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30–174 PDF 2006

FOSTERING ACCURACY AND

TRANSPARENCY IN FINANCIAL REPORTING

HEARING

BEFORE THE

SUBCOMMITTEE ON 

CAPITAL MARKETS, INSURANCE, AND 

GOVERNMENT SPONSORED ENTERPRISES

OF THE

COMMITTEE ON FINANCIAL SERVICES

U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED NINTH CONGRESS

SECOND SESSION

MARCH 29, 2006

Printed for the use of the Committee on Financial Services

Serial No. 109–80

(

(II)

HOUSE COMMITTEE ON FINANCIAL SERVICES 

MICHAEL G. OXLEY, Ohio, Chairman

JAMES A. LEACH, Iowa 

RICHARD H. BAKER, Louisiana 

DEBORAH PRYCE, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

EDWARD R. ROYCE, California 

FRANK D. LUCAS, Oklahoma 

ROBERT W. NEY, Ohio 

SUE W. KELLY, New York, Vice Chair 

RON PAUL, Texas 

PAUL E. GILLMOR, Ohio 

JIM RYUN, Kansas 

STEVEN C. LATOURETTE, Ohio 

DONALD A. MANZULLO, Illinois 

WALTER B. JONES, JR., North Carolina 

JUDY BIGGERT, Illinois 

CHRISTOPHER SHAYS, Connecticut 

VITO FOSSELLA, New York 

GARY G. MILLER, California 

PATRICK J. TIBERI, Ohio 

MARK R. KENNEDY, Minnesota 

TOM FEENEY, Florida 

JEB HENSARLING, Texas 

SCOTT GARRETT, New Jersey 

GINNY BROWN-WAITE, Florida 

J. GRESHAM BARRETT, South Carolina 

KATHERINE HARRIS, Florida 

RICK RENZI, Arizona 

JIM GERLACH, Pennsylvania 

STEVAN PEARCE, New Mexico 

RANDY NEUGEBAUER, Texas 

TOM PRICE, Georgia 

MICHAEL G. FITZPATRICK, Pennsylvania 

GEOFF DAVIS, Kentucky 

PATRICK T. MCHENRY, North Carolina 

JOHN CAMPBELL, California 

BARNEY FRANK, Massachusetts 

PAUL E. KANJORSKI, Pennsylvania 

MAXINE WATERS, California 

CAROLYN B. MALONEY, New York 

LUIS V. GUTIERREZ, Illinois 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

JULIA CARSON, Indiana 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

BARBARA LEE, California 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

WM. LACY CLAY, Missouri 

STEVE ISRAEL, New York 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

ARTUR DAVIS, Alabama 

AL GREEN, Texas 

EMANUEL CLEAVER, Missouri 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

GWEN MOORE, Wisconsin, 

BERNARD SANDERS, Vermont

Robert U. Foster, III, Staff Director 

(III)

SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED

ENTERPRISES

RICHARD H. BAKER, Louisiana, Chairman

JIM RYUN, Kansas, Vice Chair 

CHRISTOPHER SHAYS, Connecticut 

PAUL E. GILLMOR, Ohio 

SPENCER BACHUS, Alabama 

MICHAEL N. CASTLE, Delaware 

FRANK D. LUCAS, Oklahoma 

DONALD A. MANZULLO, Illinois 

EDWARD R. ROYCE, California 

SUE W. KELLY, New York 

ROBERT W. NEY, Ohio 

VITO FOSSELLA, New York, 

JUDY BIGGERT, Illinois 

GARY G. MILLER, California 

MARK R. KENNEDY, Minnesota 

PATRICK J. TIBERI, Ohio 

J. GRESHAM BARRETT, South Carolina 

GINNY BROWN-WAITE, Florida 

TOM FEENEY, Florida 

JIM GERLACH, Pennsylvania 

KATHERINE HARRIS, Florida 

JEB HENSARLING, Texas 

RICK RENZI, Arizona 

GEOFF DAVIS, Kentucky 

MICHAEL G. FITZPATRICK, Pennsylvania 

JOHN CAMPBELL, California 

MICHAEL G. OXLEY, Ohio 

PAUL E. KANJORSKI, Pennsylvania 

GARY L. ACKERMAN, New York 

DARLENE HOOLEY, Oregon 

BRAD SHERMAN, California 

GREGORY W. MEEKS, New York 

DENNIS MOORE, Kansas 

MICHAEL E. CAPUANO, Massachusetts 

HAROLD E. FORD, JR., Tennessee 

RUBE ́ N HINOJOSA, Texas 

JOSEPH CROWLEY, New York 

STEVE ISRAEL, New York 

WM. LACY CLAY, Missouri 

CAROLYN MCCARTHY, New York 

JOE BACA, California 

JIM MATHESON, Utah 

STEPHEN F. LYNCH, Massachusetts 

BRAD MILLER, North Carolina 

DAVID SCOTT, Georgia 

NYDIA M. VELA ́ ZQUEZ, New York 

MELVIN L. WATT, North Carolina 

ARTUR DAVIS, Alabama 

MELISSA L. BEAN, Illinois 

DEBBIE WASSERMAN SCHULTZ, Florida 

BARNEY FRANK, Massachusetts 

(V)

C O N T E N T S 

Page 

Hearing held on: 

March 29, 2006 ................................................................................................. 1

Appendix: 

March 29, 2006 ................................................................................................. 45

WITNESSES 

WEDNESDAY, MARCH 29, 2006

Cunningham, Colleen, President, Financial Executives International ............... 34

Gradison, Willis, Acting Chairman, Public Company Accounting Oversight 

Board ..................................................................................................................... 9

Herz, Robert H., Chairman, Financial Accounting Standards Board ................. 11

Hirschmann, David, Senior Vice President, U.S. Chamber of Commerce .......... 30 

Lackritz, Marc E., President, Securities Industry Association ............................ 32

McEnally, Rebecca, Director of Capital Markets Policy, Center for Financial 

Markets Integrity, CFA Institute ....................................................................... 38

Melancon, Barry, President, The American Institute for Certified Public Accountants .............................................................................................................. 36

Taub, Scott A., Acting Chief Accountant, Securities and Exchange Commission ........................................................................................................................ 13

APPENDIX 

Prepared statements: 

Oxley, Hon. Michael G. .................................................................................... 46

Clay, Hon. Wm. Lacy ....................................................................................... 48

Davis, Hon. Geoff .............................................................................................. 49

Browning, Candace ........................................................................................... 51

Cunningham, Colleen ....................................................................................... 53

Gradison, Willis ................................................................................................ 64

Herz, Robert H. ................................................................................................. 72

Hirschmann, David .......................................................................................... 149

Lackritz, Marc E. .............................................................................................. 154

Melancon, Barry ............................................................................................... 166

McEnally, Rebecca ............................................................................................ 183

Stevens, Paul Schott ........................................................................................ 195

Taub, Scott A. ................................................................................................... 208

(1)

FOSTERING ACCURACY AND 

TRANSPARENCY IN FINANCIAL REPORTING 

Wednesday, March 29, 2006

U.S. HOUSE OF REPRESENTATIVES, SUBCOMMITTEE ON CAPITAL MARKETS, INSURANCE, AND GOVERNMENT SPONSORED ENTERPRISES, COMMITTEE ON FINANCIAL SERVICES, Washington, D.C. 

The subcommittee met, pursuant to notice, at 10:00 a.m., in room 

2128, Rayburn House Office Building, Hon. Richard H. Baker 

[chairman of the subcommittee] presiding. 

Present: Representatives Baker, Castle, Biggert, Shays, Davis of 

Kentucky, Kanjorski, Velazquez, Hinojosa, Miller of North Carolina, Scott, and Wasserman-Schultz. 

Ex officio: Representatives Oxley and Frank. 

Also present: Representative Cleaver of Missouri. 

Chairman BAKER. Good morning. Welcome, all of our distinguished participants this morning. I have been advised that Mr. 

Kanjorski is on his way, but did not express any concern about us 

convening the hearing in his absence, and we will proceed accordingly. 

The purpose of the hearing this morning is to begin what I hope 

will be a helpful discussion relative to current corporate requirements for financial disclosures. 

Since 1934, public companies have been required by the SEC to 

file certain financial information with the SEC. As is usually the 

case, over a considerable number of years, those reporting requirements have become increasingly complex, and much more sophisticated. All of this, of course, is disclosed in conformity with GAAP 

standards. 

In addition to SEC requirements, of course, the Financial Accounting Standards Board, known as FASB, has also required the 

filing of certain supplementary information. The picture that is 

now presented every 90 days to the public, the ‘‘beat the Street’’ 

mentality, is a cause of some concern. 

On the one hand, the intended purpose of the frequent financial 

disclosures is to enable an investor to create, in his own mind, an 

accurate assessment of the corporation’s true financial condition. 

Because of the complexity of the disclosures, the typical investor, 

really, is overwhelmed by the data, and most don’t really make 

much use of the inordinate amount of disclosure that is required. 

On the other hand, it’s my view that, at least during the 1990’s, 

the effort to ‘‘beat the Street’’ every quarter by management 

incentivized the presentation of a corporation’s financial condiVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00007 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
2

tion—although in a legal—but in the most advantageous manner 

possible, to present to the markets and to potential investors the 

most optimistic perspective of the corporation’s operating condition. 

It has resulted, I believe, in the more disturbing disclosures 

made later in the decade, where there was intentional manipulation of the financials to mislead the markets and investors. 

Although those were the exceptions and not the rule, clearly the 

incentives are now in place, I believe, to cause the CFO, the CEO, 

and others, to report, as best they can, a clearly optimistic view of 

the corporation’s condition. 

I think now it’s time to hear from those in the market, and those 

who regulate markets, as to whether there is a shared view that 

there is a better way to do this. 

Specifically, the FDIC has recently concluded a pilot program 

with about 300 insured financial depositories implementing, to my 

knowledge, the first broad-based use of extensible business reporting language, XBRL. Although now poised to move forward at some 

point to require all financial entities to report in similar fashion, 

that action has not yet been taken. 

Although there are some individual corporations who have, on 

their own, begun to file in a manner very similar to an XBRL-like 

system, there is not yet an industry or SEC view that we are ready 

to move to replace the quarterly earnings with something of this 

nature. 

I would hope that, in a very broad perspective, in looking from 

the 50,000-foot level down, perhaps, that we could consider moving 

away from the retrospective, rules-based reporting, which tells you, 

perhaps, if you’re smart, where the corporation was about 4 months 

ago, as opposed to a more forward-looking view—without liability 

attaching—of where the corporation might be at the moment, and 

more importantly, where it might be going. 

My best example to support that perspective is if one was in the 

business of manufacturing widgets, and under the current system 

you showed the sale of $100 million worth in the last quarter under 

the current reporting system, but in current time, real time, your 

customer satisfaction surveys were indicating that 90 percent of 

the customers didn’t like your widget. As an investor, which would 

you rather know? 

I think disclosure of real-time material facts in user-friendly 

form could be a very helpful thing in comparative analysis by investors. 

And finally, the reason why this is so essential to Members of 

Congress is that over half of all Americans now, through the workplace, through direct investment, or in some fashion, are invested 

in our markets. They are a source of an inordinate amount of capital. And we have the obligation to make sure that the working 

families of this country, who rely on the information given to make 

investment decisions, are getting accurate information that can be 

relied on. 

And I think this discussion will help us determine whether the 

current system does that, or whether there is potential for modifications that would be helpful to all who share an interest in this 

very vibrant marketplace. 

With that, did you have a statement, Mr. Kanjorski? 

3

Mr. KANJORSKI. Thank you, Mr. Chairman. Mr. Chairman, I, like 

you, am so excited about this hearing today because of the content 

that we are going to get into, and I know that you called me at 

2:30 in the morning and you couldn’t sleep because of the— 

Chairman BAKER. Calm down, you’re going to be okay. 

Mr. KANJORSKI. But quite frankly, I want to congratulate you for 

calling the hearing. We look forward to this. This is an important 

issue, we can do an awful lot with it. 

I have had the occasion to meet with some of the witnesses in 

the last several weeks, and I know how dedicated they are to fostering accuracy and transparency. 

So, I congratulate Mr. Chairman on the hearing. Thank you. 

Chairman BAKER. I thank the gentleman. Mr. Shays? 

Mr. SHAYS. Mr. Chairman, I have an introduction. Should I wait 

later, and do that? 

Chairman BAKER. Yes, sir. I think at the appropriate time, yes. 

Mr. Frank, did you have a statement? 

Mr. FRANK. Thank you, Mr. Chairman. I am particularly glad 

we’re having this hearing, because I think it is a chance for us to 

talk about some things that were done well, and to focus on how 

to build on what has been done well, and improve it. 

The question of the Sarbanes-Oxley bill is obviously an important 

one for people, especially since next year we will be SarbanesOxley-less in both houses. And the two guardians of that effort will 

no longer be with us. But their handiwork will be. 

And there has been some criticism of it. I think it is in 

everybody’s interest to focus on improvement in that, rather than 

to talk about any substantial cut-back. And I welcome the participation of the people to whom I think we are ready to entrust the 

responsibility of some refinement. 

And I think we could make it clear—and I would want to say 

now—as the entities we are dealing with look at Sarbanes-Oxley, 

I hope they will be willing to make some appropriate adjustments—not exemptions, but adjustments—in how this applies, particularly in part, based on size, and I hope—we would tell them 

that if there were any things that they thought made sense, that 

they thought they might like statutory authority to do, they should 

ask us. I think there would be a great willingness to give them the 

statutory authority, rather than to make changes in the text of the 

law, but to give the administrators the flexibility that ought to be 

necessary with something of this complexity. 

I also want to say, Mr. Chairman—maybe it’s a little too early, 

I don’t think so—I know one of the great hypocrisies in life is when 

people say, ‘‘I don’t like to say, I told you so.’’ In my experience, 

everyone likes to say, ‘‘I told you so.’’ I should add, with my birthday 2 days away, that I find it to be one of the few pleasures that 

improves with age. I can do it unaided, there are no negative consequences, and you just do it, even as you get older. 

And I guess I have a riddle that I ask people: ‘‘What does same 

sex marriage in Massachusetts have in common with the expensing 

of stock options by corporations?’’ And the answer is, ‘‘A big hoohah 

that resulted in nothing.’’ That is, in both cases, we had people predicting all sorts of adverse consequences for something which turns 

out, in practice, to have had virtually none of those consequences. 

