[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

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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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