. Thank you to 
everyone that is here today that is going to enlighten us.
    Again, Mr. Chairman, thank you for your leadership. I could 
not mean that more.
    [The prepared statement of Hon. Anna G. Eshoo follows:]
Prepared Statement of Hon. Anna G. Eshoo, a Representative in Congress 
                      from the State of California
    Thank you, Mr. Chairman, for extending to me the courtesy of 
joining your subcommittee today for this hearing. I commend you for 
your leadership in holding this important hearing on this issue which 
is so critical to our economy.
    Mr. Chairman, when I first came to Congress in 1993 I raised 
questions about the actions of the Financial Accounting Standards Board 
(often referred to by its acronym, FASB). I may have been the first 
Member of Congress to offer legislation addressing FASB and their 
proposal to prohibit a method of accounting for the value of stock 
options.
    Back then, one could count on one hand how many Members of Congress 
knew what a FASB was, and still fewer knew that FASB was a private 
organization that exercised a strong influence on our economy through 
its standard-setting decisions. I spent just as much time explaining 
who FASB was to our Colleagues as I did explaining how its decision 
could have a tremendously negative impact on the New Economy and the 
technology industries that drive it.
    Today this hearing is about an issue--again involving a potential 
decision by FASB. This time it doesn't involve prohibiting an 
accounting method for the valuation of stock options, but rather FASB's 
intention to prohibit an accounting method for business combinations 
and intangible assets.
    I find myself again warning of the implications this decision could 
have and the potential negative impact on the New Economy and the 
industries that are still driving it. As Yogi Berra said, ``It's deja 
vous all over again.''
    However, there have been some important developments between 1993 
and today, and they are seated before this subcommittee this morning.
    Mr. Dennis Powell is here today representing Cisco Systems. Since 
the time FASB made its stock option decision and its proposed standard 
on business combinations Cisco Systems has become the most admired 
business in America.
    FASB's business is to set standards. Let me point out some 
standards Cisco has set: In the past three years, IndustryWeek chose 
Cisco as one of the best-managed companies in the nation; and Fortune 
ranked it as one of the best companies to work for in America.
    We welcome Gene Hoffman, President of Emusic, an Internet digital 
music company. When I was making the case that FASB's proposal on stock 
options could hamper the growth of Internet companies, Mr. Hoffman's 
company didn't exist. Since 1993, an entire technology industry has 
been created by entrepreneurs like Mr. Hoffman.
    I raise these examples to demonstrate that the issues we're 
discussing today are not dry and mundane theoretical questions. They 
are decisions that effect entire industries and our national economy.
    This leads me to the issue of FASB's responsibility and the role it 
plays in setting accounting standards. During my legislative career, 
I've become familiar with the process FASB goes through in its 
standard-setting and I respect the work its leadership and staff does 
in developing proposals.
    But I remain deeply concerned about FASB's perception regarding its 
process of private-sector standard setting, and the Federal 
government's role of steward of the nation's economic health.
     FASB is not the exclusive forum for the due process given to 
business standards. What may appear to the leadership of FASB as 
threats of government intervention may, in fact, be the Federal 
government fulfilling its responsibility as guardian of the national 
economy.
    Put simply: FASB is a private board and accountable to its 
leadership and its profession. The Congress is a public institution and 
accountable to the American people.
    Again, Mr. Chairman, thank you for holding these hearings and 
allowing me the opportunity to participate. I look forward to an 
interesting and thoughtful discussion regarding these issues and I 
welcome all of the witnesses here today.

    Mr. Oxley. The Chair recognizes the gentleman from Iowa Mr. 
Ganske.
    Mr. Ganske. Thank you, Mr. Chairman. I will be brief 
because I want to hear the testimony. I am hear to listen and 
learn, primarily.
    I was intrigued by a quote from Mr. Jenkins on page 3 of 
his testimony where he quotes an article by Floyd Norris called 
``Can Regulators Keep Accountants From Writing Fiction?''
    He says, ``Pooling accounting is ridiculous because it 
allows corporations to pretend that they paid much less for an 
acquisition than they did. Let's say company A buys company B 
for $100 million in stock and then a few years later sells 
company B for $50 million. In reality, it was a disastrous 
acquisition for company A. But, thanks to the magic of pooling, 
company A would have shown the original acquisition as costing 
not the $100 million it paid, but a number that would be far 
lower, say $20 million, reflecting the book value of company B. 
Presto, company A reports a profit of 30 million when it 
actually lost $50 million.''
    I don't know whether this is true or not. I am anxious to 
listen to the testimony and find out. I yield back.
    [Additional statement submitted for the record follows:]
 Prepared Statement of Hon. W.J. ``Billy'' Tauzin, a Representative in 
                  Congress from the State of Louisiana
    Thank you Mr. Chairman.
    We are here today to answer one question: Should Pooling of 
Interest be completely eliminated as an accounting method for Business 
Combinations?
    Well, without a whole lot of thought, I can answer that question 
fairly easily. The answer is No, unless either purchase accounting as 
we know it is improved or we can all agree on an alternative method of 
accounting that does not suffer from the same shortcomings that 
purchase accounting suffers from.
    I have four primary concerns with the FASB proposal to require all 
merging companies to use purchase accounting.
    First, I am not convinced that purchase model accounting makes much 
practical sense in today's new economy. For new economy companies, 
intangibles make up a major portion of purchase price allocation not 
adequately addressed by purchase model accounting. Put simply, this 
method provides inadequate guidance on how to identify and value 
intangible assets. To the contrary, purchase accounting seeks to 
amortize goodwill to expense over a 20 year period in a way that just 
doesn't reflect economic reality.
    So essentially, there is a real incompatibility between purchase 
accounting and the mechanics of many business combinations that are 
taking shape in our country.
    If FASB's real concern is ensuring that companies are accurately 
valued for the benefit of capital market investors . . . a concern I 
might add that the SEC shares as well . . . then it should be promoting 
an accounting method that makes clear how best to appraise 
intangibles--technology, intellectual property, brand identification, 
patents, and the like--as opposed to asserting that purchase accounting 
must carry the day despite that it is defunct in its treatment of 
intangibles. Furthermore, if FASB wants accurate valuations, then it 
should propose something more creative than simply forcing companies to 
amortize goodwill over an arbitrary 20 year period--which we all know 
often results in synthetically, or artificially, reducing reported 
income.
    The bottom line here then is that purchase accounting is designed 
for old world brick and mortar outfits, and therefore must be revamped 
itself before I will concede that it is a better alternative to 
pooling.
    Second, I am afraid that eliminating pooling in favor of present-
day purchase accounting will significantly reduce merger activity in 
this country. In 1998, there were 11,400 mergers in the Unite States 
alone which accounted for $1.62 trillion in aggregate value. 
Significantly, the pooling of interest method was used in 55% of these 
mergers.
    Over half of the mergers in 1998 relied on the pooling method, and 
it certainly makes sense as to why. The ability for a company to deal 
in stock is what in fact has enabled many companies to grow, provide 
more jobs, and eliminate inefficiencies in our economy. Without the 
ability to offer stock in exchange for ownership interest in another 
entity, many acquiring companies would not even consider some of the 
business combinations that they have pursued or achieved to date. This 
to me is quite troublesome.
    Third, I feel that eliminating pooling at this juncture imposes 
somewhat of a retroactive hardship on many businesses that have relied 
upon pooling for years. The two accounting methods in question have 
been around for years, and I think, have effectively served as 
alternatives to one another--kind of a natural Yen and Yang, if you 
will. Precisely because the economics of these methods is so different, 
companies have always been afforded the opportunity to make a business 
decision of going one way or another, depending on the nature of the 
deal in question. To take pooling off the table at this juncture, 
without any attempt to retain the flexibility afforded by a two method 
regime, amounts to nothing more than changing the rules on business 
mid-stream.
    As a lawmaker, I have always had serious reservations about 
changing laws in a retroactive manner. My experience is that this 
usually leads to harming established industries and businesses in ways 
that Congress never intends.
    Fourth, and finally, I have grave concerns about process in this 
debate. FASB contends that its administrative process is modeled after 
the APA, and that it fiercely adheres to that process. FASB also states 
that it will make no final decision about the proposal or consider 
whether to issue a final standard until it is satisfied that all 
substantive issues raised by all parties have been considered. Well, 
despite that most of the comments received, as far as I can tell, 
oppose making purchase accounting the sole method for business 
combinations, FASB continues to publicly make the case for the 
elimination of pooling.
    In addition, its actions suggest that FASB is paying little mind to 
the interested parties' recommendations for either retaining pooling or 
improving purchase accounting in some reasonable fashion.
    Furthermore, upon learning that some of its constituents were 
``unfortunately, encouraging Members of Congress to intervene in the 
independent private-sector standard setting process,'' the Financial 
Accounting Foundation (FAF) issued an open letter criticizing the very 
notion that Congress should have some say so in the process of deciding 
how American businesses disclose financial information. While I do not 
deny that FASB's independence is central to its mission, much like the 
Federal Reserve's, the FAF letter gives the impression that 
independence in this context means ABSOLUTE independence.
    Well, I'm here to say that it is entirely appropriate for Congress 
to oversee the FASB and the SEC's supervision and delegation of its 
authority to set accounting standards. After all, this very authority 
is derived from the '34 Act, a piece of legislation that was drafted by 
this very Committee.
    In the end, I hope that the FASB will take my concerns to heart and 
respond with a plan that makes the most sense for today's business 
world.
    With that, Mr. Chairman, I yield back the balance of my time. Thank 
you.

    Mr. Oxley. The Chair is pleased to recognize our 
distinguished panel of Members, and as I understand it, you 
prefer to go first, Mr. Goodlatte, because you have a markup?
    Mr. Goodlatte. Mr. Chairman, if I may, we are in the middle 
of another issue of great interest to the Internet economy, and 
that is the tax moratorium extension that I know this committee 
has also held hearings on. If I can get back, my substitute is 
on the floor of the committee right now.
    Mr. Oxley. The Chair is pleased to recognize the gentleman 
from Virginia, Mr. Goodlatte.

 STATEMENT OF HON. BOB GOODLATTE, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF VIRGINIA

    Mr. Goodlatte. Thank you, Mr. Chairman.
    Mr. Chairman, I very much appreciate your holding this 
hearing and allowing me to testify this morning. As you know, 
the Internet has fueled our economic growth at such a rapid 
pace over the last 5 years.
    According to the Department of Commerce, traffic volume on 
the Internet doubles every 100 days. By October of last year, 
U.S. Web pages averaged $1 billion cumulative hits per day. In 
comparison to other forms of communication, the U.S. Postal 
Service delivered 101 billion pieces of paper mail in 1998. 
Estimates for e-mail messages sent in 1998 ranged from $618 
billion to 4 trillion. The impact of the Internet on our daily 
lives is mind-boggling.
    For businesses, the impact is equally great. The Internet 
economy has grown to $507 billion in 1999 from $301 billion in 
1998. It is expected to grow to $1 trillion in 2001 and $2.8 
trillion by 2003. The Internet economy accounts for 2.3 million 
jobs, that was last year, 35 percent of the U.S. real economic 
growth between 1995 and 1998, and its share of the U.S. economy 
nearly doubled between 1977 and 1998, growing from 4.2 percent 
to 8.1 percent.
    This development has been spurred by the ability of 
companies to innovate, and the growth of the new economy has 
occurred because startup companies have been able to combine 
creative thinking with low barriers to entry in the form of low 
costs and regulations. These characteristics of the new economy 
must be protected in order for small companies to continue 
reacting and adjusting.
    One way in which these characteristics are threatened is 
the ongoing review by the Financial Accounting Standards Board 
of accounting rules governing business combinations. In today's 
rapidly growing technology and information markets, the need 
for maintaining an accounting system that is best suited to 
handle the growing trend of the technology sector mergers is 
key.
    The pooling system of accounting has made possible some of 
the most important mergers of our time, creating innovative new 
companies and benefiting consumers. If the use of pooling had 
not been permitted, the unifications of NetScape and America 
Online, CitiCorps and Travelers, NationsBank and Bank of 
America and the Daimler-Chrysler merger quite possibly would 
never have taken place.
    Current regulations allow many high-tech companies to use 
the pooling method by allowing corporations to easily merge 
without attaching a goodwill accounting charge. This charge is 
the amount paid in an acquisition that is added to the fair 
market value of a company's tangible assets.
    If the Financial Accounting Services Board proposal is 
implemented, it would require that all mergers be viewed not as 
the melding of separate entities, but as a direct purchase, 
forcing companies to accept the purchase method of accounting. 
That would be a big mistake. This system may have worked for 
the bricks-and-mortar corporations of the past, but in the age 
of high-tech companies whose value lies in information, the 
purchase method of accounting has no place. Forcing these high-
tech, high-performance companies to use the direct purchase 
accounting system will only serve to stifle growth and limit 
our country's edge in this information age.
    We should take every opportunity to support and ensure 
continued innovation and expansion in this technology sector 
that has done so much to energize our economy.
    I support clear and understandable accounting rules, which 
do need adjustments from time to time. I agree with those who 
believe that we should thoroughly examine possible adjustments 
to current standards. However, the type of wholesale changes 
currently under consideration should be abandoned.
    I therefore believe that the Commission designated by 
Geoffrey Garten, Chairman of the Securities and Exchange 
Commission, to study the role of intangible assets in the new 
economy should be allowed to complete its work. We should then 
examine the Commission's conclusions in the broader context of 
how intangible assets are reported in a rapidly changing 
economic environment.
    I would urge the FASB to follow its stated mission to 
ensure that its standards ``reflect changes in methods of doing 
business and changes in the economic environment.'' However, 
single-shot, piecemeal changes to accounting standards should 
not be the mode of operation. Pooling accounting is essential 
for small startups and new online businesses. These ventures 
act as a magnet for capital investment, lower costs, create new 
jobs, and fuel economic growth. Acting in a piecemeal manner to 
alter existing accounting principles could threaten this growth 
by limiting the availability of capital and restricting the 
expansion of this new sector of our economy.
    I am hopeful that the FASB will step back, take a deep 
breath, and see the forest that is the new economy rather than 
the trees that are the individual accounting standards. I look 
forward to working with you and others who are concerned that 
our system of accounting standards should move along with the 
rest of the economy into the new century, Mr. Chairman.
    I might add that while we are enjoying and experiencing 
tremendous dynamic growth with many of the companies in this 
new Internet economy, there are others who are struggling, 
others with good ideas, with good intellectual property, but 
who should nonetheless have the ability to make sure that if 
there is an appropriate merger that can strengthen their 
situation, as I think the AOL-NetScape merger is an excellent 
example, we should have the opportunity to do that with 
accounting principles that support that kind of combination and 
take into account that the value of intellectual property in 
this information economy is very, very different.
    I am being signalled that my vote is needed in the 
Committee on the Judiciary. Thank you for allowing me to 
testify.
    [The prepared statement of Hon. Bob Goodlatte follows:]
Prepared Statement of Hon. Bob Goodlatte, a Representative in Congress 
                       from the State of Virginia
    Thank you for allowing me to testify before you this morning. As 
you know, the Internet has fueled our economic growth at such a rapid 
pace over the last five years. According to the Department of Commerce, 
traffic volume on the Internet doubles every 100 days. By October of 
last year, U.S. web pages averaged one billion cumulative hits per day. 
In comparison to other forms of communication, the U.S. Postal Service 
delivered 101 billion pieces of paper mail in 1998. Estimates for e-
mail messages sent in 1998 range from 618 billion to 4 trillion. The 
impact of the Internet on our daily lives is mind-boggling.
    For businesses, the impact is equally great. The Internet Economy 
has grown to $507 billion 1999 from $301.4 billion in 1998. It is 
expected to grow to $1 trillion in 2001, and $2.8 trillion by 2003. The 
Internet Economy accounts for 2.3 million jobs last year, 35% of U.S. 
real economic growth between 1995 and 1998, and its share of the U.S. 
economy nearly doubled between 1977 and 1998, growing from 4.2 percent 
to 8.1 percent.
    This development has been spurred by the ability of companies to 
innovate, and the growth of the new economy has occurred because start-
up companies have been able to combine creative thinking with low 
barriers to entry in the form of low costs and regulations. These 
characteristics of the New Economy must be protected in order for small 
companies to continue reacting and adjusting. One way in which these 
characteristics are threatened is the ongoing review by the Financial 
Accounting Standards Board of accounting rules governing business 
combinations.
    In today's rapidly growing technology and information markets, the 
need for maintaining an accounting system that is best suited to handle 
the growing trend of technology sector mergers is key. The ``pooling'' 
system of accounting has made possible some of the most important 
mergers of our time, creating innovative new companies and benefitting 
consumers. If the use of ``pooling'' had not been permitted, the 
unifications of Netscape and America Online, Citicorp and Travelers, 
NationsBank and Bank of America, and the Daimer Chrysler merger quite 
possibly would have never taken place.
    Current regulations allow many high-tech companies to use the 
pooling method by allowing corporations to easily merge without 
attaching a goodwill accounting charge. This charge is the amount paid 
in an acquisition that is added to the fair market value of a company's 
tangible assets. If the Financial Accounting Standards Board proposal 
is implemented, it would require that all mergers be viewed not as the 
melding of separate entities, but as a direct purchase, forcing 
companies to accept the purchase method of accounting. This system 
worked for the bricks and mortar corporations of the past, but in the 
age of high-tech companies whose value lies in information, the 
purchase method of accounting has no place.
    Forcing these high-tech, high performance companies to use the 
direct purchase accounting system will only serve to stifle growth and 
limit our country's edge in this information age. We should take every 
opportunity to support and ensure continued innovation and expansion in 
this technology sector that has done so much to energize our economy. I 
support clear and understandable accounting rules which do need 
adjustments from time to time, and I agree with those who believe that 
we should thoroughly examine possible adjustments to current standards. 
While we should should step back and determine the benefits and 
disadvantages of the various methods of business reporting, we should 
avoid the type of wholesale changes currently being considered.
    I therefore believe that the commission designated by Jeffrey 
Garten, Chairman of the Securities and Exchange Commission, to study 
the role of intangible assets in the New Economy should be allowed to 
complete its work. We should then examine the Commission's conclusions 
in the broader context of how intangible assets are reported in a 
rapidly changing economic environment. I would urge the FASB to follow 
its stated mission--to ensure that its standards ``reflect changes in 
methods of doing business and changes in the economic environment.'' 
However, single-shot piecemeal changes to accounting standards should 
not be the mode of operation.
    Pooling accounting is essential for small start-ups and new online 
businesses. These ventures act as a magnet for capital investment, 
lower costs, create new jobs, and fuel economic growth. Acting in a 
piecemeal manner to alter existing accounting principles could threaten 
this growth by limiting the availability of capital and restricting the 
expansion of this new sector of our economy. I am hopeful that the FASB 
will step back, take a deep breath, and see the forest that is the New 
Economy, rather than the trees that are individual accounting 
standards. I look forward to working with you, Mr. Chairman, and others 
who are concerned that our system of accounting standards should move 
along with the rest of the economy into the new century. Mr. Chairman, 
thank you for having me here today.

    Mr. Oxley. Thank you. Thank you for your leadership on this 
issue.
    Our very patient colleague and good friend, the gentleman 
from California, who has been here for a long time and listened 
to a lot of opening statements, we appreciate your patience, 
and the Chair is now pleased to recognize the Honorable Cal 
Dooley from California.

    STATEMENT OF HON. CALVIN M. DOOLEY, A REPRESENTATIVE IN 
             CONGRESS FROM THE STATE OF CALIFORNIA

    Mr. Dooley. Thank you, Chairman Oxley. I was privileged to 
hear the statements of the various members of the committee. I 
really am in agreement with most of the sentiments that were 
expressed.
    I would also at this time like to ask unanimous consent 
that two letters that myself and Anna Eshoo and others have 
sent to Chairman Levitt of the Securities and Exchange 
Commission as well as Chairman Jenkins of FASB be included in 
the record.
    What might well appear to be an arcane accounting matter 
could prove to be something that has significant public policy 
implications. That is why I commend you for having this hearing 
today.
    In many ways, the issue we are touching on today really is 
a reflection of how we are changing from an industrial-based 
economy to an information-based economy, and how many of the 
companies that are now providing the engine and the energy for 
the growth of jobs as well as the creation of wealth are doing 
so not necessarily by the production of hard assets and taxable 
assets that would characterize a lot of the older industries 
within the United States.
    I think what we have to understand is some of the 
accounting systems that were developed back in the industrial 
age are no longer as effective in identifying and accounting 
for the real value of the companies in this new economy. There 
has not been an accounting system that has been developed that 
can accurately measure the precise value of human and 
intellectual capital. Yet, in the new economy businesses, it is 
human and intellectual capital that are the foundations and the 
most important elements in assessing a company's true worth.
    I am concerned that FASB's decision draft takes the 
approach that you can define the value of goodwill and 
intangible assets. Furthermore, it goes as far to assume that 
they are wasting assets and that they should be depreciated, 
and that they will lose all value in a period of no more than 
20 years.
    Intellectual capital is critical to the success of any 
company. In this information age, many of these companies would 
be most adversely impacted by FASB's draft proposal. Their 
value is to be intellectually innovative, their ability to 
bring products to market very quickly, their ability to adapt 
and have market penetration, and it puts a premium on these 
companies that are the entrepreneur innovators that have the 
ability to match up and coordinate innovations quickly with 
well-executed product delivery effort.
    I think we are at the point now where we have to be 
concerned about making a change in the way that we account for 
mergers and acquisitions that would have some significant 
adverse impacts. The potential impact, I think, was identified 
to some extent by an article that was in the Wall Street 
Journal today which talked about in the first quarter of this 
year, there was over $22 billion in investment and 1,557 
startup companies. That was an increase over the first quarter 
of 1999 of $6.1 billion.
    What I am concerned about is that if you make this change 
in accounting practices, you can have a significant adverse 
impact on the dollars. There is venture capital and risk 
capital going into these startups. These startups we are 
talking about, not every one is going to mature to the point 
that they are going to have IPOs. Some are going to be acquired 
or assimilated through mergers.
    If we are not allowing pooling to be utilized, there is a 
great concern that the real intellectual capital, the goodwill 
that is identified with those companies, will not be able to be 
recognized. We will put downward pressure on the values of 
these companies that will make them less attractive to 
eventually be acquired or merged into others. What that has the 
potential of doing, I think, is harming the United States' 
clear superiority and having the greatest relative advantage in 
the technology sector.
    FASB and others have talked about trying to make our system 
more consistent with other international standards. Why would 
we want to do that? It is clear that the United States is the 
leader in this area. I don't think we ever want to adopt a 
system that could impede the flow of venture capital into the 
technology sector, which is so very, very important. What we 
have to be concerned with in the public policy issue here is 
make sure we do not have a reform in our accounting practice 
which reduces or impedes the flow of capital into high-risk 
investments.
    It also is going to have the impact of decreasing the 
ability of a lot of these startup companies to attract 
employees and human intellectual capital. I also think it has 
the risk of almost contributing to greater consolidations, 
because E*TRADE probably would not have purchased Teledyne if 
we did not have the ability to use pooling. It probably would 
have resulted in that company being purchased by one of the 
bigger financial institutions. I don't think that is something 
we want to encourage by adopting an accounting practice.
    Just in closing, I also want to make it clear that pooling 
is not a system without some imperfections. It has some 
imperfections. We also at the same time have to acknowledge 
that purchase accounting also has some major imperfections.
    Before we move forward with eliminating pooling, I think we 
have to step back and say, is it time for us to start from a 
broader context in trying to determine what is the most 
effective way to value our companies. I am very concerned we 
are taking a piecemeal approach here.
    I also want to commend Mr. Jenkins for his openness and 
willingness to have a dialog with a lot of us who have spent a 
lot of time on this. I am hopeful through this issue and 
continued discussion and dialog that we can come up with a 
system that will ensure that we can continue to have the most 
robust venture capital system in the world which is leading to 
some of the greatest advancements in technology and the 
creation of some of the most exciting companies in the world.
    [The prepared statement of Hin. Calvin M. Dooley follows:]
  Prepared Statement of Hon. Cal Dooley, a Representative in Congress 
                      from the State of California
    Mr. Chairman, Ranking Member Towns, distinguished colleagues and 
friends on the Finance Subcommittee, I want to thank you for the 
opportunity to appear before you today to talk about a matter of great 
importance in the economy--the question of how companies account for 
mergers and acquisitions. I would also like to submit for the record 
two letters that a number of us have sent to Chairman Levitt of the 
Securities and Exchange Commission and Chairman Jenkins of the 
Financial Accounting Standards Board with our concerns about this 
issue.
    As I am sure you are all aware, the tremendous performance we have 
seen in the technology sector in the past decade is attributable not 
only to the wealth of creative ideas in this country, but also to the 
capital that helps to turn those ideas into products and services and 
brings them to the market. It is the technology community's success at 
combining these two essential ingredients that has turned it into the 
powerful economic engine it is today. That engine, in turn, has helped 
to propel the entire economy into the longest expansion in U.S. 
history. Furthermore, it is changing the complexion of the economy. 
More and more, we are realizing the value of intangible assets, not 
just at Internet start ups, like ``eGM'' for instance, but at bricks 
and mortar companies like . . . GM! Put simply, the ``Old Economy'' is 
becoming the ``New Economy.''
FASB's Proposal
    Mergers and acquisitions, or business combinations, are an 
important means by which ideas and capital are paired in the technology 
sector and throughout the economy. FASB, the Financial Accounting 
Standards Board, is currently considering a proposal that will alter 
the method by which many businesses account for business combinations. 
This proposal would require companies to account for all such 
combinations as purchases, with the acquiring company being forced to 
write off any goodwill included in the purchase price as a charge 
against earnings over the course of several years.
    Naturally, this proposal poses serious concerns for the technology 
sector because of the large difference that often exists between 
technology companies'' book and market values. This is a legitimate 
concern and I think that FASB, by only addressing part of the issue 
through the elimination of pooling, is still not addressing the core 
problem. If they are going to take on this issue, they need to take a 
more comprehensive approach.
Pooling and Purchase are Both Flawed
    Experts can and do argue over whether, as FASB has determined in 
its Exposure Draft on Business Combinations, all business combinations 
are purchases and should be accounted for as such. What really concerns 
me and a number of others in Congress and the private sector is the 
process that FASB has followed. It is moving to force the use of 
purchase accounting for all mergers and acquisitions without giving due 
consideration to the fact that purchase does not adequately account for 
so many of the intangible assets that companies possess today. In other 
words, FASB is considering the elimination of pooling in a vacuum and 
neglecting to consider the fact that many consider both pooling and 
purchase to be flawed and inadequate methods of accounting for business 
combinations. This is an important point that has been lost in all of 
the rhetoric about how the tech sector is seeking special treatment 
from FASB by urging them to keep pooling, so I want to reiterate it: 
pooling and purchase are both flawed and inadequate methods of 
accounting for business combinations. This is especially true for 
companies with large amounts of intangible assets, such as financial 
and pharmaceutical companies. It's not just about the technology 
sector.
    Given that many believe that neither method adequately accounts for 
many of the intangible assets one finds in today's businesses, the 
development of a method of accounting that does effectively deal with 
intangibles should be pursued before we scrap the old ones. The 
elimination of pooling without paying any attention to what's left over 
is like blowing up the old bridge that gets us across the river before 
the new one is built.
The Need for Oversight
    FASB's process illustrates why it is so important that the Finance 
Subcommittee is exercising its congressional oversight authority today. 
I feel confident in saying that none of us here wants to compromise the 
integrity and independence of FASB. At the same time, however, it is 
appropriate for us to focus on the potential economic consequences of 
FASB's proposals; to think about whether or not the benefits of their 
proposals outweigh the costs; and to ask the hard questions. In the 
end, congressional oversight on contentious issues doesn't weaken the 
process, it strengthens it. What weakens the process and its product is 
when FASB stubbornly ignores the concerns of its constituents; and when 
the Financial Accounting Foundation, which oversees, funds, and 
appoints the members of FASB, characterizes congressional interest and 
concern about a FASB project as ``Explicit or implicit threats, . . .'' 
as they have in a May 1, open letter.
    I remain convinced that if FASB has ears to hear, we can still 
persuade them to address the serious concerns we have about the flaws 
in purchase accounting first before abolishing pooling.
    In closing, I want to thank you again for allowing me to appear 
today to discuss this issue. I commend you for holding this hearing. I 
also want to commend FASB Chairman Ed Jenkins for his patience and 
thoughtfulness in dealing with others and me on this issue. In fairness 
to him, FASB is not a committee of one, and I know we all recognize 
that he has a tough job. I believe that his continued openness and 
willingness to discuss our concerns is key to coming to some sort of 
resolution on this matter.
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    Mr. Oxley. Thank you, Mr. Dooley, for your excellent 
testimony.
    The committee will stand in brief recess while we empanel 
the next group.
    [Brief recess.]
    Mr. Oxley. The subcommittee will reconvene.
    Let me introduce our distinguished panel, second panel; Mr. 
Edmond L. Jenkins, Chairman of the Financial Accounting 
Standards Board; Mr. Dennis D. Powell, vice president, 
corporate controller from Cisco Systems, San Jose, California; 
Mr. Peter R. Bible, chief accounting officer for General Motors 
Corporation from Detroit; Mr. Gene Hoffman, Jr., president and 
CEO of EMusic, Redwood City, California; finally, Dr. William 
Frederick Lewis, president and CEO, Prospect Technologies, here 
in Washington, DC, on behalf of the U.S. Chamber of Commerce.
    Gentlemen, welcome to all of you. Mr. Jenkins, we will 
begin with you.

