SPEAKERS CONTENTS INSERTS
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PROMOTION OF INTERNATIONAL CAPITAL FLOW THROUGH ACCOUNTING STANDARDS
THURSDAY, JUNE 7, 2001
U.S. House of Representatives,
Subcommittee on Capital Markets, Insurance, and Government Sponsored Enterprises,
Committee on Financial Services,
Washington, DC.
The subcommittee met, at 10:00 a.m., in room 2128, Rayburn House Office Building, Hon. Richard H. Baker, [chairman of the subcommittee], presiding.
Present: Chairman Baker; Representatives Shays, Cox, Gillmor, Royce, Oxley, Ose, Kanjorski, Bentsen, J. Maloney of Connecticut, Hooley, Mascara, LaFalce, Sherman, Inslee, Moore, Lucas, Shows, Israel, and Ross.
Chairman BAKER. I'd like to call this hearing of the Capital Markets Subcommittee to order. I am informed that we will have a journal vote or a vote at approximately 10:30. Mr. Kanjorski, the Ranking Member, is on his way, but I thought we would convene the hearing this morning in an effort to get the opening statements on the record prior to breaking for whatever vote is required on the floor.
With that advisory, I do expect Mr. Kanjorski's arrival momentarily.
Today, we have under consideration accounting issues which are new to this Committee's jurisdiction this year. Financial accounting and transparency are vitally important for all investors, practitioners, regulators and others who have interest in the market's conduct.
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We begin today by reviewing the efforts to harmonize international accounting standards, given the nature of the changing world economy.
Transparency regarding the financial condition of a company is a key component in an investment decision. Accounting standards are intended to serve investors by imposing a framework for financial reporting so that all investors may evaluate and compare on a common platform.
The United States capital markets are the deepest and most complex in the world. And while there are very legitimate concerns about the rules, the markets consider the Generally Accepted Accounting Principles, or GAAP, the most comprehensive standards in the world.
Of course, these standards are only used by companies filing financial statements domestically. The globalization of markets and new technology now more than ever allow investors to diversify portfolios and seek opportunities both here and abroad.
Additionally, U.S. companies are able now to find capital in growing sources from those outside the country. However, without harmonization of accounting standards, investors face uncertainties. We must carefully scrutinize this process so that the field is made level across national borders and that standards are effective and meaningful to the investors whether here or abroad.
This does not merely mean reconciliation of foreign standards to GAAP. There is the hope that the international effort to harmonize will take the best ideas of all national standards and do away with those principles which unduly burden issuers or do not provide meaningful information to investors.
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Most importantly, this effort should be responsive to the needs of investors worldwide and should consider the types and manner of disclosure most appropriate.
It is a pleasure today to welcome Chairman Volcker here. I will have a formal introduction at a later moment. But to have his prestige brought to bear on this important matter in his new capacity is indeed an important addition to this process.
With that opening statement, I'd like to turn to Mr. LaFalce for his words.
Mr. LaFalce.
Mr. LAFALCE. Thank you very much, Mr. Chairman. Chairman Volcker, it is always a pleasure to have you before us. We can always learn treasures and gems when you come. And Mr. Chairman Baker, I can't tell you how very pleased I am that you are having this hearing. We had a dialogue in your office about a month or two ago about the importance of accounting, and I'm glad you're chairing this Committee, and I know you're going to be looking into this issue the way it should be.
I believe it's very important to harmonize international accounting standards. Yet I'm also concerned that in the process we do not undercut the generally strong standards we have in the United States. These standards and the strength of our accounting and auditing professions play a fundamental role in protecting investors and maintaining the integrity of our capital markets.
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I'd also like to take the opportunity to thank Chairman Volcker for his efforts to improve the international accounting standard-setting process. I believe these efforts will make an important contribution to the integrity and transparency of both our markets and those abroad.
Accounting issues have recently begun to catch the attention of the media, and I'm delighted at that. It's difficult now not to notice daily reports of financial fraud and restatements of financials by major corporations, not just small corporations, but major corporations. And I'm extremely concerned about this. In fact, ''outraged'' may be a much better word.
The SEC, particularly its Chief Accountant, has also been expressing concerns about various accounting issues and practices involving the accounting profession and corporate management. And I hope they will step up their enforcement efforts. But most importantly, I hope we give them the resources necessary to do that. That ball is in our court.
Today's hearing obligates me to express my strong conviction that our Committee and the Congress must not take the strength and integrity of our own accounting system for granted. And most importantly, we have to make it clear that harmonizing international accounting is not an excuse to lower U.S. accounting standards.
In other words, standardizing accounting practices around the globe cannot be a race to the bottom. Investors, shareholders and increasingly global capital markets all benefit from access to the highest quality information.
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Now this aspect of accounting on which we're having a hearing today should be only the beginning of a tremendous Committee focus on domestic accounting issues and how the application of accounting standards is affecting the integrity of our capital markets. It's certainly an area that I personally shall be pursuing with the greatest aggressive effort I can muster.
This is particularly important in view of the tremendous growth in stock ownership throughout the country. Estimates for the most recent survey data indicate that approximately half the households in the United States now own corporate stock, either directly or indirectly, through a mutual fund, retirement account or defined contribution pension plan.
This represents over a 60 percent increase in the number of individual shareholders over just the last decade. This trend, combined with the decreasing availability of defined benefit pension plans, means that more Americans than ever are relying on the performance of their stock investments for their savings and retirement.
Twenty years ago, two-thirds of all pension plan participants were in defined benefits plans. Today, more than two-thirds are in defined contributions plans. Now, that change is profound in its implications and profound in the obligations it imposes upon us, the SEC, and so forth.
High quality accounting standards and financial reporting are essential for sound investment choices to be made. At the same time that Americans have become more reliant on the performance of their stock investments, the pressures on firms to manipulate their financial results have grown tremendously. Executive compensation is increasingly tied to market valuation of corporate stock, creating ever more pressure to meet earnings estimates to the penny. Fourteen cents rather than 15 cents could result in the stock price and market valuation of a company being pummeled.
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Judging by the numbers of companies that have had to restate their financial statements after they were released, many companies have succumbed to the temptation to manipulate their results. According to the SEC, the number of restatements has more than trebled from the early 1990s, from an average of less than 50 per year to 156 last year.
More than half of the companies accused of financial fraud and shareholder class action lawsuits last year have already been forced to restate their earnings. These figures are very troubling when one notes that these are restatements of financials that had been signed off on by the firm's auditors.
Regrettably, there is increasing and disturbing evidence that the problem is widespread. An article this month by a senior editor of that ultra-liberal Harvard Business Review describes the insidious effects of the so-called earnings management, saying that: ''the earnings game is now so commonplace that it can sometimes seem like a collective agreement to believe the unbelievable.''
While many of the techniques used may be technically legal, they are economically indefensible. And the conduct of many companies may well cross the line into fraud on investors in the markets.
Further, while I would like to think that the conduct of these companies is an aberration, what may look like an ice cube is much more likely to be the tip of the iceberg, as the Chief Accountant of the SEC noted only last week. I suspect that iceberg may be gigantic.
Our Committee needs to focus seriously on the importance of accounting standards and their proper application to our capital markets. High quality financial reporting is essential to protecting investors and maintaining investor confidence. We need to ensure the high quality of financial information from all firms that compete for capital in our markets, whether they are U.S. companies or foreign corporations.
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Today's hearing is a start, but only a small start in that effort. Looking forward, it's imperative that we look at all issues affecting investor protection in a balanced, objective way. This Subcommittee under the leadership of Chairman Baker and Mr. Kanjorski will be having a hearing next week on analyst independence, which we certainly should do. But if we are to do a serious analysis of the problem, the regulators must also be invited to be part of that dialogue.
And, Mr. Chairman, I understand that full Committee staff may be very reluctant to that, and I ask that you make the decision as to who should testify rather than staff. I thank the Chairman.
Chairman BAKER. Thank you, Mr. LaFalce. And for the record, you'll note substantial time was allocated to your remarks in deference to your evident strong feelings on the matter, and I assure you the hearing next week is only a minor beginning to our Committee work on the subject, and we look forward to your continued interest. Thank you, sir.
Chairman Oxley.
Mr. OXLEY. Thank you, Mr. Chairman. And today our subcommittee begins its consideration of significant issues in public accounting and investor disclosure. I want to congratulate you, Mr. Chairman, for taking the initiative in holding this hearing. And I also want to welcome the distinguished former Chairman of the Federal Reserve, Paul Volcker, who once again is playing a leading role in international finance and welcome Chairman Volcker back to the Committee.
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I appreciate the work of the AICPA and the Financial Executives Institute and the willingness of their representatives from KPMG, Peat Marwick and General Electric, to testify today.
We live in a time of growing interdependence in world financial markets. However, financial reports on publicly traded companies upon which investors and regulators depend on based on accounting practices that can vary widely by country. These differences result in a lack of comparability and reliability in financial disclosure.
Harmonizing accounting standards will benefit preparers and users of financial statements, promote international trade and investment and reduce costs for multinational companies. Investors will be better able to make informed investment decisions.
With integrated financial markets, economic crises are not deterred by national borders. By streamlining international accounting standards, we're improving our changes of detecting and preventing financial problems before they reach global proportions.
Businesses, regulators and the markets must be able to compare apples with apples when it comes to financial report. Mr. Chairman, I look forward to hearing about the work that the International Accounting Standards Board and others are doing to harmonize global rules and the benefits for investors in the capital markets.
I encourage you in further efforts to set a new benchmark for the highest quality financial reporting, and I thank the Chair and yield back the balance of my time.
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Chairman BAKER. Thank you, Mr. Chairman, not only for your attendance here today, but for your significant interest in this whole subject matter. It's most appreciated, Mr. Chairman. Thank you.
Ranking Member Kanjorski.
Mr. KANJORSKI. Thank you, Mr. Chairman.
First of all, Mr. Chairman, I want to congratulate you for bringing about this hearing. I look forward to Mr. Volcker's testimony. I'm going to ask unanimous consent to introduce into the record my full statement.
Chairman BAKER. Without objection.
Mr. KANJORSKI. But, I just wanted to make one or two points. One, can the Federal Government assist financially in moving this process along faster? I think that perhaps staff and funding of expenses may be helpful. If there is something we can do, like using some of the excess funds at the SEC that can be guided toward this effort, I would like to know.
Second, I am interested to know whether or not we are developing any concept of a stick-and-carrot for those corporations and countries internationally that are hesitating or perhaps taking too long in adopting these standards. We have the IMF, the World Bank, and other institutions that, on the one hand, could be utilized to look more favorably upon those nations and those corporations that move faster in adjusting their standards, and on the other hand, have some penalty if they do not comport with the need for international standards.
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But, at a meeting I had last week, I learned that there may be 10 or 15 years before world standards are able to be implemented. I am not sure that is speedy enough. With those few questions in mind, I look forward to Mr. Volcker's statement and yield back my time.
Chairman BAKER. Thank you very much, Mr. Kanjorski.
Mr. Mascara, did you have a statement?
