Are You the Gatekeeper? SEC’s Hunt Reminds Auditors of Their Role

Commissioner worried investors may confuse pro forma results with audited financial statements.
Stephen TaubOctober 30, 2001

Isaac Hunt Jr. has weighed in once again on the state of financial reporting. And once again, it appears the SEC commissioner is not pleased with what’s going on out there.

Four days after newly appointed SEC chairman Harvey Pitt warned that his administration would crack down on “pro forma” earnings, Hunt made pro forma financials and managed earnings the focus of his speech to the Federation of Schools of Accountancy in Arlington, Virginia.

“Markets are only viewed as safe and stable if investors trust and understand the underlying financial reporting structure,” he said.

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Hunt said that he is especially concerned about the growing use of pro forma earnings, which he described as essentially unaudited financial statements or statements not in conformity with GAAP. Hunt said he is worried that investors who are overwhelmed by the sheer volume of filing information might not understand the difference between pro forma earnings and audited financial statements, or may not fully comprehend the importance of audited financial statements.

“Even more disturbing is that pro forma earnings may be ‘materially misleading’ to reasonable investors, violating the federal securities laws,” he added.

He argued that the pressure to meet past or projected earnings levels has caused some managers to engage in manipulation or “smoke and mirrors” to enhance their companies’ earnings and, in turn, their companies’ share prices. “When such chicanery is discovered, the resulting and inevitable restatements of earnings have caused investors to lose billions of dollars, and confidence in the market,” he said.

Hunt gave notice to auditors that they share the burden of making sure the financial statements and supporting documents issued by corporations are accurate, complete, and provide a reliable picture of the company. “The federal securities laws — to a significant extent — make accountants the ‘gatekeepers’ to the public securities markets,” he reminded his audience. “Without an opinion from an independent auditor, a company cannot satisfy the statutory and regulatory requirements for audited financial statements and cannot sell its securities in the U.S. markets.”

Hunt also stressed the increasing need to improve the quality and comparability of fair value measures and the auditing of those measurements. “In today’s dynamic economy, investors have become increasingly interested in the fair value of a company’s assets and liabilities, as well as historical cost information provided in financial statements,” he said. “Further, many existing and proposed accounting standards require companies to measure more assets and liabilities at fair value.”

Hunt said that the commission has urged the American Institute of Certified Public Accountants (AICPA) to take a more proactive leadership role, by developing detailed, broad-based guidance on valuation models and methodologies. He also said efforts should be made to educate accounting professionals.

“Preparers, auditors, and even investors need to become more educated on fair-value estimates — how they are calculated, what they mean, and when they are used,” he said. “In addition, educational curricula need to be modified to more effectively teach valuation techniques, the meaning of value, and how financial instruments work.”

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