[House Hearing, 109 Congress]
[From the U.S. Government Publishing Office]
FOSTERING ACCURACY AND
TRANSPARENCY IN FINANCIAL REPORTING
=======================================================================
HEARING
BEFORE THE
SUBCOMMITTEE ON
CAPITAL MARKETS, INSURANCE, AND
GOVERNMENT SPONSORED ENTERPRISES
OF THE
COMMITTEE ON FINANCIAL SERVICES
U.S. HOUSE OF REPRESENTATIVES
ONE HUNDRED NINTH CONGRESS
SECOND SESSION
__________
MARCH 29, 2006
__________
Printed for the use of the Committee on Financial Services
Serial No. 109-80
U.S. GOVERNMENT PRINTING OFFICE
WASHINGTON : 2006
30-174 PDF
For Sale by the Superintendent of Documents, U.S. Government Printing Office
Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800; (202) 512-1800
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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
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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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