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Transparency, Integrity and Trust

(Building Public Trust) Joel Kurtzman

PricewaterhouseCoopers

December 5, 2002

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The Public’s Trust in our Markets and Companies Has Been Shaken

• Incomplete, misleading and fraudulent corporate reporting

• Enormous levels of executive compensation for illusory performance

• Doubts that directors are really representing shareholders

• Investigations into the practices of sell-side analysts

• Questions about the competence and integrity of auditing firms

• Internet leveraged to defraud investors

• Multiple stakeholders affected – not just investors

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So What Do People Think?

• 77% believes that CEO greed and corruption caused the U.S. Financial meltdown CNN/USA Today 7/22/02

• 71 % of investors think accounting fraud is rampant Survey of Investors, 7/02

• 82 % of investors believe tough new laws are needed Harris poll 7/02

• 54% of portfolio managers believe its not just a few bad apples F.D. Morgan Walke Poll, 8/02

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So What Do People Think?

• 81% of fund managers and analysts say executives play their interests ahead of shareholders Broadgate Consultants 4/02

• 71% of fund managers say executive pay is too high, 0% say its too low or just right Pear Meyer, 6/02

• 70% of corporate frauds studied between 1987 and 1999 involved the CEO – The Wall Street Journal, 7/8/02

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The Cost of Being “Opaque”

Studies in 35 countries found capital costs measurably influenced by transparency in 5 CLEAR areas:

• Corruption – how rampant?

• Legal system – it works for whom?

• Economic policy – how predictable?

• Accounting standards and Governance – whose interest are served?

• Regulatory system – is it effective?

Transparency lowers the cost of capital, opacity raises it

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Lack of Investor Confidence Is Damaging the Markets

• $6-7 trillion dollars in wealth has been lost in the U.S.

• News events and concerns about quality of information are creating nervous and volatile markets

• Problems in the markets will lead to a weakened economy

• Corporate executives now presumed “guilty” until proven otherwise

• Employee morale has suffered due to retirement program losses

• Erosion of consumer confidence – an end to the “wealth effect”

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News Events and Concerns Create Nervous and Volatile Markets

Dow Jones Index Performance (DJIP) 1/02-8/02

7500.00

8000.00

8500.00

9000.00

9500.00

10000.00

10500.00

1/2/2002 2/2/2002 3/2/2002 4/2/2002 5/2/2002 6/2/2002 7/2/2002 8/2/2002

Enron fires its auditor Arthur Andersen

Indictment of Andersen is unsealed

$100 Mil settlement in Merrill stock research case

Telecom stocks drop on Ericsson, WorldCom earnings warnings

Allied Irish Banks currency- trading scandal breaks

Andersen convicted

ImClone’s Ex-CEO arrested for insider trading

Tyco Ex-CEO indicted

Corporate scandals grow, Dow falls 215 pts

Bush speaks beforethe NYSE

WorldCom files for bankruptcy

WorldCom Ex-Controller arrested

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Consumer Confidence Shaken

Consumer Confidence Index (CCI) - 7/01-8/021985=100

7580859095

100105110115120

Jul-0

1

Aug-01

Sep-0

1

Oct-

01

Nov-0

1

Dec-0

1

Jan-0

2

Feb-0

2

Mar

-02

Apr-02

May

-02

Jun-0

2

Jul-0

2

Aug-02

Source: The Conference Board, July 2002

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Market Problems Lead to a Weakened Economy

The Conference Board U.S. Leading Index (CBLI)

111111.5

112112.5

113113.5

114114.5

115

Jan Feb Mar Apr May Jun Jul

U.S.

Source: The Conference Board U.S. Leading Economic Indicators, July 2002

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Nervous and Volatile Markets/ Consumer Confidence Shaken

7500.00

8000.00

8500.00

9000.00

9500.00

10000.00

10500.00

1/2/2002 2/2/2002 3/2/2002 4/2/2002 5/2/2002 6/2/2002 7/2/2002 8/2/2002

Enron fires its auditor Arthur Andersen

Indictment of Andersen is unsealed

$100 Mil settlement in Merrill stock research case

Telecom stocks drop on Ericsson, WorldCom earnings warnings

Allied Irish Banks currency- trading scandal breaks

Andersen convicted

ImClone’s Ex-CEO arrested for insider trading

Tyco Ex-CEO indicted

Corporate scandals grow, Dow falls 215 pts

Bush speaks beforethe NYSE

WorldCom files for bankruptcy

WorldCom Ex-Controller arrested

85

90

95

100

105

110

115CCI 1/02-8/02DJIP 1/02-8/02 CBLI 1/02-7/02

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Sarbanes-Oxley is a Short-Term Solution

Solutions Must be Supplemented by a Long-Term Vision

• Current solutions take the existing financial reporting model as a given

• Tuning up a Model T when we need to be building a space ship

• To stop now would be to miss a rare opportunity

• Need to address the Corporate Reporting Supply Chain

• A “step-change” improvement in reporting and auditing is needed for the markets of the 21st Century

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The Corporate Reporting Supply Chain

Markets require an information infrastructure

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True Capital Market Reform Can Happen

Six key actions for restoring public trust and investor confidence:

