"CPAs and CEOs: A Relationship at Risk"

Remarks by

Arthur Levitt, Chairman
U.S. Securities and Exchange Commission

The Economic Club Of Detroit
Detroit, Michigan

May 19, 1997

Since ancient times, it's been a practice of soldiers to carry a
flag bearing the emblem of their company into battle.  If the
person carrying the emblem falls, another picks it up and keeps
it moving forward.  The flag acts as a marker for all to see, and
a rallying-point for the troops.  To plant it in the field of
battle is to state, "Here we stand.  From this point we will not
retreat."

That flag is known as a "standard" -- in fact that's the origin
of the word.

I've come to Detroit today to talk to you about the importance of
standards.  I realize that in doing so, I'm preaching to the
converted.  Few industries have pursued high standards as
aggressively and successfully as the American automotive industry
during the present decade.

In the battlefield of international business, standards establish
our framework for interaction, facilitating communication,
encouraging entrepreneurial development, and guaranteeing levels
of quality.  How many of us, when traveling in Europe, have
cursed the lack of standardization for electric outlets as we try
to recharge a laptop computer?  And you know better than I do the
difficulties in redesigning left-hand drive cars for right-hand
drive markets -- because the world does not agree on a standard
side of the road to drive on.

The standards you set -- whether it's requiring ISO 9000
certification for your suppliers, or striving for a "six sigma"
standard for defect control in manufacturing -- are central to
managing and improving your business.

Well, my business is capital markets -- and high quality
ACCOUNTING standards are a key part of my strategy for assuring
that US markets retain their preeminent position in the 21st
century.

If anyone doubts the huge difference that accounting standards
can make, let's recall the experience of Daimler-Benz, which in
1993 became the first German company to register securities in
the US.  Under German accounting standards, Daimler had reported
a profit of 168 million Deutschmarks for the first six months of
1993; under US standards, the company reported a loss of almost a
billion Deutschmarks for the same period.

But over the years, some have thought our accounting standards
too high.  A number of corporate leaders, many from the financial
sector, have been publicly and privately critical of accounting's
highest authority: the Financial Accounting Standards Board, or
FASB, a private-sector body that sets standards for companies
that report to the SEC.  Consider some of the following
headlines:

     "The First Thing We Do is Kill All the Accountants" -- that
     came from Business Week.
     
     "Can FASB Be Considered Antibusiness?" -- from The Wall
     Street Journal.
     
     "FASB Faces Siege by Business Leaders" -- also from The Wall
     Street Journal.
     
     "No Fans of FASB" -- from Institutional Investor.
     
     And the latest:  "Corporate America Is Fed Up with FASB" --
     in a recent issue of Business Week.

What is FASB's great sin?  It has asked companies to tell
investors the whole truth about their financial performance,
including exposure from their own investments.

Now I did not come here today to tell you that FASB is perfect.
Like any organization, FASB needs to consider how it can improve
its processes and its products.  One might debate, for example,
whether the FASB asks for too much detail; or whether it imposes
too many costs; or whether it takes too long to issue rules; or
whether a given proposal will really help investors.

But that is not what's been happening here.  The effort has not
been to fix FASB, but to weaken or even eliminate it.

In 1996, for example, the Financial Executives Institute, a group
of senior corporate financial officers, made a series of
recommendations that would have reduced the size of FASB and made
other changes that would have effectively hobbled it.  I think it
is only fair to acknowledge that many of those recommendations
were quickly dismissed as extreme.  Nevertheless, to guard
against any such threat in the future, the SEC fought to have
greater public representation on the FASB's oversight board.
It's my belief that high-quality accounting standards can best be
developed by a public-private partnership -- and you don't
sustain a partnership by undermining your partner.

While that particular attack was beaten back, a second front was
opened.  Its most visible aspect was a stream of overblown
rhetoric that attempted to tar the FASB as "anti-business" --
which is a little bit like calling the College of Cardinals "anti-
Catholic."

In fact, this rhetorical strategy has backfired.  Complaints
about FASB have been so overstated that I think we've all learned
to discount them.  I've now seen this process from both sides.
During a lifetime in the private sector, I sometimes fought off
attempts at government intrusion with the statement, "This will
hurt business."  The result was rarely as bad as I'd imagined it,
and often much better.

The debate over accounting standards has been characterized by
hyperbole.  In 1990, for example, the FASB required companies to
record retirement health benefits as liabilities.  An article
opposing the measure opened with this statement:

 "Imagine an accounting rule that will cripple the
competitiveness of thousands of American companies, put untold
billions of dollars in business loans into default, send stock
prices skidding, and deprive many workers of health care benefits
after retirement.  This may sound like a plot for a bad novel,
but it's actually something that the Financial Accounting
Standards Board is actively promoting."

