Proceedings of the Standing Senate Committee on
Banking, Trade and Commerce
Issue 47 - Evidence
OTTAWA, Wednesday, June 12, 2002
The Standing Senate Committee on Banking, Trade and Commerce met this day at 4:00 p.m. to examine and report upon the present state of the domestic and international financial system.
Senator E. Leo Kolber (Chairman) in the Chair.
[English]
The Chairman: We are here to examine and report upon the present state of the domestic and international financial system, loosely translated as Enronitis.
Mr. David Smith, FCA, President and Chief Executive Officer, Canadian Institute of Chartered Accountants: Mr. Chairman, senators, on behalf of Canada's chartered accountants, I would like to thank you for inviting us here today. With me today is Gerard Caron, President and CEO for Québec and Brian Hunt, President and CEO for Ontario.
The Canadian Institute of Chartered Accountants represents a membership of 68,000 chartered accountants. Our members work in both large and small public practices, as sole practitioners, in industry, in government, and in academia. They work in diverse careers such as auditors, CFOs, tax advisers and management consultants. We are pleased to assist the committee in the examination of the state of the domestic and international financial system in the post-Enron world.
The Enron scandal has raised fundamental questions and vividly demonstrates what can happen when governance fails. Enron has raised important questions concerning the dependability of financial information, auditor independence, the role of regulators, company management, the board of directors, conflict of interest, fraud and ethics in business. I submit that all of these issues had a hand in the demise of Enron and the corresponding increase in anxiety on the part of investors.
Diminished investor confidence is a very serious matter for those involved in corporate governance and the CA profession. Chartered accountants play a crucial role in maintaining the trust of investors and the confidence in capital markets.
We are working closely with federal and provincial regulators, chartered accounting firms and other stakeholders, to strengthen the financial reporting system. At the same time, we are paying close attention to our profession's discipline process, practice inspection and rules of conduct.
Additional initiatives relating to accounting standards, auditor independence, oversight and discipline have been announced or are underway. An announcement on public oversight of the auditing and assurance standards-setting process will be made before the end of June. An announcement on improvements to the oversight and quality control procedures of firms that audit public companies in Canada will be made by midsummer.
Even though Enron occurred in another marketplace, it gives all key stakeholders an opportunity, with some urgency, to collaborate and make changes. When we are through, I am confident we will have an even more effective Canadian approach.
I will begin by briefly outlining how auditing and assurance standards are set in Canada and how standards of practice are monitored and enforced. Next, I will highlight some of the principles that contribute to good corporate governance. I will then describe some of the steps that the CA profession is taking to respond to concerns arising out of Enron.
Throughout my remarks, I will be referring to three different types of standards: accounting standards, auditing and assurance standards, and standards of practice.
Accounting standards are authoritative standards for financial accounting and reporting. They are the primary source of generally accepted accounting principles, commonly known as GAAP. The Canada Business Corporations Act and provincial corporations and securities legislation generally require companies to prepare financial statements for their shareholders in accordance with GAAP.
In Canada, the Accounting Standards Board sets accounting standards. There is public oversight of the Accounting Standards Board provided by the Accounting Standards Oversight Council. I believe that the chairs of both these bodies are appearing before you later today.
Generally accepted assurance standards, or GASS, govern the conduct of independent audits. In Canada the Assurance Standards Board sets these standards.
The third kind of standards refers to standards of practice. In Canada, the chartered accounting profession has nationally harmonized rules of professional conduct adopted and enforced by all provincial chartered accounting institutes. The profession also has a mandatory practice inspection program designed developed and carried through provincial institutes. Each provincial institute has a process for investigating all complaints received about any institute member where professional misconduct may have occurred. If it is determined that professional misconduct has occurred, the sanctions can range from a reprimand, to additional mandated training, to a fine, to suspension or to being expelled from the profession and being unable to practice as a chartered accountant. Additional sanctions can be imposed through the justice system. This is a very brief overview.
Before moving on to the topic of the initiatives of the profession, I would like to talk about my philosophy of corporate governance and its underlying principles. Corporate governance is not just about regulatory or structural remedies. It is about culture. It is a culture in which there is a common understanding of the roles of management and of the board. It is a culture in which both parties respect each other's role. It is a culture of continuous open dialogue and communication and in which there is strong board leadership. In the end, it is all about people. It is about people doing the right thing, not just what the rules tell them to do.
Five principles underlie this philosophy on corporate governance. They are based on a recent report by the Business Roundtable, a group out of the U.S.
The number one duty of the board of directors is to select a chief executive officer and to oversee the CEO and other senior management in the competent and ethical operation of the corporation.
Second, it is the responsibility of management to operate the corporation in an effective and ethical manner in order to produce value for shareholders. Management should never put personal interests ahead of, or in conflict with, the interests of the corporation.
Third, it is the responsibility of management under the oversight of the board, and its audit committee, to produce financial statements that fairly present the financial condition of the corporation. It is also up to management to make the timely disclosures investors need to assess the financial and business soundness and risk of the corporation.
Fourth, it is the responsibility of the board and its audit committee to engage an independent accounting firm to audit the financial statements prepared by management based on GAAP.
Fifth, it is the responsibility of the independent accounting firm to ensure that it is in fact independent and is without conflicts of interest. It should ensure that it employs highly competent staff and carries out its work in accordance with GAAS.
It is also the responsibility of the auditor to inform the board, through the audit committee, of any concerns over appropriateness or quality of significant accounting treatments or business transactions that affect the fair presentation of the corporation's financial condition. The auditor should do this in a clear and timely manner, regardless of whether management has discussed these matters with the board or audit committee.
Before moving on, I would also like to express our support for many of the recommendations in the report of the Joint Committee on Corporate Governance set up two years ago by the TSX and the CICA. In particular, we support the recommendation that the roles of the CEO and chair should be separate functions. We also agree that the audit committee be fully independent of management. As well, we agree with the Business Roundtable recommendation that audit committee should conduct an annual evaluation of outside auditors.
Let me turn now to some of the initiatives of the CA profession. We are looking to our reporting and disclosure standards because Enron has had implications for Canadian standard-setting. We are looking at our reporting and disclosure standards and also addressing any vulnerabilities in order to ensure our system is the best it can be.
Decisions taken by our standard setters affect thousands of companies and those who invest in them. We want to be sure that financial statements reflect the true health of companies, and we want to make financial information more understandable and transparent.
Our accounting standard-setting process already has strong public oversight processes in place, and we have taken steps to make them better. Two years ago, the CICA created an independent group called the Accounting Standards Oversight Council. As I mentioned earlier, the council oversees the Accounting Standards Board. This council is independent. Its chair is lawyer, Tom Allen. Its vice-chair is Senator Michael Kirby. There are 20 other individuals on the council. It is accountable to the public, and the public can attend its meetings and present any concerns. It issues a public report at least once a year.
This council has developed an action plan to deal with accounting and financial reporting issues raised by the Enron failure and to determine what action the Accounting Standards Board should take. This plan was discussed at a public meeting in early May.
One key area being investigated is the treatment of special-purpose entities. Enron is a vivid example of how abusive the use of off-balance-sheet structures can be when taken to extremes. The Accounting Standards Board is looking at actions to eliminate any potential abuses. It is also looking at the guidance on guarantees and hedge accounting.
While Canada has good public oversight of the standard-setting process, we believe it can be improved upon. Public oversight of the body that sets accounting standards has existed for two years. We believe the time has come for public oversight of the body that sets auditing and assurance standards in the country. We are currently establishing this oversight body and will announce the details by the end of June.
There is a lot more to financial reporting than financial statements and accounting standards. Another key element is Management Discussion and Analysis, MD&A. A good MD&A report provides a broader context to help investors more fully understand a company, its performance and its prospects. Moreover, we believe that enhanced MD&A disclosure leads to lower cost of capital, better capital allocation decisions, and improved corporate governance. A good MD&A provides additional context in which to consider and approve GAAP financial statements. A MD&A can help directors understand the company's business and help them to evaluate the appropriateness of management's business strategies and assessment of risk.
We are working to improve MD&A disclosure. Last December, we issued proposed guidance on preparing these reports. The type of reporting we propose would help investors and would also be an invaluable source of information for boards of directors and audit committees. The consultation period on this draft guidance has just recently concluded, and we are now reviewing the responses.
I also support efforts by securities regulators to restrict the use of pro forma accounting. As you know, some companies report their financial statements in press releases using pro forma numbers. These numbers often differ significantly from GAAP results, and they lack comparability because they are not required to confirm to rules or standards.
Despite what some may say, we believe that GAAP is the best reporting framework that exists. GAAP is fundamental to the effective functioning of capital markets. It provides the framework that ensures consistency in reporting and therefore the comparability of financial results. It ensures that investors get the complete picture. To strengthen the financial reporting system and do it in the absence of GAAP just does not make sense.
Another key issue raised by Enron is auditor independence, and once again the profession has taken action. The question at hand is whether the selling of consulting services to public company audit clients can give audited companies the ability to pressure their auditors. There is a strong consensus that auditors should not be providing certain consulting services to their public company clients, particularly services involving major IT systems designs and internal audits. In Canada, the largest CA firms are already in the process of divesting themselves or have divested themselves of their consulting operations.
CICA had been developing measures to enhance auditor independence before the Enron situation occurred. One major initiative that has been announced is a new assurance standard that requires auditors to communicate with audit committees about issues of independence and to disclose their non-audit fees. This new standard, which applies to both public and private companies, brings Canada into closer alignment with the U.S. and the international standards.
