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

Edward E. Nusbaum, CEO and Executive Partner, U.S. Grant Thornton

Despite the recent accounting scandals and economic downturn, Edward E. Nusbaum is optimistic about the U.S. capital markets and the capitalistic system. He believes the accounting profession can improve itself, and he sees a day when there will be "plenty of public offerings and the public market system will flourish." Meanwhile, the CEO and executive partner of Grant Thornton U.S., the 5th largest accounting firm, believes that many companies -- after testing the waters and finding no benfits to being a public company -- will go private. Grant Thornton serves the middle market (companies with revenues between $25 million and $2 billion), with clients from both publicly and privately held firms. Nusbaum responded to questions posed by Financial Executive's Managing Editor, Ellen M. Heffes.

All that's come to light -- accounting scandals, Wall Street practices -- are being somehow connected and bringing the economy to a standstill. Is the current turmoil due to "real" problems or is it overblown?

EN: I think some real problems exist in financial reporting -- serious problems that have existed the last few years. While the vast majority (99 percent) of companies are probably preparing their financial statements accurately and fairly, the press tends to make it sound like every company is misstating its financial results. That's certainly not true, but clearly there are too many re-statements, and there is too much abuse. We are never going to eliminate financial fraud one hundred percent; it's naive to think that it'll go away after 2002 because we adopt some new legislation.

What we can do is improve financial reporting, the accounting standards and auditing standards. We can improve the accounting profession and the internal controls that exist within companies. It's up to everyone involved to take the necessary steps to fix the problems and in-sure that they don't re-occur. We can also im-prove what the other professionals do -- investment bankers, attorneys, commercial bankers -- so that the entire business community focuses on accurate and fair financial reporting.

What's the impact of the "changed" environment on your firm and its business practices?

EN: The changes have impacted us greatly. First, we quickly decided that Grant Thornton had to play a leadership role in helping fix the problems. Earlier this year, we recommended a five-point plan, and many of those points are already being adopted. (See it at www.GrantThornton.com.) There is a movement towards principles-based accounting standards; we see that at the FASB, [and] maybe we'd like to see everybody move quicker.

Other points [include] making sure that accounting firms really focus on accounting, auditing and tax services, the services that you would expect from an accounting firm. We've already seen many accounting firms divest some of their consulting practices, and we've seen the SEC push accounting firms to focus more on rewarding people for audit and tax services. We sold a chunk of our if-consulting practice, about two years ago, to make sure that we were not doing anything that we think would impair independence. We believe that the American Institute of Certified Public Accountants must play a critical role in approving the quality of audits and auditing standards, as well as in leading the charge. We're very proud of the global audit approach that we at Grant Thornton designed several years ago, [one] that's completely electronic and applied throughout the world. But we would benefit, and everyone would benefit, by sharing audit approaches and best practices.

Secondly, we re-examined everything that we were doing. We're very confident of our standards, and our quality-control standards and auditing policies, procedures and programs have served us well, but we re-examined everything to make sure that it was appropriate, and we tweaked some; fortunately, we didn't require any major overhauls.

Also, Andersen's demise has provided Grant Thornton [with] a tremendous opportunity in the marketplace. We have obtained many of its clients, and we've acquired and hired a significant portion of its middle market practice, including about 60 partners and 500 people. The reorganization of the accounting profession has provided this opportunity for Grant Thornton to grow dramatically, and it's incumbent upon us to insure that we are delivering high-quality services with professional excellence, both in the audit and tax areas, and any time we provide business advice.

When Arthur Levitt headed the SEC, he launched rules on auditor independence, and firms started to separate assurance practices from consulting practices. Large firms spun off (Accenture from Andersen), while at the same time, smaller firms were consolidating (roll-ups). So why does this now sound like a new concept? EN: Auditor independence has been and continues to be extraordinarily important; auditors have to be independent. Clearly, in many cases, the audit fee became a very small fraction of the fee that was being paid to accounting firms, and that's probably not a healthy environment. Nevertheless, an accounting firm needs to provide some business advice, especially since many companies, particularly in the middle-market, turn to their accountants for business advice. So, the accounting firm should continue to provide audit services, but should also continue to provide tax services, and some general business advice.

