    [House Hearing, 109 Congress]
    [From the U.S. Government Publishing Office]

                             FOSTERING ACCURACY AND

                      TRANSPARENCY IN FINANCIAL REPORTING

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

                                    HEARING

                                   BEFORE THE

                                SUBCOMMITTEE ON
                        CAPITAL MARKETS, INSURANCE, AND
                        GOVERNMENT SPONSORED ENTERPRISES

                                     OF THE

                        COMMITTEE ON FINANCIAL SERVICES

                         U.S. HOUSE OF REPRESENTATIVES

                           ONE HUNDRED NINTH CONGRESS

                                 SECOND SESSION

                                   __________

                                 MARCH 29, 2006

                                   __________

           Printed for the use of the Committee on Financial Services

                               Serial No. 109-80

                        U.S. GOVERNMENT PRINTING OFFICE
                               WASHINGTON : 2006
    30-174 PDF

    For Sale by the Superintendent of Documents, U.S. Government Printing Office
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                     HOUSE COMMITTEE ON FINANCIAL SERVICES

                        MICHAEL G. OXLEY, Ohio, Chairman

    JAMES A. LEACH, Iowa                 BARNEY FRANK, Massachusetts
    RICHARD H. BAKER, Louisiana          PAUL E. KANJORSKI, Pennsylvania
    DEBORAH PRYCE, Ohio                  MAXINE WATERS, California
    SPENCER BACHUS, Alabama              CAROLYN B. MALONEY, New York
    MICHAEL N. CASTLE, Delaware          LUIS V. GUTIERREZ, Illinois
    EDWARD R. ROYCE, California          NYDIA M. VELAZQUEZ, New York
    FRANK D. LUCAS, Oklahoma             MELVIN L. WATT, North Carolina
    ROBERT W. NEY, Ohio                  GARY L. ACKERMAN, New York
    SUE W. KELLY, New York, Vice Chair   DARLENE HOOLEY, Oregon
    RON PAUL, Texas                      JULIA CARSON, Indiana
    PAUL E. GILLMOR, Ohio                BRAD SHERMAN, California
    JIM RYUN, Kansas                     GREGORY W. MEEKS, New York
    STEVEN C. LaTOURETTE, Ohio           BARBARA LEE, California
    DONALD A. MANZULLO, Illinois         DENNIS MOORE, Kansas
    WALTER B. JONES, Jr., North          MICHAEL E. CAPUANO, Massachusetts
        Carolina                         HAROLD E. FORD, Jr., Tennessee
    JUDY BIGGERT, Illinois               RUBEN HINOJOSA, Texas
    CHRISTOPHER SHAYS, Connecticut       JOSEPH CROWLEY, New York
    VITO FOSSELLA, New York              WM. LACY CLAY, Missouri
    GARY G. MILLER, California           STEVE ISRAEL, New York
    PATRICK J. TIBERI, Ohio              CAROLYN McCARTHY, New York
    MARK R. KENNEDY, Minnesota           JOE BACA, California
    TOM FEENEY, Florida                  JIM MATHESON, Utah
    JEB HENSARLING, Texas                STEPHEN F. LYNCH, Massachusetts
    SCOTT GARRETT, New Jersey            BRAD MILLER, North Carolina
    GINNY BROWN-WAITE, Florida           DAVID SCOTT, Georgia
    J. GRESHAM BARRETT, South Carolina   ARTUR DAVIS, Alabama
    KATHERINE HARRIS, Florida            AL GREEN, Texas
    RICK RENZI, Arizona                  EMANUEL CLEAVER, Missouri
    JIM GERLACH, Pennsylvania            MELISSA L. BEAN, Illinois
    STEVAN PEARCE, New Mexico            DEBBIE WASSERMAN SCHULTZ, Florida
    RANDY NEUGEBAUER, Texas              GWEN MOORE, Wisconsin,
    TOM PRICE, Georgia
    MICHAEL G. FITZPATRICK,              BERNARD SANDERS, Vermont
        Pennsylvania
    GEOFF DAVIS, Kentucky
    PATRICK T. McHENRY, North Carolina
    JOHN CAMPBELL, California

                     Robert U. Foster, III, Staff Director
     Subcommittee on Capital Markets, Insurance, and Government Sponsored
                                  Enterprises

                     RICHARD H. BAKER, Louisiana, Chairman

    JIM RYUN, Kansas, Vice Chair         PAUL E. KANJORSKI, Pennsylvania
    CHRISTOPHER SHAYS, Connecticut       GARY L. ACKERMAN, New York
    PAUL E. GILLMOR, Ohio                DARLENE HOOLEY, Oregon
    SPENCER BACHUS, Alabama              BRAD SHERMAN, California
    MICHAEL N. CASTLE, Delaware          GREGORY W. MEEKS, New York
    FRANK D. LUCAS, Oklahoma             DENNIS MOORE, Kansas
    DONALD A. MANZULLO, Illinois         MICHAEL E. CAPUANO, Massachusetts
    EDWARD R. ROYCE, California          HAROLD E. FORD, Jr., Tennessee
    SUE W. KELLY, New York               RUBEN HINOJOSA, Texas
    ROBERT W. NEY, Ohio                  JOSEPH CROWLEY, New York
    VITO FOSSELLA, New York,             STEVE ISRAEL, New York
    JUDY BIGGERT, Illinois               WM. LACY CLAY, Missouri
    GARY G. MILLER, California           CAROLYN McCARTHY, New York
    MARK R. KENNEDY, Minnesota           JOE BACA, California
    PATRICK J. TIBERI, Ohio              JIM MATHESON, Utah
    J. GRESHAM BARRETT, South Carolina   STEPHEN F. LYNCH, Massachusetts
    GINNY BROWN-WAITE, Florida           BRAD MILLER, North Carolina
    TOM FEENEY, Florida                  DAVID SCOTT, Georgia
    JIM GERLACH, Pennsylvania            NYDIA M. VELAZQUEZ, New York
    KATHERINE HARRIS, Florida            MELVIN L. WATT, North Carolina
    JEB HENSARLING, Texas                ARTUR DAVIS, Alabama
    RICK RENZI, Arizona                  MELISSA L. BEAN, Illinois
    GEOFF DAVIS, Kentucky                DEBBIE WASSERMAN SCHULTZ, Florida
    MICHAEL G. FITZPATRICK,              BARNEY FRANK, Massachusetts
        Pennsylvania
    JOHN CAMPBELL, California
    MICHAEL G. OXLEY, Ohio

                                C O N T E N T S

                                  ----------
                                                                       Page
    Hearing held on:
        March 29, 2006...............................................     1
    Appendix:
        March 29, 2006...............................................    45

                                   WITNESSES
                           Wednesday, March 29, 2006

    Cunningham, Colleen, President, Financial Executives
      International..................................................    34
    Gradison, Willis, Acting Chairman, Public Company Accounting
      Oversight Board................................................     9
    Herz, Robert H., Chairman, Financial Accounting Standards Board..    11
    Hirschmann, David, Senior Vice President, U.S. Chamber of
      Commerce.......................................................    30
    Lackritz, Marc E., President, Securities Industry Association....    32
    McEnally, Rebecca, Director of Capital Markets Policy, Center for
      Financial Markets Integrity, CFA Institute.....................    38
    Melancon, Barry, President, The American Institute for Certified
      Public Accountants.............................................    36
    Taub, Scott A., Acting Chief Accountant, Securities and Exchange
      Commission.....................................................    13

                                    APPENDIX

    Prepared statements:
        Oxley, Hon. Michael G........................................    46
        Clay, Hon. Wm. Lacy..........................................    48
        Davis, Hon. Geoff............................................    49
        Browning, Candace............................................    51
        Cunningham, Colleen..........................................    53
        Gradison, Willis.............................................    64
        Herz, Robert H...............................................    72
        Hirschmann, David............................................   149
        Lackritz, Marc E.............................................   154
        Melancon, Barry..............................................   166
        McEnally, Rebecca............................................   183
        Stevens, Paul Schott.........................................   195
        Taub, Scott A................................................   208

