Mr. Sutton was a member of the Emerging Issues
Task Force of the Financial Accounting Standards Board (FASB) from
1987 to May 1995, and served on the FASB's Financial Accounting
Standards Advisory Council from 1983 to 1986. He was chairman of
the FASB Committee to Review the Emerging Issues Task Force and
vice chairman of the Special Committee on Financial Reporting of
the American Institute of Certified Public Accountants (AICPA).
He also served on the AICPA's Accounting Standards Executive Committee
from 1980 to 1983.
Mr. Sutton is a graduate of the University of
Tennessee. He received a B.S. in accounting in 1962 and an M.S.
in accounting in 1963. ]
Looking back over the last decade, we have seen dramatic political
and economic change worldwide -- change that has created major new
demands for capital and opportunities for investors. It has been a
time in which U.S. capital markets have been enormously successful
in attracting investors and raising low-cost capital for businesses
at home and around the world.
It also has been a time characterized by calls for financial reporting
to respond to an ever-broadening range of expectations. As we address
those calls, I urge that we keep in focus the fundamental objectives
of financial reporting and its critical role in serving the interests
of investors, a focus that has been a hallmark of capital markets
in the United States.
In my remarks tonight, I will attempt to sharpen that focus and discuss
financial reporting in the context of the Commission's role of protecting
investors. In that context, financial reporting that seeks to provide
credible, decision-useful information, regardless of the range of
investment objectives, helps protect investors by enabling them to
make more informed decisions.
THE COMMISSION'S ROLE IN FINANCIAL REPORTING
The origins of the Securities and Exchange Commission are familiar
to this audience. It was born in the wake of the greatest financial
disaster the U.S. has ever experienced, the stock market crash of
October 1929. Substantial investment holdings became worthless in
a matter of minutes, hours, and days, and investors and the public
lost confidence in the fairness of the U.S. securities markets.
One of the serious weaknesses in the system recognized at the time
was that financial reporting to investors lacked credibility. In response,
the Congress passed the Securities Act of 1933 and the Securities
Exchange Act of 1934, which created the Commission and granted to
it the authority to establish accounting principles for public companies
and to prescribe the form and content of financial statements filed
with the Commission. Those laws, and related rules and regulations
subsequently adopted by the Commission, mandate initial and continuing
disclosures that companies must make if their securities are sold
to or traded by the U.S. investing public. The goal was to restore
investor confidence by promoting full and fair disclosure and preventing
misleading or incomplete disclosure.
Practically since its inception, the Commission has looked to the
private sector to provide leadership in establishing and improving
accounting principles used by public companies. The Commission's willingness
to look to the private sector, however, has been with the understanding
that the Commission will oversee the process and, if necessary, exercise
its statutory authority to supplement, override, or otherwise amend
private sector standards.
From the outset, and particularly since the formation of the Financial
Accounting Standards Board in 1973, this partnership with the private
sector has been exceptionally successful. It has fostered accounting
and disclosure that has served well the interests of both the investing
public and the companies they own.
ACCOUNTING AND INVESTOR PROTECTION
Today, however, there are so many calls for financial reporting to
respond to one concern or another that, I fear, the primary goal of
providing credible, decision-useful information to investors sometimes
gets drowned in the clutter.
The staff often hears, for example, that accounting should reflect
the intent of business decisions, and almost daily we encounter requests
to accept or encourage in accounting treatment that will not deter
some form of business or capital market activity that is argued to
be highly desirable. This includes assertions that, if a particular
accounting treatment is not allowed, it will not be possible to pursue
a desired transaction or strategy. Those arguments, however, have
another side. What may be "good" for selling shareholders
in a particular circumstance may not be good for the buying shareholders.
Similar pleas also are heard in the context of the accounting standard-setting
process. We have heard, for example, that the FASB's proposed accounting
for derivatives will cause companies to forego available risk management
tools and, as a result, cause those companies to be exposed to greater
When I hear this argument, I am reminded of the Board's project on
accounting for health care benefits a few years ago that led to Statement
106, Employers' Accounting for Postretirement Benefits Other Than
Pensions. In the final stages of developing that standard, some
affected interests predicted that the new accounting would cause companies
to abandon their health care plans and cause countless citizens to
be without much-needed benefits. That didn't happen, and I think with
hindsight, most now agree that, to the contrary, improvements in the
accounting brought needed attention to and consideration of the real
issue, the costs of health care. With every important standard-setting
project, some will object strongly to change and predict dire consequences
if change is made.
