An Update on Emerging Issues in Banking 

Enhancing Financial Transparency

July 24, 2002 

Summary

In response to the recent wave of corporate accounting controversies that has 

shaken investor confidence in U.S. financial markets, the FDIC gathered 

prominent policymakers, academic experts, and business and accounting 

professionals on June 4, 2002 to participate in a daylong symposium addressing 

transparency issues. Participants in the "Enhancing Financial Transparency" 

conference discussed the strengths and flaws inherent in the U.S. financial 

reporting process and suggested ways of modifying not only the reporting 

mechanism, but also the accounting standards that underlie financial 

statements, audit opinions, credit ratings and analyst reports. Ethics and 

compliance were important areas of concern, as participants identified the 

growing need to instill ethical conduct as a core value in corporate America. 

This issue of FYI and an accompanying Bank Trends report summarize the 

comments provided by participants in the June FDIC symposium. 

Paul Volcker calls for action, 

stating that "We can't legislate 

ethics, but we sure can point 

in appropriate directions."

The collapse of Enron in December 2001 underlined 

the issue of accounting transparency in the minds of 

investors in U.S. financial markets. As revelations of 

accounting improprieties have continued, investors 

appear less certain of how to assess companies' 

profitability and performance and more likely to 

question the accuracy of financial reports. Investors 

and regulators alike need dependable financial 

disclosures if they are to assert effective market 

discipline; without such oversight, investors cannot trust 

market values. This need has become more acute in 

recent years as individual investors have increasingly 

taken charge of their own investment portfolios and 

retirement funds. 

Charged with maintaining public confidence in the U.S. 

banking system, the FDIC shares responsibility for 

safeguarding the vitality of our financial markets and 

institutions. To this end, the FDIC hosted a June 4, 

2002 symposium entitled "Enhancing Financial 

Transparency" to address timely issues concerning 

financial reporting, accounting standards and regulatory 

remedies. This issue of FYI provides a high-level 

summary of the issues discussed at the symposium. A 

description of the comments made by symposium 

participants is provided in an accompanying Bank 

Trends report. The summaries synthesize the 

participants' views, and do not necessarily express the 

opinions of the FDIC. 

One of the largest problems facing today's investors is that poor quality financial 

reports preclude effective, informative fundamental analysis. The reasons for 
inaccurate financial reporting are varied -- a small, but dangerous, minority of 

companies actively intends to defraud the investor, while others may set forth 

information that is misleading but technically conforms to legal standards. In 

particular, the rise of stock option compensation has increased the incentives to 

misreport key information. For instance, companies have increased their reliance 

on pro forma earnings, which can include hypothetical transactions, and the use 

of similar techniques. Many other companies simply find it difficult to present 

financial information in compliance with complex, evolving accounting standards. 

To facilitate investor access to the "right" information, corporations should stress 

timeliness and plain language in their financial reports, and analysts should 

recognize the need for comprehensive manual analysis that can handle the 

financial details that even the most sophisticated computer model could miss. 

Individual investors should also receive appropriate education to help them 

decipher financial statements. 

The accounting standards themselves can be another obstacle to financial 

transparency. Today's standards are increasingly criticized as convoluted and outof-date; they are not seen as applicable to a financial era that is change-driven 

and risk-focused. Instead, a more generalized approach, which would allow audits 

to assess the overall financial health of an organization and identify emerging 

risks rather than focus on strict compliance with standards, might be more 

appropriate. Consistency, both across U.S. financial reports and internationally, is 

also desirable. Standardized definitions of such key concepts as earnings and 

earnings per share would facilitate comparisons of companies' financials. In 

addition, international convergence is important in today's global marketplace; 

while the U.S. accounting system is superior in some respects, international 

accounting organizations can offer guidance in other areas. The standards setting 

process, too, should be modernized and streamlined to ensure that guidelines can 

be altered, created, or eliminated as changing conditions dictate. 

The acceptance of ethical behavior as a key corporate value is essential to 

achieving financial transparency. Because there will never be enough "accounting 

cops" to constantly monitor every organization, corporations need to be 

encouraged to practice self-compliance and incentives should be structured so as 

to promote ethical conduct at all levels of the corporate hierarchy. Suggested 

corporate strategies include the creation of ethics hotlines, the installation of 

corporate officers dedicated to governing ethics and compliance, and the 

development of codes of conduct to be signed by all employees. Auditor 

independence is also crucial to the ethical ideal, as serious conflicts of interest 

can exist when accountants and their clients have relationships that go beyond 

the professional audit function. 

Consideration of the problems associated with financial reporting, accounting 

standards and ethics and compliance has led to the proposal of several regulatory 

changes to improve financial transparency. There are many opinions regarding 

the form that such changes should take. While some conference panelists 

championed stronger government regulation as the only way to ensure an 

effective financial reporting structure, other participants questioned the need for 

additional regulation, preferring to let market forces and private oversight bodies 

perform the regulatory role. Advocates of stronger regulation would enhance 

enforcement by increasing the staffing and resources of the Securities and 

Exchange Commission (SEC), and would seek to improve corporations' internal 

audits by requiring audit committee members to possess appropriate skill sets 

and accept greater responsibilities. 
As pressure mounts to remedy the current investor 

insecurity and prevent future accounting scandals 

and financial collapse, policymakers have 

incorporated some of the suggested technical, 

cultural and regulatory reforms into specific policy 

initiatives. President Bush has outlined a ten-point 

plan to bolster corporate responsibility and protect 

the investor by controlling the quality of financial 

disclosures, increasing corporate officers' 

accountability, stressing the independence of the 

audit process and creating an independent 

regulatory body. The House of Representatives 

passed the Corporate and Auditing Accountability, 

Responsibility and Transparency Act (CAARTA) in 

April 2002 and the Senate passed its version of the 

legislation, the Public Company Accounting and 

Investor Protection Act, in July. Both bills would 

clarify and limit the permissible relationships 

between accounting firms and their clients, impose 

stronger penalties for corporate fraud, and establish 

some form of accounting oversight board. While 

there are important differences between these 

executive and legislative proposals, each stresses 

the need for government involvement in overseeing 

the accounting profession and financial reporting 

infrastructure. Although the policy process is often 

lengthy and contentious enough to bar meaningful 

reform, financial transparency issues have gained a 

degree of import and salience that demands 

policymakers' dedicated attention. 

Representative Michael Oxley 

outlines his accounting reform 

legislation, which was passed 

by the House of 

Representatives in April.

Last Updated 07/24/2002