Mr. MASCARA. Mr. Chairman, I ask unanimous consent to have an opening statement prepared later and introduced.
Chairman BAKER. Without objection.
Mr. MASCARA. Thank you.
Chairman BAKER. Mr. Maloney.
Mr. MALONEY. No thank you.
Chairman BAKER. Ms. Hooley.
Ms. HOOLEY. Thank you, Mr. Chair, and Ranking Member Kanjorski for convening this hearing today and for the witnesses that have been asked to testify. I'm constantly telling the people back home that you can't turn back the hands of time, that globalization is here to stay. And it seems to me each passing day our economy is more intertwined with the global economy than ever before.
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And more and more investors from the United States are dipping their toes into the foreign markets, and more and more foreign markets and companies are listed here. I think if international markets are going to function properly, a single set of high quality international accounting standards must exist. As Mr. Kanjorski has stated, stocks aren't lottery tickets. And to make sure investors are protected, we need to create an independent system that is not only high in quality, but high in consistency. I'm looking forward to your testimony and I'm looking forward to seeing how quickly this can be done.
Thank you.
Chairman BAKER. Thank you, Ms. Hooley.
Mr. Volcker, it's apparent that we'll have a vote. It may be, however, I'm advised, slightly later than 10:30. It would be at least a 15-minute vote, which would mean Members would likely be here 5- or 10-minutes after it goes off.
Given that and to use time effectively, I'd like to proceed with your introduction and request that you proceed with your remarks.
Mr. Volcker was the Chairman of the Board of Governors of the Federal Reserve from August of 1979 to August of 1987. Initially appointed to the position by President Carter, he was reappointed in 1983 by President Reagan. He worked for the Federal Government for almost 30 years, serving under five Presidents, he retired as Chairman and Chief Executive Officer of Wolfensohn and Company in 1996.
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However, in a review of your resume, Mr. Volcker, I thought the most outstanding line of its entire content, all of which is distinguished in achievement, is the fact that you claim ''four brilliant grandchildren,'' which I quote.
We indeed welcome you back, sir, and have great regard for your insight and abilities. Welcome.
STATEMENT OF HON. PAUL VOLCKER, CHAIRMAN, INTERNATIONAL ACCOUNTING STANDARDS TRUSTEES
Mr. VOLCKER. Thank you very much, Mr. Chairman. And I might say that the oldest of those brilliant grandchildren just graduated from school here in Washington on Saturday. So we've got him through one hurdle, anyway.
I really appreciate being here. This is the first time I've been before the Committee in its new guise and enlarged guise. But it gives me an opportunity to congratulate you and the Congress, I think, on this reorganization that from my experience makes a great deal of sense. Back in the days when I had to testify before the Banking Committee and the Securities Committee on issues that obviously, overlapped.
Chairman BAKER. And could you pull the mike just a bit closer so we can hear you a little better? Just pull the whole mike to you.
Mr. VOLCKER. You have a copy of my statement, and I won't read it. It's a rather comprehensive statement on the origin of this work.
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We have also distributed, I will just bring to your attention, a brief description of the new International Accounting Standards Board and Committee, notably, particularly because it's got the names of the various trustees and Board members on it and where they come from and where their background is. So you may find that of some interest.
Let me just make a few points here in the time that we have before the vote. I really do appreciate your initiative in these hearings, as some of your associates have said. This is not, I realize, a subject that makes for big headlines, and it doesn't make the political blood run, but I do think it's a very important subject that we need to be better informed about and understand what both the advantages are, the potential is, and what the problems are. I am greatly encouraged by the interest that Members here have expressed.
The fact of the matter is that the need for international accounting standards is one reflection of what is really the inexorable, inevitable globalization of finance that Ms. Hooley just referred to. I think the internationalization of finance has great potential benefits, but there have been enough events recently to show that it's also filled with very considerable hazards and uncertainties.
And in a most general sense, it seems to me the venture that we have launched here to create some high quality and internationally accepted standards is a response to what's going on in the world. And I want to emphasize both parts of that, because we won't have done our job if they're not, a: of high quality; but, b: internationally accepted. So we have to combine those two criteria if we are indeed to maximize the benefits of international finance and minimize the hazards. It is just simply a building block for an efficient international financial system, and obviously of great significance to the United States in that respect.
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Now let me just make a very few points. The idea of an international accounting standards committee is not new. A Committee has been around for a long time, but the effort that I chair as trustee or Chairman of the trustees of the Committee really reflects a ground-up revision and restructuring of the old international committee, which it basically abolished. They adopted a new constitution. That's what we're talking about.
And this was really done as a result of an international effort by regulators, by professionals, and by affected businesspeople working together in something called a Strategy Working Party to develop a new framework.
And you will recognize that this administrative framework in many ways follows the FASB precedent, because it was important to maintain the professional objectivity and competence of this group, and that was the great emphasis certainly that the American participants and others had in this effort.
What we have is a committee of trustees that I chair. The trustees are responsible for general oversight. We're, not incidentally, responsible for raising the money to finance it. And we appoint the Board members. The Board is the body that makes the standards, not the trustees. That is all delegated to the independent Board which has been appointed, and it has now begun work. It is a group of high-level professionals drawn from around the world which is reflected on the sheet of paper you have.
We have been concerned as trustees, and Sir David Tweedie, who chairs the Board is equally concerned, that we get input from all the relevant and interested parties in the best way we can do it. There is a provision for an Advisory Council, which we are in the process of appointing. It is an interesting fact that to get all the various points of view reflected, that Advisory Council has grown to considerable size. It will have close to 50 members, and it is a broadly representative body that, I think, you will find will indeed be able to provide input from a wide variety of points of view.
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I am here today really somewhat to my surprise, not being a close follower of these things in the past. I am here because I was invited by the Chairman of the SEC, who chaired the effort to find a new committee and a new framework, to become the Chairman. I was surprised, because I think traditionally the United States has taken the attitude we have the best standards. That's good enough. The rest of the world can come and join us if they're interested in approaching the big American markets. And indeed, that approach has had some influence on the world.
But, I think, it is also true and it's come to be understood, I think, by the American regulators, by FASB itself, that this is a big world and the rest of the world isn't necessarily willing to agree that all wisdom lies in Norwalk, Connecticut with the FASB. We may have—and indeed, do have—the best developed standards—I think most people would agree internationally, the highest set of standards—but they still can reflect input from the rest of the world. We want a truly international standard and an improvement on the American standards, not a diminution. That's certainly our objective.
And second, I think there has been a clear recognition as I look at the picture in recent years, a recognition by the SEC and FASB itself that these are very contentious matters that in some cases have attracted political interest, and that indeed, advancing the platform to an international level may provide a more appropriate perspective than a purely national level.
So far as other attitudes are concerned, the European Commission, the European Union, has had a particular interest. They are in the process of passing European legislation that they say will demand by 2005 that European countries report according to international standards.
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Now they've also reserved the right, and will appoint a body to review the international standards, or particular standards to see whether they will be acceptable in Europe. Just how that works, I don't know. But in principle, they're looking forward to international standards just as other countries are. And, I think, there is broad support in industry around the world. We have been reasonably successful in raising money to support this industry effort, and I would say rather unusually, we have had contributions from international organizations, from central banks, from regulatory bodies around the world individually, not in huge amounts, but symbolically very important to show the official support for this effort right around the world.
The second point I would make, I've already touched upon. We are dealing with inherently controversial and difficult matters upon which there are contrasting views between industry groups, very strongly contrasting views in some cases, and there are different approaches and attitudes out of national traditions, a certain amount of suspicion among various national bodies whether this is an American takeover on the part of the United States, whether this is dilution of high standards. We have to deal with those suspicions and get everybody working together.
Now I won't go over all those controversies today. Let me just mention two of them to give you some sense of it. One, it's not really a matter of substance, but of approach. I think the American approach historically has been to state a standard and then write several hundred pages explaining how to apply the standard. Some of the other countries feel it's very important to get the standard right, but the particular application will evolve in more common law tradition, a case-by-case application, putting very heavy weight on the auditing profession itself to develop. And, obviously, there will have to be some oversight of that process. But how those two different approaches get reconciled will be an interesting thing to watch.
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The other point of substance, a real point of substance to which the accounting profession, I think, all around the world has to become sensitized to, is the increasing importance of intangibles in accounting statements and in balance sheet statements. And good-will just dominates in the new economy. But even companies in the old economy so-called, you look at their equity and you look at their balance sheet and most of their equity is reflected in something called good-will. How do you evaluate good-will? It is a very large problem that has arisen in recent FASB discussions which I don't think anybody feels satisfied is fully resolved.
Now I could go on and on with other issues, but I just want to give you a flavor of what we're grappling with.
The final point I would make is really a point that touches upon Mr. LaFalce's great emphasis. Standard setting is one thing. It's very important. It's a beginning point in developing a high quality set of accounts by individual companies. But at least as important is how those standards are enforced.
Setting them out and stating them is one thing, but individual companies are applying them, and they're applying them under the surveillance of auditors, and, I think, if we're going to have good accounting standards internationally, we have to recognize there is a very great burden on the auditing profession itself in developing its standards for enforcing the accounting standard itself.
Having said that, I think it is also clear that having a common set of standards around the world will greatly ease that job of the accounting profession itself and the auditing profession and companies in enforcing the standard. When they're not dealing with many standards, they're dealing with one. So I think the enforcement and the standard work together, but I just want to emphasize that our work is primarily on developing the standards. The enforcement will remain national. So it's an important point.
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Just a word about the outlook. I am conscious of my own age, so I'm not looking forward to a 25-year project here. Let me set out a target. I hope it's not totally unrealistic. But we've had some discussion with David Tweedie, who I might say, is a Scotsman, who will lead this effort. I think that's got some symbolic value, having a nice, dour Scotsman raised in the Calvinist tradition to lead this international effort.
But, we can foresee that, say within a period of 3 years or so, we get enough commonality between the international standard and let's say GAAP so that reconciliation will become a lot easier. And, reconciliation might become easy enough so that it's easier for foreign companies to do the reconciliation and get access to American markets or vice versa.
But, you've got to think at least in a 5-year time perspective to have a complete set of international accounting standards that we and other countries and the European community with their 2005 deadline will say, OK, this is the basis for using internationally in a fairly complete way.
That may be a very optimistic outlook, but I think that's the kind of framework in which we should be thinking.
With that much, I will cease and desist and welcome your questions.
Chairman BAKER. Thank you very much, sir. I very much appreciate your skill and determination being brought to this most difficult subject. I certainly recognize the difficulty of it even in the treatment of our own domestic reporting requirements and the rules that FASB has promulgated in recent years have brought about considerable discussions with derivatives treatment and other controversial matters.
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So I can only imagine what it must be like internationally where nationalism enters the picture and one assumes that all intellect does not reside in the United States. So I come at this with something less than a nationalistic view, I hope with an understanding that there are perhaps different ways of achieving the same goal.