4

Now, my hope is, with regard to the expensing of stock options, 

that now that I think it is accepted as a fait accompli, we will get 

cooperation in improving the method by which we value them. 

I agree, there were legitimate concerns about the methodology. 

I think one of the problems was that people who were opposed to 

it in principle understandably didn’t want to collaborate in improving it. And that’s not a bad attitude. We all take that position. If 

we don’t think something should happen, we are not going to work 

to make it better. But now that it’s clear that it’s not going away—

and I think the absence of adverse reaction helps with that—I 

hope, again, we will all work together. 

And it’s obviously in the expertise of the people before us, that 

joint responsibility among the three, to help and solicit the input 

from the companies that are affected, so we can make this work 

better with even more smoothness. 

The final point I just want to raise is—and I appreciate what’s 

been done by the SEC, and I look forward to a collaborative effort 

again on the question of executive compensation. 

And I want to repeat what I have said before. The question of 

what appears to me to be excessive executive compensation is not 

simply a matter of envy—although that certainly is not an absent 

factor in politics, as many know, including our former long-time 

colleague who know chairs the PCAOB—but I think it has significant negative social consequences. 

First of all, you cannot look at the increased resistance to America’s involvement in the global economy, the adoption of labor-saving information technology, and pro-productivity devices, and disconnect it from the unhappiness many people feel about what they 

think is excessive inequality. And excessive inequality has two 

sides to it: no real wage increase for the average worker; and what 

appears to me and many others to be excessive compensation on 

the other side. 

And I would simply add again, for people who think this is just 

a matter of envy, in the study done by Lucian Bebchuk and others 

at Harvard—and it has not been contested—the percentage of the 

after-tax profits of the 1,500 largest corporations, according to him, 

that in 2003 went to compensation for the top, I think, 3 executives, was 10.3 percent of the profits. That’s a macro-economically 

significant statistic, and it has almost certainly increased since 

then, because if you look at the table, it had increased from—it had 

doubled from, like, 1995 to 2003. So we are talking maybe 11 or 

12 percent of after-tax profits. That’s real money that can be used. 

So, I look forward to further work, and I think the SEC has 

taken a good first step. I don’t think—there was no significant support—and I will finish in 30 seconds, Mr. Chairman—for us setting 

salaries. What I think we need to do is to increase the public notion of this, the transparency, and then also work together so there 

is a mechanism for the owners of these companies, the stock holders, first to get the information, and secondly, to decide on it. 

Thank you, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. Mr. Davis, did you 

have a statement? 

Mr. DAVIS. Thank you, Mr. Chairman. I want to thank Chairman 

Oxley and Ranking Member Frank for their support of this issue. 

5

Thank you, Chairman Baker, and Ranking Member Kanjorski, for 

holding this hearing on such an important and relevant topic. 

Thank you also to the members of the panels for coming here 

today. I appreciate your willingness to discuss this issue about reducing the complexity and many of the arcane regulations designed 

for a different era and a different economy, regarding financial reporting. 

We have enjoyed a great working relationship from the committee with the SEC, with the Financial Accounting Standards 

Board, and also with the Public Company Accounting Oversight 

Board. I know the chairpersons and representatives of these organizations have been very forthcoming and willing to testify on Capitol Hill. 

Yesterday I introduced H.R. 5024, the Promoting Transparency 

in Financial Reporting Act of 2006, with Mr. Scott and with Mr. 

Israel as original co-sponsors. This bill will require annual testimony for the next 5 years before the committee by the respective 

chairmen or their senior appointed designee of the SEC, FASB, and 

the PCAOB, relating to their efforts to reduce complexity in financial reporting. 

I appreciate the efforts of these organizations thus far to reduce 

complexity, and Chairman Cox and Chairman Herz’s public statements of support for such efforts. 

I want to emphasize the importance that the members of the 

Capital Markets Subcommittee and the Full Committee leadership 

have placed on the issue, and I want to ensure, through this bill, 

that we are continually updated on the progress that is being 

made. This will keep members up to date, and also serve as a reminder to the agencies that promoting transparency and simplicity 

must be a top priority. 

In the post-Enron financial era, transparent reporting has become an important aspect of promoting a healthy corporate environment. Financially stable corporations are essential for expanding the U.S. business sector, promoting investor confidence, and 

strengthening the economy. 

As a former small business owner, and a consultant, I know, 

firsthand, the difficulties that are faced during time-consuming, 

costly processes of accounting, financial disclosure, and especially 

the compliance in section 404, with the Sarbanes-Oxley bill. What 

we want to see, ultimately, is a financial reporting system that is 

simple, that focuses on value-adding processes, simplifying compliance, which in turn will simplify a transparency, speed the processing for businesses and for the Federal Government, and reduce 

cost, in the long run. 

Some of these efforts should include reassessing complex and 

outdated accounting standards, moving from rules-based to principle-based accounting standards, and promoting the use of plain 

English in disclosures, improving the ability of the average investor 

to read and understand accounting and auditing literature, and encouraging the use and acceptance of extensible business reporting 

language. 

I would make a parenthetical statement on the side, as somebody 

who has done a lot of work in manufacturing in the high-technology arena. Many of the manufacturing, production, and competiVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00011 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
6

tive processes that we need to compete in the global economy are 

not compatible with the prior generation’s forms of financial accounting. And what I saw many companies have to do was use a 

state-of-the-art production system, and import it into a prior generation’s accounting system for compliance with the Federal Government. And hopefully, we can see that simplified. 

In closing, I would encourage all members of the Capital Markets 

Subcommittee to co-sponsor H.R. 5024, and join me in making this 

a priority. I want to say thank you again to Chairman Baker and 

Ranking Member Kanjorski, and thank you to the members of the 

panels for joining us today. We look forward to hearing your 

thoughts on the progress made thus far, and the plan for the future. 

I yield back the remainder of my time. Thank you. 

Chairman BAKER. I thank the gentleman. Mr. Hinojosa? 

Mr. HINOJOSA. Thank you, Mr. Chairman. I thank you and 

Ranking Member Kanjorski for calling this Congressional hearing 

on fostering accuracy and transparency in financial reporting. 

I am looking forward to hearing the presentations by the Hon. 

Willis Gradison, as well as the Hon. Robert Herz, and Mr. Scott 

Taub. 

I think that this issue is something that is very important to the 

State of Texas. We have had so many working families lose the 

savings that they had, and I think that it is our responsibility in 

this committee to have the oversight in public company accounting. 

And I believe that your presentations will be very important to us, 

and I look forward to hearing them. I yield back, Mr. Chairman. 

Chairman BAKER. I thank the gentleman. Chairman Oxley? 

The CHAIRMAN. Thank you, Mr. Chairman. Sorry for being tardy, 

but I was busy bragging on the House Floor about the Republican 

victory over the Democrats in the basketball game last night— 

Chairman BAKER. I thought you were going to be talking about 

LSU in the final four, but that’s okay. 

The CHAIRMAN. Well, I will leave that up to you. But this game 

was all about bragging rights, so I took advantage of it in my one 

minute. I—probably because the gentleman from North Carolina 

didn’t play for the other side. I don’t know what ever happened 

with that. Does my friend from Massachusetts seek a— 

Mr. FRANK. Well, I just say to the gentleman, enjoy the gym 

while you can. 

[Laughter] 

The CHAIRMAN. Well, I joined my friend from Massachusetts and 

voted against that terrible rule. 

Welcome to all of our distinguished witnesses. We are here today 

to review the status of our public company financial reporting system. For over 70 years, public companies have been filing their financial statements with the SEC. Congress mandated these filings 

so that the investing public would understand the financial condition of public companies. And these statements and the explanations accompanying these statements are at the heart of investor 

disclosure. 

It is critical for investors making decisions about where to put 

their money, that these statements are readable, accessible, and 

meaningful. Although we have been—we have seen some bad acVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00012 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
7

tors purposely and fraudulently deviate from accounting standards, 

the complexity of these standards can also be a factor in undermining compliance in well-intentioned companies. 

I commend the FASB and the SEC for working towards reducing 

that complexity. I know we have had discussions ongoing on that 

very issue. 

One approach to clarifying financial statements that the SEC 

and FASB are encouraging is the adoption of a principles-based—

also called an objectives-oriented—accounting system. Far too 

often, we have seen companies engineer transactions to circumvent 

bright-line accounting rules, making any purpose behind these 

rules meaningless. 

Under the Sarbanes-Oxley Act, we asked the SEC to study the 

adoption of a principles-based system, and the SEC concluded in its 

report that such an approach should ultimately result in more 

meaningful and informative financial statements. However, this 

movement towards principles-based accounting requires more than 

just the efforts of our regulators. 

I encourage public companies, auditors, attorneys, and the securities industry to join in this initiative. There must be a concerted 

effort on the part of all market participants to move away from 

rules-based accounting and auditing standards to a principlesbased financial reporting system. 

I look forward to hearing from our witnesses on how we can most 

quickly and successfully adopt such a system. 

I would also like to commend the U.S. Chamber of Commerce for 

encouraging its public company members to cease issuing quarterly 

earnings guidance. It is too tempting, once that guidance is issued, 

for a company to manage its business to meet those short-term 

earnings numbers, rather than to manage its business for the longterm health of the company. 

This may lead to poor decisionmaking, but also sometimes to 

earnings manipulation. For the continued vitality of our capital 

markets, management and investors need to focus on long-term 

company health. One way, perhaps, to distance ourselves from relying on these quarterly earnings forecasts is to make progress toward real-time disclosure. 

Again, I must commend the SEC under the leadership of Chairman Cox, for promoting a new way to more easily digest and analyze financial information through interactive data, or an eXtensible business reporting language, XBRL. Interactive data will 

allow investors to quickly download relevant financial information 

into their own software applications for analysis. No longer will 

time and money be spent on entering financial data into spreadsheets. 

I look forward to hearing from our witnesses how they believe 

that XBRL will revolutionize the reporting and analysis of financial 

information. 

I would also like to thank our colleague and the chairman of the 

subcommittee, Chairman Baker, for holding this timely hearing. 

Chairman Baker has, once again, taken the lead in improving financial reporting for investors. He took an interest in XBRL years 

ago, when few understood its benefits, and thought it was probably 

8

some kind of a new car. And even fewer knew what it stood for, 

at that time. 

I again welcome our distinguished witnesses today, our former 

colleague, Bill Gradison, from the Buckeye State, and Mr. Herz, 

Bob Herz, who has been an outstanding leader at FASB. And I 

want to also welcome the acting Chief Accountant at the SEC, 

Scott Taub, for his efforts on our behalf. 

And with that, Mr. Chairman, I yield back. 

Chairman BAKER. I thank the gentleman for his leadership on 

this matter. Mr. Miller, did you have a statement? Mr. Scott? 

Mr. SCOTT. Yes, I thank you very much, Mr. Chairman. I want 

to thank you, Chairman Baker, and Ranking Member Kanjorski, 

for your leadership on this, and also Ranking Member Frank. And 

certainly Chairman Oxley, for the overall leadership in guiding our 

committee to this. 

This is an important issue to so many, particularly small business owners. As a small business owner myself, I know the issues 

that we are faced with. One of the biggest complaints that we get 

in the financial service industry itself, a lot of the smaller companies, it’s so complex, it’s difficult, it has sprung up a cottage industry of professional explainers that they have to spend extra money 

going to, which costs them dearly. 

And it is incumbent upon us to create more clear and accurate 

financial reporting. And I am very proud to join with my distinguished colleague from Kentucky, Mr. Davis, in working on a bill, 

Republicans and Democrats working together on a bill in a very 

strong bipartisan way that will require that the SEC and FASB 

and PCAOB provide an annual report to the Financial Services 

Committee. This will help us to keep our finger on the pulse, and 

be able to foresee problems as they develop. 

This is an ongoing situation as business continues to grow. We 

want to make sure that our markets maintain vibrancy. We want 

to make sure that they maintain liquidity, and we want to lessen 

the complexity of financial statements, while at the same time increase the usefulness of the information gathered. 

We have to also ensure that our reporting system does not lead 

to an overly hostile legal environment. And that is another complaint that we are getting, where auditors and accountants are 

afraid to provide information beyond, say, a rigid check-box system. 

More information is helpful for our investors. 

But at the same time, we should ensure that information is reported in a way that is accurate. And I am sure all of you and the 

panelists agree that clear regulation of the markets will help keep 

our economy and our financial system strong. We have several reform models going forward, and many of you are advocating those. 

We look forward to hearing your testimony on this very, very important matter. And I yield back the balance of my time, Mr. 

Chairman. 

Chairman BAKER. I thank the gentleman. Mr. Castle, did you 

have a statement? Mr. Cleaver? 

Mr. CLEAVER. Thank you, Mr. Chairman. I am not a member of 

this subcommittee, so I appreciate the opportunity to be here. 

The—I have been paying close attention to the Enron trial, and 

one of the most amazing things that I am hearing from people—

9

and perhaps it’s not anything unique to Kansas City, Missouri; it’s 

probably nationwide—and that is that there is still a great deal of 

concern out in the real world about whether or not we are continuing to get reliable and accurate information from the Herculean 

corporations like Arthur Andersen and MCI WorldCom, and other 

companies. 

So, I am here, in particular, to hear Mr. Gradison’s statement, 

because I think for most of us, particularly on this committee, who 

celebrate the fact that Sarbanes-Oxley came from this committee, 

that we ought to be in a position to go back home and say that 

there are real efforts being made to reduce the likelihood of this 

happening again. 

So, thank you, Chairman Baker, for the opportunity to be here, 

and to speak. 

Chairman BAKER. I thank the gentleman. There being no additional members with opening statements, I want to express to my 

first panel my surprise at the number of members who are participating this morning, and that we have members not on the committee attending. So it’s perhaps surprising to you that there is 

such intense interest among the members on this subject. 

And we are particularly grateful to have the regulatory panel we 

have here today, starting first with our distinguished former member, Hon. Willis Gradison, who served with distinguished service 

for many years here, and now serves in his capacity as acting chair 

of the Public Company Accounting Oversight Board. 

I know you are familiar with our customs, but for everyone, the 

formality is if you would proceed as you like, attempting to keep 

your remarks to 5 minutes, and your formal statement will be 

made part of the record. And we welcome you here. Please proceed, 

Mr. Gradison. 

