Opening Remarks: Aiming Toward the Future

About the Speakers

Wesley Bricker serves as the chief accountant for the SEC’s Office of the Chief Accountant (OCA). (Editor’s note: Bricker left the SEC in June 2019 after this speech was given.) The accounting group advises the SEC on accounting and auditing matters, and works closely with private sector accounting bodies such as FASB. Bricker was previously the OCA’s deputy chief accountant. Before joining the SEC, he was a partner at PricewaterhouseCoopers, where he was responsible for clients in the banking, capital markets, financial technology, and investment management sectors.

Russell Golden has served as chair of FASB since 2013, after previously being a board member for three years. Prior to that appointment, he served for two years as FASB’s technical director, overseeing FASB staff work on accounting standards and technical application and implementation activities. He also chaired the FASB’s Emerging Issues Task Force (EITF). He has been with the board since 2004.

Bricker and Golden presented the opening remarks at Baruch College’s 18th Annual Financial Reporting Conference, held on May 2, 2019. The following is an edited transcript of their remarks. The views expressed are their own and not necessarily those of the SEC, FASB, the commissioners, the board members, or the staff. Official positions of FASB are only reached after extensive due process and deliberations.

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Bricker and Golden presented the opening remarks at Baruch College’s 18th Annual Financial Reporting Conference, held on May 2, 2019. The following is an edited transcript of their remarks. The views expressed are their own and not necessarily those of the SEC, FASB, the commissioners, the board members, or the staff. Official positions of FASB are only reached after extensive due process and deliberations.

The world stops for no one. Financial reporting, of course, is not exempt from change. This conference also provides an opportunity for us to talk about those changes, as well as current issues in financial reporting, and to peer into the future together and explore the role of financial reporting in a rapidly changing society. I’ll use a four-year timeframe to describe changes.

My ambition is to provoke thought about 1) where we’ve been and 2) several trends and ideas to incorporate into planning for the future of financial reporting. In doing so, I will use as an essential starting point in framing the discussion the overall financial reporting structure, which was the blueprint I introduced at this conference last year.

Over time, the structure of financial reporting has been strengthened through comprehensive efforts. The structure, I believe, is solid. It is supported by clear responsibilities for and certifications from management, requirements to devise and maintain internal accounting controls, and requirements to have an independent expert audit committee or others charged with governance. It’s supported by clear accounting and reporting standards. It’s also supported by strong audit firms, a well-resourced audit regulator, and ultimately, timely prevention-first regulatory approaches.

While I remain optimistic about the long-term role of financial reporting in the United States and the world, I think we’d all agree that the backdrop is a complex one. In my view, we face a long-term overall trend of less trust and confidence in virtually all institutions, from corporations to audit firms. This trend must be reversed, and we all must work to do so. The future must be met with all of us involved in financial reporting being clear-minded, evidence-based, frank, and courageous regarding the objectives, responsibilities, and sensible expectations for each of us involved in financial reporting. Confusion or lack of action in this regard ultimately undermines purpose, trust, quality, and confidence; ultimately, it increases the costs borne by shareholders.

Improving Financial Reporting

Let me turn to financial reporting and our work in advancing it. Confidence in financial reporting is essential to any healthy economy, including in the capital markets; however, financial reporting is a means to an end, not itself the end. Its purpose is to measure, to reflect, to describe, and in some ways to interpret or otherwise disclose business events that have taken place in a decision-useful manner. High-quality, general-purpose financial statements are designed to help investors make well-informed investment decisions.

And while most professionals are certainly doing the right thing, instances of financial statement fraud, though relatively rare, do occur. When they do, they can have a profound effect on investors. Thus, it helps policy makers and practitioners alike to ask, “How can we analyze previous failures? How do we understand the root causes to learn from them and find effective and efficient ways to limit failure, while restricting burdens and costs on honest, well-run companies?”

In answering this question, it is also essential that the correct lesson be learned by the party with the corresponding responsibility to limit failure—that is, management is responsible for preparing the financial statements, subject of course to board and audit committee oversight. The independent external auditors then evaluate the fair presentation of those financial statements in relation to a financial reporting framework.

Our work over the past four years has emphasized several very well established themes. There are ten of them: Number one is talent and integrity. We have focused on and will continue to focus on inspiring future generations of accountants to enter the profession. I think that is an important element certainly of what Baruch College and the Zicklin School of Business have done so well.

Two, we focused on new GAAP accounting standards. OCA has supported the implementation of new GAAP standards by FASB.

Third, non-GAAP measures. We’ve talked about non-GAAP at this conference over the years. The commission rules require that disclosure controls and procedures should be designed to prevent timely detection of error, manipulation, or mischief with the numbers.

Fourth, we’ve focused on ICFR, internal controls over financial reporting, on which my colleagues at the SEC and I have worked diligently—together with the PCAOB, an essential partner in this regard—to communicate to companies and auditors the resources available to them to help address requirements to maintain effective ICFR and evaluate its effectiveness.