1. Create principles-based global accounting standards

2. Develop additional industry-based performance information

3. Improve external reporting beyond regulatory requirements

4. Use the Internet to enhance performance reporting and analysis

5. Perform audits which present a “true and fair” view of the business

6. Strengthen all links in the Corporate Reporting Supply Chain

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Action #1 – Create Principles-based Global Accounting Standards

• A global economy needs a global set of generally accepted accounting principles

• Investors want to choose companies regardless of country

• Companies want access to capital from all over the world

• Global GAAP should be based on principles, not detailed rules

• Support the IAS convergence

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• Company performance and future potential cannot be reduced to a single number (e.g., earnings or cash flow)

• Global GAAP information must be supplemented with other financial (e.g., pro forma earnings) and nonfinancial information (e.g., customer retention)

• A supplemental framework is needed

• Each industry will develop standards within a Tier II framework

Action #2 – Develop Additional Industry-based Performance Information

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An Example From Telecommunications And Pharmaceuticals

Action #2 – Develop Additional Industry-based Performance Information

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Action #3 – Improve External Reporting Beyond Regulatory Requirements

Articulate the company’s “Holistic Story”

• Strategy and plans• Targets and benchmarks• Actual and desired risk profile and

risk management procedures• Internal control systems and

compliance programs• Compliance policies and programs• Principles of corporate governance• Compensation policies and amounts• Other performance metrics,

including company-specific ones• Commitments to other stakeholders

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The ValueReporting Framework

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The ValueReporting Framework for Banks

MarketOverview

Competitive Environment

Strategy GovernanceEconomic Performance

Financial Position

Risk Management

Segmental Customers

Market share Delivery channels

Quality of management

Loan Loss Assets under management

Risk management practices

Performance by business segment

Customer retention

Market Growth Plans for growth

Earnings Capital management

Asset/liability management

Customer penetration

Return on risk adjusted capital

Core deposit growth

Asset quality

Fee-based revenue growth

Capital adequacy

Market risk exposure

Investment performance

Cost/Income

Economic profit

Value PlatformValue Strategy Managing for Value

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The Challenges in Improving External Reporting

• Model external reporting on internal reporting

• Determine the information that stakeholders need

• Report relevant information from external sources

• Ensure that internal systems deliver the correct, reliable information

• Weigh the risks and costs of greater disclosure against the benefits

Action #3 – Improve External Reporting Beyond Regulatory Requirements

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Action #4 – Use the Internet to Enhance Performance Reporting and Analysis

Content and format are integrally linked

• Information formats provided today are not transparent and do not enable the user

• XBRL provides a reporting platform that leverages the Internet– Exponentially lowers cost to consume reported information– Provides more accurate and trustworthy information to constituents– Transforms the corporate reporting supply chain– Format is more transparent than anything provided today

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What the Regulators are Hearing

“We believe that XBRL will not only meet the SEC's current requirements but also enable more sophisticated and complete analysis of financial information than is possible using EDGAR……… we would urge the SEC to fully consider to what extent and how quickly XBRL may impact on the future use of EDGAR.

Australia and New Zealand Banking Group Limited

in a letter to the SEC on December 3, 2001

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Microsoft CFO on XBRL

"Through Internet delivery, XBRL will also provide analysts and investors with extensible financial data to make informed decisions about the company. We see XBRL as not only the future standard for publishing, delivery and use of financial information over the Web, but also as a logical business choice."

John Connors, Chief Financial Officer, Microsoft

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How XBRL Changes the Consumption of Corporate Reports

Action #4 – Use the Internet to Enhance Performance Reporting and Analysis

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How XBRL Changes the Consumption of Corporate Reports

Action #4 – Use the Internet to Enhance Performance Reporting and Analysis

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Action #5 – Perform Audits Which Present a “True and Fair” View of the Business

Today’s audit opinion is about the financial position of the company

• Accounting and auditing standards vary by country

• Historical financial statements are an incomplete picture

• An “Expectations Gap” exists about what an audit opinion really means

• The audit needs to “stand for more”

• Leverage the assurance model to address Internet-based reporting

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Action #6 – Strengthen All Links in the Corporate Reporting Supply Chain

The Need for Better Corporate Governance

• Directors need to remember that they represent shareholders

• Much of the current focus is on structural reforms

• Equally important are issues of qualifications, process, resources

and compensation

• Legislation and regulation should be balanced with market forces

• Regulated solutions should consider market collaboration

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Action #6 – Strengthen All Links in the Corporate Reporting Supply Chain

Every Group Must Take Responsibility for Improving our Markets

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The Future of Corporate Reporting

Principles-based Global Accounting Standards

Strengthen Corporate Reporting Supply Chain Links

Audits Present a “True & Fair” View of the Business

Enhanced Performance Reporting & Analysis using the Internet

Improved External Reporting Beyond Requirements

Additional Industry-based Performance Information

Building Public Trust

Spiritof

Transparency

Cultureof

Accountability

People of

Integrity

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Transparency & Trust

• Transparency & trust and the cost of capital are integrally linked

• Transparency of information is enabled via the XBRL format

• Supply Chain participants collaborate in their mutual interests

• More work is needed to– Engage the supply chain participants– Move the content forward – Establish/Agree the process/framework for Tier II

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