Of recent interest to me was a publication called Value Reporting, written by Eccles & Hertz, which got into a discussion of the adequacy of the current reporting methodologies and what investors in the market really are looking for.
There was some discussion, for example, along the lines of Mr. LaFalce's comments, of—I hate to use the word ''manipulation''. ''Management'' perhaps is a better word, to perhaps beat the street expectations by a penny and what takes place immediately prior to that quarterly report.
The quarterly report, though, is really a historical perspective, not a forward-looking statement. Given the impact of Reg FD of recent vintage, it appears that those forward-looking statements may all too often result in litigation if the forecast is not extremely accurate.
But, the current standard as you, I think appropriately, note with regard to the calculation of good-will is only one element of the problem. For example, a customer satisfaction survey may well be a much better indicator of future sales than the last quarter with old technology which may now be brought about, in this fast-moving world, to be obsolete.
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The short life of a computer: by the time I buy one and get it home, the first service call is ''where did you get this old thing?'' So, the world is changing so fast it seems to me that if we're taking this on, it ought not to be just a rehash of GAAP, but it ought to be with recognition that the information informed investors need is more a roadmap of the future than a historic report of past conduct.
And I think that publication, I would recommend it to Members. It's only been out now 4 or 5 months. It's with the international foundation, several prominent CPAs, domestic are involved. And it's rather a comprehensive view of the market needs and what the market currently receives.
My most important question, Mr. Volcker, is how do you see the role of this Committee being most helpful to you in your organizational responsibilities in proceeding with this topic? Would you like to see this Committee engage in some regular interchange with you and other members of the Commission to have a platform in which points of concern could be reflected on? I know you have one rather large Advisory Committee already. I don't know that you need another one. But how can we be helpful?
Mr. VOLCKER. Well, I think you have already, from my point of view, performed a very considerable service by having this hearing. And in your comments, the interest that exists and the sympathy that I hear expressed about the idea of an international standard is a very important contribution you can make. There is a danger that this gets bogged down in particular nationalistic interests, even though I don't think the substantive issues fall easily into national differences.
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When you talk to industrialists, when you talk to bankers, when you talk to other people, the bankers tend to see things alike, the industrial preparers, chief financial officers tend to see things alike. Some of the users tend to see things alike internationally. And they may disagree among themselves, but it doesn't typically necessarily fall on national lines.
So I think we have to keep that understanding, and anything you can do to understand the importance of an international standard of high quality and effective enforcement is important.
Now it gets a little tricky, I think, because the Americans who participated in reorganizing this process were particularly those that wanted to be sure that these rules were made by professionals, and that they be insulated as far as possible from political pressures. And I think we want to preserve that kind of professional decisionmaking.
But, in my experience, I would say, even in my experience in the Federal Reserve, it's good for professionals to hear outside thinking once in a while as they go about their task. So I think having an occasional hearing and kind of assessing where we are and prodding us a bit would be helpful. But I don't think you want to get too much into the specifics of particular accounting issues.
Chairman BAKER. Thank you very much.
Mr. Kanjorski.
Mr. KANJORSKI. Thank you very much.
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Mr. Volcker, let me address this subcommittee to something in which you did participate in a very big way by establishing the predicate for the solution of the S&L process. As we look now at Japan, isn't part of their economic difficulty related to banking and the failure for adopting acceptable banking standards? Therefore, can we really evaluate the value of their banks?
Mr. VOLCKER. It was certainly true in the S&L crisis in the United States. But as you indicate, I had some occasion to be rather closely involved with that at one point.
And I think it is also true in Japan, where there are substantial changes now going on in Japanese accounting practices.
But, you see it on two sides and it again reflects the complementarity between the standard and its enforcement. But the Japanese banks have had large equity positions which were not brought to market and accounted for in a way that lent any precision to the process historically. Now that's changing.
Their standards in evaluating loans, I think it's fair to say, were not adequately disciplined, to be kind about it. Now that's a matter of enforcement. The official enforcement of some kind of standard counts as much as the standard itself, but I think it's a combination of both.
So, yes, I think there were lapses that have led to real problems of a profound nature in Japan, and a considerable nature even in the United States, where the S&Ls had their own accounting system, which was not very adequate.
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Mr. KANJORSKI. When we made those adjustments in the early 1980s, we used a concept in the United States, which I suspect was governmentally-imposed, called ''supervisory good-will.'' Will a world accounting system deny governments the ability to take those extraordinary positions and qualify good-will as an asset in a different way because of a particular domestic difficulty?
Mr. VOLCKER. Well, you're going to exhaust my technical knowledge of accounting pretty quickly. But I do know enough to know that international practice, in a combination maybe of government and private accounting practices, treated good-will very differently in the case of mergers and acquisitions.
And that raises a question apart from what is right or wrong in some sense, which is very difficult in this area. When it's different in different jurisdictions, particular companies find themselves at a relative advantage or disadvantage in making mergers or acquisitions. And American companies in particular have complained that accounting rules in other countries have made it possible for other companies, foreign-based companies, to make acquisitions that they could not make because of the accounting treatment and the effect that it therefore had on their published earnings and so forth.
So one of the benefits, the benefits very clearly seen by some of the companies I've talked to, is leveling the playing field with respect to the treatment of good-will in mergers and acquisitions.
Mr. KANJORSKI. Whenever we have a standard imposed, whether it be by government or in the private sector, there is a cost factor. Are you conducting an economic analysis of what the international cost factor would be to the various corporations and countries to impose this new international standard?
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Mr. VOLCKER. I think the fair answer to that is, I don't know of any clear study that's been made of that. We are operating on the assumption that the most important benefit is a very general benefit that is very hard to quantify: having more efficient international capital markets. Now, how do you measure that benefit?
Now the fact is there are also direct benefits that are measurable in terms of the expenses of a multinational company in conforming to accounting practices and laws in, you know, numerous jurisdictions. And, depending upon a particular company, what kind of business it's in, how long he's been in business, if you have to install that system, it's very expensive.
Some companies tell me, well, they've had them in operation for a long time, so it's a lesser expense now than it used to be, but it's an expense. It's just honest-to-goodness money in hiring accountants and bookkeepers and all that goes with keeping separate sets of accounts.
Mr. KANJORSKI. A cynic would say it is an accounting relief act?
Mr. VOLCKER. Pardon me?
Mr. KANJORSKI. A cynic would say it is an accounting relief act?
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Mr. VOLCKER. Yes. This is the opposite, I guess. The existing situation is full employment for accountants. We want to divert their energies to more productive uses.
Chairman BAKER. Thank you, Mr. Kanjorski. I read somewhere that to convert from the international standard for a sophisticated corporation to GAAP, the estimated cost of conversion today is about $10 million for a large corporation, which I find extraordinary.
Chairman Oxley, please proceed as you choose if you would like to take your time now, or we'll recess and come back at your judgment.
Mr. OXLEY. I'd be glad to take 5 minutes, Mr. Chairman. Thank you.
Chairman BAKER. Certainly. Go right ahead.
Mr. OXLEY. Mr. Volcker, you had indicated in your comments that in the past at the SEC and FASB it generally historically considered our GAAP standards to be superior to the rest of the world. And you indicated, I think, in your statement that that appears to be changing, that the internationalization of finance and the like is such, and I would heartily agree.
Is there still some feeling out abroad that perhaps we are still being too aggressive in trying to put our stamp of approval on some of these standards?
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Mr. VOLCKER. I think without question. Let me make clear, I think there is truth to the proposition that we have the best and most comprehensive standards. That doesn't mean that they can't be improved and that we cannot benefit from this international effort, which I believe is the case.
But there is a feeling historically that we were rather imperialistic about this, and the carryover of that is, I think, reflected in some of this feeling in the European Union, for instance, that they want to reserve judgment. While they want international standards, will put that in community law and regulation, they also want to reserve the right to look them over on an individual basis, because there is some feeling this should not be an American takeover. There's a certain amount of emotion in that.
The counterpart is, of course, the concern in the United States that it not be a weakening of high quality. So we've got to bridge that.
I might mention one of the encouraging things to me in getting involved in this was to see the interest that FASB people themselves expressed in a most direct way of wanting to participate in the international effort—be on the International Board, to be on the advisory committees.
And we've had people who have been either current Board members or past Board members of FASB on our International Board, because they wanted to be there. Now, let me also make sure there are Europeans on the Advisory Board in some size. There are Europeans, of course, and Japanese and Australians and Canadians and so forth on the Board. So, we're going to get a variety of points of view. But we have to overcome those residual suspicions.
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Mr. OXLEY. Could you explain to me how this would work, given the European Union structure? That is, once the international accounting standards were to be adopted, would that be done by the European Commission?
Mr. VOLCKER. Yes. As I understand it, this is a matter of the European Commission in this area. It's in their jurisdiction, and they are exerting that jurisdiction.
Mr. OXLEY. So, it would not be—the individual member states then would not necessarily——
Mr. VOLCKER. Well, I said the European Commission. I think this is something that would actually be approved by the European Parliament, too. I'm not sure about that. But it is a European matter, not a national matter. They will assert European jurisdiction, as I understand it.
Mr. OXLEY. And would it be your guess that that would be the first breakthrough? That is in Europe as opposed to perhaps Asia? Or do you see this entire thing coming together simultaneously?
Mr. VOLCKER. I think it all has to come together simultaneously. Given my impression, because I'm not a deep expert in this, Japan accounting in the past—as we mentioned—has been further removed from what we consider acceptable standards. But they are in the process of moving pretty fast by their standards. But still, there are going to be big problems there in bringing them up to the international standard and international enforcement.
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Mr. OXLEY. Well, is it safe to say that historically and culturally, our standards would tend to be closer to the European Union member states as opposed to Japan, for example, or some of the other Asian countries?
Mr. VOLCKER. Oh, I think that's true, yes. I used to see this just as a personal experience. I used to be a director of Nestle, a big international company headquartered in Europe. And, I hope it's true that they had reasonable accounting standards and approached it honestly and straightforwardly.
But the management of that company felt very strongly that they shouldn't be subject to U.S. GAAP. They were a European company, and while they have a big operation in the United States, they didn't agree with some of the GAAP approaches, and I think there was a certain national feeling about it. Why should they have to conform in every respect to GAAP when they were perfectly capable of following what they thought is a reasonable Swiss standard and a more general European standard?
Now, through the years, they were following the old international standard, and they have come closer together before this effort started. But there's still a lot to get over.
Mr. OXLEY. Thank you.
Thank you, Mr. Chairman.
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Chairman BAKER. Thank you, Chairman Oxley. It would be my intention, Mr. Volcker, Mr. Shays has fortunately been able to make it over for a vote and can take the chair on our departure. Mr. LaFalce will be recognized for his question or comment, and then we would excuse ourselves for the vote. But there should be Members coming back just momentarily. We won't have to recess the hearing.
Mr. LaFalce.
Mr. LAFALCE. Chairman Volcker, I think I've got about 4- or 5-minutes to go over for a vote, so I'll be very, very brief. A couple of bumper sticker slogans. The second bumper sticker is Harmonize Up Rather Than Harmonize Down. And the first bumper sticker slogan is Enforce First. And I was so pleased that your comments supported the concept that, you know, standards are super important.