STATEMENTS OF EDMUND L. JENKINS, CHAIRMAN, FINANCIAL ACCOUNTING 
 STANDARDS BOARD; DENNIS D. POWELL, VICE PRESIDENT, CORPORATE 
  CONTROLLER, CISCO SYSTEMS; PETER R. BIBLE, CHIEF ACCOUNTING 
    OFFICER, GENERAL MOTORS CORPORATION; GENE HOFFMAN, JR., 
  PRESIDENT AND CEO, EMUSIC.COM; AND WILLIAM FREDERICK LEWIS, 
            PRESIDENT AND CEO, PROSPECT TECHNOLOGIES

    Mr. Jenkins. Thank you, Mr. Chairman. I certainly 
appreciated all of the comments from the members of this 
committee this morning. Please be assured at the outset that 
those comments are important to me and to my fellow Board 
members at the FASB, and we will be considering them carefully 
as we proceed with our redeliberations on this important 
subject.
    I am Edmond Jenkins, Chairman of the Financial Accounting 
Standards Board. Behind me is Kim Petrone, the project manager 
on the subject of today's hearing.
    I am very pleased to be with you today. I plan to discuss 
something about the due process of the FASB and our proposed 
standard to improve the accounting for business combinations. I 
have brief prepared remarks, but I would respectfully request 
that my full statement and supporting materials, referred to as 
the biggest package ever, be entered into the public record.
    Mr. Oxley. With some trepidation, it is so ordered.
    Mr. Jenkins. Thank you, Mr. Chairman. I wouldn't want to 
have to carry them all back.
    Mr. Chairman, the FASB is an independent organization, one 
that is funded entirely by the private sector. Our mission is 
to set accounting and reporting standards to protect the 
consumers of financial information. Most notably, those 
consumers are investors and creditors. Those consumers rely 
heavily on credible, transparent, and comparable financial 
information for effective participation in our great capital 
markets.
    To quote a recent letter from the Association of Investment 
Management and Research, the leading organization of investment 
professionals in the United States with over 40,000 members, 
``The `lifeblood' of United States capital markets is financial 
information that is: (1) comparable from firm to firm; (2) 
relevant to investment and financing decisions; (3) a reliable 
and faithful depiction of economic reality; and (4) neutral, 
favoring neither supplier nor user of capital; neither buyer 
nor seller of securities.''
    This notion of neutrality is a fundamental element in our 
standard-setting process. To create or tolerate financial 
reporting standards that bias or distort financial information 
to favor a particular transaction, a particular industry or 
special interest group undermines the credibility and value of 
that information and the proper functioning of the capital 
markets and impairs investors' capital allocation decisions.
    It is important to remember that our standards affect all 
public and private nongovernmental organizations, not just 
companies in one or two industries.
    Our decisionmaking process is thorough. It is open to 
public observation and provides numerous opportunities for all 
interested parties to actively participate in and express their 
views. The issues that the FASB addresses are necessarily 
difficult ones for which reasonable people can and do hold 
differing views. As you know, we have often made significant 
changes to our proposals in response to concerns that have been 
raised.
    The subject of this hearing is our proposal to improve the 
accounting for business combinations. The current accounting in 
this area was established in 1970. That accounting requires 
that business combinations be reported using either of two very 
differing methods, the purchase method or the pooling of 
interests method. Those two methods produce dramatically 
different financially reporting results for essentially the 
same or similar economic transactions.
    Under the purchase method, the acquiring company records 
the net assets of the acquired company at the price paid, 
including any intangible assets, that have so often been 
referred to this morning as the most important assets of the 
new economy companies, to the extent that they can be 
separately identified and reliably measured. The excess of the 
purchase price paid over the fair value of the acquired 
company's net assets is recorded as an asset called goodwill.
    The purchase method is consistent with the accounting for 
all other acquired assets. All purchases, whether a piece of 
machinery or a patent or a royalty right, are recorded at the 
price paid and are generally charged against earnings over 
their useful economic life.
    An alternative to the purchase method, the pooling method 
is only available if 12 specific criteria are met. A key 
criterion is that the consideration exchanged must take the 
form of stock rather than cash or debt. However, it is 
important to note that stock can also be used as consideration 
in a purchase accounting acquisition.
    In contrast to the purchase method, under the pooling 
method the book values of the combining companies are simply 
added together. There is no recognition of the full price paid 
and, therefore, no charge in the recorded amount of the 
acquired company's net assets to reflect their fair value, no 
recognition of these important intangible assets not previously 
recorded, and no resulting goodwill, and thus the true cost of 
the transaction is not reflected in the income statement.
    Congressman Ganske referred to the article in the New York 
Times by Floyd Norris. Congressman, let me confirm for you that 
this is a real transaction. The numbers have been changed, but 
it is a real transaction, and, in fact, under pooling of 
interests accounting, the company did record a profit of $30 
million in our example when it really lost $50 million. That is 
a true example.
    As you are aware, a key requirement of our proposal is that 
all business combinations would be accounted for under one 
method, the purchase method, and that the pooling of interests 
method should be eliminated.
    The rationale for that proposed decision includes the 
following points: First, the pooling method ignores the values 
exchanged in a business combination, while the purchase method 
reflects them.
    Second, having two disparate methods of accounting for 
essentially the same transaction makes it difficult for 
investors to compare companies that have used different methods 
to account for their business combinations.
    Third, because future cash-flows are the same, whether the 
pooling or purchase method is used, a boost in earnings under 
the pooling method reflects artificial accounting differences 
rather than real economic differences.
    The important point is that under either purchase or 
pooling accounting, the future cash-flows are the same, and the 
impetus to have an acquisition or not should really not be 
influenced at the end of the day by the method of accounting.
    Fourth, under the pooling method, financial statement users 
cannot tell how much was invested in the transaction, nor can 
they track the subsequent performance of that investment in 
future years.
    Congressman Dingell made reference to my testimony in the 
reference to the $9.5 billion that simply disappeared in the 
transaction. That is, as Congressman Lazio pointed out, the 
AOL-NetScape transaction, and there was, in fact, no reporting 
of the $9.5 billion in the financial statements of the combined 
company. Thus, it was impossible for investors to relate 
subsequent performance against 95 percent of the purchase price 
paid for the acquired company.
    I would also like to emphasize a couple of things that our 
proposal does not do. First, our proposal does not preclude 
companies from entering into business combinations that are 
stock-for-stock transactions. Second, our proposal does not 
make significant changes to the current basic accounting model 
where accounting for intangible assets.
    Congressman Goodlatte in his testimony referred to the 
Garten panel, the panel set up by Chairman Arthur Levitt to 
look at value creation in the new economy. I would like to read 
from the enabling article with respect to that panel because 
intangibles are nowhere mentioned in it.
    ``The purpose is to assemble a panel of experts and other 
thoughtful individuals to assess the capital markets' 
understanding of the recent changes in the economy attributable 
to technological innovation and globalization; it is to 
identify the changing forces now driving the value creation of 
business enterprises; it is to assess whether the investment 
community and the financial markets adequately understand these 
changes based on the information currently being made available 
in the marketplace.''
    There is no recognition in that of intangibles whatsoever.
    Since first adding our project on business combinations to 
its agenda in 1996, the Board has held over 40 public meetings. 
We have issued two preliminary documents, an exposure draft for 
public comment that has been referred to here this morning, and 
carefully analyzed and discussed at public meetings over 400 
comment letters received from a broad range of companies, 
investors, and other constituents.
    In February of this year, we held 4 days of public hearings 
to discuss the proposal with interested constituents. Over 40 
individuals testified.
    In April we began our redeliberations of all of the issues 
contained in the proposal. This redeliberation process will 
include numerous public meetings held over the next several 
months. At those meetings, the Board will carefully consider 
the comment letters, the public hearing testimony, what we 
learn from this hearing, and all other relevant information 
provided by interested parties. Let me assure you that no final 
decisions will be made until that process is completed.
    We presently expect to complete our work and be in a 
position to issue a final standard by no earlier than the end 
of the year 2000. That estimate may change depending on the 
progress of our deliberations. We will not rush to a 
conclusion.
    In closing, I want to be clear that the FASB understands 
and supports the oversight role of the subcommittee. We will 
carefully consider what we learn from this hearing, from the 
testimony of Congressmen Dooley and Goodlatte.
    Let me assure you again, Mr. Chairman and members of this 
subcommittee, that our open due process and our independent and 
objective decisionmaking will be carefully and fully carried 
out. To do otherwise would jeopardize the very foundation upon 
which the FASB was created and for which it has proven 
invaluable to the U.S. capital markets and to investors and 
creditors, the consumers of financial information.
    Thank you very much, Mr. Chairman.
    [The prepared statement of Edmund L. Jenkins follows:]
Prepared Statement of Edmund L. Jenkins, Chairman, Financial Accounting 
                            Standards Board
Summary
    A key requirement of our proposal to improve the accounting for 
business combinations is that all business combinations would be 
accounted for under one method, the purchase method, and that the 
pooling-of-interests method (``pooling method'') should be eliminated.
    The proposal's requirement to eliminate the pooling method will 
benefit investors, creditors, and other financial statement users by 
providing more information and more relevant information about all 
business combinations. The proposal's provisions also will benefit 
those consumers by improving the comparability of financial reporting, 
thereby making it possible to more easily contrast companies that 
participate in business combinations.
    The proposal will also benefit companies that prepare financial 
statements and the auditors of those statements by providing a single 
method of accounting for all business combinations. Having one method 
will reduce certain costs to companies and auditors, both monetary and 
nonmonetary, which are currently related to the existence of the 
pooling method. In addition, having one method benefits companies by 
leveling the playing field for competition among companies in the 
business combinations market.
    In April, we began our redeliberations of all of the issues 
contained in the proposal. As part of that process, we will carefully 
consider the comment letters, public hearing testimony, what we learn 
from this hearing, and all other relevant information provided by 
interested parties. No final decisions will be made until that process 
is completed.
    Mr. Chairman, Members of the Subcommittee, I am Edmund Jenkins, 
chairman of the Financial Accounting Standards Board (``FASB'' or 
``Board''). With me is Kim Petrone, the project manager on the subject 
of today's hearing. I am pleased to be here today. I plan to discuss 
the due process of the FASB and our proposed standard to improve the 
accounting for business combinations (``Proposed Standard''). I have 
brief prepared remarks, and I would respectfully request that my full 
statement and supporting materials be entered into the public record.
What Is the FASB and What Does It Do?
    The FASB is an independent private-sector organization. We are not 
part of the federal government and receive no federal funding. We are 
funded entirely from private-sector sources, primarily voluntary 
contributions and sales of publications.
    Our mission is to establish and improve standards of financial 
accounting and reporting for both public and private enterprises. Those 
standards are essential to the efficient functioning of the economy 
because investors and creditors rely heavily on credible, transparent, 
and comparable financial information.
    The FASB's authority with respect to public enterprises comes from 
the US Securities and Exchange Commission (``SEC''). The SEC has the 
statutory authority to establish financial accounting and reporting 
standards for publicly held enterprises. For over 60 years the SEC has 
looked to the private sector for leadership in establishing and 
improving those standards. Therefore, the FASB may be viewed as an 
independent private-sector alternative to government regulation.
    The focus of the FASB is on consumers--users of financial 
information such as investors, creditors, and others. We attempt to 
ensure that corporate financial reports give consumers an informative 
picture of an enterprise's financial condition and activities and do 
not color the image to influence behavior in any particular direction.
    To quote a recent letter from the Financial Accounting Policy 
Committee of the Association for Investment Management and Research, 
the leading organization of investment professionals in the United 
States with over 40,000 members:
          The ``lifeblood'' of United States capital markets is 
        financial information that is: (1) comparable from firm to 
        firm; (2) relevant to investment and financing decisions; (3) a 
        reliable and faithful depiction of economic reality; and (4) 
        neutral, favoring neither supplier nor user of capital, neither 
        buyer nor seller of securities.
    The notion of neutrality is a fundamental element of our standard-
setting process. The FASB's Rules of Procedure explicitly require that 
the Board be objective in its decision making to ensure the neutrality 
of information resulting from its standards.
    Neutrality is an essential criterion by which to judge financial 
reporting standards, because information that is not neutral loses 
credibility and value. For example, surely, we would all agree there 
would be little value to Congress or the federal government of 
purposely altered and manipulated information about the rate of 
inflation or about unemployment.
    Similarly, to create or to tolerate financial reporting standards 
that bias or distort financial information to favor a particular 
transaction, industry, or special interest group undermines the proper 
functioning of the capital markets and impairs investors'' capital 
allocation decisions.
    As former SEC Chairman Richard C. Breeden stated in testimony 
before Congress almost a decade ago:
          The purpose of accounting standards is to assure that 
        financial information is presented in a way that enables 
        decision-makers to make informed judgments. To the extent that 
        accounting standards are subverted to achieve objectives 
        unrelated to fair and accurate presentation, they fail in their 
        purpose.
    The FASB sets standards only if, in the Board's independent 
judgment after carefully considering the input from all interested 
parties, there is a significant need for the standard and the costs the 
standard imposes are justified by the overall benefits. The objective, 
and implicit benefit, of issuing an accounting standard is increased 
credibility and representational faithfulness of financial reporting. 
However, the value of that improvement to financial reporting is 
usually impossible to measure and the Board's assessment of an 
accounting standard's benefit to companies that prepare financial 
reports and to investors and creditors that use financial reports is 
unavoidably subjective.
    The US capital markets are the deepest, most liquid, and most 
efficient markets in the world. The unparalleled success and 
competitive advantage of the US capital markets are due, in no small 
part, to the high-quality and continually improving US financial 
accounting and reporting standards. As Federal Reserve System Chairman 
Alan Greenspan stated in a June 4, 1998 letter to SEC Chairman Arthur 
Levitt:
          Transparent accounting plays an important role in maintaining 
        the vibrancy of our financial markets . . . An integral part of 
        this process involves the Financial Accounting Standards Board 
        (FASB) working directly with its constituents to develop 
        appropriate accounting standards that reflect the needs of the 
        marketplace.
What Process Did the FASB Follow in Developing Its Proposed Standard?
    Because the actions of the FASB affect so many organizations, its 
decision-making process must be thorough. The FASB carefully considers 
the views of all interested parties--users, preparers, and auditors of 
financial information. Our Rules of Procedure require an extensive due 
process that was modeled on the Federal Administrative Procedure Act, 
but it is broader and more open in several ways. It involves public 
meetings, public hearings, and exposure of our proposed standards to 
external scrutiny and public comment. The Board makes final decisions 
only after carefully considering and understanding the views of all 
parties.
    The FASB's due process for developing a new financial reporting 
standard is best illustrated by describing the process followed in 
developing the Proposed Standard:

 When we began the project in 1996, we established a business 
        combinations task force comprising individuals from a number of 
        organizations representing a wide range of the Board's 
        constituents. (Attachment 12 lists the members and their 
        affiliations.) The first public meeting of the task force was 
        held in February 1997.
 In June 1997, we published for public comment a Special Report 
        that contained some of the Board's initial tentative decisions 
        about the project's scope, direction, and content. We received 
        54 comment letters in response to the Special Report.
 In November 1998, we held the second public business 
        combinations task force meeting to discuss issues related to 
        the project.
 In December 1998, we published for public comment, in 
        participation with other members of an international 
        organization of accounting-standard-setting bodies, a Position 
        Paper that addressed a number of issues related to the methods 
        of accounting for business combinations. We received 148 
        comment letters in response to the Position Paper.
 We held over 40 public meetings since 1997 to address the 
        issues associated with the methods of accounting for business 
        combinations and the accounting for goodwill and other 
        purchased intangible assets and to consider constituent 
        comments.
 After each meeting, we updated a paper that summarized all of 
        the Board's decisions. The updated paper was available on the 
        FASB webpage and was sent by mail to anyone who requested it.
 Our weekly newsletter, Action Alert, announced each meeting in 
        advance and reported a summary of the results of each meeting. 
        (In addition, press reports of some of the meetings were 
        available in certain business publications.)
 The Board and staff discussed the project on business 
        combinations and intangible assets with representatives of 
        companies and trade associations and with investors and 
        creditors at dozens of liaison meetings, public conferences, 
        and forums throughout the US and the world.
 In September 1999, we published for public comment an Exposure 
        Draft (the Proposed Standard) that contains proposed changes to 
        the existing standards of accounting for business combinations 
        and intangible assets. We received approximately 200 comment 
        letters in response to the Exposure Draft.
 In connection with the issuance of the Exposure Draft, we 
        prepared and issued the following explanatory documents to 
        assist constituents in understanding the Board's proposed 
        decisions: ``September 1999 FASB Exposure Draft, Business 
        Combinations and Intangible Assets: An Overview'' (Attachment 
        4); ``FASB Business Combinations Project: September 1999 FASB 
        Exposure Draft, Business Combinations and Intangible Assets: 
        Frequently Asked Questions'' (Attachment 9); FASB Viewpoints, 
        ``Why Eliminate the Pooling Method?'' (Attachment 7); and FASB 
        Viewpoints, ``Why Not Eliminate Goodwill?'' (Attachment 8). All 
        of the documents were available on the FASB webpage and were 
        sent by mail to anyone who requested them.
 We held four days of public hearings in February 2000 (two 
        days in San Francisco and two days in New York City) to discuss 
        the Exposure Draft with interested parties. More than 40 
        individuals and organizations testified.
 In March 2000, the business combinations task force met with 
        members of the Board and staff to discuss a number of issues 
        raised in the comment letters and at the public hearings.
What's Wrong with the Present Accounting for Business Combinations?
          There are few areas in the current accounting literature that 
        need reform more than business combination accounting . . .

 Jack T. Ciesielski, CPA, CFA, President, R.G. Associates, 
                                                      Inc.,
               Investment Research/Investment Management, 11/29/99.

    The current accounting for business combinations is governed by the 
requirements of APB Opinions No. 16, Business Combinations, and No. 17, 
Intangible Assets, which were issued in 1970 by the Accounting 
Principles Board (``APB'') of the American Institute of Certified 
Public Accountants.
    Under APB Opinions 16 and 17, business combinations are reported 
using either of two very disparate methods--the purchase method or the 
pooling-of-interests method (``pooling method''). Those two methods 
produce dramatically different financial reporting results for 
essentially the same or similar economic transactions.
    Under the purchase method, the acquiring company records the net 
assets of the acquired company at the price paid, including any 
intangible assets to the extent they can be separately identified and 
reliably measured. The excess of the price paid over the fair value of 
the acquired company's net assets is recorded as an asset called 
goodwill, which is subsequently charged against earnings over time.
    The purchase method is consistent with the accounting for all other 
acquired assets--all purchases, whether a piece of inventory or a 
patent, are recorded at the price paid and are generally charged 
against earnings over their useful economic life.
    In contrast to the purchase method, under the pooling method, the 
book values of the combining companies are simply added together. There 
is no recognition of the full price paid. There is, therefore, no 
change in the recorded amount of the acquired company's net assets to 
reflect their fair value, no recognition of intangible assets not 
previously recorded, and no resulting goodwill, and thus the true cost 
of the transaction is not reflected in the income statement. By not 
recognizing that cost, the future earnings of the newly combined 
company are artificially inflated.
    In commenting on what's wrong with the pooling method, a September 
10, 1999 article in the New York Times entitled ``Can Regulators Keep 
Accountants from Writing Fiction?'' by Floyd Norris, states:
          Pooling accounting is ridiculous because it allows 
        corporations to pretend that they paid much less for an 
        acquisition than they did. Let's say Company A buys Company B 
        for $100 million in stock, and then, a few years later, sells 
        Company B for $50 million. In reality, it was a disastrous 
        acquisition for Company A. But thanks to the magic of pooling, 
        Company A would have shown the original acquisition as costing 
        not the $100 million it paid but a number that could be far 
        lower--say, $20 million--reflecting the book value of Company 
        B. Presto: Company A reports a profit of $30 million when it 
        really lost $50 million.
    In addition, an article entitled ``Big Banks Debunked,'' by Amy 
Kover, in the February 21, 2000 edition of Fortune describes what's 
wrong with the use of the pooling method in several recent business 
combinations in the financial services industry:
          Used just for stock transactions, pooling of interest allows 
        the acquirer to add to its books only the book value of the 
        acquired company--not the full price it paid for the target. 
        That's a pretty neat trick if you've paid a fat premium for an 
        acquisition, as Banc One did for First USA (43% over the market 
        value), First Union did for CoreStates (18% over), and 
        NationsBank did for Barnett (37% over). In the magic of 
        pooling-of-interest accounting, those premiums simply vanish.
          What's so useful about that? Well, because the acquisition 
        appears to add little to the surviving company's equity base--
        even as it captures all the extra earnings from the acquired 
        company--the new bank's return on equity looks as if it's on 
        steriods. The effect is anything but trivial. For example, when 
        Michael Mayo of Credit Suisse First Boston recalculated each 
        bank's cash return on average tangible equity as if it had used 
        purchase accounting, Bank One's 1998 return on equity went from 
        27% to 12%. At First Union, it fell from 35% to 11.8%. And Bank 
        of America's 29% return on equity dropped to about 10.8%. As 
        Dale Wettlaufer of Legg Mason says, ``The end result is that 
        the cash return on tangible equity is a totally bankrupt 
        measure.''
    To use the pooling method, 12 specific criteria must be met; a key 
criterion is that the consideration exchanged takes the form of stock 
rather than cash or debt. The vast majority of business combinations 
today, including the many stock-for-stock transactions that fail to 
meet one or more of the pooling method criteria, are accounted for 
using the purchase method.
    As the pace of business combinations has increased over recent 
years, the availability of two different accounting methods for very 
similar transactions that produce dramatically different levels of 
information to the market has become more and more problematic. A study 
of business combinations of public corporations over the period 1992-
1997 found that the quantity and dollar magnitude of pooling method 
transactions rose dramatically from 105 transactions valued at $16.9 
billion in 1992 to 321 transactions valued at $213.8 billion in 1997 
(Attachment 6). A letter from the Consumer Federation of America to the 
FASB commented on that phenomenon:
          Over the last decade, a tidal wave of merger activity has 
        swept through nearly every corner of the American economy. 
        According to the Federal Trade Commission, the number of 
        federal pre-merger filings has nearly tripled since the 
        beginning of the decade, from 1,529 in 1991 to an estimated 
        4,500 last year. The market value of those mergers has risen 
        even more dramatically, from $600 billion in the previous peak 
        year of 1989 to more than $2 trillion in 1998. And several 
        factors, not least passage this year of the financial 
        modernization legislation, lead us to conclude that this 
        activity is unlikely to abate any time soon. Ensuring that 
        investors get complete and accurate information about the 
        effects of mergers is, thus, a timely and important issue for 
        the Financial Accounting Standards Board to tackle.
    Beginning in the early 1990s, the Financial Accounting Standards 
Advisory Council (``FASAC''), a group composed of over 30 senior-level 
individuals from business, public accounting, professional 
organizations, and the academic and analyst communities, consistently 
ranked a possible project on improving the accounting for business 
combinations as a high priority for the Board. (Attachments 10 and 11 
provide a listing of the members of FASAC and their affiliations and a 
description of FASAC, respectively.) At the July 1996 FASAC meeting, 
members indicated overall support for adding a project on improving the 
accounting for business combinations to the Board's agenda.
    The Board agreed with the recommendation of FASAC and, in the fall 
of 1996, decided to add to its agenda a project on accounting for 
business combinations. Among the more significant reasons that led the 
Board to reach that decision included the following:

 The Board wanted to address perceived flaws and deficiencies 
        in APB Opinion 16. One significant flaw is the fact that two 
        economically similar business combinations can be accounted for 
        using different accounting methods that produce dramatically 
        different financial results. The availability of two methods 
        makes it difficult for financial statement users to compare the 
        financial reports of companies that use different methods of 
        accounting for business combinations.
 Many believe that having two accounting methods affects 
        competition in markets for business combinations. Companies 
        that cannot meet all of the conditions for applying the pooling 
        method believe they face an unlevel playing field in competing 
        for a target against those that can apply that method. Because 
        companies that can use the pooling method do not have to 
        account for the cost of the investment or its subsequent 
        performance, some believe those companies are willing to pay 
        more for a target than companies that cannot use that method.
 There has been a continuous need to interpret APB Opinion 16. 
        Despite the fact that APB Opinion 16 was issued almost 30 years 
        ago, the volume of inquiries about its application remains 
        high, an indication that the existing literature might be in 
        need of significant repair. Many of those inquiries are 
        concerned with whether a specific transaction meets the 
        criteria for use of the pooling method.
 Because of the rapidly accelerating movement of capital flows 
        globally, there is a need for financial reporting to be 
        comparable internationally. Part of the Board's mission 
        includes promoting international comparability of financial 
        reporting, and accounting for business combinations is one of 
        the most significant areas of difference in accounting 
        standards. In most parts of the world, the pooling method is 
        either prohibited or used only on an exception basis.
 Finally, the Board took note of the historical justification 
        of the pooling method. (Attachment 4 contains a summary of the 
        history of the pooling method.) The Board observed that the 
        pooling method has been regularly challenged since the term 
        pooling-of-interests was first coined in the 1940s. The APB 
        considered eliminating the pooling method when APB Opinion 16 
        was developed in the late 1960s. Although the pooling method 
        was retained, the slimmest possible majority approved Opinion 
        16--six members of the APB dissented from the decision. Three 
        of the six dissenters to APB Opinion 16 stated:
        [Opinion 16] seeks to patch up some of the abuses of pooling. 
            The real abuse is pooling itself. On that, the only answer 
            is to eliminate pooling.
What Does the Proposed Standard Require and Why?
    Three of the key requirements of the Proposed Standard and a brief 
summary of the Board's basis for those requirements are described 
below. Paragraphs 92-366 of the FASB's Exposure Draft provide a 
detailed description of the basis for all of the Board's decisions.
    Proposed Requirement #1: The purchase method of accounting would be 
required for all business combinations. Use of the pooling method would 
be prohibited.
    Basis: In current practice, the underlying economics of the 
transactions to which the pooling method is applied are often similar, 
if not identical, to the underlying economics of those transactions 
that are accounted for by the purchase method. Under the pooling 
method, however, investors and creditors are being provided with less 
information--and less-relevant information--than is provided by the 
purchase method. That is because the pooling method ignores the values 
exchanged in a business combination transaction, whereas the purchase 
method records those values on the face of the balance sheet. As a 
result, the pooling method does not provide users of financial reports 
with full information about how much was invested in the combination. 
More important, because the investment is not fully recorded in the 
financial reports, the pooling method does not provide investors and 
creditors with the information they need to assess the subsequent 
performance of that investment and compare it with the performance of 
other companies.
    For example, in one very visible acquisition that was accounted for 
under the pooling method, the value of the stock issued as 
consideration by the acquiring company was about $10 billion. The book 
value of the company acquired was only $500 million. The acquisition, 
therefore, was reported at $500 million in the financial statements of 
the combined company, and $9.5 billion of value ($10 billion less $500 
million) simply disappeared. There was no reporting of the $9.5 billion 
in the financial statements of the combined company; thus, it is 
virtually impossible for investors to relate subsequent performance 
against 95 percent of the purchase price paid for the acquired company.
    The example is not unique, a study of a sampling of 756 pooling 
method transactions of public corporations entered into over the period 
1992-1997 found that $267 billion of assets, constituting about 66 
percent of the total acquisition price, went unreported in the 
financial statements (Attachment 6).
    The information that the pooling method provides about individual 
assets and liabilities is also less complete and less comparable than 
that provided by the purchase method. It is less complete because the 
pooling method does not record any acquired assets or liabilities that 
were not previously recorded, including valuable trademarks, customer 
lists, and other intangibles, and thus ignores their presence, even 
though they were acquired at a cost and can be separately identified 
and reliably measured.
    In contrast, the purchase method reveals those hidden assets and 
liabilities by recording them. Moreover, the acquired assets and 
liabilities that the pooling method does record are not measured on a 
basis that is comparable with how acquisitions generally are measured 
(that is, at the values exchanged in those transactions), as does the 
purchase method. Because the values exchanged are not recorded, 
subsequent rate-of-return measures are artificially inflated.
    Proposed Requirement #2: The maximum goodwill amortization period 
would be reduced from the current 40 years to 20 years.
    Basis: The Board based this proposed requirement on a number of 
factors. The Board observed that the rapid pace of technological change 
was shortening product life cycles and requiring enterprises to 
reinvent themselves more regularly in order to survive. Thus, in 
general, the average useful economic life of goodwill has been 
diminishing since 1970. That observation was supported by evidence 
provided by companies, including those that participated in limited 
field tests.
    The Board also observed that in current practice the amortization 
period used by many companies, including those in the technology and 
financial services industries, is generally less than 25 years.
    Finally, the Board observed the relatively recent decisions of 
several other national accounting standards-setting bodies that have 
addressed this issue. Those bodies have generally concluded that 
goodwill should have a presumptive useful life of 20 years or an 
absolute maximum amortization period of 20 years.
    Proposed Requirement #3: Companies would be required to present 
goodwill amortization as a separate line item on the income statement, 
preceded by a subtotal, to make the charge to earnings more transparent 
to investors and creditors.
    Basis: The Board decided that goodwill amortization should be 
presented as a separate line item in the income statement because 
goodwill is a unique asset, the useful life of which cannot be 
determined precisely. In addition, some investors and creditors often 
weigh goodwill amortization differently from other expenses in their 
financial analysis, and the proposed presentation would benefit those 
users.
    Intangible Assets: It is important to note that the Proposed 
Standard would not require the separate valuation, reporting, and 
amortization of intangible assets that are not reliably measurable, 
such as many forms of knowledge-based intangible assets so often 
associated with technology companies. A review of the comment letters 
and public hearing testimony reveals that this point has continued to 
be a source of some confusion for some constituents. To clarify, under 
current accounting standards and the Proposed Standard, only purchased 
intangible assets that can be separately identified and reliably 
measured, like many trademarks and customer lists, are required to be 
separately valued, reported, and amortized over their useful economic 
lives.
    Unlike current accounting, however, the Proposed Standard does 
provide certain circumstances in which intangible assets are not 
amortized. The Proposed Standard provides that, if an intangible asset 
has an indefinite useful economic life and meets certain other 
criteria, the asset shall not be amortized until its life is determined 
to be finite. Thus, if an intangible asset was increasing in value, the 
Proposed Standard would provide circumstances in which that asset would 
not be amortized.
    The Board is aware of, and the FASB staff is actively participating 
in and monitoring, various studies and research currently being planned 
or performed by various constituent groups that might be relevant to 
the accounting for intangible assets. In addition, the FASB staff is 
currently performing independent research in this area. The scope of 
our research involves determining whether changes in the US economy 
should result in changes in the type of information included in 
financial statements and the manner in which that information is 
presented and delivered to users. That research includes a review of 
the accounting treatment for intangible assets.
    The Board will carefully evaluate the results of the studies and 
research of the constituent groups and FASB staff. We anticipate that 
those results might help us expand our understanding of financial 
reporting issues related to accounting for intangible assets. Those 
results might also assist in developing future formal agenda projects 
of the Board.
Who Will Benefit from a Change in the Accounting for Business 
        Combinations and How?
    The Proposed Standard will benefit the public--investors, 
creditors, and other users of financial statements--as well as 
companies that prepare and audit those reports.
    The Proposed Standard's requirement to eliminate the pooling method 
will benefit investors, creditors, and other financial statement users 
by providing more information and more relevant information about all 
business combinations. The Proposed Standard's provisions also will 
benefit those consumers by improving the comparability of financial 
reporting, thereby making it possible to more easily contrast companies 
that participate in business combinations.
    Many consumers have expressed support for elimination of the 
pooling method. As one example, a letter from the Financial Accounting 
Policy Committee of the Association for Investment Management and 
Research states:
          The FAPC is unequivocal in its support of the FASB's proposal 
        that there be only one method of accounting for business 
        combinations in the United States. We also agree that the 
        purchase method is the one that reflects properly the economics 
        of all business combinations, and that pooling-of-interests 
        should be eliminated . . .
          The pooling method fails to revalue the assets and 
        liabilities of the acquired enterprise at fair value and the 
        excess, commonly called ``goodwill,'' is not recorded. Hence, 
        pooling does not faithfully represent the values of the assets 
        and liabilities exchanged, nor does it reveal the actual 
        premium paid by the acquirer in the transaction. Users of 
        financial statements are thus impeded in their attempts to 
        understand the underlying economics of the business 
        combination.
    Many companies that prepare financial reports also agree. Those 
companies that have written letters to the FASB supporting the 
elimination of the pooling method include IBM Corporation, Eaton 
Corporation, American Electronic Power, General Motors, Caterpillar, 
Inc., IMC Global, and PPG Industries, Inc., to name a few. The IBM 
Corporation letter stated:
          IBM agrees with the FASB that all business combinations are 
        acquisitions and, thus, we support the FASB's proposal to 
        eliminate the pooling-of-interests method of accounting for a 
        business combination. We believe that financial statement users 
        are ill-served by the existence of two methods to account for 
        the same economic transaction. We agree with the FASB that 
        using the purchase method to account for all business 
        combinations will increase the comparability of financial 
        statements and will reflect the true economics of the 
        transaction, that is, an arm's length investment that should be 
        accounted for at the fair value of the assets and liabilities 
        that are acquired.
    The Proposed Standard will also benefit companies that prepare 
financial statements and the auditors of those statements by providing 
a single method of accounting for all business combinations. Having one 
method of accounting for all business combinations will reduce certain 
costs to companies and auditors that are currently related to the 
existence of the pooling method.
    For example, the availability of the pooling method often puts 
companies and their auditors under pressure to employ that method 
because it typically produces higher reported earnings and rates of 
return subsequent to a business combination than the purchase method. 
Moreover, because the pooling method is applied retroactively, the 
comparative earnings reported for periods preceding the combination are 
also higher than under the purchase method--even before the companies 
were, in fact, combined.
    As a result of those pressures, companies often must bear 
significant costs, both monetary and nonmonetary, in seeking to use the 
pooling method. In positioning themselves to try to meet the 12 
criteria for applying that method, companies may refrain from engaging 
in appropriate economic actions that they might otherwise undertake, 
such as asset dispositions or share reacquisitions. They also may incur 
substantial fees from auditors and consultants in seeking to meet those 
criteria. The efforts to meet those criteria also may lead to conflicts 
between companies, auditors, and regulators with respect to judgments 
about whether the criteria have been met, thereby adding uncertainties 
and their attendant costs to the process and raising questions about 
the operationality of those criteria.
    A report published by the Silicon Valley office of McKinsey & 
Company, an international consulting firm, stated:
          The fear that purchase accounting, by lowering reported 
        earnings, will destroy shareholder value is a myth. In fact the 
        opposite is true. Efforts to qualify for such treatment 
        actually destroy value. FASB's proposal to eliminate pooling 
        accounting is a blessing in disguise. Why? Because the 
        transition to purchase accounting will require corporations to 
        adopt more robust deal evaluation processes and enhance their 
        shareholder communications.
    Similarly, a letter to the FASB from the Financial Institutions 
Accounting Committee of the Financial Managers Society (``FIAC''), a 
group of 15 financial professionals working in executive level 
positions in the thrift and banking industries, stated:
          Formal research supports the proposition that reporting firms 
        consume substantial resources in structuring transactions 
        solely to achieve a favorable financial reporting outcome. Lys 
        and Vincent (1995) report that AT&T paid at least $50 million 
        (and possibly as much as $500 million) to achieve pooling-of-
        interests accounting for its acquisition of NCR. . . . A single 
        method of accounting for business combinations would redirect 
        these corporate resources into more productive areas.
    In addition, having one method of accounting for business 
combinations benefits companies by leveling the playing field for 
competition among companies in the business combinations market. The 
ability--or inability--to use the pooling method often affects whether 
a company enters into a business combination and also affects the 
prices they negotiate for those transactions. Companies that cannot use 
the pooling method because they cannot meet the criteria required for 
its use (for example, criteria that prohibit certain share 
acquisitions) often conclude that they cannot compete for targets with 
those that can meet the criteria.
    Many companies that cannot use the pooling method believe that 
companies that can use it often are willing to pay higher prices for 
targets than they would if they had to use the purchase method because 
they do not have to account for the full cost of the resulting 
investment. Thus, by using the pooling method, they can understate the 
income statement charges (primarily related to goodwill and other 
intangible assets).
    In a letter to the FASB, KeyCorp explained:
          Since most publicly-traded companies are gauged by EPS 
        performance, there is a strong incentive to use the ``earnings-
        friendly'' pooling method. The desire to avoid the earnings 
        consequences of the purchase method has almost certainly 
        resulted in uneconomic behavior. It is well understood in the 
        investment banking community that a company is willing to 
        ``pay'' more for a target if the pooling method is available 
        for the resulting transaction. Clearly, there is a view that 
        the pooling method results in a type of accounting arbitrage . 
        . .
    Even though using the pooling method rather than the purchase 
method might result in being able to report higher per-share earnings 
following the combination, the fundamental economics are not different 
because the actual cash flows generated following the combination will 
be the same regardless of which method is used. As a result, the added 
earnings reported under the pooling method reflect artificial 
accounting differences rather than real economic differences.
    To the extent that the markets respond to artificial differences, 
they direct capital to companies whose financial reporting benefits 
from those differences and they direct capital away from companies 
whose financial reporting does not benefit. As a result, markets 
allocate capital inefficiently rather than efficiently. While 
inefficient allocation of capital may benefit some companies and even 
some industries, it imposes added costs on many others, depriving them 
of capital that they need and capital they could employ more 
productively. The outcome is detrimental to those companies--but more 
important, to the capital markets as a whole.
What Happens Next?
    On April 12, 2000, the Board began the next significant stage of 
its work on the business combinations project. That stage will involve 
redeliberation of all of the issues contained in the Proposed Standard. 
As part of that redeliberation, the Board will carefully consider the 
feedback it has received through the comment letters, public hearing 
testimony, the testimony at this hearing, and any and all relevant 
information provided by interested parties.
    The Board will hold as many public meetings as necessary to 
thoroughly discuss all of the feedback received and to decide what 
modifications or clarifications to the Proposed Standard are 
appropriate. The Board will not make any final decisions about the 
Proposed Standard or consider whether to issue a final standard until 
it is satisfied that all substantive issues raised by all parties have 
been considered.
    The Board presently expects to complete its work and be in a 
position to issue a final standard by no earlier than the end of the 
year 2000. That estimate may change depending on the progress of the 
Board's redeliberations. Any final standard will be effective no 
earlier than the date of its issuance.
    In closing, I want to be clear that the FASB understands and 
supports the oversight role of this Subcommittee. We will carefully 
consider what we learn from this hearing. Let me assure you, Mr. 
Chairman and members of the Subcommittee, that our open due process and 
our independent and objective decision making will be carefully and 
fully carried out. To do otherwise would jeopardize the very foundation 
upon which the FASB was created, and for which it has proven invaluable 
to the US capital markets and to investors and creditors--the consumers 
of financial information.
    Thank you, Mr. Chairman. I very much appreciate this opportunity 
and would be pleased to respond to any questions.

    Mr. Oxley. Thank you, Mr. Jenkins. Once again we appreciate 
your cooperation and openness throughout this entire process. 
As the other member said, it has been a pleasure to work with 
you in such a manner.
    Before I introduce our next witness, let me introduce our 
good friend Joe Crowley, from New York, who is not a member of 
the committee, but is interested in this subject and has agreed 
to be with us this morning. Welcome.
    Mr. Powell?

                 STATEMENT OF DENNIS D. POWELL

    Mr. Powell. Good morning. Thank you for inviting me to this 
hearing.
    I am vice president and corporate controller for Cisco 
Systems. Cisco is the worldwide leader in networking, with 
revenues currently approximating $17 billion per year. We are a 
multinational corporation with more than 28,000 employees and 
200 offices in 55 countries. In the U.S. we have significant 
operations in California, Texas, Massachusetts, and North 
Carolina.
    The two methods of accounting that we are discussing today, 
purchase and pooling of interests, have been generally accepted 
in practice since 1945. In 1970, the Accounting Principles 
Board studied and discussed the pros and cons of the two 
accounting methods and issued APB16 entitled ``Business 
Combinations,'' which reaffirmed the validity of both the 
purchase and pooling of interests method.
    This viewpoint was again reaffirmed in 1994 by a task force 
commissioned by the American Institute of Certified Public 
Accountants, as we heard earlier, to study the usefulness of 
financial reporting. This report, entitled ``Improving Business 
Reporting, a Customer Focus,'' concluded after 3 years of study 
that a project to do away with either method would be very 
controversial, require a significant amount of FASB time and 
resources, and at the end is not likely to improve 
significantly the usefulness of financial statements.
    So the arguments for and against the pooling and purchase 
methods of accounting haven't changed for the past 30 years. We 
are still debating the same issues.
    However, the problems with the purchase method are still 
with us, but the implications today are much more severe than 
they were in 1970. In 1970, most of an acquisition price was 
allocated to tangible, hard assets. Today, for knowledge-based 
technology companies, most of the acquisition price is 
allocated to intangible assets and very little to hard assets.
    For example, since 1993, Cisco has acquired over 50 
companies amounting to over $19 billion. Of these acquisitions, 
only $900 million or 5 percent is attributed to hard assets; 
$18 billion or 95 percent of the acquisitions would be left to 
allocate to intangibles or goodwill. So the limitations of the 
purchase method have become much more problematic. Yet the new 
FASB proposal would force all acquisitions to be accounted for 
under the purchase method, without having solved its defects.
    The most significant defect of the purchase method is the 
accounting for goodwill once it is recorded as an asset on the 
balance sheet. The FASB proposal requires that goodwill be 
treated as a wasting asset and requires that it be amortized 
over 20 years. This model incorrectly assumes that goodwill 
declines in value over time, which artificially reduces net 
income and misrepresents economic reality.
    For example, we studied four technology mergers that 
occurred in 1996 and 1997. The results of the four companies in 
the study are summarized in attachment B to my testimony. As 
you can see from that exhibit, the purchase accounting model 
significantly reduced actual earnings by an average of 48 
percent because of the amortization of goodwill. This would 
suggest that goodwill has declined in value. However, over the 
same period, goodwill actually increased from the date of the 
merger by an average of 43 percent.
    Based on the above study, it is clear that in successful 
mergers, the presumption that goodwill is a wasting asset is 
not valid. Goodwill increases in successful acquisitions and 
declines rapidly in unsuccessful acquisitions. Goodwill does 
not decline radically over 20 years. The FASB model simply does 
not report true economic performance.
    The FASB argues that the pooling of interests method 
provides investors with less information and less relevant 
information than provided by the purchase method because the 
pooling method ignores the values exchanged, whereas the 
purchase method records these values on the face of the balance 
sheet.
    I disagree that the pooling method provides less 
information. At the time of a merger, the number of shares 
exchanged and the related share values are known, so the value 
of the transaction is known. Furthermore, the pooling method of 
accounting reports a more conservative balance sheet, reports 
the results of operations more accurately, and presents 
investors and creditors with more relevant information to 
assess subsequent performance of the combined entities than the 
purchase method.
    If I could refer you to attachment C as an illustration, if 
companies A and B would combine, the pooling method would 
report a combined equity of zero dollars, in the example that I 
provided. However, the purchase model creates an inflated 
equity of $4,000, giving the impression that these two anemic 
companies have been made well simply by combining.
    Furthermore, because the purchase method incorrectly 
assumes that goodwill reported on the balance sheet declines 
over 20 years, the combined companies' operations are 
artificially reduced from the actual performance under purchase 
accounting. The pooling method more faithfully reports true 
economic performance as illustrated in the attachment C.
    Finally, application of the purchase method would mislead 
the reader of the financial statements, the combined financial 
statements, into believing that the revenues had increased 100 
percent from $2,500 in year 1 to $5,000 in year 2. However, the 
pooling method would correctly reflect the true view that sales 
had been flat between the 2 years because this method requires 
that previously reported financial statements be restated to 
report the combined operations as if they had always been 
together. In this case, both years 1 and 2 would reflect sales 
of $5,000.
    In summary, the pooling method reports a more conservative 
balance sheet, more accurate income, and a better comparison of 
operations and a truer picture of sales trends.
    In conclusion, the U.S. accounting rules for business 
combinations, which includes both the pooling and the purchase 
methods, has for the past 50 years generated and supported the 
strongest capital markets in the world. Before the FASB 
radically changes these accounting rules to a model that will 
certainly stifle technology development, impede capital 
formation, and slow job creation in this country, the FASB 
should make sure that the new proposed method is without 
question the absolute correct answer.
    In reality, the FASB's proposed standard does not improve 
financial reporting, it merely changes it. Worse yet, the 
proposed changes require companies to use a purchase model that 
does not work for companies in the new economy, where most of 
the acquisition value cannot be attributed to hard assets, 
forcing companies to report an arbitrary net income number that 
is irrelevant and misleading.
    We believe that, first, the FASB should retain the pooling 
of interests method of accounting. The pooling method of 
accounting continues to have broad support, as evidenced by 
two-thirds of the respondents to the current FASB exposure 
draft, and all of the Big 5 accounting firms disagreed with the 
FASB's plan to eliminate pooling accounting.
    Second, revise the purchase method to correct its 
deficiencies, such as charge purchased goodwill directly to 
shareholders' equity, or amortize it through comprehensive 
income, or reduce goodwill only when it has actually declined 
in value, or the impairment method; and then limit the 
allocation of purchase price only to those intangibles that can 
be objectively and reliably valued; and third, engage a task 
force which would include evaluation experts to develop 
adequate guidance on how to identify, value and account for 
intangible assets for new economy companies.
    I agree with Mr. Jenkins in his statement with respect to 
the Garten Commission. It was not commissioned to address this 
point. As a member of that commission, I can verify that. What 
that means, though, I think, is that someone needs to address 
this issue, because it is not being addressed today. I think 
that is the FASB's job. I think they should do that before they 
issue their pronouncement.
    Thank you very much.
    [The prepared statement of Dennis D. Powell follows:]
   Prepared Statement of Dennis D. Powell, Vice President, Corporate 
                    Controller, Cisco Systems, Inc.
                              introduction
    My name is Dennis Powell. I am Vice President and Corporate 
Controller for Cisco Systems, Inc.
    Cisco is the worldwide leader in networking with revenues currently 
approximating $17 billion per year. We are a multinational corporation 
with more than 28,000 employees in 200 offices and 55 countries. In the 
U.S., we have significant operations in California, Texas, 
Massachusetts and North Carolina.
                               background
    The two methods of accounting--``Purchase'' and ``Pooling of 
Interests''--have been generally accepted in practice since 1945. In 
1970, the Accounting Principles Board studied and discussed the pros 
and cons of the two accounting methods, and issued APB16 ``Business 
Combinations'', which reaffirmed the validity of both the purchase and 
pooling of interests methods.
    This viewpoint was again reaffirmed in 1994 by a task force 
commissioned by the American Institute of Certified Public Accountants 
to study the usefulness of financial reporting. This report, entitled 
``Improving Business Reporting--A Customer Focus'' concluded, after 
three years of study, that, ``A project to do away with either method 
would be very controversial, require a significant amount of FASB time 
and resources, and in the end is not likely to improve significantly 
the usefulness of financial statements.''
    The arguments for and against the pooling and the purchase methods 
of accounting haven't changed over the past 30 years--we are still 
debating the same issues.
    However, the problems of the purchase method are still with us, and 
the implications today are much more severe than they were in 1970. In 
1970, most of an acquisition price was allocated to tangible, hard 
assets. Today, for knowledge-based technology companies, most of the 
acquisition price is allocated to intangible assets--and very little 
allocated to hard assets. For example, since 1993, Cisco has acquired 
over 50 companies amounting to $19 billion. Of these acquisitions, only 
$900 million, or 5%, is attributed to hard assets--$18 billion or 95% 
would be left to allocate to intangible assets or goodwill. So the 
limitations of the purchase method have become more problematic. And 
yet the new FASB proposal would force all acquisitions to be accounted 
for under the purchase method, without having solved its defects.
                         goodwill amortization
    The most significant defect of the purchase method is the 
accounting for goodwill once it is recorded as an asset on the balance 
sheet. The FASB proposal requires that goodwill be treated as a wasting 
asset, and be amortized ratably over 20 years. This model incorrectly 
assumes that goodwill declines in value over time, which artificially 
reduces net income and misrepresents economic reality. In reality, the 
value of goodwill is dependent upon the success of the merger, and is 
not a function of time.
    For example, we studied four technology mergers that occurred in 
1996 and 1997, which were reported as poolings. We then recast the 
poolings as if they were purchases, and restated the financial 
statements for periods after the acquisition to show the impact of 
goodwill amortization. The results of all four companies in the study 
are summarized on Attachment B. The purchase accounting model 
significantly reduced actual earnings by an average of 48% because of 
the amortization of goodwill. This would suggest that goodwill has 
declined in value. However, over this same time period, goodwill has 
actually increased from the date of the merger by an average of 43%.
    Based on the above study, it is clear that in successful mergers, 
the presumption that goodwill is a wasting asset is not valid. Goodwill 
increases in successful acquisitions and declines rapidly in 
unsuccessful acquisitions. Goodwill does not decline ratably over 
twenty years--the FASB model simply does not report true economic 
performance.
                              intangibles
    Regarding valuation of other intangible assets, the FASB proposal 
obligates companies to identify and value all intangible assets, 
without giving adequate guidance on how these assets should be 
separately identified and valued. There are no standards in the 
valuation community to provide any consistency or reliability around 
the valuation of these intangibles.
    At risk is a loss of credibility in financial reporting. FASB must 
provide more guidance and tools around how their requirements should be 
implemented.
                             comparability
    The FASB has stated that elimination of pooling solves a 
comparability issue between purchase transactions and pooling 
transactions. But elimination of pooling simply trades one 
comparability issue with a set of new comparability problems. First, 
mandating the purchase method creates significant comparability issues 
between companies who grow from internal organic development and those 
who grow through acquisition.
    For example, a company that generates significant goodwill from its 
internal operations will report no goodwill value while the company 
that acquires goodwill through a merger will report the ``value'' of 
the goodwill at the time of the acquisition. So, while both companies 
may have the same value of goodwill, only the company who obtained the 
goodwill through a merger will report any amount on its balance sheet.
    Secondly, elimination of pooling prevents comparability within the 
same company--in comparing operations before the acquisition, which do 
not include the activities of the acquired company, to operations after 
the acquisition, which do include the activities of the acquired 
company. Eliminating pooling does not solve the comparability issue.
    I believe the comparability issue would be more effectively 
addressed by correcting the inherent problems of the purchase method 
than by eliminating pooling accounting as an option.
                     defense of pooling accounting
    The FASB argues that the pooling method provides investors with 
less information--and less relevant information--than provided by the 
purchase method, because the pooling method ignores the values 
exchanged whereas the purchase method records these values on the face 
of the balance sheet. I disagree that the pooling method provides less 
information. At the time of a merger, the numbers of shares exchanged 
and related share values are known, so the value of the transaction is 
known. Furthermore, the pooling method of accounting reports a more 
conservative balance sheet, reports results of operations more 
accurately and presents investors and creditors with more relevant 
information to assess subsequent performance of the combined entities 
than the purchase method. Using Attachment C as an illustration, if 
Companies A and B would combine, the pooling method would record a 
combined equity of $0. However, the purchase method would create an 
inflated equity of $4,000, giving the impression that these two anemic 
companies had been made well by simply combining.
    Furthermore, because the purchase method incorrectly assumes that 
the goodwill recorded on the balance sheet declines over 20 years, the 
combined company's operations are artificially reduced from its actual 
performance under purchase accounting. The pooling method more 
faithfully reports true economic performance as illustrated in 
Attachment C.
    Finally, application of the purchase method would mislead the 
reader of the financial statements of the combined financial statements 
into believing that the revenues had increased 100%, from $2,500 in 
Year 1 to $5,000 in Year 2. However, the pooling method would correctly 
reflect the true view that sales had been flat between the two years, 
because this method requires that previously reported financials be 
restated to report the combined operations as if they had always been 
together; in this case both Years 1 and 2 would reflect sales of 
$5,000.
    In summary, the pooling method reports a more conservative balance 
sheet, more accurate income, a better comparison of operations and a 
truer picture of sales trends.
                                summary
    In conclusion, the U.S. accounting rules for Business Combinations, 
which includes both the pooling and purchase methods, has for the past 
50 years, generated and supported the strongest capital markets in the 
world. Before the FASB radically changes these accounting rules to a 
model that will certainly stifle technology development, impede capital 
formation and slow job creation in this country, the FASB should make 
sure the proposed new method is without question, the absolute, correct 
solution. In reality, the FASB's proposed standard does not improve the 
accounting--it merely changes it. Worse yet, the proposed changes 
require companies to use a purchase model that does not work for 
companies in the New Economy, where most of the acquisition value 
cannot be attributed to hard assets, forcing companies to report an 
arbitrary, artificial net income number that is irrelevant and 
misleading.
    We believe the FASB should:

(1) Retain the pooling of interests method of accounting. The pooling 
        method of accounting continues to have broad-based support. 
        Two-thirds of the respondents to the current FASB exposure 
        draft and all of the Big 5 accounting firms disagreed with the 
        FASB's plan to eliminate pooling accounting.
(2) Revise the purchase method to correct its deficiencies, such as:
    (a) Charge purchased goodwill directly to shareholders' equity, or 
            amortize it through comprehensive income, or reduce 
            goodwill only when it has actually declined in value; and
    (b) Limit the allocation of purchase price to only those 
            intangibles that can be objectively and reliably valued;
(1) Engage a task force, which would include valuation experts, to 
        develop adequate guidance on how to identify, value and account 
        for intangible assets for New Economy companies.
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    Mr. Oxley. Thank you.
    Mr. Bible?

                   STATEMENT OF PETER R. BIBLE

    Mr. Bible. It is a pleasure to be with you here today, 
especially a fellow Buckeye, Mr. Chairman. In the land of 
Wolverines and Spartans, it is kind of lonely up there.
    To put my comments in context, Mr. Chairman, I think it is 
important to understand that the General Motors Corporation is 
a participant in both the new and the old economy. Some of our 
new ventures, eGM, Trade Exchange, Hughes Electronics, are 
among some of the darlings on Wall Street as the high-tech 
industry. Those businesses have been built on purchase 
accounting acquisitions.
    Presently there is an exchange offer for $9 billion for GM-
1 and 2 shareholders to exchange their one and two-thirds 
shares for shares of Hughes. I am not sure how their growth 
through nonpooling transactions has impeded their value.
    Now to my written testimony.
    The act of bringing together two or more independent 
businesses to function as one business is known by many names 
on Wall Street and in the media. For purposes of my testimony 
here today, I will use the term ``business combinations'' to 
refer to that act.
    A business combination can be and often is a very 
significant financial and cultural event in the life of a 
business. That financial significance is the very heart of the 
topic of your hearings, and that is the combined income 
statement of the businesses subsequent to the business 
combination.
    Why the income statement, you ask? The answer is, that is 
where investors and other users of financial statements look to 
see if the business combination was accretive, a good thing, or 
dilutive, a bad thing, to net income and earnings per share, 
two of the key determinants for stock price for many 
businesses.
    Why is this the very heart of the topic of your hearings, 
you ask? The answer is, under purchase accounting, the 
difference between the amount paid for a business and the 
historical net book value of that business's net assets or 
equity find its way to the income statement over time as 
expenses. This dilutes net income and earnings per share of the 
combined businesses.
    Under the pooling method, however, that difference between 
the amount paid for a business and the historical net book 
value of that business is never recognized in the financial 
statements of the combined businesses; thus, the game. 
Therefore, at worst, net income of the combined businesses is 
equal before and after the business combination. Accordingly, a 
business combination on an economic basis could be and often is 
dilutive, but that dilution is never reflected in the income 
statement of the businesses.
    The contrarion to this view would tell you that investors 
and analysts are not ignorant, and they can see through the 
differences between purchase and pooling of interests 
accounting. This may be true, but in today's world of ``you're 
as good as your last quarterly results,'' memories fade fast.
    The Accounting Principles Board in their Opinion 16 
recognizes that there are business combinations that represent 
a uniting of shareholders' interests, or what is referred to in 
today's world as a merger of equals, that would be best 
accounted for by combining the historical financial statements 
of the combined businesses.
    To define this type of business combination, the Accounting 
Principles Board put in place 12 tests to be passed. Since its 
issuance in August 1970, Wall Street and others have been 
gainfully employed navigating around the 12 tests in AB16.
    This has given rise to countless interpretations of the 
pooling of interests rules by the Accounting Principles Board, 
the Financial Accounting Standards Board, the Emerging Issues 
Task Force, and the Securities and Exchange Commission.
    Do mergers of equals really exist? Sure, just like Michael 
Jordan and Jack Nicklaus exist, but they are rare, and to 
define them is close to impossible.
    I mentioned earlier in my testimony the cultural 
significance of business combinations. Perhaps that is why the 
term ``merger of equals'' is often used in the press to 
describe an acquisition. I would be shocked if you do not hear 
today that the Financial Accounting Standards Board's Proposed 
Statement on Business Combinations will bring a plague on high-
tech and startup businesses. You should ask those testifiers on 
what basis the stock of a high-tech or startup business trades: 
net income or revenue?
    Not being in the proposed standard affects the recognition 
of revenue. If your concern is there, talk to the SEC on their 
staff accounting bulletin 101.
    Historically, many acquisitions have been accounted for 
using the pooling of interests method because of the use of 
stock as the currency. It is often the case that, for tax 
reasons, stock is a more efficient currency than cash.
    In closing, as you will see in my written testimony, there 
are several provisions of the proposed standard that I do not 
agree with. However, I do support the elimination of the 
pooling of interests method.
    Thank you very much.
    [The prepared statement of Peter R. Bible follows:]
Prepared Statement of Peter R. Bible, Chief Accounting Officer, General 
                           Motors Corporation
    The act of bringing together two or more independent businesses to 
function as one business is known by many names on Wall Street and in 
the media. For purposes of my testimony here today, I will use the term 
``business combinations'' to refer to that act. A business combination 
can be, and often is, a very significant financial and cultural event 
in the life of a business. That financial significance is at the very 
heart of the topic of your hearings, and that is the combined income 
statement of the businesses subsequent to the business combination. Why 
the income statement you ask? The answer is: that is where investors 
and other users of the financial statements look to see if the business 
combination was accretive (a good thing) or dilutive (a bad thing) to 
net income and earnings per share, which are two of the key 
determinants of stock price for many businesses. Why is this at the 
very heart of the topic of your hearings, you ask? The answer is: under 
purchase accounting, the difference between the amount paid for a 
business and the historical net book value of that business' net assets 
or equity finds its way to the income statement over time as expenses. 
This dilutes the net income and earnings per share of the combined 
businesses.
    Under the pooling of interests method, however, that difference 
between the amount paid for a business and the historical net book 
value of that business is never recognized in the financial statements 
of the combined businesses. Therefore, at worst, net income of the 
combined businesses is equal before and after the business combination. 
Accordingly, a business combination on an economic basis could be, and 
often is, dilutive, but that dilution is never reflected in the income 
statement. The contrarion to this view would tell you that investors 
and analysts are not ignorant and can see through the differences 
between purchase and pooling of interest accounting. This may be true 
but, in today's world of ``you're as good as your last quarterly 
results,'' memories fade fast. The Accounting Principles Board in their 
Opinion No. 16 recognized that there are business combinations that 
represent a uniting of shareholders interest, or what is referred to in 
today's world as a merger of equals, that would best be accounted for 
by combining the historical financial statements of the combined 
businesses. To define this type of business combination, the Accounting 
Principles Board put in place twelve tests to be passed. Since its 
issuance in August 1970, Wall Street and others have been gainfully 
employed navigating around the twelve tests in Opinion No. 16.
    This has given rise to countless interpretations of the pooling of 
interests rules by the Accounting Principles Board, the Financial 
Accounting Standards Board, the Emerging Issues Task Force, and the 
Securities and Exchange Commission. Do mergers of equals exist? Sure 
they do, just like Michael Jordan and Jack Nicklaus exist, but they are 
rare and to define them is close to impossible. I mentioned earlier in 
my testimony the cultural significance of business combinations. 
Perhaps that is why the term ``merger of equals'' is used so often in 
the press to describe an acquisition. I would be shocked if you did not 
hear today that the Financial Accounting Standards Board's Proposed 
Statement on Business Combinations will bring a plague on high-tech and 
start-up businesses. You should ask those testifiers on what basis the 
stock of a high-tech or start-up business trades: net income or 
revenue? The topic of your hearing has no affect on revenue. 
Historically, many acquisitions have been accounted for using the 
pooling of interest method because of the use of stock as the currency. 
It is often the case that, for tax reasons, stock is a more efficient 
currency than cash.
    In closing, as you will see in my written testimony, there are 
several provisions of the Proposed Standard that I do not agree with. 
However, I do support the elimination of the pooling of interests 
method.
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[GRAPHIC] [TIFF OMITTED]64765.056

    Mr. Oxley. Thank you, Mr. Bible.
    Mr. Hoffman.

                 STATEMENT OF GENE HOFFMAN, JR.

    Mr. Hoffman. Mr. Chairman, thank you very much for holding 
the hearing. Thank you very much for inviting me and giving me 
the opportunity to speak. I will submit my written testimony 
for the record, and speak quickly, hopefully remaining in my 
time here, on some of the various topics that are brought up.
    First of all, let me tell you what EMusic is and where I 
came from and what I do. We have a unique perspective on 
intangibility, as we are one of the few companies that actually 
sells no physical goods whatsoever. We actually sell 
downloadable music in the form of bits over the Internet for 99 
cents a song or $8.99 an album.
    We also own or operate, or I should say operate, 
RollingStone.com, to which we sell advertising and sponsorship 
revenues and drive downloadable music sales from the Internet 
at that magazine's Web site.
    Because of this, we are uniquely impacted by intangible 
accounting. Unlike Cisco, which is probably one of the tech 
leaders, frankly, we do not even ship a box. When we make or 
made approximately $2.8 million in gross profits last quarter, 
all of that was directly delivered over the Internet; no 
physical goods; no pick, pack and ship; no warehouses. We are 
always in stock.
    It is interesting when we look at these issues, because 
what we are really concerned with overall is the handling of 
intangible accounting. I think my associate from Cisco said it 
well. My concern is that the purchase method accounting has yet 
to really well understand those issues that are fully 
intangible.
    One of the issues I would like to point out specifically 
is--and before I go too deep in this, I want to say that again, 
I have a different and unique perspective. I am the son of an 
accountant, hard-
ly an accountant myself, and the youngest NASDAQ CEO, so I look 
at this, again, from a very different perspective than many 
companies in the space.
    There seems to be a prevalence of a concern that this is 
just a technology company situation. I want to challenge any 
company to admit that they are not a technology company. Every 
single company is a technology company. Even my associate here 
from General Motors admits to the fact that GM is a technology 
company, a very good and successful technology company. Even 
the auto division strives with Armstrong and other programs to 
become more of a service and an intangible asset-based 
business.
    So these are issues for any company that looks at strong 
growth and the ability to monetize, the ability to be weighed 
against their intangible assets.
    I want to make an interesting point and bring the tangible 
assets a little bit more home to the everyday American. Twenty 
years ago a song was written by Don McLean called American Pie. 
Well, that song as an asset. It faded from memory, so in some 
ways, yes, it absolutely decreased in value, but with no 
expenditure by the original songwriter, a small artist we all 
have heard of once in a while called Madonna decided to 
rerelease that song. That intangible asset, the ownership of 
the copyright in American Pie, has tremendously increased in 
value without any expenditure of asset, any expenditure of 
cash, any expenditure of promotion by the original copyright 
owner. That is an important aspect, now, very specific to my 
industry, but telling in the same way that this happens in 
software companies and others.
    Brand names and other pieces, part of which--for example, 
our own public disclosures are heavily laden with the write-
down of goodwill for the acquisition of Tunes.com, 
RollingStone, the EMusic name, the music rights themselves are 
heavily laden with.
    One other important point I want to make, we have heard 
from various people who have had quite a bit more accounting 
experience than I do, but anyone who does a pooling acquisition 
absolutely shows a cost. When AOL acquired NetScape, there was 
a dilutionary cost. It was a direct impact to earnings per 
share.
    This brings me to what I think is the most important issue 
facing us. I personally do not really concern myself with 
whether or not pooling will really be an available and 
acceptable accounting method in the future. What concerns me is 
is it truly transparent to not have it.
    Let me make my point here. Currently when the average 
mother and father, a 40-year-old, tries to evaluate my company 
and other companies in technology space, and I will use the 
company Excitehome, which actually did a purchase method 
acquisition of Excite, there are now two different disclosures 
that are looked at. There are cash basis pro forma and earnings 
per share.
    For the not-as-sophisticated investor who does not have 
access to sell and buy side analysts and equities analysts and 
all the other levels of information that your mutual funds and 
pension funds have, it is very difficult to understand the 
difference between pro forma and actual EPS.
    Most people are used to AT&T in the classic sense, where 
EPS was the No. 1 way they judged a company. Growth in EPS, 
actual EPS, was how they looked at companies. The elimination 
of pooling means a direct double charge in some senses to EPS, 
both dilutionary and then the write-down of the goodwill, the 
acquisition itself. That is the issue. The issue really is not 
how we account for it, it is are we providing the level of 
disclosure and the level of transparency to the individual 
investor.
    I am not concerned about California Teachers Pension Fund. 
I am quite sure that with the type of assets they bring to 
bear, they will be able to easily evaluate my firm and other 
firms quite like me to figure out whether or not we are 
actually performing and whether or not that merger was actually 
a good, positive, accretive merger, or simply a bad mistake and 
something that should never have happened before.
    What I am concerned with is the person who today bought 
1,000 shares at the opening of the market because they thought 
that what we were doing was the right thing, and they looked at 
our EPS and were concerned, how could they lose this much cash, 
because your average individual investor does not know the 
difference between losing cash and losing goodwill, frankly.
    That really is the summation of my concerns. As long as we 
look at this issue in a careful and slow manner, because this 
is a very important change, we are talking about changing 40-
some plus years of generally accepted accounting principles, as 
long as we first tackle the issue that has arisen around 
intangible assets--and again, I put my company to the table 
here and say that very few companies that ever come before you 
have no tangible assets, period. Even Cisco has inventory, 
chips and boxes and various pieces that they are going to sell. 
I can show you a hard drive. That is my inventory. Is it the 
value of the hard drive itself, or is it the 8 percent of the 
U.S. music market that is represented by the files included in 
that which, in the offline world, generated $1.2 billion?
    That is an interesting question. As long as we address that 
question first and then tackle how we do business combinations, 
I am comfortable.
    But as an entrepreneur, I am not comfortable if there is a 
significant disincentive for a smaller, but larger than my 
firm, company to have a disincentive because of the EPS impact 
that a buying company like mine would have to acquiring my 
company. That is a disservice to my shareholders, as much as it 
would be a positive service to say this is a write-down in my 
income statement.
    Thank you.
    [The prepared statement of Gene Hoffman, Jr. follows:]
 Prepared Statement of Gene Hoffman, Jr., Founder, President, and CEO, 
                            EMusic.com, Inc.
Introduction.
    It is a pleasure to take part in this morning's hearing on FASB and 
the important issue of purchase and pooling accounting. My remarks 
today will focus on public policy and not accounting technicalities. I 
am not a CPA. I am an entrepreneur. First, let me take a few moments to 
tell you about EMusic. Since it was founded in January 1998, EMusic has 
established itself at the forefront of how new music will be 
discovered, delivered and enjoyed in the next decade. In addition to 
having the Internet's largest catalog of downloadable MP3 music 
available for purchase, EMusic operates one of the Web's most popular 
families of music-oriented Web sites--including RollingStone.com, 
EMusic.com, DownBeatJazz.com, and IUMA. The company is based in Redwood 
City, California, with regional offices in Chicago, Los Angeles, New 
York and Nashville.
    EMusic.com is the Web's leading site for sampling and purchasing 
music in the MP3 format, which has become the standard in the digital 
distribution of music. Through direct relationships with leading 
artists and exclusive licensing agreements with over 650 independent 
record labels, EMusic.com offers music fans an expanding collection of 
more than 100,000 tracks for purchase--individual tracks for 99 cents 
each or entire downloadable albums for $8.99. EMusic.com features top 
artists in all popular musical genres, such as Alternative (Bush, Kid 
Rock, They Might Be Giants, Frank Black), Punk (Blink-182, The 
Offspring, Pennywise), Jazz (Duke Ellington, Dizzy Gillespie, Louis 
Armstrong, Concord Records), Blues (John Lee Hooker, B.B. King, Buddy 
Guy), Hip Hop (Kool Keith, The Coup), Country (Willie Nelson, Merle 
Haggard, Patsy Cline), Rock (Phish, Goo Goo Dolls, David Crosby), World 
(Nusrat Fateh Ali Kahn, Lee ``Scratch'' Perry) and Vintage Pop (Liza 
Minnelli, Eartha Kitt, Judy Garland).
    To give you an idea of how fast the downloadable music industry is 
growing, the company has now sold over 1 million songs in the popular 
MP3 format since its launch. This total includes single-track sales as 
well as tracks included as part of albums and special collections. In 
addition, EMusic.com's catalog has grown to offer more than 100,000 
high-quality MP3s for sale from over 650 independent labels.
    I am the youngest CEO in NASDAQ. I am twenty-four years old. I am 
one of those freaks of nature in the high tech world--but in a very 
good sense. I am very proud of the fact that I have taken ideas and 
created companies with my friends and with many new people that I have 
been fortunate to meet along my journey. EMusic is my third company. My 
first, PrivNet, I created while in college. I sold it to PGP, Inc., and 
went to work for PGP. PGP was sold in 1997 to Network Associates. While 
at EMusic I have bought four companies. Creating companies, jobs, 
economic wealth--all depend on sound accounting principles supported by 
well thought out public policy. EMusic is a young company that has 
grown by acquisition. So far EMusic has done purchase transactions 
because we are not poolable. But I will come back to that point 
shortly.
    It is important to understand that EMusic represents significant 
intangible assets. Many companies in the New Economy do not nor will 
not have any physical assets. Their value is either between the ears of 
their employees or on the hard drives of their computers and networks. 
EMusic digitally delivers music to consumers. Our only physical asset 
is a farm of computer servers; but frankly, I prefer to outsource that 
to a vendor who really knows that business better than I do and can do 
it for me more cheaply than I can on my own. So far my earnings are not 
too significant; they are increasing however. I am in a loss basis. I 
can tell you that my intangible losses are much more significant than 
my cash base losses because I do write down a lot of intangibles.
Purchase vs. Pooling
    I don't think good public policy here should make this an either or 
discussion. There are problems with both purchase and pooling 
accounting. At the high level the overall process has flaws. FASB needs 
to fix purchase accounting first before it can go after pooling. There 
is a large problem in the high tech community: the growing disparity 
between book value and market value. FASB has yet to effectively engage 
the high tech community on this issue. I have testified to FASB on this 
issue and invite them here today before this Committee to meet with me 
at my offices in Silicon Valley to continue the conversation after this 
hearing is over. We really need a better method for measuring 
intangibles. As more economic wealth moves into intangibles, the 
accounting methods and their supporting public policy have to keep up. 
By not fixing purchase accounting and by eliminating pooling accounting 
FASB only makes matters worse for the New Economy. Moreover, there will 
be no improvement in the flow of information about companies out to the 
markets and investors. As we all know the past few years have enabled 
more Americans to directly invest in the stock market and individual 
companies. Many Americans do so via the Internet; many have stock from 
their employers; many have their retirements and investments in stocks 
and mutual funds. Transparency and the flow of information are critical 
to the success of democracy; the same is true in an increasingly 
democratic, egalitarian and participatory stock market.
The Entrepreneur's Dilemma: An Example.
    As an entrepreneur I have two options to perform a transaction. I 
can utilize purchase accounting method and I have to take an EPS impact 
in the future, or I can do pooling, which obviously has positive 
benefits for myself as a high tech company and an intangible asset 
company. Those companies who have built their intangible assets from 
ground zero don't have that hit against their earnings, frankly, 
because those intangible assets have never been valued. But when I buy 
a company that has valued its intellectual property assets (i.e., its 
intangible assets), that value is against my doing business. Simply 
put, the valuation process is not black and white. A company can see 
the value of its assets increase without doing anything. For example, 
an artist such as Madonna can perform an old song and increase its 
value even though the song is owned by a company unrelated to Madonna 
and her record label. The problem is that valuation is confusing, and 
if it is confusing to companies in the business who know or should know 
as much as there is to know about valuing intangibles, then where does 
this leave the individual investor and institutional investors? One of 
my biggest concerns here is how intangible assets are valued because I 
am not sure that the public really knows what stated assets are really 
worth or are not worth. Institutional investors may be able to get down 
into the details and ascertain from their own perspective what value 
may be but the average Josephine is not likely to decipher what is and 
what is not included in a company's pro forma presentation of earnings 
before they make their personal investment. Notwithstanding the great 
amount of information available to individual investors via the 
Internet the average individual investor simply does not have access to 
the analysts that companies and institutions do.
    This touches upon an even larger public policy issue. And this 
issue underscores why it is so important for the Congress to increase 
its scrutiny of FASB and how it changes the accounting rules. This 
larger public policy issue is a matter of who gets the information, in 
what form and when. Individuals may not get all the information at all, 
in a useable form, or at the last moment after others have seen it and 
made their move in the market. This is an increasing market 
inefficiency given the expanding amount of capital flowing into the 
market from individuals and the growth of margin debt.
Conclusion.
    When so much of the value of the American economy is tied up in 
intangibles, in intellectual property, how the pieces of intellectual 
property are perceived is really the driver of value and not the 
methodology of some accounting practice or rule. If the market is being 
driven more by perception than by the principles and rules that 
government, industry and professionals have set out, then effective 
governance no longer works and the anarchy of the market has taken 
over. This is not fair to individuals and is not reflective of our 
nation's democratic values. Intellectual property is an extremely 
important part of our nation's export economy. Jack Valenti of the 
Motion Picture Association of America (MPAA) and others have testified 
to Congress that movies and other content products have contributed to 
America's economic bottom line. Whether it is Hollywood in southern 
California or Silicon Valley in northern California, ideas and 
intellectual property are drivers of our nation's economic growth and 
international economic influence. Valuation of intangibles like 
intellectual property must be grounded on sound public policy and 
democratic values.
    In closing, I want to leave a clear impression with you. The 
current process is flawed and FASB needs to fix purchase accounting 
first before they should do anything with regard to pooling or other 
rules. The big problem for high tech companies is the fact that current 
purchase rules do not provide investors with better or more useful 
information. The high tech community has been engaged on this issue 
through organizations such as TechNet but to date the feed back from 
FASB has been less than satisfactory. While I am not in favor of any 
new governmental role here or in any new body charged with setting 
accounting standards, we do need to work together in a new way to 
develop a better method for measuring intangibles such as intellectual 
property. FASB's proposal to require all companies to use purchase 
accounting will only make these issues worse and will not improve the 
flow of information to investors, especially the individual. I am 
pleased that Congress is exercising its proper oversight over the FASB 
process on this important economic issue and look forward to working 
with the Congress in the future on this issue.

