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Fixing Systemic Breakdowns in American Business

Restoring confidence in American business will require better rules, improved access to information, and the stricter corporate governance provisions of the Sarbanes-Oxley Act, said regulators, policymakers and executives at a recent conference.

When it comes to accounting fraud in American business, it's not just a case of bad apples.

That was the overall message from the regulators, policymakers and industry participants at the April 21st "Restoring Confidence in American Business" conference, sponsored by the Harvard Business School Association of Boston and the Boston Security Analysts Society.

"The checks and balances in the system weren't strong enough," said Senator Jon Corzine (D-NJ). He pointed out that during his tenure as co-chairman of Goldman Sachs, the firm's accountants and controllers outnumbered those of the SEC by a factor of three.

SEC Commissioner Harvey Goldschmid had similar sentiments: "Forget about rotten apples," he said. "It has been a systemic breakdown of the people we were counting on."

Still, there's hope for the future. "In this country, out of scandal almost invariably comes healing and reform," said Goldschmid. For instance, the SEC itself was formed after the failure of about half of the companies started in the 1920s. This time around, the business world is counting upon better rules, improved access to information, and the stricter corporate governance provisions of the Sarbanes-Oxley Act.

By many accounts, the climate within the corporate boardroom has changed already. "Auditors understand that they are in charge," said James Turley, chairman of Ernst & Young. With their strengthened mandates, auditors are taking a more conservative approach to financial reporting and seeking out information independent of that which corporate management provides, according to Turley.

The rulemaking bodies have also gathered momentum in efforts to improve the system. Before the various accounting debacles, "there was very little investor involvement" in FASB rulemaking, said Robert H. Herz, chairman of the Financial Accounting Standards Board. "They probably figured things were kind of O.K.," Herz said. "We've learned otherwise."

Now, FASB has increased investor involvement through a user advisory council, and has worked to harmonize the rulemaking process between FASB, its Emerging Issues Task Force, the SEC, and the AICPA. "What we want is a system where we can achieve more consistency, and more comparability," said Herz. Going forward, his main priorities include improving GAAP; simplifying several complex items such as pooling-of-interest exceptions, revenue recognition, employee stock compensation, and leasing; and internal convergence of financial accounting standards.

But even had better rules been available, they would not necessarily have helped to prevent scandals. "Recent problems were not the result of flawed accounting standards, but the failure to apply the GAAP that existed," said Pat McConnell, senior managing director, Bear Stearns.

Nevertheless, McConnell sees room for improvement in GAAP. "For many years, the focus on whether cost produced an asset or an expense," she said. "Standard-setters almost never mention how it should be reflected on a cash flow statement."

Added McConnell: "What you call a cost is almost as important as whether it's an asset or an expense."

New information for the cash flow statement would enjoy an eager audience in the investor community. Even so, the demand may not be uniform across the industry. "We live in a bifurcated world," said E&Y's Turley, calling professional investors "sponges" for as much information as the industry can provide, as compared to retail investors, who are already "overwhelmed by the information they get today."

No matter how data-thirsty the investment community, it's the public companies that have to churn out the data - to whatever level they see fit, at or beyond the regulatory requirements. So, while it's technically possible for companies to provide the ultimate in investor transparency by exposing, via the Web, a virtual window into their global supply chain operations, it's unlikely that they would do so in the near future.

The SEC's Goldschmid pointed out some of the factors that act as a brake upon greater levels of disclosure, including the need for confidentiality and the requirement for accuracy given the threat of litigation from improper disclosures. "The periodic system works to some degree," he said.

This article originally appeared in Bank Systems & Technology eNEWS, a weekly e-mail newsletter. To order a free subscription, click

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