Don't believe what you read in those annual reports and quarterly earnings statements. That, in essence, was the message that Arthur Levitt Jr., chairman of the Securities & Exchange Commission, delivered in a Sept. 28 speech at New York University. Earnings accounting, he said, is a "game of nods and winks." His warning: "Integrity may be losing out to illusion."
Surprising words at any time, but coming at a moment of relative economic strength in the U.S., they are startling. As the domestic economy shows signs of slowing and pressure mounts to produce earnings by any possible means, Levitt has put companies and their auditors on notice: Think twice before playing accounting games.
But Levitt has a much broader community in mind in launching these salvos. By telegraphing plans for the U.S. to get even stricter about its accounting practices, he is laying the groundwork for rigorous financial reporting around the world--an important move as stock exchanges go increasingly global and lobbying accelerates for the adoption of more lax international accounting standards.
Levitt has picked an important moment to draw a line in the sand, as financial markets worldwide seek stability. The London-based International Accounting Standards Committee is mapping out new rules for global bookkeeping with the hope that the U.S. will sign on. Levitt's message: If you want to play with U.S. investors and raise capital in U.S. markets, then you have to play by tougher rules. "We're not going to embrace any standard that isn't as good as our own," Levitt insisted in an interview after the speech. "We're the best capital market in the world."
Who could argue with that? Not investors, who experienced the panic created in less transparent emerging markets as the enormity of the meltdown took many by surprise. Frederick D.S. Choi, dean of NYU's Stern School of Business, believes that the extent of the decline in Asia, Russia, and Latin America was exacerbated by a lack of financial forthrightness and resulting skittishness among investors. "The market needs information on which it can assess risk," he points out.
Even so, Levitt's stance will certainly take plenty of heat--at home and abroad. U.S. corporations yearn for the day when either their foreign competitors are held to the same rigorous accounting they are or they will be let off the hook on U.S. reporting demands. And the stock markets, another powerful lobby, argue that the U.S.'s staunchly independent stance for tough standards has kept more foreign companies from listing here.
That's certainly not apparent when one reviews the record number of foreign companies willing to comply with U.S. generally accepted accounting practices (GAAP) in order to trade on U.S. exchanges: 361 companies on the New York Stock Exchange and 455 more on NASDAQ. This is not always an easy decision for the foreign company. While adopting U.S. rules makes foreign companies easier for U.S. investors to evaluate, it also often makes them less financially attractive than they seemed under their own standards. Daimler Benz, which made the decision to conform to U.S. GAAP in the early 1990s, for example, found its German profits disappear quickly into a net loss under our standards. Still, the opportunity to grab some U.S. investment money seems to be a potent enough enticement for many.
Levitt wisely recognizes this advantage. He also is smart enough to know that his battle for integrity will not be an easy one, even in light of recent trillion-dollar hedge-fund blowups and international turmoil. "There's going to be enormous pressure," he says. "So we need everyone on our side."