    Mr. Oxley. Thank you, Mr. Hoffman.
    Mr. Lewis?

              STATEMENT OF WILLIAM FREDERICK LEWIS

    Mr. Lewis. Mr. Chairman and members of the committee, my 
name is Bill Lewis. I come to you today as president and chief 
executive officer of Prospect Technologies, an advanced 
computer technology and international Web-based firm providing 
numerous computer solutions to governments, associations, and 
commercial firms. I also appear today as a member of the United 
States Chamber of Commerce Small Business Council.
    Mr. Chairman, I appreciate this opportunity to comment on 
the FASB's proposal, and I commend you for holding these 
hearings. I also ask that my full written testimony be included 
in the record.
    Mr. Oxley. Without objection, all statements will be made 
part of the record.
    Mr. Lewis. Thank you, sir.
    When firms combine, there are two long-standing accounting 
methods for combining financial statements, the pooling method 
and the purchase method. Historically each has worked 
reasonably well and has given firms the opportunity to 
accurately reflect to their shareholders their balance sheet 
and income statements.
    I believe that FASB's proposal to eliminate the pooling 
method is unjustified. Remember, again, with the pooling method 
the balance sheets of each partner in the merger is simply 
added together. Furthermore, its adoption may have a dramatic 
negative impact on our economy.
    I strongly disagree with FASB's assertion that all of 
business combinations should be accounted for as purchases 
rather than mergers. This fact ignores the reality that 
business combinations may vary substantially as to the traits 
of the combining entities and aspects of the combining 
transactions. Clearly many of today's combinations do not meet 
FASB's assertion that one firm necessarily gains control over 
the other.
    Furthermore, forced use of purchase accounting, with its 
creation and amortization of goodwill, can result in misleading 
financial statements. Often the benefit, the very synergy of 
combining two companies, continues and grows over time, rather 
than depreciating.
    I can speak extensively to this point as 2 years ago 
Prospect Technologies merged with a computer hardware 
manufacturing service support firm. Once this marriage, 
marriage of our two firms, occurred, Prospect Technologies, now 
formed from two firms, was able to enter into markets which 
heretofore it was impossible for either company to enter and 
penetrate by themselves.
    To arbitrarily force the financial statements to reflect a 
write-off of goodwill, an item which can significantly distort 
an Internet or .com, if you will, firm, distorts financial 
information, giving misleading indications of the combined 
firms' profitability. It understates the firm's bottom line, 
which in turn would hamper a firm's ability to attract outside 
capital, go public, or, in more simple terms, grow and make 
jobs.
    With this ruling, as CEO of Prospect Technologies, I would 
look very carefully at merging with another firm to expand our 
growth, form new jobs, and help fuel the American economy.
    One FASB rationale for eliminating pooling is to reduce the 
SEC's staff time devoted to mergers and acquisitions using this 
method. Another is to harmonize or force convergence of our 
accounting standards with international conventions.
    Staffing constraints should not force the rejection of a 
useful and workable accounting approach, nor should the 
international ``standards'' for which universal consensus is 
lacking be a motivating or driving force on this.
    Mr. Chairman, it is my opinion that over the past several 
years United States technology and information-based firms have 
been the preponderance of buyers of firms. It appears that the 
world looks to us in terms of getting accurate or reasonable 
pictures in terms of what the accurate portrayal of a financial 
statement is, not vice versa.
    I am not asking Congress today to adopt accounting 
standards or even to establish an official oversight board over 
Mr. Jenkins and his fine work that he has done at FASB, but 
rather to encourage FASB to rethink this rush to judgment. 
There are no egregious market failures driving this proposal 
for change. However, as pointed out by many on this panel, 
including my colleague Mr. Hoffman, there are legitimate 
concerns over the proper accounting for intangibles or goodwill 
especially prevalent in the high-tech Internet, the .com 
companies.
    To ameliorate this situation, various groups and 
commissions have been delegated to examine this issue. I 
believe you will find under way studies currently done by the 
Brookings Institute and another one done by a graduate school 
of business. Clearly, as the owner of a high-tech Internet 
company creating jobs and fueling this economy, I ask you not 
to take action until these study groups have come back--these 
study groups I mentioned before have come back and helped us 
understand the nature of this problem by shedding light on the 
wide disparity that has been pointed out by Mr. Powell in his 
testimony here as well as in the Senate between what the market 
value of the firms are and what the book value is.
    As a small business owner, I believe we have time to wait 
and evaluate. Prudence dictates that this is the action we 
should so take.
    Mr. Chairman, thank you very much for having me here today.
    [The prepared statement of William Frederick Lewis 
follows:]
    Prepared Statement of Wm. Frederick Lewis, President and Chief 
Executive Officer, Prospect Technologies, on Behalf of the U.S. Chamber 
                              of Commerce
    Mr. Chairman and members of the committee, I am Bill Lewis, 
President and Chief Executive Officer of Prospect Technologies a small 
business headquartered in the District of Columbia. Our firm employs 23 
individuals dedicated to providing information solutions for 
corporations and government agencies both here in the United States and 
internationally. Our business includes computer hardware manufacturing, 
computer software, and Internet and Web based solutions. I also come 
before you as a member of the U.S. Chamber of Commerce's Small Business 
Council.
    Working with organizations like the U.S. Coast Guard, the Federal 
Maritime Commission, the Department of Defense, Princeton University, 
Enterprise Rent-a-Car, the Government of the District of Columbia and 
McGraw Hill, we provide solutions that help to dramatically improve 
business processes through the use of technology and the Internet. Our 
work has received a great deal of recognition including winning Vice 
President Gore's Golden Hammer Award for streamlining government, 
cutting through red-tape, and improving the quality of customer 
satisfaction that is delivered by the Federal Government. This year we 
have been nominated again for this prestigious award by the Federal 
Maritime Commission for automating all of the FMC's service contracts 
and amendments filings via the Internet and the Web.
    Mr. Chairman, we appreciate the opportunity to testify on the issue 
of accounting for business combinations, in particular the question of 
whether the pooling-of-interests method of accounting should be 
eliminated. We commend you for holding these hearings.
    We oppose the decision of FASB to prohibit the use of the 
``pooling-of-interest method of accounting'' for all business 
combinations and to force the use of the ``purchase method'' with the 
subsequent amortization of goodwill over, at most, a twenty-year 
period. Not only will changes in this longstanding practice and the 
adoption of new standards not further the goals of providing more 
accurate, transparent and reliable financial statements, but they also 
may well have a substantial negative impact both on the economy's and 
my company's ability to grow.
Prospect Technologies
    I am the CEO of a thriving private company, Prospect Technologies, 
and I am looking for opportunities to expand my business. Two years ago 
I merged with PC's & Systems, Inc., a computer hardware manufacturing 
and services company. The transaction was reported using the pooling-
of-interests of both companies and combination of our two historical 
balance sheets. However, in spite of Prospect Technologies recording 
this on its balance sheet as a simple sum of the assets of the two 
firms, the result of the merger created a synergy that allowed us to 
bid and win contracts that would not have been possible by either of 
the two previous companies individually.
    Due to the positive results that the recent merger has had on the 
growth of my business, I am looking to combine with other businesses in 
the near future, especially with other Internet firms--``dot com'' 
related businesses--whose assets may be largely made up of 
``goodwill.'' If I am required to use the purchase method of 
accounting, with its adverse effects on reported earnings, I may have 
second thoughts. If the combination results in a company that is 
required to amortize a large amount of goodwill, then the emerging 
enterprise will have a diminished capacity to access capital. For a 
growing company that reinvests most of its cash flow into its future 
revenue, even the smallest variance in its apparent profitability could 
have a major impact in capital formation. Moreover, if in the future, I 
were to decide to ``go public,'' artificial reductions of net income 
due to the use of purchase accounting could make such an offering less 
appealing.
Pooling-of-interests vs. Purchase Accounting
    When firms combine, there are two alternative methods for computing 
and reporting for financial statement purposes the combined entity: the 
pooling-of-interest method and the purchase accounting method. Each 
combination is evaluated according to a 12-factor test. Those 
combinations that meet all 12 factors must use the pooling-of-interest 
method, whereas those failing any of the 12 factors must use the 
purchase accounting method.
    Under the pooling method, the balance sheets of each partner in the 
merger are simply added together. The new entity reports the combined 
historical book value. Under purchase accounting, one firm must be 
designated the acquirer and the other the acquiree. The acquired firm's 
identifiable assets are valued at current fair market value, and the 
difference between the fair market value of those assets and the 
purchase price is recorded as an intangible asset--goodwill. The 
financial statement of the combined entity is reported as the 
combination of the acquiring firm's historical book value and the 
acquired firm's fair market value plus the goodwill. Thereafter, over 
the years, the goodwill must be ``written-off'' or charged against 
reported income. As a result, under purchase accounting, there is a 
subsequent drag on reported earnings. The magnitude of this drag will 
depend upon the proportion of intangible assets in the acquired firm 
and the length of the amortization period--currently 40 years, but 
shortened to 20 under FASB's proposal.
    The pooling-of-interest method of accounting is a generally-
accepted method that has been in use for a long time. It is not, as 
some recent press accounts have alluded, an artificially advantageous 
method designed to bolster financial statements so that its proponents 
can boost stock prices or attract outside financing. If all of the 12 
requisites are present to permit its use, pooling-of-interests requires 
the combining companies to add the historical book values of assets, 
liabilities and shareholder equity, and presents them on integrated 
financial statements. If one or more factors are not met, then use of 
purchase accounting is required. In fact, because of its restrictive 
nature, this pooling method can have a potential downside. For 
instance, if a company that recently engaged in a pooling-of-interest 
transaction found its stock price artificially depressed and good 
business sense indicated a repurchase of its shares on the market, it 
would be prohibited from making that repurchase.
    Use of the purchase method of accounting is not without its 
problems, too. The calculation and reporting of intangible assets and 
goodwill is dependent upon subjective and speculative ``measurement.'' 
The accounting profession continues to grapple with how to properly 
value intangible assets and goodwill, and, as of yet, there are no 
clear-cut solutions.
Technical Issues
    FASB's decision to eliminate the pooling-of-interest method and to 
shorten the allowable amortization period of goodwill to 20 years is 
based on two assertions: first, that all business combinations are 
equivalent to a purchase where one firm acquires another and gains 
control; and second, that all goodwill and other intangible assets 
degenerate over time. We disagree on both counts.
    Clearly, many of today's combinations do not meet FASB's assertion 
that one firm gains control. For example, when the new entity has a 
combined board of directors, management and staff, no clear-cut control 
is established. In such cases, the exposure draft states that one firm 
will be designated the acquirer based on the ``evidence available'' 
without stating what that evidence is or how it should be weighted in 
the decision process. We do not believe that disallowing a longstanding 
accounting method that addresses such an ambiguity without prejudice 
against either partner, and substituting a methodology that may 
ultimately rely on an arbitrary decision, is an improvement. When a 
market activity does not fit an accounting model, arbitrarily forcing 
it rarely achieves the desired result.
    We also disagree with FASB's assertion that purchase accounting, 
with its creation and amortization of goodwill, will result in more 
accurate or more reliable financial statements. While some intangible 
assets are definable, measurable, and have discernable lives, many do 
not. For example, the same exclusive shopping mall part of a 
nationally-recognized web site would have a very different value then 
one as part of a simple family Web site created by any one of you or 
your children. Its value--and concomitant ``goodwill''--would be 
determined by ``on what Web site it was located.''
    Furthermore, it is hard to see how the purchase accounting 
convention--which lumps intangible assets that are unidentifiable or 
identifiable but not measurable into an amorphous category called 
goodwill that is immediately assumed to depreciate in value--provides 
more accuracy. The excess of the purchase price over the fair market 
value of the identifiable assets, i.e., the goodwill, is the result of 
a complex interaction. In past times, it was interpreted as the premium 
paid for the value of the ``ongoing'' concern--the brand name and the 
customer and community relationships. While these factors are still 
part of goodwill today, intangible assets in the new economy are much 
broader and more pervasive. Education, management style, and 
entrepreneurial spirit can easily represent the bulk of assets in 
today's information technology-driven firms. Whereas, goodwill in the 
old economy may have been a depreciating asset, goodwill in the new 
economy may not be. The synergies achieved by modern combinations 
create intangible assets that are designed to appreciate in value. That 
is why the free market values them so highly. Plus, I have seen this 
first hand when I merged my firm Prospect Technologies with another 
firm two years ago.
    While purchase accounting may have been useful for acquisitions of 
firms with a large percentage of physical assets, it is inadequate for 
combinations of firms composed primarily of intangible assets, 
especially when those intangible assets are largely unidentifiable, 
immeasurable and of indeterminate lives. It is hard to see how 
combining the historical book values of an arbitrarily designated 
acquiring firm with the estimated market value of an arbitrarily 
designated acquired firm and some dubious measure of goodwill yields a 
more reliable financial statement than a combination of book values, 
especially if the combined entity engages in successive combinations. 
Moreover, resorting to the approach of forcing a ``write-off'' of an 
intangible asset merely because accountants cannot understand or 
quantify it, is unacceptable.
    A better course of action might be to examine the issues 
surrounding the accounting of intangible assets and goodwill, and to 
develop suitable methods for addressing this problem before prohibiting 
a longstanding and well-understood accounting method. We urge FASB to 
adopt this more cautious approach.
General Policy Considerations
    In addition to the previously discussed technical objections, we 
believe that the proposed action by FASB has broad economic 
ramifications as well. We understand that FASB should, indeed must, be 
concerned primarily with the ``relevance'' and ``reliability'' of 
financial information, and not the economic consequences. However, the 
Exposure Draft states two reasons for undertaking this project, neither 
of which are relevance and reliability concerns. One concern was the 
increasing amount of staff time at both the SEC and FASB being devoted 
to mergers and acquisitions using the pooling-of-interest method. The 
other concern was a desire to achieve international convergence of 
accounting standards given the increase in international capital flows. 
We believe proposals to change accounting standards undertaken for 
staffing and/or international policy considerations ought to also 
include domestic economic considerations in the evaluation process.
    The fact that SEC staff are being asked to devote more time to 
business combinations using the pooling method is as much an indication 
of the increased importance of the high technology sector in today's 
new economy, as it is an indication of excessive use of what some might 
call a ``loophole.'' Today's high technology firms are composed 
primarily of intangible assets. They are in many cases relatively cash 
poor and, as such, are not in a position to buy other firms. They do, 
however, wish to create synergistic value through business 
combinations, and the financial markets have voted their approval. 
While we share FASB's belief that accounting standards must remain 
credible and reliable, the current method is well established and 
widely understood and, in our view, clearly meets that standard. 
Staffing constraints should not be sufficient cause for changing a 
useful and workable approach.
    We find FASB's other rationale equally non-compelling. There is no 
plan currently in place to achieve convergence of accounting standards 
for business combinations. Some countries allow the pooling method, 
some do not, and others allow it in fairly restrictive circumstances. 
If we want to adjust our standards on the basis of achieving 
convergence of international policy, then we should have assurances 
from the other countries of a similar commitment in advance, and the 
decision process to adopt such changes should include domestic economic 
consequences.
    The technology and financial services sectors have played a crucial 
role in our current position as a world leader. One reason for the 
success of these sectors has been their ability to grow. We do not 
believe that this opportunity for economic growth should be curtailed 
because of staffing constraints or the desire to adjust our standards 
to conform to our international competitors, especially when there is 
no consensus abroad. We should not change our standards without more 
compelling reasons.
    Prospect Technologies and the U.S. Chamber of Commerce urge FASB to 
reconsider its position and withdraw its exposure draft on this issue 
until the issues surrounding the proper accounting of intangibles has 
been vetted and all concerned parties have had the opportunity to 
digest the findings. The issues at stake are of great concern to our 
members and to all who want to encourage the continued economic growth 
we are currently enjoying.
    In conclusion, I would like to add that we are not asking Congress 
to adopt accounting standards or to establish an official oversight 
role, but rather to encourage FASB to rethink this rush to judgment. 
While having its faults, the current accounting framework has worked 
well. There are no egregious or exigent market failures driving this 
proposal for change. There are legitimate concerns over the proper 
accounting for intangibles and various groups and commissions have been 
delegated to examine this issue.
    Clearly, let us not take action until these groups help us by 
shedding light on this growing problem. As a small business owner, I 
believe we have time to wait and evaluate. Prudence dictates that we do 
so. Thank you.

