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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.
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Dec
14
Written by:
Jack Ciesielski
12/14/2005 8:02 AM
On December 1, Ernst & Young Chairman & CEO James Turley delivered a thoughtful and thought-provoking speech to the U.S. Chamber of Commerce.
The tone of the speech was surprisingly conciliatory: it wasn't a blast at the costs of Section 404 compliance, a tack you might have expected in order to get on the right side of an audience like this one. Don't believe it? Try this snippet:
"Let me say this: for those of us in the public accounting profession, the events of the past few years have been humbling.
Certainly, the accounting profession, our firm included, has taken some shots from regulators and others over the last several years, and I'm here to tell you that we deserved some of those shots. I do feel somewhat fortunate, though, that my profession has faced some very tough times, and not only survived, but emerged better for the experience.
The times have taught us the dangers of being arrogant ... of not listening."
Mea culpas aside, Mr. Turley goes on to make an interesting comparison of the criticism of auditors before and after Sarbanes-Oxley, and why it's different now:
"... It wasn't long ago that public company auditors were being criticized for being too cozy with clients, for underpricing audit work to sell other services, or simply for not auditing enough.
Today, some critics say auditors are too distant from corporate management, overauditing, and that we're charging too much.
Perhaps the courtesy of consistent criticism is just too much to ask.
However, as we think about this inconsistent criticism, there is something important to bear in mind. The criticisms of yesterdayâ€â€auditors being too easyâ€â€and those of todayâ€â€auditors being too toughâ€â€come from different camps and different points of view.
The criticism that got us hereâ€â€the criticism that demanded that auditors tighten upâ€â€came from investors. It was their outcry that brought about the near unanimous support of the Sarbanes-Oxley Act and the creation of the PCAOB.
Today's criticismâ€â€calling for auditors to lighten upâ€â€comes from some in the corporate community who are bristling at the new mandates, particularly the 404 internal control reporting requirements."
Mr. Turley nailed that one: there's certainly an inconsistency in the origin of the criticism. You don't hear investors complaining about SarbOx nearly as much as managers. He goes on to cite some statistics about the period after the passage of Sarbanes-Oxley - and they're very useful to consider when you hear overinflated hyperbole about dangerous costs imposed on business by a piece of legislation that essentially required firms to do what they were supposed to be doing all along. His list:
"Since the enactment of SOX in mid-2002, the stock markets are up. The Dow-Jones average has risen over 20 percent and is hitting near 11,000, the Nasdaq is up nearly 58 percent, and the S&P 500 hit new four year highs just last week.
Mergers and acquisitions are up. The value of U.S. M&A deals in 2004 was nearly double that in 2002.
Looking at IPOs, in 2004, there were 242 initial public offerings, including 150 on Nasdaq. By comparison, there were 100 or fewer IPOs in each of the three previous years. In 2005, IPOs are on pace to match or exceed 2004 totals.
New listings on the New York Stock Exchange rose 43 percent in 2004 over 2003, and through the first three quarters of 2005 have risen 6 percent over the same period in 2004.
At Nasdaq, new listings doubled from '03 to '04â€â€from 134 to 260. And the upward march has continued in 2005, with 193 new listings through the end of the third quarter.
Market cap on the NYSE and NASDAQ climbed from $11.6 trillion at the end of 2002 to $17.4 trillion on June 30, 2005.
The loan market is improving. 2004 was the busiest year for loans since 2000, and the pace hasn't slowed in 2005.
Public company bankruptcies have dropped by two-thirds since 2001, to some of the lowest levels in history."
Of course, you can't directly attribute any of it to Sarbanes-Oxley - but in fairness, you have to wonder: if it's been as bad as its critics say it is, how could so many good things have happened?
Turley then proposed that there are three upcoming issues for the accounting profession:
Accounting standards - and the need for reduction of complexity in them.
A focus on the information investors receive - which is also a focus of the SEC.
The health and sustainability of the accounting profession.
It's the last one where Mr. Turley's speech was its weakest. He argued that all participants in the capital markets have a stake in the health and sustainability of the accoutning profession (they do) but argued that the Big Four firms face significant financial risk from litigation (they do). The irony is that the same firms argued for consolidation to bulk up and protect themselves from financial risk. Now that they're facing litigation for having dropped the ball after mergers, they're arguing that they should be treated as too big to fail, with consequences for everyone in the marketplace besides themselves.
It's a very good speech, nevertheless - worth a read to gain another perspective on the world of accounting and auditing.
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Pension & Other Benefit Plans: A Look Ahead
Investors in firms with defined benefit pension plans always face the risk of suddenly being pushed farther back in line when it comes to being served their returns. Variability in plan assets and variability in benefit plan obligations are the reason: poor asset returns coupled with sinking interest rates always spell tough times for defined benefit plan funding. In that regard, this year’s asset returns combined with the Fed’s “Operation Twist” add up to “Operation Agony” for defined benefit pension plans. If trends continue along their current path, firms that may have anticipated moving to more realistic pension accounting - like Honeywell, AT&T and Verizon already have done - might forego that decision. It could be just too painful.
Pensions aren’t the only kind of benefit plan affected by Operation Twist. Other postemployment benefit (OPEB) plans share much the same accounting model as pensions, including the calculation of a projected benefit obligation that similarly incorporates a discount rate - one that will also be affected by Operation Twist. The net OPEB obligations were slightly less than pension obligations at the end of 2010, but also promise to grow in 2011. Investors perceive them as less threatening than pension obligations because they don’t require funding. Strangely, there are a number of firms that are recognizing income from these benefit plans - without ever creating a dime of cash for investors.
A recent edition of The Analyst’s Accounting Observer dissects these issues, and is available only to paid subscribers. A condensed version is available for free upon request. To receive it, send an e-mail to Brenda Rappold at brappold@accountingobserver.com, with “PENSIONS” in the subject line.
For information about subscribing to The Analyst’s Accounting Observer, click here.
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