We've got some pretty good standards in the United States. Let's enforce those standards. And I'm most concerned that we are not adequately enforcing those standards, and I am also concerned that we do not have the regulatory resources to bring about the type of enforcement that the investor deserves.
Mr. VOLCKER. Well, I absolutely agree with that, and in relation to Mr. Baker's question earlier. And for the United States, that's within your jurisdiction.
Mr. LAFALCE. That's why I said the ball is in our court.
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Mr. VOLCKER. You've got the SEC that enforces, and the SEC reports to you. So we can set the standards, but then the ball goes in your court.
Mr. LAFALCE. As I've said, the ball is in our court. And the first thing we're doing is saying let's reduce the fees.
Mr. VOLCKER. Right.
Mr. LAFALCE. The third thing is, one thing we can do, too, is make sure that before any company is listed on any U.S. exchange, they can do whatever they want overseas, but before they're listed on a U.S. exchange, let's adopt and apply and insist upon U.S. standards.
Mr. VOLCKER. Excuse me. I didn't hear the first part of that.
Mr. LAFALCE. I apologize. I just said that before any company is listed on the U.S. exchange, we ensure that they adopt——
Mr. VOLCKER. U.S. standards.
Mr. LAFALCE. Enforce the application of U.S. standards. And now I've got to go vote.
Mr. VOLCKER. Well, that's, of course, the current posture. But I would hope when we get an international standard, the international standard will be good enough.
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Mr. SHAYS. [Presiding]. Thank you. Mr. Volcker, other Members are going to be coming back, so we're not going to go to the next panel. So I have some questions and maybe other Members will come back and we can kind of filibuster together if you want to.
Would you just tell me, the IAST founded in 1973, has it had much clout over the years, or has it been pretty much an advisory group?
Mr. VOLCKER. Well, I think it has had some. Now, again, you'll have to direct that question to somebody who has more historical exposure than I have. But as I have observed it a little bit, for instance, as the director of Nestle, it has had some influence.
But there's a general feeling that it was a large body, it was a part-time body. There was from our perspective anyway too much of a tendency to seek compromise for compromise sake, that the issues were not posed as sharply as they might have been, and it simply didn't have the standing or the intellectual integrity the GAAP, for instance, had.
So, yes, I think it made some progress.
Mr. SHAYS. So, now it's a smaller body, and now it's full time?
Mr. VOLCKER. Well, it's predominantly full time. Two members are part-time. The people who set this out, the authority now lies with trustees. In the constitution that we inherited, established the general framework and they decided to include two part-time, two half-time members in effect, because you might want to get somebody with particular expertise or an academic who could participate on a part-time basis, but not a full-time basis. But essentially, it's meant to be a full-time, active professional body.
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Mr. SHAYS. It still needs to exert more authority over time. It still needs to become a greater force internationally.
Mr. VOLCKER. No question.
Mr. SHAYS. What would be the thorniest issues that you need to address?
Mr. VOLCKER. What?
Mr. SHAYS. The thorniest issues? What are the most difficult issues that you need to address?
Mr. VOLCKER. Well, I mentioned this one of intangibles, good-will, which goes over a lot of different companies, different issues, mergers and acquisitions and so forth. The issue of derivatives has been one to tear people's hair out for a long time, and I'm told that FASB has 600 pages of explanation which nobody fully understands. It's an inherently complex area, which has, you know, grown like Topsy in recent years. And, I am told, nobody is particularly happy with the present standards and their application.
An issue, which indeed from my earlier life I was very much aware of, is the general move toward mark-to-market accounting, which I find is rather euphemistically described as ''fair market accounting.'' I guess it has a lot of logic to it, but a lot of people question whether it is applicable to all situations in all circumstances. And people feel very strongly on both sides of that issue. And it's an issue that's particularly important to the commercial banking world, to the insurance world, and some other worlds.
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And stock options are another. I might say that the Congress has been rather familiar with a very specific issue, how do you account for stock options and other forms of remuneration of that sort?
Mr. SHAYS. So, some of the same things we're having to address here we're having to address internationally as well?
Mr. VOLCKER. Yes. All these issues have been addressed here, but some of them have been kind of left in limbo. There was a retreat on stock options from what FASB initially was thinking about, as you know. There's been a shift of thinking, as I understand it, on FASB on the good-will, intangibles question. They now have changed their position, but not defined just what to do.
It's a very, by the very nature of it, intangible, a little hard to evaluate.
Mr. SHAYS. The primary message that I heard from you was that politics has to stay out of the——
Mr. VOLCKER. That is the whole intent of this structure. Politics stay out of it so far as setting the standard is concerned.
Mr. SHAYS. What I don't fully understand is we're talking about an extraordinary number of different countries that have to buy in. And, so, some countries are going to buy in, some countries aren't. But you're not going to see a compromise to get a country to participate?
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Mr. VOLCKER. No. The aim of this structure was to delegate the decisionmaking to a body that was some insulation from politics and that definitely could bring different points of view to bear so far as experience is concerned. It was set out rather carefully that some of these members should have auditing experience, some should have preparer's experience. They should have experience within companies. Some of them should be analysts and users of accounting information. Some should be academic.
The purpose is to make sure a variety of different professional points of view are brought to bear. But they should not be picked on the basis of nationality. Now, in fact, we have a spreading of nationalities. There are a number of Americans, a number of Europeans. There is, I guess, one Japanese, one or two from emerging countries, a Canadian and an Australian. So the countries that have been most active in this area are certainly fully represented. A relatively small number of countries have active accounting standard boards of our type.
Mr. SHAYS. Now, the International Accounting Standards Board is basically, what they determine, in my understanding, is basically going to be enforced by the national regulators in each country?
Mr. VOLCKER. Yes. Well, first of all, they presume they will be enforced by auditors themselves.
Mr. SHAYS. OK. I just said it in reverse. I was going to say national regulators and the audit firms. You want me to say audit firms and national regulators.
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Mr. VOLCKER. Right.
Mr. SHAYS. OK. Do you see this working effectively?
Mr. VOLCKER. There is an effort going on as I understand in the auditing profession itself to exchange views and develop approaches and processes to add to the confidence in the auditing process itself, which, I think, is fair to say has been damaged by the kind of thing that Congressman LaFalce was talking about. The auditing firms themselves have something to worry about in terms of the integrity of their processes, and I think they're at work on them.
Mr. SHAYS. I'm new to the Committee, frankly, and I don't have a comprehension of whether audit firms around the world are similar in their approach.
Mr. VOLCKER. Well, there are five auditing firms around the world that account for a big portion of the business all over the world.
Mr. SHAYS. OK. So the auditing firms here are the major players.
Mr. VOLCKER. Well, the auditing firms here, you think of the big five American auditing firms, they're all international and pretty much all over the world in different organizational structures. Some of them are more uniform than others. Some of them are, I guess, a collection of existing firms that retain some degree of independence. Others are more centrally operated.
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Mr. SHAYS. In that case, though, given that they're international in nature, if the national regulatory body of a country seems not to be as eager to comply, does the market in a sense force them to, because the auditing firms, the international firms are simply going to have a consistent standard around the world?
Mr. VOLCKER. That's the aim.
Mr. SHAYS. So the question, though, I'm saying is, so even if the national regulatory body isn't as aggressive as it should be, the hope is that the auditing firms will still set the standard?
Mr. VOLCKER. That is my understanding with the exception that if a particular country said companies domiciled in our borders has to follow a different standard, obviously, they have to follow the law. But as I said, in Europe, a big important area, they say they will adopt international standards. I think the presumption is Japan will do that. The hope is eventually the United States will do that. And it could be done either by adopting GAAP or adopting the international standard, that's good enough. That may be hypothetical out in the future, but you could say the international standard correctly audited is good enough for entry into our market.
Mr. SHAYS. Are we dealing with the European Union as a body, or do we have to deal with each specific country?
Mr. VOLCKER. I think in this area we're getting them as a body.
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Mr. SHAYS. So they have, for the most part, have uniformity within the Union?
Mr. VOLCKER. They don't now, I don't think, but they are aiming for it. That's what they're saying.
Mr. SHAYS. And is it more difficult to get compliance among the more economically powerful countries as opposed to those that are trying to become players?
Mr. VOLCKER. Well, I would guess. You could talk to people who have had practical experience, but I would assume that those nations that have more effective governments generally, tradition of rule of law and due process and transparency and so forth, are going to have more effective enforcement than countries that don't have any of those, that basic infrastructure.
Mr. SHAYS. We have our Members here, so we'll continue. The gentleman from Texas can have the floor if he would like. Thank you very much, Mr. Volcker, for responding to my questions.
Mr. VOLCKER. Thank you.
Mr. SHAYS. The gentleman from Texas has the floor.
Mr. BENTSEN. Thank you, Mr. Chairman.
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Mr. Volcker, always good to see you.
Mr. VOLCKER. Thank you.
Mr. BENTSEN. With respect to the international standards, how much do you think—you talked about in your testimony that standards are one thing, enforcement is another thing, which is sort of stating the obvious, but——
Mr. VOLCKER. We had quite a bit of discussion about that this morning.
Mr. BENTSEN. Right. How much do you believe that as the markets become more interdependent, how much do you believe that the more sophisticated capital markets and institutional investors will drive to the highest standard? Do you think that's a simplistic view of things? Or do you think that institutional investors will be more inclined to seek safety in high standards?
Mr. VOLCKER. Well, I wish the answer was as unambiguous as it could be. Obviously, the investor ought to go to the higher standard and be very interested in the higher standard.
The reason I waffle a little bit in my answer—I don't want to make too much of this—but, one of my mild disappointments in this effort has been to somehow see what I perceive, maybe wrongly, as less strong interest among the analysis community, among the investment community than in the preparer community or the auditing community. And I puzzle over why that is the case. And maybe I'm misreading it. But that seems to be curious.
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Mr. BENTSEN. So you're not optimistic, I guess, that it would move in that direction? I ask that because we have had recently a situation where there's been an attempt—and this is a little bit like apples to oranges—but this whole concept of tax harmonization through the OECD, and the Administration, in particular Secretary O'Neill, have come out opposed to this. And it's a fairly controversial issue.
Mr. VOLCKER. Right.
Mr. BENTSEN. Some view it as an approach toward purer tax harmonization. Others see it as an approach for more income reporting harmonization. It seems to me that ultimately—and I don't think this is a bad idea—but ultimately, we're moving toward some form of accounting harmonization. If the European Union moves forward with it, then I think the U.S. may find itself having to follow suit.
And, I mean, I gather from your statement you don't view this as a bad thing. That ultimately we should have this harmonization.
Mr. VOLCKER. No. I think that if we can make progress in international standards that a failure to follow international standards will be noted. Let's assume we make progress toward high quality international standards and it's accepted that these are good standards, that they're internationally applicable. The momentum among investors will be to insist that people use them more commonly than is now the case when there's a lot of confusion over what the best standard is. The Europeans will argue that their standard is better than the American standard. The Americans argue our standard is better.