                             FOSTERING ACCURACY AND
                      TRANSPARENCY IN FINANCIAL REPORTING

                                  ----------

                           Wednesday, March 29, 2006

                 U.S. House of Representatives,
            Subcommittee on Capital Markets, Insurance,
                  and Government Sponsored Enterprises,
                               Committee on Financial Services,
                                                       Washington, D.C.
        The subcommittee met, pursuant to notice, at 10:00 a.m., in
    room 2128, Rayburn House Office Building, Hon. Richard H. Baker
    [chairman of the subcommittee] presiding.
        Present: Representatives Baker, Castle, Biggert, Shays,
    Davis of Kentucky, Kanjorski, Velazquez, Hinojosa, Miller of
    North Carolina, Scott, and Wasserman-Schultz.
        Ex officio: Representatives Oxley and Frank.
        Also present: Representative Cleaver of Missouri.
        Chairman Baker. Good morning. Welcome, all of our
    distinguished participants this morning. I have been advised
    that Mr. Kanjorski is on his way, but did not express any
    concern about us convening the hearing in his absence, and we
    will proceed accordingly.
        The purpose of the hearing this morning is to begin what I
    hope will be a helpful discussion relative to current corporate
    requirements for financial disclosures.
        Since 1934, public companies have been required by the SEC
    to file certain financial information with the SEC. As is
    usually the case, over a considerable number of years, those
    reporting requirements have become increasingly complex, and
    much more sophisticated. All of this, of course, is disclosed
    in conformity with GAAP standards.
        In addition to SEC requirements, of course, the Financial
    Accounting Standards Board, known as FASB, has also required
    the filing of certain supplementary information. The picture
    that is now presented every 90 days to the public, the ``beat
    the Street'' mentality, is a cause of some concern.
        On the one hand, the intended purpose of the frequent
    financial disclosures is to enable an investor to create, in
    his own mind, an accurate assessment of the corporation's true
    financial condition. Because of the complexity of the
    disclosures, the typical investor, really, is overwhelmed by
    the data, and most don't really make much use of the inordinate
    amount of disclosure that is required.
        On the other hand, it's my view that, at least during the
    1990's, the effort to ``beat the Street'' every quarter by
    management incentivized the presentation of a corporation's
    financial condition--although in a legal--but in the most
    advantageous manner possible, to present to the markets and to
    potential investors the most optimistic perspective of the
    corporation's operating condition.
        It has resulted, I believe, in the more disturbing
    disclosures made later in the decade, where there was
    intentional manipulation of the financials to mislead the
    markets and investors.
        Although those were the exceptions and not the rule,
    clearly the incentives are now in place, I believe, to cause
    the CFO, the CEO, and others, to report, as best they can, a
    clearly optimistic view of the corporation's condition.
        I think now it's time to hear from those in the market, and
    those who regulate markets, as to whether there is a shared
    view that there is a better way to do this.
        Specifically, the FDIC has recently concluded a pilot
    program with about 300 insured financial depositories
    implementing, to my knowledge, the first broad-based use of
    extensible business reporting language, XBRL. Although now
    poised to move forward at some point to require all financial
    entities to report in similar fashion, that action has not yet
    been taken.
        Although there are some individual corporations who have,
    on their own, begun to file in a manner very similar to an
    XBRL-like system, there is not yet an industry or SEC view that
    we are ready to move to replace the quarterly earnings with
    something of this nature.
        I would hope that, in a very broad perspective, in looking
    from the 50,000-foot level down, perhaps, that we could
    consider moving away from the retrospective, rules-based
    reporting, which tells you, perhaps, if you're smart, where the
    corporation was about 4 months ago, as opposed to a more
    forward-looking view--without liability attaching--of where the
    corporation might be at the moment, and more importantly, where
    it might be going.
        My best example to support that perspective is if one was
    in the business of manufacturing widgets, and under the current
    system you showed the sale of $100 million worth in the last
    quarter under the current reporting system, but in current
    time, real time, your customer satisfaction surveys were
    indicating that 90 percent of the customers didn't like your
    widget. As an investor, which would you rather know?
        I think disclosure of real-time material facts in user-
    friendly form could be a very helpful thing in comparative
    analysis by investors.
        And finally, the reason why this is so essential to Members
    of Congress is that over half of all Americans now, through the
    workplace, through direct investment, or in some fashion, are
    invested in our markets. They are a source of an inordinate
    amount of capital. And we have the obligation to make sure that
    the working families of this country, who rely on the
    information given to make investment decisions, are getting
    accurate information that can be relied on.
        And I think this discussion will help us determine whether
    the current system does that, or whether there is potential for
    modifications that would be helpful to all who share an
    interest in this very vibrant marketplace.
        With that, did you have a statement, Mr. Kanjorski?
        Mr. Kanjorski. Thank you, Mr. Chairman. Mr. Chairman, I,
    like you, am so excited about this hearing today because of the
    content that we are going to get into, and I know that you
    called me at 2:30 in the morning and you couldn't sleep because
    of the--
        Chairman Baker. Calm down, you're going to be okay.
        Mr. Kanjorski. But quite frankly, I want to congratulate
    you for calling the hearing. We look forward to this. This is
    an important issue, we can do an awful lot with it.
        I have had the occasion to meet with some of the witnesses
    in the last several weeks, and I know how dedicated they are to
    fostering accuracy and transparency.
        So, I congratulate Mr. Chairman on the hearing. Thank you.
        Chairman Baker. I thank the gentleman. Mr. Shays?
        Mr. Shays. Mr. Chairman, I have an introduction. Should I
    wait later, and do that?
        Chairman Baker. Yes, sir. I think at the appropriate time,
    yes. Mr. Frank, did you have a statement?
        Mr. Frank. Thank you, Mr. Chairman. I am particularly glad
    we're having this hearing, because I think it is a chance for
    us to talk about some things that were done well, and to focus
    on how to build on what has been done well, and improve it.
        The question of the Sarbanes-Oxley bill is obviously an
    important one for people, especially since next year we will be
    Sarbanes-Oxley-less in both houses. And the two guardians of
    that effort will no longer be with us. But their handiwork will
    be.
        And there has been some criticism of it. I think it is in
    everybody's interest to focus on improvement in that, rather
    than to talk about any substantial cut-back. And I welcome the
    participation of the people to whom I think we are ready to
    entrust the responsibility of some refinement.
        And I think we could make it clear--and I would want to say
    now--as the entities we are dealing with look at Sarbanes-
    Oxley, I hope they will be willing to make some appropriate
    adjustments--not exemptions, but adjustments--in how this
    applies, particularly in part, based on size, and I hope--we
    would tell them that if there were any things that they thought
    made sense, that they thought they might like statutory
    authority to do, they should ask us. I think there would be a
    great willingness to give them the statutory authority, rather
    than to make changes in the text of the law, but to give the
    administrators the flexibility that ought to be necessary with
    something of this complexity.
        I also want to say, Mr. Chairman--maybe it's a little too
    early, I don't think so--I know one of the great hypocrisies in
    life is when people say, ``I don't like to say, I told you
    so.'' In my experience, everyone likes to say, ``I told you
    so.'' I should add, with my birthday 2 days away, that I find
    it to be one of the few pleasures that improves with age. I can
    do it unaided, there are no negative consequences, and you just
    do it, even as you get older.
        And I guess I have a riddle that I ask people: ``What does
    same sex marriage in Massachusetts have in common with the
    expensing of stock options by corporations?'' And the answer
    is, ``A big hoohah that resulted in nothing.'' That is, in both
    cases, we had people predicting all sorts of adverse
    consequences for something which turns out, in practice, to
    have had virtually none of those consequences.
        Now, my hope is, with regard to the expensing of stock
    options, that now that I think it is accepted as a fait
    accompli, we will get cooperation in improving the method by
    which we value them.
        I agree, there were legitimate concerns about the
    methodology. I think one of the problems was that people who
    were opposed to it in principle understandably didn't want to
    collaborate in improving it. And that's not a bad attitude. We
    all take that position. If we don't think something should
    happen, we are not going to work to make it better. But now
    that it's clear that it's not going away--and I think the
    absence of adverse reaction helps with that--I hope, again, we
    will all work together.
        And it's obviously in the expertise of the people before
    us, that joint responsibility among the three, to help and
    solicit the input from the companies that are affected, so we
    can make this work better with even more smoothness.
        The final point I just want to raise is--and I appreciate
    what's been done by the SEC, and I look forward to a
    collaborative effort again on the question of executive
    compensation.
        And I want to repeat what I have said before. The question
    of what appears to me to be excessive executive compensation is
    not simply a matter of envy--although that certainly is not an
    absent factor in politics, as many know, including our former
    long-time colleague who know chairs the PCAOB--but I think it
    has significant negative social consequences.
        First of all, you cannot look at the increased resistance
    to America's involvement in the global economy, the adoption of
    labor-saving information technology, and pro-productivity
    devices, and disconnect it from the unhappiness many people
    feel about what they think is excessive inequality. And
    excessive inequality has two sides to it: no real wage increase
    for the average worker; and what appears to me and many others
    to be excessive compensation on the other side.
        And I would simply add again, for people who think this is
    just a matter of envy, in the study done by Lucian Bebchuk and
    others at Harvard--and it has not been contested--the
    percentage of the after-tax profits of the 1,500 largest
    corporations, according to him, that in 2003 went to
    compensation for the top, I think, 3 executives, was 10.3
    percent of the profits. That's a macro-economically significant
    statistic, and it has almost certainly increased since then,
    because if you look at the table, it had increased from--it had
    doubled from, like, 1995 to 2003. So we are talking maybe 11 or
    12 percent of after-tax profits. That's real money that can be
    used.
        So, I look forward to further work, and I think the SEC has
    taken a good first step. I don't think--there was no
    significant support--and I will finish in 30 seconds, Mr.
    Chairman--for us setting salaries. What I think we need to do
    is to increase the public notion of this, the transparency, and
    then also work together so there is a mechanism for the owners
    of these companies, the stock holders, first to get the
    information, and secondly, to decide on it.
        Thank you, Mr. Chairman.
        Chairman Baker. I thank the gentleman. Mr. Davis, did you
    have a statement?
        Mr. Davis. Thank you, Mr. Chairman. I want to thank
    Chairman Oxley and Ranking Member Frank for their support of
    this issue. Thank you, Chairman Baker, and Ranking Member
    Kanjorski, for holding this hearing on such an important and
    relevant topic.
        Thank you also to the members of the panels for coming here
    today. I appreciate your willingness to discuss this issue
    about reducing the complexity and many of the arcane
    regulations designed for a different era and a different
    economy, regarding financial reporting.
        We have enjoyed a great working relationship from the
    committee with the SEC, with the Financial Accounting Standards
    Board, and also with the Public Company Accounting Oversight
    Board. I know the chairpersons and representatives of these
    organizations have been very forthcoming and willing to testify
    on Capitol Hill.
        Yesterday I introduced H.R. 5024, the Promoting
    Transparency in Financial Reporting Act of 2006, with Mr. Scott
    and with Mr. Israel as original co-sponsors. This bill will
    require annual testimony for the next 5 years before the
    committee by the respective chairmen or their senior appointed
    designee of the SEC, FASB, and the PCAOB, relating to their
    efforts to reduce complexity in financial reporting.
        I appreciate the efforts of these organizations thus far to
    reduce complexity, and Chairman Cox and Chairman Herz's public
    statements of support for such efforts.
        I want to emphasize the importance that the members of the
    Capital Markets Subcommittee and the Full Committee leadership
    have placed on the issue, and I want to ensure, through this
    bill, that we are continually updated on the progress that is
    being made. This will keep members up to date, and also serve
    as a reminder to the agencies that promoting transparency and
    simplicity must be a top priority.
        In the post-Enron financial era, transparent reporting has
    become an important aspect of promoting a healthy corporate
    environment. Financially stable corporations are essential for
    expanding the U.S. business sector, promoting investor
    confidence, and strengthening the economy.
        As a former small business owner, and a consultant, I know,
    firsthand, the difficulties that are faced during time-
    consuming, costly processes of accounting, financial
    disclosure, and especially the compliance in section 404, with
    the Sarbanes-Oxley bill. What we want to see, ultimately, is a
    financial reporting system that is simple, that focuses on
    value-adding processes, simplifying compliance, which in turn
    will simplify a transparency, speed the processing for
    businesses and for the Federal Government, and reduce cost, in
    the long run.
        Some of these efforts should include reassessing complex
    and outdated accounting standards, moving from rules-based to
    principle-based accounting standards, and promoting the use of
    plain English in disclosures, improving the ability of the
    average investor to read and understand accounting and auditing
    literature, and encouraging the use and acceptance of
    extensible business reporting language.
        I would make a parenthetical statement on the side, as
    somebody who has done a lot of work in manufacturing in the
    high-technology arena. Many of the manufacturing, production,
    and competitive processes that we need to compete in the global
    economy are not compatible with the prior generation's forms of
    financial accounting. And what I saw many companies have to do
    was use a state-of-the-art production system, and import it
    into a prior generation's accounting system for compliance with
    the Federal Government. And hopefully, we can see that
    simplified.
        In closing, I would encourage all members of the Capital
    Markets Subcommittee to co-sponsor H.R. 5024, and join me in
    making this a priority. I want to say thank you again to
    Chairman Baker and Ranking Member Kanjorski, and thank you to
    the members of the panels for joining us today. We look forward
    to hearing your thoughts on the progress made thus far, and the
    plan for the future.
        I yield back the remainder of my time. Thank you.
        Chairman Baker. I thank the gentleman. Mr. Hinojosa?
        Mr. Hinojosa. Thank you, Mr. Chairman. I thank you and
    Ranking Member Kanjorski for calling this Congressional hearing
    on fostering accuracy and transparency in financial reporting.
        I am looking forward to hearing the presentations by the
    Hon. Willis Gradison, as well as the Hon. Robert Herz, and Mr.
    Scott Taub.
        I think that this issue is something that is very important
    to the State of Texas. We have had so many working families
    lose the savings that they had, and I think that it is our
    responsibility in this committee to have the oversight in
    public company accounting. And I believe that your
    presentations will be very important to us, and I look forward
    to hearing them. I yield back, Mr. Chairman.
        Chairman Baker. I thank the gentleman. Chairman Oxley?
        The Chairman. Thank you, Mr. Chairman. Sorry for being
    tardy, but I was busy bragging on the House Floor about the
    Republican victory over the Democrats in the basketball game
    last night--
        Chairman Baker. I thought you were going to be talking
    about LSU in the final four, but that's okay.
        The Chairman. Well, I will leave that up to you. But this
    game was all about bragging rights, so I took advantage of it
    in my one minute. I--probably because the gentleman from North
    Carolina didn't play for the other side. I don't know what ever
    happened with that. Does my friend from Massachusetts seek a--
        Mr. Frank. Well, I just say to the gentleman, enjoy the gym
    while you can.
        [Laughter]
        The Chairman. Well, I joined my friend from Massachusetts
    and voted against that terrible rule.
        Welcome to all of our distinguished witnesses. We are here
    today to review the status of our public company financial
    reporting system. For over 70 years, public companies have been
    filing their financial statements with the SEC. Congress
    mandated these filings so that the investing public would
    understand the financial condition of public companies. And
    these statements and the explanations accompanying these
    statements are at the heart of investor disclosure.
        It is critical for investors making decisions about where
    to put their money, that these statements are readable,
    accessible, and meaningful. Although we have been--we have seen
    some bad actors purposely and fraudulently deviate from
    accounting standards, the complexity of these standards can
    also be a factor in undermining compliance in well-intentioned
    companies.
        I commend the FASB and the SEC for working towards reducing
    that complexity. I know we have had discussions ongoing on that
    very issue.
        One approach to clarifying financial statements that the
    SEC and FASB are encouraging is the adoption of a principles-
    based--also called an objectives-oriented--accounting system.
    Far too often, we have seen companies engineer transactions to
    circumvent bright-line accounting rules, making any purpose
    behind these rules meaningless.
        Under the Sarbanes-Oxley Act, we asked the SEC to study the
    adoption of a principles-based system, and the SEC concluded in
    its report that such an approach should ultimately result in
    more meaningful and informative financial statements. However,
    this movement towards principles-based accounting requires more
    than just the efforts of our regulators.
        I encourage public companies, auditors, attorneys, and the
    securities industry to join in this initiative. There must be a
    concerted effort on the part of all market participants to move
    away from rules-based accounting and auditing standards to a
    principles-based financial reporting system.
        I look forward to hearing from our witnesses on how we can
    most quickly and successfully adopt such a system.
        I would also like to commend the U.S. Chamber of Commerce
    for encouraging its public company members to cease issuing
    quarterly earnings guidance. It is too tempting, once that
    guidance is issued, for a company to manage its business to
    meet those short-term earnings numbers, rather than to manage
    its business for the long-term health of the company.
        This may lead to poor decisionmaking, but also sometimes to
    earnings manipulation. For the continued vitality of our
    capital markets, management and investors need to focus on
    long-term company health. One way, perhaps, to distance
    ourselves from relying on these quarterly earnings forecasts is
    to make progress toward real-time disclosure.
        Again, I must commend the SEC under the leadership of
    Chairman Cox, for promoting a new way to more easily digest and
    analyze financial information through interactive data, or an
    eXtensible business reporting language, XBRL. Interactive data
    will allow investors to quickly download relevant financial
    information into their own software applications for analysis.
    No longer will time and money be spent on entering financial
    data into spreadsheets.
        I look forward to hearing from our witnesses how they
    believe that XBRL will revolutionize the reporting and analysis
    of financial information.
        I would also like to thank our colleague and the chairman
    of the subcommittee, Chairman Baker, for holding this timely
    hearing. Chairman Baker has, once again, taken the lead in
    improving financial reporting for investors. He took an
    interest in XBRL years ago, when few understood its benefits,
    and thought it was probably some kind of a new car. And even
    fewer knew what it stood for, at that time.
        I again welcome our distinguished witnesses today, our
    former colleague, Bill Gradison, from the Buckeye State, and
    Mr. Herz, Bob Herz, who has been an outstanding leader at FASB.
    And I want to also welcome the acting Chief Accountant at the
    SEC, Scott Taub, for his efforts on our behalf.
        And with that, Mr. Chairman, I yield back.
        Chairman Baker. I thank the gentleman for his leadership on
    this matter. Mr. Miller, did you have a statement? Mr. Scott?
        Mr. Scott. Yes, I thank you very much, Mr. Chairman. I want
    to thank you, Chairman Baker, and Ranking Member Kanjorski, for
    your leadership on this, and also Ranking Member Frank. And
    certainly Chairman Oxley, for the overall leadership in guiding
    our committee to this.
        This is an important issue to so many, particularly small
    business owners. As a small business owner myself, I know the
    issues that we are faced with. One of the biggest complaints
    that we get in the financial service industry itself, a lot of
    the smaller companies, it's so complex, it's difficult, it has
    sprung up a cottage industry of professional explainers that
    they have to spend extra money going to, which costs them
    dearly.
        And it is incumbent upon us to create more clear and
    accurate financial reporting. And I am very proud to join with
    my distinguished colleague from Kentucky, Mr. Davis, in working
    on a bill, Republicans and Democrats working together on a bill
    in a very strong bipartisan way that will require that the SEC
    and FASB and PCAOB provide an annual report to the Financial
    Services Committee. This will help us to keep our finger on the
    pulse, and be able to foresee problems as they develop.
        This is an ongoing situation as business continues to grow.
    We want to make sure that our markets maintain vibrancy. We
    want to make sure that they maintain liquidity, and we want to
    lessen the complexity of financial statements, while at the
    same time increase the usefulness of the information gathered.
        We have to also ensure that our reporting system does not
    lead to an overly hostile legal environment. And that is
    another complaint that we are getting, where auditors and
    accountants are afraid to provide information beyond, say, a
    rigid check-box system. More information is helpful for our
    investors.
        But at the same time, we should ensure that information is
    reported in a way that is accurate. And I am sure all of you
    and the panelists agree that clear regulation of the markets
    will help keep our economy and our financial system strong. We
    have several reform models going forward, and many of you are
    advocating those.
        We look forward to hearing your testimony on this very,
    very important matter. And I yield back the balance of my time,
    Mr. Chairman.
        Chairman Baker. I thank the gentleman. Mr. Castle, did you
    have a statement? Mr. Cleaver?
        Mr. Cleaver. Thank you, Mr. Chairman. I am not a member of
    this subcommittee, so I appreciate the opportunity to be here.
        The--I have been paying close attention to the Enron trial,
    and one of the most amazing things that I am hearing from
    people--and perhaps it's not anything unique to Kansas City,
    Missouri; it's probably nationwide--and that is that there is
    still a great deal of concern out in the real world about
    whether or not we are continuing to get reliable and accurate
    information from the Herculean corporations like Arthur
    Andersen and MCI WorldCom, and other companies.
        So, I am here, in particular, to hear Mr. Gradison's
    statement, because I think for most of us, particularly on this
    committee, who celebrate the fact that Sarbanes-Oxley came from
    this committee, that we ought to be in a position to go back
    home and say that there are real efforts being made to reduce
    the likelihood of this happening again.
        So, thank you, Chairman Baker, for the opportunity to be
    here, and to speak.
        Chairman Baker. I thank the gentleman. There being no
    additional members with opening statements, I want to express
    to my first panel my surprise at the number of members who are
    participating this morning, and that we have members not on the
    committee attending. So it's perhaps surprising to you that
    there is such intense interest among the members on this
    subject.
        And we are particularly grateful to have the regulatory
    panel we have here today, starting first with our distinguished
    former member, Hon. Willis Gradison, who served with
    distinguished service for many years here, and now serves in
    his capacity as acting chair of the Public Company Accounting
    Oversight Board.
        I know you are familiar with our customs, but for everyone,
    the formality is if you would proceed as you like, attempting
    to keep your remarks to 5 minutes, and your formal statement
    will be made part of the record. And we welcome you here.
    Please proceed, Mr. Gradison.