The Public Interest and Integrity Committee is currently developing revised rules of conduct that directly address the issue of auditor independence. The proposed standards would prohibit specified types of activity such as consulting services that are incompatible with audit. The intent is to maintain the full independence and objectivity of auditors. These draft rules will be released for public comment later this summer. Once they are approved, we expect they will be quickly adopted across the country.
I will ask my colleague, Gérard Caron, to talk about the issues of quality control, oversight and discipline.
[Translation]
Mr. Gérard Caron, FCA, President and Chief Executive Officer and Secretary General, Ordre des comptables agréés du Québec, Canadian Institute of Chartered Accountants: Mr. Chairman, I greatly appreciate the opportunity to be here today. In Canada, the provincial institutes have operated a system of quality control, oversight and discipline that is viewed by many as better than the United States system which is based on peer review.
Since it is my main responsibility, let us talk a little about what happens in Québec as far as the safeguard of public interest is concerned. In Québec, the member inspection and discipline processes are governed by legislation which provides for frameworks and public accountability, and entrusts the supervision of professional orders to a government agency, l'Office des professions.
With respect to inspection, all members in public practice are inspected over a four-year cycle and must concretely demonstrate their competence. To this end, their quality control systems and audit files are reviewed . If the outcome is negative, the member may be prohibited from practising, be required to take refresher training and will necessarily be subject to subsequent control.
As regards discipline, the law calls for the constitution of an administrative tribunal called the ``committee on discipline.'' The committee is chaired by a government-appointed lawyer with at least 10 years of experience. The procedure and timing for dealing with complaints lodged by members of the public are set out in the legislation, which also provides for an appeal process. Depending on the seriousness of the case, the sanction may consist in a reprimand, a fine, a suspension or being struck off the roll.
When it comes to investigating instances of professional misconduct, some provinces now have processes in place to initiate these investigations and hearings prior to the completion of court cases or actions by regulators. This is namely the case in Ontario and in Québec.
As well, the institutes in three provinces — Ontario, New Brunswick and Alberta — have the authority to discipline firms and not just individual members. Other provincial institutes are seeking similar changes.
While the system is strong, we believe it can be improved, particularly for CA firms that audit public or listed companies.
We are now working on specific proposals and plan to announce the details by mid-summer. I don't want to pre- empt that announcement, but I can tell you that the enhanced system is based on independent, public oversight, tougher practice inspection and more rigorous quality control mechanisms. It will demonstrate our profession's commitment to improving both the quality of the audits of public companies and the public's confidence in the audit process.
I'd now like to call on my colleague, Brian Hunt, to talk to you about some recent changes to Ontario's disciplinary system.
[English]
Mr. Brian Hunt, FCA, President and Chief Executive Officer, Institute of Chartered Accountants of Ontario: On May 23, the Institute of Chartered Accountants of Ontario announced reforms that substantially broaden the reach of the ICAO`s existing rules of professional conduct. In particular, they underscore the institute's position that, in the course of exercising their professional duties, CAs are expected to avoid and discourage reliance on any fringe interpretations of GAAP. These new rules will apply not only to CAs who actually perform corporate audits but also to any and all members of the profession on management teams, audit committees and boards of directors.
To enhance existing oversight of its disciplinary system, the institute is establishing an Independent Discipline Oversight Board. A majority of this board's members will be from outside the CA profession, and the institute has asked the Ontario Attorney General to appoint its chair. The institute is also establishing an independent board of review to enhance its existing complaints process. These changes follow a two-year independent review of the Ontario institute's disciplinary system conducted by Tom Allen.
While the review started long before Enron, the changes will help address issues raised by that situation. The Ontario reforms reinforce the core values of the CA profession of ethics, integrity, independence and objectivity. I am pleased to say that other provincial CA institutes are considering similar changes. While our rules can only apply to our members, it is our hope that they will serve as a benchmark for everyone in management, audit committees and on boards of directors.
Mr. Smith: Let me offer a final thought: Systems and rules are only as strong as the people who observe and apply them. If people want to find loopholes, they surely will. In the end, it all comes down to ethics, not only professional ethics but personal ethics as well. This is why the integrity of the corporate governance system is paramount. It must to act as a fail-safe mechanism to catch as many transgressions as humanly possible.
We have known for a while that good corporate governance leads to good corporate performance. In the wake of Enron, we are now seeing that it is also the key to restoring investor confidence. This confidence is crucial to our country's economic heath and to maintaining the kind of society that we want to live in.
The CA profession has an important role to play in reforms to our financial system, particularly in the areas of accounting standards, auditor independence, quality control, oversight and discipline. Working with business leaders and regulators, we are well on the way to a Canadian approach that is timely, significant and sound.
A recent article in Business Week asked the question, ``Can you trust anybody anymore?'' I am here to tell you: ``Yes, you can.'' We will hold up our end of the corporate governance system and we will continue to work to maintain the public's trust, because trust has been the cornerstone of the chartered accounting profession for the past 100 years.
We need safeguards. We need to be diligent. We need to take steps to ensure that our oversight mechanisms, reporting standards and professional conduct rules conform to the new business realities. We are taking these steps. We will ensure that the standards and principles guiding our profession continue to place the public interest first and foremost.
Senator Meighen: I do not think there is an accountant on this side of the table, there may be on the other side. That will become readily apparent to you before long.
In order to avoid the pitfalls of trying to engage any of you gentlemen in a technical discussion, I shall direct my comments to the concluding remarks. I find them both reassuring and encouraging. That is what the ordinary Canadian, investor or not, hopes to hear. I applaud you for the steps you are taking to modernize and to ensure that accountants within your sphere of jurisdiction perform properly and efficiently.
What comfort can you give us, if any, that an Enron-type situation is less likely to happen in Canada than in the U.S.? You know as well as I do that people always allude to the rules-based system that allegedly exists in the United States as opposed to the principle-based system in Canada. As you say, it does not matter how many rules you put down. We have a Criminal Code full of them and there are still criminals out there. Whether it is because we follow a principles-based system, I do not know, but, on the other hand, many critics say that our rules are much looser in Canada.
I was just given a copy of the BCE 2000 annual report. Looking at a reconciliation of earnings reported in accordance with Canadian GAAP and U.S. GAAP. Under the Canadian GAAP, net earnings are reported at $7.43. Under U.S. GAAP, basic earnings are a loss of 53 or 55 cents. That is a difference of at least $8. That is quite a swing. If I am the poor investor trying to decide whether I should buy a share of BCE, which figure do I believe? There is quite a difference between a 55-cent loss and a $7.43 gain.
Senator Kroft: Especially when you apply a multiple.
Senator Meighen: While I agree with your comments, I want to know how an ordinary investor can proceed, given the apparent dichotomy between these two methods.
Mr. Smith: This is a difficult question to answer. I do not have the set of financial statements to analyze. To be quite frank, I am not the expert to do that.
I agree that there would be confusion for the non-educated and non-accounting individual reading those financial statements. The issue of whether we use U.S. accounting principle-based figures is a debate that continues. I know you are seeing the standard setters later who will probably answer this question in a much more informative way than I can.
For the time being, Canadian standards, must somehow reconcile with the American standards. That country is our major competitor and where our capital markets are. The U.S. is also our major trader. The U.S., Canada, and other major standard-setters in the world, have set 2005 as the deadline for one set of standards. In some ways, Enron will help us move towards that objective. To move toward that goal today or to do it overnight is impossible because of the marketplace that we operate in. That marketplace is where we get most of our funding and capital for our large organizations. There is confusion for the not-sophisticated investor, for sure. I agree with you on that.
I am certain that the accounting experts will be glad to make further comments on that particular question.
Senator Meighen: Does it surprise you that there would be that difference under Canadian GAAP vis-à-vis American GAAP?
Mr. Smith: It does not surprise me that there could be a difference, no.
Senator Meighen: This is a substantial difference.
Mr. Smith: A substantial difference does not surprise me either.
Senator Meighen: Mr. Al Rosen has appeared before us as a witness. He is not a fan of the Canadian accounting system. I am sure that does not come as a surprise to you. He calls the Canadian accounting system ``loose.'' He certainly left many of us with the impression that, in his view, our system is far inferior to that of the United States. I do not necessarily share that opinion, but that was Mr. Rosen's strong view.
Mr. Rosen drew our attention to the Hercules Managements Ltd. v. Ernst & Young Case. In that case, the Supreme Court ruled that investors should not use financial statements as a guide to investment. I was as surprised when I heard that as when I found out that auditors are not supposed to catch people who are stealing money from your corporation when they are preparing financial statements. That is an aside. That happened to me as a young lawyer. Our office manager stole from us. We were told that providing such information is not the job of the auditor.
Tell me about the view of the CICA with respect to the ruling of the Supreme Court. Did you intervene? Do you have a view on it now?
Mr. Smith: I do not believe we intervened in that situation. I would be glad to share with you the reasons why. It is rather detailed.
Senator Meighen: What is your view on the judgment?
Mr. Smith: I do not have a view on that particular judgment. There was a subpoena to provide a certain document or certain information regarding it and we did so. The judgment was the judgment. We did not participate in the sense of an intervener.
Senator Meighen: According to the top court in the land, I cannot use financial statements as a guide to investment. That sounds incredible to me.
Mr. Smith: A guide to investment should not be just the financial statements. People use them, but there are the MD&A reports and all other sorts of things that tell you about the company and the type of management it has.
Senator Meighen: Is the financial statement a tool? Should they be used? Are we being told not to look at them?
Mr. Smith: It is the wrong interpretation to say one should not look at the financial statements. That would be one of the many things that you would look at. It only makes sense to do so.
