Jenkins: It would be sort of a scarlet letter. [Laughter] Of course, we don't want to say that derivatives are bad per se, because in fact they can be very good for investors if they're properly used. But we do need to account for them properly. Our standard [SFAS 133], as complex as it is, is complex because it reflects complexity. And I think it does provide new information that we're just now learning how to deal with in the marketplace.
Griep: I'd like to comment on this point. Fundamental analysis — to the extent that it's difficult because of complexity to understand the nature and risk of the business as disclosed in the financials — has shifted to focusing on the risk-management function. The more opaque the financials are, the more that fundamental analysis has to focus on the systems in place to control risk.
It's interesting to look at the energy-trading companies. Many of them have risk-management systems in place, but no two approach the valuations with the same kind of assumptions. No two have the same VAR [value-at-risk] methodology or system in place.
Clapman: If I could just pick up on this point of complexity and conflicts. When Enron was the seventh-largest company in America, how many analysts were saying, "We just can't understand this company — therefore, we are neutral and have no recommendation on it?" I am concerned that the analysts with the conflicts that have been identified here were affecting the market [on Enron].
Hill: On the eve of the third-quarter report from Enron that started the ball rolling, of the 16 analysts that covered it, 13 had a strong buy or their equivalent terminology, and 3 had a buy. There were no holds, no sells, no strong sells, and nobody with no recommendation.
How do we get rid of the conflict? Should we go back to fixed brokerage commissions?
Hill: I don't know if fixed rates are the ultimate solution, but that's the problem: How does a brokerage firm get paid for research? In the old days, you got paid by doing good fundamental research. If you did something for the investment-banking side of the house, there might be a little sweetener there, but it was the frosting on the cake. Today it's the cake.
Nusbaum: I think the majority of people involved in this — from the analysts to the accounting firms to the regulators — all have the same goals in mind. What you're talking about is getting back to some of the fundamentals: the research done, the disclosures done so you can get the research, what kinds of disclosures are really needed to do the right research.
Willens: To do better research — that's so intangible. I think the public is going to demand some concrete steps.
Nusbaum: The worst thing, as Ed [Jenkins] pointed out, would be to have the government take over the setting of accounting standards, the setting of auditor standards, the setting of standards for analysts.
Off-Balance-Sheet Questions
Certainly there will be a demand for new rules on off-balance-sheet accounting, as with SPEs.
Jenkins: Remember, it was only a year or two ago that our process was being criticized because we were moving too fast [on pooling-of-interests accounting]. Now we're being criticized for being too slow — for not having properly addressed special-purpose entities in particular, and some other things as well. So it depends on which side of the bed you wake up on, so to speak, and I think there are some lessons to be learned: that we absolutely have to have a full due process for our standards, but there are ways that we can respond to legitimate concerns about financial reporting more quickly.
One thing we can do is take things in smaller chunks. And that is exactly what we are doing on the SPE side. We've decided to focus on just some of the issues on SPEs, the ones where we think we can make the most progress the fastest. It's important that we come up with quality management reporting that has good transparency for analysts and investors to use.
Some people wonder whether there should be any off-balance-sheet activities — that is, if you're giving up control of assets, then what economic purpose does it serve?
Willens: As an investment banker, I have found through the years that the principal objective a company and client will have with respect to any transaction or project is to quote-unquote keep the debt off the balance sheet. Which is fine with us; that seems to be a legitimate goal. And I would ask S&P, is that effective? If a company is properly not consolidating an SPE, will you take that at face value? Or will you make adjustments to that based on your analysis, and therefore the objective the company had of keeping the debt off the balance sheet is thwarted?
Griep: From a rating-agency perspective, we make adjustments. We will reflect the rate to what we believe to be economic reality.
Willens: Well, isn't the accounting supposed to capture the economic reality? Then you're telling me that there's some problem with the accounting principle.
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