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

James E. Copeland Jr., retiring in May and ending his 36-year career, is deeply concerned about the accounting environment and the tarring his profession has received for the wrongs of a few. In an interview with Financial Executive's Managing Editor Ellen M. Heffes, he discusses the state of corporate reporting and the unintended consequences of new legislation that he says is "on-point" yet focused on fixing the wrong problems. William G. Parett will become the firm's Global CEO on June 1.

EH: While the immediate urgency of the U.S. accounting/corporate reporting scandals has abated some, from your perspective, are there real problems with the U.S. system?

JC: It's a good news/bad news situation. The bad news is we've been through a terrible period of time. A lot of people have suffered, reputations of many people have been damaged -- some who deserved it, and some who didn't -- and there have been massive losses in the markets. People have suffered, and people lost their jobs.

The notion of efficient market hypothesis, that historical financial statements really don't matter, had sort of taken hold and had gotten a lot of traction. People, basically, were treating the audit as if it did not matter, and the historical audited financial statements as if they did not matter. That was a serious mistake, and we have paid for it.

The good news is that we are entering a period that will probably be a high watermark for financial reporting in terms of the integrity and the accuracy of it, because everyone is focused on this issue now.

That really needed to happen. I'm hopeful that the light at the end of the tunnel is not a train, and that we will see the best financial reporting that we've seen, at least during my career.

EH: Discuss the environment going forward, and some of the remedies in place -- like Sarbanes-Oxley -- and others that might follow.

JC: I think the forces for good are already in motion, as everybody is paying much more attention to the quality of financial reporting now -- boards of directors, audit committees, management, the auditing profession, analysts, investment bankers -- and this should give us a good result.

The unfortunate part is some of the unintended consequences that evolved in the form of "reforms" are also in place. Some of those consequences will be realized over the next several years, and they won't all be good.

I'm concerned going forward that we are focused on the wrong issues. Everybody believes that this is in some way an "independence of auditors issue;" even the press seems to have picked that up, and it actually has nothing to do with the problem. And, they are trying to solve it by stripping away the very competencies that we need in order to do quality auditing.

The first major blow, to us, was having to separate [from] Deloitte Consulting. That separtes a world of intellectual capital from our organization -- industry knowledge, technology competencies -- that we have to work hard to replace in the audit activity, not in the consulting activities.

For example, [the consulting arm] helped us develop an SAP audit approach, which was very important to be able to do world-class audits of very complex information systems underlying large-scale companies. Those resources are no longer available to us. In fact, Sarbanes-Oxley appears to close the door to insourcing those competencies from other organizations, so, we can't go to, say IBM, to insource that capability.

[Thus] I'm very concerned that the intent for reform was exactly on-point [but that] it has focused on the wrong place to put the emphasis.

EH: Do you believe some of the focus had to do with the general public and media-projected image of what "should" be changed?

JC: We had two or three high-profile people, who really don't know much about auditing, focus on this, because it was a simplistic answer. Then, the press picked up on that and helped legitimize the notion. It's unfortunate, because I don't think that it was the problem, nor is the problem today.

We should be focused on much more difficult issues to understand, like: how you do audits, and also the investing public's knowledge of what an audit can do and what it can't do, even when it is well-performed. It is not a guarantee of financial statements, even when done right.

There is a vast misunderstanding and expectation gap between what is possible for auditors to do. It's not even a question of what we are doing, but one of "Is it even possible to meet that expectation?" The answer to which is, "No." I believe the business press has a responsibility to help educate the public about the limitations of an audit, even when well performed.

And we [as a firm] have a responsibility, obviously, to improve the way we audit -- to do a better job.

EH: There's an added challenge, especially now, with CEOs and CFOs having to guarantee the audit.

JC: There is [also] this strange notion that we ought to also do away with our tax competencies and everything else except accounting and auditing. You can't audit a world-class company with just accounting and auditing capabilities. You have to have actuarial science, tax and technology capabilities, and you have to have world-class people in all of those areas.