Mr. Rosen makes a lot of comments about many different things. He is involved with the profession in a sense of doing reviews. We would like to correct one point on Mr. Rowsen's testimony regarding his acting on behalf of the insurers of the profession and having access to many of the files under review for insurance purposes. The statistic that came from the insurer on it in the last three years, Mr. Hunt?
Mr. Hunt: Since 1999 to date. This insurance provides insurance for small practitioners and small firms. There is about 10,000 chartered accountants under the policy. I think Mr. Rosen stated he was the main participant in looking at a number of these insurance things.
If you were to check with the insurer, Mr. Rosen actually acted for less than 1 per cent of all the issues that were brought before that group. That is a very minor player in those initiatives.
Senator Meighen: Did I understand you to say that the CICA is working with your counterparts in the United States, given our trade relationship once again, to increase the interoperability and compatibility of GAAP in both countries? Are you working on the international front covering Canada, U.S. and the rest of the worlds' set of standards?
Mr. Smith: Clearly, having one set of accounting standards worldwide would be the answer. No one could debate that.
The target date for having international accounting standards of substance agreed on is 2005.
The Enron situation has probably caused the player that was most likely to slow that down, to be a participant now, more than they ever would have been. Many of the statements on rules-based in the U.S. and moving toward a more principles- based, or at least a rules-based with some judgment, is the road that we seem to be going down now.
I am optimistic that, perhaps, we can achieve that date. Before Enron I think it would have been a difficult journey. Will it be an amalgam of U.S. and global? As long as it is one set, it does matter. Being one is important in order that there is no confusion.
Even if we do follow the U.S. route right now of trying to harmonize where possible, Canadian law and how we set it up provincially and federally is different. You cannot take what they do and apply it 100 per cent in this country. You have to Canadianize it a little bit or it will not work. We still have that issue to deal with before we even get to global principles. Each country has that same challenge to reach one standard.
Senator Meighen: The Americans seem to find that a particular challenge.
Mr. Smith: Absolutely. While the fire is going it seems to be the mood. We certainly find it encouraging.
Senator Meighen: Let us know if you see any real movement soon. Thank you very much, gentlemen.
Senator Fitzpatrick: I have a supplemental question on the reconciliation of Canada's GAAP and the United States GAAP. After you look at the BCE financial statement and reconciliation of the earnings, it makes you wonder why we do it. It is one of the tools we use.
My concern is with the accuracy of statements. You are talking about the possibility of using the same standards by 2005. You said we have to go to our financial markets here to raise funds. I am concerned that if we have this kind of a discrepancy, our financial sources will be more and more limited. It is not just a question of the investors' problem as to where to invest. It will be a question of whether we will have the pools of capital in the Canadian market and Canadian exchanges to provide the funding that is required to sustain the development of businesses. Will businesses move out of Canada and list on the New York exchange? It seems to me that it is crucial that we move on this matter. I would like your opinion on that.
Mr. Smith: The robustness of the capital markets in Canada depends on many things. They depend on: confidence in the government; corporate governance; how we handle ourselves; and the pools of money beyond that. Of course, accounting principles must be understandable.
The movement toward harmonizing U.S. accounting in Canada is an important one until we do have a global benchmark. We do not have another choice. The U.S. is our trading partner and that is where we get most of our capital.
I would clarify something about the Hercules Managements Ltd. v. Ernst & Young Case. I was not with the CICA when it happened, so I would be glad to make a point of clarification, if it is okay.
The question asked was whether shareholders depend on financial statements from that court case. The Supreme Court said that auditors do have a duty to investors, but as a policy decision court said that auditors do not have liability for an interminable amount of liability to an intermediate unknown class of people for an indeterminate amount of time. The conclusion was that shareholders are able to sue auditors. It really was a rather narrow, specified case.
Senator Kroft: I would like to follow up a little more on this issue of Canadian and U.S. accounting standards and GAAP. I think you should understand, as I am sure you do, that this committee, when talking about Canadian GAAP and U.S. GAAP, understand that it is not just talking about which is system better. If everything was great in the U.S. there would not have been an Enron. There would not have been a lot of other things.
The fundamental issue of comparability is critical. That is why we are all so pleased to hear about your agreement to move toward one standard. Your attention has been drawn to the BCE statement. We have heard other evidence about types of hybrid securities issued that are considered equity in one way and debt in another. These produce enormous discrepancies.
These hearings tend to have certain language that we all hear and we pretend to understand or we do not pursue it. Could you for the record make a clear statement of what you would like to have us understand by the difference between a rules-based system and a principles-based system.
Mr. Smith: With your permission, I would let our standard setting group explain that. They actually do this and could explain it in a much more concise way than I could.
Senator Kroft: I will hold that question. I would like to move to a slightly different area.
You talked about audit committees, and at the bottom of page 5 in the printed version of your remarks you state: ``We also agree that the audit committee be fully independent of management.''
We have become quite preoccupied with audit committees, and many of us who have served on audit committees know how appropriate that preoccupation is.
In pursuit of that independence, how would you feel about audit committees having independent audit advice? When I say ``independent,'' I mean retained by the audit committee independent of management and of the company's auditors.
Mr. Smith: That is a very interesting way of looking at it. My personal opinion, with my experience from having attended a lot of audit committees in my career, would be that the audit committee should be able to seek counsel on any issues that it is having difficulties with.
Senator Kroft: You are using ``counsel'' in a generic sense.
Mr. Smith: The audit committee should be able to seek counsel in a generic sense on anything it wants.
Personally, the relationship should be as it was always intended to be. The relationship of the auditor should be with the audit committee and not management. It really is, technically, but I believe that if you look at the changes that are taking place as we sit here today, that stool or that leg of the stool now is becoming much more proactive, and the auditors themselves really want the relationship with the audit committee because they are really representing the shareholders. This is a positive step that is taking place right now.
Should we involve another audit firm to give an audit opinion on the audit? That starts to get complex. Having enough expertise on that audit committee to be able to talk intelligently with the auditors is the other issue that surrounds this, and it should be independent of management.
Senator Kroft: I agree with you about the independence of the audit committee and the expertise inherent in the membership of the audit committee itself. My question did not so much go to a separate and independent view of the company's statements. It would go more toward the audit committee that is reviewing the quarterly reports, and having advisors there to say ``Is there something we are missing?''
I am not talking about a duplicate audit. That is another issue, by the way, and we have been given other models of second audits and change of auditors. There are many things on this agenda, and I only want to limit myself to one part of it. Let me put it one way: If you were the main auditor to a firm, how would you feel about the audit committee saying, ``We would like to have somebody at our elbow to help us look at what we have to do here?''
Mr. Smith: I think an audit committee can ask the auditors to do further work on anything they would like them to do work on.
Senator Kroft: I am talking about another auditing firm.
Mr. Smith: It would difficult for another auditing firm to do that because they would not have the knowledge of the company to be able to do that. That might be the issue.
The Chairman: If they do not have the knowledge, how can the directors be expected to have the knowledge to know what questions to ask?
Mr. Smith: I meant in the sense of the systems and whether you can rely on them, et cetera.
Senator Kroft: I am talking about just the kind of questions that audit committee members could ask, even if they are macro-type questions. I happen to feel it could be a useful thing. Do you feel, that it would somehow interfere with your audit relationship?
Mr. Smith: I do not think it interferes. My feeling is that it would be better to do it with the existing auditors and develop a better relationship with the audit committee in the first place. It would be more effective and cost effective as well.
Senator Kroft: I am not suggesting one or the other.
Senator Fitzpatrick: I would like your opinion on a mandatory change of auditors every several years. There has been some suggestion that it is more efficient if auditors are retained on a long-term basis because they become more familiar with the company and procedures, et cetera. On the other hand, that familiarity may work to the detriment of an objective audit. In your view, should the audit committee be changed every three years or so?
The Chairman: The audit committee or auditors?
Senator Fitzpatrick: The auditors.
Mr. Smith: My view is that it would be pretty inefficient and costly to do that. Italy is the only country in the world that does that. Throughout the debate in Europe where they are trying to bring together their principles that idea seems to have been left at the side of the road.
Senator Mahovlich: Italy has its reasons.
Mr. Smith: Again, if the relationship with the audit committee is where it should be, I think this helps a lot, versus being primarily a management relationship.
Senator Fitzpatrick: With a change in partners, should there be a Chinese wall between the partners so that, when you change partners or members from the auditing firm, there is no continued discussion between the partners? In other words, when the new partner or the new auditing team looks at it, they look at it independently and separately from the previous team or partner.
Mr. Smith: I would not go to a Chinese wall because there are second partners and there are reference partners beyond that. I certainly think they should not be in charge of that audit any longer and should not have that role. The fact that there are second partner reviews and reference partners on the account kind of offsets that, because that is who that new partner would go to for consultation, and approval to release the statements.
Senator Oliver: It seems to me that the one of the most important sentences that you had in your entire report was found on page 5 where you said:
It is also the responsibility of the auditor to inform the board, through the audit committee, of any concerns about the appropriateness or quality of significant accounting treatments or business transactions that affect the fair presentation of the corporation's financial condition.
In yesterday's Globe and Mail, there was a statement of some of the things that the Americans are looking at in relation to new corporate governance principles for audit committees. One of the statements was as follows:
Making boards of directors and their key audit and compensation committees truly independent and responsible to their owners, rather than the managers, is one of the crucial governance rules changes being urged by the New York Stock Exchange.
Later, it states:
Under the NYSE proposals, those on the audit committees would receive no payment other than their directors' fees and would also have to work harder for their annual stipends, meeting management and auditors, separately, at least once every quarter.
What do you say to that proposal? Is there any significance to it? Would it help us in Canada?
