VideoThe alternative methodologies are to factor it directly into the rating, in the form of reduced financial flexibility; or, secondarily, just signal the presence of this contingent risk in a way that's incremental to the rating. But we're going through a process of differentiating the degree to which these triggers represent risks.
You know, rating agencies are in a difficult position. Our goal is to opine on creditworthiness, not create it. So where we have a company that is rated triple B minus and has substantial triggers, if they were to fall to noninvestment grade, the debate internally is the extent to which we lower that rating. It becomes self-fulfilling. Is there another way to signal that risk?
The related issue, from our perspective, is what we call "credit cliff" situations, which are situations where if a happens, the company is rated triple B, but if a doesn't happen, the company is rated single B or triple C. And the market demands ratings to be forward-looking.
We base the rating on what we believe is the most likely scenario, encompassing some range of other scenarios as well. But when you run into a case where the alternative scenarios are widely divergent, it becomes challenging to make that into a single symbol. So we're in dialogue with market participants, particularly investors, on how they would like us to share that information in those situations — whether it's by completely discounting all these remote but very negative scenarios in the rating itself, or whether they would like more disclosure from us in the form of our rationale on the credit implication of alternative scenarios.
Auditors and Consulting
How do we eliminate auditor conflicts of interest? Should accounting firms split off their consulting arms?
Unger: I spent a lot of time analyzing auditors' conflicts of interest. Part of it is competition: a firm doesn't want to do more than its competitor in terms of conservative approaches. Because if a company isn't happy, if that conservative approach is [depressing its] earnings, it will walk down the street to accounting firm number two — taking with it not just its auditing fees, but also its consulting fees. The question is whether you can manage that conflict sufficiently, or whether it's too overwhelming to have a firm with both of those components servicing one company.
Clapman: From our point of view — and I'm not saying that the accounting firms themselves should split consulting and the auditing function — we strongly believe that a company being audited should not use the same firm for consulting services. That's our basic position.
Ed, if your firm were forced to split off auditing and consulting, could you attract the people you need?
Nusbaum: If you limited auditing to audit services as currently defined in proxy rules, that would be overly limiting. But I think [we could continue to attract new auditors] if you expanded audit services to include the things that accounting firms traditionally provided, which is the audit, tax services, general business advice — even while avoiding the multimillion-dollar system implementations that really do create conflicts of interest.
So you don't think that the conflict of interest that even the auditors have with their clients is unmanageable?
Nusbaum: Auditors, like analysts, are paid by the companies, either directly or indirectly, and there's an inherent conflict of interest associated with that. But it's still the best system we could possibly have. There are alternatives. You could have the auditors paid by the stock exchanges, or paid by the investors: every securities transaction contributes to an audit. Those things are possible, but that's a pretty radical change. I don't see that happening in the near future.
Willens: I assume that even when it's priced correctly, auditing is still the least-profitable activity. But if you do separate the auditing out, how do we make that a profitable situation?
Nusbaum: You have to separate nonaudit services from what's in consulting. There's a lot of stuff in nonaudit services — for example, internal audit outsourcing, which is a conflict of interest, in my view — that is not normally in consulting. Even providing accounting advice or tax advice is not traditionally considered consulting.
Some people would argue that you shouldn't provide any tax services, but I think you need to provide tax services to be a public accounting firm and do a decent job. So there are some things you're going to do. Something as simple as a letter to the underwriters, which is now classified as a nonaudit service, it's hard to believe you would do the audit and not do the letter to the underwriters.
If we're charging appropriate fees, then the auditing should be extremely profitable. So we've got to limit the services that we can provide, and then set up controls.
Political Pressures
Ed Jenkins, do you feel that the way FASB is financed is a constraint on your ability to create standards effectively?
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