STATEMENT OF WILLIS GRADISON, ACTING CHAIRMAN, 

PUBLIC COMPANY ACCOUNTING OVERSIGHT BOARD 

Mr. GRADISON. Thank you, Chairman Baker, Ranking Member 

Kanjorski, and members of the subcommittee and of the Full Committee. I am pleased to appear today to testify on accuracy, transparency, and complexity in financial reporting. 

My remarks address the auditor’s role in evaluating public companys’ application of accounting and financial disclosure standards 

and rules. I will also discuss PCAOB’s experience in establishing 

and monitoring the implementation of auditing and related professional practice standards, as they relate to audit quality. 

The Sarbanes-Oxley Act directed PCAOB to establish an auditor 

oversight program in order to protect the public interest. PCAOB 

is also responsible for setting public company auditing standards. 

And PCAOB is responsible for evaluating auditor application of 

these standards, to promote high-quality audits, audits that focus 

on preventing financial reporting failures that we saw in companies 

ranging from A to Z—Adelphia to ZZZZ Best. 

There has been a great deal of discussion about whether principles-based standards result in more accurate, reliable, and understandable financial statements than do prescriptive rules-based 

standards. True, principles-based standards allow more flexibility 

10

and professional judgement, but they can also lead to undesirable 

variability in results. 

On the other hand, rules-oriented standards may promote complexity, by encouraging companies to engineer transactions to 

achieve particular financial statement results. 

PCAOB has received many requests for specificity and for exceptions to existing auditing standards. We are mindful that granting 

these requests could result in overly prescriptive standards, rather 

than providing a framework for the exercise of appropriate, professional judgement. 

In my view, overly prescriptive auditing standards can actually 

weaken audit quality if they encourage auditors to focus on technical compliance, rather than the use of professional judgement. 

Merely completing a checklist of required procedures may not give 

the auditor the basis on which to form an opinion. Judgement is 

essential to the auditor’s formation of an opinion. 

To facilitate a smooth implementation of our auditing standards, 

the board and its staff have periodically issued guidance, giving 

careful attention to avoid detailed, rules-based or exceptions-laden 

approaches. 

In addition, PCAOB can see, firsthand, how auditors are implementing auditing standards through our inspections program. 

When PCAOB inspectors find significant auditing deficiencies, we 

invite the firm to comment. This comment process not only helps 

us to verify or modify our own assessments, but also helps firms 

to identify the causes of sub-standard audit work. 

Our inspectors discuss the relevant issues with firm representatives, ranging from the engagement team leader to the chief executive of the firm. Perhaps, more than anything else we do, it is our 

discussions with the firms that drive them to improve audit quality. 

In addition, the board is committed to educating and seeking 

input, not just from auditors, but also from preparers, investors, 

regulators, academics, and other users of financial statements on 

how to improve audit quality, and thereby protect investors. 

Whether through speeches or forums on auditing in the small 

business environment, or special reports summarizing inspection 

findings, PCAOB seeks to promote high-quality audits through its 

communication opportunities, only in cases involving more serious 

violations as the board relies on its various disciplinary tools. 

The debate over accuracy, transparency, and complexity in financial reporting has enhanced public companies’, auditors’, investors’, 

and regulators’ awareness of the challenges our financial reporting 

system faces. In my view, this is the beginning of a collaborative 

effort to find solutions to these challenges, including finding the 

right balance between principles-based and rules-based standards. 

I very much look forward to participating in the continuing dialogue, and want to thank you once again for the opportunity to address these very important issues. 

[The prepared statement of Mr. Gradison can be found on page 

64 of the appendix.] 

Chairman BAKER. Thank you very much, sir. For the purpose of 

introduction of our next witness, I call Mr. Shays. 

11

Mr. SHAYS. Thank you, Mr. Chairman. I am very pleased to introduce our FASB chairman, Robert Herz. And just to say, parenthetically, that being on the Financial Services Committee for 

someone in the fourth Congressional District is like being on the 

Agricultural Committee from Iowa. I have lots of opportunities to 

introduce people, but Mr. Herz, I take tremendous pride in the 

work that you do, the work that FASB does. 

Being from the fourth Congressional District, I know you live 

across the Hudson River in New Jersey, and that is still something 

that you need to think about. 

[Laughter] 

Mr. SHAYS. But your facilities in Norwalk, and what you people 

do, is terrific. And I congratulate you for a distinguished career as 

a senior partner with PricewaterhouseCoopers, as an author, and 

as an active participant in so many accounting industry organizations. 

I thank you for your good work. I appreciate you being here 

today, and all of us look forward to your testimony. 

Chairman BAKER. Please proceed, sir. But I might add, if Mr. 

Shays has gotten you into the relocation business, there are some 

really good buys down our way right now, so— 

[Laughter] 

Chairman BAKER. Please proceed. 

STATEMENT OF ROBERT H. HERZ, CHAIRMAN, FINANCIAL 

ACCOUNTING STANDARDS BOARD 

Mr. HERZ. Well, thank you, Congressman Shays, for that very, 

very kind introduction. Thank you for your long-standing support 

of our organization and our efforts. And thank you, Chairman 

Baker and Ranking Member Kanjorski, for inviting me here to participate in this very timely and important hearing. 

I think the enactment of the Sarbanes-Oxley Act, and the subsequent related actions by the SEC, the PCAOB, and by the FASB, 

as well as many reforms within the business community, have 

strengthened financial reporting and increased public confidence in 

reported financial information. 

However, we at the FASB, and we believe many others, think 

that there is much more work to be done to continue to improve 

financial reporting. 

In our opinion, the complexity that pervades the reporting system, as evidenced by the volume and detail of standards, rules, and 

regulations, now poses a major challenge to maintaining and enhancing the accuracy and transparency of financial information reported to investors, creditors, and to the capital markets. 

We are concerned that complexity has engendered a form over 

substance approach to accounting, auditing, and reporting, sapping 

professionalism and increasingly necessitating the involvement of 

technical experts to ensure compliance. 

Complexity has also added to the growing cost and effort involved in financial reporting, and is a contributing factor to the unacceptably high number of restatements of financial reports by 

public enterprises. 

12

Moreover, and perhaps most importantly, it results in analytical 

complexity for investors and others seeking to use financial information in their economic decisions. 

While some of the complexity is a natural consequence of reporting on diverse and complicated business transactions, I think there 

are many other sources of complexity in our system, including: the 

focus and emphasis on short-term earnings; the often conflicting 

perspectives and agendas of different market participants; an evolutionary approach to standard-setting that has resulted in nonconceptually-based compromises at times and inconsistencies over 

time; regular demands for detailed rules, bright lines, and exceptions, driven in part by the fear of being second-guessed, and in 

part by those seeking special treatments and exemptions; continuing use of accounting-motivated structuring in an effort to obtain form over substance results; and resistance to change, and 

slowness in embracing and implementing new technologies and reporting models. 

The FASB has recently undertaken a number of measures aimed 

at reducing complexity and improving relevance and transparency 

of financial reporting. First, we have been systematically readdressing specific accounting standards that are overly complex, 

are rules-based, and do not result in reporting that properly reflects the underlying economic activity. 

Major areas that we are currently readdressing include revenue 

recognition and accounting for pensions and other post-employment 

benefits. 

We also recently issued two new standards, and we have other 

active projects on our agenda, designed to improve and simplify the 

accounting for derivatives and other financial instruments. 

Second, we have undertaken a very major project to develop and 

maintain a comprehensive and integrated codification of all the existing accounting literature. That will result in an easily retrievable single electronically based source for all of U.S. generally accepted accounting principles. 

Third, we have been pursuing several activities directed towards 

the development of more principles-based, or objectives-oriented accounting standards, including a major project to strengthen our existing conceptual framework, that should provide a more solid and 

consistent foundation for the development of objectives-oriented 

standards in the future. 

Consistent with our commitment to international convergence of 

accounting standards, this project, like many of our other current 

major projects, is being conducted jointly with the International Accounting Standards Board, whose standards are in use in some 100 

countries around the world. 

Finally, while the development in the United States of XBRL has 

been under the direction of the XBRL consortium, the FASB has 

been working with the consortium, the SEC, and others, to further 

the use of XBRL and other evolving technologies in financial reporting. 

Now, as important as all those measures are, unfortunately, in 

my view, when taken alone, they are unlikely to significantly reduce the complexity that burdens the U.S. financial reporting system. In our view, that will require concerted and coordinated action 

13

by all key parties in the reporting system to address the structural, 

cultural, and behavioral forces that generate complexity and impede transparent reporting. 

Recently, we have been discussing the issues surrounding complexity with the SEC, with the PCAOB, and with many other interested parties. As part of those discussions, we have begun exploring the kinds of steps that might be necessary to identify the issues 

that lead to complexity, and to develop proposed solutions and recommendations. 

We believe that an initiative involving all key parties would be 

the most effective means to bring about broad-based improvements 

aimed at both reducing complexity and increasing the accuracy and 

transparency of financial reporting. While such an effort would not 

be easy, and would take time, we believe it is one of national importance. 

We look forward to continuing to work closely with the SEC, the 

PCAOB, this subcommittee, and all other interested parties, to ensure that U.S. financial reporting meets the needs of investors, 

creditors, and our capital markets. Thank you again, Mr. Chairman, and I will now yield to Mr. Taub. 

[The prepared statement of Mr. Herz can be found on page 72 

of the appendix.] 

Chairman BAKER. Thank you for your comments and your participation here today. 

And it’s my pleasure to introduce Mr. Scott Taub, acting Chief 

Accountant, Securities and Exchange Commission. Welcome, sir. 

STATEMENT OF SCOTT A. TAUB, ACTING CHIEF ACCOUNTANT, 

SECURITIES AND EXCHANGE COMMISSION 

Mr. TAUB. Thank you. Chairman Baker, Ranking Member Kanjorski, and members of the subcommittee and the Full Committee, 

thank you for the opportunity to testify today on behalf of the SEC. 

My name is Scott Taub, and I currently serve as the acting Chief 

Accountant for the Commission. With help from the approximately 

55 others in my office, I serve as the primary advisor to the Commission on matters of accounting and auditing policy, and the application of financial reporting and auditing standards. 

The past few years have seen unprecedented change in the financial reporting environment, but the SEC’s goal in this area remains 

the same: full disclosure by public companies of information that 

allows investors to understand companys’ operations and financial 

position, and to make informed investment decisions. For that to 

occur, the information that is presented in financial reports must 

be clear and informative, or as accountants use the term, ‘‘transparent.’’ 

Recently, in accordance with the Sarbanes-Oxley Act, the SEC 

staff released a report commonly called the Off-Balance Sheet Report, that notes that achieving transparency depends on the efforts 

of many parties. Preparers of financial information must focus on 

communicating with investors, rather than just complying with 

rules. The legal system must operate in a way that rewards and 

encourages the use of unbiased professional judgement, and preparers and auditors must be willing to make those judgements. 

14

Investors must be willing to make an attempt to understand the 

information presented to them, rather than simply looking to one 

figure, like earnings per share, in their analysis. And regulators 

must formulate a disclosure regime that requires disclosure of important information, without overburdening preparers or investors. 

Of course, good financial reporting also depends on strong accounting standards. U.S. GAAP represents a comprehensive set of 

standards, and is respected around the world. And development of 

GAAP has always appropriately focused on promoting transparent 

reporting. However, various factors have resulted in GAAP becoming a large and complicated body of literature. 

One of those factors that is highly visible today is the fear that 

market participants have of being second-guessed. This fear has 

helped create a demand for detailed rules, bright lines, and safe 

harbors that can overwhelm the basic principles that underlie accounting standards. 

Pressure on GAAP also comes from the way the market looks at 

financial information, such as its emphasis on short-term performance, and its rewards for predictability and consistency. These 

pressures have sometimes led to overly prescriptive rules, different 

accounting for economically similar transactions, and the inclusion 

in standards of exceptions from key principles. 

Many now are concerned that complexity is harming the quality 

of financial reporting, while simultaneously adding to its costs. 

Some contend that this complexity is a root cause of restatements, 

while others note that detailed and complicated standards can be 

used to hide information, rather than disclose it. Complex standards can also stand in the way of attempts by users to understand 

the effects of transactions and events. 

However, it is important that we do not simply look to the standard-setters to resolve the problems of complexity. The state of our 

financial reporting system is the cumulative product of pressure 

from many constituencies, and considered and coordinated action 

by all market participants is essential in order to move forward. 

Commission staff have been talking with many different parties 

about the need for such an effort, and we find widespread agreement amongst those in many different roles. We believe, therefore, 

that the time is right to encourage and foster a broad effort to address complexity and improve transparency. 

Also important is to make sure that the information that is provided can be used effectively. Today, through the use of interactive 

data, we can see the possibility for information filed on electronic 

reports to literally come to life. 

The best known and most advanced method for using interactive 

data is XBRL. XBRL uses identifying computer codes to tag data 

in financial reports, so that each piece of data carries a broad range 

of information about itself, such as whether it is a monetary item 

or percentage, an asset or liability, revenue or expense, and how 

the item is calculated. 

For the preparers of financial reports, interactive data could 

streamline the collection and reporting of financial information to 

the SEC and the public. And the use of interactive data in Commission filings could provide consumers of data real-time access to 

data in an instantly usable format. Those consumers, including anVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00020 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
15

alysts, investors, and others, could determine for themselves what 

data is important to them, and generate different types of analyses 

and reports with a minimum amount of effort. 

In recognition of the potential of data-tagging technology, the 

Commission established a program that allows registrants to voluntarily submit financial information in an XBRL format. The goal 

of the program is to allow preparers, users, and the SEC to better 

understand the issues surrounding XBRL, and evaluate its benefits. 

Approximately a dozen companies have submitted filings under 

the voluntary program, and Commission staff is currently working 

to increase the number of companies that participate in the program. 

In addition, beginning in June and continuing through the remainder of this year, the Commission will host a series of 

roundtables focused on the implementation of XBRL. Discussion 

will include: assessing what investors and analysts are looking for; 

finding ways to accelerate the development and use of software 

tools to permit the use of interactive data; and how best to design 

the requirements for company disclosures to take maximum advantage of the technology. 

As you can see, I believe that projects that reduce the complexity 

in reporting, and make financial information more user-friendly, 

have the potential to benefit investors and reporting companies, 

alike. The Commission, FASB, and PCAOB are all committed to 

the effort. 