Mr. Smith: That is the direction that audit committees are moving in this country, except perhaps that the composition part has not been dealt with. Audit committees should be independents and have in camera sessions. In fact, my experience within my world of audit from which I came is that we look forward to having those meetings with the audit committees. That is why we can come with our solutions to you. I believe we have some good solutions, but we have been working with the regulators and the auditors too. This stool has a lot of legs on it that provides solutions. Some of the solutions that are suggested by the New York Stock Exchange would fit in this country and I believe that some of them are being considered.
It is important that the governance, management, board, audit committee and auditors, understand their relationship. We have been speaking out on things like MD&A, audit committee independence, pro forma earnings. Even though, those things are a bit out of our reach they are a part of making financial statements stand the test for transparent reporting. We cannot do it as a profession on our own. We have to sort out the governance side and the audit committee side. All of these things are being considered amongst our other friends who we have been working and trying to make a more transparent system.
Senator Oliver: On the last page of your presentation you referred to an article in Business Week, and I have a Business Week article here dated May 6. It is entitled ``How to Fix Corporate Governance.'' I will ask you to comment on it and whether it might apply to Canada.
Meanwhile, despite a decade or more of boardroom reforms, many directors seem to have become either passive or conflicted players in this morality play, unwilling to question or follow up on even the most routine issues. If the governance of the modern corporation isn't completely broken, it is going through a severe crisis of confidence.
Will you comment on that? Have you found that to be your experience with Canadian corporations?
Mr. Smith: That is certainly not the experience in Canada. I think the Enron episode has been a bit of a September 11 for the financial world, in the sense that everyone woke up. It did not happen in Canada, yet it has made corporate directors, audit committees, regulators, you, everyone stand back and ask: ``What we can do to make it better?'' To have all parties discussing it at the same time is unusual. There is an opportunity to create a better environment and to create a higher ethical code.
Mr. Hunt mentioned the new Ontario standard that we are trying to put out for chartered accountants. If that becomes a benchmark for directors, audit committee members and management, it will raise the bar from where it was.
The relationships and ethics in Canada are not the same as in the U.S., so I do not think that statement would apply in Canada to the extent that it applies in the U.S.
Senator Oliver: In my general readings about Enron I keep reading that one of the big problems with members of audit committees and board of directors is that because of payments, options, and a number of other potential conflicts they are reluctant to ask tough, important questions. This seems to be particularly true in the audit committee.
This committee cannot change the world and is limited in what it can recommend and do. Is there anything that we might look at, or would we be baying at the moon?
Mr. Smith: We need your continued encouragement. I do not think you can regulate or make rules to accomplish our purposes. I believe the world changed because of Enron.
Will it stay that way? We hope to change enough so that all the players are playing at the same table. We are making progress. Since taking on my new role I have not attended any audit committees, but in discussions with firms who do major corporations, and the audit committees that they have been attending, they report that things have changed dramatically. It is happening as we speak, and that is good news.
Senator Kelleher: I would like to hear your opinion on the comparison between the American and Canadian accounting systems. I have been told that Canadian corporations can issue hybrid securities that are part debt and part equity. I understand that they are considered only as a debt under U.S. accounting rules. Is that correct?
Mr. Smith: May I ask that you delay that question until the people who actually understand these standards can tell you the exact difference? I am not trying to duck the question but I know they are coming on later and they will have the correct answer for you.
Senator Kelleher: Do Canadian companies ignore compound interest effects?
Mr. Smith: I will give you the same answer on that.
The point we are trying to make today is that our standard setters and the people who deal with accounting are independent from us. Therefore, because of our separate roles it is not right for us to try to explain their roles. We have an overall role to the profession on all these matters, but we elected to have standard setting of accounting separate from the CICA. That is why they are here today in that capacity. If you do not get an answer from them, you can feel free to call me back again to give you an answer.
Senator Kelleher: I will still get the same answer.
Mr. Smith: I will look into it for you.
Senator Kelleher: Can you tell me about the different accounting treatment of stock option plans and whether they are to be expensed or not?
Mr. Smith: I have an opinion on that, but I do not have the accounting standard on that issue.
Senator Kelleher: We know George Bush's opinion. I think some of his friends may have reached him and I know you have not been tainted in that way. Could we have your opinion?
Mr. Smith: There is a huge debate over this issue. I am certain that you could sit for the next two years and have a different opinion every time someone appears before you and presents a solution. My opinion is that they have to be dealt with in some way, shape or form because they are an expense to the company. However, how to accomplish that is a complicated task. Even if you do find a solution we are left with the problem that the U.S. standard is so different from ours. There is a movement afoot to start to expense them. You can see it is an option to do either. I am sure both Mr. Cherry and Mr. Allen will have a lot more to say about that when you talk to them later.
It is not as simple as just saying ``do it in this country.'' I think it would affect our capital, our own interpretation of our financial statements, and create more differences like the ones you have pointed to.
Senator Kelleher: It would have quite an effect on some companies' statements, would it not?
Mr. Smith: Yes, especially if they did not do it in the U.S.
Senator Biron: In the United States, Alan Greenspan supported a legislative proposal that would require a corporation to recognize a charge to its earnings for financial accounting purposes when it grants stock options to employees, officers, and directors.
Does the Canadian accounting treatment of stock options differ from the United States? Should stock options be treated as an expense on financial statements when they are issued to employees, officers and directors?
Other than division of shareholding and earnings per share, what are the costs of stock options for shareholders and corporations?
Mr. Smith: The issue of stock options is debateable as to what we should do with them in Canada. The overriding factor is that it is very difficult to make a change in this marketplace for our companies to be disadvantaged if the U.S. has not done the same thing. Persuading and influencing our friends south of the border to consider and deal with this matter has been our tactic to date.
I am sure Mr. Cherry will have further comments for you on that particular matter. He is listening, so he will be prepared to answer that question as well.
One must always measure the different reporting between our Canadian companies as compared to U.S. companies.
The Chairman: I should like to return to the macro-problem rather than the micro-problem. The basic thrust of these hearings is to determine if we can better protect the Canadian investor. That is really what we want to do.
Mr. Smith: I compliment you for doing that.
The Chairman: We would like to send a message that the Government of Canada cares that the Standing Senate Committee on Banking, Trade and Commerce is probably the best committee to try to address this, even though we enter upon these hearings with limited expectations.
A journalist wrote recently that all the laws are in place, but if 25 crooks want to get together and break the law, there is nothing much one can do.
Mr. Smith, you started that a financial statement is not necessarily the best tool for an investor to look at. You also spoke about corporate governance. Could you explain to me the difference between the accountant's responsibility and the director's responsibility?
I am in a unique position: I have had approximately 110 years of corporate boards. That sounds like a significant amount, but that is a fact. In all the years that I have sat on boards, I have felt almost completely impotent to do anything. Things have changed over the years. Forty years ago when I sat on my first board it did not have all of the committees that we have today: nominating committees, audit committees, compensation and human resources committees. All of these things have developed over the years.
I am totally convinced that the amount of information that a director would have to absorb in order to do the things you think he should do just does not make any sense.
Mr. Smith: It is huge.
The Chairman: Should one-third of each board be composed of professional or trained directors? I have no idea. We hope to come up with some answers.
Can you please explain to me why a financial statement should not be something that an investor can look at and have faith in? It does not matter what the directors do, because directors are not accountants. Why should the financial statement not be a holy writ?
Mr. Smith: Financial statements are not the only source that investors should rely upon.
The Chairman: What should they rely on?
Mr. Smith: The MD&A report is very detailed.
The Chairman: Who draws that up?
Mr. Smith: That is drawn up by the management of the company and tabled with the board.
The CICA has put out a 70-page framework explaining how the MD&A report should work. They assess risk and where the company is doing and put matters in perspective. It is a very important document. How quarterly results are released, how management portrays itself with the media, how the reporting is put out other than financial statements are all items that an investor looks at to make these decisions.
Auditors are only responsible for the financial statement that is in the annual report.
The Chairman: You say, ``Only responsible for the financial statement.''
Mr. Smith: The audit opinion they give is on the financial statement.
The Chairman: You write out a certificate saying that you verify these figures.
Mr. Smith: That is correct.
The Chairman: They are the correct figures.
Mr. Smith: We write an audit report. I do not think we use the word ``correct.'' An audit report opines on the financial statements. It does not opine on the MD&A or on the quarterly results.
The Chairman: I understand that. Let us focus on the audited statements. I am not sure what you are saying. Are you saying auditors are just bean counters that get the numbers and write them down, and say, ``Maybe they're right; maybe they're wrong''?
Mr. Smith: No, I am saying that management prepares the financial statements and the auditors complete the work on the financial statements.
The Chairman: What does that mean, ``complete their work''?
Mr. Smith: They do a complete audit of the accounts of the company.
The Chairman: For the record, what does that mean?
Mr. Smith: The auditor satisfies himself using generally accepted audit assurance standards that every auditor uses when they go in to look at financial statements. They apply those tests and conclude whether they can opine on those statements or not. Sometimes those statements need correction and management will correct them if they find an error. Eventually, financial statements are produced, signed by the board and audited by the auditor.
The Chairman: You say: ``signed by the board.'' How does the board know that the numbers are correct?
Mr. Smith: They have been participating in board meetings all the way along.
The Chairman: I am not arguing with you. I am just telling you that I am totally nonplussed. I have sat for so many years on boards and I cannot tell if the numbers are right. It is not my job to tell you that the numbers are right.
Mr. Smith: That is correct. Management prepares the statement. The auditors audit them. The board asks the questions of management and auditors to satisfy themselves.
