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October 8, 2007

Dear Mr. Levitt & Honorable Committee Members,

I would like to draw your attention to a simple idea that would
dramatically improve audit quality, industry conditions, investor
confidence and communications. As a wise man wrote in the book *Take on
the Street*, "to stop the numbers game, Warren Buffet believes, and I
agree, that corporate boards should require auditors to rate the
aggressiveness of accounting policies." (This has been echoed by several
academics.) However, going one step further, checks and balances will be
enhanced if the analysis is conducted by a third party, instead of their
auditors. Actually, this already exists today, and it's a \$60 million
business. But, by making it a regulatory requirement, the dynamics of
this fast growing research service would dramatically change, and in its
place would be a "rating agency" type structure leveraging market forces
to improve accounting. As a former Sr. Director at Standard & Poor's, I
have seen first hand how benchmarks can temper management's
aggressiveness and increase the flow of information to the capital
markets.

*Earnings Quality Rating*

Non-auditing, third party accounting examiners exist today. According to
Integrity Research Associates, there are 19 companies currently sell
earnings quality/forensic accounting research. They observe how
conservative/aggressive management is in their application of accounting
polices (choices within Generally Accepted Accounting Principles), while
alerting investors to possible "shenanigans." Bought mostly by hedge
funds, its primary value is identifying "red flags" or short
opportunities.

This research [must]{.underline} be democratized! By simply making it a
listing requirement, researchers would change their business model from
subscription (available only to wealthy investors), to "issuer paid"
(available to everyone similar to financial statements). (Note: The
credit rating industry transitioned to an issuer paid model when bank
regulators mandated that only "high quality" bonds could satisfy reserve
requirements). Earnings rating agencies would be hired by a company's
Independent Audit Committee to ensure unprejudiced analysis. They'd
issue letter grades (AAA, AA,... B,\... D, etc) that would be freely
distributed though the Internet to all investors. I'm sure Mr.
Autoworker would like to know if there's a "D" rated company in his
retirement account. Extensive research and tools would be sold to
institutional investors.

It's true the credit rating agencies have come under fire recently, but
as they say "you can't let perfection be the enemy of good." Image where
the financial world would be today if investors didn't have easy access
to corporate or municipal bond ratings?

*Business Model Benefits*

While the concept of an earnings ratings agency is simple, the benefits
would be enormous:

• More Conservative Accounting - According to CFO.com, 47% of America's
CFO's still feel pressure from management on accounting. After all, the
more aggressive they are (without stepping over the line) the bigger
their bonus will be. There's little downside. But the scandals occurred
when previously good people influenced by fame and the seduction of
stock option rewards crossed the narrow line they had been inching
towards.

Earnings ratings are a necessary counter incentive that can easily be
written into management compensation agreements, investment policy
statements, loan convents, etc.. Their gradual grading method would keep
managers far from the edge. Currently, management is free to choose
their level of allowance for doubtful accounts, and it may be used to
manipulate earnings. But would they if they if variation from previous
levels risked a downgrade? This gives the CFO's cover.

It also gives auditors cover. According to many, their relationship with
the companies has become adversarial to the point where valuable advice
is being withheld due to "paranoia." By establishing an earnings rating
agency structure it would allow audit firms to return to their role as
"good cop."

Earnings ratings also provide upside for managers. How many chief
executives would be anxious to have their conservative accounting
recognized versus their aggressive peers?

• Ever-Present Watchdog - In the aftermath of the scandals, Congress
sought to examine the breakdown of "watch-dog groups" including
securities analysts, the Securities & Exchange Commission (SEC), and the
credit rating agencies. The report concluded that none were fully
equipped or oriented to serve that function.

Effectively, little has changed with these groups. Securities analysts
have been separated from investment banking, but realistically their
bonuses are still dependent upon the overall bonus pool, which
ultimately is driven by investment banking profits. Credit agencies
maintain their role is not auditing. The SEC did increase its staff to
do more spot checks, but will they have the same budgets a few years
from now when the scandals have faded from memory?

Initially, Congress pushed for mandatory auditor rotation. They reasoned
accounting firms would be less likely to be seduced (e.g. Anderson
audits of Enron) if the chance of discovery was greater. Industry pushed
back citing the high costs, and congress instead established the Public
Company Accounting Oversight Board (PCAOB). Although they do quality
control checks on auditors, the bottom line is that there still isn't a
watch dog on every audit. But, as banking analyst Joseph Stieven of
Stifel Nicholas observed on the SEC's Advisory Panel for Smaller Public
Companies, "there is a true extra set of eyes in the bank regulators."
As a result, he "defied anyone to name five major bank failures \[from
accounting\]."

Can an accounting "watch-dog" be establish at a reasonable cost to
issuers? Leave it to private enterprise. Credit rating agencies, which
are granted special access to non-public information, charge issuers a
reasonable fee, but earn revenues in multiple ways. Publishers are adept
at repurposing the same information with varying depths for different
markets. Earnings rating agencies can accomplish the same. The \$60
million now paid by the buy-side can used to subsidize accounting
investigation for all.

• Increase Information Flow -- For individual investors, earnings rating
agencies would broadcast their "seal of approval" through every
financial distributor and website (e.g. Bloomberg, Reuters, Yahoo
Finance, Google Finance, etc). It would be a daily reminder of the
presence of another watch-dog. This availability and branding will truly
restore investor confidence.

Institutional investors would be able to purchase accounting analysis
like what is produced today, but for every listed company. Though it's
no longer a short idea since everyone is aware, it does reduce the
analyst's work. The first stage of equity research is accounting
examination in order to establish a solid base for which to make
projections. Since this same work is performed by every analyst
researching a company, it is redundant (and generally outsourced to
India today).

This solution is especially ideal for smaller public companies that have
no Wall Street analyst coverage, which is a separate but critical
problem in the capital markets. With the accounting investigation
already completed, Wall Street analysts can increase the number of
companies they cover. Perhaps they still won't cover the smallest
companies, but the reports still provide a company a means to get their
message to the institutional investor community since they contain an
examination of current earnings streams, which is included in most all
definitions of earnings quality.

• Facilitate Investment Comparison -- Leaving aside fraud, let's look at
accounting from a means to facilitate investment comparison. In 2002,
Standard & Poor's calculated what they considered to be "core earnings",
or earnings associated with the operations of the business (thus
excluding investment windfalls, adding stock option expenses, and other
items).

How big was the difference between core and reported? According to S&P,
companies in the S&P 500-stock reported on average \$26.74 earnings per
share for the 12-months ending June 2002, but the core earnings were
just \$18.48, a [31%]{.underline} difference. Clearly, with a 31%
average variation in the denominator, the widely used price-to-earnings
ratio has little true value.

Earnings ratings examiners look at the accounting policies and whether
they mirror the operations of the business. Entities in similar
businesses should have made similar accounting choices. Earnings ratings
would put pressure on management to confirm to others in the industry
and this will naturally narrow that gap.

*In Conclusion*

In short, earnings ratings would be an effective measure that uses
market forces to encourage more conservative accounting while constantly
reminding the public of another watch-dog. It would correct the
shortfalls in our financial systems that directly led to the accounting
scandals and would right a gross misconception in equity evaluation.

Sincerely,

Richard S. Furlin