    Mr. Oxley. Thank you, Mr. Lewis.
    Thanks to all of our panel.
    The Chair recognizes himself for 5 minutes for questions.
    Now I know why I avoided an accounting class, which is 
literally right across the street from my fraternity house. But 
I am reminded of our good friend, Dick Armey, the Majority 
Leader, who was introduced recently and said that he was an 
economist. His mother wanted him to be an accountant, and he 
didn't have the personality.
    Anyway, this has actually been an interesting debate. Let 
me begin with just a general question to our panelists, and I 
will go the other way this time and end with Mr. Jenkins.
    This is a general question. How would the elimination of 
pooling accounting make financial statements more or less 
accurate for investors and creditors under those circumstances? 
Mr. Lewis?
    Mr. Lewis. As I understand it, one of the issues, and I 
will just point to one right off the bat, is the amortization 
of the goodwill issue.
    We have heard today and we understand that merging and 
synergy is one of the reasons why companies come together and 
merge. That is considered to be a depreciable asset.
    I can tell you from personal experience when I did a 
merger, or a marriage as I rather call it, it was not for a 
depreciable asset, it was for increased asset. Yet, by FASB 
rules, I would have to take that as a depreciation expense 
against my balance sheet, not over 40 years, but over now 20 
years. That could significantly reduce my--artificially 
significantly reduce my income statement to my stakeholders and 
stockholders in my firm. That is one of the issues right off 
the bat.
    Mr. Oxley. So that was less accurate.
    Mr. Lewis. Yes.
    Mr. Hoffman. To answer that directly, less accurate.
    One other consideration that factors into the 
consideration, generally when we are talking about intangible 
assets, the only really fair way to value this is based on the 
market. That value is based on comparables.
    An interesting presentation I have seen by others, I will 
try to briefly describe the concept, if you have three 
companies, one of which decides to do two complimentary 
technologies, both in-house and build them from scratch, then 
one company does part of that technology, and the third does 
the other part. Two and three merge. Comparability is lost, 
especially on an EPS basis and a balance sheet basis, even 
though, frankly, the actual success of the business is about 
the same. So basically, now, you are forced to look only pro 
forma, which is a different number than what is reported 
publicly in the SEC filings.
    So basically now you are relying on, frankly, Wall Street 
sell side analysts and the PR machines of these individual 
companies to state what the reality of their competitiveness is 
on a comparable basis. That is a concern because sophisticated 
investors have no real issue being able to ascertain the 
difference there. The unsophisticated investor, which, frankly, 
I think is the SEC's larger mandate, is the one who has a 
difficult time seeing the difference.
    Mr. Oxley. Thank you.
    Mr. Bible?
    Mr. Bible . Mr. Chairman, I can make it more accurate. 
There is an accounting fiction out there. That is, equity has 
no cost to it. The reality is cash and stock of a company both 
represent the currency.
    The accounting fiction is if I use stock, I don't have to 
account for the economics of that transaction, and the example 
the gentleman brought up over here is a perfect example.
    Mr. Oxley. Thank you.
    Mr. Powell?
    Mr. Powell. Mr. Chairman, I think that elimination of 
pooling would make the financial statements less accurate. The 
reason is that it forces companies to go through a pooling 
method that is not equipped to deal with intangible assets, 
which represents 90 to 95 percent of the purchase price of 
acquisitions today. It assumes that they depreciate over time, 
and, in fact, that is not the case. As I mentioned in my case, 
if a good acquisition, it increases, it does not decrease. 
Therefore, the earnings per share number that would be 
reflected in purchase transactions would be inaccurately 
reflected in the financial statements.
    Investors would make bad decisions as result of that, and 
companies would make decisions about whether they should make 
that investment based on whether they could afford the hit to 
their earnings that was a fictitious hit.
    Mr. Oxley. Mr. Jenkins?
    Mr. Jenkins. Clearly, I believe they would be more accurate 
and comparable, Mr. Chairman, because all companies would 
account for acquisitions in the same manner. All companies 
would account for acquisitions based on the value of the 
currency that they use, whether it is stock or cash or a 
combination of the two.
    If I could quote really from a study made by an investor, 
Credit Suisse First Boston, with respect to bank acquisitions 
that were accounted for as pooling of interests, Credit Suisse 
First Boston recalculated each bank's cash return on tangible 
equity as if it had used the purchase method of accounting 
rather than the pooling method of accounting.
    Bank One, for example, in its acquisition of First Chicago, 
the 1998 return on equity went from 27 to 12 percent. At First 
Union it fell from 35 percent to 11.8 percent. BankAmerica's 
return fell from 29 percent to about 10.8 percent.
    The premium paid for these acquisitions ranged from 18 
percent to 43 percent over the market value of those 
acquisitions at the time. Without reflecting the acquisition 
price paid, investors lose track of how much of their wealth, 
how much of their dilution was involved in these acquisitions, 
and they never can find it out again.
    Mr. Oxley. Your statement is that those were bad 
acquisitions?
    Mr. Jenkins. No, not at all. They may not have been bad 
acquisitions, but their subsequent performance with respect to 
those acquisitions, their rate of return, rather than 
reflecting 27 percent, really should have reflected 12 percent. 
The 12 percent return may have been an appropriate and a 
profitable return. It may have been a very good acquisition.
    I am certainly not saying, for example, the example that we 
use mostly around here, the AOL-NetScape acquisition was a bad 
acquisition. All I am suggesting is that the investors needed 
to have the information with respect to the excess of the 
purchase price over the underlying value, underlying amounts 
that were, in fact, recorded under pooling accounting.
    Mr. Oxley. Aren't you in essence looking in your rear-view 
mirror at this?
    Mr. Jenkins. All investors need to evaluate subsequent 
performance against the investment made.
    Mr. Oxley. I thought that is what markets were all about, 
that people made those decisions in the marketplace based on 
their broker's advice, based on the particular company that was 
advising them.
    Mr. Jenkins. The markets do, in fact, make those decisions, 
but they make them on information, on transparent information. 
They cannot make it if they have no information.
    Financial statements, financial presentations have been 
widely acknowledged as being perhaps the single most important 
area of information in assessing and keeping strong our capital 
markets and providing a level playing field between investors 
and sellers.
    Mr. Oxley. Our time has expired.
    I recognize the gentleman from Michigan, the ranking member 
of the full committee, Mr. Dingell.
    Mr. Dingell. Thank you, Mr. Chairman.
    Gentlemen, is there anybody down there at the committee 
table who would take issue with the fact that the purpose of 
accounting is to get the truth so that the government 
regulatory process and investors and the market may function 
efficiently and correctly according to the law? You all agree 
with that?
    Let us take the gentleman, the second from your left, if 
you please. I would like you to focus your attention, if you 
please, on this question.
    Two firms merge. They have the choice of using pooling, or 
they have the purchase accounting for the acquisition. Are the 
results going to be exactly the same in terms of their reports 
and the accounting on that particular acquisition?
    Mr. Hoffman. The reports as reported----
    Mr. Dingell. The answer is, there will be a difference 
between the two methods of accounting; will there not?
    Mr. Hoffman. There will be a difference in what is 
reported, yes.
    Mr. Dingell. Let's take a look. One is going to say one 
thing under one method, the other--the other method will give 
you a different result. The two results are different. Which 
will be the true result?
    Mr. Hoffman. The problem is that that is not something that 
is easy to say. I don't necessarily say one result is better 
than the other. What my biggest concern----
    Mr. Dingell. You have two statements, one of which says one 
thing, one of which says another. Neither of them agree with 
the other. You have two different results. Only one of two 
differing results may be true. Which of the two results will be 
true?
    Mr. Hoffman. That is an awful assumption that one is 
actually accurate at all.
    Mr. Dingell. I am making the rather generous assumption 
that one is correct and one is not. It may well be that both 
are incorrect.
    Mr. Hoffman. I think that is partially what the concern is 
here, sir.
    Mr. Dingell. We now, Mr. Bible, have ourselves in a 
situation where we have--Mr. Bible, would you give us the 
answer, your view on that?
    Mr. Bible. On the question you rose with Mr. Hoffman?
    Mr. Dingell. You have two statements coming in with 
different results. One may be true. If it is, the other is not. 
Which is true, using the----
    Mr. Hoffman. What I am trying to say, I would tell you that 
is too hard to answer in all cases. The reality is that the 
balance in different kinds of transactions is rather complex.
    Mr. Dingell. Mr. Bible, what is your comment?
    Mr. Bible. The statement that reflects purchase accounting 
would be the most accurate. Whether you use cash or stock to do 
the acquisitions should not make a difference.
    Mr. Dingell. The gentleman on the end?
    Mr. Lewis. Mr. Dingell, you, like several in the room, are 
not a CPA but do have a legal education.
    Mr. Dingell. I also know how to find truth.
    Mr. Lewis. That is what we are all trying to do, sir. One 
of the things my attorney says to me is, it all depends. I 
believe that is what we are saying today.
    Mr. Dingell. I am like Harry Truman. I am still looking for 
a one-handed economist, because I know I am going to get the 
truth.
    Mr. Powell. Could I answer that question, Congressman?
    Mr. Dingell. Quickly, Mr. Powell.
    Mr. Powell. I want to back up and say, first of all, you 
don't have a choice as to which method of accounting you use. 
There are rules which determine whether you have to use pooling 
or----
    Mr. Dingell. I am not quarrelling with that. Which am I 
going to believe? My problem in a nutshell here is a very 
difficult one. I don't mean to be discourteous to any of you, 
but there is a vote on the floor, and our time is limited.
    We have two different results. Let us say that a major U.S. 
high-tech company buys another high-tech company. The investors 
out there are going to see that if the high-tech acquired uses 
purchase or uses the other system, they are going to have two 
different results.
    So then the result--the result of that acquisition is 
acquired by a third high-tech company. The question is, who is 
going to believe and how will they believe the resulting 
accounting? You have now got accounting which can be different, 
depending on the kind of accounting system used and the 
assumptions made. How is an investor going to understand what 
the facts might be, and how is the market going to properly 
evaluate the result of that succession of three or rather two 
acquisitions?
    Mr. Hoffman. Mr. Dingell, the answer is, the truth is, what 
is the cash situation? The reality is that most of these 
companies that we are talking about, as they get more and more 
layered, and various goodwill charges, and have amortization 
situations, we start talking about other things.
    The question is, are you continuing to generate more cash? 
Are you continuing to grow your ability to generate cash 
without spending significant assets?
    Mr. Dingell. Some, however, you would note, are, in the 
language of what I learned back in law school, committing daily 
acts of bankruptcy by preferring one creditor over another, 
making payments when they are incapable of addressing all of 
their debts.
    I am no advocate of any particular view, but you gentlemen 
are here before us as a learned panel to advise us as to what 
the system of accounting should be. I don't have any views on 
this, but I don't think that we are here in a position where 
you are able to tell us that the accounting system that you are 
suggesting or not suggesting is going to arrive at the kind of 
truth that we need to have a workable, transparent, intelligent 
marketplace.
    The problem that you confront is you are going to get 
differing results, results which may or may not be believable. 
But remember, I remind you, the accounting system is to produce 
truthful results so that the company's management can 
understand what the hell is going on in the company.
    The Japanese did not do it, and as a result they have had a 
continuing period of depression there that has gone on for 
about 10 years. Other countries have the same situation where, 
quite frankly, their accounting system lies most diligently to 
all and sundry.
    All I am trying to do is to have you tell me what is an 
accounting system which would tell us the truth, which will 
enable us to do business? You are here as a strong proponent of 
one system. I am asking you to tell me, if you please, what is 
that one system that is going to give me the truth?
    Mr. Oxley. The Chairman would inform the members that we 
have about 3 minutes left on the vote.
    Mr. Dingell. I apologize, Mr. Chairman.
    Can Mr. Jenkins just give us a quick answer, and we will 
hear what he has to say?
    Mr. Oxley. Briefly, please.
    Mr. Jenkins. I believe there is one method that gives you 
the truth.
    Mr. Dingell. What is that?
    Mr. Jenkins. That is the purchase method of accounting, I 
believe, not the pooling of interests method of accounting, for 
the reasons that I explained in response to Chairman Oxley's 
question, that we need to reflect in the financial statements 
for the benefit of investors, the consumers of that 
information, the price paid for an acquisition, whether that 
price be denominated in the currency called common stock or 
denominated in cash. That gives the truth.
    Mr. Oxley. The gentleman's time has expired.
    The Chair notes there is a vote on the floor. There may be 
another one subsequent. The Chair would have the subcommittee 
in recess until 1 o'clock to give everybody the opportunity to 
get something to eat for lunch, and then we will return at 1.
    [Whereupon at 12:07 p.m., the hearing recessed to reconvene 
at 1 p.m., the same day.]
    Mr. Oxley. The subcommittee will reconvene.
    Staff informed me a couple of our guests have to leave by 
2:15, is that correct?
    Mr. Hoffman. Yes.
    Mr. Oxley. We will do our best. We understand if you have 
to parachute out of here.
    I recognize now the gentleman from Iowa, Dr. Ganske.
    Mr. Ganske. Thank you, Mr. Chairman.
    I thank our guests for being patient. This is the way it is 
when we have votes. We go back and forth. We have to interrupt 
these hearings.
    Mr. Jenkins, in one of the addenda to your testimony, you 
have quotes from various people in support of the change. I 
notice that Warren Buffet is quoted, and he said, ``In essence, 
there are some areas that I disagree with this proposed change, 
but in general I firmly believe that this nongovernmental 
organization ought to be the one doing this.''
    First of all, what were Mr. Buffet's objections?
    Mr. Jenkins. Let me paraphrase what I believe he said.
    First of all, I believe he said that we should have one 
method of accounting for business combinations, and it should 
be the purchase method. Where he has some objections then deals 
with the area of accounting for goodwill, and goodwill that 
arises in a purchase business combination.
    Whereas our current proposal requires that goodwill be 
amortized over a period of not longer 20 years, Mr. Buffet 
would suggest that it not be amortized at all but, rather, 
tested for impairment. If the goodwill is concluded to have 
lost some or all of its value, then a write-down should take 
place at that point in time.
    The difference that Mr. Buffet has with our current 
proposal is completely focused on the question of amortization 
of goodwill.
    Mr. Ganske. Is there merit in his argument? Is there is 
that something you are looking at in terms of changing?
    Mr. Jenkins. It is something we are looking at. There are a 
variety of ways that you could address the goodwill question, 
and certainly I believe at this point in this project, in these 
redeliberations, and based in particular on what we have heard 
here and in our own hearings that we held, that the focal point 
of the issue is on goodwill and how it should be treated once 
it is recognized under a purchase business combination.
    We have already allocated the majority of the time that we 
expect to spend redeliberating this issue on that very 
question. The issue of not amortizing goodwill at all but 
testing it only for impairment is an approach that we will 
consider carefully.
    There are a variety of other approaches, too. One might say 
not limit it to 20 years but leave it to the judgment of 
management and the auditors. That is an approach. Another 
approach is to recognize it but write it off immediately 
someplace or another.
    There are 4 or 5 different approaches. We are going to be 
carefully considering all of those and balancing them against 
the proposal that we made initially in our exposure draft. But 
we have reached no final conclusions. We really have not begun 
our redeliberations in this what I believe is the key focal 
point of this discussion at this point in time.
    Mr. Ganske. Okay.
    Let me see if we can get agreement on this panel. Does 
anyone on this panel think that Congress should get involved in 
writing the regulation of this? You can just say yes or no 
going right down the aisle.
    Do you want Congress to--the political process to start 
really getting involved?
    Mr. Lewis. No.
    Mr. Hoffman. We are glad Congress is showing a leadership 
position in addressing the issue. I don't think there is any 
real need for specific addressment of that issue.
    Mr. Bible. No.
    Mr. Powell. I don't believe that Congress should be 
promulgating accounting principles. However, I do believe that 
there is a place for congressional oversight, and that is when 
it comes to when this is going to have significant implications 
on the Nation's economy. FASB's role is not to do that. It is a 
stated role not to do that. There has to be a forum someplace 
that someone is looking at that.
    Mr. Ganske. I am not arguing against a forum. I am asking 
specifically, do we go to the floor of the House with a bill? I 
don't know how much politically aware you are of the situation, 
but, boy, some bizarre things can happen on the floor.
    Mr. Powell. We are not in favor of accounting being 
legislated on an issue-by-issue basis.
    Mr. Ganske. I assume, Mr. Jenkins, you feel the same way?
    Mr. Jenkins. I agree.
    Mr. Ganske. My final question would be this, then. Let us 
go back to the actual case as described by Mr. Jenkins that is 
reported in the New York Times where the quote is, ``Pooling 
accounting is ridiculous because it allows corporations to 
pretend that they paid much less for an acquisition than they 
did. Let's say company A buys company B for $100 million in 
stock, and then a few years later sells company B for $50 
million. In reality, that was a disastrous acquisition for 
company A, but thanks to the magic of pooling, company A would 
have shown the original acquisition as costing not the $100 
million that it paid but a number that could be far lower, say 
$20 million, reflecting the book value of company B. Presto, 
company A reports a profit of $30 million when it actually lost 
$50 million.''
    I would just like to go down the row here. To me as an 
individual investor wanting to really know how much a company 
owes or has spent on an acquisition, I just want to know, 
doesn't this specific case strike members of this panel as 
something of concern?
    Maybe we could start on this end. Isn't there some valid 
concern about this type of accounting?
    Mr. Hoffman. I am going to go ahead and step ahead, if you 
don't mind. There are a couple pieces of data that are missing 
to make a real judgment here.
    One is, what were the relative valuations of the company at 
the time the transaction was done? Did the market fairly value 
that? The issue is the capital stock of the corporation. 
Because when two companies come together you are talking about 
a set of shareholders and another set of shareholders, and the 
relative ownership of the entire company is diluted based on 
the shares relegated to that acquisition.
    Mr. Ganske. I understand that, but I am an investor out 
there looking at the balance sheets.
    Mr. Powell. Congressman, could I answer that question?
    Mr. Ganske. Okay.
    Mr. Powell. First of all, I think it is an interesting 
theory, but, in reality, it rarely happens often.
    I have had this question posed to me before. I had one of 
the major banking firms, international banking firms, review 
this to find examples of where this had happened, and they 
could not locate examples where this had occurred. I think that 
is the first point that I would like to make.
    Mr. Ganske. But how do you respond to Mr. Jenkins, who gave 
several examples of a recalculation by Swiss Credit, for 
instance, on bank acquisitions, where there was a difference?
    Mr. Powell. I think that the issue that Mr. Norris is 
reporting is a different issue, which is you sold off assets 
and reported a gain, when in fact you sold them for less than 
what you paid for them. I think--so I would like to speak to 
the Norris issue, if I could.
    If you think about the fact that--let's suppose in the 
example that I used, a company A, company B, you have twice as 
much stock outstanding. If you are going to sell the company 
that you expected to generate twice as much income, what 
happens the day that you sell that is you have lost your 
revenue stream and profit stream, and your income, in the 
example that I give, is going to go from $2 a share to $1 a 
share.
    I don't know many management people that are going to be 
around once that happens. To view that in some sort of positive 
way is wrong. It is going to be viewed very negatively, and it 
will have an impact on that management team.
    The other thing is that if you look at one-line types of 
transactions, as we see in in-process research and development 
or restructuring charges, analysts have a tendency to discount 
those and not give credit to those reductions.
    The same thing happens on one-time gains. Management is not 
going to look at that gain and give a credit to the management 
team for the fact that that one-time gain occurred. They are 
going to look more to what is the impact on the earning stream.
    The last thing that I would say is if FASB thinks that this 
is an issue that is subject to abuse, let us deal with the 
abuse but not throw the baby out with the bath water. I think 
that is the same position that the committee on corporate 
reporting of the FDI suggested in their FASB testimony, if 
there are abuses, let us fix them, but not throw out the entire 
methodology.
    Mr. Oxley. The gentleman's time has expired.
    Mr. Ganske. Maybe Mr. Bible can answer that.
    Mr. Bible. All I would say is that you all have your 
constituents. Our constituents are shareholders. If I give you 
a tool to make it look like you are doing better than you 
actually are, would that be fair?
    Mr. Oxley. It happens all the time.
    Mr. Bible. We are trying to get rid of it in the accounting 
world.
    Mr. Powell. I would turn that around to say, should we be 
penalized for a negative transaction that in reality does not 
reflect the economics of what the transaction is?
    Mr. Oxley. Thank you.
    The Chair recognizes the vice chairman of the subcommittee, 
the gentleman from Louisiana.
    Mr. Tauzin. I thank the Chair.
    Mr. Jenkins, I chair the Subcommittee on 
Telecommunications. My interest in these high-tech companies 
and what they are doing for the economy stems from that work.
    Let me first ask you about our relationship, Congress, to 
your agency. I am very pleased to hear you today indicate that 
concerns expressed by Members of Congress about the work of 
FASB, making sure that you account for those concerns, is in 
fact a relevant relationship, because I hope it clarifies the 
open letter that FASB sent out.
    It seemed to indicate that we had no business engaging in 
any legislative activity, that that might threaten the 
independence of FASB. Your quote is, ``Explicit or implicit 
threats of increased legislative activity create a real risk of 
continued viability of private sector standards setting.''
    Do you really believe that? Do you believe we don't have a 
role here in oversight, in recommendations and in letters like 
our chairman has sent to you, urging that you go slow and 
examine some of the concerns that have been raised by the other 
side or concerns about the purchase method of accounting?
    Mr. Jenkins. Congressman Tauzin, I stated in my testimony, 
not only here but earlier in my testimony before the Senate 
Committee on Banking and Financial Services, that we support 
and understand and accept the oversight responsibility of 
Congress. I have no problems with that.
    Mr. Tauzin. I should hope so.
    Mr. Jenkins. Just as a matter of clarification, please, the 
letter that you are reading from is not a letter from the FASB, 
it is a letter from the trustees of the Foundation. My 
understanding, having talked with the trustees about that 
letter, is perhaps it is inartfully worded.
    Mr. Tauzin. That is not your view?
    Mr. Jenkins. I'm sorry.
    Mr. Tauzin. That letter does not reflect your view?
    Mr. Jenkins. No, it does not reflect my view.
    Mr. Tauzin. Let me ask you, with reference to another 
letter, however, that you did send to Members of the Senate who 
wrote to you concerned about problems in the purchase 
accounting method and addressed recommendations to you, I think 
the tone of their letter was, before you go around repealing 
pooling that you had better doggoned fix up the purchase 
accounting. If you have two systems, neither one of which are 
working good, you don't want to throw one out and accept 
another equally bad. Fix that up first.
    I thought that was a pretty good letter. I thought the 
chairman's letter to you was excellent, particularly when he 
pointed out that intangibles do not necessarily depreciate, 
often they appreciate. If you set some arbitrary depreciation 
schedule on intangibles in this new economy that you will, in 
fact, be encouraging false and inaccurate information to the 
public, when the truth is that intangibles in this new economy 
may be an increasing and appreciating asset that investors 
ought to know about and ought to have real information about.
    But you wrote to the Senators in effect saying that, look, 
we haven't made any final decision about this; we are going to 
consider everything. But the only thing you did in your letter 
was to cite examples of complaints about the pooling method.
    As I read your letter, it seems to me you have made some 
preliminary judgments that you plan to abandon it and go to 
purchase accounting, with no necessary attention paid to the 
flaws in that system. It seems you are saying we are not 
interested in your recommendations. We insist that the pooling 
method is no good. Here are the reasons why. And, by the way, a 
whole range of the Board's constituents have told us that and 
you have not paid attention to them yet because you did not 
allow them to testify at some Committee on Banking and 
Financial Services, Housing, and Urban Affairs. That is the 
gist of your letter.
    Is that the way you respond to congressional concerns that 
the purchase accounting method has serious flaws in it that 
ought to be adjusted for this new economy?
    Mr. Jenkins. I think it is evident that we do intend and 
have addressed concerns with respect to purchase accounting. We 
will reconsider all of those decisions in our redeliberations.
    With specific respect to intangibles, in our proposal we 
did change--we did propose to change the current requirement 
for intangibles, which is in place and has been in place since 
1970, that required them all to be amortized over some common 
period. We did change that to permit flexibility on the part of 
management in determining the lives over which intangibles 
should be amortized.
    Mr. Tauzin. The point is, what happens when they are 
appreciating in value? What happens when 80 percent of the 
company is all about knowledge, it is all about eyeballs, about 
the potential of this company attracting customers to products 
that are advertised that surround a package of information, and 
all of that is appreciating as more and more people come to 
that site, that e-com business, and use those services and view 
those advertisements and buy those products?
    Are you saying that the company has no choice but to write-
down that intangible asset over some arbitrary, fixed period? 
Is that not false information?
    I notice the ranking minority member, Mr. Dingell, talking 
about the search for the truth. But is that not the opposite of 
the truth?
    Mr. Jenkins. I think the first thing we have to do is get 
the intangibles recognized in the first place. Recognizing 
intangibles in the first place does not come about through the 
use of the pooling of interests method.
    The second point is to your point. Some intangibles are 
going to increase, some intangibles perhaps are going to 
decrease. We don't always know. But under our system of 
accounting, that has been true for a long time. Some of our--
some trademarks of old line companies increase in value and 
some decrease, but we generally don't recognize them.
    Mr. Tauzin. Mr. Jenkins, I just want to say one thing, and 
then ask you a final question.
    The first is that of all the things I have seen that can 
severely impact the extraordinary growth of this new economy, 
what you do here may have more impact than what we do in policy 
up here. How you handle this issue and how carefully you handle 
it and how well you handle it may well determine whether or not 
this new economy continues to grow, whether we inflate or 
whether we deflate it.
    We are deeply concerned about that. We have tried to 
express that to you. I want to second the comments of the 
chairman of our committee in his letter to you. I think it is 
an excellent letter of concern that I hope you folks have taken 
seriously.
    In his letter he makes a request of you. He requests that 
FASB commence a comprehensive study of the accounting treatment 
of intangibles, and he further requests that you wait until 
those results of the separate studies being conducted by the 
SEC and hopefully by yourselves on this issue might be 
concluded where we can all get a good handle, a good look at 
it.
    What is your response to his request?
    Mr. Jenkins. I responded in part in my testimony when I 
made the point that the one study is not really relevant to 
dealing with intangibles. Mr. Powell, who was a member of that 
group, concurred in that.
    We are beginning in our own process to consider 
intangibles. We will be giving careful thought as we go forward 
as to whether or not it is or is not appropriate at the end of 
the day for us to go forward with this standard without coming 
to a final conclusion on accounting for all intangibles.
    We do intend--with respect to the intangible that is most 
significant by a long ways in respect to purchase business 
combinations, goodwill, we do intend to carefully consider all 
of the various alternatives that I described for the 
Congressman from Iowa in open meetings before we reach a final 
conclusion. We will listen carefully to what we have heard in 
these meetings.
    Mr. Tauzin. Can I inform the chairman as a result of our 
conversation today that your answer to him is yes?
    Mr. Jenkins. The answer is not necessarily yes, because I 
cannot guarantee you that we will solve all of the problems of 
intangibles before we go forward.
    Mr. Tauzin. He simply asked that you let all these studies 
happen, that we have a chance to look at all these studies and 
get a chance to analyze the different outcomes of these studies 
before you move. Can I inform him at least that that is a 
likely outcome here?
    Mr. Jenkins. We will consider those studies as we go 
forward. The outcome----
    Mr. Tauzin. You are going forward as the studies are being 
done?
    Mr. Jenkins. The timing of those studies is out of our 
control.
    Mr. Tauzin. So the answer to the chairman is, you may move 
even before the results of the studies are in?
    Mr. Jenkins. I do not even understand or know what the 
nature of those studies are, with all due respect. I can't 
commit myself or my board to the outcome of studies about which 
I do not know their approach or anything.
    Mr. Tauzin. Mr. Jenkins, with the indulgence of the 
chairman, let me just say, sir, that you are inviting 
legislative action when you give an answer like that. When the 
chairman of our committee--and you have heard the expression, I 
think, of many members of the legislature that we consider this 
of such a serious note that we have asked you to make sure that 
these studies are in before you make this momentous change in 
the way these accounting rules--these generally accepted rules 
are applied to this new economy--I think you have heard enough 
of us telling you that over and over again that when you tell 
us that you might not wait for the results of the studies, you 
might plow ahead with some preconceived notions even, that just 
invites legislative action.
    Mr. Jenkins. We don't have any preconceived notions. We 
will consider all of the evidence. We will consider very 
carefully and take very seriously your admonitions to us and 
what we have heard today from everyone on this subcommittee, 
and we will do our very best to make sure that we consider all 
of the evidence before we make any decision and the 
applications of our decision.
    Mr. Oxley. The gentleman's time has expired.
    The gentleman from California, Mr. Cox.
    Mr. Cox. Thank you, Mr. Chairman.
    I would like to thank each of the members of our panel, 
some of whom I had a chance to say thank you to during the 
break, for your presence here and your willingness to indulge 
the Congress' interest in this.
    I think that the topic that Chairman Tauzin has gotten us 
into here is worth pursuing in two respects.
    First, I think, as I mentioned in an aside to Mr. Jenkins, 
that the real issue here is the accounting treatment of 
intangibles. There has been a lot of change in our economy over 
the last many years, and the relative role played by what we 
loosely call goodwill M&A is significantly larger now than ever 
before.
    The second issue that Chairman Tauzin raised that I think 
is worth pursuing is what the Congress ought to do in this 
circumstance. I think my colleague, Mr. Ganske, certainly 
crystallized, at least with you, this panel, about whether 
Congress should write a law and describe the proper accounting 
treatment for intangibles in all cases or the proper accounting 
treatment for business combinations, managers, acquisitions, 
and so on.
    I would not be inclined to do that myself. Although I think 
the best answer to your question, Greg, as to whether it would 
be a good idea for Congress to write the accounting standards 
is, is the congressional proposal as bad as FASB's? If it is 
not, then it would be superior, at least in that instance.
    But I think your question really goes to the precedent we 
would be setting and the kind of system we would inherit if we 
willy nilly got into the business of writing accounting 
standards.
    What Congress might do, with greater restraint and wisdom, 
however, is force a delay, a moratorium until the information 
is in. I did that with Internet taxes, and my legislation which 
I wrote with Senator Wyden is going to be on the floor next 
week.
    Again, we already have a moratorium in place as a result of 
legislation I passed a couple of years ago, and the Internet 
Tax Freedom Act moratorium as a result of what was just 
reported out of the Committee on the Judiciary will now be 
extended a further 5 years, assuming that we are successful on 
the floor of the House and on the floor of the Senate, as we 
were today on the Committee on the Judiciary, where I think the 
vote was 29 to 8.
    It would not be irresponsible, although it would be quite a 
change from the way normally we do business, I think, for 
Congress to require FASB to look at the information. And if the 
information is not in before you make your rule, I think it 
raises serious questions.
    If you don't know what the studies are about, that scares 
me right there, because that is where we ought to be focused.
    The bread and butter accounting, as we all learn in 
business school or wherever we first learn accounting, is based 
on a paradigm in which book value is the only thing you can 
really sink your teeth into. We recognize book value doesn't 
represent real value, but it is a real number. We know where it 
comes from, so we put a lot of our heart and soul into that 
back value figure.
    In that paradigm, goodwill is the fudge factor. But what 
happens is that the fudge factor, which is something we never 
really could get our arms around, has sort of taken over the 
universe, in much the same way that the Arab mathematicians 
flirted with the idea of irrational numbers when they first 
tried to solve cubic equations.
    Remember, Omar Khyam, for example, figured out how to solve 
cubic equations but looked at this multiple of the square root 
of minus one as a false root. They didn't know what to do with 
it. They screwed around with it for a long time. These days, 
not only are we comfortable with the square root of negative 1, 
but you cannot manage an electric circuit without it.
    I think we need to get a little more comfortable with 
goodwill, with intangibles, because that is the 21st century. 
That is really this hearing ought to be focused on. It is what 
it really ought to be about.
    If I were to ask you the same unfair question that Chairman 
Dingell or former Chairman Dingell, Ranking Member Dingell, 
asked a moment ago when he said what is the truth, purchase or 
pooling, in an arbitrary transaction, the facts of which none 
of us is informed, and if I were to ask you what is the 
depreciable life of goodwill, Mr. Jenkins, what is the answer 
to that?
    Mr. Jenkins. I would acknowledge that the amortization of 
goodwill as a single number is arbitrary, but that doesn't mean 
that it is necessarily wrong. It is an estimate of life. We 
have had goodwill being amortized for a long time over varying 
lives.
    While there is an outside limit, there is certainly not a 
prohibition against using anything shorter than that. And, in 
fact, in the many, many acquisitions in the high technology 
area, for example, that have not been accounted for as purchase 
transactions, they utilize goodwill life that is significantly 
shorter than 20 years, or 40 years, for the most part.
    I think you are correct, that the focal point of this issue 
is on goodwill. I acknowledge that. I expect that we will be 
spending very much of our time over the next many months as we 
work on this issue trying to resolve the goodwill question.
    I described several alternatives a few minutes ago that we 
intend to reexplore. Many of those concerns and our attention 
to this come out of this hearing and out of previous hearings 
and listening carefully to our constituents.
    So I agree with you. The focus is on goodwill. I think we 
will address it. We have a group that has asked if they can 
make a presentation to us on a methodology for dealing with 
goodwill. I do not know what it is, but we certainly have 
agreed to do that. We will be having a public meeting of our 
board at the end of this month where that will be displayed for 
us, and we will carefully consider it.
    I agree with you. That is the focus and where we need to 
spend our efforts as we proceed to explore this issue.
    Mr. Ganske. Will the gentleman yield?
    Mr. Cox. Sure.
    Mr. Ganske. I am trying to get my hands around this 
goodwill concept. Let me see if I can put it into a specific 
example.
    In Des Moines, we had a company called Pioneer which was 
bought by DuPont at a premium above what the stock was selling 
for. So that difference, is that what you would call goodwill?
    Mr. Jenkins. No, not necessarily.
    Mr. Ganske. Okay. Because I wonder whether it is part of 
it.
    Mr. Jenkins. It could be part of it.
    Mr. Ganske. That was premised on the management for 
Pioneer, which was well respected, sticking with the new, 
larger company for a period of time. It did not work out that 
way. Management left rather quick.
    I am just wondering whether in fact there aren't some 
intangibles that are always going to be intangible, and how 
well you think you can actually get your hands around that 
component of so-called goodwill.
    Do you have a comment on that?
    Mr. Jenkins. Yes, I do. I think that is a good example of 
an intangible that probably cannot be specifically valued but 
does get subsumed into goodwill. It is a portion of goodwill.
    One could also conclude that if the entire difference 
between the market value and the purchase price was due to this 
management and then they left, that at that point you ought to 
write off that portion of goodwill, because it is no longer 
there.
    That might be what we would say is one of the approaches I 
suggested to you, that we recognize goodwill, we recognize this 
need for superior management to stick around, but we don't 
amortize it. But if they leave, you write it off.
    Mr. Ganske. That is where I see that Dr. Lewis and Mr. 
Hoffman and everyone else on the panel--you are all very 
bright, but let's say that Mr. Hoffman's company gets scarfed 
up by a bigger guy. I would want Mr. Hoffman to stick with my 
company, my bigger company. The premium that I would pay for 
that would include him. But if he left, I think I would be--I 
wouldn't have gotten the value.
    Mr. Cox. Let me add to your question another example we 
might think about. Let's say that the Tribune Company and Times 
Mirror combined. How much, Mr. Jenkins, did that cost?
    Mr. Jenkins. I don't remember the number.
    Mr. Cox. No, I mean what is the cost of that combination?
    Mr. Jenkins. I think the cost is the consideration that the 
Tribune Company paid for the Times Mirror.
    Mr. Cox. Does it matter if they used outstanding shares or 
newly issued shares?
    Mr. Jenkins. It doesn't matter if they used outstanding or 
newly issued, or if they use cash or shares.
    Mr. Cox. So your sense--I use that because the Times Mirror 
and Tribune Company are roughly comparable in size, and there 
are some bragging rights going on about who got whom in the 
deal. And if you are from Chicago, there is no question. If you 
are from California, there is some question there.
    But at least to read the newspapers, which seem to be 
carrying fair and full accounts of all of this, they are really 
going to combine the operations. That is really what is 
happening in economic reality. What is the cost of that? What 
is the economic cost of that combination?
    Mr. Jenkins. I still believe that in that case, and I have 
not examined it in detail, that you can determine which company 
acquired the other company.
    Mr. Cox. What if that is not really what happened?
    Let us back off of that example, if you think that there is 
a flaw in my analogy.
    Let's take a situation in which, having done M&A work for a 
decade, I can tell you happens fairly frequently, and you know 
this better than I because you have done this for more of your 
life, if you have two partners in a business transaction and 
they get together--and they really get together, one did not 
swallow the other--they get together, they--somebody used the 
term ``marriage'' earlier, community property, let us say that 
is the economic reality. What is the cost?
    Mr. Jenkins. I just think in that case I think the best 
answer is to say that you have a new entity. You have put two 
companies together. You have created a brand new entity.
    Mr. Cox. How much in economic terms--to put on your 
economist's hat, in economic terms how much did that cost?
    Mr. Jenkins. I would say that you would recognize the value 
of the assets of both parties that have contributed to that 
transaction, the fair value of the assets.
    Mr. Cox. That is a different question. That is a question 
of how you write up the assets on the balance sheet.
    My question is, what is the economic cost? Think of this as 
sort of a physics question. You have some molecules. They bump 
into each other. What is the energy expended? It is that sort 
of question. In economists' terms, what is the costs?
    Mr. Jenkins. Again, I think it is the fair value of the 
assets that they each contribute.
    Mr. Cox. The assets are still there. The assets did not go 
away. They are still there.
    Mr. Jenkins. I understand, and you are recognizing all of 
those assets from both parties at the fair value when they are 
contributed.
    Mr. Cox. You are making a different and valuable point, 
which is that this might be a good opportunity to recognize the 
current market value of those assets and not run them at the 
old book value. If you come up with a better way than purchase 
or pooling, probably that is one of the things you will want to 
take a look at.
    Mr. Jenkins. Yes, we are.
    Mr. Cox. I am asking a different question. I am asking 
whether or not there is a real economic cost to the 
combination. Rather than trying to beat my answer out of you, 
let me give you my answer to that, which is that the cost of 
the combination is probably the extra lawyer fees that you paid 
to file with the SEC and your Hart-Scott-Rodino fees and your 
extra accounting fees to do whatever is necessary, and, you 
know, if it is a big combination, that is a trivial amount.
    In fact, there is no business asset lost or consumed in the 
transaction. All the cash of the one company and all the cash 
of the other company is still there. In fact, they probably got 
a new joint bank account and you can see all the money still 
there. You can keep your eyeballs on it.
    So that a bias in the accounting system that absolutely 
requires in that case that somebody be the acquirer and 
somebody be the acquiree and that there be a cost of the 
transaction and that it be a significant amount and measured in 
terms of the full value of the assets of one of them, that it 
seems to me to be strange to use a paradigm that is not always 
the right one.
    To use another one of those ancient analogies, it is like 
that Procrustean bed where Procrustes stretched all of his 
victims to fit. Sometimes it does not work. Purchase accounting 
is designed with some paradigms in mind, and it is absolutely 
perfect for some business combinations, but in other cases it 
is not.
    Mr. Bible has been desperate to get a word in edgewise I 
think, with the chairman's indulgence.
    Mr. Oxley. We will make this the last word edgewise.
    Mr. Bible. I would add, Mr. Chairman, it depends on what 
economic school you believe in. But the bringing together of 
both, there was a decision made. That is, I can achieve the 
most value for my interest by combining with you, Mr. Chairman, 
in a joint venture, rather than selling to a third party. I 
think that is the economic reality that Ed is speaking of.
    Mr. Powell. Could I make one comment? In reality, this is 
two groups of shareholders coming together and combining their 
interest. No one acquired anyone else.
    The reflection of that is that if I own 10 percent of that 
company before, I will now own 5 percent of that company. The 
cost is in the dilution of me as a shareholder. But in terms of 
one company acquiring another, Congressman Cox is exactly 
right. There was no cash exchanged. No company gave up assets 
to purchase this. There was simply a combining of those two 
companies, and that is what pooling is all about.
    Mr. Bible. No, they made a decision to give up cash to a 
third party sale to join with the Congressman in a merger.
    Mr. Cox. I want to point out that some people think 
accounting is boring, but this, you can see, it is just loaded 
with interest.
    Mr. Oxley. This is put on your helmets.
    I recognize the ranking member for a unanimous consent 
request.
    Mr. Towns. Thank you, Mr. Chairman.
    I ask unanimous consent that I place in the record 
Congressman Crowley's statement and also questions to be 
answered in writing to Mr. Jenkins.
    Mr. Oxley. Without objection.
    [The prepared statement and questions of Hon. Joseph 
Crowley follow:]
Prepared Statement of Hon. Joseph Crowley, a Representative in Congress 
                       from the State of New York
    Thank you Mr. Chairman for holding this critical hearing and for 
allowing me to be here today.
    I have a serious concern about the impact of the Financial 
Accounting Standards Board's (FASB) proposal, in its Exposure Draft on 
Business Combinations and Intangible Assets, to eliminate the pooling 
of interest's method of accounting. I am very concerned that this will 
have a negative impact on the American economy, particularly on the 
fast-growing companies driving our increasingly knowledge-based 
economy-what people are calling the new economy.
    Financial experts have said that the proposal will have the 
greatest impact on the financial services, information technology, and 
pharmaceuticals sectors, areas of our economy that, according the to 
Commerce Department, accounted for nearly 30 percent of America's GDP 
in 1998. Information technology alone was responsible for over 28 
percent of U.S. real economic growth in 1997. Those percentages 
represent a large number of jobs, both in those industries directly, 
and in collateral and support industries.
    I understand that FASB has received nearly 200 comment letters on 
its Exposure Draft. In its own summary of the comment file, FASB noted 
that more than three quarters of the letters addressed the proposal to 
eliminate pooling. Of those, the banking and high-tech sectors strongly 
disagreed, and the rest were ``split.'' This does not sound like the 
kind of endorsement of a proposal that compels immediate action. 
Rather, with such disagreement on the value of the proposal, I would 
suggest the wiser route is to reconsider and address some of the 
concerns raised.
    It is also my understanding that the responses, in fact, were 3 to 
1 in favor of retaining at least some form of pooling, or for not 
eliminating pooling until significant other issues related to the 
purchase method, the only remaining method, were resolved. And these 
responses include the Big 5 accounting firms. In light of such 
significant opposition and the very real concern about the impact of 
the proposal on our economy, what is the rush?
    The pooling method of accounting has been around for many decades. 
I know of no clamor, and no crisis, which demands immediate action on 
the issue. In fact, only six years ago, Mr. Jenkins, in a comprehensive 
AICPA study on business reporting that he headed before he became FASB 
chairman, found that ``the existence of the two accounting methods is 
not a significant impediment to users' analysis of financial 
statements. A project to do away with either method would be very 
controversial, require a significant amount of FASB time and resources, 
and in the end is not likely to improve significantly the usefulness of 
financial statements.'' Why then the rush to act?
    It may well be that something needs to be done regarding pooling of 
interests accounting. I am not an accounting expert. But I am concerned 
when so many experts in their field express the kinds of concerns I 
have been hearing. In fact, I understand that eleven Members of the 
Senate Banking Committee, a bipartisan majority, have written a letter 
to the FASB suggesting that it defer its decision on pooling until the 
concerns and issues relating to the purchase method have been resolved. 
I have also joined Congressman Cal Dooley and a number of my colleagues 
in sending our own letters on this topic.
    FASB has stated the importance it places on international 
harmonization of accounting standards as justification for this 
proposal. I would only point out that the home countries of many of 
U.S. companies' strongest competitors permit pooling. Britain, Germany 
and Japan all permit some form of pooling. Our economy is the strongest 
in the world, based in part on the ability of companies to innovate and 
reach productivity through mergers. Do we really want to throw this new 
hurdle in front of U.S. companies?
    I would hope that FASB is taking these concerns seriously. I 
certainly do. I urge FASB to take some more time to consider the very 
serious concerns raised over this issue.
    Mr. Chairman, once again, thank you for calling this important 
hearing. I look forward to working with you and my colleagues on this 
important issue.
                                 ______
                                 