EH: Let's talk about Deloitte & Touche and Deloitte Touche Tohmatsu. How has the firm and its processes been impacted by the new environment?

JC: In an odd way, it's had a positive impact on our firm because we've always focused on a high-quality audit practice -- and for a long time didn't get much credit for that. The marketplace was looking for low cost and a number of other decision points in deciding on an auditor, and it was very hard to differentiate among the Big Four -- or Five or Six, at that time -- on the basis of quality.

Now, [quality] is what everybody is trying to use as a differentiating factor. They are trying to differentiate among the firms because they have seen one fail, and they clearly don't want to be a part of that scenario again.

In that environment, the flight to quality is a natural reaction, so we've done very well in the marketplace because of our reputation for quality. People might have viewed us as "not flexible enough" in times past. In fact, as you probably know, we lost the Enron account because Mr. Lay, according to his chief financial officer, said that we were not creative enough as auditors. To some extent, that did hurt us a bit -- we were viewed as sort of the tougher auditor [and] not everybody was looking for that. Now, all of a sudden, there is a laser-like focus on quality of work, protecting the board and protecting the shareholders. That is as it should be.

EH: On international convergence: do you think that in our lifetimes that we are going to see some movement? Both the IASB and FASB seem inclined to reach some agreements. JC: Right now, the FASB is struggling with the horns of this principles-based/rules-based dilemma. The IASB Chairman, Sir David [Tweedie], clearly favors a principles-based approach, but he would also be satisfied, as they are in the U.K., with a lot more judgment in the execution of those principles. You have to be. And we in the U.S. very much want the same; we want consistency in the application of those principles -- the same transactions accounted for in the same way on the books of every company that has that transaction. You won't get that with principles.

So, I guess what they are really struggling with right now [is] that separation between those two concepts. But I do think, yes, they will make en-ormous progress on many of the key issues, like stock option accounting and other things like that. It's when you then push down from that and say, "Okay, they are going to be expensed; but then there are eight million different variations of stock option plans." In the U.S., we would try to anticipate every one of those in a document we would issue; in the U.K., they wouldn't.

EH: Talk about the profession you've been a part of for 36 years -- the people, what surprises you, what you like, and what you don't like. Where is your thinking?

JC: The reason to be in this profession is the same as it's always been: the quality of the people that you get to work with, both internally and externally, the clients. [Near] the end of my career, I'm still here for the same reason I joined in the first place: the wonderful people. It's a young organization with a constant inflow of thousands of new, young, bright minds adding to the organization's intellectual capital.

On the regrets side: We've had things happen in the environment that have tarnished the reputation of the finest people that I know. It's heartbreaking to see politicians, reporters and others challenging the integrity of people that they shouldn't be in the same room with. I have a hard time with that; I've made no bones about it. It's hard to watch them being tarred by the same brush that appropriately tars the people in our profession who have not done what they ought to do. The external environment right now is something I can't control [nor] understand why people feel and have reacted the way that they have.

Most people don't understand the discipline that takes place within a firm like ours. Talk about having a disciplinary board for our profession -- you only get one chance to make a mistake; if you do, you're effectively gone. But it happens in a quiet, not a public way. There are no public hangings, [but] you get your firm sued over an auditing failure, and your career is pretty much over. Unfortunately, the public doesn't have that perception.

On the one hand, I empathize with the people who lost their life savings, their jobs and everything else. And I understand we have a tremendous public responsibility to investors, and we have a responsibility for continuous improvement for getting better at everything we do. But this is out of proportion; [it] doesn't quite capture it. All of the frustration and pain seems to have been focused on the people in our profession, whether or not they have ever been involved in any problems. It's as if, if you've ever made a mistake on an audit, you must be an unethical person. This is crazy.

Understanding all of the emotion and everything else, it hurts me a lot to see, again, the best people I know period, full stop, maligned.

Read the entire interview at: www.fei.org/mag/articles/3-2003_FR.cfm.