The Chairman: I am submitting to you that the board does not have enough knowledge to ask those informed questions. Alan Greenspan, in testimony before Congress a couple of months ago, said that when he was in private practice he sat on a number of audit committees and did not have a clue as to what questions to ask. He is a pretty bright guy. How would you explain that? I am not attacking you. We are here to try to solve the problem.
Mr. Smith: Board members and audit committee members must have a better understanding of the company.
The Chairman: How do you achieve that?
Mr. Smith: We can achieve it by training. Some groups in the country are giving courses to people before they become a director or member of an audit committee. The course explains the responsibilities of the position and what informed questions to ask. A board should seek counsel if it is unable to answer a question or get an answer to a question. A board needs to be independent enough to do that. There is no simple answer, but education is always a good start.
The Chairman: I do not want a simple answer. I am trying to understand what you people think. You come across somewhat as negating your responsibility.
Mr. Smith: That is not so.
The Chairman: That is the impression I got.
Mr. Smith: I would certainly like to spend time to clarify that. That is not what we feel. That is why we say, ``Here is what MD&A should look like. Here is what you should look at and here is the format for doing it.''
We are encouraging corporate directors to develop a program to help board members by educating them. This approach is very much part of the solution.
The Chairman: You are an accountant?
Mr. Smith: I am an accountant, but I have not practiced for a while.
The Chairman: I was on the audit committee of Dupont about 15 years ago. They did $40 billion gross business. They were in 80 or 100 countries and Price Waterhouse used to walk in with stacks of stuff. Where do you start? How do you possibly know what to ask? Are we being stolen blind? Would that be a good question? I am being facetious, but it was almost ludicrous.
Mr. Smith: The best thing an audit committee can ask of an auditor is to have time with that auditor without management being present.
The Chairman: We had that.
Mr. Smith: You need a large amount of time. The questions have to get answered. The board should be ask them. They should be answered to the satisfaction of that board. That is a start.
The Chairman: One of the problems with all these discussions is that we all mouth motherhood statements. Motherhood statements are comforting and we get the warm fuzzies from them, but I am not sure how good they are.
Most members of this committee would agree that the majority of companies are honest, straightforward and decently run.
Mr. Smith: Absolutely.
The Chairman: We are dealing with the recalcitrant crooks. We are dealing with big differences in accounting or GAAP. Cleaning that problem up is your job. I do not have a clue how you are going to do that.
Senator Kroft: Whenever I can, I like to look for low-tech solutions to high- tech problems. I find most people can communicate better on that level.
We had dinner one night with the CEO of a major Canadian corporation and asked him how he got comfortable with the statements that his auditors provided him with. We asked him to give us the list of the key questions that got him the answers that he wanted.
He question that is most meaningful to him is ``I have all this. Does this fairly represent the health of our business?'' It is a very general question.
Is that meaningful discourse? If you are asked that question, can you meaningfully relate to questions at that kind of a level? Surely, if an auditor can answer that question looking the CEO in the eye and be correct in answering it, it follows that all the rest of the stuff is okay.
Mr. Smith: I wish more CEOs would ask that question. That type of dialogue between management, auditors and the board has to take place. The conversation includes ethics and trust.
You cannot make rules estoppel. Most financial organizations in this country are honestly trying to do their best and trying to do properly. It is a matter of assessing when an organization is not doing so.
If you have a strong board, bad management and good auditors, it will still work if there is dialogue. If you have a bad board, bad management and bad auditors, you have a real problem.
Dialogue is more important than anything. In camera sessions with the auditors is a very important part of the dialogue, as is frankness by the board with the CEO. If you do not like the answer, remove yourself from that board. That is how I would solve the problem if I were a board member.
Senator Fitzpatrick: How long you think an audit committee, of a medium to large company, should take to review a set of financial statements? How long before the audit committee sits should you get that set of financial statements? If you use outside counsel, when do you have your formal audit committee meeting to examine the issues and get some professional help?
Please comment on the problem of directors who get financial statements two days before an audit committee meeting. Very often the directors read the statements on the plane before their audit committee meeting the next day. They do not know what the hell the statements are all about. They do not know what the questions are, and they do not have time to consult an outside source.
Mr. Smith: That is not very good governance and poor policy to have that situation occur. It does exist, however, and I agree with you.
Senator Fitzpatrick: It is fairly normal.
Mr. Smith: There is pressure now by audit committees to say that they want the statements a week ahead. They want to have a longer audit committee. You cannot legislate that. It is up to the audit committee to be confident enough to be able to do insist that they get the documents well ahead of the meeting date.
We still have a debate about getting outside advice. If you have a serious issue, you do need counsel. However, I do not see passing it through another test to meet with the audit committee. The audit committee needs to change itself to have enough knowledge on board to be able to make those calls.
Senator Fitzpatrick: Should the audit committee meet together before they meet with the auditors? Should the audit committee meet informally and look at financial statements and determine what areas they should pursue and then call in an independent counsel for questions?
Mr. Hunt: Yes.
Senator Fitzpatrick: How long should it take for an audit committee to review financial statements?
Mr. Hunt: An audit committee that is functioning appropriately may wish to meet prior to the year-end of a corporation to discuss how the audit will be approached; what the risks are; and to study the various significant transactions that have occurred over the last year. They could discuss that with the auditor, before the audit is started.
I remind the committee that a public company in Canada has six months to hold an annual meeting after their year- end. You get into this time crunch. Even the largest in the country can close their books and get their audit completed in two to three months. They have another three months before they have to hold the annual meeting. The current legislation provides a lot of time for people to sit down and go through this in a logical manner.
The audit committees need to rethink their activity. A lot of audit committees meet once a year and do exactly as you say. There needs to be an examination of the role of the audit committee.
Should they meet prior to the audit being conducted? Yes. They should talk to the auditors about how the auditors plan to do the audit. Auditors can relate to the audit committee that the financial statements fairly represent the financial position of the organization. You probably have six-to-eight months to accomplish that out of the year.
As Mr. Smith related, there is a function of education that must take place. Part of the education is that audit committee members can demand to not have handed to them a set of financial statements for Dupont or CIBC two days before the meeting. If these things are managed properly, you will be able to ask the appropriate questions and have a very detailed plan of audit committee's responsibilities.
Senator Fitzpatrick: It was the practice of the company for which I had responsibility to have a pre-audit meeting with the auditors. I think that is a very good practice.
If an audit committee receives a set of financial statements and has sufficient time to review them informally with the audit committee, and there are still problems, do you recommend that you get independent counsel before you meet with the auditors?
Mr. Smith: I think you should just meet with the auditors and get on with it. If you are not satisfied, then you can seek other advice if you need it.
Senator Fitzpatrick: However, it is customary that an audit committee meets the day or the night before the board of directors meeting. When you go to a board of directors meeting, a timetable must be met. Usually, you have to approve those financial statements the next day and submit them to the board of directors for the board of directors to approve them. I have never been to a board of directors meeting where they have said that they want to take the financial statements back and to an independent counsel. It does not work that way. Perhaps you need to have that opportunity ahead of time.
Senator Kroft: It is fine to focus on the year-end statement. Let us talk about the world of an audit committee member with a large corporation and the way today's financial world works in terms of quarterly statements. Everything that you talk about in terms of the year-end gets incredibly compressed. You already have grey numbers out there, and you have first call and all these people. Then you have a conference call set up. The conference call is set up, and that is predetermined. If you do not appear at the conference call on the right schedule, the market reads all sorts of things into that. There is a period of time between closing the figures, having the market, and needing to be ready for the release of the numbers. The reality is that there is a compression of time before the last numbers are taken off on a quarterly statement. I submit to you that markets move probably more often on quarterly statements than they do on year-end statements.
Mr. Smith: Yes, they do.
Senator Kroft: There is compression between the availability of the numbers and disciplines of the security exchange, the conference calls and analyst needs. All this fine talk about taking the time you need goes out the window because the schedule that an audit committee gets as to when everything must happen is ridiculous in terms of opportunities of time.
The year-end is relatively unimportant in terms of markets because by then there are three quarters and forward- looking statements. By the time it gets to year-end, everyone is close on to what the numbers are.
Mr. Smith: This conversation would not have taken place six months or a year ago. The awareness level has risen in the last year. Now is the time to do something about these problems.
In mid-September we are holding a leadership forum for audit committees. We are inviting a number of leaders in the country, including regulators, to have dialogues around the issues you are talking about today. We want to discuss what should be done in light of the AcSoc meetings, the OSC's new releases, the TSE's guidance and the auditors' new independence rules.
You sound like ideal candidates for contributing to this conference. We really do want to see what we can do to help with the situation. I do not think you would have had this open dialogue in the public domain to talk about these issues. That is what we have to do to make this reporting more transparent.
The Chairman: The shareholders appoint the auditors. One would have to assume they are working for the shareholders. Do you think that auditors have any obligation to educate shareholders? Over the last 40 years, new concepts have been built into analyzing statements. I think that the EBITDA is a huge fraud. Do you think the auditors should point out to the shareholders what EBITDA means and how it can distort matters? Would you see that as a responsibility of auditors?
Mr. Smith: I think that auditors have statutory responsibility and then they have responsibility. I think we have a responsibility to go way beyond what we do. I do not mean in a legal sense, but in the sense of educating the public.
The Chairman: You have spoken about good people and ethics and so on. I am sure that applies to auditors.
Mr. Smith: Absolutely. It has really been an amazing exercise for me. I had a lot of media talk to me and ask me questions, and so on. The publics' general understanding of the financial world is very low everywhere in the world. Approximately 60 per cent of this country invests either in the market, in mutual funds, in pensions and so on. I think we have to go right back to high school levels to educated the young concerning financial matters. Understanding finance has become a necessary life-skill. I think we need to start with our young people, and with the media. It is important that we start with our children.