Thankfully, the writer was wrong -- I suppose it was the plot for
a bad novel, after all.  The new accounting was not without pain,
as some of you in this room know -- total shareholders' equity at
General Motors, for example, went from $27 billion to $6 billion.
But I think that, with the benefit of hindsight, most executives
today would admit that this was the right move on the FASB's
part.  And it has provided CEOs with valuable information that
helps them run their businesses.

A more intense firestorm broke out in 1993, after the FASB
proposed to count compensation paid in stock options as an
expense.  The SEC was swamped with phone calls from CEOs and CFOs
warning that the end of Western civilization was nigh.  Expensing
the fair value of stock options would reduce earnings, the
argument went, causing stock prices to fall, and driving the cost
of capital up.

In deference to concern about a potentially heavy burden on
business, the FASB allowed companies to disclose the estimated
cost of stock options -- not in the financial statements
themselves, but in a footnote.  It's interesting that a recent
study by the Harvard Business School found that top executives in
companies that complained about the FASB proposal were paid more
in options than those in companies that did not complain.
Business Week described the study's conclusions this way: "The
concerns expressed about the impact of expensing options on stock
prices and borrowing costs seem to have been a smoke screen to
avoid publicizing bosses' high pay."

Although I wouldn't endorse that characterization, it reflects a
broad skepticism about why some corporate leaders would fight
high standards.  A recent article in Fortune suggests a desire to
manage earnings may be an answer -- especially when compensation
plans are increasingly tied to earnings targets and stock prices.
Standards that promote comparability and transparency limit the
ability to manage earnings.  Again, I'm not endorsing that
conclusion, but there's an impression out there that some
companies are unwilling to be as forthcoming as they should be.

The latest skirmish in the accounting wars was set off when the
FASB proposed that companies account for their derivatives
exposure.  This is an issue that has particular poignancy for me.

We all remember the events of 1994.  Americans saw millions of
their investment dollars go up in smoke as major derivatives
positions went sour at such well-known companies as Eastman
Kodak, Gibson Greetings, and Procter & Gamble.  The problem was
not just the losses, but the fact that they took investors and
analysts by surprise.  The risks companies took in derivatives
were not described in annual reports and other disclosure
documents.  Obviously, there were serious shortcomings in the
guidelines for derivatives accounting and disclosure.

Derivatives were propelled into the headlines.  Each new loss
brought forth calls for restrictions on their use -- including
several from the halls of Congress.  The New York Times advocated
intervention.  But the SEC resisted calls for more regulation,
and chose instead to study how to ensure that derivatives and
their potential risks could be better communicated to American
investors.

After three years of inquiry, the Commission adopted derivatives
disclosure rules that will provide a reasonable amount of
information to investors at a reasonable cost to companies.  At
the same time, the FASB proposed a framework for derivatives
ACCOUNTING, which has come under heavy fire.

Of course, the substance of any criticisms must be assessed and
weighed carefully.  But we are in a situation today in which the
notional amount of derivatives outstanding has reached some $70
trillion.  Accounting has simply failed to keep pace with this
exponential growth.  The FASB believes that "the truest and most
relevant picture of a company's derivatives position is fair
value -- which is certainly not zero, although that is how many
derivatives are reported today."  That strikes me as an eminently
reasonable position.

The way criticisms are being put forward is also alarming.
Critics are focusing too much on lobbying the decision-making
process, and not enough on thoughtful, substantive input INTO
that process.  The FASB has spent 7 months analyzing the more
than 200 comment letters it received on its draft proposal.  As a
result, the Board has debated a number of changes to address
concerns raised in those letters.  But, unfortunately, those
changes are now being held out by opponents as reasons for
further delay -- and with some success.  A few critics have
suggested that further study is necessary before the FASB races
ahead with its proposal -- a proposal that comes AFTER 10 YEARS
OF STUDY AND DEBATE.

These delaying tactics are inconsistent with the way the standard-
setting process should be conducted.

Another disappointing trend has been an increase in attempts to
circumvent the accepted framework for standard setting.  Our
current standard setting process is designed to provide
opportunities for all stakeholders to express their views, and to
have those views considered.

The attempts to prompt Congressional override of the FASB's stock
compensation proposals were alarming; only slightly less
troubling are current suggestions that the SEC should intervene
to soften or delay the FASB's derivatives accounting project.