However, we cannot fulfill the potential without the assistance of 

and input from investors, members of managements and audit committees, accountants, lawyers, analysts, and many other participants in the American securities markets. We, of course, will also 

highly value the views of Congress and other regulators and standard-setters. 

On behalf of the Commission, and myself, thank you for holding 

this hearing and highlighting these significant issues in such a 

timely manner. I look forward to answering any questions. 

[The prepared statement of Mr. Taub can be found on page 208 

of the appendix.] 

Chairman BAKER. Thank you, sir, for your comments this morning. Mr. Taub, I will start with you. It is my understanding that 

perhaps later this morning, the SEC may announce formally—I 

would call it a pilot program for the utilization of interactive data/

XBRL. 

Are you in a position to be able to comment further about the 

scope or intention of that activity? 

Mr. TAUB. I can, a little bit. We have been working to increase 

the number of companies that take advantage of the XBRL voluntary program, and we announced a couple of months ago that, 

for companies that were willing to file using an XBRL format for 

a year, we would be willing to give them expedited review status, 

such that if their filing was going to be reviewed, it would move 

to the front of the line, essentially. 

We have had a number of companies that have taken us up on 

the offer, and we do have an announcement planned for any 

minute now, as far as I know, that indicates the companies that 

16

have volunteered to participate. I think we have somewhere between 15 and 20 companies that have indicated a willingness to 

participate in the program, and we look forward to their input. 

Chairman BAKER. Do you see this as—if successfully implemented, is this a step leading toward more broad-based disclosure, 

using interactive data, or is this sort of a, ‘‘Let’s wait and see how 

this thing turns out,’’ at this point? 

Mr. TAUB. At this point, we are certainly in an evaluation stage. 

I think many of us at the SEC certainly believe that there are huge 

potential benefits of this, and hope to see it rolled out broadly. 

But there are certainly a number of hurdles and obstacles to 

broad implementation of this kind of reporting, and that’s the reason we’re hosting roundtables, to try to explore ways to get over 

some of those obstacles, and to make improvements in areas that 

are needed in order to make it such that we can roll it out much 

more broadly. 

Chairman BAKER. Thank you very much. Mr. Herz, in your comment—I take great interest in FASB’s views. 

The purpose of disclosure is to give the market an accurate picture of financial condition as of the date of preparation. With the 

current system, we manage that picture to be a 90-day snapshot. 

Some have suggested that if we move to a sort of real-time material fact disclosure, some of the more sophisticated financial enterprises, as of close of business 5:00, they know their position, internationally, where they are. 

If we assume that a company, in the first month of the next reporting period, lost its major customer, obviously a material fact to 

future viability. Today, that team has 68 days left to manage how 

they’re going to make that disclosure. 

If you only require disclosure of material fact—and I know the 

next question is, ‘‘Well, what constitutes material fact,’’ but assuming we can arrive at that—is it not advisable in the complex world 

we now face, with the extraordinary amount of data that is provided, to move to almost a daily snapshot to get out of this spike 

and trough mentality that seems to have substantial economic effect on capital markets without any real meaningful value to anyone, other than sharp speculators? 

Is that something, in concept, that a FASB principle could support, or what is it that we’re in pursuit of? If it’s to minimize complexity, what is the net principle around which the reorganization 

should center? 

Mr. HERZ. Well, thank you for that question. And I will answer 

partly, from my FASB role, but also partly from my prior involvement in some of these issues related to real-time reporting, and 

richer reporting of other key performance data, non-financial data, 

as you say, material information. 

I think, probably just a factual matter first—I might refer to—

check with Scott—but there are some things that are material 

events that the SEC does require on what they call an 8K. And I 

think those are within, generally, 5 days now, which may include, 

for example, the loss of a major customer. But it’s not a comprehensive reporting, as you are envisioning on a daily basis of financial 

position, and changes in that financial position on a daily basis. 

17

I certainly believe that is the kind of world we want to move towards. I am not certain at this point whether the infrastructure 

has developed in order to do that. I think we would have to think 

about all the components of that infrastructure, including to what 

extent that ought to be attested to or not attested to, what periodicity that ought to have, what level of detail, you know, which 

components of that, should it be a full integrated set of financial 

statements on a daily basis, or not, or whatever. 

But there are clearly, evolving over time, more and more information that goes out to the market, both from companies and from 

other people following companies and people who follow industry 

trends, who follow weekly car sales, you know, all sorts of book-tobuild ratios, that kind of thing. And that, to me, certainly seems 

to be the future that we ought to be trying to evolve towards. 

But getting there, and the infrastructure needed to support that, 

I think are—still require some thought and development. 

Chairman BAKER. I thank the gentleman. My time has expired. 

Mr. Kanjorski? 

Mr. KANJORSKI. I feel a little perplexed, because I was going to 

suggest what would be the advantage for the American economy if 

we ended the quarterly reporting, and went to the yearly reporting, 

so we didn’t have this tremendous effect on Wall Street, just by not 

considering some of the plans and conditions a company has laid 

in place to accommodate. It seems we’re accounting for that quarterly release all the time. 

You would like to go on a 24/7 schedule? Wouldn’t that cause a 

great fluctuation in the marketplace? 

Mr. HERZ. Well, I think we have to decide as to, really, whether 

or not—you know, how the market wants to operate, in terms of 

investment in securities, and people changing investments in securities. 

If the market continues to operate the way it does now—and I’m 

not making a normative judgement, one way or the other, on 

that—I would see the path one of more frequent reporting. But it’s 

kind of like if you have a game, you want to have the play-by-play 

as it goes along. Right now, what we seem to have is, in the quarterly earnings guidance, it’s kind of saying, ‘‘Here is where I’m 

going to end up at the end of the quarter,’’ rather than, I think as 

Chairman Baker is suggesting today, ‘‘Where am I,’’ and then people do kind of a Kabuki dance around that expected number. 

Mr. KANJORSKI. I am just curious as to whether or not you think 

that would affect the long-term—the difference between long-term 

planning of corporations and investments, or responding to the immediate play-by-play situation, for purposes of the effect on the 

market. 

Isn’t that part of the criticism in our system today, that we are, 

unlike Japan in many ways, that they plan for long-term investments, and long-term considerations, and as a result, they sometimes, at the end of the day, may beat us on the field, when you 

take the whole game, as opposed to the play-by-play? 

Mr. HERZ. Well, certainly that is a consideration, I mean, I think 

ultimately you would want to design a system where the shortterm reported results are consistent with the long-term, people understanding what the long-term strategy is, and what the benchVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00023 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
18

marks towards that are, being able to evaluate progress towards 

that. 

Mr. KANJORSKI. I guess, being a politician, I am sensitive to the 

24/7 news cycle, and not at all certain that that has helped in national policy. It seems that everybody has a headache every day as 

a result of everything, as opposed to sitting back and having it 

given to you in a comprehensive way, with potential solutions for 

problems, as opposed to just hearing problems. 

I haven’t given a lot of thought, but day-to-day accounting, that 

would be interesting. I should imagine that those people have nothing else to do in life, but sit and read those statements every day 

would find that enjoyable, but I suspect that a good portion of their 

lives would be taken up with that endeavor. That’s interesting. 

Do you have any thought on whether or not we could go back to 

the yearly reporting, final reports, as opposed to these games we 

play that everybody—it seems to indicate in Enron and so many of 

the other companies, they were trying to beat the analysts on Wall 

Street. And as a result, they were finding clever mechanisms to use 

to do that. And I think we even have that in Fannie Mae. There 

was too much of a concentration on anticipating what the earnings 

figure would be, and they wanted to make adjustments to miss 

that. 

Mr. HERZ. I think that is part of the issue, continues to be part 

of the issue. People make a projection for what the end of the quarter results are going to be, or the annual result is going to be, and 

then at least—and this experience is a little bit dated, from when 

I was in practice, but I—people tell me this still happens—that if 

you don’t make the numbers based on just the business flow, then 

you try next to alter the business flow. You may try and accelerate 

sales, and the like. 

If that still doesn’t work, some people have tried to find ways 

to—through accounting, either aggressive or stepping over the 

line—to try and make those numbers for the quarter. But it’s like 

trying to predict the outcome of a basketball game, you know, once 

the first ball is dribbled. 

Mr. KANJORSKI. Mr. Gradison, did you have a comment on that? 

Mr. GRADISON. Thank you. I think, in many respects, we have to 

start by focusing on the investors. Who are they? What are their 

interests? Are they short-term or long-term? And then, what kind 

of information are they looking for? 

One thing that has struck me in the years that I have been involved in this—and I used to be in the investment business in an 

earlier life—has been what I perceive to be a shift towards investors in major companies having a very short-term focus. 

The turnover rate of holdings, for example, of investment companies is much higher today, as I read the numbers, than it was 

many years ago. And so, I think that the reaction of reporting companies has to be thought of in terms of what—not just what the 

market in general wants, but who is holding their shares, what are 

their interests, and are they long-term or short-term? 

The only other point I would make is that—and I think this is 

just reinforcing a point already made—is the distinction between financial information, which is reported quarterly, and other very 

important information, which may not be strictly financial: ‘‘Did 

19

you lose’’—‘‘Did the customers like the widgets,’’ as Chairman 

Baker said. 

And I think that while the auditors—who are the folks that we 

oversee—are, by their very nature of their work and responsibilities, focused on the financial reporting—and that’s very important—there are other things which, in many cases, will be every bit 

as important, sometimes more important, that bear upon the reaction of the markets, and the desire of—the desires of investors, 

with regard to what kind of things they want to know about. 

Chairman BAKER. The gentleman’s time has expired. Mr. Shays? 

Mr. SHAYS. Thank you. I would like to pursue this issue a little 

more in depth. And it’s my understanding that the Chamber is basically recommending the elimination of the forecast, and particularly the quarterly, earnings. And it does relate to this whole issue 

of whether the marketplace gets manipulated because of it. 

So, I would like to know your opinion about the Chamber’s view. 

And then I would like to ask why investors seem to look so much 

at the superficial. Because it seems to me, anyone who is investing 

a lot of money would probe deeper, and understand what is actually happening. Why don’t we start with you, Mr. Taub? 

Mr. TAUB. Thank you for the question. I think it is an excellent 

one. 

To me, as I look at what happens in the market, it isn’t necessarily the mere fact that there was an earnings forecast that is 

the problem, it is what happens after that, the management of the 

numbers to then meet that forecast. 

At the SEC, we have long been on an effort to stamp out socalled earnings management that happens around those numbers. 

Mr. SHAYS. Let me just interrupt you. Is it difficult for the investor to know that it is being manipulated, or is it relatively self-evident? 

Mr. TAUB. I think that it all depends, frankly, on the sophistication of the way that the management is done. Certainly, we have 

tried to require disclosures, as has the FASB, to give people information that will at least let them evaluate what is happening with 

these numbers. 

But it is something that really is—many people say you can’t legislate ethics, and that is a problem— 

Mr. SHAYS. Let me ask Mr.—I’m sorry, I have such little time, 

here. Mr. Herz, the answer to the question? 

Mr. HERZ. Well, I guess, it’s a free country, so people can give 

whatever forecasts they— 

Mr. SHAYS. I would like to know what you think of the recommendation of the Chamber. 

Mr. HERZ. Well, I agree with that recommendation, personally. 

Of course, we at the FASB do not—that’s not our role, per se. 

Mr. SHAYS. Okay. 

Mr. HERZ. But I personally agree with that, from what I have 

seen are some problems around that whole process. 

Mr. SHAYS. Then explain to me why the investor can’t see 

through the manipulation. 

Mr. HERZ. Well, the— 

Mr. SHAYS. Or whether you think they actually can. 

20

Mr. HERZ. The investors—I think investors who keep enough of 

a tune on the company may be able to. 

For example, there are various ways you can manage earnings 

in a ‘‘legal’’ way. Like I said, accelerate sales, cut expenses. But 

you’re kind of robbing from Peter to pay Paul in the— 

Mr. SHAYS. We are doing that. But is it evident to the investor? 

Mr. HERZ. I think the investor who follows the company may be 

able to do it. I think the investor who—if the company is transparent in its disclosure, for example in its quarterly MDTA disclosure, those kinds of things are supposed to be talked about. 

Mr. SHAYS. Okay. 

Mr. HERZ. If the company is just plain violating rules, that may 

not be found out until there is an audit, or until the SEC finds it 

out. 

Mr. SHAYS. Or it may never be found out. Mr. Gradison, any 

opinion? 

Mr. GRADISON. I think it’s very hard for the investors to tell. For 

one thing, as more disclosure takes place, and you could see it in 

the annual reports and in the proxy statements; they’re getting 

thicker and thicker—there is more and more information out there. 

But then the question arises, how many folks are really analyzing 

that? 

And there is a real question, how many public companies, out of 

the 15,000 or whatever public companies, really have sponsorship 

in the sense of analysts professionally analyzing these things as 

they come out? I don’t mean to minimize the number, but it certainly is not 15,000. 

And so, for the average investor, trying to sort through these 

numbers is, in my opinion, well nigh impossible. 

Mr. SHAYS. Okay. Let me close with you, Mr. Herz, and just have 

you speak briefly about what you’re trying to do to codify all existing accounting literature to reduce this complexity. In the short 

time that I have left, could you just talk a little about it? 

Mr. HERZ. Yes. I need probably about a 2-minute history lesson 

here, that what we call generally accepted accounting principles is, 

as Scott mentioned, something like over 2,000 separate pronouncements that emanated from many different bodies—not just the 

FASB and predecessors, but the AICPA in different forms, task 

forces, the SEC in various forms, over a long period of time. 

And they were written in different ways to different depths, different levels of coverage. And we are now taking all of that and resorting it by topic in a structured way, so that it will now be almost 

like chapters. It will be electronic, but you will have a chapter on 

inventory accounting, and it will have a standard structure with all 

the other chapters, so people will know exactly what the sum total 

of GAAP is in that area. 

And by doing that, we also feel we will probably come across certain conflicts between different— 

Mr. SHAYS. Right. 

Mr. HERZ.—pronouncements, which we will have to resolve. 

Mr. SHAYS. Great. Thank you. Thank you, Mr. Chairman. 

Chairman BAKER. The gentleman’s time is expired. Mr. Frank? 