     STATEMENT OF WILLIS GRADISON, ACTING CHAIRMAN, PUBLIC COMPANY
                       ACCOUNTING OVERSIGHT BOARD

        Mr. Gradison. Thank you, Chairman Baker, Ranking Member
    Kanjorski, and members of the subcommittee and of the Full
    Committee. I am pleased to appear today to testify on accuracy,
    transparency, and complexity in financial reporting.
        My remarks address the auditor's role in evaluating public
    companys' application of accounting and financial disclosure
    standards and rules. I will also discuss PCAOB's experience in
    establishing and monitoring the implementation of auditing and
    related professional practice standards, as they relate to
    audit quality.
        The Sarbanes-Oxley Act directed PCAOB to establish an
    auditor oversight program in order to protect the public
    interest. PCAOB is also responsible for setting public company
    auditing standards. And PCAOB is responsible for evaluating
    auditor application of these standards, to promote high-quality
    audits, audits that focus on preventing financial reporting
    failures that we saw in companies ranging from A to Z--Adelphia
    to ZZZZ Best.
        There has been a great deal of discussion about whether
    principles-based standards result in more accurate, reliable,
    and understandable financial statements than do prescriptive
    rules-based standards. True, principles-based standards allow
    more flexibility and professional judgement, but they can also
    lead to undesirable variability in results.
        On the other hand, rules-oriented standards may promote
    complexity, by encouraging companies to engineer transactions
    to achieve particular financial statement results.
        PCAOB has received many requests for specificity and for
    exceptions to existing auditing standards. We are mindful that
    granting these requests could result in overly prescriptive
    standards, rather than providing a framework for the exercise
    of appropriate, professional judgement.
        In my view, overly prescriptive auditing standards can
    actually weaken audit quality if they encourage auditors to
    focus on technical compliance, rather than the use of
    professional judgement. Merely completing a checklist of
    required procedures may not give the auditor the basis on which
    to form an opinion. Judgement is essential to the auditor's
    formation of an opinion.
        To facilitate a smooth implementation of our auditing
    standards, the board and its staff have periodically issued
    guidance, giving careful attention to avoid detailed, rules-
    based or exceptions-laden approaches.
        In addition, PCAOB can see, firsthand, how auditors are
    implementing auditing standards through our inspections
    program. When PCAOB inspectors find significant auditing
    deficiencies, we invite the firm to comment. This comment
    process not only helps us to verify or modify our own
    assessments, but also helps firms to identify the causes of
    sub-standard audit work.
        Our inspectors discuss the relevant issues with firm
    representatives, ranging from the engagement team leader to the
    chief executive of the firm. Perhaps, more than anything else
    we do, it is our discussions with the firms that drive them to
    improve audit quality.
        In addition, the board is committed to educating and
    seeking input, not just from auditors, but also from preparers,
    investors, regulators, academics, and other users of financial
    statements on how to improve audit quality, and thereby protect
    investors.
        Whether through speeches or forums on auditing in the small
    business environment, or special reports summarizing inspection
    findings, PCAOB seeks to promote high-quality audits through
    its communication opportunities, only in cases involving more
    serious violations as the board relies on its various
    disciplinary tools.
        The debate over accuracy, transparency, and complexity in
    financial reporting has enhanced public companies', auditors',
    investors', and regulators' awareness of the challenges our
    financial reporting system faces. In my view, this is the
    beginning of a collaborative effort to find solutions to these
    challenges, including finding the right balance between
    principles-based and rules-based standards.
        I very much look forward to participating in the continuing
    dialogue, and want to thank you once again for the opportunity
    to address these very important issues.
        [The prepared statement of Mr. Gradison can be found on
    page 64 of the appendix.]
        Chairman Baker. Thank you very much, sir. For the purpose
    of introduction of our next witness, I call Mr. Shays.
        Mr. Shays. Thank you, Mr. Chairman. I am very pleased to
    introduce our FASB chairman, Robert Herz. And just to say,
    parenthetically, that being on the Financial Services Committee
    for someone in the fourth Congressional District is like being
    on the Agricultural Committee from Iowa. I have lots of
    opportunities to introduce people, but Mr. Herz, I take
    tremendous pride in the work that you do, the work that FASB
    does.
        Being from the fourth Congressional District, I know you
    live across the Hudson River in New Jersey, and that is still
    something that you need to think about.
        [Laughter]
        Mr. Shays. But your facilities in Norwalk, and what you
    people do, is terrific. And I congratulate you for a
    distinguished career as a senior partner with
    PricewaterhouseCoopers, as an author, and as an active
    participant in so many accounting industry organizations.
        I thank you for your good work. I appreciate you being here
    today, and all of us look forward to your testimony.
        Chairman Baker. Please proceed, sir. But I might add, if
    Mr. Shays has gotten you into the relocation business, there
    are some really good buys down our way right now, so--
        [Laughter]
        Chairman Baker. Please proceed.

      STATEMENT OF ROBERT H. HERZ, CHAIRMAN, FINANCIAL ACCOUNTING
                            STANDARDS BOARD

        Mr. Herz. Well, thank you, Congressman Shays, for that
    very, very kind introduction. Thank you for your long-standing
    support of our organization and our efforts. And thank you,
    Chairman Baker and Ranking Member Kanjorski, for inviting me
    here to participate in this very timely and important hearing.
        I think the enactment of the Sarbanes-Oxley Act, and the
    subsequent related actions by the SEC, the PCAOB, and by the
    FASB, as well as many reforms within the business community,
    have strengthened financial reporting and increased public
    confidence in reported financial information.
        However, we at the FASB, and we believe many others, think
    that there is much more work to be done to continue to improve
    financial reporting.
        In our opinion, the complexity that pervades the reporting
    system, as evidenced by the volume and detail of standards,
    rules, and regulations, now poses a major challenge to
    maintaining and enhancing the accuracy and transparency of
    financial information reported to investors, creditors, and to
    the capital markets.
        We are concerned that complexity has engendered a form over
    substance approach to accounting, auditing, and reporting,
    sapping professionalism and increasingly necessitating the
    involvement of technical experts to ensure compliance.
        Complexity has also added to the growing cost and effort
    involved in financial reporting, and is a contributing factor
    to the unacceptably high number of restatements of financial
    reports by public enterprises.
        Moreover, and perhaps most importantly, it results in
    analytical complexity for investors and others seeking to use
    financial information in their economic decisions.
        While some of the complexity is a natural consequence of
    reporting on diverse and complicated business transactions, I
    think there are many other sources of complexity in our system,
    including: the focus and emphasis on short-term earnings; the
    often conflicting perspectives and agendas of different market
    participants; an evolutionary approach to standard-setting that
    has resulted in non-conceptually-based compromises at times and
    inconsistencies over time; regular demands for detailed rules,
    bright lines, and exceptions, driven in part by the fear of
    being second-guessed, and in part by those seeking special
    treatments and exemptions; continuing use of accounting-
    motivated structuring in an effort to obtain form over
    substance results; and resistance to change, and slowness in
    embracing and implementing new technologies and reporting
    models.
        The FASB has recently undertaken a number of measures aimed
    at reducing complexity and improving relevance and transparency
    of financial reporting. First, we have been systematically
    readdressing specific accounting standards that are overly
    complex, are rules-based, and do not result in reporting that
    properly reflects the underlying economic activity.
        Major areas that we are currently readdressing include
    revenue recognition and accounting for pensions and other post-
    employment benefits.
        We also recently issued two new standards, and we have
    other active projects on our agenda, designed to improve and
    simplify the accounting for derivatives and other financial
    instruments.
        Second, we have undertaken a very major project to develop
    and maintain a comprehensive and integrated codification of all
    the existing accounting literature. That will result in an
    easily retrievable single electronically based source for all
    of U.S. generally accepted accounting principles.
        Third, we have been pursuing several activities directed
    towards the development of more principles-based, or
    objectives-oriented accounting standards, including a major
    project to strengthen our existing conceptual framework, that
    should provide a more solid and consistent foundation for the
    development of objectives-oriented standards in the future.
        Consistent with our commitment to international convergence
    of accounting standards, this project, like many of our other
    current major projects, is being conducted jointly with the
    International Accounting Standards Board, whose standards are
    in use in some 100 countries around the world.
        Finally, while the development in the United States of XBRL
    has been under the direction of the XBRL consortium, the FASB
    has been working with the consortium, the SEC, and others, to
    further the use of XBRL and other evolving technologies in
    financial reporting.
        Now, as important as all those measures are, unfortunately,
    in my view, when taken alone, they are unlikely to
    significantly reduce the complexity that burdens the U.S.
    financial reporting system. In our view, that will require
    concerted and coordinated action by all key parties in the
    reporting system to address the structural, cultural, and
    behavioral forces that generate complexity and impede
    transparent reporting.
        Recently, we have been discussing the issues surrounding
    complexity with the SEC, with the PCAOB, and with many other
    interested parties. As part of those discussions, we have begun
    exploring the kinds of steps that might be necessary to
    identify the issues that lead to complexity, and to develop
    proposed solutions and recommendations.
        We believe that an initiative involving all key parties
    would be the most effective means to bring about broad-based
    improvements aimed at both reducing complexity and increasing
    the accuracy and transparency of financial reporting. While
    such an effort would not be easy, and would take time, we
    believe it is one of national importance.
        We look forward to continuing to work closely with the SEC,
    the PCAOB, this subcommittee, and all other interested parties,
    to ensure that U.S. financial reporting meets the needs of
    investors, creditors, and our capital markets. Thank you again,
    Mr. Chairman, and I will now yield to Mr. Taub.
        [The prepared statement of Mr. Herz can be found on page 72
    of the appendix.]
        Chairman Baker. Thank you for your comments and your
    participation here today.
        And it's my pleasure to introduce Mr. Scott Taub, acting
    Chief Accountant, Securities and Exchange Commission. Welcome,
    sir.