Five, we’ve focused on auditor independence. In May 2018, of course, the commission proposed amendments to its auditor independence rules for situations where the auditor has a lending relationship with certain shareholders of an audit client. Issuance of final rules is on the commission’s agenda for 2019.

Number six, we focused on audit regulation in 2018. Of course, the SEC appointed five new board members to join the PCAOB. The new board will continue to innovate and to evaluate its oversight. They’re off to a terrific start. I was very pleased that board member [Kathleen] Hamm will be here for the keynote address later in the conference.

Number seven, we’ve focused on audit firm governance. Five of the six largest U.S. firms have appointed independent directors or advisors with very meaningful governance responsibilities. And in that regard, I’d like to emphasize that the effectiveness of those members lies in their having an independent mindset and adequate opportunities to make active and substantive contributions, both in monitoring as well as in advising firm leadership.

Number eight, we’ve focused on independent audit committees of public companies. In my experience, the drivers of audit committee effectiveness include members’ independence, their training, their experience, and the quality of a committee’s information and communication, including with the auditors. And I encourage audit committees to think along those dimensions as they assess on an ongoing basis how to improve their effectiveness.

Number nine, we’re very active in international cooperation. Among the commission’s extensive international work is the participation in the monitoring group as a new addition. I was honored to be appointed to serve in the roles of last year vice-chair, now co-chair, and in a few weeks, I will assume the role of chair of the monitoring group. That’s a group focused on developing recommendations, among other things, to reform the international audit standards-setting structure, as well as governance.

And then number ten, and perhaps most pervasive of all, is technology, data, and innovation. We have engaged with market participants on their innovative ideas and technological developments.

These are just examples of changes over the past four years that have both strengthened the structure of financial reporting and sharpened our focus on areas to make what we do even better.

Financial Reporting Today

Now let me talk about several observations that buttress my belief in the current strength of the U.S. financial reporting structure; that is, restatement rates in the most recent past are at the lowest level in about two decades. There’s always more work that we can and should do to prevent failures in financial reporting, but I’m also pleased to say a survey of investors indicates a high degree of confidence in financial reporting. Again, our work is never done, but the trend is in the right direction.

Also, companies with ineffective disclosure controls have decreased for the second year in a row, after peaking in 2015, with IT-specific controls being the most frequently identified deficiency. Again, there’s always more that we can and should do, but the trend is in the right direction.

During 2018, there were 209 new engagements and 186 departures among major global and national audit firms, suggesting that audit committees can and do change audit firms as a matter of their own judgment. That is to say, audit committees are well positioned to assess the quality of the audit services being received, and they are executing their responsibilities under the Sarbanes-Oxley Act to hire, fire, and set compensation.

Finally, just as anecdotes, auditor inspection findings are on the decline among the largest registered firms, both in frequency and severity. But again, with this point, there’s always more work we can and should do to bring that down even further.

These points are anecdotal, but I believe they are consistent with an emphasis on maintaining high-quality financial reporting throughout a comprehensive structure that fosters investor confidence, promotes effective or efficient capital allocation, and ultimately makes the United States more competitive in the global marketplace. But we cannot and we must not rest on our laurels, so I’d like to touch on two broad areas that have gone through significant change and identify opportunities for the accounting profession.

The first broad area is economic trends, a subset of which is the evolution of technology which contributes to economic development. Technology is a prominent force that has been a catalyst of profound change to business models, business processes, and even accounting and audit. The opportunities and benefits that technology provides also come with risks and complexities.

For example, data security and privacy concerns are coming to the fore. How we respond to these challenges will have a profound effect on our capital markets. As such, we need to understand the changes through the lens of those capital markets, and particularly their impact on financial reporting. Adequately preparing the next generation of the accounting profession for such challenges will be critical to that understanding.

A second broad trend is investment strategies. On the investing side, retail investors are and have been critical to our capital markets. Over the past four decades, they have been increasingly relying on financial intermediaries to help them make investment decisions. For example, almost 45% of U.S. households own funds, generally ETFs [exchange-traded funds] or mutual funds, either directly or indirectly through other intermediaries, which is a sharp increase from only about 6% in 1980.

Think about the dramatic shift in the pervasiveness of funds and financial intermediaries. That’s a result of innovative and valuable institutional services. In that regard, U.S. issuers, equities, and securities markets have been increasingly intermediated, further separating companies from their ultimate retail investors. These shifts can impact how accounting and audit information serves those investors.

For example, passive investors are not necessarily passive owners. Their governance and trading decisions rely on the consumption of high-quality, consistent, comparable financial information and other metrics, in part because it reduces their trading and monitoring costs. Also, passive investing relies on the efforts of active investors, whose buying and selling activities determine share price.

