The future of corporate reporting: from the top. (Financial Reporting).

James S. Turley, Chairman and Chief Executive Officer, Ernst & Young LLP 

Fresh out of college, in the late 1970s, James S. Turley began his career with Ernst & Young's audit staff in Houston, serving clients in the energy sector. The advent of energy trading, he says, has significantly changed the business from the traditional exploration, production, refining and marketing businesses that he was familiar with in his early days. Having grown his entire career with the firm in a variety of audit positions, Turley's extensive experience eventually led to his being named Chairman in July 2001.

A self-proclaimed "optimist by nature," Turley says that personal quality has been a helpful asset, especially recently. He believes the current financial reporting issues to be a global phenomenon, and following what has been a difficult and tragic year -- for not just the capital markets or the accounting profession, but for all of Corporate America and the world -- that things will improve.

Also, in an interview with Financial Executive's Managing Editor, Ellen M. Heffes, Turley said he believes that the increased focus on all sectors of financial reporting and performance is very positive for the future and has, in fact, "reinvigorated the relevance of our profession."

Down the road now from the recent wave of corporate accounting scandals, what are the "real" issues, and what problems do you see?

JT: As I look back to the ending of, if you will, a 10-year bubble of dramatic increases and enhancements in earnings and stock prices -- what [Federal Reserve Chairman Alan] Greenspan talked about as "irrational exuberance" -- I think there was an element of the environment creating, in investors and companies, a suspension of disbelief in some ways. Looking back in history, after long bubbles, there are problems. [Also] fees were dramatically exaggerated by individual greed on the part of some, [and] by some egregious behaviors. And, I think our profession could have done, and should do, a better job of warning earlier. So, there are real issues.

The biggest problem today is the loss of confidence, in not just our profession, but in financial management, executive management, audit committees and boards. [While] I see no silver bullets to turn that around, I think it is going to be turned around by sustained, outstanding performance, high quality [and] high integrity by all the parties -- management, audit committees, audit firms.

What impact is the "changed" environment having on your firm and your business practices, and are you now doing anything differently?

JT: There are a lot of differences, and I'll discuss some of them. One is that because of the tragic loss of one of the "Big Five," our firm is very different than it was a year ago. It's 25,000 people stronger and over $2 billion stronger around the world. And, in more than 55 of the over 80 countries that were Andersen operations, the partners elected to join Ernst & Young. Understand that these are not combinations or acquisitions -- we're not writing checks to them. The partners made choices, like clients make choices. They chose Ernst & Young, they tell me, because of our commitment to the core businesses, so important to markets today; our real sense of teaming as partners; our deep commitment to quality; and our commitment to people.

So the firm has changed. As part of that, we were [also] engaged as auditors by more of Andersen's public clients in the U.S. than any other firm. There's a lot of talk around during these times, on what firms should do and shouldn't do for their clients, and it's important to recognize what Ernst & Young does. Four or five years ago, we looked in the mirror and asked, "Who do we want to be?" We concluded at the board level that we wanted to be the best audit and tax firm in the world, so we sold our consulting business three years ago.

Today, we deliver audit and audit-related services, tax and tax-related services and transaction services. That's what the marketplace wants. So, from a service perspective, this has changed us; but it has really changed the profession more to what we've already been essentially a first-mover towards.

Another impact is a dramatic recommitment to quality being in the center of our firm. It's always been the core promise of our firm. Some 18-20 years ago, we had a tagline [that read]: "Quality in everything we do." We brought that back to center stage. [While] we have changed taglines over time; the promise had never changed. You, and others in the market, haven't seen the tagline change, because it's not about marketing. It's about us convincing and communicating, making sure that every one of our people around the world, [all] 110,000 of them, knows that that is the most important thing that we are.

In today's climate, what is Ernst & Young doing differently with client engagements, to improve audits, catch problems earlier and bring "flags" to the client's attention?