    STATEMENT OF SCOTT A. TAUB, ACTING CHIEF ACCOUNTANT, SECURITIES
                        AND EXCHANGE COMMISSION

        Mr. Taub. Thank you. Chairman Baker, Ranking Member
    Kanjorski, and members of the subcommittee and the Full
    Committee, thank you for the opportunity to testify today on
    behalf of the SEC. My name is Scott Taub, and I currently serve
    as the acting Chief Accountant for the Commission. With help
    from the approximately 55 others in my office, I serve as the
    primary advisor to the Commission on matters of accounting and
    auditing policy, and the application of financial reporting and
    auditing standards.
        The past few years have seen unprecedented change in the
    financial reporting environment, but the SEC's goal in this
    area remains the same: full disclosure by public companies of
    information that allows investors to understand companys'
    operations and financial position, and to make informed
    investment decisions. For that to occur, the information that
    is presented in financial reports must be clear and
    informative, or as accountants use the term, ``transparent.''
        Recently, in accordance with the Sarbanes-Oxley Act, the
    SEC staff released a report commonly called the Off-Balance
    Sheet Report, that notes that achieving transparency depends on
    the efforts of many parties. Preparers of financial information
    must focus on communicating with investors, rather than just
    complying with rules. The legal system must operate in a way
    that rewards and encourages the use of unbiased professional
    judgement, and preparers and auditors must be willing to make
    those judgements.
        Investors must be willing to make an attempt to understand
    the information presented to them, rather than simply looking
    to one figure, like earnings per share, in their analysis. And
    regulators must formulate a disclosure regime that requires
    disclosure of important information, without overburdening
    preparers or investors.
        Of course, good financial reporting also depends on strong
    accounting standards. U.S. GAAP represents a comprehensive set
    of standards, and is respected around the world. And
    development of GAAP has always appropriately focused on
    promoting transparent reporting. However, various factors have
    resulted in GAAP becoming a large and complicated body of
    literature.
        One of those factors that is highly visible today is the
    fear that market participants have of being second-guessed.
    This fear has helped create a demand for detailed rules, bright
    lines, and safe harbors that can overwhelm the basic principles
    that underlie accounting standards.
        Pressure on GAAP also comes from the way the market looks
    at financial information, such as its emphasis on short-term
    performance, and its rewards for predictability and
    consistency. These pressures have sometimes led to overly
    prescriptive rules, different accounting for economically
    similar transactions, and the inclusion in standards of
    exceptions from key principles.
        Many now are concerned that complexity is harming the
    quality of financial reporting, while simultaneously adding to
    its costs. Some contend that this complexity is a root cause of
    restatements, while others note that detailed and complicated
    standards can be used to hide information, rather than disclose
    it. Complex standards can also stand in the way of attempts by
    users to understand the effects of transactions and events.
        However, it is important that we do not simply look to the
    standard-setters to resolve the problems of complexity. The
    state of our financial reporting system is the cumulative
    product of pressure from many constituencies, and considered
    and coordinated action by all market participants is essential
    in order to move forward.
        Commission staff have been talking with many different
    parties about the need for such an effort, and we find
    widespread agreement amongst those in many different roles. We
    believe, therefore, that the time is right to encourage and
    foster a broad effort to address complexity and improve
    transparency.
        Also important is to make sure that the information that is
    provided can be used effectively. Today, through the use of
    interactive data, we can see the possibility for information
    filed on electronic reports to literally come to life.
        The best known and most advanced method for using
    interactive data is XBRL. XBRL uses identifying computer codes
    to tag data in financial reports, so that each piece of data
    carries a broad range of information about itself, such as
    whether it is a monetary item or percentage, an asset or
    liability, revenue or expense, and how the item is calculated.
        For the preparers of financial reports, interactive data
    could streamline the collection and reporting of financial
    information to the SEC and the public. And the use of
    interactive data in Commission filings could provide consumers
    of data real-time access to data in an instantly usable format.
    Those consumers, including analysts, investors, and others,
    could determine for themselves what data is important to them,
    and generate different types of analyses and reports with a
    minimum amount of effort.
        In recognition of the potential of data-tagging technology,
    the Commission established a program that allows registrants to
    voluntarily submit financial information in an XBRL format. The
    goal of the program is to allow preparers, users, and the SEC
    to better understand the issues surrounding XBRL, and evaluate
    its benefits.
        Approximately a dozen companies have submitted filings
    under the voluntary program, and Commission staff is currently
    working to increase the number of companies that participate in
    the program.
        In addition, beginning in June and continuing through the
    remainder of this year, the Commission will host a series of
    roundtables focused on the implementation of XBRL. Discussion
    will include: assessing what investors and analysts are looking
    for; finding ways to accelerate the development and use of
    software tools to permit the use of interactive data; and how
    best to design the requirements for company disclosures to take
    maximum advantage of the technology.
        As you can see, I believe that projects that reduce the
    complexity in reporting, and make financial information more
    user-friendly, have the potential to benefit investors and
    reporting companies, alike. The Commission, FASB, and PCAOB are
    all committed to the effort.
        However, we cannot fulfill the potential without the
    assistance of and input from investors, members of managements
    and audit committees, accountants, lawyers, analysts, and many
    other participants in the American securities markets. We, of
    course, will also highly value the views of Congress and other
    regulators and standard-setters.
        On behalf of the Commission, and myself, thank you for
    holding this hearing and highlighting these significant issues
    in such a timely manner. I look forward to answering any
    questions.
        [The prepared statement of Mr. Taub can be found on page
    208 of the appendix.]
        Chairman Baker. Thank you, sir, for your comments this
    morning. Mr. Taub, I will start with you. It is my
    understanding that perhaps later this morning, the SEC may
    announce formally--I would call it a pilot program for the
    utilization of interactive data/XBRL.
        Are you in a position to be able to comment further about
    the scope or intention of that activity?
        Mr. Taub. I can, a little bit. We have been working to
    increase the number of companies that take advantage of the
    XBRL voluntary program, and we announced a couple of months ago
    that, for companies that were willing to file using an XBRL
    format for a year, we would be willing to give them expedited
    review status, such that if their filing was going to be
    reviewed, it would move to the front of the line, essentially.
        We have had a number of companies that have taken us up on
    the offer, and we do have an announcement planned for any
    minute now, as far as I know, that indicates the companies that
    have volunteered to participate. I think we have somewhere
    between 15 and 20 companies that have indicated a willingness
    to participate in the program, and we look forward to their
    input.
        Chairman Baker. Do you see this as--if successfully
    implemented, is this a step leading toward more broad-based
    disclosure, using interactive data, or is this sort of a,
    ``Let's wait and see how this thing turns out,'' at this point?
        Mr. Taub. At this point, we are certainly in an evaluation
    stage. I think many of us at the SEC certainly believe that
    there are huge potential benefits of this, and hope to see it
    rolled out broadly.
        But there are certainly a number of hurdles and obstacles
    to broad implementation of this kind of reporting, and that's
    the reason we're hosting roundtables, to try to explore ways to
    get over some of those obstacles, and to make improvements in
    areas that are needed in order to make it such that we can roll
    it out much more broadly.
        Chairman Baker. Thank you very much. Mr. Herz, in your
    comment--I take great interest in FASB's views.
        The purpose of disclosure is to give the market an accurate
    picture of financial condition as of the date of preparation.
    With the current system, we manage that picture to be a 90-day
    snapshot. Some have suggested that if we move to a sort of
    real-time material fact disclosure, some of the more
    sophisticated financial enterprises, as of close of business
    5:00, they know their position, internationally, where they
    are.
        If we assume that a company, in the first month of the next
    reporting period, lost its major customer, obviously a material
    fact to future viability. Today, that team has 68 days left to
    manage how they're going to make that disclosure.
        If you only require disclosure of material fact--and I know
    the next question is, ``Well, what constitutes material fact,''
    but assuming we can arrive at that--is it not advisable in the
    complex world we now face, with the extraordinary amount of
    data that is provided, to move to almost a daily snapshot to
    get out of this spike and trough mentality that seems to have
    substantial economic effect on capital markets without any real
    meaningful value to anyone, other than sharp speculators?
        Is that something, in concept, that a FASB principle could
    support, or what is it that we're in pursuit of? If it's to
    minimize complexity, what is the net principle around which the
    reorganization should center?
        Mr. Herz. Well, thank you for that question. And I will
    answer partly, from my FASB role, but also partly from my prior
    involvement in some of these issues related to real-time
    reporting, and richer reporting of other key performance data,
    non-financial data, as you say, material information.
        I think, probably just a factual matter first--I might
    refer to--check with Scott--but there are some things that are
    material events that the SEC does require on what they call an
    8K. And I think those are within, generally, 5 days now, which
    may include, for example, the loss of a major customer. But
    it's not a comprehensive reporting, as you are envisioning on a
    daily basis of financial position, and changes in that
    financial position on a daily basis.
        I certainly believe that is the kind of world we want to
    move towards. I am not certain at this point whether the
    infrastructure has developed in order to do that. I think we
    would have to think about all the components of that
    infrastructure, including to what extent that ought to be
    attested to or not attested to, what periodicity that ought to
    have, what level of detail, you know, which components of that,
    should it be a full integrated set of financial statements on a
    daily basis, or not, or whatever.
        But there are clearly, evolving over time, more and more
    information that goes out to the market, both from companies
    and from other people following companies and people who follow
    industry trends, who follow weekly car sales, you know, all
    sorts of book-to-build ratios, that kind of thing. And that, to
    me, certainly seems to be the future that we ought to be trying
    to evolve towards.
        But getting there, and the infrastructure needed to support
    that, I think are--still require some thought and development.
        Chairman Baker. I thank the gentleman. My time has expired.
    Mr. Kanjorski?
        Mr. Kanjorski. I feel a little perplexed, because I was
    going to suggest what would be the advantage for the American
    economy if we ended the quarterly reporting, and went to the
    yearly reporting, so we didn't have this tremendous effect on
    Wall Street, just by not considering some of the plans and
    conditions a company has laid in place to accommodate. It seems
    we're accounting for that quarterly release all the time.
        You would like to go on a 24/7 schedule? Wouldn't that
    cause a great fluctuation in the marketplace?
        Mr. Herz. Well, I think we have to decide as to, really,
    whether or not--you know, how the market wants to operate, in
    terms of investment in securities, and people changing
    investments in securities.
        If the market continues to operate the way it does now--and
    I'm not making a normative judgement, one way or the other, on
    that--I would see the path one of more frequent reporting. But
    it's kind of like if you have a game, you want to have the
    play-by-play as it goes along. Right now, what we seem to have
    is, in the quarterly earnings guidance, it's kind of saying,
    ``Here is where I'm going to end up at the end of the
    quarter,'' rather than, I think as Chairman Baker is suggesting
    today, ``Where am I,'' and then people do kind of a Kabuki
    dance around that expected number.
        Mr. Kanjorski. I am just curious as to whether or not you
    think that would affect the long-term--the difference between
    long-term planning of corporations and investments, or
    responding to the immediate play-by-play situation, for
    purposes of the effect on the market.
        Isn't that part of the criticism in our system today, that
    we are, unlike Japan in many ways, that they plan for long-term
    investments, and long-term considerations, and as a result,
    they sometimes, at the end of the day, may beat us on the
    field, when you take the whole game, as opposed to the play-by-
    play?
        Mr. Herz. Well, certainly that is a consideration, I mean,
    I think ultimately you would want to design a system where the
    short-term reported results are consistent with the long-term,
    people understanding what the long-term strategy is, and what
    the benchmarks towards that are, being able to evaluate
    progress towards that.
        Mr. Kanjorski. I guess, being a politician, I am sensitive
    to the 24/7 news cycle, and not at all certain that that has
    helped in national policy. It seems that everybody has a
    headache every day as a result of everything, as opposed to
    sitting back and having it given to you in a comprehensive way,
    with potential solutions for problems, as opposed to just
    hearing problems.
        I haven't given a lot of thought, but day-to-day
    accounting, that would be interesting. I should imagine that
    those people have nothing else to do in life, but sit and read
    those statements every day would find that enjoyable, but I
    suspect that a good portion of their lives would be taken up
    with that endeavor. That's interesting.
        Do you have any thought on whether or not we could go back
    to the yearly reporting, final reports, as opposed to these
    games we play that everybody--it seems to indicate in Enron and
    so many of the other companies, they were trying to beat the
    analysts on Wall Street. And as a result, they were finding
    clever mechanisms to use to do that. And I think we even have
    that in Fannie Mae. There was too much of a concentration on
    anticipating what the earnings figure would be, and they wanted
    to make adjustments to miss that.
        Mr. Herz. I think that is part of the issue, continues to
    be part of the issue. People make a projection for what the end
    of the quarter results are going to be, or the annual result is
    going to be, and then at least--and this experience is a little
    bit dated, from when I was in practice, but I--people tell me
    this still happens--that if you don't make the numbers based on
    just the business flow, then you try next to alter the business
    flow. You may try and accelerate sales, and the like.
        If that still doesn't work, some people have tried to find
    ways to--through accounting, either aggressive or stepping over
    the line--to try and make those numbers for the quarter. But
    it's like trying to predict the outcome of a basketball game,
    you know, once the first ball is dribbled.
        Mr. Kanjorski. Mr. Gradison, did you have a comment on
    that?
        Mr. Gradison. Thank you. I think, in many respects, we have
    to start by focusing on the investors. Who are they? What are
    their interests? Are they short-term or long-term? And then,
    what kind of information are they looking for?
        One thing that has struck me in the years that I have been
    involved in this--and I used to be in the investment business
    in an earlier life--has been what I perceive to be a shift
    towards investors in major companies having a very short-term
    focus.
        The turnover rate of holdings, for example, of investment
    companies is much higher today, as I read the numbers, than it
    was many years ago. And so, I think that the reaction of
    reporting companies has to be thought of in terms of what--not
    just what the market in general wants, but who is holding their
    shares, what are their interests, and are they long-term or
    short-term?
        The only other point I would make is that--and I think this
    is just reinforcing a point already made--is the distinction
    between financial information, which is reported quarterly, and
    other very important information, which may not be strictly
    financial: ``Did you lose''--``Did the customers like the
    widgets,'' as Chairman Baker said.
        And I think that while the auditors--who are the folks that
    we oversee--are, by their very nature of their work and
    responsibilities, focused on the financial reporting--and
    that's very important--there are other things which, in many
    cases, will be every bit as important, sometimes more
    important, that bear upon the reaction of the markets, and the
    desire of--the desires of investors, with regard to what kind
    of things they want to know about.
        Chairman Baker. The gentleman's time has expired. Mr.
    Shays?
        Mr. Shays. Thank you. I would like to pursue this issue a
    little more in depth. And it's my understanding that the
    Chamber is basically recommending the elimination of the
    forecast, and particularly the quarterly, earnings. And it does
    relate to this whole issue of whether the marketplace gets
    manipulated because of it.
        So, I would like to know your opinion about the Chamber's
    view. And then I would like to ask why investors seem to look
    so much at the superficial. Because it seems to me, anyone who
    is investing a lot of money would probe deeper, and understand
    what is actually happening. Why don't we start with you, Mr.
    Taub?
        Mr. Taub. Thank you for the question. I think it is an
    excellent one.
        To me, as I look at what happens in the market, it isn't
    necessarily the mere fact that there was an earnings forecast
    that is the problem, it is what happens after that, the
    management of the numbers to then meet that forecast.
        At the SEC, we have long been on an effort to stamp out so-
    called earnings management that happens around those numbers.
        Mr. Shays. Let me just interrupt you. Is it difficult for
    the investor to know that it is being manipulated, or is it
    relatively self-evident?
        Mr. Taub. I think that it all depends, frankly, on the
    sophistication of the way that the management is done.
    Certainly, we have tried to require disclosures, as has the
    FASB, to give people information that will at least let them
    evaluate what is happening with these numbers.
        But it is something that really is--many people say you
    can't legislate ethics, and that is a problem--
        Mr. Shays. Let me ask Mr.--I'm sorry, I have such little
    time, here. Mr. Herz, the answer to the question?
        Mr. Herz. Well, I guess, it's a free country, so people can
    give whatever forecasts they--
        Mr. Shays. I would like to know what you think of the
    recommendation of the Chamber.
        Mr. Herz. Well, I agree with that recommendation,
    personally. Of course, we at the FASB do not--that's not our
    role, per se.
        Mr. Shays. Okay.
        Mr. Herz. But I personally agree with that, from what I
    have seen are some problems around that whole process.
        Mr. Shays. Then explain to me why the investor can't see
    through the manipulation.
        Mr. Herz. Well, the--
        Mr. Shays. Or whether you think they actually can.
        Mr. Herz. The investors--I think investors who keep enough
    of a tune on the company may be able to.
        For example, there are various ways you can manage earnings
    in a ``legal'' way. Like I said, accelerate sales, cut
    expenses. But you're kind of robbing from Peter to pay Paul in
    the--
        Mr. Shays. We are doing that. But is it evident to the
    investor?
        Mr. Herz. I think the investor who follows the company may
    be able to do it. I think the investor who--if the company is
    transparent in its disclosure, for example in its quarterly
    MDTA disclosure, those kinds of things are supposed to be
    talked about.
        Mr. Shays. Okay.
        Mr. Herz. If the company is just plain violating rules,
    that may not be found out until there is an audit, or until the
    SEC finds it out.
        Mr. Shays. Or it may never be found out. Mr. Gradison, any
    opinion?
        Mr. Gradison. I think it's very hard for the investors to
    tell. For one thing, as more disclosure takes place, and you
    could see it in the annual reports and in the proxy statements;
    they're getting thicker and thicker--there is more and more
    information out there. But then the question arises, how many
    folks are really analyzing that?
        And there is a real question, how many public companies,
    out of the 15,000 or whatever public companies, really have
    sponsorship in the sense of analysts professionally analyzing
    these things as they come out? I don't mean to minimize the
    number, but it certainly is not 15,000.
        And so, for the average investor, trying to sort through
    these numbers is, in my opinion, well nigh impossible.
        Mr. Shays. Okay. Let me close with you, Mr. Herz, and just
    have you speak briefly about what you're trying to do to codify
    all existing accounting literature to reduce this complexity.
    In the short time that I have left, could you just talk a
    little about it?
        Mr. Herz. Yes. I need probably about a 2-minute history
    lesson here, that what we call generally accepted accounting
    principles is, as Scott mentioned, something like over 2,000
    separate pronouncements that emanated from many different
    bodies--not just the FASB and predecessors, but the AICPA in
    different forms, task forces, the SEC in various forms, over a
    long period of time.
        And they were written in different ways to different
    depths, different levels of coverage. And we are now taking all
    of that and resorting it by topic in a structured way, so that
    it will now be almost like chapters. It will be electronic, but
    you will have a chapter on inventory accounting, and it will
    have a standard structure with all the other chapters, so
    people will know exactly what the sum total of GAAP is in that
    area.
        And by doing that, we also feel we will probably come
    across certain conflicts between different--
        Mr. Shays. Right.
        Mr. Herz.--pronouncements, which we will have to resolve.
        Mr. Shays. Great. Thank you. Thank you, Mr. Chairman.
        Chairman Baker. The gentleman's time is expired. Mr. Frank?
        Mr. Frank. Thank you. I was listening to my colleague, and
    I was intrigued by this Chamber position. I think it makes a
    great deal of sense. Of course, the problem is that people will
    be in a competitive situation, and no one company will want
    to--or two companies do it.
        I am wondering whether we might not institute a situation
    where, yes, companies are free to do that, but inaccuracy could
    lead to a suspension of the right. That is, we might say, ``If
    you have a pattern of inaccuracy and you have to restate at
    some point,'' you might give the SEC the authority to say,
    ``Well, we are going to suspend that.'' I think that's
    something to be examined.
        But let me ask related to that, to what extent does the
    linkage between the compensation of the two or three top
    executives in the company add to the problem of the inaccuracy
    here? Mr. Gradison?
        Mr. Gradison. Well, I have to focus--will focus, of course,
    on the role of the auditors in this regard, because that's what
    we do. And the role of the auditor with regard to disclosure of
    compensation basically comes down to whether that information
    is disclosed in the 10K's and the financial reporting, or
    whether it is disclosed separately through the proxy statement.
        If it is in the financial statements, then the auditors
    have a responsibility to read these disclosures and to consider
    whether they are consistent with the auditors' knowledge that
    was gained during the financial statement audit.
        If, on the other hand, they are in the proxy statement--
        Mr. Frank. Who decides now where they are? The company?
    Well, let me put it this way. Should we require, then, that
    they be in the financial statement so they can get that kind of
    scrutiny?
        Mr. Gradison. I would imagine that would be up to the SEC
    to make that determination.
        Mr. Frank. Well, sometimes they let us make decisions too,
    Bill.
        [Laughter]
        Mr. Gradison. We certainly follow any decisions you make,
    sir.
        Mr. Frank. Right. But what about from the--given what you
    say, that where they are determines whether or not they are
    auditable. Would it make sense, in your judgement, for us to
    put them in a place where we--that would be audited?
        Mr. Gradison. Yes, it would.
        Mr. Frank. All right. Let me go back--and I just want to
    follow up on what my colleague from Connecticut said--on the
    question of stock options, because this is--we're talking about
    accuracy, and I think, in the years I've been here, the biggest
    single dispute over accuracy really was over how you reported
    stock options. Is that still--is undoing that decision in--
    still on the table, or is that now an accepted fact?
        Let me go down the list. Mr. Taub, start with you.
        Mr. Taub. I guess, to my mind, it isn't on the table. There
    is certainly nothing that I am aware of that the FASB is
    currently considering, as far as potentially undoing--
