The Role of Financial Writers and the PCAOB in the U.S. Capital Markets
I was delighted to receive – and accept -- Myron Kandel’s gracious invitation to speak to the New York Financial Writers’ Association.
I was pleased to accept because I feel at home among journalists – and I mean that literally. My beautiful wife, Suzanne, is a former journalist, and so, I am truly at home with a journalist.
I was pleased to receive the invitation because your association is both a respected and respectful organization – as evidenced by the recognition and honor you paid tonight to Myron and to Barney Calame.
You chose to recognize two men who have contributed much to the practice of your specialized craft. Financial reporting and writing are not and never will be easy – I should know, because I spent 10 years as an acolyte protecting what William Greider so famously labeled the “Secrets of the Temple.”
Many of the younger people in this room will be astonished to know that Myron Kandel and Barney Calame began working to pierce the secrets of the Fed, of the stock exchange, of corporate boardrooms, before there was an Internet, before email, and – unimaginable – before Bloomberg!
They had to get their information the old-fashioned way: they had to earn it – with shoe leather, ink stains and, above all, patience.
Twenty years ago, many of your news organizations were still required to buy a share of stock in a local company in order to gain entry to that company’s annual shareholder meeting. So, the current reality of 24-hour news channels, of the ticker delivering real-time stock quotes to your BlackBerries and pagers, is still very, very new.
At the risk of suggesting that either Myron or Barney was there, I wonder when the first financial reporting and writing were done. We know that reporters were present when the first U.S. securities market was being organized under the buttonwood tree, but how far back does it go?
Remember that one of the most famous tax opinions ever issued was attributed to Jesus Christ, who said, “Render unto Caesar that which is Caesar’s.”
Were there enterprising financial reporters then, checking the financial statements of local companies to see if the full taxes due Caesar were properly accounted for? Or whether some early tax-avoidance scheme had cheated Caesar of that which was Caesar’s? And was Ebitda any easier to explain in ancient Greek than it is today?
I digress, but only a wee bit. I want to make the point that when ever it was that financial writers began reporting on financial transactions, they have certainly played a vital role in the credibility and endurance of the U.S. capital markets – truly the greatest capital markets in the history of the world.
Investors in our markets rely on the transparency of those markets and their participants. And transparency requires much more than the delivery of quarterly and annual reports from the companies that raise, or want to raise, capital in our markets.
The additional reporting provided by the members of the financial press – the analysis and, yes, even the scoops – is an invaluable underpinning of our capital markets.
The founders of our democratic system of government could not have foreseen that the basic tenets of democracy – majority rule, checks and balances among the branches of government, and a free press – would have also been a model for the functioning of our capital markets.
To be sure – as my friends at the Wall Street Journal like to say – it took many years after the revolution that founded our democratic political system for the same revolution to occur in our markets.
Yet, beginning a little over 70 years ago, that revolution took place. The federal securities laws enacted in 1933 and 1934 provided the mechanics for the ascendancy of the majority rule of shareholders and for the checks and balances that would be provided by directors, by regulators and by the markets.
The requirement for public reporting of financial statements and significant business changes opened wide the door for the financial press to see for themselves and their readers how corporate America was operating.
Notice that I said “opened wide the door.” Financial reporters had prodded and pried and cracked that door well before Congress acted. Remember that Ida Tarbell’s groundbreaking reporting on the Standard Oil Company was done decades before 10-Ks and 10-Qs were regular sources of information.
Yet the wide and immediate availability of Ks and Qs and reams of other financial data have not diminished the need for the tenacity and resourcefulness of reporters and the disinfectant sunshine of publication.
If anything, the speed and complexity of businesses and financial transactions today demand more dogged reporting from financial writers, not less. In an ideal world, investors would learn everything they need to know about the companies that raise capital in our markets from the companies themselves.
But as we have been reminded too many times in the last few years, what we would like to imagine as an ideal world of corporate disclosure may actually be more of a fantasy.
That is not an indictment of our corporate citizens. Yes, some companies’ financial reports are nothing more than sins of both omission and commission – bound and printed in four colors on glossy paper. But even the most revealing, honest and best-written financial reports can be enhanced for investors by the perspective of financial writers such as yourselves.
I will give you an example without naming names so as not to show favoritism. There is a large, largely gray publication that uses few photographs but insists on definitions of financial instruments that are probably familiar to the majority of its readers.
Nevertheless, a news story last week about hedge funds that trade convertible bonds defined both hedge funds and convertible bonds – in the second paragraph, no less! I think that is a terrific service to readers and to investors.
From its very beginning 2½ years ago, the Public Company Accounting Oversight Board has done its best to use similarly straightforward definitions and writing its rules and standards.
Keep in mind that this was a brand new organization, under the pressure of very tight deadlines set by the Sarbanes-Oxley Act, tasked with doing things that had never been done before. The Board had to design and fill a registry of public accounting firms, issue rules for inspecting and disciplining those firms, and write the rules for the Board’s own operations – while it was running! It would have been easy for the Board to meet its deadline by issuing rules in a language that only accountants and lawyers could love.