There is much more at stake here than derivatives accounting --
it is the process by which the private sector sets accounting
standards in the United States.  This public-private partnership
has been at the core of our financial reporting framework for
more than 60 years.  We must interfere in it only with the
greatest reluctance, for each intervention erodes the
independence of the process and undermines confidence in the
impartiality and fairness of new standards.

I am determined not to let that happen.  Indeed, in an era of
global securities markets, it has never been MORE important for
the U.S. to have a strong and independent body standing guard
over our accounting standards.

As you may know, the International Accounting Standards
Committee, or IASC, currently is working to establish a core set
of accounting standards to help capital flow across borders more
easily.

Certainly, it would be much easier to integrate separate markets
if they all spoke in the same language -- the same way it is
easier to network a group of computers if they all use the same
software.  But this project will not provide benefits if it
becomes merely a search for the lowest common denominator, or an
excuse to weaken demanding but effective national standards.

Our work with the IASC is a cooperative effort.  For our part, we
have pledged to support that effort; to encourage the FASB's
thoughtful participation; to be willing to challenge and question
our own standards; and to provide criticism that is both timely
and tough.

In return, we expect the IASC to conduct its dialogue in the most
open way possible; to value the quality of the result over the
speed of the process; to expose and resolve differences of
opinion, not gloss over them; and, most importantly, to hold the
interests of investors supreme in every rule and every
interpretation.

Commission acceptance of international standards is not a
foregone conclusion.  It bears repeating that while harmonization
is a desireable goal for the U.S., our standards are already
accepted in capital markets throughout the world, and their
quality is unmatched. We can only accept a framework that will
enhance, rather than diminish, the strength and stability of U.S.
capital markets.

Some have predicted, perhaps wishfully, that international
standards will diminish the role of the FASB.  I strongly
disagree.  Who is better qualified to set high U.S. standards,
and protect, preserve, and defend them, than the FASB?

This is a crucial time for the FASB.  Its trustees are about to
choose a successor to Denny Beresford, its chairman of the last
10 years.  This selection is an enormous responsibility.  The new
chairman will lead the FASB into the millennium.

It is in the highest interest of our capital markets for the
FASB's trustees to find a person of extraordinary talent to face
the extraordinary challenges ahead.  We need someone who is
knowledgeable, tough and fair -- someone with a vision for the
future -- someone who can balance the interests of those who
provide capital with the interests of those who seek capital --
someone who will help U.S. markets remain pre-eminent.

Our markets are the deepest, most liquid in the world, not
because God made them so, but because no other nation has as
broad a base of investors as we do.  Accounting standards are a
cornerstone of that broad public involvement.  People feel more
comfortable about investing when they're confident that financial
statements aren't pulling any punches.

That's why we can't sacrifice quality.  Detroit learned many
years ago the hard lesson of what happens when you reduce quality
in the face of competition.  Let's not make the same painful
mistake in our capital markets.

Instead of sacrificing quality, we should COMPETE on it.  We
should remind all our constituents that the highest standards
yield the lowest cost of capital.   The number of foreign issuers
we have here is proof that we don't need to dilute our standards
to compete with foreign markets.  We shouldn't be looking at ways
to lower our standards -- we should be looking at ways to IMPROVE
them.

And in the end, that's what this entire debate is about:
standards.  Standards are like a house that we raise over our
heads.  They protect us.  They define an area within which a
person, family, business, or community can function.  Without
them, civilized life is not possible.  We live by the standards
we set, and we dismantle them at our peril -- as we know from the
broader experience of our society:

     * Compromise educational standards, and you get high school
     graduates who don't know where Russia is;
     
     * Reduce the standards of public discourse, and violence and
     obscenity creep into the media;
     
     * Lower the standards of political debate, and see attack
     ads proliferate;
     
     *Ignore monetary standards, and the result is inflation --
     and so on.

I hope I've shed some light on the importance of standards -- in
the securities markets as well as anywhere else.

More than that, I hope you will join in our effort to keep U.S.
standards high, and capital costs low.

For me, it would be unthinkable to take standard setting out of
the private sector; unthinkable to replace government oversight
with government control; unthinkable to bring the independence,
quality, and fairness of accounting standards into question by
politicizing the process that creates them.

I know most of my colleagues in the business community share
these beliefs.  And I hope that those few who may not, will at
least hear me out, and work with me to find ways to improve the
standard-setting process.

The FASB has planted the flag, and the Commission has rallied to
its support.  But it is corporate America that has the most to
gain or lose in this struggle.  We did not become the economic
miracle of the 20th century by compromising on the quality of our
standards -- let's bear that in mind as we enter the 21st.

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