                      Congress of the United States
                                   House of Representatives
                                                        May 4, 2000
The Honorable Michael G. Oxley
Chairman
Subcommittee on Finance and Hazardous Materials,
Committee on Commerce
2125 Rayburn HOB
Washington, D.C. 20515
    Dear Mr. Chairman: I would appreciate your assistance in including 
the following questions for Mr. Edmund L. Jenkins, Chairman of the 
Financial Accounting Standards Board, in the record for today's 
Commerce Subcommittee Hearing on the Financial Accounting Standards 
Board's proposal to eliminate the ``pooling of interests'' accounting 
method. I would also like to thank you for your leadership on this 
issue and for calling this important hearing.

1) Many knowledgeable people have said that FASB's decision to 
        eliminate pooling could have a damaging impact on economic 
        growth. In a recent white paper, Merrill Lynch concluded that 
        the change could result in a notable decline in the 
        consolidations that have enhanced productivity, encouraged 
        innovation, and stimulated dynamism in the U.S. economy. And, a 
        Goldman Sachs study specifically says that FASB's changes could 
        have a dramatic impact on certain industries, including 
        information technology and medical devices. Why is FASB willing 
        to take the chance that they are right?
2) You have received a number of thoughtful alternative proposals to 
        the elimination of pooling. You have a great deal of concern 
        about the valuation of intangibles. What is the rush to 
        eliminate pooling rather than looking first at the valuation 
        questions? If the problem with studying the issues is that it 
        will take some time, why not do it right the first time rather 
        than in a piecemeal fashion, especially when the consequences 
        of ``getting it wrong'' could be so severe?
3) A review of the comment letters sent to FASB shows that two-thirds 
        of all of those who sent comment letters and all of the Big 5 
        accounting firms advocated either retaining at least some form 
        of pooling or not eliminating pooling until significant other 
        issues were resolved. Why is FASB determined to abolish pooling 
        in light of this significant opposition to its decision?
4) Your Exposure Draft specifically states that international 
        harmonization is one of the reasons for your decision to 
        eliminate pooling. Let's assume for a minute that that is a 
        valid goal. Given the fact that countries like the U.K., 
        France, Japan and Germany permit pooling, at least in some 
        form, how could eliminating pooling here increase international 
        harmonization? Assuming that various foreign and international 
        accounting rules are moving away from allowing pooling 
        accounting, why should the U.S. be following a trend in Europe 
        or elsewhere rather than encouraging the adoption of U.S. 
        rules?
    Once again, thank you for your assistance in this important matter. 
I look forward to working with you, the Committee and our colleagues 
who support the burgeoning high-tech economy.
            Sincerely,
                                             Joseph Crowley
                                                 Member of Congress
cc: The Honorable Edolphus Towns, Ranking Member

    Mr. Oxley. Should anyone else wish to submit written 
questions, that would be acceptable, as well.
    The Chair would ask unanimous consent that extraneous 
materials, including a study called ``Valuing the New 
Economy,'' a white paper, be made part of the record.
    Without objection, so ordered.
    Gentlemen, thank you very much for your appearance today. 
Mr. Cox is correct. We have put a new twist on an old 
profession, and that is always exciting. Thank you for your 
participation.
    The subcommittee stands adjourned.
    [Whereupon, at 2:04 p.m., the subcommittee was adjourned.]
    [Additional material submitted for the record follows:]

               Financial Accounting Standards Board
                                       Norwalk, Connecticut
                                                       May 23, 2000
Mr. Robert E. Simison
Legislative Clerk
Committee on Commerce
United States House of Representatives
Washington, DC 20515
    Dear Mr. Simison: The following is our response to the questions 
raised by Congressman Joseph Crowley in his May 4, 2000 letter to 
Chairman Michael G. Oxley in connection with the May 4, 2000 hearing of 
the Finance and Hazardous Material Subcommittee of the Committee on 
Commerce (``Subcommittee Hearing''):
    Question 1 Congressman Crowley writes: ``Many knowledgeable people 
have said that FASB's decision to eliminate pooling could have a 
damaging impact on economic growth. In a recent white paper, Merrill 
Lynch concluded that the change could result in a notable decline in 
the consolidations that have enhanced productivity, encouraged 
innovation, and simulated dynamism in the U.S. economy. And, a Goldman 
Sachs study specifically says that FASB's changes could have a dramatic 
impact on certain industries, including information technology and 
medical services. Why is FASB willing to take the chance that they are 
right?''
    Response: The Financial Accounting Standards Board (``FASB'' or 
``Board'') has issued an FASB Exposure Draft, Business Combinations and 
Intangible Assets (``Exposure Draft''), for public comment that has 
proposed to eliminate the pooling-of-interests method (``pooling 
method''). The Board will hold as many public meetings as necessary to 
carefully evaluate all of the feedback received in response to the 
Exposure Draft and to decide what modifications or clarifications, if 
any, to the Exposure Draft are appropriate. The Board will not make any 
final decisions about the Exposure Draft, including whether or not to 
retain the pooling method, or consider whether to issue a final 
standard, until it has completed its full due process and is satisfied 
that all substantive issues raised by all parties have been carefully 
considered.
    The Board has proposed to eliminate the pooling method because the 
Board believes that the elimination of the pooling method will benefit 
consumers--investors, creditors, and other users of financial 
statements--as well as companies that prepare those reports, by 
providing more information, and more relevant information, about all 
business combinations.
    The Exposure Draft's provisions also will benefit consumers by 
improving the comparability of financial reporting, thereby making it 
possible to more easily contrast companies that participate in business 
combinations.
    Many consumers have expressed support for elimination of the 
pooling method. As one example, a letter from the Financial Accounting 
Policy Committee of the Association for Investment Management and 
Research, the leading organization of investment professionals in the 
United States with over 40,000 members, states:
          The FAPC is unequivocal in its support of the FASB's proposal 
        that there be only one method of accounting for business 
        combinations in the United States. We also agree that the 
        purchase method is the one that reflects properly the economics 
        of all business combinations, and that pooling-of-interests 
        should be eliminated . . .
          The pooling method fails to revalue the assets and 
        liabilities of the acquired enterprise at fair value and the 
        excess, commonly called ``goodwill,'' is not recorded. Hence, 
        pooling does not faithfully represent the values of the assets 
        and liabilities exchanged, nor does it reveal the actual 
        premium paid by the acquirer in the transaction. Users of 
        financial statements are thus impeded in their attempts to 
        understand the underlying economics of the business 
        combination.
    In addition, Moody's Investors Services, the leading global rating 
agency, stated:
          Moody's supports the objectives of accounting standards 
        setters to improve the harmonization of accounting standards 
        globally, and welcomes the FASB's proposal to eliminate the 
        pooling of interests method. We believe that a single 
        accounting method can improve analytic efficiency, especially 
        in cases where a single transaction or essentially identical 
        transactions would produce dramatically different accounting 
        results, and thus enhance the ability of cross border capital 
        market participants to compare, easily and accurately, 
        alternative investments.
    Many companies that prepare financial reports also agree. Those 
companies that have written letters to the FASB supporting the 
elimination of the pooling method include IBM Corporation, Eaton 
Corporation, American Electronic Power, General Motors, Caterpillar, 
Inc., IMC Global, Cigna Corporation, and PPG Industries, Inc., to name 
a few. The IBM Corporation letter stated:
          IBM agrees with the FASB that all business combinations are 
        acquisitions and, thus, we support the FASB's proposal to 
        eliminate the pooling-of-interests method of accounting for a 
        business combination. We believe that financial statement users 
        are ill-served by the existence of two methods to account for 
        the same economic transaction. We agree with the FASB that 
        using the purchase method to account for all business 
        combinations will increase the comparability of financial 
        statements and will reflect the true economics of the 
        transaction, that is, an arm's length investment that should be 
        accounted for at the fair value of the assets and liabilities 
        that are acquired.
    The Exposure Draft's provisions will also benefit companies that 
prepare financial statements and the auditors of those statements by 
providing a single method of accounting for all business combinations. 
Having one method of accounting for all business combinations will 
reduce certain costs to companies and auditors that are currently 
related to the existence of the pooling method.
    For example, the availability of the pooling method often puts 
companies and their auditors under pressure to employ that method 
because it typically produces higher reported earnings and rates of 
return subsequent to a business combination than the purchase method. 
Moreover, because the pooling method is applied retroactively, the 
comparative earnings reported for periods preceding the combination are 
also higher than under the purchase method--even before the companies 
were, in fact, combined.
    As a result of those pressures, companies often must bear 
significant costs, both monetary and nonmonetary, in seeking to use the 
pooling method. In positioning themselves to try to meet the 12 
qualifying criteria for applying that method, companies may refrain 
from engaging in appropriate economic actions that they might otherwise 
undertake, such as asset dispositions or share reacquisitions. They 
also may incur substantial fees from auditors and consultants in 
seeking to meet those criteria. The efforts to meet those criteria also 
may lead to conflicts between companies, auditors, and regulators with 
respect to judgments about whether the criteria have been met, thereby 
adding uncertainties and their attendant costs to the process and 
raising questions about the operationality of those criteria.
    A report published by the Silicon Valley office of McKinsey & 
Company, an international consulting firm, stated:
          The fear that purchase accounting, by lowering reported 
        earnings, will destroy shareholder value is a myth. In fact the 
        opposite is true. Efforts to qualify for such treatment 
        actually destroy value. FASB's proposal to eliminate pooling 
        accounting is a blessing in disguise. Why? Because the 
        transition to purchase accounting will require corporations to 
        adopt more robust deal evaluation processes and enhance their 
        shareholder communications.
    Similarly, a letter to the FASB from the Financial Institutions 
Accounting Committee of the Financial Managers Society, a group of 
financial professionals working in executive level positions in the 
thrift and banking industries, stated:
          Formal research supports the proposition that reporting firms 
        consume substantial resources in structuring transactions 
        solely to achieve a favorable financial reporting outcome. Lys 
        and Vincent (1995) report that AT&T paid at least $50 million 
        (and possibly as much as $500 million) to achieve pooling-of-
        interests accounting for its acquisition of NCR . . . A single 
        method of accounting for business combinations would redirect 
        these corporate resources into more productive areas.
    In addition, having one method of accounting for business 
combinations benefits companies by leveling the playing field for 
competition among companies in the business combinations market. The 
ability--or inability--to use the pooling method often affects whether 
a company enters into a business combination and also affects the price 
it negotiates for that transaction. Companies that cannot use the 
pooling method because they cannot meet the criteria required for its 
use (for example, criteria that prohibit certain share acquisitions) 
often conclude that they cannot compete for targets with those that can 
meet the criteria.
    Many companies that cannot use the pooling method believe that 
companies that can use it often are willing to pay higher prices for 
targets than they would if they had to use the purchase method because 
they do not have to account for the full cost of the resulting 
investment. Thus, by using the pooling method, they can understate the 
income statement charges (primarily related to goodwill and other 
intangible assets).
    In a letter to the FASB, KeyCorp explained:
          Since most publicly-traded companies are gauged by EPS 
        performance, there is a strong incentive to use the ``earnings-
        friendly'' pooling method. The desire to avoid the earnings 
        consequences of the purchase method has almost certainly 
        resulted in uneconomic behavior. It is well understood in the 
        investment banking community that a company is willing to 
        ``pay'' more for a target if the pooling method is available 
        for the resulting transaction. Clearly, there is a view that 
        the pooling method results in a type of accounting arbitrage . 
        . .
    Even though using the pooling method rather than the purchase 
method might result in being able to report higher per-share earnings 
following the combination, the fundamental economics are not different 
because the actual cash flows generated following the combination will 
be the same regardless of which method is used. As a result, the added 
earnings reported under the pooling method reflect artificial 
accounting differences rather than real economic differences.
    To the extent that the markets respond to artificial differences, 
they direct capital to companies whose financial reporting benefits 
from those differences and they direct capital away from companies 
whose financial reporting does not benefit. As a result, markets 
allocate capital inefficiently rather than efficiently. While 
inefficient allocation of capital may benefit some companies and even 
some industries, it imposes added costs on many others, depriving them 
of capital that they need and capital they could employ more 
productively. The outcome is detrimental to those companies--but, more 
important, to the capital markets as a whole.
    Finally, two further clarifications. First, Question 1 states that 
the ``Goldman Sachs study specifically says that FASB's changes could 
have a dramatic impact on certain industries, including information 
technology . . .'' Unfortunately, the statement is not accurate. The 
May 29, 1999 Goldman Sachs survey by Gabrielle Napolitano, CFA, and 
Abby Joseph Cohen, CFA, to which the question refers, states that the 
FASB's pre-Exposure Draft preliminary decisions on accounting for 
business combinations may adversely affect some industries including 
the ``healthcare information technology'' industry. The survey does not 
conclude that the Board's decisions may adversely affect the entire 
information technology industry as implied in Question 1. More 
significant, the overall conclusion of the Goldman Sachs survey was 
that the Board's preliminary decisions, including the elimination of 
the pooling method, would ``not have a material adverse effect on 
future business combinations.''
    Second, Question 1 refers to conclusions of a Merrill Lynch ``white 
paper'' on the impact of the Board's proposed decision to eliminate the 
pooling method. For purposes of the Subcommittee Hearing record, it 
should be noted that in a March 3, 1999 Merrill Lynch ``In-depth 
Report'' on regional banks, Sandra J. Flannigan, CFA, first vice 
president, Global Securities Research & Economics Group, Global 
Fundamental Equity Research Department, concluded:
          In our opinion . . . the economics of a ``purchase'' and 
        ``pooling'' are the same. We, therefore, don't think 
        elimination of pooling-of-interests accounting will halt 
        consolidation. Indeed, ultimately, required usage of purchase 
        accounting could generate more transactions given greater 
        comparability from an international accounting standpoint and 
        fewer earnings reporting/share buyback constraint issues.
    Question 2 Congressman Crowley writes: ``You have received a number 
of thoughtful alternative proposals to the elimination of pooling. You 
have a great deal of concern about the evaluation of intangibles. What 
is the rush to eliminate pooling rather than looking first at the 
valuation questions? If the problem with studying the issues is that it 
will take some time, why not do it right the first time rather than in 
a piecemeal fashion, especially when the consequences of `getting it 
wrong' could be so severe?''
    Response: Since first adding the project on business combinations 
to its agenda in 1996, the Board has held over 40 public meetings, 
issued 2 preliminary documents and the Exposure Draft for public 
comment, and carefully analyzed and is still in the process of 
discussing at public meetings over 400 comment letters received from a 
broad range of companies, investors, and other constituents. We have 
hardly rushed to complete this project, as Question 2 suggests. As 
stated in response to Question 1 above, the Board will hold as many 
public meetings as necessary to carefully evaluate all of the feedback 
received in response to the Exposure Draft and to decide what 
modifications or clarifications, if any, to the Exposure Draft are 
appropriate. The Board will not make any final decisions about the 
Exposure Draft, including whether or not to retain the pooling method, 
or consider whether to issue a final standard, until it has completed 
its full due process and is satisfied that all substantive issues 
raised by all parties have been carefully considered.
    With respect to the issue of the ``valuation of intangibles,'' 
feedback received in response to the Exposure Draft reveals that some 
constituent concerns, including, possibly, the concerns raised in 
Question 2, result from having misread or misunderstood the Exposure 
Draft's provisions regarding intangibles. To clarify, those provisions 
do not require the separate valuation of any intangible assets, such as 
many forms of knowledge-based intangible assets so often associated 
with technology companies, that cannot be separately identified and 
reliably measured. Under current accounting standards and the Exposure 
Draft, only purchased intangible assets that can be identified and 
reliably measured, like many trademarks and customer lists, are 
required to be separately valued, reported, and amortized over their 
useful economic lives.
    Question 3 Congressman Crowley writes: ``A review of the comment 
letters sent to FASB shows that two-thirds of all of those who sent 
comment letters and all of the Big 5 accounting firms advocated either 
retaining at least some form of pooling or not eliminating pooling 
until significant other issues were resolved. Why is FASB determined to 
abolish pooling in light of this significant opposition to its 
decision?''
    Response: Many of those commentators that wanted to retain pooling 
wanted it retained in only very limited circumstances. Those 
circumstances were (1) where there was a true merger of equals (a very 
rare occurrence) and (2) where companies under common control were 
combined (a pooling-method-type result would be required under both 
current accounting and the Board's proposal).
    The Board is addressing and will resolve all of the ``significant 
other issues'' raised in the comment letters about the proposed 
accounting for goodwill and purchased intangibles before it 
redeliberates whether the pooling method should be retained.
    The FASB's Rules of Procedure provide for an open and thorough due 
process that includes analysis and public discussion of the relevant 
information and persuasive arguments contained in the comment letters, 
and other feedback, received in response to an FASB proposal. The 
Board's mandate is to establish and improve standards of financial 
accounting and reporting that result in credible, transparent, and 
comparable financial information for the efficient functioning of the 
US capital markets.
    As former US Securities and Exchange (``SEC'') Chairman Richard C. 
Breeden stated in testimony before Congress almost a decade ago:
          The purpose of accounting standards is to assure that 
        financial information is presented in a way that enables 
        decision-makers to make informed judgments. To the extent that 
        accounting standards are subverted to achieve objectives 
        unrelated to fair and accurate presentation, they fail in their 
        purpose.
    The US capital markets are the deepest, most liquid, and most 
efficient markets in the world. The unparalleled success and 
competitive advantage of the US capital markets are due, in no small 
part, to the high-quality and continually improving US financial 
accounting and reporting standards. As Federal Reserve System Chairman 
Alan Greenspan stated in a June 4, 1998 letter to SEC Chairman Arthur 
Levitt:
          Transparent accounting plays an important role in maintaining 
        the vibrancy of our financial markets . . . An integral part of 
        this process involves the Financial Accounting Standards Board 
        (FASB) working directly with its constituents to develop 
        appropriate accounting standards that reflect the needs of the 
        marketplace.
    As stated in response to Question 1 above, the Board will hold as 
many public meetings as necessary to carefully evaluate all of the 
feedback received in response to the Exposure Draft and to decide what 
modifications or clarifications, if any, to the Exposure Draft are 
appropriate. The Board will not make any final decisions about the 
Exposure Draft, including whether or not to retain the pooling method, 
or consider whether to issue a final standard, until it has completed 
its full due process and is satisfied that all substantive issues 
raised by all parties have been carefully considered.
    Question 4 Congressman Crowley writes: ``Your Exposure Draft 
specifically states that international harmonization is one of the 
reasons for your decision to eliminate pooling. Let's assume for a 
minute that that is a valid goal. Given the fact that countries like 
the U.K., France, Japan and Germany permit pooling, at least in some 
form, how could eliminating pooling here increase international 
harmonization? Assuming that various foreign and international 
accounting rules are moving away from allowing pooling accounting, why 
should the U.S. be following a trend in Europe or elsewhere rather than 
encouraging the adoption of U.S. rules?''
    Response: Because of the rapidly accelerating movement of capital 
flows globally, the Board believes there is a need for financial 
reporting to be comparable internationally. In response to that need, 
part of the Board's mission includes promoting international 
comparability of financial reporting, and accounting for business 
combinations is one of the more significant areas of difference in 
accounting standards.
    For example, in most parts of the world, the pooling method is 
either prohibited or used only on a rare exception basis. A recently 
issued exposure draft from the Canadian Accounting Standards Board 
would prohibit use of the pooling method, the International Accounting 
Standards Committee has established a Steering Committee on accounting 
for business combinations that will consider whether the pooling method 
should be prohibited, and in the United Kingdom, the technical director 
of the Accounting Standards Board has stated:
          If the US bans pooling, the International Accounting 
        Standards Committee (IASC) will come under pressure to ban it 
        and then the UK will have to ask itself whether it wants to be 
        the only country that allows it.
    The part of the Board's mission that includes promoting 
international comparability is secondary to the Board's central mission 
of establishing standards that result in credible, transparent, and 
comparable financial information for the efficient functioning of the 
US capital markets. The Board, and many of its constituents, believes 
that the proposed elimination of the pooling method is consistent with 
the both the Board's central mission and the Board's secondary mission.
    I hope that my effort to provide thorough answers to the questions 
posed by Congressman Crowley has been helpful. I would be pleased to 
meet with the Congressman in person to further discuss any of his 
concerns.
            Sincerely,
                                             Edmund Jenkins
                                                           Chairman
                                 ______
                                 