        Mr. Frank. Let me ask Mr. Herz. Are you aware of any effort
    to overturn that decision?
        Mr. Taub. Not that I am aware of.
        Mr. Frank. Yes. Mr. Herz?
        Mr. Herz. No. We still get some grumblings from certain
    folks, but everybody is doing it now, and--
        Mr. Frank. All right. Mr. Gradison?
        Mr. Gradison. The question this year for auditors, as they
    finish up their work, is whether they find problems in terms of
    simply the calculations, the application--
        Mr. Frank. Right. I think that's important, and I think--I
    would hope we could all move on to the next phase. This is now
    one of those questions that has, for now, been settled and I
    think settled forever. But I would hope that it would now be a
    genuine collaborative effort of the three of your operations
    and the private sector to refine that.
        Before I go on to my next question, Mr. Taub, in his
    absence--would you just convey to your chairman my appreciation
    of the very decisive way in which he acted when subpoenas were
    issued to journalists? I think that what Mr. Cox did in that
    case was a very good demonstration of the appreciation of a
    free press.
        And I just wanted to say publicly that I--you know, it's
    not easy. I understand. And he is the chairman, and he has
    staff to work with, and these are not people who did something
    malicious. It was not easy to do what he did, and I appreciate
    that he did it.
        Let me just ask, finally, with regard to executive
    compensation, what's the status of the SEC's current proposal
    to make it more transparent?
        Mr. Taub. We issued proposals in January of this year. The
    comment period extends another 10 days or so, it expires on the
    10th of April. So, we are, of course, actively seeking
    comments.
        I am sure the Commission will seriously consider all of the
    comments that are received. The release that came out when we
    proposed the rules indicates that we hope to have the rules in
    place for the 2007 proxy season, and I believe that certainly
    is still the hope. And we will actively be considering this
    issue on--
        Mr. Frank. All right. Let me finish up. I appreciate that.
    I hope you will move forward with them. I think there is a
    great deal of support for it.
        Beyond that, it would then lead to another issue that had
    come up under the previous chairman, and I think it may come up
    again, and that is once that information is out there, I think
    it will--some people will not be surprised; some of it may be
    new.
        The question, then, of the accountability of the board of
    directors to the stockholders will again be on the table.
    Because some people have said, ``Well, what's the point of
    giving us that information, we the stockholders, if we have
    directors who are immune if we don't like it? And if our votes
    as stockholders are essentially about as useful in electing
    directors as the voters of Belarus in electing a new president,
    then you have given us ice in the winter. You have given us
    information which we are unable to use.''
        So, I hope that we will then take the logical next step--
    and again, I think this is totally consistent with a free
    market, this advances a free market, none of this involves any
    government restriction on what corporations can do. What we are
    talking about is, I think, recapturing some of the power for
    the stockholders that has been taken away from them.
        So, I think the transparency, I hope, will go forward. But
    I hope it will then be given some muscle by improving the
    ability of the stockholders to act vis a vis the board of
    directors if they don't like what they see.
        Chairman Baker. I want to make clear that, as one of the
    proponents of not expensing in the last Congress, that I am
    very interested in that accounting assessment and real world
    implementation consequences, and don't want the chapter to be
    closed, and not acknowledge the gentleman's concern about it
    being a resolved issue.
        It is resolved, but absent the knowledge that it actually
    is working without adverse economic consequences, and absent
    that, I certainly concur with the gentleman's agreement. But I
    want to reserve, as one engaged in this effort on the other
    side, that should there be a showing that there is a concern,
    then we need to come back and talk about it some more.
        The gentleman--I would be happy to yield, yes, the
    gentleman from--
        Mr. Frank. If the gentleman would yield, I would concur
    with the philosophy we all know about, that it ain't over until
    it's over. So--
        Chairman Baker. That's the kind of music I like to hear. I
    thank the gentleman. Mr. Scott, I believe, is next. Excuse me,
    Mr. Cleaver, you were actually next in line. Did you have--
        Mr. Cleaver. I have no questions.
        Chairman Baker. Mr. Scott?
        Mr. Scott. Yes, thank you very much, Mr. Chairman. I would
    like to ask my first series of questions about what we refer to
    as XBRL, in our efforts to make this more simple and less
    complex. I think it refers to extensible business reporting
    language. And I hope we--I hope this technology will help us in
    that regard.
        But let me ask you first of all, Mr. Herz, and each of you,
    if you could respond to this, would the cost of implementing
    XBRL be prohibitive for some issuers?
        Mr. Taub. I will give you a few things that we have found
    out from our voluntary program. We have had about a dozen
    companies that have participated.
        In general, their response has been that the cost was
    perhaps slightly more than negligible, but certainly not to the
    point where it would be prohibitive. A couple of large
    companies have indicated an all-in cost, dollar-wise, of
    something in the $25,000 range, and time-wise, once an employee
    is trained on how XBRL is used, it's 6 to 8 hours each time a
    report needs to be prepared.
        Mr. Scott. Mr. Taub, given the fact that while we are on C-
    SPAN, and I don't question the fact that our ratings are sky-
    high, and everybody is watching across America, but let's
    assume that there are some people who are very much interested
    in this hearing. Could you just give a brief explanation of
    what we are talking about, when we refer to XBRL?
        Mr. Taub. What XBRL does is, through a glossary that's
    known as a taxonomy in technology circles, it assigns a
    definition, as it were, to each piece of information. And that
    definition would carry with it information, then, about the
    item that is tagged with that definition, such that what
    happens is a user of financial information, rather than pouring
    through a bunch of reports to pull, let's say, revenue data
    from a number of companies, can instead use a piece of software
    that would go out and find that data for whichever companies
    the user wanted. So, it greatly reduces the time needed to
    collate data and do analysis.
        Mr. Scott. As you know, several of us--this whole
    committee, as a matter of fact, and certainly the bill that Mr.
    Davis and I are putting forward--our aim is to simplify and
    make it clearer. But can the taxonomies of XBRL be effectively
    used by a wide variety of issuers?
        Mr. Taub. That's an excellent question. And indeed, the
    issues with regards to taxonomies are amongst the things that
    we plan to discuss at the public roundtables that we have.
    There has been a lot of discussion about how to improve the
    existing taxonomies, and how to design industry-specific
    taxonomies, to make sure that all companies will have
    taxonomies they can use.
        Mr. Scott. Okay. Would you like to comment on that, Mr.
    Herz? I have a couple of more points and my time--the chairman
    moves with an iron fist here, so if you could be brief and
    answer that, I have a couple of more questions, too.
        Mr. Herz. Well, I agree with what Scott said. I think one
    of the things that needs to be focused on is the taxonomy
    development, which is, as I understand at this point, not
    complete in certain areas. And that may be a partial barrier to
    further expanding the use of XBRL into the SEC's fine voluntary
    filer program. I think there is some effort needed to take it
    to the next level.
        Mr. Scott. Okay. Now, let me ask the gentleman this
    question. Will efforts, these efforts to simplify financial
    reporting, be conducted in conjunction with international
    standard-setters?
        Mr. Herz. Yes, that's also an excellent question. And
    certainly, I am a big proponent of that being done. We have a
    real opportunity, to the extent that the simplification would
    result in kind of a revised way of reporting, and even a
    revised architecture of reporting, to make that international,
    almost like, you know, the old hard-wire and telecom going to
    cellular. You leap-frog a whole generation, and you can make it
    by building it in, you can make it international.
        We work very closely with the International Accounting
    Standards Board to come up with common accounting standards and
    financial reporting standards. To the extent that we do that,
    XBRLizing those, the same data definitions would apply
    commonly.
        Mr. Scott. My time is about to run out, but I do want this
    final question, because auditors are very concerned about this.
        Are auditors at too much risk for being sued over their
    best attempts at meeting the reporting requirements?
        Mr. Gradison. I think, Congressman, that the question of
    liability hangs over the work of auditors every minute of the
    day. The responsibilities of auditors, at bottom, are based
    upon principles that involve the exercise of professional
    judgement, and the exercise of professional skepticism.
        Auditors have to decide, case by case, the scope, extent,
    testing, and timing of testing of major categories. These are
    judgement calls. And there are legitimate reasons for them to
    be concerned that, after the fact, they may face serious
    financial risks if they miss something.
        So, I think we have to recognize that is a fact of life,
    and would, frankly, strike me as a subject that you all might
    want to take a look at quite separately from some of the other
    things that we are talking about today.
        Mr. Scott. Yes, absolutely. If I may, while the chairman is
    talking there, let me proceed for a second.
        [Laughter]
        Mr. Scott. What would you recommend that we could do to
    lessen the liability of the auditors?
        Mr. Gradison. I don't have any specific answer to give to
    you right now. I do think that it is an entirely proper
    question, especially since our role is providing oversight of
    the auditors under the general supervision of the SEC.
        And I think that it would be entirely appropriate if you
    wanted to, perhaps in a different context, for us to think
    together about that issue. It is an extremely important
    question. It is related not just to the workings of the court
    and the liability issues alone, but also to the form of
    organization of the accounting firms which operate in the
    former partnerships, or limited partnerships. And that is not
    unrelated to the question that you are asking about.
        In many instances, these organizations are fundamentally
    self-insured for their very major risks, because of the
    uncertain nature of claims that might be brought against them,
    as well as the historical experiences of the Arthur Andersens
    of this world.
        Mr. Scott. Yes. So they are at risk. We need to take a look
    at it. Let me ask you one question about FASB, before I--
        Chairman Baker. And this will be your last one. I finally--
        Mr. Scott. This will be my last one. Thank you, Mr.
    Chairman. I appreciate it. As you know, I am very interested in
    this issue here.
        But Mr. Herz, you are with FASB. Do you believe that FASB,
    or any other standard setter, can gain the cooperation of the
    private sector to make the necessary changes in our reporting
    system?
        Mr. Herz. I believe so. I think that from my discussions
    with many parties--some of whom you will hear from in the
    second panel--and from discussions with my colleagues in the
    SEC and the PCAOB as well, that I think that the time is right
    to sit back and get together and think about, you know, where
    the system is at, and where it is going, and make the kind of
    improvements that would both reduce complexity and improve the
    usefulness and transparency of reporting.
        So, I am definitely a guy with the half--the glass half
    full on that subject.
        Mr. Scott. Thank you, Mr. Chairman, for your kindness and
    generosity.
        Chairman Baker. Yes, sir. And Ms. Velazquez?
        Ms. Velazquez. Thank you, Mr. Chairman. Mr. Gradison, I
    just would like to--for you to discuss how complying with
    Sarbanes-Oxley, in particular, section 404, requires
    substantial resources, both in terms of personnel and costs.
        While large companies can more easily absorb these
    compliance costs through existing resources and professional
    staff and budget, many of the smaller cap companies, however,
    do not have resources to comply with this act, and must hire
    outside attorneys and accountants.
        Can you tell me how significant these complying costs have
    been in deterring private companies from going public and
    causing smaller companies to go private?
        Mr. Gradison. There is no question that in the first round
    of the application of section 404, which occurred last spring,
    the costs were far higher than any estimates that I was
    certainly aware of. It was the first time out.
        On May the 10th of this year, the SEC and the PCAOB will be
    hearing from more than 50, I imagine, witnesses or panelists in
    a day-long session to find out what happened the second time
    around, with regard to costs.
        We did receive encouraging comments a year ago, in April,
    when the previous roundtable was held, that costs were going to
    come down, costs that are borne internally within the
    companies, the cost of consultation from outside, and the
    auditing costs. And you know, we will see.
        The PCAOB has not been satisfied, was not satisfied with
    the first round. And this was made clear by guidance which was
    issued on May the 16th of last year, as well as our November
    30th report.
        Our inspectors are going to be going into the field in just
    a few weeks, and they are going to be using a very different
    approach in reviewing the work done by auditors with regard to
    section 404 than was used by our inspectors last year. All of
    our people are going to be trained in looking at this. It will
    be part of an integrated audit, integrated with the review of
    the financial statements, whereas last year, we did it in a
    separate manner.
        We are going to be expecting the firms to use a top-down
    risk-based approach to focus on the significant accounts. But
    in particular, we are using a word which isn't--doesn't have a
    lot of history in the auditing literature, and that is,
    ``efficiency.'' We are looking for evidences of efficiency by
    the auditors, which may relate to your question.
        I think in May there will be a lot more information than is
    available now to help answer your very appropriate question.
    COSO is working on a new framework, or revised framework, that
    may be helpful to smaller enterprises. The GAO is completing a
    report mandated by Senators Enzi and Snowe, with regard to the
    impact of Sarbanes-Oxley on small business. The SEC's advisory
    group will be coming in with a report.
        And so, while there is certainly information out there --
    frankly, on both sides--about the effectiveness, we will have a
    much more complete picture of that very, very soon, and look
    forward to sharing those results with you.
        Ms. Velazquez. I would like to discuss the SEC advisory
    committee on smaller public companies' proposed recommendations
    to provide relief for small companies.
        The foundation of the proposal is a new definition for
    smaller public companies. It defines smaller public companies
    as those comprising the lowest 6 percent of total U.S. equity
    market capitalization. Do you believe that this proposed
    definition fairly represents the universe of small companies,
    public companies? Mr. Gradison and Mr. Taub?
        Mr. Gradison. Well, I will have to pass the ball to--
        Ms. Velazquez. Sure.
        Mr. Gradison.--Scott Taub on this, simply because that
    group was created by the SEC, and the specific recommendations
    to which you refer, as I understand them, would be entirely
    within the purview of the SEC, rather than the PCAOB.
        Mr. Taub. Thank you for the question. We are watching very
    carefully, and eagerly awaiting the recommendations of the
    advisory committee. Certainly at this point, the draft
    recommendations do include the types of delineations that you
    have suggested.
        One of the things that one needs to think about if we were
    to use those kinds of delineations is what does it mean. Okay,
    a company is deemed a smaller public company, then the next
    step is what is different in the reporting framework about
    being a smaller public company, rather than an accelerated or
    larger company. And indeed, the committee's draft
    recommendations would include a number of suggestions for
    differences that would apply to the smaller public companies.
        It's probably inappropriate for me to start commenting on
    recommendations that, indeed themselves, have not yet been
    finalized. So let me just say that we are eagerly awaiting
    those recommendations. And although there is no set time table
    for considering them, I would suggest that we will be doing so
    on a timely basis.
        Ms. Velazquez. Thank you.
        Mr. Gradison. Perhaps I could add just a word, and that is
    that our intention with regard to the standard that was already
    issued, and is now in effect, was in no way that it should be a
    one-size-fits-all approach. Rather, that it should take into
    account the size and complexity of the enterprise.
        And speaking for myself, I am totally open to the
    possibility of revisions in the standard, if it appears that
    they are necessary in order to accomplish that goal. We have
    had the goal in mind all along. Now, whether we did it right is
    a matter to be determined.
        Ms. Velazquez. Mr.--yes, okay. Thank you very much, Mr.
    Chairman.
        Chairman Baker. I appreciate the gentlelady yielding back.
    Ms. Wasserman-Schultz, did you have a question?
        Ms. Wasserman-Schultz. Thank you, Mr. Chairman. If--the
    question I had relates to the impact that financial reporting
    standards has on the private market pension system, and if you
    all could comment on what the long-term, or systemic impact you
    think that there is on the private market pension system, as it
    relates to financial reporting.
        Mr. Herz. Well, thanks for that question. We are, I think,
    this Friday going to issue a proposal that would essentially
    put on sponsors' balance sheets the net under or over-funded
    position of their defined benefit pension plans, and post-
    benefit retirement plans. And that's the first phase of a more
    comprehensive project to relook at the accounting for those
    kinds of plans.
        Now, our mission, of course, is to improve the financial
    information that goes to investors in the markets. And
    certainly, we have gotten a lot of commentary, not only from
    investors, but many other people--and the SEC, in their off-
    balance sheet study--that this is an area where the existing
    accounting is in need of significant improvements. So this is
    our step towards that, our first step towards that.
        I have heard all sorts of--you know, as I have talked about
    this with groups--potential, you know, impacts. One, of course,
    is the better information that the investors, the creditors,
    and the employees will better be able to see the extent of the
    underfunding, and how that affects the sponsor's financial
    position, whether they actually seem to be in a position to
    carry out those promises that they have made.
        There has been a movement for many years, long before we
    even took up this project away from defined benefit pension
    plans. The kind of statistics that I have been told is that
    when ERISA was put in in the early 1970's, something like over
    40 percent of the covered work force was covered by members in
    a defined benefit pension plan. That is now down to something
    like 15 percent.
        And of that 15 percent, a majority of those are plans to
    incorporate or replace the more traditional defined benefit
    arrangement with what's called a cash balance plan, which is
    closer to the defined contribution plan. So there are--the
    defined benefit plans have already been shrinking a lot.
        Clearly, with the increased transparency, we have seen this
    in other areas, when you make things more transparent and the
    accounting better, it often does have behavioral reactions and
    reactions by the companies. Some companies may decide to
    terminate plans or freeze benefits, and the like. But we will
    have to see.
        Ms. Wasserman-Schultz. Could you comment on whether you
    think there are negative incentives in the underlying
    accounting standards that affect the situation?
        Mr. Herz. Yes. And obviously, we have--in being advised by
    many parties about the existing accounting standards, and
    pointing to some of its flaws, some have pointed to behavioral
    issues related to the existing accounting standards.
        One of the aspects of the existing accounting standard is
    that it does what's called a lot of smoothing over time, and
    part of that smoothing involves an estimation over a long
    period of time of an assumed rate of return on the plan assets.
        And that rate of return, the way the mechanics of the
    existing pension accounting work is that--let's say you had $1
    billion in plan assets, big company, and you assume a long-term
    rate of return of 8 percent, based upon your 60 to 40 equity to
    fixed income mix. The accounting says you can, immediately for
    that year, accrue income of $80 million. Yet the performance of
    the plan might be negative that year. Say it goes down by $100
    million, the plan assets, the market goes down, the interest
    rates go up and the bonds decrease in value. That difference of
    $180 million then gets spread over a long period of time.
        So, some people believe that that long-term rate of return
    mechanism and assumption drives people to over-investing in
    what, you know, riskier investments, rather than match-funding
    the liability, for example.
        Now, our purpose is not to change, you know, directly, that
    behavior. But when you change the accounting, behavior does
    change.
        Ms. Wasserman-Schultz. And lastly, not to prolong this, Mr.
    Chairman, but I don't know whether you have mentioned this;
    what can be done to resolve some of these issues?
        Mr. Herz. Well, of course, there are many things going on.
    Our function is to try and improve the accounting. We--as I
    said, our first step is to actually put on the balance sheet,
    pretty squarely, the company's position with regard to those
    plans, how underfunded are they. You know, generally in most
    cases, they are underfunded.
        The bigger question is what to do in the earnings
    statement, and that will be phase two of our project. Do you
    eliminate all of that smoothing, and just let the change in the
    year-to-year value of both the assets and the obligations flow
    through earnings? Do you get rid of the assumed rate of return
    assumption? But that will require a lot of study.
        Now, of course, there are other things going on, including
    bills here in Congress that I understand are in conference
    right now, to hopefully put some more health into the
    underlying system to increase the funding and the like, and
    encourage employers to get to a better position, vis a vis the
    plans.
        Ms. Wasserman-Schultz. Mr. Chairman, I see that my time has
    expired. However, I would be remiss if I did not close, before
    I yield back, by saying, ``Go Gators.''
        Chairman Baker. I can overlook that remark. Thank you.
        [Laughter]
        Chairman Baker. There being no other members with
    questions, I want to thank you for your participation. I would
    like just to make one observation that I think needs to be
    made, and hasn't been part of the hearing to date, in that
    there is another advantage of this XBRL business on the other
    end of the pipe from the corporations.
        Today, the casual investor, interested in an investment
    potential, will be delivered a large envelope full of very
    complicated material that, frankly, most people just put back
    down. They will call their broker, perhaps. They will talk to a
    friend. But that data doesn't translate to any ability to
    compare that corporation's performance to anyone else.
        What I believe the advantage XBRL will offer is the ability
    of a person who is using a laptop, who is using a MacIntosh,
    who is using an IBM, whatever they are using, it's an
    interpreter between whatever system the corporation may be
    using, the computer system, when they enter it. It then will
    sort it out, so if it needs to go to the regulator, it goes to
    the regulator. If it's in the public domain, it's in the public
    domain.
        But when I sit down at my coffee table with my laptop, I
    can get access to information to compare Corporation A--let's
    assume it's an auto company--with all other auto companies in
    that sector, or, with a specific auto company. I can compare
    Chrysler with GM and get comparability.
        So, I think the biggest net gain, besides reducing cost to
    corporations, ultimately, in data preparation, is to empower
    the individual investor to get accurate, closer to real-time
    information that enables that person to make a more informed
    decision, perhaps as well as nothing else has been able to do
    that in the past.
        And that's my sales pitch to the committee about why XBRL
    ultimately offers some advantage. And if you choose to comment,
    fine. None required. But I think that's a point that had not
    been made in the hearing to date, and I think it important.
        The fact that we now have a vote pending, I want to thank
    this panel for your participation--you have been very helpful--
    and announce to our second panel that we will recess briefly to
    make the vote and come back so that the members of the second
    panel may attend to necessary things while we are gone. We
    should be absent no more than 10, 15 minutes, and we will
    return. I understand it's just one vote. The committee stands
    in recess.
        [Recess]
        Chairman Baker. I want to thank the members of the panel
    for their participation here today. As you have noted, despite
    expectations, there has been a lot of member interest in this
    topic, and we certainly appreciate your market perspectives in
    how we should move forward, if we should move forward with any
    modifications to the current reporting methodologies.
        To that end, I want to recognize Mr. David Hirschmann, who
    is the Senior Vice President, U.S. Chamber of Commerce. And
    please, proceed as you wish, sir.