Mr. FRANK. Thank you. I was listening to my colleague, and I 

was intrigued by this Chamber position. I think it makes a great 

21

deal of sense. Of course, the problem is that people will be in a 

competitive situation, and no one company will want to—or two 

companies do it. 

I am wondering whether we might not institute a situation 

where, yes, companies are free to do that, but inaccuracy could lead 

to a suspension of the right. That is, we might say, ‘‘If you have 

a pattern of inaccuracy and you have to restate at some point,’’ you 

might give the SEC the authority to say, ‘‘Well, we are going to 

suspend that.’’ I think that’s something to be examined. 

But let me ask related to that, to what extent does the linkage 

between the compensation of the two or three top executives in the 

company add to the problem of the inaccuracy here? Mr. Gradison? 

Mr. GRADISON. Well, I have to focus—will focus, of course, on the 

role of the auditors in this regard, because that’s what we do. And 

the role of the auditor with regard to disclosure of compensation 

basically comes down to whether that information is disclosed in 

the 10K’s and the financial reporting, or whether it is disclosed 

separately through the proxy statement. 

If it is in the financial statements, then the auditors have a responsibility to read these disclosures and to consider whether they 

are consistent with the auditors’ knowledge that was gained during 

the financial statement audit. 

If, on the other hand, they are in the proxy statement— 

Mr. FRANK. Who decides now where they are? The company? 

Well, let me put it this way. Should we require, then, that they be 

in the financial statement so they can get that kind of scrutiny? 

Mr. GRADISON. I would imagine that would be up to the SEC to 

make that determination. 

Mr. FRANK. Well, sometimes they let us make decisions too, Bill. 

[Laughter] 

Mr. GRADISON. We certainly follow any decisions you make, sir. 

Mr. FRANK. Right. But what about from the—given what you 

say, that where they are determines whether or not they are 

auditable. Would it make sense, in your judgement, for us to put 

them in a place where we—that would be audited? 

Mr. GRADISON. Yes, it would. 

Mr. FRANK. All right. Let me go back—and I just want to follow 

up on what my colleague from Connecticut said—on the question 

of stock options, because this is—we’re talking about accuracy, and 

I think, in the years I’ve been here, the biggest single dispute over 

accuracy really was over how you reported stock options. Is that 

still—is undoing that decision in—still on the table, or is that now 

an accepted fact? 

Let me go down the list. Mr. Taub, start with you. 

Mr. TAUB. I guess, to my mind, it isn’t on the table. There is certainly nothing that I am aware of that the FASB is currently considering, as far as potentially undoing— 

Mr. FRANK. Let me ask Mr. Herz. Are you aware of any effort 

to overturn that decision? 

Mr. TAUB. Not that I am aware of. 

Mr. FRANK. Yes. Mr. Herz? 

Mr. HERZ. No. We still get some grumblings from certain folks, 

but everybody is doing it now, and— 

Mr. FRANK. All right. Mr. Gradison? 

22

Mr. GRADISON. The question this year for auditors, as they finish 

up their work, is whether they find problems in terms of simply the 

calculations, the application— 

Mr. FRANK. Right. I think that’s important, and I think—I would 

hope we could all move on to the next phase. This is now one of 

those questions that has, for now, been settled and I think settled 

forever. But I would hope that it would now be a genuine collaborative effort of the three of your operations and the private sector 

to refine that. 

Before I go on to my next question, Mr. Taub, in his absence—

would you just convey to your chairman my appreciation of the 

very decisive way in which he acted when subpoenas were issued 

to journalists? I think that what Mr. Cox did in that case was a 

very good demonstration of the appreciation of a free press. 

And I just wanted to say publicly that I—you know, it’s not easy. 

I understand. And he is the chairman, and he has staff to work 

with, and these are not people who did something malicious. It was 

not easy to do what he did, and I appreciate that he did it. 

Let me just ask, finally, with regard to executive compensation, 

what’s the status of the SEC’s current proposal to make it more 

transparent? 

Mr. TAUB. We issued proposals in January of this year. The comment period extends another 10 days or so, it expires on the 10th 

of April. So, we are, of course, actively seeking comments. 

I am sure the Commission will seriously consider all of the comments that are received. The release that came out when we proposed the rules indicates that we hope to have the rules in place 

for the 2007 proxy season, and I believe that certainly is still the 

hope. And we will actively be considering this issue on— 

Mr. FRANK. All right. Let me finish up. I appreciate that. I hope 

you will move forward with them. I think there is a great deal of 

support for it. 

Beyond that, it would then lead to another issue that had come 

up under the previous chairman, and I think it may come up again, 

and that is once that information is out there, I think it will—some 

people will not be surprised; some of it may be new. 

The question, then, of the accountability of the board of directors 

to the stockholders will again be on the table. Because some people 

have said, ‘‘Well, what’s the point of giving us that information, we 

the stockholders, if we have directors who are immune if we don’t 

like it? And if our votes as stockholders are essentially about as 

useful in electing directors as the voters of Belarus in electing a 

new president, then you have given us ice in the winter. You have 

given us information which we are unable to use.’’ 

So, I hope that we will then take the logical next step—and 

again, I think this is totally consistent with a free market, this advances a free market, none of this involves any government restriction on what corporations can do. What we are talking about is, I 

think, recapturing some of the power for the stockholders that has 

been taken away from them. 

So, I think the transparency, I hope, will go forward. But I hope 

it will then be given some muscle by improving the ability of the 

stockholders to act vis a vis the board of directors if they don’t like 

what they see. 

23

Chairman BAKER. I want to make clear that, as one of the proponents of not expensing in the last Congress, that I am very interested in that accounting assessment and real world implementation 

consequences, and don’t want the chapter to be closed, and not acknowledge the gentleman’s concern about it being a resolved issue. 

It is resolved, but absent the knowledge that it actually is working without adverse economic consequences, and absent that, I certainly concur with the gentleman’s agreement. But I want to reserve, as one engaged in this effort on the other side, that should 

there be a showing that there is a concern, then we need to come 

back and talk about it some more. 

The gentleman—I would be happy to yield, yes, the gentleman 

from— 

Mr. FRANK. If the gentleman would yield, I would concur with 

the philosophy we all know about, that it ain’t over until it’s over. 

So— 

Chairman BAKER. That’s the kind of music I like to hear. I thank 

the gentleman. Mr. Scott, I believe, is next. Excuse me, Mr. Cleaver, you were actually next in line. Did you have— 

Mr. CLEAVER. I have no questions. 

Chairman BAKER. Mr. Scott? 

Mr. SCOTT. Yes, thank you very much, Mr. Chairman. I would 

like to ask my first series of questions about what we refer to as 

XBRL, in our efforts to make this more simple and less complex. 

I think it refers to extensible business reporting language. And I 

hope we—I hope this technology will help us in that regard. 

But let me ask you first of all, Mr. Herz, and each of you, if you 

could respond to this, would the cost of implementing XBRL be prohibitive for some issuers? 

Mr. TAUB. I will give you a few things that we have found out 

from our voluntary program. We have had about a dozen companies that have participated. 

In general, their response has been that the cost was perhaps 

slightly more than negligible, but certainly not to the point where 

it would be prohibitive. A couple of large companies have indicated 

an all-in cost, dollar-wise, of something in the $25,000 range, and 

time-wise, once an employee is trained on how XBRL is used, it’s 

6 to 8 hours each time a report needs to be prepared. 

Mr. SCOTT. Mr. Taub, given the fact that while we are on CSPAN, and I don’t question the fact that our ratings are sky-high, 

and everybody is watching across America, but let’s assume that 

there are some people who are very much interested in this hearing. Could you just give a brief explanation of what we are talking 

about, when we refer to XBRL? 

Mr. TAUB. What XBRL does is, through a glossary that’s known 

as a taxonomy in technology circles, it assigns a definition, as it 

were, to each piece of information. And that definition would carry 

with it information, then, about the item that is tagged with that 

definition, such that what happens is a user of financial information, rather than pouring through a bunch of reports to pull, let’s 

say, revenue data from a number of companies, can instead use a 

piece of software that would go out and find that data for whichever companies the user wanted. So, it greatly reduces the time 

needed to collate data and do analysis. 

24

Mr. SCOTT. As you know, several of us—this whole committee, as 

a matter of fact, and certainly the bill that Mr. Davis and I are 

putting forward—our aim is to simplify and make it clearer. But 

can the taxonomies of XBRL be effectively used by a wide variety 

of issuers? 

Mr. TAUB. That’s an excellent question. And indeed, the issues 

with regards to taxonomies are amongst the things that we plan 

to discuss at the public roundtables that we have. There has been 

a lot of discussion about how to improve the existing taxonomies, 

and how to design industry-specific taxonomies, to make sure that 

all companies will have taxonomies they can use. 

Mr. SCOTT. Okay. Would you like to comment on that, Mr. Herz? 

I have a couple of more points and my time—the chairman moves 

with an iron fist here, so if you could be brief and answer that, I 

have a couple of more questions, too. 

Mr. HERZ. Well, I agree with what Scott said. I think one of the 

things that needs to be focused on is the taxonomy development, 

which is, as I understand at this point, not complete in certain 

areas. And that may be a partial barrier to further expanding the 

use of XBRL into the SEC’s fine voluntary filer program. I think 

there is some effort needed to take it to the next level. 

Mr. SCOTT. Okay. Now, let me ask the gentleman this question. 

Will efforts, these efforts to simplify financial reporting, be conducted in conjunction with international standard-setters? 

Mr. HERZ. Yes, that’s also an excellent question. And certainly, 

I am a big proponent of that being done. We have a real opportunity, to the extent that the simplification would result in kind of 

a revised way of reporting, and even a revised architecture of reporting, to make that international, almost like, you know, the old 

hard-wire and telecom going to cellular. You leap-frog a whole generation, and you can make it by building it in, you can make it 

international. 

We work very closely with the International Accounting Standards Board to come up with common accounting standards and financial reporting standards. To the extent that we do that, 

XBRLizing those, the same data definitions would apply commonly. 

Mr. SCOTT. My time is about to run out, but I do want this final 

question, because auditors are very concerned about this. 

Are auditors at too much risk for being sued over their best attempts at meeting the reporting requirements? 

Mr. GRADISON. I think, Congressman, that the question of liability hangs over the work of auditors every minute of the day. The 

responsibilities of auditors, at bottom, are based upon principles 

that involve the exercise of professional judgement, and the exercise of professional skepticism. 

Auditors have to decide, case by case, the scope, extent, testing, 

and timing of testing of major categories. These are judgement 

calls. And there are legitimate reasons for them to be concerned 

that, after the fact, they may face serious financial risks if they 

miss something. 

So, I think we have to recognize that is a fact of life, and would, 

frankly, strike me as a subject that you all might want to take a 

look at quite separately from some of the other things that we are 

talking about today. 

25

Mr. SCOTT. Yes, absolutely. If I may, while the chairman is talking there, let me proceed for a second. 

[Laughter] 

Mr. SCOTT. What would you recommend that we could do to lessen the liability of the auditors? 

Mr. GRADISON. I don’t have any specific answer to give to you 

right now. I do think that it is an entirely proper question, especially since our role is providing oversight of the auditors under the 

general supervision of the SEC. 

And I think that it would be entirely appropriate if you wanted 

to, perhaps in a different context, for us to think together about 

that issue. It is an extremely important question. It is related not 

just to the workings of the court and the liability issues alone, but 

also to the form of organization of the accounting firms which operate in the former partnerships, or limited partnerships. And that 

is not unrelated to the question that you are asking about. 

In many instances, these organizations are fundamentally self-insured for their very major risks, because of the uncertain nature 

of claims that might be brought against them, as well as the historical experiences of the Arthur Andersens of this world. 

Mr. SCOTT. Yes. So they are at risk. We need to take a look at 

it. Let me ask you one question about FASB, before I— 

Chairman BAKER. And this will be your last one. I finally— 

Mr. SCOTT. This will be my last one. Thank you, Mr. Chairman. 

I appreciate it. As you know, I am very interested in this issue 

here. 

But Mr. Herz, you are with FASB. Do you believe that FASB, or 

any other standard setter, can gain the cooperation of the private 

sector to make the necessary changes in our reporting system? 

Mr. HERZ. I believe so. I think that from my discussions with 

many parties—some of whom you will hear from in the second 

panel—and from discussions with my colleagues in the SEC and 

the PCAOB as well, that I think that the time is right to sit back 

and get together and think about, you know, where the system is 

at, and where it is going, and make the kind of improvements that 

would both reduce complexity and improve the usefulness and 

transparency of reporting. 

So, I am definitely a guy with the half—the glass half full on 

that subject. 

Mr. SCOTT. Thank you, Mr. Chairman, for your kindness and 

generosity. 

Chairman BAKER. Yes, sir. And Ms. Velazquez? 

Ms. VELAZQUEZ. Thank you, Mr. Chairman. Mr. Gradison, I just 

would like to—for you to discuss how complying with SarbanesOxley, in particular, section 404, requires substantial resources, 

both in terms of personnel and costs. 

While large companies can more easily absorb these compliance 

costs through existing resources and professional staff and budget, 

many of the smaller cap companies, however, do not have resources 

to comply with this act, and must hire outside attorneys and accountants. 

Can you tell me how significant these complying costs have been 

in deterring private companies from going public and causing 

smaller companies to go private? 

26

Mr. GRADISON. There is no question that in the first round of the 

application of section 404, which occurred last spring, the costs 

were far higher than any estimates that I was certainly aware of. 

It was the first time out. 

On May the 10th of this year, the SEC and the PCAOB will be 

hearing from more than 50, I imagine, witnesses or panelists in a 

day-long session to find out what happened the second time 

around, with regard to costs. 

We did receive encouraging comments a year ago, in April, when 

the previous roundtable was held, that costs were going to come 

down, costs that are borne internally within the companies, the 

cost of consultation from outside, and the auditing costs. And you 

know, we will see. 

The PCAOB has not been satisfied, was not satisfied with the 

first round. And this was made clear by guidance which was issued 

on May the 16th of last year, as well as our November 30th report. 

Our inspectors are going to be going into the field in just a few 

weeks, and they are going to be using a very different approach in 

reviewing the work done by auditors with regard to section 404 

than was used by our inspectors last year. All of our people are 

going to be trained in looking at this. It will be part of an integrated audit, integrated with the review of the financial statements, whereas last year, we did it in a separate manner. 