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So, you know, it's a little harder to insist upon the correct standard when you don't have agreement on what the correct standard is or the best standard or uniform standard. Whether it's the best or not, it's uniform. I think you will get more discipline. I would think you would get more discipline in the investment community, because it will stand out more if you're not following the international standard.
Mr. BENTSEN. From a practical matter, if I understand correctly now, a foreign-based corporation that sells shares in United States markets can use their home-based accounting standards, but there are certain GAAP standards that they have to comply with supplemental to whatever their audit is.
Do you believe that even if we go toward—if we don't get to a full harmonized standard, but the international standards are set forth and there's a variation between that and GAAP, do you think that we can continue with sort of a bifurcated capital market system between the United States and the European markets, or do you think the capital markets themselves will force this?
Mr. VOLCKER. Well, I think you can continue with a bifurcated, but in a different situation than exists at present. You could exist, not as good as with a clear international standard, but you could exist if it's easier to reconcile. I don't think it's easy to reconcile now, from what I'm told. So it's theoretically possible, but in practice, difficult.
If there was enough consensus, but there were two or three points upon which there was a difference that were pretty clear cut and fairly simple, you could present accounts that reconciled the two, you would have made a very big step forward.
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Mr. BENTSEN. Thank you. Thank you, Mr. Chairman.
Mr. SHAYS. Thank you, Mr. Bentsen. Mr. Cox, did you have a question?
Mr. COX. Well, I apologize for having been down at the signing ceremony on the floor, and so I have just now confronted your written testimony and I'm not really prepared to address to you any complicated questions. But I want to——
Mr. VOLCKER. I'm not prepared to answer too complicated a question. So we're in the——
[Laughter.]
Mr. COX. But I want to wish you Godspeed in your role as Chairman and just emphasize what I know you take to be the importance of what you're doing. Because rather rapidly, more rapidly than most of us have been able to absorb, the world has changed around us, and the things that we were all accustomed to and the ways of doing business that we were accustomed to simply won't serve for the future, and we've got to do precisely what it is that you are focused upon. So I want to thank you for it. And beyond that, if I feel compelled, I'll have to send you a written question at some point.
Mr. VOLCKER. You know, I really appreciate your interest and the other Members of the Committee, because I think it is important. And I think the end result will be something, I'm inclined to say different than GAAP. I don't know how different it's going to be, but something that has international support instead of pure American support, and I think that's important in the world that you're talking about.
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Mr. COX. If I may, Mr. Chairman. Apart from standard-setting, which is a difficult intellectual task, there is the matter of examination and enforcement, because it's easy enough for people to say or to claim that they are adhering to an international standard or to a uniform standard. But our system in the United States is superior not just because innately our standards are the right ones, but perhaps even more so because there is what we'd like to call transparency and there is a rule of law. There are consequences for failing to do what you said you did.
Mr. VOLCKER. Absolutely.
Mr. COX. What, if anything, in your role as Chairman can you do about that aspect, perhaps the larger aspect of the problem?
Mr. VOLCKER. Our mandate is confined to the standards. But, I think in reality, the uniform international standard will create pressures for better enforcement. And, I think, there's bound to be some interaction between the standard-setter and the enforcers in practice, at least I hope that will be the case.
But, we don't have any authority for enforcement. That's up to the auditors themselves in the first instance and then the national bodies to back that up or direct it. You're absolutely right in, I think, emphasizing the importance of enforcement.
Mr. COX. Thank you. Thank you, Mr. Chairman.
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Chairman BAKER. Thank you, Mr. Cox.
Mr. Israel, did you have a question?
Mr. ISRAEL. Mr. Chairman, I was at a Science Committee markup and then on the floor, so at the risk of asking a question already asked, I will hold off except to thank the Chairman for leading this Subcommittee into the important issue of accounting.
Chairman BAKER. Thank you very much, Mr. Israel.
Mr. Volcker, I think you have responded to all the questions of the Committee this morning. We certainly appreciate your continued leadership in this matter, and as you feel we may be of further assistance in your task, we want to offer the Committee's services in any way you deem appropriate.
Mr. VOLCKER. I might say that we are intending to have a meeting of the trustees and the Board in Washington. I don't remember the exact dates, but you will certainly get invitations to some meetings so we can explore these issues further to the extent that you care.
Chairman BAKER. I certainly think that it would be a welcome opportunity, and I think one appearance would probably cure the Committee's interest in hearing from us again. Thank you very much, Mr. Volcker.
[Laughter.]
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Chairman BAKER. At this time I'd like to invite our two participants on our next panel to come forward. Thank you.
I'm pleased this morning to have two distinguished participants in our hearing that will bring, I think, important perspectives to the necessity for an international standard. The first is Mr. Phil Ameen, Vice President and Comptroller of General Electric Company and Chairman of the Committee on Corporate Reporting of Financial Executives International, known as FEI.
We also have with us this morning Mr. Robert Elliott, who is the Immediate Past Chairman of the Board of Directors of the American Institute of Certified Public Accountants, a partner today in KPMG LLP in New York.
Gentlemen, I welcome both of you here this morning and we will make both your statements part of our official record. And welcome you here, Mr. Ameen, to begin the remarks, sir.
STATEMENT OF PHILIP AMEEN, VICE PRESIDENT AND COMPTROLLER, GENERAL ELECTRIC COMPANY; CHAIRMAN, COMMITTEE ON CORPORATE REPORTING OF FINANCIAL EXECUTIVES INTERNATIONAL, REPRESENTING THE FINANCIAL EXECUTIVES INSTITUTE
Mr. AMEEN. Thank you, Mr. Chairman. On behalf of FEI it is indeed an honor and a privilege to be here today. My official comments have been submitted to you in writing earlier, and I shall confine my remarks this morning to a brief summary of what I've already submitted, with your permission.
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Three broad summary points. First of all, we believe that international accounting standards are inevitable and a good thing.
Second, I'd like to spend a moment thinking about the extreme difficulty which has already been hinted at this morning of developing accounting standards at all.
And, finally, spend a moment thinking about the status of the United States and particularly U.S. reporting companies, in a world of international standards.
First of all, the inevitability. Within the international world in which we deal, currency flows, capital flows are rapid and have no respect for borders. Thus, we already live in what is very much a global environment, both in the investment world and in the mergers and acquisitions world more pointedly.
Earlier this week, I was with one of our Italian affiliates. We were talking about some U.S. application of revenue recognition principles, and it was necessary for me to describe pretty quickly which of the seven ledgers that they are required to maintain I was interested in, that being, of course, the one necessary for reporting in the United States.
The change necessary for international companies to adopt international standards when they're issued will be dramatic, but it is also an ordinary course of events for them.
We believe at FEI that the faster we move to a high standard set of global accounting standards, the better the world is going to be, and that we should not think of this strictly from the standpoint of international companies being required to adhere to these standards, but we should think as quickly as possible about moving all reporting companies, including U.S. registrants, to these standards so that everyone trading in the U.S. markets will be talking the same language.
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Second, on the issue of the difficulty of setting accounting standards, I respect your ability to talk about this issue with Chairman Volcker without getting into specifics. Accounting standards are very much like theology. Those who have a view, and it's just about everyone involved in them, believe that their view is right to the exclusion of just about every other view.
This creates an enormous amount of strain during the debates surrounding accounting standards. Oftentimes, you will see reports from preparers and reviews by analysts that dismiss an entry or an accounting result as just the accounting. My view is that we have to view that as a failure of the standards, that the responsibility of standards is to communicate the financial results, the financial position, in a clear, unambiguous fashion, and not introduce bias.
Oftentimes, the accounting standards themselves can be viewed as more or less just a deadweight tax levied on the system, and the proceeds that that tax extracts are simply a drain on the system.
Accounting standards are often set by the theologians who have a view that their answer is the one that will solve the problems in the accounting standards world. Many examples of that. Mark-to-market, or as Chairman Volcker said, fair value accounting, stock option accounting, the recent instability in consolidation of affiliates. All of these rules have changed dramatically. And our view would be that the faster we reach stability in the accounting standards, the better off we are from a reporting and from a usability of financial statements standpoint.
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Finally, I think it's necessary for us to think about the diminished status of U.S. companies as international accounting standards come into being. We simply have fewer votes at the table in what has been the most complex application of standards. If standards work in the U.S., they'll work just about anywhere is a fair view from the U.S. standpoint. But, I think, we have to understand and respect that that isn't necessarily going to carry the day internationally and will not necessarily influence these standards.
Finally, just a word about what we view as the reliability of U.S. financial reporting. FEI recently published a study of restatements from 1977 through the year 2000, and it's interesting, I think, that the level of restatements indicating the reliability of financial statements is under half a percent, and on a market cap weighted basis, under a tenth of a percent of registrants during the period. We don't know what we don't know. We don't know those misstatements that haven't yet been discovered. But all in, I think we would all conclude that we have a very reliable and excellent set of reporting, enforcement and auditing in the United States.
Thank you.
Chairman BAKER. Thank you very much, Mr. Ameen.
Mr. Elliott, welcome, sir.
STATEMENT OF ROBERT ELLIOTT, PARTNER, KPMG PEAT MARWICK LLP; REPRESENTING THE AMERICAN INSTITUTE OF CERTIFIED PUBLIC ACCOUNTANTS
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Mr. ELLIOTT. Thank you, Mr. Chairman and Members of the Subcommittee for giving us the opportunity this morning to talk about such an important issue as international accounting standards and their effect on global capital flows.
I also have submitted my statement for the record, and I will not repeat that. But, I want to emphasize a few high points.
First, I want to start by saying that accounting is a language. It's a language devised in order to describe business enterprises. And accounting standards, in effect, represent the vocabulary and the grammar of that language. Historically, each country has developed its own language. And these languages differ one from the other, and it's for good and proper reasons in the past. It depends on what the objectives have been.
In some countries, the objective has been to facilitate central control of the economy. In some countries, it's been to facilitate the banking system financing companies. In some countries, it has been to facilitate tax collection. In a few countries, mainly the United States, the United Kingdom and other advanced capital markets, it has been developed in order to serve investors in public companies.
So, naturally, the language would have developed differently along all of these lines. Now, we have these global markets that everyone in attendance here is well aware of, and the International Accounting Standards Committee has been in place for quite a while to attempt to develop a common language that could serve investors across this whole waterfront.
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And, I would say, that over the period that they've been in existence, they have done a fine job of developing accounting standards. And international accounting standards are better than the local accounting standards in most countries. And if companies in those countries would use international standards, investors would be better served.
But, international accounting standards are not better than the accounting standards in every country; in particular, the United States, the United Kingdom and Canada arguably have more rigorous standards. And, therefore, to adopt at this time international accounting standards would actually result in a reduction of the quality of information available to United States investors.
In time, as Chairman Volcker put it, we hope that international accounting standards will rise to be the best in the world. But in the meantime, it's important for U.S. investors to have the benefit of the best standards in the world.