The Chairman: I agree with you. We had Ms Stymiest of the stock exchange in a teleconference the other day. She and I agreed that we are poorly educated in this subject.
Mr. Smith: It is a life skill that is needed.
Do we have an obligation? We do not have a legal obligation, but I believe that we have a moral obligation. We are the standard setters in this country. We have to play more of a role in that and encourage it and participate in it.
The Chairman: Do you believe, as I do, that people in their mid 40s and 50s believe that their governments will not look after them forever or will not be able to? Do you believe that they now realize that 1.5 per cent on deposits from banks will not be enough, and that they will have to do something to make their money grow? The only option is the stock market. Too many people say, ``I play the market.'' You have heard that expression a trillion times.
Mr. Smith: Absolutely.
The Chairman: That is the problem; they are playing. We have to teach them to get serious and learn how to make informed decisions.
Mr. Smith: I agree 100 per cent. In my own personal conclusion on whether the government will take care of me as I get older, I am old enough to realize that that will not be so.
The Chairman: We agree on something.
Senator Fitzpatrick: Do you think that the shareholders should have an opportunity to question the auditors at an annual general meeting? The shareholders receive the financial statements in plenty of time, and some large shareholders, particularly now with the funds, can determine some good questions to ask. If the auditors are there on the behest of the shareholders, should the shareholders have an opportunity to question them at an annual general meeting?
Mr. Smith: I have been at annual general meetings where the shareholders ask the auditors questions.
Senator Fitzpatrick: It is not a routine procedure. I know that at some meetings they insist on asking the auditors questions, but do you think it would help if that became a routine procedure?
Mr. Smith: I think people should be more aware that they can question the auditors, but making it a routine procedure would add a lot of time to an annual meeting. If management does not give a satisfactory answer, usually the auditor is asked to comment on it.
Senator Fitzpatrick: A little time could resolve several problems, too, especially if management knew it would happen at their annual general meeting.
The Chairman: Honourable senators, our next witnesses are from the Accounting Standards Oversight Council. Welcome, gentlemen.
Mr. T.I.A. (Thomas) Allen, Chairman, Accounting Standards Oversight Council: I have only a few introductory comments. The useful part we can play here is to share in a dialogue and try to respond as best we can on behalf of the Accounting Standards Oversight Council.
AcSoc was formed two years ago by the CICA in an effort to respond to criticisms by regulators and others that various aspects of the profession, including independence, and a lack of public understanding, needed some attention.
In particular, it created AcSoc to address the public view that that accounting standards were less attentive to the public interest than they should be.
In the vernacular, the issue might be that accounting standards arrived from Mount Olympus unaffected by a pragmatic view as to what the business community, both users and issuers of financial statements, might require. If I have that right, AcSoc was designed to respond to that issue and was structured with I believe 25 members. These members were drawn from various representations around the country. Some of those who populate AcSoc are there ex officio as representatives of particular organizations. An example is the superintendent of OSFI. Not to suggest that he does not have merit on his own, but he is there because he is the superintendent of OSFI.
There are others on the council who do not represent any particular group, but who are there because they happen to be at work in the community either as an issuer of financial statements or as a consumer of financial information.
The end result is a very good cross-section of views that is then directed toward an oversight role. One must understand that the oversight role is not to set accounting standards, but to monitor the activities of the Accounting Standards Board, which Mr. Cherry heads. The oversight role is designed to monitor activities; debate with the Accounting Standards Board its tentative conclusions as to directions to follow; and to ensure that the views of consumers, issuers and regulators are brought to the attention of the board. The board will be unable to come to conclusions as to GAAP without being fully aware of the views of those stakeholders in what it does.
With that task in front of us, AcSoc has three meetings each year and each meeting has been open to the public. There have been some public presentations to us. Those public presentations were more numerous at the meeting held in May, largely because that meeting was presented as a meeting to address post-Enron issues.
While I suspect that everyone on the council is concerned about the issues that swirl around the Enron debacle the people at AcSoc are focused on one limited aspect of the problem. That limited aspect is the adequacy or inadequacy of Canadian GAAP and its vulnerability to a similar problem to that which occurred in Houston.
I would now like Mr. Cherry to make his presentation about Canadian GAAP.
Mr. Paul Cherry, Chair, Accounting Standards Board: The paper that was distributed in advance and the remarks I am making today are my personal views and not necessarily those of my board.
The issues we are discussing go well beyond Enron. However, it is important to note that Enron was not, first and foremost, a failure of accounting standards. Many accounting experts believe that if Enron had simply complied fully with U.S. accounting standards in their present form, investors would have had sufficient warning of the disaster.
The Accounting Standards Board is not, however, complacent about the risk of similar financial reporting problems in Canada. We are actively engaged in finding solutions in areas to which our mandate properly extends, namely, to financial reporting and accounting standards. We cannot deal with the many other important areas such as corporate governance or the conduct of audits, nor can we deal with how our standards are actually interpreted and applied in practice.
Before we change our system, we should be clear as to what the problem is that we are trying to fix, and why the changes that we are contemplating will produce substantive improvements.
The Canadian accounting standards system is highly respected in the international community. We should be careful not to destroy what is widely perceived as a highly valuable, knowledge-based intangible asset called Canadian GAAP. It has taken us decades to get to the point where we have our standard-setting processes and infrastructures in place.
Standard-setting requires highly skilled resources. I have been surprised from my experience in the international scene how scarce those resources are. It is not a deep pool. Once dispersed or fundamentally altered, as Australia has learned to its bitter experience, they are not easily reassembled.
There is room for improvement. We are currently undertaking an in-depth review of our standard-setting processes and resources. We will report back to the oversight council at its next meeting in September. That will be a public meeting.
A question frequently put to me is: ``Should our board be more independent?'' It is not obvious to me that the financial accounting standards board in the United States has actually been more independent in its decisions than our board. By way of example, I believe, and I believe others share this view, that the Canadian board has a better track record than the FASB in the U.S. in hanging tough on tough issues.
Although CICA appoints our oversight council, the council controls all appointments to my board. I report to the council; I do not report to CICA. The council evaluates my performance.
Finally, our board must consult our oversight council, and it is the board, not the council and not CICA that determines decisions on our technical agenda.
A particular example has come up in your questioning already. When our board decided to take on stock-based payments, people thought we were suicidal. We concluded, after deliberation, that the cost of stock-based compensation, including stock options, ought to be booked. We are were advised by virtually everyone that that decision, if implemented, would harm Canadian business because it is stricter than the U.S. GAAP answer.
We carved the project into three pieces. The first piece, which we have done, is we have essentially arrived at where the U.S. is. That piece is a major achievement in financial reporting. The U.S. and Canada are the only countries in the world to have gone that far. The new standard captures the most prevalent type of award in Canada, the so-called stock appreciation right.
The second piece is currently underway. We are working with our international colleagues through the International Accounting Standards Board that has a project under way on stock-based compensation. They will issue an exposure draft later this year. Their tentative decisions are exactly the same as those reached by our Canadian board. If that exposure document leads to a final standard, the international community will return to the U.S. and apply peer pressure to get them to converge. Based on the feedback we have been getting, it is possible, that the mood has changed in Canada, and perhaps we have worried too much about the competitive harm issue. I think the jury is still out, but we are starting to hear a balance of views.
Do we want a system that is principle-based with some detailed rules, or do we want the U.S. system? That U.S. system is roundly criticized as being excessively rule-oriented. The problem with the U.S. system is not the rules; it is the corollary which people have taken as motherhood now, that if there is not a rule, you can do what you want; it is open season. That is the problem. It is not the rules. If you are to have complete rules, they had better cover every last opportunity.
You cannot have it both ways. You cannot have a lot of detailed rules and then tell people to stand back and apply judgment and general principles when there is not a detailed rule.
This sort of anything-goes mentality is already creeping into Canada. In a principle-based system, which is what we believe we have in Canada, you cannot simply combine any and all of the numerous possible accounting treatments arbitrarily and without judgment or other constraint. That has never been the appropriate application of Canadian GAAP. Our board is in the process of expanding guidance on the role of professional judgment, and making appropriate accounting policy determinations in a principled and reasoned fashion.
When you have a principle-based set of accounting standards, the important issues usually involve judgment, what I call soft numbers, not the black and white rules. If we are to have this type of system it is important that we have an enforcement system that addresses not only the easy black and white issues but also the areas of judgment and soft numbers.
Another core issue before us is whether we should not simply adopt either international accounting standards or U.S. standards instead of Canadian GAAP. In my judgment, the international standards are simply not ready, and they will not be for several more years. More to the point, we do not yet have the infrastructure in Canada to use them on a widespread basis.
The tougher question is: ``Should we move to U.S. GAAP instead''? This approach does have considerable appeal, in particular for large Canadian public companies that are cross-listed in the U.S. These are large cap companies, which are important, but there are a number of small to medium-sized public companies that are not cross-listed and not at all interested in U.S. GAAP.
If we do adopt the U.S. system, that means, in my view, not merely the fairly massive amount of standards that they have, but a whole lot more implementation guidance, as well as the SEC accounting requirements. If you are to have comparability, you cannot take part of it; you have to take it all. In my judgment, the costs of doing that would be staggering. I have spent a lot of time with large public companies and it is expensive. For small to medium-sized public companies, it becomes extremely expensive, if not prohibitive.