We are going to be expecting the firms to use a top-down riskbased approach to focus on the significant accounts. But in particular, we are using a word which isn’t—doesn’t have a lot of history in the auditing literature, and that is, ‘‘efficiency.’’ We are 

looking for evidences of efficiency by the auditors, which may relate 

to your question. 

I think in May there will be a lot more information than is available now to help answer your very appropriate question. COSO is 

working on a new framework, or revised framework, that may be 

helpful to smaller enterprises. The GAO is completing a report 

mandated by Senators Enzi and Snowe, with regard to the impact 

of Sarbanes-Oxley on small business. The SEC’s advisory group 

will be coming in with a report. 

And so, while there is certainly information out there —frankly, 

on both sides—about the effectiveness, we will have a much more 

complete picture of that very, very soon, and look forward to sharing those results with you. 

Ms. VELAZQUEZ. I would like to discuss the SEC advisory committee on smaller public companies’ proposed recommendations to 

provide relief for small companies. 

The foundation of the proposal is a new definition for smaller 

public companies. It defines smaller public companies as those comprising the lowest 6 percent of total U.S. equity market capitalization. Do you believe that this proposed definition fairly represents 

the universe of small companies, public companies? Mr. Gradison 

and Mr. Taub? 

Mr. GRADISON. Well, I will have to pass the ball to— 

Ms. VELAZQUEZ. Sure. 

Mr. GRADISON.—Scott Taub on this, simply because that group 

was created by the SEC, and the specific recommendations to 

27

which you refer, as I understand them, would be entirely within 

the purview of the SEC, rather than the PCAOB. 

Mr. TAUB. Thank you for the question. We are watching very 

carefully, and eagerly awaiting the recommendations of the advisory committee. Certainly at this point, the draft recommendations 

do include the types of delineations that you have suggested. 

One of the things that one needs to think about if we were to 

use those kinds of delineations is what does it mean. Okay, a company is deemed a smaller public company, then the next step is 

what is different in the reporting framework about being a smaller 

public company, rather than an accelerated or larger company. And 

indeed, the committee’s draft recommendations would include a 

number of suggestions for differences that would apply to the 

smaller public companies. 

It’s probably inappropriate for me to start commenting on recommendations that, indeed themselves, have not yet been finalized. 

So let me just say that we are eagerly awaiting those recommendations. And although there is no set time table for considering them, 

I would suggest that we will be doing so on a timely basis. 

Ms. VELAZQUEZ. Thank you. 

Mr. GRADISON. Perhaps I could add just a word, and that is that 

our intention with regard to the standard that was already issued, 

and is now in effect, was in no way that it should be a one-sizefits-all approach. Rather, that it should take into account the size 

and complexity of the enterprise. 

And speaking for myself, I am totally open to the possibility of 

revisions in the standard, if it appears that they are necessary in 

order to accomplish that goal. We have had the goal in mind all 

along. Now, whether we did it right is a matter to be determined. 

Ms. VELAZQUEZ. Mr.—yes, okay. Thank you very much, Mr. 

Chairman. 

Chairman BAKER. I appreciate the gentlelady yielding back. Ms. 

Wasserman-Schultz, did you have a question? 

Ms. WASSERMAN-SCHULTZ. Thank you, Mr. Chairman. If—the 

question I had relates to the impact that financial reporting standards has on the private market pension system, and if you all could 

comment on what the long-term, or systemic impact you think that 

there is on the private market pension system, as it relates to financial reporting. 

Mr. HERZ. Well, thanks for that question. We are, I think, this 

Friday going to issue a proposal that would essentially put on sponsors’ balance sheets the net under or over-funded position of their 

defined benefit pension plans, and post-benefit retirement plans. 

And that’s the first phase of a more comprehensive project to relook 

at the accounting for those kinds of plans. 

Now, our mission, of course, is to improve the financial information that goes to investors in the markets. And certainly, we have 

gotten a lot of commentary, not only from investors, but many 

other people—and the SEC, in their off-balance sheet study—that 

this is an area where the existing accounting is in need of significant improvements. So this is our step towards that, our first step 

towards that. 

I have heard all sorts of—you know, as I have talked about this 

with groups—potential, you know, impacts. One, of course, is the 

28

better information that the investors, the creditors, and the employees will better be able to see the extent of the underfunding, 

and how that affects the sponsor’s financial position, whether they 

actually seem to be in a position to carry out those promises that 

they have made. 

There has been a movement for many years, long before we even 

took up this project away from defined benefit pension plans. The 

kind of statistics that I have been told is that when ERISA was put 

in in the early 1970’s, something like over 40 percent of the covered 

work force was covered by members in a defined benefit pension 

plan. That is now down to something like 15 percent. 

And of that 15 percent, a majority of those are plans to incorporate or replace the more traditional defined benefit arrangement 

with what’s called a cash balance plan, which is closer to the defined contribution plan. So there are—the defined benefit plans 

have already been shrinking a lot. 

Clearly, with the increased transparency, we have seen this in 

other areas, when you make things more transparent and the accounting better, it often does have behavioral reactions and reactions by the companies. Some companies may decide to terminate 

plans or freeze benefits, and the like. But we will have to see. 

Ms. WASSERMAN-SCHULTZ. Could you comment on whether you 

think there are negative incentives in the underlying accounting 

standards that affect the situation? 

Mr. HERZ. Yes. And obviously, we have—in being advised by 

many parties about the existing accounting standards, and pointing 

to some of its flaws, some have pointed to behavioral issues related 

to the existing accounting standards. 

One of the aspects of the existing accounting standard is that it 

does what’s called a lot of smoothing over time, and part of that 

smoothing involves an estimation over a long period of time of an 

assumed rate of return on the plan assets. 

And that rate of return, the way the mechanics of the existing pension accounting work is that—let’s say you had $1 billion in 

plan assets, big company, and you assume a long-term rate of return of 8 percent, based upon your 60 to 40 equity to fixed income 

mix. The accounting says you can, immediately for that year, accrue income of $80 million. Yet the performance of the plan might 

be negative that year. Say it goes down by $100 million, the plan 

assets, the market goes down, the interest rates go up and the 

bonds decrease in value. That difference of $180 million then gets 

spread over a long period of time. 

So, some people believe that that long-term rate of return mechanism and assumption drives people to over-investing in what, you 

know, riskier investments, rather than match-funding the liability, 

for example. 

Now, our purpose is not to change, you know, directly, that behavior. But when you change the accounting, behavior does change. 

Ms. WASSERMAN-SCHULTZ. And lastly, not to prolong this, Mr. 

Chairman, but I don’t know whether you have mentioned this; 

what can be done to resolve some of these issues? 

Mr. HERZ. Well, of course, there are many things going on. Our 

function is to try and improve the accounting. We—as I said, our 

first step is to actually put on the balance sheet, pretty squarely, 

29

the company’s position with regard to those plans, how underfunded are they. You know, generally in most cases, they are underfunded. 

The bigger question is what to do in the earnings statement, and 

that will be phase two of our project. Do you eliminate all of that 

smoothing, and just let the change in the year-to-year value of both 

the assets and the obligations flow through earnings? Do you get 

rid of the assumed rate of return assumption? But that will require 

a lot of study. 

Now, of course, there are other things going on, including bills 

here in Congress that I understand are in conference right now, to 

hopefully put some more health into the underlying system to increase the funding and the like, and encourage employers to get to 

a better position, vis a vis the plans. 

Ms. WASSERMAN-SCHULTZ. Mr. Chairman, I see that my time has 

expired. However, I would be remiss if I did not close, before I yield 

back, by saying, ‘‘Go Gators.’’ 

Chairman BAKER. I can overlook that remark. Thank you. 

[Laughter] 

Chairman BAKER. There being no other members with questions, 

I want to thank you for your participation. I would like just to 

make one observation that I think needs to be made, and hasn’t 

been part of the hearing to date, in that there is another advantage 

of this XBRL business on the other end of the pipe from the corporations. 

Today, the casual investor, interested in an investment potential, 

will be delivered a large envelope full of very complicated material 

that, frankly, most people just put back down. They will call their 

broker, perhaps. They will talk to a friend. But that data doesn’t 

translate to any ability to compare that corporation’s performance 

to anyone else. 

What I believe the advantage XBRL will offer is the ability of a 

person who is using a laptop, who is using a MacIntosh, who is 

using an IBM, whatever they are using, it’s an interpreter between 

whatever system the corporation may be using, the computer system, when they enter it. It then will sort it out, so if it needs to 

go to the regulator, it goes to the regulator. If it’s in the public domain, it’s in the public domain. 

But when I sit down at my coffee table with my laptop, I can get 

access to information to compare Corporation A—let’s assume it’s 

an auto company—with all other auto companies in that sector, or, 

with a specific auto company. I can compare Chrysler with GM and 

get comparability. 

So, I think the biggest net gain, besides reducing cost to corporations, ultimately, in data preparation, is to empower the individual 

investor to get accurate, closer to real-time information that enables that person to make a more informed decision, perhaps as 

well as nothing else has been able to do that in the past. 

And that’s my sales pitch to the committee about why XBRL ultimately offers some advantage. And if you choose to comment, fine. 

None required. But I think that’s a point that had not been made 

in the hearing to date, and I think it important. 

The fact that we now have a vote pending, I want to thank this 

panel for your participation—you have been very helpful—and anVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00035 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
30

nounce to our second panel that we will recess briefly to make the 

vote and come back so that the members of the second panel may 

attend to necessary things while we are gone. We should be absent 

no more than 10, 15 minutes, and we will return. I understand it’s 

just one vote. The committee stands in recess. 

[Recess] 

Chairman BAKER. I want to thank the members of the panel for 

their participation here today. As you have noted, despite expectations, there has been a lot of member interest in this topic, and we 

certainly appreciate your market perspectives in how we should 

move forward, if we should move forward with any modifications 

to the current reporting methodologies. 

To that end, I want to recognize Mr. David Hirschmann, who is 

the Senior Vice President, U.S. Chamber of Commerce. And please, 

proceed as you wish, sir. 

STATEMENT OF DAVID HIRSCHMANN, SENIOR VICE 

PRESIDENT, U.S. CHAMBER OF COMMERCE 

Mr. HIRSCHMANN. Mr. Chairman, thank you very much. I am, as 

you mentioned, David Hirschmann, senior vice president at the 

Chamber, the world’s largest business federation, representing 

more than 3 million businesses. 

I am here today to share our views on how to improve auditing 

and accounting procedures, and ensure the viability of the auditing 

profession, which we think is threatened, and encourage a greater 

focus on long-term performance measures to help investors, companies, and the economy. 

First, I will—let me address the widespread practice of projecting 

a company’s future earnings as a way to inform and guide investors. In fact, this practice is inherently flawed. Earnings guidance 

is a precise measurement, down to a penny or two per share, based 

on educated accrual estimates about the value of income, expenses, 

liabilities, assets, such as pensions, oil reserves, and bad debt, just 

to name a few. 

It used to be that companies were encouraged to manage these 

earnings. They would have a few honest, legitimate, acorns in the 

basement, as the saying goes, to support 1 or 2 cents of earnings 

per share for a rainy day. As one former auditing executive put it, 

‘‘Analysts viewed any CEO who couldn’t legitimately legally manage earnings within a penny or two to meet forecasts as not being 

in touch with what was happening at the company.’’ 

But in the current accounting environment, there are no acorns. 

And anyone who tries to create them is asking for trouble. Quarterly earnings guidance misrepresents a company’s true financial 

strength, and puts pressure on executives to meet quarterly expectations. Companies often sacrifice creating long-term value, if it 

means missing quarterly projections. And that is a disservice to the 

company and to investors. 

Instead of issuing earnings guidance, companies should better 

communicate their strategies and objectives, and come up with alternative benchmarks that will show real progress towards meeting 

those goals. More communication, and not less, between companies 

in the investor community is needed. And that is why the SecuriVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00036 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
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ties and Exchange Commission should re-examine regulation, Fair 

Disclosure Regulation, FD. 

This regulation, passed with legitimate intention of leveling the 

information playing field, so that a favorite analyst or investor 

would not receive better or more timely information. Unfortunately, 

in part due to the way this rule has been enforced at the SEC, it 

has the unintended consequence of restricting and reducing communication. 

We also support efforts by Chairman Cox to move to clearer and 

easier forms of electronic communication between companies and 

investors. XBRL is one example, and proves the capability of the 

market to assess information and reward those companies that are 

doing well. 

XBRL, which has been championed by AICPA and others, will 

help everyone better assess financial statements. But the smart 

money will still take the time to carefully understand industry factors and long-term strategy. 

Let me move to the second area, which is the area of fair-value 

accounting. The concept of developing well-reasoned estimates for 

certain intangible assets and liabilities, and including them on the 

corporate balance sheets. There are, no doubt, limitless things that 

could be both estimated in companies, and added to the financial 

statements. And many of them would be well consistent with 

GAAP. 

However, we can’t lose sight of the fact that they are estimates. 

The move towards fair-value accounting should be tempered by a 

thorough examination of the implications, both to business and investors, of adding another imprecise estimate to the financial statements. 

In multiple arenas, companies are being required to develop systems for assigning and estimating values to such items, and thereafter continually reassessing and revaluing those items. These educated guesses generate additional risk for companies and their 

auditors. 

If someone thinks the guess is wrong, the company will be sued. 

When the company relooks at the guess, any significant change will 

create volatility in the financial statements, creating both stock 

price and generating more lawsuits. 

Fair value accounting also puts great pressure on the auditing 

profession to certify the appropriateness of these value estimates. 

These estimates are purely hypothetical, and not at all indicative 

of the true cash flow that a company expects to receive or incur. 

The U.S. Chamber will be asking both FASB and the International Accounting Standards Board to recognize their efforts to 

create a perception of accounting precision which may have potentially significant consequences for both companies and investors. 

While the push towards fair-value accounting may be theoretically 

pure, and even desirable in some cases, the costs may end up being 

much greater than the benefits. 

Finally, the business community has great concerns about the future of the auditing profession. In the post-Sarbanes-Oxley litigation and regulatory environment, auditing firms are under attack 

from several different parties. Much of this criticism results from 

erroneous perception that there is precision of financial reporting. 