      STATEMENT OF DAVID HIRSCHMANN, SENIOR VICE PRESIDENT, U.S.
                          CHAMBER OF COMMERCE

        Mr. Hirschmann. Mr. Chairman, thank you very much. I am, as
    you mentioned, David Hirschmann, senior vice president at the
    Chamber, the world's largest business federation, representing
    more than 3 million businesses.
        I am here today to share our views on how to improve
    auditing and accounting procedures, and ensure the viability of
    the auditing profession, which we think is threatened, and
    encourage a greater focus on long-term performance measures to
    help investors, companies, and the economy.
        First, I will--let me address the widespread practice of
    projecting a company's future earnings as a way to inform and
    guide investors. In fact, this practice is inherently flawed.
    Earnings guidance is a precise measurement, down to a penny or
    two per share, based on educated accrual estimates about the
    value of income, expenses, liabilities, assets, such as
    pensions, oil reserves, and bad debt, just to name a few.
        It used to be that companies were encouraged to manage
    these earnings. They would have a few honest, legitimate,
    acorns in the basement, as the saying goes, to support 1 or 2
    cents of earnings per share for a rainy day. As one former
    auditing executive put it, ``Analysts viewed any CEO who
    couldn't legitimately legally manage earnings within a penny or
    two to meet forecasts as not being in touch with what was
    happening at the company.''
        But in the current accounting environment, there are no
    acorns. And anyone who tries to create them is asking for
    trouble. Quarterly earnings guidance misrepresents a company's
    true financial strength, and puts pressure on executives to
    meet quarterly expectations. Companies often sacrifice creating
    long-term value, if it means missing quarterly projections. And
    that is a disservice to the company and to investors.
        Instead of issuing earnings guidance, companies should
    better communicate their strategies and objectives, and come up
    with alternative benchmarks that will show real progress
    towards meeting those goals. More communication, and not less,
    between companies in the investor community is needed. And that
    is why the Securities and Exchange Commission should re-examine
    regulation, Fair Disclosure Regulation, FD.
        This regulation, passed with legitimate intention of
    leveling the information playing field, so that a favorite
    analyst or investor would not receive better or more timely
    information. Unfortunately, in part due to the way this rule
    has been enforced at the SEC, it has the unintended consequence
    of restricting and reducing communication.
        We also support efforts by Chairman Cox to move to clearer
    and easier forms of electronic communication between companies
    and investors. XBRL is one example, and proves the capability
    of the market to assess information and reward those companies
    that are doing well.
        XBRL, which has been championed by AICPA and others, will
    help everyone better assess financial statements. But the smart
    money will still take the time to carefully understand industry
    factors and long-term strategy.
        Let me move to the second area, which is the area of fair-
    value accounting. The concept of developing well-reasoned
    estimates for certain intangible assets and liabilities, and
    including them on the corporate balance sheets. There are, no
    doubt, limitless things that could be both estimated in
    companies, and added to the financial statements. And many of
    them would be well consistent with GAAP.
        However, we can't lose sight of the fact that they are
    estimates. The move towards fair-value accounting should be
    tempered by a thorough examination of the implications, both to
    business and investors, of adding another imprecise estimate to
    the financial statements.
        In multiple arenas, companies are being required to develop
    systems for assigning and estimating values to such items, and
    thereafter continually reassessing and revaluing those items.
    These educated guesses generate additional risk for companies
    and their auditors.
        If someone thinks the guess is wrong, the company will be
    sued. When the company relooks at the guess, any significant
    change will create volatility in the financial statements,
    creating both stock price and generating more lawsuits.
        Fair value accounting also puts great pressure on the
    auditing profession to certify the appropriateness of these
    value estimates. These estimates are purely hypothetical, and
    not at all indicative of the true cash flow that a company
    expects to receive or incur.
        The U.S. Chamber will be asking both FASB and the
    International Accounting Standards Board to recognize their
    efforts to create a perception of accounting precision which
    may have potentially significant consequences for both
    companies and investors. While the push towards fair-value
    accounting may be theoretically pure, and even desirable in
    some cases, the costs may end up being much greater than the
    benefits.
        Finally, the business community has great concerns about
    the future of the auditing profession. In the post-Sarbanes-
    Oxley litigation and regulatory environment, auditing firms are
    under attack from several different parties. Much of this
    criticism results from erroneous perception that there is
    precision of financial reporting.
        Also, there is pressure on auditors to do more when
    conducting audits. This has resulted in higher audit fees for
    their clients. Even as the auditing costs have increased,
    however, clients are receiving less overall advice and support
    from their auditors, because of auditors' legitimate fear of
    litigation, or being second-guessed, or having questions raised
    by the SEC and the PCAOB about their independence.
        The cumulative result of all of this is the very real
    potential in the near term for further concentration of the
    auditing profession. There are now only four major firms
    serving a large majority of the listed and actively traded
    public companies in the United States. Further contraction of
    this profession would threaten its viability, and could shake
    public confidence in our capital markets.
        The Chamber has issued a number of recommendations for
    fortifying the auditing profession. First, the profession
    should become insurable against catastrophic litigation.
    Second, the PCAOB standards should be further clarified. And
    third, we need an expansion and greater competition among the
    big four accounting firms.
        In the interest of time, I will not go into detail to all--
    in all our recommendations. But I have provided them to the
    committee as an attachment to the formal statement, which I
    know will be included in the record.
        In conclusion, Mr. Chairman, the United States Chamber of
    Commerce is fully committed to highly accessible, transparent
    capital markets, and we will leverage our full resources to
    ensure accounting and auditing practices that are necessary for
    achieving this goal. Thank you very much for the opportunity to
    speak today.
        [The prepared statement of Mr. Hirschmann can be found on
    page 149 of the appendix.]
        Chairman Baker. Thank you very much for your statement,
    sir.
        Our next witness is Mr. Marc E. Lackritz, president of
    Securities Industry Association. Welcome, sir.

     STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES INDUSTRY
                              ASSOCIATION

        Mr. Lackritz. Thank you, Mr. Chairman, and thank you very
    much for the invitation to testify today. SIA, and our over
    600-member firms, share your interest in improving the clarity
    and the relevance of financial information, and we applaud you
    for holding this very timely hearing.
        As financial intermediaries, Mr. Chairman, our livelihood
    depends on the quality, consistency, and reliability of
    financial information. Indeed, our capital markets are the envy
    of the world, precisely because the quality of information has
    continued to evolve and improve. We are eager to work with your
    subcommittee, other Members of Congress, regulators, and all
    interested parties, to further improve the quality of financial
    information.
        Our markets have thrived largely because of investors'
    ability to obtain, digest, and appropriately price securities
    derived from information about companies and the economy. Three
    factors allow information to flow fully, efficiently, and
    fairly.
        First, companies have powerful motives to disclose
    information. Certainty, clarity, and comparability in the
    disclosure of financial information lowers the cost of capital.
        Second, the Federal securities laws have long buttressed
    the efficient flow of information to the markets, especially by
    punishing the dissemination of deliberately false information.
        And third, our markets have excelled in embracing advances
    in technology, from the telegraph to the Internet. This has
    enormously enhanced the capabilities of market participants to
    receive and absorb information in their trading decisions.
        Now, none of this would be possible, Mr. Chairman, without
    the public's trust and confidence that all market participants
    adhere to stringent rules, vigorously and fairly applied. A key
    element of public trust is access to reliable and timely
    information, both by the public directly, and by investment
    advisors, mutual fund, pension, and 401(k) plan managers who
    manage trillions of dollars of savings.
        At a time when nearly 57 million American households, or
    more than half of all U.S. households, own stock, directly or
    indirectly, the securities industry is committed to ensuring
    that individual investors can achieve their financial goals,
    such as planning for a child's education, or for a comfortable
    retirement. With 76 million baby boomers hurtling toward
    retirement, we recognize that the quality of information must
    be paramount.
        Current information in the marketplace comes from three
    basic sources: regulated disclosures, voluntary issuer
    guidance, and research analysts' reports. In total, all this
    information comprises a comprehensive and effective disclosure
    regime.
        Although we believe the SEC's current financial disclosure
    regime works exceptionally well to provide the highest quality
    information to investors, we do support the SEC and, Mr.
    Chairman, your recent technology initiatives such as the use of
    XML tag data, to make it easier for investors to compare
    companies.
        We do not believe, however, that it is necessary to mandate
    any additional disclosure of financial information at this
    time. High quality accounting standards are absolutely critical
    to ensuring that financial reporting results in clear, timely,
    and relevant disclosure to users of financial statements.
        We believe accounting standards can be improved in three
    ways. First, by using fair value to measure all financial
    instruments. Secondly, by simplifying standards. And third, by
    converging differing national standards. SIA believes that
    using fair value forces firms to confront adverse market
    movements at an early stage, and gives investors an earlier
    warning of developing problems.
        We also agree with regulators that disclosures that provide
    insight into an entity's risk position and exposures, could
    enhance regulatory and market discipline. Similarly, accounting
    standard setters, regulators in the private sector, have all
    recognized the benefits that would result from a more
    principles-based approach to accounting.
        Principles-based accounting standards are more consistent
    and comparable, and will allow investors to more easily analyze
    and compare investment choices, and make fully informed
    decisions. In addition, such improvements in global accounting
    standards will facilitate the seamless flow of capital across
    national borders, as well as reduce the costs of providing
    relevant information to investors.
        In addition to the SEC-mandated quarterly reporting, many
    corporate issuers voluntarily provide periodic earnings
    guidance. Guidance is not mandated by statute or regulation.
    But most companies choose to provide this information in
    response to market demands.
        Recently, several large U.S. issuers have discontinued the
    practice of issuing earnings guidance, in favor of issuing more
    detailed performance information. We believe the decision to
    issue earnings guidance should rest with the issuer, and should
    not be mandated by law or regulation.
        The current system of financial disclosure has served
    investors, issuers, and the securities industry extraordinarily
    well. We believe that the greater use of fair value accounting,
    and the simplification and convergence of accounting standards
    would further assist issuers in providing better quality
    information to investors.
        We look forward to working with you, Mr. Chairman, and the
    committee and the Congress, as well as investors, issuers,
    accountants, and regulators, to further improve the quality,
    consistency, and clarity of information, so that we can
    maintain the global preeminence of the U.S. capital markets.
    Thank you very much.
        [The prepared statement of Mr. Lackritz can be found on
    page 154 of the appendix.]
        Chairman Baker. Our next panelist is Colleen Cunningham,
    president of Financial Executives International. Welcome.

         STATEMENT OF COLLEEN CUNNINGHAM, PRESIDENT, FINANCIAL
                        EXECUTIVES INTERNATIONAL

        Ms. Cunningham. Thank you, Mr. Chairman, for this
    opportunity to appear before you today. My name is Colleen
    Cunningham and I am the president and CEO of Financial
    Executives International. FEI is the leading organization of
    about 15,000 members, which includes CFO's, treasurers,
    controllers, and other senior financial executives.
        FEI members represent the preparer community. That is, the
    senior financial executives responsible for the preparation of
    financial statements. Importantly, we're also users of
    financial statements relying on financial statements of other
    companies in our investment and credit decisions.
        In both roles as a preparer and user, we applaud the goal
    of today's hearing. I am pleased to share FEI's views with you
    today on the important issue of fostering accuracy and
    transparency in financial reporting.
        The complexity and technical demands of accounting
    standards have increased considerably in recent years to the
    point where many otherwise capable accountants are no longer
    confident that they can apply the new requirements without
    outside assistance from subject matter experts. This is
    happening at a time when, in the United States financial
    reporting environment, there is heightened sensitivity and
    attention given to accounting and financial reporting.
        FEI believes that undue complexity harms, rather than
    enhances, the ability of users of financial statements to
    understand the information provided by financial reporting.
    Simple, easy-to-understand standards should be our mutual goal.
        FEI concurs with the views of the leaders of the SEC, the
    FASB, the PCAOB, and all interested--that all interested
    parties must come together to address what I like to call the
    complexity conundrum. We applaud the FASB's current projects on
    simplification and codification, and the conceptual framework.
    They should go a long way towards enabling preparers, auditors,
    and users of financial statements to find applicable accounting
    literature.
        However, when the rules themselves are unduly complex, they
    impede the ability of preparers to provide accurate and
    transparent financial reporting. No doubt, the growing
    complexity of business transactions adds to the challenge of
    developing appropriate accounting standards.
        We're currently operating in an environment where companies
    are second-guessed by their auditors, perhaps third- and
    fourth-guessed by various regulators, such as the SEC and
    PCAOB, and then maybe fourth or fifth-guessed by the
    plaintiff's bar. Is it any wonder there are constant requests
    for bright lines and interpretations by auditors and preparers
    to seek additional guidance to ensure that they are doing the
    right thing?
        Additionally, overly theoretical standards can result in
    financial reporting of questionable accuracy, and create a
    significant cost burden with little benefit to investors. Even
    simple, principles-based standards can create undue complexity
    in their implementation.
        For example, a simple principle--record everything at fair
    value--may be incredibly complex to apply, and imprecise,
    particularly when there is no ready market for the underlying
    transaction. This operational complexity cannot be ignored as
    principles-based standards are created.
        I would like to quickly highlight four potential solutions
    to this complexity conundrum, which are discussed in greater
    detail in my written testimony.
        Number one, the need for FASB to prioritize its conceptual
    framework and codification project, and follow with principles-
    based rulemaking, which must be practical in application, and
    understandable by preparers, users, and auditors, and result in
    information that is auditable. While this will be helpful going
    forward, existing standards would also need to be addressed in
    the context of a new conceptual framework.
        Number two, the need for regulators to avoid second-
    guessing reasonable interpretations of standards, and avoid
    issuing informal guidance for significant matters that could
    lead to a large number of restatements.
        Number three, the need for Congress to assist in correcting
    today's litigious environment.
        And number four, the need for preparers, auditors, and
    users of financial statements to be part of the solution, by
    educating themselves about changing accounting and auditing
    standards, participating actively in the standard-setting
    process, and making recommendations for simplifications and
    transparency in accounting standards in their financial
    reports.
        In conclusion, FEI believes that it is feasible to reduce
    the complexity of financial reporting standards, and make them
    easier and less costly to find, understand, remember, and
    implement. But to do so will require a concerted effort among
    all financial reporting stakeholders, many of whom are here
    today.
        I support the SEC's encouragement of studying the use of
    interactive data, such as XBRL, and the benefits it can
    provide. However, I urge a note of caution, that technology is
    not a panacea, and that transparency provided through
    electronic links, or the old-fashioned way, through non-
    linkable disclosure, will not reduce the operational complexity
    imposed on preparers to develop the numbers provided in
    financial reports. Nor will such transparency improve the
    understandability of underlying numbers to investors.
        The creation of a special committee with wide
    representation from all constituencies to address the full
    breadth of the complexity conundrum can help us arrive at
    practicable solutions that will reduce the level of complexity
    with respect to existing standards, and at the same time,
    maximize the utility of financial reporting to investors.
    Everyone has a role to play in this effort to reduce
    complexity, and FEI is ready to be part of it.
        That concludes my remarks. I want to thank the chairman and
    the members of the subcommittee for inviting us to participate
    in today's hearings.
        [The prepared statement of Ms. Cunningham can be found on
    page 53 of the appendix.]
        Chairman Baker. Thank you very much. Next, I welcome Barry
    Melancon, president of the American Institute of Certified
    Public Accountants. Please proceed, sir.

    STATEMENT OF BARRY MELANCON, PRESIDENT, THE AMERICAN INSTITUTE
                    FOR CERTIFIED PUBLIC ACCOUNTANTS

        Mr. Melancon. Thank you, Mr. Chairman, and members of the
    subcommittee. My name is Barry Melancon, and I am president and
    CEO of the American Institute of Certified Public Accountants.
        On behalf of the 330,000 members of the AICPA, I truly
    appreciate the opportunity to present testimony to this
    subcommittee about increased accuracy, accessibility, and
    transparency in corporate, financial, and other business
    information, including non-financial information, that is
    useful to investors and other users in making decisions.
        I request that my written statement and its exhibit be made
    a part of the official record of this hearing.
        The existing financial reporting model provides a solid
    foundation. Today, the nature of modern corporations, how they
    are managed, and the evolving performance indicators that
    senior executives routinely use, however, underscored the need
    for an expanded reporting model.
        Third party research shows that for many companies, only 25
    percent of an entity's market value can be attributed to
    accounting book value, with the remaining 75 percent based on
    value drivers, such as strategy, distribution channels, product
    innovation, people, and customer loyalty.
        Research also tells us that only about one-third of the
    value drivers generally associated with industry sectors are
    published in formal filings.
        As you, as chairman of this subcommittee, has said, if U.S.
    markets are to remain on top in an increasingly competitive
    global marketplace, we need to move away from the complex and
    cumbersome, and explore technological and other methods of
    enhancing the clarity, accuracy, and efficiency of our
    accounting system.
        We agree with this position, and have been actively working
    for more than a decade to draw meaningful progress toward a
    more relevant, reliable, understandable, timely reporting
    model.
        In 1993, the AICPA's special committee on financial
    reporting--which is better known as the Jenkins Committee,
    named after its chairman, former FASB chairman, Ed Jenkins--
    published a report dealing with improving business reporting.
    We have undertaken many other activities since the Jenkins
    Committee, which led to the AICPA establishing the enhanced
    business reporting consortium, a market-driven collaborative
    effort involving corporations, investors, the accounting
    profession, and other key participants in the corporate
    reporting supply chain.
        The consortium aims to achieve the right mix of fully
    disclosed high-quality information made possible not only by
    adding critical information that is not currently disclosed,
    but also by advocating for improvement in the consistency and
    relevancy of existing disclosures. The consortium is on the
    cutting edge of developing internationally recognized voluntary
    framework for the disclosure of key business information, in
    addition to traditional financial statements.
        We believe that transparency can be further enhanced
    through a stronger focus on the quality, not quantity, of
    reported information.
        In addition, the enhanced business reporting consortium's
    reporting simplification task force, made up of accountants in
    business and industry and public practice and FASB staff, and
    observers from SEC staff members, who provide valuable input,
    intends to make thoughtful recommendations for simplifying
    existing disclosure requirements based on research findings.
        I was happy to hear this morning the considerable
    discussion on XBRL. The AICPA charted the XBRL international
    consortium in 2000 to foster the global growth and adoption of
    XBRL, extensible business reporting language, which we started
    in 1998. XBRL is a language for the electronic communication of
    business and financial data. It is the technology that enables
    more efficient and effective financial and non-financial
    business reporting. My written testimony contains details on
    how XBRL operates, and exactly what it is capable of doing.
        Today, investors, lenders, and other users of the
    information, need to make decisions much faster and more often,
    based on what may happen in the future, rather than what has
    occurred in the past.
        I am pleased to say that this is no longer just a dream.
    Coupled with enabling technologies like the Internet and XBRL,
    enhanced business reporting will provide users the breadth of
    information they require, at the speed that they need to be
    successful in today's economy.
        We believe that the benefits will include reduced
    uncertainty, lower market volatility, and a decline in the
    over-emphasis on quarterly earnings. With richer information,
    investors can be encouraged to take a longer-term view.
        Your efforts to stimulate meaningful dialogue about
    enhancing transparency and reducing complexity will contribute
    significantly to creating a reporting model that meets today's
    market needs. We likewise believe that involving more market
    participants in the development and adoption of enhanced
    business reporting and XBRL will contribute to providing
    investors with a financial reporting system that is transparent
    and more reliable.
        The AICPA wants the promise of enhanced business reporting
    and XBRL to be realized as quickly as possible. We are looking
    forward to working with this subcommittee, the SEC, FASB,
    corporate America, the investment community, and public
    accountants to make this happen. I will be happy to answer any
    questions that the members of the subcommittee may have.
        [The prepared statement of Mr. Melancon can be found on
    page 166 of the appendix.]
        Mrs. Biggert. [presiding] As you can see, I am not Mr.
    Baker any more, but I am happy to be here. Next, we have Ms.
    Rebecca McEnally, director of capital markets, Policy Center
    for Financial Markets Integrity, the CFA Institute. You are
    recognized for 5 minutes. Thank you.