But there's a more important issue, and that is that accounting, like any language, can be either primitive and rudimentary like the language that the Neanderthals would have used, or it can be a rich, sophisticated, descriptive language like modern English.
Today's accounting language in virtually all countries was developed in order to describe industrial era enterprises, companies like the B&O Railroad, like the Packard Motor Car Company, like the National Cash Register Company, and like Montgomery Ward. These accounting principles were not developed to describe modern post-industrial companies, and they therefore do not well describe them, companies like Amazon and Cisco and Intel and Microsoft.
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So it's very difficult to describe these companies given our accounting standards, just as it would be very difficult for a Neanderthal with his limited vocabulary to describe a steam engine let alone a computer.
So it's not just uniformity of accounting that's important, desirable as that is. We also have to be concerned about modernizing accounting so that it is more descriptive of the types of post-industrial enterprises that are leading the way into the development of our economy for the 21st century.
There is an element here of suppression of innovation at work. The regulators generally are very concerned with preventing and suppressing fraud, which is certainly something much to be desired. But it does leave the regulatory agencies, generally speaking, in a position of suppressing innovation and change in the way in which these things are done.
And one role that the SEC could do is to encourage innovation and let the private marketplace develop a richer language, a richer vocabulary to describe these post-industrial enterprises.
So basically, my points are that while uniformity around the world would be a good thing, it would not be a good thing if it were at the expense of having American investors deprived of the best possible information about the investments that they're making, and it would not be necessarily a good thing if it were at the expense of modernizing the accounting language to better describe modern companies, and that our regulators, including the SEC, have a role to play in encouraging the modernization of accounting.
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Mr. Chairman, that completes my informal remarks. And thank you very much.
Chairman BAKER. Thank you, gentlemen, both for your appearance here, and your formal statements both were very instructive and very helpful.
In coming at this, describing the accounting reporting language in whatever style we wish—richer, boring—it would seem that we have to be careful even within the English language whether it's English brogue or Southern drawl or rap music in Los Angeles, that there tends to be an inability to communicate even on that platform.
More important than that, perhaps, is the intended use of the reporting data. And I have concerns, perhaps not well founded, that much of the reporting today is based on standards developed over the past 50 years that tend to be more brick-and-mortar traditionalist views of the market participation and activity.
It would seem, for example, in the case of a concept stock, where there are few assets at all other than perhaps a patent, a new drug being developed, how does one look at that in the old style of evaluation and come up with anything that's relative to the real dollar value or any economic potential since it is for the purpose of the investor that this information is generated?
I would presume that management within a corporation will use this data, but management generally feels they have more insight into the activities and direction of the corporation than the mere financials and metrics can indicate.
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So if it is for the purpose of the investor to understand the real risk and potential return or potential loss associated with the investment, if that's the goal, should we while we have this opportunity to reconfigure without a nationalistic bias, I would add, isn't it time, given the changing nature of the dynamic of the economic system, more appropriate to have forward-looking analysis as to corporate strategies? Where do you intend to invest?
Even social and environmental sensitivities. If you're going to build a nuclear power plant and sell shares in that activity and you're going to do it in a region which has some political sensitivity to that, those disclosures might well change the investor's view, even though management appears competent, the plan seems sound, and they have a track record of doing it well in another country.
Finally, my last observation is, I think, I understand the cost for the international firm to go from IAS back to GAAP, to come to the United States to get on the big board. What is the cost, if there is such a thing as an average, for a domestic corporation to go abroad and participate in European markets in light of the IAS standard? The figure I had gotten for a large corporate transfer from IAS to GAAP was $10 million. Is it that expensive for us to do likewise? And, if that's the case, doesn't that add some sense of urgency to simplification and unification? And, I'm going to quit, because that's just sort of a statement more than anything else. Either gentleman.
Mr. AMEEN. If I could address the last point first. For the most part when my company, General Electric, trades in European exchanges, we do so based on U.S. financial statements without translation to local financial statements. There are very few exceptions to that.
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Until recently, in order to trade on the Tokyo exchange, one had to translate one's financial statements into Japanese accounting principles and into Japanese in fact. But for the most part, U.S. standards are accepted as the trading vocabulary for European markets.
Mr. ELLIOTT. Mr. Chairman, I agree with your comments about the forward-looking information. Sometimes people think that it's going to be very difficult to take these soft assets of the types you were describing—a patent or knowhow or the capacity to innovate—and put it into dollars and cents and put it into the financial statements.
But that's not the only way to address the problem. There could be supplemental disclosure about these matters that would be very informative to investors without necessarily clouding the financial statements with such soft types of numbers.
Several years ago, the AICPA had a committee known as the Jenkins Committee. Mr. Jenkins is now the Chairman of the FASB. They suggested a more forward-looking business reporting model for American companies, and that's under consideration by the FASB now, and I'm sure it will be by the new IASB.
But it talked about more in the way of leading indicators, risks and opportunities for the company, and the types of things that you were talking about. Those would be substantial improvements in corporate reporting that would help investors.
But there is a counter to this, and that is that the more that companies reveal to investors, the more they accidentally reveal to their competitors, and there's a balance point. On one hand, the more they reveal, the lower their cost of capital, because the information risk to investors is lower. But, on the other hand, there are competitive costs. And companies must seek a balance in that, and that is really a fundamental part of the job of any accounting standard-setter—to make those balances in such a way that we have the maximum economic benefit.
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Chairman BAKER. But one might also well argue that the more you disclose, the lower your cost of capital, the less you disclose, the higher the cost. And the tradeoff is competitive pressures verse the cost of capital to expand your business enterprises. Is that a fair statement?
Mr. ELLIOTT. That is precisely correct.
Chairman BAKER. Well, I think in the long haul, given the nature of the economy being an information-based economy and that change in values occurs so dramatically and quickly, I can only imagine if one had a disclosure of Bill Gates's original travel meter, which was his first product that he actually sold, and you were an investor in the travel meter corporation, what his valuations might have looked like as opposed to Microsoft.
Mr. AMEEN. Mr. Chairman, I'd just like to add an observation to what's already been said. I think it's important from a financial reporting standpoint to permit financial statements to do what they do well. What has happened, in my view, in the last—perhaps 20 years, as we've moved into a technology age, is that the pipeline of data is vastly greater than what's contained in financial statements.
The amount of data that comes from my company through the investor relations community, through the press relations community so far exceeds what's in financial statements that that becomes the principal trading information. What one would say about a company with no sales and a billion dollar market cap within the financial statements quite escapes me. However, there is a story to be told and there are unofficial, unaudited, non-financial statement means of communicating that story that seem to work reasonably well, and we should respect that communication mechanism.
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Chairman BAKER. I am continually amazed that when a brick-and-mortar corporation fails to meet a seven cents earning expectation and only makes six, gets treated more harshly than a dot.com who only loses a nickel instead of ten. You can't explain that rationale to me, I don't think. Mr. Kanjorski?
Mr. KANJORSKI. The receptiveness of international standards, how culturally driven is that? It is my understanding that there are many foreign companies that really do not like to have transparency or disclosure, because they consider their business their own business, and they may find it difficult to adopt. Is this a cultural problem or a national problem? Or is the world global market just overcoming this with abandonment?
Mr. ELLIOTT. As I had indicated, Congressman Kanjorski, a lot depends on the history in a country and why things are the way they are today. So, for example, many countries, including those in Europe, do not have a tradition of allocating capital through open capital markets, but rather through the banking system and other ways.
The systems of accountability there are developed for other purposes rather than informing investors. They might be to make the most conservative type of statements to shareholders and the banks, rather than to be transparent and so forth. And it's difficult to overcome those because those are deeply seated historical situations.
But as these companies get to the point where they need public money and they need to come to the capital markets for money, then they must step up to world class standards of transparency and accountability. So, absolutely, there is a cultural issue. And to a large extent, it comes at a national level because of the national history of each of the accounting systems.
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Mr. KANJORSKI. Is this going to be a process where the large corporations and the international corporations first adopt these principles, and then the intermediate-sized companies, and then ultimately in the long term, the small businesses will adopt the standard? Is that what is going to occur, because the drive is to get into the public markets?
Mr. ELLIOTT. That is a very likely scenario, yes. I mean, to some degree, that's already happened, as one looks at the large German companies that have come into the U.S. markets by adopting U.S. standards and vastly increasing their transparency. The effect on what's disclosed by Daimler Benz when they became a U.S. registrant, the difference in their reported earnings, German principles versus U.S. principles, and the amount of transparency in that registration was quite enlightening to those who were providing capital for that company. And, I think, that's a trend that's got to continue.
Mr. KANJORSKI. In my opening statement I asked Mr. Volcker to give me some stick-and-carrot type considerations that the United States Government or the American economy could lend to this effort. Do you see any need for the United States Government to act in order to help facilitate this transition, or are we doing just what we should do in staying out of it? Or, is there a need for something that we can provide to encourage the transition?
Mr. AMEEN. In an oversight capacity with responsibility for the U.S. capital markets, I think oversight is the right approach at this point. I think that Chairman Volcker is right. The standard setters need to be left to operate independent of political pressures lest we bring political pressures from the rest of the world to bear, and that would not be the right standard-setting environment, in my view.
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Mr. ELLIOTT. We should also point out that Chairman Levitt of the SEC was instrumental in the design of this system, so it's not that the United States has had little or no influence on how it has been designed.
Mr. KANJORSKI. Very good. Mr. Chairman, I yield back the remainder of my time.
Chairman BAKER. Thank you, Mr. Kanjorski.
Mr. Cox.
Mr. COX. Thank you very much, Mr. Chairman.
Mr. Ameen, I want to ask you about one part of your written testimony that is especially frightening, I think, if you consider the implications of it. You have said that—I think you've said very politely that the due process of international standard-setting is more nuanced than its U.S. counterpart, by which I infer you mean that we don't know exactly how it's going to work.
There is, you go on, a very real risk that the economic interests of the United States, and that's something about which, if nothing else, the Congress must concern itself, will get lost in the avalanche of feedback that the new International Accounting Standards Board will face. So, in addition to not knowing precisely how the due process is going to work, one of the issues that the International Accounting Standards Board is going to face is just an enormous volume of information, and how they're going to process it and what weight they're going to give to it is anybody's guess.
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Lastly, you say in this passage that it's already clear that the United States leads the way with the most innovative transactions and structures that the world has ever seen, but that the U.S. concerns will carry relatively modest weight with members of the new IASB. And, if we missed the point, you have said also it seems to me with remarkable diplomacy, ''inevitably, representatives from simpler environments will be hard pressed to cast knowledgeable votes''.
Do you want to tell us why we shouldn't be scared to death of what you're saying here?
Mr. AMEEN. I expressed those as concerns, not as the inevitable outcome. I think it will require particular energy on the part of the IASB members to understand transactions and economic environments with which they are not individually familiar. These are all professionals. They have been dealing in a professional environment their entire careers, and I am hopeful that they will meet the test. But, I think it's something that we need to watch very carefully. That contrasts, I think, with standard-setting in the U.S. where the substance of all feedback is coming from a very similar economic environment.