32

Also, there is pressure on auditors to do more when conducting 

audits. This has resulted in higher audit fees for their clients. Even 

as the auditing costs have increased, however, clients are receiving 

less overall advice and support from their auditors, because of 

auditors’ legitimate fear of litigation, or being second-guessed, or 

having questions raised by the SEC and the PCAOB about their 

independence. 

The cumulative result of all of this is the very real potential in 

the near term for further concentration of the auditing profession. 

There are now only four major firms serving a large majority of the 

listed and actively traded public companies in the United States. 

Further contraction of this profession would threaten its viability, 

and could shake public confidence in our capital markets. 

The Chamber has issued a number of recommendations for fortifying the auditing profession. First, the profession should become 

insurable against catastrophic litigation. Second, the PCAOB 

standards should be further clarified. And third, we need an expansion and greater competition among the big four accounting firms. 

In the interest of time, I will not go into detail to all—in all our 

recommendations. But I have provided them to the committee as 

an attachment to the formal statement, which I know will be included in the record. 

In conclusion, Mr. Chairman, the United States Chamber of 

Commerce is fully committed to highly accessible, transparent capital markets, and we will leverage our full resources to ensure accounting and auditing practices that are necessary for achieving 

this goal. Thank you very much for the opportunity to speak today. 

[The prepared statement of Mr. Hirschmann can be found on 

page 149 of the appendix.] 

Chairman BAKER. Thank you very much for your statement, sir. 

Our next witness is Mr. Marc E. Lackritz, president of Securities 

Industry Association. Welcome, sir. 

STATEMENT OF MARC E. LACKRITZ, PRESIDENT, SECURITIES 

INDUSTRY ASSOCIATION 

Mr. LACKRITZ. Thank you, Mr. Chairman, and thank you very 

much for the invitation to testify today. SIA, and our over 600-

member firms, share your interest in improving the clarity and the 

relevance of financial information, and we applaud you for holding 

this very timely hearing. 

As financial intermediaries, Mr. Chairman, our livelihood depends on the quality, consistency, and reliability of financial information. Indeed, our capital markets are the envy of the world, precisely because the quality of information has continued to evolve 

and improve. We are eager to work with your subcommittee, other 

Members of Congress, regulators, and all interested parties, to further improve the quality of financial information. 

Our markets have thrived largely because of investors’ ability to 

obtain, digest, and appropriately price securities derived from information about companies and the economy. Three factors allow information to flow fully, efficiently, and fairly. 

First, companies have powerful motives to disclose information. 

Certainty, clarity, and comparability in the disclosure of financial 

information lowers the cost of capital. 

33

Second, the Federal securities laws have long buttressed the efficient flow of information to the markets, especially by punishing 

the dissemination of deliberately false information. 

And third, our markets have excelled in embracing advances in 

technology, from the telegraph to the Internet. This has enormously enhanced the capabilities of market participants to receive 

and absorb information in their trading decisions. 

Now, none of this would be possible, Mr. Chairman, without the 

public’s trust and confidence that all market participants adhere to 

stringent rules, vigorously and fairly applied. A key element of 

public trust is access to reliable and timely information, both by 

the public directly, and by investment advisors, mutual fund, pension, and 401(k) plan managers who manage trillions of dollars of 

savings. 

At a time when nearly 57 million American households, or more 

than half of all U.S. households, own stock, directly or indirectly, 

the securities industry is committed to ensuring that individual investors can achieve their financial goals, such as planning for a 

child’s education, or for a comfortable retirement. With 76 million 

baby boomers hurtling toward retirement, we recognize that the 

quality of information must be paramount. 

Current information in the marketplace comes from three basic 

sources: regulated disclosures, voluntary issuer guidance, and research analysts’ reports. In total, all this information comprises a 

comprehensive and effective disclosure regime. 

Although we believe the SEC’s current financial disclosure regime works exceptionally well to provide the highest quality information to investors, we do support the SEC and, Mr. Chairman, 

your recent technology initiatives such as the use of XML tag data, 

to make it easier for investors to compare companies. 

We do not believe, however, that it is necessary to mandate any 

additional disclosure of financial information at this time. High 

quality accounting standards are absolutely critical to ensuring 

that financial reporting results in clear, timely, and relevant disclosure to users of financial statements. 

We believe accounting standards can be improved in three ways. 

First, by using fair value to measure all financial instruments. Secondly, by simplifying standards. And third, by converging differing 

national standards. SIA believes that using fair value forces firms 

to confront adverse market movements at an early stage, and gives 

investors an earlier warning of developing problems. 

We also agree with regulators that disclosures that provide insight into an entity’s risk position and exposures, could enhance 

regulatory and market discipline. Similarly, accounting standard 

setters, regulators in the private sector, have all recognized the 

benefits that would result from a more principles-based approach 

to accounting. 

Principles-based accounting standards are more consistent and 

comparable, and will allow investors to more easily analyze and 

compare investment choices, and make fully informed decisions. In 

addition, such improvements in global accounting standards will facilitate the seamless flow of capital across national borders, as well 

as reduce the costs of providing relevant information to investors. 

34

In addition to the SEC-mandated quarterly reporting, many corporate issuers voluntarily provide periodic earnings guidance. 

Guidance is not mandated by statute or regulation. But most companies choose to provide this information in response to market demands. 

Recently, several large U.S. issuers have discontinued the practice of issuing earnings guidance, in favor of issuing more detailed 

performance information. We believe the decision to issue earnings 

guidance should rest with the issuer, and should not be mandated 

by law or regulation. 

The current system of financial disclosure has served investors, 

issuers, and the securities industry extraordinarily well. We believe 

that the greater use of fair value accounting, and the simplification 

and convergence of accounting standards would further assist 

issuers in providing better quality information to investors. 

We look forward to working with you, Mr. Chairman, and the 

committee and the Congress, as well as investors, issuers, accountants, and regulators, to further improve the quality, consistency, 

and clarity of information, so that we can maintain the global preeminence of the U.S. capital markets. Thank you very much. 

[The prepared statement of Mr. Lackritz can be found on page 

154 of the appendix.] 

Chairman BAKER. Our next panelist is Colleen Cunningham, 

president of Financial Executives International. Welcome. 

STATEMENT OF COLLEEN CUNNINGHAM, PRESIDENT, 

FINANCIAL EXECUTIVES INTERNATIONAL 

Ms. CUNNINGHAM. Thank you, Mr. Chairman, for this opportunity to appear before you today. My name is Colleen 

Cunningham and I am the president and CEO of Financial Executives International. FEI is the leading organization of about 15,000 

members, which includes CFO’s, treasurers, controllers, and other 

senior financial executives. 

FEI members represent the preparer community. That is, the 

senior financial executives responsible for the preparation of financial statements. Importantly, we’re also users of financial statements relying on financial statements of other companies in our investment and credit decisions. 

In both roles as a preparer and user, we applaud the goal of today’s hearing. I am pleased to share FEI’s views with you today on 

the important issue of fostering accuracy and transparency in financial reporting. 

The complexity and technical demands of accounting standards 

have increased considerably in recent years to the point where 

many otherwise capable accountants are no longer confident that 

they can apply the new requirements without outside assistance 

from subject matter experts. This is happening at a time when, in 

the United States financial reporting environment, there is heightened sensitivity and attention given to accounting and financial reporting. 

FEI believes that undue complexity harms, rather than enhances, the ability of users of financial statements to understand 

the information provided by financial reporting. Simple, easy-to-understand standards should be our mutual goal. 

35

FEI concurs with the views of the leaders of the SEC, the FASB, 

the PCAOB, and all interested—that all interested parties must 

come together to address what I like to call the complexity conundrum. We applaud the FASB’s current projects on simplification 

and codification, and the conceptual framework. They should go a 

long way towards enabling preparers, auditors, and users of financial statements to find applicable accounting literature. 

However, when the rules themselves are unduly complex, they 

impede the ability of preparers to provide accurate and transparent 

financial reporting. No doubt, the growing complexity of business 

transactions adds to the challenge of developing appropriate accounting standards. 

We’re currently operating in an environment where companies 

are second-guessed by their auditors, perhaps third- and fourthguessed by various regulators, such as the SEC and PCAOB, and 

then maybe fourth or fifth-guessed by the plaintiff’s bar. Is it any 

wonder there are constant requests for bright lines and interpretations by auditors and preparers to seek additional guidance to ensure that they are doing the right thing? 

Additionally, overly theoretical standards can result in financial 

reporting of questionable accuracy, and create a significant cost 

burden with little benefit to investors. Even simple, principlesbased standards can create undue complexity in their implementation. 

For example, a simple principle—record everything at fair 

value—may be incredibly complex to apply, and imprecise, particularly when there is no ready market for the underlying transaction. 

This operational complexity cannot be ignored as principles-based 

standards are created. 

I would like to quickly highlight four potential solutions to this 

complexity conundrum, which are discussed in greater detail in my 

written testimony. 

Number one, the need for FASB to prioritize its conceptual 

framework and codification project, and follow with principlesbased rulemaking, which must be practical in application, and understandable by preparers, users, and auditors, and result in information that is auditable. While this will be helpful going forward, 

existing standards would also need to be addressed in the context 

of a new conceptual framework. 

Number two, the need for regulators to avoid second-guessing 

reasonable interpretations of standards, and avoid issuing informal 

guidance for significant matters that could lead to a large number 

of restatements. 

Number three, the need for Congress to assist in correcting today’s litigious environment. 

And number four, the need for preparers, auditors, and users of 

financial statements to be part of the solution, by educating themselves about changing accounting and auditing standards, participating actively in the standard-setting process, and making recommendations for simplifications and transparency in accounting 

standards in their financial reports. 

In conclusion, FEI believes that it is feasible to reduce the complexity of financial reporting standards, and make them easier and 

less costly to find, understand, remember, and implement. But to 

36

do so will require a concerted effort among all financial reporting 

stakeholders, many of whom are here today. 

I support the SEC’s encouragement of studying the use of interactive data, such as XBRL, and the benefits it can provide. However, I urge a note of caution, that technology is not a panacea, and 

that transparency provided through electronic links, or the oldfashioned way, through non-linkable disclosure, will not reduce the 

operational complexity imposed on preparers to develop the numbers provided in financial reports. Nor will such transparency improve the understandability of underlying numbers to investors. 

The creation of a special committee with wide representation 

from all constituencies to address the full breadth of the complexity 

conundrum can help us arrive at practicable solutions that will reduce the level of complexity with respect to existing standards, and 

at the same time, maximize the utility of financial reporting to investors. Everyone has a role to play in this effort to reduce complexity, and FEI is ready to be part of it. 

That concludes my remarks. I want to thank the chairman and 

the members of the subcommittee for inviting us to participate in 

today’s hearings. 

[The prepared statement of Ms. Cunningham can be found on 

page 53 of the appendix.] 

Chairman BAKER. Thank you very much. Next, I welcome Barry 

Melancon, president of the American Institute of Certified Public 

Accountants. Please proceed, sir. 

STATEMENT OF BARRY MELANCON, PRESIDENT, THE AMERICAN INSTITUTE FOR CERTIFIED PUBLIC ACCOUNTANTS 

Mr. MELANCON. Thank you, Mr. Chairman, and members of the 

subcommittee. My name is Barry Melancon, and I am president 

and CEO of the American Institute of Certified Public Accountants. 

On behalf of the 330,000 members of the AICPA, I truly appreciate the opportunity to present testimony to this subcommittee 

about increased accuracy, accessibility, and transparency in corporate, financial, and other business information, including non-financial information, that is useful to investors and other users in 

making decisions. 

I request that my written statement and its exhibit be made a 

part of the official record of this hearing. 

The existing financial reporting model provides a solid foundation. Today, the nature of modern corporations, how they are managed, and the evolving performance indicators that senior executives routinely use, however, underscored the need for an expanded 

reporting model. 

Third party research shows that for many companies, only 25 

percent of an entity’s market value can be attributed to accounting 

book value, with the remaining 75 percent based on value drivers, 

such as strategy, distribution channels, product innovation, people, 

and customer loyalty. 

Research also tells us that only about one-third of the value drivers generally associated with industry sectors are published in formal filings. 

As you, as chairman of this subcommittee, has said, if U.S. markets are to remain on top in an increasingly competitive global 

37

marketplace, we need to move away from the complex and cumbersome, and explore technological and other methods of enhancing 

the clarity, accuracy, and efficiency of our accounting system. 

We agree with this position, and have been actively working for 

more than a decade to draw meaningful progress toward a more 

relevant, reliable, understandable, timely reporting model. 

In 1993, the AICPA’s special committee on financial reporting—

which is better known as the Jenkins Committee, named after its 

chairman, former FASB chairman, Ed Jenkins—published a report 

dealing with improving business reporting. We have undertaken 

many other activities since the Jenkins Committee, which led to 

the AICPA establishing the enhanced business reporting consortium, a market-driven collaborative effort involving corporations, 

investors, the accounting profession, and other key participants in 

the corporate reporting supply chain. 

The consortium aims to achieve the right mix of fully disclosed 

high-quality information made possible not only by adding critical 

information that is not currently disclosed, but also by advocating 

for improvement in the consistency and relevancy of existing disclosures. The consortium is on the cutting edge of developing internationally recognized voluntary framework for the disclosure of key 

business information, in addition to traditional financial statements. 

We believe that transparency can be further enhanced through 

a stronger focus on the quality, not quantity, of reported information. 

In addition, the enhanced business reporting consortium’s reporting simplification task force, made up of accountants in business 

and industry and public practice and FASB staff, and observers 

from SEC staff members, who provide valuable input, intends to 

make thoughtful recommendations for simplifying existing disclosure requirements based on research findings. 

I was happy to hear this morning the considerable discussion on 

XBRL. The AICPA charted the XBRL international consortium in 

2000 to foster the global growth and adoption of XBRL, extensible 

business reporting language, which we started in 1998. XBRL is a 

language for the electronic communication of business and financial 

data. It is the technology that enables more efficient and effective 

financial and non-financial business reporting. My written testimony contains details on how XBRL operates, and exactly what it 

is capable of doing. 

Today, investors, lenders, and other users of the information, 

need to make decisions much faster and more often, based on what 

may happen in the future, rather than what has occurred in the 

past. 

I am pleased to say that this is no longer just a dream. Coupled 

with enabling technologies like the Internet and XBRL, enhanced 

business reporting will provide users the breadth of information 

they require, at the speed that they need to be successful in today’s 

economy. 