To the trained ear, some of the concerns we hear today about the
dire consequences of more transparent accounting are so extreme that
they lack any sense of balance or acceptance of the important role
of financial reporting in serving the needs of investors and our capital
markets. Some are so far removed from a rational cause-and-effect
relationship that they might be compared to outcries against a 55-mile-per-hour
speed limit because the opponents fear that imposing such a limit
could cause millions of people to be late for work.
I see nothing in the Board's derivatives accounting proposal that
supports the argument that the new accounting would deter companies
from engaging in the risk management activities they deem appropriate
or that would be in the interests of the public owners. The new model
would, however, provide investors with much-needed information about
those activities and their impacts on the financial statements.
Sometimes, regulators that have diverse public policy responsibilities
look at financial reporting through different eyes. Regulators of
financial institutions, for example, may focus on "safety and
soundness," and that focus may suggest certain biases in how
transactions and events should be portrayed or what public disclosures
would be considered desirable. As another example, regulators of public
utilities may have policy priorities for assuring adequate supplies
of energy to consumers at a reasonable cost.
Clearly, these are important public policy objectives, but they should
not supplant or compromise the essential goal of financial reporting
to public investors -- providing reliable, decision-useful information
to shareholders and prospective shareholders. Accounting and disclosure
should have no other public policy objectives than to provide the
best possible financial reporting to investors that will serve as
a sound basis for investment decisions. To accomplish those objectives,
financial reporting must portray economic transactions and events,
and economic performance, in a neutral way, without slanting the results
to favor any one economic interest.
We should be wary of arguments that accounting will make or break
a deal, or create or destroy a particular market, or advantage or
disadvantage a particular economic interest. While accounting can
be an important factor in some decisions, accounting that masks or
fails to capture meaningful information for the benefit of all investors
is not sound and puts investors at risk. The goal of enhancing the
ability of accounting to express the story of an enterprise's financial
performance in a meaningful, accurate, and consistent way for the
benefit and protection of investors must remain clearly in focus.
CREDIBILITY AND INVESTOR CONFIDENCE
To accomplish the goal of protecting investors, financial reporting
also must maintain a high standard of credibility. Many factors go
into maintaining credibility, but one of the essential elements is
independence -- certainly, independence in the process by which accounting
standards are established, but, equally importantly, independence
in the application and enforcement of those standards. The auditing
profession, as an independent overseer of compliance with financial
reporting standards, plays a crucial role in preserving the integrity
of financial reporting.
The Commission's concern for the independence of the auditing function
really is quite basic and straightforward. The essential public purpose
of the independent audit is to build trust and confidence in our capital
markets by providing comfort to investors that the information they
receive from companies can be trusted to reveal what should be revealed.
The Commission's perspective reflects a fundamental, underlying belief
that the success of our markets, the deepest and most liquid in the
world, rests on maintaining and enhancing investor confidence.
Investment decisions made in a vacuum are gambles. Informed investment
decisions require decision-useful financial information, and highly
reliable information is more useful to investors than information
of uncertain believability. By adding credibility to the information
provided by companies coming into capital markets, the auditing profession
supports more informed investment decisions and, thereby, protects
Maintaining investor confidence in the independence of the audit
process is a more complex issue and one that gives rise to perplexing
new questions for the Commission and the auditing profession with
each passing year. It is an issue that has many dimensions. It is
critical, of course, that information provided to investors be, in
fact, reliable. But what investors believe about the reliability of
the information is just as important, and therein lies the more difficult
You may be aware that the Commission and the AICPA worked together
to create a new Independence Standards Board, an independent, private-sector
body that is charged with addressing auditor independence issues and
establishing appropriate standards for auditors of public companies.
The goal is to preserve and strengthen confidence in the independent
audit; the challenge to the Board is to address the difficult issues
that have emerged from an increasingly complex business and professional
environment. As the trends toward expanding services by the accounting
profession and mergers and restructurings of accounting firms continue,
the need for effective standards and guidance becomes more intense.