Our board has been eliminating most of the major differences on the major points of principle between Canadian and U.S. GAAP. This makes it easier for a Canadian company that wants to comply with both Canadian and U.S. GAAP to do so. It makes it easier for them to access the U.S. capital markets. That is what we call `''harmonizing''; it is not the same thing as adopting U.S. GAAP. We think this strategy serves the interests of investors and public companies.
In the last five years, we have issued 12 major pronouncements affecting public companies in Canada. In going back and looking at them, all 12 are substantially harmonized with U.S. GAAP. That is a deliberate result of the boards' policy to eliminate the differences. I brought with me a handout that you may wish to refer to later which specifically identifies those standards and the areas of difference.
Why do we attach so much importance to this distinction between harmonizing with U.S. GAAP as opposed to adopting it? I mentioned the cost factor, but there are some other larger-picture strategic considerations. First, if we were to adopt U.S. GAAP, it would polarize the world. We would very firmly be in the U.S. camp. That would almost certainly cause Europe to close ranks, which they have been threatening to do for some time, and we would probably get another cluster in Australasia. One possibility of that would be that the International Accounting Standards Board could very easily devolve from global aspirations to becoming essentially the European standard setter.
Secondly, I think it would significantly reduce, and perhaps all but eliminate, the Canadian perspective from financial reporting requirements. Some have suggested: ``Why not try to get a seat on the FASB board''? They have seven members. I am not sure they would even consider us. If we did get a seat, it would not come anywhere close to matching the peer pressure and the status that we have as a full-blown national standard setter.
The Chairman: What do you mean by ``eliminate the Canadian perspective''? What is the Canadian perspective in numbers?
Mr. Cherry: This question regarding foreign currency comes up often: ``Are Canadian companies more heavily dependent on foreign sources of capital than American companies''? I argue that when the U.S. adopted their standard on foreign currency translation it was a much smaller issue for them, than it was for many of our Canadian companies. I think that has a bearing on the extent to which some issues are examined. Other issues would be our income tax system and our statutory system, which are a little different.
From an accounting point of view, we try to take into account the economic environment and the circumstances that influence Canada. Our agenda is not necessarily the same as in the U.S. .
Does that respond to your question?
The Chairman: Not really. I am thinking about it.
Mr. Cherry: The third point is that Canada very much supports a single set of global standards as a long-term solution. We are in formal partnership with the international board to achieve that, as are the Americans. In my judgment, if Canada did not have a full-fledged standard setting system here, the prospects of that international partnership achieving success would be significantly diminished. We are seen as the ``honest broker'' that knows how to reach accommodation with the U.S. Most of the rest of the world is strongly opposed to U.S. GAAP being the basis of global consensus.
Another point to which I would like to respond to is that it has often been observed that Canadian GAAP produces higher income than U.S. GAAP. You were challenging Mr. Smith to explain the reconciliation. I would be happy to come back to that. I point out that in the 2000 annual report, as far as income from continuing operations is concerned — and most investors and analysts put primary emphasis on income from continuing operations — the U.S. GAAP number was higher than Canadian GAAP in both years. I have heard this so often, it is extremely tough to generalize. As an accounting standard setter we seek neutrality. The objective is we do not try to be conservative. We do not try to be optimistic. We truly try to be neutral.
At times, that means our system can produce a higher number than the U.S., while at other times it could be much lower. To predict in advance is almost impossible, even on a single topic like foreign currency translation.
Our staff looked at 100 public companies in 1998 based on published reports and reconciliation's and identified 20 categories of reconciling items. Eight of them are no longer relevant, because we have eliminated the differences through this policy of harmonization. Four more will be eliminated by projects that we already have under way. Three are areas where the international consensus supports the Canadian treatment; that is, where the international community is saying that they disagree with the U.S. answer. There are five more and, from the information we had, we simply could not tell whether it was a difference in the standards or whether it was a highly unusual fact pattern or whether it was an application of fringe GAAP, as the OSC have referred to it.
Finally, I would like to mention this question of soft numbers because there have been references to financial statements being ``accurate'' as if it is just a question of tallying things up. Soft numbers is a reflection of measurement uncertainty. It is shared by all standard setters and by all systems of reporting that I know. The causes of measurement uncertainty are driven by such factors as more use of fair value. Fair value can be very hard to determine once you get away from the New York Stock Exchange and other deep and liquid markets.
Shareholders are increasingly interested in predicting future cash flows. That brings uncertainties when you try to do that sort of projection. The SEC have recently called for proposals about more disclosure of what they are calling critical estimates arising from critical accounting policies and about the initial adoption of accounting policies that materially impact the financial statements. Our board will look at them to see if they merit consideration for Canada.
I observe that there are not any quick fixes or easy solutions, even if we contain the remarks to the accounting side. We have a strong system, and I believe it will continue to improve. Increasingly, we are finding that our agenda as a standard-setter is driven by global factors and not just by national issues. In the final analysis, the standards and rule making cannot substitute for management integrity, corporate governance, auditors with backbone, or regulators with the resources and the clout. That concludes my remarks, and we would be happy to take questions.
Senator Kelleher: Mr. Cherry, on page one of your remarks in the final paragraph, I thought you were being a little defensive when you said:
Canadian accounting standards are highly respected ... We must be careful not to destroy them highly valuable, knowledge-based intangible based asset called Canadian GAAP.
I hope you do not mean that one cannot be critical of our standard or hold it up to examination.
Mr. Cherry: Absolutely not. There is not an aspect of our Canadian standards that is not being challenged day in and day out. That is also true of the U.S. and internationally as well. You would think that after a few years there would be closure on some of these issues. However, there are few absolutes.
Senator Kelleher: I am glad to hear that. Our friend and yours, Mr. Al Rosen, was not very complimentary about our great Canadian accounting standards when he appeared before our committee. I have found that we are not dealing in black and white; we are dealing in shades. Surely, some of what Mr. Rosen had to say may be accurate. You are telling me what a great standard we have; and Mr. Rosen is disagreeing. I would like to have your comments.
Mr. Cherry: I think we have a very good system, one of the three or four best in the world. That is what I refer to as great standards. They are in constant flux. I have read a great many of Mr. Rosen's articles and have dealt with him on various issues. He has raised a number of important concerns and issues. Our board strives for a comprehensive, balanced analysis of the issues. People will disagree with our conclusions. We disagree amongst ourselves very often. However, I believe we take all reasonable efforts to identify the issues and to identify the pros and cons.
I do not see that balance in Mr. Rosen's material. It is what is not said that troubles me. For example, in the question of how we approach impairment of assets, a matter on which he commented recently, he failed to point out that, up until approximately 1995, the U.S. had no standard whatsoever. They were not even required to think about it, while Canada had a standard. It is true that they issued No. 121 in about 1995. They now have a standard.
Mr. Rosen wrote a commentary a few months ago criticizing our system because we have not yet adopted something like the U.S. standard. He did not mention the fact that we have an exposure draft that has been through public comment and we are about to finalize a standard that will be harmonized with the U.S. I agree that there was a concern. We have dealt with it. I worry that we are alarming people on some of these issues.
I seek a balanced discussion and the board routinely invites suggestions for how to fix things. I have just done an analysis based on the Caldwell status report issued in May this year. On eight areas that were identified as ``quicksand's'' of Canadian GAAP'', at least six of those items are equally valid observations of U.S. GAAP. Yet the tenor of it is that our Canadian system is terrible and we ought to be moving to the U.S. This is not, in my judgment, about Mr. Rosen's personal views. As a board, we are trying the best we can to get the input. The troubling part is this notion that there are clear-cut answers and we should go to the U.S. In my judgment, the case has not been made.
Senator Kelleher: I agree with harmonization between the U.S. and Canadian standards. It is a great objective. Have we been able to resolve harmonization with respect to how stock options should be treated?
Mr. Cherry: We have a standard in place, which requires recognition of the cost in the same circumstances as in the U.S.
Senator Kelleher: Do we treat it as an expense?
Mr. Cherry: In all cases other than what I would call a pure stock option. There are many complex arrangements that involve cash settlement or net settlement. Our standards require them to be accounted for and recognized. The one where we have stopped short, for reasons that people said would be competitively very harmful to Canada, is where you have a pure stock option.
That is my phase one. We had the same approach in the U.S. It is either booked as an expense or disclosed as supplemental net income telling the shareholder what the effect would have been if it had been booked. The shareholder gets the information. The difference is between whether it is right in the income statement or by way of disclosure.
Our Canadian board is not satisfied with that answer. We are working with the FASB and the international board to get global agreement to eliminate that choice on a pure stock option, and have supplemental disclosure rather than booking it.
Senator Kelleher: Have we been able to do anything with hybrid securities?
Mr. Cherry: Yes. In my judgment, if you get into the technical analysis, some might disagree with our answer, but Canada led the world in a project to deal with financial instruments. We were the first country to adopt a standard that, based on principles, not the legal status of the instrument, that requires instruments to be classified as debt or equity based on the economic substance of those instruments. The U.S. has not gone that route. My fellow standard setters would argue that the U.S. is lagging behind, and they are now the ones who are trying to catch up.
The international standard is substantially the same as the Canadian standard. It means that for something that is called a ``share'' under our criteria, we could conclude it has more of the characteristics of debt than it does equity. Our standard says if that is so you have to classify it as a debt. However the reverse holds true. It could be labelled a ``debt'' and our standard would say in substance it is ``equity.''
Senator Kelleher: What about resolving the problem, if it is a problem, of the compound interest effects? Is this much of a problem?
Mr. Cherry: It is a huge problem. I would need further clarification. Interest is a very important element in making fair value measurements. Our standards do require at times that you estimate fair value and use it as the basis of measurement.
