U.S. Treasury Secretary Paulson Asks: “Have We Struck the Right Balance?”; FEI Responds
March 13, 2007
In his opening remarks at the U.S. Treasury conference on Capital Market Competitiveness taking place on March 13, 2007, Treasury Secretary Henry M. Paulson, Jr. said:
· “At Treasury, we will carefully consider the views we have heard today along with the recommendations of a number of other groups which have studied this subject.”
· “Together they will inform us as we develop specific follow up steps in the coming months to keep U.S. capital markets the strongest and most innovative in the world.”
· “There will be things we at Treasury, working with the regulatory agencies, will do in the near term and some other actions over a longer time frame to address these challenges to our competitiveness.”
· “This is a high priority for me.”
The “fundamental question” to be addressed at Treasury’s March 13 conference, said Paulson, is: “Have we struck the right balance between investor protection and market competitiveness.”
He outlined three areas of focus for the conference: the regulatory structure, the accounting profession, and the legal and corporate governance environment.
FEI Backs Regulators’ Call to Reduce Complexity in Financial Reporting; Continues to Back Four-Pronged Approach
As the U.S. Treasury and various regulators consider the recommendations of “other groups” noted in Secretary Paulson remarks above, FEI released recommendations in an Issue Alert on March 12, “FEI Backs Regulators Call to Reduce Complexity in Financial Reporting.”
In a previous speech (November 20, 2006) on Competitiveness of the U.S. Capital Markets, Paulson cited the impact of complexity: “A common theme in my remarks today is the desirability, where practical, of moving toward a principles-based system. Nowhere is this issue more relevant than in the accounting system. Added complexity and more rules are not the answer for a system that needs to provide accurate and timely information to investors in a world where best of class companies are continually readjusting their business models to remain competitive.” He also noted many of the over 1,000 restatements by public companies in the past few years have been by “well-intentioned companies struggling to cope with a redefinition of rules in a complex system.” He noted, “These restatements draw time and attention away from other value-enhancing activities – and they represent an added cost to shareholders. Businesses and auditors are searching for something that doesn't exist in today's constantly changing world – a rules-based safe haven that still provides investors with an accurate portrayal of a company's financial performance.” Further, Paulson noted: “Auditors should be able to focus on one fundamental objective – ensuring the integrity and economic substance of management's financial statements, said Paulson in his November 20 speech. “To get there, we must recognize that accounting is not a science. It is a profession, requiring judgments that cannot be prescribed in a one-size-fits-all manner that undermines the usefulness of financial statements to investors.”
FEI agrees with Secretary Paulson that complexity of financial reporting should be a fundamental consideration as part of the discussions on competitiveness, and continues to recommend a four-pronged approach, consistent with the areas of focus addressed at Treasury’s March 13 conference.
FEI’s recommended four-pronged approach, as noted in FEI’s Issue Alert, is:
1. FASB should prioritize its conceptual framework and codification projects, and follow with principles-based rulemaking, which must be practicable in application, understandable by preparers, users and auditors, and result in information that is "auditable."
2. Regulators should avoid second-guessing reasonable interpretations of standards, and avoid issuing "informal guidance" instead of formal rulemakings for significant matters that could lead to a large number of restatements.
3. Congress should enact legislation to curb frivolous lawsuits.
4. Preparers, auditors and users of financial statements all must participate in being part of the solution.
Additional highlights from the March 13 Treasury conference -
Corporate, Investor and Regulatory Leaders on Treasury’s Panels
Paulson and U.S. Securities and Exchange Commission Chairman Christopher Cox moderated the panels at the March 13 Treasury conference. The first panel, on “market issues,” including corporate CEOs (Warren Buffett of Berkshire Hathaway, Jamie Dimon of JPMorgan Chase, Jeffrey Immelt of General Electric, and Charles Schwab of Charles Schwab Corporation), NYSE CEO John Thain, and Council of Institutional Investors Executive Director Ann Yerger.
They moderated a second panel on and a panel on “regulatory issues” featuring New York City Mayor Michael Bloomberg (who commissioned a recent study on competitiveness) as well as former Federal Reserve Board Chairmen Alan Greenspan and Paul Volcker, former SEC Chairman Arthur Levitt Jr. and former Treasury Secretary Robert Rubin.
Fundamental question: “Have we struck the right balance?”
Paulson observed the U.S. capital markets have faced challenges arising from the addition of new regulators (and regulations) over time, including the recent implementation of the Sarbanes-Oxley Act, and growth of overseas and private equity markets. He said there is a need to consider the individual and cumulative impact of these challenges on U.S. public companies.
“The fundamental question,” said Paulson, is: “Have we struck the right balance between investor protection and market competitiveness – a balance that assures investors the system is sound and trustworthy, and also gives companies the flexibility to compete, innovate, and respond to changes in the global economy?”
Three issues in focus
To address the question of “have we struck the right balance,” Paulson said the conference will focus on three issues in particular:
1. Our regulatory structure.
“W]e should … consider whether it would be practically possible and beneficial to move toward a more principles-based regulatory system, as we see working in other parts of the world,” said Paulson.
2. The accounting industry
“[T]he cumulative impact of all the [regulatory] change has significantly affected the accounting industry, fundamentally altering the interactions between auditors and corporate management and boards in a number of ways, some of which might not be constructive,” said Paulson.
“Also,” he said, ’we have seen great concentration among the major accounting firms and there are legitimate questions about the sustainability of the accounting profession's business model.”
Additionally, Paulson said, “We should also consider whether our system is producing the high-quality audits and attracting the talented auditors we need.”
3. The legal and corporate governance environment
“The basic principles that underpin a robust corporate governance system are accountability, transparency, and the need to identify and manage conflicts of interest,” said Paulson.
“As a result of Sarbanes-Oxley and other regulatory changes, corporate directors are more independent, more aware of real and perceived conflicts, more diligent about their fiduciary responsibilities… [and] directors must now spend much more time engaged in compliance processes…,” he added.
“But good corporate governance is a means to an end, not an end in itself,” said Paulson. “Our goal should be better managed, more competitive corporations that earn investor confidence through sound leadership, thoughtful governance, and outstanding performance.”
“In my judgment,” Paulson repeated from his November 20, 2006 speech on the Competitiveness of the U.S. Capital Markets, “we must rise above a rules-based mindset that asks, ‘Is this legal?’ and adopt a more principles-based approach that asks, ‘Is this right?’”
Further, Paulson added, “And we should consider whether our legal system appropriately protects investors or gives too much latitude to unscrupulous lawyers.”
Prepared March 13, 2007 by Edith Orenstein eorenstein@FinancialExecutives.org Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not represent FEI opinion unless specifically noted above.