But we take very seriously our mission to protect investors’ interests in the preparation of informative, fair and independent audit reports. We want investors to read and understand what we are asking of the auditors of public companies, and we want their comments, which we seek for every rule and standard we propose.
We are also careful to provide the reasoning behind our rules and auditing standards. For example, when the Board adopted its standard for audits of internal control over financial reporting, the Board members insisted that the standard be accompanied by a plain-English explanation of why this standard would be so important.
We said: “The context for the passage of the Sarbanes-Oxley Act, and the President's signing it into law on July 30, 2002, cannot be ignored: Corporate leaders and advisors failed. People lost their livelihoods and their life savings. The faith of America and the world in U.S. markets was shaken to the core.
“In that context, the PCAOB adopted the standard for auditors to use when assessing whether managers of a public company have accurately reported on companies' internal controls over financial reporting.”
I think that context is important for investors and for the auditors and companies to whom our standards apply.
I must make an aside here, in light of the recent complaints that the Board’s standard for audits of internal control is too costly. We are doing everything we can to provide additional guidance to auditors in an effort to bring those costs down, especially for smaller companies.
But I have to point out that the Board included a warning about costs when we adopted the internal control standard in March 2004:
“Section 404 and the Board's requirements will entail extra work and, for companies, extra expense, particularly in the first year of implementation,” we said. “The Board does not underestimate the demands this auditing standard will impose on auditors and public companies.
“But in the end, the Board, public companies and the accounting profession answer to the higher demand of accuracy, reliability, and fairness in the financial statements that provide the basis for trust in our financial markets.”
As you and your colleagues have reported, we were certainly right about the “extra expense” that companies would incur as they document their internal controls. But I would submit that the Board was also right in reminding companies and their auditors that we all have a higher calling to restore investor confidence in our markets.
Two years ago, on June 11, 2003, I joined the Public Company Accounting Oversight Board as its chairman. I had an inkling when I joined that my fellow Board members and the then-still small staff shared my view that the PCAOB truly had a mission to fulfill on behalf of investors.
I was pleased to learn almost immediately that the Board and the staff not only shared my view, but they are fully committed to the public service that Congress envisioned for our organization. That commitment has not lessened or dispersed as the PCAOB has grown.
I was Employee No. 42 when I joined in June of 2003; today we number almost 350 accountants, attorneys, analysts and other professionals. Each new employee is asked why they joined the PCAOB, and the answers are published in our staff newsletter. The answers are remarkably similar and can be summarized easily: “I joined the PCAOB to make a difference.”
It is a true pleasure to work with such colleagues, to come to work every day in a place where you know that your labors have a broader purpose.
From my wife and other journalists I am privileged to know, I am aware that the majority of reporters and editors have the same feeling about their work – that the purpose isn’t just to fill column inches or word count or air time, but to truly serve the public by providing the information that will enable readers, listeners and watchers to make informed decisions.
That sense of purpose infuses the PCAOB as we go about our duties of overseeing public accounting firms and setting the standards that will guide audits of public companies.
We are as open as possible about our work, posting both our proposals and the comments on our proposals on our Web site.
Three weeks ago, we made public our first enforcement action against an accounting firm. Essentially, we told the firm that our inspectors were coming, and three CPAs at the firm got together and decided that they needed to clean up their records. They omitted some damaging information in response to our questions, and they made up some other information to tuck into the files.
Fortunately, two of the partners decided that what they had done was a bad idea and came and told us about it. Those two partners were censured by the Board, but the firm and the managing partner were put out of the business of auditing public companies.
As we proceed with our work, we may bring more enforcement cases – and we may not. I would be just as happy if we didn’t. You see, our real success will be in persuading and prodding auditors to do the right thing without our ever having to use the stick of our considerable enforcement powers.
Our foot soldiers in this effort are actually an elite force of highly experienced auditors, and they are fanned out across the country as I speak, preparing for a new day of inspections of accounting firms. Those inspections involve both interviews and examinations of specific audit engagements.
If our inspectors find a problem in an audit, they will pull in the people who performed the audit, and perhaps their supervisors. If an audit is bad enough, we’ll call in the supervisors’ supervisors. It’s then up to the auditors to inform the audit client if there’s a problem in the audit. If we think it’s bad enough, we will inform the Securities and Exchange Commission.
If that’s not a process that will focus the attention of an accounting firm, I don’t know what is. But, unfortunately for you, my friends in the press, it is a process that will occur behind the scenes and out of the public eye.
What we hope will be public will be the changes wrought by our inspections and other oversight activities. As a result of our pointing the accounting profession in the right direction, and kicking them to get there if need be, we hope we will see fewer restatements by public companies, fewer accounting scandals, and fewer names to fill out the “Executives on Trial” sections of your newspapers and broadcasts.
It will be a long-term effort on the part of the Board, and we will not take the word of the accounting firms that they have seen the light. We will be mindful of the advice imparted from the City News Bureau in Chicago. Cub reporters there received this admonition: “If your mother says she loves you, check it out.”
We will. Thank you for your attention, and good night.