                Biotechnology Industry Organization
                                           Washington, D.C.
                                                        May 4, 2000
Brian McCullough
House Committee on Commerce
316 FHOB
Washington, DC 20515
    Dear Brian: Per my conversation with Jim Conzelman, enclosed for 
the Finance and Hazardous Materials Subcommittee's hearing record are 
six copies of the testimony BIO presented at the Financial Accounting 
Standards Board's (``FASB'') hearing on February 11, 2000 in New York 
City.
    The biotechnology industry is totally opposed to the FASB proposal 
to repeal the ``pooling'' method of accounting. In our industry, more 
so than in any other industry, appropriate business combinations are 
often the only source of capital for struggling companies. The use of 
the pooling method of accounting facilitates these arrangements. If 
pooling is repealed, there will be a dramatic downturn in combinations 
in our industry. This will result in many companies simply going out of 
business.
    Thank you for including our testimony in the Committee hearing 
record. Please feel free to call if you wish to discuss this matter in 
greater detail.
            Sincerely,
                                           Philip J. Ufholz
                                            BIO Tax/Finance Counsel
  Prepared Statement of Richard Pops Before the Financial Accounting 
                   Standards Board On Exposure Draft
              business combinations and intangible assets
                 Grand Hyatt Hotel, New York, New York
                           february 11, 2000
    Good afternoon, my name is Richard Pops. I am the Chief Executive 
Officer of Alkermes, Inc., a biotechnology research and development 
company located in Cambridge, Massachusetts. I wish to thank you for 
allowing me the opportunity to testify today on behalf of the 
Biotechnology Industry Organization (BIO), the national trade 
association that represents over 850 biotechnology companies worldwide.
     My testimony will focus on the Financial Accounting Standards 
Board's (hereafter, ``the Board'') proposal that would repeal the 
``pooling'' method of accounting which allows companies that merge to 
record their assets in the ongoing entity by simply combining their 
assets and liabilities. This testimony will supplement my comments that 
were submitted to the Board on December 3, 1999.
    If pooling is eliminated, all mergers will be treated as purchases 
of one company by another. The result of this mandatory application of 
``purchase accounting'' will be that biotechnology companies will be 
required to recognize and value at the time of the transaction a 
variety of intangible assets, including goodwill. This asset would have 
to be amortized, according to Generally Accepted Accounting Principles 
(GAAP), over the course of twenty years. This has at least two 
important implications for biotechnology companies. Both relate to the 
critical issue facing entrepreneurs seeking to build and grow 
successful biotechnology companies: the ability to raise large sums of 
capital over a period of several years prior to first profitability.
    First, elimination of pooling accounting means a potential delay in 
profitability for businesses that merge to build critical mass. 
Biotechnology companies are unique in that they typically operate for 
years (average approximately 14.5 years by BIO's estimate) in a loss 
position. Raising enough money to survive is incredibly challenging. 
The pooling method of accounting allows a profitable or potentially 
profitable biotech company to acquire a non-profitable company without 
incurring an adverse charge to its earnings. In most cases, a merger or 
acquisition is the only viable option for the loss company. The 
alternative, due to a lack of cash flow and resultant inability to 
continue vital research and development efforts, is frequently 
financial failure. This is generally not the case in other high 
technology industries where profitable companies acquire or merge with 
other profitable companies in order to create synergy and improve 
efficiency. With biotech companies, it is a case of survival. For 
investors supporting these companies, the timing of profitability is a 
critical consideration in their investment decision. A delay in 
profitability due to non-cash amortization charges can add years to the 
time that a biotechnology company operates at a loss. This extends the 
time that its securities are unattractive to many investors and, 
therefore, increases the already difficult task of fundraising.
     Second, it means that, once profitable, biotechnology companies 
that merged to build critical mass may report significantly depressed 
earnings per share over the course of many financial reporting periods. 
This has the potential to severely damage the company's overall value. 
This has a profound effect much earlier in the company's life as 
investors make the investment decision prior to profitability. If the 
eventual valuation of the company is lower once it is profitable, the 
present value of its equity is lower today. This affects the company's 
ability to raise capital.
    It is important to recognize that for biotechnology companies, 
tangible book value is low in comparison to total company value. 
Biotechnology mergers often occur between companies of similar size, 
and result in large amortization charges in purchase accounting. The 
effect of the elimination of pooling accounting is magnified for small 
biotechnology companies, where the non-cash amortization charges can 
dwarf total profitability of the combined business in the early 
quarters of profitability.
    Biotechnology companies are part of a new generation of companies 
that presents a financial profile profoundly different from traditional 
``bricks and mortar'' enterprises. The issue of pooling should be 
addressed in the context of a larger examination of how GAAP can best 
handle the financial disclosure for these types of companies. For the 
same reason that the Board recently decided to defer consideration of 
new rules governing in process research and development, because the 
issue was too closely intertwined with the treatment of research and 
development costs generally, the Board should defer consideration of 
the pooling issue.
    Repeal of the pooling method will reduce the likelihood that some 
desirable combinations will occur. This would be an unfortunate outcome 
for the biotechnology industry, where mergers of complementary 
technologies are often necessary to enable the development of 
innovative new drugs and diagnostic products for the benefit of 
patients and families around the world.
    The problems of comparability, relevance, reliability, and 
neutrality that the Board says drives its proposed change are recreated 
in purchase accounting by the need to confront the many problems 
inherent in the treatment of intangible assets, in general, and 
goodwill in particular. With so much of the value of biotechnology 
companies lying in these intangibles, the financial presentation under 
the mandated use of purchase accounting will be significantly more 
problematic than under pooling.
    One of the foundations of financial accounting is comparability 
across time as well as between companies. Users of financial statements 
should be able to look across periods and evaluate a company's 
performance over time, to see and be able to evaluate trends and 
significant new developments in its financial situation. The strength 
of accounting for business acquisitions by pooling is that it allows 
for just such a comparison. The merger of two entities by their owners, 
the shareholders, is undertaken with the expectation that the new, 
combined entity will allow for greater value to be generated going 
forward. By preserving the historical values of assets carried on the 
books of the predecessor companies, such a comparison can be made 
easily. The assets, income flow, and other financial elements of the 
two companies are simply combined and not altered, and so any change in 
the future, good or bad, is readily apparent.
    Purchase accounting departs from this model of combination and thus 
undermines the users of financial statements' ability to compare 
performance over time easily. Under purchase accounting, the historical 
valuation of assets of one of the predecessor companies is preserved, 
while the assets of the other company are revalued according to the 
fair market value at the time of the business combination. Thus, going 
forward there is an amalgam of valuation of assets, some at historical 
cost and some at this new, fair market valuation.
    The Board's proposed rule does not adequately take into account the 
true worth of a biotechnology company's intangible assets and would 
slow their growth, which is more important than detailed accounting. 
Investors do not care about accountants' estimates of a company's 
various hard-to-measure intangible assets. What they really want to 
know is, does this merger contribute to the bottom line.
    I do not pretend that there are any easy answers to the problem of 
dealing with intangible assets and their role in biotechnology 
companies. The rapid changes in the biotechnology industry have created 
new situations where traditional accounting principles no longer can be 
relied upon to provide accurate, transparent, public disclosure. The 
worth of biotechnology companies is increasingly related to intangible 
assets that traditional accounting fails to measure. It is a difficult 
problem, and I applaud the Board for continuing to grapple with it. 
However, in the face of this recognized difficulty, the elimination of 
pooling alone means not that problems with accounting reliability, 
comparability and neutrality will be eliminated, but instead will be 
exacerbated.
    The magnitude of this proposed rule change requires a careful 
weighing of the possible costs of change against the conviction that 
the public will enjoy significant benefits.
    The risk of adverse impact to the biotechnology industry due to the 
elimination of pooling is significant enough to require an equally 
significant showing of the benefits to be realized. In fact, none of 
the benefits claimed on behalf of the proposed rule change meet such a 
standard either separately or collectively.
                                 ______
                                 
                      National Association of Manufacturers
                                                        May 3, 2000
The Honorable Michael Oxley
Chairman, Subcommittee on Finance and Hazardous Materials
House Commerce Committee
2233 Rayburn House Office Building
Washington, DC 20515
    Dear Mr. Chairman: I am writing on behalf of the National 
Association of Manufacturers (NAM) regarding the subcommittee hearing 
on business combinations scheduled for Thursday, May 4. The NAM--``18 
million people who make things in America''--is the nation's largest 
and oldest multi-industry trade association. The NAM represents 14,000 
members (including 10,000 small and mid-sized companies) and 350 member 
associations serving manufacturers and employees in every industrial 
sector and all 50 states. As many of our members are current or 
frequent participants in mergers and acquisitions (M&As), we have a 
vested interest in this issue and have, in fact, testified before the 
Financial Accounting Standards Board (FASB) and the Senate Banking 
Committee in February and March of this year, respectively.
    While the NAM fully supports the independence of the FASB and 
strongly believes that setting of accounting standards should be left 
to the private sector, we are also very concerned about some of the 
changes the FASB has suggested in its proposal on Business Combinations 
and Intangible Assets. Most notably, the FASB has proposed to eliminate 
the pooling-of-interests method of accounting and to halve the maximum 
amortization period for goodwill (currently 40 years, would be 20 years 
under the proposal). The NAM opposes both of these changes for the 
reasons set forth in our enclosed statement for the record.
    Our primary purpose for writing to you today is to clarify the 
scope of those who would be harmed by these proposals, should the 
project move forward unmodified. In much of what has been written and 
said about this issue, it has been characterized as a ``high tech'' 
issue. (The NAM insists that modern manufacturing and ``high tech'' are 
increasingly synonymous but, for the sake of this discussion, will 
accept the distinction.) And the FASB has correctly asserted that 
accounting rules should be equally applicable to all sectors of the 
economy and not favor one sector over another. However, while it is 
certainly true that much of the incredible growth of the high tech 
sector has been achieved through mergers relying on pooling, pooling 
has also played, and continues to play, a very significant role for 
more traditional manufacturers. It is important to note that the NAM's 
very active involvement in this issue is not due solely--or even most 
significantly--to the interests of our many high tech members. We are 
consistently hearing, primarily from more traditional manufacturers, 
that this merger or that merger would not have occurred had it not been 
for the applicability of pooling. This is not to say that all mergers 
are inherently good, but that is up to the market to decide--not the 
FASB.
    The FASB has made it quite clear that it is not its mission to take 
into account economic consequences when promulgating new accounting 
standards. But there is no ``abuse'' being addressed in this case that 
would require drastic or expedited action, and the potential risks far 
outweigh the potential benefits. Consequently, we are heartened that 
this subcommittee has seen fit to fill the gap by considering the 
potential economic consequences of the FASB's Business Combinations and 
Intangible Assets proposal. Please feel free to call me or the NAM's 
director of corporate finance and tax, Kimberly Pinter (202-637-3071) 
if you have further questions.
            Sincerely,
              Michael E. Baroody, Senior Vice President    
                     Policy, Communications and Public Affairs,    
                              National Association of Manufacturers
Enclosure
 Prepared Statement of Kimberly J. Pinter, Director, Corporate Finance 
    and Tax, National Association of Manufacturers on Behalf of the 
                 National Association of Manufacturers
                            i. introduction
    The National Association of Manufacturers (NAM) appreciates this 
opportunity to present its views on the Financial Accounting Standards 
Board's (FASB) Business Combinations and Intangible Assets proposal. 
The NAM is the nation's largest and oldest multi-industry trade 
association, representing 14,000 members in every industrial sector and 
in all 50 states. A significant number of our members are frequent or 
current participants in merger and acquisition (M&A) activity and have 
a vested interest in the outcome of this project.
                              ii. pooling
    The centerpiece of this project is the proposed disallowance of the 
pooling-of-interests method of accounting. The NAM finds this proposal 
objectionable based on a number of different factors.
    First of all, the NAM disagrees with the FASB's underlying premise 
that all business combinations are substantively the same. My personal 
observation as a non-accountant is that it seems very odd that the term 
``M&A'' would be standard jargon if ``M's'' and ``A's'' were really 
exactly the same thing.
    Substantively, a transaction in which a shareholder remains a 
shareholder fundamentally differs from one in which the shareholder 
cashes out. The pooling method respects this continuity. The criteria 
for using the pooling method are already quite strict and reflect the 
primary factors of such continuity. The FASB contends that by 
eliminating pooling they will be aiding comparability of financial 
statements--making like things look alike. It is the NAM's position 
that not all transactions are alike, and that while like things should 
look alike, dissimilar things should look different.
    Additionally, there are substantive problems with the purchase 
method that should be addressed, particularly before the elimination of 
pooling, should its elimination ultimately be determined to be an 
appropriate goal. These problems center around the valuation of 
intangibles.
    The NAM's first concern in this area is the proposed halving of the 
maximum allowable period over which to amortize goodwill charges. The 
FASB has taken the position that goodwill is a diminishing asset. The 
NAM disagrees with this premise. In the case of a successful merger, 
goodwill should actually increase. Goodwill results because the value 
of a company is greater than the sum of its parts. Following from that, 
every merger participant is hopeful that a successful merger will yield 
more than the sum of its parts.
    Furthermore, even if we were to accept the idea of goodwill as a 
wasting asset, it has been conceded that goodwill cannot be reliably 
measured nor its actual useful life determined. Therefore, the 
arbitrary limit of 40 years was set some time ago. Companies and 
markets have acclimated to this standard. Now, with no more accurate or 
useful way to account for goodwill, the FASB is proposing to replace 
one arbitrary limit with another--in a way that would significantly and 
adversely affect our members' financial statements.
    The problems inherent in the valuation of goodwill are not unique 
to goodwill. Technological advance has fueled a whole host of new 
intangibles, many of which are equally difficult to characterize and 
value. They are, if you will, a by-product of the ``new economy.'' But 
let me explain for a moment what I mean by the ``new economy.'' It is 
not a place or a specific industry segment. It is a pervasive concept 
affecting all industries to varying degrees. The NAM has done several 
reports, in fact, on ``Technology on the Factory Floor.'' Traditional 
manufacturers are huge consumers and producers of technology, whether 
it's to improve methods of cutting steel using laser-like streams of 
super-cooled chemicals; to locate oil, gas, or other natural resources; 
to automate an assembly line; or even to provide all of their employees 
with home computers. Such a dramatic evolution in the way our companies 
do business seems to warrant at least an examination of whether 
traditional accounting principles are still accurate and appropriate.
    I have personally discussed the proposed elimination of pooling 
with many of our member companies, and I have been truly surprised by 
the number of times I have heard that this merger or that merger would 
not have happened had it not been for the applicability of pooling. And 
I have heard these comments across the board from all kinds of 
manufacturers. Even those that don't use pooling are very concerned 
about its possible unavailability for future transactions.
    Manufacturing is the largest contributor to economic growth, and 
the recent surge in M&A activity has coincided with a surge in 
productivity growth. By mentioning these facts, I don't mean to suggest 
that pooling should be retained because it somehow ``encourages'' 
business combinations; rather, it appears that the existence of only 
the purchase method to account for a diverse array of transactions 
would discourage such activity--and that result could well have a 
negative effect on the economy.
                              iii. process
    Finally, the NAM is concerned that the FASB is not hearing from all 
parties who may be critical of the project. Too often we have found 
that companies are very reluctant to too visibly criticize the merits 
of a FASB proposal due to concern that such activity might invite 
increased SEC scrutiny. Regardless of whether such concerns are 
founded, as they say, perception is reality, and it does have a 
chilling effect on full participation in the process. That said, the 
NAM appreciates the FASB's extensive efforts to thoroughly evaluate 
these issues with significant outside input and participation, and we 
do fully support the FASB's independence and private-sector setting of 
accounting standards.
                                 ______
                                 
                               American Business Conference
                                                        May 3, 2000
The Honorable Michael G. Oxley
United States House of Representatives
Washington, DC 20510
    Dear Congressman Oxley: I write in regard to the upcoming hearings 
in the Subcommittee on Finance and Hazardous Materials on the efforts 
of the Financial Accounting Standards Board (FASB) to change 
substantially accounting rules for business combinations.
    The American Business Conference (ABC), a coalition of CEOs of 
fast-growing, midsize companies, is very concerned about FASB's 
proposal. We hope that the Subcommittee's hearing will illuminate the 
many important issues put into play by the FASB initiative--issues we 
regard as far from settled. As background, I have enclosed with this 
letter a memorandum I wrote on FASB's business combinations project. I 
hope it may prove of use to you and your colleagues.
    In the view of ABC members, the single greatest service your 
hearing can perform is to underscore the comprehensive nature of FASB's 
business combinations project. The project is not, as some have 
suggested, merely an effort to eliminate pooling-of-interests with a 
few extra details thrown in. FASB's project seeks to change all 
business combinations--accounting--the pooling-of-interests method, 
used in about 5 percent of merger and acquisition deals, and the 
purchase method, used in the vast majority of merger and acquisition 
transactions.
    Because the FASB business combinations project is a comprehensive 
agenda for change, it carries critical implications for every business 
enterprise in the country, regardless of industry and regardless of 
which method of accounting--pooling or purchase--they have used in the 
past or may plan to employ in the future. Interest in and concern about 
various aspects of FASB's proposal accordingly can be found in all 
segments of the American business community, among accounting firms, 
and among investors.
    This is the essential point for understanding the controversy 
swirling around FASB's project. The fact is, as a reading of comment 
letters to the FASB demonstrates, there is no meaningful consensus in 
the private sector in support of the business combinations project.
    For example, defenders of FASB's plan to abolish pooling-of-
interests accounting point to the Association for Investment Management 
and Research (AIMR), for support of their position. And it is certainly 
true that AIMR, the leading association of investment professionals, on 
balance advocates the elimination of pooling. However, the AIMR 
``disagrees strongly'' with another crucial aspect of FASB's proposal, 
namely the display under the purchase method of goodwill amortization 
charges net of tax and after operating earnings.\1\ (The enclosed 
memorandum discusses the latter issue in greater detail.)
---------------------------------------------------------------------------
    \1\ Letter of the Association for Investment Management and 
Research, to Mr. Timothy Lucas, Director of Research and Technical 
Activities, Financial Accounting Standards Board, December 7, 1999 
(Letter of Comment No.: 56A).
---------------------------------------------------------------------------
    A review of the positions of the major accounting firms also 
displays misgivings about the FASB proposal. PricewaterhouseCoopers, as 
an instance, disagrees with FASB's position regarding the elimination 
of pooling and with some of the Board's proposed changes to purchase 
accounting, including the display of goodwill amortization. For its 
part, KPMG does not support the total elimination of pooling or the 
separate treatment of goodwill amortization from other intangible 
assets under purchase accounting.\2\
---------------------------------------------------------------------------
    \2\ Letter of PricewaterhouseCoopers LLP to Mr. Timothy Lucas, 
Director of Research and Technical Activities, Financial Accounting 
Standards Board, December 7, 1999, (Letter of Comment No: 1A) and 
Letter of KPMG to Timothy Lucas, December 7, 1999, (Letter of Comment 
No: 35A). Most of the other accounting firms submitting comment letters 
to FASB cite similar problems in the exposure draft. These misgivings 
are mirrored in letters from leading investment banks, commercial 
banks, and money management firms.
---------------------------------------------------------------------------
    The comment letters to the FASB from corporations constitute a 
litany of dissent. Thus Ford Motor Company, although it does not use 
the pooling-of-interests method, is nonetheless ``not in favor of its 
elimination.'' As for FASB's proposed reform of purchase accounting, 
Ford does not agree with the Board on goodwill recoverability, 
disclosure requirements for acquisitions, the new twenty-year period 
for goodwill amortization, or the separate line-item disclosure of 
goodwill amortization. Ford's dissent is more or less typical of the 
response of other corporations, big and small, ``old'' economy and 
``new'' economy.\3\
---------------------------------------------------------------------------
    \3\ Letter of Ford Motor Company to Timothy Lucas, Director of 
Research and Technical Activities, Financial Accounting Standards 
Board, December 3, 1999 (Letter of Comment No.: 92).
---------------------------------------------------------------------------
    Although the Board's rulemaking process. is not complete, FASB 
members thus far have shown little inclination to rethink their 
proposal. In spite of the considerable criticism that the Exposure 
Draft has attracted, the Board seems determined to move forward on the 
elimination of pooling accounting and the alteration of purchase 
accounting. Undoubtedly the Board will have to ``tweak'' aspects of its 
proposal, but it seems unlikely that those marginal changes will speak 
to the broader objections of the private sector.
    If I am correct about the Board's attitude, the result will be 
unfortunate. It will be unfortunate first because FASB will force on 
the business, accounting, and investment communities a ``reform'' of 
business combinations accounting that I believe is deeply flawed and 
that will almost surely have to be revisited, sooner rather than later.
    It will be unfortunate, too, because a decision by the Board to 
press ahead with a rule that has met with so much resistance during the 
comment period threatens the Board's long-term capacity to exert 
leadership on a host of other cutting-edge accounting issues. The Board 
very well may have its way in this matter, but at what price? ABC 
strongly supports the FASB and respects the Board's independence. We 
believe, however, that FASB's ability to maintain that independence is 
directly proportionate to its constituents' faith in the Board's 
capacity to respond to constructive criticism. Fairly or not, many of 
our colleagues in the business community harbor serious doubts on this 
point.
    We at ABC believe that a responsible, intellectually tenable 
compromise is possible in regard to business combinations accounting. 
We also believe the FASB process itself is sufficiently flexible to 
allow for that compromise to happen, provided that all the interested 
parties are willing to take the time to do the job correctly. I do not 
pretend to know the exact lineaments of a workable compromise but I 
suspect it would, as a first step, entail a satisfactory, mutually 
agreeable recasting of purchase accounting, particularly as it pertains 
to intangible assets including goodwill.
    In closing, let me state a view that I suspect you share: Congress 
ideally ought not to have a legislative role in the setting of 
accounting standards. What Congress can do, and indeed, what I hope it 
will do through the Finance. Subcommittee's hearing, is to exert its 
traditional oversight function in such a way as to inform citizens of 
the issues at stake while encouraging intelligent compromise within the 
private standard-setting process. To that end, ABC stands ready to 
assist you and your colleagues on the Subcommittee.
            Sincerely,
                                           Barry K. Rogstad
                                                          President
cc: The Honorable Edolphus Towns



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