THE ROLE OF INTERNATIONAL ACCOUNTING STANDARDS
Another difficult challenge facing financial reporting today is the
desire for more international harmony in accounting standards. As
businesses needing capital and investors seeking opportunities have
broadened their horizons beyond national markets, the call for more
common standards to encourage efficient cross-border capital flows
has been growing. Here, again, as we attempt to address these calls,
we must keep our focus on the critical importance of protecting investors
and maintaining investor confidence.
For the past several years, the International Organization of Securities
Commissions (IOSCO), of which the SEC is a member, has been working
with the International Accounting Standards Committee (IASC) on a
project to develop a core set of accounting standards that could become
a framework for financial reporting in cross-border securities offerings.
Because the Commission will need to assess the acceptability of the
core standards for use in U.S. markets, the SEC staff has been active
in following the IASC project. For example, SEC staff members have
attended IASC steering committee and Board meetings as IOSCO observers,
and the SEC staff has provided detailed written comments on proposed
Tonight, I will not comment on the status of the IASC project, or
the prospects for the timing or success of the project, except to
point out that the Commission's participation does not mean that it
is obliged to accept the resulting product. Rather, it reflects a
commitment to the goal of improving financial reporting in capital
markets around the world and an undertaking to support the IASC's
initiative with timely input. As has been stated many times, the acceptability
of IASC standards for filings in the U.S. will be decided after the
project is completed, with appropriate public input, and based on
the substance of those standards and the degree to which they meet
the needs and expectations of U.S. investors and capital markets.
Instead, I will comment briefly on some of the tensions that underlie
the international harmonization process. At times, some of the debate
and dialogue is seen as provincial bickering over whether "my
way is better than your way." What underlies much of this tension,
however, is much broader than preferences in accounting theory and,
in some respects, reflects historical and cultural differences in
the development of financial reporting and capital markets.
Recently, a financial officer at a major European industrial company
commented on his perception of U.S. accounting standards and the Commission's
registration and listing requirements. He said, "People at the
SEC...have their rules, and when something does not comply exactly,
then it's unacceptable. You may be very healthy financially, but they
can't judge that unless it is set out in a particular way."
This statement suggests that, at times, the Commission may be perceived
to be slavishly bound to a fixed set of rules and resistant to other
points of view. It also suggests, I fear, that there may be some misunderstanding
about our perspectives and our motives. Yes, we do seek rigorous interpretation
and application of high quality accounting and disclosure rules. But,
we do so because we believe that comparable and transparent reporting,
reporting that allows individual and institutional investors to make
their own evaluation of a company's financial health, protects the
interests of U.S. investors.
In U.S. capital markets, investor protection is achieved not through
a system of merit regulation that allows only companies that are judged
to be "healthy" to offer their securities, but by a system
of market regulation that seeks to assure that all who seek access
to U.S. markets provide to investors transparent portrayals of the
risks and opportunities involved. Underlying that approach is a strong
belief that the success of U.S. capital markets is due in large measure
to the high quality of the accounting and disclosure standards used
by U.S. public companies.
In the final analysis, I believe that even those who view U.S. standards
as being too rigid or too demanding, or as imposing too many reporting
obligations on management, also recognize that there is a reason why
U.S. accounting and disclosure has evolved differently from that in
other countries -- and a reason for its attractiveness to capital
market regulators. While other financial reporting regimes have been
developed in environments that are oriented to the interests of creditors
or tax policy, the U.S. system has been shaped to meet the needs of
investors and capital markets. It is this orientation that differentiates
the U.S. financial reporting system from those developed in many other
The U.S. accounting and disclosure system supports -- indeed, makes
possible -- the deep and far-reaching tradition of participation by
individual investors in U.S. capital markets. The willingness of individual
households to invest in stocks and bonds creates a much larger pool
of investor funds in the U.S. than anywhere else in the world. As
the process of harmonizing financial reporting continues, the desire
to increase the access of foreign registrants to U.S. markets should
not be allowed to take priority over the interests of U.S. investors.
In closing, let me emphasize the essential role that financial reporting
plays in making our capital markets the most efficient and most trusted
in the world. While the challenges of change and innovation surely
will continue, constant and consistent nurturing of the fundamentals
of our success -- decision-useful and credible financial reporting
for the benefit and protection of investors -- must remain our constant
Securities and Exchange Commission, as a matter of policy, disclaims
responsibility for any private publication or statement by any of
its employees. The views expressed herein are those of Mr. Sutton
and do nor necessarily reflect the views of the Commission or the
other member of the staff of the Commission.