      STATEMENT OF REBECCA MCENALLY, DIRECTOR OF CAPITAL MARKETS
     POLICY, CENTER FOR FINANCIAL MARKETS INTEGRITY, CFA INSTITUTE

        Ms. McEnally. Thank you. I am happy to be here today,
    Chairman Baker, Ranking Member Kanjorski, and members of the
    subcommittee. I am Rebecca McEnally, director of capital
    markets policy for the CFA Institute Center for Financial
    Market Integrity, and we do appreciate this opportunity to
    testify.
        The Center was established to promote the highest standards
    of ethics, integrity, and professional excellence in the global
    investment community. It shares this goal with its parent, CFA
    Institute, which is a non-profit organization of more than
    81,000 investment professionals in 126 countries.
        CFA Institute is widely recognized as the organization that
    administers the chartered financial analyst examination, and
    awards the CFA charter, a designation that I share with nearly
    68,000 professionals worldwide.
        High quality financial information is critical to the work
    of our members and other investors. So, for more than 3
    decades, members of CFA Institute have been actively involved
    in the public debate about how best to improve financial
    reporting standards and disclosures.
        The corporate reporting scandals and bankruptcies over the
    past few years have underscored how crucial clear, accurate,
    and complete financial reporting is to the health and wellbeing
    of capital markets. The U.S. standard setters, principally the
    FASB and SEC, as well as the IASB, have made good progress in
    improving the clarity and accuracy of financial reporting.
        But they would agree with us that a vast amount remains to
    be done. To help propel their efforts forward, the center
    recently released its White Paper, a comprehensive business
    reporting model which was developed by our global panel of
    experts. The paper outlines 12 principles that we believe would
    greatly increase the clarity, accuracy, and completeness of
    financial reporting. My written statement summarizes these
    principles, but I will highlight a few of them here.
        First, we believe that financial statements should be
    prepared from the perspective of the common stock owner, the
    last residual claimant on the company's resources. Share owners
    can't properly evaluate a company's potential risks and returns
    unless the statements completely and accurately reflect both
    the assets available to the company, and the claims of all
    others that must be settled before those of the common share
    owners.
        In this regard, financial instruments, pensions, and leases
    were listed as items requiring attention in the SEC's report,
    which was submitted to the House Financial Services Committee
    in June of last year. These need to be fully reflected in the
    financial statements, and not hidden in the footnotes. These
    items are at the top of our own list, as well, and we're
    pleased that the FASB is moving forward on them.
        A second principle is that items in the financial statement
    should be measured at fair value. The reason for this is a
    simple one. The only information that is useful for financial
    decision-making, including investment decisions, is fair value
    information. And because the financial statements are
    investors' major source of information, items in these
    statements should be measured at fair value.
        Doing so would remove one significant source of complexity
    in financial reporting, that which derives from the mixture of
    both historical cost and fair value measurements.
        For example, if all the financial instruments were to be
    measured at fair value, as we have argued for some time, there
    would no longer be the need for highly complex hedge accounting
    for those positions that are hedged. Neither would there be an
    accounting mismatch that could lead to unintended consequences.
    We were pleased to learn that the FASB and IASB last October
    reaffirmed their commitments to fair value reporting for all
    financial instruments, and are working jointly to resolve the
    remaining issues.
        A third principle is that all changes in assets and
    liabilities should be recorded in a single new financial
    statement, which we call the statement of changes in net
    assets, available to common share owners. This statement would
    build upon and expand the reporting in the current statement.
        A current hot topic of discussion is whether company
    managers should provide quarterly earnings forecasts to
    analysts, investors, and the markets. Two weeks ago, we asked
    our global membership if this practice should be discontinued.
    And we were not surprised to learn that three quarters of those
    responding said, yes, it should be stopped.
        For those who answered yes, we also asked if companies
    should provide additional information on the fundamental
    longer-term drivers of the business, and 95 percent said yes.
        We conclude from these results that our members find little
    value in the current earnings guessing game, but they would
    value clear and timely information on the basic economic
    factors that affect the company.
        I commend the subcommittee for your leadership in
    addressing investors' concerns about the accuracy and
    transparency in financial reporting. I appreciate this
    opportunity to provide the views of CFA Institute, and I look
    forward to responding to any questions you may have. Thank you.
        [The prepared statement of Ms. McEnally can be found on
    page 183 of the appendix.]
        Mrs. Biggert. Thank you very much. I will now recognize
    myself, since there is nobody else here.
        First of all, Mr. Melancon, AICPA's consortium has been a
    leader in promoting the use of XBRL. Where do you see the XBRL
    development going in the next few years?
        And, second of all, do you see a more systematic adoption
    of XBRL leading to real-time financial reporting?
        Mr. Melancon. Well, XBRL is an enabler. I think you have to
    look at XBRL in concert with what are we reporting, and that's
    why I would say an enhanced business reporting to get away from
    just an earnings number, but key economic value drivers of a
    business.
        I think that programs such as the FDIC's use of XBRL for
    call report filing shows the use of and the efficiency of using
    XBRL. I think that will continue and grow. I think the SEC, and
    certainly Chairman Cox, have been tremendous supporters of it.
    They have a voluntary program now. And I think that it's
    important to find, in various components of government,
    incentives to encourage people to use this on a voluntary
    basis. And I think companies, in fact, will do so.
        Clearly, more work needs to be done. It has come an
    incredibly long way in a relatively short period of time. And
    1998, I would dare say that very few people would even know
    what XBRL was, and today it's being adopted throughout the
    world, and certainly in many corners of the U.S. regulatory
    process, as well.
        I think also that there is work to be done in the area of
    taxonomy development. And it takes the involvement of all of
    the people in the supply chain area. And it will also be used
    in areas that are not related, necessarily, to the topic of
    this hearing, which is more on the financial and GAAP basis.
    But, for instance, the IRS is involved in it, for the use of
    compliance work in that area, making things more efficient from
    their own enforcement perspective.
        So, a lot of work to be done in areas such as taxonomy
    development, but tremendous progress, as well.
        Mrs. Biggert. Are there any other challenges that companies
    will face in implementing XBRL?
        Mr. Melancon. I think it was reported by Scott Taub at the
    earlier panel that, at least in the pilot, the companies that
    have been using it from an SEC perspective have found the
    cost--I think his term was, ``slightly more than negligible.''
        I think that it really is a notion of a wider knowledge of
    it. I think the building of the taxonomies, I think, clearly,
    the leadership of members of this committee, of Chairman Baker,
    and of Chairman Cox at the SEC, helped to make it much more
    accessible, much more known. And therefore, I think that bully
    pulpit is a very important aspect to getting it adopted and
    being widely known.
        Mrs. Biggert. All right, thank you. Then, Mr. Hirschmann,
    the Chamber has been at the forefront of convincing public
    companies to cease issuing quarterly earnings guidance. And as
    you stated in your testimony, this practice of issuing these
    quarterly earnings guidance is detrimental to the long-term
    health of our capital markets.
        Some of our largest public companies have agreed, and have
    stopped issuing such guidance. Would you elaborate a little bit
    on the Chamber's initiative?
        Mr. Hirschmann. Thank you. We think all parties have a
    responsibility here. Companies have a responsibility to step
    forward and stop issuing earnings guidance. We are using our
    bully pulpit at the Chamber to create some room for them to do
    so.
        We believe the SEC has a role to play in making it easier
    for companies to communicate with investors, by reforming
    Regulation FD. We believe the analyst community has a
    responsibility by focusing on longer-term growth opportunities
    in companies. And we're looking at long-term performance, and
    we know that the better analysts already do. So, I think there
    is a role for everybody in the financial system to achieve
    this.
        Companies--fully a quarter of the larger companies--have
    already stopped issuing earnings guidance. Those that have,
    have found it greatly advantageous. The real challenge is with
    smaller companies, who fear that they will lose coverage by the
    analyst community, and that that is the one way they can get
    their story out.
        Efforts like what AICPA is leading on, enhanced business
    reporting, provides them a better way to get their story out,
    certainly much better than simply focusing on short-term
    earnings guidance, which is really a fool's game.
        Mrs. Biggert. Do you--well, and this is for the rest of the
    panel, too--do you think that managers, in doing the quarterly
    earnings guidance, sometimes make business decisions that may
    not be in the best long-term interest of the company, by having
    to do that every quarter? Mr. Lackritz?
        Mr. Lackritz. Well, I think we have to remember that there
    is going to be--we need a balance here that's going to work in
    the marketplace.
        You know, on the one hand, we get concerned about issuers
    and demands on the issuers, but we have to remember there are
    57 million households out there that own securities, directly
    or indirectly. And they need good information on which to base
    decisions.
        So, on the one hand, if we're concerned about a short-term
    mentality because of quarterly reporting, the answer is not to
    eliminate quarterly reporting and make it longer in between
    periods. I mean, it would almost be like saying, ``Let's not
    have the sun rise every day, because it creates too short a
    day.''
        I mean, the answer really is to encourage better, more
    frequent reporting of quality, you know, high-quality,
    comparable, consistent information. And I think we have to make
    sure to keep investors in this equation, because the
    marketplace really functions most effectively and allocates
    limited capital most effectively with the highest quality
    information.
        Mrs. Biggert. Okay, thank you. Ms. Cunningham?
        Ms. Cunningham. Sure. I think a lot of what has been said
    already. I think more communication of strategy, vision,
    enhanced business reporting model, and operating metrics,
    rather than reporting a number, will go a long way towards
    enhancing transparency and accuracy.
        And I do think, though, that, you know, companies, in a lot
    of instances, particularly the smaller companies, do feel
    trapped in that if they don't provide it, they won't get the
    coverage. Therefore, they take a hit on their stock price
    there.
        I think investors really need to recalibrate their current
    short-term focus as well, to one that's more focused on the
    long term.
        Mrs. Biggert. Thank you. Mr. Melancon?
        Mr. Melancon. I would agree, that the focus on a single
    number is problematic. And the disclosure and finding ways to
    cost effectively do that, hopefully through the use of
    technology, on some key drivers of the company, what senior
    management looks to, that can be fully disclosed and give
    investors, those millions of households, a peek into the
    company as to what's important.
        I think by moving away from a single number, we actually
    reduce some volatility, but at the same time, help people focus
    on a longer term. And that is absolutely important. And I think
    that, you know, let's go along with our notion that it is not
    necessarily more--not necessarily a volume of information, but
    a mount of digestible, accurate information that people can use
    to make good decisions.
        Mrs. Biggert. Ms. McEnally?
        Ms. McEnally. Thank you. I think we need to make a very
    clear distinction here between giving earnings guidance and the
    quarterly reporting that is essential to the valuation of
    investments.
        Investors require not only clear, accurate, and complete
    financial information, but they have to have timely
    information. Otherwise, markets can't be efficient, and
    investors can't do what they have to do to properly allocate
    their capital.
        So, I would not want there to be any confusion at all
    between the issue of earnings guidance and the requirement for
    clear, complete, quarterly information.
        Mrs. Biggert. Thank you. Then Mr. Lackritz, could you
    explain why principle-based accounting standards would assist
    investors in analyzing investment choices between countries
    with different regulatory regimes and different accounting
    standards?
        Mr. Lackritz. Sure. I think the key here is that we need to
    move toward converged--or at least comparable--kinds of
    standards, because that's going to facilitate the seamless flow
    of capital.
        If you have principles-based accounting standards, it will
    make it easier to converge those standards from differing
    jurisdictions, number one. Number two, it will provide more
    opportunity for CFOs and companies to use their judgement,
    which of course, everybody is running away from now, because of
    the potential liability that everybody has.
        And I think we have seen the results of some of the
    problems by not having converged accounting standards today. I
    mean, 6 years ago, $9 out of $10 raised in initial public
    offerings was raised in the United States. Last year, of the
    top 10 initial public offerings, none of them were listed in
    the United States, and 23 out of the top 25 initial public
    offerings were not listed in the United States.
        One of the reasons for that is the liability system here. A
    second reason is the costs that are being imposed by some of
    the regulations that have evolved. And the third reason, I
    think, is because accounting standards are not converged.
        So, by moving to principles-based accounting standards,
    that will really facilitate the flow of capital across borders,
    and also reduce the cost of providing information to investors,
    as well.
        Mrs. Biggert. Okay. Do any other panelists have thoughts on
    this issue?
        [No response.]
        Mrs. Biggert. Then I would like to insert into the record a
    statement of Merrill Lynch regarding earnings guidance, and a
    speech of Paul Schott Stevens, the president of the Investment
    Company Institute, given last week, regarding ICI's interest in
    XBRL. Without objection.
        Mrs. Biggert. And with that, the Chair notes that some
    members may have additional questions for this panel, which
    they may wish to submit in writing. So, without objection, the
    record--hearing record--will remain open for 30 days, for
    members to submit written questions to the witnesses, and to
    place their responses in the record.
        And with that, I would like to thank all of you so much for
    your excellent testimony, and I know it's a long day, and--to
    sit, and with two panels, but we really appreciate your help in
    our deliberations on this issue.
        So, with that, the hearing is adjourned.
        [Whereupon, at 12:34 p.m., the subcommittee was adjourned.]
                                A P P E N D I X

                                 March 29, 2006

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