Part of what, I think, we need to be cautious of is that the complex transactions in the U.S. are presented fairly, however the standards are ultimately developed.
It is in the best interest of the international community to look at where the markets and the transactions in the U.S. are because inevitably, they will follow, given some time lag.
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Mr. COX. I suppose that one of the inferences that one might draw from the concerns that you've raised is that inasmuch as the United States is the leading capital market in the world, among other things, it has the most capital, and inasmuch as we're talking about international economics and international business, which is in the end competitive, that U.S. leadership and U.S. modeling, which is then emulated by the rest of the world, is another way to achieve similar results, or at least another, if you're an academic, potential way, another route to achieving the same end. Should we be thinking about ways to capitalize, if you will, on the U.S. native advantage here at the same time that we think about international bureaucratic political structures to accomplish the same result?
Mr. AMEEN. I think so. I think that the structure that Chairman Volcker has designed and his associates have designed is meant to be responsive to input from a wide variety of constituents and certainly constituents in the U.S. will have the obligation to communicate clearly with the Board potential perils of the path they're exposing and selecting.
And we will attempt to keep the calories behind that effort, both as FEI and as individual registrants in the U.S. That's our principal means of applying influence.
Congressman Cox, the——
Mr. COX. Mr. Elliott, I wanted to invite your comments on this. I simply started with Mr. Ameen because it was the passage from his testimony that I was quoting. Thank you.
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Mr. AMEEN. Thank you. I just wanted to add that we could hypothesize that the International Accounting Standards Board goes in either of two directions, either they have the good structure and the quality of the accounting standards that they develop goes up, or we could also hypothesize that politics results in a sort of least common denominator, and they go down.
If they go up, then they will at some point be as good as, and better than, U.S. standards, and everybody around the world will be better off.
If they go down, our SEC is not going to permit companies to file under those lower standards. They will still be required to give United States investors the benefit of the higher United States standards.
So, if they go down, we're protected, and if they go up, we'll be better off. I, for one, believe that the structure that's been put in place deserves a good chance to operate, and I'm optimistic that it will result in improvements.
Mr. COX. Implicit in your comment is that the Congress should not cede any turf legislatively from the SEC to this or other international standard-setting bodies so that as a failsafe always, U.S. standards can be implemented from our own vantage point.
Mr. AMEEN. I think the status quo as it exists right now provides the level of protection necessary. The SEC is doing what it needs to do in the interest of American investors and the Congress is overseeing the SEC, and I think it's working to the advantage of our investors.
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Mr. COX. That's very helpful. Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Cox.
Mr. Bentsen.
Mr. BENTSEN. Thank you, Mr. Chairman. Let me say first off, in following up on what the Chairman had talked about of how as we move forward, how you'd value assets. I want to compliment Mr. Ameen. I agree with you.
Much to my dismay, the older I get, the more old-fashioned I find myself. And, I think that we ought to be cautious in not trying to assign values to intangible assets that may or may not have value and should be cautious about certain exuberance that might exist in the current times.
I think I hear what both of you are saying, and particularly, Mr. Elliott, that we should allow this to go forward. But, let's be cautious that we might not come out with the best structure. And I understand your concern or your comment that even if the international standards were lesser than what we would view as appropriate and what our current laws and regulations provide for participation in American capital markets, given the growing international structure of the capital markets, there might appear to be some systemic risk that could occur where you would have a race to the bottom in other markets where larger companies, public companies would be able to use lesser standards in other markets. And, I think, we have to be concerned about that.
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But I want to ask you, I'd ask Mr. Volcker this, and Mr. Ameen, you may have a better viewpoint on this, coming from a public company. Mr. Volcker was not particularly optimistic, I think, that institutional investors would necessarily demand the highest standards. That as the markets become more intertwined and international that we couldn't necessarily rely on market discipline to acquire the most appropriate or most transparent standards. I would certainly hope that would be the case. But I'd be curious of what your opinion is.
Mr. AMEEN. It's an intriguing question.
The academic research that I'm familiar with has been inconclusive at best. Where we stand now, I think, is an interesting case study—that is, regardless of what your domestic native economy's standards are, they may be used as a basis for filing in the U.S. with reconciliation to U.S. accounting principles.
Reconciliation, one can argue, is probably less than half of a complete solution, because of the robust disclosures that are required in U.S. financial statements. But at least it's a start, and it calibrates something of the difference between what you see in the financials and what they would have presented had they been presented in the U.S. One would presume that reconciled financial statements would carry with them, because of the lack of transparency and the lack of total comparability, some sort of risk premium.
I think if the markets could demonstrate clearly that the higher standards carry a lower risk premium, then the rush to U.S. or high-quality international standards would be universal. Obviously, we haven't made that case with sufficient compulsion that that's been the answer, and it's unclear to me why.
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Mr. BENTSEN. I think you would excuse fraud. You're always going to have some actors that are going to be fraudulent, and those would be separate.
Mr. AMEEN. I think one has to argue that errors in financial reporting are more likely to occur in more complex standards environments. It's an unfortunate result of the complexity of the standards themselves.
We will see errors in application of derivatives accounting just because the rules are so horrendously complicated.
Mr. BENTSEN. You talk about Daimler-Benz and others, and Mr. Elliott, you as well talked about the various forms of allocation of capital.
But again, as we see the capital markets become more international, at least in more industrialized countries, are you seeing assimilation of the allocation of capital similar to the United States model and away from the more bank-funded model, or not?
Mr. AMEEN. That certainly seems to be the case.
Mr. BENTSEN. Do you think the standards might follow suit as a result of that, or is there any empirical evidence of that?
Mr. AMEEN. I have not seen evidence that the standards are necessarily following suit yet.
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Mr. ELLIOTT. The investors themselves, I think, are pretty well aware of the risks that they're taking when they invest in different economies and under different standards. And while they might not, as Chairman Volcker suggested, demand to invest only under United States or very high standards, nevertheless when they invest in other places they demand a higher risk premium, which results in a higher cost of capital for those companies.
Why do overseas companies want to come to the United States to raise capital? Well, one answer is there's more capital here. But another answer is, the cost of capital is lower here. But that's not an accident. It happens because of the high standards of accounting and disclosure and enforcement in the United States.
So you can say that there is a race to the top in that sense, that companies anywhere in the world who want to tap our capital markets have to step up to our standards. So while Mr. Ameen, I think, is right that the academic evidence is not as strong as we would like in order to be able to make policy decisions, I think it's fairly clear that the more transparent a company is, and is seen by its investors as being, the lower the risk premium that they demand. And the more opaque they are, the less they tell to investors, the higher the price of capital that they pay.
Mr. BENTSEN. Thank you, Mr. Chairman.
Chairman BAKER. Mr. Bentsen, I wasn't suggesting that they value dot coms based upon what they become. But my point in making the statement was that there are significant intangibles that often give someone a more clear understanding in supporting your comment, the more transparency the better, up to the point at which it becomes competitively disadvantageous. That's my point.
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Mr. Royce.
Mr. ROYCE. Yes.
Mr. Elliott, when you argue that it's a 50/50 proposition whether the input of these new constituencies will frankly increase the likelihood that the standards will be more useful, beneficial worldwide, versus the proposition that it will be the least common denominator that determines the outcome, I would just reflect—Phil Ameen has made the point in his written testimony. He used the word, inevitably.
He said, inevitably, representatives from simpler environments—environments without the transactions that test the limits of a proposed accounting standard—will be hard-pressed to cast knowledgeable votes.
It seems to me that there was another course of action here. Rather than attempt to democratize this process in a way which those interests that already had lacked the impetus to reform their own economies in a way to bring transparency, they would be given a seat at the table. And it was reflected in the testimony that I was not here for, but Chairman Volcker's testimony, in which he alludes to the past and he said, the SEC had considered U.S. GAAP to be the best in the world. In effect, they had long taken the position other countries and companies should conform if they wanted to access U.S. capital markets.
In fact, it is seen that increasing numbers of global corporations were accepting that verdict. They were conforming.
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Then he went on to argue why we were going to change course, why we were going to develop this concept of developing international standards collectively. He puts it to the Asian financial crisis, and that led him and others to a different emphasis. They've made clear the importance of effective auditing internationally.
See, I'm not sure that's true. I think what it has made clear to us is that our own insistence on U.S. standards was gaining ground. I think the Asian financial crisis is probably a reflection of moral hazard, of what happened when you basically have a situation where investors feel they're going to be bailed out, and you have investment in a hot market.
And I think our rush to judgment here has led us to embrace a strategy that perhaps is not the best. I think the SEC was originally correct in their assumption. If we stuck to our guns and recognized that ours was the most innovative system in putting forward standards, that we would end up basically having the world come along.
Now, Volcker went on to say the U.S. does not have all the right answers. Well, I think we have more of the right answers than anyone else in the game. Furthermore, developing de facto global standards from Connecticut has seemed increasingly unrealistic, both politically and economically in the age of globalization. I just think he's come to the wrong conclusion.
But I'd ask for your consideration on that observation.
Mr. ELLIOTT. I think it's a very interesting observation.
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Before the new structure was put in place, and we were working with the old volunteer basis in the International Accounting Standards Committee, there was a competition going on, and that competition was between international accounting standards and U.S. accounting standards. In Germany, for example, under the law it's permissible for public companies to adopt either German GAAP or U.S. GAAP, and many German companies were beginning to adopt U.S. GAAP, because it resulted in their capital cost improvements.
But also, I would say parenthetically a lot of those companies looked at Daimler-Benz, and they looked at the way that that company's internal management processes were improved once they had better accounting information at their disposal. And these companies were thinking, maybe adopting U.S. GAAP would not only give them the capital cost advantage, but would also give them better internal management information to run the company.
So, the direction seemed to be going that it was at least a reasonable horse race that U.S. GAAP would win the day against the old IASC. I think that with the restructuring of the old IASB, which reflects Chairman Levitt's views of what would constitute a high-quality system, and with getting full-time members on there and with substantial funding and so forth, I think the horse race needs to be handicapped in a different way, and that while it's still possible that U.S. accounting principles would dominate in the end, I think the smart money would now go to the IASB as winning the game in the long run.
But it is not determined. You're absolutely right. There is a marketplace at work here, and it will be determined by the choices made by companies in different countries over the next couple of years.
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Mr. ROYCE. It was interesting, because if I were to graph the capitalized value of our capital markets and then compare it to the capitalized value of the European capital markets, and then the Asian capital markets, and then Australian and African capital markets—people are voting with their feet, in a sense. I mean, the disparity is absolutely phenomenal.
Part of that is security with our laws relative to transparency and reporting. But I was going to go lastly back to Mr. Ameen. As you say in your written testimony, there is a very real risk that the economic interests of the United States will get lost in the avalanche of feedback that the new International Accounting Standards Board will face.
Let me ask you, Phil, for your view of my tack on this, and whether you think there is a possibility that, in the long run, our standards would perhaps create enough leverage, if we stuck to that position, that Asia and Europe would probably begin to cede to those rules.