There is a second aspect that is our exposure draft on impairment. It is a standard that will take what I would call a long-lived asset. We used to think of it as ``property, plant and equipment''. Our approach to accounting, and it is almost universal, it is the same in the U.S. and internationally, is that most of those assets are carried at cost, and fluctuations in their current fair value are considered to be secondary. Every now and then, it becomes clear that the cost amount is unlikely to be recovered. That is what we call ``impairment.''
The debate at the moment is: How to take the interest factor into account when you recognize impairment? We are in the process of adopting the same approaches as the U.S. Right or wrong, we think what it does is it says you do an undiscounted future cash flow calculation as the first part of the impairment test. That step does not take interest into account.
There is another school of thought, which the international standard has, that the first step ought to be a discounted cash flow, in which case you would recognize impairment more often.
Did you have a specific context in mind?
Senator Kelleher: No.
One of the witnesses who appeared before us was from the teachers' pension fund. He said, ``We were looking at our investments one day and we saw a big investment in Enron. We thought because it had gone up so much in value it represented quite a percentage of our portfolio.'' They said to themselves, ``We better take a look at Enron and see what we should be doing.'' He said that it took them about one hour to realize the problems of Enron, and they sold the whole thing out. They are not financial analysts. There were some chartered accountants involved. He said, in effect, that it was not that difficult to realize that the company was in trouble. Everything he said was contained in the footnotes.
Everyone is saying that Enron was so clever, sneaky and devilish, and that you could not figure out what was going on. I am beginning to wonder if really a lot of the fault here does not lie with other people and other agencies for not figuring it out.
I am not trying to defend you people, but we are heaping a lot of the problems on the accountants. Yet, the teachers' fund did not have a problem sorting it out. I am wondering if there is not a failure of a lot of other people that should not be spread around here. We should be careful before making too many new rules about Enron when it was not all that difficult to sort out.
I would like your comments.
Mr. Cherry: I do not think you even had to go to the footnotes. Page two of the Enron annual report had a summary of financial information. A number of people have observed that most of the significant clues were right there. I certainly agree that no amount of accounting horsepower would solve this problem. It will take a concerted effort on several fronts, including the help of financial analysts.
As a board we meet regularly with the analyst community. I think the financial press will play a part in this. The reality is people say that the financial statements are so complicated why can they not be simplified? They are not going to get shorter. We could try to simplify them but the problem is we are simply trying to keep up with all the creative stuff that is going on in the business place. I do not see any end in sight.
There are the educational programs that we talked about earlier, and there must be an attitude change. The market is sophisticated; it moves quickly. To invest is a lot like any other job. You either hire someone who is your advisor and let them do the work for you, or you do the work. Picking up even one set of financial statements or a quarterly release is a troubling issue if people are using that as their main basis for making a decision. There seems to be a lot of that going on.
Senator Kelleher: In light of how quickly the teachers' pension fund was able to sort out the problem are we perhaps, both in Canada and in the United States, overreacting to a certain degree? Everything was there to be found it is just that people were not really looking into it quite well enough.
Mr. Cherry: I believe it would be a serious overreaction if, in your deliberations and in what our board does, we had Enron first and foremost in our minds. We certainly are going beyond that.
In some respects, it is a lesson of sorts. Maybe it is just a lesson on greed, and how we think that the market will constantly rise. When you look more broadly, there are messages that we must not ignore.
Senator Kelleher: Do you mean over and above Enron?
Mr. Cherry: Yes, over and above Enron. Perhaps the most encouraging thing for me is the attitude change; it is astounding. Six months ago, if we had talked about stock-based compensation, I would expect to be the lone voice arguing for it. The mood of analysts has changed. The proposals that the Association for Investment Management and Research have made, and are advocating, are very encouraging.
Senator Kroft: I believe you are the first of our witnesses to suggest how long-term it will before we can expect international standards. I may be wrong. I have been left with the idea we may get the standards sooner. You mentioned ``several years.'' Obviously, your statement stands alone. You are pretty much saying that we should not be waiting for that to happen.
Mr. Cherry: It will take a number of years.
Senator Kroft: In answer to a question about stock options, you commented that you broke it down into components and that you were cautioned not to be too aggressive, because it might work to a competitive disadvantage for Canada. A senior player in the Canadian financial community has cautioned us not to try to go too far ahead. He advised us not to get ahead of the Americans, because it may discourage American or other foreign investors to invest in Canada or to make investment decisions that rely on Canadian markets.
I find this perplexing. There are stock markets that have sought their place in the sun by making it easier to access financial markets. Even in the relative scheme of things, they have not been happy stories.
Would you comment on how much pressure there is on you to go easy in this regard? Do you believe that we should not be too diligent so as to appear to be unattractive because our standards are more stringent? Should we state that, ``Canada is the place to go, because you know there is good, clean, effective, informed and regulated markets''?
Mr. Cherry: It is great we are hearing that latter type of statement these days. We are getting strong support from colleagues in academia and the analyst community who are starting to remind people that there can be very significant costs of capital when you have a weak system, and that maybe there is a real premium and cost advantage to taking the high road.
To be blunt, that has not even been a strong minority view up until now. I am not just speaking about the corporate community. I am also referring to view expressed by all sectors: individual investors, institutional investors, retail and corporate investors. All of these sectors have been pretty much been unanimous that the better course of action is to seek the highest quality reporting possible, but do it in close cooperation with the Americans.
We do work very closely with the Americans, but it is somewhat like a see-saw relationship. We will get ahead on one topic; they get ahead on another. This is the first time that I can recall hearing strong, thoughtful proposals that we may have been overly worried about the competitive harm issue, and that we ought to take the higher road.
That is something upon which we will have to consult broadly and seek the continuing views of our oversight council. It will be interesting to see what the views are in the international community. Clearly, there are pressures being put on the Americans to change parts of their system as well.
The Chairman: We hear such conflicting advice and statements that it is sometimes difficult to reconcile them. Mr. Caldwell, of Caldwell Securities, told us that:
American investors see Canada in terms of the Wild West and that current financial reporting of public companies is inadequate.
He also said that:
The perception in the U.S. is that Canadian accounting is overly aggressive and that financial statements are not worthy to be trusted.
The gentleman representing the certified general accountants said that:
There is no Canadian standard that prescribes how to measure the value of financial instruments or how to put them on to a financial statement.
He went on to say that:
The U.S. has had one for years and that we lack a rule on something that has been considered to be major shortfall in Canadian accounting standards for more than 50 years.
I am not suggesting they are right or wrong. I frankly do not know. Listening to them and listening to you is like living in two different worlds. Obviously, you will tell me they are wrong, but how would you suppose we deal with these issues?
Mr. Cherry: It is not that we do not have rules dealing with how to measure financial assets and financial liabilities; it is that we have different ones. They are too cost-oriented, I admit that. We have a project underway. That is what I find frustrating. I am sure honourable senators must find it frustrating. On the topic the CGAs were referring to, it is an active project. Within two years, we will have a standard that will be fully harmonized with the U.S. and internationally.
The only reason we did not do it sooner was that we were leading a global project that had great ambitions of the deluxe solution that covered all the related issues.
The push back to greater use of fair value, just when you talk about investments in stocks and bonds, was enormous and overwhelming, and is still highly resisted. We are fully expecting that when that standard goes out for public comment in about 18 months time, the vast number of comments that we receive will oppose it.
The reason we held off is that we thought it was in the better interests to introduce a globally-accepted and comprehensive solution, rather than put our community through two or three rounds of change. Unfortunately, that global solution is too far off, so we are moving.
I have heard comments before of Canada being like the Wild West. I believe that comment to be somewhat sector- specific. I have heard that comment made in terms of some of our junior companies. At times, I have not been sure whether it was an observation about the financial statements or whether it was a larger question about our approach to regulation or enforcement. There are very significant differences in the approach to securities regulation and the level of enforcement.
If I was comparing Canada and the U.S., I would be more concerned about looking at the other links in the chain. We must work on our standards. We have a strategy with a clear vision behind it. That brings us closer to the U.S., not as the end objective, but to get both the U.S. and Canada eventually on to a global world standard.
Mr. Allen: Mr. Chairman, with respect to that last issue, in a backhanded way, perhaps, I take a bit of comfort from the fact that someone would make such a statement about the reputation that Canada's markets have. One of the factors that all of us who are talking about these issues sometimes overlook is the self-policing aspect of markets. If Canada's markets, or Canadian GAAP as it affects those markets, has a Wild West reputation, those who are damaged by that are those who are seeking to raise capital in those markets. There is, by inescapable logic, a cost of the capital factor that that imports. Those who seek to raise capital have every opportunity to clean up their act. If there is a breadth of GAAP that allows a range of interpretations, and if an issuer chooses to be adventurous, imaginative, liberal, then that has a cost of capital implication for that issuer. It is not just the job of the internal policeman to moderate that liberal, adventurous attitude.
I am saying we have another partner in all of this; capital markets.
The Chairman: On the front page of the New York Times, there was a lead story on the Enron hearings in Congress. There seemed to be a mood in Congress that they were pulling back and they felt that markets had already begun to self-regulate. As you saw, there was a 23-page item from the New York Stock Exchange, et cetera. Do you share the view that perhaps governments will play a much smaller role than the United States government originally thought when they sued Andersen and all the executives of Enron and talked about making huge changes?
Mr. Allen: Many people question the judgment that was brought to bear in the obstruction of justice action in the United States because of the tremendous fallout for thousands of innocent families.
The Chairman: The question I am posing to you is whether you agree that it is already starting to happen.
Mr. Allen: Yes.
The Chairman: Thank you, gentlemen.
The committee adjourned.