All of those things must be done through a high level of independence, and we should not be doing things to provide any type of service that would impair independence. It's a fine line that you have to walk, but, clearly, the recent steps to eliminate internal audit work and to eliminate development of IT financial systems for publicly held companies are very positive steps to insure independence.

You mentioned the roll-ups. We're seeing a major dichotomy between the services provided to publicly held and privately held companies. Accounting for the smaller firms that continue to provide services to privately owned companies continue to provide many other services, and some of these rollups still exist. It will be very interesting to see what happens over the next few years in the case of the roll-ups. Obviously, they won't be able to really provide those kinds of services to publicly held companies.

Just a short while ago, the U.S. was known for its high-quality financial reporting. Now we're hearing about needing more transparency, and the IASB proposals on principles-based accounting are gaining acceptance in the international community. Will you comment on this situation?

EN: A movement towards principle-based standards is advantageous, because no matter what rule you write, there is always going to be someone who can get around the rule. Now, principles-based standards also need some interpretation, so a blend of principles and rules-based is needed. But clearly, [in the U.S.] the pendulum had swung far too much towards strict rule-making, and everybody was trying to beat the rules.

Now we need that pendulum to swing much more towards principles-based standards. I think there is a natural tendency to say, "my standards are better than your standards," and in the U.S. we did have a high-quality set of standards over the last 50 years. Long-term, the U.S. standards were far better than any others around the world, but, over time, the international accounting standards have developed and become very good.

I think we'll see more of a convergence as the U.S. moves more towards the international accounting standards (IAS), and maybe a little vice versa as well. Certainly the goal would be to get one set of worldwide standards.

Back in the mid-1990s, when Grant Thornton developed its worldwide audit approach, I felt that the quality of the audit approach was improved by involving people from other countries and coming up with a global approach. Similarly, the accounting standards can be improved if we work hand-in-hand with the IASB to develop better international standards.

What's your view on the thinking that the new regulations could stifle the normal business risk-taking in our capitalistic society and thus curtail the U.S.'s business as usual?

EN: The new regulations certainly don't allow business to go on as usual -- because they put some restrictions on us, and only time will tell as to whether the results are "over-restrictive." Certainly one area that I share concern with many is the area of litigation; over-exposure to litigation is detrimental, and limiting some of the litigation is something I think society would benefit greatly from.

The bigger issue is that we had a stock market that was booming, and that got a little over-valued -- maybe a lot over-valued. That bubble has burst, and we are seeing a correction. Once that correction takes place and the market starts moving up again, we'll see stock offerings (IPOs) more frequently. Once people start making money in the market again, I think we will see capital start reinvesting.

Also, we will see more companies reporting greater fluctuations in earnings. The reality is that the economy goes up and down, companies have ups and downs, and we need accurate financial reporting to report those ups and downs. Companies shouldn't be penalized just because they missed their analyst's prediction by a few pennies. Instead, companies should be more concerned about getting the correct financial reporting, on the up side and on the down side.

So, I don't think that will cause people to no longer take risks. What it will do is enable better-educated investors, who will recognize that with those risks come ups and downs. So, I don't think that America will not be entrepreneurial or, will stop taking risks. That's our nature -- that's the nature of the capitalistic system, and that is what is good about it.

On the other hand, we will see some companies go private. I think we'll see a series of going private transactions, where smaller publicly held companies say, "Being public isn't worth it to us. Our shareholder base isn't that large. We are not benefiting significantly from being a publicly traded company." I can't predict how many, but we will see some number of companies going private. I don't think that that is an unhealthy process, as clearly there is a cost associated with being a public entity -- both in terms of disclosure and expenses, and the rest. If a company isn't benefiting from this cost, it should go private.

We will also see some companies delay public offerings until they have more proven track records. But at the end of the day, we will see plenty of public offerings, and the public market system will flourish.

Note: See the complete interview at: www.fei.org/magazine/.