Transparent financial disclosures are essential for active investors to set informationally efficient prices, and thus there exists a strong demand for extensive, refined financial data for both corporate managers and investment advisors. Opportunities in this area, particularly for the profession, go to those who identify the changes, how those changes affect market participants, and how the needs for financial data used by investors have changed and might continue to change.

Another broad economic influence is the pace of small business formation. While attention is sometimes focused on large corporations, the growth and reporting of small business is vital to our economy. I have two very broad observations in this regard.

First, auditors serve a vital role in providing candid feedback to the small businesses that they audit, in either a financial statement–only audit or an integrated audit. They can and they should engage in twoway communications with the companies they audit because such communications help them elicit useful information from management and improve audit quality.

At the same time, an auditor may also provide management and audit committees with ideas regarding matters involving internal controls, complex accounting matters, and other matters impacting the audit. The value of this feedback flows ultimately to a company’s investors. It is consistent with the public interest. I believe auditors can effectively serve this role within the boundaries of the independence rules.

Relative to large and mature companies, small businesses likely have a shorter history and hence less experience in building up robust internal control systems, so they may particularly benefit from objective, seasoned feedback regarding the role and consequences of useful information. We’re all better off when auditors fully embrace their role in providing audit feedback and other services, which facilitates improvement to financial reports prepared by management, and increases the effectiveness of the audit committee’s oversight. That is an important responsibility.

Second, it is essential to note that mandates for disclosure always come at a cost, and such costs can be disproportionately burdensome on small businesses. In my view, the experience with graduated disclosures or even phased implementation has been positive. For example, the PCAOB’s new auditor reporting standard permits phased implementation. Auditors of companies that are not large, accelerated filers will have an additional 18 months to implement the requirements. This phased approach can apply to other standards-setting activities as well.

Phased implementation enables all involved in the implementation of new or revised standards to monitor the experience of earlier adopters, including consideration of any unintended consequences. It can facilitate more timely and effective postimplementation reviews and provide support for regulatory or standards-setting changes, education, and coordination where necessary.

International Trends

Let me now transition to several international trends. There has been extensive international cooperation to promote convergence where possible between domestic and international accounting and audit standards, and work against fragmented regulation. The SEC has for decades considered accounting convergence, just as one example.

It is crucial, I believe, to identify similarities and differences in financial reporting and auditing standards across countries and to reconcile them where possible. Differences in these standards and their applications contribute to uneven financial reporting quality and audit quality. This in turn manifests in additional costs that investors bear in acquiring and processing information about foreign companies relative to domestic companies, and imposes significant costs on foreign companies that seek cross-listing. Overcoming such information barriers is vital for companies and their investors to realize the benefits of cross-border capital flows and a diversified investor base.

Given the nature and the size of our U.S. capital markets, I would expect the United States to set a benchmark in the quality of financial reporting and audit services, in no small part due to the coordinated, intensely collaborative, and informed thinking regarding the overall financial reporting structure.

I also recognize that countries around the world have different legal, governance, and capital market systems, as well as regulatory approaches. For example, regarding regulating the audit market, some organizations within the United Kingdom have recently issued several reports with varying objectives. In my view, some recommendations require more development; otherwise, they might in fact present risks to audit quality.

For example, a point in one of the reports recommends that the governance regime for an audit firm’s audit business should include a board comprising “a majority of nonexecutive directors” that reports on measures related to audit quality to a newly formed regulator. Those nonexecutive appointments of individuals would be “approved” by the new regulator. This regulator would be charged with establishing wider public interest responsibilities that extend beyond investor interests.

I am concerned about national approaches that structurally intertwine private sector and public sector responsibilities, thus blurring the lines of responsibility and accountability of each, and adding additional undefined, and in many ways multilayered, incentives. For example, the path of embedding within a private sector audit firm’s chain of command a board answerable to a regulator can undermine and over time impair the auditor’s independence, its objectivity, and its impartiality, with deleterious effects on investor and public confidence in the reliability of the auditor’s report.

A regulatory process that lacks transparency and consistency can risk placing other interests well ahead of investors’ interests. It is our obligation, I believe, to investors’ interests first, and notably their long-term interests first.

More broadly, it illustrates the essential responsibility for all of us—policy makers, practitioners, investors, academics—in contributing to the work of problem identification, root cause analyses, and ultimately informative evidence and other comprehensive data gathering on the audit market and audit quality to inform the policy making process.

A Bright Future

In conclusion, my colleagues and I firmly believe that a bright future beckons, but it’s not a certainty. Even as we advance high-quality information in the capital markets, it’s critically important for us to understand and maintain a focus on the core principles that will move us forward, and continue to act by them. Having fair, orderly, efficient capital markets that facilitate capital formation while protecting investors is a pillar of our economy. It’s also vital to the quality and the performance of the U.S. economy, which supports and promotes many of America’s other strengths and public policy initiatives. The future belongs to those with the courage to lead and the imagination to make things better.