Financial Reporting

September 28, 1998, Chairman of the U.S. Securities and Exchange Commission

Arthur Levitt sounded the call to arms in the financial community. Levitt asked
for, "immediate and coordinated action... to assure credibility and
transparency" of financial reporting. Levitt's speech emphasized the
importance of clear financial reporting to those gathered at New York

University. Reporting which has bowed to the pressures and tricks of earnings
management. Levitt specifically addresses five of the most popular tricks used
by firms to smooth earnings. Secondly, Levitt outlines an eight part action plan
to recover the integrity of financial reporting in the U.S. market place. What
are the basic objectives of financial reporting? Generally accepted accounting
principles provide information that identifies, measures, and communicates
financial information about economic entities to reasonably knowledgeable users.

Information that is a source of decision making for a wide array of users, most
importantly, by investors and creditors. Investors and creditors who are
responsible for effective allocation of capital in our economy. If financial
reporting becomes obscure and indecipherable, society loses the benefits of
effective capital allocation. Nothing illustrates the importance of transparent
information better than the pre-1930's era of anything goes accounting. An era
that left a chasm of misinformation in the market. A chasm that was a
contributing factor to the market collapse of 1929 and the years of economic
depression. An entire society suffered the repercussions of misinformation.

Families, and retirees depend on the credibility of financial reporting for
their futures and livelihoods. Levitt describes financial reporting as, a bond
between the company and the investor which if damaged can have disastrous,
long-lasting consequences. Once again, the bond is being tested. Tested by a
financial community fixated on consensus earnings estimates. The pressure to
achieve consensus estimates has never been so intense. The market demands
consistency and punishes those who come up short. Eric Benhamou, former CEO of

3COM Corporation, learned this hard lesson over a few short weeks in 1996.

Benhamou and shareholders lost $7 billion in market value when 3COM failed to
achieve expectations. The pressures are a tangled web of expectations, and
conflicts of interest which Levitt describes as "almost
self-perpetuating." With pressures mounting, the answer from U.S. managers
has been earnings management with a mix of managed expectations. March of 1997

Fortune magazine reported that for an unprecedented sixteen consecutive
quarters, more S&P 500 companies have beat the consensus earnings estimate
than missed them. The sign of a quickly growing economy and a measure of the
importance the market has placed on consensus earnings estimates. The singular
emphasis on earnings growth by investors has opened the door to earnings
management solutions. Solutions that are further being reinforced to managers by
market forces and compensation plans. Primarily, managers jobs depend on their
ability to build stockholder equity, and ever more importantly their own
compensation. A growing number of CEO's are recieving greater percentages of
their compensation as stock options. A very personal incentive for executive
achievement of consensus earnings estimates. Companies are not the only ones to
feel the squeeze. Analysts are being pressured by large institutional investors
and companies seeking to manage expectations. Everyone is seeking the win.

Auditors are being accused of being out to lunch, with the clients. Many
accounting firms are coming under scrutiny as some of their clients are being
investigated by the SEC for irregularities in their practice of accounting.

Cendant and Sunbeam both left accounting giant Arthur Anderson holding a big
ol'bag full of unreported accounting irregularities. Auditors from BDO Seidman
addressed issues of GAAP with Thing New Ideas company. The Changes were made and

BDO was replace for no specific reason. Herb Greenberg calls the episode,
"A reminder that the company being audited also pays the auditors'
bill." The Kind of conflict of interests that leads us to question the idea
of how independent the auditors are. All of these pressures allow questionable
accounting practices to obfuscate the reporting process. Generally accepted
accounting principles are intended to be a guide, not a procedure. They have
been developed with intended flexibility so as not to hinder the advancement of
new and innovative business practice. Flexibility that has left plenty of room
for companies to stretch the boundaries of GAAP. Levitt focus's on five of the
most widespread techniques used to deliver added flexibility. "Big

Bath" restructuring charges, creative acquisition accounting, "Cookie

Jar" reserves, "Immaterial" misapplications of accounting
principles and the premature recognition of revenues. These practices do not
specifically violate the "letter of the law," but are gimmicks that
ignore the spirit and intentions of GAAP. Gimmicks, according to Levitt, that
are "an erosion in the quality of earnings and therefore the quality of
financial reporting." No