Corporate governance and reporting.

• Author: Viets, Gilbert F.

Overwhelmingly, company financial statements and tax returns are prepared with integrity by honest managers and audited by competent professionals with proper skepticism. Fraud and misleading reporting barely impact economic projections.

Confidence in financial statements has been damaged, though, because a few people took advantage of trust and position, supported by others who did not carefully guard company assets and the sanctity of financial reports. Unfortunately, examples have been prominent and the media properly made certain we did not miss any.

Financial reporting is self-regulated. Managements prepare reports, interpreting how to report results. Reports are seldom immediately reviewed by regulators and may never be reviewed. Managements' greater fear is that analysts, strike lawyers, competitors, or reporters will find errors in the financial statements. Self-regulation will not change, and there is no need to change it.

Notwithstanding this conclusion, we have learned, or have at least been reminded from recent experiences, that certain aspects of the financial reporting system need to be fixed.

Standards for Financial Reporting

We need to fix Generally Accepted Accounting Principles (GAAP), the benchmarks for financial reporting. Accountants are overwhelmed with the standards setting process.

Financial statement readers want reports on assets and liabilities in a world that is trading elements of assets and liabilities. It is difficult to reduce business complexity to simple, transparent financial statements. Assets and liabilities today are carved into elements, dividing shared responsibility and ownership. For example, engineered transactions like special purpose entities have never been dealt with effectively by those who decide GAAP. Today, two years after Enron, a debate continues over variable interest entities, as companies try to understand a proposed standard that is getting old before it is even implemented.

The standards setting process is emotional and political. Debate is less about accounting theory than the impact on financial position and capital allocation.

To address the GAAP problem, a new law, Sarbanes-Oxley, directed the Securities and Exchange Commission (SEC) to do two things: decide who is in charge of GAAP and whether GAAP should be principles-based or rules-based.

So far, the SEC's answers are weak, perhaps demonstrating the depth of the problem. A year after the passage of Sarbanes-Oxley, the SEC has...