JT: There is much more focus by our firm, in fact by all firms, [and] this is not a marketing issue, it's competitive, [that] we are all focused around quality. What has changed is that we are seeing much more attention given to the audit committees as our client [in addition to management], and to the levels of dialog that are taking place in the committees.

The dialog is around important things [such as] the complexity of the businesses and the risks that those businesses have within their operating models, within their financial statements. When something is too complex for audit committees to grasp the risks, today they are saying, "Stop, I want to learn more from the audit firm. I want to learn more from management."

The second thing is around creativity. When companies are financially-engineering transactions to creatively reach the end they want, audit committees, and our firm, are both saying, "Wait, we need to understand what is the principle behind this? What is the substance behind this?" and not weave our way through to create rules. Also, there is a lot more focus and dialog with independent audit committees around the choices the companies have -- choices of policies as to estimates, to judgments, and open dialog around how conservative or how not conservative financial statements are.

Real-time, auditors began doing that even before Sarbanes-Oxley, but are ramping them [up] now. Some of the Sarbanes-Oxley provisions, including the CEO/CFO certification, has heightened all of that dialog.

Finally, as I've explained, we have dramatically recommitted our firm towards quality being at the center of our strategy. I've asked one of our top client-serving partners to be my lieutenant and leave no stone unturned -- [to] look at every process that can impact quality and delivery of our services: client acceptance, client continuance, who we work with, who we keep working with, how we staff engagements, how we partner engagements, [and] what our methodology is.

There are other things that aren't about as much: what is the consultation process when tough technical issues; how we promote people -- what is valued in the promotion process; how we compensate people; what the learning and development processes are. Every process is being scrubbed with the idea of making sure that it is world-class.

No one promotes theirs as the "low-quality" firm, and I'm certain that your firm, and others, stressed "high quality" before Enron. What's different now -- did a light go on?

JT: There is a difference. There is a difference between quality being an implied and understood piece of any organization and it being central and the message that people hear every day of their lives. That's why we brought back this tagline I referred to -- not for the market, but so that our 110,000 people see it every day.

Following the U.S. investors' loss in confidence, remedies are emerging. What do you expect will really get the markets moving? Is it SEC enforcement? Is it principles-based, rather than rules-based financial reporting? Is it converging with international standards?

JT: In the highly politically-charged environment, Sarbanes-Oxley is a very solid piece of legislation. So, I think that implementing the bill is going to be positive for the markets. However, as I said, it's not a silver bullet. It is now up to management, audit committees and us, ourselves, to deliver high-quality, excellent performance, and [then] confidence will return.

I think that we are going to see harmonization of standards on a global basis -- we have to see that. The analogy I use is: [consider] watching the World Cup soccer tournament, as many of us did last summer, and picture a tournament where every country comes playing by different rules. You'd have chaos.

As quickly as capital moves around the world today, we can't afford to have different rules. The International Accounting Standards Board and Bob Herz, [chairman] of the Financial Accounting Standards Board, and others, are deeply committed to harmonization.

So, while Sarbanes-Oxley wasn't the piece of the legislation, per se, it's clearly the intent that they have, [that] we all have. It is [also] important that we move more towards a principles-based than being so strongly a rules-based approach, because in a rules-based environment, smart attorneys, investment bankers and accountants are going to thread the needle to creatively achieve a result that is financially appealing, but may not be consistent with the principles that we would all like. And, I believe it is going to happen more quickly than any one thinks.

The European Union has mandated filings by 2005, which includes comparative statements, so, there are going to be early adopters. Some tough issues [for convergence include]: business combinations, how to account for purchases; but some of the changes in U.S. GAAP -- eliminating pooling treatment, and now the changes in how to treat goodwill -- I think, brought things closer together. In the debate that's ongoing in the U.S. around stock options and expensing, the discussion here directionally is towards international-type standards. Accounting for pensions will be another interesting discussion.

You personally, as well as some other top executives in your profession, have not been very vocal recently -- except, in your case, for your op-ed piece in the The Wall Street Journal in January 2002. Why no comments?