Chairman BAKER. Mr. Royce, we'll have to make this your wrap-up, too, as well.
Mr. AMEEN. It's a very interesting question, and one that I do not have a clear answer to.
We recite so often, as those who are influential in shaping U.S. GAAP, that we are the best in the world, and the rest of the world should follow along behind us. We forget that our standards are far from perfect. There are many legitimate criticisms that Europeans and Asians levy at our standards that are levied internally within the U.S. at our standards.
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What we have is an opportunity to work with the rest of the world on a clean sheet of paper, and achieve in fact higher-quality standards that will serve not only us, but the rest of the world, exceptionally well. I think that's the opportunity that we need to capitalize on and we need to take advantage of.
It would be almost impossible, I think, to achieve that sort of end in the U.S. This is a very dynamic process.
Mr. ROYCE. I will wrap up. But if past experience had not been that, on balance, we had been more innovative, we had been more accurate, our costs of capital had not been so much lower, then I would concur.
But I spent a lot of time in Asia and around the world. And looking at the lack of transparency and the lack of emphasis there from corporations or from governments in making the right moves, that's why I lean toward the other.
Mr. AMEEN. That's true. I think we have yet to see the effect of the pool of Europe, all of that capital and all of those resources which were separate countries heretofore. I think that's an influence that's going to be very strong in the near future.
Mr. ROYCE. Thank you. Thank you, Mr. Chairman.
Chairman BAKER. Mr. Sherman.
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Mr. SHERMAN. Thank you, Mr. Chairman.
Our capital markets and accounting system are indeed the envy of the world. In large part, we got there by always insisting that we make it better and asking the tough questions, and inviting tough questions from the rest of the world as to how we could make our accounting systems better.
And there is domestic criticism. It is said that we do an outstanding job of reporting the irrelevant in a transparent manner to investors. And I want to focus on something I've studied over the years that has been ignored under generally accepted accounting principles in this country, but is a large portion of GAAP or its equivalent in Spanish, in Latin America and other countries: that is, inflation adjustments to accounting.
Now, inflation has been low enough in the United States, except in the 1980s, so that you could claim that it was ignorable. But even rates of 2 or 3 percent are relevant. And then, unless you're marking everything to dollars, if you're preparing accounting systems to be used in other currencies they have much higher inflation rates.
I'd like our witnesses to comment on whether the very well-established and detailed mechanisms for accounting for inflation have been worked out as a matter of necessity in countries that have often experienced 10, 20, 30 percent inflation in a year—whether those should be part of our domestic financial statements.
Mr. ELLIOTT. There was a time when we had inflation accounting on the books in the United States. And even with low rates, as I'm sure you're aware, over time there could be a big distortion in numbers. But those results were not highly demanded by the investment community, and we did away with them some years ago.
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But when you get to the question of what are the valuable assets of post-industrial companies, they are not, in general, exceptions; the land that was bought 100 years ago, or the factory that was built 50 years ago, or the machinery that was bought 30 years ago and are most likely to be distorted by the inflationary adjustment factor.
In fact, the important assets of companies today are things like customer satisfaction, good relations with customers and vendors, capacity for innovation, research and development, the ability to leverage knowledge to create value. These are the things that are missing from the financial statements.
So we could go back and adjust the trackbed of the railroad to today's dollars, and we could spend an awful lot of resources in doing that. But it might be less of an important thing to focus on in getting better information to investors than getting them more information about the knowledge assets, the intangibles, the sort of post-industrial assets that drive modern companies.
Mr. SHERMAN. If I could interrupt, I do think though that the land and equipment is valuable, and especially on an international basis. Yes, we'd like to think that our future is all Silicon Valley. But certainly in many developing countries, the most valuable company is the railroad or the real estate holding company rather than, you know, the leading Paraguayan software developer.
But, that does bring another issue. That is, I think the last FASB that was published before I left full-time practice of the profession was FASB 2. I'm not saying I disagreed with it so much that I left, but if memory serves me correctly—and I may have the number wrong—that was the one that said that all research and development was written off.
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Mr. ELLIOTT. That was the number, right.
Mr. SHERMAN. That illustrates the problem that I see in developing our accounting standards, and that is the tension between reporting the relevant and reporting the verifiable, given the fact that if you report the verifiable, then your likelihood of being sued is considerably less, since you can go out and do a competent job and verify the verifiable, and defend any lawsuits.
We not only have the best capital markets. We have the world's most robust tort law system. I'm not saying there's a correlation.
So what I would ask is, should we revisit the idea of writing off all research and development as an expense, and producing financial statements that are identical for two companies, one of which does a successful R&D program and one of which does an unsuccessful R&D program?
Mr. ELLIOTT. I think you may not have been here when Chairman Volcker indicated that he felt that the new IASB was going to have to address the question of intangibles. And so I don't regard the write-off of research and development as a settled issue for all time for the whole world, as I infer you feel about this.
I don't believe that that was the right choice. But that was a choice that was made in the middle 1970s. Things are very different today, and they might not make that choice today.
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Mr. SHERMAN. I'm sure that it was the right choice, so long as I was with an accounting firm that could have been sued for failing to correctly assess the very difficult-to-assess value or success of a research program. Now that I no longer have a stake in whether the unverifiable is part of what has to be verified, and now that I'm an investor and a consumer of these statements rather than a producer of them, I may have changed my mind.
Mr. ELLIOTT. You put your finger on a very important issue, which is the disincentive to disclosing soft information and forward-looking information because of the litigation risk.
Mr. AMEEN. Just to use my company as an example, we don't do inflation-adjusted statements. Our historical equity is about $50 billion. If we were to capitalize R&D and amortize it over, say, a 10-year period and adjust everything for inflation, that might get as high as $70- to $75-billion.
Our market cap is about half-a-trillion dollars. So there's a big gap between what we can reasonably achieve through manipulating the old historical numbers and what the market perceives our value to be. I hope the market is right.
Mr. SHERMAN. I would point out the market is going to be based on your income statement, not your balance sheet. And I would point out the things I'm talking about would affect not only your balance sheet, which as you point out seems to be irrelevant to your stock price, but would also affect your earnings per share, which probably is relevant.
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Thank you, Mr. Chairman.
Chairman BAKER. Mr. Shays.
Mr. SHAYS. Thank you, Mr. Chairman.
Mr. Sherman, almost every hearing has someone from the Fourth Congressional District or near it, and it just tells me how important issues that come before this subcommittee are to our district. I'm delighted that FASB is part of the Fourth Congressional District, and extraordinarily proud that GE is.
I'm delighted to have both of our witnesses here today, both FASB and GE, which I consider to be one of the greatest, if not the greatest, company in the country and world is in our district. Proud to have you.
I love the tension between what I see between the two of you and FASB. I get the sense, Mr. Ameen, that you are supportive of ISB, but a little more skeptical than you are, Mr. Elliott.
I would love to have both of you mention the concept of quality. You were, Mr. Elliott, describing the fact that it's great that we have compatibility and so on, but the quality of that matters a great deal. I'd like you to define quality, if both of you would, to me.
Mr. ELLIOTT. You raise, obviously, a very difficult and esoteric question, Congressman Shays, as to how you would define quality of accounting statements and accounting standards.
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I would define it in terms of the ability that it has to permit investors to assess the potential returns on their investments, and that the higher the correlation between what the company discloses and their ability to make those predictions, the higher the quality.
Specifically, that gets around two questions. One is the range of information that's disclosed, and how relevant it is. Congressman Sherman was talking about the tradeoffs between reliability or auditability and relevance. But part of the quality is to focus on relevance to investors, and part of it, of course, is to focus on the reliability of the information—that is, is it honest? Is it a fair statement of what it purports to be?
So both reliability and relevance are components. But another component you would have to bring up is timeliness. Excellent information delivered 6 months late would not be high quality, so you really have to balance relevance, reliability and timeliness to get to the most high-quality information.
Mr. SHAYS. But you view that, obviously, as of greater importance than just uniformity.
Mr. ELLIOTT. Uniformity is important, but not at the expense of quality. That's my position, yes.
Mr. AMEEN. Mr. Shays, just to put another dimension on the quality question: the measure of quality that we use in my company and a number of companies throughout the U.S. is a 6-sigma measure, which is a measure which quantifies the amount of defects permitted by a particular system. 6-sigma is almost unachievably precise.
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One of the dimensions of accounting standards that has become apparent to us in the last couple of years, and that is increasingly of concern, is that it is clear that the higher the complexity of an accounting standard, the less capable systems are of applying that standard precisely. I mentioned earlier the derivatives standard. I think there are other examples of extraordinarily complex rule sets that we very much would like to apply as they were intended. But the number of decisions necessitated by those rule sets means that errors will occur. I think that's very unfortunate.
Mr. SHAYS. Do companies like yours, and do you in particular, tend to view FASB as almost being academicians? In other words, a sense that you're out in the real world fighting the battle, and they're out sitting on the sideline, kind of seeing the world as they'd like it to be?
Mr. AMEEN. I'm not sure academic is the characterization. I think there is a certain insensitivity to costs of application of complex standards. It's an interesting issue. It's an interesting tension, yes.
Mr. SHAYS. When you say the so-called flight to quality can ruin economies and companies, and lay waste to the best global strategies, Mr. Elliott, I felt you had a very eloquent statement; and, Mr. Ameen, you had a very provocative statement. That's provocative to me. I don't understand it.
Mr. AMEEN. The flight to quality——
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Mr. SHAYS. Can ruin economies and companies; not cause them problems, but ruin them. And the concept of going to quality ruining something is an interesting concept.
Mr. AMEEN. Capital flight would have that kind of consequence. And I think that's the sort of thing that you need to be very concerned about, absolutely.
Mr. SHAYS. Thank you, Mr. Chairman.
Chairman BAKER. Thank you, Mr. Shays.
Gentlemen, I want to express our appreciation to both of you for your responsiveness and your time today. It's been a great help to the subcommittee.
I think everyone here is torn between wanting to have international markets where capital flows freely, and not creating regulatory circumstances which lead to 6-sigma events. Given those two contrasting perspectives, we have a difficult role—and also being advised by Chairman Volcker not to politicize these activities, but members do have strongly held opinions about what is in the investors' best interest.
We will—next week, for example—have a hearing on how analysts are making their recommendations to investors in the market, which directly relates to the question of the quality of reporting that they get access to. These are indeed complex issues, but have extraordinary impact potentially on the formation of capital and the growth of business, not only here, but internationally.
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We thank you for your comments, and I'm certain there will be Members who wish to follow up with written questions at a later time. We will certainly make your written statements part of the official record. We thank you for your participation.
I am also in receipt of a statement from the Association of Investment Management and Research with regard to the SEC concept release on international accounting standards. Without objection, I would make that a part of the official record here today.
Chairman BAKER. Unless there's further comment from anyone else, our hearing stands adjourned. Thank you very much.
[Whereupon, at 12:15 p.m., the hearing was adjourned.]