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Complete Accounting Overhaul Urged Noted Author Tells Fund Industry to Spearhead Reforms

PALM DESERT, Calif. - Outdated and risky in this age of accounting scandals plaguing Wall Street. That is how a fund consultant and author described the fund industry's model for reviewing corporate reporting. To stave off future legislation, a new model is needed, the speaker told the 700 fund accountants gathered here last week at the Investment Company Institute's Tax & Accounting Conference.

Robert Eccles outlined an aggressive plan for reviewing corporate reports, which, he said, will help ensure that earnings statements reflect the true value of a company. In addition, Eccles, president of Advisory Capital Partners, and co-author of Building Public Trust: The Future of Corporate Reporting (John Wiley & Sons) called on the mutual fund industry to pressure companies to adopt the new reporting model.

Eccles' remarks kicked off a conference that was designed to help executives navigate a particularly brutal climate. Indeed, ICI Accounting and Treasuries Committee Chairman Joseph A. Carrier, in welcoming executives to the meeting, noted that the conference was canceled last year because of the terrorist attacks in New York, Washington and Pennsylvania, and that, since Sept. 11 of last year, mutual fund assets have slipped 20%. Carrier said that public trust has been dampened by corporate scandals involving Enron, WorldCom and other firms, and that volatile markets have frightened investors away from equities [see MFMN 9/23/02].

"Not since the 1970s has it been this bad," Carrier said.

From Model-T to Spaceship

Eccles told the accounting executives that the scandals have resulted in a "demonizing of the [accounting] profession," and that the best way to solve the problem was to cast aside the decades-old model for analyzing securities and adopt a new one.

"We're fine-tuning a Model-T," he said. "What we need to be doing is building a spaceship."

"The investment community should come forward and say, This is what we want. This is what we need,'" he continued. "You have an opportunity to do so. You are the owners."

"Otherwise," he said, "it's up to the SEC." [See related story, "Regulator Seeks Stiffer Accounting Rules," p. 1]

The call to arms echoed comments by John Bogle, the staunch and outspoken shareholder advocate who founded The Vanguard Group, of Valley Forge, Pa.

Earlier this year, Bogle said that because mutual funds control trillions in assets, fund executives should use their leverage to pressure operating companies to adopt better corporate governance standards, including checking executive compensation packages [see MFMN 2/25/02].

By contrast, Eccles' remarks were not focused on corporate governance but standards for reporting and forecasting earnings. His plan essentially standardizes corporate reporting and encourages general operating companies to provide more information than the minimum required by the SEC. In general, the plan is designed to result in more transparent earnings statements that are entrenched in what Eccles calls a "culture of accountability."

Fund officials who attended the conference received Eccles' remarks warmly. Many agreed that accounting reform of some kind will take shape, but they were reluctant to embrace the specific tenants of Eccles' plan.

"I think it's feasible," said Greg Smith, director of compliance and fund accounting at the ICI. "I don't know if the Institute would take a leadership role in that. We're more focused on the legal [side of the issue], whereas this is more portfolio management."

"He's on the right track," said Douglas Wade, the manager of separate accounts at American United Life Insurance Co. of Indianapolis. "I don't know if anyone formally needs to adopt it. [But] there needs to be more corporate transparency."

An executive at a prominent fund complex, who asked to remain anonymous, said that "change is needed" and there is no doubt that the industry "will back something up."

Eccles called for the adoption of new global Generally Accepted Accounting Principles (GAAP). By contrast, he said that every country with a public capital market within its borders uses its own GAAP standards.

Most significantly, he called for additional industry-specific accounting standards that would be adopted, with input from auditors and investors, by sectors such as telecommunications and pharmaceuticals. These standards would allow "investors to compare companies in any given industry in ways that go beyond required financial reporting," he maintained. The standards would include a unique set of "value drivers," or factors that affect the value of a company.

For example, Eccles said the value of a pharmaceutical company would likely be measured in part by the amount of research and development it is conducting and new products "in the pipeline." Other factors that companies should disclose include pro-forma earnings and free cash flow. Neither is currently included in GAAP standards, Eccles said.

In addition, he said that companies should be measured against their peers, and that sectors should not be compared to each other the way they are today. "These are published like they're apples to apples," Eccles said.

Top Dog

Companies should disclose yet more information in the form of written statements from top executives that tell investors how a corporation is building its value. These reports would go beyond industry requirements and would, according to Eccles, tell investors about "management's views of the competitive environment, company strategies, unique company value drivers and the company's commitments to other stakeholders."

Such information is generally not available to investors under the current standards.

He proposed publishing such standards via a Web publishing protocol called XBRL.

Many firms will worry about disclosing too much information to competitors, Eccles said. But competitors already can, and do, find most of this information if they know where to look. Now, he said, it's a matter of making it available to investors.

"You could demand it," Eccles told fund executives. "My plea is that this group supports this [and] gets mobilized."