We believe that the benefits will include reduced uncertainty, 

lower market volatility, and a decline in the over-emphasis on 

quarterly earnings. With richer information, investors can be encouraged to take a longer-term view. 

38

Your efforts to stimulate meaningful dialogue about enhancing 

transparency and reducing complexity will contribute significantly 

to creating a reporting model that meets today’s market needs. We 

likewise believe that involving more market participants in the development and adoption of enhanced business reporting and XBRL 

will contribute to providing investors with a financial reporting system that is transparent and more reliable. 

The AICPA wants the promise of enhanced business reporting 

and XBRL to be realized as quickly as possible. We are looking forward to working with this subcommittee, the SEC, FASB, corporate 

America, the investment community, and public accountants to 

make this happen. I will be happy to answer any questions that 

the members of the subcommittee may have. 

[The prepared statement of Mr. Melancon can be found on page 

166 of the appendix.] 

Mrs. BIGGERT. [presiding] As you can see, I am not Mr. Baker 

any more, but I am happy to be here. Next, we have Ms. Rebecca 

McEnally, director of capital markets, Policy Center for Financial 

Markets Integrity, the CFA Institute. You are recognized for 5 minutes. Thank you. 

STATEMENT OF REBECCA MCENALLY, DIRECTOR OF CAPITAL 

MARKETS POLICY, CENTER FOR FINANCIAL MARKETS INTEGRITY, CFA INSTITUTE 

Ms. MCENALLY. Thank you. I am happy to be here today, Chairman Baker, Ranking Member Kanjorski, and members of the subcommittee. I am Rebecca McEnally, director of capital markets policy for the CFA Institute Center for Financial Market Integrity, 

and we do appreciate this opportunity to testify. 

The Center was established to promote the highest standards of 

ethics, integrity, and professional excellence in the global investment community. It shares this goal with its parent, CFA Institute, 

which is a non-profit organization of more than 81,000 investment 

professionals in 126 countries. 

CFA Institute is widely recognized as the organization that administers the chartered financial analyst examination, and awards 

the CFA charter, a designation that I share with nearly 68,000 professionals worldwide. 

High quality financial information is critical to the work of our 

members and other investors. So, for more than 3 decades, members of CFA Institute have been actively involved in the public debate about how best to improve financial reporting standards and 

disclosures. 

The corporate reporting scandals and bankruptcies over the past 

few years have underscored how crucial clear, accurate, and complete financial reporting is to the health and wellbeing of capital 

markets. The U.S. standard setters, principally the FASB and SEC, 

as well as the IASB, have made good progress in improving the 

clarity and accuracy of financial reporting. 

But they would agree with us that a vast amount remains to be 

done. To help propel their efforts forward, the center recently released its White Paper, a comprehensive business reporting model 

which was developed by our global panel of experts. The paper outlines 12 principles that we believe would greatly increase the clarVerDate 0ct 09 2002 13:00 Nov 06, 2006 Jkt 030174 PO 00000 Frm 00044 Fmt 6633 Sfmt 6633 F:\DOCS\HBA088.160 HFIN PsN: TERRIE
39

ity, accuracy, and completeness of financial reporting. My written 

statement summarizes these principles, but I will highlight a few 

of them here. 

First, we believe that financial statements should be prepared 

from the perspective of the common stock owner, the last residual 

claimant on the company’s resources. Share owners can’t properly 

evaluate a company’s potential risks and returns unless the statements completely and accurately reflect both the assets available 

to the company, and the claims of all others that must be settled 

before those of the common share owners. 

In this regard, financial instruments, pensions, and leases were 

listed as items requiring attention in the SEC’s report, which was 

submitted to the House Financial Services Committee in June of 

last year. These need to be fully reflected in the financial statements, and not hidden in the footnotes. These items are at the top 

of our own list, as well, and we’re pleased that the FASB is moving 

forward on them. 

A second principle is that items in the financial statement should 

be measured at fair value. The reason for this is a simple one. The 

only information that is useful for financial decision-making, including investment decisions, is fair value information. And because the financial statements are investors’ major source of information, items in these statements should be measured at fair 

value. 

Doing so would remove one significant source of complexity in financial reporting, that which derives from the mixture of both historical cost and fair value measurements. 

For example, if all the financial instruments were to be measured at fair value, as we have argued for some time, there would 

no longer be the need for highly complex hedge accounting for 

those positions that are hedged. Neither would there be an accounting mismatch that could lead to unintended consequences. We 

were pleased to learn that the FASB and IASB last October reaffirmed their commitments to fair value reporting for all financial 

instruments, and are working jointly to resolve the remaining 

issues. 

A third principle is that all changes in assets and liabilities 

should be recorded in a single new financial statement, which we 

call the statement of changes in net assets, available to common 

share owners. This statement would build upon and expand the reporting in the current statement. 

A current hot topic of discussion is whether company managers 

should provide quarterly earnings forecasts to analysts, investors, 

and the markets. Two weeks ago, we asked our global membership 

if this practice should be discontinued. And we were not surprised 

to learn that three quarters of those responding said, yes, it should 

be stopped. 

For those who answered yes, we also asked if companies should 

provide additional information on the fundamental longer-term 

drivers of the business, and 95 percent said yes. 

We conclude from these results that our members find little 

value in the current earnings guessing game, but they would value 

clear and timely information on the basic economic factors that affect the company. 

40

I commend the subcommittee for your leadership in addressing 

investors’ concerns about the accuracy and transparency in financial reporting. I appreciate this opportunity to provide the views of 

CFA Institute, and I look forward to responding to any questions 

you may have. Thank you. 

[The prepared statement of Ms. McEnally can be found on page 

183 of the appendix.] 

Mrs. BIGGERT. Thank you very much. I will now recognize myself, since there is nobody else here. 

First of all, Mr. Melancon, AICPA’s consortium has been a leader 

in promoting the use of XBRL. Where do you see the XBRL development going in the next few years? 

And, second of all, do you see a more systematic adoption of 

XBRL leading to real-time financial reporting? 

Mr. MELANCON. Well, XBRL is an enabler. I think you have to 

look at XBRL in concert with what are we reporting, and that’s 

why I would say an enhanced business reporting to get away from 

just an earnings number, but key economic value drivers of a business. 

I think that programs such as the FDIC’s use of XBRL for call 

report filing shows the use of and the efficiency of using XBRL. I 

think that will continue and grow. I think the SEC, and certainly 

Chairman Cox, have been tremendous supporters of it. They have 

a voluntary program now. And I think that it’s important to find, 

in various components of government, incentives to encourage people to use this on a voluntary basis. And I think companies, in fact, 

will do so. 

Clearly, more work needs to be done. It has come an incredibly 

long way in a relatively short period of time. And 1998, I would 

dare say that very few people would even know what XBRL was, 

and today it’s being adopted throughout the world, and certainly in 

many corners of the U.S. regulatory process, as well. 

I think also that there is work to be done in the area of taxonomy development. And it takes the involvement of all of the people in the supply chain area. And it will also be used in areas that 

are not related, necessarily, to the topic of this hearing, which is 

more on the financial and GAAP basis. But, for instance, the IRS 

is involved in it, for the use of compliance work in that area, making things more efficient from their own enforcement perspective. 

So, a lot of work to be done in areas such as taxonomy development, but tremendous progress, as well. 

Mrs. BIGGERT. Are there any other challenges that companies 

will face in implementing XBRL? 

Mr. MELANCON. I think it was reported by Scott Taub at the earlier panel that, at least in the pilot, the companies that have been 

using it from an SEC perspective have found the cost—I think his 

term was, ‘‘slightly more than negligible.’’ 

I think that it really is a notion of a wider knowledge of it. I 

think the building of the taxonomies, I think, clearly, the leadership of members of this committee, of Chairman Baker, and of 

Chairman Cox at the SEC, helped to make it much more accessible, much more known. And therefore, I think that bully pulpit 

is a very important aspect to getting it adopted and being widely 

known. 

41

Mrs. BIGGERT. All right, thank you. Then, Mr. Hirschmann, the 

Chamber has been at the forefront of convincing public companies 

to cease issuing quarterly earnings guidance. And as you stated in 

your testimony, this practice of issuing these quarterly earnings 

guidance is detrimental to the long-term health of our capital markets. 

Some of our largest public companies have agreed, and have 

stopped issuing such guidance. Would you elaborate a little bit on 

the Chamber’s initiative? 

Mr. HIRSCHMANN. Thank you. We think all parties have a responsibility here. Companies have a responsibility to step forward 

and stop issuing earnings guidance. We are using our bully pulpit 

at the Chamber to create some room for them to do so. 

We believe the SEC has a role to play in making it easier for 

companies to communicate with investors, by reforming Regulation 

FD. We believe the analyst community has a responsibility by focusing on longer-term growth opportunities in companies. And 

we’re looking at long-term performance, and we know that the better analysts already do. So, I think there is a role for everybody 

in the financial system to achieve this. 

Companies—fully a quarter of the larger companies—have already stopped issuing earnings guidance. Those that have, have 

found it greatly advantageous. The real challenge is with smaller 

companies, who fear that they will lose coverage by the analyst 

community, and that that is the one way they can get their story 

out. 

Efforts like what AICPA is leading on, enhanced business reporting, provides them a better way to get their story out, certainly 

much better than simply focusing on short-term earnings guidance, 

which is really a fool’s game. 

Mrs. BIGGERT. Do you—well, and this is for the rest of the panel, 

too—do you think that managers, in doing the quarterly earnings 

guidance, sometimes make business decisions that may not be in 

the best long-term interest of the company, by having to do that 

every quarter? Mr. Lackritz? 

Mr. LACKRITZ. Well, I think we have to remember that there is 

going to be—we need a balance here that’s going to work in the 

marketplace. 

You know, on the one hand, we get concerned about issuers and 

demands on the issuers, but we have to remember there are 57 

million households out there that own securities, directly or indirectly. And they need good information on which to base decisions. 

So, on the one hand, if we’re concerned about a short-term mentality because of quarterly reporting, the answer is not to eliminate 

quarterly reporting and make it longer in between periods. I mean, 

it would almost be like saying, ‘‘Let’s not have the sun rise every 

day, because it creates too short a day.’’ 

I mean, the answer really is to encourage better, more frequent 

reporting of quality, you know, high-quality, comparable, consistent 

information. And I think we have to make sure to keep investors 

in this equation, because the marketplace really functions most effectively and allocates limited capital most effectively with the 

highest quality information. 

Mrs. BIGGERT. Okay, thank you. Ms. Cunningham? 

42

Ms. CUNNINGHAM. Sure. I think a lot of what has been said already. I think more communication of strategy, vision, enhanced 

business reporting model, and operating metrics, rather than reporting a number, will go a long way towards enhancing transparency and accuracy. 

And I do think, though, that, you know, companies, in a lot of 

instances, particularly the smaller companies, do feel trapped in 

that if they don’t provide it, they won’t get the coverage. Therefore, 

they take a hit on their stock price there. 

I think investors really need to recalibrate their current shortterm focus as well, to one that’s more focused on the long term. 

Mrs. BIGGERT. Thank you. Mr. Melancon? 

Mr. MELANCON. I would agree, that the focus on a single number 

is problematic. And the disclosure and finding ways to cost effectively do that, hopefully through the use of technology, on some key 

drivers of the company, what senior management looks to, that can 

be fully disclosed and give investors, those millions of households, 

a peek into the company as to what’s important. 

I think by moving away from a single number, we actually reduce some volatility, but at the same time, help people focus on a 

longer term. And that is absolutely important. And I think that, 

you know, let’s go along with our notion that it is not necessarily 

more—not necessarily a volume of information, but a mount of digestible, accurate information that people can use to make good decisions. 

Mrs. BIGGERT. Ms. McEnally? 

Ms. MCENALLY. Thank you. I think we need to make a very clear 

distinction here between giving earnings guidance and the quarterly reporting that is essential to the valuation of investments. 

Investors require not only clear, accurate, and complete financial 

information, but they have to have timely information. Otherwise, 

markets can’t be efficient, and investors can’t do what they have 

to do to properly allocate their capital. 

So, I would not want there to be any confusion at all between the 

issue of earnings guidance and the requirement for clear, complete, 

quarterly information. 

Mrs. BIGGERT. Thank you. Then Mr. Lackritz, could you explain 

why principle-based accounting standards would assist investors in 

analyzing investment choices between countries with different regulatory regimes and different accounting standards? 

Mr. LACKRITZ. Sure. I think the key here is that we need to move 

toward converged—or at least comparable—kinds of standards, because that’s going to facilitate the seamless flow of capital. 

If you have principles-based accounting standards, it will make 

it easier to converge those standards from differing jurisdictions, 

number one. Number two, it will provide more opportunity for 

CFOs and companies to use their judgement, which of course, everybody is running away from now, because of the potential liability that everybody has. 

And I think we have seen the results of some of the problems by 

not having converged accounting standards today. I mean, 6 years 

ago, $9 out of $10 raised in initial public offerings was raised in 

the United States. Last year, of the top 10 initial public offerings, 

43

none of them were listed in the United States, and 23 out of the 

top 25 initial public offerings were not listed in the United States. 

One of the reasons for that is the liability system here. A second 

reason is the costs that are being imposed by some of the regulations that have evolved. And the third reason, I think, is because 

accounting standards are not converged. 

So, by moving to principles-based accounting standards, that will 

really facilitate the flow of capital across borders, and also reduce 

the cost of providing information to investors, as well. 

Mrs. BIGGERT. Okay. Do any other panelists have thoughts on 

this issue? 

[No response.] 

Mrs. BIGGERT. Then I would like to insert into the record a statement of Merrill Lynch regarding earnings guidance, and a speech 

of Paul Schott Stevens, the president of the Investment Company 

Institute, given last week, regarding ICI’s interest in XBRL. Without objection. 

Mrs. BIGGERT. And with that, the Chair notes that some members may have additional questions for this panel, which they may 

wish to submit in writing. So, without objection, the record—hearing record—will remain open for 30 days, for members to submit 

written questions to the witnesses, and to place their responses in 

the record. 

And with that, I would like to thank all of you so much for your 

excellent testimony, and I know it’s a long day, and—to sit, and 

with two panels, but we really appreciate your help in our deliberations on this issue. 

So, with that, the hearing is adjourned. 

[Whereupon, at 12:34 p.m., the subcommittee was adjourned.] 

(45)

A P P E N D I X

March 29, 2006

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