JT: Why haven't we been more public? is basically what you are asking. This has been -- unfortunately [and] tragically, in my opinion -- a highly politicized time. It's one of my bigger concerns, that the SEC is now a politicized agency, and I think we've got to figure out a way out of that.

In that politically-charged time, I came to the conclusion--and clearly others not out there on "stump" speeches made similar conclusions--that discretion was the better part of valor; that if we stated a position that we felt very deeply and principled about, one side or the other would say: "That doesn't go far enough in reform," if they're in favor of it. On the flip side, if we publicly disagreed with something, we would be labeled "obstructionistic."

So, I believe, the best course of action was to simply let those varying constituencies who were trying to fix the problem fix it and voice their opinions. I had confidence that everybody, in his or her heart, wanted to strengthen--not hurt or kill--the profession. With people of goodwill all trying to make something better, I had confidence that they would do so, and I think that the bill that came out did that.

By the way, that was the same position that I had when there was discussion around who should be on the Public Company Accounting Oversight Board. It was so politicized, [that] I said, "We are staying out of this." And, I am delighted there is a board because we have serious work to get done.

RELATED ARTICLE: International

IASB Publishes Proposal On Share-Based Payments

The International Accounting Standards Board (IASB) has published for public comment proposals on how entities should account for share-based payment transactions, including grants of share options to employees (known in the U.S. as stock options). The IASB invites comments on Exposure Draft ED 2 Share-based Payment by March 7,2003.

The objective of the proposals in ED 2 is to ensure that share-based payment transactions are recognized in financial statements. There is no existing International Financial Reporting Standard (IFRS) on share-based payment. This gap has become a cause for concern as the use of share-based payment has expanded greatly in recent years.

In developing the proposals, the IASB concluded that share-based payment transactions involving grants of shares or share options to employees should be accounted for in the same way as other transaction in which an entity receives resources as consideration for its equity instruments. This means recognizing an expense for the consumption of the resources re-ceived, wether in the form of employee services, other services or goods.

IASB Chairman Sir David Tweedie said the IASB has taken a leadership role, with support from its partner national standard-setters. "Typically, transaction in which share options are granted to employees are not recognized in an entity's financial statements. As a result, the entity's expenses are understated and its profits are overstated. The time has come to close this gap in accounting standards," said Tweedie.

For complete information, visit the IASB Web site at www.iasb.org.uk.

FASB and IASB Work Toward Converging Global Standards

The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) in October announced a memorandum of understanding, signifying a major step toward formalizing their commitment to converging U.S. and international and accounting standards.

The agreement follows the decisions reached in September by both boards to add a joint short-term convergence project to their active agendas. The project requires both boards to use their best efforts to propose changes to U.S. and international accounting standards that reflect common solutions to certain specifically identified differences.

Working within each board's due process procedures, the FASB and IASB expect to issue and Exposure Draft to address some, and perhaps all of those differences, together with commitment by both boards to eliminate or reduce remaining differences through continued progress on join projects and coordination of future work programs will improve comparability of financial statements across national jurisdictions.

FASB Chairman Robert H. Herz said, "By working with the IASB on the short-term convergency project, as well as on longer-term issues, the chances of success are greatly improved."

Sir David Tweedie, the IASB chairman, said, "While we recognize that there are many challenges ahead, I am extremely confident now that we can eliminate major differences between national and international standards, and by drawing on the best of U.S. GAAP, IFRSs and other national standards, the world's capital markets will have a set of global accounting standards that investors can trust."

Domestic

Sarbanes-Oxley Resource: FEI's Web

FEI aims to help ease the burden of compliance with the Sarbanes-Oxley Act of 2002 by providing Web-based resources from a range of highly-respected sources.

To access these resources, go to FEI's Web site at www.fei.org, and in the top right-side panel, click on "Sarbanes-Oxley Act." Clicking will lead to a page which houses--besides the complete Act itself--a growing range of helpful information.

These include: SEC proposals, summaries and analyses of provisions and implementation guidance.